CIBC 18th Annual Eastern Institutional Investor Conference

Sep 25, 2019

Okay. Our next participant is Rod Bolger. He's the CFO of Royal Bank, and he's been with the bank since 2011. In his current role now, help me out, Rod. About three years. Three years. Thanks for joining us. Thanks for having me. I'd like to start a little bit almost, it's not really a philosophical question, but there's a lot of talk. People think about acquisitions and how you're going to grow and the need to do acquisitions to continue to grow. You would think the largest bank in Canada would have a need for acquisitions to fuel the growth. It feels like you guys are quite comfortable that the organic story has a lot of runway in all directions. Can you talk to me a little bit about what it is about that organic story that you're still excited about? Then maybe we will talk a little bit about capital deployment after that, but just the organic story and how things are going. Yeah. We probably looked about four or five years ago and saw that your trajectory for banking globally was going to change, and customer client needs, both on the commercial and the retail and corporate side would change over time. At that point, we made a decision to begin investing differently in our business. We've really ramped it up over the last few years as interest rate increases gave us revenue tailwinds. As we've been increasing, in technology, in RBC Ventures, in distribution, and we've increased our connectivity with clients in our retail branch network and our commercial network, as well as in the U.S. Both on the retail side, the commercial side both north and south of the border, the wealth management side and attracting financial advisors. With City National, we've increased the sales force significantly since the acquisition almost four years ago. As well, on the capital market side, we've also been increasing and growing our market share there. We feel that the organic growth is what drives shareholder value in the long run. By investing in technology and different capabilities, we can attract more clients and punch above our weight, so to speak, in terms of market share growth. We've been seeing that. As a result, we've been growing faster than the marketplace across almost all of our businesses. Whether it's the retail bank, where we've been averaging growth that's 150 basis points higher than the industry, and we're seeing our volume grow at about a third of the industry, where our natural share would be 20%-25% across most products. In the wealth management space, on the asset management side, we've seen net inflows over the past year, whereas the industry as a whole has seen outflows. Capital markets were up to 10th in the global league tables on the Dealogic side. On the profitability side, we're up to number six on the capital markets from a global net income perspective. Then you go across our insurance business as well, our sales growth has been double digits. All of this is through natural acquisition, and as well organic growth. On our wealth management side, both in the U.S. and in Canada, we are adding financial advisors. I think we grew more financial advisors net in the U.S. than any of our competitors. Even though we're number six in the market there. In Canada, we're number one in the market, and we've been growing consistently over the last six years, where the market has seen a net outflow of financial advisors. We're quite confident that this organic growth strategy can continue. As a result, we're happy to pursue that path. If an acquisition comes along that makes sense, we would consider it, but it is not necessary for us to continue growing. Okay, so there's a lot to unpack in that. I want to start with the comment you made about Canadian banking. In fact, the top share and still taking share, is something that doesn't feel like it can at least intuitively continue forever. Obviously, you become the market at some point. What is it in the Canadian banking market that is seeing you still take share, even given your size? Is it the benefit of the size? Is that what we're seeing, the benefit of scale? Or is there something else that is truly driving that organic growth domestically? Well, if you look at our partnerships, basically through RBC Ventures, our partnership with Petro-Canada, where we've signed up one million Canadians, and they have saved CAD 25 million on gas since we launched that program and connecting our Avion card with the Petro-Points. At the pump, Canadians are saving money by getting both higher rewards on both programs and saving three cents a liter. Through our NOMI artificial intelligence tool, where we've given out three-quarters of a billion pieces of financial advice through AI, and have two million Canadians spending time on that, is something that again, is driving our market share growth. When you look at our mobile adoption, 94% of our time engaged with clients is spent either online banking or through our mobile app, which has more stickiness with clients. Because of that AI and because of the advice that we're giving, we are able to capture more attention of our clients. Same thing with our branch network, where we've done a terrific job of bringing in more advisors into the branches. We've rotated from transactional activity in the branches to advice and problem-solving in the branches. So yes, foot traffic is down, and tends to go down about 5% a year in our branch network. But the time spent in branches is not down. In fact, we saw that clients were coming in and not being able to schedule appointments immediately because our branch colleagues were too busy. So we've actually