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

Welcome back, and good morning. I'd like to welcome, Neil McLaughlin to the stage. Neil is Royal Bank's Group Head, P&C Banking, and he has had that job since 2017. I would suspect the last year would have been the most interesting of the 4. And yes, well, first of all, thanks, Neil, for joining us.

Yes, I appreciate it. Glad to be here.

Well, one, I want to start off with one of the bigger, I guess, takeaways from your business performance last -- over the past year, and it's the massive mortgage growth and the massive deposit growth and industry leading growth, and it's not from a small base or anything like that. So these are pretty big numbers. Both on the mortgage side and on the deposit side, what are some of the strategies you chose to enact that helped deliver those outcomes?

Yes, sure. I'll start with mortgage. And we've touched on this probably on most quarters, I'd say, over the last year, but maybe I'll just spend little more time expand on some of the comments we've given. So you've mentioned 2017, that was about the time we were actually losing some market share in mortgage, which clearly isn't where we wanted to be, high ROE, sticky relationship product, and what we found was we just needed kind of a good old-fashioned sort of deep dive into the entire business. And what we really circled around was we needed to treat it like a value chain, we needed to look at where -- what's the client looking for? Where does those transactions start and we maybe become a little inwardly focused. And so we sort of broken up and we looked at what does the front end look like? How are we generating leads? What's our time line to turn those leads around? What's our adjudication process? What are the SLAs we've set in the adjudication process, made changes there. We adjusted a couple of policies that we were out of market and maybe not just as market sensitive as we needed to be. And then we did some work in the back end. Really with this idea that it's an entire value chain, and it wasn't -- we were not at our best. And this was a bit of a competitiveness call for us, frankly, to say, this is an important category, and we weren't at our best. We did that work, and we came out, I think, exactly where we wanted. We came out, we built a ton of momentum, and you saw that in the subsequent year. You saw us really strong through, say, the mid part of 2018, all of 2019. And so I think in some ways, this is a little bit -- it's not like the most recent story of 2020. We'd say we started all the way back then into 2018. I would say 2 things really helped us in the last year on this. One would be we had that momentum coming into the year. We continue to hire mortgage specialist, which is -- it is a very large part of our model. We don't participate in broker. We have confidence in the model and growing that sales power was part of that quotient. So we have a consistent approach to that. And then the other part was so we had momentum and then you caught this big wave of people being at home, a lot of people, I think, pulling up purchases that they may have been thinking about into 2022 or further in saying, I need more space now or I want to get out of the city now, and we were in the right place. I mean, our business was really strong. And the last part I would say is because we had such a strong proprietary mortgage specialist sales force, we were used to operating in a remote environment. I mean these folks make their living over the phone, getting in the car to go see people. Their doing business over video was very, very natural. So you saw their productivity also really ramp up. And we managed to steer clear of our mistakes in, I'd say, '16 and '17, where we tried to be outside, we tried to charge prices higher than the market. And we realized you can be at the upper bound of the market, but you can't be 10 basis points over the market. And we brought -- those things are really what led to, say, sort of the back part of '19 and all the 2020 results. And so it's what we would really say. It's not a -- it's a consistent strategy. It's a product we highly value for the stickiness of the relationship, the high ROEs. And we feel we've -- we're much closer to our best at this point versus where we were 3.5 years ago. So that's it on mortgages, you also asked on deposits, so I should touch on that. Really sort of 2 things I would point to on deposits. The first one was we were very public that we felt we needed to drive a lot more new client origination. And we got off to, I think, a really good start, posted a couple of good years. Increasing, especially on the consumer side, where we were new clients. So that helped drive that deposit growth to your question. The second part was really around an internal capability. We've talked about, we have 2.5 million clients on our MyAdvisor platform, which is a, what we call, democratizing financial planning. And that just allowed us to connect with a lot more consumers and really understand what's important to them, and that led to a lot of new savings accounts being opened over the last couple of years. So those 2 things, and then there was a bit of a safe harbor effect as clients made a decision where to park that excess liquidity, we would say we got more than our fair share. But those would be, I think, the 3 factors that lead into the deposit side.

