Investor update

Jun 20, 2011

Slides

Good morning, ladies and gentlemen. Welcome to the RBC Investors and Analyst Conference Call. I would now like to turn the meeting over to Ms. Josie Merenda. Please go ahead, Ms. Merenda. Good morning, everyone, and thank you for joining us. Speaking to you this morning are Gord Nixon, RBC's President and CEO, and Janice Fukakusa, RBC's Chief Administrative Officer and CFO. I am also joined by Jim Westlake, Group Head of International Banking and Insurance, Jamie Anderson, Head of RBC's Corporate Strategy and Development Group, and Morten Friis, our Chief Risk Officer, who are here to answer your questions. Remarks this morning are accompanied by a slide presentation which is available on RBC's investor relations website. 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 describe factors that could cause our results to differ materially from these statements. Following the prepared remarks, we will open up the call for a question and answer period. Please limit yourself to one question and then re-queue. With that, I'll turn the presentation over to Gord Nixon. Thank you, Josie, and good morning, everyone, and thank you for joining us. We wanted to share with you the details of our recent decision that you've all read about regarding RBC Bank. After evaluating and exploring many alternatives, we have decided to accept PNC's offer to purchase our U.S. retail banking operations for approximately $3.62 billion. We're happy with PNC's purchase of RBC Bank as PNC is an outstanding organization with market-leading U.S. franchise and has significant scale and a proven ability to succeed in this market. We feel this is the right decision for all of our stakeholders. Given the dynamics and highly competitive nature of the U.S. retail market and the increasing challenges as a result of both the economy and regulation, success in our view will require operational scale which can only be achieved by making large capital investments. We believe we can achieve greater shareholder returns by investing the proceeds from this sale into higher return businesses. Specifically, the additional capital can be used to fuel organic growth across all of our business segments and invest in other businesses such as wealth management, where we have been targeting some international asset managers. As you have heard me say before, strengthening our capital position in light of the increased future capital requirements, particularly given the economic environment, will give us a competitive advantage and allow us to capitalize on a number of unprecedented opportunities as well as the potential to return more capital to our shareholders through dividend increases or share repurchases. I would comment that RBC remains fully committed to the U.S. market, and today's announcement sharpens our strategic focus and reaffirms our U.S. growth strategy. This strategy centers on maintaining our cross-border banking services to meet the current and future needs of our clients and the continued growth of our two largest U.S. businesses, RBC Wealth Management and RBC Capital Markets. Meeting the needs of our cross-border clients remains a priority for us, and as we announced this morning, we will maintain U.S. operations to service the needs of Canadian clients across the U.S. and provide banking services to our wealth management customers and capital market services in the United States. RBC will continue to offer RBC Access USA products, including funds transfers between Canada and the United States, the option of preferred foreign exchange rates, and a no-fee RBC U.S. Dollar Visa Gold card. Cross-border banking clients will continue to have seamless access to funds and banking products like mortgages, loans, ATM access U.S. dollar accounts, and debit and credit cards, as well as integrated online banking. Growth in the United States through our wealth management capital markets businesses, which combined employ over 8,000 people, forms a critical part of our overall global strategy to be a leading provider of wealth and capital market solutions globally. Following significant growth in the past five years, RBC Wealth Management is now the fifth-largest wealth manager and full-service advisory firm in the United States, while RBC Capital Markets is the eleventh-largest global investment bank by fees. RBC Wealth Management in the United States ranked highest in investor satisfaction, according to the J.D. Power 2011 U.S. Full-Service Investor Satisfaction Study, which was just released. We have built global capabilities in capital markets and wealth management, and we will continue to leverage our strengths as we enhance our cross-selling opportunities, deepening relationships, and offering the best solutions for our customers. Although Janice will take you through the financial details and implications of this transaction, I wanted to make a couple of comments. The completion of this transaction will stabilize and improve the quality of earnings, adding an estimated $0.10 per share to earnings in fiscal 2012 based on the conservative assumption that proceeds from this sale are reinvested at our current cost of capital. On a pro forma basis, this transaction results in an immediate benefit to both our Tier 1 capital and Tier 1 common ratios, which we think are extremely important. I would conclude by just emphasizing my view that the current economic and regulatory environment that banks must ensure that capital is deployed in areas where they have competitive strengths and where they can earn strong returns. I believe this decision is in the interest of our shareholders and various stakeholders, as it will provide us great flexibility to take advantage of opportunities in an unstable market as we move forward. With that, I am going to turn it over to Janice to outline some of the financial implications. Thank you, Gord, and good morning. Turning to slide 4, the sale of our U.S. retail banking operations will result in total proceeds of $3.62 billion US, consisting of $3.45 billion US dollars for the purchase of RBC Bank USA and $165 million US for the purchase of certain credit card assets of RBC Bank (Georgia), National Association. The purchase price is comprised of a minimum of $2.62 billion US in cash and up to $1 billion US in common stock of PNC at PNC's option. Any PNC shares received at closing can be sold without restrictions. As noted on slide 5, we expect to record an estimated after-tax loss of $1.6 billion in the current quarter. The majority of the loss reflects an estimated pre-tax $1.4 billion write-off of goodwill in our international banking segment. Under IFRS, we expect the loss will drop to about $300 million as we anticipate that goodwill will be impaired, and this impairment will be recognized as part of the transitional adjustments to RBC's opening balance sheet as at November 1st, 2010. As a reminder, we will begin reporting our results under IFRS on November 1st, 2011, which will include fiscal 2011 comparative results. As Gord mentioned, we anticipate this transaction will be accretive to earnings in 2012. RBC's balance sheet will come down with the removal of RBC Bank, and we expect assets to decline by $26 billion and liabilities to decrease by $21 billion. Moving to capital on a pro forma basis as at April 30th, we expect RBC's Tier 1 capital ratio to increase by 140 basis points and the Tier 1 common ratio to increase by 100 basis points. This increase largely reflects the $24 billion decline in risk-weighted assets associated with the sale. This transaction is subject to customary closing conditions, including regulatory approvals, and we anticipate the sale to close in March 2012. With that, I will now open up the call for questions. Operator? Thank you. We will now take questions from the telephone lines. 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. Our first question is from Robert Sedran from CIBC. Please go ahead. Hi. Good morning. Gord, can I just ask you to clarify that comment about $0.10 accretive, assuming you reinvest at your cost of capital? When I think about potential wealth management acquisitions, often in the first couple of years, you are actually not returning your cost of capital. So are you thinking organic growth with the money or a potential deployment through acquisitions to get the $0.10? Rob, good question. The answer is that the assumption we are using for that statement is just that whatever the capital is used for, we would expect to earn our cost of capital. The way we would build a model is we would, for instance, buy back shares in the model or would just assume that it would generate that kind of return. The point that I am making is if we were to do nothing, and we look at the return on our capital relative to the returns that we would be generating on RBC Bank, which would continue to be low in 2012, even though we would have expected it to return to profitability in 2012, the incremental return would be accretive to earnings. For our modeling purposes, and I would emphasize it is a modeling exercise, it is not based on an assumption of an acquisition, we assume that on that capital, we would be generating a return of approximately our cost of capital, which, Janice, we would use? Yeah, our cost of equity is about 10%. Right. Are you able to tell us how much or what the impact of RBC Bank (USA) was on H1 2011 on an earnings per share basis or earnings basis? On the first half? Yeah, the first half actual numbers. Oh, the actual. Just give me a minute there. For RBC Bank, Rob, you are asking? Yeah. Just the drag. Well, I assume it was a drag in the first half. Yeah. Yeah. It was a drag. We had losses in the first half, and in fact, we can get back to you on that. For Q3, we will be providing all of the comparative information so you can remove it out of your models and some history as we report our Q3 results. But we will get back to you on those numbers. Okay. Thank you. Thank you. The next question is from Steve Theriault at Bank of America Merrill Lynch. Please go ahead. Thanks very much. I will follow up with Josie. I would be very interested in seeing the first half numbers as well. Gord, in your commentary, you said you spent a lot of time weighing many options. Can you tell us a little bit about the process, how long the negotiation was? I assume this was a competitive process. Can you give us any sense of how many bids might have been put forth? Yeah, I would not provide too much disclosure as it was a private process. Suffice to say, we had a number of discussions with a number of potential partners or potential transactions. It was a very competitive process that in the end we felt very comfortable in that we had, as I say, a number of people very interested in the asset, various types of transactions. I will not comment specifically on what it came down to, but clearly, I think we concluded in the end that the best decision from all of our stakeholders' perspective was the PNC transaction. Obviously, price had a large part to do with that, but there were other factors built into the equation as well, including things like liberating capital and the ability to have financial flexibility going forward. But it was, in the end, a very competitive transaction. When you say liberating capital, that is really a function of cash versus shares, I guess? Yeah, absolutely. We looked at different alternatives and different structures. As you know, the new rules and regulations make it very challenging depending on the structure of a transaction. We looked at the pros and cons of different alternatives and different structures and the risk and reward. As I say, we felt from a risk-reward shareholder perspective, this was clearly the optimal transaction for our shareholders. Okay. Just to follow up, if I might. No restrictions you mentioned on the sale of any PNC shares received. This might be a tough one to answer, but would it be your intention to sell the shares in relatively short order, or could this remain as a pretty modest-sized investment for some time? Yeah. The comment I'd make is that we wouldn't comment on that. We wouldn't be in a position to provide you guidance on that