Barclays 2016 Global Financial Services Conference

Sep 12, 2016

Well, good morning, ladies and gentlemen. Quite pleased to kick off the Canadian content of our financial services conference here in New York. Very pleased to have Janice Fukakusa, who is Chief Administrative Officer and Chief Financial Officer at Royal Bank of Canada. Janice is a veteran of this conference, and we are pleased to have you here once again. As usual, we are doing the fireside chat format, so please get some questions ready for Janice. I promised her that I am not going to ask anything about energy or housing, so it is going to be up to you. But since I am up here in the dais, I get to be greedy and ask the first couple of questions. Janice, I wanted to start off with from looking at the City National acquisition, which is not necessarily transformative for Royal, but was a very big step. It was a strategic acquisition, but from our standpoint, tactically, the timing was excellent in terms of getting exposure into the U.S. when the Canadian economy is not doing as well, and I guess coincidentally, getting less exposure to your energy portfolio. When you are looking at deploying capital, either organically or inorganically, how do you balance between deploying into international operations versus the domestic? Does your outlook for the economy have any influence on how you balance that? That is a great question, and I think that given the economic environment today, we have been on a long path of ensuring that we diversify our earnings across business segments and across geographies so that at any given point in the economic cycle, we are able to generate and drive sustainable earnings growth and solid returns. I would say that when you look at the Canadian environment and you look at the fact that while there is still growth in the environment, it is not as high growth rates as it was, say, five to six years ago. But we still need to sustain growth in our bank as a whole, and the U.S. is our second home market. So from our perspective, it is worth the investment in capability given the fact that the U.S. economy is picking up, and that is what drove our acquisition of City National. When you look at the impact, and it is capital deployment, if you look at the impact of any marginal CAD of capital that is deployed in other than Canada, it is of course a little more expensive from a returns perspective, but we believe that if we can see a line of sight to good accretion and to getting back to our return on equity objectives, then it is worthwhile to invest in earnings growth. If you look at City National, it has been a great acquisition for us. So just a bit about City National. I think that year-to-date, we have earned about over $330 million on a run rate basis. It is a terrific growth platform. Assets are growing at about 12%-14%. Deposits are growing at 16%, and we see a ton of great revenue synergies across the board with our other businesses. From that perspective, it is about growth for us. In terms of the synergies, you have done better than, I believe, what the Street had expected in terms of the synergies that have come through. Do you have more coming through on the expense side? I know it was not hugely material, and have you started to see the revenue synergies start to pick up at this stage? Well, we have some expense synergies. We specifically chose to focus only on revenue synergies because it is about growth for us. So we have the typical leveraging contracts and real estate and that sort of thing, and some of those synergies have come through already. Some of them will be coming through in the next couple of years. On the revenue side, we have seen some good cross-platform marketing from our capital markets platform, referring clients back and forth, and City National, the same thing. We have our U.S. wealth platform. We have the deposit generation capability that is now part of it flowing into City National. So part of the outstanding growth in deposits relates to our wealth management platform. Then we see some north-south activity. I would say it is early days. A lot of the growth you see is organic within City National, but we see a pretty good trajectory over the next two to three years to get going on some of the synergies we talked about at the investor day. Fantastic. In terms of capital, there's, my words, a looming issue outstanding for Royal in terms of being potentially designated as Canada's first globally systemically important bank. Honestly, I think the City National acquisition didn't help you in any regards from that standpoint. What impact do you see for your operations if you are actually designated as a global SIFI, and what advantages may this actually convey to Royal, if any? I think, yeah, you're right. We are pretty close to the metric, and the metric is 130 points or whatever the measurement is, and it's a numerator and denominator, so our own complexity is measured against the base group of G-SIBs. We're pretty close. When you look at what our regulator did, because there was that issue around G-SIB three or four years ago, they actually put a D-SIB capital buffer on the six Canadian banks. If you look at what's happening with Basel and G-SIB versus D-SIB, you can either be one or the other. You can be a D-SIB or a G-SIB, and there's already 100 basis point increment on our capital. If we tiered as a G-SIB into the lower end, and we'd be lower down in the bucket, it may be about a 1% capital increase. From that perspective, we think that there won't be a burdensome regulatory capital issue there, and we're running our ratio now at about 10.4, 10.5%, with our guidance being 9.5% from our regulators on a total all-in basis. When you look at that, we think that any