UBS Best of Americas Conference

Sep 13, 2013

It's a great pleasure to be able to introduce Royal Bank of Canada to you today at the Best of Americas Conference. RBC is by far the most premier financial services company within Canada and has a number one market position in almost every business segment that they operate in. Outstanding capital position, incredibly high ROE, and a market capitalization of around CAD 91 billion, which is basically Credit Suisse and Deutsche Bank combined. The company is represented by Janice Fukakusa, who is the CFO of the company, and I will hand it over to her to explain why you should be owning the company today. Thanks. Good morning, and thank you, Ben. I can assure you that our composition is really not like Credit Suisse and Deutsche Bank combined. I'll go through sort of the fundamentals of who we are, and I'd like to begin first by our normal caution slide that the remarks made here and during the Q&A session may contain forward-looking statements which involve assumptions, have inherent risks and uncertainties, and may differ from actual results. Turning to slide 3, RBC is Canada's largest company by assets and market capitalization, and we're among the largest banks in the world. We're a diversified financial services company with five business segments and operations that span Canada, the U.S., and 44 other countries. We employ approximately 80,000 people, serving close to 50 million clients globally. Just over two weeks ago, we reported record third quarter earnings of CAD 2.3 billion and year-to-date earnings of CAD 6.3 billion. Our third quarter results were underpinned by strong fundamentals across the board with most of our businesses, and that included record earnings in our personal and commercial banking and wealth management segments. We also announced a CAD 0.04 or 6% increase to our dividend, bringing the quarterly dividend to CAD 0.67 a share, our fifth dividend increase in nine quarters, representing a 34% jump. The increase in the quarterly dividend, which was higher than more recent increases, clearly demonstrates the confidence we have in our ability to consistently grow our earnings. We have a diverse and strong portfolio of businesses that generate significant earnings that we can invest in new growth opportunities while also returning capital to our shareholders. Canada is our core market, where we generate two-thirds of our revenue and are a leader in all of our key domestic businesses with a strong track record of outperformance. Outside of Canada, we're leveraging this domestic strength and expertise to successfully grow the business globally. We're focused on the largest markets and serving the complex and evolving needs of key global client segments, institutional, corporate, and high and ultra-high net worth individuals. We're well-positioned to serve them through our capital markets, wealth management, and investor and treasury services businesses. Our strong risk culture is an important strength and helps build our brand and reputation and also underpins our strategy. We're focused on delivering high quality and sustainable earnings growth, which means pursuing profitable growth. It also means we will pursue opportunities that are aligned to our view of the global trends that build on our strengths and deliver strong returns to our shareholders. Now, before I move on to some details about the business segments, let me briefly discuss the Canadian economy and the housing markets because it is topical. As you can see on slide seven, Canada performed well over the past several years amid the global economic uncertainty, thanks to strong underlying fundamentals and the ongoing fiscal discipline. Going forward, we expect the Canadian economy, although moderating, to continue to perform well relative to economic growth globally. As you know, the Canadian housing market has received a lot of focus over the past years, with rising house prices and higher consumer debt levels. Overall, we believe housing affordability remains at fairly reasonable levels in most markets across Canada, with supply and demand generally remaining in balance. We don't expect that Canada will have a significant downturn experienced by many of the other countries. Instead, what we are seeing now is the housing market moderating and undergoing a transition to more long-term sustainable levels of activity. Absolute consumer debt levels have increased over the last several years, but these levels are stabilizing now, reflecting in part the measures taken by our federal government to cool down the leveraging in the housing market. I would note that the consumer debt service ratios, which is the more relevant measure of how the consumers are doing, continue to be at historic low levels. Turning to our segments, starting with personal and commercial banking. Canadian banking remains the cornerstone of our business, representing more than half of our earnings. We're number one or two in market share across all leading product categories, and we continue to extend the lead. We also lead the industry in volume growth, taking a disproportionate share of the market, and we continue to achieve or exceed our objective of a 25% growth premium to the market for several key reasons. First, the size and scale of our multi-channel distribution network allows us to reach more clients when and how they want. We have the largest branch, ATM network, and mobile sales force. Leading online banking capabilities and innovative partnerships with top retailers, like the partnership that we announced with Target, and we continue to