Wednesday, November 01, 2017

Darryl White — New BMO CEO

  
The Globe and Mail, James Bradshaw, 1 November 2017

Darryl White is not sure what is ailing his beloved but slumping Montreal Canadiens. "It's confidence, right? It's got to be confidence," he ventures.

Mr. White officially starts as Bank of Montreal's new chief executive officer on Wednesday, and also happens to serve as a director of the storied hockey club. At 46, with close-cropped brown hair, he is youthful, trim and small in stature. But he radiates confidence.

Striding past the polished marble columns and century-old teller windows in BMO's historic Montreal main branch to sit for an interview days before taking over as CEO, Mr. White seems to embody a new generation of bankers tasked with leading Canada's oldest bank into its third century in business – and determined to push ahead at a faster pace.

His ambition at the outset is not to change the bank's fundamental course. Board chairman Robert Prichard said Mr. White's priority will be keeping "continuity of strategy and continuing acceleration of performance." That means driving faster growth – particularly in BMO's U.S. operations – by boosting spending on technology and "actually thinking like a customer," Mr. White said.

"I think we've been doing a pretty good job of it," he said. "I think we can do a better job as we go forward."

Yet, squeezing more performance out of an established bank that ranks as Canada's fourth-largest will be no simple task. BMO's share price has hovered around the $100 mark of late, but has gained only 2.3 per cent year-to-date – which trails all of its Canadian peers. The bank's return on equity, watched closely by shareholders, stood at a healthy but unspectacular 13.4 per cent at the end of its most recent fiscal quarter.

And red flags are on the horizon.

Uncertainty about the fraught renegotiation of the North American free-trade agreement (NAFTA) could spell particular trouble for BMO, which calls itself Canada's largest trade bank. At the same time, there are continuing concerns about Canadians' high consumer-debt load and soaring urban-housing prices, as interest rates begin to rise from historical lows. And new technologies are threatening to upend banking conventions, forcing financial institutions everywhere to adapt quickly.

Unlike departing CEO Bill Downe, who stepped into the job in early 2007 and quickly faced a global financial meltdown, Mr. White inherits BMO on a stronger footing, with a more optimistic economic outlook. On Mr. Downe's watch, total assets roughly doubled to $709-billion, while its U.S. footprint through the BMO Harris Bank subsidiary, which will be crucial to its growth prospects, expanded to serve more than two million personal and commercial customers with 600 branches across the U.S. Midwest.

BMO has similarly lofty expectations for Mr. White, a father of three who has worked at the bank for half his life. For the lion's share of that tenure, he was an investment banker in its capital-markets arms, known for giving sharp strategic advice to blue-chip companies and for his deep devotion to his roster of clients.

But last year, as his name rose to the top of the bank's succession chart, Mr. White took on much broader duties as chief operating officer. That gave him global responsibilities spanning retail and commercial banking, wealth management, marketing and even technology. As he delved deeper into corridors of BMO that were less familiar to him, he discovered a willingness to adapt embedded in the bank's culture that fuels his confidence in its prospects.

"I don't want the culture to change," he said. "And if there's a change, it's perhaps at a pace that's taking advantage of the foundation that we've built – so a pivot from foundational investments to acceleration."

Made in Montreal

As he prepared to lead BMO into the future, Mr. White took a step back into the bank's past on Sunday, revisiting the city that raised him.

More than 100 current and former executives, board members and their families assembled in Montreal. It was a rare gathering of multiple generations of the bank's most senior leaders: Mr. White and Mr. Downe, as well as previous CEOs Tony Comper and Matthew Barrett; Mr. Prichard, the current chairman; and past chairman David Galloway; plus an array of financial-sector heavy hitters, including Bank of Canada governor Stephen Poloz.

They came together for a ceremony unveiling a stone tablet in the foyer of the bank's historic and opulent Montreal main branch, first built in 1847 and expanded in the early 1900s. The setting and timing were carefully chosen for their symbolism, as a culmination of a year-long celebration of the bank's 200th anniversary, which arrives on Friday.