mechanism or additional capital, if they choose to do so, will be future related, and it won't be a burden. When you look at the actual reporting and the additional transparency on disclosure, we're already there as a Canadian large bank. I think that the issue is complexity in the business, and some of that complexity flows through with our capital markets platform. You would've seen us in the last two to three years, taking down some complexity through our fixed income business and looking at exposures and right-sizing the capital that's attributed there so that we can really get some consistency on earnings and returns there, and more of the mix in capital markets being corporate investment banking as opposed to trading exposure. If you play that out, we think that being a G-SIB or a D-SIB is, from our perspective, relatively consistent with the way that we're growing our business, and we can't see any sharp turns from the regulators in terms of changing the rules of the game. Fantastic. Before we open the questions up to the audience, can we actually start with the first polling question? For those of you that are not familiar with this, question is here. You do have handsets in front where you can vote. For those that are on the webcast, the question is: how do you view Royal's acquisition of City National? One, very positive, two, modestly positive, neutral, modestly negative, very negative. If you can add one vote in for Janice, she'd like number one. Well, definitely skewed to the positive. That's very good. Actually only 6% on the negative side, no very negative. I'm not going to ask you to comment on the results, but I think that's definitely where we're seen most in the marketplace. Do we have any questions from the audience to kick off? You've stunned them into silence. Okay. Janice, in part of the opening discussion, we talked about the outlook for the Canadian economy not necessarily being as fantastic as it is for the U.S. What is your or Royal's outlook for growth within the retail banking segment in Canada? I think when you look at economic growth, it was pretty subdued in the first half. Some of that relates to, of course, the first calendar half, the fires in Alberta, and the continued downward pressure in the Alberta region. I think overall growth rates are down, but we expect them to come back in this next quarter. I would say that there is a trifurcation of growth in the Canadian economy, where you have BC and Ontario experiencing very good growth in the economy, very good consumption. In the Alberta region, the price of oil is still weighing heavily on what's happening there. When you look at it from our perspective as operators in the market on the retail side, our production and our operations are pretty well in alignment with the population base of Canada. We don't have a regional skew. When you look at what's happening in things, generally, overall credit quality, we see that while on the personal unsecured side, there are some signs of a bit of weakness in the Alberta region, meaning on credit cards, some non-payment of monthly payments, that sort of thing. It is in no way, shape, or form astronomical. It's at the margin, a little bit weaker credit quality offset by stronger credit quality in Ontario and BC. It is a case of monitoring areas where you see there's some stress or tail risk, and then making sure that from a productivity and sales perspective, we have the right resources in the areas that are growing. To touch on the consumer book within Alberta specifically, because that is the oil-producing provinces where the concerns are emanating from. A little bit of a quirk within the Canadian industry is that there actually is non-recourse within the Alberta mortgage portfolios. Royal typically runs with a little bit more uninsured mortgages than the peer group. What do you have that gives you comfort on your uninsured mortgage portfolio in Alberta that's not going to cause any problems with the slowdown that we're seeing on the consumer? I think when you look at the actual portfolio, the tracking of losses is very consistent with the rest of the portfolio. This past quarter, one basis point of losses. What is critical in a region that is distressed, like Alberta, is to get ahead of the decision with the consumer. We do very active monitoring on a postal code and borough-by-borough basis. We look at, for example, if there's a credit card payment that's missed, and generally speaking, for our customers, we have at least three products with them being the checking account, the credit card, and the mortgage. If we see they've missed a payment, we look at their debt load and see to what extent we can reschedule some of the payments so that they can reduce their credit card debt or eliminate it and generally have room in their mortgage and their payment there. If you look at the portfolio, it tracks what's happening with our portfolio at the national level. The LTVs are between 50% and 55%. The debt serviceability is still relatively good, even in the face of the unemployment, and it's a matter of working with our clients and managing through that. We have gotten ahead of a lot of what's happening. It's the same thing, by the way, on the corporate side. We are vigilant that as credit quality changes, we will be on top of it, but we haven't seen any cracks in our portfolio. Fantastic. Any other opportunity for anyone in the audience? Anyone? Thank you, Janice. This is Esra Turan from Barclays. I'd like to ask about your European ambitions, mainly in asset management and investment banking space. On the asset management, you made a great acquisition with BlueBay. Is the plan look for opportunities, or very much focusing on integrating BlueBay with maybe Royal Bank of