Royal Bank of Canada at RBC Capital Markets Financial Institutions Conference
Mar 10, 2015 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at RBC Capital Markets Financial Institutions Conference
Mar 10, 2015 / 04:45PM GMT
==============================
Corporate Participants
==============================
* Dave McKay
Royal Bank of Canada - President & CEO
* Marc Harris
RBC Capital Markets - Head of Global Research
==============================
Conference Call Participants
==============================
* Gerard Cassidy
RBC Capital Markets - Analyst
==============================
Presentation
------------------------------
Marc Harris, RBC Capital Markets - Head of Global Research [1]
------------------------------
Good afternoon. I'm Marc Harris. I'm the Head of Global Research here at RBC Capital Markets and I really want to thank you for the opportunity to be here with you today and to serve you as our clients and trusted business partners from RBC Capital Markets.
RBC Financial Institutions Conference, this event actually for anybody who is unfamiliar has an extraordinarily long history that dates back even before my arrival at the firm a 11-plus years ago. We held this event at Martha's Vineyard, we held it in Boston. So we're proud to actually have moved it to New York and as a result of that, the largest tenants we've ever had. We got 450 attendees at the event today, 75 different presenting companies at the event and we'll host a 1,000 different one-on-ones with those corporate, investors and our clients. So we thank you for that support and we thank you for being here today and making this conference a successful one as we continue to grow and invest in it.
The success of the event, I would note is also indicative of the growth of our professionals that we have supporting our clients. Our FIG team for anybody unaware, it ranks amongst the top ten in M&A advisory and capital provision for US banks and was instrumental as you would expect in RBC's recent acquisition of City National. This was for anyone unfamiliar though, the largest banking deal since the financial crisis and RBC's largest deal ever and obviously Dave McKay, our guest first one. The leaders of our IB efforts Jerry Wiant and Henry Micheals as well as my whole team of research analysts in the financial group are incredibly excited to have you here today.
Now with us today, as I mentioned, is the person responsible for that transaction, the President and Chief Executive Officer of RBC, Dave McKay. Dave has a long and successful carrier with a diverse experience across RBC. He started his journey at RBC, to fully embarrass him, in 1998 as a -- 1988 as a computer programmer before moving it to banking and I will note I share that background with him, I was computer science major, I started in banking and computer programming, so nothing wrong with that and then progressed to a variety of very, very senior roles in Canada, in Japan, in retail banking and business banking, risk management, corporate banking a long and obviously fantastic carrier that led him to where he is today. His tech background actually may account for that interest and passion he has in innovation in the financial space. Dave is a proven innovator, a future-oriented leader who is highly attuned to the changes in the marketplace and client references and is a champion for our investing and the industry's investing in technology and innovation overall. His extensive experience in retail banking most recently as group head of personal loan Canadian banking earned him the title of retailer banker of the year by Retail Banker International in 2012.
Now, our format for the chat today is going to be informal. We'll be having senior large cap bank analyst, Gerard Cassidy, leading the Q&A. I would note that considering Gerard has covered the bank since Dave was a long-hair computer programmer in the 1980s, this should be an exciting and innovative session. So with that, I'll just say I hope you enjoy your time here. Thank you again very much for attending and let me introduce Dave McKay and Gerard Cassidy.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [2]
------------------------------
Good afternoon. Thank you for joining us today, Dave and thank -- like Marc said, we'd like to thank everybody for attending today's fireside chat here at lunch time. On the Q&A, we'd like to have questions coming from the audience, so what we've decided to do, you can see on your table there are index cards and we'll have guys walking around collecting those cards. So, if there is a question you would like asked, please fill out the card, hold your hand up, so one of the guys can grab it and they'll bringing it up here and I'll be able to ask, Dave, your questions.
Dave, maybe we could start off. I'd like to approach it from a macro standpoint, from a top down first, a lot of investors here in the United States have questions about the Canadian economy. So, really we'd like to get your view on the Canadian economy and view of the lower oil prices and what impact that might be having on the economy.
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [3]
------------------------------
All right. Thanks, Gerard. When you're -- where do you stand in the Canadian economy is, our view is it's still going to see reasonably good growth. Our forecast is somewhere around [2-3, 2-4] still, but you're seeing obviously a regional shift in where that growth is occurring from the West to Central Canada. The west obviously impacted by lower oil prices impacting spending and infrastructure on the E&P side and we've cut our growth forecast for particularly Alberta from roughly 4%-plus maybe a year ago to somewhere near zero, maybe slipping into the slight negative depending on how prolonged the downturn is.
Where we're seeing the benefit of particularly a weaker Canadian dollar, the benefit of lower gas prices and transportation costs is in the Central Canadian economy and export oriented industries into the US marketplace, which demand signals are certainly there. We are seeing private sector investment, business investment into growth and into technology and equipment. So, all things being balanced, we're seeing shift in growth, but we are still seeing very positive signs of growth and we're adjusting to what the future may bring, but all-in-all despite the signal from the Bank of Canada, concern over the economy with a cut in our Bank of Canada where they are down 75 basis points. They held at the last rate setting meaning signaling, now they weren't sure if they would cut again and that they may hold where they are.
