24 January 2019

TD Bank’s Bharat Masrani on Managing Through Chaos and His Bank’s Bright Future

The Globe and Mail, Trevor Cole, 24 January 2019

Since Bharat Masrani took over TD, the bank's adjusted income has soared 50%. Bankers like predictability, and a few things have stayed unchanged since late in 2014, when Bharat Masrani became the first person of colour to run a major Canadian bank. At the time, TD was the second-largest bank in Canada, and it remains so. Masrani’s unassuming middle-management wardrobe eschewed flashy cufflinks then, and his shirts continue to be buttoned at the wrists. And more than four years after his newsmaking ascendance, Masrani is still the only example of diversity at the top of Canadian banking. Aside from all of that, things look very different.

Banking has gone highly mobile. The economy appears tilted toward recession. Interest rates are climbing as oil has plunged. And there’s a destabilizing narcissist in residence at the White House who seems intent on cooking up trouble. None of that has unsettled Masrani. Since he took over, TD’s adjusted income has soared 50%, and Masrani’s calm demeanour suggests everything is fine. For the man who helped TD weather the storms of 2008, maybe there’s nothing more predictable or manageable than chaos.

Why did the stock prices of all the banks struggle so much in 2018?

Banks are a reflection of what happens in general economies, and there are a lot of macro headwinds in the world, such as trade, what’s happening to global growth, Brexit. In Canada, we’ve seen some numbers that would suggest that perhaps there are real issues. There are views emerging that we are in for a volatile period here. I think that is reflected in the valuations you see.

In a recent interview, you said, “We enter the new year with good tailwinds in our business. The economic prospects in Canada and the U.S. are positive.” Have you changed your view?

I have not changed my view. You are asking me why the markets are behaving the way they are. From a tailwinds perspective, look at what has happened in the past year. Economic growth has been strong in the U.S. and Canada, which is where most of our businesses are. Interest rates have started to normalize, and for banks, that is positive. If you look at unemployment, there are very strong numbers in both the U.S. and Canada. So there’s a lot of momentum on our side. But that doesn’t mean there are no headwinds.

Do you see specific challenges ahead?

Trade is the worrisome one. There are real issues with respect to China, for example, on technology transfer, intellectual property. But a prolonged trade war is never positive. I think that is a big headwind going forward, and my hope is that sensible minds prevail.

“Sensible minds"—that’s asking a lot of the Trump administration.

Listen, there are stylistic issues. Economies work in different ways. The U.S. is a major economic engine for the world. I’m so glad we have a trade agreement that is refreshed now. There are chapters in the USMCA that make sense that did not exist before.

What do you expect regarding interest rates in the coming year?

Normalization is good. What is the new normal—the ideal interest rate that allows for very good employment, and deployment of an economic system versus inflation? I think that is what the world is searching for. If we go too high and too quick, it's going to be negative. For any bank, very high interest rates are not good because they cause our customers and the companies that bank with us to suffer. So I worry about it. And I think there is still more to come by way of normalization.

You spoke recently of there being “a benign credit environment.” But consumer debt levels are very high. Do you have any concerns?

Consumer debt as a headline number is high. But a lot of the Canadian consumer debt is in mortgages. The mortgage regime in Canada is a lot different than in the rest of the world—what kind of down payments are necessary, the interest rate risk financial institutions assume.

You said it’s different. How would you characterize it?

It’s better. It’s more sustainable. You know, at TD, mortgages are the biggest asset class on our balance sheet. I think that’s a positive for the Canadian system and economy. More than indebtedness, I think if the unemployment number starts to inch up, that would be a big indicator of potential problems in the economy and, frankly, potential losses.

That’s inevitable, isn’t it?

Regarding mortgages, you and Ed Clark smartly got out of mortgage-backed securities prior to 2008.

TD used to be a major player in the business of “structured products,” and thankfully we decided to exit. I don’t think we could have predicted the whole world was going to fly itself into a mountain through those products, but that’s what happened. And we were out of it. That allowed us to build out our U.S. business more quickly, because other banks were otherwise occupied.

Do you think that decision is one of the reasons you’re in the seat you’re in now?

