M&A announcement

Apr 3, 2012

Good morning, ladies and gentlemen. Welcome to the RBC Acquires Full Ownership of RBC Dexia Investor Services conference call. I will now like to turn the meeting over to Ms. Amy Cairncross, Head of Investor Relations. Ms. Cairncross, please go ahead. Good morning, everyone, and thank you for joining us. Presenting this morning will be Gord Nixon, President and Chief Executive Officer, Jim Westlake, Group Head of International Banking and Insurance, and Janice Fukakusa, Chief Administrative Officer and CFO. Also joining you for questions is José Plácido, CEO of RBC Dexia Investor Services. 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 until 8:30. 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, and good morning, everyone. Today I'm pleased to announce our definitive agreement to purchase Dexia's 50% stake in RBC Dexia Investor Services, which is the tenth largest global custodian as ranked by assets under custody. Following the transaction, RBC will own 100% of what is now RBC Dexia. Before we discuss the RBC transaction, I'm sure that you saw the news release we issued yesterday regarding the CFTC. We certainly reject the allegations as unwarranted. This is not a financially material event to RBC, but we certainly take the situation seriously, and we intend to vigorously defend our reputation. Moving to the deal, we are certainly excited about this transaction for a number of reasons. First, this transaction is consistent with our overall strategy. It enhances our position as a leading provider of select financial services in targeted markets and provides additional global diversification. It also aligns well with our vision of earning the right to be our clients' first choice through award-winning service and superior product capability, as RBC Dexia is consistently recognized globally for its excellence in execution as well as client service. Second, the investor services business is highly complementary to our wealth management and our capital market segments, with similar market dynamics and a premier institutional client base, which aligns well with these global businesses. Additionally, having 100% ownership of a leading custodian business in Canada furthers our position as the undisputed leader in our domestic market. As shown on slide 5, our long history in the global custody business provides us with an in-depth understanding of its strong fundamentals and the opportunities that it provides for growth. Prior to the joint venture, RBC was a clear leader in the Canadian marketplace with full-service capabilities for all client segments and was recognized as a leading global custodian for institutional investors. In 2006, we joined forces with Dexia to leverage our combined leadership positions in both the Canadian as well as the European markets, and to achieve the necessary scale to compete on a global basis. To date, we have seen great success from this venture. With 100% ownership, we believe we can take the business to the next stage by leveraging our reputation, brand, and financial strength to support RBC Dexia's long-term growth strategy. With our credit ratings, capital base, and balance sheet, which are amongst the strongest of banks globally, RBC Dexia clients will benefit from the strength and stability that RBC provides, as well as our commitment to unmatched global custody investor administration services to our corporate and institutional investors around the world. The relatively stable earnings and the lower capital-intensive nature of this business is a good complement to RBC's diversified business mix. I would note that given the level of the purchase price, we are required from an accounting perspective to take a write-down on our current investment in RBC Dexia to reflect the current purchase price level. To illustrate the accounting complexity, generally speaking, if we had paid a premium to the book value, we would have recorded a gain. We are buying this asset at what we believe is a very attractive time at a very attractive price, and as a result, it will have this accounting impact, and Janice will elaborate further on that in her remarks. With that, I am pleased to turn the call over to Jim Westlake. Well, thank you, Gord, and good morning, everyone. Turning to slide 6, as Gord noted, RBC Dexia has grown to become the tenth largest global custodian based on assets under custody and continues to be a leader in Canada. It is truly a global business, headquartered in London, with over 5,500 employees in 15 countries around the world. It is the clear market leader in Canada and has a leading position in Luxembourg, which is one of the top markets in the world for global fund distribution, and in fact, is the second-largest fund distribution market in the world after the U.S. For the last 12 months ended December 31, 2011, RBC Dexia had earnings of EUR 123 million. Notwithstanding the challenging operating environment in recent years, driven by low interest rates and volatile equity markets, this is a strong business with attractive industry fundamentals, and it is well-positioned to benefit from higher interest rates and an improvement in market asset values. Turning to slide seven, RBC Dexia is in a strong