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

Yes. Now let me come back to why I think it's going to be with us for a little while. When you think back to the taper tantrum as quantitative easing was being unwound by the Fed coming out of the financial crisis. Anytime that happen, the markets tend to seize up and get all agitated. And so I don't think Bank of Canada, the Fed, the Bank of England, the ECB will be pulling back that liquidity anytime soon as long as the pandemic is hovering above us, and there's not a foolproof vaccine and we haven't kicked this thing. So I think that liquidity is going to be out there. RBC with our strong market share, flight to quality bank, safety and soundness, we get our share or more than our fair share of those deposits, especially here in Canada. City National is getting its -- more than its fair to share in U.S. So we have a strong deposit growth. And again, these are low-cost deposits. So the deposits themselves, if they're in a checking town, not getting any interest from us. It's not hurting us from an earnings standpoint that much. What it's doing is lowering our NIM because it's increasing the denominator in terms of our assets. And then the deployment that you cited, we want to keep these, a, in high-quality liquid assets. So we're ready if the markets do need that liquidity to go back into the system. But when you look at commercial clients, when you look at corporate clients, their utilization rates are below where they were in February. Why? Because they're sitting on excess cash as well. So rather than drawing those lines, they have paid a lot of those lines back. And so we're at lower levels, whereas we saw a huge spike up in March and early April, that has all come back down. So we're not deploying those deposits there. Where we are deploying it is in our mortgage growth, which has been very strong, and we forecast it to be high single digits for the rest of the year, and then mid-single digits next year. We expect commercial loan growth to continue. Yes, it's come off the double-digit growth here in Canada than it was for a few years, but it's still mid-single digits, which is healthy. Credit card growth on a sequential basis, we'll see some declines. But -- I'm sorry, on a year-over-year basis, we'll see declines. But on a sequential basis, the low point should have been Q2 on a spot basis and Q3 on an average basis, and we should see some lift here as consumers get more confidence and utilize credit cards more. So we are deploying this into assets that are organic, that are, again, client-driven, that have good returns, that are good for the client to undertake. But we're not going to put a whole bunch of these deposits into low-quality assets or other assets that are not as liquid because we want to hold those in case the economy does turn for the worse.

Rod, we've talked about mortgages and you expand upon your high single-digit growth expectations. One of the things I wanted to dive into a little bit deeper is on the commercial loan growth side. You do expect commercial lending to grow. And of course, in the last couple of quarters, we have seen that accordion as they drew the lines and paid off last quarter. What are your expectations for commercial growth overall? What's driving that? Is there any difference between expectations in Canada and the U.S.? And then as a third follow-on, if I can throw 5 questions at you at one time. What are the expectations on the energy market? Because, of course, that's one of the main concerns about gaining from investors outside of Canada.

