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Royal Bank of Canada (NYSE:RY)

CIBC Eastern Institutional Investor Conference

September 18, 2013 01:30 PM ET

Executives

George Lewis - Group Head, Wealth Management and Insurance

Analysts

Robert Sedran - CIBC World Markets Inc.

[No formal presentation for this event]

Robert Sedran - CIBC World Markets Inc.

Okay. Welcome back everybody. Each of the Canadian Banks is pursuing growth in their existing core businesses, but also expanding into new businesses or geographies among those initiatives. At Royal Bank, perhaps none has hoped as high as the Wealth Management Business.

So I’m pleased to welcome George Lewis to the stage. He is responsible for all of RBC’s Global Wealth and Asset Management Businesses, including RBC Global Asset Management, RBC Dominion Securities, PH&N, and BlueBay. He is also responsible for RBC Insurance. He has previously held other executive roles at RBC, Head of Institutional Equities and Director of Research at RBC Capital Markets and he is a former equity analyst as well. So for those of us still stuck in the trenches we’re all pulling for you. So welcome to the conference.

George Lewis

Thanks, Rob.

Question-and-Answer Session

Robert Sedran - CIBC World Markets Inc.

And thanks for taking the time today. I think we will just kind of launch directly into the Q&A, if that’s okay. So, we’ve talked a lot about growth potential in the business. And before we get into any potential acquisitions or what the acquisition environment might look like, I wonder if you maybe could update us on where you see the best opportunities for organic growth in your wealth businesses, either by geography or by product or whatever you’re seeing?

George Lewis

Sure and thank you. And thanks for the invitation to participate. I think the organic growth we have before us in RBC Wealth Management, really crosses all of our businesses where we’ve seen that the strongest organic growth in the last year or two has come and both in our Asset Management Business globally and that includes our business here in Canada both retail funds and institutional. That is a business that is very leverageable for us since where we spend most of our focus on acquisitions. But as organic growth opportunities now are considerable that represents over 50% of our segments earnings with about 10% of my employees. So that’s a very leverageable business that we can continue to expand and gain market share as we have been doing in Canada and also take more of our global capabilities and deepen our penetration in the U.S.

I would say secondly, we continue to have very strong organic growth in our North American Wealth Business, which focuses on high net worth and ultra-high net worth clients clearly in Canada we’re a market leader in that space with about 18% market share from 15% a couple of years ago. Our U.S business is moving up market in that regard. And we continue the third leg of our growth really comes from our British Isles and Emerging Market business which focuses pretty well exclusively on high net worth and ultra-high net worth clients. That’s our smallest area that now one -- we’re investing more in, but has good growth prospects as well. So I would probably rank them in that order in terms of order of magnitude, but three primary drivers.

Robert Sedran - CIBC World Markets Inc.

One of the area -- and again sorry, if anybody has any questions, please do just throw your hand up, I’m happy to just stop at any time. One of the areas that has been showing some growth I guess is in the credit book. When you think about -- and we generally think of the demographics and being favorable to the Wealth Management business, but at the same time we have what we hear regularly is the over levered consumer who had -- the people are retiring with debt need to pay down, their debt and all the rest. So when you think about the demographic set up and the macroeconomic backdrop, can we still assume that favorable demographic profile is still a positive driver to the Wealth business long-term?

George Lewis

Yes very much. So there is two primary tailwinds that we believe in 2007 when we set up the Wealth segment we’re in place for many years and still believe that one is the one you refer to, which is the demographic trend of aging populations, particularly in North America. And so our businesses that are pointed towards at opportunity including our Asset Management and Wealth businesses, we still think that’s an enduring long-term trend and its not -- it hasn’t been all that impacted nor do I think it will be by the fact that personal lending growth has been so high in North America as well in terms of the trend you’re pointing out.

But importantly the second tailwind, which really all of our businesses are benefiting from is the growing the growth of the high net worth and ultra-high net worth segment of clients globally. And this is apparent over the last number of years; it’s driven partly by the knowledge based economy, partly by free trade, partly by growth in the Emerging Markets. And we see that trend continuing and all of our businesses are really pointed towards that. So those two things we think will continue to drive faster industry growth for this relative -- for Wealth versus other aspects of financial services. But we’re going to have tailwinds or headwinds from time to time too. The biggest one right now would be the low interest rate environment.

Robert Sedran - CIBC World Markets Inc.

