NORTH TO CANADA: AN AMERICAN INVESTMENT BANKER LOOKS AT CANADA TODAY
Richard J. Schmeelk, Senior Executive Director Salomon Brothers Inc.
November 12, 1987
Chairman: Ronald Goodall, President
As we sip our coffee this lunch time, we should reflect. After all, if it were not for coffee, we would not be here today.
Coffee was introduced to London, England, from the Middle East in 1652. Coffee houses then appeared in London with each coffee house attracting a special group of customers. They became centres for spreading news and political gossip, and centres for specific trade purposes. One London coffee house was owned in 1688 by an Edward Lloyd. Shipping and insurance men gathered there and the marine insurance industry came into being. Jonathan's Coffee House attracted brokers and eventually became the place for trading securities of governments or securities of the joint stock trading companies. The stock exchange, with traders and members, came into being.
In 1711, the South Sea Company was incorporated and issued a prospectus which defined the purpose of the company as, "A company for carrying on an undertaking of Great Advantage, but no one to know what it is.' The South Sea Bubble and the first Black Monday shortly followed.
In 1910, America's biggest investment bank, Salomon Brothers, recently labelled by The Economist as "leader of the bond;' originated as a money broker. Over the years, the firm has earned revenues from issuing, trading and distributing securities. In 1986, the firm lead-managed 452 corporate issues worth $51.8 billion U.S. and managed or co-managed 764 issues worth in excess of $100 billion U.S. The total volume of purchases and sales of securities in that year approximated $4.4 trillion U.S.
The firm is a serious competitor in the global financial market, a 24hour-a-day market, serviced by offices in London, Tokyo and New York. A lot of coffee must be consumed in these offices!
Richard J. Schmeelk served with the US. navy submarine service in the
Pacific before joining Salomon Brothers in New York in 1946. He was appointed manager of the Canadian department in 1956, admitted as a general partner in 1966 and appointed to the executive committee in 1973. In 1986, he retired from his position on the executive committee. The financial press included Mr. Schmeelk in a list of the 100 highest-paid people on Wall Street in 1986, a list titled, "Wall Street's Superstars," and recorded that, as head of corporate finance, Mr. Schmeelk helped Salomon Brothers become the leader in corporate underwritings.
A past American co-chairman of the Canadian-American Committee , Mr. Schmeelk is a member of the executive committee of the National Planning Association. He serves on the board of the America's Society, and the British-North American Committee. He is also vice-chairman on the board of governors of the United Nations Association, chairman of the Covenant House Endowment Fund and serves on the board of Covenant House.
Our guest has a fondness for Canada and established a Canadian scholarship foundation for the purpose of creating a better understanding between English and French-Canadians and fostering a better understanding between business and government.
Mr. Schmeelk is a family man and I am delighted that one of his eight children, Garrett, has joined us here today.
Sir, I understand from your colleagues-and I have no reason to doubt their words, so far-that your retirement from Salomon Brothers was prompted by some suggestion from Masters tennis champion Ken Rosewall that you spend more time with him playing tennis on world tours. You have a reputation as an avid tennis player.
History repeats itself and I shall repeat the words recorded in The Empire Club 1936-37 yearbook as then-President, Major Gordon B. Balfour, K.C., introduced the guest speaker, tennis champion Fred Perry: "The Empire Club of Canada is delighted today to welcome to its meeting those who take a prominent part in the game of tennis."
Ladies and gentlemen, I have great pleasure in calling on Richard. J. Schmeelk, a senior executive director of Salomon Brothers Inc., to address us on "North to Canada: An American Investment Banker Looks at Canada Today."
I am very grateful to The Empire Club for allowing me to visit here today with so many old friends and competitors whom I have shared my life with these many years. Today, there are also memories of many great Canadians who are no longer with us whose friendship and wisdom I will always cherish. Speaking of competitors and sharing, just recently three
Canadian competitors and four of us in the United States donated blood to the British Red Cross and are now awaiting knighthood from Mrs. Thatcher's government.
