RBC Capital Markets Global Financial Institutions Conference

Mar 8, 2022

Good morning and welcome. I'm Derek Neldner, CEO and group head of RBC Capital Markets. On behalf of all of my colleagues at RBC, it is my pleasure to welcome you to our Annual Financial Institutions Conference. Absolutely terrific to see, once again, the tremendous interest in participating in the conference. This year I'm pleased to say, we have over 125 presenting companies, over 400 institutional investors, and over 1,000 participants in the conference overall, which should make for a great discussion. Obviously, we're living in very uncertain times. When we look at the rapidly evolving macro and economic landscape, I think the conference is even more timely and should make for some very interesting dialogue amongst all the participants over the next few days. Again, thank you for taking the time to join us. We really appreciate your attendance. Without further ado, it is my pleasure to introduce and welcome Dave McKay, President and CEO of RBC. Since assuming the role of CEO in 2014, Dave has provided tremendous leadership to RBC, importantly during the last few years, which were very tumultuous amidst all of the dynamics of the pandemic. Dave continues to very proactively and successfully lead and transform RBC for the future, capitalizing on the power of technology and leveraging digital to deliver digitally enabled solutions with a very holistic client-centric approach, leveraging insights to deliver very differentiated experiences for our clients. He's been a driving force behind our Beyond Banking strategy, building ecosystems through RBC Ventures that enable RBC to participate in an even broader part of the client journey and value chain. As a very active thought leader, Dave has been vocal on the many critically important social and economic issues that are impacting all of us today. It is a very big part on how Dave has personally delivered on RBC's purpose of helping our clients thrive and our communities prosper. Dave is very passionate about the success and future for Canada, including Canadian youth. He has personally led the development of the RBC Future Launch Program, which is a 10-year, CAD 500 million commitment to skills development for our young people as they prepare for a very evolving and rapidly changing future. Dave also chairs RBC's Diversity Leadership Council, which is particularly notable with today being International Women's Day. He's personally very strongly committed to driving RBC's leadership in this important area, which I'm pleased to say was recently recognized with the 2021 Global Catalyst Award. More broadly, Dave has been a leading voice on ESG, including RBC's own climate strategy and our approach to a thoughtful transition to a lower carbon economy, including our own commitments to net zero. Dave, it is absolutely terrific to have you with us today. Lots to talk about given everything that's going on in the world around us, and really looking forward to the discussion. Well, thanks, Derek, and good morning, everybody. I wish we were in New York and we were together and a chance to mingle before and after, but lots going on in the world and great to connect. I look forward to our conversation. Terrific. Well, in the interest of time, we'll jump right into it, and I think very appropriate to start at the macro level. We've navigated through a very tricky couple of years. The good news is it feels like the headwinds from the pandemic are behind us, but still lots of challenges with ongoing inflationary pressures, supply chain disruption, labor pressures, and then obviously the very unfortunate situation we're now seeing in Russia and the Ukraine. I think it makes for a difficult task for policymakers on how they balance the ongoing inflationary pressures as we move into a tightening cycle, both in terms of rate increases and quantitative tapering. How they can effectively do that while maintaining the economy on a good growth trajectory will not be an easy job. Starting with a very tough question, Dave, but would love just to hear your perspectives on the macro environment and how you see this playing out. Well, certainly the thematic, and I'll pick up on your question and theme. As we came through the pandemic, as you talked about, we are challenged as business leaders to manage supply chain disruption. I would characterize it by one very large systemic supply-demand imbalance across labor and labor markets, across liquidity mismatch between savings and investment, emerging energy mismatch well before the crisis in Ukraine and Russia, that we saw supply chain disruption and goods and services mismatch. As we saw that mismatch in our economy in an attempt to recover, certainly presented strong inflationary numbers that were historic in some ways. But we had a good feeling of confidence that the central bank, while late in reacting to it, was going to react to it with a predictive schedule with rate increases. We saw the Bank of Canada move last week, 50 basis points. We still expect the Fed to move. The signals and the coordination and