added more folks in the branch. We've also done more so with our commercial bankers as well as our mortgage specialists, and as a result, we're able to grab more market share. On the investment side, some of these investments that we are making, either in RBC Ventures or in new technology, is also increasing our throughput. Based on what our ROI is for some of these investments that we have been making, we expect this market share growth to continue, I would not say forever, that cannot happen, but at least for the foreseeable future. RBC Ventures, you mentioned it a couple of times now, and even the technology spend, to me it was all about client acquisition and really broadening the funnel to be able to acquire customers earlier in the process. Is it actually working that way? Are you already seeing the benefits of this spending and these initiatives? Certain of the initiatives certainly are, but other initiatives, we are basically trying to help clients. We are trying to help clients with things that matter to them. Home buying, for instance. We have a number of Ventures apps out there that are helping clients buy homes, relocate, and move. Have we basically taken on a lot of mortgages through that? Not yet, but you know what? We are not out there to do that yet. We believe that by being more relevant to our clients through the home buying experience, we will attract more clients. We also do not want to spend too much time when they are on these apps selling them something. If you are basically on an app that you have, if they are always trying to sell you something, you are going to spend less time on it. Yeah. We are not out there to sell product. We are there to provide advice and simplicity for those clients. In time, we will get more clients. Our goal was to convert approximately 10% of the 5 million Canadians that we are trying to attract into RBC Ventures over a three or four-year cycle. We are still keeping to that goal, but that is going to take some time, and we are not going to see one third of that each year. It is going to take a little bit of time for that to happen. In your original answer on the organic side, you mentioned City National, and that's one area where I think people probably would have assumed for a couple of reasons. One, it's not very big in the context of all of Royal Bank, and two, we've just been accustomed to repeated acquisitions in the U.S., I guess, that might be an area where you'd see more. But perhaps the nature of the bank, the nature of the commercial bank, the nature of your ability to expand offices and not needing to buy 500 flags, right? You don't need 500 branches to gain scale. Is this a business you can just keep growing organically and don't need to add an acquisition to at some point? We can. We have what we call an organic growth plus strategy. If there were to be an acquisition that would make sense strategically, operationally, financially, and culturally, of course, and would fit in with the brand, we would consider it. But those are some pretty high hurdles to overcome. But we have seen a significant growth there, and we expect that to continue. In the years leading up to the acquisition almost 40 years ago, City National's grown loan growth by about 15% organically. Since then, we've maintained that 15% growth rate, which over a long period of time sounds pretty incredible. But when you think about the small base they have in the markets that City National is in, there's still a ton of opportunity. I think our highest market share in any MSA in Southern California is almost 5%, and these are markets that are growing. California's been growing well above the national rate for several years now, well above 3% for many years. We have a lot of room to grow in Southern California. Much of our growth is in Southern California. We've also expanded in Northern California, and then we've expanded in New York City. We'll be expanding into Long Island. We've expanded into Boston, Washington, D.C., Minneapolis. We're growing in Atlanta, Tennessee, Nashville. You'll notice that there's a theme here of wealthy Americans as well as the entertainment industry, where we have a great niche in the entertainment industry, and that's where we have been making inorganic play, but from a technology standpoint. So we acquired FilmTrack this year, Exactuals since the acquisition of City National. City National had acquired Datafaction. These are all technologies that basically incorporate banking into our clients' day-to-day business, and we become the back office for the client as well. We help them save money by providing a lot of accounting functions, as well as payments functions, and that attracts deposit dollars. So there is an inorganic play here, but it's in a different way than traditional banking. The organic growth and the performance that you've been putting up creates an interesting dynamic in that you've already got a pretty big CET1 ratio. None of these initiatives draw it down. They grow it, right? Earnings growth is going to continue to push that number higher over time, notwithstanding the odd regulatory change here and there. Has buybacks become really the only source of drawing that down a little bit? Can you get more aggressive? Should we expect to see, particularly as EPS gets a little harder to find in a falling rate environment, is the buyback an opportunity for you that you can dial up a little bit to get a couple of percent or 3% a year out of the EPS side? Buybacks is certainly something that we consider. We do basically like to grow our dividend, and we've been growing that in line with our earnings growth over the last several