My involvement in Canada began in the 1950s.
On my very first trip disaster struck. I had just been appointed the guardian of our commercial paper operations in Canada. I had a little black book listing all the maturities coming due with various institutions. My job was to visit Mr. Smith or Garneau, or whoever, carefully noting the date of maturity and see if they would roll over their outstanding paper.
Well, I was on a bus between Hamilton and Toronto, or Stelco and Inco, and I lost the little black book which was really the only decent record we had. I can still remember the panic I felt as I thought the trip would be my first and last to Canada. Little did I know of the long lifetime involvement that lay ahead. These were the days before investment bankers discovered stretch limousines and fine wines. Now that investment bankers will be back on the buses again, if any of you should be travelling between Hamilton and Toronto, I would appreciate your looking under the seats and returning the book if you find it.
Let me spend a few minutes looking back at the Canadian financial scene of my early years.
In the '50s, there was a gentleman in Montreal named James Eccles. He worked alone with a secretary and handled shortterm investments, and pension funds for many of your largest institutions. At that time there was no treasury bill market, no liquidity in short-term securities and very little liquidity in Canadian bonds other than the Government of Canada.
The staffs of corporate treasurers were practically nonexistent, as they were in the U.S., and other than occasional borrowings, life moved at a very slow pace, contrasting the vigorous management of corporate assets and liabilities that exists today.
In the late '50s, some interesting leadership developed in the Canadian financial community. Manufacturers Life and
Sun Life traded their portfolios, taking profits and losses and swapping securities in the marketplace based on their spread relationships. They were soon followed by other Canadian companies and eventually it spread to the United States. The Canadians discovered matrix trading.
These companies were very important in the development of Salomon Brothers as they provided market depth, sensitivity and intelligence to our trading operations.
Our investment banking expertise was built on our trading and marketing ability and as we moved into the mid '60s, Salomon was able to parlay this strength into helping Canadians raise capital. Truly investment banking at Salomon started in Canada; as we moved into Europe and other markets, we built off the Canadian model.
Along with my partners-John Wiley, our first Canadian partner; Jim McKay; and later Peter Gordon, our second Canadian partner-we struck a little terror into the hearts of our competitors, as we became bankers for a host of provinces, municipalities, Crown corporations, corporations, and eventually the Government of Canada.
This period was both the most satisfying and enjoyable of my long career. We didn't think about it at the time, but one might say by changing the establishment we brought about a form of deregulation which indirectly helped to make Canadian firms more competitive.
During the late '60s for several years Canada represented 30 to 35 per cent of our negotiated underwritings, a truly staggering amount. Canadian investment banks were the first international dealers in New York. Canada was the first nation to float its exchange rate. Further innovation was shown by another Canadian institution in doing the first interest-rate swap in the Euromarket. J. R. Timmins, I believe, was the first foreign firm to join the New York Stock Exchange. Other Canadian firms followed and actively distributed Canadian bonds in the United States and participated in many other areas of the securities business.
It is fair to say the Canadian and United States markets were insular to a large extent until the late '60s. Currencies other than the U.S. dollar and Canadian dollar held little or no interest to us. However, during the late '60s, Hydro-Quebec and Ontario became two of the five largest borrowers on the international markets. The Canadian internal markets simply could not accommodate the large demands of Canadian borrowers.
Both Hydro-Quebec and Ontario completed huge private placements in the U.S. along with British Columbia Hydro, taking advantage of a lull in borrowing by U.S. corporations brought about by a slow growth in U.S. capital spending.
Canadian borrowers established new markets around the globe and innovation in syndication as well. Bell Canada's multi-tranche equity offering was another first in international markets and was followed by another Canadian multinational-Alcan.
With the huge demands of Canadian borrowers, we and others spent a considerable amount of time bringing potential investors to Canada and Canadian borrowers to various parts of the U.S. Bonds of friendship, and valuable additional purchasing power were developed. Old bench marks of yield relationships were changed both internally and externally by aggressive marketing abroad.