So, I think you're seeing a stable situation, diversified growth in the economy, consumer that continues demonstrate low delinquency and low credit loss. If you look at our Q1 numbers and overall situation where we feel positive about our growth in Canada, mid-single digit kind of loan growth is probably what the market will drive on a consumer side, a little bit higher than in the commercial side. So, overall I would say diversified economy, strong neighbor to the south right now that will pull quite significantly a cheaper dollar driving exports and overall I think pretty good job creation.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [4]
------------------------------
Good. Another question many investors ask us about the Canadian economy of course is your housing market. You're very resilient, you came through 2008, 2009 very strong. Can you share with us some of your thoughts on what you're seeing in the housing market?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [5]
------------------------------
We feel good about the Canadian housing market. This is a question I fill that endlessly for the last four years as everyone expects something bad to happen. Even if you look at the IMF report on housing on Canada recently, they are concerned. But overall, as we look at the balance and how we're structured, so first if you look at housing in itself and supply-demand, our supply demand equation remains largely in balance. Numbers came out today on housing starts are down 16% as supply side adjusts for lower demand side and we don't have the speculative creation of multi-family residential housing and that we will not finance the construction of multi-family residential units without at least 70% or 80% pre-sell in place with down payments. So, there is not a speculative build of excess supply.
There has been a shortage of single family home creation in core markets like Vancouver and Toronto, which has really driven the price increases and as not new land been released into single family home construction, there's significant demand for that. So, a lot of the price inflation that you're reading about in the Canadian housing market is largely driven by lack of supply in single family home, strong household formation, strong immigration numbers coming in the county. So, demand is still there and lack of supply where the supply is being created is the multi-family residential.
So, overall I think a very healthy balance of supply/demand, [sales to leasing] ratio if we watch it very closely, but we are not out of walk and speculative supply which could exacerbate a price run if there is anything.
When you're talking about our mortgage and credit book, what we keep in -- trying to educate is that our first loss is covered by government guaranteed insurance. So, any loan to value in excess of 75% today historically get balanced between 75% and 80%. So, let's say 75% requires insurance backed by the Canadian government. So first loss on your high LTV ratio portfolios is all insured. So you only back-in to the bank balance sheet if the loss on a property is greater than 25%, and you look at our uninsured portfolio, which is roughly about 60% of our portfolio, our average LTVs are 55%. So you have 45% equity in those homes and therefore strong distribution, strong supply-demand economics. Historic 1 basis point loss ratio in that portfolio, no signs of growth impaired loan formation. So you can see why we sit here today and looking forward, we feel good about the housing market in our loan portfolio in Canada.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [6]
------------------------------
Good. RBC has the number one market share in most of the businesses that you're in. Can you share with us the strategies that you have in place to grow that market share organically in a profitable way?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [7]
------------------------------
We have the largest distribution, multi-channel distribution network in the country, whether it's on the wealth management side with our broker dealer business, our financial advisors, the largest branch network in the country, I think the top online banking capabilities.
We have scale and we have distribution and we have brand power. We're just ranked again as Canada's most valuable brand across all sectors and obviously most valuable banking brand. So we combine brand with distribution scale with the fact that on average, on the retail side, we have about 15% to 17% market share of the country. On the commercial side, we have 28% market share. There's still a lot of room to grow to use our scale, to use our distribution and brand power.
Second thing is that scale allows us to invest in new capabilities and consecutively run really high-end successful marketing programs and invest in client acquisition. So we find many of our competitors in today's technology environment, in today's tough revenue environment, are making choices between investing in technology, trying to meet an ever higher regulatory standards or regulatory criteria, the first thing they tend to cut is the marketing budget and the advertising budgets, which we don't have to do.
So, on the retail side, when you combine the ability to spend with the best brand, with the best team, with the largest network, you can see why we're very confident wherever growth is going to occur in the Canadian retail marketplace, we're well positioned. I said the same thing about our wealth management platform, particularly in Canada that we've got the top broker dealer capability in RBC Wealth Management. We capture almost twice the industry profit as our volumes would indicate and our market share. So a very profitable, successful broker that again as demographic population change and ages and there is more saving in the economy, we're very well positioned to capture that changing Canadian consumer and their saving and investing needs going forward.