invest in expanding our distribution network. RBC is also at the forefront of emerging payments and mobile-based technologies, a trend we believe will significantly reshape the industry. In the last few months, we announced a number of innovations in this space, including the first cloud-based secure mobile payment solution in Canada. Second, we're growing faster than our peers because of the breadth and quality of our product offering. We have superior financial planning and investment capabilities and an extensive cards portfolio and a strong commercial banking franchise. We're also focused on developing differentiated products and services to capture a greater share of the key high-growth client markets, such as retirees, business owners, and newcomers to Canada, which is a key segment for us. Finally, RBC has a proven ability to cross-sell more effectively than our Canadian peers. We lead the industry with close to 22% of our clients having at least three key products or services with us, checking, investments, and lending, compared to the peer average of 15%. While growing volumes is a priority, we are committed to controlling costs and improving efficiency and productivity, particularly in this lower growth economic environment, and we remain focused in this segment in driving our efficiency ratio to the low 40s. The insurance segment is on slide 11, and we are transforming the way that we sell insurance by going directly to the consumers. We can do that because we have both a comprehensive product offering and the largest distribution network. We are also selling more insurance through lower cost channels, such as our retail insurance stores, proprietary sales force, contact centers, and online presence. By going directly to the client, we can reach them more efficiently, deepen our relationships with them, and offer more product. We now sell 1.5 insurance products per client, and our goal is to double that number over the next several years. Turning to wealth management on the next slide. As global economic and market conditions are improving, favorable industry trends, such as an aging demographic and a significant increase in the number of high and ultra-net worth individuals, offer us very attractive growth opportunities. In Canada, our asset management business is the largest retail fund company and continues to extend its mutual fund market share. By leveraging our Canadian bank distribution network and our wealth management business, we consistently rank number one for both all lend and long-term fund assets. We are also a leading Canadian institutional manager and continue to grow in the U.S. Internationally, we are focused on bringing our BlueBay Asset Management fixed income expertise to institutional and retail investors in Canada and globally. We are also looking to complement international activities by looking at asset management capability internationally on the equity side. Turning to our wealth management businesses, we are the largest and most comprehensive wealth manager in Canada, a leader in fee-based assets, more than double that of our competitors, and our revenue per advisor is 45% higher than the Canadian industry average. Overall, we have industry-leading high net worth market share of 18%, and we continue to extend this lead by offering superior advice, best-in-class solutions. In the U.S., we are the seventh-largest full-service brokerage firm by advisors. We continue to shift towards a more fee-based model, and average fee-based client assets are up 10% this year. Outside of North America, we are building our U.K. wealth presence and establishing international wealth centers in Singapore, Hong Kong, and Switzerland to serve the offshore wealth management needs of the high and ultra-high net worth individuals. The next segment I will be talking about is our investor and treasury services segment. We are focused here on creating a specialist custody bank that provides excellence in asset servicing with an integrated funding and liquidity business for financial and other institutions. In Canada, we are the leading custody business with more than 40% of the market share of assets under administration. We also have offshore expertise, primarily in Luxembourg, where we are the third largest third-party asset servicer. Some of you may recall that we acquired the other 50% of the investor services business. We had a joint venture with Dexia Bank just over a year ago, and we've been improving operating efficiency there and streamlining operations. At the same time, we're building revenue opportunities by leveraging our strong reputation brand and financial strength through the investor services business and also cross-sell. These were things we couldn't do when we were part of the 50% joint venture with Dexia. Finally, looking at our capital markets segment. Global capital markets, of course, continue to face increasing regulatory reform, and we are adapting our business model to the changing landscape. We believe our strategic business mix, targeted geographies, and strong, stable earnings are a real competitive advantage and distinguish us from the other Canadian banks' wholesale operations. Our rebalancing towards more corporate lending and traditional investment banking activities or an originate to distribute model is reducing our reliance on secondary trading activities, which created some volatility for us over the past few years. Our disciplined growth in lending is generating opportunities for our origination and advisory businesses, as a borrowing client will typically use RBC Capital Markets for at least three