So you see Canada did not take a back seat in financial innovation. In fact, quite the opposite, you were leaders. There was another interesting development I noticed in discussions with my friends going back to the '50s. Canadians were much more interested in discussing events in the U.S. rather than Canada. I was, I thought, the unofficial U.S. Secretary of State in Canada constantly called upon to defend U.S. policies not always to my liking.
Most Canadians were unabashed free traders-close to the mother country and Europe-and voted the straight Democratic ticket, unofficially of course. When you brought up Canadian politics, Canadians seemed somewhat disinterested. Gradually in the late '60s, the dialogue changed to a heavy emphasis on Canada's problems and politics.
During the Trudeau era "the third option" was put forward in trade and, as we all know, it did not become a reality as trade continued to expand sharply between the giants of the north. French-English dialogue; east-west rivalry; the government's national energy policy; the federal-provincial dialogue regarding the Constitution and Confederation. Government business strains and other concerns preoccupied Canadians and the development of the Pacific Basin lessened somewhat the European connection, at least from a trade standpoint.
The two areas that were closest to my heart were FrenchEnglish relations and, for a considerable period, the lack of a healthy dialogue between government and business. I viewed the resolve of both issues as paramount to Canada's wellbeing as a nation and for that reason I spent a good deal of time trying to be an honest broker on the subjects. To foster better understanding, l endowed a scholarship fund in Canada for those purposes.
Today, I am pleased to see that both areas have shown better progress. I am delighted to see the resurgence in the Quebec economy. I hasten to add that I take no credit for either development.
During my involvement in Canada, there have been various strains that have tested the bonds of friendship-interest equalization; U.S. attempts at imposing extraterritorial law; withholding tax; national energy policy; FIRA; Vietnam; potash; expropriation; the stumpage dispute; subsidies on both sides of the border; plus acid rain, and other areas of friction. Fortunately, the good sense of both countries usually wins out and I have always believed neither country tolerates fools for a prolonged period. The golden rule should be that neither country takes action that affects the other without serious consideration and consultation.
You have supported us at times when perhaps your heart was not in it 100 per cent.
We on the other hand gave you strong support as a nation when separatism threatened Confederation.
Through all these times, good and bad, the investment banker has the responsibility to keep his clients informed on market perception, country perception, and the availability of capital in international capital markets.
Let me talk a little about the role of a foreign investment banker specifically in Canada and as one who has represented several provincial governments of different political leanings.
As an investment banker, one's duty is to get the lowest possible borrowing cost for his client. The borrower's responsibility is to maintain the highest possible rating. I am referring to sovereigns, provinces, and municipalities.
You advise borrowers of various leanings, the consequence of certain actions in the marketplace, the constraints of the marketplace, and, of course, the marketplace is the ultimate discipline as to how well one conducts their affairs.
I have had some very frank dialogue with various government leaders over the years. I have tried to analyze and advise on the consequences of their action or lack of action as it would affect them in the marketplace, the effect on other government borrowers, on the private sector, foreign confidence, etc. How well I advised, I leave to the receivers to judge.
A good foreign investment banker must immerse himself in the affairs of a country, the politics, the economy, the financial \ strength, the regional differences, the people differences, and in the case of Canada must realize that Canadians are different and when you cross that long border, you are in a country with its own identity, opinions, and aspirations.
I will say that I received an insight into the many pressures imposed on government by conflicting interest groups.
While on the subject, let me say a word about relationships,,. in banking. I grew up believing, and still believe, relationships are the most important thing we investment bankers have to offer; that you literally killed for your client; each deal deserved a 100 per cent commitment; you never took anything for granted. The confidence and respect of your clients determined your success and self-respect as an individual. Success was not measured in material terms. Now comes the day of instant short-term performance; certain exorbitant fees for bankers; and some clients foregoing a long relationship for a basis point or two; and some investment bankers hungry for fees forgetting about relationships.