I want to come back to that one, but you -- I guess I combine two questions when I ask the growth in the credit book and how that was going, what’s driving it and is it easier now to grow that credit book when the markets are starting to behave themselves a little more favorably?

George Lewis

Do you mean the credit book that we have within the Wealth segment or …?

Robert Sedran - CIBC World Markets Inc.

Yes.

George Lewis

Okay. Yes, I’m sorry. Yes, that -- that's a good question. When we looked at our Wealth business, when we brought it together couple of years ago, the portion of loans we had to our clients globally was something like 2% -- actually 1.5% of our client assets. And our global peers like UBS, Barclays, Credit Suisse would be more in the 5% to 7% area. So we view this -- viewed it and still view it as a growth opportunity for us. So our growth in that book has been north of 20% for the last three years. It is primarily secured by marketable securities. It’s pointed directly against high net worth and ultra-high net worth clients.

So these clients are not in our view over levered. They’re using our credit, so they don’t have to monetize operating businesses when they come to for example purchase a second or third home in prime London real estate or New York real estate. So we manage the book in very clear parameters. We have minimum level of the book that needs to be underpinned with liquid securities, a maximum that can be underpinned with residential real estate and so the trends in terms of the North American consumer are not the ones that are really driving the growth of our Wealth Management credit book. In fact I think about half of that would be outside of North America.

Robert Sedran - CIBC World Markets Inc.

So what was the reason for the under penetration originally?

George Lewis

It’s a great -- yes, historically our businesses within Wealth Management in North America have been primarily investment led and investment focused. We have broadened that out over time to include a full Wealth Management approach. So insurance solutions, trust solutions, but in Canada we’ve a credit partner which is Bank -- Canadian Banking and so a lot of our clients credit needs back all of them are taken care of through that, through our partner there.

Outside of North America, our business is historically been focused on trust and its just recently added investments and a credit focus as well. So we were admittedly late to the game because we weren’t really thinking about ourselves as a Global Wealth Business up until 2007 when we created the segment. So part of the value of focusing on our business globally is taking a look at not only what the domestic peers are doing, but what -- we’re the sixth largest wealth manager in the world and when we looked at the other top 9 or 10, they were doing a better job than we were of meeting the legitimate credit needs of our client base.

The other thing that’s helped us since we realize that and put more focus on it is the strength of the Canada brand and the RBC brand in particular globally has significantly improved over the last five or six years since the market crisis. And so clients know about us, know about our capability and particularly in the ultra-high net worth segment they’re very focused on counterparty risk. And wanting to deal with an institution who they know will be with them through thick and thin and make a credit decision and stick to it. And so that’s helped us grow that business as well.

Robert Sedran - CIBC World Markets Inc.

So you mentioned 1.5% before you sort of made the question, have you disclosed where you might be.

George Lewis

Yes. We are little over 2% now and I think we will be quite comfortable if we go to 3% over the next several years. And I should point out that our segment is still has a positive liquidity contribution to RBC overall. And so one of the attractive feature strategically to us and the other banks about growing Wealth Management is on the capital side apart from acquisitions, it’s a very capital light business to grow organically. And it’s also historically been a very positive liquidity business because we do have more deposits from our clients and we do have loans outstanding. So we’re focused -- even as we grow our credit book, growing our deposit book as well, so we maintain roughly two to one gap between deposits versus loans within the segment.

Robert Sedran - CIBC World Markets Inc.

And is that sort of the constraint or as you mentioned some of your peers in your size range will be up as much as 6% to client assets, is that more than liquidity or is it that maybe a little bit too large of a book for Royal Bank?

George Lewis

Yes, I think well we have to. We defined our risk appetite very tightly in my view and appropriately so. So others who are at that 5% or 7% or higher percentage level may have allow their book to be comprise more of security of real estate or operating businesses or non-market or non-liquid assets. And we’ve been quite consistent in keeping the vast majority of our loan book underpinned by marketable securities and I don’t see that changing.

Robert Sedran - CIBC World Markets Inc.

So do you treat it as a secured loan book or do you treat it as -- I’m lending to the person and I’m adjudicating the credit even as if there is no security against that like how much do you rely on that security?