Okay. That was very thorough. If I look, though, at some of the other categories in the P&C Bank cards, personal loans, commercial and I stack those up against the peer group. I'm seeing Royal on par, in some cases, below the group average in terms of growth, albeit in a down market for -- in some cases. Like is that a situation where your product mix like travel rewards, in particular, was one of the factors that explains that outcome? Are there other issues like you missed some opportunities in commercial or wherever? Like what's going on there to explain that? And then what are you doing to address it, I guess?

Sure. And maybe I'll break them down one at a time. So you started with cards. So if you look at our credit card business over time, we consistently gained share, and we took over the #1 market share position. We did that without making a large acquisition, which is what we saw one of the competitors do. So we have a proprietary program. We've talked about that. We don't have the renewal risk you see in signing up with a large co-brand partner that is really defining kind of the shape of that portfolio. So our goal is really to have the #1 travel product in the category, and we're exceptionally proud of our relationship with WestJet, just a great partner. So that is a great portfolio. And our customers can choose the WestJet option on the Avion product as well. So over time, we would say that we've absolutely been gaining share in the credit card business. As you look more recently, since the pandemic, because of that product mix and because of our credit strategies, we've probably skewed to a better credit customer than the industry average. And what you saw was the higher spending customers, especially on that Avion portfolio, when they put their cards away because dining and travel -- entertainment and travel with -- like right now, those are the only 2 categories that are down year-over-year, thus disproportionately where those affluent high spending customers made those purchases. And so I think you're seeing the issuers with those large travel portfolios and more of a prime customer base, you're seeing that deleverage effect happen more and more. If you got a little more risk in the book, got more revolvers, your balances are going to stay up. So I think that's mirrored what we've seen with our view of some of the competition. But if I look value proposition, how that -- those portfolios have performed, the economics we're getting from owning our own program, I mean, we're very bullish on the credit card portfolio. And you'll see some new value propositions come out towards the end of the year just to continue our investment in that business. You've touched on commercial lending. I think there's a bit of a story about which window you look at. If you get back about 5 or 6 years ago, again, we were not unlike for a longer period of time, the mortgage story where we'd lost share for about 3.5 years and we hadn't adjusted to the marketplace. We weren't growing. We didn't like what we were seeing. We had to go through into a much larger reset of that business. And then we gained over 250 basis points in commercial lending over the period of about 3 years. So very, very strong growth. Then I think you saw some -- more recently, what you saw was some competitive reaction. And I think, in particular, 1 or 2 who really frankly took on some credit risk that we weren't about to follow. And we reviewed our risk appetite, it just felt we liked where it was, and we liked where it was in the cycle. More recently, let's say, in the last sort of 3 quarters, you're seeing the market really converge, and you're seeing some of those players who are driving strong double-digit commercial loan growth come back to the pack. When we look at sector and size of client in that business, we're still winning -- we're still growing our share in all -- every segment but one. And it's really in the $5 million to $25 million credit segment, the $0 to $250,000, $250,000 to $1 million, $1 million to $5 million and then the $25 million and over category, we're still growing our share in all of those. So that is a segment that we think we have a little bit of work to do, not a lot. And as our -- and similar effect in terms of deleveraging, we believe we liked the risk in our book. A lot of our entrepreneurs, we think, again, delevered during the pandemic. Our performance has shown that as you look at our PCL. But again, you're going to see us continue to go out and compete in commercial lending. The last one in terms of consumer lending. Consumer lending, maybe a couple of things. At any given quarter, of overall consumer lending, our mortgage business makes up north of 85% of the earnings. So the 2 other segments are really branch-based consumer lending on an unsecured basis are auto. And then the branch-based lending makes up kind of 2/3 of the remainder in auto, the last part of that. What you're seeing there is you're seeing, again, we have the highest market share in the industry. We're not looking to take on excess of credit risk. I think you're seeing some other players do more on an unsecured basis, where we're doing a lot more with our consumer on a secured basis. Moving some of that unsecured volume into the HELOC product, which is very strong for us. And again, we like the risk. So the growth rates there. Again, why it's not concerning? The mortgage business is the 30-plus percent ROE business. It's the sticky relationship. The branch-based unsecured consumer lending is really a life stage product. It's early in your career, don't own a home yet. We need to anchor those relationships and grow them. So of course, we're going to be in that business. But in terms of the overall earnings growth, it's not going to be the major driver. So we don't get -- we look at it as [indiscernible] consumer stage of life over the long-term and a risk appetite view. So that's, I guess, the way we would look at that, but we look at consumer lending in aggregate as well, and we feel really good about the market share leadership. And the last one you didn't touch on, but I think related to the deposits business is just the outperformance in the mutual funds. And our investing business is -- continues to lead. And we saw a record quarter in Q1, and it's a byproduct of to your earlier question about what's driving the deposit growth, it's we're exceptionally proactive during the pandemic, that we've built that 2.5 million customers to share with us what they're trying to save for. That's allowing us to take about what we call money on the sidelines and term GICs or the savings accounts, move that over into higher margin long-term mutual funds for us. So again, that would be another outperforming business.