generally the confidence that we should progress through this in as much as an orderly process as we can was there. All that, again, was further disrupted, to your point, with the horrible humanitarian crisis and war between Russia and Ukraine, and therefore, energy markets have dislocated. Supply chain in a number of areas have dislocated. Investors are looking at markets and trying to predict will central banks tighten or not tighten at the same pace? Therefore, an emerging thematic that we were grappling with was, with all the savings, corporate and consumer savings, with this pent-up demand that was still there in the economy, yet with such lack of supply of labor to meet that demand, lack of goods to meet that demand because of supply chain disruption, lack of inventory, and just weren't ready to capitalize on that. Would that demand lead to inflation? Would it lead to inflation and growth, or would it lead to growth? I think we're increasingly becoming concerned that with the lack of supply of labor, lack of supply of goods, the cost of energy increasing, that will we consume these savings, and will the spending power just lead to an inflationary environment without growth or in a worst case, stagflation? I think that risk has increased, and therefore, as we try to figure out where are we in the economic cycle. There are signals that we're in the early part of an economic recovery, to your point, where through the pandemic or through the worst of the health crisis, we should be coming out strongly with demand for goods and particularly services that were pent-up demand. Yet the markets are telling us with a flat yield curve that we could be in mid to late cycle. When you look at the capacity in the economy and the lack of capacity, lack of labor capacity in particular, that's probably a mid to late cycle signal. At the same time, you see inventory builds and commercial utilization of credit lines, probably early cycle. There's a confusing range of early, mid, late cycle signals that probably lead that we're probably closer to a mid-cycle economy than we are early cycle. All that, difficult for investors to read, difficult for business leaders to understand the effects on margins, the effects on cost and delivery. We are in a trickier place for sure, and therefore, we're trying to sort through that. Markets are trying to sort through that, and all business leaders are trying to figure out what's the revenue equation here, particularly in banks. How am I going to manage my cost structure, and can I deliver a positive operating margin with confidence over the next two years? That's a great segue in terms of where I wanted to go next, Dave, is against an uncertain backdrop, but one where I think it is clear that we are going to see rates move higher as we get into a tightening cycle. Yep. As you know, there's a question on what's the pace of that now given some of the headwinds on growth. But when you think about the macro environment you just described, maybe you can spend a few minutes, Dave, and talk about specific implications for the financial sector and obviously RBC in particular. Okay As you think about rate sensitivity in a rising rate environment, implications for costs given the inflationary pressures and operating leverage, and overall the credit environment. Yeah And risks that may be on the horizon depending how this all plays out. It is important. Investors are certainly trying to size the tailwind behind banks from interest rate increases. The first thing I think you have to look at is where are deposits coming from? What is the nature of those deposits? What is the surplus level of deposits in the U.S. economy and in the Canadian economy? It differs. If you look at the U.S. economy and the roughly $2.5 trillion of surplus consumer deposits that have been built up over the last two years, 60%-65% of that, or $1.5 trillion, sit in the top quintile of U.S. consumers. They have accumulated two-thirds of those savings. When you look at the bottom two quintiles, the bottom 40% of U.S. consumers by income, they have actually de-accumulated through the pandemic. The support services from the government helped, but they used savings, they used credit cards, they overspent in many ways, if you look at some of the credit card numbers. Therefore, there has been a de-accumulation there. If you are looking at your balance sheet and your customer franchise, and you are trying to figure out where does that $1.5 trillion go if you are catering to the higher end of the consumer market from an income perspective, where is consumption going to be in the middle and lower income brackets? Therefore, that is really important to understand when you try to project, well, my surplus savings are stable. Will they grow, or will they start to become de-accumulated through time? The Canadian story is a little bit different. This is the backdrop to say how do you project then the interest rate impact. Canadian story is a little bit different in that all quintiles had surplus savings because of the massive stimulus and fiscal stimulus and support programs that came