Royal Bank of Canada at National Bank Financial Canadian Financial Services Conference
Mar 31, 2016 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank of Canada at National Bank Financial Canadian Financial Services Conference
Mar 31, 2016 / 03:15PM GMT
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Corporate Participants
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* Doug McGregor
Royal Bank of Canada - Chairman and CEO, RBC Capital Markets
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Conference Call Participants
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* Peter Routledge
National Bank Financial - Analyst
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Presentation
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Peter Routledge, National Bank Financial - Analyst [1]
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All right. Welcome back, everyone. To my right sits Doug McGregor, Chair and CEO of RBC Capital Markets, and Group Head of Capital Markets and Investor & Treasury Services at Royal Bank of Canada. Doug joined RBC Capital Markets in 1990, and worked there ever since and is now running the show. So, Doug, thanks for being here.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [2]
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Yes, thank you.
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Peter Routledge, National Bank Financial - Analyst [3]
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Doug, I'll start with the question, what are the key messages you hope to leave investors with today?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [4]
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I'll just spend a couple of minutes talking about RBC Capital Markets in terms of what we're trying to do, and give you a little bit of insight into some of the things we're grappling with. And I'm sure you're going to ask if I don't mention anyways.
So I'll start with, the strategy hasn't changed. We are still trying to be first in Canada. I think we're first in Canada in every category. We've had a very good run recently. We've just overnight book run for Silver Wheaton $500 million, and we did a large TRP deal a week and a half ago, Pembina, Stantec. There's been a significant improvement in capital markets activity in Canada over the last several weeks. It was very difficult in early February, but it has certainly improved.
But in terms of what we're trying to do at RBC Capital Markets, we want to keep that market share. Canada is a very good environment for us. Our costs are good here. Our tax rate is good here. And I think the fact that we are larger than the other Canadian investment banks, I think is starting to have its impact, in terms of our global reach with some of the customers who are recognizing the difference. So we think there is room to grow the business here.
In the US, that has been our core growth market. We've been at it now for about a decade since the financial crisis. It has been a good experience for us. We have put out a lot of capital in our loan book and we have hired a lot of people. Retention of the people has been good. The customer activity gets better and better every year. So going forward, we expect that we're going to keep doing that.
We think there may be a competitive opportunity in the US as most of the European banks struggle with some of the CCAR and FBO requirements and the costs associated with it, the capital required to capitalize the holding Company in the US. So I would say the US, we are very focused on continuing to try to improve there. And I think it's important because if you are not moving forward, you might be moving backward in the US, because the US banks are competitive.
I would say the US generally, it's been a difficult operating environment for the last six months. Credit has been tough really since last August. Leveraged finance, high yield, which is a big part of the market there, has been very quiet. And it's just opened back up over the last week and a half, I'd say. I think there will be about [$]15 billion of high yield done this week. So if you see those markets recover, then I think activity will improve.
In Europe, Europe would be about -- in terms of our headcount, would be about 750 people. It's a full investment banking business. It's equity and debt, sales and trading, research. We have about 100 investment bankers, seven industry verticals from mining to consumer to healthcare to infrastructure to oil and gas. Did I mention healthcare?
And we're trying to do in Europe in a much smaller scale what we did in the US, which is to build a balanced origination and sales and trading platform. And I would say that we have good leadership there and our results are improving significantly there. And it's good, but it doesn't have the kind of financial results or leverage that you would see in the US. So, yes, we're building our business.
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Peter Routledge, National Bank Financial - Analyst [5]
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So I'm going to start with the question I'm asking everyone, and we're trying to focus on risk management issues in the conference. But I'm going to preface it with an observation about RBC, which I've covered in one form or another since the early 2000s.
We'll just go to the financial crisis. RBC outperformed virtually all its global peers in terms of stability of its earnings and an absence of really significant asymmetric losses. There were some, but I think if you look at it on a comparative basis, they were pretty low.
And what I observed when I was following RBC on the credit side was that the business leaders in capital markets owned the risk and had accountability for risk in a way that was unique pre-crisis. I think after the crisis, things have changed, but certainly in a way that was unique pre-crisis.
So with that in mind with the culture of owning the risk at the line of business, I'd put the following question to you. What, as head of RBC Capital Markets, what keeps you up at night?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [6]
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What keeps me -- I would say the things that most concern me or the big tail event would be regulatory risk. I'd say the fines that have occurred are certainly through
$200 billion between the Europeans -- Europe and the US. The numbers are astounding. The impact on the -- from regulatory sanctions, that can be game changing. So that's something that we spend a lot of time with on culture, on really just operations risk, and just managing as best we can against that.
