M&A announcement

Jan 22, 2015

Slides

Good morning, ladies and gentlemen. Welcome to the RBC conference call to announce the acquisition of City National Corporation. I would now like to turn the meeting over to Ms. Amy Cairncross, VP and head of investor relations. Please go ahead, Ms. Cairncross. Good morning, everyone, and thank you for joining us. Presenting this morning will be Dave McKay, President and Chief Executive Officer, and Janice Fukakusa, Chief Administrative Officer and CFO. Following their comments, we will open the call for questions from analysts. The call is 30 minutes long and will end at 9:00 A.M. To give everyone a chance to participate, please keep it to one question and then re-queue. We will be posting management's comments on our website shortly after the call. As noted on slide 2, our comments may contain forward-looking statements, which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. Also, please note that all financial information in the prepared remarks is in USD. I will now turn the call over to Dave McKay. Thank you, Amy, and good morning, everyone. Today, I am very excited to announce that RBC has entered into an agreement to acquire City National Corporation, a premier U.S. private and commercial bank with a growing wealth and asset management business. You have heard me mention for some time that we want to enhance our U.S. franchise by adding product capabilities to better serve our clients. City National is the perfect fit. It is uniquely focused on serving high-net worth and commercial clients in high-growth markets. It is a high-quality franchise with a long track record of profitable growth. Excuse me, as I fight through a bit of laryngitis. It is a great cultural fit with RBC, as both companies share a strong commitment to client service and doing what is right. By combining RBC's scale and strength with City National's capabilities and position in attractive markets, we will create a powerful platform for long-term growth in the U.S. Please see slide 3, as it provides a brief summary of the transaction. The total purchase price is approximately $5.4 billion, which will be paid with approximately $2.7 billion in cash and approximately 44 million RBC shares. This deal offers long-term earnings growth, and given the strength of our capital position, it will not impact our ongoing capital management program. In a few minutes, Janice will walk through the transaction in more detail. Like me, Russell Goldsmith, the current CEO of City National, is enormously excited about this opportunity. As a sign of Russell's commitment, the Goldsmith family will receive RBC shares for their entire City National holdings, a large portion of which they have committed to hold for the medium term. City National's headquarters will remain in Los Angeles, and Russell will continue in his role as CEO of City National and will report directly to me. Once the transaction closes, we will combine our U.S. wealth management operations with City National into one line of business to be reported as part of our global wealth management segment. John Taft, RBC's U.S. Wealth Management CEO, will report to Russell and will be responsible for leveraging City National's private and commercial banking expertise to expand the financial solutions provided by our investment advisors. Let me tell you more about the strength of City National's franchise, starting on slide 4. City National is a specialist private and commercial bank that delivers customized banking, credit, and wealth solutions. It has an award-winning commercial banking platform with expertise in entertainment, real estate, technology, and healthcare. City National's clients are largely high-net-worth individuals and commercial enterprises, two of the fastest-growing client segments in the U.S., as you can see on slide 5. Turning to slide 6, one of the greatest strengths of City National's franchise is that it's strategically positioned in the largest and most attractive U.S. markets, such as New York, Los Angeles, and San Francisco Bay Area. In fact, the combined high-net-worth population of these three markets is over 4.5 times the entire high-net-worth population of Canada. Like RBC, City National has a great reputation as a client-focused company and has received many awards for its excellent customer service. A considerable amount of City National's growth has come from referrals, demonstrating the great reputation it has among clients. With its high-touch approach and a broad suite of products and services, City National has developed deep relationships with its clients. For example, nearly half of City National's clients have five or more products, and over half use City National for both their personal and business banking needs. City National's client and market strategies produced a strong track record of both loan and deposit growth, handily outpacing the industry average, as you can see on slide 7. Like RBC, City National has a conservative and disciplined risk profile. Its loan portfolio is well-diversified, and its credit performance has outperformed the industry through the cycle due mainly to the quality of its clients. Turning to slide 9, City National has a market-leading deposit franchise across our branch-light footprint. In fact, its average deposits per branch are over four times the median of medium-sized U.S. banks. Additionally, City National is highly asset sensitive and is well-positioned for rising rates, as over 60% of deposits are non-interest bearing, and nearly 80% of its loans are either floating or adjustable rates. Excuse me while I just have a little bit of water here. Turning to City National's wealth management franchise on slide 10, City National provides investment management and advisory services that complement RBC's current product offerings. Its wealth and asset management business is a high-quality franchise and has been ranked by Barron's as one of the top 40 U.S. wealth managers for the past 14 years. It is also growing fast, and since 2011 has seen double-digit growth in client assets, now over $61 billion, and double-digit growth in fee income. As you can see on slide 11, City National is exceptionally strong on a standalone basis, and when combined with RBC, creates a