M&A announcement

Oct 23, 2012

Slides

Good morning, ladies and gentlemen. Welcome to the RBC conference call. I would now like to turn the meeting over to Ms. Amy Cairncross, Head of Investor Relations. Please go ahead, Ms. Cairncross. Good morning, everyone, and thank you for joining us. Presenting this morning will be Gord Nixon, President and Chief Executive Officer, Dave McKay, Group Head of Personal and Commercial Banking, and Janice Fukakusa, Chief Administrative Officer and CFO. Remarks this morning will refer to a slide presentation, which is available on RBC's investor relations website. Following these remarks, we will conduct a Q&A session, and the call will conclude at 9:00 A.M. Please note that our remarks may contain forward-looking statements which have inherent risks and uncertainties. Slide 2 of the presentation contains our caution regarding forward-looking statements, which describes factors that could cause our actual results to differ materially from these statements. I will now turn the call over to Gord Nixon. Thank you, Amy. Good morning, everyone, and I apologize if there's static on my line, but I am in transit, so when I finish my comments, I will be putting it on mute. Today I am pleased to announce RBC's definitive agreement to purchase Ally Financial's Canadian auto finance and deposit business for a net purchase price of CAD 1.4 billion, which is a CAD 614 million premium to book value. We're very excited about this transaction for a number of reasons. First, the deal is consistent with our goal of being the undisputed leader in all areas of financial services in our domestic market, as the acquisition positions RBC as a leader in the auto finance business in Canada. As well, this business is perfectly aligned with our Canadian banking strategy. As you will hear from Dave, Ally Canada brings an exceptionally strong sales force with deep relationships, and the scale of their operations significantly enhances our distribution network. Finally, we believe this deal will deliver long-term strategic value and provide significant opportunities given the strength of the combined business and the attractive dynamics of the industry. In summary of the deals that we have looked at in Canada, this was the one that we really wanted as it's a business that we like. It's a business that we have not been a leader in, and this clearly positions us as a leader. We're very excited about it. With that, I will turn it over to Dave McKay to expand on the strategic benefits of this transaction. Thank you. Thank you, Gord, and good morning, everyone. Turning to slide 4 on your deck, RBC is acquiring a leading Canadian auto finance services company with over 90 years of experience. Ally Canada has a full-service platform providing nationwide auto financing service to dealers and consumers. Their strength lies in their deep industry expertise and unique business model focused on dealers, both of which are key competitive advantages in the market. They have a long-standing relationship with approximately 1,600 dealers and offer floor plan financing contracts to more than 580 auto dealerships. Through this strong dealer distribution network, Ally's auto finance business has over 450,000 consumer loans. This is a high-quality portfolio and stable. Ally Canada's historically low loan loss experience reflects their disciplined risk management and their commitment to excellence in customer care, a differentiator in the market. Turning to slide 5, this deal positions RBC as a leader in auto financing in Canada, as Gord referenced. At closing, the combined business will have approximately CAD 24 billion in receivables, offering floor plan financing to more than 890 auto dealerships. Additionally, RBC's consumer business will offer financing through approximately 4,000 dealer relationships, and a combined portfolio will have more than one million consumer loans. We know this industry very well and believe it provides attractive dynamics for growth. Turning to slide 6, the acquisition strengthens our market position and aligns perfectly with our Canadian banking strategy. Extending our sales force is a key element of our strategy. The addition of Ally Canada significantly expands our distribution network and provides the ability to leverage RBC's superior cross-sell abilities to offer additional banking products to both consumers and auto dealerships and their owners. Ally Canada's highly experienced and knowledgeable sales force brings a commitment to exceptional service and advice consistent with RBC's vision of always earning the right to be our clients' first choice. Finally, as you know, driving efficiencies and improving the customer experience is an ongoing focus for our business. This deal provides a tremendous opportunity to leverage RBC's size and scale to drive synergies, and we look forward to working with the Ally management team to bring together the best of both businesses. I will now turn the call over to Janice, who will address the financial aspects of the deal. Thanks, Dave. Slide 7 contains a summary of the transaction details. The investment of the acquisition is CAD 1.4 billion net of excess capital, subject to certain closing adjustments and including the excess capital. This results in total consideration of CAD 3.1 billion to CAD 3.8 billion, depending on the size of the dividend taken out by the seller