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

All right. Good morning. Welcome back, everyone. Our next presentation, we have Royal Bank of Canada. Joining me today from RBC is their CFO, Katherine Gibson. Katherine, welcome back.

Thank you very much. It's great to be here.

Okay. Thanks a lot. It's been a little more than a year since Investor Day. Can you update us on your progress towards the strategic goals outlined at that event?

Yes, for sure. It's hard to believe that it's almost been 1.5 years since Investor Day and the time has just flown by. And we're really excited about the progress that we've made against our Investor Day strategy that we communicated as well as our target. So I thought I could break it down into the pieces for you, like what we've accomplished to date, where we see ourselves today and then a bit of what does that mean as we look going forward. So what we've accomplished so far, we're feeling really good on the progress that we've made against the strategy, the targets, you'll see that some of the targets were already hitting those targets. So if I start with our Canadian business, definitely seeing growth in our Canadian business. And I'll reference Q3 is kind of our recent results that have come out. So on mortgages, seeing really good growth. Mortgages were up 4% year-over-year, in line with our guidance. It's very important to us to be focusing on client growth. And so from a market share perspective, that 4% equated to us taking about 50% of the market share just in that quarter-over-quarter growth. We're also seeing really good growth in our Avion acquisition. We had a historical high in Q3 with our acquisitions. And the other item I would just call out is on our commercial deposits. We had a 9% year-over-year growth in our commercial deposits. And again, that equated to about 50% of the market share growth on a year-over-year basis. Now it's not just Canada. I know Royal Bank of Canada. We got a focus on the Canadian front, but we're also seeing growth in the -- our global businesses as well. Our investment banking, we're seeing increasing market share. We've just recently announced our focus on building a global transaction bank. And then if you look at our U.S. region results, also making really good progress on the strategy that we outlined on Investor Day of really focusing on like a one region, one RBC focus. And so we're moving through that quite well. So where does that take us? Where are we today? In Q3, we reported an ROE of just over 18% on a CET1 basis of 13.5%, which again, we were very pleased with. And that's been a focus of growing that ROE over multiple years. And if you look back in 2024, we had an ROE of 15.5% in 2025. That was 16.7%. And now year-to-date for 2026, that's already at 17.6%. And what has underpinned that has been a combined focus on improving our revenue productivity as well as driving cost efficiencies. So on the revenue productivity front, so there's a couple of items to call out there. If we look at our NIM, we've had our NIM expand over the last years by 18 basis points. And then we've also seen a metric that we threw out there for Investor Day was a focus on increasing our revenue per RWA. And so we've seen a 15 to 20 basis points increase there, really underpinned by the growth that we're seeing in wealth management as well as capital market. And then on the cost efficiency front, in Q3, we had an efficiency ratio at the all bank level of just over 52%. So ahead of our Investor Day target of 53%, and that's reflecting our ongoing focus on driving cost efficiencies. Also is reflective of our success on our HSBC cost synergies where we achieved $760 million ahead of schedule. So feeling really good about that. And that's even before we see the AI benefits that we called out at our Investor Day coming on board. Now the next part, the third part, I would expect the question would be, well, what does that mean going forward? You have an ROE of 18%. These efficiency ratios, you're hitting some of the targets that you've put out there for our Investor Day. And the way that we're thinking about that is we have a medium-term objective of 17% plus. And we add emphasis to that plus. The plus means that we're not holding ourselves back. We'll continue to see expansion on the ROE front. Now why do we feel that we've got growth continuing to underpin that as we go forward? There's things that we called out at our Investor Day that underpinned our targeted ROE. And they're still coming on board. One I just briefly mentioned was our AI benefits. So we had a target of $700 million to $1 billion, and that was net of investment. So we were very clear as net of investments. We've been at that for a couple of years now, and we're really starting to see hitting the milestones with the scale up to come on board in 2027. We've also called out our HSBC revenue synergies. We've put out a target of $300 million. So there's a good portion of that still to come online in 2027. And then the other item that I would mention would be in our U.S. region. And so I commented on how we're pleased with the progress that we're seeing there, but there's still areas where we're looking for that to continue to improve on efficiency on our funding optimization as well as on our top line revenue growth. So feeling kind of really good on kind of the journey so far where we're currently positioned. I think we're in a really good foundational place of strength, and we've got some tailwinds that are within our control as we think about the headway as we point going forward.

