Royal Bank of Canada's Management Presents at the Barclays Capital Global Financials Conference (Transcript)

Sep.10.13 | About: Royal Bank (RY)

Royal Bank of Canada (NYSE:RY)

Barclays Capital Global Financials Conference

September 10, 2013 11:15 AM ET

Executives

Janice Fukakusa - CFO

Analysts

John Aiken - Barclays Capital

John Aiken

Okay ladies and gentlemen, we are going to carry on with the next session. I am, again very pleased to have Janice Fukakusa here from RBC who is Chief Administrative Officer and Chief Financial Officer. Janice, welcome back. We are very pleased to have you here. Janice is going to open up with some remarks; we will then do the audience polling and open up to Q&A. So, Janice please go ahead.

Janice Fukakusa

Great, thanks John and good morning everyone and thanks for the opportunity to present. Before we get started, I want to make a note that all of my remarks including those made during the Q&A session may contain forward looking statement which involve applying assumptions, have inherent risk and uncertainties and may differ materially from actual results.

So to begin, two weeks ago, we reported record third quarter earnings of $2.3 billion and year-to-date earnings of $6.3 billion. Our third quarter results were underpinned by strong fundamentals with record earnings in personal and commercial banking and wealth management. We also announced a $0.04 or 6% increase to our quarterly dividend brining our payout to $0.67 per share, our fixed dividend increased in nine quarters representing a 34% jump. The increase in the quarterly dividend higher than most recent increases clearly demonstrates the confidence we have in our ability to [indiscernible].

In Canada, we are the largest bank and leading market share; outside of Canada we are leveraging our domestic strength and expertise to successfully grow our businesses globally. In doing so, we are focused on the largest markets and serving the complex needs of our global client segments institutional, corporates and high alternate worth individuals. Let me now briefly discuss our five business segments starting with personal and commercial banking.

Canadian banking remains the cornerstone of our business representing more than half of our total earnings. We are number one and number two in market share across all key product categories and we continue to extent this lead. We also continue to lead the industry in volume growth and take a disproportionate share of the industry growth with profitably growing our market shares. While growing volume is a priority, we are committed to controlling costs and improving the efficiency and productivity and we remained focused in driving our efficiency ratio to the low 40s.

Moving on to insurance, this business is a strong compliment to our retail franchise and our focus product and distribution strategy serves to differentiate ourselves than our performance.

In wealth management, we have been number one franchise in Canada with leading high network market share. Our asset management business is the largest retail fund company and a significant institutional asset manager.

In the U.S. we are the seventh largest full service brokerage firm by advisors and outside North America, we are building our UK wealth management presence and establishing international wealth centers in Singapore, Hong Kong and Switzerland.

With investor and treasury services, we are focused on creating a specialty custody bank that provides excellence in asset servicing with an integrated funding and liquidity business for financial and other institutional investors worldwide. Since acquiring 100% of the investor services last year, we have been operating to improve our efficiency, streamline our operations, while leveraging our strong reputation brand and financial strength to cross-sale a lot of the products and services.

In capital market, we believe our strategic business mix, targeted geographies and our strong stable earnings is the real competitive advantage and distinguishing feature with respect to other Canadian banks wholesale operations.

In Canada, we are the clear market leader and in the U.S. we are becoming a significant player and growing. The U.S. provides both diversification and an attractive growth opportunities for RBC as the economy recovers.

In the UK and Europe, we are selectively building our invest bank in core areas where we have key strengths with primary focus on clients in the UK, Germany and France. We are also rebalancing our capital market business more towards corporate lending and traditional banking businesses on an originate to distribute model to reduce our reliance on secondary trading activities.

So, in closing, our financial strength, diversified business model and leading market position remain a clear competitive advantage in today’s environment. They give us the flexibility to find the rate balance between investing in our businesses for longer term growth and returning capital to our shareholders. Our Canadian leadership and global strategy combined with our focus on delivering high quality and sustainable earning positions us well going forward.

So thank you all for your time today and I am happy to take your questions, and will move over there John.

