1999 James Gillies Alumni Lecture

June 10, 1999

Remarks By:
A. Charles Baillie
Chairman & Chief Executive Officer
Toronto Dominion Bank


To:
The Schulich School of Business Alumni
Toronto, Ont.

Let me begin by thanking Dean Horvath and the Schulich School of Business for the opportunity to be here with you this evening.

It is a great honour to have been asked to deliver this year's James Gillies Alumnae Lecture. Since its inception 25 years ago, this lectureship has become a very fine tradition - as befits a very fine School.

TD enjoys many strengths. One is the fact that we employ more graduates of the Schulich School than any other company in the country. As CEO of TD, let me take advantage of this podium to express my gratitude to them for the tremendous contribution they have made - and continue to make - to our organization.

You will no doubt be relieved to know that I am not here to revisit the recent bank merger decision.

Clearly, on that merger the government shared the view once expressed by a Wisconsin state legislator, "I'm in favour of letting the status quo stay as it is".

This evening, I would like to focus on a broader set of issues - on the challenges and choices we confront at TD Bank - and indeed across the entire banking industry - as we face the new century that begins six and a half months hence.

My bottom line is this: that we are in the midst of sea-change. Not the ebb and flow of old tides, but rather a new tidal wave of unprecedented proportions.

It is a sea-change that has its source in the synergy between globalization and technological change. A synergy that is erasing the old distinction between local and foreign markets. A synergy that is eliminating distance and destroying the value of geographic incumbency. A synergy that means you can be based anywhere -- and compete everywhere. A synergy that is both increasing the number of competitors we face and raising the bar on the resources required to stay in the game.

It demands, I believe, that we re-examine old assumptions -- about necessary size and about the relationship between quality and quantity. As importantly, it demands that we recognize as never before the need to make choices. That we are well beyond the time when a bank could be everything to everybody. That in today's market, to try to do so means risking becoming a company that, in the end, won't do anything for anybody very well.

At TD, we have always believed in the virtue of being where banking is going -- not where banking has been. Well, today, that virtue has become necessity.

Let me begin by focussing on the issue of scale.

Academic studies on this issue have been inconclusive. Depending on the time frame or the example, the analytical case for scale in banking has been far from crystal clear, something reconfirmed in a recent Conference Board study.

But the reality is, those studies cover a period of time that pre-dates the extraordinary application of technology we have seen over the past two or three years. And because of that, I would suggest, they verge on the irrelevant. It is tantamount to driving through a rear view mirror.

Consider the implications of technological change.

One, electronic transactions have exploded. Fully 85 per cent of transactions are now handled outside the traditional teller-based system.

Two, those banks and other institutions who have had the foresight and capacity to invest heavily in technology have an almost unassailable advantage. They are able to produce more varied and more sophisticated products, to better segment and target customers and to secure strong economies of scale.

Certainly, 'off the shelf' technology products have proliferated. But in terms of being at the leading edge, setting the technological standards, larger institutions have a major advantage in being able to spread design, development and deployment costs over a bigger base. And even with 'off the shelf' products, economies of scale still matter in terms of spreading acquisition and adoption costs over a larger customer base.

This is not rocket science. It's simple arithmetic.

Consider a real life example.

TD once spent more than NationsBank on technology. NationsBank, now Bank of America, has gone through several mergers. In 1998, we spent $550 million on technology. In 1997, NationsBank was able to spend Cdn $3.8 billion.

Another example.

At one time TD and MBNA spent about the same on credit card technology. MBNA has grown through acquisition. In 1997, MBNA spent Cdn $150 million on card technology. TD spent $6.5 million.

The implications of the technology and communications revolution for the issue of scale are widely talked about. I'm not sure they're as widely understood.

The qualitative difference between the old paradigm of investment in physical plant -- in buildings, in bricks and mortar, is very large. In the past, the investment was up front, one-time only. You built a branch. Then you simply maintained it. Generally speaking, the only investment required over a period of decades would be new paint or new carpet or linoleum.

With technology, however, the investment never stops. It's large -- up front. It's large -- over the long run. And it's not incremental.

Every two years or so, you have to do it all over again, from the ground up, to the tune of hundreds of millions of dollars. It's like rebuilding -- re- tooling -- your whole system time after time after time. And that's not to race ahead. Usually, it's only to keep up. The point is, to play in that league, you simply have to be able to spread the costs over a larger and larger base. That means scale.

Now, the argument for scale does not stop there. It is not just about the competition. It is about customers too.

Consolidation is occurring in virtually every industry. In other words, our potential clients are growing - and as they grow, their borrowing requirements increase correspondingly. They will only look to partners who can finance their scale.