Under the branch's ceilings adorned with gold leaf, the tablet now bears brass lettering spelling out 66 names – Mr. White's among them – of the bank's foremost leaders through its most recent century, steps from a similar memorial erected in 1917. "Our chief financial officer is quite happy to know we don't build [branches] this way any more," Mr. Downe joked in a speech at the ceremony, before guests decamped upstairs to toast the retiring CEO's career over a dinner of mustard-crusted rack of lamb and caramelized black cod.

Mr. White's own roots in Montreal are more modest. He grew up in a middle class, West Island home five minutes from the city's largest airport, before studying business at the University of Western Ontario and Harvard Business School.

Beginning at the bank with a gruelling apprenticeship with Nesbitt Thomson (now BMO Nesbitt Burns Inc.), he charged through BMO's ranks. And eventually, in 2006, he returned to Montreal for a five-year homecoming that proved an important testing ground, where he caught the attention of senior executives.

Jacques Ménard, the current president of BMO in Quebec, was one of Mr. White's mentors during his time in Montreal. "He made me look good every day," Mr. Ménard said, but he eventually advised BMO's leadership "to get him out of here" and see what he was capable of.

Mr. White moved to Toronto in 2011, but has kept close ties in Montreal. He keeps a summer home in Quebec, and pledged to maintain a regular presence in Montreal, which "will continue to be the heartbeat of the company."

Day one and beyond

Mr. White's first day as CEO, Nov. 1, will begin with client meetings and end with parent-teacher interviews at his children's school.

In the intervening hours, he will fit in visits to two Toronto branches, to the bank's computing centre in Scarborough to see its chief technology officer and to an off-site gathering on inclusion and diversity at the BMO Institute for Learning – which he calls "BMO University."

The day marks a milestone for the bank, but Mr. White's agenda is fairly typical of his own education over the past year. As COO, he has spent much of his time getting an immersion course in BMO's diverse business lines, making countless branch visits, joining the phone lines at call centres and meeting an array of customers.

"For me, that's been an extraordinarily valuable experience to cut across all of our businesses," he said, and it has also made him more attuned to what's happening outside the bank.

One of Mr. White's early plans to hedge against uncertainty is to boost BMO's spending on technology. He declined to attach dollar figures to the existing budget or the increase he has in mind, but pledged that the bank will stay disciplined about digital investments. "A strategy whereby one splashes capital at technology because it's a trendy thing to talk about falls short," he said.
In the United States, Mr. White expects to quicken the rise of BMO Harris as a share of the bank's overall earnings. Like many of its Canadian peers, BMO has looked to the hard-fought U.S. banking market for an opportunity to grow faster than the mature Canadian market will allow.

Over the past six years, the bank's U.S. arm has grown at a compound annual rate of 24 per cent and now contributes about a quarter of the bank's income, with 70 per cent of that coming from personal and commercial banking, nearly 25 per cent from capital markets and the remainder from wealth management.

"That's the earnings growth story in the U.S., and that'll continue to be the case," he said.

He is bullish on the prospects for U.S. tax reform, and sees room to grab market share. Within five years, he predicts the U.S. arm's overall contribution to earnings may be "approaching a third" on the strength of its existing assets. "In order for it to be much greater than that, you'd have to look at growing by acquisition," he said.

But Mr. White concedes that the prospect of a breakdown in NAFTA talks as Canada, the United States and Mexico struggle to make headway in negotiations could put the brakes on trade flows that are vital to BMO's cross-border business.

"NAFTA's important. If NAFTA goes away, would we see a slowdown in economic trade? Yes. How much? I don't know," he says, noting that 32 U.S. states count Canada as their biggest export market. "Is it an impact that we're going to worry about unduly from the perspective of our delivery to our customers and our shareholders? No. We're going to continue to serve those customers in the markets that we have under the regimes that will exist."

The bank has also been adapting to a new reality for credit in Canada, as federal measures have been rolled out to tax foreign home buyers and require tougher stress testing on mortgages, just as interest rates have begun to climb. Mr. White reiterated that "we've been supportive of those" new regulations.

But he also believes "credit, writ large, is well managed," and that the banking system, both in Canada and globally, is more sturdy than it was a decade ago.

