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How RBC grew to become Canada’s greatest financial institution


While Royal Bank centered on dealmaking within the U.S., its greatest home rival, TD, embraced retail banking — a ‘cutthroat’ enterprise south of the border — sowing the seeds of their diverging fortunes

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J.M. Smucker Co. chief government Mark Smucker leaned on shut advisers when he made the choice to bolster the jelly and low firm by means of a US$5.6-billion acquisition in 2023 of Hostess Brands Inc., an equally well-known identify in meals, they usually got here from a seemingly uncommon place: a Canadian financial institution.

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The transaction involving the Ohio- and Kansas-based meals firms appeared like simply one of many many mid-sized offers that occur yearly within the United States. But for Royal Bank of Canada, it was the fruits of a strategic shift within the aftermath of the good monetary disaster, when it decided that the good transfer was to give attention to snapping up dealmaking superstars instantly lower unfastened from their American and European corporations in order that it might compete with the largest world gamers in funding banking.

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The technique paid off, with RBC’s group in place to pitch the acquisition of Hostess to New York Stock Exchange-listed Smuckers, positioning its group of bankers because the lead monetary adviser on the deal that mixed household-name manufacturers equivalent to Twinkies, DingDongs, Folgers espresso and Jif peanut butter. The group was additionally in a position to organize a dedicated bridge facility to fund the acquisition and suggested on the following everlasting capital construction.

The strategic pivot to funding banking within the U.S., which coincided with pulling out of an unsuccessful and capital-intensive foray into the ultra-competitive and regulation-heavy retail banking market there, put RBC in a main place when one other world monetary providers participant, HSBC Holdings PLC, was making ready to half with its Canadian franchise for $13.5 billion.

TD, RBC market cap chart

RBC was the client, beefing up its place in private and business banking, the most important and most profitable phase of Canadian monetary providers, by including practically 800,000 prospects and 100 branches.

Personal banking could be the powerhouse, however capital markets is a robust second plank for RBC, accountable for 26 per cent of its web revenue in fiscal 2024, with greater than half the unit’s income now coming from the U.S.

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While Royal Bank was going about successful deal mandates equivalent to Smuckers-Hostess, its greatest home rival, Toronto-Dominion Bank, was changing into engulfed in an enormous money-laundering scandal south of the border. TD in the end paid hefty fines to U.S. authorities in a settlement that additionally capped its limits on asset development there, all of which helped cement RBC’s place because the unchallenged greatest of the Big Five Canadian banks.

“RBC definitely stands out now that its share worth has gone in the wrong way of TD’s,” mentioned Jeremy Rudin, former head of the Office of the Superintendent of Financial Institutions, the nation’s prime banking regulator.

Big Bank market cap chart

Even extra hanging, maybe, is how shareholders seem like bestowing a premium on RBC moderately than merely rewarding the gathering of belongings equivalent to loans, securities and reserves amassed by what will not be solely the No. 1 financial institution in Canada, however the No. 1 firm within the nation with a lead of about $32 billion in market cap over its nearest rival, Shopify Inc.

“Measured by belongings, the Top Five are extra intently clustered than by market cap,” Rudin mentioned, nodding to the quantity by which RBC has overtaken TD on the latter. “I’d guess that’s at all times been the case, nevertheless it’s … notably marked now.”

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RBC is approaching $2.2 trillion of belongings, with TD not too far behind at $2.06 trillion. But RBC’s market cap has soared to $244 billion, placing the valuation hole between the No. 1 and No. 2 banks at greater than $100 billion. Though TD and RBC have at instances jostled for the highest spot through the years, it’s often been a a lot tighter race. In late 2011, TD briefly pulled forward of RBC, however each firms’ market caps have been hovering round $65 billion.

RBC has additionally change into “a transparent standout” amongst its Canadian rivals in the case of the ratio of advisory revenues to lending revenue, a metric analysts use to find out how efficient every financial institution is at producing higher-margin funding banking income in relation to lower-margin company lending, based on National Bank Financial analyst Gabriel Dechaine.

Nevertheless, Rudin, like different longtime financial institution watchers, isn’t able to declare the tip of the Big Five or to switch the catch-all moniker with one thing like a “Big One and some others,” however the divergence in market capitalization is tough to disregard and it dates again to the latter half of the primary decade of the 2000s once they started to pursue very completely different methods within the U.S.

