All right. I'd like to welcome to the stage our next presenter, Graeme Hepworth, Chief Risk Officer of Royal Bank of Canada. No, we've updated the screen. Good. Graeme, thanks for coming to Montreal. I think this might be your second time at the conference.
I think so. Yeah, I think I've joined you for a few roundtables over the years. So yeah, it's great to be here.
Usually in March, it's a surprisingly interesting time, and this year is no exception to that.
March is in October, so it's months to avoid.
The first question is, I guess, a very simple, stupid one, but how do you do your job in this situation when the rules are changing every day and the outlook can seem to be on a random path? I guess it's, and yeah, let's go with that.
Yeah, well, I think the business of risk management is the business of uncertainty at the end of the day. And I often get this question, your life must be panicked right now and stressful, et cetera. I think, quite frankly, if you are in that situation of being panicked and stressed about it, I don't think you probably have the right risk management construct to begin with. And I think for many who've heard me talk before, you always will kind of hear this refrain about we certainly manage our institution through the cycle. And this is really just a good kind of proof point and evidence of what that means. At the end of the day, as an institution, as risk managers, we assume that every business cycle will have a downturn.
We may not know what causes that or when it will happen, but we will, with 100% certainty, know there is going to be a downturn. Right now, what we're seeing is we're just seeing what might be causing that downturn, right? The tariff situation, the timing of that is becoming more evident, potentially, and so that really then just points out to and leads into all the risk management constructs we build and create to make sure we are resilient as we head into these downturns, and just to bring that to life, what do we do from a risk management perspective to kind of prepare for these types of situations? First and foremost, we have very kind of formal and rigorous processes just around risk identification.
We run what we call kind of a top and emerging risk program where we're kind of constantly scanning the landscape for what are the biggest risk factors out there that could really impact RBC. What are kind of emerging risk factors that we need to start thinking about more thoroughly? And that's constantly happening. And then that in turn triggers kind of a whole series of kind of tools and practices that really help us give us confidence that we're able to kind of weather these types of downturns. And some of those tools, like one of the most powerful tools we have in our toolkit, would be stress testing. We take those top emerging risks and we build up the storyboards that then define kind of what do we think the macro landscape would look like under that scenario?
What do we think the markets would look like under that kind of scenario? We translate that through with a lot of rigor into our balance sheets, our financial statements to understand everything from, OK, if markets are down, what's that going to mean to the fee income from our wealth management business, through to what's this going to mean for credit losses or RWA migration in our books? We play that through over one-, two-, and three-year periods to really then give us that sense for what's going to be the financial impact, the earnings, the capital profile, et cetera. When we get into these scenarios, that's what we're evaluating. How impactful is this compared to what kind of resilience we've really built into play?
We're also taking that and we do tabletop exercises, right, to really then kind of drill deeper into it to better understand everything from what portfolios we might be worried about and what we want to evaluate further, our operational readiness, evaluating things like, OK, this type of scenario might mean there's going to be more pressure on our workout groups. What are our resource plans against those? We might be worried about things like call centers and people, clients dialing into those more. And again, do we need to activate playbooks there, et cetera? And then ultimately, this translates right through into client engagement plans and who do we need to reach out to on a timely basis, et cetera. And so all of those are kind of the actions that kind of we build those playbooks, we build those capabilities.
And now really in this environment, we're just enacting them, really, or we're running them with more frequency, if you will, to really make sure we feel comfortable and confident about the resilience we've built into play. Because certainly, that's all then underpinned by a risk appetite that makes sure that we are financially and operationally resilient to deal with downturns so we can be very consistent and persistent in our strategy and our support of clients, ultimately.
So as far as the outlook, which is maybe evolving more rapidly than we'd like, I think it was during the Q4 call, you had indicated you expect peak loan loss provisions to arise during Q4 this year or back half of 2025, whatever. Is the timing of that more fluid now? Like maybe it's 2026 because.
It's certainly more fluid. I think we're one week away from election dates, we call it now, so maybe we'll find out more in a week from now. But yeah, I mean, if we break up a couple of parts of 2025 and how we're thinking about it from a credit loss perspective, certainly kind of let's put tariffs aside just for a second. Certainly, as we looked at 2025, we still saw, generally speaking, loan losses continuing to accrete through 2025 and kind of getting to kind of the peak levels at the back end of that year. It took one quarter to make a liar out of me when we had kind of higher than kind of anticipated losses in Q1. That really kind of centered around one particular file on the wholesale side. And wholesale certainly can be lumpier.