Part of the capital markets operation where we lead the league tables in almost everything we do in Canada. In the US, we're very proud of this progress and success we've had here, particularly since 2008 as the top 10 capital markets capability based on fee income, we've built our FIG capability as you know, we've built out a number of sectors, we've hired teams recording balance sheet out there and we're building long-term customer relationships and we're very proud of the progress and well positioned to capitalize on the growing US economy and maybe one where some foreign competitors pulled back a bit, advance us just forward. So, overall capital markets, wealth, retail, really confident, a lot of room for growth.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [8]
------------------------------
Great. When you look at the breakout of your revenues in the most recent period, personal and commercial banking still is the biggest part; you have [51%], capital markets about 23%, wealth management, I think, is 12% and insurance is about 9%. When you look out over the next five years, do you see that mix changing much, or what's your view when you look out long term?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [9]
------------------------------
We're very happy with the universal bank model we have and the synergies that we see and I know some large US banks under attack with universal banking model and are defending their synergies between, we really do see those synergies between our capital markets, our commercial banks, retail bank and our wealth franchise. But when look at the balance of earnings and not only earnings, but where we deploy capital and balance sheet almost as importantly, we do like to keep the capital markets business within that 25% earnings stream.
Having said that, the nature and how we are in the business is the greater confidence we have in the earnings stream by deploying balance sheet gives us confidence around that 25% number on capital markets. But when you look at the balance between retail, wealth and capital markets, we are going to try to keep that 75-25. Where you'll see balance mix changes, our earnings are almost 70%-plus from the Canadian marketplace with the US capital markets operations, I think, by far our strongest non-Canadian profit contributor along with our investor and treasury services group out of Europe.
You'll start to see as we invest in City National, as I'm sure we'll talk about soon, we start to build out that US wealth franchise, we see that taking a greater proportion of growth going forward and kind of re-bouncing a little bit towards wealth in the US marketplace. So greater diversification of the Canada, greater diversification of the balance sheet and capital towards wealth and I think that's where certainly the western economy demographics point to a saving, investing and where we're positioning our bank to be successful.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [10]
------------------------------
Is there any ideal percentage that you'd like to see the Canadian revenues as a percentage of the total picture, I think they're about 68%, 70%, US has grown nicely over the last 10 years, is that a balance, I think US is about 18%, is that a balance you're comfortable with or do you really want to make that US bigger?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [11]
------------------------------
We certainly want to make the US bigger, hence the acquisition of City National and building out what I think will be a foundational high net worth private bank franchise and commercial franchise in the US and we still see making that our franchise in the UK larger too. So when we look at the three-legged strategy of commercial bank, capital markets operation and a private wealth manager. We've got those pieces in place in the US, now on the cross-selling synergies between those three pieces. We are now going to try to replicate that in the UK marketplace on the very similar lines organically. So, we think that's the right model for us. And the Canada piece that we have in Canada, we don't have externally is the large consumer mass banking, that's just a market that we're not going to play in outside of Canada. We're really focused on high net worth customers, capital markets, institutional corporate customers and higher-end commercial customers. That is the franchise model that we were having a great success with that we're building out with City National and we're going to replicate in largely western-based markets.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [12]
------------------------------
Talking about the expansion here into the US with City National, maybe you can give us some color behind the thinking of building that triangle that you just described and how that City National is going to fill that point position of it?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [13]
------------------------------
We're incredibly excited about City National and I think we surprised everybody, not in the sense that I was signaling to the market that I need -- really with covenant of private commercial bank, the fact that City National actually sold. And I think we talked about that just at the lunch I had that across the US that this is a crown jewel of our franchise, one that no one thought was for sale, we were -- I won't say pursuing, but largely pursuing Russell and Bram and the City National franchise for over two years because we just thought it's the perfect fit to A, lever our strong capital markets operation, but also lever a nascent broker dealer wealth franchise, the [old Dane Rocher] franchise where we have 400,000 high net worth affluent customers and households in our US wealth franchise, and it's a top 10 broker dealer wealth franchise in the US. But, we have no other product shelf to sell that customer, they've rated us on many years number one in J.D. Power for satisfaction with our advisory relationship, but we can't go in there and offer a jumbo mortgage capability, core checking accountability, credit card ability and our research indicates just talking to your customers that 25% of their wealth was created through small business and commercial entrepreneurship and we're not able to walk in there and talk them about cash management, term lending, revolving credit needs.
So, we have a customer with a deep and broad financial wallet and we serve just a sliver of it. So, hence the strategy to try to complement our product shelf with a private banking service and a commercial bank service and you look -- we look [scout] the US marketplace, City National was the perfect franchise for us, a high net worth -- ultra high net worth private bank capability, great brand, largely California-based but with an emerging capability in New York and Nashville, Atlanta marketplace, a little bit in Las Vegas. But a very strong private bank, they have the product shelf, they have the business model, they have the service level capability and they do one thing really, really well and that's entertainment.
You always look for a franchise in a very competitive market like the US, an incredibly competitive market where profit pool shifts and they get competing. You look for a firm that can do one thing really, really well and has a reason to be and that's the entertainment business for Russell and the team. They're exceptional, they've got great relationships and that's the foundation that they've used to grow into healthcare and into the technology in the Valley.
