Can you hear me? All right, perfect. There we go. Thank you very much. Very happy that, everybody could join today. I'm very happy Nadine Ahn is here.
Thank you.
Chief Financial Officer of Royal Bank. As in all of my other sessions, I just wanna remind everybody that banks reported last week in Canada. We're gonna be basically rehashing some stuff from the earnings call and maybe diving into things...
Yeah.
a little more deeper than what you typically would in earnings call, Nadine.
Sure.
One of the things that I've been asked to ask you from some investors is to maybe let's revisit the Net Interest Margin discussion from the quarter. Talk about the one basis point improvement, how that arrived-.
Yeah.
Your forward outlook, please, if you could, just on the margin. That's a start.
No, for sure. I mean, it's obviously a hot topic of conversation, and I think it'd probably be easy to break it down a bit for you if I focus on kinda what happened quarter-over-quarter, how that changed from what we initially thought was gonna happen at the, at the end of last year, and then kind of what our forward-looking is, guidance on it. I think part of it, you know, we've talked a lot, and I'm sure you've heard it from others around when you think about NIM, think about NII trading 'cause we obviously were down the 9 basis points on a, quarter-over-quarter. A lot of that has to do with the way we report from a capital market standpoint, in particular for some of the products there.
Sometimes you've got your NIE representing your funding cost sitting in your NII. Your funding cost, and then what you're seeing is the offset coming through other income. That was about 10 basis points driving on the -9. That was primarily off of our repo business, and in addition our equities business, about six basis points and four basis points there. That takes us to that one basis point accretion on a quarter-over-quarter basis. A lot of that driven off of the Canadian banking margin expansion, three basis points. You know, we did see in the quarter the 10 basis point margin expansion that we were looking for in terms of the structural deposit base, our low beta core deposit base where most of our interest rate sensitivity comes from.
As a result of that, you did see that margin expansion we were anticipating. One of the things that, and I'll talk a bit more about it later from the guidance standpoint, we saw the rotation a bit stronger than maybe we'd anticipated in terms of the GICs. While those are a very, you know, strong high margin deposit product versus where we were on the savings product, where a lot of it rotated out from, obviously that resulted in some of the eating up of the margin expansion we saw on our deposit base. That is overall, we still saw strong revenue generation off of our savings and our GIC deposit. That is a great source of wholesale funding for us.
If we look at what we saw, we actually had growth in our deposits year-over-year, CAD 14 billion on the GICs alone, and half of that was actually new money. It speaks a lot to our client acquisition strategy. You know, I think we've been working through building this deposit franchise over a number of years. It doesn't happen overnight. A lot of it has to do also with that client connectivity we have. You think about it from the number of clients of ours that hold all four products, that's at 18% and 19%. We have strong ability to cross-sell off of that deposit base. While we did see rotation for clients looking to see yield, still speaks to the fact that we had a very strong revenue generation overall from it.
When you looked at what happens in the U.S. and City National, you know, the five basis point NIM contraction in the quarter, that doesn't translate obviously to five basis points at the top of the house when you look at all bank margin. A lot of that driven off of the increase we had in FHLB in the quarter, particularly as it related to improving on the liquidity position overall for City National. That is something, though, that we are looking at from a deposit funding base for the City National Bank. Obviously, they've had very strong asset growth. We do have a low beta deposit product there, but similar to what you've seen elsewhere, you've seen some of those deposits start to run off.
I would say with our City National franchise, we've got a very high net worth client base, and there's other opportunities for them where we put that deposit. We are still very focused on that deposit retention, so they're working back at making sure that they speak to the client base around that. While we do expect some pressure from City National as it relates to that deposit mix, you know, we expect that to subside a bit going forward. If you think about what other we saw dynamic, our liquidity position improved overall for the bank. That was really a consequence of our constructive markets for our wholesale funding. That will start to get absorbed really, as we move through the year and the loan book starts to accrete.
That was kind of what happened from the, from the margin expansion on a quarter-over-quarter basis. As I mentioned, as it related to our guidance, it was really that rotation of the GIC book a bit quicker than we had anticipated. In addition, I mean, everyone saw yesterday with Powell's comments what's been happening with the inversion of the yield curve. When we actually, you know, set our plan, the five-year swap rate, which is a bit of a benchmark in terms of where we look at some of our margins, it's moved around like to the tune of like 50 basis points over the last few months.
