RY - Royal Bank of Canada (RY) Management Presents at RBC Capital Markets 2024 Canadian Bank CEO Conference (Transcript)

2024-01-09 12:08:02 ET

Royal Bank of Canada (RY)

RBC Capital Markets 2024 Canadian Bank CEO Conference Transcript

January 9, 2024, 8:40 AM ET

Executives

Dave McKay - President and CEO

Analysts

Darko Mihelic - RBC Capital Markets

Presentation

Darko Mihelic

Thumbs up. Ready to start?

Dave McKay

Great.

Darko Mihelic

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 have 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 the -- and when the fax machine died and punching it didn’t fix it, I ran across the street to TDs 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. I had a front row seat through the tech wreck, financial crisis and the pandemic.

There were almost 600 U.S. bank failures over the time that I 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, two by the way.

So all of this to say that despite all of my experience and 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 me? Is this 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 ask 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.

Submit a question during any of the sessions, please click on the QR code on your table. Log in to Slido and once you’re in Slido, choose the corresponding room and please ask a question. It has been a great privilege to be up here and trusted to to ask these questions of the CEOs for all these years, but I know I can’t get it quite right and so I do absolutely hope that all ask questions today.

So now I’m going to give you the list of my top CEOs. Yeah. 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?

Dave McKay

Good morning. Congrats on 25 years.

Darko Mihelic

Yeah. Yeah. Thank you.

Dave McKay

So where is he going with this?

Darko Mihelic

Can I answer the question?

Dave McKay

Sure. Welcome.

Darko Mihelic

Now, one thing hasn’t changed in 10 years. It’s going to snow today.

Dave McKay

Yeah. So, thank you.

Question-and-Answer Session

Q - Darko Mihelic

Yeah. It’s always for everyone who came in from out of town who traveled to get here. So it’s always a tough -- 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 the macro outlook. This is -- it’s been a remarkable last six months where expectations for interest rates have 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 can talk and you can flush 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 earlier this year?

Dave McKay

Yeah. Yeah. I think the rate environment is the big -- one of the big uncertainties out there as it keeps changing it. I think forward curves keep coming down as we, monetary policy does its job and slows the economy, both the U.S. and Canada a little more quickly in Canada, obviously, because 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 invest 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, you’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, about 200 points and then probably a resting place around 3% where I don’t think we’re going back to, 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 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 at and depending 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.

And as 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 two years, you’ll start to see that money move and you saw a little bit of that before the holidays, as 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 are positioned as the money is within our control. It’s in our accounts, it’s in our GICs will help customers make the right choices about moving that into different productive assets over time.

Then some of it will get consumed. Some of it’s 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 and a shallow -- a 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 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 a 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 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 a continued rally in equities. So from the Capital Markets perspective, it feels like pipelines are strong and it’ll 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 a driving, differentiated performance for our shareholders.

Darko Mihelic

So if 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 growth…

Dave McKay

Yeah…

Darko Mihelic

…maybe so you could tie that in together with a sort of over…

Dave McKay

It’s a great point Darko. So obviously demand is suppressed both on the corporate lending side, and I would say the consumer side, there’s a number of projects on 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 a point where it’s uneconomic for many consumers to make that commitment to a pre-sale. So lower rates will trigger more confidence in pre-sale 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 pre-sale 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.

Darko Mihelic

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 today 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?

Dave McKay

Yeah. There’s absolutely going to be the competition. There is competition, significant competition to 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 years to 25 years, it’s the value creation, it’s the technology we 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 Rexall, to Metro, to all the all the partners in our suite that create value for our customers, it’s 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 NIM 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 funder at the end of the day and we have the highest ratings. 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 aren’t doing that 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 will become, to your point, more acute, as you know, 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.

Darko Mihelic

And so despite that deposit competition still looking for some NIM expansion. So it’s going to be like a mix 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 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 is this changed the concern for you on mortgage renewal shock?

Dave McKay

As -- for us as we look at the renewal segments that are coming through, 2024 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 -- and 25% again in 2025 and then over 30% in 2026. So it’s still back ended renewals to 2025 and 2026 and we fully expect, based on my previous comments, that rates will be come down significantly by 2025 and 2026.

But if you think about the renewal strip that’s going to come through in 2024, if we look at the current rate forecast or rate forecast from December, which are even lower now under 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 at RBC is, consumers are doing a very good job of using their savings, of changing 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 of necessary, they’re handling that $400 increase very well for all three 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 than actual loss of jobs. We got to continue to create more jobs in Canada, which is one of our challenges.

So the consumer for those three 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 the 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 a home there is a 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 two worlds. So to your point, consumers, particularly in Canada and in the U.S., are handling this payment shock very, very well for those three reasons.

