Royal Bank of Canada at Deutsche Bank Global Financial Services Investor Conference
Jun 02, 2015 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at Deutsche Bank Global Financial Services Investor Conference
Jun 02, 2015 / 01:35PM GMT
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Corporate Participants
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* Janice Fukakusa
Royal Bank of Canada - CFO, Chief Administrative Officer
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Presentation
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Unidentified Participant [1]
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Well, look, welcome everybody to our session with Royal Bank of Canada this morning. Maybe I will just open by asking you, Janice, I know you reported earnings last week; it seemed to be well received, although I think there are a couple of emerging themes around the Canadian banks and investors' thoughts. But can you maybe just share with us your perspective on the results and the investor response?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [2]
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I think we had a pretty strong quarter. We reported record earnings of CAD2.5 billion, which were up 14% over the prior year. On an adjusted basis -- we had a one-time FX gain -- that would be 9% up. And it's really on the strength of our continued strength of our Canadian banking platform; very respectable strong results.
Capital Markets platform performed very strongly, and our Investor & Treasury Services also had record results. We finished the quarter with very stable credit ratios, so pretty benign credit environment, and finished off with a very strong capital position with our common equity Tier 1 at 10%.
Maybe what I can do is go through a little bit more detail on the various platforms. Our Canadian banking platform is about 50% of our earnings base and revenue, and it performed well this quarter. Very solid earnings of 7% earnings growth, which is right along our medium-term objective of 7%-plus.
They had -- their volumes are starting to grow at a lower rate of growth than I would say a couple of years ago. So we had pretty solid volume growth of about 5%; more -- 6% on the deposits and investment side. There's a mix shift. And then about 4% on the mortgages.
So with the strong cost control and efficiency management that drove our 7% earnings growth and on the back of an operating leverage of 2.4%. 2.4% is a little bit high, because we had unusually high marketing expenses last year. But we are targeting for 1% to so, in the face of declining growth rates and volumes, keeping our eye on the ball on the cost side to make sure we can still drive stable earnings growth.
Our Capital Markets platform earned CAD625 million, which was 23% above last year and about 5% on a trailing-quarter basis. So pretty strong results given their shift in business focus to more corporate investment banking earnings, less on the trading side -- although the trading markets were also performing very well. We're pretty happy with that result.
And then as I said before, our Investor & Treasury Services was strong through a stable earnings stream on the Investor Services side, plus some pretty good earnings on the Treasury Services side from FX volumes and securities lending. So of a lot more on the support side for the asset managers.
Our Wealth platform is performing strongly on a core basis. We had some unusual items in the expense side on their reconfiguration of our international Wealth business and some unusual PCL on an individual account.
So I think all in all we're pretty happy with our diversified earnings model, because it really allows us to perform with less earnings volatility through the cycle because of the mix of earnings and platforms.
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Unidentified Participant [3]
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And just maybe you could comment briefly on the rest of the year and the outlook for the rest of 2015. More of the same? Or do you expect any shifts at all in growth and outlook?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [4]
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Right. I think that while the economy and the economic environment is uncertain, the GDP growth in Canada is lower than we would have first forecasted at the beginning of the year. It's tracking at about 2%.
We know that with the sharp drop in the price of oil we are monitoring our portfolios and our clients and looking also at all of the press around the consumer environment. We're looking at all of the macro trends.
We don't have -- we haven't seen any signs of any negatives. In fact if you look at things like the housing market, we think that the housing market is supported by still strong fundamentals. The unemployment rates are still fairly low in Canada; they are tracking at 6.8%.
There seems to be a balance in the supply and demand side. A lot of the new origination has to do with the population growth in Canada; and 50% of our growth is through net immigration, so it's in some of the urban centers like Toronto.
There are regional disparities of course across -- with the cities that are in the oil patch having less or even no price increases, and in fact a little bit of instability in that market. But if you look at the net consumers of gasoline and stuff like that, you see it in the Toronto region and in the BC region, in Vancouver area. You see still signs of growth in the market, new home construction, and pretty much a balance.
So while we are always looking at the uncertain economic environment, we think that for outlook we can't see any reason not to continue in our solid performance.
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Unidentified Participant [5]
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It's interesting, because if you read a lot of the commentary around the Canadian banks clearly there's been a number of years of terrific growth that you've all enjoyed, and Royal Bank in particular on the back of the diversified business model. But it does seem that people are concerned about the underlying economy and particularly what oil might do to the market going forward.