John Aiken

Well, Janice is moving over, can we start the polling questions please?

And the first question is, how do you think the Canadian bank valuations will performing against the US peers over the next 12 months? It's fairly straightforward.

It’s actually very much consistent with -- the other time we had this question asked in the room, so either everyone is of same mind or we haven’t refreshed the audience at all.

Can we go ahead with the next question please?

What’s your view on the [indiscernible] Housing market; a bubble about to burst, overvalued but price declines will be manageable, fairly valued or not an issue at all?

Overvalue for price declines would be manageable. It seems to be the overwhelming response. Janice, what’s Royal’s view on the Canadian Housing market and whether or not it actually represents any material risks.

Janice Fukakusa

That’s a great pull and I think that I can agree generally with the overvalued except for the fact that I think it is in specific markets. So when you look at what’s happening with the housing market, there are concerns about the overleveraging of consumers, then our government is talking down the leverage. I think that in certain cohorts of the market, for example, in British Columbia and Vancouver lower mainland we saw rapid price escalation there. The prices are actually coming off the cyclical highs in terms of values and we see in markets like the Toronto Condo markets that the prices are going up but not as higher rate as was happening previously.

I think that the issue for us has to do with debt serviceability and managing our customers through potential of price fluctuations when the prices remain flatter or declined, and from our perspective our portfolios are pretty well managed. We haven’t seen any ramp up at all in our provisions profiles. We have seen fairly rational behavior of the Canadian consumer. So we are cautiously optimistic that we will be able to continue to grow our volumes and our revenues not as higher rate as previously. We think that focusing on that and then focusing on a lot of the cost to delivery we will be able to still generate pretty solid earnings growth.

John Aiken

Would you go with the next question please? How do you think Royal Bank Canada will perform against its Canadian peers? Singularly, or perform modestly, or perform in line [indiscernible].

Janice I won’t obviously comment, have you comment on [indiscernible] were wrong. We will get through that through the Q&A.

I think there was one final polling question. What’s the greatest risk to Royal Bank of Canada’s premium evaluation, and the performance in capital markets, we are going to expect a consumer recovery or further deterioration in Canadian Housing market?

Pretty much even although I think that the capital market sensitivity is definitely there; Janice, can you address the outlook for capital markets and then maybe add in other areas that it may keep you up and that we missed in a couple of questions.

Janice Fukakusa

It’s good to start with a positive. So when -- with respect to our capital markets platform what you’ve seen over the past few years is the retooling of the dominance of the trading revenue streams in terms of our overall market volatility and more of a back to basics to where we can earn less volatile and more consistent earnings and revenues through corporate investment banking.

So if you look at where the growth is, that’s where you see the growth and it’s primarily here in the U.S. where we've actually being focused for the last 10 years on growing out that platform and we are seeing really good trajectories in terms of the lending exposure that we have down here in supporting the growth and also following on to the fee revenue that we’re generating through M&A activity and equity issuance. When you look at the historic quotes underperformance in capital markets I think it's more about the volatility between the quarters. If you look at the annual earnings that a capital market shows, it’s pretty consistent earnings growth throughout the past few years, however on a quarterly basis there is some volatility with respect to trading.

If you look at our past results this past quarter we reported over $380 million of earnings despite the fact that there was some weakness on the trading revenue side in terms of some of the European activity and in terms of the tapering and the impact it had on the longer dated fixed income product and that consistency and lower volatility is the result of this retooling, I think that as the economy improves we're really well positioned from the capital markets perspective to step in and support our clients in terms of the investment in the economies the M&A activity and the expansion through debt and equity issuance. With respect to the overall platform we continue to have a governor on the amount of exposure we have to capital markets and its 25% of our earnings, give or take, it's running just over 20% now and I think that we will continue to see growth in the capital markets platform along the same rate as the growth in our three other retail platforms.

John Aiken

And Janice, are there any other areas in your business that you're keeping a close eye on right now in terms of where weakness or risk may emanate from.