Maybe just to actually that -- is that something that -- it seems to me as an outsider, that'd be an easy thing to do. You got somebody with a lot of deposits or a bunch of customers with a lot of deposits and doing nothing and convert them to mutual fund clients. Is that, I mean, easier said than done, like have you had to enhance any strategies or whatever to kind of make that happen?

Yes. No, I mean, it's not rocket science to your point. It's a big ground game, though, right? I mean, you need to have the CRM systems to identify what customers are actually sitting on an amount that makes sense that you don't think they're going to need. You need to know what the client preference is. And a good example I'll give you is, we'll see some older clients who'd just say, I don't want any risk at all. So my risk tolerance is very, very low, and I've got a lighter GIC strategy. So maybe I'll pull those out and say, I'm not going to want to go into a long-term fund and take on market risk. But yes, I mean that's exactly what we do is we have a large sales force. We mine our data looking for those clients. We send out the leads. And you're able to demonstrate to them that over that -- you're not going to need this liquidity anytime soon, get the market working for you. And we have a plan, and then we can revisit that plan over time with the client. And it's also one of the reasons that we have something we call preauthorized contributions. We have a lot of customers. We'll -- again, we'll take that excess liquidity out of the checking account because we don't have a minimum balance requirement on our deposit accounts, and again, we'll put that into working for the client into long term funds, again, stickier relationships. So that's -- it's been core to our strategy for quite a long time.

So I asked you this question on the Q1 call, but we got a bit of maybe more time to kind of dive into it. But I look at -- and in Royal's case, I think it's $40 billion or so of consumer deposits in the Canadian bank, an increase versus last year. I look at that number and I think, well, that's great. But how does that affect the lending outlook? Are people even going to have to borrow money outside of mortgages. Obviously, there's borrowing going on mortgages, but cards and all these other categories, that's -- that looks to me like a pretty big headwind from a credit demand standpoint.

Yes. I think it will -- and it was a great question you asked on the Q1 call. I think there was a -- I think, yes, we don't have a crystal ball exactly kind of what the shape of the curve look like. And I think I touched on a couple of the what are the factors that are going to go into play. And the first one we talked about is that consumer spending is going to have to rebound. So you have this liquidity. Some of what we're trying to get moved over for clients into long-term mutual funds. I mean that's -- with the amount that's been built up, we think that's a really good advice for a large group of clients. For the clients who don't put most of it into a longer-term wealth creation strategy like that, it will be able to fund some of that lifestyle as the economy opens up. And we're seeing right now, we're seeing credit cards spending get into the positive territory, whereas earlier in Q1, we were still negative. And so you're seeing, as the economy starts to open up, those 2 categories of dining -- sorry, dining, entertainment and then travel, being the only 2 that are negative. You're seeing dining and entertainment come back, and that will start to burn away some of that excess liquidity. But in terms of what does -- how long does that take and where is that mix and where that flow goes, I think for the next couple of quarters, we're going to continue to see some depressed demand for credit, but it's going to follow the shape of the economic activity. And one of the examples we looked at was the segment of new, what we call, transactors, credit card customers who pay their bill every month. There's a material number who had paid interest as a regular part of their behavior that because of all this extra liquidity, are able to make their payments. Those are the types of clients that as they ramp up their spending and they're not able to carry those -- pay off those credit card balances, that type of... [Technical Difficulty]

