City National Corporation Announces Definitive Agreement to be Acquired by Royal Bank of Canada Call
Jan 22, 2015 AM EST
RY.TO - Royal Bank of Canada
City National Corporation Announces Definitive Agreement to be Acquired by Royal Bank of Canada Call
Jan 22, 2015 / 01:30PM GMT
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Corporate Participants
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* Amy Cairncross
Royal Bank of Canada - VP of IR
* Dave McKay
Royal Bank of Canada - President and CEO
* Janice Fukakusa
Royal Bank of Canada - CAO and CFO
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Conference Call Participants
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* John Aiken
Barclays Capital - Analyst
* Gabriel Dechaine
Canaccord Genuity - Analyst
* Peter Routledge
National Bank Financial - Analyst
* Brian Klock
Keefe, Bruyette & Woods - Analyst
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Presentation
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Operator [1]
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Good morning, ladies and gentlemen. Welcome to the RBC conference call to announce the acquisition of City National Corporation.
I would now like to turn the meeting over to Ms. Amy Cairncross, VP and Head of Investor Relations. Please go ahead, Ms. Cairncross.
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Amy Cairncross, Royal Bank of Canada - VP of IR [2]
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Good morning, everyone, and thank you for joining us. Presenting this morning will be Dave McKay, President and Chief Executive Officer, and Janice Fukakusa, Chief Administrative Officer and CFO. Following their comments we will open the call for questions from analysts. The call is 30 minutes long and will end at 9 AM.
To give everyone a chance to participate, please keep it to one question and then requeue. We will be posting management's comments on our website shortly after the call.
As noted on slide two, our comments may contain forward-looking statements which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. Also please note that all financial information in the prepared remarks is in US dollars.
I will now turn the call over to Dave McKay.
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Dave McKay, Royal Bank of Canada - President and CEO [3]
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Thank you, Amy, and good morning, everyone. Today I'm very excited to announce that RBC has entered into an agreement to acquire City National Corporation, a premier US private and commercial bank with a growing wealth and asset management business.
You have heard me mention for some time that we want to enhance our US franchise by adding product capabilities to better serve our clients. City National is the perfect fit. It is uniquely focused on serving high net worth and commercial clients in high-growth markets. It is a high quality franchise with a long track record of profitable growth, is a great cultural fit with RBC as both companies share a strong commitment to client service and doing what is right.
By combining RBC's scale and strength with City National's capabilities and position in attractive markets, we will create a powerful platform for long-term growth in the US. Please see slide three as it provides a brief summary of the transaction.
The total purchase price is approximately $5.4 billion which will be paid with approximately $2.7 billion in cash and approximately 44 million RBC shares. This deal offers long-term earnings growth and given the strength of our capital position, it will not impact our ongoing capital management program. In a few minutes Janice will walk through the transaction in more detail.
Like me, Russell Goldsmith, the current CEO of City National, is enormously excited about this opportunity. As a sign of Russell's commitment, the Goldsmith family will receive RBC shares for their entire City National holdings, a large portion of which they have committed to hold for the medium term.
City National's headquarters will remain in Los Angeles and Russell will continue in his role as CEO of City National and will report directly to me.
Once the transaction closes, we will combine our US wealth management operations with City National into one line of business to be reported as part of our global wealth management segment. John Taft, RBCs US Wealth Management CEO, will report to Russell and will be responsible for leveraging City National's private and commercial banking expertise to expand the financial solutions provided by our investment advisors.
So now let me tell you more about the strength of City National's franchise starting on slide four. City National is a specialist private and commercial bank that delivers customized banking, credit and wealth solutions and has an award-winning commercial banking platform with expertise in entertainment, real estate, technology and healthcare. City National's clients are largely high net worth individuals and commercial enterprises, two of the fastest-growing client segments is the US as you can see on slide five.
Turning to slide six, one of the greatest strengths of City National's franchise is that it is strategically positioned in the largest and most attractive US markets such as New York, Los Angeles and San Francisco Bay area. In fact, the combined high net worth population of these three markets is over 4.5 times the entire high net worth population of Canada.
Like RBC, City National has a great reputation as a client focused company and has received many awards for its excellent customer service. A considerable amount of City National's growth has come from referrals, demonstrating the great reputation it has among clients.
