Royal Bank of Canada at Barclays Global Financial Services Conference
Sep 17, 2015 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at Barclays Global Financial Services Conference
Sep 17, 2015 / 02:30PM GMT
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Corporate Participants
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* Janice Fukakusa
Royal Bank of Canada - Chief Administrative Officer and CFO
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Presentation
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Unidentified Participant [1]
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Good morning. We're carrying on today with Royal Bank, Janice, who is the Chief Financial Officer and a whole litany of other titles on Royal. Janice, thank you very much. You're actually a veteran at this conference these days, and we appreciate your participation. Just wanted to open with Royal along with the other banks just reported third quarter, what's your perspective on results that you guys pointed out in terms of where you had strengthened and where the opportunities where you may be able to improve performance over the coming quarters?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [2]
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I think that's a great way to start-off our talk today, John. I think that when you see our quarter, we think we had pretty solid results across the board in all of our platforms. And it's the type of quarter that we have continued to have in the face of all the economic uncertainties, so what we always say is, we congratulate each other on a great job done, and then we think about how does it look going into the future.
So why don't I just talk a little bit about where we see, maybe, some of the different businesses being and some of the macro risks. So when you look at our retail platform, we had another record quarter in retail. And I think that what you saw there was pretty solid revenue trajectories and pretty good control over cost. So looking forward in retail, obviously, the mortgage market is slowing down, given where we are in this cycle, and what's happened with low interest rates.
So where we see some opportunity in retail, really leveraging off our core significant strength in all the products is on the deposit and investment side. So you will see our volumes in deposit and investment products. They're in the higher single digits. We're focused on those as products, because if you're looking at the uncertainty in the market eventually when the GDP picks up, they're a great position for us to start in the cross-sell that we have, and it's really important at that point in time to get more heavily into credit products.
We see some good signs of strength on the business and commercial side, particularly in Ontario and Quebec. I think that that's the net result of having low oil prices and the weakening of the Canadian dollar, making some of our companies really see the advantages of getting more heavily into the export market with the US. And so when you look at that from a domestic perspective, in those sorts of lines of businesses, we think that we can continue with fairly solid revenue trajectory. And obviously, clearly keep an eye on cost, because I think for us, we need to make sure that as we look at how we're managing our cost that we continue to drive operating leverage of 1% to 2%. So I think from the Canadian banking side, that's sort of how we're looking at the future, cautiously optimistic and making certain bets on certain types of activity that will get us very well-positioned when the economy picks up.
If you look at -- with respect to the other (inaudible) for example in capital markets, they had two quarters very hard comparables, but we continue to drive that model of over-waiting on corporate investment banking. We have pretty good activity in the US and so we're seeing the benefit of the fact that over 50% of our revenues and earnings are in the US and therefore are leverage to some of the economic uptick in the US. So I think with that platform, it's about carrying on with the model of diversifying across the geographies and continuing to sort of weight more heavily on the corporate investment banking side. I think with wealth to see, wealth is not necessarily performing as well as we think. I think part of that has to do with our international wealth management restructuring. Once we're through that next quarter, we're going to renew our focus on things like the cost side plus continuing to drive revenue in our asset manager and in our retail distribution networks there. And then with insurance and investment treasury services, I think both of those platforms are moving on quite well. So I think I would characterize the quarter as good job, but we're still cautiously optimistic, but looking for the signs in certain of the things that I think you'll be talking about it in a minute.
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Unidentified Participant [3]
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Well, I actually think my next line of questioning is going to try to preempt some of the -- at least one of the major questions we'll have at the audience and Royal being a victim of its own success, the largest bank in Canada and obviously these discussions around if and when Royal will be designated as a global SIFI. Can you give us your thoughts on this and what the potential impact maybe for Royal's platform?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [4]
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That's a great question and you're right in terms of the fact that the designation of G-SIFI is one of the areas that we have been focused on for a few years. So when you look at the metrics themselves, I think the metrics are already set and I know that recently we had a conversation -- I had a conversation with Mark Zelmer, because he's actually going over to Basel, to discuss, among other things G-SIFI. When we look at G-SIFI, it's in the context of our overall capital management. And so for us being a G-SIFI is something about we are where we are, because we're very comfortable with our business mix. We know that certain of our businesses drive a disproportionate or have a disproportionate weighting in the metrics like our investor in treasury services business and some of our capital markets businesses. But we think that it's really about overall how we manage our capital. So you -- when you look at the potential for a G-SIFI additional capital buffer, you'll recall that our regulators actually put a G-SIFI on all the Canadian banks in anticipation of any one of them becoming one so that they would be more competitive or less competitive. So when you look at the concept of a potential G-SIFI buffer, the conversations we've been having with them have not been conclusive, but we think that when you look at Canadian banks generally, running ratios of 9.5% plus, that's for 250 basis points buffer over the 7% requirement, and you look at G-SIFI regime, it's sort of tiers in there well around the middle of what G-SIFI buffer is.