"There's always going to be risk in a system," he said. "We've taken that risk throughout history, we have it today. But I think it's in a reasonable place on the curve."
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Monday, October 16, 2017

Scotiabank is Most Attractive on P/E Valuation, Adjusting for Excess Capital

  
Canaccord Genuity, 16 October 2017

In this report, we focus on Canadian banks P/E valuation analysis relative to the S&P/TSX Composite, bank stock 1-year return analysis under different P/E (NTM) multiple ranges, and looking at implied P/E taking into consideration each bank’s excess capital. Our main findings below are as follows: (1) group bank P/E (NTM) of 11.7x (vs. historical avg. of 10.9x) represents a 32% discount to the TSX Composite (vs. 30% historical avg.); (2) banks trade at P/E (NTM) between 11-13x over 50% of the time (since 2002) with price return over NTM lowest at 6% on average; (3) banks perform well historically when the group is trading above 13x; and (4) BNS’ relative P/E valuation is most attractive (vs. historical) taking into account their excess capital position (see Fig. 6). At Q3/F17, Scotiabank reported the highest CET 1 ratio at 11.3%.

Investment highlights

• Canadian banks trading slightly above historical average. YTD, banks stocks have outperformed the broad index with NA total returns leading at >15% (Fig. 7). The Canadian bank group (Big-6) average now trades a slight premium to its historical average (see Fig. 1). Currently, the group trades at a P/E (NTM) of 11.7x vs. its historical average of 10.9x (since 2002). During this time frame, group bank P/E’s have ranged from a low of 6.6x (during financial crisis) and high of 13.5x (prior to crisis). We believe the market is likely factoring in excess capital build, continued strong quarterly results (FQ4 upcoming), and potential future 2018 EPS upward revisions concurrent with year end results (i.e. stronger NIM and credit trends). Currently, market consensus calls for Big-6 bank EPS growth of 5% (similar to CG) in 2018E, below the S&P/TSX Composite EPS growth expectations of <10%.

• Relative group P/E valuation still trading at discount vs. broad index. In Fig. 1, we compare group bank P/E (NTM) multiples relative to the TSX Composite Index (NTM). On this basis, we find that bank stocks still look quite attractive. Currently, the forward group bank P/E of 11.7x compares to the TSX Composite of 17.3x. This represents a 32% discount, slightly favourable compared to the historical average of 30%. Based on historical trends, we note that investors should be underweight Bank stocks during crisis. Referring to Fig. 1, the three main periods during which Canadian banks traded at larger-than-average discounts related to the Tech bubble (2001-2002), financial crisis (2008-2009), and Oil price collapse (2015, 2016; WTI oil reached $26 in Feb/16).

• Canadian banks trade at P/E (NTM) between 11-13x more than half the time. Dating back to 2002, we looked at S&P/TSX Bank Index P/E (NTM) multiples that traded within four buckets or ranges. We found that the Index valuations traded within a P/E (NTM) range of 11-13x (see Fig. 3) for 54% of the time. Currently, the banks sit at the lower end of this range (11.7x). The group P/E between 9-11x, and 13-16x occurred 22%, and 21%, respectively. At the low-end (P/E of 6-9x) happened just 3% of the time, which was during the financial crisis.

• Looking at Bank performance during certain P/E trading ranges. After that, we took weekly P/E valuation data points and ran stock price returns over the next twelve months using the TSX Bank Index. Not surprisingly, we found that largest stock gains followed the financial crisis with average 1-year returns of 64%. The second highest return periods have come from when banks trade between 9-11x, compiling an average return of 13%. Using historical data, this suggests that it is best to overweight banks when the group trades below P/E (NTM) of 11x. From the group’s trading sweet spot of 11-13x; 54% of time), stock returns over the next year were lowest, averaging 6%. Interestingly, when Canadian banks trade above 13x, returns continued to be solid, averaging 11%. The historical analysis demonstrates that Canadian banks are momentum stocks and that higher valuations don’t necessarily indicate an underweight signal. By way of context, the TSX Bank Index has generated a ~8% CAGR (price return) since 2002 proving that the latter are solid long-term investments.