That inversion of the yield curve does make it a bit challenging in terms of estimating out into near term and some of the puts and takes around net interest margin, which is why we focused a lot of our guidance on NII. What we've seen, as I mentioned, around our deposit franchise, the strength we're seeing Really seeing that accretion overall from a revenue standpoint. That's why we thought it was probably more important given some of the near-term dynamics that you can see in net interest margin to speak to NII growth trajectory. For the retail bank, we're looking at that mid-teens trajectory. For City National, we are gonna continue to benefit from the rate increases, in particular what we heard yesterday.
As a result of that, we do expect that to be even more significant than for the retail bank in Canada, so about 20% on a year-over-year growth basis. You know, I talked about the margin. We are focusing more on NII, but you will expect to see more of that pressure happening into Q2, in part for City National, 'cause you would have had a full core impact of the FHLB funding and, you know, we'll see how the deposit performance is overall. The retail bank similarly. There's gonna be some pressure in the near term as it relates to margins, but just really thinking that NII trajectory going forward.
With respect to the pressure, that you just highlighted, what about the liquidity? I mean, it shouldn't that sort of help a little bit?
Start to help a little bit as it absorb. That's really dependent upon how the loan book starts to come on and absorb some of that funding.
Do we dare talk about the rest of the year and the back half of the year, or is the environment just simply too difficult to?
Well, I think that's why we're really looking at our full-year guidance, right? I do think that when we speak to what we expect the trajectory to be to the latter half is really where you're gonna see that margin expansion start to come.
Okay. another topic of interest for a lot of people, as they relate it to me was really expense control.
Yeah.
You spoke about, and you gave a pretty good waterfall, I thought, in the presentation for the earnings. In particular, a couple of things stood out, and it was talking about hiring and some discretionary spend. Maybe can you just touch on those two topics specifically, and how should we think about, especially comp, because that's, it's a tough one for banks. We have been hearing that, you know, obviously there's some inflation, and many companies have had a lot of initiatives on the go. Can you touch maybe on the FTE side and what that means for your expense base?
Yeah. I'll just start off. I mean, you're right. With why we did the breakdown on the waterfall because 17% growth on a year-over-year basis is not a headline number, we like to see either, and you would have heard some of Dave's comments overall. If we kinda step that back a bit, just to get to your point around FTE, we did have one item related to reversal from prior year. It takes off about 1%. The way I've been trying to think about it even internally a lot more is really around operating leverage. I mean, at the end of the day, that's what everybody should be focused on.
When we take out those items that either have offsets in revenue, either relates to accounting through our wealth accumulation plan, when you think about FX as well, and obviously with the addition of Brewin Dolphin, and that's a great thing. When you look at just from an NIE line, it looks like a significant increase year-over-year. When we take that, we get to that piece that's remaining, and that's really where we're about 8% year-over-year. When I break that down, half of it does relate to the salaries. About 4%. The inflation piece of that is a component of it, but I would say that it's also just around our FTE growth.
One of the things that we talked about on the call was maybe you will recall towards the end of last year, you couldn't keep up with hiring, right? Like, the employee base was really in the driver's seat. We had opportunities through the market, you had a bit of the attrition probably at a higher percentage point. You couldn't keep up. Like, the funnel was just emptying before you could actually get sufficient employee base. It changed so fast, and this is just another thing that we're seeing overall with the market when I commented on NIM. Things are changing fast. What we found was that we got our recruiting engine all started up, and then this was about front office sales type roles, particularly in the retail bank. Great from a...
You know, we talked about our client acquisition strategy, we talked about our revenue growth, our volume's really strong. We got ahead of ourselves and on the hiring, and then the attrition stopped. You know, they got over their skis in terms of total headcounts at start of the year. Now, when I think about my plan, I'm starting with a higher FTE base. As a result of that, we're really working through, and you may have heard Dave's comments on the call. We are excuse me, laser-focused on ensuring that we think through about that FTE complement. Now that we've done a lot of our hiring already on the front office side, it's gonna be absorbed through.
Because we up-fronted a lot of it, now we have to think about where were we gonna hire that maybe we don't need to, right? Particularly around things like, you know, head office or support roles, right? What do we need to stop doing? So that's been a big part of what you saw from the overall NIE. What you see from an NIE standpoint is obviously a lot of the benefit from past investment coming through. That has been an area that we've been investing not just from the client perspective, but also You've heard us talk about our zero-based budgeting and increasing in efficiency, operational efficiency, processing automation. You spend the money to take the time to take the cost out.