powerful and scalable engine for growth. First, it allows RBC to expand into U.S. private and commercial banking, creating one of North America's leading full-service private and commercial banks. RBC's U.S. wealth business has been recognized by J.D. Power as a top U.S. service and advisory franchise. For some time, we have been focused on adding product capabilities to better serve our U.S. clients. We will now be able to offer City National's full suite of banking products, including commercial lending, private banking, cash management, and other services to the 340,000 U.S. wealth households, and 204,000 cross-border clients, and 88,000 Canadian commercial clients that we serve. Second, this deal enhances our overall U.S. wealth and asset management business, creating a combined platform with approximately $320 billion in client assets. It also expands the distribution channels for both City National and RBC asset management products, as we will have around 2,100 advisors distributing products for both banks' platforms. In addition, City National clients will have access to RBC Capital Markets advisory, capital raising, and risk management capabilities. Third, this transaction allows us to extend RBC's commercial and corporate capabilities to City National's key industry specializations. For example, being a top 10 investment bank, we can leverage RBC Capital Markets' large technology practice to broaden and deepen City National's middle market and new venture platform. In addition, we can expand City National's commercial platform by adding verticals that RBC has sector expertise in, such as energy. If you turn to slide 12, you will note that we expect to achieve a number of synergies. First, on the expense side, while we will preserve City National's high-touch client strategy, which has been key to its success, we will see opportunity to consolidate infrastructure across businesses and achieve benefits of scale across functional areas like procurement and technology. We will also improve productivity by cross-selling City National products to RBC clients and vice versa. Second, we will be able to build a deposit base from our wealth management and capital markets clients and deploy low-cost sweep balances from our U.S. wealth management. Lastly, we will see many long-term opportunities, including increasing City National's market penetration in its existing footprint and accelerating expansion into new high-growth U.S. markets. In conclusion, this deal aligns with RBC's strategic goals, gives us best-in-class capabilities that enhance and complement our existing U.S. businesses, and creates a powerful platform for long-term growth that I'm confident will deliver significant value to shareholders. It is a great transaction for both RBC and City National, and we can now serve our clients in a way that wasn't previously possible. Before I turn it over to Janice, I'd like to mention that City National has a great team of about 3,600 employees, or colleagues, as they call themselves. Like RBC employees, they are very focused on collaboration and building deep, long-lasting relationships with their clients. I've had the opportunity to visit several City National branches. I've met with many City National colleagues, and I've been very impressed with the depth and breadth of their expertise and experience. I'm enormously excited to have Russell and his talented team join RBC. With that, I will now turn it over to Janice, who will discuss the financial aspects of the transaction. Thanks, Dave. Turning to the transaction details on slide 13, as Dave mentioned, the total consideration is approximately $5.4 billion U.S., or $93.80 per share of City National, comprised of, on average, approximately $47.25 in cash and 0.7489 RBC common shares for each share of City National common stock. City National common shareholders can elect to receive either cash or shares for their consideration, subject to certain adjustments. The aggregate consideration will be paid with approximately $2.7 billion U.S. in cash and approximately 44 million RBC shares. We expect that City National's loan, deposit, revenue, and earnings growth will be on average above 10% through the years 1 to 5. In addition, as Dave outlined, we estimate that the deal will generate significant synergies. In year 3, we expect to generate synergies of $100 million, which are made up of $70 million in expense synergies and $30 million in deposit synergies. By year 5, we expect to generate $210 million, which includes $120 million from expense and deposit synergies and $90 million from expansion opportunities. The transaction costs are $181 million pre-tax, most of which we will incur in year 1. I would point out that we have factored in all expenses, capital, and operational costs associated with City National being part of our U.S. bank holding company with assets greater than $50 billion. The transaction is expected to be accretive to earnings per share in the latter part of year 3, excluding amortization of intangibles, and accretive to earnings in year 2. We've been working on this transaction for some time, during which interest rate forecasts have been very volatile. As City National is an asset-sensitive company, this volatility impacted our performance outlook. To be conservative, our financial model reflects recent changes in the forward curve. An improving U.S. economy should result in rising interest rates, which would be favorable to our projections. Given our strong capital base and our internal capital generation, we expect to maintain our ongoing capital management program, and we expect to maintain a common equity Tier 1 ratio at closing, broadly in line with our current level, which was 9.9% at October 31, 2014. I would note that today our stock will trade ex-dividend. The deal is expected to close in the fourth quarter of calendar 2015, subject to customary conditions, including regulatory approvals and a 50.1% approval from City National shareholders. At this point, I'll turn the call over to the operator to begin the questions and answers. Please limit yourself to one question and then re-queue. Thank you. Operator? Thank you. We will now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register. Thank you for your