A slow yet radical shift in growth priorities at Canada's biggest banks is threatening to break a long-standing promise to investors.
Because Canada is a small country whose banking industry isn't subject to much foreign competition, domestic investors have long sworn by certain home-grown strategies for sound investing. At or near the top of this list: buy Canadian bank shares; hold them forever; reap the dividends.
For decades, the country's largest lenders, often referred to as the Big Six banks, looked more or less the same, and investors could clean up by simply plowing money into their shares. The underlying assumption was that although individual banks could have their hiccups, over the long haul they would churn out better profits and treat their quarterly dividend payments as sacrosanct.
The theory was so widely trusted because it kept reliably paying off. Gold miners have gone on wild runs, but banks could be counted on decades down the road. Over the past ten years, investing in the S&P/TSX bank index more than tripled shareholders' money after adding in dividends.
Such blind hope can no longer be justified. The banks may yet succeed, but they likely won't do so as a group – what used to be a homogeneous collection of Canadian lenders has morphed into a diverse set of banks, many of which have distinct growth strategies beyond Canada's borders.
"As a result of the last 10 years, you have an à-la-carte menu," said National Bank Financial analyst Peter Routledge.
Since 2004, Toronto-Dominion Bank has spent more than $15-billion (U.S.) on American acquisitions; Bank of Montreal has doubled down on the U.S. Midwest by buying Milwaukee-based lender Marshall & Ilsley Corp. for $4.1-billion; Royal Bank of Canada has expanded its wealth management and capital markets arms in both Europe and the U.S.; and Bank of Nova Scotia has pushed heavily into Latin America, with acquisitions of everything from personal and commercial banks to wealth managers.
"Most people would look at the banks in Canada and say we all look very similar – we're all in the same businesses, we all have the same products," RBC chief executive officer Gordon Nixon said. That still holds true for Canadian operations, Mr. Nixon added, but not so for the banks' international arms.
Until now, Canadian banks have prospered because they are lenders at their core, and domestic households have been happy to take on more debt over the past two decades.
But Canadian household debt now sits at 164 per cent of disposable income, according to Statistics Canada, up from roughly 110 per cent a decade ago. "That gravy train has hit its terminus," said Mr. Routledge. The result: Growth is going to have to come from elsewhere.
The biggest banks already earn a substantial chunk of earnings from outside their home market. In the previous quarter, 43 per cent of Scotiabank's revenues came from its international operations, while over 50 per cent of RBC's capital markets revenues originate in the U.S. TD Bank's substantial investment in the United States added $548-million of personal and commercial banking profit last quarter – 26 per cent of total net income – and BMO's equivalent U.S. arm brought in $155-million, roughly 15 per cent of its total bottom line.
But there is already talk at lenders such as Scotiabank of generating 50 per cent of the bank's profits from abroad.
The seeds of these growth strategies were planted long ago. Once the bank mergers were scrapped in 1998, "it was very clear that the [domestic] strategies of the Canadian banks would diverge," said BMO chief executive officer Bill Downe.
Along the way there have been speed bumps, some more severe than others. In the wake of the financial crisis, RBC sold its entire U.S. personal and commercial banking business in 2011, and even today both BMO and TD Bank are also struggling to reap major profits from their big investments south of the border because the U.S. economy is still rather anemic.
The trick now is for investors and analysts to determine the best way to track these far flung operations. "It's more work," said Mr. Routledge, the analyst, adding, "It's not harder, you just have to pay attention to what's going in the Chilean pension market, or the Mexican credit card market."
And even though the diversity has tossed out the decades-old investing strategy, it's not all bad news for investors.
"As much as we like to outcompete all the other banks, if TD is growing outside of Canada, we're growing outside of Canada, Scotia's growing outside of Canada – that's good for Canada," Mr. Nixon said.