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RBC CEO Dave McKay
David McKay, RBC’s chief government, has been open about steering away from the U.S. retail banking sector. Photo by Peter J. Thompson /Financial Post

‘Apples and orangutans’

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TD’s current troubles within the U.S., although at first blush pushed extra by regulatory scrutiny than aggressive forces, might remind a few of RBC’s former troubles down south, when it was badly stung by the robust competitors in U.S. retail banking following a shopping for spree within the late Nineteen Nineties and early 2000s.

After promoting that loss-making franchise within the southern U.S. in 2011, RBC has spent the previous decade and a half specializing in funding banking and high-net-worth shoppers by means of California-based City National Bank.

David McKay, RBC’s chief government, has been open about steering away from the U.S. retail banking sector, telling attendees at an trade convention in September that he feels no stress to “wager the group” on U.S. banks even at instances once they seem low-cost or ripe for consolidation.

Brian Madden, chief funding officer at First Avenue Investment Counsel, whose holdings embrace each RBC and TD shares, isn’t shocked.

“If you attempt to examine U.S. department banking or conventional P&C (private and business) banking enterprise to a Canadian franchise, it’s like evaluating apples and orangutans,” he mentioned.

They’re simply evening and day. In the U.S., you’ve obtained a fragmented, hypercompetitive panorama … It’s fierce; it is cutthroat

Brian Madden, CIO, First Avenue Investment Counsel

“They’re simply evening and day. In the U.S., you’ve obtained a fragmented, hypercompetitive panorama of 4,000 gamers. Granted, solely a handful or just a few handfuls of them actually matter, however there are millions of opponents. It’s fierce; it’s cutthroat. There’s net-interest-margin stress competing for deposits and loans.”

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There’s additionally a distinct threat urge for food within the U.S., Madden mentioned, and a way more adversarial relationship between U.S. banks and their regulators.

“American lending tradition is simply type of extra risk-seeking, much less risk-averse. There are structural variations in necessary classes of lending within the U.S., like mortgages,” he mentioned. “Putting all of it collectively, the competitors and the loss/credit score expertise after which, to not be ignored, the extra adversarial relationship with the regulators the place it isn’t an impossibility that somebody’s going to smack you down with a US$3 billion high-quality … all of it rolls as much as a decrease ROE (return on fairness).”

In October, TD, which ramped up its U.S. retail banking as RBC was pulling out, paid a record-breaking US$3 billion in fines and different penalties to settle with U.S. authorities after pleading responsible to failing to place ample controls in place to cease criminals, together with drug traffickers, from collectively laundering lots of of thousands and thousands of {dollars} by means of TD Bank accounts in three separate schemes.

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TD Bank
TD Bank’s aggressive development in retail banking within the U.S. fell aside in 2023 over a stalled regulatory clearance, a company tremor that additional shook the financial institution that August when it first disclosed the brewing money-laundering investigation. Photo by Andrew Lahodynskyj /The Canadian Press

But taking a look at TD’s technique over the previous decade and a half suggests solely a few of RBC’s rising market cap lead is attributable to the current fines and development constraints confronted by its rival.

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TD’s aggressive development in retail banking within the U.S., fuelled by acquisitions, was underway for years earlier than a deliberate $13.4-billion takeover of Memphis, Tenn.-based First Horizon Corp. fell aside in 2023 over stalled regulatory clearance, a company tremor that additional shook the financial institution that August when it first disclosed the brewing money-laundering investigation.

The development technique within the U.S., with retail deposit-taking because the anchor, gave the impression to be working till it wasn’t, mentioned Robert Colangelo, a vice-president and senior credit score officer within the monetary establishments group at Moody’s Investors Service.

“TD has been pursuing a enterprise mannequin that might leverage its retail banking, capital markets in addition to wealth-management capabilities, maybe just like what RBC is pursuing within the U.S., however any progress on this plan will now be challenged by its U.S. asset cap,” he mentioned.