I would say I'm very comfortable with the type of trading books we have now. To be frank, they are different than they were pre-crisis. And we got through the financial crisis, but we had a few things that we would have preferred not to have. So I would say that the trading business is, if you look at our VAR, it's lower than it was in 2006.
We have taken on credit risk in our loan book, so -- and we're seeing some of that in the oil and gas portfolio. I've said publicly that -- and our CRO has -- as it relates to my book or in the investment bank. it's about -- exposure default, it's kind of a CAD200 billion book. It's drawn CAD85 billion. It's got 1700 names. It's bigger in the US now than it is in Canada.
It goes US, Canada is about half the size of the US, and UK and Europe is about half the size. In terms of single name limits, sector limits, and managing the risk, I'm very satisfied. I would be interested in your comment about what you think has changed pre-crisis and after crisis. But I think we keep a very good eye going into a loan and also throughout the term of the loan.
In terms of the energy space, we took a lumpy loss last quarter. It's a structure that isn't repeated very often in our loan book. And I have said I think 40 basis points on CAD85 billion is a reasonable estimate this year for PCL. And I don't have line of sight on all that now, but that's what we go into the year thinking it's going to be and I haven't -- we haven't changed our view.
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Peter Routledge, National Bank Financial - Analyst [7]
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Just along the line -- you mentioned in your kickoff a lot of equity issuances over the last three weeks. What's the market telling us about an outlook towards the energy sector overall, just based on what you see?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [8]
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I would say it's decidedly different than it was two months ago, and so clearly there is -- in the public markets you're seeing reasonably stable, stronger midstream issuers for the most part. We are seeing some E&P, and not necessarily the large cap E&P names in the states get done. So the people who are financing right now are people who could take advantage of having money or just want or are thinking safety first, and are just shoring up their balance sheet. But yes, there is certainly public capital available.
I would say in terms of private capital and M&A capital, it is quite active in the energy space. A lot of assets being traded, a lot of hedge funds and private equity investors around some of the companies that are struggling and have to restructure. There were a number of deals going on out there.
So I would say it's -- we're going into the next stage of that restructuring cycle where some will have to be restructured and ownership will change, but there is certainly interest.
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Peter Routledge, National Bank Financial - Analyst [9]
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I'll go out to the audience see if we have any questions. Down here in front.
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Questions and Answers
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Unidentified Audience Member [1]
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Thanks for the question. So a lot of your major US and European peers have been struggling with FICC trading, fixed income, currency, commodities, and have laid off good portions of their workforce in relations to declines in activity in that trading area, in combination with higher regulatory burdens, we'll say. So what are you seeing in your FICC trading areas?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [2]
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Yes. So I'll divide the comments into a couple. First of all, FICC rates, which is governments, SSAs, it's a very tough place; really very little margin, dominated by the large American dealers in particular globally, a lot of electronification. occasion. We're the market leader in Canada, we're always profitable, and the FICC -- the rates derivative part of the business is at least as much revenue as the cash rates trading.
In the states, it's more difficult for us, and we take the view in the states -- in the US and Europe that really we're in the rates business so that we can face large real money customers with other products, and that the margins we make outside of Canada in cash rates and rates derivatives has never been significant like big, but we do want to stay away from losing money which we are doing.
In credit, it's a little different. So investment-grade credit in Canada, we'd be first again in terms of new issue activity and market share and so on. It continues to be profitable. But since last summer, last August really, what the world's dealers have been dealing with is a very difficult credit market.
So high-yield leverage loans have all backed up very considerably. And the new issue environment isn't good and the secondary trading environment, there is not much liquidity. That's just changed really in the last week and a half to two. There is, as I said, a lot of high-yield issuance right now. So our credit results outside of Canada haven't been as good as we would like them to be.
Leverage finance and high yield would be almost one-third of the fee pool from investment banks in the US, and that's been very quiet. But it's actually -- they've been better than they've been for years in Europe. And I think our analysis of that is, frankly, just dealers taking credit products off their inventory to get their RWA down has given us more market opportunity.
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Unidentified Audience Member [3]
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(inaudible -- microphone inaccessible) (inaudible) So in summary, against yourself as a market leader in Canada and you do quite well there. Challenges elsewhere (inaudible).