With its high touch approach and a broad suite of products and services, City National has developed deep relationships with its clients. For example, nearly half of City National's clients have five or more products and over half use City National for both their personal and business banking needs. City National's client and market strategy has produced a strong track record of both loan and deposit growth handily outpacing the industry average as you can see on slide seven.
Like RBC, City National has a conservative and disciplined risk profile. Its loan portfolio is well diversified and its credit performance has outperformed the industry through the cycle due mainly to the quality of its clients.
Turning to slide nine, City National has a market-leading deposit franchise across our branch light footprint. In fact its average deposits per branch are over 4 times the median of US sized medium sized US banks. Additionally, City National is highly asset sensitive and is well positioned for rising rates as over 60% of deposits are non-interest-bearing and nearly 80% of its loans are either floating or adjustable rates.
Turning to City National's wealth management franchise on slide 10, City National provides investment management and advisory services that complement RBC's current product offerings. Its wealth and asset management business is a high quality franchise and has been ranked by Behrens as one of the top 40 US wealth managers for the past 14 years. It is also growing fast and since 2011 has seen double-digit growth in client assets now over $61 billion and double-digit growth in fee income.
As you can see on slide 11, City National is exceptionally strong on a standalone basis and when combined with RBC creates a powerful and scalable engine for growth.
First, it allows RBC to expand into US private and commercial banking creating one of North America's leading full-service private and commercial banks. RBC's US wealth business has been recognized by J.D. Power as a top US service and advisory franchise and for some time we have been focused on adding product capabilities to better serve our US clients. We will now be able to offer City National's full suite of banking products including commercial lending, private banking, cash management and other services to the 340,000 US wealth households and 204,000 cross-border clients and 88,000 Canadian commercial clients that we serve.
Second, this deal enhances our overall US wealth and asset management business creating a combined platform with approximately $320 billion in client assets. It also expands the distribution channels for both City National and RBC asset management products as we will have around 2100 advisors distributing products for both banks' platforms.
In addition, City National clients will have access to RBC Capital Market's advisory capital raising and risk management capabilities.
Third, this transaction allows us to extend RBC's commercial and corporate capabilities to City National's key industry specializations. For example being a top 10 investment bank, we can leverage RBC Capital Market's large technology practice to broaden and deepen City National's middle market and new venture platform.
In addition, we can expand City National's commercial platform by adding verticals that RBC has sector expertise in such as energy.
If you turn to slide 12, you will note that we expect to achieve a number of synergies. First, on the expense side while we will preserve City National's high touch client strategy which has been key to its success, we will see opportunity to consolidate infrastructure across businesses and achieve benefits of scale across functional areas like procurement and technology. We will also improve productivity by cross-selling City National products to RBC clients and vice versa.
Second, we will be able to build a deposit base from our wealth management and capital markets clients and deploy low-cost suite balances from our US wealth management as an attractive source to fund City National's future loan growth.
Lastly, we will see many long-term opportunities including increasing City National's market penetration in its existing footprint, and accelerating expansion into new high-growth US markets.
In conclusion, this deal aligns with RBC's strategic goals, gives us best-in-class capabilities that enhance and/or complement our existing US businesses and creates a powerful platform for long-term growth that I'm confident will deliver significant value to shareholders. It is a great transaction for both RBC and City National and we can now serve our clients in a way that wasn't previously possible.
Before I turn it over to Janice, I would like to mention that City National has a great team of about 3600 employees or colleagues as they call themselves that like RBC employees, are very focused on collaboration and building deep, long-lasting relationships with their clients. I've had the opportunity to visit several City National branches, have met with many City National colleagues and I been very impressed with the depth and breadth of their expertise and experience.
I'm enormously excited to have Russell and his talented team join RBC. With that I will now turn it over to Janice who will discuss the financial aspects of the transaction.
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Janice Fukakusa, Royal Bank of Canada - CAO and CFO [4]
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Thanks, Dave. Turning to the transaction details on slide 13, as Dave mentioned, the total consideration is approximately $5.4 billion or $93.80 per share of City National comprised of on average approximately $47.25 in cash and 0.7489 RBC common shares for each share of City National common stock.
City National common shareholders can elect to receive either cash or shares for their consideration subject to certain adjustments. The aggregate consideration will be paid with approximately $2.7 billion in cash and approximately 44 million RBC shares. We expect that City National's loan, deposit, revenue and earnings growth will be on average above 10% through the years one to five.