prior to closing. RBC expects Ally Financial's Canadian auto finance business to generate approximately CAD 120 million in net income on a standalone basis in the first 12 months after closing. This is before integration costs, amortization of intangibles, and transaction costs, which are anticipated to impact 2013 earnings by approximately CAD 50 million. These figures are based on estimated average receivables of CAD 9 billion, which factors in our assumptions on attrition, including a reentry of GM into the business and our different arrangements with manufacturers. This transaction is expected to be modestly accretive to earnings per share in the first year after closing. This deal is subject to customary closing conditions, including regulatory approval, and is expected to close in the first quarter of 2013. At closing, the acquisition is expected to reduce RBC's July 31, 2012 Tier 1 capital ratio of 13% on a pro forma basis by approximately 60 basis points. On an estimated Basel III basis, we expect our common equity Tier 1 ratio to remain above 8% following the close, given our strong capital position and internal capital generation, and there is no need to raise any equity. At this point, I will now turn the call over to the operator to begin the Q&A. Please limit yourself to one question, then re-queue. Thank you. Operator? Absolutely. Should you have any questions, please press star one on your telephone keypad. There will be a brief pause while participants register for question. We thank you for your patience. Our first question is from Mr. Rob Sedran from CIBC. Please go ahead. Hi, good morning. I just wanted to confirm, Janice, that the capital implications under Basel III would also be about 60 basis points. The pro forma right now would be around 7.7. On a related note, wondering if this has any impact on the buyback that was announced earlier, I guess in October. Thanks for the questions, Rob. With respect to Basel III, it is not 60 basis points. On a pro forma basis, it is lower than that. Remember that the denominator constantly goes up with capital accretion, and that is why it is much lower. I think it is around 30, about 30-40, and that would be at the time that we close. That is why we did not size it the way we sized the Tier 1 capital hit. With respect to the buyback, I had always said that our capital deployment is around funding strong organic growth, making acquisitions where they make sense and are accretive, and then looking, of course, at dividend increase in buybacks. We still intend, as we build very strong capital positions to 2013, to consider buybacks as one of the capital usage instruments that we will deploy in order to enhance shareholder value. But perhaps not as soon as it otherwise might have been? Well, I think that it won't be as soon, but we're still looking at it for the 2013 timeframe. Okay, thanks. Thank you. Our next question is from Gabriel Dechaine, Credit Suisse. Please go ahead. Hi. Just a question on the funding. Ally has a pretty high-cost deposit base. Wondering if, Dave, you can provide some clarification on your plans there. Are you just going to run that off and we can expect some additional spread enhancement through that and using your existing funding sources to replace that essentially, and what kind of timeframe there is for that, if at all? Just a clarification on the CAD 1.4 billion net investment. You talk about it being CAD 1.1 billion in 2014. How does that work, and does that just mean CAD 300 million is freed up in 2014? Let me take the first two questions. Certainly, if you look at the funding of the balance sheet and the expected CAD 9 billion of assets, there is an opportunity on the wholesale side to reduce costs there. As far as the ResMor Trust deposit base and the CAD 3 billion, as we work with the Ally management team, we will determine our strategy going forward and how we are going to deal with that business. Really, we will work through that at this point and see what we are going to do. You think there is an opportunity there, though, that you are going to take advantage of. Can you kind of quantify it possibly? It is built into our synergies, as Janice referenced. When we look at the operational synergies of moving off of the U.S. systems, Ally US largely runs the systems and ops for Ally Canada. As we move off of those, there are synergies. As we look at funding synergies offset by new competition coming to the marketplace. There is a number of moving variables that we plan for. But right now, I cannot comment on ResMor and the Ally business. We are going to continue to run it as is until we sit down with management and determine what is the most effective way of managing this business. Sure. Gabriel, it's Janice. With respect to the capital, we're talking about the net investment being underpinning about CAD 600 million of goodwill and intangibles and CAD 800 million risk-weighted assets. As we move into Basel III AIRB approach, we expect that that number will go down on the RWA side. Okay. That's where you have the difference. Got you. All right, then. Thank you. Our next question is from Sumit Malhotra from Macquarie Capital Markets. Please go ahead. Sorry, Janice, just to start, can you just repeat that goodwill and RWA number from the portfolio you acquired? The goodwill is just over CAD 600 million, the goodwill and intangible goodwill. Then