more products within the first three years following the loan. In terms of geographic footprint, we're strategically located in the largest investment banking fee pools around the world, Canada, the U.S., the U.K., and Asia Pacific, with 80% of our people and assets concentrated in North America. In Canada, we're a clear market leader, and we remain committed to extending our lead and capturing greater market share by focusing on execution, building long-term relationships, and expanding our cross-sell ability. We've had several significant wins lately. We were advising Shoppers Drug Mart on their CAD 14 billion sale to Loblaw, a grocery chain, and the Hudson's Bay Company on their CAD 3 billion purchase of Saks. We now rank number two globally in retail M&A. In the U.S., which is by far the largest market, we're a significant player and also growing. Our market share is close to 2.5%, which is significant given the fragmentation in the U.S. market. With more employees in the U.S. than Canada, and with over half of our capital markets revenue being generated out of the U.S., this provides us with diversification in total for the enterprise and also an attractive growth opportunity as the U.S. economy recovers. Recently, we've been involved in a number of high-profile U.S. deals, including our role in the financing of the proposed $24 billion Dell privatization. In the U.K. and Europe, we're selectively building our investment banking core areas where we have key strengths. Similar to the U.S., our goal is to shift from trading to more lending and origination, with a primary focus on clients in the U.K., Germany, and France. In closing, our financial strength, diversified businesses, and leading market share remain a clear competitive advantage in today's environment. It gives us the flexibility to find the right balance between investing in our business for longer-term growth and returning capital to our shareholders. I believe that our domestic leadership and global strategy, combined with our focus on delivering high-quality, sustainable earnings, positions us very well going forward. With that, I'll open it up to any Q&A. Janice, perhaps I can start. Sure. Just turning back towards kind of macro environment within Canada, perhaps you could add a little bit more detail about what you foresee over the next 12 months, and any thoughts you might have about the intentions of the Bank of Canada, specifically under new leadership. That's a great question. Generally, on GDP growth, we are seeing that we're exiting at about 1.9% GDP growth out of 2013. Generally, the forecasts are for that GDP growth to ramp up to just under 3%. What we're seeing is some cautious optimism. Our GDP growth is definitely linked towards what's happening in the U.S., as well as Europe. But we've seen resiliency. These are the Europe and the U.S. in terms of maintaining GDP growth that is solid despite having some volatility elsewhere. When we look at what's happening with respect to interest rates, inflation is running a little higher, and with our Bank of Canada, their stance is that rates will generally have to go up towards the end of 2014. They're committed to maintaining the low interest rates until they see some signs of the economy picking up, then they have signaled potentially a rate increase towards the mid to back end of 2014 calendar. I think when we look at the outlook in Canada, we're positioning ourselves as being very cautious and in terms of our own operations, focusing more to drive our. We have a 7% earnings growth medium-term objective and return on equity target of 18%+, which we've exceeded. We've exceeded that in the three quarters to date, and we're positioning to continue to grow earnings despite the potential softness on the revenue line, given the uncertain economic environment, by focusing more on efficiencies and costs and driving a lot more of the activity around taking a disproportionate share of the growth in the market because the GDP will still be growing, and we can drive the solid earnings trajectories that way. Thank you. Can you talk a bit about how you think of the balance of the business between Canada and other international areas, and also address the issue of non-organic expansion, particularly outside of Canada? Right. All of our businesses are pretty dominant in Canada. The areas, of course, Canadian banking operates in Canada. With respect to the Canadian market, as I said, we still think there's growth there, and the strategy across the board across everything from our Capital Markets business to the retail bank is to take a disproportionate percentage of growth. We are investing internationally in growth. If you look at our Capital Markets platform, over 50% of the revenue base is now in the U.S., and we're expanding specifically because that's where the fee pools are and that's where the markets are. With respect to wealth, the expansion in wealth is by way of acquisition on the international asset management side. We have a pretty good distribution across the board in North America, so it's more about product capability and bringing that back to North America. When you look at the way that we allocate capital, we fund all the organic growth we can because it's very high return on equity business. We also believe in returning capital to the shareholders. That's why you see the consistency of dividend increases. Then we look at acquisitions. We have fairly strict acquisition criteria in that we expect accretion at least by year 2. We know that while the acquisition will be diluted to our return on equity because we have very