Royal-Montreal Bank Merger

But they co-operate, nonetheless, in the conviction that everything they say and do on this day will be worthwhile if it helps them push through the merger.

Bank Towers, Toronto
The Royal Bank and Bank of Montreal are two of several Canadian banks attempting to merger (courtesy Maclean's).

Royal-Montreal Bank Merger

It is Friday afternoon, and John Cleghorn and Matthew Barrett have spent the better part of the past 24 hours in each other's company. The two bank chairmen, respectively the biggest of the cheeses at the Royal Bank of Canada and the Bank of Montreal, attended meetings of their boards of directors the night before, then got up for a predawn signing ceremony at which they pledged to meld their operations into the largest lending and deposit-taking institution in Canada. Since the signing, Cleghorn and Barrett have been all but inseparable, working their way through a tightly orchestrated series of presentations to the media, financial analysts, employees and anyone else who has been able to grab a few minutes of their attention on what, stock-market meltdowns and failures of real estate giants notwithstanding, is shaping up as one of the most mind-boggling days in the history of the Canadian financial services industry. They are not completely comfortable when a photographer asks them to put their heads together for a portrait. "I don't get this close to my wife," Cleghorn quips.

But they co-operate, nonetheless, in the conviction that everything they say and do on this day will be worthwhile if it helps them push through the merger. "I've been in the business for 35 years," Barrett says in his soothing Irish lilt, "and this opportunity to take two great historic Canadian institutions, and out of them create one of the great banks of the world, is a banker's dream."

Dream is a good word for it. The deal they are proposing would, by a wide margin, qualify as the largest corporate merger ever in Canada. With 85,000 workers, the organization would rank as the country's largest single employer. The new bank, which has yet to be named, would be a true behemoth of international proportions, with $453 billion in assets and a stock-market valuation of $39 billion, based on last week's closing share prices. When ranked according to market capitalization, the combined entity would be the 10th-largest financial institution in North America, and 22nd in the world.

The notion that Canada needs such a massive creature to compete in the increasingly cutthroat global market has been the subject of no end of bankerly speeches in recent years. Cleghorn and Barrett have been among the idea's most passionate advocates. But it is still an alien concept to many of the banks' customers, who worry that the country's major financial institutions are rich and powerful enough, and that any further concentration in the sector will inevitably lead to higher prices and less choice for borrowers - not to mention more consolidations.

Will they pull it off? Will Ottawa let this one go through, thereby opening the floodgates to all of the other mergers and consolidations that are bound to follow? The question has the entire Canadian business community buzzing. One investment dealer overheard a colleague talking about how he would always remember where he was when he first heard the Royal-Bank of Montreal news, much as people talk about what they were doing when John F. Kennedy was shot. In fact, the idea that the Royal and the Bank of Montreal would embrace each other in corporate marriage seemed so farfetched that some downtown Toronto bankers and brokers thought the news might be some sort of hoax. "I have to tell you, I was blown off my seat," one corporate financier said. "I thought it was one of those trick Internet things." Another saw the news scroll across his computer screen and blurted out: "What is this, April Fool?"

For Cleghorn and Barrett, however, this is no joke. In the months ahead, they will do their utmost to make sure their dream, however ambitious and politically charged, becomes a reality. For much of the past year, they have been crisscrossing North America, preaching the gospel of bigger banks. They both insist that when it came time to select a potential merger partner, they were each at the top of the other's list.

Ostensibly, they came up with the idea over a glass of punch at a Christmas get-together on the 68th floor of the Bank of Montreal's headquarters on Bay Street, the tallest office tower in the country. They pitched it to their key executives and stickhandled it through the "rigorous examination," in Barrett's words, of both boards of directors, starting early in January and going right up to 10 p.m. the night before the deal was signed.

Their challenge now is to persuade Canadians that this surprising marriage of the country's No. 1 and No. 3 banks, ranked by assets, will be good for more than the blue suits on Bay Street. Already, the banks are under fire over rising service fees, complaints of meagre financing for small business, sweeping workforce reductions, billion-dollar-plus profits, and the multimillion-dollar salaries and bonuses enjoyed by bank executives.

They acknowledge that there is a huge job ahead, and that it will not be easy. "We never thought it was going to be anything less," says Cleghorn, the pragmatist. Adds Barrett, the silver-tongued visionary: "Our attitude is, why wouldn't you want to approve the creation of an international financial player à la Alcan, or the Bombardiers, or the Nortels? Why wouldn't you want to have one of your banks in that league?"

After a day of such presentations, the two bankers are functioning smoothly as a team. They have a polished script, and they know it by heart. By three in the afternoon, they are not quite at the point where they are jumping in to finish each other's sentences, but they are getting close. Barrett, the superior showman, introduces the larger concepts and colorful analogies, while Cleghorn, the no-frills thinker, follows up with the details.

