One by one, Canadian investment banks are creeping south of the border. Either there's some irresistible force luring our dealers to the United States, or they all have a fear of missing out on something special.
Canadian Imperial Bank of Commerce and Toronto-Dominion Bank are the latest to the party. Over the past six months, both lenders have made it very clear they are looking to the United States for capital markets expansion. They're following independent dealers, such as GMP Securities and Canaccord Genuity, as well as other Big Six rivals, all of which have taken the plunge – for better or worse.
Before any executives get too giddy about the prospects, here's a sober reminder of something that's far too easy to forget: American expansion ain't easy. It looks so reasonable on paper and the reason makes perfect sense – for lenders, Canadian banking growth is slowing; for independents, resource-driven advisory work has been incredibly weak – but the execution is tricky.
U.S. expansion requires a commitment to the cause. Without a long-term vision, it's easy to lose tens, if not hundreds, of millions of dollars.
The biggest problem? Timing the market is tough. In early 2014, GMP opened a Houston office, with hopes of capitalizing on lots of lucrative energy deals. Roughly half a year later, the oil and gas market nosedived. With $20-million already sunk into the effort, the return on this investment looks rather anemic right now. (The dealer has stressed it is staying the course.)
Similar timing struggles have played out in retail banking. Both TD and Bank of Montreal inked major U.S. personal and commercial banking acquisitions in the past decade, but both banks are still suffering from single-digit returns on equity on these investments. The simple reason: The economic recovery from the 2008 financial crisis has taken far longer than anyone predicted.
Undoubtedly, the United States looks promising to investment banks right now. Merger-and-acquisition deal flow is at record highs, which means fees are through the roof. And straightforward equity and debt underwriting, in which the Canadians are expanding their interest, is still pretty robust.
It's just that no one knows how long the party for non-resource companies will last.
Some dealers stress their move into the U.S. isn't about profiting on a recent phenomenon – it's about tweaking their broad strategies. TD says it is underweight on capital markets as a total share of revenue. The bank has long sought an 80-20 split – with 20 per cent of revenue coming from its securities arm – but right now that mix looks more like 90-10.
CIBC already generates a good chunk of its revenue from capital markets, but it wants to expand the proportion that comes from outside Canada. Right now, the foreign portion is roughly 30 per cent; by fiscal 2018, the bank wants it to be 40 to 50 per cent of the unit's revenue.
And deal flow, the dealers argue, is increasingly cross-border. Canadian pension funds keep buying and selling abroad; Emera Inc.'s $6.4-billion (U.S.) acquisition in September was a U.S. deal. To better serve their domestic clients, our investment banks believe they need bankers where the deals are.
The good news is that their current excursions are into safe stuff – our dealers aren't doubling down on collateralized debt obligations (CDOs). Plain-vanilla banking products, such as corporate loans, are the hot ticket. The thinking? Lend money to a big company and they'll be more willing to give you underwriting or advisory fees on their next big deal. Investment banking 101.
But that doesn't mean there will be a guaranteed return on investment. U.S. banks have largely recovered from their recession wounds and they're all looking to lend money. That means loan pricing is incredibly competitive.
Ramping up can also cost a pretty penny. Whereas RBC played the game quite smartly, expanding its U.S. corporate loan book after the financial crisis and hiring bankers (at a relatively cheap rate) at the same time, it isn't as easy now to bring new people on board. The last thing any dealer should want to do is hand out two-year guarantees. No one knows where the market will be in 12 months.
The big unknown is whether Canadian dealers can show restraint. It's one thing to go in with a niche strategy, but if they get some early wins, they may start thinking about full-scale investments. Truly ramping up in the United States can be a money pit – to advise top clients, a bank can't just lend; it often needs to add services, such as research coverage, too.
Maybe Canadians have learned their lessons from years past. TD, for one, was badly burned on telecom loans after the tech bubble burst. But just in case any of them start to lose their wits, let this be a reminder to tread carefully – for shareholders' sake.