Barclays Global Financial Services Conference

Sep 13, 2022

Good afternoon. I'm Jacquelyn Titus. I'm a Managing Director in the Investment Banking Division at Barclays, and I head up the Canadian FIG team based out of Toronto. Today, I have the pleasure of hosting the fireside chat with the CFO of RBC, Nadine Ahn. I'd like to welcome Nadine. I'd like to welcome all of you in the audience. Due to the firm policy, following Royal Bank's announcement of the acquisition of Brewin Dolphin, research could not participate in this session, so you're stuck with me. I'm quite happy to have you, Jacqueline. It's fine. Thank you. Thank you. Nadine, let's start with a couple of macro questions. Sure. What's the bank's view on Canadian and U.S. interest rates in light of the macro geopolitical environment, elevated commodity and energy prices, employment, rising inflation, and the potential risk of a recession? I know there was a lot in there. Yeah. But Well, I think there is a lot going on, which is leading to a high degree of uncertainty. But I think the expectation, just given where we are seeing with inflation, with the aggressive response from the central banks to really bring down interest rates, that coupled with the labor shortage, it is going to have an impact on growth overall. We are expecting and forecasting that there will be a contraction in the economy in Canada. Although, we do think it will be moderate, and there is a couple of fundamentals that are really looking to help that land on a soft landing, as opposed to a deep recession. Part of that, obviously, is employment. We were sitting at quite low unemployment levels, and while we have seen that start to tick up over the last few months, we are still sitting with about 60% higher job openings than we did in February before we started the pandemic. So you are still seeing that robustness and that demand in the economy, particularly in the services sector. And so unemployment is a big driver of credit losses. So as long as we continue to see that, we have seen our favorable credit position with very low PCL in the last number of quarters. And so that is obviously a positive sign continuing to see. But as you expect, the interest rate driving is putting more pressure on individuals and their cash flow needs. But what you are seeing, in particular in Canada, is such a high degree of surplus liquidity. I would say in Canada versus what you may have seen in the U.S., where it is sitting more in the top 20% of the country base, you are seeing in Canada that it really got into the hands of both the consumer and the commercial. And for RBC in particular, given our leading deposit franchise, we have actually gained more than our fair share in terms of that increase in surplus liquidity. So you have got consumers and commercial clients sitting on a much healthier balance sheet, which you would expect to have a mitigating factor in terms of the overall impact to what we are seeing from the interest rates, which is why we are expecting that contraction to hopefully be muted over time. But given RBC's strength in that deposit franchise, and given our diversification of our business model, we think we are well-positioned given our strength in capital and reserve overall to weather whatever comes from the macro standpoint. Okay. That's helpful. There's a couple other topics such as credit and deposit franchise that I'd like to unpack a little bit Yeah as we go through the discussion. What do you think the biggest risks to the bank might be going forward? Well, I think it's going to be the corollary to that, if we do see the over-rotation really from the central banks in terms of creating a broader, deeper recession. The expectation is that we're driving forward on the interest rate hikes, which are a big tailwind for us from a banking standpoint. However, if that starts to overtip in terms of putting too much pressure on individuals from a cash flow basis and really causing sentiment to deteriorate and people sitting on the sidelines, that's where you're going to see that further contraction in the economy. I think as we've seen, particularly over the last year, the geopolitical impacts that can happen is associated with what we saw between the war in Russia and Ukraine. If that starts to further put pressure either on supply chains or on pricing, whether it's in further inflationary impacts, which could just drive the economy down further. I think that's really where you're going to see it sustained. But again, given our prudency in our reserving and our capital, I think that we can weather it. It's just what it's going to mean for growth overall. Got it. Just before we move to our first polling question, any questions from the audience at this point? Okay. Can we pull up the first polling question, please? Is it coming up? Maybe they were expecting you a bit later in the Okay. Oh, okay. Well, I guess we'll just move on from the first polling question. Maybe we can talk a little bit about the housing market. During COVID, we saw a migration of home buyers from urban to suburban, a movement away from city core in search of more space. Post-COVID, what trends is Royal Bank seeing in the Canadian housing market, and its impact on the bank's mortgage lending renewals and refinancing? Yeah. Well, I think what we're seeing is that the increase in interest rates from record lows is slowing down the buyer market. That's essentially what the Bank of Canada is looking to do. We had