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

So good morning. My name is Darko Mihelic. I'm the research analyst here in Toronto. I cover the large Canadian bank space, and I'd like to formally welcome you all to the 2024 RBC Canadian Bank CEO Conference. Similar to prior years, the presentations today will be in a fireside chat format. Now the schedule and each speaker's biography are available on the website. So this allows me to dive right in. I wanted to say a few words, though, before we start. So this will be the 10th year that I run this conference for RBC. And calendar 2024 is also a special year to me too. In 1999, RBC hired me to be a research associate covering the Canadian banks stocks. So by the summer of this calendar year, I will have been professionally researching Canadian bank stocks for 25 years. Thank you. And in fact, a funny story in my very first quarter of being a research associate covering the bank stocks, I'll never forget this. I waited beside the fax machine to get the results. And when the fax machine died and punching it didn't fix it, I ran across the street to TD's IR department to get the results printed, and they were just waiting for me to hand me over the results. So a lot has changed. Technology has really changed the way we do our work. But over this time period, for fun, I saw the Canadian banks go from Basel I to Basel II and now to the final vestiges of Basel III. I've watched them purchase over $150 billion of acquisitions at a front row seat through the tech wreck financial crisis and the pandemic. There were almost 600 U.S. bank failures throughout the time that I've covered the Canadian banks. I don't think I'm going to see a Canadian bank ever fail. Throughout my professional career, I have interacted with 26 different CEOs of Canadian banks and 12 different Lifeco CEOs, too, by the way. So all of this to say that despite all of my experience covering the banks over this long period of time, a lot of people come to me and say, Darko, what makes a good bank CEO? And is this actually a legitimate question to be asking. This is a legitimate thing you all need to know. I absolutely believe that it is. Here's the trouble though. At this conference, the very nature and timing of it necessitates that I ask questions about the outlook. I mean we just had Q4 earnings. And it's the beginning of the year. So I asked a lot of my questions aimed at getting the outlook. And I try to sneak in a strategy question here and there to help you all with your investment decision. But the reality is, I'm never going to get that right. I'm never going to get all your questions properly asked and answered at this conference. So all of this has been leading up to something that I really want to impress upon you today, which is there is an opportunity for audience Q&A. You can use the Slido app, and I intend to put aside a couple of minutes for each one of these fireside chats, and I'm going to ask the most popular questions voted by you, the audience. [Operator Instructions] It has been a great privilege to be up here and trusted to ask these questions at the CEOs for all these years. But I know I can't get it quite right. And so I do absolutely hope that you all ask questions today. So now I'm going to give you the list of my top CEOs. Yes, right. 25 years. I want another 25. So I won't do that. So without further ado, I'm going to ask Dave McKay to join me on the stage for our very first session. Dave? Good morning.

Congrats on 25 years.

Yes. Yes. Thank you. So where is he going with this?

Can I answer the question?

Sure. You're welcome.

Now one thing hasn't changed in 10 years: it's going to snow today.

Sure. So thank you. Yes, it's always...

Thanks to everyone who came in from out of town who traveled to get here.

It's always a tough thing to have these terrible snow days on the conference. But so as I mentioned in my opening remarks, I think we'd love to get a little bit of discussion going on, on the macro outlook. This is -- it's been a remarkable last 6 months where expectations for interest rates haven't really changed. And so maybe this is a great chance to sort of flesh out some of the issues around perhaps falling interest rates and maybe they fall significantly. So let's start first, I think, with your outlook. I mean, last year, Royal had a bit of a run with net interest margins. We had some deposit betas move fast on us, some issues. So maybe we think we can talk and you can flesh out how you see net interest margin evolving throughout the year, NII? And what happens if we do, in fact, get aggressive rate cuts later this year or even early this year?

