Royal Bank of Canada at Deutsche Bank Global Financial Services Conference

RY.TO - Royal Bank of Canada
Royal Bank of Canada at Deutsche Bank Global Financial Services Conference
May 31, 2016 / 02:15PM GMT 

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Corporate Participants
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   *  Janice Fukakusa
      Royal Bank of Canada - Chief Administrative Officer & CFO

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Conference Call Participants
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   *  Venkat Badinehal
      Deutsche Bank - Analyst

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Presentation
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 Venkat Badinehal,  Deutsche Bank - Analyst   [1]
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 Good morning, everybody. Thanks for joining us. We're very excited to have Janice here today from Royal Bank of Canada.

 As many of you know, Royal Bank of Canada is the largest bank and the largest financial institution in Canada. And one of the exciting things with RBC has been its tremendous growth, balanced growth over the years but most importantly recently has been its expansion in the US both in terms of RBC Capital Markets and in terms of its acquisition of City National in the US.

 Janice has a very esteemed career. She is both the CFO and the Chief Administrative Officer of Royal Bank of Canada and is in the group of eight senior executive officers that set the strategic direction of the Company in terms of the future and global growth.

 Janice, thank you for being here. We are very excited to have you here.

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [2]
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 Great, thanks, Sidney.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [3]
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 I know it's supposed to be a fireside chat. I apologize again for not having a proper fireside for you but we were happy here.

 I know you recently came out with maybe just in terms of the quarterly earnings. If we could start with at least as you think about in terms of the key highlights that you see from the quarter from an investor perspective and just generally as you think about trends for the year that you would be relevant and comfortable sharing.

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [4]
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 Okay, great. So we reported our results last Thursday and we had pretty solid results.

 Our earnings were over 2.5 billion, up 3% from the prior quarter. And if you adjust out for the prior year's an FX gain we had on a subsidiary we closed down, 7% adjusted earnings growth and 5% growth after last quarter. And I think when you look at our results they were pretty clean and they truly reflect the underlying strength across all of our businesses.

 So let me go through the businesses that we have. Our Personal & Commercial banking segment is about 50% of our earnings and it includes our Canadian banking which is the largest retail platforming network across Canada. Our earnings are up 4% over last year in that platform and 1% over the last quarter.

 We saw volume growth across the board of about 6%. The spreads widened slightly at 2 basis points, so our net interest margins are holding and widening a bit. While we had credit losses elevated, more in the personal loans, credit card loans in the oil-affected regions, when you look at the net result of that because of the solid cost control, and we had positive operating leverage of over 3%, that solid cost control allowed us to drive the solid earnings growth and really earn through a lot of the elevated credit losses. So it was a pretty solid and respectable quarter for us with the view that we had very very good cost control.

 If you look at the Caribbean, Caribbean banking earnings were about CAD50 million. And it's a smaller part of the platform. That would be higher than the CAD9 million we earned last year.

 When you look at Wealth Management, we had earnings of over CAD380 million. And we have benefited from the acquisition of City National that Sidney talked about. City National earned $66 million in the quarter in that segment.

 And if you look at the growth in Wealth Management, aside from City National, our earnings are up 18%. So what you see there is despite the market volatility so you know that markets were up and down and client activity wasn't as high as it has been in previous quarters, you see the results of very strong cost control last year. In the fourth quarter, we did some very measured cost reduction, and you see the benefits of that coming through in the pretax margins which are improving and then driving that growth of 18% year over year.

 Our Insurance segment earned about CAD175 million. It's a pretty solid segment. Mostly it's about creditor life.

 And some of you will recall that we announce the sale of our home and auto manufacturing which should come through next quarter. We should have the approvals to go ahead next quarter and that's about a CAD200 million gain that we will be booking at that time.

 Our Investor & Treasury Services segment earned about CAD140 million. It's down year over year because we are undertaking this very large technology investment in working with our clients mostly in the Asset Management segment and having the spoke technology build to actually increase our service there. So you will see a bit of a drag on the cost there as we work through that technology program. The revenue trajectories have been pretty solid there throughout.

 The Capital Markets segment is about 25% of our earnings base. And they earned over CAD580 million this past quarter which is down 7% from a record quarter last year in Q2. So despite the fact that there has been some volatility in the markets, particularly in the trading markets, what you see with our Capital Markets segment is pretty solid, low volatility earnings, which really reflects that shift in business mix to about 60% corporate investment banking.