and stable business serving a premier list of global institutional clients, including asset managers, pension funds, insurance companies, and financial institutions. RBC Dexia is one of the only truly global firms with extensive cross-border capabilities. It provides a full suite of competitive core products, including custody, fund administration, and transfer agency. It is differentiated in the market by its high-touch service and relationship model and value-added solutions, which help clients to grow their businesses and sustain enhanced performance through efficiency improvements and robust risk management practices. As Gord mentioned, RBC Dexia has been consistently recognized for excellence in service. In the Global Custodian Survey, one of the largest client surveys in the industry, RBC Dexia recently won top ratings in five categories. We have listed a few of the many recent awards and recognition RBC Dexia has received on slide 12 of our presentation. This is a very scalable business with leading infrastructure and processes already in place to compete for sizable mandates. In addition to a strong business, the long-term industry fundamentals are attractive. First, the growth trajectory of the business is aligned with the global wealth management industry, and as favorable demographic trends drive demand for wealth accumulation products, solutions, and advice, we should see growth in assets under care at RBC Dexia. Second, as Gord mentioned, the lower capital-intensive nature of this business means it does not require significant balance sheet to grow. Finally, with increasing market complexity, including regulatory changes, global institutions that provide investor services in-house are increasingly outsourcing these activities and operations in order to focus on their core businesses. RBC Dexia is well-positioned to attract this new business. As slide eight shows, full ownership of this business allows us to leverage RBC's strengths to truly support RBC Dexia's long-term growth strategy. Going forward, RBC Dexia will continue to increase its broad geographic coverage of key onshore, offshore, and distribution markets, expand and evolve its product and service capabilities, and deliver a globally integrated and differentiated client experience. We will remain a premier partner to top asset managers worldwide and a leading global provider of fund services by differentiating ourselves through award-winning superior client service. Furthermore, RBC Dexia can leverage the strong risk culture and robust systems of RBC to ensure a disciplined approach to future growth. RBC Dexia is a powerful franchise that can compete in the high-growth security services market around the world, and we are happy to have the opportunity to own 100% of this business. At this time, I'll turn the call over to Janice Fukakusa. Thanks, Jim. Slide 9 contains a summary of the transaction details. The purchase price for this transaction of CAD 1.1 billion will be paid in cash, and we are not required to issue any equity to fund this acquisition. The expected closing will be mid-2012 and will be subject to customary closing conditions, including regulatory approval. This transaction is expected to be moderately accretive in fiscal 2013. In conjunction with this announcement, RBC Dexia Investor Services has sold EUR 1.4 billion in nominal value of Dexia Group securities back to the Dexia Group and has acquired approximately an equivalent amount of U.S. dollar-denominated securities consisting primarily of notes issued by large global financial institutions. As a result of the sale of Dexia Group securities, RBC Dexia will recognize a loss, and our proportionate share of this loss is approximately $30 million after tax. We expect to record this loss in the second fiscal quarter. With the acquisition of the other 50% interest in the joint venture that we do not already own, we are required from an accounting perspective to revalue our existing investment in the joint venture to reflect the purchase price. This revaluation results in a non-cash loss of approximately $170 million after tax, primarily reflecting a write-down of intangibles. A majority of this loss will be recorded in the second fiscal quarter. During the time of announcement of this transaction and up to closing, we will continue to revalue our existing investment in the joint venture. Our proportionate share of any earnings of the joint venture will be offset by a corresponding accounting adjustment. At closing, we expect this transaction to reduce our Tier 1 capital ratio on a pro forma basis by approximately 25 basis points. The disposition of our U.S. retail banking operations, which closed March 2, 2012, improved our Tier 1 capital ratio by 100 basis points. Our January 31, 2012 Tier 1 capital ratio, adjusted for both transactions and the disposition of our U.S. retail banking operations, would be 12.9%. At this point, I will turn the call over to the operator to begin the questions and answers. Please limit yourself to one question and then requeue. Thank you. Thank you. We will now take questions from the telephone lines. If you have a question, please press *1 on your telephone keypad. There will be a brief pause while participants