Barclays Global Financial Services Conference

Sep 17, 2015

Good morning. We are carrying on today with Royal Bank. Janice Fukakusa, the Chief Financial Officer, and a whole litany of other titles on Royal. Janice, thank you very much. You are actually a veteran at this conference these days, and we appreciate your participation. Just wanted to open with Royal, along with the other banks, just reported third quarter. What is your perspective on the results that you guys pointed out in terms of where you had strengths and where are the opportunities where you may be able to improve performance over the coming quarters? I think that is a great question, and that is a great way to start off our talk today, John. I think that when you see our quarter, we think we had pretty solid results across the board in all of our platforms. It is the type of quarter that we have continued to have in the face of all the economic uncertainty. What we always say is we congratulate each other on a great job done, and then we think about how does this look going into the future. Why don't I just talk a little bit about where we see maybe some of the different businesses being in some of the macro risks. Please. When you look at our retail platform, we had another record quarter in retail, and I think that what you saw there was pretty solid revenue trajectories and pretty good control over cost. Looking forward in retail, obviously the mortgage market is slowing down given where we are in the cycle and what has happened with low interest rates. Where we see some opportunity in retail, really leveraging off our core significant strength in all the products is on the deposit and investment side. You will see our volumes in deposit and investment products. They are in the higher single digits. We are focused on those as products because if you are looking at the uncertainty in the market, eventually when the GDP picks up, they are a great position for us to start in the cross-sell that we have. It is really important at that point in time to get more heavily into credit products. We see some good signs of strength on the business and commercial side, particularly in Ontario and Quebec. I think that that is the net result of having low oil prices and the weakening of the CAD, making some of our companies really see the advantages of getting more heavily into the export market with the U.S. When you look at that from a domestic perspective in those sorts of lines of businesses, we think that we can continue with fairly solid revenue trajectories and obviously, clearly keep an eye on cost, because I think for us, we need to make sure that as we look at how we are managing our costs, that we continue to drive operating leverage of 1%-2%. I think from the Canadian banking side, that's sort of how we're looking at the future, cautiously optimistic, and making certain bets on certain types of activity that will get us very well-positioned when the economy picks up. If you look at with respect to the other platforms, you'll see, for example, in capital markets, they had two quarters, very hard comparables, but we continue to drive that model of overweighting on corporate investment banking. We have pretty good activity in the U.S., and so we're seeing the benefit of the fact that over 50% of our revenues and earnings are in the U.S., and therefore leveraged to some of the economic uptick in the U.S. I think with that platform, it's about carrying on with the model of diversifying across the geographies and continuing to sort of weight more heavily on the corporate investment banking side. I think with wealth, you see wealth is not necessarily performing as well as we think. I think part of that has to do with our international wealth management restructuring. Once we're through that next quarter, we're going to renew our focus on things like the cost side, plus continuing to drive revenue in our asset manager and in our retail distribution networks there. Then with insurance and investor and treasury services, I think both of those platforms are moving on quite well. I think I would characterize the quarter as good job, but we're still cautiously optimistic, but looking for the signs in certain of the things that I think you'll be talking about in a minute. Well, actually, I think my next line of questioning is going to try to preempt at least one of the major questions we'll have of the audience. Royal being a victim of its own success is the largest bank in Canada, and obviously there's discussions around if and when Royal will be designated as a global SIFI. Can you give us your thoughts on this and what the potential impact may be for Royal's platform? What is that? I think they are moving. Oh, they are moving. Okay. Okay. Sorry. I thought it was some groundswell. I do not think the building is going to fall on us. Yeah, exactly. That is a great question, and you are right in terms of the fact that the designation of G-SIFI is one of the areas that we have been focused on for a few years. When you look at the metrics themselves, I think the metrics are already set, and I know that recently we had a conversation— I had a conversation with Mark Zelmer because he is actually going over to Basel to discuss, among other things, G-SIFI. When we look at G-SIFI, it is in the context of our overall capital management. For us, being a G-SIFI is something about we are where we are because we are very comfortable with our business mix. We know that certain of our businesses drive a disproportionate, or have a disproportionate weighting in the metrics, like our investor and treasury services business, and some of our capital markets businesses. But we think that it's really about overall how we manage our capital. When you look at the potential for a G-SIFI additional capital buffer, you'll recall that our regulators actually put a G-SIFI on all the Canadian banks in anticipation of any one of them becoming one, so that they wouldn't be more competitive or less