Royal Bank of Canada (RY) Earnings Call Transcript & Summary

Right. So I think we put fintechs into a couple of categories. One, the category where you're a mono line and you're relying on price discounts to acquire customers and you're losing money and the promise of future cross-sell to make money. Those competitors are diminishing in their threat level. And you're seeing a number get into trouble in Europe where investors aren't willing to continue to fund losses against that business model. Where are the competitor set, were mostly focused on is where a platform is able to create the space for a value exchange in the economy. And the banks have always invested a significant amount of capital and have curated the platforms, whether it's moving cash in society or making credit card payments or online payments, we created the infrastructure to enable a buyer and seller to exchange value and financial value to go with it. And in the future, you're looking at platforms who are now creating capabilities for value exchange, and we're going to have to plug into that. So how does a bank build a strategy for this new era of platform effects, Shopify included, it comes back to that grid I talked about. You have to leverage your scale. I think scale becomes the most important. Operating scale and data scale become incredibly important. And that scale allows you to build reciprocal value and relationship scale. So you -- as you bundle value, as you create capabilities for customers, horizontal, as I talked about across mortgages, credit cards, deposits, investments, secured and unsecured lending, as you create reciprocal value for the greater of the relationship, it becomes harder to pull that apart, and there's a different value proposition for your customers. So horizontal breadth of relationship becomes a play operating scale to create and absorb margin impacts as we price differently against a new competitive set becomes really important. So -- which is our core strength. Then the second thing you have to do is you have to compete head on in creating that vertical scale I talked about before. And within a mortgage segment, within a core deposit and payments product segment, how are you creating value upstream to compete with the incumbents. So on the small business space, as you talked about, and if you look at Shopify specifically, some of our ventures that we've launched, whether it's helping businesses register and create their companies, create their brand, manage their books through wave, use our data and to help them understand their customer set in the marketplace through our ventures, we have built a whole series of ventures that create a very similar model to Shopify in the retail sector and delay speed that create ancillary value upstream and downstream that allow us to be a more expansive player into that value creation space and defends our financial franchise from potential disruptive play. So it's the vertical and a horizontal play with scale, with brand, with technology, with ventures makes us feel confident that we will have a role to play in that new ecosystem and a point-of-sale play the way they're being constructed will be hard to pull our customer away from those horizontal and vertical attachments that they have to. It's very important to continue to evolve that and build that, which is why we're enhancing both the horizontal and vertical value creation for each of our customer groups. So that is the core strategy that allows us to maintain a relevancy. We use our margin to do that. Our technology, scale and business scale and our brand and the trust in our organization to compete in the long term. So I think for us, we feel strong, really good about where we are. The role that we're on, the strategies that we're pursuing maintains a relevancy and a competitive business model going forward.

That's really fascinating. And I wanted to talk about that strategy in the context of capital deployment specifically. If I was listening to you, and I was a banker, I'd want to give you a call right away. And so the question is, are you in the business of -- or are you thinking about deploying a large amount of capital in pushing this strategy forward and buying a fintech and buying some capability. It strikes me that the venture strategy is a good one, but it's relatively -- especially for the scale of your bank, very relatively small investments. Are you getting closer to the point where you'd consider pulling the trigger on something much larger, I don't know if you call it transformational, but a significant amount of capital in one of these tech platforms or one of these kinds of strategies?

