NBF 20th Annual Financial Services Conference 2022

Mar 22, 2022

All right. I'd like to welcome our last speaker before lunch to the stage. Before I forget, lunch is on the other side of this wall, correct? We have a lunch speaker, Neil McLaughlin, Group Head of Royal Bank's Canadian personal and commercial banking unit. I'd like to thank you for coming to Montreal and taking the time to sit down with us and go over a bunch of questions. One place I'd like to start is on the Royal's been pretty transparent in this, talking about low interest rate environment and mixed shifts on the balance sheet has been a CAD 2 billion revenue source of erosion. Yep. I think that's a consolidated figure. It is. The lion's share of it would be in your business. If you could talk maybe a bit more about where that's coming from. For sure. About half that over the pandemic would be in our business. Okay. It's coming from a couple places. We have a really strong deposit franchise. Obviously, deposits, just as rates have come down, haven't been worth anywhere near what they used to be. Unlike the Europeans, we've floored our rates. We haven't gone negative, so there's only so much you can not pay a customer to hold their deposits. That has been part of the NIM decline. The other side would be we have the leading credit card franchise in the country. We've seen a de-leveraging of the consumer. Big part of that in terms of a very high margin credit card portfolio is contribution to NIM. The other thing is just things like utilization on revolvers, whether that's from a commercial client, from a consumer. You're seeing this de-leveraging effect as just more liquidity's built up, both in terms of entrepreneurs and consumers. You bring it all together, and you end up with the impact that you talked about. The reverse of that is obviously, as we looked at finally we started to see rate movement and we led up by 25 as you would expect and the government would expect and starting to see that rate impact start to come back. Unless there's a real curve ball, we expect many more between now and the end of the year. So that's the rate environment and it's been punitive. We're just glad that we think the Bank of Canada is now at a place that the right thing to do is to start the march back up. The credit card business, which you mentioned, that is an obvious one and one where a lot of questions around what is the direction of revolver rates. When are they going to normalize or whatever? Do you think that with inflation, with higher rates, that can actually accelerate the return to normal if it pushes consumers to have to carry balances? I think the main drivers there are going to be consumer spending and then burning away the liquidity that consumers have on their balance sheet. The revolve rates we have in our credit card business are still down about 500 basis points from where they were. We peaked our portfolio was about CAD 20 billion. We got to a low of CAD 16 billion, and we have bounced off the bottom. We are now just about 4% growth year-over-year. So you have seen, I think, the bottom of the trough, and I would think that is us. My expectation is everybody will start to see that trend, and it is because the consumers are getting out, the economies are starting to open up. People can consume, and there is a lot of, I would say, pent-up energy for people to get out and enjoy life who have not been able to do that. A lot of that gets paid for on your credit card, and a portion of those customers find that is the most convenient way to finance that is to pay it on your credit card. And we would look at this from, it is the first place we are seeing the revolve rates come back. We are still not seeing it as much on the consumer and secured lines of credit. The only place we are seeing it on revolve rates on the commercial business is at the upper end of the market. So I think this idea of de-leveraging, you are starting to see it come to an end, and credit cards will be the first place it bounces back, and the rest of them will start to come back. But we are still looking at getting back to probably a normal revolve or payment rates normalize still quarters away. In terms of those, for the most part, the largest portfolios in the country, our expectation would be second half of 2023 to get back to the peak of where those books were performing. One thing that I think people underestimated was the amount of revenue contribution that carrying balances on a credit card actually represents for a bank. I think of it in a couple ways. One, we hear from banks, not just yours, our credit card customers are high net worth, ultra high net worth. But how do you square that against, well, these ones that are individuals, consumers that are carrying monthly balances? That doesn't exactly line up to that description. Does that mean we have an underappreciated sense of maybe the lower end of the market as well? If you look at the different, you almost kind of look at it product by product. There's some products that are meant to revolve on it. Like us and most of our competitors will have something in the sort of 10%, 11%, 12% category. It's meant to carry a balance. The revolve rates would be over 95%. On other things where you're getting a really rich value proposition in terms of points in our program, our Avion product- is the largest product in terms of spend and balances in the country, you have a much lower Because they are more affluent, to your point, and there for the points. The revolve rates would be a lot lower, but you are making it up on the spending and the interchange line. So it would almost go product by product, Gabriel. But if you look at in terms of where is the risk in there, yeah, you are getting the losses are coming from, for the most part, they are coming from higher-risk credit customers. Think about it as sort of sub 680 FICO scores, usually combined with a disruption of employment or some sort of loss of income. That is