at this point in time. What I will tell you is that we think that PNC is a very attractive organization, and their shares will, now this is, as you know, six to nine months out, but we believe their shares represent a very attractive investment opportunity. But in terms of what our intentions would be, it's certainly premature. We can't really comment on that at this point in time. I guess I'd just ask then on the capital side, the sensitivity you're giving to capital, the Tier 1 common up 100 basis points. Does that assume no shares received or CAD 1 billion of shares received? It is based on the three, the whole proceeds of the cash. Yeah, that is based on the 3.6. Yeah. Okay. It is cash. Thanks very much. Thank you. The next question is from John Aiken at Barclays Capital. Please go ahead. Good morning. Janice, it is very interesting that you are talking about providing the historical information for RBC Bank going back. Has there been any thoughts on how you are going to report international banking going forward? Is the segment essentially going to collapse on a reporting basis, or is this going to carry forward in future quarters? Well, from an accounting perspective, John, we will be reporting RBC Bank as discontinued operations, so it will be out of international banking, the international banking segment, but we will still have an international banking segment that will consist of our Caribbean bank plus our interest in RBC Dexia. Great. Thank you. Gord, I know that it is difficult to assess at this stage, and particularly when the transaction is closing March of next year. But in terms of your global expansion strategy on wealth management and capital markets, how long would you be sitting on essentially this capital, the inflow, even though it is just from risk-weighted asset reductions, but how long would you sit on this before actually starting to aggressively return capital to shareholders where you can? I think from a timing perspective, John, March isn't bad from a planning perspective because I think we'll have much greater clarity around things like the capital rules and so forth by that point in time. Hopefully, we will. I would say that because we are generating these proceeds does not mean that we have any intention to rush out and reinvest them in specific businesses. I think our strategy, as it has always been, is to continue to deploy capital across all of our businesses, which would include Canadian banking, insurance, international banking, potential opportunities, as well as our capital markets, and particularly wealth management. From a strategic perspective, this liberation of capital doesn't change those strategies. They will continue on. Given the fact that this closes in March and there should be greater clarity, I think it will be easier for all banks to have a better picture of their capital plans by that point in time than we do today because I think most banks today, as much as we have our internal capital plans, there's still a tremendous amount of lack of clarity and noise in terms of what the regulatory expectations are going to be in terms of core Tier 1. We feel very comfortable that we're going to be in very strong shape, and we will deploy capital across our businesses, and if there's excess capital we will have the opportunity to do things like buy back shares, and I think by next March should be a pretty good point for you to zero in on from a timing perspective. That's great, Gord. Thanks. Much more fulsome than I was expecting. Thank you. The next question is from Gabriel Dechaine from Credit Suisse. Please go ahead. Hi. Good morning, and congratulations. On a pro forma basis, your core Tier 1 at around 8%, is that a level that you think is going to, would you consider that excess capital or about where you'd want to be from a management perspective? On the use of proceeds, you did indicate that organic growth was one of your priorities, but also expanding the global wealth management platform. Could you give us an indication of which areas you're looking at? You've recently done a deal in the U.K. Is it the U.S. to add scale to the former Dain Rauscher or Asia? If you can provide any clarity there, that would be appreciated. With respect to the core 1 capital, I would make two comments. First, whether 8% is the right number or 7%, which is the current number, or whether that changes, will to a large degree be driven by regulation. As I said earlier, as much as we have more clarity today, there is still a degree of uncertainty as you read about every day in the papers what the ultimate expectation is. But I would remind people a couple of things. Firstly, we are very strong as we sit today. Pre this transaction, we already meet the 2019 Basel requirements. But more importantly or equally important is that we are continuing to generate more and more excess capital on an ongoing basis. If you look forward, there is no question that a combination of our current capital position and the internal capital generation of the organization, we feel very comfortable that it will put us in a very strong position to have the flexibility to invest. I might say at a time when most banks around the world are going to be in the opposite position, where they are going to be divesting because they are going to have to be building up their capital base, particularly the European banks, and to repatriate capital through dividend shares, et cetera. From a capital planning perspective, we clearly feel comfortable. If anything, I think we could be criticized as being overly conservative. But in today's environment, I would prefer to be criticized for that than the alternative. But where we end up in terms of 7%, 8%, et cetera, ultimately, that will be a determination of the regulators. In terms of the use of proceeds, as I say, we will deploy capital across all of our businesses. Our intention is to grow assets in even businesses like Canadian banking. Our international banking assets are still businesses that we are looking at opportunities. In terms of wealth management, it is a priority for us to continue