I’m sure there are lots of decisions that go into the seat I am in. You should ask my board.

GM recently announced the closure of its Oshawa plant. What do you think about the future of manufacturing in this province?

Of course there is concern. It is a terrible thing for any community to go through. But our system has a way of transforming itself, and some new jobs will appear down the road. Many years ago, folks would not have thought of Toronto as a hub for artificial intelligence engineering talent, and today it is a major, major centre. Our system, with democracy and openness, produces terrific ideas that turn themselves into big industries. I’m confident that will happen.

Let’s talk about oil and gas. How much has TD reduced its exposure to the energy sector since 2016?

Our exposure is less than 1% of our total gross loans. So that is not a big issue. I think it’s the second-order effects we should look at—what happens to individuals when jobs are lost, GDP and all that. All those issues, from a TD perspective, are manageable. But that doesn’t mean this is pain-free.

So you are focused on the current state of the oil patch and what they’re going through?

Of course I am. At TD, we are all for the low-carbon economy. We multiply our lending to that area. We are one of the largest green-bond issuers. I think we are the only Canadian bank on the Dow Jones Sustainability World Index. But we also acknowledge that trying to get there instantly is not feasible.

You’ve talked in the past about TD’s “unique” culture. What’s unique about it?

It’s a unique and inclusive and performance-driven culture. Diversity plays a big role. As a bank, we don’t make anything. We don’t make cars; we don’t make computers. Our business is based on people. So, for us it’s a very serious matter. We think driving a very positive culture is not only the right thing to do but also the only way to be successful.

How does the notion of diversity manifest itself at TD?

We start with the premise that, of course, it’s the right, moral thing to do. From a business perspective, unless we reflect the communities we serve, we will not be as successful. Unless we have the best talent out there, we will not be successful. It goes right through our training programs, our leadership development programs, what targets we set. Look at how many women, for example, we have on our board. I am very happy with the progress we’ve been making.

On the retail side, more than 80% of TD transactions take place via mobile apps or online, but one of your key initiatives has been to invest in physical branches. Why?

Listen, every new channel that gets introduced, people love it. And it multiplies the number of transactions. I’m happy to report we are the largest digital bank in Canada. And we are rated No. 1 by App Annie, which is the industry standard. But 70% of our customers in Canada visited a branch in the last little while. And what we do in our branches, how those branches look, the type of service we provide, the level of advice we provide, is a lot different than it used to be.

Does that mean more branches? More people in the branches? Different functionality?

The physical nature of the branch is changing. You go to some TD locations and say, “Really? This is TD Bank?” There are branches in Canada, for example, where there is no cash! There are stores in Manhattan where there are no humans. This is what customers want, so we will adapt. And there’s a science to it.

How are the needs of customers changing?

They want to touch the bank in the way they prefer to touch it. So they want the best digital experience. And when desired, they want a branch interaction. And there, people want more than a transactional relationship. They want more information, more advice. The issue of confidence is playing an increasingly important role. Am I confident of what my needs are going to be down the road?

Let’s talk about succession. When Ed Clark was CEO, he saw you as somebody to groom for an eventual rise up. Did you talk to him? According to research I’ve done, he targeted you. Because you know a lot about Ed Clark’s mind. Well my question is, are you doing that for someone else?

You know, succession planning in a bank of TD’s size is always an important issue—at every level in the organization, not just my role. It’s a big board responsibility. It’s an ongoing exercise, and I think our bank does a pretty good job at it.

You don’t want to tell me whether or not you’ve got your eye on someone?

That's for you to find out.

09 January 2019

Banks Brush Off New Capital Rules, Saying They Have ‘No Impact’

The Globe and Mail, James Bradshaw, 9 January 2019

The chief executives of Canada’s largest banks are shrugging off tougher capital requirements introduced by the banking regulator, saying the change will have no impact on plans for acquisitions, dividend hikes or share buybacks.

