(Part 3 of 3) Conversation with Gordon Nixon, CEO, RBC – branding and positioning vis-a-vis competitors – developing a culture around risk-reward – the impact of the US economy on Canada.
Here is the transcript of the video.
1. Strengths of Canada’s financial services industry
Emmanuel Daniel (ED): Gordon Nixon is President and CEO of RBC, the Royal Bank of Canada, Canada’s largest bank, and perhaps one of the most profitable and stable in the world today. We would like to talk to him about how Canada’s financial services ministry has held up in the context of today’s global economic environment.
The big thing about Canada, and speaking to you here in Canada, is that looking at Canada from far away, it’s very difficult to decouple Canada from what’s happening in the neighboring US. Top of mind, your currency is doing very well. Your banks are still being projected as some of the most profitable and stable banks in the world today. What in your mind, is the real difference between the Canadian financial services industry, and the US financial services industry?
Gordon Nixon (GN): I would say the biggest difference is the structure of our residential mortgage market, which is a huge source of strength in Canada and a huge source of weakness in the United States. In Canada most mortgages stay on the balance sheets of banks. They’re well-underwritten. They tend to have fixed terms of no longer than five years, even though they might have 25 or 30-year amortization periods. We don’t have things like mortgage deductibility. We don’t have a big sub-prime market and so forth.
As a result, we didn’t have the same bubble in our real estate market, and when the crisis came, our mortgage market continued to perform exceedingly well, whereas, at the heart of the problem in the United States, was a massive failure in their residential mortgage market and the regulation of their mortgage market. That’s probably been the biggest differentiator. I should also say that home ownership is actually higher in Canada than it is in the United States, which goes to show you that bad lending standards don’t necessarily result in the best outcomes.
But that was probably the most important issue. I would say, in addition to that, I think the fiscal situation of our country enabled Canada to manage through the economic crisis in much better shape than the United States. We did have a recession and unemployment went up, but it was a very short recession. Unemployment has come back down. The economy has shown some pretty good growth, as contrasted with a marketplace like the United States, which is still well below what its potential was in 2008.
ED: From the time you became CEO in 2001, you’ve been somewhat reticent in terms of building any linkages with the US. You actually sold your business in the US in 2004, and you have a view about the US, about excess in the US market, which is somewhat different from a lot of other views. How would you describe –
GN: I mean we still think the US is a very high potential market from our standpoint. We still have fairly significant operations in the United States. We have a big wealth management business there. We have a big capital markets business there. We had a retail banking business, which we’ve now announced the sale of, which closes in March. We will still have some retail operations, but it’ll be at a much more diminished level. And that was done for a specific business reason, in terms of performance and operating potential, relative to other ways to deploy that capital. But we continue to look to the US as being an important secondary market for us.
ED: So in your view, what would that source of income be to tap into that important market?
GN: Well, today, I mean if you look at it today, it’s primarily for us, wealth management and capital markets, where we have big operations in both, and I would say longer term, whether they’re opportunities in the retail space in the United States, not necessarily just retail banking, but other retail components of financial services. It’s something that we pay a lot of attention to, but I think in the short term, we continue to view that market to be operating under very stressed conditions. And so we’ll remain very cautious, but we do have big wealth management and capital market operations.
ED: It’s interesting that being the largest retail commercial bank in Canada, you seem to have put a finger on the wealth management business. How are you constituted to run a wealth management business? In terms of everything from brand to cross selling to customers, and also the product configuration that you have. I mean you are essentially a retail bank in that sense.
GN: Well, yeah, not really. We are the sixth largest wealth management firm in the world. We are a global player. We’ve got the biggest brokerage operation in Canada, the fifth largest brokerage…
ED: On the back of a brokerage business.
GN: No, because we’ve got a very large global private banking business in Europe and in the UK. We’re one of the biggest trust banks in the world. We’re the largest employer, for instance, in the Channel Islands, which is the heart of our trust operations. We have many customers throughout Europe, Eastern Europe, the Middle East, Asia, and we’re continuing to grow that business. So if you look at our business today, we’ve got well over close to $300 billion of assets under administration.
We’ve got close to a trillion dollars of assets under care, and it’s a business that is quite global. We are large in every region of the world, so we feel it’s a good opportunity for us to invest in. It’s also a business where a lot of customers or potential customers, look at Royal Bank of Canada, or RBC, and say this is a bank that’s got a very good track record, very stable, very good credit ratings, in a world where a lot of people are concerned about the financial institutions that they deal with, so it plays right into our strength as an institution.