we've estimated about CAD 800 million to support the RWA under Basel II. CAD 800 million of capital. What's the actual RWA amount? That's probably. I guess I can back- It's about 9. It's under CAD 9 billion, I think. When you look at the portfolio, we talk about the CAD 9 billion of assets, that would be the RWA. Okay. That's helpful. On the earnings number, which you put at 120, or I think you're estimating you can get 120 as a standalone the first year. I saw a filing from Ally for what they called Ally Credit Canada Limited, which indicated something like 135 million was the profit they had in the first half of the year. Just wondering why the target that you folks are looking at looks so much smaller. I can shed some light, and I haven't gone over, in detail, that direct filing, but they can include the leasing business, which is not part of this deal. As we look at the balances of CAD 9 billion and the expected competition coming into the marketplace from General Motors, that would explain some of the difference between historic performance and what we're projecting for the first year. Just to be clear, I'll stop here, on the way Janice phrased the capital. If we were to look at this deal, not looking at the earnings accretion or capital accretion that Royal would generate in Q4 and Q1, just the impact today from adding the CAD 9 billion of RWA and the CAD 600 million of goodwill, I think that would be in the 50-60 basis point range, Janice, right, on the current 8.3%? If we pro forma-ed it at the July timeframe, I think it would be a little more than that. It'd be, I think, somewhere about 40-50. Okay. Pro forma-ing it at July. One of the things I wanted to add, with respect to Dave's explanation, is there's also an insurance business in Ally that's not part of the deal. So it is about mix. Well, I'm with you. Okay. Thank you for your time. Okay. Thank you very much. Once again, please press * one on your telephone keypad if you have a question. Our next question is from Darko Mihelic from Cormark Securities. Please go ahead. Hi, good morning. Dave, could you flesh out a little more for me what you mean, and maybe perhaps provide some details around the possible re-entry of GM as a competitor? What precisely does subvented business provider mean? What does the end consumer see, the person who is buying the car? He is going to see an RBC loan. What are you expecting? Are you expecting GM Canada to come back with a leasing program, a lending program, and how much business or competition do you think will come about as a result of that? Is it simply a spread compression? Can you just maybe provide some more detail around that? Yes. Great question. GM has certainly been very public during this process that they planned on re-entering the subvented retail consumer lending business in Canada and in other countries at the same time, in order to provide financing support largely at the near-prime, subprime end of the scale in order to support their dealerships in moving product, obviously. We have had discussions, you see as part of our announcement, that we have signed a subvention agreement with General Motors. We work very closely with General Motors and have a strong partnership there. Having said that, as we looked at the current market share that Ally has, we have forecasted that to come down somewhat, both on the floor plan and on the subvented side. There will be largely four core partners on the GM subvented business, of which RBC/Ally combination will be one. General Motors is expected to be another, and there is likely two other lenders in that mix. As we forecasted market share and balances, that drove our expectation of the CAD 9 billion average assets versus carrying, I think their last disclosure was probably closer to CAD 11.5 billion. We have taken that into consideration as we have modeled our financials and looked at this business going forward. We are very comfortable with the relationship with GM and the subvented agreement that we signed prior to negotiating the definitive agreement with Ally. Maybe just as a follow-up, the expectation is obviously a squeeze on loan balances. Do you also assume, presumably, maybe tighter spreads? Just lastly, again, from a branding point of view, what is the consumer seeing? Right. This will be an RBC loan on the consumer document. This is standard. The industry structure won't change as the loan is sourced through the dealer. However, it is an RBC loan, and it's all done in an interconnected system with the dealer. So it is an RBC loan and will continue to be managed that way. As far as margins go, we've taken existing industry margins, which I know are holding up quite well and are providing good ROEs for us. So I think there is an orderly competition in the marketplace, and we don't expect the entry of GM largely into the near-prime, subprime space to drastically change margins in the business. It's a fourth main provider coming in for the GM dealer consumer business, and it shouldn't drastically alter the price landscape. Just the balances that will sit on the balance sheet. Okay. Thank you. Thank you. Our next question is from Brad Smith, from Stonecap Securities. Please go ahead. Thanks very much. I just sort of had a general question about this move into domestic auto lending. You really, I don't think were there very significantly in the past, and I'm just wondering, was