 Our PCLs are elevated in capital markets mostly because of the oil and gas industry. The provisions are around where they were last quarter but elevated over last year, but that being said still a pretty strong earnings stream that we have from that platform.

 In the quarter, we also finished the quarter at a common equity Tier 1 ratio of 10.3% which is 40 basis point increase from last quarter. And last quarter we were down because we closed the acquisition of City National. The 40 basis point increase is due to very strong earnings accretion plus very active balance sheet optimization.

 So I think that summarizes where we are. We are expecting to have elevated PCL for the balance of the year around where it's been for the first two quarters. But we are still -- still we think we are on track with the solid earnings trajectory you've seen in some of our largest businesses.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [5]
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 Thank you, Janice. I think that was a good, helpful summary.

 Obviously you touched on the cost side and I know obviously runs a very efficient, a high ROE business. Congratulations on that.

 But that set aside, and I'll take the first few questions before opening up the podium. Really what's an investor mind and I'm sure you knew this question was coming was really on oil and gas. You've been able to contain at least the losses on the sector so far but oil prices come up a little bit but it's still 50 and now it's not lower than 30 so little bit better.

 But we'd like to have you walk you through sort of the exposure, not just dollar exposure but just a different areas, secured/unsecured, the different areas of oil and gas that you have seen? And what are you saying the concerns and maybe how you maybe view that for the rest of the year going forward?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [6]
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 Okay, great. So I'll get into a little bit of detail. I may not have the most granular numbers detail but the oil and gas portfolio is about 1.5% of our total portfolio.

 Our drawn oil and gas exposure is about CAD8 billion. The E&P portion of the clients represent about two-thirds of our loans outstanding and the remainder is split between drilling and services and refining and marketing and distribution.

 The book itself is largely split almost evenly between Canadian and US clients. When we look at the drawn book, 81% of the drawn book is noninvestment grade. And some of that also has to do with the downgrades occurring as we go through the redetermination reviews whereas the aggregate bucket, if you look at our total loan book, it's 58% noninvestment grade.

 So that just shows you a difference between E&P and where we sit, vis-a-vis the total book. The bulk of our exposure is fully secured and linked to borrowing base reviews. We are about 80% through our borrowing base review for this season.

 And in total it resulted in about 15% to 20% reduction in the facilities as we went through the borrowing base. I think that when you look at the exposure, what you would've seen this quarter was again a ramp-up in oil and gas exposure primarily in our capital markets business. So I think we are tracking at about CAD100 to CAD125 million of PCL, which is way above what they had in the prior year and coming off of the nine credit period that we've had.

 And we think that looking at the trajectories and even with oil price being slightly higher than it was last quarter the trajectory would be probably for our capital markets business to have similar PCL in the next two quarters if the markets go where we think they are. I think that when you look at our overall provisions for the enterprise, we are looking at the 30 to 35 basis points as our historic range and we are now at the higher end of that range. And this quarter that also has to do with setting up a general reserve or a collective allowance of $50 million.

 We think that for the balance of the year we will likely trend towards that high-end of the ratio of 30 to 35 basis points. So that gives you in a nutshell where we stand with respect to the oil and gas exposure.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [7]
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 Janice, maybe think about the rest of the year, where do you feel you would be based upon different prices of oil or in general it shouldn't matter as much?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [8]
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 I think that the borrowing base reviews for this season were done on a higher price than they were in the fall. There's been relatively some stability in the price of oil, so I think that if there is a sharp decline in oil that that would be slightly more negative. But what we are seeing in the industry is a lot more of our clients actually voluntarily bringing in a restructurer and also getting the job done.

 And because we are very senior ranked in our exposure, this would impact the subordinated debt levels but getting a prepackaged restructuring. So some of what you have seen in the gross impaired loans buildup has to do with what we call management actions. And that's about the clients getting head of the cycle, getting their affairs reorganized, doing what they have to, restructuring and then filing prepackaged restructures.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [9]
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 All right, thank you. Obviously two other things that are in front of the press and investors' mind is obviously one is the Alberta fires. And maybe you can touch a little bit on that.

 And I know you're heading there the end of this week in terms of the impact that you see on your portfolio and the overall business given the peripheral. And I know any of us who visit any part of Canada continue to see the large number of cranes in Canada. So maybe if you can also talk to us about a little bit on the condo and housing market and how that's playing out.

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [10]
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 Okay, great. So why don't we start with Alberta. And of course, the recent fires are pretty devastating.