competitive. When you look at the concept of a potential G-SIFI buffer, the conversations we've been having with them have not been conclusive, but we think that when you look at Canadian banks generally running ratios of 9.5% plus, that's a 250 basis point buffer over the 7% requirement. You look at the G-SIFI regime, it sort of tiers in there well around the middle of what the G-SIFI buffer is. So we have looked at our own capital position, and our regulator is going to Basel to talk about this, and so we've had extensive discussions about our own capital planning, and that's why you see us running our capital at around the 10% level. Because we think that at the 10% level, if there is a possibility of having an add-on, it may not be large, and also there'll be an adoption period. So we think that at the 10% level, we are pretty solidly capitalized to support the businesses we're in. So with respect to capital management, you'll see us running that ratio a little higher to the end of the year because we are anticipating closing City National in November, which is the first month of our next fiscal year. The funding of City National's balance sheet will require 70 basis points of common equity Tier 1. So that'll drop us down to about 9.5% on closing, and we should accrete back by the end of the quarter to the high nines, and then be in a position of our 10% sort of soft target, and be able at that point in time to look at more ongoing capital management activities like returning capital to the shareholder by way of buybacks. Maybe looking at selective acquisitions, although that would be episodic given the fact that we will have our hands full with City National and the acquisition integration. Well, thanks, Janice. That dovetails in with the first polling question, if we can put that up, please. How would Royal being designated a global SIFI change your opinion on its attractiveness as an investment? More positive, no impact, or more negative? You may have actually skewed some of the votes after your commentary. More negative. More negative. Not overly surprising. However, as you've been talking about this more and more publicly, it obviously is Royal has comfort around the potential impacts on this, and it should not disrupt your outlook, if I paraphrase correctly. Yes. Okay. Do we have any questions in the audience at this stage in the game? We have one in the front. Thank you. The direction of travel for capital ratios that the regulators globally would like to see is generally higher. I think most bankers are saying that, and you're nodding your head a little bit. If you look at what the Canadian banks have actually done over the last six to eight quarters, the capital ratios have been creeping up without any sort of explicit message from OSFI, and that may be idiosyncratic to each bank. Nevertheless, you look at what they do, and it's up. My question is: If we look out two or three years, all else equal, will 10% still be your targeted capital ratio, or will it be higher given this sort of generally higher direction of travel for capital ratios? I agree with you that the direction has been going up. I would say that with the Canadian banks, the business mix is different in all of the banks, and the geographies that we operate in is different. When we look at our own capital planning and capital ratios, the discussions that we have continually with our regulator, and they review our capital forecast. We present five-year forecasts every quarter in terms of where we stand. We feel that 10% is a solid capital level to be in. That's the level we model to with the regulators. That's the level that we have discussions with. When you look at where Canadian banks tier vis-à-vis other regulatory regimes and countries, we tier in about the middle of the skew of the countries, which I think from a regulatory perspective, the signals we've been getting is that while pre-crisis, Canada always was way more conservative on the capital level vis-à-vis other jurisdictions. Given a lot of the work done around capital and the modeling, and given where Canada sits, they have signaled to us that they are fairly comfortable with the tiering being in the mid-range of the jurisdiction. I think that with that in mind, that's how we are planning our capital. Of course, as our regulators are going through the Basel meetings this month, we'll hear from them by October as to where we stand on this. I think that from our perspective, planning at 10% for the midterm is where we think we can operate. I would say that the flip side of planning and the capital that's accreting in RBC is the fact that we are earning 18% plus return on equity. When you look at the investment of that capital, I think that you have to look at it from the construct of what returns are being earned on that capital and what's being driven in terms of shareholder value. I think that's the flip side of the capital, the build. There's one. Hi. Could you talk about your oil and gas exposure and your commodity company's exposure as well? Secondly, your exposures to the second-order effect of impact on residential mortgages and consumer lending, particularly in some of the western provinces, obviously including Alberta. Good question, and we've had that question before. I think that if you looked at our reporting and disclosure, we tried to actually add a little more granularity, but I'll give you a brief overview. With respect to oil and gas exposures, they are about 1.5% of our total portfolio. If you look at the concentration vis-a-vis, for example, the Canadian economy, the exposure that we have in our portfolio is actually lower than the concentration of oil and gas in the Canadian economy. If you look at the exposure levels, half of our oil and gas exposure is to E&P companies. Of that half, on the drawn side, 50% of the E&P exposure is here in the U.S., and the other 50% is in Canada. When we look at the exposure overall, we have seen a very slight tick-up in non-accrual loan