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PRINT EDITION
Remaking Scotiabank Brian Porter is making big changes, but will investors buy in?
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By JAMES BRADSHAW, ANDREW WILLIS
  
  

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Saturday, May 25, 2019 – Page B6

In 2014, shortly after taking over as chief executive officer at Bank of Nova Scotia, Brian Porter took 150 or so of the bank's most senior executives to the Sheraton in Toronto for an off-site strategy session. The presentation included a slide that listed the words staff most closely associated with working for the country's thirdlargest bank.

Mr. Porter highlighted words drawn from employee surveys that talked of a collegial, almost familial organization. It spoke to a deeply ingrained culture of loyalty and continuity. Most managers in the ballroom were lifelong Scotiabankers. At times, their promotions and paycheques reflected seniority as much as talent.

But apart from front-line staff, only 10 per cent of employees had used the word "customer" in the surveys.

Mr. Porter told the bank's leaders that Scotiabank could no longer rest on its familial spirit alone. He intended to push a different culture, defined by different words, such as "performance" and "accountability." He has been true to his word.

Five and a half years into his tenure, the 61-year-old has remade a 187-year-old bank. Your view of his handiwork depends on where you sit.

There are clients, employees and institutional investors who say his constant push for transformation is essential to ensuring Scotiabank can keep pace with digital and regulatory changes.

And there are detractors, including long-time employees both current and former, who say the CEO is moving too quickly and knock him for curbing the collegiality that made Scotiabank a great place to work and for sacrificing institutional memory.

Moreover, there's a dissenting view from the market: After years of commanding a premium valuation, the stock now trades at a significant discount to peers.

Mr. Porter wanted the bank to measure itself against rivals more often. But many of the large strategic moves he's made - such as a $7-billion string of acquisitions over the past year - are multiyear bets that have yet to strengthen the bottom line, and investors have been loath to pay for potential. The bank's total return of 28.8 per cent in the past five years ranks it leagues behind four of its Big Six competitors.

Last August, when Scotiabank had the worst-performing stock among Canada's big banks, CIBC World Markets Inc. analyst Robert Sedran wrote in a research note that its share price had been "hurt by macro themes like the outlook for global trade, emerging markets and bank-specific issues like an aggressive acquisition calendar. ... We think these issues have obscured some of the things that are going right for this bank." In 2019, Scotiabank shares are still near the back of the pack and Mr. Sedran's sentiments hold true.

Everyone agrees Mr. Porter won the top job in November, 2013, with a mandate to retool Scotiabank. As the most international of Canada's banks, with significant operations in South America, the Caribbean, Asia and the United States, it was heavily buffeted by the regulatory winds of change that blew through markets after the global financial crisis in 2008. And yet, it was relatively small in Canadian retail banking, especially in lucrative business lines such as wealth management and credit cards.

The debate now is about whether Mr. Porter is making the right changes, at the right pace. On the issue of speed, the CEO's mind is made up: He says the bank is "not rash, we're not impetuous" - that colleagues yearning for the Scotiabank of yesterday need to adjust to a new reality.

"I don't want to leave here when my time's up saying 'coulda, woulda, shoulda,' and 'we weren't bold enough,' or 'we didn't have the courage,' " Mr. Porter said. A voracious reader, he highlights a business book that studied the common traits of successful CEOs: "When asked, 'What would you do differently?,' they all said, 'I would have moved faster.' They mean that in a thoughtful, rigorous way."

AGENT OF CHANGE Scotiabank's board anointed Mr. Porter as CEO in part because he proposed an ambitious agenda: Streamlining international operations, expanding the wealth management business and embracing digital technology. He also wanted the bank to focus more on customer satisfaction and to benchmark itself more often against rivals.

Tom O'Neill, who recently retired as chairman after overseeing Mr.Porter's first five years as CEO, called the plan "off-the-charts brave."

Mr. Porter broke with the bank's tradition of rewarding loyalty. He replaced virtually all of the most senior executives around him - some retired, but a number of veterans departed abruptly and unceremoniously. The core Canadian banking and capital-markets divisions have cycled through two sets of leaders in five years. And the bank's succession plans have been redrawn almost from scratch.