The costs do come out, but they're not gonna come out because you've got to build on from an infrastructure standpoint. That's what you see a lot from the, from the NIE standpoint. I think similar to what everybody's been dealing with, one area that inflation has hit just besides our own FTE cost base is in terms of some of our third-party suppliers. When you look at marketing has gone up in terms of cost. You look at business development. We're all here, we're traveling. This is great to be in person, but we all recall last year we did this conference virtually. Right? You're seeing those costs tick up, especially on a year-over-year basis, but that's where we're gonna see it start to moderate going forward. I am really focused on operating leverage.
At the end of the day, that is what's driving earnings going forward, and that's why we have very targeted approach to target for positive operating leverage for the year. You're gonna see obviously as we saw, you know, inter-quarter movements, but that's where we're really focused on. You know, you think about, I talked about Canadian banking, I talked about how I'm getting a bit ahead on terms of some of their hiring. You know, we are still looking at a sub 40% efficiency ratio. I know, Darko, you look at a number of banks, but I think that you consider that as global leading. That doesn't mean that we stop there, and we're still very focused on it.
Should people think about, well, you hire a lot of front office, so should we start to see some revenue?
Yeah, absolutely. Productivity is increasingly important. I think that's one of the things that the diligence around ensuring that as you add the people, they are delivering on the revenue. I think that's something that we've been much more focused on the past part of our zero-based budgeting work that we've been doing, is really looking at that productivity.
That should be a back half phenomenon of the year, do you think?
Yeah, in terms of volume. I mean, everything you got in constructive markets, but yeah, that's really where you're seeing the drive for the positive operating leverage come to the revenue. Yeah.
I'll maybe just move on to another topic, and I'll, I'll pull for questions after we sort of hit some-
Sure.
-of the hot button topics that people have been sending me. Capital. Clearly, capital has been topical ever since the regulator changed the DSB. Royal's in an area where they've got a strong capital ratio, and then you've got a big benefit coming next quarter, a little bit outsized relative to everybody else. I wanted to just ask what it is that Royal is getting such a big benefit on the capital, and then maybe also speak to the final reforms as they get implemented in next year.
Sure. Yeah. Well, we are in our final chapter, although I don't know if everybody believes it. Just for background context, right? For Basel III, the reforms, this is really looking to set that consistency, that standardization across the industry. What you're seeing is more of a movement towards the foundational view of the IRB. What we're looking at is that is removing then what they called the scaler, right? On this mainly relates obviously credit risk on the banking book. Well, every bank is gonna benefit from removing of the 6% scaler. It was basically just an add-on.
When you look at then the actual adoption of what the new parameters are around the foundation IRB, that is where you're seeing the standardization, and particularly the impacts are on the corporate and commercial books. It may be no surprise to those of you who deal with RBC in terms of our conservative nature. What we're actually finding is that the new parameters are less severe than or conservative than our own internal ones. That's where you're seeing a better significant portion of the improvement, about half of it's relating to the scaler, and then another half of it's relating to that dynamic.
This is obviously driving what we talked about in terms of our guidance around capital, and that is all included as it relates to the guidance we had for the 12% on the close as it relates to pending HSBC transaction. You get into the next phase, which comes in 2024. In Canada, for those of you in the U.S. that follow it, we are early adopters, if you will, versus the rest of the world. Australia, I think, is also going this year. FRTB, the trading book, changes are coming in 2024. From our perspective, again, back to we were primarily on standardized for our trading book. This is impacting our equities business, rates business, some are repo business.
Because primarily for the groups that were being impacted, we were already on standardized, so it's not like we were on models and now we're going to a more punitive, standardized view. That's why we're not expecting to see as much of an impact under FRTB, but we're obviously still working through, the rest of it. That's all been factored into the guidance we've been providing on capital overall. Do not expect it to be as significant as maybe for others, just given those dynamics.
Okay. That's really great color on the dynamic there. Which brings me to the question on where could things go wrong. One of the things we haven't seen in Canada, and I haven't seen it for many banks, is RWA inflation. It's been a bit of a topic. We haven't seen much credit migration. What's your view on, on RWA inflation? Maybe we'll weave this into a discussion on mortgages at some point because, you know, loan to values are falling with house prices in Canada. That might be an area of RWA migration. Can you give us some initial thoughts on that as potential headwind?
We did see a bit of credit migration this quarter. I think we're still sitting with a bit from where we were back post-COVID. I do think that if you looked at what's been happening and you commented on the mortgage book overall, like I think that, you know, we're still seeing very healthy balance sheets for a lot of our clients, particularly on the commercial side. We're not seeing to the great extent the clients defaulting from a credit standpoint, you know, we're seeing a bit more on the where you would expect on the unsecured, on the retail side. That's why you've seen some of the tick up, particularly in the Stage three.