So, strategy number one, cross-sell our existing high net worth customer base. 400,000 hot customers are looking for those three types of services; so great synergies to be obtained there. Two, City National's growth been constrained by the size of their balance sheet, sector concentration risk and single name appetite limits with their core customer group. So, putting a trillion-dollar balance sheet behind an [$18 billion] firm allows them to grow their franchise on the residential mortgage side, allows them to grow in the commercial banking side, allows them to breakout some of their sector limits and allows them to grow with their best customers where firms like JPMorgan and Wells are taking those customers as whole limits get beyond the appetite of a small bank and we can come in and help our customers grow with that franchise.
So, significant opportunity to grow the franchise and the last thing is expand geographically and accelerate growth in the New York marketplace. I think City National has been an accommodation lender and reactive to customer demand for consumer mortgages obviously, but didn't proactively go out and offer jumbo mortgages with significant deposits on their balance sheet, significant deposits that we have in our wealth management franchise. We have an opportunity to accelerate that client acquisition strategy more mortgage and jumbo mortgage-oriented going head-to-head with some of their traditional competitors and accelerate the growth of their franchise outside of the California marketplace.
So, in our analyst call, in our announcement, we said there were $200 million in synergies in this business, which we paid [$1 billion] premium for and I think it's a pretty reasonable ratio of costs and premiums of synergies and we feel really confident that they're all there and we can go after them.
So that's the genesis of the City National deal and the rationale behind why we're so excited about it and why we spent two years convincing Russell we're the perfect partner.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [14]
------------------------------
Can you share with us, you mentioned the UK is similar. It's kind of trying out, being built. If you kind of had to rank it, how much further behind is it than your US advances or can you kind of lay out what that is?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [15]
------------------------------
Yes. Great question. I think it's well behind our US advances. You have that secular opportunity where from 2008 to 2011, 2012 you had so much balance sheet pulled back from the marketplace. We had teams available to move over who are looking for support balance sheet, a company that was looking to grow. We did a great job in building out capability across multiple sectors, building customer relationships and lever that and cross selling of these -- of our balance sheet in a competitive marketplace.
When you look at where the UK and Europe is in that journey, again, it's quite easy, you don't have the secular disruptions that you had. So growth will be slower. It's more competitive. There is not the same openness to trying new challenger brands and challenger companies to get work harder at it. So I would say we're probably and the team might disagree or agree, we're probably 5 to 10 years behind in our US capital markets operation, but I am patient to say we are the large bank, one of the top 15 banks in the world, we got balance sheet, we got great people, we've got a lot to offer and as Europe recovers and US continues to grow, there is room for RBC Capital Markets to add a lot of value on both sides of the Atlantic and we're really excited about it.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [16]
------------------------------
Your numbers bear out particularly in Canada how successful RBC has been. Can you compare the two markets, US and one of the similarities that you've seen between Canada and the US and some of the differences, we often hear the US is more competitive, but what are you seeing being in both markets?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [17]
------------------------------
I would call it inefficiently competitive in United States. When you look at, everyone [sees fans] in oligopoly, oh, I wish I could operate in oligopoly, how nice is that? You look at our margins, they are less than the -- third less than yours. So we operate at much lower NIMs in Canada than you do in the US. We have a much better productivity ratio, productivity ratio on our retail banks 42% and it's because we have a national network, but more importantly the structure of how the client thinks about a relationship in Canada is very different than the US. And US is evolving I think more to the Canadian model, but the Canadian will say I want to lever my buying power with one firm and get reciprocity by giving you multiple products in multiple lines of business. Therefore, we have very significant multi-product relationships with our client and all the analysis that we've done is how do you get to an 18%-plus ROE in your business or 35% in the retail bank and cross sell a lot of product to get efficiencies on that second, third, and fourth product cross sell.
So we have a significant cross sell across credit cards, consumer lending, deposits with our customer base and that creates ROE. In the US, obviously as you see it, it's a more fragmented market, it's tougher to get that cross sell, consumer mindset is to lever their buying power by trading companies offering into moving their business around more and it's tougher to get the synergies because you're acquiring more, you're spending more and you don't have a cross-sell synergy hence you've got lower productivity, but you do have higher NIMs, you have higher credit losses, you got to cover off against those NIMs. So it's a very different marketplace from credit appetite perspective, from a structure of consumer perspective and we've had a number of, most of the large US banks have forayed into Canada, most have gone. It's tough to break into the marketplace when we control most of the corners, we've got our branches in every major corner in every major city.