Inside Scotiabank, some departed managers are characterized as "blockers" - a management-consulting term for those unwilling or unable to change. Yet, some say the unrelenting churn in the senior ranks has had an unintended consequence: Employees whose mentors have left now live in fear of making mistakes, making them loath to take necessary risks.

The new wave of Scotiabank leaders is younger, hard-charging and fiercely loyal to Mr. Porter. They include Dan Rees, who was just named head of the core Canadian banking division, and Jake Lawrence and James Neate, the new co-heads of the corporate- and investment-banking arm.

Mr. Porter also recruited key executives who had built their careers at rivals, marking a radical shift for a bank that had historically promoted from within. Michael Zerbs came aboard to head the technology group in 2014 after running a money manager and an arm of IBM.

Ignacio (Nacho) Deschamps arrived in 2016 to run the international unit and shape its digital transformation after serving as CEO of Mexico's largest bank, Grupo Financiero BBVA Bancomer.

The bank had traditionally aspired to be a fast follower on technology but was late to innovations such as ATMs and mobile apps.

"That's not the case today. We put a line in the sand," Mr. Porter says.

Mr. Deschamps and Mr. Zerbs were tasked with driving a new digital agenda. Early on, Mr. Porter took senior bankers and board members to Silicon Valley for a lesson in pace.

"He wanted that mindset to be understood," Mr. Zerbs says. "A mediocre outcome is clearly not okay any more. Like, we have to be the best ... and also make mistakes along the way."

Much of the heavy lifting on technology occurs behind the scenes, as the bank strips costs out of its legacy infrastructure through automation, cloud computing and advances in artificial intelligence. But to incubate the necessary sense of urgency, Scotiabank set up "digital factories" in five countries - Canada, Mexico, Peru, Chile and Colombia. The labs undertake rapid-fire projects aimed at solving bank-wide pain points for customers, sometimes rewriting computer code that can be deployed in the span of a few days.

Mr. Porter "didn't tell us, 'Build a digital factory.' He asked us the question: How does it become impactful? How do you scale? And then we came back with the idea of the factory," Mr. Zerbs says. It took only a short discussion with Mr. Porter and a visit to the bank's powerful operating committee to get the green light. "[After] maybe a 10- or 15-minute discussion, we had the go."

A CALLING Mr. Porter isn't shy about breaking with tradition, but he knows Scotiabank's roots. He points with pride to an oak table stacked with papers in his Toronto office. Bank directors gathered around this same table in the 1800s, when the bank shared office space in Halifax with Dalhousie University. The school surprised Mr. Porter, a graduate of its commerce program, by giving it to him when he became CEO.

His great-grandfather Hector McInnes was a director at the bank, as was Mr. McInnes's son, Donald. "I see banking as a calling," Mr. Porter says. "We take seriously our role in the economic and social fabric of every country we operate in."

Mr. Porter was born in Calgary, where he attended high school, before graduating from Dalhousie in 1981. Unlike his predecessor CEOs Rick Waugh, Peter Godsoe and Cedric Richie, he is not a career Scotiabanker. His first job in finance was at employee-owned investment dealer McLeod Young Weir. The firm was a powerhouse in Canadian bond markets, run by traders who thrived on quick market calls, and the rapid-fire culture shaped Mr. Porter's approach to business.

He joined Scotiabank in 1988, when the bank bought McLeod. Two decades later, Scotiabank is still trying to knit together two cultures in its capital-markets arm to win more lucrative investment-banking business. It consistently ranks among North America's largest corporate lenders but lags rivals such as Royal Bank of Canada when it comes to turning credit relationships into broader advisory mandates.

Mr. Porter embraced both worlds. He first emerged as one of several candidates for the top job in the late 1990s, as the head of its equity capital-markets team. Succeeding in the role required close ties to corporate clients, skills honed by investment bankers. It also meant he was responsible for committing significant amounts of the bank's capital to deals, which require a credit officer's tool box. He subsequently served as the bank's chief risk officer, then head of international operations and president.