quite a robust mortgage activity coming out of the pandemic. We had exceptionally low interest rates. I mentioned that clients were sitting on that surplus liquidity, and it drove house prices quite up high. Right now what we're seeing is that projection in terms of a slowdown. But realistically, that's a bit of a healthy pullback in terms of where we were seeing not only house prices run up to, but in terms of our mortgage volumes. I would say that one of the things in Canada, in particular, is it's really a bit of a supply-demand dichotomy, because in Canada, we do have a very strong economic growth as it relates to our immigration policies, so that really drives increase in demand. You're seeing a number of individual single first-time homebuyers, or homebuyers in terms of single buyers, about 30%. That's up from 15% 10 years ago. So that's putting further pressure on our demand. While you're seeing a bit of a calibration as it relates to housing prices coming down from quite significant levels, becoming almost unaffordable, in addition to the rising interest rates, it's starting to temper that demand. So we do expect that slowdown coming into the next year. But I think that is the opportunity as well to improve some of the profitability. We have a great cross-sell across our mortgage product. Over 75% of our mortgage clients started with a product other than a mortgage, so it's a great opportunity for us in terms of our premium growth and franchise value to continue to improve the profitability on that. But I do think it's something that you're expecting to see from the central bank. But I do think that supply-demand dichotomy that exists in Canada means that it will mitigate some of the pressure from a housing standpoint. We have a very strong underwriting and adjudication around our mortgage book, so I'm not concerned as much from the credit standpoint. When we look at what's coming up for renewal, our LTVs on our mortgage product across the book are 45%. Our whole mortgage or across our banking book in Canada overall from a retail standpoint, as well as we're at FICO scores of 800. So we've got a very strong credit position. I think what you're seeing from the demand standpoint and the supply concern is actually starting to rebalance things a bit, maybe to a bit more of a healthier perspective. Great. Do we have the polling questions up now? You are not going to get polling questions. You guys are going to have to ask your polling questions. You guys are definitely going to have to ask questions, because I had 10 minutes taken up with polling questions, so you are all going to have to help me out. Okay. Oh, we got a question. Oh, thank you. A little pressure. You're a little bullying there, I would say, but it's working. Yeah. Okay, well, you gotta do what you gotta do. There you go. A couple of follow-ups just on the LTV. 45%? That seems really low. That's for the book as a whole. Sorry. 70% upon origination. That was my question. Yeah. I will ask another question about loan originations in the U.S. operations. They've been fairly robust. Does that give you any concern about the underwriting quality and whatnot? No. Our platform within the U.S., our City National platform, is a high net worth client base. We've got very strong credit profile as it relates to them, so not concerned. But they're in jumbo mortgage product, you're right. We have seen great traction in that product. We do expect that as well to temper, but not from a credit standpoint as it relates to the quality of our client base there. Yes. Same track on mortgages here. So there is a short seller thesis out there, especially on the Canadian banks' mortgages exposure, is that quite a bit of given the run-up in the housing prices quite a bit of mortgage borrowers to get the down payment, they have access some third party, like they have borrowed capital not from their primary bank from whom they have taken the mortgage, but they have borrowed capital from someone else to put down that down payment. And to that extent, I don't know. Sorry? Bridge mortgage financing. Oh. Bridge mortgage financing. Yes, sorry. I don't follow the sector that closely, but apparently that bridge mortgage financing is not reflected in your LTV numbers. But when the rates rise, probably some of those mortgages could come under pressure. I think that would probably be relatable maybe to a different type of mortgage financing company than RBC in terms of we don't operate in the subprime. Like I mentioned, our FICO scores across the book are 800, and in terms, again, that's even for our insured book. So that's not something that would be party to the type of credit that we would be lending to from a credit adjudication standpoint. The other thing that we have a lot of insight into our client, given our deposit franchise in terms of their cash flow as well, given we've got a number one leading deposit franchise in Canada. So that's not the construct that you would be seeing from our type of lending. We don't do the subprime. Yeah. If I can have second question here. The variable rates mortgages, what proportion of the book is variable rates? I understand there are different kinds of variable mortgages out there, wherein the borrowers would see immediate rise in the payment and some may not. There are some triggers point out there at which they will have to basically start making additional payment. If you can elaborate on some kind of clarity on those aspects as