George Lewis

Yes, it varies from loan to loan. I think at the -- from the vast majority of our business and it’s a very relevant question because we’ve just moved to a standardized approach for our securities lending portfolio, which has allowed us to reduce the risk weighted assets we have against it, because we do primarily look where we have liquid security at the security itself. Other for – particularly for ultra-high net worth clients where we have loans against their holding companies or personal guarantees or more complex structures obviously we adjudicate those differently and look -- very much look to the credit worthiness of the person.

Robert Sedran - CIBC World Markets Inc.

So one of the caveats that you put on earlier when we just talked about the capital intensity of the businesses acquisition. So let’s and obviously there is not a whole lot of tangible common equity that you’re getting when you buy pretty much in any business line in the Wealth Management segment? How does the bank think about the impact in the financial statements in terms of -- does a deal need to be accretive, does a deal you watch the ROE impact, I mean all of that like the top of the financial implications and then after that or maybe we should start rather with the strategic implications, what are you looking for, what do you want to buy and what kind of an environment are we sitting in from an acquisition perspective, right now?

George Lewis

So -- yes, I’ll go backwards and the -- our historical focus since ’07 in this segment has been primarily on the asset management side of Wealth Management and for the reasons I outlined earlier, its almost leverageable business into our highest pre-tax margin business. So beginning with Philips, Hager & North in 2008 that acquisition brought us unquestioned leadership within the asset management space in Canada. Brought us back into the institutional business in Canada from which we’ve have now built out internationally and that’s gone extremely well, about $1.4 billion.

So keep that number in mind and then two years later, at the end of 2007 -- 2010 rather we brought that our Global Fixed Income franchise by purchasing BlueBay Asset Management in the U.K. Similar size acquisition, excellent specialists in the European Investment Corporate Grade, Debt, Emerging Market Fixed Income, they’ve grown from $38 billion to $56 billion since we acquired them. And that kind of an acquisition size, if you will, it has an impact on the ROE from my segment, but I watch that carefully. So we’re back up well north of 15% going to 20% and I think that another similar acquisition of that size, one that brought us a little more equity assets, given the point of the cycle we’re at, perhaps in distribution in the U.S. It would be something of interest. But we’ve a lot of organic ways to get at that without the need for an acquisition, but now would be the one area that we would be focused on in terms of a sizeable one in that -- in a range.

The other area, which would be much smaller, would be if we could find an opportunity that would allow us to build scale in those key international centers that we’re growing in, Hong Kong, Singapore, primarily those are areas we’re investing in, we’re building new investment platform, investing in risk management compliance, client facing professionals. If we found something where there is a lot of expense synergies that came with that we’d be interested in that as well. But we will evaluate it on -- we'd like the acquisitions would be cash, EPS accretive relatively quickly. We are primarily focused on opportunities that would have revenue synergies in the asset management area because there’s not a lot of cost base within those businesses. And we have a demonstratable track record of success in both of those areas. So, we are not going to stray from that in terms of our focus on asset management primarily with the exception of perhaps focus on some bolt-on acquisitions in the international wealth space.

Robert Sedran - CIBC World Markets Inc.

Can you just remind us what kind of size constraints you’ve talked about in the past in terms of how big an acquisition you might be contemplating and if we’re looking more at bolt-ons or if we’re looking at potentially a larger one.

George Lewis

Yeah, so I think in the asset management space you can look at what we’ve done in the past and extrapolate that into the future in terms of the ideal size that we would be looking at. Clearly if there was something that brought us equity capability alternatives U.S. distribution, we might stretch ourselves beyond the 1.5 level. But we very much look at the segments, returns and focus not only on earnings growth and pre-tax margin but on ROE and our use of acquisition capital.

Robert Sedran - CIBC World Markets Inc.

I think you mentioned BlueBay, and now you’ve talked about perhaps something that’s more equity capability rather than fixed income capability. How much -- when you think about the performance of BlueBay I guess you actually had a longer run, the bull lasted a little bit longer, I suppose than anyone thought it would, probably not what you were assuming when you purchased it if I had to guess. So what was the thinking when you bought BlueBay in terms of the interest rate environment and how relevant that was? And then when you think about potential equity purchases it again that’s on a great rotation that we’ve heard about is that, what's the thinking behind it?

George Lewis

I think the -- and thank you for the comments on BlueBay. There as a specialist fixed income manager their focus is on two primary areas, emerging market fixed income which was done quite well since it's gone from $2 billion to $18 billion since we acquired them. I expect that to take a bit of a pause given the backup in rates, but it's been very good growth. The biggest asset they had when category when we purchased them was European Investment-Grade Corporate. So for the first 6 to 12 months after we purchased them we went through the Eurozone crisis.