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [4]
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Currently challenges. We make -- we expect to, in a constructive market environment, make good money and credit US, investment-grade and noninvestment grade especially, high yield and loans. So -- and I expect that we will as this market repairs. But our FICC results first quarter in reasonably difficult market circumstances were quite good.
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Unidentified Audience Member [5]
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(inaudible -- microphone inaccessible)
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [6]
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It's trading around new issue business. I mean with Volcker in the US now, you have limited opportunity to be holding inventory on trading books.
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Peter Routledge, National Bank Financial - Analyst [7]
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We have a question over here on the left.
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Unidentified Audience Member [8]
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Yes. I have, again, a question on the conversion features of specialty instruments in the case of a bailout. So where we're seeing strike price in the case of preferred shares that are pretty low versus the common equity stock price, we hear that there are conversion features on the debt instrument which are much, much lower.
My question to you is, would you expect in the future that we're going to be heading with higher strike price for the conversion of those special instruments?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [9]
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Are we talking about TLAC now?
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Peter Routledge, National Bank Financial - Analyst [10]
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Yes, we're talking about, I believe, NVCC preferred shares in subdebt, and then bail-in debt which may come later this year.
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Unidentified Audience Member [11]
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Yes. So more instrument in terms of absolute amount of dollars, or are we going to be hitting with higher strike price that would force the conversion of such instrument in the case of a bailout?
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Peter Routledge, National Bank Financial - Analyst [12]
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So just as a -- the current conversion price set by the regulator for prefs and subdebt is CAD5.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [13]
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Right.
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Peter Routledge, National Bank Financial - Analyst [14]
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So you take your par, divide by 5 and that's how many shares you get.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [15]
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Yes, yes. I don't know. I don't know what would drive that, I'm sorry.
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Peter Routledge, National Bank Financial - Analyst [16]
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We have a question over here on the right.
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Unidentified Audience Member [17]
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The question concerns the acquisition in the United States. I just wanted to know what synergies or how that's going to affect the earnings, or if there is a bigger platform in the United States. I forget the name of the company (multiple speakers).
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [18]
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It's called City National.
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Unidentified Audience Member [19]
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Yes.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [20]
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Yes, so it is a retail bank, but it's really a wealth bank. It's a services sort of a high net worth clientele. A lot of it is focused around the entertainment industry in Los Angeles. They have been growing market share in New York as well.
I think we bought that bank because it was a good, established franchise that we thought we could grow. In the past we've had other retail operations in the US in markets that just didn't turn out to be attractive, and I think really in local economies that weren't as attractive as City National.
I mean the idea for Royal Bank is it wants to grow its earnings in the United States. We see it as a second home market. We didn't have a retail product and so for us, it's something that we can offer to the Capital Markets customers. There's a lot of crossover in terms of our origination of wholesale loans in the US that we can offer them participation. They're deposit rich and could use some assets, so we can help them with that.
And we're just cross-selling, and I think we are going to offer that bank capital and we're going to try to grow that at a reasonable, quick pace.
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Peter Routledge, National Bank Financial - Analyst [21]
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Do we have other questions? Just follow along just on the -- regarding City National. One of the opportunities the banks mentioned following the close of the deal is it's a great client base for RBC Capital Markets to penetrate. So how is RBC Capital Markets going to penetrate this now captive distribution channel?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [22]
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Well, I think that it's not so much a distribution channel for us as it is -- there's a couple of other obvious opportunities. One is we're trying -- we have to put the infrastructure in place where we can take advantage of their excess deposits and funding. So I think that that work is being done because we wholesale fund a lot of what we do in the US right now, and that would certainly help our margins. So that's going on.
We have put RBC bankers in LA to service their customers, which are really around the entertainment business. And we have loans out to everything from Disney to some of the major studios, and so we're just cross-selling.
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Peter Routledge, National Bank Financial - Analyst [23]
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Okay. Let me come to a question about performance at RBC Capital Markets over the last year. The US, which has been on a tremendous trajectory for several years, I notice over the last year it plateaued a little. But then up comes Asia and Europe with a very strong year in terms of revenues.
So can you talk about what revenue trends have been over the last year and what you think might happen over the next couple years from a geographic perspective?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [24]
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Canada has been reasonably flat, but I would say -- I've just talked about the activity in Canada. I think that's actually quite good when you consider that the mining industry and the energy industry for the most part over the last three or four quarters have been very, very quiet. So I would say I am not unhappy with -- certainly am very happy with the activity, the recent activity.