Yes. So I'll take the last one first, and hopefully, I'll remember the other questions, but the energy market, we did multiple deep dives back in our fiscal second quarter. We did one earlier in the quarter when oil prices fell. And then as the pandemic hit, the economy shut down, and the prices remained low. We did a second review. So we have a good knowledge of each of those clients and have a good understanding and believe we're adequately reserved. I don't see a lot of growth happening in that segment in the near term when you look at how much what the global oil demand is and natural gas demand and the like, there's not going to be a whole lot of new exploration. I wouldn't expect, given the pricing, especially recently as the pricing has come down again on oil. That's going to further suppress the exploration for new supply. So I wouldn't expect much growth there, and I think that's healthy. On the commercial side, in Canada, I mentioned that the growth had -- growth rate had been double digits for 2 or 3 years, and now it's come back down to mid-single digits. For us, again, that's healthy. We wouldn't want to see our clients borrowing a lot of money in this pandemic. And part of this is the utilization rates are down. But now that -- I think I saw the statistics this morning that's something like 70% of Canadian companies are at basically full operations. And so as they are at full operations, as consumer demand continues to move up, as supply chains get restarted, the need for working capital, the need for plant equipment is starting to increase. So that's a healthy sign. This have a little bit of a pause which is quite good. Then you move to the U.S. and our City National Bank. There the -- our commercial loan growth has been strong, and that's through increased market share. That's we have been moving into new markets. We've been adding a lot of new bankers, and that's where we're taking market share. We're taking market share from clients -- I mean, sorry, from competitors as we've been able to attract new clients. You look at the PPP program. We're up and running on that very quickly. That's going to enable us to attract a lot of new clients that we otherwise would have struggled to -- struggled a few years to try to get. That brings a whole lot of new clients here to us fairly quickly. But again, back in the City National, we're also reemphasizing and emphasizing the private bank growth and that jumbo mortgage, where you have a 40%, 50% down payment and you have high net worth of clients, who are basically engaging in that mortgage for liquidity reasons and potentially for tax reasons, given the tax deductibility of mortgage interest on the first million in the U.S. So that's been a good growth engine for us. We grew in the mid-20s year-over-year in our most recent quarter on our mortgage book in City National. And so the commercial loan growth has come down a bit. Our reported numbers were through the roof because of the PPP program, but a lot of those were government related, they're not going to be sustained, hopefully, as the economy recovers. But I would expect our commercial growth in City National to remain in lower double digits. We've been in kind of the mid-teens since the acquisition 5 years ago. And again, that is not going up the risk curve at all. That is by bringing on new bankers and new clients that we want to bank through the cycle.

Fantastic. I actually do think you remembered all the questions, but that's great. Rod, one of the things that I think is missed on Royal Bank is the diversification that your platform has. And I think one of the things is because the absolute numbers that you have on -- particularly in your domestic lending book. Everyone thinks credit, net interest income impact is the same with you guys. But honestly, it's not. Can you talk about one of the larger platforms capital markets. We've seen 2 exceptionally strong quarters, what is your outlook? How sustainable is this? Are we going to look for drop off or if we see volatility continuing, can we actually see these levels maintain or even grow from here?

Sure. And I'm going to touch on your diversifying -- diversification comments, I should have given that when I answered your first question about our strength going into 2021. I mean I'm going to mention 2 of our other segments, really briefly, if I could. Our insurance segment is a very consistent earner, slower growth business, but we have a lower market share due to the Bank Act than we do for a businesses here in Canada. The Bank Act doesn't allow us to sell insurance products through the branch network of RBC insurance products. And so that business is a smaller market share, but 50% of Canadians are underinsured. And so we're trying to help them ensure that they have adequate insurance and that's been a good, steady business for us. And then second and third quarters, they had very strong quarters. And again, well-run business. And then investor treasury services, which you didn't ask about it, the fact that I'm bringing it up just because we had a record quarter in our second quarter when we had a lot of credit losses and in the lower quarter and the third quarter when capital markets had a record quarter. So again, this demonstrates the benefits of our diversified business model and certain businesses have really good quarters when other businesses might have a lower quarter, and that's what benefit for our shareholders because it reduces our volatility. And that brings me to capital markets, where, again, our capital markets earnings, if you compare the volatility of our capital markets earnings over time. So the standard deviation over the average, it is lower than most capital markets businesses. And that's because we have more consistent income streams there. We like that business. It's been a good grower for us in terms of earnings growth and disciplined growth. It's not a business that we're looking to make an acquisition and grow double digits. This is not going to be a business that we're going to add a lot of risk-weighted assets to in the medium term. But we have been able to leverage the relationships we have, the clients we have and the bankers that we have and the trading platforms that we have. You go across the business, again, diversify -- diversification benefit is there. FICC had a great quarter in the third quarter, strong quarter in the second quarter. Our central funding business, which is our reverse repo business. Again, a terrific quarter in second quarter and third quarter. The outlook is not going to be as high in either of those businesses as volatility comes down. Global equities, which is business that has had its returns challenged across all companies in recent years as our products has gotten more to commoditized, has had a good quarter and the volatility has remained high. So the trading businesses have remained strong and have been very strong this year. Even as we've taken our risk-weighted assets, our market was down over the last 5 years. And then you get back to the investment banking and the core banking business. Yes, our loan draws were high through Q2 and we started coming down Q3, continue to come down a bit, which is okay. Clients should be putting that money to work if they can use it, and given it back to us as they can. And then on the investment banking side, you look at DCM and ECM and M&A and LevFin. And I would say, DCM and ECM have been good. DCM especially so, has had a record year so far, both in investment-grade and in high yield. The leverage fin market and the M&A markets are a little soft and have been a little soft and they were soft even during that record third quarter that you mentioned. So the business performance has been good and again, it's -- a lot of it is prudent risk management, high-quality talent and strong relationships with our clients. And we were there during the pandemic to provide balance sheet for those clients who needed it.