I recognize the need to restructure in our world economies, that many mergers, acquisitions, and divestitures make sense. At the same time it becomes a numbers game to a lot of bankers, raiders and greenmailers; it disenfranchises large numbers of people; closes down towns; and sours a lot of people on the system.
Make no mistake, there will be a strong political reaction somewhere along the line and our industry and free enterprise will be the worse for it.
One of my industry concerns is that firms will be tempted to over-leverage to maintain lifestyles. Balance in areas of profitability, judgment, relationships and service, I believe, is still the key to investment banking.
Let me now move toward Canada's role in a global financial market. When the Hon. Thomas Hockin, Minister of State for Finance, tabled his policy paper on December 18, 1986, he said, "What we all want is a sound financial system that provides Canadians with innovative and competitive services, that broadens the range of choice for Canadian savers and investors, and that fosters safe and well-supervised financial institutions that can compete around the world." Aptly said.
The events of October have been a sobering experience in global markets-the link of instant communications and investors' presence in various markets, the interdependency of the world markets came home with a vengeance.
There certainly is no single cause for what happened. Two writers said it had to do with Judge Bork not getting confirmed; some said if only Secretary Baker had not dumped on the Germans; and it goes on and on. A proposed change in tax laws that would come down on mergers, greenmail, and LBOs was also given as a reason. The Iran-contra episode and the weakening of the presidency and the lack of action in Congress have been prominently featured; the perception that
West Germany was not playing ball and moving its rates up instead of down. All this and more have been cited.
The Schmeelk theory is to liken it to the San Andreas fault. A serious crack had developed, it was there; exactly when the earthquake would strike and how severe the shock would be on the Richter scale were the unknowns.
The U.S. has roughly a $450 billion cumulative foreign deficit; the trade deficit has shown little improvement; consumer debt levels are far above normal; the dollar was shaking; a high post-World War equity relationship to book value; fixed income rates versus equity yields were at a postwar high; a stock market awash with liquidity; and a high degree of speculation with takeovers, leveraged buyouts, and junk bonds, stocks being bought on the next likely takeover and huge buy-back programs supporting the market optimism; program trading; and low margin on future trading adding to volatility. A U.S. consumption rate some 4 per cent greater than productivity made up for by foreign borrowing. Suddenly a market awash in liquidity that had bred speculation found itself in a strong quarterly GNP upward move at the same time the money supply was contracting and interest rates were rapidly rising-an unsustainable position-and the massive earthquake struck.
In Australia the exchange index is down 44 per cent from the peak in late September. Davis Delins, senior economist at County National West Australia Ltd., said, and I quote, "The collapse of entrepreneurial shares has removed the momentum of takeover expectations that fueled the market the past 12 to 24 months" (November 2, 1987, The Wall Street Journal). The same could be said for many markets in various degrees. London down 33 per cent; New York 32 per cent; Hong Kong 44 per cent; Singapore 48 per cent; and Canada 26.6 per cent.
The simplicity of global markets and innovation, to raise capital debt and equity on the best possible terms, had given way to the casino society and the realization that all these new global markets did not create stability.
My colleague Henry Kaufman recently pointed out that foreign purchases in the U.S. equity market over the last 18 months were second only to mutual fund purchases, some $35 billion in foreign purchases. So any lack of confidence in the dollar could and did lead to massive selling.
So when they are going through the roof, the psychology is "it will never stop," and when the crack appears and a shortterm liquidity problem occurs there are dozens of reasons why. Mostly we forget the lessons of history and now a whole new generation stops to look back on previous shocks to the marketplace.
I've lived through many market corrections before in the United States. I was in Mexico before the debt crisis; and one could only see the sky in Venezuela during the oil boom; real estate in Caracas would never go down. l can remember reading a book, One Hundred Years of Banking in Canada, and I was struck by the various parts of the economy that had experienced boom and bust during that period.
The lessons of history are often repeated. Excesses lead to corrections; speculators usually get punished with a vengeance during this period; the conservative investor, while hurt, lives to fight another day. Liquidity and quality reign.