Last June, the Office of the Superintendent of Financial Institutions (OSFI) revealed for the first time that the country’s six largest banks must hold extra capital, called the “Domestic Stability Buffer,” as an added cushion to help them cope in the event of an economic downturn. The regulator promised public updates on the buffer at least twice a year, and at its first opportunity in December, chose to boost it to 1.75 per cent from 1.5 per cent of a bank’s risk-weighted assets, starting April 30.

The move caught investors and analysts by surprise, as OSFI highlighted “systemic vulnerabilities” in Canada’s economy, suggesting that it is watching closely for signs of strain. Analysts speculated that OSFI’s swift move could fuel expectations that the buffer would continue to be nudged higher, adding to constraints imposed on banks since the last financial crisis.

But at a conference in Toronto on Tuesday, the CEOs of Canada’s big banks responded with a collective yawn.

“It doesn’t change anything,” said Toronto-Dominion Bank CEO Bharat Masrani.

Bank of Montreal CEO Darryl White said he sees “no impact” on the way he manages the bank, even if OSFI were to reduce the required buffer again, “because we wouldn’t chase them down.”

Royal Bank of Canada CEO Dave McKay said RBC will continue to “manage our surplus capital with the same margins," and Canadian Imperial Bank of Commerce CEO Victor Dodig said the move “hasn’t changed our view on what is the right level of capital for CIBC.”

An OSFI spokesperson declined to speculate on “future actions by the banks should stress conditions materialize,” but said that banks “are responsible for their own capital management strategy.”

In recent public comments, OSFI officials have voiced concerns over high household debt relative to incomes and uncertainty about housing markets, even as bank executives insist that Canada’s economic fundamentals are still sound. In raising the required buffer, OSFI assistant superintendent Jamey Hubbs said that “in light of positive credit performance and generally stable economic conditions, now is a prudent time for banks to build resilience against future risks to the Canadian financial system."

Currently, Canada’s Big Six banks must keep their common equity Tier 1 (CET1) capital ratios – a key measure of a bank’s resilience – at or above 9.5 per cent. That consists of a base level requirement of 4.5 per cent, a 2.5-per-cent “capital conservation buffer,” an extra 1-per-cent surcharge because of their size, plus the newly disclosed Domestic Stability Buffer. After April 30, the minimum will be 9.75 per cent.

Yet Canada’s six biggest banks had CET1 ratios ranging from 11.1 per cent at Bank of Nova Scotia, which recently completed a string of acquisitions, to 12 per cent at TD, as of Oct. 31, and appear to believe they’ve built adequate reserves.

“We’re so massively ahead of the buffer anyways, it doesn’t change anything,” said National Bank of Canada CEO Louis Vachon.

08 January 2019

RBC, BlackRock Team Up to Create Canada’s Largest ETF Brand

The Globe and Mail, Tim Kiladze & Clare O'Hara, 8 January 2019

Royal Bank of Canada and BlackRock Inc. are joining forces to sell exchange-traded funds, forming a rare partnership between Canada’s largest asset manager and the country’s biggest ETF provider.

Under the brand RBC iShares, the firms will create and market ETFs, which are best-known as passive investments that track major indexes at lower fees than most mutual funds. The new brand will be the biggest in Canada, based on assets under management.

For RBC, the partnership is a way to bolster its competitive position in the race to gather ETF assets. Save for Bank of Montreal, Canadian lenders have been slow to embrace ETFs – even as investors have increasingly used them to fill at least a portion of their portfolios.

By teaming up with RBC, BlackRock will gain better access to a distribution network. Despite a wave of digital disruption in financial services that has helped ETFs emerge as a popular do-it-yourself investing phenomenon, the vast majority of investment funds are still sold through advisers in Canada – and RBC manages one of the largest adviser networks.

“There is an industrial revolution happening in asset management,” said Martin Small, the head of iShares in Canada and the United States, in an interview. “The modern portfolio is going to be different than the portfolio of yesteryear.”

The partnership is BlackRock’s means to keep up with all of the change. RBC also runs the country’s largest asset management business, and BlackRock will lean on its expertise to create ‘active ETF’ strategies. The iShares brand is best-known for simple index-investing, such as the S&P/TSX 60 Index ETF, which is the biggest ETF in Canada and tracks the largest companies on the Toronto Stock Exchange for only 18 basis points annually, or 0.18 per cent.. However, the ETF market has become commoditized. To stand out, fund providers are creating more complex products that cost investors a little more money.