Yes. I think the rate environment is the big -- one of e big uncertainties out there as it keeps changing it. I think forward curves keep coming down as the monetary policy does its job and slows the economy in both the U.S. and Canada, a little more quickly in Canada, obviously, because of the consumer borrowing costs. Slower in the U.S., obviously, because the 30-year fixed makes it harder to slow down the U.S. consumer, which has been driving the economy along with the U.S. fiscal deficits keep it going. But in Canada, so as we think about lower more quickly. And we did come off some pretty aggressive beta changes overall as clients put their money to work with rates moving so quickly, clients shifted into fixed income assets across the spectrum, not just wealthy clients, but all clients, commercial entities. Everyone made an effort to divest their surplus cash, as they should. So we come into a world where you're going to see kind of lower rates at the short end, for sure. Longer end, we'll see some movement as well, but certainly, we expect the short end to come down in the next -- by the end of '25, certainly by 200 points and then probably a resting place around 3%, where I don't think we're going back to where we were. So that's good overall, I think, for banks to see 3% kind of net neutral rate in the economy. And that's a positive for overall profitability. So as we navigate then a rising rate environment last year to a declining rate environment this year, we think we're really well positioned to capitalize on that. One, we still think NIMs are going to increase modestly year-over-year as we have a roll on, roll off as mortgages roll off and roll on it. Any -- I think on duration choices of the customer, anywhere up to 200 basis point increase, even though that's be a bit less. So I think that is positive overall. As we think about our business, you'll see some margin expansion even in this environment, which is positive. Then you're going to see money in motion. You're going to see consumers make different choices. You're seeing markets -- equity markets start to move. As you see institutional money shift, you see consumer money start to shift. And when you have the largest deposit franchise and the largest wealth management franchise, capturing that money in motion is a core part of our capability that we've proven. And our strategy going forward is you see it shift from fixed income and savings into equities, into long-term funds at higher margins as consumers put their money to work in different ways. We're really well positioned to capture that money in motion at a higher earned margin in our wealth business, and we're earning in our core deposit business or even our GIC business today. So I think from that perspective, we'll see the magnitude of that shift and the choices that consumers and businesses make about investing their surplus cash. But over the next 2 years, you'll start to see that money move. And you saw a little bit of that before the holidays is there was a really significant bullish move on markets. We'll see if that sustains at that pace or it slows for the coming year, I would expect a little bit. But overall, there will be a money in motion play that we intend to capitalize on and our position is the money is within our control. It's in our accounts, it's in our GICs and we'll help customers make the right choices about moving that into different productive assets over time. Then some of it will get consumed. Some is going to get consumed in higher interest payments as a buffer to potential payment challenges on unsecured products and credit products. So I think that the lower rates are going to help on the credit side. They're going to alleviate some of the payment shock we're seeing in our economy, going to free up more cash flow for consumers to spend in the economy and help drive a quicker recovery in a shallow -- shallower recession, softer landing, as you might say, particularly in Canada. So I think from that perspective, lower rates more quickly help on the credit side, help the economic growth and recovery mode for the country out of a shallow recession. So I think from that perspective, it's good, right? It helps alleviate that payment shock that we're seeing. And the consumers are -- for sure, we'll talk about it, are handling that payment shock quite well right now. And this will make it easier for them going forward. So from that perspective, lower rates help on the credit side. And the third thing I will say in the capital markets business, you'll see more confidence in moving deals forward. There's a lot of discussion. There's a lot of advisory work going on. Customers will get conviction now that they can fund at a certain rate, that did the economics work on their transaction and they're ready to move it forward. And therefore, you'll see pipelines firm up, and you'll see more activity come to close and more commission and more advisory fees at that point in time, you'll see more debt capital markets work and more issuance. So on the bond side and then hopefully continued rally in equity. So from a capital markets perspective, it feels like the pipelines are strong and it will be a good year, and we'll capitalize on that. So when you think about our franchise, retail, wealth, the capital markets, we are the best positioned, most diversified bank to capture, whichever way consumers and businesses make choices. And whichever way rates go, we have the business to capture the flow and take advantage of the margin expansion and profitability expansion. So sitting here with a franchise, I feel very good about handling whatever comes at us in the new year. We're ready to handle that and excel at driving differentiated performance for our shareholders.

So we can expect a little bit of margin expansion, but what about loan growth? Are people waiting for lower rates before they make that big commitment? Commercial loan maybe -- so you could tie that in together with a sort of over...

It's a great point, Darko. So obviously, demand is suppressed both on the corporate lending side. And I would say the consumer side is a number of projects in the development side aren't going forward. There's a huge need for housing as everybody knows in our economy. And -- but rates are at the point where it's uneconomic for many consumers to make that commitment to a presale. So lower rates will trigger more confidence and presell activity will allow more projects to go forward and start to build that capacity. So we have a lot of work going on to clear the red tape, to create zoning, to create infrastructure, to create housing. We need some rate support that consumers feel confident in making that presale commitment, and then we'll see that go forward. So in the absence of that in a higher-for-longer world, you'll see slower mortgage growth. You'll see slower mortgage demand as you've seen that resell activity come off significantly. That will stimulate obviously, certainly, new construction, but also resell activity. So more positive for volumes on the mortgage side as well.