So we have looked at our own capital position and our regulator is going to Basel to talk about this, and so we've had extensive discussions about our own capital planning, and that's why you see us running our capital at around the 10% level. Because we think that at the 10% level, if there is a possibility of having an add-on, it may not be large and also there will be an adoption period.
So we think that at the 10% level, we are pretty solidly capitalized to support the businesses we're in. So with respect to capital management, you'll see us running that ratio a little higher to the end of the year because we are anticipating closing City National in November, which is the first month of our next fiscal year. The funding of City National's balance sheet will require 70 basis points of common equity Tier-1, so that'll drop us down to about 9.5% on closing. And we should accrete back by the end of the quarter to the high 9s and then be in a position of our 10% sort of soft target and be able at that point in time to look at more ongoing capital management activities like returning capital to the shareholder by way of buybacks, maybe looking at selective acquisitions, although that would be episodic, given the fact that we will have our hands full with City National and the acquisition integration.
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Unidentified Participant [5]
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Well, thanks Janice. That dovetails in with the first polling question, if we can put that up, please. How would Royal being designated a Global SIFI change your opinion on its attractiveness as an investment, more positive, no impact or more negative? You may have actually skewed some of the votes after your commentary. More negative, not overly surprising, however, as you've been talking about this more and more publicly, it obviously is Royal has comfort around the potential impacts on this, and it should not disrupt your outlook, kind of, if I paraphrase correctly. Okay. Do we have any questions in the in the audience at this stage in the game? One in the front.
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Questions and Answers
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Unidentified Audience Member [1]
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Thank you. So the direction of travel for capital ratios that the regulators globally would like to see is generally higher. I think most bankers are saying that and you're nodding your head a little bit. And then if you look at what the Canadian banks have actually done over the last 6 quarters to 8 quarters, capital ratios have been creeping up without any sort of explicit message from OSFI and that may be idiosyncratic to each bank, but nevertheless you also do what they do it's and up. My question is, if we look out 2 years or 3 years, all else equal, will 10% still be your targeted capital ratio or will it be higher given the sort of generally higher direction of travel for capital ratios?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [2]
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I agree with you that the direction has been going up and I would say that every -- with the Canadian banks, the business mix is different in all of the banks in the geographies that we operating is different. So when we look at our own capital planning and capital ratios, the discussions that we have continually with our regulator and they review our capital forecast, we present 5-year forecast every quarter in terms of where we stand. We feel that 10% is a solid capital level to be in. That's the level we model to with the regulators, that's the level that we've discussed, we have discussions with. When you look at where Canadian banks tier, vis-a-vis other regulatory regimes and countries, we tier in about the middle of this SKU of the countries, which I think from a regulatory perspective, the signals we've been getting is that pre-crisis Canada always was way more conservative on the capital level vis-a-vis other jurisdictions given the -- a lot of work done around capital and the modeling and given where candidates sit, they have signaled to us that they are fairly comfortable with the tiering being in the mid-range of the jurisdictions. So I think that with that in mind, that's how we are planning our capital and of course as our regulators are going through the Basel meetings this month, we'll hear from them by October as to where we stand on this. But I think that from our perspective, planning at 10% for the mid-term is where we think we can operate. I would say that the flipside of planning and the capital that's accreting in RBC is the fact that we are earning 18% plus return on equity. So when you look at the investment of that capital, I think that you have to look at it from the construct of returns are being earned on that capital, and what's being driven in terms of shareholder value. So I think that's the flip side of the capital to build.
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Unidentified Audience Member [3]
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Hi, could you talk about your oil and gas exposure and your commodity company's exposure as well? And then secondly, your exposures to the second order effect of impact on residential mortgages and consumer lending, particularly in some of the western provinces, obviously, including Alberta?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [4]
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Good question. And we've had that question before. So I think that if you look at our reporting and disclosure, we tried to actually add a little more granularity but I'll give you sort of a brief overview. So with respect to oil and gas exposures, they are about 1.5% of our total portfolio. So there, if you look at the concentration vis-a-vis, for example, the Canadian economy, the exposure that we have in our portfolio is actually lower than the concentration of oil and gas in the Canadian economy. If you look at the exposure levels, half of our oil and gas exposure is to E&P companies, and of that half on the drawn side, 50% of the E&P exposure is here in the US, and the other 50% is in Canada.