We are seeing a bit more on credit card and unsecured RCL. The delinquencies, we're just not seeing them there as it relates to the commercial book. I think when we look at one of the advantages around having that strength of client franchise and that deposit base is you get a lot of insights into your clients. They're still sitting with a significant amount of liquidity over and above where they were pre-pandemic. That's been, you know, it slowed down some of the utilization rates. We're expecting those to tick up again towards the end of the fourth quarter. We're starting to see from a credit card perspective, we're starting to see continued growth there, revolve rates coming up, maybe expect that to come back to pre-pandemic levels.
You're starting to see some utilization from a credit standpoint. But from overall health, I would say of the client base, when you think about credit migration, you know, we are very, I would say, prudent in the way that when we downgrade from our end, we're probably more slower to build them back up, hence why we still have negative credit migration from what we've seen from post-COVID. We are quite prudent in that regard. But I think that when you look at it from an overall book perspective, it's not something that you're seeing is gonna be significant in the near term.
Which brings me to maybe a discussion on something that's been topical, in the news lately with respect to just the overall situation in Canada with respect to housing and mortgages. You know, one bank had disclosed, that they had, 20% of their mortgage portfolio effectively negatively amortized. Now this is Canada, you know, most of the banks do the same thing, so I got to think structurally, this is probably happening at Royal. I wondered if you can comment on that phenomenon and why or why not that should be a concern for investors?
I think when it really helps to break the book down and kind of understand the worry about around that tail risk, right? When you look at our balance sheet, CAD 355 billion of mortgages, we're about two-thirds of it is roughly a fixed rate, sorry, about a third of it's floating rate. When you look at our variable rate book, you know, it's about CAD 75 billion, 20% is roughly hit that trigger rate, which means that they're paying interest only. Right?
When you look at from our client standpoint, when we're looking at what their cash flows are, when we're looking at the insights that we get in terms of their ability to pay, like we're sitting here, they've got their CCLTVs for the book as a whole is at 51%, right? New originations are at 70%. FICO score is at 800. You're talking about a book that is quite healthy overall. You've got that equity in the home. When you start to break it down then and look at the, at the cohorts, right? Most of our book, when you're talking interest only, so that means their payment is going to reset on maturity. If you think about both our fixed rate and our floating book, a lot of the volume came in during the COVID period.
A lot of that is going to be up for maturity in 2025 and 2026. Fifty percent of the book is pretty much gonna have the maturities at that point in time. When you look at it from what that means from a client payment standpoint, you're seeing about maybe CAD 400 on average increase in payments, maybe a 30% increase overall. What we see from our cash flow standpoint with our clients, it's quite manageable. When you're thinking of 2025 to 2026, you're also talking about the wage inflation that's benefiting the client. That from a percentage standpoint, people could argue, is it really keeping up with inflation?
One thing when you just look at the absolute dollar amount, if you look at the time horizon, you know, since pre-2019, you know, you've had three times more increased appreciation in your salary base versus what you're seeing from the mortgage payment. The tail risk is there, right? You have to look at that and break it down. When we take that cohort of those that are going to be into 2025, 2026, if we look at it from who has a CCLTV greater than 80%, FICO is less than 700, when you look at that piece of the book, that is like, you know, low single digits of our total mortgage portfolio.
You do focus on that, and you do work through with the clients to make sure that they're gonna be ready to be able to manage that cash flow. From a client conversation overall, like we haven't seen actual people rotating into fixed rate mortgages. We've actually seen people looking to try and speed up some of their amortization, just more of the broader book in terms of double up payment, et cetera, just to bring down that overall interest cost. It is definitely a risk, but I tried to size it for you in terms of where you have to really start to break down the cohorts and see where you've got an area that you have to focus. That's where you're getting into that really small portion of our overall mortgage book.
Then you think about our loss rates on something that has so much equity overall in the house. It's, it's not, I would say, significant. I see it almost more as a societal impact in Canada, right? That the cost of housing more generally, that we still suffer from a supply-demand imbalance. You know, Canada is been recognized for its immigration policies, you know, looking up to take half a million people in. These are people who are producing, they need housing. You know, we're actually in a situation where we don't think the housing market's gonna go into free fall because there is that tension around supply-demand. Those of us who live in Toronto, we just found out what the house prices actually went up last month.
It still means that people have value in the home as well. It's definitely from a style, it's more of a cost burden, you know, price of housing overall, which trying to address, but it's not as easily quick solve either.