"Look how he grew up in the bank. He was in the markets advising clients on big deals, doing big trades. Upstairs, these guys are making decisions every minute that count," says Mr. O'Neill, the former chairman. "So he's used to velocity, I guess is the way I'd put it, whereas a lot of the bank isn't used to velocity. And so the speed with which he acted was 100 per cent supported by the board."

There have been plenty of tough decisions to make, not least of which was the jarring overhaul of the bank's employees. But Mr. Porter - a private person who is most often described as decisive, focused and demanding - doesn't see those decisions as personal. To him, business is business, even if many former Scotiabankers resent the way their careers were cut short.

"He's not running the bank for the moment. He's running the bank for the future," says Barbara Mason, a member of Scotiabank's nineperson operating committee and its chief human resources officer.

Ms. Mason has worked at the bank for 37 years - including a stint running wealth management - and adds: "The balance between today and tomorrow is different under Brian's watch. The balance of today and tomorrow in previous regimes would have been much more weighted toward today."

PRUNING BRANCHES For ages, Scotiabank has pegged its brand to being Canada's most international bank, with a history that goes back to 1889, when it ventured into the Caribbean to finance trade in sugar and rum. By the time Mr. Porter took over as CEO, the bank was in 54 countries spanning 17 time zones. It had planted many of these flags opportunistically, taking minority stakes in foreign banks and opening outposts to follow clients as they did business abroad.

The strategy landed it in countries such as Turkey, Egypt, Venezuela and Russia. Occasionally, it landed the bank in deep trouble, such as with its investment in one of Argentina's largest commercial banks. In 2002, after the country defaulted on foreign debt, Scotiabank walked away, incurring a $540-million writedown. More recently, the bank has all but written off its 26-per-cent stake in Venezuela's Banco del Caribe and barred employees from travelling to the country, amid an economic collapse and political unrest Mr. Porter calls a "human tragedy."

In the Caribbean, Scotiabank still holds a commanding position.

But several of the region's economies have fallen on hard times and have restructured sovereign debt in recent years. And the island countries remain vulnerable to a range of risks, including climate change and money laundering.

Before the global financial crisis, when regulations were looser and banks had access to plentiful capital and liquidity, a strategy to plant flags in far-flung locales was defensible. The assets were profitable and helped the bank stand out from its Canadian peers. But after the crash, regulators required banks to hold more capital and liquidity, and the costs of complying with local rules in dozens of markets increased. Under new rules, banks were required to deduct minority stakes in other banks from their capital requirements, making it more punitive to hold the investments. Suddenly, aspects of Scotiabank's vast reach started to look as if they were liabilities.

Mr. Porter set about pruning the bank's international ambitions.

The idea was to double down in four Latin American countries where Scotiabank believed it could be a real player: Mexico, Peru, Chile and Colombia. With combined populations of 230 million people and a growing middle class, Mr. Porter saw the potential for higher returns than Scotiabank could earn in North America or Asia. Net income after taxes from international banking has grown 82 per cent since 2013, both by acquisitions and internal growth.

Scotiabank's boldest move to bolster its Latin American business on Mr. Porter's watch was a $2.9-billion deal to acquire control of rival bank BBVA Chile from Banco Bilbao Vizcaya Argentaria SA. Previously, it had also outmanoeuvred BBVA to buy a controlling interest in Peru's Banco Cencosud, making Scotiabank that country's secondlargest credit-card issuer.

In 2018, 85 per cent of Scotiabank's profits came from Canada, the United States and those four Latin American countries. It now has more Spanish-speaking employees than English speakers and is the third-largest bank in Peru and Chile. But without additional acquisitions, it could be years before Scotiabank reaches the 10-per-cent market share it aspires to have in Mexico and Colombia, where it ranks sixth and fifth, respectively.

At the same time, Scotiabank sold assets it didn't consider vital in the Dominican Republic, El Salvador and Thailand, among other countries, and pulled out of nine Caribbean countries. That pared its global presence to 36 countries, and it has cut its assets in Asia by half to divert capital elsewhere.

