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

All right. I'd like to welcome our next guest, Neil McLaughlin, RBC's Group Head of Canadian Personal and Commercial Banking. Neil, thanks for joining us. Again this year. Not much has changed. I don't think since last -- not maybe.

I'd like to start off you're the biggest deposit business or depending on which category you look at in Canada. So your perspective is very important. A couple of things. Percentage of uninsured deposits, people are asking about that and then the trends? So we've obviously seen what's happened in the U.S. Are we seeing any indication of similar customer behavior in Canada start with that.

I mean, so maybe the first thing, I mean, we've seen a real consolidation of liquidity over the pandemic. I would say we've probably seen peak core deposits in terms of in our business. That liquidity is starting to -- as rates have moved up, really go out and get yield on that, and we're playing a role to really help clients go out and get that yields. I mean, you see some very attractive GIC rates out there. But so liquidity is strong. Deposits, I think we're -- we really look at that funding, that access to funding as a core competitive advantage. And it's anchored in their relationship strategy. If you own a relationship with a consumer or the entrepreneur, that's going to be the primary place you can deep for deposits. But in terms of the trend and what you saw south of the border with the regional banks and SVP in particular, mean we haven't seen any of that. I mean, we've been monitoring all the liquidity trends daily. We saw a bit of a bump up after SVB's naturally sort of flight to quality and the credit rating, we saw some inflows but generally, it sort of takeaway was nothing concerning and the parallels with the U.S. just aren't there. So we don't have for example, we have an LCR we have to report. It's a regulatory requirement. You don't have the concentration of deposits you saw with SVB. You don't have a concentration in the sector. So we have an exceptionally diverse deposit base in terms of both consumer and commercial. By region, by sector, by segment, whether it's small business, consumer, affluent, mass affluent, ultra-high net worth. So the conditions just aren't there. Similarly on the business side, we're seeing generally up drop with very stable business deposits, I would in Q1, we always have a little bit of fluctuation in our Q1 numbers. We have a couple of very large corporates who put some capital to work, whether it's for dividends or at large CapEx expenses. But we would say sort of very stable type flows there. Probably the biggest trend to call out in our business is we are seeing that movement of deposits from the core checking account. We're actually seeing some of it come out of mutual funds as the retail investor is still in a risk opposition and put it into a term deposit, where they're getting north of 4%. And that has been an exceptionally strong trend for us. and it's put some pressure on margins. But generally, it's been allowed us to gather more deposits, put that funding to work and strengthen the relationship.

So what I was hearing from a couple of other presenters today was some of those trends, the shift out of core into term GIC products is still happening, but the pace of it is decelerating with RBC's experience.

We would say it's still going on. So I wouldn't -- it may be a little bit slower Q1, I'd say was one of our strongest quarters. We were from Q4 to Q1, we were up $15 billion. We were up 40 year-over-year, and it's coming in multiple flows, it's coming in external to the -- to RBC. It's coming in from the core checking and it's also coming in, like we said, from the mutual fund book, but it's still strong.

And well, I guess that's the -- so you're seeing a lot of inbound GIC. Some of it's the substitution effect, but some of it's wealth customers coming into secure products. Is it mostly that? Or is it a 50-50 kind of thing?

It would be almost a mix of those 3 categories. I wouldn't say it's -- it's probably not -- the biggest flow is not from new customers. This is mostly from existing customers just sort of deciding where they're going to get that yield, what type of risk appetite do they have? And then some of them, they're just saying, oh, I'm building up excess liquidity in my core checking account. I just don't need it there. And there's actually now a reason to move it. So I'm going off. I'm going to put some term on it or even some of them are saying, I'm just going to put it into 1 year cashable which, again, good for the relationship a little bit of pressure on margin.

Another source of margin pressure that has been talked about. Royal has been very transparent and vocal about is the deposit betas, which are still low, but moving higher. My question is, given your market position. Can't you hold the line a bit more on betas and minimize that pressure?

Yes. Well, listen, I think maybe 2 comments. One would be we have some deposits that are actually prime linked, and so they're going to move in lockstep, particularly on our commercial deposits. So you have more sophisticated commercial clients who are just saying, I expect to have that benefit. On the consumer side, for example, in savings, I would say we did show some constraint. Early on in the pandemic, we actually moved up a little bit slower than some of our competitors. We just felt that if you looked at where our margins were and how much we've given back, we floored a whole bunch of these deposit products earlier on, and we were sort of making up for that as we started to come back. And then over time, you saw the competitive dynamics kind of really even out, and I think everybody ended up in pretty close to the same place scape. But we'd say we started with a little bit of that, but there's more in the business side, we just have less control over that.

