Royal Bank of Canada at CIBC Eastern Institutional Investor Conference
Sep 16, 2015 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at CIBC Eastern Institutional Investor Conference
Sep 16, 2015 / 01:10PM 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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Conference Call Participants
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* Robert Sedran
CIBC - Analyst
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Presentation
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Robert Sedran, CIBC - Analyst [1]
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So, our next guest is Janice Fukakusa. She is the CFO and Chief Administrative Officer of RBC Financial Group, what we used to call Royal Bank of Canada. Since joining RBC in 1985, she has held various positions across several businesses. She is the prior winner of the CFO of the Year Award and is the longest-serving CFO in Canadian banking today. So, that's all good stuff. That's all good stuff.
So I tried to think of someone who'd be longer and it has to be.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [2]
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(inaudible)
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Robert Sedran, CIBC - Analyst [3]
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Close.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [4]
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(inaudible)
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Robert Sedran, CIBC - Analyst [5]
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So, welcome.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [6]
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Thank you.
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Robert Sedran, CIBC - Analyst [7]
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I thought we'd start sort of a bit of a general question. Just it's a bit of an uneven operating environment these days. I know you are going through the planning for upcoming years and all. What is the planning scenario when you think about the business in terms of are we charging forward to get growth, are we being careful because of the environment we're in, how does the Bank positioning itself for where we sit today?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [8]
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That's a really good question because you're right, Rob. We're -- all of the banks are in the process of going through our annual operating plans that we're taking to the Board in October. So I would say this -- about the environment versus what's happening in reality with results. As you saw in the third quarter, again we had -- we reported a solid quarter. Despite the fact that we're looking at a lot of negative overhang risks, I think that our businesses did an excellent job at getting through that all and continuing to drive earnings growth across the board in our businesses.
And when you look at our diversified earnings mix, you see the strength that some businesses aren't tracking as much as others but we deliver a good core result for the shareholder. So I would say that going into the planning season there are a few things.
First of all, there is a little bit of an unstable economic backdrop in Canada. So it's everything around specific events like the price of oil and how long that's going to last and had we stress tested it, what are the first, second order impacts and how will that affect general growth.
So if you're looking at our retail platforms, we need to have a good line of sight on things like where we think GDP growth is going to be, which areas across Canada and as you know, we have pretty even distribution across Canada, but each of the areas operates differently.
So from our perspective, let's take oil and gas. So, what do we do about productivity, production, what are we launching in Alberta, how are we going to ramp up for the growth that we're seeing in Ontario, because we're seeing pretty good business volumes and business growth on -- and we're seeing more confidence in the economy in Ontario. And I think that some of the numbers you're seeing about exports in that we're just getting to see the impact of the low Canadian dollar, so how do we retool a lot of our productivity to take advantage of where we think there will be growth so that we continue to -- we can continue to drive earnings.
And then -- so you have the backdrop, but how are we going to continue to take a disproportionate share of the market, what are the general economic conditions and what will that do for our forecast of earnings growth? Then you look at the flip side about our expenses. So what's happening with our trajectory of investments, are we still going to maintain a pretty cautious overtone in terms of looking at maintaining our expense growth at a lower rate than revenue growth so that we can actually continue to drive earnings growth and we can have some give in in terms of looking at forecast of revenue trajectory.
So, I would say that that's what's happening in the various platforms and then of course, you always have human nature that you always want to promise low and deliver high. So it's about that, about looking at a risk weighting that's more 50-50 about outcomes and being able to put a stretch in the targets for various things happening or not happening.
So stretch so that we have to continue to ensure that every business is driving earnings growth, but then thinking what is our fallback position in terms of looking at project and spend in NIE and trajectories in terms of what we do there. I think one of the hardest things to predict as you know is our provisions for credit losses, because we are in a pretty benign credit environment.
We think that when you look at things happening like oil and gas that if there is sustained oil price -- low oil prices, of course the longer it is the more companies become under stress. And we think that with our PCL in the 23 basis points, 24 basis points probably a reasonable level could be 30 basis points. We know that through the cycle. We're still saying 35 basis points to 45 basis points may be where it should be, but that's based on the past.
So it's a tough one, but I think that from our perspective when we go through our planning, we plan for a full load of PCL. So an economic loss sort of a forecast in there and so we have enough that goes in the plan so that we have enough of a realistic scenario in case something does happen and we can tweak as we go through the year. So I'd say that's how we are looking at them.