The banks that have done well in Canada are the Cap Ones and able to come in with a product offering that didn't require a distribution network, digital work stuff in the mail box for a longer time. But, they've also left as long as ING is also sold in Canada, because you still have to balance your balance sheet. If you just originate deposits and kind of fund an asset, you're going to be a single-digit ROE bank, same as in the United States. You got to find that asset, if you originate just assets and can't find a cost-effective deposit, you're going to be a single-digit ROE bank. So, balancing your balance sheet, both sides of the border, is the key to success. And it's tough to do, but it's tougher to do in this marketplace, because the asset that you're missing in the balance sheet is the mortgage. Because, you're through to your open mortgage and structure and how you fund your mortgages, you can't put a lot of them on the balance sheet.
We have a CAD1 trillion balance sheet of which, almost CAD300 billion of that is 1 basis point loss residential mortgages, driving an ROE of 35%. That's pretty nice. Take that any day, you don't have that asset class in United States, hence you're putting a lot of your surplus deposits (inaudible) into securities and other lower-yielding assets. So it's -- there are a lot of structural differences and a number of similarities, but that's how you get to 18%-plus ROE and productivity ratio of 42 versus the market here etcetera, very aware of that. Hence our disinterest in mass consumer banking in the United States, and the reason, we sold their franchise and that we didn't see a future for that franchise, given the structure of the market and the competitive -- hugely difficult competitive dynamics in mass consumer, changing regulatory environment to the negative, it was -- we are fortunate.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [18]
------------------------------
Again, if you have questions, please fill out a card and one of the guys will pick it up.
Dave, you just touch on something about the MBNAs and stuff about digital?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [19]
------------------------------
Yes. We're undergoing a revolution with digital, with the iPhone as the mobile channel, smart watch, (multiple speakers).
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [20]
------------------------------
Can you share with us your thoughts on how you see it reshaping the delivery of your products, whether it's a retail product, wealth management product, and what is RBC doing to grasp that channel?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [21]
------------------------------
Let me start with more of the benefits than the threat. So, we think about digital a number of ways. One, digitizing our business end to end has been a huge focus for the last decade and we've invested enormous amount of money, recently CAD0.5 billion in a new end to end mortgage digital capability. So, digitizing and taking up the cost end to end of our back-office and front-office operations for all of us is a huge opportunity to streamline and add shareholder value or client value RB want to distribute those savings. So we're all in that journey in digitization and taking document. So we used to ship 20 million documents across the country for protesting every year by courier and we don't ship those documents anymore. So we digitized them and we send them and it's just the savings in transportation and processing and paper, very, very huge.
The second critical transformation from the customer end is around payments and digitizing cash and digitizing the world of e-commerce and physical commerce, Apple Pay being the most significant manifestation of that and I think how it challenges all of us, including our institution it's going to force us to be more than just the end of the commerce transaction, the payment part. So the challenge is we're being disrupted by digital phones or wallets, we're being disrupted by apps and service apps, so you think about Uber as a great example. Customer pre-registers their payment vehicle inside Uber and doesn't actually pay when they leave the car anymore. That used to be a key moment of truth where you pull out your credit card, it'd be reinforced that this is a great loyalty card I get airline points or I get cash back or whatever it is and you brand reinforcement of your payment vehicle in your home bank brands or reinforce millions of times a day and you're hitting in the Uber wallet and someone get a taxi and doesn't even think about your brand anymore, you've loss something. You've got the payment because if you're successful in getting your card into the first part in that Uber wallet or to the Apple spot that everybody's playing prisoners dilemma, trying to get into the top spot in the Apple wallet, you're going to get the transaction, but you've lost a brand value and you open yourself disintermediation over time and you paid a nice premium to Apple to have that luxury. So that is a long-term risk.
So the challenge it poses to us as bankers is we cannot afford to be at the end of the value chain anymore and you're going to have to integrate into the customer value proposition and get in front of your customer. And the last thing anybody wants in the mass consumer is to have someone between you and your customer and that's what we now have in the payment space at first, we thought it might be the telcos in front of us, but it's not, it is service providers, and it's the mobile OEM manufacturers through their digital wallets whether it is the Googles of the world or PayPals of the world. So our challenge is we have to pull ourselves to top of wallet inside Apple Pay or Google Pay. We have to pull ourselves to top of wallet inside Uber and every other service app that your clients decide to put on their phone or on their iPad or on their watch for ease of use, and that's the harder challenge to make sure that when they sign up for service to take in your card and putting it there and keeping it there is a critical challenge and then you have to build out your capability with your own wallet to integrate from just being that last step in paying to building out a loyalty program, an incentive program that keeps your brand in front of the customer, and so you don't get pushed to the side line by Apple and by Google and by PayPal, and that's what we've been working on.
The assets that we have as an industry and as a bank is number 1, trust. So you look at not only do consumers not trust completely Apple and others they give their private information, but merchants don't trust in the long run. So, you've got to trust the merchants and consumers to play in this space. Trust around security and protection of information, trust around you've been my finance provider, you've got their right for the most part, I trust you to do the transactions for me and it's safe to keep my money and my deposits. So, trust and security are our key assets. They buy us time, but we're going to have to innovate into this space. So we're building consortiums with merchants, we're trying to build value propositions, we're trying to use geo-location, we're trying to stay in front of our customer in real-time before the purchase decision is made and before the payment transaction happens creating value for our customers and for our brands, beyond I'm going to pay now I've made all my decisions.