out of Canadian government. It was, I think, almost CAD 300 billion. All cohorts saw a net savings increase, but again, it was skewed towards the higher quintile, higher two quintiles. It was not even, but all segments grew. As we try to forecast where does that $1.5 trillion in the U.S. get spent, where does that surplus get spent? Does it get invested? Does it get invested in housing? How much stays on the balance sheet? That impacts your beta understanding, and are you in low-beta deposits? I think as we pivot all CEOs, all banks are trying to figure out position of those deposits and then the beta of those deposits. Does the beta change, and therefore, what is the range of impact on the income statement? As we look at ours, I think one of the great strengths that we have is that we spent the last two decades, but certainly the last 15 years, building low-beta deposits. A focused, concerted investment in our core checking, core deposit, both on the consumer side, but also on the business side. Creating more value for customers, bringing in partners like Petro-Canada as one, Rexall as another, launching RBC Vantage recently to continue to add more value, continue to invest in that core deposit experience, more channels, more ATMs, more service people. Number one in J.D. Power in service. All that investment in experience and capability and functionality has led to significant market share increase for us in the core deposit, low beta business, and zero beta in many ways. Also, our savings accounts, which are higher beta, have grown significantly. That investment has really shown up in significant market share growth. Our franchise tends to cater to probably the upper three quintiles, in Canada, and certainly U.S., probably the upper decile in the United States, as we are more of a private bank and high-end affluent, high net worth, and sometimes ultra-high net worth franchise in the U.S. Certainly our franchise focuses on where the bulk of those surplus deposits have flown. That's been part of the story in the deposit growth. The other is we've just acquired more net new clients through our active marketing and our active investment in value. We feel very good about the franchise and the durability of that franchise, and therefore, as we think about interest rate impacts on that deposit franchise, you can look at it two ways. There's the index metric I call it, which is a risk measurement standard that gets applied to this, which is a 100 basis point parallel shift in the curve. I asked the team when's the last time we actually saw 100 basis point parallel shift, but it is a good index metric that investors can use to baseline each bank against each other. For us, across the organization, a 100 basis point parallel shift, would be roughly CAD 1.8 billion of incremental income and NII in the second year and CAD 850 million of that CAD 1.8 billion showing up in the first 12 months of the cycle. I think that is very significant contribution to our bottom line. But maybe a more accurate representation of how you should think about the yield curve, because we have a flattening yield curve, is what does a 25 basis point increase result in at the short end of the curve and pricing the short end of the curve? For us, you look at the U.S. market where we're strong deposits and the Canadian market we're match funded almost 99% deposit to loan ratio. So we've got the best deposit to loan ratio in Canada, and that's the result of a lot of the investments I just talked about. But when you look at the impact at the short end of the curve of 25 basis point increase, it's roughly CAD 150 million between Canada and the U.S. CAD 75 to CAD 80 million in Canada and another CAD 70 million in the U.S. And you can currency convert that to a little over CAD 160 million. But that's the in-year impact of a 25 basis point increase at the short end of the curve, which we saw 50 in Canada, and we expect, we hope to see another 25, I think, this week in the U.S. So I think from that perspective, that's how we kind of measure a very significant interest rate sensitivity, both at the short end of the curve and obviously in our mortgage book at the longer end of the curve. So I think that is a result of a lot of investment, the franchise that we carry, where savings have accumulated in society, play to the strengths of RBC, both in Canada and in the U.S. And I think from that perspective. What it also does, to your point around credit, is one of the challenges, I think one of the worries more than challenges we had, because it was a challenge. But one of the worries we had, do consumers, particularly in Canada and in the U.S., have enough of a cushion for shocks in the system? As we went into the pandemic, I would say when you looked at all the metrics, the cushion was pretty thin at the end of the day. What the pandemic has caused, certainly in the upper three quintiles, as I talked about, is a greater buffer against personal shock, whether it is divorce or illness or loss of job, but certainly economic shock. Therefore, it has acted as a mitigant through most of the pandemic, also