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Robert Sedran, CIBC - Analyst [9]
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The oil impacts some of that. The loan loss issue is an interesting one because everyone is talking about how unsustainably low we are and comparing it to history. Should loan loss ratios be grinding lower over time just based on the evolution of the loan book, but also we should be getting better at risk management too, right?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [10]
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Right.
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Robert Sedran, CIBC - Analyst [11]
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So is history really the right guide for where the mid cycle ratio would be?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [12]
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Well, that's the big debate because I think that we look at history and portfolios and if you look at, for example, I was looking at this over the last 40 years to see the data, figure out, if you look at where we peaked, the last time we peaked, we had pretty high loan losses out of our US regional bank and we knew that because they were real estate led and so we had a ratio I think in the high double digits.
But if you look at the degree and difference in credit concentrations, exposures and single name exposures and the number of techniques we have at our disposal today versus even 10 years ago, for example, if we under rate a large credit on the corporate side, that's outside of our limits we actually hedge some of that credit exposures so that it's within the limits. We monitor a lot more [the] pipelines of loan exposures, pipelines of underwritings, all the things that could be chunky in nature and create losses. And we are way more vigilant because we're in a benign credit environment in doing more detailed checking and we have more analytics.
We have -- on the retail side we use a lot of analytics around current accounts and that to drill down into postal codes. So you have that versus the trauma of unexpected versus expected losses. So you can actually, based on history, build in an expected loss profiles. But I think the trauma of PCL has to do with episodically having two or three events happen at the same time and it ratchets up from that perspective. So it could be a one-quarter or a two-quarter event and then come off. But I think we are looking and we used to say 40 basis points to 50 basis points, we're saying now 35 basis points to 45 basis points, but there is definitely the feeling that some of the benign credit environment has to do more about better and more effective credit risk management.
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Robert Sedran, CIBC - Analyst [13]
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Okay. And one of the things that I've been thinking about and assuming, I guess, as we work through some of these challenges is that if there is something to be concerned about, it's a bit of a regional issue and that sounds like in the commentary that there are other parts of Canada that are starting to have a better outlook with the currency where it is and the US doing okay. And so, is it feeling like a regional issue or is there a reason to have a pan Canadian concern about the Canadian market?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [14]
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I think that it is a bit of a regional issue in, for example, retail portfolios, because a lot of it -- a lot of, for example in the oil and gas issue, the second orders, companies laying off people, people moving that sort of thing. And similarly, if you look at what's happening with house prices across Canada, it's different across Canada. So you have still a little more robust market in the Ontario region.
Even in Vancouver and Lower Mainland, it's fairly robust versus what's happening in the western provinces. It's similarly pretty muted in the eastern provinces. So, I think it is about a regional view, but for us we do more than the sort of geographic regional overlay when we're looking at our credit portfolios and in particular on the retail side because we have large numbers because our market shares are pretty high in all the products.
We actually drill them to the postal code level and try to get more granularity about what could happen because I think the critical thing is to get ahead of any of that activity before it becomes debilitating.
So for example, you see you have a client that has missed a credit card payment and they have some room on their mortgage or home equity line of credit that is first mortgage to lower their payments and then be able to service the debt. It's about identifying that and getting ahead of it and having the conversation with the client about restructuring and that sort of thing. So you see a lot more of that activity happening just because that the -- it becomes in your DNA as you work through and become more granular because it's a benign credit environment and you're always looking for what could possibly be there that you didn't look at.
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Robert Sedran, CIBC - Analyst [15]
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Okay. I'd like to switch gears a little bit and talk about capital. You may have already heard on the systemically important stuff. I find this bit of a pointless discussion because if you're not this year you will be next year or you will be the year after that. You're close enough that at some point you're going to cross over that. How does the Bank think about this? I mean, for starters, it sounds like in commentary on conference calls you're not prepared to take any evasive maneuvers here to try to avoid it, like you're going to continue to grow and you like the suite of products and businesses that you have. Is that a fair comment like this is just going to happen or it's not going to happen?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [16]
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Yes, I think basically it is what it is and of course we've been monitoring this and looking at our capital position for the last two to three years as we were building capital. So as far as the metrics go there what they are, you have no control over the euro which is the biggest driver now in sort of the translation of the balance sheets and the comparison.