That was a particularly large exposure for us, but an extraordinarily large exposure for us. So if I set that aside, I don't like usually kind of calling things out as idiosyncratic, but if I look at more kind of the core trends there, certainly we continue to see retail kind of accrete up through the year. Yes, mortgages will contribute to that as we go through this kind of refinancing wave, although I would say the mortgage impact of that is smaller. It gets a lot of focus, but its absolute impact is going to be smaller. We still see the unsecured products, the credit cards, the RCLs, the auto loans really being the bigger kind of driver of those trends in 2025. Wholesale will continue to operate, I would say, at more elevated levels, although I wouldn't say there's as much a trend there.
It's just going to be more volatile quarter to quarter. We saw, obviously, kind of better than expected performance in wholesale in Q3 and Q4 than we had, obviously, a large default in Q1. And so that's going to kind of go up and down a little bit. Overall, we still think we're going to be in the range of where we had anticipated in 2025. Again, before tariffs, we were seeing maybe some green shoots there. Unemployment was coming in a little better than we had expected. GDP a little better than we expected. So those were positive things. Now you kind of overlay on the tariff situation uncertainty. I would say in 2025, we wouldn't expect tariff implications to really play out in our kind of Stage 3 loan losses in a significant way in 2025. I would think that will play out more in 2026.
So to your question, yes, if we're kind of getting to peak levels in 2025, the question will be, does tariffs really kind of push those levels into 2026 now? We probably would have saw that peak around the end of 2025, first half of 2026. The question is, does this now kind of push it further? And right now, that's more uncertain than known. And so we're kind of really trying to think about how to evaluate that uncertainty and kind of provision for that and ready for that. But that's kind of how I think we balance how we're thinking about 2025 right now.
So the other timing question relates to the performing provision and potential releases. It seems kind of a far-off notion at this point, but what kind of conditions do we need to see before the performing releases start to show up at Royal or across the sector? You're going to have much faster growing economy and lower unemployment, basically?
Releases is one thing. The question will be in the near term is what kind of builds might be necessary or not, right? I think Q1 is a bit of a tricky point because we were really just at the inception of that. A lot of the story was playing out in February. I think all else being equal, we were in a spot in Q1 that if the tariff uncertainty hadn't been in play, we probably were looking at kind of reducing some of the weights on our downside scenarios that would have been leading to a release in our stage one and two losses. Again, tied to factors like the fact that some of that uncertainty driven by inflationary concerns, the market, the economy was coming in a little bit stronger than we anticipated, was giving us more confidence in kind of our baseline scenario.
We've obviously got this new wave of uncertainty. So we held off on that. And so while we didn't release, we kind of kept some of that in place. The question will be, depending on what we learn over the next month here, do we need to, in the near term, continue to build on our performing loan reserves or not, and to what magnitude? But then when do we get to that hump? When do we start to release? Really comes back to where do we expect those Stage 3 to peak out? And I mean, I would kind of generally anticipate you're kind of releasing six to 12 months kind of ahead of those kind of peak periods, if you will, because you're kind of always looking out that 12 months in those Stage 1 and 2 losses.
So if earlier we kind of thought that 2025 might be the period we start to see some releases, I would say certainly right now that's probably not likely. But again, depends on what we may learn in the coming weeks and months here.
I guess from the build standpoint, going the other direction, we've seen banks generally adding performing provisions like two, three, four basis points a quarter for the past, I don't know, two years or so. There's some exceptions quarter to quarter, of course. But I mean, could we see a chunkier build come in Q2 just given the uncertainty here?
Yeah. I mean, for ourselves, I think we've been higher than those levels for the last kind of couple of years. I think we've been more in that kind of 5 to 10 basis point range, more in that kind of CAD 150 million-CAD 200 million a quarter. Yeah, I mean, certainly, again, performing loan loss reserves are really built on those forward expectations. And so if we're going through a kind of a step change, reset in what those expectations are and/or the uncertainty around those expectations, that very much could lead to maybe a one-time build of some sort. Again, the magnitude of that is really, really uncertain, right?