where credit losses are coming. But a 3% loss rate in that business is not something to get fussed about. No. We have never got there because we disproportionately have a transactor portfolio. But yeah, there is a portion of that business that is always meant to revolve, and it is a convenience. It is really a convenience play to revolve on the same product you spent on. Another card-related risk or substitution that might be, I do not want to say flash in the pan, but everybody is talking about buy now, pay later. Yeah. Now we are seeing some of the bigger players in that industry experience some difficulties. Do you think that, A, that risk has been overstated, and B, how do you see that competitive threat evolving over time? Yeah. I think everybody's had a different point of view. Mine has been consistently that it got a lot of ink. I think there is genuine demand from a client there to say, "Yeah, this just helps me even out my cash flow. Maybe I don't want to pay interest on my credit card. This helps me normalize that. I don't have to save up to get whatever that product was." But at the end of the day, do I think it's a macro disruption to our credit card business or the industry? I don't. I think we have launched a buy now, pay later product to merchants. We're actually out there live right now. We have what, 13,000 customers that we've already brought onto that platform. It's called PayPlan by RBC. But we don't think about it as. In my mind, it's a service to the merchant. It's not a growth platform for our credit business. Yeah, that's how it manifests itself, and it needs to earn a return there. But the strategic reason we invested in it was to make sure we're competing at the point of sale and offering the types of value propositions. Sure Merchants want to convert what's in that digital checkout basket. Buy now, pay later has proven it's got a place to play. Some places, I think the stories of some of these players have gotten overblown. There will be some consolidation. Regulation's going to reign some of them in. But I would look at like, is that pay-in-four value proposition probably here to stay? I would say yeah, I think it's going to be table stakes. Auto lending, you're top three in that industry. I'll ask the question I ask everyone. The mix of origination, how does it compare to pre-COVID? You go like 60/40 used, new, and it was 50/50 before, something like that? I don't think the story in auto has been about just inventory not getting to lots. Right. If I look at the retail side, we're just seeing a lot lower originations, in terms of our subvented programs, working with manufacturers are the bulk of what we finance there. They're prime customers. Used kind of like a third or 25% of our book there. But it's really been a story of, having been in the market, if you wait five months for a car, you're lucky if you've even got a car. There are just fewer units to finance. On the other side of our business, we do a lot of floor plan financing in our commercial business, and there hasn't been inventory to finance. That's really. It's when we talk about supply chain disruption, I think the auto business is a prime example. I was saying at dinner, my wife's car came and it's supposed to have an iPhone charger pad, and the sales representative said they ran out of chips that week, so they decided that's where we're going to take your chip out of and no discount. You're lucky to get your unit at full MSRP. We said okay and drove away. So we're living a supply chain disruption in auto as probably as much as anywhere. Something that I think about that there's a threat, that's overstating it, but the substitution might be more accurate risk to auto lending is people instead of taking out a car loan, which is higher spread to the bank, they say, "Well, my house has gone up, da, da, and I'm buying these combined HELOC mortgage products. I'll just use that. It's much, much cheaper." If I had to buy a truck tomorrow, that's what I'd do. Or a tractor. Is that a big thing that the substitution effect is- It's the way I bought my car for the exact reason that you talk about. By and large, the everyday consumer goes in and it's about a point-of-sale experience. Okay. Listen, we support an awful lot of auto lenders. Point-of-sale or indirect finance is one of the offerings we have. If you look at that, I think strategically we look at that and say, there's an example where somebody got between us and a consumer and we now have to pay rent to who owns the customer. The dealer owns the customer. If you want to participate, you play by their rules. I think it's more of a lesson for other categories of if this happens in mortgage, if this happens in other categories from not an auto dealer, but a Google, a fintech, et cetera, there's a lesson there. But we don't see a lot of it. Okay. You have a more affluent consumer who says, "I'm just going to write a check, transfer from my HELOC product, and away I go." I have the discipline to-- Because the other part of it is having the discipline to make the payment, and that's where a lot of what the dealer will sell is dealer sells payment. You can afford this. It's only this much every two weeks. Yeah. Okay. Home equity lines, the combined mortgage HELOC product is drawing some regulatory scrutiny. The stuff that OSFI's talking about or focusing on, how much of a business is that for Royal? Yeah. Maybe just a little color. The combined loan product or the HELOC product that we have, their concern is that you have consumers who are essentially revolving their lifestyle on using their home as a piggy bank. I make some payments on my conventional mortgage segment, my fixed term conventional mortgage, and then I'm just levering myself up and withdrawing that money open to buy on my home equity line of credit. We get where they're coming from. We've done the analysis. I'd say, so that's a scenario of risk. We kind of put in the same category so the perpetual revolver