• Canadian banks improving capital position. Since the financial crisis, Canadian banks have continued to build excess capital. The group has increased their CET1 ratio (avg.) from 7.1% (2008) to 10.9% (F2017E). As of Q3/F17, Scotiabank enjoyed the strongest relative capital position with a CET 1 ratio of 11.3%, followed closely by NA, and BMO (11.2% each). At the low-end is now CM that accounted for the closing of PrivateBank last quarter. CM’s CET1 ratio dropped sequentially from 12.2% to 10.4%. Generally, we believe excess capital will be used for: (1) increased usage of NCIB (although still modest to overall shares outstanding); (2) dividends (we forecast group dividend growth of 5% in 2018E); (3) acquisitions (expect bolt-on acquisitions as global valuations remain high); and (4) organic growth.

• P/E implied valuation accounting for excess capital. Lastly, we take each Canadian bank's current P/E (2018E) and adjust it for the PV of excess capital. For the latter, we have assumed a CET1 floor of 10.5%, which is consistent with most bank’s comfort level. We note the regulatory minimum ratio is 8.0%. For the purpose of this analysis, we assume incremental capital will be depleted by 2020 (i.e. in 3 years) and we discount the excess capital by 10% (estimated cost of equity) to derive the PV of excess capital. The analysis is shown in Fig. 6. Our implied P/E (F2018E) for Canadian banks (adj. for excess capital) moves down on average 0.7x. This would place the group P/E at ~11x, in line (instead of slight premium) with its historical average. Under this exercise, we estimate Scotiabank's implied P/E valuation (adjusting for excess capital) trades at 10.5x (excess capital of 1.0x), a significant discount to its historical average of 11.5x (Fig. 6). We found that CM also trades at a discount, but more modest at -0.3x, while TD, BMO, NA, and RY adj. implied P/E multiples generally trade in line with their historical averages.
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Bank Stocks Are No Longer Cheap, but They’re Still Worth Owning

  
The Globe and Mail, David Berman, 16 October 2017

The great Canadian bank stock sale is over. But don't worry: There are more gains ahead.

After a five-week rally, bank stocks have jumped more than 8 per cent on average. They have now emerged as clear leaders within the S&P/TSX composite index, after briefly lagging the index earlier this year.

But valuations that were cheap by historical measures near the start of September, before the current rally kicked in, are now in line with the long-term average. While that doesn't mean that bank stocks are overpriced, it does suggest that they're no longer a steal.

If you recall, Canadian banks were going nowhere for the four-month period between May and August (inclusive), marking a curious departure from what looked to be an upbeat operating backdrop at the time.

I wrote about this apparent mismatch on Sept. 5. The Canadian economy was humming, the price of crude oil was moving up and banks had reported strong third-quarter profits that were, on average, 11 per cent higher than last year. Best of all, the Bank of Canada was raising its key interest rate, which generally increases bank profits on their loans.

Add an average dividend yield of 4.1 per cent, and – barring a housing market catastrophe – Canadian bank stocks looked hard to pass up.

Yet, share prices were going nowhere. At their low point, on Sept. 7, stocks were trading at levels seen in early December.

Investors appear to have recognized the big opportunity here and, five weeks later, bank stocks are no longer looking unloved.

The S&P/TSX composite commercial banks index, which consists of the Big Six banks, Laurentian Bank of Canada and Canadian Western Bank, has rallied 8.3 per cent from its September lows. The sector has outpaced the 5.6-per-cent gain in the broader Canadian market – itself an impressive feat – and demonstrated that when things are good for Canada, they're very good for the banks.

Royal Bank of Canada, Toronto-Dominion Bank and National Bank of Canada, in particular, have hit record highs within the past week.

Bank stock valuations are now in line with 10-year historical averages. According to data from RBC Dominion Securities, the Big Six bank stocks trade at 11.6-times estimated 2018 profit, which is above the historical average of 10.9-times estimated profit.

Bank stocks also trade at their average historical price-to-book value of 1.8. And that 4.1-per-cent dividend yield before the rally has retreated to 3.8 per cent, attributable to rising share prices.

A nice buying opportunity has passed, but there is no need to fret: If you're inclined to make bets on individual stocks, rather than own the entire sector (I own units in the BMO Equal Weight Banks exchange-traded fund, which gives me exposure to the Big Six), good deals can still be found.

Among the biggest banks, Canadian Imperial Bank of Commerce stands out with price-to-book and price-to-earnings multiples that are below the peer average. The stock also comes with a sector-leading 4.6-per-cent dividend yield.