well. Sure. Our variable rate mortgage is about 35% of the total book, and we operate under the, our mortgage product does not reset automatically with an increase in rate. Essentially what happens is your amortization extends until you reach the trigger point, at which case then you will have your payment reset, but it's not until you actually have renewal that you will get the amortization component fully vested in. We expect that roughly given the way the interest rates have been increasing, that you're going to have pretty much a larger portion of the book hit that trigger in October. But from terms of an increase in payments, about probably CAD 200 for over a 12-month period. We feel that the client base is going to be able to manage that. Then we'll work with them as they get to the actual renewal point in terms of their payment construct. Okay. Can we just maybe focus in on that sort of margin deposit piece a bit? I know we've referenced the benefit Yeah that Royal Bank has from its core deposit franchise. Could you maybe talk about how that's impacted margins? Yeah. It's definitely a competitive advantage, and it is a driver of our leading interest rate sensitivity and our position as it relates to rising rates, but it's also a core anchor product for us. We use, in terms of cross-sell ability, I commented, 75% of our deposit franchise, that's the core product that they start with, and we have 19% of our customer base has products across our four product suite in terms of transactor accounts, lending, investment, as well as credit card. So it is definitely an area that we have been focused on in terms of not only client acquisition, but also in terms of being able to differentiate ourselves and provide opportunities for our client base to get further engagement with them. You've seen that, and it's a great source of funding, in addition to providing that opportunity for client acquisition. You've seen that from our margin expansion, and our leading interest rate sensitivity. We had margin expansion of 15 basis points last quarter, and I would expect that for the fourth quarter, we should be in the neighborhood range of that 10 to 15 basis points as well. Then into 2023, based on what's baked into the interest rate forecast, that we would expect that to definitely moderate lower into 2023. But from the cross-sell ability, that's been definitely an area of focus for us. We launched a product, Vantage, which rather than looking at a minimum balance construct, actually looks at the client value proposition across our suite of products and gives them things like points, in terms of not just around certain products, but across a suite of products, and really rewards them for that interconnectivity. We've also been looking at it from a client acquisition standpoint with our partnerships around things like Rexall in Canada, which is a drug company, Petro-Canada, as well as WestJet. Really aligning across the value chain for our client base. Cross-sell ability, we see that with that type of model, you get decreases in terms of attrition with the stickiness of that product. Then it's a real great source of funding. We are match funded in Canada, so in terms of as you start to see spreads widen and the cost of funding going up, that is a huge advantage for us as well. It's an opportunity to drive that premium growth. As I mentioned, we saw the increase in surplus liquidity coming into there. We actually managed to move up about a percentage point, roughly, in terms of market share, just given that we've spent the time in terms of that value acquisition funnel for both existing and new clients. That's a real source of not only the funding and cross-sell ability for us, but also data insights. We talked a bit about how we manage our credit book, and it's really given us insights into our clients' cash flows, not just across both our retail book, which we're up about 30% pre-pandemic, but also on our commercial businesses as well. So it's a great source of information as well from a data standpoint for us. Match funding would be unique amongst your Canadian peers from a deposit perspective. You recognize in particular with the growth in the asset base that you've seen, and so that really is a differentiator to be able to be able to fund our, from a cash standpoint, our asset base and with considered growth with that deposit base. I know we've touched on credit in a couple spots, but perhaps you could give us your views on whether you see any signs of deterioration in unsecured credit in particular, and what the outlook may be for provisioning for credit losses. Well, we mentioned that from a macro standpoint and we are looking to have a moderate recession play out in Canada into next year, so we've built that into our base case. We do expect normalization in our impaired provision for PCLs into the tail end of next year. Part of what you're seeing in terms of our reserve build is both the macroeconomic scenario as well as that kind of roll-forward movement towards normalization. Having said that, given the strength of the fundamentals we talked about earlier, we're definitely seeing record low levels of impairment to date, which is obviously the benign credit environment. But unemployment is going to be the biggest driver of potential credit losses, so watching that very closely, and that's what's playing into our models overall. From an unsecured, we are starting to see a bit of a tick-up in delinquencies on the card book. But