Damon Williams, RBC’s head of global asset management, said in the interview that RBC’s move signals a realization that investor preferences have evolved.

“ETFs, there’s no question, have become a growing part of the Canadian investor landscape,” he said. “We want to make sure we continue to be relevant to those investors.”

Amid this shift, both firms were at risk of losing their leading market positions.

BlackRock manages US$6.3-trillion globally, and iShares is one of the strongest brands known to both Canadian investors and advisers. The company has almost $57-billion in ETF assets in Canada, making it the market leader here.

But in recent years BlackRock has battled a growing number of competitors. Large mutual-fund firms, which sat the sidelines of the ETF market for many years -- including major independents such as AGF Investments and Mackenzie Investments and most banks -- have entered the market in the past two years.

Today, BlackRock remains the top ETF provider in Canada, but the new entrants have stolen market share. While BlackRock used to control more than 80 per cent of Canada’s ETF market, its position has dwindled to 36 per cent, as of Dec. 31, 2018, according to a report by National Bank Financial. Second place goes to Bank of Montreal, which is the one bank that got ahead of the trend and now has $48.6-billion in ETF assets under management.

RBC is navigating its own increasingly complicated competitive landscape. Canadian banks saw their earnings soar over the past decade as interest rates fell to near-zero, spurring a lending boom. Lately, however, benchmark central bank rates have started to rise, which makes borrowing more expensive. At the same time, baby boomers are hitting retirement age and this demographic bulge is seeking investment and wealth advice. Across the Big Six lenders, wealth management is seen as the next big potential profit driver.

Although RBC already has a large asset management business, with $369-billion under its watch in Canada, it has been missing an avenue to provide clients with low-cost index investing.

Because of their size in their respective fields, BlackRock and RBC are able to spread management costs across billions of dollars in assets, helping them gain a market advantage by lowering costs for investors. But global fund giants are starting to innovate. Fidelity Investments, for one, recently launched no-fee funds as a way to bring new investors in the door.

“Both firms had a lot of scale. But both of us are in a bit of the buy-versus-build mode,” ” BlackRock’s Mr. Small said, noting the companies began talks in mid-2018 as they started to believe that a joint venture would produce the fastest results.

Mr. Small suggested BlackRock could have hired more people or acquired an asset manager to create new types of ETFs, such as in-demand funds that cater to unique market characteristics, including volatility and momentum. “But it would take years to build that business in Canada,” he said.

Meanwhile, RBC had the opposite need. Canadian investors and financial advisers are shifting away from traditional mutual funds as they pour more money into ETFs, which were set to outpace mutual funds sales in 2018.

“RBC saw the need for more traditional indexing in its core portfolio and said, ‘We could build it, too,’” Mr. Small said. But again, time is of the essence.

While the partnership is unique and the first of its kind for ETFs in Canada, the wealth management sector was built on joint ventures. In the mutual-fund market, it is common for banks to sell funds under their brand names, but for the fund managers to be external. Such relationships are known as sub-advisory mandates.

BlackRock has announced a partnership in Canada in the past – albeit in a much smaller capacity. In 2017, the firm teamed up with Bank of Nova Scotia’s Dynamic Funds arm to launch five actively managed funds sold directly through advisers.

While the new RBC partnership has elements of a full-blown merger, the two firms will remain separate legal entities while operating a combined business branded as RBC iShares that will include 106 iShares funds and 44 RBC ETFs. The partnership will be overseen by a joint executive steering committee, with an equal number of representatives from BlackRock and RBC.

Under the new brand, the majority of the iShares ETFs and RBC ETFs will remain as is, with no formal changes to either name or ticker symbols. But most will be marketed as “RBC iShares,’ and the new entity plans to launch additional co-branded ETFs in the near future.

Fees for all of the ETFs will be divided between the two asset managers, with the split varying on the type of fund and how much each firm put into it. ETFs sold through RBC advisers, for instance, could deliver a bigger cut to RBC.