register. We thank you for your patience. Our first question is from Robert Sedran of CIBC. Please go ahead. Hello, good morning. Just a quick question on the 1.9-odd billion Canadian securities taken back to replace the Dexia fixed income securities. Did those come off of Dexia's book, or was it done in the open market? I know they're denominated in USD, but perhaps if you can give us the geographic breakdown of the issuers, that would be helpful as well. Just on a related note, would any sovereign debt that may have been in RBC Dexia have been captured in previous disclosures? Rob, to answer the first part of the question, the securities that RBC Dexia Investor Services sold are Dexia securities. They are Dexia corporate securities. They sold them back to Dexia, and we replaced them with the notes issued by largely global financial institutions. So that transaction would have been valued based on market prices, but it was an exchange of securities from RBC Dexia Investor Services to Dexia Bank. When you look at, we have been proportionately consolidating our joint venture. So we have picked up 50% of all of the sovereign exposure. So in our previous disclosure about Europe and sovereigns, all of 50% of those exposures are there in our disclosure. So when we will be on a pro forma basis, picking up all of Dexia, the amount of sovereign exposure to Europe and the peripherals will not be significantly more. It will be slightly more, but not significantly more because we have been including them. Is it fair to assume that the securities that RBC Dexia took back are largely European financials? Well, they are actual securities issued by Dexia. Oh, okay. The answer is yes. I think, Janice, they would all either be covered bonds, or they would be a debt that is ultimately guaranteed by the European governments, Belgium, Luxembourg, and France. Is that not correct? Right. Yeah. And they are issued by Dexia. Okay. Yes. Got it. Thank you. Thank you. Our next question is from John Reucassel of BMO Capital Markets. Please go ahead. Thank you. I have a question for Jim. Jim, if I look at the AUC at RBC Dexia, how much of that is related to Dexia, the former partner? Are there any long-term deals to keep those around or talk a bit about that relationship? Yeah. Thanks, John. We wouldn't disclose any exact client details of any client, Dexia including. But I can say that any business directly with Dexia is very immaterial to this deal. And it is mainly a pure external third-party business. Okay. That's helpful. And then Jim, just two other quick things. You talked about a lot of growth prospects. Could you give us an idea of what you view long-term growth potential for this business? And then maybe what the interest rate sensitivity to the EUR 123 million in earnings last year, short rates are up 100 basis points. Give us some sensitivity to that earnings base. Sure. I think from a growth standpoint, I look at two things. Number one, there are many mandates that come regularly to the market. And certainly, we think that resolving the ownership will allow us to compete very effectively just as new mandates come up. Given that we won a lot of awards that our business is doing very well, this will really help us in just everyday business. The second thing, I mentioned a little bit in my remarks, but a lot of banks around the world are still doing their own custody in-house, where it's primarily for themselves, maybe a few external clients. And we think there will be a lot of opportunities in key markets to us to do lift-outs where this business becomes available. And so we're quite excited about the opportunities in both of those. In terms of interest rates, I'll maybe ask José Plácido if he'd just like to make a comment on that. Thank you, Jim. Basically, on the interest rate environment, we saw in 2011 a pickup because of some of the increases that happened in the Canadian market. It's actually been pretty stable. In terms of our deposit base, we've actually grown our deposit base, and obviously, we are taking a look at how we can manage our deposit base much more effectively as we go into RBC. But clearly, the interest rate environment is one that we've put a lot of attention on and had to become much more effective and efficient and rebalance our product suite. We've moved much more into the middle office and some of the other value-added products to make up for the shortfall from the highs of the 2007, 2008 interest rate environment. Okay. Jim, just on the growth, long-term, is this a mid to low teens grower, or is it a high single-digit grower in your view? I think it could certainly be double-digit growth. Okay. Thank you. Very good. Thank you. Our next question is from Michael Goldberg of Desjardins Capital Markets. Please go ahead. Thank you. Couple of questions. First of all, Janice, could you give us the pro forma Common Equity Tier 1 under Basel III for both the sale of RBC Bank and this transaction? The actual impact is quite similar because it's all around the equity account. I would say that if you look at the dollars impact, you can pro forma that in the tangible common equity ratio. It's the same impact. The percentages are different because the base is different. Okay. Secondly, just