On the lending side, inflation can be good and bad. On the -- more of a headwind situation, mortgage growth has obviously decelerated. What about the ancillary type of lending where people would renovate? Is that -- is inflation having a negative impact there? And then flipping it to more of a tailwind, on the credit card side, revolving balances have been much lower to recover. Is that having -- is that having more of a positive impact on revolvers is just things cost more people are carrying higher balances, things of that nature?

Yes. I mean. I think, listen, concern around inflation has slowed like some headlines around like the more macro rental boom is starting to slow as things just cost more and people, I think, are more worried about inflation, the cost of groceries and just disposable income and just not having that to be able to continue to put money into their primary residence. The other part is just this belief that, hey, whatever cost to renovate this place, it's going up 10% a year, so this is a safe investment. I think that mindset has shifted a little bit. But we still see relatively low revolve rates, for example, like an unsecured -- on HELOC line of credit or on an unsecured line of credit. So still relatively low, starting to bounce back off the bottom. Not dissimilar to how we see operating lines with commercial business. Your question on -- so we still have room to go there, I'd say, is kind of the answer on revolvers. In terms of credit cards, I think if you look across the industry, the -- one of the defining sort of metrics is what is the product and who are you tracking as a cardholder. And there's a shift between kind of the super prime prime and nonprime customers like and it manifests itself in the revolve rate. So if you think about one of our largest products is our Avion product. It's built on an exceptionally successful rewards program that we own and operate. We have a point manufacturing cost advantage there. And but it attracts a super prime customer. And the super prime customers lower revolve rates, higher payment rates. And what that does is that as the spending is increasing, and we have very robust spending growth, which sort of flows back to that -- the cardholder fee revenue line. But you don't get the layering effect of the balance build. And so you are seeing, for example, issuers who have more of a skew to transactor portfolios, grew a little bit slower. Coming out of the pandemic, and you're seeing some issuers who have more of a revolver, hey, I'm here for the credit. And I may have a little bit of a higher charge-off rate, but I'm getting more revolve interest income off the portfolio and are less reliant on that interchange side. But generally, we would look and say, strong purchase volume. And our portfolio is now back to where we were pre-pandemic. At one point, we were down about $3.5 billion. That's a 10% plus yielding portfolio. So it was material, but we're seeing exceptionally strong originations coming out of Q1, one of our best quarters for new card originations, so we're feeling quite bullish.

Some plumbing issues of stairs, I guess. The -- I noticed the offer -- the public offers for new card acquisition. They've been pretty generous and aggressive across the industry. Is that something that -- well, a twofold question, I guess, is that something that you expect to maintain in the early stages of back to normal travel patterns? And then b, well, I'll wait on the actually [indiscernible]?

Yes. Listen, I think -- listen, I think every issuer played it differently. We took a bit of a pause really in the pandemic really focused a lot of the energy to support clients we already had on the books rather than going out and trying to onboard credit risk in an uncertain environment. But we're now back to being sort of full time, a very business as usual kind of risk posture. And we're seeing really great returns. I mean, the other thing is we took a really analytical lens on those originations. They're -- 2/3 of those come in through purely digital channels, they're highly, highly targeted. And so we can calculate an ROI sort of cohort by cohort, channel by channel, product by product, month by month and understand what are the returns. We also have an airline partner in WestJet. When you're not flying, it's hard to have convinced people you need to get a WestJet card but now they're back up and we are out there visiting with the CEO, and we're seeing exceptionally strong demand for flights. So all that really helps in terms of having an environment to drive origination. So we're feeling really bullish again on the quality of what we're seeing coming through the book. We're seeing really great returns in terms of the ROIs in these cohorts, and there's nothing there that would have us kind of step back.

So the part b of my question, not really that related though is the budget last night or yesterday afternoon. Had some section on interchange fees and reducing interchange to charge the small businesses? What are your early impressions about that news. Were you expecting it?

We were expecting it. So listen, I'd say the government like, I think, the DSIBs early on, we're really concerned about small businesses in the pandemic. Let's be honest. They haven't all recovered. We put out a huge amount of about $8 billion in the SBA loans in cooperation with the government, and I think this is sort of an extension of how you get out and support small businesses. So the government went through there are very transparent. This was, I don't know, 1.5 years in the making in terms of a promise the government put out. So I think it -- one should it help small business, that there is some -- if you were a small business that actually accepts credit cards, there's some marginal benefit you get there to lowering your costs. But they've done it in a way that's not really going to offset the ecosystem. And I always think about the payment system is -- it's a 4-party model. You have a cardholder an issuer and acquirer and a merchant, and there's a value exchange there. And right now, we'd say that ecosystem of payments is in balance. And what they've done here is to say not all merchants but to small merchants. They wanted to give a little bit back. They've done that, but they've done it in a way that will keep that payment system in balance, and we're supportive of what they've announced.