not creating any equity as a scenario along with someone who's like, "I'm into my mid-50s and I'm not making-- I still have a lot of mortgage debt. At some point, where's retirement? How do you get to pay this down?" We look at those types of scenarios when we do our portfolio management. Neither are a big-- Less than 1%. I think it's less than 1% of customers we would even red circle have any type of that risk. At the end of the day, it's not a concern and we're providing OSFI all that information to kind of get their comfort level. Like 1% of the ones that have this product are perpetually levered kind of thing. Is that the- Yeah. Less than 1%. Okay. Our first take on it was, we don't see it, we've done the analysis, and it's become really an insignificant non-issue. I can't remember what side of 1% it was on, but it was exceptionally small. How do you Is it just you have this one small bucket of customers that equity just doesn't keep, it's staying flat or? Well, what happens is, even if you look at file by file, you can do a file review and you say, "Okay, so what would be your reason for it?" There's some good advice. I mean, if somebody goes in and says, "Okay, so I've created equity, but now I want to renovate my home. Okay, I'm going to take out a I don't want to get another mortgage because I'm going to have a liquidity event. I'm going to get a big bonus, sell my business. Okay, I don't want to be locked into a term product, so I'll take out 50 or 100 grand and do my renovation." That's not bad advice and that's good flexibility, and there's a lot of that that also falls in the same bucket. So it doesn't necessarily signal credit risk. If you look at from the portfolio side, we still have the LTV, we still have cushion in the deal. OSFI's appropriately sort of saying, "Are you giving good advice? Are we setting up consumers to continue this leverage path that we're on?" We're just not seeing that as a problem in our book. Switching gears a bit to what I think has been underappreciated in your business' growth over the last year or two, let's call it, is that you're at or above, in the ballpark anyway, on mortgage growth and above on deposit growth, and certainly not from a small base effect. We're seeing big growth rates off of a big base already. How do you quantify the future growth potential that what you've just delivered adds to the business? I mean Yeah that's a word full, but after three years, the mortgage customer will do this and that type of thing. Yeah. It's not lost to me the kind of the growth on growth on growth isn't like the most comfortable position to have to continually chin the bar from. I think the way we approach it is we say we have a lot of, for example, mortgage customers. Half of our deposit customers have their mortgage elsewhere. That doesn't make any sense. That's a path for growth. We believe we built the most lucrative credit card program. There's a bunch of customers we haven't convinced there. We've launched our new deposit program that provides more reciprocity than it. We know we've got the value propositions is what we'd say is like, where do you have confidence you'll continue to grow? In terms of forecasting what we've already done, the best example we'd probably say is the core of the cross-sell comes from the core deposit account. You have heard us talk about this for a number of years, which is we have set a target of how many new consumers are going to add to the business. COVID put a dent in that as everybody. We had other things that we had to take care of. We are back on the path to meet that. We just had our best Q1 in terms of new client acquisition we have ever had, and we are seeing the cross-sell and attach rates of those other products that we would hope for. I do not think we have gone through and said, "Here is the earnings that these vintages are going to provide. Yeah. We do monitor, are we getting. I will give you an example. With our new RBC Vantage, we are seeing a substantially elevated cross-sell rate of the credit card and the savings account. That is because that is the way we have constructed the value proposition. That kind of builds off of previous pre-COVID two exceptional years of new client origination. It is core to the strategy. We obviously had to pause things. We were not going to throw good money out the window when we were going to have low response rates and low returns. We are back on playing full offense and it is core to the strategy. If I just on the deposit, the numbers have been astronomical as far as absolute growth. I think last time I checked it was on the personal side, an extra CAD 100 billion in the industry. If you look at your slice of that, how much of that has been core, I am getting my paycheck deposited there? It has been a really large part of it. I think in the pandemic we did five deposit forecasts and got five wrong. I guess we just couldn't have anticipated the type of accumulation we'd see. Everyday, the sort of the core deposit has been a real focus. Term deposits, just the yields haven't been there. You're starting to see them come back a little bit, but you saw a real switch out of that into mutual funds the beginning of the pandemic. We did 13 months of CAD 1 billion or more in net mutual fund sales. Taking it from that core and we had, you mentioned sort of the industry growth. We were over 20% growth in the Everyday savings accounts, and so a lot of lazy deposits. Our strategy was reach out to the client, give them good advice, what they don't need, get into the market and get it working for them. If you go through the pandemic, we have a lot of happy customers who did really well with high teen type returns on those funds. A big portion's been there. Savings accounts have been swollen. There hasn't been a real the rates are so low and we're trying to get it out of there and get into mutual funds. It's good for the client, but our margin on the trailer fee for mutual funds is many times what