getting back to the sensitivity to interest rates, what would be the impact on the earnings from RBC Dexia of a 1% change in rates? Jose, do you have that 100 basis point increase in rates? What would that do to our deposit income and impact on that? Increase, right? Yeah. What would be the increase in that? About $20 million in revenue. Okay. Last question, going back to the legal issue that came up yesterday. In a nutshell, could I summarize this by saying that in your view, you were in full compliance with the law, you had even communicated with regulators to confirm that you were in compliance, but the legal action contends that what you did may have gone against the intent? I think, Michael, you can certainly summarize it that way. As I said, I think in our press release, we were pretty explicit in terms of what we had done to ensure that we were both compliant and transparent. I think that is a fair interpretation of our view. Okay. Is the way I put it a fair interpretation? I think so, yeah. Thank you very much. Thank you. Our next question is from Sumit Malhotra of Macquarie Capital Markets. Please go ahead. Thank you. Good morning. A couple questions just relating to. Let's start with the net income contribution. Your annual report shows that on your stake, you earned CAD 74 million from RBC Dexia in 2011. The comments around interest rates certainly make a lot of sense when I look back a few years when you were earning well above that, somewhere closer to CAD 140 million. But year-over-year, there was a pretty big pickup. Not to put you too much on the spot in terms of direct numbers, but for Jim or Janice, certainly more than a doubling of that income from 2010 to 2011 as interest rates went even lower. Can you talk a little bit about what drove that? Yeah. I think Jose Plácido should probably take that one, Sumit. Yeah. So we have substantial client deposits in Canadian denomination, and in 2010, there was a 75 basis points increase in interest rates in Canada. So that's where the lift came from. Sorry. So in 2010, your net income, as was shown to us, was 29 million. So you're saying that the benefit of that came through in 2011, that's what you mean? That's correct. Okay. I will save the forward-looking question for another time. Maybe for Jim Westlake, opportunities to grow this business. Is there a potential for acquisitions in the custodial business, and was your opportunity to participate in any transactions limited by the uncertain financial position of your former partner? Sumit, I think that there are two ways to look at that. There are very few opportunities to buy other pure custody firms. If you look at the top 10, there is not a lot of activity that will likely go on with one firm purchasing another. But activity in the lift-outs, which is the independent banks, could be very substantial over the next few years. So it is not really an acquisition of another custody firm, but it is acquiring substantial custody business. I would say that over the last couple of years, certainly with the issues that Dexia has had completely unrelated to RBC Dexia, we certainly feel that the ownership issues probably were a detriment to us from a new business standpoint. We were able to maintain all of our existing business, but felt that it was restricting us somewhat in competing, either for new mandates or on acquisitions of lift-outs. Lastly, for Janice Fukakusa, just on how this will impact how you report your results to us. So if I look at the international banking segment, you give us a revenue line for RBC Dexia. I am assuming in terms of your fee income that rolls through investment management and custodial fees. So owning 50%, how has this been reported to us? Will there be a change in non-controlling interest as reported? Maybe if you could just give us a little bit of color there. Sumit, it's actually proportionately consolidated, so it's a line-by-line balance sheet and income statement pickup. We don't have any non-controlling interest, so what you'll see is basically we're doubling everything. Sure. There'll be some change. You saw in our notes the financial statement amortization of intangibles, that will largely be gone because of the write-down. So there'll be some changes at the consolidated level, but it's a doubling on a line-by-line basis. Okay. We'll work that through. Thanks for your time. Thank you. Our next question is from Darko Mihelic of Cormark Securities. Please go ahead. Hi. Just a question with respect to I guess I am still a little confused on the EUR 1.4 billion. Why were you forced to take securities? Darko, it is Janice. The exchange was that we exchanged Dexia issued securities for other issuers, which were primarily large global financial institutions. From our perspective, it was a better mix for us given the fact that we are 100% owning this entity going into the future. I think that that was one of the areas that we discussed with Dexia in terms of the fact that they had issued those securities they would be maturing and ultimately would flow back. We wanted to actually accelerate some of those maturities. But I think, Janice, Darko's question, those would have been securities that would have been held in the treasury of RBC Dexia. Okay. These