So probably not a material revenue item for you, whatever.

In the grand scheme of the -- when you look at -- you have strong double-digit purchase volume growth from new originations and back book, not something with that type of volume that we're anticipating any real sort of call-outs in terms of the headwinds.

Okay. So it's sunny outside, the spring mortgage season is upon us, I guess. What's the early impression so far? And what are you expecting this one to look like compared to that's pretty good about '22, '21, but...

Okay. Yes. I mean it's sunny outside, but I don't think just because it's sunny, you're going to see a real spring back in mortgage originations. I mean we're coming into the season. I mean maybe 2 things. One, if you go through the pandemic, the pandemic kind of took the seasonality out of the mortgage market where we used to see this very sort of traditional kind of curve. And we based it off of that seasonality in the pandemic and all the craziness in terms of whether it was rates and affordability and people just wanting to change their environment. We got rid of that seasonality. But if we go back to sort of pre-pandemic probably more seasonality coming back, but we're still down 40-plus percent in terms of originations. And I don't think we're off -- that's pretty much where you see the market. And if you go city by city, real estate is a very local business. Mortgage origination is a market-by-market business. You're seeing -- you're already seeing 12% and 15% HPI reductions in some markets. And I think we're approaching the point where we're -- in some markets, we're getting to probably the bottom. And you'll start to see -- you're hearing some reports in some markets that prices are starting to come back. But I think you're still -- if you look at where the swap curve is you look at where like 5-year rates, you still have a lot of really short-term sort of 2-year terms of the business we are doing. And I think to really get that affordability back in check, I think you still got a little bit of room to go, whether it's coming from rate or it's coming from the price of the home, I think you have a lot of folks on the sidelines still waiting to see, hey, are rates going to come off if they do, then maybe I'll upgrade or maybe I'll get into the market. So we're anticipating a slow start to the season.

The -- correct me if I'm wrong, but I believe about 10% or thereabouts of your book is the investor might be probably less than that. Are you starting to see them come back because the rental market dynamics are still very attractive or even getting more attractive because housing supply can't keep up with...

It hasn't really changed that much. When you look at the investors, I mean, our take on the investor portion of the mortgage business is one, we do look at it as a separate segment. It performs exceptionally well. It actually performs better than the average of the mortgage book. We have a separate underwriting policy around it. So we don't allow quite the LTVs that we would allow in terms of an owner-occupied unit. But it plays an important role. I mean there hasn't been enough purpose-built apartment units in the country to really support it. We have a couple of markets like Halifax, where you have a very large percentage of that market is purpose-built rental. But in Toronto, a couple of years ago it was the first project that was brought to market in 20 years. So the private investor has played a role in actually providing inventory to help with Canada's housing problem. And so we don't have concerns about it. But I think you have the same -- it's been attractive in terms of the rent you can command but we haven't really seen a move off there. And I think it's probably the private investors saying, I'm going to pause as well, haven't really shifted as a mix.

And spreads in the business, are they -- I know they probably were at their tightest in the fall of 2022. Are they -- I don't know if you could throw in numbers, what's the mortgage spread like these days?

It's better, but not great. So what we'd say is I think we're -- we still have again room to go to get back to more traditional type spreads. It got to a place where they're exceptionally tight. And right now, you're starting to see them move up into maybe we're 2/3 of the way back to where we think they'll probably be in the long run, but we think there's still room to go. Part of it, we'd say is just the rate in which the rates moved up so quickly. The industry had a hard time adjusting. At some point, we were changing prices like 9 days, every 9 days, we're putting out a new price. And it's just the market has a hard time digesting that number of price increases in a short period of time. And so that and competitiveness, really the 2 drivers that we think kept them down. But the level of price competitiveness in that market remains intense.

It's really going as far as customers that are renewing mortgages that we're paying, I don't know, 2%, 3% and 5%, 6% today. So the payments are -- and then on the variable side, the catch-up payment to get amortization back on track? And what are you -- are you seeing any change in borrower behavior where they're just eating it versus a higher proportion or looking to refinance or renegotiate terms? Is there anything to note there?