ED: So the profile that I want to be able to create here is how is it that a bank that is very domestic, has also a critical mass in the wealth management business, and is global, what is at the core of that critical mass? What type of customers gave you that momentum to build that global wealth management business?
GN: We’ve been in the global private banking business for a long, long time, so we’ve always had big operations in the Channel Islands and Switzerland, and the UK, etc. We’ve always been large, obviously, in every aspect of wealth management in Canada, from asset management, brokerage, private counsel, etc. In the US, we bought a company called Dain Rauscher, which is the heart of our brokerage operation in the United States. It’s interesting.
Wealth management traditionally has been done differently by region. The US has been a very broker-centered model. Europe has been very much a private banking model. I would say Canada has been a bit of a hybrid between the two. Asia, I would say, is a little bit more private banking. So if you look at the nature of our operations in different jurisdictions, it’s slightly different. But one of the things that we’re trying very hard to do is to ensure that we tie in the different components of our operation, and that we really leverage between wealth management and capital markets and the strength of the organization.
If you look at Asia as an example, one of the things that we’re doing is we’re building out our distribution network in Asia. We’re hiring a lot of private bankers. We’re putting a lot of infrastructure in place to be able to provide global products and services to an Asian customer base, whether that’s trust services, whether it’s private banking, or asset management services.
2. Analysis of business mix and measuring its effectiveness
ED: As CEO, do you have some matrix in place, in terms of how you review the effectiveness of your private banking, wealth management business? What are some of the matrixes you use to know that you’re doing the right thing?
GN: We have many. We measure a lot of our different businesses in different fashions. When we look at wealth management, we look at profitability as a key driver. We look at assets under administration. We look at assets under care. We look at the number of customers, broken down by geography and region, and so on.
And so there are a lot of metrics, but ultimately, I would say that when you look at global wealth management, assets that are housed within the institution, either through money management or trust services, or private banking deposits, etc., are the most important measure, in terms of your relative size and scale.
ED: Right. That gives us the ideal way you will play and not play, and so on. The further you are from your home market, the greater risks that you take on board…
GN: That’s one of the reasons we like wealth management though, because banking, while being a global business, when it comes to retail banking, it’s still very much a local business. There are a few global banks in the world, like an HSBC who operate banks in multiple jurisdictions. But to the large extent, most of the dominant players are national banks, whether it’s the United States, the dominant players are US banks. In Canada, it’s the five Canadian banks. In Australia, it’s the Australian bank. In the UK, the dominant banks are the British banks. In Spain, it’s the Spanish banks.
In Spain, it’s the Spanish banks. So, the opportunity to really provide a lot of value add in the retail banking space, in a new market, is to some degree, limited. Wealth management, we think is very different because it is much more of a global business, and it’s a business where people are looking for different types of products and services that can’t necessarily be provided by local banks. They’re looking for strength and stability. So, as I say, it is a business, which I think internationally, plays to a much greater degree to our strengths than retail banking.
ED: For someone with a very strong investment banking background, before you became CEO, you don’t talk very much about investment and corporate banking. How does that fit into your profile?
GN: It’s very important. It represents about 25% of our institution, and that’s what we’ve targeted, and that’s been a target, going back ten years, not just today. We think it’s a good mix. In today’s world, if the investment banking component of your bank is too large, it’s challenging from both a regulatory and a market perspective, but having said that, it’s still a good business and a good opportunity to employ capital, and it’s a business we want to continue to invest in.
ED: 25% of your total income…
GN: It’s a big business.
ED: It’s a big business and in some ways, that brings to question, your dominance in the local marketplace, in the sense that you seem to dominate in three or four of the major business lines, retail, corporate investment banking and so on. Is that combination being withered in any way, being tested at the moment?
GN: No, although I wouldn’t use the word domination. Canada has six big national banks, and it’s got a much larger number of smaller banks and credit unions and cooperatives, etc. We tend to be number one or two in virtually every product line in Canada, which on a combined basis, makes us the largest. One of our objectives is to be the dominant bank in Canada, but it’s hard – you’ve got five large banks in this domestic marketplace, it’s hard to argue that one is dominant today.
If you look at our relative market shares, while they are largest in aggregate, you know, the other – particularly the other four major Canadian banks are not that far behind. One of our objectives in Canada is to create distance between ourselves and the rest of the industry by continuing to outgrow the industry by about a 25% premium. We’ve been able to do that over the last five years. We’re still doing it. We think we can do it into the future.
ED: The analysts in Canada, the banking analysts, seem to understand your business very well. They measure you along with the big players. This year, you seem to have somewhat under-performed, but generally, the banks in Canada have been doing quite well. But an analyst from outside of Canada, looking at you, would say that you’ve been incredibly conservative. You’ve not taken the non-organic road very well. What is your sense of organic versus non-organic?
