(Part 1 of 3) Conversation with Rick Waugh, CEO, Scotiabank – the curious history of Scotiabank – the big differences to banks in the United States – marketing Canada as ‘America Lite’.
Here is the transcript of the video.
1. Analysis of business mix and a focus on emerging markets
Emmanuel Daniel (ED): Scotiabank is one of Canada’s largest banks and perhaps Canada’s most international bank, very well-represented in far-flung areas of the emerging market economies. I’m very pleased to be able to speak with Rick Waugh, the president and chief executive of Scotiabank.
Tell us a little bit about Scotiabank in terms of how an emerging market client could understand what is it that you do, your position in your domestic marketplace, and the rationale by which you internationalize.
RW: Sure. Well, by Asian standards, Canada is a relatively young country, but as banks go, we’re a relatively old bank. We’re almost 180 years old. The Bank of Nova Scotia—which in our retail operations you’ll see is called Scotiabank—we’ve been the same bank for almost 180 years. So, as private banks go, we’re one of the oldest banks in the world, and I think one of the most successful banks.
Our roots were here in Canada. We came from Halifax, Nova Scotia. Our executive offices are here in Toronto and have been since around 1910, but we were in many places outside of Canada before we came to Toronto.
ED: So you were Canada’s original trading bank.
RW: We were. We opened up in Kingston, Jamaica over 115 years ago, and we were in Kingston, Jamaica before we were in Toronto or Montreal.
ED: Did it have anything to do with the owners of the bank, the businesses that they were doing?
RW: Well, it had more to do with our customers. Our customers in Halifax were taking the lumber and the wheat down to Kingston, Jamaica, and, of course, we were taking the rum from Jamaica back, so we got a good trade on that one. We gave them lumber. We brought back the rum.
ED: How you make money on that…
RW: We did. So that was where it began. We followed our customers, and that’s where trade finance came and what have you, and, of course, that was the first step.
ED: So the composition of your asset base – how much of that is trade? How much of that is domestic lending?
RW: Well, that’s a very good question because we’re all trying to figure out these business models of banks. The way I like to describe our bank, and hopefully this will help everybody in Asia, over 90% of our revenues are what I call in the real world economy: dealing with people, dealing with small businesses, dealing with corporations, large corporations, as well, dealing with institutions but who are all servicing the real world economy. I start off from there.
We only have really, when you break it down, 5% or 6% which is capital markets trading. Some of that capital markets trading is very good. It’s day-to-day foreign exchange or very basic commodities that we all have to use. We’re one of the biggest and oldest precious metal banks in the world.
We do a lot of that at ScotiaMocatta. We bought from Standard Chartered Bank the old Mocatta. This was a number of years ago when they decided to exit the business. We bought that because we had always been in the gold business, primary in Latin America to all the central banks in Latin America.
One interesting story that ties to the trade is because Canada has all these gold mines and copper mines and whatever, but particularly in gold and silver. We didn’t have foreign markets in those days, so we would go down to Central America, South America and go to the central banks and say that, you know, the gold that you have in your vaults, we’ll pay you to store it because we would take it and then lend it to the – and we have very good AAA rating – we would take their gold and either store it for them and pay it and then, with our guarantee, lend it to some of the Canadian mines who would then pay it back out of production. This was like over six or nine months.
The other thing is we would store it, of course, outside their country. In those days, because of the days of coup d’états and a lot of civil unrest – it is the people’s gold, so you had to have it in a safe place in case a general came in and claimed it for himself.
ED: The agenda on gold seems to be right on top of all the newspapers these days as well. There’s a lot of talk in terms of making the trade of gold more liquid and gold futures and so on. Are there any activities on that front?
RW: Gold is very liquid, and by the nature of the product itself it’s a very liquid market. Back 20 years ago it wasn’t, and that’s when we played this role between banks, and we were the intermediary. Now you have exchanges and what have you. We deal in the physical, so you can go into branches in Canada, you can go into branches in India and what have you, and you can get – we will deliver gold. In Canada, you can get the physical gold at one of our branches. Downstairs here – you liked this nice big wooden building, but there’s a lot of gold way down deep.
ED: For an OECD bank you seem to target emerging markets and you seem to have exclusively left out the developed markets, so you’re not in Europe. You’re not in – you’re not very much in the U.S. Is that a deliberate strategy?
RW: That was absolutely a deliberate strategy. We were all over Europe back in the ‘80s and the ‘90s and even into the 2000s, and we decided to consolidate our European operations. We were in Rome and Paris and Frankfurt and Oslo and Madrid and whatever, and we had branches in Ireland which we closed. We had branches in Greece which we ended up selling. So we concentrated that. That was a conscious decision. Let me tell you why.