Yes. I mean we're spending a lot of time on this, especially on the variable rate product where we've had customers hit their trigger rates because we've had about $75 billion of volume where customers have hit their trigger rate. I think there's a couple -- probably the one surprising trend we've seen is customers actually come in at renewal. Actually come with a onetime payment to almost kind of buy down the outstanding balance to sort of moderate their payments. We didn't anticipate that. We've had a lot of client reach outs as we sort of subsegmented the book to look at places where we think there could be some capacity weakness. Thankfully, there's a lot of -- there's more false positives than there are concerns. So a lot of places where you'd reach out and we do a lot of work to understand the liquidity of our clients where we have a view of the liquidity or just to see the flow coming through the deposit account. A lot of the clients will say, listen, I have other income you don't see or I have support from other places, investor in private investment income support from friends and family. So I think that's been a positive. But you're seeing increase in mortgage payments in like depending on, to your point, what rate they are coming off, what they're renewing into between $200 and $600. So this is for some clients, it's pretty material. And we're seeing on those variable rate products, probably the other trend worth noting. The delinquency rates in that book started much lower than the fixed rate book. They're moving up where we're actually seeing the fixed rate book kind of move side away slightly down. And so that's what we're monitoring and kind of drilling into. But in terms of the overall quantum, as we overlay our LTVs and HPI, there's not a very, very small percentage of the book that we we're spending this type of due diligence and to make sure we support the borrower. So not unexpected, we'd say.

I want to spend the last 5 minutes or so on commercial lending. In the Canadian P&C bank, how much of the commercial book is commercial real estate?

In terms of our commercial work, about 1/3.

So consistent with the overall, I guess, wholesale portfolio?

Yes. Yes, about 1/3 of the book, and it's made up of -- there's -- we more -- the majority of the book is commercial mortgage, and we have a strong developer book as well. And we almost have almost exceptionally little office. That's not really a category we put a lot of focus on.

So commercial -- so various industries mortgages against okay. But having said that, I'm just -- I think about the linkage between commercial lending, which has been -- the growth has just surpassed the mortgage growth, how long does it take for the mortgage growth slowdown to start dragging down commercial lending because commercial lending is feeding off of the housing market in Canada?

Yes. I mean you just have to look in terms of -- the link I kind of mentally draw there is just like HPIs that links to GDP, right? Listen, I think we've been quite transparent in our book. We were underperforming a couple of years back. We've taken some strategies to really look into this and we have a funding advantage in the category. There's no reason we shouldn't be out there. We like the risk. We had to do some work to really get our salespeople lined up against the right segments, and you've seen us we ended Q1 at up about 14%. And our non-real estate book is growing as fast or faster region by region as our real estate book. And so our story is really one about we're accelerating our growth in commercial real estate. We think the funding advantage is part of that. But probably the bigger driver is that we've just really retooled the team and got them and upskilled the team, put them in front of the larger clients. And we now have, I'll say, a very updraft diversified commercial lending story going on, mortgage operators, working capital right across the spectrum. And I was actually with that team who's having a meeting here in Montreal this morning. And we're just seeing like the pipeline and deal flow is exceptionally strong. So that's kind of where we are. We know some of our peers were maybe a little bit more concentrated more recently in commercial real estate, and we like the asset class. It's not about that. We just -- we're expecting to see strong growth throughout the rest of this fiscal and into next.

So what -- I mean, you're in double digits now, probably heading towards more sustainable level of high single digits? Or...

Yes, I think by the end of the year.

Okay. Now what about -- I mean when growth slows -- I mean that's still a good number, don't get me wrong. But when growth is decelerating in commercial and on other areas, the pricing and competition intensifies. Are you seeing that yet? Or are you still -- are spreads today better than they have been or not?

In commercial?

Yes.

Is there a little bit tighter in commercial, I think the other thing to point out, though, is you can look at it right now, commercial lending has much better spreads than the retail -- the residential mortgage book. So that's something we're looking forward to actually providing a little bit of buoyancy to spreads, whereas historically, we've been -- when I mentioned we were -- we're growing our commercial lending as fast as we're growing residential. We have the opposite. So you're starting to see -- we're going to end the year residential mortgage probably mid-single digit. And like I said, we will end the year in terms of commercial lending high single digit, low double digits. So net-net, that will -- just the asset class mix will actually be better for margins.

Got it.

But commercial margins, lending margins are in a little bit, not like mortgage all.

Got it. Any questions from the crowd? Well, I guess that's it. Thanks again for coming this year. If you're back next year, hopefully, it's a quieter in-between period, so I doubt it.

Yes. I appreciate it, a good to see you. All right. Okay. Got your piece next.