A bit of old history. One of the reasons the Bank of Toronto and the Dominion Bank came together in 1955 was the fact that each was losing its best customers. Why?

Because their clients were outgrowing the individual capital bases of the two banks. After merging, that changed. Toronto Dominion was able to keep pace.

Now, a bit of recent history.

Last month, Chase Manhattan and Goldman Sachs each underwrote U.S. $5 billion for AT&T's proposed acquisition of Media One.

And a few weeks earlier, Chase, Lehman and DLJ each committed almost $5 billion Cdn for Olivetti's proposed acquisition of Telecom Italia.

TD has been able to legitimately claim to be one of the world's leading media and communications banks. In fact last year the International Finance Review named us Media and Telecommunications Bank lender of the Year. But the capital requirements of the AT&T and Telecom Italia deals were simply too big for us to be able to lead those transactions.

The reality is the demand for commitments of that size is becoming more and more frequent.

Once again, to be able to play, you need scale.

Finally, there is the issue of marketing. As players and providers proliferate, branding will be even more important in the future. You may have good products and good services. But that will be irrelevant if you are unable to draw attention to yourselves. As price, product and placement differentials diminish through competition, advertising and marketing become all the more important. Once again, the ability to consistently spend the resources required to get noticed is a fairly straightforward function of scale. And that phenomenon is compounded by the internet. While technically, anyone can have a website, practically, only strong brands will attract users.

In summary, then, larger institutions are able to outperform on technology. They are able to outcommit on loan underwriting. And they are able to outspend on advertising. Scale may be no guarantee of success. But over time, lack of scale will certainly become a guarantee of failure. Therefore, we at TD must continue to strive for greater scale.

As an aside, let me say that it was these factors that lay behind our proposed merger with CIBC -- to achieve the synergies of size in an in-market merger, to thereby increase our earnings and our market capitalization, and, as a result, in an increasingly North American market place be better positioned as an acquirer, rather than an acquiree.

That was the logic. That was the business case. That is why large U.S. banks, through merging, have been able to reduce their operating costs ratio well below those of Canadian banks. That is why bank mergers are occurring the world over.

And that's why I found it - let us say unusual - that here in Canada pundits outside the banking industry told those of us most familiar with it - bank leaders - that we were completely wrong about the economic imperatives of scale.

Looking to the future, we have a three-pronged strategy to secure scale.

The first is to buy it.

The second is to build it.

The third is to borrow it.

I will begin with the buy and build side, starting with discount brokerage.

For TD, discount brokerage is our defining business of the future.

We are the largest such brokerage in Canada by far.

And we are now the second largest discount brokerage in the world.

At a time when others questioned our judgment, we saw discount brokerage as a wave of the future. A way to capitalize on the reinforcing trends of technology, of wealth management and of demographics.

We were fortunate to have the time to build that business first in Canada - during the period when the unhappy marriage of Charles Schwab and Bank of America discouraged other U.S. banks from entering the fray.

We formed Green Line Investor Services. We then bought the Gardiner Group and Marathon Brokerage. In 1996, we bought Waterhouse Investor Services in the U.S., the largest acquisition TD has ever made. Many said we overpaid. The following year, Waterhouse acquired Kennedy Cabot and Jack White, both in California. Green Line acquired Pont Securities and Rivkin Croll Smith in Australia. And last year, we opened in Hong Kong and we acquired Gall and Eke in the UK, creating a platform for European expansion.

As we now speak, TD's global discount brokerage represents close to two and a half million accounts and close to $140 billion in assets under administration. More than two and a half thousand new accounts are being added every day. And the Wall Street Journal's Smart Money magazine has ranked Waterhouse the number one or two discount brokerage in the U.S. for the last several years.

We intend to continue a concerted strategy of further acquisition in our discount brokerage business--building scale. The returns in this business are strong. And the logic of consolidation is clear -- back office synergies and enhanced capacity to establish an even stronger brand.

As part of our strategy, we are taking TD Waterhouse public.

We believe the reasons for this move are compelling.

First, most of the acquisitions we've made in the discount brokerage business have been cash transactions. It is a business that is consolidating quickly. To make further acquisitions, cash is not likely to be the best option for our shareholders because those deals will simply be too expensive and prospective sellers are seeking share exchanges to shelter their capital gains. It is for these reasons that share exchanges, rather than cash, will be the predominant way that deals are done in the future.

As a bank, TD does not now have a distinct discount brokerage share currency -- a currency equivalent to those of the others in the business. By going public, we will achieve that, and thereby be in a much better position to pursue further acquisitions.