 When we look at our Alberta portfolio in the region of Fort McMurray we have about CAD1.3 billion of market exposure there. When you look at the -- and I think about a little higher than 50%, maybe 54% of it is insured. And when you look at the underwriting of those markets as they evolve, there's a requirement as you underwrite and give a mortgage that they do have insurance on on the mortgage and the property.

 So from that perspective, we think that our losses if any will be manageable and we won't be able to size them at this time because as you know because of the devastation we have been working with our clients and have offered forbearance and really trying to help them get through the crisis and not have them worry about where they stand with respect to that. We also have a home and auto insurance business. We reinsure most of the risk in insurance, so it's a pretty manageable loss, potential loss for us and it's not at all significant.

 So from that perspective with respect to the fires it's pretty contained. And that's why our biggest concern is about helping our clients and making sure that they can get back on their feet and do what they have to and provide any assistance we can.

 If you look at the retail portfolio overall in the Alberta region, what we have seen on a second order impact is that credit card losses are increasing, net charge-offs are increasing, auto loans are increasing and some unsecured debt is increasing. So at the margin in the region, we have increased provisions and some of the elevation of provision slightly in our retail platform has to do with that. If you look across the portfolio of Canada for those particular exposures, in fact, there is no other stress, there is no other contagion.

 Everything else is more business as usual. In the Ontario and the BC region, the economies are strengthening so we see some strength in those portfolios in those particular regions. So it is pretty isolated in the Alberta region.

 And then the third area was the construction cranes. I would say there are a lot of construction cranes, in particular in the Greater Toronto area. I would say they are up for a lot longer time than they were in the past.

 So what's happening? We don't do very much condo lending at all but what we are seeing in the region is that while there are still new immigrants and new household formations in the region, and most of the construction is vertical in that area and not horizontal so you see a lot of that construction in the sales team being taken up by increases in the population base, there is a lot more rigor now than there was three or four years ago around insurance, around government insurance and requiring higher down payments, lower amortization periods from 30 to 25 years and then also loan-to-value ratios that are more robust.

 So there is a slowdown in the purchase of housing but there is still increase in in sales and sale prices. The construction periods are much longer than they would be so I would say they could average even between three and five years. So they are making sure that they have robust sales.

 So while we see home price increases, they're not increasing at the same rate as they were in the past. And from our perspective the underwriting is sounder. And so we, for example, underwrite all of our mortgages at five-year fixed payment rates and charge five-years fixed as a payment.

 If you are on a variable rate mortgage you just amortize the principal more as you are paying it down. So there are these sorts of measures in place to make sure that the consumer isn't at risk with respect to any blowout of the markets.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [11]
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 Great. I probably have two questions and if people can get ready for questions in the audience that would be great. One, maybe just going into your Capital Markets business, you are coming off a record year, obviously this year talking a little bit on the losses in the oil and gas side.

 But maybe -- and also we came across probably in the first quarter one of the, at least when you listen to everybody, probably one of the toughest markets we've had in recent history. Maybe just talk a little bit about your performance of the capital markets area, the strategies there, where do you see things going well, where do you see some of the weaknesses and where maybe some of the things you are investing in or some things you are downplaying?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [12]
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 I think in the Capital Markets area, the one thing that you would have seen over the past two years, two to three years, is the lower level of earnings volatility despite the fact that about 40% of business is still in the trading business. And I think that is a result of re-focusing more traditional corporate investment banking and putting the client in the center of what we do.

 So if you look at our fixed income trading operations, we definitely need to be there to service our clients on all the issuance business and portfolio management. But it's about where we can at the margin pairing that activity with looking at our balance sheet, optimizing our returns. I think our capital markets platform return on equity was around 13% this quarter and that would be with the additional capital being overlaid this year.

 We overlaid more capital from the center on all of our businesses. So it reflects rough, rough a 9% CET 1 allocation. So what you see in capital markets is more active combing of their operations to take up businesses where they aren't at least returning our cost of capital which is about 9% and 10% and looking at really more client support.

 So for example, what was positive in the past quarters, our lending operations, where we had pretty good returns in lending compared to in the past, we are still at the margin building out our corporate investment banking. Salesforce and coverage there to make sure we are well-positioned at the margin for the economies to pick up while still considering our expense trajectories.