bolstered by very long fiscal support programs out of our governments. Certainly excess savings now will continue to act, I think, as a risk mitigant to many of our customers as we go forward. It makes it very difficult to predict when we are going to and how fast we are going to normalize credit losses. They will normalize over time. But it makes it more difficult because we have never seen this much surplus liquidity on a consumer and business's balance sheet, and the normalization has taken longer than we even thought it would. After most of the support fiscal programs have started to wean off, we still see very low cyclical credit metrics. I think from that perspective, it is good for consumers and businesses, it is good for banks that we have more of a buffer going into this. That is great. Maybe one other quick question, Dave, just on the macro before we go into a few more RBC specific items. But, obviously with the low rate environment, we have seen significant strength in the housing market, and that has been exacerbated by supply constraints, population growth, immigration, all fueling demand. But obviously lots of headlines and questions that as we go into a tightening cycle, what are the implications for the housing market? So maybe you can provide your thoughts a little bit on what you see in Canada specifically, but even more broad observations. The housing market, both U.S. and Canada, but particularly in Canada, has really suffered from, again, in a systemic supply-demand imbalance. I should have mentioned housing is one of the most acute when we think about supply, demand imbalance, and it has led to increases in our core urban areas like Toronto, Vancouver, and Montreal in year-over-year into the 30%-40% range. We have got sales to listing ratios kind of off the charts and so strong into sellers market. We have too few new listings coming out, and therefore, that is the strong demand. So we have a very strong demand market. We have lack of supply, which would indicate there is price stability around this. The good news for our portfolio, if you're thinking about the credit risk side of things, is that we're building significant equity in the back book of the portfolio, which allows us to really just focus on how are we adjudicating the new cohorts, and are we stressing those enough to higher rates? We do. We have a government-mandated program, but we do it as a good risk practice anyway. We adjudicate to a much higher rate than the current contracted rate with the client, and therefore, we make sure there's a stress built into the adjudication process on all those loans. Consumers have just made the decision to stretch themselves into a house, and to really stretch themselves into a house. It's a lifestyle trade-off. I worry about the drag it has on the economy. Obviously, as we raise rates and we have more disposable income going to servicing debt, we're not concerned about that from a debt perspective. We're concerned about, well, that's less dollars to travel. That's less dollars for goods and services in our economy. Consumers are making that trade-off, but we're uncertain as to the longer-term impact on growth from that trade-off that they're making right now in the short term, driven by the pandemic in some ways, and needing more space or different lifestyle or work from home, whatever it happens to be. That could have implications on long-term growth. It will also have implications on salaries and costs and inflation to your workforce and the ability for cities like Toronto and Vancouver and New York and others to attract talent into that city, given the elevated cost structure, and to attract businesses into that city. We do worry about the growth and systemic impacts from that. We've seen a little bit of relief in February that we started to see more resale activity and new listings, so we're hopeful that's a trend that rebalances, but at the same time, we brought in 400,000 immigrants last year. We're going to continue in Canada. We're going to continue to bring in an elevated level of immigrants into the country to spur growth and continue to perform very strongly as an economy, and therefore, we're going to have to increase the supply at the end of the day. We stress from a risk perspective, as business leaders, we have to be concerned about the cost of living, the cost to our salary structures, and the ability to attract talent in the long term into markets with such elevated housing costs. But those are the dimensions. We're hoping there's a bit of cooling there, and that's been a real driver of some of the strong volume growth that you've seen in the industry, most recently in the Q1 numbers, very strong kind of double-digit mortgage growth on top of double-digit market growth driven by changing consumer preference to invest cash flow in housing. Okay. Terrific. Switching a little bit to RBC specifically. Obviously, throughout the pandemic, many banks had strong profitability, built up capital ratios. There were various restrictions, depending what jurisdiction you are in, on the ability to distribute capital through