Secondly, the market value of our discount brokerage activities is currently buried with other bank activities under the rubric of wealth management. By taking TD Waterhouse public -- carving it out -- not only will the market, for the first time, be able to establish the value of our discount brokerage business, the market will also be able to separately value our non discount brokerage business. As a result, we believe higher capitalization will result.

Thirdly, the public issue will markedly increase our capital base and therefore enhance our flexibility and scale. Finally, by establishing a separate equity presence, we believe the profile of our discount brokerage business will increase -- allowing us to add value through the attraction of more accounts.

I have focused on discount brokerage thus far because it offers, in TD's case, one of the most striking examples of the rewards and the rationale of building and buying scale.

Others include the extraordinary success of TD Securities, our acquisition of Central Guaranty Trust -- and most recently Trimark Trust.

In the future, we will continue to buy and build scale in a range of high growth areas with high earning potential.

And we will do so through the rigorous application of a strategy we have had in place since 1995 -- the first Canadian bank to do so. That is to allocate capital to each line of business on a stringent return on investment basis and to constantly gauge performance.

The fact of the matter is, today and into the future, with the competitive environment being what it is, with spreads being as low as they are, with the ongoing technology investment required, no bank -- at least no bank that wants to maximize shareholder value -- will be able to operate losing propositions. Loss leaders are not on. Every line of business must stand on its own.

And so, based on returns, we will continue to feed lines of business, to maintain them, to starve them -- or to divest them.

I have spoken of areas where we can build and buy profitable scale. But there are also areas where we believe we simply can't. For example, at one point in time, both the payroll and custody business made sense for us. But in recent years, it became clear they no longer did. Others had a customer base -- scale -- that far exceeded ours' and they, therefore, had the capital and customer base to make the technology investments those businesses had come to demand. So we sold our payroll and custody interests. We simply could not trump scale.

The point is, today's dynamic environment not only demands that we choose what we do wisely, but that we also be prepared to recognize what we can no longer do well. There is today an unprecedented need to make choices that we didn't have to make before. We are all to some extent niche players now. We cannot be content to simply 'get big'. Success in the 21st century will be based not on scale alone -- but on smart scale.

Now, in the face of all this, the question arises, what, then, about bricks and mortar? What is the point in maintaining it -- or adding to it? Is this, after all, not banking as it once was, not banking as it will become?

It is true that bricks and mortar will, over time gradually assume less importance.

But any suggestion that branches are an out-moded burden, is, I would submit very wrong.

The fact is, the vast majority of financial products are still sold through branches -- and are likely to be for some time. The fact is, branches provide the human face of banking -- the glue which keeps the banking relationship together. A place that is real, not virtual; a location where people can get problems solved by people and advice offered by people. People they can see. People with whom they are familiar. People to whom they can go back. People who live in their community.

But there is more to bricks and mortar than that. Not only are branches an essential conduit for business. The maintenance and acquisition of branches is the most effective way to maintain and acquire customers.

There is customer inertia in the banking industry. Customers seldom move. Market share remains remarkably stable. If we, at TD, see a movement towards us which is measured in the hundredths of one percentage point of a competitor's total customer base, we are ecstatic.

The reality is, it is much easier to build value by maintaining and converting existing or acquired customers than it is to attract customers that are totally new. It is about securing customers. In short, it is about securing scale. That is not to say we shall rely on bricks and mortar.

We are at the leading edge of electronic banking in Canada with 1.8 million customers and Waterhouse National Bank, our electronic bank in the U.S. holds tremendous value creation potential.

Thus far, I have talked about scale from the point of view of the necessity to buy it or build it. But there is a third track -- a third option -- that I believe will become an increasingly important element of bank strategy. Certainly, it will at TD.

And that is borrowing scale.

Borrowing scale involves outsourcing -- something we are doing with cash and currency management through a new arrangement with Intria, which has the scale we do not.

Outsourcing makes sense where our primary objective is securing the lowest cost.

Borrowing scale means joint ventures -- like the one we formed with the Royal Bank and Bank of Montreal for cheque and document processing, through Symcor; Or Interac or Visa. Joint ventures are appropriate where we not only seek lower costs but also wish to retain the economic returns.

Another approach. Hitherto, TD's merchant bank business has involved drawing solely on our own capital base. However, we are now putting together a $600 million fund, 25 per cent of which will be our money, 75 per cent of which will come from others. That will give us scale we don't currently have -- and greater clout at the table.

There is a fourth way to borrow scale -- and that is to represent someone else's product.