In the US, what you're seeing is the impact of that backup in credit in particular. So as I said, leveraged finance and high-yield issuing and issuing high yield around the energy patch is a big business in the US. These are very capital-intensive businesses and when they're not issuing and that market isn't constructive, it hurts everybody. And you're seeing a lot of headlines right now where global banks are really struggling with their numbers period.
So I'm optimistic, actually, that credit is repairing, that people have recovered from the prospects that if China growth slows, it's not going to impair the rest of the world dramatically. And whatever else was bothering them doesn't seem to be bothering them to the same extent. So if credit repairs, then I think things will be pretty good.
Europe is challenging because the GDP and the local economies in Europe haven't been robust; not terrible but not terrific. But I think the competitive environment has gotten a little bit better and, frankly, we've just gotten better. We've got good leaders in the fixed income business, the investment banking business, equity sales and trading, research.
We've got the right people doing the right things there. So I'm encouraged by it, and the numbers are getting much better there so -- and I expect that will continue.
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Peter Routledge, National Bank Financial - Analyst [25]
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Okay. Coming back -- you mentioned oil and gas, so let's jump into the Capital Markets oil and gas exposure. RBC bankwide says the drawn lending exposure to oil and gas clients is about CAD8.4 billion, I think at the last quarter, and then an undrawn exposure of CAD13.7 billion.
Can you remind us of the breakout of investment grade versus noninvestment grade in those portfolios?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [26]
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That total book of CAD20 billion or CAD21 billion is about 50-50 investment grade/noninvestment grade. Of the drawn CAD8 billion, it would be about 80% noninvestment grade, which investment grade borrowers use money more often than -- or sorry, noninvestment grade borrowers draw money more often.
In terms of the credit of that book, as I mentioned, I think the noninvestment grade borrowers almost all are borrowing on a borrowing base, and I think most people here know how that works. So it's the proven resource valued at the strip, the forward strip for oil or gas price, whichever it is. And then there is a haircut, whether it be 35% I think in Canada and 25% in the US, and that establishes a borrowing base that they can draw.
Those structures have held up quite well. There is no question that the redetermination last fall was more difficult with lower prices, and banks have to make a decision how hard they want to push customers, but I think the discipline around that process has been working.
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Peter Routledge, National Bank Financial - Analyst [27]
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Some of your peers have mentioned -- and I want to get your thoughts on the RBC portfolio -- that particularly in this cycle, particularly for your senior loans to noninvestment grade oil and gas borrowers, there is more loss absorption within those companies.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [28]
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Yes.
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Peter Routledge, National Bank Financial - Analyst [29]
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So you're senior. Can you --?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [30]
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Well, I think in the US that's -- and our book's slightly bigger in the US. Where the pain has been felt, obviously, is in the equity but also in the high yield. So there has been a lot of capital raised in those noninvestment grade borrowers with high yield. And being senior in that structure, yes, has worked out pretty well.
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Peter Routledge, National Bank Financial - Analyst [31]
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So -- and I get this call from investors. They see a high-yield bond quoted at CAD0.20 on the dollar. Do the banks have a problem?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [32]
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Not necessarily.
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Peter Routledge, National Bank Financial - Analyst [33]
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Because of the seniority of your loan?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [34]
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Yes, yes.
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Peter Routledge, National Bank Financial - Analyst [35]
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And the secured nature, given the clearer borrowing base.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [36]
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Yes.
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Peter Routledge, National Bank Financial - Analyst [37]
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Just one other question; this is the other worry bead I get from investors. They see a press release from an oil and gas company that talks about how their lenders have eased covenants. And I get calls from investors saying, well, such and such eased covenants and these two banks, they are forbearing on the loan. And they are really just putting -- kicking losses down the downstream.
So what is your -- what would your response be to that concern?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [38]
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I think it's about sitting across from management of a business and determining whether or not they have a plan that's credible and would benefit us. So if you are sitting across from constructive management who has a good handle on their business and they are talented and say, look, I can -- given a certain amount of time, I can take costs out of my business or a can remove CapEx or I can sell property or I can -- most of them will cut the dividends already -- but I can do things to make my business sustainable, hopefully into recovery. Then we will make an assessment and if we think it's in our best interest, then we'll do it.
It's not about wanting or not wanting to take losses, and in many cases if we're having that discussion, we've already taken a provision. It's really just being practically -- or being practical in terms of the commerce.