But as you say, when you look at the oil and gas exposures, can you talk a little bit more about how you -- obviously you're doing pretty thorough portfolio reviews etc. at the moment and really diving into that. But the oil prices really haven't come through and given you any concern at this point?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [6]
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About 1.5% of our portfolio is in oil and gas exposure to producing companies. About half of that is in the US and about half of that in Canada.
The US exposure, a portion of it or a larger portion of it is investment grade. And of course the US producers have been hedged through at least the first year, and you see more on the M&A side to manage cash flows in that.
We have just finished for our portfolio and on the Canadian side our borrowing base reviews, which -- where you look at the price of oil, and look at the cash flows of the individual company, and look at the stress testing of those. And the reviews have been pretty much what we expected.
We have had situations where we look at the cash flow profile and what options are available to some of the companies in terms of doing CapEx, or also looking at selling certain pieces of rights or things like that that could generate cash flow. We haven't had -- and we've had some restructuring; but I would say the restructuring is pretty nominal.
We haven't had any nonpayment of interest. No covenant defaults. So we're in a pretty good position.
What we have done of course is put a lot of the companies on what we call it internally a watchlist, so that we actually continue to monitor the watchlist extensively and ensure that we're on top of anything that could possibly happen before it happens with our borrowers. That's why, when we look at the fundamentals, we think that the industry is fairly solid for the next period.
I think that it also depends on what happens over the next year in terms of where the price of oil is. We have also stress tested our portfolio at $45, and we know that from that perspective the provision may increase a bit, but not significantly.
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Unidentified Participant [7]
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Maybe shifting gears a little bit and talking a bit about the United States for a minute then, and I think -- firstly I think we should congratulate you on the City National acquisition, which I think had been a bank that a lot of other people had long coveted. So it was a terrific acquisition from our perspective.
Can you just talk a little bit about the strategic decision-making that was behind your decision to acquire City National and how you see the US retail strategy relative to your broader strategic vision?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [8]
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That's a great question, because City National is a company that we've looked at for close to three years. When you look at our overall strategy as a bank, we have -- first of all we target an earnings mix of 75% retail and 25% capital markets. So the acquisition of City National is great in terms of keeping that composition diversified so that we can achieve the earnings diversification that we think is necessary through the cycle.
We also feel that the US is our second home market. If we look at what we have in the US, we have an expanding Capital Markets platform, where now over 50% of the revenue and close to 60% of the earnings are coming out of our US platform, so it's a fairly robust platform.
When we look at what we have in terms of our broker-dealer, we have a top 10 IA network in the US, but we don't have any banking capability. So our financial consultants are selling bank accounts of other banks offering private banking.
We have sweep. We sweep deposits, which we really can't use here in the US, so they go to other banks. So the acquisition of City National was about finding a quality bank in the private banking space that was very similar to us in terms of risk appetite, culture, and very long in expertise.
I think that when you -- some of you may remember that we also owned a retail bank in the Southeast, and I think that what we realized from that acquisition is that we should never be in a position of buying something and thinking we're going to fix it up and add to it. Because if you don't have any other retail presence to really test (multiple speakers) thing to do, whereas if you buy something that is really a quality asset that fits with your strategy -- as City National does -- and fits with our culture, it is way easier to build from a position of strength and focus on where you can get synergies with your existing client base and network. So I think that that is the major difference between the two.
Of course we recognize that it was a little expensive, but usually premiere platforms are. And that's why we spent so long looking at it.
Our CEO Dave McKay started to look at City National when he was head of retail banking, so he got to know the principals of City National. And we've had some really positive feedback in the market about the acquisition and about the possibility of actually growing the revenue base.
So it fits with our view that the US is our second home market, and as our retail banking platform -- the rates of growth in Canada are slowing. They are still growing but slowing. We need to invest in earnings growth capability.
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Unidentified Participant [9]
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Maybe a two-pronged question, follow-up to that. As you think about future growth of the City National platform, is it going to -- would you -- could you see yourselves doing more acquisitions in the United States to add to that? Is it going to be more trying to grow organically using that as a Wealth platform? How do you think about that?
And I guess a related question to that a little bit is some of your other peers obviously have very big presences here in the United States. Sometimes it does cause some issues around balance between Canada and North America and how they're perceived locally. That's obviously something that you're quite mindful of as you think about your US expansion, presumably.
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [10]
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I think when we look at City National, given our track record -- and so I always stress that, because I think that we really want to make this work -- we will be focused on leveraging City National in the Wealth space to have a more integrated offering and more organic growth there.
Looking at our client base in our financial consultant network we have about 450,000 clients. City National has about 90,000. So we have to be extremely selective in product offerings, markets, and expanding where we are in City National.