So, of course we know that when you look at the metric we're pretty close. We know what our October 31, 2014 balance sheet is. But let me just take a step back and tell you about our capital position. We think that we're in a pretty solid capital position. We ended the quarter at 10.1% common equity Tier 1 ratio. And when we look at our capital, we started about two to three years ago optimizing for capital usage because one of the critical things about capital positions are that you have to plan into them, you've know what activity the business platforms are planning and what is supporting the earnings growth and then make sure that you're making the right choices on deployment.
And what I mean by that is that we look currently at a five-factor optimization. So we optimize for use of common equity Tier 1, impact on leverage, liquidity impact and then does this grow earnings and what's the impact on return on equity. So when you look at that, that's the lens we look at proposals.
So if someone wants to do a portfolio of some sort of business even in our retail platform before going after a different segment of that, looking at all of these metrics to make sure that at the margin as we deploy our capital we're actually looking at the trade-offs we're making in any of those categories. So if you look at, for example, the acquisition of City National, we have financed 50% of that through share issuance.
We carefully looked at where we thought our capital forecasting would be and where we would have to build capital to accommodate the 50%, that's the cash portion of the purchase, so when we look at our capital position, we know that we're running our ratios at, say -- I would say roughly 9.5% plus, a one-way buffer so we're at 10.1%.
We look at the dilution of -- or funding the balance sheet of City National 70 basis points. We think that if we can close at the beginning of November which is where we're targeting, we would have a 70 basis point drop and we will be around 9.5% and accrue back to the high 9%s. So we think that that's a pretty solid capital position to be in.
When you look at running the 9.5% plus about a 50 basis point buffer, we think that's pretty solid from even looking at constructs like potential buffer or a potential add-on and that sort of things. So that's how we look at measured capital. So, of course our regulator has something to say about capital, and I would say that you've seen our regulator being very extremely thoughtful and measured about when they put on quotes prudential limits and you see that they monitor our capital position. For example I sit down with them quarterly to go through our five-year capital forecast and where we think we'll be. And where you see them suggesting sort of prudential limits it's generally where everyone sees them approachable in their capital forecasting. So you don't have, what I would call, more draconian actions of saying if you need to be here, you're here, figure it out, it's more about we're working with you.
So I think that from our perspective it's a thoughtful use of capital. We definitely have a focus on both return on equity and earnings growth knowing that sometimes earnings growth like in City National is somewhat dilutive to return on equity, but making sure that we know what a path back is because we think that in order to deploy the capital, we have to maintain a fairly solid return on equity in addition to earnings growth.
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Robert Sedran, CIBC - Analyst [17]
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The Bank often sort of behaves like a big brother or a big sister in the Canadian marketplace, kind of doing what's right and leading by example oftentimes. You're the first bank to raise equity during the downturn and that kind of stuff. Do you think about your relative positioning on a capital basis in the Canadian marketplace or are you comfortable 9.5% plus a buffer, (inaudible) happy, we're happy, shareholders are happy, I don't care if somebody wants to run at 11%, we don't need to?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [18]
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Yes, we recognize relative capital position, we also recognize that all of our competitors have totally different strategies on deploying of capital and business mix. And so we look at it more in absolute terms that we think given our portfolio and where we sit on buffers, we're comfortable. Of course, we know we can't be a massive outlier in the context of our peer group, but it's being -- positioning anywhere in the peer group is not a driver for us. It's more about our comfort level and being somewhat there in the region.
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Robert Sedran, CIBC - Analyst [19]
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The investor and treasury services business is often, like the old Dexia, is often one of those that's poked out as a, well, if you got rid of that you wouldn't have the (inaudible) problem so quickly or that kind of thing. Can you talk about -- you talked about the sort of optimizing capital and how you look at various businesses? How does that business fit in to the overall because it sounds like you're committed to that business? So it must be -- it must show well on those four characteristics you are talking about.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [20]
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If you look at the progress we've had on performance, I think that since we acquired a 100%, it is all about improving the operating performance. So it was about rightsizing the whole cost infrastructures and it's really important in a business like that because it's pretty much of a commodity-based offering, so improving that and maintaining revenue trajectory. So we think we had excellent performance from our investor and treasury services platform.
We moved our treasury services unit in there so that we could leverage on an institutional basis everything from FX flows that come out of some of the asset managers and some of the assets we're custodying, securities for lending and the suite of treasury products that we thought we could leverage and of course we use them also to manage our own balance sheet and that's what treasury services does. It manages our balance sheet plus is able to access institutional markets.