high return on equities, we want to see the path back within 3 to 5 years because we believe we need to balance the return on equity target with always funding new earnings growth. When we look specifically at acquisitions, we're looking in the wealth area primarily. We also look at our overall business mix, which is 75/25 retail to wholesale. The governor on our wholesale activity is that it will grow at the same pace as what the retail platforms are growing at. I'll follow up with another question about returns to shareholders and any kind of dividend policy over the next kind of 12 to 18 months and anticipated buybacks that you might put in place or have in place. Our dividend payout ratio is 40%-50%, and we're tracking around 45%. We clearly are generating a lot of capital. We have very solid earnings trajectory. We have actually started the buyback two quarters ago. We started buying back. We believe that in the absence of having excellent other ways to use the capital, we need to return capital to the shareholders by way of buyback. When you look at the other use of the capital, it is for acquisitions, and some of our criteria beyond accretion are that the acquisitions have to be right-sized with our ability to integrate them right away because we don't have a hugely fantastic track record in acquiring larger businesses. From that perspective, it is a choice between doing those acquisitions. If we don't see a clear line of sight on them, given the fact that every quarter we have pretty good earnings, then we will be engaging more on the buyback front. I think it's mostly a result of the choices to be made and then the way that we're returning capital to the shareholder. Janice, the Canadian banks tend to get lumped together quite often, I think due in large part to their strength through the financial crisis. For the average generalist investor, how do you differentiate yourselves, at least in your own mind, when comparing yourself to the likes of a Bank of Montreal, TD, Bank of Nova Scotia, et cetera? I think that every Canadian bank has a distinctly different strategy. When you look at our strategy, it's about dominance in Canada, so taking a disproportionate share of the market and then growing internationally institutionally with our institutional, corporate, and high-net-worth clients, and that's about Capital Markets and the wealth businesses. When you look at ourselves with respect to the North America presence and the U.S. presence, we have a small retail bank. We had a larger retail bank, and some of you will remember that we sold that retail bank. We closed it last year. When you look at our presence in the U.S. market, it's quite significant on the wealth management and on the Capital Markets side, and we recognize that that's a large pool of growth for us. Then we're also looking at nascent opportunity. I talked about, for example, some of the capability on the wealth side and the banking side of that. So we are offering and expanding our product breadth on the banking side to tap into those pools. So it's a pretty directed strategy. It's not a play on North American retail like a couple of the other Canadian banks. It's not a play on emerging markets like one of the other Canadian banks. It's more about size and scope and selectively expanding to increase earnings growth through mostly our wealth management and institutional platforms. Okay. Can you just elaborate a little bit on the housing market in Canada, at least for an outsider it's hard to understand, and also there's a lot of supply coming on in Toronto, I believe. Then also perhaps explain how the government guarantee scheme works for you as a bank. Okay. I'll start with the second question on the government guarantee. All the mortgages or the bulk of the mortgages and any mortgages underwritten by the major banks are on the balance sheet. There is a requirement that if you have a loan-to-value ratio of above 80%, you have to have the mortgage insured, and it's insured by the government, by one of the government agencies. That's what the requirement is to make. When you look at the portfolios, our mortgage portfolio has one to three basis points of losses in it. It's a pretty low-risk proposition on our balance sheet. The market is structurally different than the U.S. Interest is not deductible. We also take in the lending wrap guarantees when we do a HELOC, a home equity line of credit. It's wrapped into the first mortgage, so it's like one document, one charge. When we underwrite, we underwrite on the basis of fully drawn HELOC plus mortgage, and we look at the loan-to-value and debt service ability. The underwriting's pretty conservative. The over loan-to-value ratios that are higher are guaranteed by the government, and then the average term to maturity is five years. After five years, the mortgage needs to be refinanced, so an amortization period of 25 to 30, but a five-year fixed. If you look at the real estate market, Canada is pretty large, so the real estate market varies depending on where you are. I'll talk about two markets that are generally the ones that are talked about in the press. Lower Mainland Vancouver, because the house price appreciation is the highest in Lower Mainland. In fact, the pricing has come off over the past six months, and it's actually gone down about, I think, 3%, as opposed to climbing as much as I think 15%, and so when you see that, what's happening there is some moderation in the pricing. A lot of the new sales in that market relate to Asian investors, where they have a second home in Canada, and there is some condo supply, but