I think that what is critical for us is to making this acquisition work. So we don't really like to talk about what we'll be doing way down the road in terms of leveraging a platform, because we really need to make this one work.
So as far as we're concerned it is about organic growth in the next few years and making sure that the acquisition works. I think that's pretty consistent with the other areas of growth that we have in terms of the other platforms.
In Capital Markets all of our growth is organic. We may on the Wealth side, asset management side, look at some capabilities there in terms of equity capability. But for now with respect to the Wealth Management banking, we think that it is getting this right and pursuing organic growth.
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Unidentified Participant [11]
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Okay. One of the questions that some people have raised is as a result of making this investment in the United States, you along with one or two of your other peer banks in Canada may attract the attention of the regulators and end up being designated as a G-SIFI. Clearly that's something that played into your analysis and thinking about the acquisition.
Do you think that's a probability? And to the extent it does come to pass, how will that impact Royal Bank?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [12]
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I think it is a concern or a thought that we have had, because we know that -- well, we know what the metrics are for us standalone. Because we're a Canadian bank we have our 2014 balance sheet already out. I think the issue with respect to where we end up tiering has to be the strength or relative lack of strength of the euro vis-a-vis the Canadian dollar.
So when you look at our discussions with respect to City National, I would say that that wouldn't be a turning point for us because we're talking about CAD30 billion in assets, 5% of our market cap. It's more fundamentally around the composition of our bank and the size.
When you look at what are regulatory capital constraints in Canada, we already have a D-SIFI -- so a domestic SIFI -- buffer over the 7% of 1%. And we run a prudential buffer of about 1.5% over that, so we're at 9.5% plus a buffer for balance sheet exchange rate fluctuations, mostly for us. So when you look at the construct of any or one of the Canadian banks becoming a G-SIFI, our regulators have talked about the weighing off of the making one bank noncompetitive and looking at the international community and what has to take place there.
But if you start from scratch we have a pretty large buffer. So we are talking to our regulators, because we know that the time frame may be imminent, and trying to judge where we think our capital should be.
So let me talk a little bit about our capital management. We finished our first quarter with common equity Tier 1 at 10%. And we had -- in our second quarter -- in the first quarter we had some CET1 fluctuation because of the sharp decline in the value of the Canadian dollar, but we have actually fully hedged our ratio now. And we think that when you look at the buffer we have on 7% and where we end, for the near future we will be building capital to fund the City National acquisition.
We think it's going to close hopefully by the end of the calendar year. 50% of the purchase price is funded with share issuance; the other half, so about 70 basis points, is through capital accretion. So we will be building our capital to just over 10%; and we will at that point in time probably drop down to about the 9.5%, 9.6% level and then continue to build capital.
So for us, we think that building at the 10% level seems to be a reasonable buffer for any activity that could happen. And we should be in the -- we should be able to resume more active capital management after we close the City National deal.
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Unidentified Participant [13]
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You mentioned your Capital Markets business a couple of times. We obviously see them increasingly as a very strong competitor here in the United States. Can you talk a little bit more about the strategy around the growth of your Capital Markets business, both here in the United States?
And any thoughts you have around Europe and just more broadly on your international strategy away from the United States? You did mention you've scaled back a little bit or restructured the Wealth business in some parts of the world. But as you think about expansion away from Canada and the United States and the North American footprint, what are the areas of focus?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [14]
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I think when you look at our Capital Markets platform, we have reconfigured that business over the last five years to be over 50% corporate investment banking. So really traditional corporate investment banking activity, leading with loan exposure and then hoping to achieve for every dollar of spread that we earn CAD2 of fee income.
So a very traditional model. Our trading platforms are more now configured to supporting clients in terms of new debt and equity issuance and helping people in balancing portfolios and those sorts of activities.
We look at the UK and Europe as our third home market because we've been there for a long time. We have three platforms operating there: our Capital Markets platform, our Investor & Treasury Services platform, and our Wealth Management platform, including our asset manager out of the UK, BlueBay Asset Management.
When you look at Europe and the UK they are a little bit challenging in terms of the economic environment, so we have spent some time rightsizing our infrastructure in Europe while still being able to continue to attract teams on the corporate investment banking side. Because we really want to be positioned there for the financial uptick and have people on the ground that are ready to do business, similar to our US expansion over the last 10 years and having people ready to be there when the economies turn. Because we think that that will happen, and we want to have the capability there and not be in a position of trying to build it once that happens.