As long as the business continues to grow, has solid returns and we can see that we're serving our clients well, it's a good core business for us. So that's the way we look at it is is to make sure that the same filters we've across the board are applied and of course every business is different, every business has different horizons as to when they're going to get to some of our enterprise goal levels, but I think that as long as they're contributing we think that they tier well up there in terms of the choices we're making on capital.
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Robert Sedran, CIBC - Analyst [21]
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And is this a case of at some point, I'm not going to guess what a normalized interest rate environment is any more, but the Fed may be up and moving tomorrow, is this a case of once interest rates begin to rise some serious earnings power will get unlocked and we're not -- even if we were thinking that it might not be the business we want at the long term now wouldn't be the time to sell it or is this just the business for the long term?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [22]
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Well, we think that definitely it's one of the businesses that will benefit from interest rates rising. We look at some of the core capability that it has for the enterprise like the deposit capability that it has and we're looking, for example in Europe, optimizing some of our funding structures to ensure that we're effectively deploying that deposit base taking some of our asset generation businesses. So I think it fits well into our diversified business mix.
So for us it's a business that's still growing. You can't never say definitively about businesses because circumstances change. But definitely, for that business, for our wealth business, for our banking platforms, yes, we would like interest rates to rise, definitely.
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Robert Sedran, CIBC - Analyst [23]
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I'd like to come back to the oil and gas issue in the United States in particular and some of the disclosure around the quarter showed a percentage of investment grade and non-investment grade that got people talking for sure about some of the qualities of that portfolio. I guess, investment grade borrowers don't tend to borrow as much, I guess, is part of the answer, but can you kind of give us a sense of -- because the flip side of the concern is that Royal Bank has been growing its loan book rapidly in the United States. Maybe they've been doing it in areas we don't want them to do it in. So can you talk a little bit about the credit quality or at least the quality of the portfolio in the US?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [24]
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The oil and gas portfolio, right?
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Robert Sedran, CIBC - Analyst [25]
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Well, and even more broadly, you can answer more broadly.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [26]
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Okay. So if we look at the -- I'll just address the oil and gas portfolio. So if you look at the splits between investment grade and non-investment grade, first of all we use different credit grading. Everyone has a bespoke credit rating system. So you can't really do an identical mapping. But when you look at the drawn exposures on the E&P side that we have, those drawn exposures are probably split equally between Canada and the US.
So drawn exposures do not necessarily lead to credit losses. So you have to remember that these exposures are fully secured. When you look at, say, 50% of the exposures that are in the US basically as we've said before, there's more hedging happening in the US. We are at the top of the stack in terms of the layers of debt underneath us. So we're at the senior secured level. There are other levels of mezzanine, sub debt, all underneath us in equity that would have to go down before the senior debt goes in and it is secured.
And then if you look at Canada, there's not as much hedging activity but we were to be very similar in exposure to a lot of our competitors because a lot of us are in the same loans and from that perspective there is a lot more activity in working with the companies as we go through and we're going through the next borrowing base reset in the next couple of months working through what is possible in terms of CapEx, asset sales that sort of thing.
So I would say that we are fairly comfortable with our exposure and the fact that we are collateralized where we are and we know from our portfolio what those stats are. It's really hard because we don't know what the other banks are doing where they sit on that, but we do know our exposures are all secured.
If you look at what's happening with the growth on the US side, in terms of authorized credit there is still the mix of about 70-30 investment grade (inaudible). When you look at some of the -- you see in the market, some of the deals we are in, they're all -- if you look at the leverage lending, for example, all in accordance with the OCC guideline. So they are not extreme. And the OCC guidelines have moved around a bit, but they are well within the construct of what is leveraged lending, but not huge leveraged lending.
And if you look at what's happening with respect to the underwritings versus [behold] that's where I talked about the whole pipeline management issue and making sure we know what the valuation is and making sure that we know what the valuation is and making sure that when we go into these underwritings we have a good path and line of sight to what the take down is. And the [hold] positions are relatively small vis-a-vis the actual underwritings and that sort of thing. And so, we had pretty good experience in making sure that we clear out the pipelines and that we get to where we want to be in our overall credit exposure and it's consistent with our risk appetite.
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Robert Sedran, CIBC - Analyst [27]
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Okay. Sure. Can I just bring it out so that we can kind of play a little [Donahue] here.
