Conservatism and consistency are the hallmarks of successful banks, and Canada’s financial institutions demonstrate these traits far better than their international peers. The CEOs of our banks exude a comforting Canadian blandness. On the surface, they’re not so much individual personalities as embodiments of their respective institutions’ knowledge and culture. So when a bank gets a new leader, no one expects the new guy (so far, it’s always been a guy) to make any drastic changes. The news that Toronto-Dominion Bank and the Bank of Nova Scotia were bringing in new CEOs barely created ripples on Bay Street last year, but a changing of the guard at Royal Bank of Canada could prove to be an exception.
In August, Dave McKay will replace current CEO Gord Nixon, assuming control of Canada’s largest—and most profitable—financial institution at a pivotal time. For one thing, the bank is sitting on a lot of cash (possibly as much as $4 billion by the end of the year, according to one estimate) and continues to churn out excess capital. McKay needs to do something with all of that money, and analysts say acquisitions are a strong possibility. The domestic market is also set to slow, and McKay will have to grow other areas of the company to compensate. For the first time in a while, there is a cloud of uncertainty around RBC. Its competitors have clearly defined strategies: Scotiabank is building out its overseas operations, while TD and Bank of Montreal are expanding in the U.S. Analysts aren’t sure where RBC is headed. “McKay has an awful lot of capital to deploy,” says Robert Sedran, an analyst with CIBC World Markets. “He’s going to be a transformational CEO. So we are expecting change. We just don’t know what.”
In the meantime, the Canadian market is losing steam, and that will curb the blockbuster earnings growth that all of the banks have enjoyed over the past decade. Enticed by low interest rates, Canadians borrowed heavily from lenders and ultimately juiced bank profits. (RBC, the sector leader, saw profits of $8.3 billion over the past year.) With household debt-to-disposable income at 164%, Canadians are unlikely to keep borrowing at the same pace. “That growth engine is sputtering,” says Peter Routledge, an analyst at National Bank Financial. Canada is, of course, the biggest and most important market for RBC. Domestic personal and consumer banking accounts for about half of the company’s earnings, whereas TD, Scotia and BMO are slightly less reliant on Canada. (CIBC, on the other hand, gets approximately 65% of its earnings from Canada.) “Royal Bank is overweight in Canadian banking,” Routledge says. “They need to shrink its proportion by either growing other businesses organically or through acquisition.”
Don’t count on McKay (who was unavailable for an interview) to bring a lot of foreign market experience to the table—his background lies primarily in domestic banking. He joined RBC in 1988, and worked his way up through various positions, including spearheading the credit cards and financing products division before becoming the group head of Canadian banking in 2008. Since then, RBC’s net income from personal and commercial banking has grown roughly 70% to $4.4 billion in 2013. (He also added Caribbean and U.S. banking to his portfolio in 2012.) It’s worth noting that during his tenure, McKay has been an enthusiastic adopter of new technology, helping to push RBC further into mobile banking. He’s even made trips out to Silicon Valley to keep tabs on tech developments and search for partnerships, though nothing major has arisen yet. It’s wise for McKay to pay serious attention to online banking and mobile payments. With major tech companies like Amazon, Apple, and Google looking at payments, RBC can’t risk getting sidelined.
On the Canadian front, though, the bank is well equipped to deal with shifts in the domestic market. “Despite the deleveraging, we still continue to expect to see mid-single digit growth in consumer lending and growth in business financing as businesses take advantage of the low interest rate environment,” wrote RBC chief administrative and financial officer Janice Fukakusa in an e-mail. The bank also owns and controls much of its branch and distribution network, so it doesn’t rely on third-party mortgage brokers, for example. That means RBC doesn’t have to compromise on a deal and forgo the best return for itself in order to keep partners happy, unlike some of its competitors. The bank will have to cut costs, too, and RBC has been thinking about this for a while, according to Routledge. “They’re a little bit ahead of their peers,” he says. As the Canadian market slows down, RBC can pull back even further on marketing spending and branch upgrades.
Cutting can only take the bank so far, and McKay will ultimately have to look outside of Canada for growth. The United States provides some of the best opportunities. RBC already has a sizable capital markets business south of the border: the U.S. accounts for 60% of RBC’s capital markets division, up from 40% just a few years ago. RBC went on a hiring spree during the financial crisis. As investment banks were forced to shed employees to survive (and others simply imploded), RBC attracted workers with its relative stability and generous pay packages. It ended up with a lot of talent. “That’s the way you want to grow in a capital markets business,” Sedran says. “You want the people and the knowledge. You don’t want the legacy assets or issues that might come with an acquisition.” RBC will probably never compete with the likes of Goldman Sachs in the U.S., but it can fare well as a mid-sized player, especially because of its strong balance sheet. It already has one landmark deal under its belt. Last year it was one of four banks, along with Bank of America Merrill Lynch, that helped Dell go private in a US$29-billion deal.
Wealth management is another business in which RBC can expand, although it’s a smaller one compared to capital markets. The U.S. is fertile ground, given that the country has an increasing number of millionaires. “The U.S. has got such a phenomenal amount of money that wealth management is going to be a very hot business,” says Richard Bove with Rafferty Capital Markets in New York. “Not just for RBC, but for anybody who takes a shot at it.”
One area that could prove tricky for RBC, though, is American retail banking. In 2001 the company purchased Centura Banks, a traditional bricks-and-mortar operation, for more than $2 billion and attempted to build a footprint in the southeast U.S. Centura was a lousy business to start with, and RBC was ill-equipped for the intensely competitive U.S. marketplace. RBC sold it in 2011 and took a $1.6-billion paper loss. In past interviews, McKay likened Centura to an “albatross” that the bank was happy to get rid of. Still, the company is not dissuaded on U.S. retail banking. It just won’t go the bricks-and-mortar route again. Competing in online banking and mobile payments could be a possibility, given where McKay’s interests lie—plus both are lower cost and carry less risk.
Although RBC can grow organically in all of these areas, analysts are expecting McKay to make a sizable acquisition, especially because the bank is sitting on more cash than it’s had in years. The hitch is finding not only the right company to buy, but getting it at the right price. Stocks have been caught up in a five-year-long bull market, and valuations are pricey. RBC risks overpaying, and would then have to spend years justifying the acquisition. Sumit Malhotra, an analyst with Scotiabank, says RBC could buy back its shares in the near term instead of making a splashy purchase. “Buying their stock is going to look more attractive than the price of some of the acquisitions in the market,” he says. Fukakusa was circumspect in addressing the question, writing the bank will “look for the right balance between investing in our businesses for long-term growth, returning capital to shareholders through dividends and share buybacks, and pursuing select acquisitions that fit our strategy and risk appetite.”
McKay has been immersed in that culture for more than two decades, and chances are he’ll continue to live and breathe it. But with billions of dollars at his disposal, he’ll leave his mark at RBC soon enough.