Darko Mihelic

So you want to switch gears and talk a little bit about capital…

Dave McKay

And maybe even jump into…

Darko Mihelic

Actually, why don’t we talk about HSBC here, because you reported your earnings and then we find out later…

Dave McKay

Yeah.

Darko Mihelic

… 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?

Dave McKay

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 savings, roughly about 55% of the overall cost base, I think, is right on track for us. We’ve had 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 -- it was really important to us, because we’re looking at consolidating work from the U.S. into Canada to save on costs, particularly from California, where it’s very expensive to hire bank employees. They’re harder to find given all the consolidation the California market.

So creating a center of expertise in B.C. 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 it makes 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 multi-currency accounts, on global view of overall -- of your overall banking structure on the consumer side, on the business side, all that capability is now going to be on the RBC tech stack and has been built there and we offered 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 two 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’re 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’s 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.

Darko Mihelic

You mentioned $740 million of cost saves and you said the word revenue synergy. Is it too early for me to pin you down on a number today?

Dave McKay

It is, not today, but we will -- as we get closer to the close in the coming months, we will certainly articulate that number. And we’ll have an Investor Day later on in the year. We expect to go through more formally the longer term plans for a number of our businesses. But certainly as we get closer in coming weeks to that close and we get locked in on the close date and we will articulate the full suite, but firming up to $740 million plus, we’ll come back to you on the revenue synergies around those categories that we talked about.

Darko Mihelic

So you’ll -- when you close HSBC, you’ll have comfort -- I think it’s comfortably above 12% common equity Tier 1 ratio.

Dave McKay

Yeah. Yeah.

Darko Mihelic

So last year at this conference we were thrown a bit of a curve ball. The DSP was increased. It was increased again in June and the whole -- throughout the whole year we watched as other parts of Basel III Reform were being implemented. We’ve now got a floor coming up, FRTB and then there’s just this general view that, globally there’s a fight for more capital, there’s pressure for more capital everywhere. And yet when I sit back and I see this pressure for higher capital, I’ve seen it for 10 years. You haven’t changed your ROE outlook. And so the question is, do you not -- do we -- shouldn’t we expect a bit more pressure on capital ratios and why was this -- why would this not pressure the long-term ROE objective of RBC?

Dave McKay

Well, there’s two parts to that question. Maybe I’ll start with the first part around capital ratios and I think you’ve heard from the Superintendent of Financial Institutions that he feels Canadian banks are strongly capitalized. He’s got a better feel for the overall cycle that we’re going through, and therefore, you know, kept the DSP at 3.5% and we expect that to kind of remain that way unless there’s a significant change in the outlook for the economy and the risks that you see systemically within Canada.

So we’re operating with a construct of 12% plus, then we’ve always operated with a 50-basis-point buffer to the regulatory minimum, as you should, in a prudent way. You never want to touch that regulatory minimum, and therefore, we will continue to operate with that, that philosophy of 50-basis-point kind of premium there for 12% plus.

We’ve told you for a year now that we will continue to be have the ability [Audio Gap] and close the HSBC transaction with a 12% plusCET1 ratio and we continue to expose that view of these strongly above 12% plus. So absorbing that that will be accretive to ROEs and they’ve been obviously dragging down our ROEs carrying 240 plus basis points of surplus capital to do that, and therefore, that will be part of an ability for us to continue with all the synergies that we’ve talked about, with the revenue synergies coming on.

So we are maintaining our view of 16% plus to 17% ROE, because it’s very important for our franchise to continue to deliver that for our shareholders. And we feel our franchise is positioned to do that with a growing Wealth platform, with more tailwinds behind the Wealth business, it’s a higher ROE business, continue to do that.

The operating efficiencies that we feel we can gain will continue to play into that, stronger performance out of our U.S. franchise will continue to provide tailwinds. So when you look at the mix of businesses and how we feel we’re positioned to capitalize on Capital Markets growth, on U.S. Wealth growth, Canadian Wealth growth, bringing HSBC into the fold on our overall competitiveness as a cross-border and Canadian Retail and Commercial Bank, the Commercial Banking momentum that we have and we think about the mix of that and the margin expansion we think we can attract and the overall operating efficiency, we feel confident that we’re going to drive a 16% plus ROE notwithstanding, we’re carrying higher absolute capital levels than we were five years ago, that there may be some buffer impact in 2026 that will manage through.

With all that going on we feel that this franchise, given the diversification, the strength across those businesses, can deliver over the medium-term, longer term the premium ROE in Canada 16% plus and we’re still strongly of that view and it’s a really important message to deliver today.