The learnings that we've had over the last 3 years running our venture are incredibly important and a core part of our we call our secret sauce. And what we've learned is, it's fairly easy to scale a venture into their core space of acquiring relationships and acquiring users. What is more difficult is embedding that venture into the overall value chain of your financial services company. And it's how we take owner and we build owner into the overall value chain of a small business, how we take home search and OJO into the overall value chain of our mortgage, how we take the mortgage concierge business and embedded into the mortgage. So where the secret sauce really comes in is how you embed it and how you get cross-sell and financial relationships and banking relationships from your ventures. Therefore, we've tended to make whether it's film tracked in the U.S. or OJO and others, we've tended to make smaller ventures investments because we have to prove the hypothesis of conversion first. And therefore, if you are about to make a large acquisition and significant capital of a venture that has not proven the cross-sell, you're taking on a significant amount of risk. And therefore, we would have to be more short footed around that conversion opportunity and what role it's going to play in the overall ecosystem. And we've shown already that we can take a small venture and scale it to $4 million pretty quickly. That's not the hard part. So the hard part is the integration and conversion. So I would say we are on a lookout for all types of opportunities. I wouldn't preclude it but I'd say it's lower probability because of the risks you take on and overall monetization of the opportunity into a core banking relationship. And we've already shown that we can do the first part that they've done quite well ourselves. It's the overall integration that becomes more important. And therefore, we think we have the right strategy right now of self-curation and acquisition of smaller ventures, scaling them and integrating them into our overall value chain is probably the faster and smarter and has a much higher financial return. But if a platform comes along where we have significant confidence in the integration and conversion and can really accelerate a North American strategy, we would consider it.

Have you seen a platform like that? Obviously, you're not going to name any names, but have you seen anything outside out there that sort of matches that description in any shape or form?

We've seen a couple, and they've traded recently. They've merged and integrated as challengers versus being acquired by a traditional bank at exorbitant prices. At the end of the day, and the price points would have scared us off initially, but they chose to partner with another nontraditional competitor versus with a traditional competitor. So yes, there are models out there that have proven that they can integrate a few, not many, and they continue to grow through merger.

And I wanted to go back, maybe not quite to expenses, but well, it's related. I mean, I think we came through Q3 a lot more comfortable about credit, certainly, capital as well, and that was the process that we saw in Q2. And I think that the reason expenses have come to the forefront so much is because when we look out into 2021 and frankly, even 2022, the -- it's hard to make a case for a very robust revenue growth environment, either in Canada or in the United States. And I'm wondering whether you would agree with that assessment, how cloudy is the future in order to even be able to make such a statement, but your view on the outlook for revenue growth, next year and the year after?

Certainly, the interest rate environment provides the largest year-over-year headwind in revenue growth. Having said that, quarter-over-quarter now, we think we've absorbed the biggest part of the margin compression in the United States, which was quite significant as you saw in our City National franchise, which is growing organically very well. And the Canadian bank will see some small margin compression, but we've seen, I think, the majority of that margin compression quarter-over-quarter. So still the year-over-year impact in the first part of next year are still to happen from a significant decrease in Central Bank rates. So yes, we are facing kind of the shorter-term headwinds to absorb that. That's offset by significant volume growth and market share that we've seen, and we're quite happy with some of the margins we're seeing in the new business coming on, but we're repricing our back book as it renews. So I think we're absorbing all of that. And that, as I said, we'll have the type of margin impact slow in the U.S. a little bit more in Canada, but not nearly what we've seen before. So revenue growth will be compressed as far and impacted by the activity of clients in capital markets on the trading side and on the advisory side, and we expect to see some renewed activity in advisory, M&A and on the equity side. But certainly, maybe not what we've seen historically. So markets are very important to our noninterest income and our fee-based business in wealth management, and we'll see how markets perform over time. So these are all kind of external drivers of overall revenue growth on noninterest income and interest income that we're building scenarios around. Net-net, I think you have to expect a challenging environment. And therefore, we are very conscious of managing our costs, focusing on those opportunities that drive the growth that you're seeing to continue the organic growth and focusing on those activities that are critical to the long-term franchise value and building a franchise that competes with traditional and nontraditional competitors, I think all investors would encourage us to continue to invest in that, which we have. And that's what we're focused on. And we will have to cut costs in areas that aren't poor to our regulatory long-term competitiveness, short-term growth aspirations and prudence of managing the platform.

I'm curious, taking that a little bit further in terms of sitting at the top of a very large organization with so much uncertainty. How do you make investment decisions right now? How do you make a go, no-go decision when you don't really know what the outlook is, but you know that belt-tightening is probably reasonable. And so what kind of metrics do you look at? How you trade-off short-term versus long-term considerations?