07 January 2019

RBC Devoted to Slow-but-Steady Approach to Becoming International Powerhouse in Investment Banking

The Globe and Mail, Andrew Willis, 7 January 2019

Doug McGregor contends that he knows exactly what it would take to quickly vault Royal Bank of Canada’s capital markets business into the very top ranks of global investment dealers.

“All we would have to do is take on more risk, or accept lower profitability,” Mr. McGregor says. And as he begins his second decade as CEO of RBC Capital Markets, Mr. McGregor is quick to explain why he has absolutely no interest in either strategy as he continues a slow-but-steady push to build Canada’s largest investment bank into an international powerhouse.

RBC is grinding its way to the top of the mountain. By a number of measures − lending, advising on takeovers − the dealer now ranks among the top 15 players worldwide, with aspirations to climb higher. Parent Royal Bank is a top-10 global player by most measures. But the 61-year-old CEO says growth is always about improving bottom-line results and "we never set targets based on market share.”

Over a four-decade career in finance, Mr. McGregor watched a series of rivals, including Royal Bank of Scotland, Deutsche Bank and most memorably, Lehman Brothers, expand rapidly by aggressively deploying their own capital and diving into new sectors and regions. None built platforms and cultures that could survive a market downturn.

Having had a front-row seat for the global financial crisis when he began his tenure as CEO in 2008 has clearly shaped Mr. McGregor’s approach to expansion. Over the course of an hour-long interview on the bank’s global growth strategy, the CEO uses the word “safe” at least a dozen times. RBC is recruiting aggressively in the U.S. and Europe − landing 31 senior bankers in recent months − but Mr. McGregor says the bank’s goal is to ensure new hires are a “safe” cultural fit, which means “understated and team-oriented.” RBC is spending hundreds of millions on technology and compliance, to ensure "we keep out of trouble.”

The quick route to expansion into new markets is through acquisitions. It’s a proven tactic in manufacturing, where you’re buying factories, but far more difficult to execute in investment banking, where the asset you acquire goes up and down the elevator each day.

RBC tried to bulk up in the United States in 2000 by buying Minneapolis-based brokerage Dain Rauscher Wessels, which catered to technology companies. Looking back on the move, Mr. McGregor said it proved difficult to integrate the U.S. firm’s focus on small capitalization companies with RBC’s expertise in serving large corporate clients. On Mr. McGregor’s watch, RBC has eschewed acquisitions, opting instead to hire individual bankers or teams from the largest U.S. and European firms, and build organically around these financiers.

RBC now has roughly the same number of bankers in the Canada and the U.S. − there are 3,000 employees in the home market and 2,800 in the U.S. − along with 1,100 staff in Europe and 113 bankers in Australia. Everyone covers the same sectors.

The next step in RBC’s growth plan is to back bankers outside Canada with the capital and services they need to deepen relationships with global clients. It’s a subtle transition, but one that can be hugely lucrative.

A decade back, RBC’s European bankers would have targeted secondary roles in deals. For example, they would strive for a role as one of a dozen big banks lending money on a takeover, in a process known as syndication. On these sorts of deals, fees are minimal and profits are measured in fractions of a percentage point.

By upgrading talent and committing more capital, RBC moved to the centre of the action. RBC advised on tactics and lined up financing last year on an £8-billion ($13.6-billion) takeover of GKN PLC by Melrose Industries, the largest hostile British deal in a decade. In the U.S. market, RBC was a leading player last year in transactions from some of the world’s largest companies, including The Walt Disney Co., T-Mobile USA Inc. and Blackstone Group L.P. Roles like these translated into an impressive 17 per cent return on the investment dealer’s capital.

In 2008, Mr. McGregor’s first year at the helm, RBC’s capital-markets unit earned $1.2-billion. Last year’s profit was a record $2.8-billion − more than the second and third largest Canadian investment banks put together. But sticking to his theme of safe growth, Mr. McGregor points out that the group’s profits are consistently less than 25 per cent of RBC’s total earnings. That’s right at the median point for investment-banking earnings at the six largest Canadian banks, which means Royal Bank’s exposure to sometimes volatile capital markets is in line with that of domestic rivals.