Canada asset management business? In under investment banking space, Europe is changing a lot recently with huge consolidation potentially coming. Do you see you have a role to play in that changing landscape, or you prefer to stay away? Those are both great questions, and I think it speaks to the fact that we talked earlier about the U.S. being our second home market and Europe is our third home market. Definitely, in the wealth management space, we continue to look on adding capability at the asset management side. I would say that capability is very expensive in the market, and I think that with the success we've had with BlueBay, and BlueBay is both about having product manufacturing that in emerging markets, which of course are a little bit soft at this point in time, but distributing that product through our North American distribution. We're looking at similar sorts of capability on the equity side. We recently, well, I guess not so recently, but in the last two years, acquired a very solid equity team in the U.K. So those are the sorts of acquisitions we think are possible, and then we will look for anything else that's available, but always looking at the multiples and the price. With respect to corporate investment banking, we have retooled the platform to be more of a corporate investment banking, traditional banking and lending and issuance support, and less about a trading platform. So it is all about positioning and making sure that we have pretty solid European operations that can withstand some of the fluctuations that are happening now and stay with the course of time to be there positioned well to take advantage of the upturn when it does take place in hopefully the next few years. Very similar to our position in the U.S. on the corporate investment banking side, where we had through the financial crisis, had a fairly solid performance, but we had been building our corporate investment banking teams. As the economies picked up, we were able to capitalize on that. We recently opened offices in Frankfurt and in Paris specifically for corporate investment banking because we believe that we need to be there for the long term and hope to be participating in the upswing there while making sure that we keep our costs and our activity at least returning for us solid returns so that we do not have to ever think about the fact that should we be there or not. I think resoundingly, we are there, and we are committed to the markets for the long term. Janice, if I can tag in on that question. For Europe in particular, obviously, the competitive environment has changed both with the challenges that the European-based financials are having, but also in terms of the regulatory capital environment and how costly some of these operations are. How do you see Royal's competitive positioning in Europe for capital markets specifically because wealth management is nowhere near as capital intensive? I think that if you look at the regulatory capital construct and going forward on Basel, where we think there will be attention, it will definitely continue to be on trading operations. You have seen us right-size the operation there as we have in other areas like the U.S. and Canada. If you look at some of what is being proposed and credit exposures, that sort of thing, I would say that definitely when we talk to our regulator about anything happening on the Basel front, one of the things we did, of course, right immediately post-financial crisis is we early adopted everything in Canada, and now it is more of a business as usual. So we will have whatever time frames are available to the other Basel banks to tier into that. I think from a competitive perspective, we will be right there. I think that when we look at our own book and compare the difference in our book compared to some of the European financial institutions, we probably have less interconnectedness, less term exposure therefore. I think that from that perspective we will be in, I hate to say this, but maybe a slightly more favorable position to be able to deploy capital in the market as it turns around. But that is what we are monitoring, and that is why it is so important for us to maintain our position in Europe and also use capital wisely and make sure that the returns that we earn are acceptable to the shareholder. And then if I can stay with capital markets for a moment, but taking a step back from Europe and just looking at your operations in totality. You just reported your third-quarter earnings, and the performance in capital markets has been absolutely fantastic. I get to pick on you because Royal's absolute and relative contribution from capital markets is a little bit stronger than your peers. What are you seeing that's driving this strength in the capital markets where we've actually seen weakness from some of your other global peers? I think that there are a few things. I talked about the trading repositioning, and I think this past quarter, when you look at the possible impact of Brexit, we were positioned on a risk-down basis. We extended all of our liquidity. So even though we were thinking it could possibly be positive, of course, we do this a lot. We think the best, but plan for the worst. So I think that gave us opportunities in the market as things unfolded. I would say that if you look at the capital markets book alone, it is because of the strength in our corporate investment banking side. I think that Canada was particularly very strong in Q1 and Q2, our Q1 and Q2. Then I think in the third quarter, we saw some little bit of resurgence in the U.S. in some of the pipelines that we're building there. There was some issuance, and I think that if you look at that all in, it really helped us to actually earn through