Twenty years of bank success show folly of mega-merger pursuit

Of late, there haven’t been too many reports featuring the name of Hugh Brown, the legendary bank analyst who toiled for more than four decades with firms associated with Burns Fry Ltd.

But that changed this week when BMO Capital Markets — the successor firm to Burns Fry — released a report 20 years after the first Canadian bank mega-merger, a proposed link up between Royal Bank and Bank of Montreal, was announced.

Three months later, TD and CIBC announced their own intentions to merge, leaving the stranded Bank of Nova Scotia to become a vocal advocate against the deals.

But the mergers were not to be: by year-end, then-finance minister Paul Martin had nixed both.

In BMO’s report, prepared by a team led by Sohrab Movahedi, Brown was accorded a special thanks, because he was in the trenches when the flurry of activity was underway two decades ago.

The mergers were controversial as the Big Six was set to become the Big Four with the merged banks being the dominant two. The prospect of fewer players brought anxiety to businesses and consumers. But the feeling was the local banks had to get bigger to compete on the global scale.

In its report, BMO rejects that view, given the performance of the banks and the extent to which they have expanded to other parts of the world, largely in the U.S. but also in Latin America.

“The concept of having to be bigger to be successful has proven to be a flawed strategy,” says the report, noting that foreign competitors “have come and gone” while the Canadian banks’ diversified business models “have stood the test of time.”

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BMO’s report says bank profitability has become “less cyclical” because they have learned from prior mistakes and have “become both more diversified and better capital allocators.”

They now dominate more of the domestic financial services business than in almost any other country, and have been “able to generate very strong absolute and relative terms.”
The report shows the many ways in which banks now dominate: For starters, asset growth (7.9 per cent a year) has been almost twice as large as nominal GDP growth, which has checked in at 4.4 per cent. Since 1997, bank earnings are up almost six times; common share dividends are up almost nine times while the S&P/TSX bank index is up by 4.4 times almost twice the 2.4 times gain for the overall stock market. On a total return basis, the banks have bested the overall index. Five of the 10 largest companies are banks: Enbridge, Suncor, Canadian National, Canadian Natural Resources, and Manulife are the other five.

In relation to the U.S. banks, the local players have been stellar: over the 20-year period from 1997 to 2017, the U.S. bank index is up by 40 per cent. Many of banks in the U.S., U.K. and Europe were hit hard during the global financial crisis, with a number disappearing.

The results flow from changes the banks made, including: better governance (splitting the role of chairman and chief executive and having independent boards not dominated by big borrowers); focusing on wealth management and investment banking while downplaying corporate banking; investing in technology (BNS spent $3.1 billion last year); refocusing their customers away from branches to on-line; and through fee hikes.

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As well the regulators have played a “disciplined yet rational” hand given that the banks now have greater capital strength.

‘The Canadian banks continue to find a way to maintain their ROE,” said Movahedi on Tuesday. “The Big Six rule the roost.”

Financial Post

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