That's great. And when we talk about capital markets, can you speak to the integration that it has for the other parts of your business, most notably City National in terms of how that the City National acquisition did help to bolster capital markets in the U.S. as long as I'm not misconstrued. Can you talk about the integration and how City National outlook is benefiting?

Yes. I mean, the capital markets business, certainly here in Canada, have benefits our wealth management franchise. It benefits the brand. And then we have a strong brand in the U.S. It's been increasing over the last 3 or 4, 5 years at a very impressive rate. And then we just have more products and more offerings to bring to our clients. And so City National used to have to work with capital markets businesses of other banks for their clients, who needed capital markets activity. Now they can work with RBC, and there's good trust that's been built there. Additionally, capital markets benefits are U.S. wealth management private client business with our financial advisers by having manufacturing product that can be distributed through that channel that is beneficial to our clients, that our clients might not have access to were it not for a strong capital markets business. So these businesses all work well together. And then with City National, our U.S. wealth business also have integration points as well. So the 3 -- leveraging the 3 businesses together has been very beneficial. And each business has benefited from the addition of City National and even our Canadian commercial business has also benefited from this, as a lot of companies still do activity cross-border. There's not much personal travel cross-border, but there are goods and services transferring cross-border right now in a safe manner. And City National -- having City National in the U.S. and RBC in Canada, enables us to take care of clients on both sides of the border.

Rod, coming out of the third quarter were all benefit of what I would characterize as an exceptionally strong capital position. Can you talk to how much of the capital is defensive? And how much of this is dried powder for growth, be it organic or inorganic? And what your outlook is?

Yes. Thanks. So we have a 12% CET1 ratio. The current minimum is 9%, and that includes our GSIB buffer as well as our domestic stability buffer. We did decline as far down as 11.7% during the pandemic. So we have significant buffer. It's about $16.5 billion of extra capital over the 9%. And if the DSP goes back to the 10% that it was pre-pandemic, it's still over $10 billion of surplus capital. So we have very strong capital position, and we're happy to have surplus capital right now, given the uncertainties in the economy, given the uncertain outlook, having that powder dry is very important to us. And we built that capital ratio as we thought that we are getting to late innings of the economic recovery. We were around 11% and one of the lower ends in our Canadian peer group because of our stewardship of capital, but then as we thought we were coming towards the late inning stages, we increased that capital to 12% out of prudence. And we would expect to be at those levels on a go-forward basis as long as the pandemic is out there. You mentioned organic growth. We are supporting our organic growth in our wealth businesses, our Canadian banking on the commercial and retail side. Those don't add a lot of new capital requirements on a quarterly basis. And in fact, we have surplus earnings typically coming out of those businesses that we can redeploy into organic growth. And so for now, that's a good thing because we -- some of the Stage 1 and Stage 2 losses right now, will turn into Stage 3 losses, that will have a capital impact on us on a go-forward basis given the modifications that OSB made in the second quarter. So we're ready for that. And in terms of inorganic, our messaging continues to be the same. We would be open to something, but we're not really expecting that, that would be the case. The likelihood of having something to be a good strategic, financial, cultural, operational fit with RBC at this point, is something that we're not aggressively seeking. So we would be okay to have the capital levels creep up a little bit here. That will be a good problem to have. And then sometime next year, perhaps OSB relaxes the dividend buyback restriction that they put in place at the height of the pandemic, which was sensible a thing to do, but the need for that will lessen, in my opinion over time as all the Canadian banks are very well capitalized and have sufficient liquidity.