some of the issues in the quarter. Before we go to the next question, can we have the second polling question, please? What's the most undervalued segment of Royal's operations? One, capital markets. Two, wealth management. Three, domestic retail. Four, investor and treasury services. Or five, insurance. I'm actually hoping it's not five. It's the wealth management. So Janice, if you wouldn't mind expanding upon wealth management. I know we talked about the City National acquisition, but of course, you have a very strong platform to begin with in North American base. Do you want to touch upon that? Yeah, I think that if you look at our asset manager, it's a pretty strong asset manager. We talked a bit about BlueBay, but when you look at the AUA and AUM, they're in our asset manager, and it is the top asset manager. I would say that as the top asset manager, it enjoys pretty good margins, and we're able to sort of get ahead of things like the potential for pricing to come off mutual funds by actually being more proactive and taking some of the fee load down, that sort of thing. Our distribution in North America is pretty strong. I would say that it wouldn't be as well known, and even our U.S. distribution, when you consider that we have 2,000 IAs working throughout, and it's tough with the mega firms, but it's still a pretty respectable distribution network, and that's why we have that unit now under the management of Russell Goldsmith, our CEO of City National. It's not because we think that every one of the clients that we have there, we have 350,000 clients, is going to have City National bank accounts. But it's because in certain areas where there's a possibility of stronger cross-sell, we can actually affect that more quickly. I think that the other thing that has happened in wealth is you saw us repositioning the international wealth management business. Given that it was not efficient, we had, for example, 35 delivery centers, we're down to three, and basically looking at the business base from an OECD lens. So those results or lack of results have been bled through our earnings over the last year. So I think that as we reposition, it's always tough because you are a bit inwardly focused on repositioning to get our story out about the rest of wealth management. Yeah. Any questions from the audience? Okay. Janice, in terms of the spillover impact from the Canadian economic growth or lack thereof, debate surrounding whether or not the Bank of Canada is actually going to cut rates versus increase rates to see how can Royal manage to defend its profitability in what's quickly approaching a zero interest rate policy. Do you think that there is even a sizable chance of the Bank of Canada ever going to zero? That's a tough one. That's two cuts away. Two cuts away, but that's a tough one. I think that definitely export sales seem to be improving, and it's always hit-and-miss. I think that the Bank of Canada is very concerned about stability. I don't know if they're thinking about rate movement one way or the other. We used to think it would be up, but I think it may be more to be flat. When you look at our position, our net interest margins on the retail side are reducing one to two basis points a quarter because of the mix. When we look at the environment of relatively low interest rates, we're focused on actually doing things like continuing to gather deposits because we think that that positions us well into the next cycle in terms of new client acquisition. We are, of course, totally transfixed on our cost management agenda too, because we believe that our operating leverage, despite the revenue environment, should be 1%-2%, and we've been embarking for a number of years on programs to make sure that we continue to invest in digitization and taking steps out of the back office so that we can actually leverage that productivity, and keep our operating leverage working where it's still working for the shareholder in terms of generating earnings growth. I'm going to circle back to expenses, but want to touch on the point about deposit gathering. It makes an absolute ton of sense, but how much pressure is that putting on margins when, if you're not seeing the loan growth materialize, you're obviously having to put it into lower-yielding securities, which puts the additional pressure on margins. Is that something that obviously you're willing to take on in the near term? Well, if you look at our loans to deposit mix, it's tracking at about 90%. So at the margin, it is better to have deposits in. It's interesting because for us, we're the exact opposite in the U.S. So in the U.S., with the deposit gathering that's taking place there, we have more deposits than loans, and they're positioned in securities with a very short duration. So in anticipation of a Fed rate move, whenever, I think that you'll see some positive influx there. But with respect Are you willing to give us a timeline on that? No. I think everyone in the room should. We should do a vote on that. That's the next vote, right? That's the next polling question, yes. I think that when you look at where we are positioned in Canada, it makes sense to actually get our deposit ratio as close to maybe 95%-100% as we can, because it'll still be beneficial to our net interest margin at the margin. Okay. Just to this point, Janice, can we go with the third polling question, which has nothing to do with the Fed rate? How would Royal being designated as a global G-SIB change your opinion on the attractiveness as an investment? More positive, no impact, or more negative? Although you may have skewed the result with your commentary earlier. More negative. Yeah, actually, based on your commentary and our belief, I'm actually a little bit surprised