When we looked at, I talked a bit about this on the call. We've been running a whole series of different scenarios, right, from kind of more temporal scenarios where tariffs come in and then kind of were pulled back as maybe CUSMA negotiations evolved to really kind of more severe global recessionary type scenarios if we had 25% scenarios across the board type of outcomes. When we look at those, the range of outcomes there are quite disparate, obviously. I would say even the worst-case scenarios there aren't outside the set of scenarios we already use in our provisioning. This might cause us to weight them differently. We are right now potentially looking at, quite frankly, we're ready to put a tariff scenario into our IFRS 9 framework this quarter.
Whether we do that or not will really depend on what plays out in the coming month and whether we need to change or pivot that or not. And so that would just give us a much more structural ability to really kind of say, here's how we've evaluated that and reflected that in loan loss reserves. So yeah, I mean, again, it's very going to be dependent on the path we see here in the next month because if this is more targeted, for example, I mean, some of the tariffs are already in place, like the steel and aluminum as an example, some of the stuff that's coming out of China.
This is quite targeted, yes, impactful for those sectors, but those sectors don't represent big parts of our portfolio and so not necessarily massively consequential, very different when you start to talk about 25% across the board, right? So I often get asked a lot, is this kind of like pandemic type of level? No, I don't put it in that category of severity. The pandemic was, I would say, more unique in that that was kind of an instantaneous global shutdown of the economy. And so you saw huge instantaneous builds against that. This is, I would say, less universal and less instantaneous than that. And so yes, it could be significant, but not to that magnitude.
Other than the pandemic being its different set of circumstances and today, that type of comparison, did you actually, on a standalone basis, learn anything? Because that was the first big test of IFRS 9 where the severe volatility of provisionings was apparent. Was there any big takeaway from that such that now we're probably a little less volatility should be expected in the provisioning line?
Yeah. Again, I think that was a good experience. I think we're just more comfortable with IFRS 9 overall from its inception days. I mean, we've refined our capabilities and our tools, the governance around it. I mean, so all of that, I think, gives us just much more confidence around how it works and how we use it overall. But yeah, I mean, I think it does provide good reference points. It does provide good kind of consideration for actions. Quite frankly, at the time, I think one of the things we, when we took those initial provisions at the time, we really had not properly, or maybe not properly, but maybe hadn't really thought through government actions and how that would mitigate it, right?
So we didn't really assume much on that out of the gate, whereas, again, it's supposed to be a holistic consideration of all that might happen. And so here, again, we're very much focused not just on the tariffs, but what's the retaliatory tariffs? What kind of government programs do we expect to be rolled out? And so then what is the overall impact on the portfolio? And so it's things like that that we're certainly, I think, more mindful of than we were back in the pandemic. But overall, again, I think it's a construct that we're very comfortable and confident in now.
Have you spent time thinking about the election outcome in Canada? I mean, is there a different scenario for Liberal government versus Conservative government? I mean.
I am agnostic on election outcomes from a professional standpoint.
I mean, the Liberals could be more in the, like you mentioned, the government support programs. They seem to talk about that a bit more.
Yeah. I think our evaluation on that front is we would expect support coming from both parties. It's just the form of the support might be different, right? I think you've heard from the Conservatives that the support might come more through tax cuts, if you will, whereas the Liberals might have more direct injections or direct support coming in that way, and so yes, those might kind of think through how they would benefit, but I think either way, they would still provide benefit to the sector. It's just the how rather than whether it happens or not.
Got it. Now, HSBC Canada, let's talk about that for a minute because there have been a few losses that have popped out of that portfolio. And I think Dave was the one who met, or maybe you on the call said it was tariff-exposed sectors, or maybe I'm getting that description wrong. But let me ask a simple question. What's going on?
What's going on there? Yeah. Yeah. So the HSBC portfolio, so we're almost exactly one year in, right? It'll be this coming weekend. It was a year ago that we did the conversion and acquisition. And so in the aggregate now, we've had a year to really bring it on. Day one, we converted it, but now we've had a year to run it through all of our credit processes. So in day one, we had done a lot of statistical analysis. We'd done a lot of file reviews. We'd kind of really gone into their AIRB data to make sure we could map them across to our rating scale.