CIBC has another thing going for it: The stock lagged the returns of its big bank peers in 2016. As I've pointed out in previous articles, lagging bank stocks have a tendency to close the gap with their peers, meaning that last year's underperformer tends to be this year's outperformer.

So far in 2017, CIBC has bucked this trend with a year-to-date gain of just 2.5 per cent – compared with a group average gain of 6.8 per cent. Perhaps this stock-picking strategy won't work this year. Or perhaps CIBC remains an outstanding buying opportunity.

But there's another reason to stick with bank stocks following the group's impressive rally. While valuations have risen from bargain levels, they're not excessive today. That means there is room for stocks to rise further with profit growth, dividend hikes and interest-rate increases – all of which seem likely.

There are good times to buy Canadian bank stocks; there are not bad times to own them.
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Tuesday, October 10, 2017

Scotiabank’s AT1 Security A Hit; Other Banks Expected to Follow Suit

  
The Globe and Mail, Christina Pellegrini and Niall McGee, 10 October 2017

More Canadian banks and possibly life insurers are expected to follow Bank of Nova Scotia's lead and take advantage of a novel source of funding that has proven to be a hit with investors, bankers and analysts say.

Last week, Scotiabank raised $1.25-billion (U.S.) from institutional investors mostly in the United States, Europe and Asia through the sale of a new hybrid security that has many attributes of preferred shares, but is legally debt. The notes were crafted in such a way that the money raised qualifies as additional tier 1 (AT1) capital, which is part of a cash reserve that Canada's top banking regulator expects banks to hold to maintain a minimum level of financial stability.

The Canadian banks have primarily raised this type of capital by issuing preferred shares into the domestic market, which is heavily dependent on retail demand. But preferred shares have been a tough sell for banks to export beyond Canada because Canada Revenue Agency puts a tax of 25 per cent on any passive income generated by investors who are not residents of Canada.

Scotiabank's hybrid note was well-received partly because it was structured in such a way that avoids this tax on foreigners. It also offers investors a yearly interest rate of 4.65 per cent in the first five years and a floating rate after that. It has no scheduled maturity, and converts into equity during times of distress, satisfying the banking regulator's requirements.

Scotiabank lined up 330 interested institutional buyers and amassed an order book that was about seven times oversubscribed, Vivek Selot, an analyst at RBC Dominion Securities Inc., said this week in a research note. The deal was led by UBS AG and featured Scotia Capital Inc., Merrill Lynch, and Citigroup Global Markets Inc. as joint bookrunners.

Scotiabank declined comment on the offering.

Greg McDonald, the director of debt capital markets at TD Securities Inc., called the AT1 issuance "an important step" in Canadian banks' bid to gain access to additional U.S. dollar funding avenues. "Any time you can open up a new market for either funding or capital … it's definitely a plus," he said.

He expects many of the Canadian banks to consider it as a new potential future source of funding, and weigh it against existing options such as preferred shares.

BMO Nesbitt Burns Inc. analyst Kris Somers called Scotiabank's note a "gamechanger," adding in a report that the new structure has the potential to result in reduced supply of preferred shares sold by financials.

This type of offering is being billed as a solution to a problem that Canada's largest financial institutions have been wrestling with for years: The country's market for preferred shares has become a less reliable and more costly way of sourcing AT1 capital.

In 2015, it became clear that the preferred-share market in Canada was encountering stumbling blocks.

After the financial crisis, banks sold preferred shares with a built-in feature that would see the dividend rates reset after a certain period of time. This was done so that when interest rates eventually rose as the economy recovered, so, too, would the income generated by the shares. Except, by 2015, interest rates were not rising – they were still falling. The dividends were resetting lower and investors were earning a lot less, spurring mass selling and pushing preferred-share prices lower.

Opportunistic institutional investors stepped up to fill the void, demanding hefty dividend yields. Banks had little choice but to pony up and swallow the costs. The episode spurred banks and their lawyers to look for another way of sourcing these funds. Two years later, Scotiabank has done just that.
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Sunday, September 24, 2017

Canadian Banks Make Push to Beef Up Utilities Expertise in the US

  
The Globe and Mail, Christina Pellegrini and Niall McGee, 24 September 2017

When word got out in July that Hydro One Ltd. had retained Moelis & Co. to advise on its $4.4-billion deal for Spokane, Wash.-based utility Avista Corp., the reaction from many on Bay Street was: Hydro One hired who?