 In Canada, we had actually an excellent quarter in Canada because you know the issuance pipeline in Canada was quite good this past quarter. And in the US we are now seeing signs of less stickiness and perhaps more of a trend towards increasing issuance pipeline. So I think with capital markets it comprises between 20% to 25% of our earnings mix and that was in the face of the other platforms that are growing.

 We expect it to continue to be that proportion of earnings and continue to have solid earnings to earn through some of the oil and gas and provision elevation that we are having and remembering that's where the provisions are about where our expected historic average is. And so it's an amount that we think is quite manageable that we can earn through. So I think that's what you are seeing is the business that at the margin is being reconfigured and basically it's to drive lower volatility of earnings.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [13]
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 Janice, is there a goal of how much you want to see from Canada and how much outside of Canada? And then as you look -- obviously the US has been a big area of growth, what the current strategy is there?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [14]
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 Our platform has been built out the most of course in Canada and the US and we are maintaining coverage in Europe. So we don't really have targeted geographic regions. But we want to be strong in all three regions because as what happened last quarter, Canada was pretty strong, the US wasn't as strong and so it really eliminates some of the volatility.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [15]
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 Obviously building on obviously and as you've said US being a key market on the Capital Markets side, you've successfully closed on the acquisition of City National, so congratulations on that. Can you talk to us a little bit about how that's been going since the closing and where do you see the rest of the US presence, any additional organic or inorganic strategy in terms of the US?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [16]
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 So when you look at City National, we actually believe we underestimated the business case on City National because we are having extremely strong contributions from City National. What we are seeing on the underlying business is double-digit asset and deposit growth, which shows you how they are operating in their markets and the strength of their own business model which is very targeted at the commercial high net worth and private banking segment that they operate in.

 We are -- when you look at their earnings they earn CAD66 million all in after amortization of intangibles and one-time costs. If you look at the amortization of intangibles and one-time costs, I think we have about CAD100 million in earnings. We are also benefiting from their positioning with respect to interest rates, so their asset sheet, their balance sheet is positioned relatively short, on a short basis.

 So as the interest rates went up in the fall here, we saw that good earnings trajectory manifest itself in the earnings for City National. We are working on a lot of synergies with both our Capital Markets platform and our Wealth Management division, that is the 1,800 broker platform that we have across the US. And it, in fact, is being run by Russell Goldsmith who is the CEO of City National.

 So in targeted areas, you'll see more integration and more cross-selling and working together in areas where they think there's some potential for synergies. We're going to be having an Investor Day in two weeks specifically on City National, so we will be going for a lot more details at that Investor Day.

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Questions and Answers
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Unidentified Audience Member   [1]
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 Can you just elaborate on the whole bank M&A appetite in the US, whether what that would potentially look like, what you ultimately want to see over the next couple years in terms of potentially more full bank M&A? Thank you.

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [2]
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 Thanks for that question. I think because we've only had City National for two quarters and we are fully focused on really acquisition integration and not really looking at any potential growth by way of acquisition until we are quite sure that we have the right synergies and the right sales forces and the right way of working together to drive value.

 So I would say that in the future the expansion we are looking at is more on a targeted geographic basis. So it could be either return through teams of individuals in areas like for example Atlanta or Houston or maybe in the Washington, DC area. And to the extent that the teams come as part of different, smaller entities that might be a possibility, but for now we want to make sure that we can prove out the organic growth and synergy model before pressing on.

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Unidentified Audience Member   [3]
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 Could you talk about any plans for the use of proceeds from the insurance sale and any potential run rate impacts on the insurance business from that disposition?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [4]
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 Yes, that's a good question and I think that, first of all, with respect to the run rate on insurance, we sold the manufacturing and then we've retained the distribution. So there is a small run rate differential of about CAD10 million or CAD15 million, and I think a quarter it is pretty small. And we hope to actually build on a broader suite of distribution to more than overcome that to make up for the earnings loss initially that we have.

 The proceeds from the sale of the home and auto business will factor into our overall Capital Management plan. And you would have seen the fact that we announced the share buyback program this quarter as we reported our results because we think that we need to really, given where our CET 1 ratio is today and then with the completion of City National we will be more into the mode of more balance Capital Management activity such as buybacks.

 Of course, we increase our dividend at the same rate of growth as our earnings and we've had one dividend increase already this year and also we support any organic growth from a (technical difficulty) perspective. So it's more about balancing the tools we have available to give back to our shareholders.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [5]
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 Any other questions? A couple of other questions. Just I know we talked a little bit in terms of the efficiency, obviously operate the most cost-efficient bank in Canada.