Rod, on that last point, has there been any discussions with the regulator, any thoughts in terms of when the regulator may actually ease that moratorium?

Yes. I don't want to comment on conversations with the regulator. It's something that we have one-on-one with the regulator, and we want to keep it that way. I would point to the public disclosures that when obviously came out with the guidance, they said that they would reduce the domestic stability buffer from at the time it was going to raise 225 down to 100 basis points and that would be in place for 18 months. They said they could lower it again. They didn't need to because of the strength in our system. And I don't think -- I don't expect that they will do so going forward. Now they could release that and relax that 18 months, we'll see what happens. But they've committed that for 18 months. That was at the same time when they said no increases in dividend and no share buybacks, but they didn't put a time stamp on that. So they could relax that in that period earlier than 18 months. But 18 months, you're talking about September time frame of 2021. And given some of the impaired loans that we would expect to come on the books in 2021. Having that much surplus capital would be a good problem to have over the next 6 to 9 months.

Rod, we're getting close to time. So my last line of questioning is going to be a long expense is something that I assume is near and dear to your heart. What -- you talked about the technology spend and leapfrogging the competition. On a go-forward basis, do you think that technology spend is going to continue to grow at the same pace? Or should we see that actually start to ease off? And will that help benefit your operating leverage?

Yes. And recall, if you will, that the technology spend, the accounting requirement is making, it required you to capitalize a portion of those costs, a meaningful portion of those costs. So it will impact you as you spend, say, as your spend goes up in '17, '18 and '19, the years, it will impact you for 3, 4, 5 years, and you'll have some inflation and the amortization of that. And so that's something to keep in mind. So as we level off that growth, we did take it down slightly this year, but I'm slightly at the margin this year just because of executing on a working-from-home basis. We wanted to make sure that we are funding our best projects with our best people and making sure that those were continuing. Some of the other programs, kind of you got to -- they've basically got shrunk a little bit in terms timing or extended, if you will. And so we were able to take it down slightly. We're not going to take a massive decrease. We believe that the investment technology is essential for me. Client needs, for helping our employees deal with and -- an engage with clients and bring solutions. It's also important from a productivity point. So I would expect that technology spend to kind of have been gone up and then kind of come like this and then kind of stay that way for a year or 2. And we'll see beyond that what happens with the revenue stream. And we were able to take down, obviously, costs like travel and business development, things like that. We're able to take those costs down as well. But a lot of people ask about commercial real estate, and you see a lot I'm impressed about people looking to shed space, and that likely will happen. But that's going to be a longer-term thing as most of the buildings have 5, 10-plus year leases. So this is not going to be an immediate cliff that's going to impact that industry, but it's going to be a little bit slower, but that would be an area where I would expect this to be able to reduce costs as well. And we have zero-based budgeting, work that's been ongoing for well over a year, that is showing some signs of benefit. And you saw that in our third quarter. If you take out foreign exchange and variable stock-based comp, which were -- stock-based comp goes up because the Royal Bank share price went up, but that's offset with hedges that we have in revenue. So we backed out a variable comp. We're happy to have a record quarter in capital markets and we pay the market price for that and same with wealth management recovery. So if you back all that out, I think our growth rate in Q3 was about 0.4% and we had over $90 million of the COVID-related costs. So we backed that out, we were flat to down. So that is sort of expense discipline we can have. Even as we're growing market share and putting more volume on and through our system, it's a clear indicator of the benefits of scale. And the benefits of scale, I think, are going to be even more important as we move forward.

Right, we've bumped up against time. Pleasure as always. Thank you very much for the discussion this morning.

Thank you, John. Appreciate it. And thanks for you -- thanks for the interest of everyone attending today.

Thank you very much.