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Questions and Answers
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Unidentified Audience Member [1]
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Thank you. Just going back to the security services (inaudible) business, you mentioned it's a commodity business. So at the end of the day, it's really a matter of execution. Do you think the right sizing is really the only thing you have to do in order to maintain profitability in that business or what's going to be the next step in order to stay competitive versus some of the pure play companies that are really investing heavily in technology?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [2]
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That's a really good question and it does involve our next strategy. So when you look at it, the type of custody that we do through our investor services platform is more a bespoke custody which is tailored towards what the asset managers want. So we're in the process and it requires a very large technology investment.
So in order to speed up that investment so that we do stay competitive, we are in the process now in that platform of what we call digitizations for instance and actually we're doing this across more than investor services. But it's one of the businesses where we're -- this is just an example of what they're doing. So it's about providing our asset managers with a lot of the constructs they need on the portfolios, the ability to look at the information, cut it different ways.
And the way they're doing that is through an agile program where we have the asset manager, our client there with the development team and with the people in operations and so you get interactive back and forth. So if something is developed over night they look at it and say, this is good, not good.
So this is early stages for investor services, it's a digitization program that we started about a year and half ago. We started in our wealth management business set with a front-end system. So what it involves is with anything that requires a large technology spend looking at a shorter time frame, more agility, minimum viable product to get to some target and then developing it further so it gets us faster to market and gets us more into developing something that the client wants. So, you're absolutely right. The second stage after efficiency for us is to continue to pursue the technology investment and so we're trying that. So we've started with our asset management clients in Europe first and I think I haven't seen -- I was just talking to our Head of Investor Services yesterday, but I haven't seen the full program, but that's one of the areas that we are focused on on improving the technology. So it's more about what our clients want to do.
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Unidentified Audience Member [3]
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Maybe to continue in the same vein, in terms of technology in this Dexia business, we hear a lot about the blockchain technology as maybe being something that's kind of -- that might be pervasive eventually. It feels to me that, and it's from a high-level understanding admittedly, that this is what kind of business where there could be some major changes due to that specific blockchain technology. So could there be some sort of disruption along the way in terms of what's -- out of them the business is operated?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [4]
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I think -- so we are looking at blockchain and it's on the payment side. And the reason we're looking at blockchain on the payment side is because of that to make sure that we know the potential for disruption and how we can look at blockchain in terms of what we do and whether there is some similarity or whether we should be actually looking at it in one of our labs and thinking how can we replicate it. But that -- I've actually never thought about it in the context of investor services, but that is something -- yes, that I'll ask about too. But I know for blockchain the work we've been doing over the last year is about the payment process and mostly the retail prepayments process.
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Robert Sedran, CIBC - Analyst [5]
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We have got about a minute left. I want to ask about City National and since you haven't closed it so as much you can say, so a minute is about right. How does this --
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [6]
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We have more than a minute to say.
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Robert Sedran, CIBC - Analyst [7]
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How does this fit to RBC in the US? It seems like the management is quite excited about this one?
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [8]
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So when you look at City National, it's an acquisition of a private commercial bank. So there are four verticals that we see have terrific synergy with other capability we have, so the entertainment verticals. And by a vertical I mean doing everything from banking, the person -- personally so credit lines, deposits, also cash management, operating services for their companies right up to film production, right up to film financing that we do in our capital markets platforms. So it's that vertical. Technology, very similar, very good synergies with the US.
We also have healthcare as another stack. And energy I think is another stack that we're looking at creating very good synergies. The other thing to keep in mind is that we think that City National being a fairly conservatively managed business has been a little bit capital constrained. And so we think that we can actually grow the asset side of the balance sheet. You know they are a deposit-centric business and we can grow the asset side in product capability like jumbo mortgages and the loss experience on jumbos is very similar to Canadian mortgages, 1 basis points to 3 basis points but they haven't been in that product category.
And then I think the third area has to do with leveraging our US Wealth Management broker network. So it's not about having themselves City National like our 2,000 [IAs] and our 450,000 clients having City National accounts. It's about for selected areas where they are contiguous, where it fits to actually provide that broader wealth management offering. It also gives us a bank to aggregate deposits in that we've been accumulating in the wealth network. So I would say in a nutshell, we look at City National as a revenue synergy play.
Of course, there's going to be cost synergies along the way, but it's more about how do we leverage that core capability they have and put it with some of the capability we have in our capital markets and wealth platform to get more of a full service for the clients that we have.
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Robert Sedran, CIBC - Analyst [9]
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Okay. We're out of time. Thanks for this, Janice. Much appreciated.
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Janice Fukakusa, Royal Bank of Canada - CFO & Chief Administrative Officer [10]
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Okay. Great. Okay. Thanks, Rob.
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