When we look at the exposure overall, all we have seen a very slight tick up in non-accrual loan formations, I think two loans were there, one of them with a direct E&P company, another one with a company that provides services to the sector. We haven't seen any ramp up in oil and gas negative exposure in terms of a pipeline of more impairments, we've been just recently through the spring foreign base, our review, where we are going to be starting the foreign base review for the fall in the next few weeks. And the price check that we're using will be based on what it is today. So it's a bit -- a little more negative because the lower oil prices have been sustained for some time.
So if you look at the first order impacts, while we had an increase in impaired loan formations, we haven't seen any defaults, few covenant breaches, we've done some restructuring at the margin. So I think that the issue with oil and gas is the lower oil price and the amount of time that the price is going to be low. That being said, we have a lot of companies that we have put on the watch list for added vigilance around what's happening with respect to their individual circumstances and the price of oil.
When we look at the retail exposure in the Alberta region, we have seen very little uptick. So we first of all look at our unsecured exposure, mostly in credit cards. We have seen very little uptick in credit card non-payment. There have been some, a few but nothing that strikes us as systemic to the region. We are monitoring on the retail side by postal codes, which is like zip code areas, where we see that perhaps there is in play there that has laid off people. When we do monitoring on our retail portfolio, generally speaking, we have the current account of the persons of the checking account with the mortgage and credit card. So it's very easy for us to monitor at the individual level looking at the depth of data that we have. And in the process of that getting ahead of some of the potential negative impacts, like for example, if one of our clients misses a credit card payment, we look at what their -- what they have in a mortgage, whether they have room and with their home equity line of credit, which is fully secured as part of the first mortgage and rescheduling their repayments to sort of make the debt more manageable. So we had some of that activity on a proactive basis, but nothing that would indicate to us there is a wholesale shift in the overall quality of the portfolio. So we've looked at second order impacts and we're continuing to monitor. The other second order impacts that we've seen on the positive side is, that as a result of oil prices being low and the Canadian dollar being low, we've seen some resiliency in the Ontario and Quebec districts and more business activity as a result of it. So I think that if you look at our portfolio, because we have a pretty even distribution of cost across Canada that, here's the population base. Well, there's one region that maybe a little bit challenged, we see other regions where there is room for growth. So I think that kind of summarizes our view on what's happening. So we continue to be vigilant and we're watching all the time, but we haven't seen anything falling totally off the rail.
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Unidentified Participant [5]
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Great, thanks. Can we go to our next polling question before we ask mine. How do you view Royal's acquisition of City National? One very positive, two modestly positive, three neutral, four, modestly negative and five, very negative. Can you guess what my next question is going to be?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [6]
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No don't ask.
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Unidentified Participant [7]
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Well, we have an overwhelming majority on the positive side. So Janice, can you just elaborate on the strategic aspects of this acquisition? Why it's in place and what you hope to see coming out of it once when the integration is completed?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [8]
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So with respect to City National, particularly, the City National acquisition is about expanding our banking side and our banking side on the private banking and commercial side to supplement our current wealth management network in the US, which is really an IA network. We've 2000 IAs, 450,000 clients. So to give you a little bit of order of magnitude, City National has about 90,000 clients, and operates in actually fortified really good vertical, and it's -- we call them a national firm, and by that we don't mean that they operate everywhere nationally, but their verticals are focused sort of front to back, and it's not about being in specific regions.
So their five stacks are basically entertainment, technology, real estate, healthcare, and then, the fifth stack that we're sort of looking to is perhaps on the energy side in the Houston and Texas area. So when we look at City National, it's really about revenue synergies. So what we hope to do is to provide our balance sheet, so that on the commercial banking side, for example, if they have an average hold position of $35 million to $50 million, we think that in looking at loans to their clients, we can actually hold more of that given the strength of our balance sheet.
We think that we can leverage the growth that they're having, for example, in markets like New York. Here in New York, I think they have two branches on Park Avenue and they have been very slowly expanding their presence in New York. We think that we can help to facilitate a quicker expansion, especially with respect to the fact that we have actually 5,000 employees in New York that work for our capital markets division. And so we think that that's a pretty good synergy just to get going.
And then we're looking at, in terms of products, that there are products like, for example, jumbo mortgages, which have actually pretty good loss experience, pretty similar to actually Canadian mortgages that they have not been active in the market because of the infrastructure they need to do that, plus the balance sheet that that's a good product category for us to supplement from their perspective. And then of course, with our broker network in the US, in selective geographies, expanding that product capability to encompass private banking, cash management services, more commercial banking services, in addition to what they do around the wealth services.