while we've seen strength in volumes, we're still seeing it sitting at about 15% below our pre-pandemic levels in terms of our revolve balances. Although we've got increase lately in delinquencies, we're still seeing that overall health, and you're really seeing in that buildup of the liquidity of the client base. Canadians are sitting over CAD 300 billion of surplus cash relative to where they were pre-pandemic. We're seeing strength still in spending, which I'm sure the central banks are hoping is going to start to peel back over time. But we're not seeing that manifest in Canada, really given that surplus liquidity and those savings rates being more evenly distributed, I would say, in Canada into tick-up in our revolve rates. We don't really expect to see that probably through until maybe later in 2023. Got it. Any questions at this point? Yep. Sure. In Canada, about 45% of our deposit base is low beta, low cost deposits. If I look at that from the retail standpoint, our retail book is about 23% of beta of our commercial book, so commercial book being a bit more beta sensitive. We've started to see a slight tick-up, but in Canada, it's holding quite well actually. Realistically, it will probably take another 100 basis points from the Bank of Canada before we start to see that move to more normalized levels. For the U.S., in City National, we have a very low beta deposit base there. It's about 35 basis points. That is based off of our high net worth client. We do have sweep money funding from our U.S. wealth management business, which is at a higher beta. We have started to see that tick up a bit, so you may have noticed in our disclosure around our sensitivity as it related to our U.S.-based businesses, that some of that sensitivity has come off a bit, just given some of the increase in beta on in particular the wealth management deposit balances. I think we're finding that it's holding in quite well overall given the increase in rates that we've seen. Again, in Canada in particular, you've got the massiveness of that deposit franchise overall that's really driving that interest rate sensitivity. It's quite low cost, so the expectation is that we'll still have a lot of room to grow in terms of rates increase. We haven't really disclosed that, but if you can think of it, that we're still below where we were normally. Yes. I was just wondering if you could speak to potential growth opportunities for RBC in the U.S. and opportunities to deploy our excess capital in that market. Sure. Thank you. The U.S. is our second home market. I will probably get to one of your questions. We run a very diversified model there. City National Bank, which is a leading commercial and private bank, we have tripled the size of that bank, so we have really been investing a lot in infrastructure. In terms of future opportunities there, something that fits in with that is what we have always been looking at. You want to look for something strategic that culturally would fit as well. The other area of growth that we have in the U.S. is our wealth management business, so seventh in terms of full service advisory. We have grown that business quite a bit organically already, and with the acquisition of IAs in terms of not only our culture of our organization, but I would say also the technology opportunities that we have provided to the IAs in terms of tools for them, for their clients, onboarding as well, which has improved their productivity. That is another area that we have been focused on in terms of opportunity for growth. Our capital markets business, a top 10 global investment bank, multi-service product. We have grown that business substantially organically. I would say for that business, we have done a lot in terms of bringing in investment bankers. Now we have got the brand and the size to be able to attract the talent to really grow there, and we are looking to broaden out our opportunity there from a fee-based standpoint. I think the focus we have on our global markets, again, that would be more organic. We have been investing in our infrastructure there and think we have opportunities to get more active with certain clients across certain product suites. I would say that area of things that we are looking at, we have been able to do quite organically within the capital market space. I would think that as they are being our second home market and given the strength of our capital position, it is something that we look at. Valuations have come in a bit, but this is a point in the cycle where you are going to be very discerning, and from our playbook standpoint, it has to make strategic fit. You are going to be dilutive to shareholder. You want to make sure that you are going to be able to add an opportunity from a revenue growth standpoint and bring a differentiated opportunity for growth for that growth trajectory. That is the way we think about it and look at things. But we have always been very disciplined and patient in that regard to make sure that it really can drive the shareholder value given our premium ROE business. A couple follow-on questions around U.S. strategy. Given the underwriting marks taken across the industry this quarter, can you speak to the bank's strategic approach to the leveraged finance business in particular? Yeah. This has been a core part of our business. We've been consistent in terms of size. We rank about seventh in the league tables, but our market share has been pretty consistent, around 