patience. The first question is from John Aiken of Barclays. Please go ahead. Good morning. City National has actually been quite acquisitive in the past, although I understand recently it hasn't done anything terribly large. What does this acquisition do to the outlook for City National trying to continue to expand? Do we need time for the dust to settle, or can City National be active almost from this point going forward? I think we see two opportunities, John. One, first and foremost, we see fantastic organic growth strategies that will come out of this. In the short term, I'd say we're going to be focused predominantly on organic growth, cross-selling into our existing U.S. wealth management franchise. As we said, we've got over 300,000 clients who need the services of a private bank and commercial bank like City National. We expand the industry verticals, as we talked about, around technology, healthcare, energy, and entertainment. So great opportunities organically to bring our balance sheet, to bring our client base, and cross-sell together. That will be the primary focus over the first couple of years. We have such significant growth opportunity that we don't need to make an acquisition to further grow and achieve the synergies and create the type of franchise we want. If there was something that allowed us to expand into a market and grow, would we consider it maybe down the road, but it's really not part of our strategy right now. Our core part of our strategy is organic growth, market expansion, cross-sell existing client bases, and grow the business that way. Great. Thanks, Dave. If I could sneak another one in, Janice, you answered my questions about the assumptions embedded in your accretion analysis. City National is, as you pointed out, very asset sensitive. How does City National's platform compare to RBC's U.S. Legacy platform in terms of the asset sensitivity? I would say that our U.S. platform in retail is quite small, and City National is very well positioned for rising interest rates because of the fact that its deposit franchise is very large, and it's a lot of current accounts. If you look at the positioning, it's positioned very favorably for rising interest rates. That's why I commented that we think using the current forward curve, we've been slightly conservative in looking at five-year trajectories. Great. Thank you. We will also have some asset sensitivity in our U.S. wealth franchise under deposit and sweep base there. John, when you combine our U.S. Wealth Legacy franchise with the City National franchise, you enhance the asset sensitivity, which we think we're legging into the right timing of the market and rate increases. We're excited about that. Great. Thank you. I want to ask you about the Canadian side. Well, we should queue the next question. Thank you. The following question is from Gabriel Dechaine of Canaccord Genuity. Please go ahead. Hey, good morning. Just on the return on invested capital, we are looking at a deal that is about 5%. If I layer on the synergies as you have presented them, could add a couple hundred basis points to that amount. You have acknowledged that you are being conservative in your rate assumption or your rate outlook. What kind of environment would we need? What sort of deliverables would you need to provide to get that return over 10%? I am just trying to get a sense for your long-term view on returns on this investment. Thanks, Gabriel. It is Dave. As we think about the rate environment and how significantly it has changed even over the last 30 days, this is a culmination actually of a two-year process, a strategy review, customer review, market segment, how we reenter the market. We have been thinking about this for two years. But recently rates have changed. As Penny went through the growth and earning to an ROE ahead of our cost of capital, one, you have to assume a certain growth trajectory that is maintained in City National, which they have been growing well above market even if you take a lower growth rate. You look at the synergies we are able to drive that you just referenced. If you go back to, say, where the curves were in early December, late November, at year five that would add upwards of $170 million of NIAT. If you look at where we are today, which is kind of the low point it has been in quite some time, you go back to early December, it could add as much as $170 million in earnings by year five. It is incredibly asset sensitive. Okay. You have to take some view of where you are today versus where a normal environment is. But if you ladder those comments in nicely, it gets us well above our hurdle rate into double-digit ROEs. I don't have the curve in front of me. Can you remind me the delta between December and today? I think it was about 75 basis points on the five-year. Okay. If I can add a broader one just from a management standpoint, Dave. Your U.S. asset size is going to be quite large after this. The City National sub $50 billion, but put the two together, you're going to be over. How does that affect the regulatory burden of your U.S. bank post this transaction, and how do you expect that to change? Well, as Janice mentioned in her comments, we've considered that in how we've put together our forecast and financials of this becoming part of our bank holding company in the U.S. and having to look at the liquidity structure of the bank and whatnot. We've incorporated all what we expect to be the regulatory changes that we imposed on City National becoming part of our bank holding company. We've definitely considered all of those changes. We've also even thought about whether this makes us closer to a G-SIFI or not, and we've taken that into consideration in our discussion. I think we've done a lot of work and taken our time to understand how this changes and how it incorporates into our overall financial plan for City National and our U.S. Wealth business. Janice, you were going to make a comment on his previous question. Right. Gabriel, just two things following up on our holding company structure. We are well on our way to reporting with the new regime with $50 billion. For us, it's a matter of incorporates into this business. This is not a game changer for us, and that's what we're talking about, enhancing