The transaction showed just how fierce the competition is for this kind of work and how Canadian investment banks have to do more to stay relevant to companies that are plotting growth outside of Canada. Moelis, a New York-based boutique bank, was well suited for the role "given their depth of M&A experience in the U.S. regulated electricity sector," a Hydro One spokesperson said last week. Canadian banks weren't entirely shut out: Three led Hydro One's equity financing deal to help pay for Avista, leveraging their vast institutional and retail distribution networks to raise money quickly. But Moelis ultimately won the lucrative advisory mandate – earning bragging rights as the top dog – and pocketed a $16-million fee, according to an estimate by Thomson Reuters.

In recent years, deal flow in infrastructure has exploded around the globe. Flush with cash, investment funds are on the hunt for assets with stable cash flow and governments are cashing in by moving to privatize certain public assets at rich valuations. This dynamic has resulted in a boom in dealmaking. Meantime, Canadian power and utilities companies have been keen on doing deals in the United States to diversify their businesses, access growing markets and boost their return on equity, says Mona Nazir, an analyst at Laurentian Bank Securities.

As companies expand into new regions, Canada's biggest investment banks are following suit. Many are bolstering their power and utility teams in the United States, hiring more bankers to work on the ground and boosting their coverage of the sector south of the border to capture more deal activity.

"Our Canadian clients' needs are evolving and are increasingly focused on the U.S.," said Pierre-Olivier Perras, the co-head of the power and energy infrastructure group at BMO Nesbitt Burns Inc. The bank is responding by looking at expanding its U.S. utilities practice, he added. "It's really about having the right relationships and the best ideas at the right time."

TD Securities too has singled out the sector as one of its key focuses over the next few years.

Scotia Capital Inc. began expanding its power and utilities franchise outside Canada years ago, following clients such as Emera Inc. and Fortis Inc. into the U.S. market. And it is still looking to add bankers to its U.S. team. In the next 12 months, the bank expects to have the same number of power and utility bankers on both sides of the border, said Charles Emond, who is co-head of global investment banking.

The bank has also built a presence in Latin America in a bid to advise local power and utilities clients or financial players such as the Canadian pension funds. While still early days in these countries, Mr. Emond estimates that roughly half of Scotia Capital's deal flow in the pipeline in the Pacific Alliance region is in power and utilities.

What matters most to acquirers is the proprietary insight their bank has about the regulatory landscape and a potential target, as well as access to that company's management and main shareholders.

"Those relationships with the target is really what resonates the most with the acquirer," Mr. Emond said. "That relationship, the access, the knowledge about the market is the way to often differentiate yourself and get hired."

But despite efforts by Canadian investment banks, they at times fall short when they compete against large U.S. firms for advisory mandates on cross-border deals.

San Francisco-based Wells Fargo Securities has advised on a number of large-cap utility, power and pipeline deals during the past few years, advising both U.S. and Canadian acquirers. When Wells is able to beat out the Canadian competition, said Eric Fornell, vice-chair of investment banking and capital markets, it's often because of lending relationships with companies that go back decades and deep ties with management.

Last year, when Wells advised TransCanada Corp. on its acquisition of Columbia Pipeline Group Inc., Mr. Fornell's relationships with decision makers on both sides was a major factor in winning the mandate; he'd known the CFO of Columbia for 20 years and the head of M&A at TransCanada since 1999. With that kind of history, bankers can have a very "straightforward, direct conversation" with management teams in a way "that's not threatening to them," he said.

Furthermore, when Algonquin Power & Utilities Corp. was negotiating to buy the Empire District Electric Co. in 2016, not only did Mr. Fornell know Algonquin's management well, he knew the Moelis adviser on the other side, having previously worked with him at another bank.

"He was not going to steer me wrong, and I'm not going to tell him anything that's untrue," he said of his dealings with his ex-colleague.

In terms of other Canadian banks in the United States, Mr. Fornell gives kudos to RBC Dominion Securities Inc., saying they have a solid team of bankers on the ground. "We're seeing RBC a lot," he said. (RBC declined to comment for this story.)