3%-4%. You have to have this very discipline around your management of the risk in that area. I think RBC in particular, it goes to speak to how we approach things from a risk management standpoint. We're very disciplined in terms of the size of the holds we take, in terms of the exposure. Everything works calmly until, as you can see, what happened, in particular with the U.S. banks in the second quarter, when there becomes a degree of uncertainty in the market and things can start to slow and freeze up. That's what you saw. There were some big deals that were set to launch, and they just put a bit of a pullback and pause, and there was a bit of a dislocation between the primary and secondary markets. That further exacerbated through June when the U.S. banks reported into July. It is something that you have to be appreciative of the risk you run in that business. We've been in this business since post the financial crisis. It's a strong revenue contributor. It's a good ROE business, but you have to manage the risk well in that business. We say 75% of the marks are unrealized, not to suggest that they may write back in full over the next quarter, but more to say that the fees are still yet to come. So there's been positive developments as the market has post Labor Day, as everyone starts into the fall with the launch of one in particular, and so I think it's looking quite favorable so far that that market's opening up a bit. Thank you. Would like to talk a little bit more about capital deployment. And one of my famous polling questions, which I've now accepted are not going to show up, was about capital deployment and where the best use of your excess capital would be, whether it be through, in particular, and as one of the audience members posed, expansion of City National, U.S. acquisition, U.S. wealth management, global wealth management, pursue acquisitions in other segments, aggressive share buybacks, run a payout ratio above 50%, return capital with a special dividend. So no idea where No one gets to vote on all those. the audience is going to come out on that. But we'd love to get your perspectives on that in the current environment and where you think the most likely direction of travel would be. Yeah. Well, first and foremost, we're very pleased with our capital position overall. It does provide for a lot of optionality. I would say that we want to make sure we've got opportunity for organic growth. And I think we've demonstrated that we've been able to leverage our balance sheet to be able to drive good shareholder returns as it relates to that. We're very consistent in terms of our dividend and our distribution to our shareholders. So that's very important to us as well. And we always look for opportunities from an inorganic standpoint. And when we look across a few spectrums, right? We look at where can we add strategically to augment and grow within our core markets. Particularly U.S. as our second home market. That does not negate opportunities within Canada, but obviously, given the banking market, that would not be a large-scale play. But also where we can differentiate in terms of tuck-ins as well, whether it be on the fintech side to further augment in Canada our client acquisition funnel or to further leverage the opportunity to provide tools for, and adjacencies for our customer base in other jurisdictions. And so right now, I would say that you're going to see those types of opportunities more often than not. You see we recently going to expect to close on our, you mentioned the Brewin Dolphin acquisition. That's a nice opportunity for us to get scale. That's what we look for. We're very conscious of the impact of dilution on the shareholder as it relates to acquisitions. So this is first and foremost a focus of us in terms of being able to be accretive and look at what that means to our overall premium growth strategy and our ROE. So we look across the spectrum, and I think, if I quote Dave McKay, "It doesn't have a half-life." So we're very constant prudent about how we manage with our capital base. Lots of options on the table, and to continue to return it to shareholders as well. Can you speak a little bit about what you think the domestic retail outlook might be? Well, I think we are feeling the benefits of an interest rate environment, which is probably the biggest tailwind, as we mentioned, benefiting our core deposit franchise. We do expect mortgage volumes to slow down, but that is also a core anchor product for us and offers opportunity to cross-sell. On the credit card front, we are seeing very strong volume growth, but as you mentioned, it is not yet translating into the revolver base, which may be a good thing in terms from liquidity management for our client base, but is yet to translate over into the revolver space. We have seen good growth in our commercial lending as well, and that is a bit more broad-based, I would say. It is not just related to commercial mortgage, but also across manufacturing, logistics, and really ensuring that we differentiate across our client base. We saw strong growth this quarter that we do expect to translate into early next year. We are focused on how we can continue to drive that client acquisition funnel. We recently announced a collaboration with ICICI Bank, which is a leading bank within the South Asian community, which represents about when we talked about immigration and the opportunity for Canada there, they are about 30% of the immigration