The events of October have shown the need for leading firms, yours and ours, to be global in their thinking, as well as the need to be well capitalized. How important it is to understand the interdependence of markets, currencies, commodities, budgetary policies, the politics of economics, war and peace, and leadership of the free world. It is fair to say global politics have not kept pace with global trade and markets.
With the opportunities of globalization such as new employment, new market instruments to reduce borrowing cost and enhance competitiveness comes the high cost of foreign operation, the thinness in certain markets along with lack of profitability, and the need to understand the culture and customs in the countries you are operating in plus, hopefully, the realization that most of us cannot supplant strong traditional firms in their country of origin.
I believe this of Canada as well. We and others cannot supplant the best Canadian banking firms in their own market.
If the proposed trade and financial deregulation bills expand opportunity and increase Canadian expertise and trade, they will be good for Canada. We and you cannot substitute the barbed wire of protection and remain a competitive society. We will soon become stagnant societies.
You Canadians have much to be proud of-brave explorers and early traders settling your land; the forging of a great rail link across your country; the magnificent efforts of Canadians in two world wars; plus chasing the Yanks south in two other skirmishes. The truly remarkable performance of Canadian industry and labour, in peace and in war.
We are here today in one of the great cities in the world. You are blessed with a country larger in area and resources although less populated than ours.
To me the heritage of the past is the future. A society must not forget where it came from and how it was built.
The lessons of sacrifice and hard work put upon modern Canada the duty to work harder than the next fellow, be more competitive and to keep your eye on higher productivity and less social spending than your competition.
Your fiscal policy should generally be to the right of ours. - You cannot blame all your misfortunes on the elephant and you can with proper policies do better than us.
Now you might say who the hell is this guy coming up here to give us advice. I claim the privilege, as an investment banker who came north to Canada some 35 years ago and fell in love with your country and shared your aspirations.
In writing this speech, many fond memories have flashed through my mind-sailing on the Bluenose out of Halifax Harbour; having a beer with my Royal Canadian Navy partner, John Wiley, in the Crow's-Nest in St. John's; dining at Cafe Martin in Montreal; carnival time in Quebec City; budget time at Parliament in Toronto; visiting with the Eskimos and Indians in Northern Ontario; the booms in Edmonton and Calgary; visiting the great James Bay project; the pride of being in Ottawa as a lead banker to the federal government of Canada; Portage and Main at 20° below contrasted by the warm friendship of Winnipeg; the eternal snow flying across the country in winter; and bouncing across the stormy skies in the summers. The wheat fields of Saskatchewan and, finally, the magnificent parks in Vancouver; the crossing to Victoria and its beautiful gardens.
On the banking side, it translates into too many billions of dollars raised from the Maritime provinces to your western border. Hopefully, it has helped to create a better living for millions of Canadians.
Now I have one request that has not been fulfilled in my Canadian career. In 1943 I came straight from the navy to Salomon Brothers. I got kind of busy and never attended college. I am in pretty good shape-won a 40-and-over tennis tournament at my club this summer and was catapulted off the carrier USS Theodore Roosevelt a few months ago.
I would like to go into the Guinness Book of Records as the oldest varsity tennis player in the history of your country. I promise I am just as competitive on the court as I was in investment banking. If there are any of you education chaps out there, give me a chance, I won't let you down.
Now let me leave one last thought with you. In 1980, Japan's net overseas investment was $11.5 billion; in 1986, it was $180.4 billion. The U.S. was net $106.3 in 1980-$263.6 in 1986. Sometime in the next five years there is going to be a massive switch in those figures. It is going to have a pronounced effect on Canada as well as the rest of the world. If you Canadian investment bankers can figure that out, exchange rates, economic consequences, interest rates, equity prices, politics, Third World debt, etc., you will make a lot of money for your clients and truly wear the badge of a global banker.
I feel today somewhat like I did on the day I returned after two years in the Pacific and was greeted by my mother. I knew
I was home, God bless Canada. I thank you.
The appreciation of the audience was expressed by Anthony van Straubenzee, a Director of The Club.