Janice Fukakusa

I think that, that we're watching the rates of growth of the Canadian economy, we're obviously watching the housing market while we haven't seen any issues at all in term and manifested in terms of our provisions profiling or even our loan loss experience and trajectory. it's something that we need to watch because of the relatively unstable markets in Europe and the spreads of recovery in the US, so that would be something that we're watching so we're hoping for the best but planning for the worst, so the focus is on really trying to generate our earnings trajectory despite some revenue softness generally overall that we may anticipate through ensuring that we're not letting our spending get ahead of our revenue and really managing our efficiency agenda.

John Aiken

We'll open up to the floor if there are questions.

Question-and-Answer Session

Unidentified analyst

You made a major on the asset management side, you made a major acquisition recently in the UK, its BlueBay Asset Management, are you pleased with the progress of this partnership so far and what is the growth plan for the asset management business internationally and locally?

Janice Fukakusa

Thank you for that question, we are very pleased with our progress on BlueBay Asset Management, what it did was added emerging markets capability and European product capability and what we have done is taking the product offering and offered it to our clients in our distribution network in North America, so it's been quite successful at expanding the product in the high net worth segment of that market and also with the support we're providing with BlueBay they've had a lot of product launches in terms of different funds that they've launched both in emerging markets and some within Europe in order to expand the breadth of that with respect, so it’s been quite successful from our perspective with respect to our acquisitions going forward, wealth management is one area where we are looking actively at acquisitions mostly in the asset management side. We're looking for similar acquisitions that you see with BlueBay that actually extend our product reach, have synergies with our distribution in North America and within Europe and also bring additional capability. So we're constantly looking, I would say that the prices are still pretty high, the multiples are high and we are looking for a similar quality in terms of the fact that we can take the acquisition and begin to leverage a lot of the synergy to add to shareholder value.

John Aiken

Janice, along those lines is the focus mainly still in Europe, are you looking at other regions to get asset management talent?

Janice Fukakusa

We're looking at all regions. I would say that Europe is a focus because of a bit of the market environment there. I would say one thing about looking at all the environments, the prices are all pretty high, multiples are pretty high in the asset management side.

John Aiken

I just was trying to understand something about this past quarter, in the trading business. So during the quarter there was a very material move in bond prices and you guys have a meaningful trading portfolio which gets marked through the PNL, you took relatively speaking a very small mark through the PNL compared to what would have been implied by bond price moves, so that tells me that you've got the book very well hedged, except, my question is, the thing that I don't understand is if you have it so well hedged how does it throw off so much carry income. The two seem pretty inconsistent with me, so I was just trying to, you know, if you don't the numbers for the quarter of the top of your head that obviously fine, but I'm just trying to understand conceptually how is that your balance sheet doesn't ever reflect moves in bond prices.

Janice Fukakusa

I think that when you look at the way that we're managing the business itself, it is about taking risk out of the securities portfolio and taking down risk in areas that are particularly volatile. So what you see saw is that despite a little bit of uncertainty in Europe we didn't experience a lot of trading volatility there. The actual volatility had to do with the prospects of tapering and the impact on the immunity and the securitization portfolio.

When you look at our overall balance sheet activity in capital markets, then you look at where the regulatory environment is going, a lot more capital is attributed to securities portfolios and in particular in more complex securities. So we've been rationalizing our capital usage on the trading side and part of that needs to be instruments that are more of a level one type of instrument that have more liquidity.

So I think that's when you see on the flipside is that while there was a significant movement on the long end we're pretty well diversified, we’re taking risk out of structured positions and more gravitating towards more liquid portfolios. And also tailoring a lot of what we have to really support the clients most, because it is about the corporate investment banking origination business and the ability to trade through a lot of the issuance.

John Aiken

I understand that, I guess the thing that even if you look at Canadian sovereign bonds or U.S. treasuries, USMBS, across the spectrum even your perspective of the levels implied risk, the fact that interest rates moved so much in such a short amount of time necessarily means that bond prices moved too and no matter whether you are in risky securitizations or in Canadian govi. So I still don't understand, how does that work?