Excellent. One of the things that maybe has been contributed to the ROE recently has been the capital markets business. How should we think about the sustainability of profitability of capital markets from the current level?

Yes, great question and definitely a very popular question has been around sustainability of capital markets, sustainability, as wealth management as well as we've seen constructive markets and constructive markets has definitely been a driver in helping us at record levels in both wealth management as well as capital markets. So specifics give me to capital markets, I would say it has been a driver, but it hasn't been the only driver. We've been investing in that business for years, and we're seeing the returns from that. We've been investing in our technology. We've been investing in our talent. And as part of our growth strategy, we've also been very focused in growing in a stable manner. And so when you look at capital markets and the underlying components of our business, yes, we've got global markets and equities, which can be volatile with markets. But we've also got corporate banking, and so we've seen good growth there. We expect that to be stable as we go forward. We set up a couple of years ago, RBC Clear, which is our transaction banking in the U.S., seeing really good momentum. We again expect that to be stable as we go forward. And then investment banking has also been a component that in talking with clients hearing positive momentum as we go forward. So could there be a pullback in markets? Yes, right? I'm sure we could see that at some point in time. What I would mention though is kind of back to like we we have seen strong growth across all of our business segments in RBC. So Capital Markets, Wealth Management have definitely been 2 of those components. But in addition to that, we've seen strong growth in our personal banking and our commercial banking and that's been underpinned by volume growth, NIM expansion as well as a focus on cost efficiency. So if you find ourselves in that thought we still have this diversification. And we also have the diversification in wealth and capital markets, diversified across regions as well as across products.

And maybe a shift towards the discussion towards capital allocation. Earlier this year, OSI announced a permanent reduction in the domestic stability buffer, lowering the CET1 capital requirement, so 11% compared to, I think, at 13.5% in 3Q. Given the NIM requirement, what do you consider an appropriate level of capital for the bank? How quickly do you want to reach it? And how has that changed your -- how does it change affected your capital allocation priorities towards buybacks?

Yes. No, great question. So a couple of components that we step through. I would start with maybe a headline in that no change to how we kind of see our capital deployment framework and our priorities. So I'll step into that. But first, let me start with like from a CET1 range, we feel comfortable that in this environment, running in a range of 12.5% to 13.5%. And with OSFI's announcement to bring down the DSP buffer by those 50 basis points, we are targeting to run in the middle of that range, around the 13%. Given the environment, we think that it's appropriate to be running with additional buffer. There's command foreseen risks that come at us. So we're well placed to address that. There's also potential opportunities that may come along. So we're well placed to address that as well. I go back to we're in no hurry to change the -- like to drive that down because we're hitting our financial metrics with an ROE of just over 18%. From a capital deployment framework, our #1 priority is to deploy into organic growth. And that organic growth is -- we're guided and that we're not constrained in that we have to choose one area over the other. We have capital to deploy across all of our businesses. What we are guided by is that the area needs to head our targeted premium ROE as well as premium growth. And in the third quarter, we put out just over $80 billion in loan growth, and that was from our retail book. That was from our commercial book, that was from our corporate book. And when you look at that compared to our peers, that amount is larger than the next 2 added together. So we are definitely deploying into organic. Second, in our kind of framework of priority would be dividends. It's very important to us to deliver a sustained dividend increase. And the range that we look to operate within is a 40% to 50% payback ratio. And our target is to get into the middle of that range. So basically growing our dividends in line with our earnings per share. Third, on the list you've asked about is buybacks and is also a very popular topic as well. So for buybacks, we continue to see buybacks as a tactical lever. We're well aware of our evaluation, and we continue to buy back, we believe strongly in our intrinsic value. It's not our only financial metric though that we look at. And so when we think about our buybacks and kind of the level pace of our buyback, we also are well aware of kind of the impact on ROE, the impact on earnings per share as well as the impact on book value per share, another important valuation metric. And I would share with you that over the last 4 quarters, our book value per share has grown 10%. If we hadn't done buybacks, it would have been 12%. So again, we feel comfortable that buybacks is an important tactical lever that we can use to keep us within this 12.5% and 13.5% range and still hit the right valuation metric. And just to kind of finish out that framework, we've got 4 items on the list. The fourth would be inorganic. We're in no hurry, I would say, to be deploying inorganic where we would see something would be maybe a tuck-in, but -- and our #1 priority continues to be organic followed by dividends and then buybacks with a tactical focus.