Because, again, we’ve got this great experience in developing and emerging markets and what have you. We had a very good business in Greece, Greek shipping, commercial landing basically into that. But, of course, with the Euro coming – this was still an emerging economy which we made a very good living on spreads, and now they were going to get cheap financing – a lot of incentive went out.
Secondly, and probably more importantly, the big European banks were going to come in and not have currency risks. They would have the advantage of lending into, say, a drachma-like spread instead of a German-like spread and picking it up which would not have…
ED: This was before the Euro?
RW: No, this was with the Euro, but with the Euro coming because, again, you could lend to Greek government and
you didn’t have a currency risk. Now you had a transfer risk and a political risk, but you didn’t have a currency risk and that’s how especially traders looked at it. Well, the Euro, I could pick up a Euro and pick up 20 basis points more than the…
ED: Right, so you leveraged off the two, yeah.
RW: And so all that was happening, and then we had no comparative advantage against the big, strong European banks. This was their backyard. Whereas in the Americas – Central America, South America, North America, Mexico – we had advantages. This was our backyard. But it’s not all one region. Each country has its own characteristics, and the characteristics that we’re in are ones that generally have their own central banks, which is very important, and, of course, the ability to make a good, solid profitability was very strong. So we made that conscious decision to move out.
Similarly, in the United States over the last several years we have significantly reduced – certainly over the last ten years – our exposure both in absolute terms, and we’ve closed most of our offices, except a very strong office that we have in Houston and a very strong office we have in New York. They’re really deals with two – Fortune 500 where we have great strong relationships. They’re all in good shape. And then the energy business out of Houston because a Canadian bank, Calgary, Houston or whatever, energy is something we do very, very well.
So those are the two areas, but all the other areas in the United States we’re not in – we didn’t do the sub-prime, we’re not in retail banking, and we have no aspirations to be in retail banking. So I feel very comfortable on that.
Did we see this crisis coming the way it did? Absolutely not. But there were some basic fundamentals that I think we did get right.
2. The Canadian mortgage model, measuring the performance of business units and capital allocation
ED: You are yet another Canadian CEO talking about the real economy in the sense that you keep using this phrase to differentiate yourself from the U.S. For someone looking at Canada from very far away, what would you say is the big differentiator between Canada and the U.S. in today’s market place?
RW: If you look at the Canadian business model, we can talk about energy and commodities and whatever – America is blessed with a lot of resources, too, but in our bank we think one of the best products a banker can provide somebody is to give them a loan for their home, a residential mortgage. That is a big part of our balance sheet: homes to Canadians and homes to people in developing countries.
But unlike the American model, we don’t securitise ite. We hold it. And we hold it for some very sound reasons. One is we do the credit analysis. We’ve got very good customers. Our customers promise to pay, and they do pay, so we’ve got years and years of experience about that. But also – and this has also some relevancy to the European banks – our mortgages are good for our customers, and they’re good for us because they’re not 30-year mortgages. You can pay if off over 30 years, but your price risk is a five-year mortgage rate.
So in the United States, banks couldn’t hold 30-year mortgages and 30-year interest rates. How do you fund 30 years? I mean the Europeans have tried it and – but look at the situation they’re in now. So we could hold it because we didn’t have a funding risk. We didn’t have a credit risk. It was good for our customers because when you borrow at a five-year rate, it’s a lot cheaper than borrowing at a 30-year rate. So they don’t have the re-pricing risks. When rates go up, their pricing rate goes up on a five-year mortgage versus if the U.S. rate goes up on a 30-year. If it’s 200 basis points increase on 30-year rates, it’s only 1% of the five-year rate, so our customers can handle it. Over the space of the 30 years you’ve saved your customers –
ED: Did that become a culture in Canada?
RW: Absolutely.
ED: Over what period of time?
RW: I’ve been in banking for 41 years. I can say it’s at least 41 years.
ED: Is that cultivated by the banks, or is that kind of a street culture that came up, and the banks had to respond to that?
RW: That’s why I say we’re a real-world bank. If it’s not good for our customers, it’s not good for the bank. If it’s not good for the bank, it’s not going to be good for our customers. So I haven’t got a good answer to that because it’s not an either/or kind of situation. We evolved into it.
We were blessed with a lot of good things. Being next to the largest economy in the world is a good thing, but it also means you’ve got to be a little bit more agile, because we also had very strong European roots, and we’re gaining more and more Asian roots all the time.