In addition, as Dave outlined, we estimate that the deal will generate significant synergies. In year three we expect to generate synergies of $100 million which are made up of $70 million in expense synergies and $30 million in deposit synergies. By year five, we expect to generate $210 million which includes $120 million from expense and deposit synergies and $90 million from expansion opportunities.
The transaction costs are $181 million pretax, most of which we will incur in year one.
I would point out that we have factored in all expenses, capital and operational costs associated with City National being part of our US Bank Holding Company with assets greater than $50 billion.
The transaction is expected to be accretive to earnings per share in the latter part of year three excluding amortization of intangibles and accretive to earnings in year two.
We have been working on this transaction for some time during which interest rate forecasts have been very volatile. As City National is an asset sensitive company, this volatility impacted our performance outlook. To be conservative, our financial model reflects recent changes in the forward curve. An improving US economy should result in rising interest rates which would be favorable to our projections.
Given our strong capital position and our internal capital generation, we expect to maintain our ongoing capital management program and we expect to maintain a common equity Tier 1 ratio at closing broadly in line with our current level which was 9.9% at October 31, 2014.
I would note that today our stock will trade X dividend. The deal is expected to close in the fourth quarter of calendar 2015 subject to customary conditions including regulatory approval and a 50.1% approval from City National shareholders.
At this point I will turn the call over to the operator to begin the questions and answers. Please limit yourself to one question and then requeue. Thank you. Operator?
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Questions and Answers
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Operator [1]
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(Operator Instructions). John Aiken, Barclays.
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John Aiken, Barclays Capital - Analyst [2]
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Good morning. City National has actually been quite acquisitive in the past although I understand recently it hasn't done anything terribly large. What does this acquisition do to the outlook for City National trying to continue to expand? And do we need time for the dust to settle or can this actually be -- can City National be active from this point going forward?
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Dave McKay, Royal Bank of Canada - President and CEO [3]
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I think we see two opportunities, John. One, first and foremost, we see fantastic organic growth strategy that will come out of this. In the short term I would say we are going to be focused predominantly on organic growth, cross-selling into our existing US wealth management franchise. As we said, we've got over 300,000 clients who need the services of a private bank and commercial bank like City National. We are going to expand the industry verticals as we talked about around technology, healthcare, energy and entertainment. So great opportunities organically to bring our balance sheet, to bring our client base and cross sell together. So that will be the primary focus over the first couple of years.
We have such significant growth opportunities that we don't need to make an acquisition to further grow and achieve the synergies and create the type of franchise we want. If there was something that allowed us to expand into a market and grow, would we consider it? Maybe down the road, but it is really not part of our strategy right now. Our core part of our strategy is organic growth, market expansion, cross-sell existing client bases and grow the business that way.
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John Aiken, Barclays Capital - Analyst [4]
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Great. Thanks, Dave. If I could sneak another one in, Janice, you answered my questions about the assumptions embedded in your accretion analysis but City National is as you pointed out very asset sensitive. How does City National's platform compare to RBC's US legacy platform in terms of the asset sensitivity?
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Janice Fukakusa, Royal Bank of Canada - CAO and CFO [5]
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I would say that our US platform in retail is quite small and City National is very well positioned for rising interest rates because of the fact that its deposit franchise is very large and it has a lot of current accounts. And if you look at the positioning, it is positioned very favourably for rising interest rates. That is why I commented that we think using the current forward curve we are being slightly conservative in looking at the five-year trajectory.
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Dave McKay, Royal Bank of Canada - President and CEO [6]
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We will also have some asset sensitivity in our U.S. wealth franchise in the deposit and sweep base there. So John, when you combine our U.S. wealth legacy franchise with the City National franchise, you enhance the asset sensitivity which we think we are legging into the right timing of the market and rate increases. So we are excited about that.
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John Aiken, Barclays Capital - Analyst [7]
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Great. Thank you. I won't ask you about the Canadian side.
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Dave McKay, Royal Bank of Canada - President and CEO [8]
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We should queue the next question.
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Operator [9]
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Gabriel Dechaine, Canaccord Genuity.