TD has been pursuing a enterprise mannequin that might leverage its retail banking, capital markets in addition to wealth-management capabilities …, however any progress on this plan will now be challenged by its U.S. asset cap

Robert Colangelo, Moody’s Investors Service

Madden mentioned that TD’s current troubles have clearly had an impression, with its shares buying and selling at a double-digit low cost to the common of their friends on measures of price-to-book worth and anticipated earnings, a reversal from the three per cent premium they carried earlier than.

RBC shares, alternatively, commerce at a 31 per cent premium on price-to-book worth and a 13 per cent premium on anticipated earnings.

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Looking again to the years main as much as TD’s deliberate acquisition of First Horizon in 2022, Madden anticipated to seek out that the financial institution had carried a premium bigger than within the low single digits, nevertheless it turned out that wasn’t the case.

A “cheap concept,” he mentioned, is that traders have been at all times a bit cautious about TD’s U.S. technique, given the return-on-equity profile of retail banking there.

Retail competitors

Also often known as private and business banking, retail is without doubt one of the best segments in monetary providers within the U.S., with lots of of banks providing quite a lot of services, and completely different “worth propositions,” mentioned James Darroch, affiliate professor emeritus at York University’s Schulich School of Business.

In Canada, against this, there are simply the 5 large banks — some would say six together with National Bank of Canada — they usually don’t provide the identical degree of differentiation in services or products and, due to this fact, the identical pricey win-or-lose competitors degree, he mentioned.

Dechaine spelled out the impression on TD by evaluating its U.S. returns with these of its Canadian retail franchise, the true cash maker.

The Canadian private and business banking phase contributed practically 50 per cent of the financial institution’s earnings in 2024, and generated returns on fairness thrice higher than within the U.S., the analyst mentioned in an Oct. 31 report. The U.S. retail banking franchise, with extra branches than the financial institution has in Canada, contributed solely 37 per cent of the financial institution’s earnings from retail and wholesale banking.

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Initially, although, TD’s technique of spending greater than US$15 billion to purchase banking franchises, together with Banknorth Group Inc., based mostly in Maine, and New Jersey-based Commerce Bancorp Inc., in 2008 paid off, pushing TD’s belongings previous market chief RBC’s in 2013.

The drawback you could have competing with these regional banks is that many of the U.S. retail banking is a single-digit ROE enterprise

James Darroch, Schulich School of Business

Operations have been expanded throughout the japanese seaboard by means of a community of greater than 1,000 branches spanning 15 states and Washington, D.C., with greater than 10 million prospects from Maine to Florida. TD rolled out about US$193 billion in loans, whereas deposits tallied as much as round US$316 billion, giving it a top-three market share place on the finish of the fourth quarter of fiscal 2024.

The financial institution’s U.S. private and business banking franchise, branded as TD, America’s Most Convenient Bank, garnered top-10 rankings in classes equivalent to business actual property and real-estate-secured loans.

However, U.S. regional private and business banking earnings are slim in comparison with these in Canada, the place prospects have a tendency to stay with their financial institution for a lot of of their monetary wants, from automobile loans and mortgages to bank cards and wealth administration, moderately than splitting their enterprise amongst a number of, mentioned Darroch, who centered on monetary providers, strategic administration and threat in his educational profession.

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As TD expanded in a fiercely aggressive market, rising profitably meant maintaining a good rein on bills.

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U.S. Attorney General Merrick Garland
U.S. Attorney General Merrick Garland, accompanied by Deputy Attorney General Lisa Monaco and Deputy Treasury Secretary Wally Adeyamo, introduced on Oct. 10, 2024 that TD would plead responsible and pay $3 billion in fines and penalties over cash laundering-related prices. Photo by Andrew Harnik /Getty Images

“Some of the dearth of controls was as a result of they have been pursuing development,” Darroch mentioned. “The drawback you could have competing with these regional banks is that many of the U.S. retail banking is a single-digit ROE enterprise.”

An unlikely place to seek out acknowledgment of the robust enterprise circumstances TD was working underneath within the U.S. is within the courtroom filings and public statements by authorities meting out the money-laundering penalties, a few of which blamed the financial institution’s ills on being too centered on revenue margins.

