Royal Bank of Canada sacrificed the soaring atrium in the middle of its headquarters tower in Toronto's financial district to build a state-of-the-art trading floor a few years ago. From his team's offices on the floor above, investment banker Gordon M. Nixon, who runs the RBC Dominion Securities unit, could peer down from his windows at the busy traders at work. But those traders could also look up to see exactly who was visiting the bankers, sending their clients' stocks on mad rides as rumors of incipient takeovers flew. In went the venetian blinds.
So the traders couldn't see Nixon meet with his counterparts at Dain Rauscher Corp. as they hammered out the details of Royal Bank's $1.5 billion purchase of the Minneapolis-based brokerage, asset manager and investment banking firm.
And the traders can expect many more deals involving Royal Bank and U.S. companies to go on behind those blinds. Among the most likely: an acquisition of a regional U.S. bank, Royal Bank chief executive John E. Cleghorn indicated to U.S. Banker in an interview last month. "We've got to go hunting," he says. "It's hunting season."
The CEO confirms that Royal Bank is also eager to acquire such financial businesses as a mutual fund family or a consumer lender. Even another regional asset manager or brokerage is possible. But Cleghorn feels Royal Bank needs a greater platform for consumer, small business and middle market banking in this country, something it would best get from a regional bank.
Cleghorn believes that within a few years, at least half of Royal Bank's business will be outside Canada, primarily in the U.S. The company now makes about one-third of its money abroad. "Our better opportunities are south of the border," he says. "There's more opportunity, it's a bigger market--and we have to become a truly North American bank."
The Dain Rauscher deal, slated to close by the end of 2000, is the latest and largest in Royal's escalating barrage of acquisitions here. In recent months, Royal Bank has also picked up Prism Financial Corp., a mortgage banking and brokerage operation based in Chicago, and the life insurance businesses of Liberty Corp. of Greenville, SC. The deal was due to close as this magazine went to press.
At a teleconference on the Dain Rauscher acquisition, Cleghorn, 59, who was a linebacker for the McGill Redmen the year they won the Canadian collegiate football championship, told reporters, "This is not an endgame, it's a forward pass."
He's not after a 98-yard touchdown, however. Cleghorn stresses whenever he's asked that Royal Bank wants only "manageable, affordable" acquisitions that will be accretive to cash flow within the first two to three years, "without betting the bank." He wants businesses that don't just produce healthy returns on their own, but that have potential to grow significantly and can benefit from Royal Bank's strengths in other arenas. As he told investors at a conference hosted by Scotia Capital earlier this fall, "We are targeting areas where we have a competitive advantage and where we can generate top-tier value and growth for our shareholders."
Royal Bank has already begun to look for ways to sell products and services across its various U.S. holdings, which also include Internet banking pioneer Security First Network Bank and Bull & Bear Securities, a small discount brokerage on the Web. It also has a majority interest in PrimeStreet, an Internet start-up that provides financing to small businesses from a variety of lenders, and it does private banking through two offices in New York and Miami, established in the 1980s.
"Royal Bank's acquisition strategy is very different from how other foreign banks approach the U.S. market," says Hather Wolf Mattes, an equities analyst who follows Canadian banks for Goldman, Sachs & Co. Instead of taking over large institutions, "it's taking bite-sized chunks and amalgamating them into a full-service bank. Dain Rauscher is really the missing link for the U.S. strategy, in that the other acquisitions were all product manufacturing. Dain Rauscher gives them the broad customer base they need."
To make the most of all of its recent purchases, Royal Bank counts on exporting its cross-selling and sophisticated targeted-marketing abilities, for which it earns high marks in Canada. That won't be easy. Although the company has already started promoting products and services among its various U.S. arms, building an information technology infrastructure and sales culture to match what it has at home will take both time and money.
Indeed, Royal Bank is unlikely ever to reach in the U.S. the level of market penetration and sheer clout it enjoys in Canada, where its $281 billion (Canadian) in assets, equivalent to about $187 billion in U.S. dollars, make it the country's largest bank.
If it were based in the U.S., it would rank eighth, just ahead of FleetBoston Financial Corp.But in Canada's much smaller and more consolidated market, its size carries a lot more heft. Says Shauneen Bruder, Royal Bank's senior vice president of the North American market, "One in three Canadians is dealing with us."
Cleghorn insists that his goal isn't size but returns. He has stated repeatedly that he intends Royal Bank to perform in the top quartile of North American banks. But he's not there yet, at least not compared with the 50 largest U.S. banks, among which Royal Bank's return on common equity would rank it in the top 40% for the most recent quarter reported (the third at Royal Bank and the second for U.S. banks).
Royal Bank reported a 19.5% ROE in its third quarter, which ended July 31, up from 15.6% in the same period in 1999, although a drop in capital markets activity during the spring and summer reduced earnings from their heights earlier in the year. (On a cash basis, adding back to net income the after-tax amount of amortization for goodwill and other intangibles, the company reported ROE of 20.3% in the July 31, 2000, quarter.) Analysts are estimating that ROE for the 2000 fiscal year, ending Oct. 31, will be 19.5%.