"We exited what we thought were higher-risk jurisdictions for all the reasons you read about in the paper, whether it's geopolitics, AML [anti-money laundering], operational risk, et cetera," Mr. Porter says.

"We could get a better return deploying that capital in Canada, the U.S.

or Latin America."

Even so, Scotiabank continues to face significant risks from its Latin American operations. Simmering trade tensions, volatile commodity prices and a crackdown on banking fees by Mexico's new leftist President, Andres Manuel Lopez Obrador, have clouded the bank's outlook in Latin America. But there are also structural challenges, as economic growth has dipped in those markets.

Money laundering also remains a major red flag. Scotiabank spends about $300-million annually to stem the flow of illicit funds across its network and has been working to set the same standards and controls in every country it does business. Mr. Porter is keenly aware of the damage done to Nordic lenders Danske Bank and Swedbank after lapses in anti-money laundering controls.

Some major banks such as Citigroup Inc. have retrenched from Latin America in the face of those risks. But Scotiabank believes it has chosen markets that are more resilient to economic and political cycles, with stronger democratic institutions, independent central banks and increasing openness to foreign investment. Mr. Deschamps says: "We operate in higher-risk markets, but also well-compensated by price. Our risk-adjusted margin is higher."

Even so, many investors still attach a higher risk rating to Scotiabank's international operations, "and I think they should," says Steve Belisle, senior portfolio manager at Manulife Asset Management, which has been buying Scotiabank shares of late. "[They're] higherrisk jurisdictions. But the key markets where they are, I think, generally are less risky than, say, Brazil, Argentina, Venezuela. The markets where they are are well-selected."

Mr. Porter knows he still has work to do to win over investors. In 2016, the bank hosted an investor day in Mexico City to give institutional shareholders a close-up look at the region. This fall, it will host a similar session in Santiago, Chile's capital. "That's our job: We've got to spend more time educating the investment community at large about the potential of our Latin American businesses," Mr. Porter says.

TROPHY ASSETS The tough work in the early years of Mr. Porter's tenure - which included cutting $1.2-billion in costs, some of which was reinvested in digital initiatives - made Scotiabank more efficient, which in turn helped it generate more capital and build an impressive war chest.

Early in 2018, it had the highest capital ratios of any Canadian bank.

But it still wouldn't be enough to digest the flurry of deals to come.

The first shoe to drop was the BBVA Chile transaction, which closed last year. It doubled Scotiabank's share of Chile's banking market to 14 per cent, adding $29-billion in assets, 4,000 staff and 127 branches.

The deal promised Scotiabank a leap forward in a key country and the bank laid out a detailed, day-by-day plan to merge the two businesses, making it easy for investors and analysts to digest.

Mr. Porter and his team then turned their attention to wealth management - an acknowledged weak spot relative to other banks, made even smaller after Scotiabank unloaded most of its 37-per-cent stake in fund manager CI Financial Corp. Less than three months after announcing the BBVA deal, Scotiabank bought independent asset manager Jarislowsky Fraser Ltd. for $950-million to get stronger in its asset-management business tailored to institutional-investor clients.

That deal never went to auction and was the fruit of careful cultivation: Mr. Porter and Charles Emond, a senior investment banker who has since left Scotiabank, repeatedly courted the firm's venerated founder, Stephen Jarislowsky. At the time, Scotiabank noted that asset managers with rosters of institutional clients are hard to come by - and more readily bought than built from scratch.

Less than four months after that, Scotiabank was back with another splash, shelling out $2.6-billion to buy MD Financial Management, a wealth manager that caters to doctors. "We were kind of surprised on the timing when it came to market," Mr. Porter says. As with BBVA Chile and Jarislowsky, he considers MD a "trophy asset" because it came with an extensive set of high-net-worth clients with complicated wealth-management needs, from medical school to retirement.

And buying MD added to the bank's existing franchise as a prominent financial adviser to dentists - for years, there's been an escalator in Scotiabank's main Toronto branch that whisks clients who are medical professionals to dedicated offices on the second floor.