So before we leave this topic, I just want to touch on a couple of things because last year -- especially last year, especially with all the events given in the U.S., there was a significant move in deposit costs. And I can't remember in my entire career so much discussion around deposits and the deposit environment. So the question for you is you're expecting margin expansion, but there's got to be a lot of competition for deposits.

Yes, there's absolutely going to be the competition, there is competition, significant competition on deposits, particularly in the public sector side and the commercial side where they come up for bid on a regular basis. And those are very expensive kind of hot deposits. But where we've invested and where the core asset of RBC is, is in our core consumer business and our core cash management business of commercial, which we've been investing in for 20 to 25 years. It's the value creation. It's the technology we've built. It's the scale that we have in distribution and branches, ATMs, it's online capability. It's all the partnerships that we've built and the value that we create from Petro-Canada to Rexel to Metro to all the partners in our suite that create value for our customers is that ecosystem that rewards the customer for the depth and breadth of their relationship with us. We've been building that for 20 years, and you can't pull a customer away on price for that. It's the whole relationship value creation that they look at saying, "I'm not going to leave, I want more because I'm getting all this value from RBC." That -- the creation of that ecosystem leads to a very significant low beta consumer and on the commercial side with the cash management investments and treasury management investments we've made and further investments in the United States now, which we should talk about, creates an ecosystem and a capability set that allows us to earn a higher and allows us to weather some of these margins. That's the margin expansion comes from the very strong core cash management and core consumer banking offering that we've been building and building and building, and you just can't come in with a price lever as a competitor and say, "Hey, I want that customer. I'm going to price that." You've got to offer all the other value. And we have the best ability to match price because we are the lowest cost punter the end of the day, and we have the highest rating. So if we want to and have to match on price if it's a price-sensitive sector or a price-sensitive product. We have the best ability to do that given our operating scale and our operating margin allows us to do that at a profit where others are doing it at a profit. So I think the investment we've made, the core capability on core cash management is an asset in a competitive space that we're already in, we have always been in. And we'll become, to your point, more acute as a number of banks wake up and find out they haven't invested in funding. And it's a long-term investment that you have to make to create value. It's not just a price game.

And so despite that deposit competition, still looking for some NIM expansion. So it's going to be like a mixed thing. It's going to be a little bit of asset reprice, pressure on deposits, but still some NIM expansion with low loan growth. I think that's a good way to sort of think about -- so that's the revenue impact of falling rates. Last year and even moving into last year, we were a little bit concerned that these high rates would cause some harm to your mortgage borrowers and create a situation where you have a lot of renewal shock. How do you look at that situation today? And maybe is there any way you can put some meat on the bones here for the crowd? Now if we were to use the implied forward curve, how much has this changed the concern for you on mortgage renewal shock?

For us, as we look at the renewal segments that are coming through, '24 is still a fairly light year by standards. Like 14% of our overall $300 billion plus mortgage book comes up for renewal in 2024. And based on -- 25% again in '25 and then over 30% in '26. So it's still back-ended renewals to '25 and '26. And we fully expect, based on my previous comments, that rates will come down significantly by '25 and '26. But if you think about the renewal strip that's going to come through in '24, if we look at the current rate forecast, well, it's great forecast from December, which are even lower now the last week's forecast, we expect roughly a $400 payment increase to the average mortgage holder in Canada, and that's somewhere between a 20% and 25% increase in payments. And that's not dissimilar to what a number of mortgage holders were going through in 2023. And our experience in 2023 as an industry and as RBC is consumers are doing a very good job of using their savings, of a change in their spending habits, if necessary, but also don't forget that, that 20% payment increase matches, on average, a 20% disposable payroll increase. So income has gone up on average 20% since 2019. So income is up. Costs are up. And that -- those reasons the income is up. They built up a bit of a cash surplus. They have the ability to change their spending patterns if necessary. They're handling that $400 increase very well for all 3 of those reasons. So that experience will likely get replicated with a very similar payment shock in 2024. Employment has stayed very stable. And you're seeing a little bit of movement on employment. It could be more from more immigrants coming in and the denominator increasing the natural loss of jobs. We've got to continue to create more jobs in Canada, which is one of our challenges. So the consumer for those 3 reasons is handling this payment shock very, very well. And when they can't, you're seeing -- because of the significant demand in Canada for housing and a shortage of housing, you're seeing home price indexes are still very strong. So in the few cases where we have to, as an industry, realize on our home, there is a little strong demand for that and the realization values on that home are good. That you can contrast a little bit to CRE where because of the interest rate cycle, because of cap rates, because of lower demand realization values on commercial real estate are being challenged. And part of the reason that you've seen losses now is that when realizing on a property, the realization values are lower than what we expected. So just to contrast the 2 worlds. So to your point, consumers, particularly in Canada and in the U.S. are handling this payment shock very, very well for those 3 reasons.