It's like it was a lot of confidence around the portfolio we were acquiring, but now we've had the year to really kind of run it through our full credit process and really kind of evaluate it in our credit scales at every account level to run it through our watchlist processes to have our workout folks look at their borrower stress files, all that. So now we have the kind of really deep and rich insights that will really allow us to look at it on apples-to-apples basis. So what are we seeing in that portfolio? So first, on the retail side, I would say there that portfolio performing very well, ratings profile, risk profile, kind of better than the rest of RBC, not really seeing any negative trends there of note or concern. So the issues more have been on the commercial side.
I would say, and again, in aggregate, this commercial portfolio is still very much a portfolio that we like. It's a very high-quality portfolio, skews to the higher end of the market. And long term, it does diversify the RBC portfolio. And so that should give us more stability as we go through future cycles, if you will. In the immediate, there's been a couple of things I would just call out. One, the significant provisions we've seen in the first year of that, we've had two files that have really contributed, I think, something like 60% of that. And so those are both larger files. I wouldn't say I don't want to put them in the idiosyncratic "don't look over here" category because certainly both of them are very much in the sectors that are very vulnerable in the current credit cycle.
I wouldn't say that's not tariff-related, but just kind of the rate and inflation cycle we've been going through. One was a forestry file. The other one was a commercial real estate office file. So those have contributed a lot to the loan loss reserves. But as I look forward, we don't see anything of that size and scale that would have that kind of provisions that we think would contribute going forward. So we'll probably be seeing kind of the higher levels that's going to come out of that portfolio. Having said that, we do expect that that portfolio will yield kind of higher than RBC commercial in the coming year. And that's a few things that are going to drive that. One is that portfolio skews more towards these vulnerable sectors than the rest of our portfolio does.
So transportation, kind of logistics sectors, et cetera, that are struggling in this environment. So that'll contribute more to it. And then two, I would just say the nature of their underwriting was a little bit different than RBC. Everyone focuses on cash flow and collateral, guarantees, sponsors, et cetera. They would have just weighed more towards the collateral side of it versus we would weigh a bit more towards the cash flow side. And so again, in the nature of this cycle with it being more of a rate-driven cycle, that's going to cause more stress on those collateral valuations, which is going to weaken recoveries a little bit. And so you put all those factors together, we just can expect a bit of a higher run rate there on that portfolio.
But again, we've already got a, now that we've gone through that first cycle with it, that we really have it kind of on our paradigm now and can kind of really project that going forward, if you will.
I just want to wrap up on the consumer side a bit more, I guess, focused on the mortgage book, how much of your portfolio is repriced at lower rates now or higher rates? The nature of that question changes over the past six, eight months, I guess, and what sort of behaviors have you been observing with some of these borrowers that were getting into five years with a two handle on it a few years back and now mid-fours?
Yeah. I mean, I would say overall, our temperature or our risk concern on the mortgage portfolio has come down over the last year. We are obviously in this cycle now of 2025, 2026 are the big refinancing years. I would say the size of that cohort is a bit overstated in the sense that through 2022, 2023, first half of 2024, you had a lot of those clients that were new to shorter mortgages because they didn't want to kind of stick with a longer-term higher rate. So all those clients are actually kind of refi into a lower payment. So there's a good chunk of that. The cohort we're most worried about are those ones that were originated back in 2020, 2021. It's kind of the highest level of house prices and the lowest interest rates.
And so there's the least kind of flexibility that they may have in it. So yes, we're going to continue to see impairments rise. I think what's happening there isn't at all unexpected. Those payment shocks aren't quite as acute as we had maybe been fearing or concerned about a year because we've seen rates come down quite a bit, both on the short term and the long end of the curve. And so the performance there is playing out very much as expected. I would say we're positively pleased. I mean, house prices have provided good stability. We've certainly seen certain markets and regions, Quebec, the Prairies, where you've actually seen some house price appreciation, which obviously helps some of the risk there. Ontario, where we see a bit higher unemployment. Even with that, you're still seeing pretty good price stability there.
