NBF19th Annual Financial Virtual Conference

Mar 24, 2021

Welcome back and good morning. I'd like to welcome Neil McLaughlin to the stage. Neil is Royal Bank's Group Head of P&C Banking, and he has had that job since 2017. I would suspect the last year would've been the most interesting of the four. Yeah, well, first of all, thanks, Neil, for joining us. Yeah, appreciate it. Glad to be here. Well, I want to start off with one of the bigger takeaways from your business performance over the past year. It's the massive mortgage growth and the massive deposit growth. We're industry-leading growth, and it's not from a small base or anything like that, so these are pretty big numbers. Both on the mortgage side and on the deposit side, what are some of the strategies you chose to enact that helped deliver those outcomes? Yeah, sure. I'll start with mortgage, and we've touched on this probably on most quarters, I'd say, over the last year. Maybe I'll just for a little more time expand on some of the comments we've given. So you mentioned 2017. That was about the time we were actually losing some market share in mortgage, which clearly isn't where we wanted to be, higher ROE, sticky relationship product. What we found was we just needed kind of a good old-fashioned sort of deep dive into the entire business. What we really circled around was we needed to treat it like a value chain. We needed to look at what's the client looking for? Where does those transactions start? We maybe become a little inwardly focused. So we sort of broke it up, and we looked at what does the front end look like? How are we generating leads? What's our timeline to turn those leads around? What's our adjudication process? What are the SLAs we set in the adjudication process? We made changes there. We adjusted a couple policies that we were out of market and maybe not just as market sensitive as needed to be. Then we did some work in the back end, really with this idea that it's an entire value chain, and we weren't at our best. It was a bit of a competitiveness call for us, frankly, to say this is an important category, and we weren't at our best. We did that work, and we came out, I think, exactly where we wanted. We came out, we built a ton of momentum, and you saw that in the subsequent year. You saw us really strong through, I'd say, the mid part of 2018, all of 2019. I think in some ways this is a little bit, it's not like the most recent story of 2020. We'd say we started all the way back then into 2018. I would say two things really helped us in the last year on this. One would be we had that momentum coming into the year. We continued to hire mortgage specialists, which it is a very large part of our model. We don't participate in broker. We have confidence in the model, and growing that sales power was a part of that quotient. We have a consistent approach to that. The other part was, so we had momentum, then you caught this big wave of people being at home. A lot of people, I think, pulling up purchases that they may have been thinking about into 2022 or further and saying, "I need more space now," or, "I want to get out of the city now." We were in the right place. I mean, our business was really strong. The last part, I would say, is because we had such a strong proprietary mortgage specialist sales force, we were used to operating in a remote environment. I mean, these folks make their living over the phone, getting in the car to go see people. Doing business over video was very natural. So you saw their productivity also really ramp up. We managed to steer clear of our mistakes in, I'd say, 2016 and 2017, where we tried to be outside. We tried to charge prices higher than the market. We realized you can be at the upper bound of the market, but you can't be 10 basis points over the market. Those things are really what led to, I'd say, sort of the back part of 2019 and all the 2020 results. What we would really say, it's a consistent strategy. It's a product we highly value for the stickiness of the relationship, the high ROEs, and we feel we're much closer to our best at this point versus where we were three and a half years ago. So that's it on mortgages. You also asked on deposits. I should touch on that. Really sort of two things I would point to on deposits. The first one was we were very public that we felt we needed to drive a lot more new client origination. We got off to, I think, a really good start, posted a couple good years, increasing, especially on the consumer side, where we were with new clients. So that helped drive that deposit growth to your question. The second part was really around an internal capability we've talked about. We have 2.5 million clients on our MyAdvisor platform, which is what we call democratizing financial planning. That just allowed us to connect with a lot more consumers and really understand what's important to them, and that led to a lot of new savings accounts being opened over the last couple of years. So those two things, then there was a bit of a safe harbor effect as clients made a decision where to park that excess liquidity. We would say we got more than our fair share, but those would be, I think, the three factors that lead into the deposit side. Okay. That was very thorough. If I look, though, at some of the other categories in the P&C Banking cards, personal loans, commercial, and I stack those up against the peer group, I'm seeing Royal on par, some cases below the group average in terms of growth, albeit in a down market in some cases. Is that a situation where your product mix, like travel rewards in particular, was one of the factors that explains that outcome? Are there other issues like you missed some opportunities in commercial or wherever? What's going on there to explain that? What are you doing to address it, I guess? Sure. Maybe I'll break them down one at a time. You started with cards. If you look at our credit card business over time, we consistently gained share, and we took over the number one market share position. We did that without making a large acquisition, which is what we saw one of our competitors do. We have a proprietary program. We have talked about that. We do not