Just some follow-ups on that. With CAD 75 billion in negative AM, I think on the quarterly conference call, correct me if I'm wrong?
Yeah.
I think Graham mentioned that there was CAD 64 million in formations.
Yes. CAD 64 million in formations.
Related to that very book there.
Yeah.
CAD 64 million on CAD 75 billion.
Yes.
Okay. All right.
Quite de minimis from a CAD 355 billion book overall. Yeah.
12 basis points of overall delinquency, which is still relatively low, I think.
Yeah
... for the mortgage book. I guess what people wanna zone in on is you're having these discussions, very few people are falling by the wayside. Is there any other risk in there? What about the fixed part of the portfolio, the fixed rate?
Well, yeah, the fixed rate is, I would say, similar while clients have been benefiting from the rate that they receive, the majority of the cohort is going to be maturing similarly in 2025 and 2026. When you look at that, again, you're looking at about a 30% increase in payment to that average, you know, CAD 350-CAD 400 range for clients. Similarly, the book overall in terms of the average base of the FICO scores is quite healthy.
Okay. All right. Maybe turning to the other aspect of credit quality, which is just, we're seeing Royal build allowance for credit losses again.
Mm-hmm.
Maybe you can just touch on that a little bit. Give us a little bit of idea as to what kind is going on there. We're seeing a bit of a change in some scenarios and some outlook. We did get a weak GDP print, but it wasn't terrible. Maybe you can just give us an idea on the reserve build and what you know, should we be thinking of more and more builds as we go quarter after quarter?
Yeah. Well, IFRS 9 is an interesting construct. I think everyone's gotten a little bit well-versed in it. Our base case essentially does have the moderate recession hitting in 2023, both for Canada and the U.S. To put that in context, we've got GDP by the end of the calendar year contracting 0.2%. We've got, this is the interesting part, we can talk a bit more, unemployment going to 6.8% by the end of the year. From an HPI standpoint, we've got the peak to trough going down by 14%. When you build that in, that's what you see from the Stage one and Stage two part of our base case.
We did comment that we actually moved some of our weightings from pessimistic into base case. Because as your base case really starts to take into account that economic scenario, that pessimistic economic scenario, then you don't need to have the extra layering on because it's already being built into the base case. As we think about that, then going forward, that is why you are seeing the expectation that we're gonna start to hit through the normalization of Stage three throughout 2023. When you think about Stage one and Stage two, that reserve building, that is really because the economic scenario has not materially changed in the last little while, what you're seeing in terms of that reserve build is almost that pull forward or that roll forward into that Stage three view.
As you get to the point-- I mean, the interesting dynamic around, and I think I've said this before, IFRS 9 is it imagines this lovely little, you know, economic cycle where we hit the trough, and then we come back up. I think the challenge with it in partic-- the standard now is that the rapidity with which we move through these cycles gets a bit challenging. That's essentially what you're seeing from the reserve build. You would liken the fact that when we actually hit that Stage three normalization, that you would then start to see the reserves release because the expectation is that you've hit the, you've hit the trough point. The kicker in all of this is that people keep waiting.
Unemployment, which is the primary driver of the poor credit, the provisioning and increases, has not been happening. We continue to see very low levels of unemployment, there's still a significant amount of jobs. You have the, you have inflation there, I think in Canada, you know, one of the things that seems to have happened is that inflation has kind of hit a point of tapering off. I think in, you know, with the comments in the U.S., it just seems like the U.S. economy and the consumer spending power, it's a lot harder to pull back on the growth trajectory there. They seem to be wanting to hammer it a little harder. The unemployment level is still what people are having jobs, right?
That's why that hitting of that, you know, Graham, for all the fact that we both give guidance, he seems to be more like the economist and be able to change this. He keeps waiting for that Stage three to happen. We are starting to see it build in. I think as in my comments earlier on commercial, you know, until the unemployment actually starts to tick up and hit, it's hard to call when exactly you're gonna start to see that. That's what the reserve build is. The reserve build is legging into that view of when the Stage three is going to hit.
We never saw it during the pandemic. Stage three never materialized, so it was.
Never materialized, but we don't like to comment on that a lot because then the government says, "See? I gave you all that money. You should pay me back more.
I promised I would ask are there any questions from the audience? We are running out of time, but we'll gladly take a quick one. No? Fantastic, Nadine. Always great to chat. Thank you very much for joining.
Oh, no, thank you so much, Darko. I appreciate it. Thank you all for attending.