by that. I would've said more neutral, but obviously, we have already talked about that, so no need to defend it. We are coming close to the warning period on my time here. Are there any questions out of the audience before I hog the puck for the rest of the day? No. Okay. Well, Janice, as promised, I do want to touch on expenses. You talked about Royal's mantra of constant expense control and getting the operating leverage at 1%-2% in this environment. But what's been very interesting is that Royal actually has not taken a restructuring charge, where we've seen almost all of your Canadian peers do the same thing. What's your thinking, particularly as CFO and CAO, behind not taking the charge and not being able to pull that out of the system right away? Well, I think that when you're on a continuous curve of taking restructuring charges, I would say that if you look at, for example, look at our FTE count, our head count, and you'll see that I think that year-over-year it's down 700 people. If you look at that and look at the different environments we operate in, we have severance charges that are flowing through every year at about the CAD 80 million-CAD 90 million range. We don't exclude them. You hear us talk about them in the segment, and you'll see, for example, in our wealth management platform that happened in Q4. You saw in the Caribbean and in our investor services business when we had to use that way of taking costs out. We have used that way of taking costs out. I think that it's not so much about the restructuring charge as it is about taking our costs down to accommodate growth, and to take costs out of the back office, and continue to digitize. Then to deal with what we're dealing with in terms of staff relocation from both an attrition and a retraining and redeployment basis. We will continue on our journey. If we think that there's an environment specifically that we have to take a restructuring charge, we will, and I think that when you look at our results of what's happening with costs, for example, in our nine months to date, if you compare our expenses this year to last year, we're down 2%. We don't have the benefit of that being an adjusted number. It's a reported number, and we think that it's more about the activity in delivering shareholder value than it is about thinking about maybe classifying something as restructuring or not. But we always say if we have to do it, we'll do it. Okay. I think we're at our last chance to ask Janice Fukakusa about housing or energy. No. Janice, I think I will close with a, and I apologize, a very open-ended question on Royal's approach to fintech, and particularly in conjunction with trying to control expenses. Because as you've alluded to, you've done a very good job of pulling out expenses, controlling the growth. Yet from my standpoint, fintech, the investment in technology- Systems to be able to not only manage what's coming in, but also combat all the competitive pressures means expenses. How do you balance this, and where do you see the competitive environment or the partnership environment 5 years out? I think that part of the taking down of expenses and spend has actually been to invest in fintech. When you look at the advent of fintech, I think that clearly we need to actually, in our current environment in retail, digitize everything we're doing, because I think that's what our client base is telling us. Then we also have to think to the future about the whole distribution model, and if that's going to happen, and make sure that we have feelers out into all sorts of activity, including small investments in technology and labs. So we've opened four or five labs around mostly North America in order to get a window on what's happening there. I think that if you look at our technology spend, it's fairly large. When we look at the allocation of spend, we used to be, I would say about 3 years ago, 80% run the bank, 20% change the bank. You need to be, of course, mission critical on running the bank. We have managed to retool that to 75/25, and in terms of digital spend, we spend, I think, a couple of hundred million CAD a year, specifically on fintech, on trying out things, on working with suppliers. One of the things we realized is that we have to change the whole way we develop product and develop front-end systems to be really fast. So we have this rapid digitization that occurs in really small chunks. So you won't hear us saying we have a three to four-year program as we did for our mortgage system. It's more about chunking it down into little pieces and being able to pivot and being more agile. So I think that if you look at our investment, it's about shifting some of the spend, plus reducing spend somewhere to invest, because definitely it's important. Philosophically, does Royal have a preference in terms of partnering up, JV-ing, or just purchasing off the shelf? I know everything is customized. Do you have any preference in terms of how you like approach that? I think that if it speeds the delivery time, we are quite happy to partner and look at different technology. Where we have the development dollars is moving it into our core systems, right? Even that, if we can find a layer that will do that in between our core system and the front-end system, we will do that because the critical thing for us is speed. There is no point in being perfect if we get done and everyone else is onto the next iteration. So it is about agility, I think. Fantastic. Well, Janice, I think we will leave it there. Thank you very much for coming out. We do appreciate it. For those of you that are interested, Bank of Montreal is up next in this room. Royal is not hosting a breakout session. Thank you. Great. Thank you, John. That was great.