Being a small country against big Europe and big United States, we had to do it. So we do – I call us America Lite because we have the same values: we believe in democracy, we believe in open markets and whatever, great admirers of that, we try to also follow the innovation and the technology and whatever, but we do things our own way; we have our own currency, we have our own central bank, we have our own political system, we have our own education system, which is different than that. I’m not saying better or worse, but it is different.
Our medical system. Things like education and medicine are already in our tax base, maybe not as much as they should be, and we’re going to have challenges in funding going forward, but we’ve crossed that bridge of doing that. Interest on mortgages are not deductible. The Americans are stunned because, of course, in American mortgages they’re deductible. But when you use the tax system, that’s how you get bubbles in certain asset classes.
So we’ve gone over all that because our Canadian customer doesn’t get an interest deduction on his mortgage, so when we do our coverage ratios and our service ratios, that has an impact. So there are all these differences.
ED: Given the fact that your core assets in the home country are solid, the home country looks like it’s going to withstand the current crisis in America, in Europe, and so on, how is your exposure in the emerging markets that you’re in at the moment?, On the trade finance front and the lending front, how does your funding base look? How domestic do you need to be in the countries that you’re doing business in right now?
RW: It’s very important that in most countries, not all, and it’s a little bit different in Asia, but we try to be very much a local bank. We are not a global bank. This is very important. We’re a local bank providing products and services, whatever they are, and they’re slightly different in all countries locally, so we’re a local bank.
We’ve chosen, as I said earlier, I think very wisely so, other countries that we’re in, even if global growth is only less than 4%, the countries we’re in are going to be more. Annual growth is all we aspire for, because that’s how we get jobs, and that’s how we get growing economies. Those countries we’re in where we’re local, providing services – under any scenario that I see, maybe the level of growth will be volatile, but it’s going to be superior to G7.
So I think – so that’s what we see in the picture we get. Right now – we just announced our nine-month earnings and very good earnings. They’re strong, and you can see by all the risk parameters, very strong on risk. Our customers in Canada, in the emerging markets, both the retail and the commercial are in good shape.
ED: Out of curiosity, as a CEO and out of – from a business perspective, how do you keep one view of your various portfolios, assuming that you’re very successful as a domestic bank in the markets that you’re in, what do you look at on a daily basis to make sure that, firstly, your various assets are safe, the risk aspect is correct, and that they’re profitable and that they are good performing assets in that sense? How do you run an international franchise? What’s in the mind of the CEO when you’re looking at a franchise internationally?
RW: Well, again, I’ve been around, and our management team have been around, a long time. So we have information systems, and we have a culture where information comes very quickly to the top, even though we rely very much on our people out in the field, wherever that is. That’s an important thing.
Now it does depend on the product. So when I mentioned that 90% is real world, that means that we’ve got 5% that we’re trading, that’s sort of instantaneous. You use your technology, your MIS kind of things, so we know where our trading positions are. And that is, and has to be, fairly quick real-time and what have you.
Now the day to day banking businesses, knowingwhat our position with an individual is today versus a week from now is not absolutely essential. Having said that, we track delinquency, 30 days, hard-core delinquency, and we have all this reporting, and it does come up, but it’s not the real-time that you have on the trading. So you just build these systems up over a very long period of time and that – and the last thing is you really rely on your local people and their reporting and their checks and balances.
ED: The reason I asked the question is that you seem to have a very cozy relationship with the analysts. The analysts understand your business. They understand the far-flung nature of your franchise. Somehow they seem to recognize that on your books, so when you report your quarterly results, they know what to look for in that sense. So to you in order to be able to give them good news every quarter, there should be some kind of a funds transfer pricing type of mindset making sure that the allocations of your capital –
RW: Well, we spend a lot of time on capital allocation. We’re very profit-driven. We’ve very efficiency-driven so we have a whole set of financial metrics when we negotiate our budgets. We try to be as transparent as we can. Not on competitive information or customer confidentiality, but where they get their comfort is our track record. And if you look at our return on equity, our profitability, you look at our efficiency, our productivity, you look at our credit history, our risk history over one year, five years, ten years, 15 years, 20. Return on equity, we are a world leader.
So even in our worst – right now we’re at about 18% return on equity.
ED: Which is very good for…
RW: But – even more important than that is in our worst years, 2008, 2009, our return on equity was 16%, 17%. Go back five, ten, 15, 20 years. Our return on equity is not only high, into the high teens, it’s very steady. Go back over 20 years, and see the number of time we ever adjusted our earnings. Very, very few.