the structure. We're well on our way to setting up to accommodate this. You asked Gabriel about return on equity, and I just want to point out that we have always discussed in terms of our long-term view, the fact that we in essence are going after earnings growth. We know that from a return perspective, there will be some dilution, but we can see clearly a walk back into our objectives in terms of return on equity with the added benefit of having earnings growth and earnings diversification. I just wanted to stress that as you're going through the modeling. Thank you. The following question is from Peter Routledge of National Bank Financial. Please go ahead. Hi there. Just looking at City National, I noticed their Tier 1 leverage ratio is quite low relative to peers. To what extent is your strategy to lever this platform up to get your accretion goals? Or would that be an add-on to your forecast? I think we've taken overall the LCR, the T1 ratio, and the leverage ratio into consideration at the bank holding company level as we manage this going forward. Janice, do you want to make Right. So Peter, I think that when you look at the strengths of the deposit franchises, both ours and theirs, we're going to deploy those deposits in terms of funding a lot of our growth expectation for City National itself and our broader U.S. platform. So it is both about adding assets as we expand the business, as well as more efficiently deploying all of the deposits and funding that we'll have when we aggregate everything. I guess in your three-year outlook, is the leverage ratio on a legal entity basis higher or the same? Just in your forecast. And where I'm going is there upside if you can get more leverage into the platform? I don't think that we look about it at the issue in terms of adding leverage. It's about adding good client assets. So it's not a binding constraint, but definitely we don't see any constraint in growing organically in the markets that we see with our clients. Okay. Thank you. Our leverage comes from utilizing our legacy sweep deposits to fund growth, using their surplus deposits to fund asset growth, becoming more competitive with customers they haven't been today. For example, we're going to become more aggressive in jumbo mortgages in cities like New York and Houston, Washington. We can attract customers that way. It's a very strong customer growth strategy that other franchises have pursued. Those are the synergies that we bring to the City National franchise that we think can accelerate growth and why we're confident in delivering those revenue synergies that we've articulated. Thanks. Do you have some sense of why they were selling? Why did they choose to sell? Well, it's a great question because they weren't selling initially. As I said, this was part of a two-year strategy that we sat down and thought about what customer do we want to serve, how do we want to serve them. In 2013, I approached Russell, and he had never met me before, and we sat down, and we just talked about how the two companies together could do something really special in the U.S. market. He says, "But I'm not for sale." I go, "But one day, if you do consider selling, would you pick up the phone and call?" That's how it started, was just a dialogue. The synergies and the opportunity for both our shareholders are so strong that we came to an agreement that this is a very exciting journey that we want to take together forward. But initially, they weren't for sale. Okay. Thanks very much. Thank you. The following question is from Brian Klock of Keefe, Bruyette & Woods. Please go ahead. Good morning. Good morning. I'll say that I've covered City National for quite a while on the U.S. side, and you have a really well-run bank you're acquiring, so congratulations on that. I'd imagine then the branding will stay City National in the U.S., especially in the deposit footprint. I was just kind of wondering about on the revenue, the deposit synergy side. I guess, were you baking in any sort of deposit runoff after the announcement of the deal? They're a 70% loan-to-deposit ratio, so there is a lot of extra deposits there. I was just kind of thinking about how you had thought about sort of the deposit retention rates. Yeah, great question. We spent a lot of time not on deposit retention rates, but on deposit betas in a rising rate environment and spent quite a bit of time thinking about it. We think we enhance City National's franchise by putting a very strong rated global institutional balance sheet beside their great service franchise. We enhance the strength of the City National franchise, and we think we're going to attract more deposits, particularly from larger corporates who may diversify their deposits because of City National's relatively small balance sheet today compared to theirs. We think from both a deposit and lending perspective, that our partnership enhances their ability to do business and attract and retain customers over time. Okay. I guess maybe just a follow-up question with Peter's question on the leverage. It always has been one of those things for City National that the TCE or the leverage ratio has been very low, and it's because they've carried a lot of securities balances. Right. I know they've kept that securities book about one third into short duration. Right I guess, would the assumption be that as that securities portfolio cash flows, you may be able to deploy that into maybe some of the other opportunities you talked about for either RBC Capital Markets or some of the other products that maybe City National couldn't offer before that you could? You've read our playbook. Okay. That's exactly it. All right. Thanks for your time. Thank you. There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. McKay. I want to thank everyone for joining us this morning on short notice. I just want to reiterate how excited we are to take this next step into the U.S. marketplace. It's a fantastic franchise in City National. I think we enhance it in so many ways, and we are going to provide a really compelling value proposition to high net worth and commercial customers in the U.S. market. Thank you very much for joining us this morning. Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your partic-