So we do there will obviously -- clearly be some expense synergies, but we're really going to -- and they could be expense synergies like using similar contracts or suppliers that sort of thing, but definitely, our focus is going to be on growing the revenue and assets side, given the fact that they have pretty good core deposit generation capability. And that from our perspective, if we grow the asset side, we'll also be able to spend effectively more organic growth.
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Unidentified Participant [9]
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And then with the National City being the expansion of the US wealth managing, you've obviously gone through a strategic review of side of Canada and US. Can you talk about what started that? Where you are in the process? And how material impact is it going to have in the financials?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [10]
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So we -- of course, Canada is our home market and we're everything to everyone. And we think that the US is our second home market and that's why we look at expanding in the wealth business. We think the demographics are right for wealth. We have the right distribution network there and it was about adding product capability in some expertise. We consider the UK and Europe to be our third home market. There is not a lot of economic activity, but what we believe is that in that market, we have to be there for when the activity picks up, so you would have seen some right sizing of the UK and Europe, we've taken some capital out of the trading side and focused on having our trading platforms be more client-centric and client-driven.
We have some capability on the corporate investment side in Europe. And we have seen some activity with European corporates that generally activities outside of Europe. So it would be in other markets like here in the US or in Canada. So it's important for us to earn a respectable return in our European and UK operations and make sure we have to stay in power to be there for the markets ticking up.
And then on the Asia side, we have longstanding operations in a lot of the countries in Asia, through our wealth management, investor and treasury service, and capital markets platforms, mostly distribution based. So they would be sort of the fourth area that we'd look at, in terms of, we call it Horizon 3 investing with a longer view on returns there.
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Unidentified Audience Member [11]
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Any color you can provide on the upcoming national election and how that could impact the banking industry? And maybe policy that also could impact banks as a result?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [12]
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That's a great question and the thing about the Canadian election, which I know it's hard to observe here in the US. This is one of the longest election periods we've had and it's like (inaudible) astronomically long. I think that there is a view based on the polls that we could have a minority government and regardless of where that minority government lands, I think that, what we're looking at is, that when you have a minority government, there could be a view about having shorter term policy fixes in preparation for saving the next majority election. So with respect to financial services, we've had a pretty open dialog with the government around regulation. And generally speaking on the retail side, you're seeing the impact of interchange, it was pretty measured in terms of how that implementation went. And I think from an RBC perspective, definitely interchange was -- we had enough scope to manage the business differently so that we wouldn't have a large negative impact on the returns of our cards business. So we see that in any policy initiatives like that, there is enough scope and we've had enough discussions that there may runway to deal with that. I think, of course it's an election year, and so when you look at things like corporate tax rates, when you look at the Canadian corporate tax rates, they're the lowest of any jurisdiction now, because there's been a step down. So they are may be at the margin, slight increases in corporate tax rate, so we've anticipated that sort of thing. On the regulatory side with respect to banks, it's a little more complex in terms of the capital and regulation. So and the posturing has been fairly measured. So we don't think that those are the sort of policy topics given a minority government that will really catch fire, we could be wrong. This is all my opinion only, nothing to do with RBC right, John. So that's how we see it.
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Unidentified Audience Member [13]
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Thank you. The head of the CMHC Canada has made public statements that you'd like to see the banks have more, I think he said, skin in the game on residential mortgage lending. And if you ever have heard these comments or if you have any opinion on them and if there may be some update as far as the CMHC potentially asking for banks to have more skin in the game, whatever that means, and also could you expand on that if there is any potential for higher-risk weightings on residential mortgages in Canada?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [14]
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Okay. Great question, and I think it's hard to determine what skin in the game is, if you look at the CMHC's policy, sort of policy perspective, from our perspective, skin in game is things like not allowing for a second residence to be guaranteed. So what we've seen with respect to that is that that down payments are higher, and it actually is taking new home buyers or first time home buyers a longer period to accumulate the down payment to make that investment in a home. When you look at things like amortization periods being shorter, I think that in terms of policy directives, it is about making sure that any risks like that that aren't standard risks are being taken on by the bank.
We have regular dialogues with the Head of CMHC. And from an industry perspective, we've been assured that any policy moves that we would get ample signaling for that which we have on some of the moves that have been made. So in terms of that I think it's about a more robust underwriting and less availability. So you're seeing that with respect to some of the securitization of mortgages and the way that that product is being used from a funding perspective, there is tightening around that. From an RBC perspective, by the way, we don't -- for our covered bond, we didn't have any insured product because we never had it typically, our funding rates were quite good without it. So it doesn't have a massive impact on us, but you can see those sorts of things were basically, it's more about insuring first time home buyers that have the rate to repayment cycle.