And then look at the total shareholder return our customers have been getting over three, five, ten years in Canada. So the comfort is all on the past, and hopefully the comfort also is understanding, which is your question, the business model which has worked and proven itself in the real world.
3. Acquisitions, investments and brand perception
ED: Right. Because in order to maintain that comfort given the fact the way you describe it, it’s like maintaining the comfort is paramount in a sense, right?
What are some of the things that you would not do as a bank in terms of acquisition, in terms of businesses that you wouldn’t go in to?
RW: We are very disciplined. One – a thing that I’ve been talking about recently is during a crisis, we’ve made over 20 acquisitions. Now we don’t make big ones, because we believe in diversification, and we’re not going to bet the bank on any one acquisition. But over that – the last three or four years, we’ve made about 20 acquisitions, about $12 billion. We made about half of that, about $6 billion, into the emerging markets: Thailand in Asia was one example, and this is before even China, which we talked about.
And then in Canada, through our wealth management, we’ve made about another five or six, and a few others areas. At the same time, because we’re highly profitable, we didn’t have to raise equity, and at the same time we kept our capital ratios very, very strong.
Why? Because we make sure anything we do is diversified, doesn’t risk the bank, meets our financial parameters and is on our strategy. We don’t change our strategy very much. We’ve had hard luck because of Basel and whatever happens – a lot of issues going on in Basel – but we’re comfortable enough that we can handle whatever the Basel re-regulations throw at us, and not change our fundamental strategy and our fundamental business model.
ED: Let’s take a look at your far-flung acquisitions and your far-flung assets. You’re in Malaysia.
RW: Yeah.
ED: And you’re very domestic in Malaysia as a foreign bank. How did that happen?
RW: Over a long period of time. I remember taking our board to Malaysia. I was vice-chairman of international, and that’s got to be 1998, so, again, we’ve been in many Asian countries for 25, 30 years. Small and, depending on the rules and regulations, different types of operations, largely commercial, and in Malaysia our branches are commercial. I remember going many, many times to meet the president or the prime minister of Malaysia saying please give us another branch, please give us another branch.
Gradually we ended up with a number of branches, so we got a very good clientele into the Malaysian business community. We’re not very big in the retail, in Islamic banking or whatever – we’re looking at it, but really we’re commercial, so we got our Malaysian management team, which has been with us a long time. We don’t have to have many ex-pats in there, maybe for a little bit of technology and whatever, so it’s a great success. We would love to do more in Malaysia and have for 25 years, but it’s been one branch at a time. So that’s the background.
Each one of our countries in Asia has a similar story. We’ve been able to accelerate South America and Americas quicker for some of those reasons I told you – our backyard – but it’s also easier. The regulations, the foreign ownership and what have you, and you know better than I do that those issue are still slow, but coming forward. Asia’s strong. It’s liquid, and it’s harder to get through the regulations and the ownership restrictions. But it’s gradually happening, and we’ll position ourselves to do that in those right markets.
ED: And there is this acquisition of 20% of Bank of Guangdong.
RW: Right.
ED: Is that part of asset diversification, or is that part of portfolio diversification, or is that part of strategy to become domestic in China?
RW: It’s both. We’ve been working on our strategy in China at least for 20 years. We own now almost 20% of the Bank of Xi’an. I remember going to the IMF meetings in Singapore in the late ‘90s. That’s when we had the handshake. This is Xi’an. We went with the World Bank and the IFC. We’ve got branches in China. We’re in Chongqing. And everybody says, “You’re in Chongqing?!” We’ve been in Chongqing for 20 years.
Because Chongqing is near the mining, and whatever, that made sense with the Canadian side, so all that is very slow; Guangzhou is really a continuation, and, of course, because of the crisis and whatever, Guangzhou will be slightly different because our partner, which is a little unique and the same with Xi’an, is, of course, the government, the city of Guangzhou. That’s good. I’m very comfortable with that because this is a city commercial bank, so we’re going to learn from them a little bit about retail banking with the Chinese customer and how you service the Chinese customers today.
What they are going to learn from us are the things we’re good at: risk management, compliance, internal audit. So it’s going to be win-win.
Will we end up ever controlling it or managing it? I doubt it, but I think we can have a very good partnership. They understand that we have to be profitable, and the way to be profitable is to be efficient and have good risk management. So they’re aligned. They know that if they’re – profitability is a good thing because it means it’s an efficient and a safe bank.