Cleghorn's concern with performance is a far cry from the Canadian banking industry of decades past. But the long arm of Wall Street has made "shareholder value" just as much a buzzword north of the border as in the U.S., and brought just as much pressure to Canadian bank CEOs. Cleghorn couches his "strong shareholder orientation" in terms not just of financial performance and returns, but "acquisition discipline and sound risk and capital management."
Says Goldman's Mattes, "In general, Canadian management teams are a little more conservative" than their U.S. counterparts, and "the regulatory environment and political environment have a much greater effect on the Canadian banks than they do here."
Because consumer activism is "extraordinarily strong" in Canada, Mattes adds, "banking fees are lower than in the U.S., but consumers still complain that they're exorbitant. Canadian banks are constrained in what they can charge." That's despite, or because, of the banks' more concentrated market shares nationally.
Although Royal Bank has done business in the U.S. for more than a century (its first branch was opened as Republic Bank in Washington State in 1897 to help miners in the area), only under Cleghorn in the past few years has it made a concerted push.
The Canadian government's quashing of Royal Bank's proposed merger with Bank of Montreal in 1998, blocking the path to further consolidation, amplified Cleghorn's resolve to expand in this country. Bank of Montreal owns Chicago's Harris Bank, which would have given Royal Bank its first significant retail foothold in the U.S.
But with the Dain Rauscher acquisition, combined with the Prism mortgage and Liberty life insurance operations, Cleghorn is finally on his way.
With Prism, which Royal Bank agreed to buy in March for $115 million and closed on in July, the bank got both a mortgage bank and brokerage in one. Prism underwrites and funds its own loans ($7.7 billion worth in 1999) and it also offers loans from more than 100 wholesale and correspondent lenders. Indeed, before it was bought, it billed itself as the largest independent mortgage brokerage in the U.S. And although it comes in 30th in mortgage originations, according to U.S. Banker's rankings (October 2000), the company does as much business as Royal Bank does in Canada--and Royal Bank is that country's biggest mortgage lender.
Prism is active on the Internet, where it private-labels its services by lending though other companies' Web sites (such as DLJdirect) and also participates in loan marketplaces such as LendingTree and E-loan. The company also has a substantial bricks-and-mortar presence, with 159 branches in 27 states, mostly in the West, Midwest and Southeast.
Royal Bank bought Prism at a tough time for the cyclical mortgage industry, with loan volumes dropping and consolidation rampant. In the first half of this year, the top 50 U.S. mortgage originators saw their volume drop by 31% compared with the first half of 1999. Prism did better than average, suffering a decline of 17% in the first half.
But Royal Bank sees the industry's ebbing fortunes as a buying opportunity. In a presentation to analysts, it characterized its Prism acquisition as "tak[ing] advantage of a low point in the market cycle to stake out a position to benefit from future growth in a consolidating industry." The bank plans to continue buying mortgage companies to add to Prism.
In June, Royal Bank negotiated the purchase of Liberty Life and Liberty Insurance Services for about $580 million. That deal, which was slated to close in October, brings it a 660,000-customer base with 1.7 million policies in force, more than 600 dedicated agents, 38 branches in six southeastern states and a national life insurance administration business that handles more than 4 million policies.
The bank's rationale for both purchases was the same: to add products, new customers and delivery channels, all with an eye to cross-selling. Royal Bank's U.S. Internet bank, SFNB, has already begun marketing credit cards to Prism's customers. As soon as the Liberty deal is closed, the company will begin marketing insurance products to SFNB and Prism customers, and vice versa. The two new subsidiaries also provide physical locations for prospective customers both of SFNB and Bull & Bear to open accounts.
The combination sets the stage for introducing entirely new products, as well. Cleghorn points to creditor life insurance, which pays off a customer's major debts, such as a mortgage or car loan, at death. Royal Bank has had a lot of success with it in Canada, since it's one of the only insurance products that Canadian law doesn't prohibit it from marketing directly to bank customers. Liberty will begin to offer such policies to all of Prism's mortgage borrowers.
Now comes Dain Rauscher, to be renamed RBC Dain Rauscher Wessels. CEO Irv Weiser will become CEO of Royal Bank's wealth management operations in the U.S. and join the corporate management committee. He has an acquisition target list of his own, and Royal Bank's capital allows him to aim at bigger targets than he would have been able to reach on his own. A former chairman of the Securities Industry Association, Weiser has plenty of personal contacts to call on, too.
The deal represents Royal Bank's biggest cross-border incursion so far. It doubles the size of Royal Bank's private client division, under which it counts brokerage; both come under the general heading of wealth management. About 60% of Dain Rauscher's $1.1 billion in revenue over the past 12 months has come from wealth management, and it has $68 billion in client assets under administration. It has 83 private client group offices in 21 Midwestern and Western states.
Royal Bank has targeted wealth management for growth for the past several years because it's so lucrative, with returns on equity running at about 40%, double what's considered a healthy ROE in the banking business. Cleghorn wants to see his company's wealth management business account for 25% of total revenues, up from about 17% before the Dain Rauscher acquisition.