“TD Bank selected earnings over compliance with a purpose to maintain its prices down,” Merrick Garland, U.S. legal professional common on the time, mentioned at an Oct. 10 information convention. “That choice is now costing the financial institution billions of {dollars} in prison and civil penalties.”

TD Bank selected earnings over compliance with a purpose to maintain its prices down. That choice is now costing the financial institution billions of {dollars} in prison and civil penalties

Merrick Garland, Former U.S. legal professional common

Deputy legal professional common Lisa Monaco chimed in, saying the Canadian financial institution had “starved its compliance program” of the assets it wanted to obey the regulation, and warning each financial institution compliance official, CEO and board member to take a look at TD’s case as a “examine of what to not do.”

Even earlier than the money-laundering disaster, Madden mentioned there have been sharp contrasts between TD’s and RBC’s development methods.

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For instance, in capital markets, TD once more leaned on acquisitions to achieve scale, notably with an all-cash buy of New York-based Cowen Inc. for US$1.3 billion in 2022.

“The most blatant threat (with buying scale) is that you simply pay a premium,” Madden mentioned, including that purchasing expertise by way of a big acquisition additionally brings the danger of tradition conflict and the prospect that staff of the acquired firm don’t stick round.

The capital play

RBC, in the meantime, has spent years constructing its capital markets presence within the U.S. “organically, by creating a fantastic platform, a successful platform, and selecting folks off, gifted rainmakers, one after the other,” he mentioned. “They have been actually aggressive in doing it counter-cyclically (within the wake of) the monetary disaster, when there (have been) a variety of dislocated bankers and merchants.”

RBC’s annual charges earned within the U.S. had greater than tripled by 2014, boosting its share of the payment pool to 3 per cent from one per cent, a feat that caught the eye of the worldwide press and resulted in a glowing story within the Financial Times.

Darroch mentioned the mergers and acquisitions enterprise RBC is chasing within the U.S. might be unstable and topic to financial and geopolitical shocks, but it stays fascinating as a result of advisory providers contain much less threat for banks than holding fairness or debt on their steadiness sheets. In addition, essentially the most senior funding bankers accumulate hefty charges for his or her experience and recommendation on offers.

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Moreover, he mentioned, such offers often contain a a lot nearer and longer-lasting relationship with the shopper, so it creates alternatives to supply further providers.

Canada big bank assets

RBC, in fact, hasn’t had a completely trouble-free path within the U.S. since promoting its struggling retail financial institution within the U.S. southeast to PNC Financial Services Group Inc. in 2011 for round US$3.6 billion, a reduction to its tangible e book worth.

For instance, a Delaware choose in 2014 ordered the financial institution to pay US$75.8 million in damages to former shareholders of ambulance operator Rural/Metro Corp. after ruling RBC Capital Markets LLC had didn’t disclose conflicts of curiosity through the buyout of the corporate.

It was the largest award for damages in opposition to an funding financial institution for its function as a mergers and acquisitions adviser on the time. More not too long ago, each RBC and TD have been amongst 26 monetary establishments fined by the U.S. Securities and Exchange Commission in a case involving the failure to protect digital communications as required.

RBC has additionally confronted challenges with Los Angeles-based City National, a personal financial institution with high-net-worth and movie star shoppers bought for US$5.4 billion in 2015. Now working as a part of RBC’s wealth-management division, City National tripled its belongings to round US$100 billion, however struggled with losses and excessive funding prices in 2023 and required a US$3-billion steadiness sheet injection from RBC.

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Derek Neldner
Derek Neldner, the Toronto-based chief government and group head of RBC Capital Markets, was the “architect” of the financial institution’s U.S. technique from 2022 till the tip of the final 12 months. Photo by Azin Ghaffari /Postmedia

City National has additionally paid fines and confronted elevated prices to beef up compliance within the wake of two regulatory settlements.

RBC put in new senior administration in late 2023 at City National, which had earned the Bank to the Stars nickname due to earlier shoppers equivalent to Arnold Schwarzenegger and Frank Sinatra.

To assist cope with the issues, CEO McKay turned to a key man behind the success in U.S. capital markets and funding banking to information the general technique within the United States and assist clean the waters stirred up by City National.