it's more about the supply of the market and the demand of not just people that are resident in Canada, but outside of Canada, and we do see that market moderating. We saw debt serviceability in certain clusters going up. That's something that we monitor individually in our portfolio management practices. Toronto's the other market that you see condo building. What has happened in Toronto on the condo building side is that the average construction period was two to three years. The builders have extended to four to five years, because they saw the view that there was a little bit of too much product coming on stream. When you look at the Toronto market itself, there are about 30,000 to 40,000 new households coming on stream. The growth in the population base of Toronto is generally net immigration, and there is hardly any new home construction. It's all about condo and density in the downtown core because of the reluctance of some of the governments to actually put infrastructure out in outside of Toronto locations. That market is being regulated both by the builders. Then, of course, the other thing that is happening in Canada is the government is talking down consumer leverage, and it actually is working. Instead of raising interest rates, it is one way of taking leverage down. But it is counterproductive to stimulating GDP growth. They are actually talking down or putting in tighter lending criteria that mostly hits not the scheduled banks so much as the smaller lenders. So limiting some of the amortization periods, putting more underwriting definitionally through limits on loan-to-value ratios and that sort of thing. In fact, consumer leverage is coming down slightly. So I think that that is why we are looking very cautiously optimistic at the environment, because we believe that while there is a correction happening, it will not happen with the same velocity as other markets because of the way that it is happening. Then, of course, across Canada, there are still other markets that are growing and growing robustly because the growth is there. For example, in the Midwest area with the growth in agri, in areas like Saskatchewan, there is still house price appreciation, there is still growth. We are talking about actual size of house pricing that is in the CAD 100,000 to CAD 150,000 range, so there is that skewing. Vancouver and Toronto would be, of course, way higher than that in terms of average house. You mentioned your market share in the U.S. of your brokerage unit, Capital Markets. What is the strategy there? Would you like to increase this presence in the U.S. or just keep the level, or where are we with your company in five years in respect of Capital Markets? We actually started building out our capability in corporate investment banking about 10 years ago. We are not saying across the board that we want market share at any cost. What we are doing is getting market share in the sectors that we focus on, that we have capability on a global basis. That is sectors like energy, technology, infrastructure, real estate. Retail, that is where you see us growing market share. Our intent is to grow profitable market share. When we lead with a loan product or loan commitment, our expectation is that within 2 to 3 years, we will have fees that are equal to double what we are earning on the loan. That is the expectation. That is actually what is happening now. We hope that as the U.S. economy picks up, we will grow. It is a very fragmented market, so we are happy with the 2.5% market share. We would like to grow it, but the critical thing is in Capital Markets is that it has to be profitable market share. We have to use our balance sheet wisely because at the margin from a regulatory front, every additional incremental dollar of capital is actually going in Capital Markets. We need to rightsize our trading businesses and increase the focus is more on the client support as opposed to secondary trading for trading's sake. You will see a retooling in the fixed income business, which is in process now to support more corporate investment banking. When you look at our mix, we have about a 50/50 mix, trading and corporate investment banking, and we are skewing more towards maybe over 50 for that corporate investment banking. Simply because we would like the Capital Markets earnings to be pretty low volatility and sustainable. That is what our core strategy is. Use the balance sheet wisely to employ capital wisely and grow profitable market share. We do not have a number in mind, but we do have, of course, our targets for profitability and return on equity. Hi. You commented in your presentation that you are comfortable with the Basel III standards, but what about higher leverage ratios in the U.S. for the Canadian banks? How do you feel about meeting those requirements? Well, when you look at the Basel III leverage ratios, first of all, we've always had an assets capital multiple constraint from our regulators. Basel III metric is a different numerator and denominator, but the concept of operating under a leverage constraint is not alien to us. There are differences in balance sheet assets between U.S. banks and US GAAP and IFRS. So there's a comparison difference. The Basel III 3% metric that has been talked about, we're comfortable that that won't constrain us. We're in discussion with our regulator because our regulator is trying to figure out how to get those metrics on a comparable basis across all the banking systems before they step out and determine whether or not they're going to put an additional national discretion surcharge on the metric.