Yes. We've constituted some new forms now that I chair that I'm getting kind of more involved in the overall trade-off decisions as I have to be was between businesses and functions. So it certainly requires my involvement to make some final decisions on that. So we've got new committees. So I'm spending more time on that myself personally because it's so important to the organization. So we have processes where we're all around the table. We agree on our mission and where we're going, we agree on our objectives, and we're trying to find balance. And I think we've got a really strong team. It's a lot of talking today and the metrics are clear. What's the trajectory of benefits? Does this enhance the long-term franchise value? What are the risks of execution, all the same things that you think you would expect to hear in trying to find that value. And it's really challenging. Does this really move the needle. And I think maybe we would have liked to do this in the past. We just can't afford to do this right now. And we've done so much. We've invested in so much technology and that we have a lead there that we have some flexibility, I think, to pause on certain things and slow things down that maybe others don't. So -- and we have a scale to absorb regulatory change within our spending envelope of $5-plus billion a year that others may not. So I think this is where scale really comes into play and helps us meet all the objectives of regulatory change, risk management in the organization, growth objectives, long-term enhancement of the franchise, adjusting to COVID, all that has -- we have to balance and scale really helps us.

We're coming close to the end. I just thought I'd throw in one more question on credit because how could we not? I think you'll maybe appreciate that I'm not going to ask you about deferrals, but I wanted to ask actually a…

I'm ready to talk about it.

A bigger picture question really about public policy, and I think you're in an important position to be able to opine on that. And that's really, how do we balance support, which we see is clearly working, government support clearly is working in this situation. How do we balance that with the need to get back to normal to get the economy on track? And what's your perspective on that in terms of finding that balance, especially at this stage when we've come through the lockdown, and we're opening up the economy, we're opening up schools?

There's a couple of dimensions at play. And I think the slides and the speed of the programs that we saw from the federal government were needed back in March and April, and they were well played. And I think they really helped Canada perform so far quite well through this crisis. What we've seen though is that some of that taxpayer support program, whether it's serve or wage subsidy has ended up in the accounts and hasn't circulated through the economy, is because of 2 things: One, consumers are concerned about their financial situation and their jobs and therefore, are more conservative and therefore have built actually some liquidity and absorption of future potential scenarios. So they're sitting on cash and those cash resides, and you've seen it in the growth in our deposit balances. There are 2, they can't spend it because the sectors that they would have spent it on are closed or have restricted capacity, restaurants, travel, gyms, spas, whatever it happens to be, those services that require proximity of contact and are COVID impacted haven't come back. And therefore, the ability to spend and the desire to spend are impacted by everything. So I think when you're crafting the next generation of policy to your question, you have to recognize that there's still stimulus embedded in the savings accounts that can get circulated through the economy that hasn't been spent yet. So that's good news. There's dry powder on the balance sheets of businesses and of consumers to absorb credit shock. In fact is a buffer for us, but also to stimulate the economy. The second round of stimulus has to really focus on those sectors and those individuals that will be -- had a prolonged impact I think, from the crisis and the uncertainty. And again, those service industries that require proximity that have capacity restrictions or close that will have volatility to them. We know all the sectors. Wage subsidy program and a derivative of wage subsidy is really important. I talked to a number of restaurant owners over the last month that aren't at capacity and wage subsidy helps keep them going, helps keep their employees engaged, helps them meet their operating costs, so they wouldn't have to close. So I think whether it's a gym, a dry cleaner, a restaurant, those sort of travel-oriented services that could take some time to come back. We have to bridge that for the health of the economy, and we have to bridge those individuals to some extent. And therefore, we need a more focused policy, maybe not of the same magnitude, recognizing that we have some stimulus still to be spent and some more targeted approaches. I think that would be my recommendation. The third thing we need is we need incenses on taxes. We can't raise taxes to -- that would affect capital investment and growth. So in the long term, I would expect something like the HST, GST to go up, PST to recoup some of that. But in the short term, we need to stimulate that spend and to continue to encourage capital investment in our economy. So it's a tricky balance to continue to bridge this for time. But those are some of the policies that I would expect to hear more about from the governments as we move forward into the throne speech and into the new year.

Great. With that, Dave, I want to thank you very much for speaking to me today and have a good day. Thank you very much.

I appreciate the invitation. Good luck with the conference.

Thank you. Bye.