And maybe drilling down into the organic aspect. The balance sheet growth in both loans and deposits was in line with or slightly better than peers in 3Q. What are you seeing in loan demand, particularly across commercial versus retail customers? And then looking ahead to 2027, how do you balance the potential benefit of government spending for Canadian commercial loan growth against the possible headwind from higher tariffs?

starting with -- I'll hit residential, commercial and then kind of a bit more into that 2027 outlook with tariffs and investment from the government in Canada, these major infrastructure projects. On the retail side, we're seeing strong growth, and I commented in the -- in the first question around like mortgages, really pleased with what we're seeing in client growth, client-driven growth. Our focus has been largely on Switch. So as mortgages are renewing, people switching between banks, we've seen really good results there. We've also been very focused on retention. Our retention are at historical highs. We're seeing retention in the low 90s. And that's important to keep focus on because from an margin perspective, as you know this well, Brian, is that from a margin perspective, from a renewal, it's higher because you don't have the same acquisition cost that you incur on that first mortgage. We're also seeing strong results for credit cards. And so on the Avion, I mentioned earlier as well that we're continuing to see that at a historical high when we look year-over-year on the growth side. On the commercial side, we are seeing strong growth across the balance sheet or a strong growth on the deposits and continued growth on the lending side. Our deposits grew 9% year-over-year. And that's really a reflection of our focus and also our deep relationships with our clients. And it's really important in this time for like a funding perspective as it equates to capital-efficient earnings that we're seeing come through. On the lending side, we are seeing impact from tariffs impacting certain sectors. But I would say like the diversification of our business is playing out quite well. And that our loan growth overall has been up 4%. But I would split it into kind of 2 parts here. We are seeing sectors that are impacted by tariffs that are having slow loan growth. Commercial real estate is just one of those areas. Commercial real estate makes about 40% of our book. And over the last 4 quarters, it's grown at about 0.5 point. What we are seeing though offset that, though is strong growth in agriculture. We're seeing growth in technology, health care and also public sector. And we're also seeing it play out different across the regions. The tariff sectors are more heavily concentrated in Ontario. So we're seeing slower growth in Ontario but what we're then seeing is stronger growth in Alberta, reflecting the oil, energy, agriculture, Prairies is strong with agriculture, and we're also seeing strong growth on the East Coast side. So all in all, that's kind of how we're seeing like a retail growth framing up in this current environment as well as our commercial growth. Now your question around what does that look like? Because there's obviously lots of headlines around tariffs, but at the same time, we're seeing lots of headlines around the major investment spend in Canada. So what we're seeing from our clients is on the commercial side is continued conservation can't get the word out comes. And what that is equating to is that we're seeing our clients be very thoughtful in that they're holding back on big major investment spend, but still spending into the operational space, being very diligent on managing their costs and at the same time, being creative and thinking about how do they transition their spend. And we're seeing that with larger clients being able to pivot that more in this space. On the consumer side, we're continuing to see kind of resilience come through in that we just recently got out -- received our credit card data, which gives us a good indication of where clients are spending and their level of spend and what we've seen is that their level of spend continues to be high on discretionary, whether it's travel, whether it's going out to residents with restaurants, which gives us confidence that, that will continue as we go forward. And so we're also feeling no optimism because we've heard a lot of headlines, right, around government of Canada, major infrastructure. And so we don't see that kicking in until the end of '27, probably more into 2028. I think we are really well placed to be supporting our clients as we see that growth come online and to support new clients that benefit from these major infrastructure projects that come online.

I think also like maybe a little bit more detail specifically on the inorganic side. Do you see any opportunities to deploy capital inorganically particularly in the U.S. to expand the City National franchise or do you see further opportunities to deploy capital in your Wealth Management segment?