We lost Neil. All right. We'll hold on a moment. I think they're getting Neil back. I think they are. There we go. Yes. Okay. I don't know where we left off.

I think we're talking about just the unsecured credit business and when do we see that coming back. So I think we touched on the factors of it. We touched on the noncredit card piece, again, in terms of earnings growth, just trying to size that a little bit for you in terms of where does it fit in our strategy. I guess the last piece on credit cards, I mean there is some spooled up earnings potential there as you look at where we are in that business. I mean there's probably -- you look year-over-year, there's probably a couple of hundred million dollars that once we get that spending back to where we are and the balances will build back to it. And we had hit $20 billion in the credit card book, and we were down -- well down below $17 billion. So if you look at the yields on that, that will come back to the exact timing. I think, again, we can predict the shape, not the exact probably slope of the curve. So -- but it will come back.

Okay. The -- yes. I asked another presenter earlier today, and this is all in the vein of consumer credit demand. But from a policy standpoint, are you thinking at all about some measures that the government may introduce that could structurally change the consumer credit market in Canada, like UBI or -- well, I'm thinking of that one, particularly. I know it's probably a few years away, but it might be something worth to talk about?

I mean if you look at the comments we're getting right now out of the government, it doesn't seem like it's coming anytime soon. If you look at how the industry -- if you look at the mortgage changes they went through, which, again, we were supportive of and the industry adjusted to. And you saw -- I mean, you saw the -- say, the Vancouver and GTR marketplace really be the most impacted, but it's sort of -- it tamped down the market. It cooled them. I think it took some of the speculation out of the market, which we think is really healthy. And other than that, I mean, we've gone through rigorous cost of borrowing, regulatory changes already. We've gone through things like the underwriting and mortgages, the thing to point out and these mortgages are underwritten with a plus 200 basis points stress test at the times of adjudication. So still think we're in a very healthy position. The credit books have -- obviously, with all the government stimulus have performed exceptionally well through the pandemic, and we'll obviously work with government as this plays out. But it doesn't feel like there's anything coming in the near term-based on some of the commentary we would see.

One regulatory change that's coming, I guess, in the near-term is the revision of the B20 and a focus on high debt-to-income ratio of borrowers being a bigger percentage of the originations, that seems to be their hot button. Any thoughts on timing of a potential change and how Royal is positioned vis-à-vis those types of originations?

Yes. I mean, we haven't really kind of got into the details, so it would be premature for -- to really get into that. And I -- frankly, I haven't really even sort of broken down kind of what their intent is there. I mean, I think the intent is probably clear. Again, when we look at the underwriting in our book, we've always been a conservative underwriter. I mean that's just the strategy that we took on. We don't participate in any non-prime as an example. But you look at the first round of B20, that was -- you saw a lot of advancement in terms of breaking down these portfolios into the different segments, having the residential mortgage underwriting policy need to be signed off all the way up to the Board. So there's a tremendous amount of granularity in the industry now. And I think we've continued to see really strong underwriting. If I look at, for example, a couple of these segments within our book, for example, like an investor segment, it actually performs better than the rest of the book. And I think there's some of these high net worth clients who were noninvestors, again, performs even better than the average of the book. So it's a little bit of what does it perform at the headline? What are some of the metrics because at the end of the day, you're not underwriting these best -- based on the more traditional adjudication metrics. And so I think tracking them -- separating them out, tracking them as separate portfolios makes a lot of sense. And again, that granularity is good for the industry. But I'm not seeing any signs of excessive stress in those books, and we continue to like the risk on the overall portfolio. So again, we'll work with the -- with OSFI on it. But I think the original B20 was probably the big quantum shift. And we've adjusted in this, and we'd say we're a better, more rigorous business for it.