For the CEO, building a global business one banker and one client at a time translates into endless hours on an airplane. In the four weeks ahead of a brief Christmas vacation – he planned to golf in South Carolina – Mr. McGregor made business trips to Australia, Britain, San Francisco, New York and Montreal. He’ll be back on the road in early January, grinding out a proven growth strategy.

02 January 2019

Bank Stocks Have Seldom Looked This Enticing

The Globe and Mail, David Berman, 2 January 2019

Add Canadian banks to the long list of stocks that delivered dismal returns in 2018. But some encouraging developments have emerged from the sell-off: Valuations are low and dividend yields have risen to 4.6 per cent on average, pointing to a good buying opportunity right now.

First, let’s recap what happened in 2018.

The Big Six bank stocks fell by an average of 12 per cent (not including dividends). Or, if you look at the S&P/TSX Composite Diversified Banks industry group, which tracks all six banks but weights them according to market capitalization, the bank stocks fell 11.2 per cent last year.

The group delivered strong profit growth of 13 per cent, year-over-year. And the banks hiked their quarterly dividends by an average of 7.9 per cent, continuing an impressive clip.

But none of this apparently mattered: Share prices fell amid weak oil prices, low mortgage growth and signs of a slowing global economy.

Canadian Imperial Bank of Commerce was the weakest of the Big Six banks, declining 17 per cent as concerns persisted about the Canadian economy and housing market, and pushing aside Bank of Nova Scotia as the year’s lagging bank stock after CIBC took a particularly sharp downturn in December.

Toronto-Dominion Bank was the best performer, but nonetheless declined 7.9 per cent. Royal Bank of Canada was a close second, with a decline of 9 per cent.

Falling share prices and rising profits translate into tempting valuations, though. According to research from RBC Dominion Securities, the Big Six trade at nine times estimated 2019 profits. That’s a bargain next to the 10-year average price-to-earnings ratio of 11.1. CIBC, the hardest-hit bank stock in 2018, trades at a mere eight times estimated profit.

Dividends are also enticing. The Big Six yield an average of 4.6 per cent, led by CIBC at 5.3 per cent. That’s hard to ignore when the yield on the Government of Canada five-year bond is back below 1.9 per cent.

There are various ways to approach the bank sector, but nothing really worked in 2018.

The strategy of buying the prior year’s worst-performer – Bank of Montreal for 2018 – outperformed the sector by one percentage point last year, which is okay if you ignore the fact that BMO fell 11.3 per cent. (For this strategy, we use returns from the biggest five banks, which declined an average of 12.3 per cent last year). Let’s hope that CIBC, the pick for 2019 using the laggard strategy, performs better this year.

Exchange-traded funds that focus on the Big Six provide instant diversification and regular rebalancing for a relatively modest fee. Unfortunately, these ETFs failed to deliver sector-beating returns last year.

The BMO Equal Weight Banks Index ETF (ticker ZEB) holds all six bank stocks in equal amounts and rebalances regularly. This means that if one bank stock lags the others, the ETF manager will buy it in order to maintain the right balance. It also means National Bank of Canada has the same weighting as giant Royal Bank of Canada.

The ETF declined 11.8 per cent in 2018. That’s in line with the 12-per-cent average decline for the Big Six, but slightly worse than the 11.2 per cent decline for the S&P/TSX Composite Diversified Banks industry group.

The RBC Canadian Bank Yield Index ETF (RBNK) weights the Big Six banks according to their dividend yields – the two highest-yielding stocks each receive a 25-per-cent weighting, followed by a 16.7 per cent weighting for the next two stocks and an 8.3 per cent weighting for the last two stocks.

That’s an appealing approach for dividend-loving investors. However, the ETF declined 12.5 per cent in 2018. Dividends ease the pain, but not enough to make the fund a winner.

Discouraged? Don’t be. Canadian big bank stocks have a remarkable track record of rebounding from sell-offs. Whether you invest in one stock or a basket of stocks, cheap valuations should work in your favour in 2019 – and you’ll be collecting a handsome dividend while you wait for the rally.