So, we're on a collision course between the Googles and the Apples of the world coming this way down the value chain and thus trying to go backwards within the value chain and would you ever pick a fight with those types of companies? No, you could not want to, but we're on that course and therefore we have great assets. We have the trust of the customer. We have incumbency with the customer, but we can't be complacent with others.
So that's how I think about digital and that we've got to build out digitizer business, we have to digitize ecommerce, we have to evolve our model, we can't sit back and just do what we always did.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [22]
------------------------------
You mentioned you've got a great branch system up in Canada, does the mobile banking channel change your thinking of the size of your branches, the number of branches over the next 10 years? Is there a change coming there?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [23]
------------------------------
We've been on that journey for almost eight, nine years now. We looked at our 1,250 branches, which were largely transaction centers whereas the transaction part, tellers were at the front of the branch and we hired a firm who had never built a branch to the future, it's kind of mystery shop and he came back after a year after mystery shop and all our customers and after mystery shopping us over hundreds and hundreds of branches I think, so I got good news and I got bad news for you. He says, the good news is you really do have the best employees. I mean they created a great experience for me. The bad news is you're selling waiting time. I mean the first -- I mean when someone walks inside a branch, the first thing they see is the queue for the teller and you don't know what you sell. You think they know you sell, but they don't. You've got to turn your branch and you got to think like a retailer and you got to reconfigure your branch.
So we've spent a year of mystery shopping, not banks, but Apple Stores and IKEAs and different brand formats, Hollister versus the Gap, looking at best in class retailers, and we came up with a concept that turned the branch on its headline and it's really became more like an Apple Store that move the tellers to the back. We got rid of all the offices that people used to love in coming, hang in their office and wait for customer, a walk down as there are consultants at the corridor of debt. What you're selling, waiting time and people hiding in offices, they should be held in the floors. We've got our employees out of their offices on to the floor, in to the ATM space, greeting customers that was step one. Get rid of offices, create a more visible workforce because that's we're selling, we're selling the capability of our people, the advice getting it right.
Second thing we did is, now that you're out on the floor, there is not enough customers coming in. We have to get you out in the community. So, we gave them mobile banking capability and asked them to start calling on small business customers and knocking on doors. We have 28% share of our commercial customers in Canada, we started arranging presentations with the employees and went into the -- kind of the employee group banking space and when took that same team. And then we signed a partnership with the CVS equivalent in Canada, the largest drugstore retailer with almost 1,500 locations to open up mini advice centers and branches with our employees in their stores, to get our employees out of the branch into the public. They had one of the 10 Canadians walk through those stores every month, created a brand presence, put ATMs in there and pull them back into our core brand structure.
So, we call it a hub-and-spoke and the goal is to just reinvent what a branch does, so that we can keep them open longer than anybody else. But, absolutely seeing footfall decline, customer interaction decline getting tougher to know to your customers and what's going on to add value at key moments of truth, you have to reinvent what you do and reinvent how you connect with customers because their lives are going on and you're hearing less about it and our business model is based on relationships and understanding customers and on offering great advice and service and financial products at the right time and you got to know, and it's harder, you've to work harder to understand and discover your customer.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [24]
------------------------------
How challenging is it when you talk about the reinvention of the input for the employees, because employees, many of them and may have come up through the traditional banking channel, how did they change or do you need to hire new employees who are accustomed to this new reinvention?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [25]
------------------------------
It's both, some opt out, some opt back into call centers or opt into the operations side. The hardest thing is to go from reactive order taking to proactive sales, it's a completely different skill set. We train for it, we hire for it, we reposition for it. It's been a difficult journey. You know how people comfortable -- people get into an office with their family pictures around them and hang in their coat, and they get to go to the safe place every day and customers walk into their space and they serve them from this base of power to being out on the floor greeting calling introducing yourself, but once you get that employee there, it's transformational for their confidence, it's transformational in their sales capability and it was easier to get them from that step into the market and outside the branch because they've built that confidence, you have a completely different employee, but some opt out which is not for them.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [26]
------------------------------
One of the questions on the index card, Dave, talks about, can you share with us the RBC's insurance efforts of expanding the opportunities for that business both in Canada and in the United States?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [27]
------------------------------
On the insurance side, not a lot of interest and we owned a small insurer I think in South Carolina, which we sold a long time ago, not a lot of interest in moving to that space. To be honest with you, if you look at our Canadian insurance business, two-thirds of it is really creditor insurance that we underwrite from mortgage and credit card insurance. So that's two-thirds the profitability of our Canadian life insurance business, which is the majority of what we do, and we sell that into the European marketplace and swap that risk.