 Can you talk a little bit about where you see that? Obviously a big challenge for you? How do you improve on what you already have or how do you even maintain it?

 Can you tell us what differentiates it? And as you think about where the business is heading and some of the areas to invest how do you see your efficiency?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [6]
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 So we have been focused on efficiency through automation, digitization, use of technology for the last seven or eight years. And so we have an investment profile that we constantly are investing in technology to actually take work out and develop scale. If you look at our one proof point in looking at our FTE count and if you take out City National this quarter you'll see that it's basically been fairly flat.

 There's not a lot of growth despite the business growth and that is because of the programs we have. I would say the programs are usually take one to two to three years in order to get any trajectory because of the investment required and that's why we are staying the course on the investment. If you look at our expenses this past quarter and if you remove City National because it was in this quarter or this year and not last year, you would have seen our expenses going down about 5%.

 So that would be a function of looking at the cost programs in addition to some adjustments on variable comp programs. And what you would have seen it is really a focus on honing in, on making sure that we can maintain our position with the industry-leading efficiency ratio, continue to invest in the business but also make sure that we take advantage of the scale we have. So there's all sorts of programs that we've been continuing that drive back.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [7]
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 Just to follow up on the efficiency side, obviously a big theme that we've seen in recent conferences like this is being the whole fintech and digitalization. Would love to hear what you are seeing in terms of your core markets and how are you incorporating that strategy into RBC's strategy?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [8]
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 That's a great question and it is a preoccupation of I would say everyone at the bank. If you look at, for example, the whole question about branch usage versus digitization, definitely it is positive that people are using way more digital means on the transactions. But what we are finding with respect to our branches is that that doesn't eliminate the need for branches because people go into our branches for advice to close loans, to close mortgages.

 What it does is it allows us to reduce the footprint as we are doing our branch buildouts. Even train people who go in there on how to use Internet banking or their mobile devices to do basic banking transactions. We definitely you've seen that we announced that we actually just gone on Apple Pay and we have a digital wallet and we have a number of the mobile-driven apps that are definitely in response to what's happening in the environment.

 I would say that the other thing we are doing is changing the way we do technology development to be more agile, to be faster, to be in line with what our nonbank competitors are doing. And so we launched a very large program about 18 months ago about digitization where we put everyone in the same room and we don't have waterfall development and we start off with 16-week program to do something. So you scope it down to what's possible.

 That's made a very large impact on what we are doing in the technology space. We are more efficient as a result of it. We get product out sooner and we've rolled out since the pilot stage.

 I think that this new way of doing things has touched just over 10% to 20% of our workforce which is remarkable in terms of the people who do the product development, develop the technology, the front office who work with clients to see what they want. So hopefully we are on a great path to get things done on a lot quicker basis and respond more quickly to some of the competitive threats that we are seeing.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [9]
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 Great. It's time for one final question. Anyone in the audience?

 Maybe, Janice, final question to wrap up. Obviously you talked a little bit about your strong capital position.

 You're actually doing a little bit of share repurchase program. Maybe you, since you are in this position, can you talk a little bit about what do you see as the growth opportunities for RBC in the near- and long-term, where do you see the bank potentially investing in and looking to grow?

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [10]
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 So I think when you look at the growth opportunity, we of course still believe Canada's a growth market and we try to take our disproportionate share of the market and use our scale to be quicker at the margin in terms of gaining more market share. Our investment in City National, our great expansion in capital markets in the US, are because we consider the US our second home market.

 And given the economic trajectories in the US, vis-a-vis Canada, we think our focus will be on expansion in the US and throwing in the markets that we operate in mostly on the retail side in Swiss City National and Wealth and then in the Capital Market side. So that's a good position for us to be in and I talked previously about our position in Europe as wanting to be there for the eventual uptick in the economies and we consider Europe our third home market.

 In the Asia region, we are there to serve our clients there so we have all of our businesses there in the Treasury Services. We have our Capital Markets business and our Wealth business. And so we are there to serve our clients better there and that are coming into North America and it would be a fourth focus but I would say for now you see where our focus is in the four geographic markets.

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 Venkat Badinehal,  Deutsche Bank - Analyst   [11]
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 Janice, congratulations again on a great quarter and good luck for the year. Please join me in thanking Janice for a very engaging and thoughtful discussion.

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 Janice Fukakusa,  Royal Bank of Canada - Chief Administrative Officer & CFO   [12]
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 Thank you.




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