Take the example of what bank executives say is the biggest reason behind the deal: the wave of bank mergers sweeping every other country of the industrialized world, and the fact that large foreign banks are now able to penetrate Canada without even setting up shop in the country, at least not in any conventional way. Barrett uses the analogy of the big-box retailers that have wreaked havoc among Canadian retailers. What Canadians are seeing now in the banking business, he says, is akin to what happened several years ago in the retail sector - only this time the bankers want to get the jump on their foreign competitors before they come north to clean Canada's clock. "It used to be said, you may remember, that oh, those Americans, they'll never come up here. Well, the Wal-Marts are here and the Home Depots are here, and what are they doing? They're offering a better value proposition. They are able to buy cheaper, they can give better value and higher-quality services in their stores. And then they put the local guy out of business, because in the end the consumer will consume from the best-priced and highest-quality provider in the marketplace."

Cleghorn - who will be co-chairman and CEO of the bank, while Barrett takes on the slightly less powerful role of co-chairman and head of the executive committee - interrupts with specifics. He rhymes off the names of all the international banks that have merged in the past two years, as well as those that have recently arrived in Canada. San Francisco-based Wells Fargo, for example, now offers cheap and plentiful small-business loans from a call centre in Colorado, while the Dutch giant ING is luring customers with the promise of a higher rate of return on savings accounts than is available from any Canadian bank. "Here's something that's generally not known," Cleghorn says. "If you take a basket of, say, 12 or 13 traditional banking services, and compare what a Canadian would pay with what an American paid, you would be talking about a 50-per-cent difference - a 50-per-cent advantage for Canadians." This, he says, is because of the size and clout of the big domestic banks, which were free to operate nationally in an era when their American cousins were restricted to local fiefdoms. But as banking evolves, Cleghorn warns, those advantages will disappear. Only bigger banks can spend the money that will be needed to compete with U.S. banks in the realm of computer and Internet banking. Foreign competitors, Barrett insists, "are starting to dwarf us." Says Cleghorn: "We have to do it this way, or we will sit here and some time in the next century we will lose our own identity, we will not be Canadian-based. To be able to compete, we will have to join forces - maybe with a big American institution."

This is the trump card, the final point that the bankers believe will ultimately persuade Canadians - employees, customers, regulators, voters and politicians - to support their plan. If the banks are forbidden to merge, Cleghorn and Barrett say, foreign-owned giants could take over the homegrown industry, sopping up Canadians' savings while funnelling much-needed loans away from Canadian companies. Those foreign banks, it is hinted, would operate with complete disregard for the Canadian consumer, laying off employees, closing branches and paying their corporate taxes in other jurisdictions.

Cynics contend that is what the Canadian-based banks do already, adding that the desire to preserve domestic control of the industry likely stems as much from a concern for its Canadian executives as its Canadian identity. Investment bankers and brokerage employees, among others, are predicting widespread job losses in their ranks should the mega-merger go through. Just as passionately as Cleghorn and Barrett present their case for global competitiveness, critics argue that it is impossible to merge anything - a brokerage or a corporate finance department, let alone two banks with 2,500 retail branches, many of them side by side or on the same city block - without a lot of human carnage.

As proof, opponents of the deal point to the bank stocks, which rose sharply last Friday in response to the Royal-Bank of Montreal announcement. The sudden jump was interpreted by some as a sign that speculators believe other bank mergers will follow. (A pairing of the Toronto Dominion Bank and the Bank of Nova Scotia is a favorite, followed by a renewal of talks between the CIBC and Canada Trust.) Yet at the bottom of it all, one portfolio manager says, "these stocks are up because everybody expects the banks to be more profitable. And they are only going to be more profitable if they lower their costs. People are just capitalizing on the value of those cost savings in the domestic business."

At bank branches across the country, however, bank employees seemed anxious to express support for their bosses' global visions. At adjacent branches of the Royal and Bank of Montreal in Vancouver, employees talked about how the merger is necessary because of global competition, even if it means they might personally lose their jobs. It was much the same in Montreal, where longtime Bank of Montreal employee Michel Bazinet said he had "anticipated this for a long time. In the banking world, we knew that in the near future there might be only three or four big Canadian banks." A co-worker echoed his sentiments. "There's no fear," said Laura Buist, a Bank of Montreal manager in the main Montreal office. "There's no concern, really. I think the Canadian government sees that we have to be able to compete outside Canada to exist."

This raises the $453-billion question: does the federal government understand and support the banks' urge to merge? Is Finance Minister Paul Martin piqued, or secretly relieved, at the way the two banks jumped the gun on a task force he had set up to advise Ottawa on competition and concentration in the financial services sector? Will he voice concern in public while privately wishing them well, or is he willing to take the heat that would come his way should he stand up to the banking establishment and pull the plug on the Royal-Bank of Montreal dream?

Cleghorn and Barrett did not, because they could not, give Martin or anybody else in Ottawa prior notice of their spectacular deal. But at about 8 a.m. on Friday, they called the minister's office to give him the news personally, shortly before it went out to the public. Martin was in a meeting at the time and asked that the bankers call back at nine. At 8:50 a.m., an aide handed him a copy of a newswire story on the announcement.