Janice Fukakusa

In terms of a trading revenue volatility?

John Aiken

Yes, you would expect, if just take the U.S. banks for example since rates started to move in the spring of this year the AOCI impact has been very material to tangible capital levels. But you guys don't have that, and I just can't understand how that works.

Janice Fukakusa

So we have compared to U.S. banks we have a relatively modest securities portfolio that actually flows through AOCI and we're in a net gain position on that portfolio and from the trading side I would say that it's about diversification across the different products and supporting clients and not having a lot of risk in positioning. There are securities portfolio pretty vanillas that you would classify as more of an available for sale portfolio. And so while there are some marks we have built quite unrealized gains, so it's calm down a bit, but it doesn't throw off the volatility in a similar fashion to what you would have in some of the U.S. banks.

John Aiken

I was wondering in the Canadian business there has been some commentary about commercial loan pricing being pressured. I was wondering if you would comment specifically about in the last whatever period of time six months, 12 months to what degree have you’ve seen spreads coming. And whether there has been spread compression in resale products maybe setting aside mortgage but in some of the other areas has there been spread compression there as well?

Janice Fukakusa

I think that, I will talk about our net interest margin and when you look at our net interest margin on -- in Canadian banking, it's been pretty consistent if you normalized for some of what's happened in terms of some accounting adjustments and some hedging volatility. We're tracking at about 272 now and we've been within one or two basis points of that. So while we see some spread compression on the horizon as our books repriced we would say that would be in the one to two basis point ranges.

With respect to the actual commercial loans portfolio there is a lot more competition in the market for commercial loans, the actual margins on the commercial exposure are coming in, but it's not a significant driver in the overall NIM position. A lot of the lending is variable rates so the impact would be on the actual spread on the loan. And I think that when we look at the makeup of that particular asset class, we may see a little bit more compression going forward because what we would have noted is that when we were looking at volumes prospectively going into the year we thought that our mortgage volume growth would [indiscernible] a bit, so grow the rate of growth of the volumes would be lower than we've had experienced the prior year. What we thought was that would be made up by commercial more volumes on the commercial side, and while we have had growth on the commercial side I would say that from the mortgage perspective we have seen a pretty good volume growth vis-a-vis how we thought we would be positioned.

On the other retail products the driver of NIM is really on the mortgage side, I think that deposits rates have basically held, interest rates have been pretty low so we haven’t seen a lot of coming off and lowering of the rates and so it would basically be the two categories on the market side and then the commercial loan side where you would see any potential movement in net interest margin.

John Aiken

Janice, on the call you’ve highlighted the new off fee rules for CDA and that would be a first year ahead of about 30 basis points to tier 1, is that correct?

Janice Fukakusa

The CDA growth are also graduating in over the next five years so I think it’s about 60% in year one and then it goes up 200 and based on today’s ratio it would be about 30 basis points and generally speaking we would actually while we’re managing our capital with respect to that where our other expectation would be that we’d also earn into that particular metric.

John Aiken

Okay so that 30 basis points is just the per share impact of the whatever 60% to 57% that comes in the first year?

Janice Fukakusa

Yes that would be the rates office clips (ph) in so it’s day one of the first…

John Aiken

Okay, are there other capital or regulatory constrains that will become binding? I don’t want to say irritants but I guess binding constrains that are now coming and that have to be managed around expectations of the new securitization framework or other things that you’re going to have to address directly?

Janice Fukakusa

There we don’t see anything at the margin that will have a material impact on the capital ratios and we always manage our ratios, so right now we’re managing with a 7% regulatory guideline plus another 1% for the domestic significantly important institution surcharge and we try to manage a buffer of around 50 to 100 basis points for balance sheet fluctuation and we also look at that buffer in terms of managing any new growth at the margin. If we don’t have the opportunity to earn into them, we don’t see anything particularly concerning in looking at our capital management framework going forward from the regulatory perspective, that’s why you would have seen us begin to do buyback two quarters ago, you saw our dividend increase, we’re committed to growing our dividend at the same rate of growth as our EPS and you’ll see the capital management in terms of always being -- having the ability to fund organic growth continuing into the future.