"They're doing business and they're lending money," he added. "It's just that in some cases, Wells Fargo and other U.S. banks have been at it longer."
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Wednesday, September 20, 2017

TD Securities Readies for Prime Time in the US

  
The Globe and Mail, Niall McGee, 20 September 2017

At the main offices of TD Securities Inc. in New York, some 250 people buzz around on its trading floor – a patch of real estate once occupied by German colossus Deutsche Bank AG.

The Canadian bank-owned dealer is bulking up – even as some of its foreign competitors pull back. Over the past three years, TD Securities has increased its hiring in the United States, adding 300 people to bring its head count to roughly 900. Over the same period, it has boosted revenue in its U.S. business at an annual clip of 18 per cent and is targeting more double-digit growth in the years ahead.

But making further gains in a region that is drastically more cutthroat than the Canadian market won't be easy. While TD is already a formidable force in the retail banking market in the United States, it's still not clear whether that strong brand presence can make it a dominant player in capital markets.

"While [the United States] is exceptionally lucrative, it is also very competitive, and you don't have the same history and you don't have the same Rolodex and access to the C Suite as you do in Canada and it becomes a much tougher slog," John Aiken, an analyst with Barclays Capital, said in an interview.

In the United States, TD Securities is a tiny fish in an enormous pond, with only about 2-per-cent market share in capital markets – a minnow compared with U.S. behemoths such as JPMorgan Chase & Co. and still smaller than rival Canadian dealer RBC Dominion Securities Inc., which has the strongest footprint of any Canadian bank in U.S. capital markets.

The United States is orders of magnitude bigger than the home market and represents a novel source of growth for TD in capital markets. Added revenue from investment banking, trading and corporate banking also acts as a buffer against any stumbles in the retail part of the business, which over the past decade has made up the bulk of the Toronto-based bank's profit and revenue.

"Our objective is to grow the wholesale earnings of the bank more significantly," Glenn Gibson, vice-chair and regional head for TD Securities USA, said in an interview this summer. "The best opportunity to do that is in the U.S. market."

TD's wholesale business – corporate lending and capital markets – has historically lingered around 9 per cent to 10 per cent of earnings, much lower than those of bank-owned Canadian competitors such as BMO Nesbitt Burns Inc. and RBC, which are closer to 25 per cent.

However, since becoming chief executive officer in late 2014, Bharat Masrani has signalled a shift in TD's strategy that puts more emphasis on expanding its capital-markets business, particularly in the United States.

It's a strategy that deviates from that of his predecessor, Ed Clark, who chiefly focused on growing the bank's retail business during his almost-12-year run.

"Where TD strategically may be more open to a venture like this stems from the fact that Bharat had spent the bulk of his time before he became CEO in the U.S.," Mr. Aiken said. "It's a very different marketplace, which has benefits as well as idiosyncrasies, which Bharat may feel a lot more comfortable with than Ed."

While TD has serious ground to make up in U.S. capital markets, it's not starting from zero. In a handful of areas it is already competitive, particularly in foreign-exchange trading and certain segments of fixed income and corporate lending. For example, in the telecom sector, TD was the 12th-biggest lender in the United States last year, according to Thomson Reuters, and the ninth-biggest dealer in supranational, subsovereign and agency (SSA) debt.

But TD sees opportunities to make greater inroads.

The dealer wants to grab a piece of prime brokerage space for the hedge-fund industry – a lucrative niche that includes providing margin financing and lending securities for shorting. It also aims to become a contender in mortgage-backed securities trading, a previously maligned but still important and profitable subset of the fixed-income market.

TD is under no illusion about how tough it will be to make it big in the United States. "We don't expect anything to be given to us," Mr. Gibson said. "We earn every piece of business that we attract in the U.S."

TD Securities has a long history in the United States. It became a fully fledged investment bank and broker-dealer in 1989. Through the 1990s it was a niche operation, focused mainly on lending to media and telecom companies and the energy sector, and operated separately from its fledgling Canadian unit.