And so all that put together, even though I think we're going to see impairments continue to trend up, we're seeing recoveries that are quite strong, and in Q4, we had released some provisions in that portfolio in large part because we had assumed recovery was going to be weaker than it was. We were seeing write-offs much lower than what we'd provisioned for, so we pulled some of that back. I think we're still quite prudently provisioned relative to where we're seeing recoveries, so overall, I think this is playing out very much as expected, and absent, I think, some more material shock in house prices in this country, I wouldn't expect that to be the kind of major driver of our PCL.
Now, if we focus more on the condo element of the mortgage book and then on the commercial side as well, it's topical again because of poor sales activity and speculation that there are investors that are underwater and all that stuff. What can you tell us about your condo book, both on the consumer and on the commercial side?
Yeah. I mean, you've obviously got some factors at play there with kind of changes in immigration policy that's playing out both directly and indirectly, like less demand for condos directly, but also pushing kind of pressure on rental income, which is then causing investors to kind of pull back on that sector as well. Again, I think the retail side, first of all, the condo world is much more of a Toronto, Vancouver story. So it's not really a national story. And even there, again, I think the underwriting standards that we just talked about served us well. And so we're not necessarily going to, not seeing and not expecting to see big losses in that regard. The developer side is probably the more interesting side of it.
For us, I think this is a good story around a very deliberate decision we made a long time ago, probably a decade ago, around strategy and risk appetite that as we looked at commercial real estate, commercial real estate growth opportunities, the developer book, that we made a very deliberate decision on risk, if you will, to say we want to focus our client strategy on the largest, most experienced developers in Canada. They're of higher quality, higher credit quality. But kind of the risk to that that we would have to accept is higher concentrations, bigger holds. The alternative is we could have built a bigger book of smaller holds, but that would then mean being more exposed to, say, less experienced kind of tier two developers that might not have the ability to weather the storm.
It's what we're really seeing right now is the benefits of that client decision and that business decision playing out very well for us. We're not seeing a lot of negative trends in our developer book. We are seeing our clients very resilient through this. They have the ability to, they have the brand, they have the balance sheet, they have the liquidity to weather it up. And they're not facing the same kind of financial distress as some of the kind of tier two developers that you're seeing kind of in the media. So not seeing a lot of distress in our book. If anything, it's maybe more challenging from a revenue growth opportunity as a lot of these clients just aren't building new developments at all right now.
Again, that ties to underwriting standards that we have a lot of strict requirements on presales, if you will. Presales are hard right now, obviously. Now, all this might be negative if we look forward in two or three years from now when we just have less supply available. Certainly in the near term, I think it's helped preserve kind of the risk profile of our book very well.
So when did you make that shift to more concentrated?
Probably a decade ago.
Oh, okay. All right.
Through the cycle.
Got it. Last one, well, I guess from a risk management standpoint, are we at the point where you hear about banks doing this every now and then, sending out letters to their credit card customers saying, "Hey, we're cutting your limit from CAD 15,000 to CAD 10,000"? Any regional or industry type approach that you're taking of that nature?
No, again, I come back to my starting point on that kind of through the cycle approach, right? And we certainly want to kind of, again, build our books, build our financial resilience so we can continue to be supporting our clients through the cycle. And so while where we're at with this level of uncertainty in this environment, I would say there's automatic kind of actions that kick in, if you will. If we want to originate a loan in the transportation sector right now, then the diligence on that, the financial forecasts are going to receive more scrutiny. But there's certainly no prohibition on lending to that sector. And likewise with clients in certain segments, again, there might be things that we start to do in terms of as we identify higher risk clients, we always have that process.
There might be more captured by it in this space. When you get put in that bucket, we would then maybe restrict proactive line increases, i.e., Gabe's not going to get the email that says, "Hey, do you want to increase your card limit from 2,000 to 2,500?" and so those kind of things kick in automatically as opposed to, because that's kind of the most predefined playbooks and strategies we have. If it gets more severe, it might go further down that curve, but right now, I wouldn't say we're making any great pivots in our policy or risk appetite structure. I think, again, we're very much built to kind of address this kind of uncertainty.
I only ask because my wife got.
Did you not get a credit card? I'm sorry.
She went for a WestJet card and they said, "Wait and see. We need more information." Anyway, thanks again for coming up. Very great timing and a very educational discussion as always.
Okay. Thank you.