Switching to mortgage risk weightings, I think that it is a topic of discussion that we've been having with our regulator. And when you look at the impact of potential floors, our regulator has been pretty adamant about the fact that the Canadian mortgage experience and the national experience is different than other jurisdictions. And they don't believe that a standardized approach picks up those nuances, they are supportive of a models based approach. So I think that when in the next discussions they are going to be having in Basel, they will be advocating for that.
And when you look at any -- so say that they advocate for it and say that they get muscled into getting somewhere, I think from an adoption perspective, the timeframe they have seeking out to us, but they are not interested in going forward, being the frontrunner in adoption of a lot of this stuff that they have been in the past. So the adoption period would be measured, I think the last discussion that we had with them, there doesn't seem to be any focus on this happening instantly. So I think that maybe it is one year to two-year period for when we'll know, but I can say that it is -- they are in active discussion because it is one of the few asset classes where they have been consistent in their posturing throughout that the Canadian mortgage experince is different. The other thing about mortgages of course is that the, there has been, as we've just talked about, with CMHC and with other -- with our regulator, a lot more intervention in terms of underwriting standards and availability of credit, I would say. So it is more actively managed by the government. It is a more actively managed asset class.
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Unidentified Participant [15]
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Before we take the next question, can we do the third and final polling, please? How can Royal maintain its premium valuation, become a top 5 global capital markets dealer, pursuing stronger growth markets inside of North America, strengthening its dominant domestic retail banking position, extending its preeminent Canadian wealth management platform on a global scale, maintaining a balanced portfolio of businesses and maintaining a hard cap on capital markets to a maximum of 25%, my numbers, not theirs. So everyone's going risk averse. Do we have any questions from the audience? Janice, there has been a lot of discussion with the Canadian banks in an environment where loan growth in revenue on the domestic side, are these going to slow or be slower than where it has been in the past, and operating leverage becomes very important. How do you, as CFO, balance trying to reduce cost, but also doing the necessary investments into your emerging areas like technology, the potential threat of disruptors, et cetera?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [16]
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You're right. That's a great question, because our first -- we always think first of all, let's forget that budget and credits, because it's quite significant. But when you look at how we've managed particularity in the Canadian banking platform, we started it three years or four years ago with fairly largest technology investments (inaudible) run rate four years ago were somewhere between $200 million and $250 million a year to invest in -- we invested in a mortgage platform, the new way of servicing business concept sort of thing. So what we are doing is, as the margin, maybe that $200 million $250 million is down to $175 million, but because we have that trajectory already built in, we're re-tooling and realigning the projects so that you'll see way more starter projects digitization, agile development and digitization of course has the added benefit of taking cost out and that maintaining that trajectory within the current NII growth trajectory.
So our focus is really on maintaining operating leverage of 1% to 2%. And doing so by curtailing a lot more of the discretionary spend, a lot of the -- if you look at FTE growth in the Canadian banking platform, it's fairly flat, because we're able to take jobs out at the service level as we progress on digitization, we can redeploy those jobs into sales level and productivity streams without actually growing our FTE count. So I think the best way to look at it is, keeping your head count manageable, continuing to invest in technology, but making the projects of shorter duration so that you can see the benefits more in a year or year-and-a-half to two years as supposed to looking longer term as to where we started with three-year to four-year trajectory.
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Unidentified Participant [17]
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And the ongoing trend within the Canadian Space of smaller footprints for the branch network is that, it's adding material contributors to cost coming down over the next little while or is that one of the things that's being sopped up into the additional technology spend?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [18]
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I would say that it is not a material contributor, simply because whenever we do those programs, we're pretty measured because of lease expiries and stuff. So every time we make a change in the branch network, it takes a few years to sort of run through, throughout the margin, our footprint is getting smaller and reconfigured less in terms of wait time and more in terms of serving clients and doing transactions. So the footprint itself will allow our NII to come down, but it's going to be a slower progression, that's why I talked about looking at the sales and service jobs coming off with digitization and the redeployment, because I think that's where you'll see more movement at the margin.
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Unidentified Participant [19]
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Fantastic. Well, I think that's lying a little bit because we're just up against time. So I think we'll leave it there. Janice, thank you very much. We appreciate it.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer and CFO [20]
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Thanks for having me, John.
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