John Aiken

Just one more follow-up on a capital question, does supplementary capital ratio, these things matter for the Canadian banks moving forward and can you give us a sense of where you guys might be?

Janice Fukakusa

What ratio is that?

John Aiken

Supplementary leverage ratio.

Janice Fukakusa

All of the Basel III leverage ratio, the leverage ratio we’ve always had an asset to capital leverage ratio as part of our regulatory construct. We are of course reviewing the Basel III leverage ratio given the fact that it is relatively new and talked about, and we are comfortable that it won’t be constrained going forward for us and for our regulated fee issue is around comfort-ability and that’s why we’re working through what it means because of the different accounting constructs U.S. GAAP, IFRS and the different way things are measured we’re actually taking a setback as our regulators are to make sure that we are on the same page in terms of what’s happening with respect to the Basel III leverage ratio and how it’s going to be implemented in Canada.

John Aiken

Janice we're potentially going to see some pretty significant disruption in the credit card business in Canada with the transfer of (inaudible) and RBC has built atop a very strong independent card platform in of themselves and tactically they are giving a too much information for your competitors but tactically what is we’re planning on due income January 1 when we start to see this I guess period of transition?

Janice Fukakusa

I think that you may have already been seeing it now that we’re ramping in on our card marketing because we believe that we have the best royalty program and the best travel program in the business because there is no restrictions that we are using one of the travel providers for fulfillment and then at the high end we have a concierge service, so you will see a ramp up in the marketing in terms of client acquisition. Everyone has two to three cards in their portfolio so we’re really focused on getting the activation of our cards, so I think that it’s something that all of the Canadian banks and we’re particularly focused on because of our great market share on revenue in cards.

John Aiken

And historically how successful has while been in once when acquiring the client on the credit card platform into increase in share of wallet in terms of getting into more I guess fundamental checking accounts, other lending products?

Janice Fukakusa

We've had really good penetration on that score and it’s all about the follow-up getting the activation on the card and the follow-up. I don’t have the statistics done but it is one of our three core products, the mortgage credit card and the operating accounts.

John Aiken

In your resell business the personal loan category is very large and I think you have a lot of personal loans that aren't [indiscernible] there is in the personal loan category. Can you give more color on what the drivers of that portfolio are and who the borrowers are kind of what in to that product versus some of the other products?

Janice Fukakusa

In the personal loan category basically unsecured loans some of them are cautiously personal loans but they could be small business loans that are secured by a guarantee as opposed to having a fix charge. So, it would be sort of hotchpotch of those categories. It's hard to drill down on it because the personal loans category is more of a balance sheet and a regulatory metric as opposed to looking at the client segments but that’s what it would be.

John Aiken

Janice, you all recently announced I guess an exit in one of the business clients in European capital markets platform in terms of the sovereign debt, can you tell us what was entertaining that decision and what the impact in terms of the balance sheet or the profitability will be from this.

Janice Fukakusa

So John I think you’re referring to the fact that we are no longer primary dealers of certain of the European countries. I think that we did that along the lines of constantly looking at our European fixed income business and our European business in terms of ensuring that while we have client coverage and we can still support debt and equity issuance, we don't -- we need to slim it down to a manageable size given the volatility. With respect to the actual getting out of the business there is no real balance sheet impact because we didn’t have a lot of inventory. I think that with the respect to the people, it would be a nominal sort of a headcount reduction that we have there.

It's more of a streamlining and ensuring the capital that we employ in the fixed income and capital markets business in Europe, is employed against clients and that we don’t disrupt that flow while taking out businesses that we really want that active in but we’re still having a little bit of peace of mind.

John Aiken

And Janice on the retail front, it’s been a continuing goal for Royal to pace the market growth and as I believe you talked about some efficiency ratio looking towards the low 40s. Royal scale was within the Canadian marketplace is very impressive. Is that truly what gives you the differentiation to be able to continue to grow maintain cost despite the fact that you have significant market share?