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Peter Routledge, National Bank Financial - Analyst [39]
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Right. And I'm wondering, do you -- if you're going to ease a covenant, you probably get something back in return.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [40]
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Well, yes. I mean if you're talking about easing covenants, then whether you are picking up something in rate or you're reducing something in terms of term or quite often you're reducing the size of the facility, yes. So there's certainly -- banks look for something. Well, they just want to improve their risk.
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Peter Routledge, National Bank Financial - Analyst [41]
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Right, okay. Still have time for some questions if anyone has them. Okay.
Doug, I'll come back to stress testing, and I know you guys take it pretty seriously at RBC. And the bank's given pretty good guidance in terms of what might happen to the PCL ratio if oil stays at $25 or $30 for the next three years.
Sort of a broader question, in the last crisis stress testing pre great financial or global financial crisis, proved to be a little bit -- not stressful enough; let's just call it like that. For certain banks who gave stress test results, the actual losses they incurred were far in excess, present company excluded.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [42]
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Yes.
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Peter Routledge, National Bank Financial - Analyst [43]
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So can you talk about how RBC's stress testing has evolved since the financial crisis, particularly -- obviously with respect to Capital Markets?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [44]
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Okay. I would say the most obvious thing that comes to mind is we run more than 10 scenarios, less than 15, and it would be like severe global recession, severe recession in Canada. Then you'd have a number of assumptions like house prices down 25% and credit spreads gapping out and liquidity doing this and that. But my observation would be since the financial crisis, the scenario that shocks our books the most almost always is the global financial crisis impact.
So I would say a scenario or the scenario is either because regulators demand it or we just progress in our thinking. We spend a lot more time and a lot more money shocking our books to make sure that our liquidity is adequate if we can't fund, or that our capital is adequate if we have a meltdown in asset values. And I would say the shocks that we're doing are just a lot more dramatic than we would have done pre-crisis.
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Peter Routledge, National Bank Financial - Analyst [45]
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Okay. And a question just about capital as it pertains to RBC Capital Markets and the Capital Markets business generally. With all the regulatory scrutiny, it sure seems like -- to me like the regulators want to have a guilty until proven innocent view towards your business. That's my opinion, not yours.
So at what point -- or is there ever a point where housing a capital markets group within a domestic systemically important bank stops making sense; i.e. the capital allocated to RBC Capital Markets within that ownership structure just doesn't make sense? Is that a foreseeable outcome?
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [46]
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Well, I suppose. You can certainly have a retail bank without an investment bank. I would say one of the best things I think that happened to the Canadian banks over the last three cycles was buying -- the best thing that happened to the banks was buying the investment banks in the late 1980s, 1990s. A lot of the growth was driven by that.
There's a number of synergies of having the ability to access public markets for customers. So there is an evolution from private market customer to public market customer. There is the benefit that we can leverage the bank's balance sheet in our business. So I don't think -- I think for Canadian banks to get smaller in investment banking, I don't expect they will. I think some are trying to get bigger.
We would be bigger than the others, but I think our growth has been very steady. The income volatility has been very low, so -- and the return equity, given some of the issues that you -- the amount of deleveraging we've had to do and the amount of capitalization of risk we've had to have, the return equity is still quite competitive.
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Peter Routledge, National Bank Financial - Analyst [47]
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And regulatory constraints or just capital constraints -- well, I should say aren't constraints. So capital isn't keeping you from your growth or preventing you from executing on your growth strategy. You have enough balance sheet to execute.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [48]
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Yes. I mean there is no question we've been managing our Common Equity Tier 1 ratio for the acquisition of the City National, and that took our Common Equity Tier 1 ratio down a bit. So we took some assets off in anticipation of that, but I would argue that the timing was pretty good.
It was just pre difficult fixed-income markets, and we just were in a good place when things backed up over the course of last fall and earlier this year. But going forward, we expect that the Bank will make CAD10 billion plus a year. It made CAD10 billion last year, and we're paying out less than half of that in dividends. So the capital accumulation from those kind of earnings has to be put to work or returned to the shareholders. So I think there will be enough money to grow the business.
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Peter Routledge, National Bank Financial - Analyst [49]
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Great. Well, thank you for your time and wish you all the best the rest of the year.
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Doug McGregor, Royal Bank of Canada - Chairman and CEO, RBC Capital Markets [50]
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Okay, thank you.
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