are just short-term securities for liquidity purposes, is that? Well, yeah. Basically for liquidity to manage the deposit flows. Sorry, Derico. They are in the available for sale securities portfolio. Right. I think important with respect to how we structured this transaction from our perspective, was to ensure that we put ourselves in a position where the securities that we replaced with were mark-to-market liquid securities, where we had the ability to manage it as opposed to some of the Dexia-related securities that were in there, which presumably would have had less liquidity to them. Okay. I think I understand. Maybe just a real quick follow-on. In the past, it was suggested that this business was actually better as a partnership. Now, there's a lot of benefits of ownership, I suppose. I guess the question is, what was the process like? Were there other people interested in actually picking up the other half? Or was your role just so strong that it was basically a negotiation between yourself and- It was more the latter, simply because of the position that Dexia found itself in given what has happened in the European marketplace. There was an ability, certainly, to go a different route, but I think it made sense from everybody's perspective to negotiate a transaction between ourselves and RBC Dexia, and that is what was done. Then I would say with respect to the partnership, I think it's important to emphasize this. The partnership was of great value we believe in terms of us building this business, in terms of the foothold, the expansion that it provided us in the European market. Dexia, through the piece, were really a terrific partner. Unfortunately, their circumstances changed. As a result, the partnership rather than being a source of strength, was becoming more a source of weakness because of the position that Dexia found itself in. When we look back in terms of where we are today versus when we announced the deal, we think it was a very good transaction in terms of enabling us to continue to build out the business going forward. It put us in a position, particularly on the continent, that was different from what we would have been on our own. I think we will benefit from that in terms of building the business going forward. I think the importance of a partnership, a lot of it unfortunately is just driven by timing and circumstances as opposed to whether it is the right structure or the wrong structure. Okay. Thanks a lot. Thank you. Our next question is from Brad Smith of Stonecap Securities. Please go ahead. Sure. Thanks very much. My question is really to the economics of the purchase, and I wanted to get some information with respect or confirmation. It looks to me like you are paying probably around 13.5 times trailing earnings, which albeit may be depressed by volatility in interest rates. I would say that this looks like a 10%, 11% earner business even historically at the best of times. I was just wondering where you see the future returns on this capital investment vis-a-vis your cost of bank capital and where you see the returns that you might be able to achieve on these so-called lift-outs going forward. Brad, why don't I start with the answer to that, and maybe Gordon, Jim, you could chime in. I think that when you look at the purchase price and you look at the number of opportunities that we have, as Jim previously said, we think that this is clearly a double-digit return business, and we see a lot of synergies. With respect to the joint venture, we had just got it started in terms of penetrating the markets when we ran into the unfortunate situation, and Dexia was in an unfortunate situation as a result of Europe. We see a lot of pent-up growth prospects here. We've also retooled the business considerably so that in terms of the cost base, they have actually gotten some really good efficiencies through moving some of the production to lower cost areas. With the revenue synergies and the revenue expansion, in addition to continuing to drive the expense synergies, we see that this will earn well above our cost of capital. I'm sorry, Janice, just to be clear, when you say double digit, that's quite a wide band. Is that less than 13% or Yeah. It's Jim, Brad. I think certainly from an earnings standpoint, earlier I said I think it's a double-digit growth business, and I would say that I would put that lower. I'd be quite happy if it were in the low double digits. Certainly mid-teens from a return standpoint. Also, I think that if you look at standalone companies in this space, they've historically traded well up in the high teens and even at 20. It's down right now, but we certainly see this as a business that can return to that type of environment as markets get better and rates increase. Thank you very much. Thank you. This concludes the question and answer session. I would now like to return the meeting over to Mr. Nixon. Great. Well, thank you very much, everybody, for participating. As we said, we are very excited about getting this deal done and moving forward. If there are any further questions, I know that Amy is happy to direct them as the day goes forward. We appreciate your participation, so thanks very much. Thank you. The conference has now ended.