Janice Fukakusa

I think it’s precisely about the way that our distribution network and our fulfillment (ph) and we’re pretty even across Canada. So, what we’re able to do in order to fulfill our objective its getting portion of market share is retail our productivity at the market and put it to the areas that are growing and by the same talking reduced it in areas that aren’t growing.

And I think that’s one of the things you can only have with scale plus having a distribution that’s relatively even across Canada. It’s important for us, it was important for us even during the financial crises to continue to invest in our network, our distributions and our fulfillment.

So, a lot of these programs that we see that are aiding us in managing our extensive started two to three to four years ago, in terms of investing in and putting the capital down to actually view automation, retail of the business, its -- and I think that that allowed us the flexibility now, that really focused on driving our efficiency ratios down. It’s important for us to continue that investment trajectory that’s when we talk about expense management, we talk about maintaining our expense growth at lower than the rate of growth of revenue. So, it’s not about cutting in to the growth, it’s about managing growth.

Unidentified Analyst

Can you speak a little bit about the trajectory for branch growth or decline in Canada and the importance of online versus branch and how that impacts your cost?

Unidentified Company Representative

That’s a great question and I think that when you look at overall branch growth in Canada, it's about where we’re growing branches versus where we’re rationalizing branches and we know that in the different urban markets because of the net immigration into Canada and that’s of course strategy for Canadian population growth is immigration. You need to have a higher density for branches to serve the market.

What we’re doing with the branches is we're retooling them in line with your question about electronic banking. Retooling them more as [indiscernible] so you know when you’re going to a branch and you see that it's really about the lineup in these branches, it’s not really about the lineup, in fact we have agents ready and we have machines and computers that where we can teach people how to do Internet banking for the transactional side because it is about getting the mortgage or doing a credit card application or getting financial advice. And so when you look at our overall branch count I think it’s probably basically flat to maybe up slightly, but the nature of branches has changed. The other thing that we’re doing is Gary asked if we are partnering with retailers like shoppers, [indiscernible] to the extent that we’re actually in the store and can open transactional accounts there in the store, so having a little bit of a more mobile focus in extending our branches beyond the traditional bank branch. That allows us to of course on the transactional side, take down our cost because if it is all through internet banking, it’s a lot easier to fulfill and reinvest some of those savings in higher order agents that are more along the advice and financial planning side as opposed to transactionally based.

Unidentified Analyst

[Indiscernible]

Janice Fukakusa

I think that our branch count would be relatively consistent but our touch points in terms of the retail touch points into marketplace will be higher because of things like the shoppers trademark for example, way of doing business inside the premises of other retailers.

John Aiken

Janice on those lines we’ve heard commentary from U.S. banks as well some of your competitors talking about decreasing size of footprint even if there is still branch rollout, is there something that Royal is looking at particularly with the new stores that you’ve launched as so far?

Janice Fukakusa

I think that’s exactly right, that’s the actual price of the branches can come down of course we have insurance branches right next door because of the little anomaly in Canada with the marketing. But because it is more about a meeting place and not transactional line up so that’s precisely it.

John Aiken

We have time for one last quick question because I will take it then towards the topic of insurance. Where is the growth in insurance going to come from considering the fact that it is now a sizable component of Royal’s earnings strength?

Janice Fukakusa

I think when you look at our insurance business it is of distribution, so we’re looking at the margin and enhancing our product base in terms of distribution into for example looking at just our pickups in example the disability market and how you can look at group visibility, insurance products for small business. So it’s all about our insurance advisors supporting with the wealth management side to get a more integrated offering. So it is -- the focus is on distribution and we believe that our insurance business should be growing at the same rate of growth as our wealth in our banking platform.

John Aiken

Well Janice it was a pleasure having you back. Thank you very much. Please join me in thanking Janice for the presentation.

Janice Fukakusa

Thank you, John. I will say thank you very much.

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