formations. I think two loans were there. One of them was a direct E&P company, another one was a company that provides services to the sector. We haven't seen any ramp-up in oil and gas negative exposure in terms of a pipeline of more impairments. We've been just recently through the spring borrowing base review, where we are going to be starting the borrowing base review for the fall in the next few weeks. The price deck that we're using will be based on what it is today. It's a little more negative because the lower oil prices have been sustained for some time. If you look at the first-order impacts, while we have an increase in impaired loan formations, we haven't seen any defaults, a few covenant breaches that we've done some restructuring at the margin. I think that the issue with oil and gas is the low oil price and the amount of time that the price is going to be low. That being said, we have a lot of companies that we have put on the watch list for added vigilance around what's happening with respect to their individual circumstances and the price of oil. When we look at the retail exposure in the Alberta region, we have seen very little uptick. We first of all look at our unsecured exposure, mostly in credit cards. We have seen very little uptick in credit card non-payment. There have been a few, but nothing that strikes us as systemic to the region. We are monitoring on the retail side by postal code, which is like zip code areas where we see that perhaps there is an employer there that has laid off people. When we do monitoring on our retail portfolio, generally speaking, we have the current account of the person, so the checking account with a mortgage and credit card. It is very easy for us to monitor at the individual level, looking at the depth of data that we have. In the process of that, getting ahead of some of the potential negative impacts. Like for example, if one of our clients misses a credit card payment, we look at what they have in a mortgage, whether they have room, and with their home equity line of credit, which is fully secured as part of the first mortgage, and rescheduling their repayments to sort of make the debt more manageable. We have had some of that activity on a proactive basis, but nothing that would indicate to us there is a wholesale shift in the overall quality of the portfolio. We have looked at second-order impacts, and we are continuing to monitor. The other second-order impact that we have seen on the positive side is that as a result of oil prices being low and the Canadian dollar being low, we have seen some resiliency in the Ontario and Quebec districts and more business activity as a result of it. I think that if you look at our portfolio, because we have a pretty even distribution across Canada that mirrors the population base, while there is one region that may be a little bit challenged, we see other regions where there is room for growth. I think that kind of summarizes our view on what is happening. We continue to be vigilant, and we are watching all the time, but we have not seen anything falling totally off the rails. Great. Thanks. Can we go to our next polling question before we ask that? How do you view Royal's acquisition of City National? One, very positive, two, modestly positive, three, neutral, four, modestly negative, and five, very negative. Can you guess what my next question is going to be? No. Do not ask. Well, we have an overwhelming majority on the positive side. Janice, can you just elaborate on the strategic aspects of this acquisition, why it's in place, and what you hope to see coming out of it once the integration is complete? With respect to City National, particularly the City National acquisition is about expanding our banking side on the private banking and commercial side to supplement our current wealth management network in the U.S., which is really an IA network. We have 2,000 IAs, 450,000 clients. To give you a little bit of order of magnitude, City National has about 90,000 clients, and operates in actually four to five really good verticals. We call them a national platform, and by that we don't mean that they operate everywhere nationally, but their verticals are focused sort of front to back, and it's not about being in specific regions. Their five stacks are basically entertainment, technology, real estate, healthcare, and then the fifth stack that we're sort of looking to is perhaps on the energy side in the Houston and Texas area. When we look at City National, it's really about revenue synergies. What we hope to do is to provide our balance sheet so that on the commercial banking side, for example, if they have an average hold position of $35 million-$50 million, we think that in looking at loans to their clients, we can actually hold more of that given the strength of our balance sheet. We think that we can leverage the growth that they're having, for example, in markets like New York. Here in New York, I think they have two branches on Park Avenue, and they have been very slowly expanding their presence in New York. We think that we can help to facilitate a quicker expansion, especially with respect to the fact that we have actually 5,000 employees in New York that work for our capital markets division. We think that that's a pretty good synergy just to get going. Then we're looking at, in terms of product, that there are products like, for example, jumbo mortgages, which have actually pretty good loss experience, pretty similar to actually Canadian mortgages, that they have not been active in the market because of the infrastructure they need to do that, plus the balance sheet, that that's a good product category for us to supplement from their perspective. Then of course, with our broker network in the U.S. in selective geographies, expanding that product capability to encompass private banking, cash management services, more commercial banking services in addition to what they do around the wealth services. There will obviously and