it just the opportunity that this acquisition presented, or is there something fundamental in your outlook for the auto loan return opportunity in Canada that's changed your thinking? Sure. This has been a very attractive, stable, good ROE business for us. As you've seen, we have roughly CAD 12 billion in auto financing receivables, CAD 12 billion to CAD 14 billion, including the floor plan. This allows us to go from what we see ourselves as a solid number 2, maybe number 3 in the marketplace, to a very strong number 1 player in the marketplace, as we said, with over CAD 24 billion of receivables. Our goal is to be 1 or 2 in every business that we compete in. We like the stability of the business. If you look at the loss profile of this business, the stability of it over time through cycles, it's a good business, and it brings in, as we see, 1 million consumer relationships and almost 1,000 high-end commercial relationships. So it's a good acquisition channel. It's a strong ROE business. It's a stable business. It's always been attractive, and the business is built off relationships with dealerships. To be strong on the consumer financing side, you need often to provide floor plan financing, and one plays off the other. You need to provide a holistic commercial consumer proposition to the dealers. This deal allows us to add more dealers, add more consumers, and build out a more substantial distribution network that will allow us to compete effectively in what we see as a modest growth business. Probably mid-single digit on the asset side, but a very strong and stable business with good relationships. Chance to cross-sell consumers credit cards and other products, chance to cross-sell dealer relationships, cash management, other products. Overall, we are very attracted to this business, and it allowed us to step up in a much bigger way. Terrific. I just had two quick follow-up questions. Could I just ask to get some sort of reconciliation between the CAD 24 billion of receivables in your page 5 of your notes here and the CAD 9 billion in the actual press release? Right. I was just wondering if I could get a comment, just for furthering your reference to a good ROE business. What is the expectation there? Thank you. The CAD 24 billion represents the combined existing RBC plus acquired Ally business. Okay. If you take the roughly CAD 14 billion that we have on our books currently and add a little bit over CAD 9 billion, that is where you get to CAD 24 billion of combined auto financing business between the combined entities. That is your reconciliation there. You can see that the acquisition almost doubles where we are today to the combined entity. The ROE in the business is strong. It is in the high single digits, and that is without the cross-sell. That is on a standalone basis. If you were to add the cross-sell into it, obviously you can improve on it from there. I think overall, it meets all our financial when you look at span, and this is the combined entity I am talking about right now. It meets all our target hurdle rates as far as the combined auto financing business. Terrific. Thanks very much. Thank you. Our last question from Steve Theriault from Bank of America Merrill Lynch. Please go ahead. Thank you very much. A couple of just quick things for Janice. Janice, when you spoke to the 30 to 40 basis points of dilution on close on a Basel III quarter 1 basis, do you have in mind there the advanced or the standardized approach, and what is the relief when you do adopt the advanced AIRB approach? AIRB. Yeah. Thanks, Steve. It would be pro forma on advanced AIRB. Okay. That's what gets it a little bit lower. Yeah. Okay. That's why it's a difficult issue to put into writing in our documents. I'm glad that it has been discussed thoroughly here on the call because it's a little tricky when we're moving into the new regime. I appreciate that. One other quick one was, we didn't discuss the loss rates at all on the Ally business, unless I missed it. Could you talk about where the loss rates on Ally's business peak this cycle? Was that any different than your legacy auto lending business? If you could give us a sense of the normal loss rates Loss rates. that'd be great. Certainly, we'll have to go back and get the peak cycle loss rates for you on this. It's usually a pretty stable business as we look at our own experience. But the expected loss on this business is in the mid-20s, so 20-25 basis points would be kind of in a normal course. It's a secured business, so you shouldn't see that much volatility. Less volatility than unsecured, I would think. But we'll go back and provide the cycle experience. But certainly with margins give you good coverage for any volatility in PCL on this. But right now, it's in around 23-25 basis points. Thanks very much. Which is a low-loss secured business. Thank you. There are no further questions registered at this time. I would now like to turn the meeting over to Mr. Dave McKay. Well, I just want to reiterate how excited we are to be able to double the size of our business in the auto finance side, and we really believe the combination of Ally and RBC presents a great opportunity for profit growth and for business growth within Canadian banking, and I just wanted to thank everyone for your attention and time on such short notice. Thank you all. Thank you. The conference call has now ended.