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Gabriel Dechaine, Canaccord Genuity - Analyst [10]
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Good morning. Just on the return on invested capital, we are looking at a deal tha6t is about 5%. If I layer on the synergies as you have presented them at a couple hundred basis points to that amount, you have acknowledged that you are being conservative in your rate assumption or your rate outlook. What kind of environment would we need, what sort of deliverables would you need to provide to get that return over 10%? I'm just trying to get a sense for your long-term view on returns on this investment.
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Dave McKay, Royal Bank of Canada - President and CEO [11]
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Thanks, Gabriel. It is Dave. As we think about the rate environment and how significantly it has changed even over the last 30 days, this is a culmination actually of a two-year process, a strategy review, customer review, market segment, how we reenter the market. So we have been thinking about this for two years but recently rates have changed.
So as -- when you went through the growth and earnings and ROE ahead of our cost of capital, one, you have to assume a certain growth trajectory that is maintained and in City National which they have been growing well above market but even if you take a lower growth rate, you look at the synergies you will be able to drive that you just referenced. And if you go back to where the curves were in early December, late November at year 5, that would add upwards of $170 million of NIAT.
So if you look at where we are today which is kind of the low point it has been in quite some time, you go back to early December, it could add as much as $170 million in earnings by year five. So it is incredibly asset sensitive. And so you have to take some view of where you are today versus where a normal environment is but if you ladder those comments in nicely, it gets us well above our hurdle rate into double-digit ROEs.
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Gabriel Dechaine, Canaccord Genuity - Analyst [12]
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I don't have a curve in front of me. Can you remind me the delta between December and today?
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Dave McKay, Royal Bank of Canada - President and CEO [13]
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I think it was about 75 basis points on the five-year.
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Gabriel Dechaine, Canaccord Genuity - Analyst [14]
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Okay. A broader one just from a management standpoint, Dave, so your U.S. asset size is going to be quite large after this, the City National sub $50 billion, but put the two together you are going to be over. How does that affect the regulatory burden of your US bank post this transaction and how do you expect that to change?
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Dave McKay, Royal Bank of Canada - President and CEO [15]
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As Janice mentioned in her comments, we have considered that in how we put together our forecasted financials of this becoming part of our holding company in the US and having to look at the liquidity structure of the bank and whatnot. So we have incorporated all we expect to be the regulatory changes that we imposed on City National becoming part of our holding company. We have definitely considered all of those changes.
We've also even thought about whether this makes us closer to a G-SIFI or not and we have taken that into consideration in our discussions. So I think we have done a lot of work and taken our time to understand how this changes and how it incorporates into our overall financial plan for City National and our US wealth business.
Janice, you were going to make a comment on his previous question?
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Janice Fukakusa, Royal Bank of Canada - CAO and CFO [16]
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Right. So, Gabriel, just two things. Following up on our holding company structure, we are well on our way to reporting with the new regime with $50 billion. So for us it is a matter of incorporating this business. This is not a game changer for us and so that is what we are talking about enhancing the structure we are well on our way to setting up to accommodate this.
You asked, Gabriel, about return on equity and I just want to point out that we have always discussed in terms of our long-term view the fact that we in essence are going after earnings growth and we know that from the return perspective there will be some dilution. But we can see clearly a walk back into our objectives in terms of return on equity with the added benefit of having earnings growth and earnings diversification. So I just wanted to stress that as you are going through the modeling.
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Operator [17]
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Peter Routledge, National Bank Financial.
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Peter Routledge, National Bank Financial - Analyst [18]
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Just looking at City National I noticed their leverage ratio, Tier 1 leverage ratio is quite low relative to peers. To what extent is your strategy to lever this platform up to get your accretion goals or would that be an add-on to your forecast?
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Dave McKay, Royal Bank of Canada - President and CEO [19]
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I think we have taken overall the LCR TC-1 ratio and the leverage ratio into consideration at the holding company level as we this going forward. Janice, do you want to comment?
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Janice Fukakusa, Royal Bank of Canada - CAO and CFO [20]
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Peter, I think that when you look at the strengths of the deposit franchises, both ours and theirs, we are going to deploy those deposits in terms of funding a lot of our growth expectation for City National itself and our broader US platform. So it is both about adding assets as we expand the business as well as more efficiently deploying all of the deposits and funding that we will have when we aggregate everything.