clearly be some expense synergies, and they could be expense synergies like using similar contracts or suppliers, that sort of thing. But definitely our focus is going to be on growing the revenue and asset side, given the fact that they have pretty good core deposit generation capability, and that from our perspective, if we grow the asset side, we will also be able to fund effectively more organic growth. With City National being the expansion of the U.S. wealth management, you have obviously gone through a strategic review outside of Canada and the U.S. Right. Can you talk about what started that, where you are in the process, and how a material impact is this going to have on the financials? Of course, Canada is our home market, and we are everything to everyone, and we think that the U.S. is our second home market, and that is why we looked at expanding in the wealth business. We think the demographics are right for wealth. We have the right distribution network there, and it was about adding product capability and some expertise. We consider the U.K. and Europe to be our third home market. There is not a lot of economic activity, but what we believe is that in that market, we have to be there for when the activity picks up. So you would have seen some right-sizing of the U.K. and Europe. We have taken some capital out of the trading side and focused on having our trading platforms be more client-centric and client-driven. We have some capability on the corporate investment side in Europe, and we have seen some activity with European corporates, but generally, activity is outside of Europe. It would be in other markets like here in the U.S. or in Canada. It is important for us to earn a respectable return in our European and U.K. operations and make sure we have the staying power to be there for the markets picking up. On the Asia side, we have long-standing operations in a lot of the countries in Asia through our wealth management investor and treasury services and capital markets platforms, mostly distribution-based. They would be the fourth area that we would look at in terms of, we call it Horizon Three. Horizon Three investing with a longer view on returns there. Anything in the audience? No, okay. Any color you can provide on the upcoming national election and how that could impact the banking industry and maybe policy that also could impact banks as a result? If you want, we can stop the recording before you answer this one. Yeah. Could you just do that? That's a great question. The thing about the Canadian election, which I know is hard to absorb here in the U.S., is this is one of the longest election periods we've had, and it's like, is it three or four months? It's astronomically long. I think that there is a view based on the polls that we could have a minority government, and regardless of where that minority government lands, I think that what we're looking at is that when you have a minority government, there could be a view about having shorter-term policy fixes in preparation for seeding the next majority election. With respect to financial services, we've had a pretty open dialogue with the government around regulation, and generally speaking, on the retail side, you've seen the impact of interchange. It was pretty measured in terms of how that implementation went, and I think from an RBC perspective, definitely interchange was capped, but we had enough scope to manage the business differently, so that we wouldn't have a large negative impact on the returns of our cards business. So we see that in any policy initiatives like that, there is enough scope, and we've had enough discussions that there may be runway to deal with that. I think, of course, it's an election year, and so you look at things like corporate tax rates. When you look at the Canadian corporate tax rates, they are the lowest of any jurisdiction now because there's been a step down. So there may be, at the margin, slight increases in corporate tax rates, so we've anticipated that sort of thing. On the regulatory side, with respect to banks, it's a little more complex in terms of the capital and regulation. The posturing has been fairly measured. So we don't think that those are the sort of policy topics, given a minority government, that will really catch fire. We could be wrong. This is all my opinion only, nothing to do with RBC. Right, John? That's sort of how we see it. We got one. Thank you. The head of the CMHC in Canada has made public statements that he would like to see the banks have more, I think he said, skin in the game on residential mortgage lending. I do not know if you have heard these comments or if you have any opinion on them, and if there may be some update as far as the CMHC potentially asking for banks to have more skin in the game, whatever that means. Also, if you would expand on that, if there is any potential for higher risk weightings on residential mortgages in Canada. Okay. Great question. I think it is hard to determine what skin in the game is, but if you look at the CMHC's policy perspective, from our perspective, skin in the games are things like not allowing for a second residence to be guaranteed. What we have seen with respect to that is that down payments are higher, and it actually is taking new home buyers or first-time home buyers a longer period to accumulate the down payment to make that investment in a home. When you look at things like amortization periods being shorter, I think that in terms of policy directives, it is about making sure that any risks like that that are not standard risks are being taken on by the bank. We have regular dialogues with the head of CMHC, and from an industry perspective, we have been assured that any policy moves, that we would get ample signaling for that, which we have on some of the moves that have been made. In terms of that, I think it is about more robust underwriting and less availability. So you have seen that with respect to some of the securitization of