So a lot of what we do on the life insurance, I think, in Canada is that second part of the business as strong as our life side and we're long term holders of life business and on the property and casualty side, we're trying to decide which direction we go with that. It's a very volatile business, we're underscale in property and casualty in the Canadian marketplace because of the lack of bank assurance and the inability to sell insurance at our branches, in Canada we did not have that ability. We can't build off scale of our retail bank, therefore distribution is difficult and costly and we're under scale and we're not sure where we're going to be in that business for the long term, but we will see, will see what we can do.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [28]
------------------------------
When we shipped over to capital markets, obviously you've got a dominant position as you pointed out in Canada, you are growing real nicely here in the US, expanded into the UK. Are there any other geographies you think the capital markets could grow or do you have enough opportunity here in the US and UK that you really don't need (multiple speakers)?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [29]
------------------------------
We're certainly interested in growing in Europe. So we've re-opened our office in Germany and Spain, we're going to focus on a hopefully a turnaround in growth. There is a little more positive signs of growth in the European corporate marketplace than they were a month ago.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [30]
------------------------------
I agree.
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [31]
------------------------------
Two months ago. So you're starting to see a nascent recovery there. So I think there is great ability to use our brand and build other teams across Europe would be our kind of third home market for cap markets, still US is really where we want to grow, where we're putting our best people and we're really emphasizing successes our second home market. Europe generally third. We have a very strong operation in Australia and we've had good success there, probably because we don't go head-to-head with some of the domestic banks and we're ancillary to them. So we like our Australian operation. That's a key for sure and again a very structure similar to the Canadian economy and our resource based economy with similar growth trends. So, it feels comfortable and we've done well there.
We struggle in Asia as many banks do where we don't have high long-term aspirations for our Asian business right now, but we're thinking, we're looking, but it's Canada, US, Europe over the medium term and Australia is kind of where our opportunities lie in capital markets, but we're very proud of the success here in the US marketplace serving you, our big clients and the sectors we've done and it's a very competitive marketplace, but we're really proud of what the teams accomplished here.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [32]
------------------------------
As we've talked about growth throughout this conversation, you have to ask yourselves about capital and the G-SIFI buffers as banks as you know become larger, they fall into different buckets. How do you balance that desire for growth and increased profitability with the potential of tripping into a higher G-SIFI bucket?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [33]
------------------------------
We obviously look at the scores as everybody does very carefully. We do not believe that City National transaction puts us into a G-SIFI category. As you look at the potential score differential it would add to our overall score, so we feel confident there. Some of the businesses that add significant score are your institutional (technical difficulty) businesses and the size of those and given that even though we've had great success in our ITS business, it does increase your score on that side.
But if you look at the level 1 G-SIFI and where the global peers are and the amount of TC-1 capital that they hold as a global G-SIFI, I think there is eight or nine or ten of them. There are around 10%-plus. So our target capital is already [98] and we're [96] this quarter. We had the impact of RWA going up in the US dollar conversion to Canadian dollars of our US-based assets. So that was punitive over the quarter. But if -- rebuild towards 98 is our target, [95] plus a 30% buffer we are already very close to what a G-SIFI Tier-1 is going to be.
So, you look at that and it's always unsure how your domestic regulator will respond to that, but the idea is to have everybody on a level playing field as G-SIFI globally and you should all be within a range of TC-1 ratios, then we're almost there. So, it should be a meaningful increase in capital you think, but you're never 100% sure if they maintain a level playing field. You always see increased supervisory effort and reporting if you're into the G-SIFI category, so there are -- I think we would be naive. We didn't think there'd be some cost increase in compliance and regulatory communication, but from a capital perspective, I still struggle to see how meaningfully different that would be from where all the Canadian banks are today, our D-SIFI Canada is almost a G-SIFI one. The average Canadian banks are probably close to 10 with a couple over (inaudible) top 5 Canadian banks pretty close to a G-SIFI capitalization already, that's our domestic regulars looked at it.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [34]
------------------------------
When you look at profitability, you pointed out the mortgage business is extremely profitable with those returns consolidated around 18%. When you look out over the next two or three years, potentially with carrying higher capital levels, are there any target levels you'd like to maintain on the return on equity for shareholders?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [35]
------------------------------
We're still targeting to get our medium term in a 7%-plus EPS growth and 18%-plus ROE as they drive our price to tangible book valuation, which is important to our investment thesis, it's getting a little harder to do. How you get to the 18%-plus is driven by a 35% ROE on 50% of our business and then a collection of businesses in that kind of 12% to 15% range. So where do you see growth occurring in the future? We do see significant growth in less capital intensive businesses, particularly on the wealth side and fee based wealth side. So that again helps maintain your ROEs where they are, where growth will shift from more asset intensive consumer lending to savings and fee-based asset management and investment management. So that will be a catalyst to maintaining.