GN: It’s interesting because your perspective is, to some degree, bang on. We have under-performed over the last year or two, in terms of our share price. A lot of that is because we are viewed, because of the size and scale of our capital markets business, to be in a business, which has been revalued, by the marketplace.
So, while you would sit back and say as an outsider that we look to be very conservative with very little risk in investment, to some degree in the Canadian marketplace, it would be the opposite. We would be viewed to be more global, more international, larger in businesses like capital markets and wealth management, in an environment where retail banking seems to be the favourite. Two years ago, investment banking was a premium business. Today, it’s a discount business. In terms of acquisition versus generic, I mean I would say that you want to have the right mix of both.
Priority number one is to invest our capital back in our businesses and grow our existing businesses. As part of our strategies, we recognize that there may be some opportunities, and there are some good decisions to fill in, in areas where we don’t have the size or the scale that we would like. We certainly continue to look for acquisitions in investment opportunities.
ED: Is it possible for an OECD bank to bring back 15-20% ROE today?
GN: We’re making over 15%. Our current ROE is around 18% on core earnings, and our objective is between 16-20%. That’s our midterm objective. So we’ll be disappointed if we don’t bring back an ROE in excess of 15%.
ED: And the driver for that is a mixture of the domestic…
GN: Yeah, it’s a mixture of our various businesses. Now, having said that, I think that we also were expecting, like most people, that interest rates would be increasing at this point in the cycle, as opposed to continuing to come down. I think as you get an extended period of low interest rates, return multiples are going to revise lower rather than higher. But that doesn’t mean we’re going to back away from our sort of objectives in terms of ROE because I think even in a slow growth environment, and a low interest rate environment, a well-managed bank can continue to generate pretty strong returns or profits from various businesses.
ED: If you look at the history of the last ten years under your leadership, you have moved forward and you’ve moved backward. You have made decisions and you’ve actually retracted from certain markets and so on. Is that synonymous with the way in which decision is made within RBC?
GN: Yeah, I think that our industry is a very dynamic industry. I think that if you’re not constantly re-jigging your capital deployment decisions, and you’re not running your bank in a very dynamic fashion, you’re going to be left behind. So by nature our industry is one that is constantly changing, constantly evolving. The stronger banks are those that stay attuned to the evolutions in the industry.
Now, having said that, what I can be very pleased with is that we’ve remained very committed to our overall strategies. So if you look at what we’ve said five years ago or ten years ago or today, our strategic objectives are very similar. The mix of our businesses are roughly the same. Our objective to be 25% wholesale, 75% retail, 50% Canada, 50% outside. A lot of those macro things have changed. What you’ve seen is decisions made within the businesses to basically exit low return assets and to invest in high return assets. I think that dynamic nature is a very important management component of how you run an institution. What you don’t want to be doing is making wholesale directional changes.
3. Implications of Basel III, market and brand perception
ED: Right, and there’s not been that for a while. How is Basel III going to affect your business, given the fact that you are a complex business and you’re holding several balls in the air?
GN: We’re already compliant with the capital requirements of Basel III, so we’re there today, given our very high levels.
ED: Does the market reward you for that?
GN: No. When you look at the multiple that Canadian banks trade at, it’s obviously much higher than Europe or the United States. So I think intuitively, yes, the market does. The market cares whether we’re well capitalized. I’m not sure it cares whether we meet a theoretical level by a date of January 2013, or 2014. As long as our capital levels are continuing to move in the right direction, we’re considered well capitalized. We’re not over-levered. We have lots of liquidity. Intuitively, that is what the marketplace looks like, but I think in today’s world, you get rewarded by being viewed conservative and stable.
ED: At the same time, you are an OECD country, so the market looking at you, would have certain reticence in terms of what the future potential is. Does the market compare you with other Canadian banks like Scotiabank that is perhaps far more aggressive on an acquisition trail. Does the market expect you to be a little bit more aggressive in the deployment of your capital?
GN: The marketplace compares us every quarter, absolutely. In terms of your question, I don’t think the marketplace looks at us as being less aggressive or less international. I think what the marketplace looks at is the business mix is a little different between Canadian banks. Scotiabank’s strategy is really emerging market retail. TD Bank’s strategy is very much US retail. Our strategy is much more international, wealth management, capital markets, so we all have slightly different business mixes.