How about the fee structures in the industry, and it's a bigger topic in the U.S., stuff like overdraft, these get a lot of attention, not so much in Canada. And in the past, actually, fees have been the lever that keeps getting pulled to drive revenue growth, like what's your perspective? And how are you adapting to dealing with your customers that way?

Yes. That's a great question. The first thing I think you'd look at is the -- on the consumer side, you're seeing -- you haven't seen the same trajectory of fee increases over the last, let's say, 3 years. And so in terms of the number of fees that were getting changed, or that it's -- it's one direction. You're seeing a bunch of actual fees actually come down. And so it's probably more balanced. I mean, in terms of overdraft fees, the other market, we would look to is the U.K. and some of the European markets, where you saw institutions really, I think, drive themselves into the ditch by getting hooked on these nuisance fees, over limit fees and NSF fees. We don't believe that's how you want to build your franchise. This is a negative client experience. And in fact, we're coming out with -- in a short while, we're coming out with a banking package that will actually waive the first NSF fee because this view that we want to have our -- we want to demonstrate to customers we have their back. We know that every once in a while kind of life happens, and it's just more of a signal of trust. And so we'd rather give up some of that fee income, build trust in the institution and over time, we think that will be -- that will pay off for us. And we'd rather build our business on positive client experiences. Things like we talked before about getting -- buying your first home, about planning for your retirement, starting your business, not about negative circumstances like that. And the other side of this is there's a big cost on the other end. You've got to go and process this fee and clients when you're back and they're disappointed and you wave part of it. So I think what we would look at is you have to demonstrate value for money for these fees. And if you look at our other income line, what you're seeing growing is discount brokerage fees, mutual fund fees and our credit card business. And we wouldn't put any of those in a negative category. And the last one is these sort of service fees on deposit accounts, and those negative fees fit in there, but again, as we drive more clients, we'll grow that line as well.

I want to sneak one more in on expense management. The past year was obviously about battening down the hatches. You've got emerging growth on the horizon. You've got competitive threats from big tech. Where are we now? Like the tightening on expenses behind us, are you back in full on investment mode? How are you approaching things?

Yes. So I think cost opportunities and efficiencies is still an opportunity for us. I don't think you're going to see us -- we've talked about low single digits on the expense side. Still think that's where we are. If we look at where are we going to drive some of these, I think there's really 2 large buckets. One of them is about end-to-end process reengineering in our operational environment. We've got about just a little bit short of $1 billion in cost that we would put into kind of the retail back office, contact centers, where we process mortgages and loans, those sorts of things. And so we've got a couple of large initiatives right at the moment, doing a large process reengineering there. And it's about really eliminating work, digitizing work, automating work. And it's about people play. It's about doing more work with fewer people. And then the other part is about really driving adviser productivity. And our mortgage business is really successful. But at the same time, we think we can make those mortgage advisers more productive and over time, start to reduce our cost to originate. And so pay them the same amount but allow them to originate 25% more transactions. That means they're going to need to be a lot more efficient. So better data, better technology to work with shorter transaction times, that's a good trade for, obviously, the business, and it's a good trade for the employee on the other end. So those are the types of things you'll see us do. But it's like, again, a lot about using technology, data and automation to drive more efficiencies into the franchise.

Well, we are into over time now. Neil, it was a good through and interesting discussion with you. I hope you have -- the rest of your meetings go very well. And thanks again for joining the conference.

Yes. I appreciate the opportunity. Great to see you.

Likewise.