So we're very committed to those markets too, and that's why we're focused on efficiencies and keeping our infrastructure pretty tight so that we don't make any knee-jerk decisions about having to adjust that. We can proceed on.
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Unidentified Participant [15]
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Okay. I might call for a question or two from the floor in a minute, but before I do maybe, just coming back to Canada, I mean clearly you have a leading market position in most businesses in which you operate in Canada. As you think about the slowing Canadian economy, is there still an opportunity for you to take share in Canada? And can you outpace system growth over the next several years, do you think?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [16]
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Well, I think that there is a view that the Canadian economy is slower growth, and I think it will grow probably at a lower pace than the US economy. When we look at our scale and scope of our operations and production, we absolutely believe that we can continue to take a disproportionate share of the market in any of the products and the services that we offer, because we have the ability by looking at our scale to apply resources to different regions of Canada.
You know how Canada has at least four different economies. So when it's more robust in certain areas, we can shift our production to that area. We have a pretty stable client base and really good client penetration.
So absolutely our strategy is to continue to grow, continue to grow volumes and revenue, while making sure that we keep a keen eye on efficiency and cost management. One of the things that we've done over the last five years is continue to invest in our technology and development to drive both projects that could add to revenue accretion as well as efficiency. I would say from our perspective today we have more of the efficiency projects on the front-end, things like digitization, streamlining process -- all of what you need to do.
We think that we still have opportunities there to continue, but it means a pretty steady investment stream. So we are committed to getting there and ensuring that we can use our efficiency management expertise to actually manage any bumps and still generate pretty solid earnings growth.
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Unidentified Participant [17]
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Okay. I'll just see if there's any questions from the floor from anybody. Maybe we can just continue on that theme of digitization.
As we were talking about earlier we have [CFL-Square] here this afternoon to talk about the impact of digitization on some of the traditional banking businesses. Is it something that keeps you up at night, worrying about disruptive technologies? Or do you feel like the bank is making the right investments to deal with the obvious changes that are coming in terms of how people interact with banks and conduct their financial services activities?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [18]
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I think definitely digitization, mobility, it's on the top of our agenda because of the demographics of the Millennials and how Millennials are transacting, and because of the fact that we are really in a defensive position. We don't want to let anyone get in between a payment or the activity and our clients, because that's how you become disintermediated.
I think Square is a good example: excellent payments capability and definitely one of the new contenders to be positioning like that. We do a lot of work around looking at companies like Square, exploring potential partnerships with companies like Google.
I think today we just announced a mobile banking capability on the Android device. I think we announced it earlier this week at the Google conference.
So trying to continue to make investments to be relevant to our clients, and it's something that we have -- we started that I would say about seven or eight years ago, and we are ramping up the activity. We are also on the backend looking more at our agility and our ability to get to market fast and really protect what we have today and continue to be relevant to our clients.
So it is something, yes, that we lose sleep over. But we don't just lose sleep over it; we have to do something about it. Yes.
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Unidentified Participant [19]
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Yes. We're almost out of time, but I guess it's hard to have one of these conversations and not talk about regulation and the cost of regulation and the impact on your business. Clearly we've all been experiencing various waves of that over the last several years here, and there still obviously some more waves to come.
Is it -- again in terms of issues that keep you up at night, do you feel like you are now on top of the various regulatory matters that you need to do? And particularly with your expansion into the United States, is it something you feel you have a good handle on?
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [20]
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I think that definitely the cost of regulation is increasing. I think I feel a little more comfortable about where we sit, because we have an extremely strong capital base.
We're currently in the process of building out our foreign banking organization and getting ready for our CCAR testing. We are already a CCAR bank, and City National just is additive to that. It doesn't cause us to go over the edge.
So we've been working on this for the past two years, and we have had really good relationship with the regulators here. But it is a lot of activity that we're doing.
I think that what's critical for us is also that the regulation has to be embraced by everyone. So the issues around conduct are becoming pretty important in financial services.
So it's taking every opportunity to reinforce the culture and the reputational aspects of that and also focusing on dealing with our clients and growing the business. So it's a juggling act.
But we feel that there are probably -- and I should touch wood when I say that -- less unknowns than knowns that we have to work towards. So I think that hopefully the industry is feeling that way, but it is a lot of heavy lifting.
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Unidentified Participant [21]
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Yes. Well, look, I think we're pretty much out of time. But Janice, thank you very much for being here today, and appreciate your time.
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [22]
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Great, thank you, Richard.
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Unidentified Participant [23]
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Thank you.
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Janice Fukakusa, Royal Bank of Canada - CFO, Chief Administrative Officer [24]
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Thank you very much.
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