mortgages and the way that that product is being used from a funding perspective. There is tightening around that. From an RBC perspective, by the way, for our covered bond, we did not have any insured product because we never had it. Typically, our funding rates were quite good without it, so it does not have a massive impact on us, but you can see those sorts of things where basically it is more about ensuring first-time home buyers that have the rate repayment cycle. Switching to mortgage risk weightings, I think that it is a topic of discussion that we have been having with our regulator. When you look at the impact of potential floors, our regulator has been pretty adamant about the fact that the Canadian mortgage experience and the national experience is different than other jurisdictions, and they do not believe that a standardized approach picks up those nuances. They are supportive of a models-based approach. So I think that when in the next discussions they are going to be having in Basel, they will be advocating for that. They advocate for it, and they get muscled into getting somewhere. I think from an adoption perspective, the timeframe, they have signaled to us that they are not interested in going forward, being the front-runner in adoption of a lot of the stuff that they have been in the past. The adoption period would be measured. I think the last discussion that we had with them, there doesn't seem to be any focus on this happening instantly. I think that maybe it is a one to two-year period for when we'll know. I can say this, that they are in active discussion because it is one of the few asset classes where they have been consistent in their posturing throughout that the Canadian mortgage experience is different. The other thing about mortgages, of course, is that there has been, as we've just talked about with CMHC and with our regulator, a lot more intervention in terms of underwriting standards and availability of credit, I would say. It is more actively managed by the government. It's a more actively managed asset class. Before we take the next question, can we do the third and final polling, please? How can Royal best maintain its premium valuation? Become a top five global capital markets dealer. Pursuing stronger growth markets outside of North America. Strengthening its dominant domestic retail banking position. Extending its preeminent Canadian wealth management platform on a global scale. Maintaining a balanced portfolio of businesses, and maintaining a hard cap on capital markets to a maximum of 25%. My numbers, not theirs. Everyone's going risk-averse. Carry on. I think that's, I agree with that, John. No, absolutely. Yeah. Do we have any questions in the audience? Janice, there's been a lot of discussion with the Canadian banks in an environment where loan growth and revenue on the domestic side is going to slow or be slower than where it has been in the past, and operating leverage becomes very important. How do you, as CFO, balance trying to reduce costs but also doing the necessary investments into burgeoning areas like technology, the potential threat of disruptors, fintech, et cetera? You're right. That's a great question, because we always think, first of all, let's look at that budget and cut it, because it's quite significant. When you look at how we've managed, particularly in the Canadian banking platform, we started it three or four years ago with fairly large technology investments. I would say our run rate four years ago was somewhere between CAD 200 million and CAD 250 million a year to invest in. We invested in a new mortgage platform, the new way of servicing business accounts, that sort of thing. So what we are doing is at the margin, maybe that CAD 200 million to CAD 250 million is down to CAD 175 million, but because we have that trajectory already built in, we're retooling and realigning the projects so that you'll see way more shorter projects, digitization, agile development. Digitization, of course, has the added benefit of taking cost out. Maintaining that trajectory within the current NIE growth trajectory. So our focus is really on maintaining operating leverage of 1%-2%, and doing so by curtailing a lot more of the discretionary spend. If you look at FTE growth in the Canadian banking platform, it's fairly flat because we're able to take jobs out at the service level as we progress on digitization. We can redeploy those jobs in the sales level and productivity streams without actually growing our FTE count. So I think the best way to look at it is keeping your headcount manageable, so continuing to invest in technology, but making the projects of shorter duration so that you can see the benefits more in year or year and a half to two, as opposed to looking longer term as to where we started with three- to four-year trajectories. And the ongoing trend within the Canadian space of smaller footprints for the branch network. Is that a material contributor to cost coming down over the next little while, or is that one of the things that's being sopped up into the additional technology spend? I would say that it is not a material contributor simply because whenever we do those programs, we're pretty measured because of lease expiries and stuff. So every time we make a change in the branch network, it takes a few years to sort of run through. So at the margin, our footprint is getting smaller and being reconfigured less in terms of wait time and more in terms of serving clients and doing transactions. So the footprint itself will allow our NIE to come down, but it's going to be a slower progression. That's why I talked about looking at the sales and service jobs coming off with digitization and the redeployment, because I think that's where you'll see more movement at the margin. Fantastic. Well, I think that's running a little bit because we're just up against time, so I think we'll leave it there. Janice, thank you very much. We appreciate it. Thanks for having me, John.