Mr. Porter calls Jarislowsky and MD "cornerstones" of Scotiabank's revamped wealth-management business. Traditional money management is changing, as passive investing puts pressure on fees just as baby boomers reach retirement age. But Jarislowsky and MD give Scotiabank a foothold with customers who are harder for competitors to dislodge: Institutional investors and high-earning doctors who often run their own practices. And Mr. Porter is already musing about exporting MD's physician-focused strategy to other countries, such as Mexico.

"We're the third-largest active asset manager in the country and we've got a whole suite of products that go along with that, so we are really pleased with what we've done," he says.

Not everyone is happy. Some doctors voiced concerns about a bank absorbing what had been an independent wealth manager. Scotiabank has spent considerable time reassuring MD clients, but rivals sense an opportunity: Toronto-Dominion Bank and Canadian Imperial Bank of Commerce have both rolled out wealth-management offerings targeting physicians.

Some investors were also less impressed. The expenditures arrived in quick succession, forcing Scotiabank to issue roughly $1.7-billion in stock to help pay for MD. The new businesses won't make a significant contribution to the bank's profits for at least two years, a reflection of the premium price and financing costs of the acquisitions, and many investors operate on far shorter timelines. The decision to sell equity was a marked contrast to that of rival Canadian banks, which were buying back shares and reaping hundreds of millions of dollars in benefits from U.S. tax cuts.

The deals also made Scotiabank less predictable. For years, Bay Street analysts joked that BNS stood for Bank of No Surprises. Quarter after quarter, its profits would modestly exceed analysts' expectations. But on Mr. Porter's watch, capital markets became more volatile and Scotiabank made occasionally chunky investments in technology and acquisitions. On occasion, it surprised markets by falling short on forecast profits and investors punished the bank.

Some shareholders also question the steep price it paid to secure MD - 5.3 per cent of assets under management, well above a typical range of 1 per cent to 3 per cent for Canadian money managers. And to Manulife's Mr. Belisle, the expected return from the Jarislowsky deal seems "questionable" - he can't model the rate of return Scotiabank has projected without using "very optimistic assumptions."

"Integration of asset managers is always very difficult. You lose people, you lose assets. So I can't really see the benefits to the bank of doing that deal and I think the market punished the stock a lot for that," Mr. Belisle said. "It's just a bad move from a capital-allocation perspective."

He's "less negative" on the MD acquisition but knows "some investors didn't like it either." After the deals, Scotiabank's share price, which had already lagged that of other Canadian banks, fell further behind the group - it trades at a multiple of about 10 times price to earnings, compared with an average of roughly 11 times among the other big banks.

"I think the next 12 to 18 months will be very important to assess what [Mr. Porter] has been able to do," he says.

Scotiabank is now pouring its energy into integrating the new businesses and pursuing organic growth. But even if Mr. Porter has made the right calls, the full benefits may not be immediately apparent.

"The bank has taken on some strategic change and there's some risk incrementally to the bank's strategy. So the market increases your cost of capital for a period. And that happens over and over again" in banking, says Robert Wessel, managing partner of financials-focused asset manager Hamilton Capital.

To improve its stock price and price-to-earnings ratio, Scotiabank will need to show its international business can continue to grow rapidly, it can weave together its new wealth-management assets to form a serious competitor and its core Canadian business can produce steady results by boosting revenue and smoothing out expenses.

In the meantime, Mr. Porter has no qualms about being held accountable for his decisions. "I think that the share price will take care of itself. We're not buying anything else. The noise will calm down on divestitures," he says. "It comes with the territory."

Associated Graphic

FISCAL UNDER ASSETS MANAGEMENT, YEARS, ASSETS FISCAL YEARS UNDER MANAGEMENT

Scotiabank CEO and president Brian Porter's great-grandfather Hector McInnes was a director at the bank, as was Mr. McInnes's son, Donald.

CHRISTOPHER KATSAROV/THE GLOBE AND MAIL


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