Another popular question sitting with high capital levels. I would frame it as our bar is like super high when it comes to M&A. And in connection with that, though, you'd expect that we would always be kind of keeping an eye open to the opportunities that are around. So for us to be open to M&A, it would need to be on our strategy, it would need to be a strong cultural fit, and we need to be like super confident about the value that it would bring to our shareholders because we've seen all too often areas where there's M&A and its destructive to value. Where we would be open and to frame it from a strategic lens. And when we look at our overall strategy, we don't feel like we're sitting with a strategy that we need to buy something to fill a hole. We feel that we've got all the right ingredients to drive it forward. Where we would be looking to use like a tuck-in through an M&A would be to accelerate strategy. I know you asked about specific areas, like where we would be more open would be in the U.S. where we think you'd be able to accelerate our Wealth Management business, accelerate our commercial banking the U.K. as well look to accelerate our wealth management there. Also like really small little ads. We've done one recently in Canada where we were looking at building out a tech solution and instead, we're able to buy a small company called pinch that was a digitization of mortgage originations. So we're able to bring that in and it basically accelerates our path going forward. So in a nutshell, high, high bar and really looking at balancing the operational risk with the value that we would see clearly to come out from an acquisition.

Okay. Maybe just moving on to NIM and net interest income. After the Bank of Canada has held rates through much of 2026, there's some people are concerned that inflationary pressures could prompt a rate increase. Maybe how would that talk about how would that impact the NIM trajectory?

Sure. Yes. Definitely, a lot of discussion around what does the interest rate outlook materialize to be, whether that's in the U.S. or in Canada. Our economics team. Their forecast reflects similar immediate kind of increase in the U.S. And then for Canada, a more, I guess, an increase as we go into 2027. So a couple of increases what they're expecting. What does that mean for RBC, if we are to see interest rates start to rise? Where would start is at the top of the house. And at the top of the house where we focus is really on net interest income, excluding trading, and I'll come into NIM in a second. But we focus on the net interest income, excluding trading because we feel it's really important to be aware of NIM but at the same time, volume. And in our Q3 remarks, we've called out that our net interest income, excluding trading, is growing at 7% year-to-date. So really seeing that strong growth in line with our guidance. And then we also noted that there's a couple of headwinds that were more almost like accounting anomalies and so with those items excluded, our net interest income, excluding trading was at 11%. And those items that I'm talking about, one would be from our HSBC headwinds from our purchase price equation that rolls off. And then the other item I just wanted to touch on would be in our capital markets space as I had a few questions around why we were showing adjusted numbers. And so in our Capital Markets space, we have certain transactions from an accounting lens we're one side of it, the revenue side goes into other income. But the funding side of it would show up in net interest income. So when you're looking at NIM, all bank NIM on its own, you get one side of the cost but not the actual revenue. And so that's why we felt it was important to pull out and show that number. And that's also why we feel it's important to be focused on net interest income, excluding trading. Now from a Canadian banking perspective though, we do feel that NIM is an important metric. And our guidance in Q3 is that we expect to see Canadian banking NIM stable as we go throughout Q4, and we haven't given any guidance outside of Q4 at this time. But as we look into Q4, continue to expect to see benefits from our structural tractor deposit strategy continue to expect that we'll see clients flows moving from our term deposits into investments, which is a positive overall to revenue, a bit of a headwind for for NIM and then we continue to see heightened competition in this space. Now to your question, the broader question around what does it look like overall on rising interest rates, a couple of things that I would leave you with one, in our disclosures, we note that a 25 basis point increase on the short end of the curve translates roughly into about $35 million annually, net interest income. So you would have that impact that would flow through. The other item to be aware of would be on the tractors. You don't see it on the long end because of this deposit tractor strategy that we have in place. But if you were to see an increase in that 5-year swap, you would see those benefits continue to push out. The third thing I would call out is just in a higher interest rate environment, what we have seen so far have been client flows moving, right, from term deposits into investment products as interest rates rise, you might see a pause and even a reversion of those flows moving back. So definitely a positive from a funding perspective but it would potentially be a negative on the revenue side the margin that we earn on investment products would be the higher than the margin that we earn on our term deposits and then just the last item is that as you see interest rates move around, there's always kind of a question on competition and how that kind of flows through and the impact on your pricing for products.