have the renewal risk you see in signing up with a large co-brand partner that is really defining kind of the shape of that portfolio. Our goal is really to have the number one travel product in the category, and we are exceptionally proud of our relationship with WestJet, just a great partner. That is a great portfolio and our customers can choose the WestJet option on the Avion product as well. Over time, we would say we have absolutely been gaining share in the credit card business. As you look more recently, since the pandemic because of that product mix and because of our credit strategies we probably skew to a better credit customer than the industry average. What you saw was the higher spending customers, especially on that Avion portfolio when they put their cards away because dining and travel, entertainment and travel, like right now, those are the only two categories that are down year-over-year. That is disproportionately where those affluent high spending customers made those purchases. I think you are seeing the issuers with those large travel portfolios and more of a prime customer base. You are seeing that de-leverage effect happen more and more. If you have got a little more risk in the book, got more revolvers your balances are going to stay up. I think that is mirrored what we have seen with our view of some of the competition. If I look value proposition to value proposition, how those portfolios have performed, the economics we are getting from owning our own program, we are very bullish on the credit card portfolio. You will see some new value propositions come out towards the end of the year just to continue our investment in that business. You touched on commercial lending. I think a bit of a story about which window you look at. If you get back about five or six years ago, again, we were not unlike for a longer period of time the mortgage story where we had lost share for about three and a half years and we had not adjusted to the marketplace. We were not growing. We did not like what we were seeing. We had to go through and do a much larger reset of that business. Then we gained over 250 basis points in commercial lending over the period of about three years. Very strong growth. Then I think you saw some more recently what you saw was some competitive reaction. I think in particular one or two who really frankly took on some credit risk that we were not about to follow. We reviewed our risk appetite and just felt we liked where it was and we liked where it was in the cycle. More recently it is in the last sort of three quarters you are seeing the market really converge and you are seeing some of those players who are driving strong double-digit commercial loan growth come back to the pack. When we look at sector and size of client in that business, we are still winning. We are still growing our share in every segment but one. It is really in the CAD 5 million to CAD 25 million credit segment, the 0 to 250 to 1 million, 1 to 5, and then the 25 and over category. We are still growing our share in all of those. That is a segment that we think we have a little bit of work to do, not a lot. As in similar effect in terms of deleveraging, we believe we left the risk in our book. A lot of our entrepreneurs we think again delevered during the pandemic. Our performance has shown that as you look at our PCL. You are going to see us continue to go out and compete in commercial lending. The last one in terms of consumer lending. Consumer lending maybe a couple things. At any given quarter of overall consumer lending, our mortgage business makes up north of 85% of the earnings. The two other segments are really branch-based consumer lending on an unsecured basis or auto. The branch-based lending makes up kind of two-thirds of the remainder and auto the last part of that. What you are seeing there is you are seeing again we have the highest market share in the industry. We are not looking to take on excessive credit risk. I think you are seeing some other players do more on an unsecured basis where we are doing a lot more with our consumer on a secured basis, moving some of that unsecured volume into the HELOC product which is very strong for us and again we like the risk. The growth rates there again why it is not concerning the mortgage business is the 30% plus ROE business. It is the sticky relationship. The branch-based unsecured consumer lending is really a life stage product. It is earlier in your career, I do not own a home yet. We need to anchor those relationships and grow them. Of course we are going to be in that business. In terms of the overall earnings growth it is not going to be the major driver. We look at it as helping the consumer at any stage of life over the long term and a risk appetite view. That is I guess the way we would look at that, but we look at consumer lending in aggregate as well and we feel really good about the market share leadership. The last one you did not touch on but I think related to the deposits business is just the outperformance in the mutual funds. Our investing business continues to lead and we saw a record quarter in Q1 and it is a byproduct of to your earlier question about what is driving the deposit growth. We were exceptionally proactive during the pandemic that we built that 2.5 million customers to share with us what they are trying to save for. That is allowing us to take what we call money on the sidelines and term GICs or in the savings accounts move that over into higher margin long-term mutual funds for us. Again that would be another outperforming business. Just actually that type, is that something that as an outsider that would be an easy thing to do? You got somebody with a lot of deposits or a bunch of customers with a lot of deposits and doing nothing then convert them to mutual fund clients. Is that easier said than done? Have you had to enhance any strategies or whatever to kind of make that happen? Yeah, no, it's not rocket science, to your point. It's a big ground game though, right? You need to have the CRM Right systems to identify what customers are actually sitting on an amount that makes sense that they don't think they're going to need. You