So I want to switch gears and talk a little bit about capital and maybe even jump into -- actually, why don't we talk about HSBC here because you reported your earnings and then we find out later in the month that the deal has been improved? So with that deal now being approved, a little bit of a delay, a few conditions around it. Can you give us a bit of an update on how to think about HSBC, and is there anything new we should be thinking about with respect to that acquisition?

I think we're very happy to see this phase and get the approval on HSBC because it's good for Canada; it's good for HSBC employees; it's good for clients, and we get to move this transaction forward at speed now. And while delayed, we are on track to deliver all the benefits that we articulated in our investor presentation in 2022, $740 million of cost saves, roughly about 55% of the overall cost base, I think, is right on track for us. We have about a year to think about that and to get to know the organization and to firm that up. So the concessions that you saw come out around the approval of the deal. The vast majority of that we had already contemplated is important in the transition of this organization to RBC, working with employees, protecting clients, protecting the front line, creating a global center of business in Vancouver is really -- was really important to us because we're looking at consolidating work from the U.S. into Canada to save on cost, particularly from California where it's very expensive to hire bank employees. They're harder and harder to find given all the consolidation in the California market. So creating a center of expertise in BC in the same time zone was a strategic part of our plan when we entered into the transaction, therefore, making that formal commitment was important to us, but it was all part of an overall strategic resourcing plan that we had thought through quite significantly. So as we thought through, so when you look at the broad range of representations we made, the vast majority are important to the transition and the health of this franchise going forward and we are happy to make them. So doesn't materially change in any aspect any of the cost takeouts or the revenue synergies that we have yet to articulate to you going forward. So we're very excited about this transaction. We're very excited about bringing HSBC clients and employees into our fold in the coming months. And we made a big positive impact to the overall investment thesis and overall profitability of RBC and scale of RBC. So when you think about the capabilities that HSBC brings on trade finance, on multicurrency accounts, on global view of the overall banking structure on the consumer side, on the business side, all of that capability is now going to be on the RBC tech stack and has been built there and then we offer to all 15 million of our consumer clients and all our commercial and corporate clients. So from that perspective, all that capability will be cross-sold into our existing customer base, and we're very excited about doing that. And then the HSBC employee side, they'll have a better cash management access, better access to mobile banking, everyday banking capability, and therefore, the cross-sell off a single-service mortgage holder into credit cards, into banking, into investments will be a material part of our overall offering to that client base. So as you think about how complementary these 2 businesses, which creates at the end of the day this very strong cross-border global consumer and commercial offering in Canada that's offered to all Canadians, that's where the investment thesis gets really exciting for us. And that's why we are so excited about pursuing this opportunity with HSBC and why we can't wait to close this and get on with it. So stay tuned to when we'll actually close this in Q1 2024. So in a number of months we'll be able to close this transaction. And what's different about this, don't forget, it's not just a financial close. It's an operating close and a financial close on the same day. So we close this and we convert the entire technology on to RBC on the day of financial close. And that's different than what you see in most transactions where you have a financial close, you take ownership of the technology and the assets and then you migrate it when you're ready. Everything will occur on one weekend in this deal, which moves forward all your synergies at the end of the day to the day of the financial close. So a lot of work has been done in the last year. What work we couldn't do, we'll start doing now given the approval by the Minister of Finance, and we're excited to move forward. So we are very excited about the future.