to fill out our global wealth management platform. I would not expect to see any significant major acquisitions, but if there are opportunities to fill in specific areas that we feel would be additive to our global strength, whether that was the U.S. or Asia, et cetera, we are certainly looking at, and would continue to look at different alternatives. I don't want people to think that we've liberated this capital, and we're going to turn around and immediately invest it in wealth management in the U.S. or Asia. All of our businesses have various both capital growth use plans, as well as they're looking at opportunities to invest either directly in their businesses or through acquisitions. It will be very much business as usual as we move forward from an investment perspective. Okay. Helpful answer on the acquisition side of things. Just to go back to the eight or the seven, I know it's difficult to ignore all the other uncertainties out there, but when you, let's say 7%, we know that's one of the minimums out there. When you think of how you manage the bank and what kind of flexibility you need given some of the peculiarities, or not peculiarities, specificities of your business, do you think 100 basis point kind of buffer is something reasonable or excessive as far as how you manage your capital? Well, my own view is it's excessive, but unfortunately, I don't have that much influence with the regulatory discussions. Look, the Basel III number is 7%, and I've been very public that it's a reasonable number. It well capitalizes the banks. We should put a pin in that number and let us manage towards it. I believe that's the right thing, both from a regulatory perspective, a safety and soundness perspective, and ensuring that the banks have the ability to continue to invest and to grow and to provide capital and so forth. There is clearly a lot of different views, particularly out of certain constituents in the U.S. and Europe. There's a lot of discussion around global SIFIs, national SIFIs, what incremental buffers are going to be expected. My expectation is it's going to be a slight premium to 7% for those institutions that are certainly nationally important, which all the Canadian banks are. Now, whether there's incremental buffers for some of the global SIFIs, I think that debate will continue to wage on. But if you were to ask me to put a pin in terms of where I would expect the Canadian banks to end up, I suspect it will be at some form of reasonable premium to the 7%. I hope that's not wishful thinking, but that would be my best guess as to where we will end up, which well capitalizes our system significantly higher than where we were pre-crisis. As you know, our system managed through the crisis very effectively, significantly higher capital. I think that's a level that we expect to be able to earn strong rates of return. I think it's probably reasonable. But as I say, there's certainly a lot of continued regulatory noise as to whether they will move off that number or not, but that would be my best guess. Thank you. The next question is from Michael Goldberg from Desjardins Securities. Please go ahead. Thank you. Gord, in your presentation, in your comments, you said that a large capital investment would've been required to achieve the necessary scale to succeed in the U.S. retail banking business. Now having said that, why would you not have stepped up to the plate and made that investment? Can you give us some idea of the range of sizes that might be required to get that scale? What level of potential IRRs were you coming up with had you instead made that decision? I ask this question so that we can get some comfort that the reason that you're selling as opposed to buying is not just an expedient to avoid what might have been a negative reaction to actually investing that money. The capital expenditure that I referred to is not necessarily acquisitions. We're talking about the expenditure in terms of building up the existing platform going forward. There's no question that what is, in my judgment at least, happening in the United States as a result of the economic environment, but largely driven by regulation, I think a very changing dynamic, is that scale having significant product capability to push through a distribution network is becoming increasingly important. So the investment that I refer to is not just should we have acquired another bank, but the investment that we would be required in terms of product development, in terms of technology capability, in terms of backend processing capabilities. It is becoming increasingly important, I think, for institutions in that marketplace to be prepared to make those investments. Very difficult to make those investments without significantly expanding the customer base and the size and the scale of the platform in that marketplace. We have looked for quite some time as to the economics of acquisition and investment in that marketplace. We are extremely comfortable that from a shareholder perspective and from a risk-reward perspective, that this is a transaction that makes a tremendous amount of sense relative to the potential alternatives of investment and acquisition. Could you give us some idea of the CAD dollar size of that investment and the type of IRR that might have been generated just to demonstrate that the economics aren't really that great? Yeah, sorry. You're talking about the IRR from what? From a capital investment in technology? Well, to get the scale and to build up the product and the technology. In other words, to make it a competitive business in the U.S., what type of investment would've been required, and what do you figure the IRR might have been on that investment? Michael, I think you're asking a question which is much more granular than we have the ability to answer. If you look at our business plan, which we don't disclose publicly for RBC Bank going forward, in terms of the capital investment in that business based on their revenue base and scale, the IRRs of that investment would be very low. We are talking about having to make hundreds of millions