it is on either the GIC or the deposit product. Win-win. On the last earnings call, something that stuck out to me was Dave talking about the economic outlook and picture of. He talked about a couple good things, but he mentioned labor shortages probably three or four times. Yeah during the call. Broad question, how is it affecting your customers? Probably more on the commercial side, is it as simple as it is just restricting our growth potential right now, and that is it? Yeah. You have nailed it, which is when we talk to commercial customers, the two things on their mind are supply chain disruption and labor shortages. Labor shortages, I think mid-pandemic, there was a lot of entrepreneurs who would be saying, "This government stimulus is we have kind of swung the pendulum too far." A lot of lesser-skilled folks are just staying home and rather, "Hey, I would rather collect the government benefit than go out and commute to my job." A lot of entrepreneurs, I think, were very frustrated on that. You are still seeing that labor shortage. I think you are seeing GDP start to really pick up and a lot of people saying, "I am willing to move, and I am willing to move for convenience. I am willing to just try something different." I would say wage inflation, labor shortage, and the second is supply chain disruption. A great example, we had a call with a number of clients from the Montreal area, and they were saying two things stuck out for me. The price of a container coming into the Montreal port went from $2,500 to $25,000 during the pandemic, that the freight companies are making more money by shipping full ships back to China empty than they are by taking the time to fill them up and sail them anywhere else. If you are importing things, that is a huge extra cost. How much can you pass along? The other part of it just was manufacturers, and a quote from a client was, "I have gone from having," what I did not know at the time was, "the most optimized supply chain, just-in-time inventory. Every single part I knew came in three days before I need it, and now it is just in case." They are essentially hoarding inventory so they do not have work in progress sitting on a shelf earning them nothing, which is not we are going to finance that inventory. The problem for the economy is that if I am sitting on all the inputs and you are my competitor and I have hoarded them all, I will produce my 100 units and you will produce none. That inventory is actually not turning into finished product and getting out the door. So that supply chain disruption is real. I asked, I think most of the presenters today about the private equity business in the commercial banking book. What's Royal's approach? What's the exposure as far as the amount of leverage loans and then how much co-investing or whatever term you want to Yeah, we- Two separate things, right? Yeah. I will start on the co-investing piece first. We have a couple different pools we put capital into. It's not a strategy in terms of just an investment strategy on itself. We do this to support other parts of the franchise. We have a legacy portfolio to support some of our larger corporate clients. In my business, a couple of them would be in our corporate banking group, sort of mid-market corporate, where we go out and we'd say investing with sponsors into a few different funds. Really to make sure, hey, we're at the table. We can bank those companies coming from the sponsors. The other one more recently, which has been very successful, is our launch of what we call RBCx, which is our tech banking vertical. We've gone from that's a business we didn't feel we were at our best. We've brought in completely rebuilt the team. We've launched a venture debt product. Co-investing there has been with the right VCs to make sure we're in the ecosystem, we're demonstrating support for their strategies, and we're getting the business back. I would say the equity appreciation is one thing, but it's in support of the core franchise. Okay. As far as the lending exposure to the private equity investment, not the funds that you're. Yeah Investing in, but the lending exposure. We don't have a lot. No. Okay. No. Operating leverage target, 1%-2% with inflation the way it is that still achievable? I guess the revenue picture is supportive of that still? Yeah, absolutely. I think one of the things you would've seen over time is that obviously we started the conversation with NIMs. We just put a real focus on saying, "Hey, when NIMs are coming down and we don't have the headroom, we're going to be really disciplined on expenses." We feel quite good about what we've done there in terms of really bending that curve to get expenses down to low single digits. We do expect to be at the top end of the range. I think we might have referenced that in the last call, so we'll be closer to 2%, hopefully above that for this year. As we move forward, I think with NIMs moving up, we should have the headroom to be able to maintain that type of zone. You will see our operating leverage target range we have traditionally given move up a notch. Another question I have been asking others is, and I have asked you this before. One day I will get a surprising answer, but the future of the branch. Yeah Digitization going up, but there is no real business case to take a more aggressive stance on branch count. We have a lot of the bankers here today. Maybe we get together and we all do it at the same time. But the issue there, frankly, is about first mover. Yeah. There's risk in being the first mover, and it comes down to the Canadian consumer has been spoiled with choice. I can go into a branch when I want, and I can get online when I want. I can go on my phone, and I call it the and value proposition. First it was branches, then it was branches and ATMs and the online and the phone, and we'll come to your house. Pulling those away, there is some risk in it. I do think the scale players do have an advantage here, where