dividends or buybacks. Many banks are now sitting flush with capital. I know for a lot of CEOs in the sector, but in particular, as the CEO of one of the largest banks with RBC sitting on a 13.5% CET1 ratio, maybe you can talk, Dave, about how do you think generally about capital allocation, organic or inorganic return of capital, and then specifically at RBC, how are you seeing the opportunities to invest for growth over the years ahead? Well, we certainly feel that we have very strong organic growth capability. You saw that in your business, and we can continue to feed capital into certainly the lending side and the underwriting side. So very strong RWA growth and love to build on that. Saw very strong growth in our City National franchise, particularly on our mid-market strategy that is emerging, and over CAD 3 billion there already. Also on the jumbo mortgage side, doesn't require as much capital, but we are seeing very strong balance sheet growth across Capital Markets, across our U.S. commercial and private bank franchise and any Canadian franchise. Mortgages, credit cards will start to revolve. The purchase activity is strong, but the revolver side of it has been suppressed a little bit, but it is starting to come back, and it has grown over 2019 pre-pandemic. That will consume capital. So very strong RWA growth opportunities. Having said that, we are generating very strong quarterly organic capital that we will probably be able to feed most of our projections around what is organic growth within our risk appetite. We are returning capital to shareholders, certainly, as we have announced our NCIB. We are actively executing against our NCIB program, as you saw in our releases over the last three months. This is a secular opportunity with some dips to continue to do that, obviously. So we are returning capital through higher dividends, through share buyback programs. The important thing to remember is capital does not have a half-life. It can only be misspent. We are at economic highs as far as asset prices and valuations. Therefore, you have to be thoughtful and careful as to the timing of when you buy, how you are deploying capital, what the shareholder return is. Often patient capital wins in the day. Therefore, we have all these opportunities to what we think organically through capital returns, through share buybacks, to prudently manage capital and outperform on total shareholder return basis. Therefore, we have the optionality and the luxury of time to do an acquisition if it makes sense and it is accretive, and it doesn't have to be at the top of a cycle. I think patience will pay. That capital is not going anywhere. It sits on our balance sheet, doesn't decay, can only get misspent. Therefore, we feel very good about outperforming without feeling the need to do something strategic or significant, but timing is important, and the right asset is very important. So it may or may not happen. Timing is also part of it and cycles, and when you want to deploy capital, what part of the cycle, and therefore, the confidence to know that we can outperform without having to do something through the inorganic route is a really strong place to be. Yeah. No, great summary. Building a little bit, Dave, off the organic opportunities and obviously investments that RBC has made historically, but will continue to make to drive organic. Yeah. You mentioned earlier, given the inflationary environment, all business leaders are under pressure to manage costs and balance off inflation. Can you spend a minute and just talk about how do you think about managing costs, delivering positive operating leverage, while also making the important investments in technology and talent to drive great customer experience and customer service over the medium to long term? That very tricky balance, in particular in a highly inflationary environment today. It is a tricky balance. When you start to talk about tightening costs and watching your costs, invariably, the investments that you're making out 3, 4, or 5 years are the easier ones to cut. As a CEO, those are the ones you've got to protect, because if you're really focused on organic growth, the secret to organic growth and strong, consistent market share gains is to invest over multiple horizons. You can't constantly knee-jerk react if one tactic or one strategy stops working. You always have something to pivot to because you invested in it 2 or 3 years ago and it's matured to the point that it can carry your organization. Software organizations, technology companies think about this all the time. What's the percent of sales that comes from a new technology, new capability, new product to market? You have to think about that as a bank CEO as well. It is the discipline to make sure that you look at each of your businesses and you have horizons of investment, knowing that they are not contributing today, like Ventures, but you are seeing the traction, you are seeing the investment, knowing that there is a moat around those once they come to fruition. Now Ventures, whether it is Ownr contributing significantly to our small business