And it adds substantially to Royal Bank's investment banking efforts in the U.S., which are focused on the energy, telecommunications, biotechnology and technology sectors, all sectors where Canadian companies have strength. Until now, Royal Bank had been adding to its investment banking abilities here by hiring teams of bankers in those sectors. Not only does this acquisition bring in more than $400 million in equity and fixed-income capital markets business (based on the past 12 months' revenues), but it extends Royal Bank's investment banking client focus to financial services, healthcare, consumer services and municipals.
Cleghorn and his investment banking chief, Gord Nixon, deny any interest in becoming a bulge-bracket firm in the U.S. "We clearly are a boutique-focused investment bank with respect to the United States," Nixon said in an interview just before the Dain purchase was announced.
The raging consolidation among big corporate banks and securities firms leave more room for the boutiques, Nixon says. "It clearly creates, I think, an opportunity for second-tier U.S. financial institutions to pick up incremental business." He also thinks it will make it easier to hire displaced bankers and perhaps help knock down the industry's soaring salaries a notch or two.
Nixon also believes Royal Bank has an edge over many of its U.S. rivals because of the decade his company spent carefully integrating investment and commercial banking, as well as banking with brokerage. "The U.S. is going to do in two years what we did in 10," Nixon says. "And I think having done it in 10 was an advantage."
Securities analysts who follow Royal Bank applaud the acquisition. "We consider Dain Rauscher to be an excellent strategic fit for Royal," HSBC Securities analyst Michael Goldberg wrote in his research note to investors the day after the deal was announced.
Acknowledging concerns that the bank may have bought at the top of the market for U.S. securities firms, and that earnings will be diluted for a few years, he said, "In our view, all of these short-term considerations are outweighed by the growth potential in Royal's evolving U.S. strategy."
Yet, with the sort of cost-savings read layoffs that usually help justify acquisitions nonexistent in this case, Royal Bank is pinning its hopes on cross-selling to reach its earnings targets. And that means investment both in consolidating (or at least coordinating) its far-flung technology infrastructure and in training employees who until now have only worked with a relatively limited product line.
"We're working on the infrastructure right now, but we'll try to leverage whatever is in place," says Bruder, the Royal Bank marketer. "And we're spending a lot of time on the training required and having everything aligned--the salesforce compensation, training, product development, reporting and controls. We have to test and learn our way into the U.S."
Analysts believe that if anyone can pull such rapid-fire mergers off, and make the most of cross-selling opportunities, it's Royal Bank. The company has one of the most sophisticated data-mining operations in North America, dating back to a stealth project in the bank in the late 1970s.
It segments customers by such factors as their life stage, use of different retail channels and vulnerability to switching financial service providers, using 30 million client records. It updates its marketing profile on each of its 10 million customers at least once a month, giving front-line staff specific guidance on what pitch to use with anyone they encounter. Its approach has paid off in rapidly escalating cross-selling rates in the past several years.
And the company has had plenty of practice integrating small acquisitions. "Royal Bank is very experienced at doing this," says Mattes, the Goldman analyst. "This was the strategy they used to build out their wealth management platform in Canada and their global banking platform. They've made over 20 acquisitions in the past five years and successfully integrated all of them."
In fact, Royal Bank executives sound downright blasé about the mechanics of integrating Dain Rauscher, concentrating instead on what they see as the cultural similarities between the two firms. W. Reay Mackay, the vice chairman who heads wealth management at Royal Bank, has participated in a dozen brokerage and investment bank acquisitions, and this, he says, is just about the best fit he's seen. "There's great chemistry between us," he told analysts in presenting the acquisition.
Perhaps it's because Toronto (and indeed, much of Canada) is a lot like the Midwest, giving Royal Bank and Dain Rauscher similar client bases for wealth management. Weiser adds that many of the Dain brokers have been cold-calling RBC Dominion Securities offices in Canada to ask their counterparts what they think of their employer. "The salesforce has been encouraging," he says. "They say they have a sense of autonomy, that they're appreciated for what they do and how they do what they do. They don't have to fit a particular mold."
The top executives are clearly still in the newlywed phase, looking for common ground and making nice with their in-laws. Cleghorn speaks fondly of Minneapolis, where he went for regular doses of opera and art when he was posted in Winnipeg with Citibank, which took over the Canadian bank he worked for in the 1960s and 1970s. Weiser, also a music and art lover, cites his childhood in Buffalo as the source of his knowledge of Canadian football rules. Speaking of Cleghorn personally, he says, "We just clicked."
Still, there's a lot of work ahead for Royal Bank in integrating all these new businesses. And Cleghorn makes it clear that he's aiming for more. "We need a stronger personal/commercial base," he says, using Royal Bank's term for consumer and small and mid-sized business banking. "Now that we've got a very strong mortgage banking and brokerage platform, we want to build up our retail distribution."
Watch out, U.S. bankers. Here he comes.