we have the most amount of convenience. We have the most ability to pay for the branch network. Our approach to it has been less about the number of branches, and we're taking them down about 25 a year, 25 to 35 a year. It's more about the productivity of the people in the branches. How do you set up the roles? How do you connect them with technology? How do you get data about your clients to the people so that their 35, 45-minute appointment is the most productive appointment they could have? Because at the end of the day, I spend three times as much on salaries and benefits for frontline people as I spend on the real estate. All right. To me, it's not a real estate story. If it is, if others believe that's their prerogative. Ours is about, we think about it as market coverage. If you were to take Gatineau or you were to take Sherbrooke, we look at it as a market and we think, "Okay, how many people do we need to cover the market? How many commercial account managers, mortgage specialists?" Then we look at where should they sit. If we're not in a convenient location, we move them to a convenient location. If we have too many square feet, we may get rid of an old branch, shrink down to a new one. It's less about just flicking branches off the network as it is making sure you're there to compete in the marketplace. Question from the crowd? I had a couple questions. You said you have more deposits, and I wanted to ask you where they're coming from. Is it property sales, distant sales, legacy? I'm sure the deposits have ballooned. If you can give us some idea. The question is. Obviously not spending. Yeah. Spending is one of them, but there's obviously an age situation where we have demographics, people are getting older, there's legacy and so on. That's the first question. Yep. The second one is blockchain. Obviously, blockchain is creating a lot of disruption, Yep particularly with Bitcoin. As a self-regulated organization, the banks are actually regulated, the brokers are self-regulated. But what is the bank doing about pushing the agenda of getting Bitcoin under the blockchain formula either out, in, or something done because there seems to be no regulation. I'm trying to figure this out. Yeah. Well, you've read the second situation exceptionally well. I got to put the questions down. First question was on. Geez, blanking. Well, the second question was. Where the blockchain and the regulation thereof and the sources of deposit growth, which has been phenomenal. Go on. Yeah. So I'll start with deposit growth. Disproportionately, deposit growth is not from selling property, it's not from inheritance and these sorts of things. It's from maintaining employment and just not having any place to really put that liquidity to use. So it's disproportionately because of the lockdown, decreased spending. This was precipitous. On consumer spending as an example, we used to be able to monitor consumer spending within like 50 basis points. It would roll 50 basis points per month would be a fairly good variation. It dropped 500 basis points in weeks. So, I can't overemphasize when the economy shut down, this was like it wasn't tapping of the brakes. It was like the whole thing just came to a stop. We'd never seen anything like it before. On the other side, the liquidity coming in is a really interesting stat. We monitored every single consumer who had been collecting any type of government benefit. The deposit accounts of consumers who were either on or started to collect government benefits actually grew during the pandemic versus pre-pandemic. They had more liquidity than they had ever had as a group, not as an individual. You bring those two sources together, and you saw the deposit account. The same thing on entrepreneurs. Entrepreneurs just said, "I'm not going to deploy this. I am generating revenue. I'm not putting it out into CapEx. I'm really shrinking to my core." Canada's entrepreneurs deserve a huge amount of kudos for how they steered through that. But it was shrink to the core ballooning deposits. On the question of blockchain, to your point, it is unregulated. Even if you're seeing right now, you separate blockchain from the underlying technology of distributed ledger, and then what are the uses of it? One of the uses is Bitcoin. You're seeing cryptocurrencies. The fundamental problem that the regulated institutions are grappling with, and we're not getting a lot of, I think progress, which is we play a role in terms of anti-money laundering and terrorist financing. It's not a small responsibility. We have a very high bar with FINTRAC. There's apparently some technologies that are coming that will give you transparency to do that work, but they haven't been really, I think, at enterprise grade. Until they get there, I don't think you're going to see a lot of progress. But our view over the last while, it's not like these currencies are going away, right? It's not like this is a fringe thing and this will all be shut down. You're starting to see central banks start to look at the topic. There was a press release earlier this week about Bank of Canada, the US Fed starting to look at central bank digital currencies. We've had the conversations, but they need to start with some of the fundamentals. Okay, how is this going to be governed? It's moving and it's moving fast. But you're getting a lot of this activity in gray markets, and there's still a lot of speculative activity in cryptocurrency. So we're monitoring it. We're not participating other than there are crypto securities that we will allow our customers to invest in. Other than that, we don't participate. Can I just piggyback? Why has this been allowed to continue for 2, 3, 4 years, Bitcoin, crypto, blockchain, all this stuff without regulation at all? I think- The sheer activity alone, I don't know, but I can only imagine. It's a great question, and if I was a regulator, I might be able to give you a better answer, but we would ask the same question.