acquisition, Mydoh contributing to our consumer acquisition, our mortgage business, and our mortgage ecosystem was not quite contributing at the rate we had hoped, but has strong potential still. You have curated a series of investments that do get you to that point. As you think about where you cut, you have to protect some of those at the end of the day, because if you take your eye off as a CEO, invariably those can be defunded, lower funded. It really is a discipline, a framework. You talk about it openly with your teams to say, "How are we doing? Are we nurturing the right things?" Technology and digitization is going to have to play an increasing role. We have more open jobs than we have had in a long time. We are thinking long and hard. Do we staff those jobs in the same way we did before? Do we staff half of them and see how technology can shift? Consumers are shifting, employee productivity is shifting. Therefore, there is an opportunity for us to manage the cost escalation on the labor side by using more technology, slowing the replacement rate of some of those empty roles, rethinking how we might do those roles. I think there is a lot of tools for CEOs, particularly RBC, to think about how do you manage inflationary environment on labor where you are going to have less labor over time. You are going to rely on technology. The consumer is going to use technology. They are going to be higher paying jobs, but we may not have many of them. I think there are short and medium term levers for us to manage that cost equation. Terrific. Last question. We have only got a couple minutes left, but I think an important one. As I mentioned, today is International Women's Day. Yep. I think for business leaders around the world and across sectors, obviously diversity and inclusion, but more broadly, ESG is absolutely a top priority. You personally have shown very strong leadership, Dave, both on diversity and inclusion, but also climate and broader ESG matters. Maybe you can just spend a minute in closing on why it's important to you, why it's important to business leaders, and the important role businesses have to play in driving impact in these areas. I think it starts with just the fundamental belief that we have to continue as a corporation, as a capitalist economy, businesses have to continue to earn their right to operate. It's not a given right to operate, but you have to earn your right from society to operate and make a profit in society. Therefore, how you do that and how you choose to do that and how you support your communities goes a long way to earning your right every year to be in a community and to earn a profit. Therefore, how you go about that. So the commitments we made to a purpose around clients and communities, defining clearly how we're going to impact communities across a number of dimensions. Our commitment, as you mentioned, on International Women's Day, we're very proud of the progress we've made. 44% of our global executives are female, women in leadership. We have a target now in the next three years to get that to 50/50, and we're very confident of getting there. We made significant progress over the last couple of years on more inclusive leadership in the organization. Our BIPOC representation has increased. In fact, we made a commitment. We went through the horrific events a couple of years ago with George Floyd, but it really pushed business leaders to make more tangible commitments and tangible focus to diversity and inclusion within our organizations. We're really proud. We set targets certainly around bringing in more interns or bringing more summer students. We said 40% of all global interns would be from the BIPOC community. I think we hit 50, 51%. So again, you start by giving people an opportunity and giving a broader, more diverse range of citizens an opportunity. We have focus on moving and progressing those individuals through our organization. So then the climate side, we haven't had a chance to talk about climate, but certainly, again, a great awakening among our global society on the urgency to not only get to net zero in 2050, but to make a meaningful impact in the next decade. You've seen RBC lead on that front, articulating clearly through four pillars about the impact that we're going to have, the commitment, signing on to Net Zero Banking Alliance, but certainly the commitments to work with clients to fund the transition. Your business has taken the lead on a CAD 500 billion commitment to help fund the transition, to advise on the transition, to work on policy, to help consumers understand this. It is a complex journey, but businesses have to lead it, and I am really proud of the role that we have taken. Well, that is a great way to close. Dave, terrific comments. Great way to stimulate some good thoughts as we kick off the conference. Thank you very much for taking the time to be with me this morning. And for all of our participants, thank you again for taking the time to join us for the Financial Institutions Conference. We look forward to your engagement over the next couple of days. Thank you very much.