So our timing was not as perhaps as great as you’ve given us credit for, but the important thing with both Phillips, Hager & North and BlueBay which is proven through the cycle here is it a very high quality franchises, great investment performance, very strong cultures and we pay a reasonable price for those franchises and then are able to withstand in the case of Phillips, Hager & North a significant downturn in the overall markets. In the case of BlueBay, a downturn in the European markets, but both of those companies have assets well north of what they were when we acquired them.

Robert Sedran - CIBC World Markets Inc.

Okay. Can you talk; I want to come back to Canada a little bit. You talked, it strikes me that Royal Bank has perhaps was a little earlier than some others in terms of integrating the retail distribution network with as a source of customers, as a source of assets but a wealth management business. And can you talk -- so can you talk a little bit about how that works, whether there is compensation in both ways in terms of assets flowing and how you worked this, I mean how important is that retail network as a source of clients and flows for the asset management?

George Lewis

Sure, yes. So there’s two large partnerships between our wealth segment and Canadian banking. The first one is between our asset management business and the bank as you highlight and going back 12 years ago, our asset management business was entirely based on the retail space and distribution through our banking network. It is still our most important channel. It represents 70% of our retail mutual fund assets. And I think you’re right, I would say that the work over the years between the two business has created -- has been responsible for creating Canada’s largest fund business. And that’s taken investments on the banking side in terms of advice giving capabilities, sales force expansion.

We have the largest mobile investment to retirement planning sales force which is focused on going out and securing business from the competition and bringing that back to RBC.

And then on the Asset Management side we’ve designed very specific portfolio solutions that now incorporate more and more of our global capability, but it delivered -- the very sophisticated institutional quality investment management delivered simply through a portfolio process that where clients are able to be served whether they’re conservative, balanced growth or aggressive growth investors and so it's -- and the business supports Canadian banking through seminars and product training and client events. So it's a very strong partnership. It's underpinned by market based compensation.

So when you look at the revenue for our asset management business it's actually after the payment of roughly 55% to 60% of the growth revenue on the retail side through as trailer fees to our Canadian banking and other distribution partners. So that’s been a huge strength. Over the last 12 years there is -- the asset management business has developed a very large external business to the banking network, part of which includes our Canadian wealth business, but part of which includes third party advisors and the acquisition of Phillips, Hager & North really helped with that because some third party financial planners and advisors like to have a Royal Bank product on their clients books, others don’t and so they’re very attracted to the page and then brand name in that respect. So, that whole asset management and banking partnership has been critical to us and we still see further growth there even with competitors looking to duplicate that, we still think that there’s growth in that basic model.

The other partnership just to take one minute which has been very important is in the high net-worth space and that’s more between our Canadian wealth business and the bank as it relates to client referrals between, for example our business and business banking where we have clients who don’t already deal with RBC either from business banking or personal banking or vice versa. And there we very much rely on local market leadership relationships, but also a senior focus performance management. So our Canadian wealth management branch advisors have part of their compensation based on referrals that their advisors make to the bank. But in that case there is no referral payments going back and forth. We just view that as the right thing to do and have installed that as part of our management disciplines.

Robert Sedran - CIBC World Markets Inc.

So that opportunity in Canada is obviously there, and has obviously worked well. I would like to touch the U.S. full service brokerage as well though, I mean because that advantage doesn’t exist in the United States. So have you made any progress at improving the productivity of the U.S. full service brokerage and where are you in terms of where you want to be?

George Lewis

Yes, it's a great question. We, about three years ago the average productivity of our advisors there would have been around $450,000 per year, kind of middle of the pack above a typical regional firm but well below the major wire-line houses in the U.S. We’ve not got that up close to the $650,000 a year level, which is not yet at the $1 million a year level where we are in Canada. In Canada we have a very premier franchise. Our advisors are 45% more productive than the next pier. We earn close to 50% of the industry’s profits. In the U.S. we still have ways to go, but I’m very happy with the progress we’ve made.