ED: How do all of these patchy – it can be somewhat described as patchy by an observer – acquisitions, investments contribute to an overall brand perception because the further you are from Canada, the more the brand of Scotiabank. It’s an interesting perception. On the one hand the bank that is very into mining and trading and those types of activities, on the other hand very strategic as an investor in specific markets, and on the other hand also with the China story. So how do you like to see foreigners sort of build his brand perception of Scotia?
RW: The brand is only important if it’s important for customers. So if the brand is important for a retail bank in a country, and the Scotia brand is better than the brand, we acquired, we’d go with Scotia. But if the brand in that country is better, like Thanachart Bank in Thailand, why would we want to change it?
We don’t aspire to be a global corporate bank called Scotiabank. We may, if that’s the way it goes. We are now going through a rebranding exercise because the markets – our counterparty on trading is so good that we call our trading operations Scotia Capital. They say, well, what is Scotia Capital? Is that Scotiabank? It is. So guess what? We’re going to go looking very seriously at changing to Scotiabank for that part of the business.
You’re absolutely right. It’s very unique. We don’t call ourselves a global bank. We don’t call ourselves a universal bank. Maybe we’re a super-regional bank. We have a very unique business model. And guess what? It’s been working very, very well.
ED: How does that all show up at the board meeting? Tell me about the composition of your board. Do you have a board that likes holding its board meetings in far-flung places?
RW: In October we are taking our whole board to Thailand, and then a part of the board, our executive committee, is going to China and celebrate and look at the city of Guangzhou.
ED: So it’s a globe-trotting board.
RW: Right. I would say we have a lot because we’ve been a public bank for 180 years. It’s based here, so the meetings tend to be here, but we have a fantastically great board. We have a Singaporean on our board. We have a Mexican on our board. We have to get more of that as we go out and what have you. So it’s very representative not only of our Canadian thing – and they’ve been – we’ve got six or seven – all of them are successful leaders in their field – about 14 people.
ED: What is the outlook for Canada as an economy given the uncertainties in Europe right now? I would like to know your take on Europe because there is an Anglo-Saxon view of what Europe should be, and if you read some newspapers, they are quite determined to make sure that the Euro breaks up. And there is the European view of Europe which is the Euro’s own which is somehow it will hold together, but it will pay a very high price in that sense.
So how does Europe look like from Canada? And how does the US – and I think you sort of answered the US question, but really more the Euro question?
RW: I have sort of a unique perspective. I’m also vice-chairman of the IIF. I’m on the executive committee. So even though we have very little European exposure, the IIF was involved in Greece.
I’ll get in to some very fundamental thoughs on this because it really gets to the crisis and what’s going on, and it tied into the debt ceiling in the United States and Europe.
Unlike the earlier crisis, this is the crisis of sovereign debt, so it’s not a private sector crisis – the cause is the private sector or banks or whatever – this cause is on a very fundamental rule for a banker who’s been around a long time or whatever: sovereigns were not supposed to default. A promise to pay by a country is a very solemn, fundamental promise. And all of a sudden, with the debt ceiling and the technical default in Congress, but more importantly the defaults, say, in Greece. So we lived through LDC (less-developed-country) debt, and rescheduling is a fact of life. There are times when countries can’t pay, but to say “I won’t pay”, or “I promised to pay, and I want to tear that up”, there’s a very fundamental difference between that and rescheduling.
The economics are the same as “a technical fault” and a rescheduling, but the consequences, both legal, contractual and I think moral, quite frankly – how can a country say I won’t pay. Countries are sovereign. People don’t go away.
Now hard, hard decisions – taxing, cutting back expenses and what have you – are one thing, but if we lose that fundamental promise, and I think this is at the heart of what we’re seeing here – a lack of trust. You may not trust a private bank, you may not trust the guy on the street, but if you can’t trust the countries to honor their promises and their leaders –
ED: But you’ve had this problem before. You’ve had Brazil –
RW: I’ve seen that, it took eight years.
ED: Argentina.
RW: We had a big exposure. Okay? We did two things. We learned from that. We don’t lend to governments because sometimes you have this. But it took eight years, but they rescheduled. It was voluntary, and there were lots of options. And a lot of money came to do that. We have to learn those lessons of the past here, because of all the complications.
ED: But Greece isn’t saying that they’re not going –
RW: No, no. I wish some people would stand up and support the leaders of Greece. Okay? They have a very tough job. I mean to go to their own people on the street and say “I’m going to take away your pension”, that’s a tough thing for a leader to say or whatever – the various things they are doing. I think we should give them credit. Other leaders should support them. I think – I find that very puzzling from a Canadian perspective.