Darko Mihelic

And if I were modeling Royal, which I don’t, but if I were, I would probably see some capital generation ramp up throughout the year and into next year. And so the question then becomes, what do you do with the capital.

Dave McKay

Right. So we’re already to that question. All right. So, yes, the answer is that, there is going to be significant capital generation from our franchise and significant core book value growth from that. And therefore, as we rebuild those capital ratios, I don’t have any significant strategic gaps to the franchise to be successful either in Canada or the U.S. So it would have to be opportunistic and create significant shareholder value.

We’ll start by removing the drip and -- this year and returning capital to you, as an ability to continue to drive a premium shareholder return that we haven’t been able to do over the last kind of 18 months. So I think that’s really exciting for us to do that.

But even with that, we’ll generate significant excess capital from the high ROE that we’re driving and the growth that we foresee, and therefore, we will prudently invest that capital in the existing businesses that we have organically, obviously, and then inorganically, the focus will continue to be in the United States, tactically, maybe to follow up on the Brewin Dolphin acquisition with a tack on there to create a little bit more scale in the U.K., but that would be a secondary objective, primarily would be in the U.S. Wealth or Commercial space.

But the opportunities are few and far between and the market is too uncertain right now to do that, and therefore, it isn’t in our short-term objectives in any way. We want to continue to rebuild capital, as we did for HSBC and do a cash transaction and find that right opportunity, which we don’t clearly see right now, to tell you the truth. There’s been a lot of volatility in the U.S. markets. There’s been a lot of volatility in betas as you talked about. There’s still a lot of uncertainty around regulatory outcomes in the U.S. as far as the rules go. And all that has to kind of lock down before you can make a significant capital investment and generate predictable returns.

So in the absence of that, we will continue to drive shareholder value by returning capital to you and looking for opportunities. But it’s not the primary objective right now. So we feel very good about being in that place and I think we’ve earned the reputation of being very judicious about how we allocate capital and we -- there is no half-life to capital that you can only misspend it. So it -- we’ll be very careful how we use that.

Darko Mihelic

So I wanted to touch on two other topics real quick, maybe credit. We’ll start with credit quality. Maybe just one of the things that, as I sit back and I look at each bank’s sort of outlook and guidance on credit quality. I wonder if you can me with a bit more color around how you see provisions for credit losses evolving, because last year we had some CRE, you talk about increase in consumer losses and the unsecured books. Can you give us like a view of how you think PCLs will evolve this year and maybe upside downside around some of that?

Dave McKay

Yeah. I think as you saw in our Q4 comments, we still expect kind of peak PCL to come through 2024, as we still will see consumers struggle with higher rates. You’ll still see some more leveraged businesses struggle with higher rates. You saw a very strong job numbers still. So consumers are working and generating cash flow, but its ability to meet their obligations.

So we -- as we forecasted from 25 basis points in 2023 upwards to 30 basis points to 35 basis points through the peak in 2024. And then when you get to that peak, you can start thinking about reducing your ACL and your Stage 1 and 2 build into a release over time. But through 2024 we expect it to be a little bit worse than 2023 in a number of fronts.

Commercial real estate will continue in the United States to see some pain as realization values, as I said before, are still low and you’ll see some office and some multifamily res depending on the markets struggle a little bit and we’ll see those losses in Capital Markets. We’ll see the odd loss in the CNB Commercial portfolio.

And while we’ve seen no losses to-date in our Canadian Commercial real estate book, you might see the odd loss. It’d be hard for me to sit here and say we’ll continue to have no losses whatsoever. But you’ll probably see some losses there. So Commercial and Commercial real estate will continue to, to you would expect to see some losses.

You’ll see some unsecured, consumer losses as you’re seeing delinquency rates increase and credit cards and consumer credit cards. That’s a normal part of the cycle. It’s still tracking as we see to towards more of a normal credit cycle there and you can time usually your cycle peaks around the unsecured business. So feel took my points before very good about the secured business, Consumer business, but the unsecured business you’d have to expect given the delinquency build a little bit more loss.

So that’s the backstop to why we think it’ll be closer to 30 basis points to 35 basis points through 2024 and that, hopefully, given everything else I’ve said, with rates coming down, with the economy performing strongly and be able to cover more cash flow released into the economy, you’ll see it get better thereafter. So I think that’s the driver, a little bit on delinquency, a little bit on weaker realization values in the Commercial side and but general strength.

Darko Mihelic

So I want to go to a question from the audience, why should investors not be concerned about City National considering the capital injection in September? What about in a lower interest rate environment.