The second catalyst to maintaining strong ROEs is our Canadian business. And now with City National acquisition, our US wealth businesses are highly levered to increase in rates. So as rates ultimately start to move up, hopefully that will unlock earnings power on the balance sheet. We're the largest core deposit gatherer in Canada with significant opportunity to higher rates were at all-time, cyclical low was when we get paid for our core deposit business. That has great upside over the medium term. So again those are without putting more assets on the balance sheet, there is I think a profit tailwind that helps maintain strong ROEs, offsetting that will be kind of asset growth and businesses like capital markets that will not be potentially at a 20%-plus ROE.
But you look at our capital markets operation and I don't know if we disclosed externally but it is a top quartile, if not top decile ROE business among the peer group. And we're really proud of that and that's something that why we would like to invest in the business. So, not quite our overall target rate but strong contributor and a best-in-class producer of returns for the shareholder in that category. So that's how the balance; good tailwinds, strong domestic retail growth in some above hurdle businesses, but not a quite target, should all balance out for us, just continue to grow at an 18%-plus ROE.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [36]
------------------------------
Very good. Another question from the audience here, Dave. If the best opportunity to grow the wealth business in the US is cross selling City National's products to more business customers and existing private wealth customers, do you need to -- over the longer-term, need to add acquisitions or other asset managers or commercial banks to grow that business even further?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [37]
------------------------------
That's a good question. We really view City National's strategy in itself in United State. We do not need to build off the City National capability, we've really pursued this acquisition and we're willing to spend [$5.5 billion] because we saw it as a core capability in itself and organically it could do everything we wanted to do. Our core challenge is finding enough good people to grow a private bank, and commercial bank model. So the number one challenge is the success of this business is hiring great people and paying well for them. Competition in this room and outside this room for great people will only intensify in the US marketplace. So it is a war for talent and that is one of the key execution challenges that we face, obviously, but we do not need another bank to grow core capabilities.
This bank has a great cash management capability. It's a great commercial capability, has outstanding private bank capability, I mean talk to customers and see their customer stats, it's got it all, it's a matter of scaling it with people is the core challenge. We don't even need branches, a lot of these can be achieved in second and third floor offices hub-and-spoke concept. So we don't need prime real estate, we'll need some core hub branches like we've got on, just down here on Park and think 50th and again up on 6 and 54th really high profile flagship branches keep your brand in a marketplace, everything else could be executed at a branch or a second-floor office, so we call it branch light.
We really did not want a heavy branch footprint, we exited that for a reason, branches will be challenge to be profitable going forward. So we only picked up 70-plus branches. It really is a branch light, core people centric strategy. We will spend our NIE on great people and advertising, that's the strategy, don't need the physicality.
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [38]
------------------------------
We've run out of time, but I had to save the hardest question for the end, [when would they leave for the] Stanley Cup?
------------------------------
Dave McKay, Royal Bank of Canada - President & CEO [39]
------------------------------
Not for a long time.
------------------------------
Marc Harris, RBC Capital Markets - Head of Global Research [40]
------------------------------
I joked with Russell and his team, I said we had to buy a bank in LA so we could watch good hockey, (multiple speakers).
------------------------------
Gerard Cassidy, RBC Capital Markets - Analyst [41]
------------------------------
Please join me and a round of applause, thanking Dave for presenting it, very good.
------------------------------
Definitions
------------------------------
PRELIMINARY TRANSCRIPT: "Preliminary Transcript" indicates that the
Transcript has been published in near real-time by an experienced
professional transcriber. While the Preliminary Transcript is highly
accurate, it has not been edited to ensure the entire transcription
represents a verbatim report of the call.
EDITED TRANSCRIPT: "Edited Transcript" indicates that a team of professional
editors have listened to the event a second time to confirm that the
content of the call has been transcribed accurately and in full.
------------------------------
Disclaimer
------------------------------
Thomson Reuters reserves the right to make changes to documents, content, or other
information on this web site without obligation to notify any person of
such changes.
In the conference calls upon which Event Transcripts are based, companies
may make projections or other forward-looking statements regarding a variety
of items. Such forward-looking statements are based upon current
expectations and involve risks and uncertainties. Actual results may differ
materially from those stated in any forward-looking statement based on a
number of important factors and risks, which are more specifically
identified in the companies' most recent SEC filings. Although the companies
may indicate and believe that the assumptions underlying the forward-looking
statements are reasonable, any of the assumptions could prove inaccurate or
incorrect and, therefore, there can be no assurance that the results
contemplated in the forward-looking statements will be realized.
THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION
OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO
PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS,
OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS.
IN NO WAY DOES THOMSON REUTERS OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER
DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN
ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S
CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE
MAKING ANY INVESTMENT OR OTHER DECISIONS.
------------------------------
Copyright 2018 Thomson Reuters. All Rights Reserved.
------------------------------