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Peter Routledge, National Bank Financial - Analyst [21]
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I guess in your three-year outlook, is the leverage ratio a legal entity basis higher or the same in your forecast? Where I am going is -- is there more upside if you can get more leverage into the platform?
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Janice Fukakusa, Royal Bank of Canada - CAO and CFO [22]
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I don't think that we look about it at the issue in terms of adding leverage. It is about adding good client assets and that so it is not a binding constraint. But definitely we don't see any constraints in growing organically in the markets that we see with our clients.
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Dave McKay, Royal Bank of Canada - President and CEO [23]
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Our leverage comes from utilizing our legacy sweep deposits to fund growth using their surplus deposits to fund asset growth, becoming more competitive with customers they haven't been today. For example, we are going to become more aggressive in jumbo mortgages in cities like New York and Houston, Washington. We can attract customers that way. So very strong customer growth strategy that other franchises have pursued.
So those are the synergies that we bring to the City National franchise that we think can accelerate growth and why we are confident in delivering those revenue synergies that we have articulated.
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Peter Routledge, National Bank Financial - Analyst [24]
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Thanks. Do you have some sense of why they were selling? Why did they choose to sell?
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Dave McKay, Royal Bank of Canada - President and CEO [25]
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It is a great question because they weren't selling initially and as I said, this was part of a two-year strategy that we sat down and thought about what customer do we want to serve, how do we want to serve them? And in 2013, I approached Russell as he had never met me before and we sat down and we just talked about how the two companies together could do really something special in the US market. And he says but I'm not for sale and I go but one day if you do consider selling, would you pick up the phone and call and that is how it started with just a dialogue. And the synergies and the opportunity for both our shareholders were so strong that we came to an agreement.
This is a very exciting journey that we want to take together forward but initially they weren't for sale.
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Peter Routledge, National Bank Financial - Analyst [26]
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Thanks very much.
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Operator [27]
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Brian Klock, Keefe, Bruyette and Woods.
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Brian Klock, Keefe, Bruyette & Woods - Analyst [28]
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Good morning. I will say that I have covered City National for quite a while on the US side and you have a really well run bank that you are acquiring so congratulations on that.
I guess I would imagine then the branding will stay City National in the US especially in the deposit footprint. So just kind of wondering on the revenue, the deposit synergy side I guess were you baking in any sort of deposit runoff after the announcement of the deal? They are a 70% loan to deposit ratio so there is a lot of excess deposits there. So I was just kind of thinking about how you thought about sort of the deposit retention rates?
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Dave McKay, Royal Bank of Canada - President and CEO [29]
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Great question. We spend a lot of time not only on deposit retention rates but on deposit betas in a rising rate environment and spent quite a bit of time thinking about it. We think we enhance City National's franchise by putting a very strong rated global institutional balance sheet beside their great service franchise. We enhance the strength of the City National franchise and we think we are going to attract more deposits particularly from larger corporates who may diversify their deposits because of City National's relatively small balance sheet today compared to theirs.
So we think from both a deposit and lending perspective that our partnership enhances our ability to do business and attract and retain customers over time.
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Brian Klock, Keefe, Bruyette & Woods - Analyst [30]
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Okay. I guess maybe just a follow-up question and with Peter's question on the leverage, it always has been one of those things for City National that the TC or the leverage ratio has been very low and it is because they have carried a lot of securities balances. So I know they have kept that securities book about one-third into short duration. So I guess would the assumption be that as that securities portfolio cash flows you may be able to deploy that into some of the other opportunities you talked about for either capital markets or some of the other products that maybe City National couldn't offer before that you could?
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Dave McKay, Royal Bank of Canada - President and CEO [31]
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You have read our playbook. That is exactly it.
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Brian Klock, Keefe, Bruyette & Woods - Analyst [32]
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All right. Thanks for your time.
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Operator [33]
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There are no further questions registered at this time. I would like to turn the meeting back over to Mr. McKay.
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Operator [34]
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I want to thank everyone for joining us this morning on short notice. I just want to reiterate how excited we are to take this next step into the US marketplace. It is a fantastic franchise at City National. I think we enhance it in so many ways and we are going to provide a really compelling value proposition to high net worth and commercial customers in the US market. Thank you very much for joining us this morning.
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Operator [35]
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Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.
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