By the mid-2000s, things started to change. Starting in 2004, TD made a number of major retail acquisitions in the United States, spending billions to buy the likes of Banknorth Group Inc. and Commerce Bancorp Inc. But despite a vast improvement in brand awareness, TD didn't make great strides in capital markets. One reason was the cautious nature of Mr. Clark, who viewed the segment as risky and volatile.

"Clark wasn't interested in competing against Goldman Sachs or other investment banks in the United States. That was pointless," Howard Green wrote in his bestselling 2013 book, Banking on America: How TD rose to the top and took on the U.S.A.

Before the financial crisis, TD had no obvious competitive advantage. With every major global dealer vying for business, TD was "struggling to add value outside Canada," Moti Jungreis, head of global markets with TD Securities, said in an interview.

But after the financial crisis, with no exposure to toxic U.S. subprime debt, TD suddenly had an edge. The Canadian dealer was seen as a reliable counterparty to trade with, and its hefty balance sheet allowed it to lend big to corporate clients when others were pulling back.

Chastened and weakened in the years since, European banks such as Deutsche Bank and Royal Bank of Scotland have become drastically weaker players in the United States, presenting a further opportunity for Canadian banks such as TD to fill the void.

Over the past six years, TD's expansion in the United States has intensified. That has meant beefing up its U.S. fixed-income, derivatives and foreign-exchange operations and broadening its corporate-lending business by getting into areas such as autos, utilities and real estate. In 2014, it became a primary dealer, which means it can trade U.S. treasuries.

While TD has mostly built out its capital markets imprint in the United States by creating its own platform, in September, 2016, it announced the acquisition of Albert Fried & Co. The boutique dealer had been in the midst of building a prime brokerage unit that services hedge funds – one of the most active of all traders in capital markets. TD has spent much of this year completing the buildout of the unit, which it has rebranded as TD Prime Services.

TD has also spent a good chunk of 2017 building a mortgage-backed securities platform, which it is close to launching. While banks' exposure to mortgage-backed securities was a major factor in causing the financial crisis of 2008-09, the sector has rebounded strongly in the past few years, in lockstep with the housing market. According to Thomson Reuters, mortgage-backed securities currently represent about 15 per cent of the fixed-income trading market in the United States.

But despite the expansion in its capital markets footprint, there are still weaknesses in TD's coverage in areas such as structured products and municipal debt.

"We need to widen our product [offerings] in the U.S. so we can be more relevant to more clients," Mr. Jungreis said.

The dealer does little business in cash equities. It has a limited institutional equities distribution and only a small cluster of people trading interlisted shares. With margins razor-thin for all banks in cash equities, TD isn't planning to make major inroads into the sector either.

But perhaps the most glaring omission in TD's playbook is in M&A advice, one of the most profitable of all areas in capital markets. Juicy mandates such as advising Shaw Communications Inc. on its $2.3-billion sale of its U.S. data centre business, Via West, earlier this year, are few and far between. While TD has made inroads in the energy and technology, media and telecom sectors, the dealer is hopeful it can win larger mandates in other burgeoning areas, such as the utilities sector.

Over the past few years, it's not just TD's product offerings that have evolved in the United States, it's the investment bank's entire ethos around the region. Long gone is the island mentality of old. The dealer now speaks in terms of its "U.S. dollar business." What that means is the firm's bankers in New York liaise seamlessly with Canadian clients who want access to U.S. capital markets, and vice versa.

But while all divisions are profitable in the United States, Mr. Gibson said, margins aren't what they are in Canada.

"To get to the same margins in the U.S that you have in Canada, you have to get a size and scale that makes sense. We're getting there."

Over the next three years, TD is targeting 15-per-cent annual revenue growth a year in the United States. One way to hit that mark is getting stronger in the "real money" space, as Mr. Gibson terms it. That means building relationships with, and winning more business with the likes of Blackrock Inc. and State Street Corp., which oversee trillions of dollars for investors, vastly more more than the biggest asset managers in Canada.

Although TD isn't aiming to supplant the likes of a JPMorgan or Goldman Sachs in the United States, Mr. Gibson says it can go head to head with the big guns in certain areas.

"We're not trying to be an aggregate league table player. We're not going to knock off the top five U.S. banks," he said. "But can we be right below that lead group of U.S. broker-dealer universal banks? Absolutely we can. And that's where we should be."
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