I think the bigger issue is the market tends to reward, depending on their perspective of what is happening within a different sector. Two years ago, we were being hugely rewarded by the marketplace because we had such a large capital markets business. I mean we were generating $600 million a quarter in earnings. It was a very profitable area, and it was a very attractive area from the marketplace’s perspective. Today, it is, as I say, more discounted as a business, and a business like retail banking is more positively impacted.
You know, Scotiabank is much more impacted psychologically by the perception of emerging markets, in Mexico in particular, because that represents the vast majority of their emerging market or retail banking exposure. So I think the marketplace intuitively makes those judgments more based on strategy, as opposed to –
ED: In fact, as you were describing how the market perceives you, again, from outside Canada and North America, the brand of RBC, it’s not as clear as, you know, the brand of UBS for example, or a true wealth management player in that sense.
You are like a quiet, stable, long-term player. In a way, you’ve got to project that brand a little bit more strongly, and the key messages. And the fact that you are willing to go with the market and decide on, focus on business that makes sense at a certain period of time, doesn’t that sort of impact the brand perception? What is the brand perception that you would like to have in the marketplace?
GN: We’re about to launch a pretty significant brand marketing effort, with respect to our global wealth management business. When you look at the global brand perception of some of the financial institutions that you have referred to, a lot of it is based on the business that they’re built up over many years. If you look at our brand in a marketplace like Asia, we have less scale, less significance, less knowledge, etc.
What we’re trying to do is invest in that brand and invest in that distribution network, so that we are better known, more familiar, more understood, if you will. So, if you look at how we want to be projected going forward, we want to be viewed as being a leading player in areas like wealth management and capital markets. A global player that has the ability to service the needs of our customer base in Asia, but we also have to have the ability to service those customers and so forth, and that’s where a lot of our investment is going into. Strength, stability, consistency of performance, high expertise and trust services and things like that are things that are going to be very important.
ED: That comes together in brand perception and especially in a customer pool that is further and further away from your marketplace, it’s quite interesting. Ten years or more as CEO, how would you describe the core people that have been with you and who are carrying this organization through?
GN: I have a very strong and capable team. I would say that we have a very strong culture. I would say two things that we’re particularly proud of. One is I think we do have a very good risk culture across the organization, all parts of the organization, so that we do look at decisions very much from a risk, reward decision. I think that’s something a lot of banks lost sight of, particularly prior to the crisis.
In addition to that, I would say that we put a lot of emphasis on our values as an institution. We’ve got a very high degree of emphasis placed around things like collaboration and how we work across different parts of the business, to grow the overall organization. I would say that, the engagement, the quality of the team, the unification in terms of how the various businesses work together, has been a real source of strength for the institution, particularly as I see relative to a lot of universal banking models, which are much more siloed in their nature.
ED: That’s exactly the amazing quality of your institution. You do have all the components of a universal bank. You seem to be holding it together well, and obviously, the key people in the organization are important. If you say that risk is the common theme that holds everyone together, then the people that you have will reflect that. You wouldn’t possibly be driven by investment bankers who pretend that they are retail bankers or something like that – you wouldn’t have that kind of a mish mash of personalities.
GN: No, I would say we’ve integrated the different parts of our business, it has worked out very effectively, and I think part of it is respecting the strength and the culture of the different parts of our business, I mean retail versus wholesale versus wealth. But at the same time, as I say, building common bridges and common cultural threads across all of our businesses, which are non-negotiable, and that everybody has to buy in and be very much a part of and subscribe to. And I think that’s worked very effectively.
ED: Final question. How is Canada going to play out what’s happening today, in terms of the uncertainties of the global marketplace? What is the next year or two going to look like for Canada?
GN: I think Canada will have reasonable, but slow growth. Unfortunately, we are still very influenced by what happens in terms of growth in the United States, although we certainly decoupled from the United States in terms of our performance over the last number of years. But if the US continues to operate in a very slow growth environment, double dip recession perhaps, but even if it’s not a double dip, it’s certainly a very slow growth environment. That is going to have an overall impact in terms of GDP growth in Canada.
Having said that, the structural and fundamental strengths of the country put us in a very good position. Our fiscal situation is very strong. Our unemployment levels, while stressed to some degree, are much lower than they are in other markets and other jurisdictions like the United States. We still have a mix of our economy, which benefits from strong demand for energy and for commodities and markets like Asia and other parts of the world. We have a much more levered consumer in Canada.
We still have a consumer in Canada that has the ability to manage current debt levels and debt, relative to what you’ve seen and other markets around the world. So when you throw that all in the mix, I think Canada will continue to do very well relative to other OECD countries, but at the same time, we are going to be operating in a slower growth environment.