Banks, as I have stated, face an unprecedented challenge from competitors whose scale -- and technology base -- can give them a real price advantage. One response can be to continue to make the investments and exercise the imagination to remain competitive with our own products. Another response can be to get out of the businesses we believe we can't win. But so too it can entail offering third party products. In other words, leveraging scale we don't have by gaining access to the scale others do.

I believe the necessity of this is very clear. Why would our customers confine themselves to considering only our products, when there is so much choice out there, and such easy access to it through the internet for example.

Why would we risk losing, for example, a mortgage customer to another provider and risk having them be told that that provider, perhaps not a bank, can also offer them RRSP's or, at some point soon, a chequing account?

The bottom line is, increasingly, our competitive advantage lies not in manufacturing, but in being an agent and a distributor. We must become champions of choice.

A recent issue of Fortune magazine stated very clearly the reality we face. "The Net is a noose for mediocrity".

We must be prepared to say we believe we have a product that satisfies your needs, but if you don't agree, we have a range of other products that might.

We must recognize that in some areas we may not be the most cost effective player on price, and that therefore we must develop and capitalize on our ability to be the most trusted adviser.

We must act on the fact that our most precious asset is not our physical capital but our human capital, our people -- who are there to guide, to filter, to fix, to make it easier.

We must hone our capacity to offer multiple services, with the convenience that entails, taking advantage of our bricks and mortar presence. In other words, we need to offer the best range of choices, the best price, the best advice.

When people come to TD, they must know that they are getting not only the best that TD offers, but the best that others offer as well.

TD is far ahead of other banks representing other people's products. In our branches, we already offer treasury-bills, commercial paper, and third party mutual funds. We hope soon to offer the GICs of several competitors; a pilot project offering deposit instruments of 7 financial institutions is already underway. An even broader base of experience has been established through Green Line and Waterhouse. It is a base we intend to continually expand.

Building scale. Buying scale. Borrowing scale. All, in my view, the foundation of a strong strategy for the 21st century. All necessary. The question is, are they sufficient?

I would say no. Not when the scale advantage of monoline competitors will continue to grow. Not when the range of services they are able to offer expands. Not when they are able to access the payments system, allowing customers to easily transfer their business to them. Not when the card and computer will make shifting allegiance so much more effortless than it is today.

The real issue is, what will then differentiate us? What will still set us apart?

And here, I believe, we get to an issue that is often overlooked, one that relates more to quality than to quantity.

An analogy, based on conventional business principles, has been drawn between banking and what has happened in the retail sector.

That sheer price comparison will drive the industry. That just as Wal-mart has shifted market share dramatically in Canada, the same will happen with the banks. That while we may need banking, we will not need banks.

But I believe there is something wrong with that proposition, with the parallel.

No financial institution thus far has been able to come in and move market share like Wal-mart.

The question is, why?

Yes, part of the answer is a lack of bricks and mortar -- the human face, the convenience, the knowledge you can go somewhere to fix a problem. Part of it is the fact that we have secured the customer base. And part of it is straightforward inertia.

But there is more to it than that.

I believe it lies in the fact that people do not regard money -- their money -- the same way they look at clothing or groceries or books. There is a unique and, I would submit, unwavering attitude towards money. People want it safeguarded discreetly, with integrity. They want it treated with the same care as they treat it themselves. They want to know the money will be there when they go to withdraw it.

The unique advantage we have is our history, our stability, our ethic. That fosters faith. It builds trust. That is why we are so fierce about protecting the integrity of the banking relationship.

Non-banks may be able to do something faster, or have a fancier website. But, the issue is, will they be able to compete on trust? I would submit the answer is no.

Shopping on line for shirts is one thing, as is a quarter point interest rate advantage. But entrusting your savings, your future, is something else. Faith is something else. And faith can't be readily bought or sold.

Commentators usually focus on the advantages monolines have that we don't. Perhaps it's time to also focus on what we have that they don't -- and can't ever hope to acquire.

All of you will know the criticism banks face daily, from coast to coast. And I'm sure many of you are active contributors to that time-honoured national pastime. But apart from whatever validity the criticism may have, I believe its fair to say that one explanation for it is that people have greater expectations of us than they do of others. The standards they have set are higher.

I have spoken about inertia. But the fact is, inertia has a reason.

Some say we will fail because we are not monoline, virtual providers.

I would venture to suggest that we will succeed for that very same reason.

Scale and trust. Expansion and ethics. Quantity and quality.

Like most things, it's easier said than done. But I believe TD today has more momentum than any of our competitors, and more than at any time in our history.

I've said we will succeed. Now, watch us do it.

Thank you very much.