For the moment, only Martin and his closest advisers know what the Liberal government intends to do about the proposal. A year ago, Martin turned down the CIBC when that bank came nosing around for guidance on a possible takeover of Canada Trust. This may explain why Cleghorn and Barrett, who are both close to Ottawa's inner circles, did not inform Martin of their agenda for Friday. For their part, the bankers say they had no choice but to keep Martin in the dark until the last minute. Otherwise, Barrett said, they might have been accused of leaking insider information. "We had legal advice - we had to go public before we told anybody." Martin, described by aides as being "steamed" by the way the banks handled the matter, responded to the bombshell by stating, in his own news release, that he will not approve anything until September at the earliest.

That is when a federal task force, established by the minister in 1996 to help shape government policy on the financial services industry, is scheduled to report. Task force chairman Harold Mackay, a Regina lawyer, said emphatically last week that nothing the big banks do in the meantime will alter his mandate or deadline. "Nothing changes as a result of this," Mackay told Maclean's. Bank mergers, he added, have always been high on the task force's agenda, along with what Mackay euphemistically calls "the changing nature of the competitive landscape." Last week's announcement by the Royal and the Bank of Montreal virtually guarantees that the impact of those changes will be felt by every Canadian.

The Marriage Terms

Royal Bank

Assets: $245 billion; Profits: $1.7 billion; Employees 50,719

Canada's Banks Small in World Context

By Friday evening, John Cleghorn's thoughts had turned to three objectives: a bowl of soup, a chat with his wife of 35 years, Pattie, and a long walk in the fresh snow with his two golden retrievers. "I can't wait to get home," he muttered softly under his breath, at the end of another interview. Small wonder: the chairman of the Royal Bank of Canada had spent the entire day in the hot glare of camera lights, explaining to employees, reporters and regulators why he was proposing to merge Canada's largest bank with the third-largest, the Bank of Montreal. But the crux of his case lies in the cold, competitive global capital markets - far from the cozy comforts of home.

Over the past decade, the nature of the banking business has been profoundly altered by global trade, sophisticated new technology and the ever-shifting demands of customers. In response, the financial services industry has undergone a massive worldwide rationalization. The reason: the larger the bank, the greater its advantages in developing new products and services, building infrastructure, upgrading employee training - and cutting costs.

Between 1987 and 1997, international bank mergers totalled $1.4 trillion by market capitalization. In the United States, the number of banks has declined by a third in the past decade. "Banks have become electronic delivery mechanisms," says CIBC senior vice-president John Pattison. "Size and economies of scale have become the name of the game."

So far, the federal Bank Act has kept Canadian banks on the sidelines. Regulations and long-standing government policies block them from merging and, the banks argue, from maximizing their efficiencies. To compensate, they have combined their cheque- and document-processing functions and expanded internationally: Scotiabank has invested in Latin America and Southeast Asia, the CIBC has bought into Wall Street, the Toronto Dominion Bank has acquired discount brokers in the United States and Australia.

For Cleghorn and his counterpart at the Bank of Montreal, Matthew Barrett, the concern of being left behind in size and efficiency has recently turned into fear. Among other things, the banks worry about their ability to service large corporate and institutional clients. Canada's domestic capital market - the total value of all publicly traded securities - now represents just two per cent of the available capital in the world. That is too small to meet the demand of growing Canadian companies, which means that borrowers must compete to obtain funds in the global capital pool.

It also means that Canadian banks are up against rivals like Citicorp, which has a bigger market capitalization than all five Canadian banks combined. Even nontraditional lenders, such as GE Capital, the financing arm of General Electric, have 19 times the market clout of Canada's second-largest chartered bank, the Canadian Imperial Bank of Commerce.

Another competitive pressure stems from the increased sophistication of modern financial markets, which have become a preferred source of financing for large corporations because of the lower costs and huge consumer demand for equities. In Canada, traditional bank loans declined to 17.5 per cent of Canadian corporate financing in 1995 from 50.4 per cent in 1980. Currently, about 46 per cent of corporate financing is accomplished through the issuing of securities. Meanwhile, the share of the corporate market held by non-bank lenders - such as GE Capital and Toronto-based Newcourt Credit Group - has climbed to 36.5 per cent in recent years.

Retail banking has not been immune from global competition either. Foreign entrants to the Canadian market, including the Dutch giant ING, can offer lower-cost service because they rely on relatively inexpensive telephone banking technology. Last year, San Francisco-based Wells Fargo entered the market by offering direct-mail loans to small businesses. Says CIBC's Pattison: "They use telephone or computer banking exclusively and that gives them a huge advantage. They don't have to pay for all those small-town bank branches in Saskatchewan." That explains why the Royal and the Bank of Montreal felt it necessary to do what they did - and also why many Canadians, including regulators, will be reluctant to accept it.

Maclean's February 2, 1998

Royal Bank

Assets: $245 billion; Profits: $1.7 billion; Employees 50,719

Bank of Montreal

Assets: $208 billion; Profits: $1.3 billion; Employees 34,286

Total

Assets: $453 billion; Profits: $3 billion; Employees 85,005

All figures as of Oct. 31, 1997