Dave McKay

Yes. So from City National’s perspective, that was just a movement of assets from one booking point to another and those assets still, so we haven’t realized a loss on those assets. So it was just taking those yielding assets, rebooking higher yielding assets. So we basically moved forward earnings into the city national franchise. But there’s been no loss to the shareholder on that and we expect those assets to pull to par over time and there was a tax -- positive tax impact of doing that that you probably should have noticed in our Q4 results, that really helped us the transaction quite significantly.

So from that perspective, it was more of a moving forward of earnings, for the City National franchise, that would have taken a number of years to let those maturities come up in those securities and then rebooking them at that time. So I think it was a really good transaction for RBC to do that.

From a City National perspective, though, they did see higher betas throughout the year, as all regional banks saw in the United States. You saw a greater volatility of cash as particularly we have a wealthy client base like we do, more clients put their money to work and it started pre-crisis, banking crisis in March. We saw our consumers move into fixed income product more significantly and to retain that business we had to increase betas.

That’s probably started in the fall of 2022, but really accelerated through 2023, particularly into the banking crisis, where a lot of different things happened and some clients moved their money right out of the U.S. banking system through money markets onto the Fed balance sheet and that was a very significant move, I think, as you saw over, what, $2.5 trillion move out of the U.S. banking system onto the Fed balance sheet and largely still there for a number of reasons and that’s hurt the liquidity of the regional banks and including City National.

So from that perspective, betas went up and that beta shock we absorbed into overall profitability and the overall costs of running a bank in the U.S. and the increased regulatory expectations just keep going up and you’ve seen that across a broad spectrum of commentary in the U.S. And City National is not immune from that.

It’s a bank that’s tripled and had to continue to invest in technology, invest in process. The cost of that with inflation has continued to go up and our cost structure and building out from a large, it’s a small regional bank into, now designated a large regional bank, just the cost of that infrastructure is now within kind of the run rate of CNB.

So you’ve seen that cost increase come, then we took a little bit of PCL on the entertainment side and media side of the business, given the strike and then a one or two properties on the Commercial real estate side. So going from zero PCL to a little bit more PCL.

So all that came at us in a given year in the United States, and therefore, you still may see some PCL going forward here and there, obviously. But as far as the cost side, we’re starting to get a much better handle on the cost structure and there remains a very significant opportunity for us to start to bring that cost structure in line with the size of the organization.

So we reduced our overall complement of employees last year by 5%. You’ll see the run rate benefits from that. We continued to manage the overall cost infrastructure to be more appropriate given the size and we benchmarked that.

A bank our size, we have a number of competitors in the U.S. market that we benchmark and the regional banking side, they’re running $70 billion to $80 billion balance sheet with a productivity ratio of around low 60s and we’re running a $70 billion bank with a productivity ratio in the high 70s.

And therefore we see that as an opportunity even at our size to be more efficient than we are and that’s the mandate for Greg Carmichael and the new team at CNB. They’ve done this at Fifth Third. They’re enormously experienced leaders and successful leaders. They have the mental model now as they’ve executed it as a team before. How do you build a regional bank from $70 billion to $200 billion? This team knows how to do that in an efficient way.

And I think with the new team, with the ability to get more leverage and revenue out of our existing assets side of the balance sheet with the ability to reduce cost will absorb the PCL, you’ll see CNB perform better in 2024 than it did in 2023 and better yet again in 2025 and we’ll be back on track.

So it’s a six-month blip. It was a hard hit to us. It’s still a small part of RBC. But it’s going to become a tailwind to us in the next couple of years and we’re very excited about the long-term potential and the new team that’s in place. This is a very experienced team that’s proven they can build a regional bank and win long-term in the regional bank space and I feel I’m very excited about the tailwind that they’ll again provide RBC going forward. Notwithstanding, it was a difficult year for us, but we earned through that.

I mean that’s the power of the diversified franchise we have that we took it on the chin in one of our businesses and we earned through that and we produced very strong differentiated earnings for our shareholders.

Darko Mihelic

Okay. So with that, we’re running out of time. So maybe…

Dave McKay

Okay. I could go on and on. Thank you.

Darko Mihelic

Yeah.

Dave McKay

Thank you, everybody.

Darko Mihelic

I could leave you maybe just a couple of key messages for -- that -- is that your key message for the for the crowd?

Dave McKay

A model -- diversified model Capital Markets, Wealth Management, Retail, Commercial that’s positioned to profit and outperform no matter what the market brings at us in 2024. So we’re feeling very, very good about things.

Darko Mihelic

Awesome. Thank you so much for your time.

Dave McKay

Thank you.

Darko Mihelic

Appreciate it.

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Royal Bank of Canada (RY) Management Presents at RBC Capital Markets 2024 Canadian Bank CEO Conference (Transcript)