need to know what the client preference is. A good example I'll give you is, we'll see some older clients who just say, "I don't want any risk at all, so my risk tolerance is very low." They've got a ladder GIC strategy. So you need to be able to pull those out and say, "They're not going to want to go into a long-term fund and take on market risk." That's exactly what we do is we have a large sales force. We mine our data looking for those clients. We send out the leads, and you're able to demonstrate to them that you're not going to need this liquidity anytime soon. Get the market working for you. We have a plan, then we can revisit that plan over time with the client. It's also one of the reasons that we have something we call pre-authorized contributions. A lot of customers will, again, will take that excess liquidity out of the checking account because we don't have a minimum balance requirement on our deposit accounts. Again, we'll put that into working for the client into long-term funds. Again, stickier relationships. So that's been core to our strategy for quite a long time. I asked you this question on the Q1 call, but we got a bit of maybe more time to kind of dive into it. But I look at, in Royal's case, I think it's CAD 40 billion or so of consumer deposits in the Canadian bank, an increase versus last year. I look at that number and I think Yeah wow, that's great. But how does that affect the lending outlook? Are people even going to have to borrow money outside of mortgages? Obviously, there's borrowing going on in mortgages, but cards and all these other categories, that looks to me like a pretty big headwind from a credit demand standpoint. Yeah. It was a great question you asked on the Q1 call. I think we don't have a crystal ball exactly kind of what the shape of the curve looks like, and I think I touched on a couple of the factors that are going to go into play. The first one we talked about is that consumer spending is going to have to rebound. So you have this liquidity. Some of it we're trying to get moved over for clients into long-term mutual funds. With the amount that's been built up, we think that's a really good advice for a large group of clients. For the clients who don't put most of it into a longer-term wealth creation strategy like that, it will be able to fund some of that lifestyle as the economy opens up. We're seeing right now, we're seeing credit card spending get into the positive territory, whereas earlier in Q1, we were still negative. So you're seeing as the economy starts to open up, those two categories of dining, entertainment, and then travel, being the only two that are negative. You're seeing dining and entertainment come back, and that'll start to burn away some of that excess liquidity. But in terms of how long does that take and where is that mix of where that flow goes, I think for the next couple of quarters, we're going to continue to see some depressed demand for credit. But it's going to follow the shape of the economic activity. One of the examples we looked at was the segment of new, what we call transactors, credit card customers who pay their bill every month. There's a material number who had paid interest as a regular part of their behavior that because of all this extra liquidity, are able to make their payments. Those are the types of clients that as they ramp up their spending and they're not able to pay off those credit card balances, that type of balance. Okay. I don't know where we left off. I think we were talking about just the unsecured credit business and when do we see that coming back. I think we touched on the factors of it. We touched on the non-credit card piece, again, in terms of earnings growth, just trying to size that a little bit for you in terms of where does it fit in our strategy. I guess the last piece on credit cards, there is some spooled up earnings potential there as you look at where we are in that business. If you look year over year, there's probably a couple hundred million CAD that once we get that spending back to where we are, the balances will build back to. We had hit $20 billion in the credit card book when we were well down below 17. As you look at the yields on that will come back to the exact timing. I think, again, we can predict the shape, not the exact probably slope of the curve. But it will come back. Okay. I asked another presenter earlier today, and this is all in the vein of consumer credit demand, but from a policy standpoint, are you thinking at all about some measures that the government may introduce that could structurally change the consumer credit market in Canada, like UBI? I am thinking of that one in particular. I know it is probably a few years away, but it might be something worth talking about. If you look at the comments we are getting right now out of the government, it doesn't seem like it is coming anytime soon. If you look at the mortgage changes that we went through, which again, we were supportive of and the industry adjusted to, and you saw the Vancouver and GTA marketplace really be the most impacted, but it sort of tamped down the market. It cooled them. I think it took some of the speculation out of the market, which we think is really healthy. Other than that, we have gone through rigorous cost of borrowing regulatory changes already. We have gone through things like the underwriting of mortgages, the thing to point out. These mortgages are underwritten with a +200 basis point stress test at the times of adjudication. So still think we are in a very healthy position. The credit books, obviously with all the government stimulus, have performed exceptionally well through the pandemic, and we will obviously work with government as this plays out. But it doesn't feel like there is any coming in the near term based on some of the commentary we would see. Well, one regulatory change that is coming, I guess, in the near term is the revisions to B-20 and a focus on high debt-to-income ratio borrowers being a bigger percentage of the originations. That seems to be their hot button. Any thoughts on timing of a potential change and how Royal is positioned vis-a-vis those types of originations? Yeah. We