Derek Neldner, the Toronto-based chief government and group head of RBC Capital Markets, was the “architect” of the financial institution’s U.S. technique from 2022 till the tip of the final 12 months when the reins have been handed to Greg Carmichael, City National’s government chair, based on an RBC spokesperson.

RBC total return chart

McKay refers back to the U.S. because the financial institution’s second “residence” market, and funding bankers garnered particular point out within the annual report printed in December.

“The power of our U.S. franchise is anchored by our capital markets enterprise,” he mentioned within the report, noting that RBC is now the ninth-largest funding financial institution within the U.S. and competes with the world’s largest world gamers.

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About 51 per cent of capital markets income now comes from the U.S., round 30 per cent from Canada and the steadiness coming largely from the United Kingdom, Europe and Asia, the place the financial institution has additionally gained market share.

“The U.S. is our greatest market and yearly continues to develop as a extra sizable a part of the enterprise,” Neldner mentioned from the financial institution’s headquarters in downtown Toronto.

Next strikes

A brief stroll away, at TD’s headquarters, the trail ahead is much less clear. With a brand new CEO set to take over in February, analysts anticipate the financial institution to show its consideration again to the Canadian market, the place it doesn’t face the identical development constraints as within the U.S. In a bullish situation, this might imply larger earnings.

Dechaine mentioned the technique “might theoretically be ROE accretive” for the financial institution, given the revenue profile of Canadian retail banking versus the U.S., however that may very well be simpler mentioned than achieved.

Based on TD’s historic development in Canadian banking, he mentioned market share beneficial properties are prone to be contingent on a extra aggressive pricing technique, which would cut back returns and dilute earnings meant to offset stalled development within the U.S.

For now, TD officers say the U.S. stays a precedence, particularly because the financial institution was in a position to set up a top-10 place there in lower than 20 years.

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“Our investments to strengthen our governance and management construction, core operations and anti-money laundering measures will place us properly for years to return,” Leo Salom, chief government of TD’s U.S. private and business banking operations, mentioned in an electronic mail. “We proceed to be deeply dedicated to the U.S. market and assured within the power of our franchise.”

In our expertise, these spreads don’t final ceaselessly and there’ll come a time when Canadian financial institution traders search extra U.S. publicity

Gabriel Dechaine, National Bank of Canada

But the uncertainty for TD was clear when fourth-quarter and year-end monetary outcomes have been launched in December: the financial institution suspended medium-term monetary targets, and mentioned they gained’t be revisited till the second half of 2025.

“The impetus is now on TD to comprehensively ‘clear home,’ placate the U.S. regulators and get the consent order that restricts their U.S. development lifted as swiftly as attainable,” Madden mentioned. “Certainly no small feat, however one thing we imagine the financial institution is eminently able to doing within the coming years and that we anticipate, in time, shall be rewarded with an upward re-rating of its buying and selling multiples and its share worth, each within the absolute and relative to its rivals.”

Dechaine is extra skeptical about TD’s rebound, however he additionally questions Royal Bank’s potential to take care of such excessive premiums when measured in opposition to the remainder of the nation’s largest banks.

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“At this juncture, we will’t assist however marvel how lengthy this commerce can nonetheless work, particularly contemplating valuation spreads which can be traditionally large,” he mentioned in an Aug. 29 be aware. “In our expertise, these spreads don’t final ceaselessly and there’ll come a time when Canadian financial institution traders search extra U.S. publicity.”

Back at RBC, Neldner, a 29-year veteran of the financial institution, was eager to speak in regards to the U.S. and the way his group is working to win extra top-notch advisory work for firms equivalent to Smuckers.

“That’s the place the story’s actually accelerated within the final 5 years,” he mentioned.

Fees earned on U.S. mergers and acquisitions have already practically doubled since 2019, climbing to US$380 million, whereas the Canadian financial institution’s M&A market share within the U.S. has climbed to 2.2 per cent, up from 1.2 per cent, based on Dealogic Ltd. information.

“Out of any of our merchandise … M&A is without doubt one of the most troublesome items of enterprise to win with a shopper,” Neldner mentioned. “Strategy and M&A are decided on the prime of a company — on the board, on the CEO. They’re searching for deep advisory capabilities and individuals who they actually belief.”

• Email: bshecter@nationalpost.com

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