base into Canada. So that type of collaboration opportunity to continue to be a bank of choice and widen that funnel, not only from a professional standpoint, the coming into the country, but also a number of students as well. So those types of venues were really giving us traction, not only the benefit associated with the interest rate environment, and gives us the opportunity to continue to invest in our sales force to drive that growth trajectory. Yeah. Other questions from the audience? Yeah, another one on mortgages as well, because that is where I feel the risk is. Rest of the loan book seems pretty strong and healthy. So you have insured and then you have uninsured, correct? For a Canadian bank, a borrower, is it better from the economics point of view for you, for the borrower to take an 85% LTV loan and have it insured so that you do not take the losses, rather than the same person take up a 75% LTV loan and rather be uninsured? Where the economics is better for you as a bank, in an uninsured or an insured borrower? We hold both our insured and uninsured to the same level from a credit adjudication standpoint. I commented to you on the LTVs. We are still sitting closer to 70% on new originations, right? The insured mortgage product, I would say in Canada, particularly given the equity value that most people have in their homes, is really focused almost on the first-time home buyer at this point. A lot of individuals have sufficient down payment in terms of making that 80% hurdle. So when we adjudicate, we adjudicate the credits in terms of looking at them the same way. We also have a tiering process as it relates to the value of the house, right? In terms of ensuring that we are managing the credit appropriately depending upon our overall exposure. We, yeah. Well, understood, but in terms of our We do not operate in a subprime mortgage market, right? Given the health of our overall client base in terms of the credit, we are sitting on very low losses on our mortgage book overall. I do not know if the team, they are sub single basis point. Right? While I appreciate the perspective, we do not see it as something of a differentiator that I am so concerned about a loss rate in terms of the non-insured book that I would over-rotate in terms of the insured. Plus, I do think in Canada, it is really the fact that you do not have as much demand on the insured side, just given the fact that you are sitting on a population base that is able to manage that down payment below the You are able to manage your 80% below our LTV. Yeah. It is not something that I would rotate over from a client base, right? I am just saying it organically happens that most of our the quality of our client because we are not in the subprime market is typically It is not that I am turning away insured mortgage in order to take a non-insured mortgage. It is more the nature of our originations that are coming through. I think that gentleman had a question as well. Macro remarks about cross-sell ability. Yes. Knowing, I guess, not knowing, assuming that the American-Canadian retail client is different, can you just talk about the opportunity in one versus the other and how you sort of pull levers both on retail and I guess on the corporate side as well? Sure. In Canada, I commented a bit on our cross-sell ability within our retail franchise directly, in terms of our number of clients who hold multiple products. We also have a very dominant wealth management franchise in Canada, right? We've got about 65% of our high net worth clients also on the wealth management side with the retail bank and 45% of our wealth clients overall in the retail bank. Part of that connectivity, if you will, within Canada, not only across our retail, but across into our wealth management franchise. We saw with clients exiting the equity market and seeing some redemptions there on the fund side. We saw our GIC book grow by CAD 10 billion. You've got that. The advice that you're offering to your clients stretches across, you've got not only great product within your wealth management, we've also got our distribution franchise across both our wealth management arm and our retail bank arm. Then, as it relates to our upper-tier commercial clients in Canada, and then the connectivity with our capital markets business. South of the border, a lot of the interplay has been, we've got our high-net-worth client base in City National with the private bank and the commercial bank. We've moved into the mid-tier market lending in City National Bank, which gives opportunity again on the capital markets side with capital markets products, but also on our advisory side of things. Then you've got within the wealth management construct, you've got the opportunity as well from the sweep deposit balances. You hit on something from us as it relates to our scale. Our scale across not only product within Canada, but what we're building in the U.S. gives us great interconnectivity throughout the bank. We have a couple minutes left. Any final questions? Thank you. Apologies, I missed this earlier, but what's the breakdown of variable and fixed in your mortgage book? About two-thirds fixed, a third variable. Great. Thanks. Well, I guess with that- Yeah. No Thank you very much. Thank you for your questions. Really appreciate the opportunity. Yes, I really appreciate the questions. You appreciate them more than I do when the polling's over. Thanks, everyone. Thank you. Thank you, Nadi. Thank you.