years, and I would expect that to continue. We're also not starving any of our businesses for organic risk-weighted asset growth. As we acquire new clients, as we make new loans, we are allocating capital to that client base. We have taken down some of the risk-weighted assets from market risk, and that business has been driving good returns and good growth in excess of the industry on our global markets side. Our global markets revenue growth on a year-to-date basis is almost 4%, where the fee pools are down. So we're taking share there and doing an effective job. But we're also being thoughtful about how we're applying that risk-weighted asset growth. Yeah, certainly buybacks are something that we consider. We also like to have a little bit of extra CET1 ratio if we are at the end of the economic recovery. I'm not suggesting that we are or are not. There's a lot of good economic data out there. But certainly, if you are towards the later stages of an economic recovery, having an extra buffer for a downturn is something that puts us in a good position. So we will consider buybacks. We're thoughtful about buybacks. We don't want to make buybacks today, and then if there's a severe recession, have to issue shares at a lower price in the future. So we're thoughtful about that and the dilutive impact that would have. But buybacks are a good tool for us to have. Our dividend yield recently hit 4%. It doesn't hit 4% very often. It's back down to the 3.9 range. But when the dividend yield's 4%, it's usually a contrarian sign, which it was recently, and so many of the stocks have had a good run-up lately. Buybacks are something we absolutely consider, but it's not something that we rely on or that we consider one of our strategic imperatives. Okay. The ROE was sort of drawn down as part of the City National acquisition mainly, a bunch of other stuff happening at the same time. It's largely been restored to a fairly high level. How important is that ROE as a gating principle as well when we think about capital deployment and how long you want to run the capital? Is maintaining the ROE somewhere around the level it is now a priority? Or if the right deal comes along, you're happy to have it drawn down again and rebuild it over time? Absolutely. One of our medium-term financial objectives is a 16% plus ROE. We've seen all of the studies, and I ask them to be run quite often that correlate price to book value or price to tangible book value to return on equity, and believe that that is fundamental investing. It's also good discipline. It's one of the reasons why when you look at our risk-weighted assets as a company, the share of capital markets risk-weighted assets four years ago was almost 50%. It was about 48%. Now it's down around 40%. We're getting above cost of capital returns in our capital markets business, and we're growing that business. But the returns are a little bit lower than they are on the retail side. Shifting that mix a little bit has helped us grow our return on equity back to the levels that we've been at, which is around 17% on a year-to-date basis. Those are levels that we like to be at. We certainly have that as a priority to remain above that 16% objective that we have. Okay. As always, if there's any questions on the app or in person, feel free to put your hand up or step up to the microphone. Happy to take a break and take some audience questions as well. I am going to assume we don't have any, and I am just going to keep moving on. I wanted to switch gears a little bit to talk about the deposit outlook a little bit. The interest rate environment has kind of whipsawed, right? When you had the unfortunate timing of having your conference call among some of the darker interest rate days, and the guidance you gave was talking about where the forward curve is, and we've come off of some of those lows. Still a tough interest rate environment. When you think about the margin kind of on both sides of the border, is this something that is becoming a meaningful headwind or just something that it's going to slow earnings down a little bit, but you can power through and still grow revenues? Well, I think we can certainly power through it and still grow revenues. It is a headwind, but it's not something that we're unaccustomed to. We've seen interest rates over the last 30 years trend down since the mid-80s. Banks have learned to manage through that. We enjoyed a couple of years of interest rate increases as a bank. On the contrast, loan growth does accelerate a bit when interest rates come down. Delinquencies do come down, and the ability to cover debt service costs go up, both on the retail and the commercial and the corporate side. It does benefit the economy. So there's some puts and takes and some natural hedges for us. We've actually seen our volume growth accelerate on the Canadian banking side, on the personal and commercial side. In the most recent quarter, it was up around 7% growth on a year-over-year basis. We're seeing strong growth continue. I mean, some simple math. If when interest rates were growing, our volume growth was shrinking to 5% or 6%, but our revenue growth was 7% or 8%, that was a good dynamic. Now, if our volume growth is increasing to call it 7%, but the revenue growth shrinks a little bit because you have margin compression, and I'm not saying that will happen, but it could happen. Yeah you're still looking at mid to high, 5%, 6% revenue growth, which is a good position to be in. Then you move south of the border to City National, which has more interest rate sensitivity. The assets there are more variable rate than they are in Canada, where we have a