of CAD in investments in technology and so forth, given the changing nature and dynamics of that marketplace, which is extremely difficult to do in an organization with $28 billion of assets and 400 branches. That was clearly one of the challenges, is that our belief, at least my belief, is that in order to justify the economics of those investments, you would have to have a much bigger platform and a much greater asset base and much greater scale to put it through. Without that, the IRRs would be well below our cost of capital. Okay. Had you made an acquisition as an alternative to get that scale, can you give us some idea of what kind of IRR might have been achievable? Looking at investments and acquisitions in the U.S. banking market for RBC Bank and where we are to get to the size and scale required, RBC Bank almost becomes secondary in that equation because you'd be potentially looking at an investment of a bank of significant larger size and scale than RBC Bank itself. So- When you go through the economics in our view of those investments, clearly from a risk-reward perspective, it would be very challenging for RBC, as I say, particularly in today's economic and regulatory environment. When you look at the valuations, when you look at the risk, when you look at the prices of potential large investments and acquisitions in that marketplace, our belief is that we can deploy capital elsewhere in our businesses at significantly higher rates of return. Thank you. Our next question is from John Reucassel from BMO Capital Markets. Please go ahead. Thank you. Janice, just a clarity, a question on clarify the accretion and the capital impact is all based on a cash purchase price. Is that right? Yeah, that's correct, because when you look at the share content of the offer, it's actually just like cash because it's the weighted average volume price for 10 days prior to closing and there's no restrictions on the stock. So when we're looking at doing our planning and capital release and that, we look to the whole proceeds being effectively cashed. Okay, great. Gord, just a follow-up. Over an 8 or 9-year period, Royal Bank invested, I don't know, $7 billion or $8 billion in U.S. regional banking. Could you maybe talk about some of the lessons learned, not just in particular on regional banking, but are there broader implications for your M&A strategy as you look at the world? I don't think so. I think that if you were to ask lessons learned, and you're going back a long period of time here. There were various investments made going back to Builders Finance and Prism Mortgage and, of course, RBC Centura, et cetera. I would say that my own view, and others may disagree with this, but my own view is that size and scale and quality is extremely important, particularly when going into a newer market or a newer business. To some degree, we've been challenged in that banking business from day one in terms of reasonable returns. We've had profitability through many of those years. But in terms of reasonable returns on capital, particularly given the pricing of those assets, I think you have to be competitive in a business to do smaller add-on acquisitions, and you need a very strong base to start from. I think that's one of the challenges that we have faced, is we really have not had that strong base from which to build on. I think that would clearly be one of the lessons learned from the investments in RBC Bank. Obviously, your wealth management and capital markets business, you believe you have the scale for the add-on deals with obviously, just having a much better position starting from Centura. As we've heard me say many times before, we believe we've got globally competitive businesses in those areas, businesses that have the ability not only to compete, but at the margin, earn good rates of return relative to others in the marketplace. As I said in my comments, this is not a complete exit from the U.S. retail business. There may well be opportunities going forward, but if they are, they're going to have to be areas where we believe we've got the strength, the franchise, and the capability to earn reasonable rates of return. A little bit coming back to Michael's question, when we looked at this business and we looked at the rates of return we were generating and expected to generate moving forward, even if we were to deploy capital and make investments and acquisitions, we just couldn't get comfortable that from a risk-reward perspective, those returns were going to be high enough compared with other businesses that we run across our various platforms. Okay. Thank you. Thank you. I would now like to return the meeting over to Ms. Josie Merenda. Please go ahead. Yeah. Thank you very much. Janice is going to actually spend a couple of minutes just on Rob Sedran's original question about the EPS impact for the first half of 2011 for RBC Bank. Right. Just to let everyone on the call know, and we'll put this up on the website, the EPS impact is about $0.06 a share loss in the first half related specifically to RBC Bank. Hopefully that's helpful, and we'll put this information up so that everyone has access to it. Okay. Can I turn it over to Gord to wrap up? Yeah. I would just thank everyone for their participation. As I say, this has been a long process from our perspective. As I said, we feel very comfortable that we've reached a decision here that is optimal for our shareholders and for all our stakeholders. I think PNC is a first-class organization. I've spent a fair amount of time with them recently. I think that they do have a franchise that I think will be able to provide the strength and the product capability and so forth to capitalize on our franchise. I think that would've been a challenge from our perspective, and as I say, we're very comfortable that this transaction will enable us to move forward and continue to look for opportunities to generate strong returns for our shareholders. Thank you for participation, and we'll speak to you at the next quarterly meeting. The conference has now ended. We thank you for your participation.