haven't really got into the details, so it would be premature to really get into that. Frankly, I haven't really even sort of broken down what their intent is there. I think the intent is probably clear. Again, when we look at the underwriting in our book, we've always been a conservative underwriter. That's just the strategy that we took on. We don't participate in any non-prime, as an example. You look at the first round of B-20, you saw a lot of advancement in terms of breaking down these portfolios into the different segments, having the residential mortgage underwriting policy need to be signed off all the way up to the board. So there's a tremendous amount of granularity in the industry now. I think we continue to see really strong underwriting. If I look at, for example, a couple of these segments within our book, for example, like an investor segment. It actually performs better than the rest of the book. I think there's some of these high net worth clients who are non-investors. Again, performs even better than the average of the book. So it's a little bit of what does it perform at the headline, what are some of the metrics? Because at the end of the day, you're not underwriting these based on the more traditional adjudication metrics. So I think tracking them, separating them out, tracking them as separate portfolios makes a lot of sense. Again, that granularity is good for the industry. But I'm not seeing any signs of excessive stress in those books. We continue to like the risk on the overall portfolio. So again, we'll work with OSFI on it, but I think the original B-20 was probably the big quantum shift. We've adjusted in this, and we'd say we're a better, more rigorous business for it. How about fee structures in the industry? It's a bigger topic in the U.S., stuff like overdraft fees get a lot of attention. Not so much in Canada. In the past, actually, fees have been this lever that keeps getting pulled to drive revenue growth. What's your perspective, and how are you adapting to dealing with your customers that way? Yeah. That's a great question. The first thing I think you'd look at is on the consumer side, you haven't seen the same trajectory of fee increases over the last, let's say, three years. In terms of the number of fees that are getting changed or that it's one direction, you're seeing a bunch of actual fees actually come down. It's probably more balanced. In terms of overdraft fees, the other market we would look to is the U.K. and some of the European markets where you saw institutions really, I think, drive themselves into the ditch by getting hooked on these nuisance fees, over limit fees, and NSF fees. We don't believe that's how you want to build your franchise. This is a negative client experience. In fact, we're coming out with, in a short while, we're coming out with a banking package that will actually waive the first NSF fee because this view that we want to demonstrate to customers we have their back. We know that every once in a while, kind of life happens, and it's just more of a signal of trust. We'd rather give up some of that fee income, build trust in the institution, and over time, we think that'll pay off for us. We'd rather build our business on positive client experiences. Things like we talked before about buying your first home, about planning for your retirement, starting your business, not about negative circumstances like that. The other side of this is there's a big cost on the other end. You've got to go and process this fee, and clients want you back, and they're disappointed, and you waive part of it. I think what we would look at is you have to demonstrate value for money for these fees. If you look at our other income line, what you're seeing growing is discount brokerage fees, mutual fund fees, and our credit card business. We wouldn't put any of those in a negative category. The last one is these sort of service fees on deposit accounts. Those negative fees fit in there. Again, as we drive more clients, we'll grow that line as well. I want to sneak one more in on expense management. The past year was obviously about battening down the hatches. You've got emerging growth on the horizon. You've got competitive threats from big tech. Where are we now? The tightening on expenses is behind us. Are you back in full-on investment mode? How are you approaching things? Yeah, listen, I think cost opportunities and efficiencies is still an opportunity for us. I don't think you're going to see us. We've talked about low single digits on the expense side. Still think that's where we are. If we look at where are we going to drive some of these, I think there's really two large buckets. One of them is about end-to-end process re-engineering in our operational environment. We've got about just a little bit short of CAD 1 billion in costs that we would put into kind of the retail back office, contact centers where we process mortgages and loans, those sorts of things. We've got a couple large initiatives right at the moment doing a large process re-engineering there. It's about really eliminating work, digitizing work, automating work. It's about a people play. It's about doing more work with fewer people. The other part is about really driving advisor productivity. Our mortgage business is really successful, but at the same time, we think we can make those mortgage advisors more productive and over time start to reduce our cost to originate. So pay them the same amount but allow them to originate 25% more transactions. That means they're going to need to be a lot more efficient, so better data, better technology to work with, shorter transaction times. That's a good trade for obviously the business, and it's a good trade for the employee on the other end. So those are the types of things you'll see us do. But it's like, again, a lot about using technology, data, and automation to drive more efficiencies into the franchise. Well, we are into overtime now, Neil McLaughlin. It was a good, thorough, and interesting discussion with you. I hope the rest of your meetings go very well. Thanks again for joining the conference. Yeah. Appreciate the opportunity. Great to see you. Take care.