preponderance of five-year fixed rate mortgages. But in the U.S., where we're more asset rate sensitive, if we're growing our asset base and our loan book by 15%, by doing that, we also came off of a very favorable loan-to-deposit ratio in City National. So as we were growing that loan book by 15%, we were shifting assets out of low-yielding securities into higher-yielding loans. So that was benefiting us. But if we're growing loans at 15%, even if it slows to low teens, you're still looking at revenue growth that would be in the high single digits, maybe even 10%. So we are in a good position, given our organic growth trajectory, to withstand some of these headwinds. And the deposit behavior, have we seen any change yet from clients? When rates were rising, there was some term extension, people taking on more deposits, almost coming back to the product because you could actually get paid to have a bank deposit again. As rates have come off, have you started to see any early indication from customers that their behavior's changing, or are they still kind of working under the old paradigm? Not significantly. Rates have not moved that much on the deposit side. We're still seeing good, we call them PBA, personal banking accounts, which is your core checking account. We've seen mid-single-digit growth there in Canada. We've seen GIC growth in the teens in Canada. We still see those trends continuing. In the U.S., actually at City National, we've seen higher deposit growth recently. So lower rates actually help us in City National, being that we have a low-beta deposit base. So we haven't chased the rates up as other banks have had to, who didn't have the same loan-to-deposit ratio and favorable funding that we had. So as rates come down, it actually helps our deposit growth in City National. So the lower rates should help from moving from more interest rate-sensitive deposits to non-interest rate-sensitive deposits, which have more value, more liquidity value, certainly. And we would expect that trend to continue if rates continue to trend down lower. But at this point, it hasn't changed demonstrably. Okay. So you've talked basically here about still the strong, call it solid, top-line outlook. Let's switch gears to the expense side a little bit. And you've touched on the fact that you've been investing a lot, and a lot of these investments were made, and you can sort of slow them down now if the revenue environment starts to slow. But there's still things like cyber and payments modernization and AML, and the list of things that you have to spend on feels like it's still growing. Do those things challenge your opportunity to moderate the expense growth the way you want to? Or do you think you still have enough flex, given some of the other investments you've been making, to moderate expense growth if the revenue environment does end up slowing the way we think it will? Yeah, well, one quarter does not a trend make. But if you look at the first half of the year, we grew expenses a little north of 6.5%. And in the third quarter, we lowered that rate to 2.3%. So we were able to toggle that down. It's a big company. There's over 80,000 employees, so it's not as though you can change the expense trajectory overnight. But we have been working at this for well over a year and a half, and we've been slowing the rate of growth down. We continue to invest, and we continue to grow. We've added FTE over the last few years, and would expect that growth to moderate. So it's not as though we have to shrink our workforce at this point, or shrink our investment spend and our technology spend. It's moderate the growth, and we have been doing that, and we're working to continue to do that. But we also don't want to sacrifice the future and the future opportunity that we continue to see out there. So part of this is making sure that we save enough money for that continued investment, so that we can continue to grow market share, and continue to invest in future capabilities for our clients. How much of this tech spend, I'm going to use a word, it's probably not the right word, but how much of this tech spend is experimental? How much is the tighter business plan, this is why we're spending money to derive this value for it, versus we're exploring. You've got these data scientists that are just basically given a data lake and go figure stuff out. How do you balance those two things? Because one of them does feel a little exploratory, frankly, in terms of see what they find. That's the part where dialing it back, you sort of potentially lose some of the optionality and momentum if you do dial it back too hard. So how do you describe the tech spending that's been going on? Every company that goes out and says run the bank versus change the bank, there's more art than science to those figures. Yeah. I would say that many banks that talk about changing the bank with an X percent, some of that is basically keeping the lights on. You have to put in new software packages that are upgrades because the old ones are getting outdated. You're constantly bringing new capabilities out there that don't necessarily advance the ball much. However, we have been making what I would say is an increasing amount, and I'm not going to give a percentage because, again, it's not an exact science. But we have been toggling that money towards items that will impact our clients, that will give them a better experience, that will give them more advice that they will be able to leverage in their client experience, and the portal is different. As well as the RBC Ventures I mentioned, and a lot of the capabilities that we have out there, both in the