We’ve closed the gap and as we add more high net-worth solutions into our platform that will continue to close the gap. And the other thing we benefited from is that the growth of our capital markets business in the U.S. particularly the investment banking franchise is such that we are now leading more deals, involved in more syndicates and so we have more capital markets products for our wealth business than we used to as well which helps that productivity. And we are now just beginning I think to tap the opportunity now that those businesses in wealth and capital markets have reached top 10 positions in their respective markets in the U.S. We are now focused more on given that those are our business in the U.S. more referrals, client referrals back and forth between those areas as well.

Robert Sedran - CIBC World Markets Inc.

Okay. We got a few minutes left and I do want to speak about insurance a little bit.

George Lewis

Sure.

Robert Sedran - CIBC World Markets Inc.

It wasn’t a great summer for the insurance business, but when Royal Bank reported results in Q3 it was a bit of shrug, it wasn’t really a whole lot of impact from a lot of the cap losses that others seem to have. So can you maybe talk a little bit how your business was positioned differently going into the summer and why it wasn’t as bigger a deal for you?

George Lewis

Sure, and we were actually in a very good position to help our clients through some challenging times both in Alberta and in Toronto. And to give you a sense of that the -- we did have over 15 -- actually almost $15 million of claims between those two incidences and some other more minor ones throughout the year. But we have put in place over the last number of year’s reinsurance arrangements where we actually limit the amount of financial exposure to any single event and also limit our exposure to a series of aggregate events within any particular fiscal year. And so putting those in place allowed us to not only service our clients, but in such a way that it only resulted in a pre-tax impact on our results of around $14 million. So, because of the interaction between both of those reinsurance arrangements where we purchased that in the global cat pool.

Premiums for that pool are likely to go up, but we don’t -- we’ve actually put in place new arrangements for next year to similarly limit our risk to future events. I think its something and I can’t take credit for because I’m relatively new to the insurance segment and Neil Skelding who heads that business for us and has a great team. They really de-risked the business over the last number of years. The other thing I’d mention in that regard is a number of years ago they extended term of our asset portfolio underpinning our liabilities. So we do not have the interest rate sensitivity that some of our piers do as well. If you look at in my view having looked at this business closely over the last 6 to 12 months, it generates capital for us rather than consuming capital. It has a very high ROE and it's focused on products that have generally less capital requirements and are less volatile rather than the average. And so, we’re conscious of growing this business but in a way that has the same quality of earnings if you will as the overall RBC.

Robert Sedran - CIBC World Markets Inc.

And can you talk I guess of the last insurance question a little bit life and health side of the business and what kind of experience you’ve been having, whether the environment seems like it's turning a little bit, whether there’s the opportunity to do a little bit more business and the price increases and the rest that have helped to restore some of the profitability?

George Lewis

I think that’s fair, and I think some of our piers who are competitors who are more exposed to the whole life product and the universal life product than we are, there’ll be some tailwinds for those as rates increase. We are going to stay focused on where we are in life and health which is primarily in term life, critical illness and disability where we are the largest provider in Canada. They’re good markets for us. We’re developing more of a small and medium size group business in that area as well, and so we will benefit as rates increase but probably not to the same extent as some of our piers in that business.

Robert Sedran - CIBC World Markets Inc.

The branch initiative got a lot of press in years passed, they don’t hear so much about adding insurance branches and next to bank branches and all the rest, is it fully built out, I mean are you -- or is it maybe gone too far or do you need more branches like from a distribution perspective, where do you sit?

George Lewis

I think we’re pretty comfortable. It's an important component of what I would call our propriety distribution strategy within our insurance business. If you look at our segment overall we’ve really go three components to it, an international component comprised of our creditor business and annuity business, and then our Canadian insurance business focused on the non-bank act products. And there we gradually migrated our distribution from one that was totally reliant on third party distribution a number of years ago to one where now we have more than 50% of our premiums coming from proprietary channels and that includes not just the adjacent branches but our contact centers, our online capability and then our proprietary sales force which we converted from a commission based sales force last year to a salary and bonus sales force that’s more focused on cross selling clients across the full range of our product. So I am very much enthused about the opportunity we have. It's not just the adjacent branches, they work well. I think they helped us highlight the fact that clients really do want to purchase insurance from a financial services provider and that’s a business that we intend to grow aggressively.

Robert Sedran - CIBC World Markets Inc.

Wonderful. We’re out of time. So thank you very much George for your participation in the conference this year.

George Lewis

Thank you. Thanks very much.

Robert Sedran - CIBC World Markets Inc.

Thank you.

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