retail bank, on the commercial side. Some of this is also to improve the customer experience from an onboarding experience. So, we have checking account opening times have gone down by more than a half an hour in the branch network. Over 90% of those customers, while they're spending less time opening the account on the manual stuff, we're still spending that time with them. So now they are digitally enabled. Now they have online banking. Now they have the app open on their phone before they leave the branch, so they're not having to do that after the fact when they run out of time. Some of this is not necessarily adding new customers, but it is making us more efficient because those clients are stickier. They bring more of their activity to RBC when they're mobile active. They're also going eStatements, which is good for the shareholder, it's good for them, they're getting less clutter, and it's good for the environment. We're able to invest in a lot of these things that have a lot of downstream benefits that won't necessarily show up immediately. I would say that we are growing that experimental spend, and had been growing that experimental spend probably faster than many or any other bank that I'm aware of. That's to say we did start from a lower base maybe five years ago where we were lagging in many of our markets in terms of our technology capabilities, but we've caught up. In many examples, we've actually leapfrogged. Okay, I want to end on almost a philosophical topic around the partnerships, because you mentioned the partnerships earlier, and some banks love them, some banks hate them, and you guys clearly love them. I want to start with the BlackRock one, which was announced not that long ago. Talk about how it's progressing. Wealth management is one of those areas where I wasn't sure that there was a partnership opportunity for a bank of your size, but you found one. Then just talk through after the BlackRock example and how that's going. Why is it that the bank likes these partnerships among the various businesses as opposed to just to go it alone? One of our strategic philosophies is to be demonstrably different and to provide a different experience for our customers and clients. If we can't provide that, then maybe we should be thinking about doing something differently. In many areas of financial services, we believe we can be demonstrably different, and so that's why we focus on those areas where we can excel. As you look at the ETF market, we excel on the advice side, on the active management side. Our global asset management business has 87% of its dollars under management are basically exceeding benchmark on a three-year basis. We charge a lower fee than the competition. We're providing value both on a return and a cost basis. However, the inactive or the passive side, we just don't have the scale. That is a scale game. It's a low-cost producer game, and we just did not have the scale because we had focused on the active side. We took a look at who was out there and who does this well, and iShares does it as well as anyone. We looked at where can we be demonstrably different in this space, and we want to bring those capabilities to our clients. We don't want our clients to have to get active management. If they want to and choose to get passive ETFs, they should be able to get that from us as well. We also couldn't scale that up anytime soon or do it any time that would be beneficial to the shareholders and to the bottom line. We looked at where does this partnership make sense? Where can we find a win-win? That's what we did with BlackRock, that's what we did with Aviva on the insurance side, on the home and auto side, where they can manufacture much more effectively than we could as a small player. We still have our distribution capabilities. We still have the RBC brand. Again, with RBC iShares, we have a terrific RBC brand. iShares also has a terrific brand. We can brand this iShares for passive and still brand RBC for active ETFs and basically leverage that partnership that way. We look at where we can bring a win-win for us, for our partner, and our clients. The Petro-Canada example is another example where our clients are winning because they're saving money and getting more Petro-Points. We're winning because we're attracting new customers. Petro-Canada is winning because they're attracting more customers. They're attracting RBC customers that weren't filling up their gas tanks and buying food at their shops. We're attracting Petro-Canada clients that used to be banking at other banks. Okay. We are just about out of time, so I want to give you an opportunity for any closing thoughts you might have in terms of the outlook for RBC. Yeah. We remain confident in the outlook. I would agree that there appear to be more headwinds on the horizon certainly with the interest rate environment, certainly with Brexit, certainly with trade uncertainty, the elections. There's always going to be uncertainty. With certain of our market-related businesses when there is uncertainty, clients will be less active, and that will impact markets and revenues somewhat. But by and large, clients remained active out there. Commercial clients are still looking to invest and grow. Employment's still strong. Our credit book is still performing very well. So it's kind of the tale of two cities where there's the risk out there, but we are looking at that risk and managing it on a day-to-day basis and tracking clients through the cycle. So we remain confident in our ability to grow. Excellent. Well, thanks for coming, and thanks for your insights, Rod. Appreciate it. Thank you. Thank you. Thank you.