Earnings Call Transcript - RY Q4 2024

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the RBC's 2024 Fourth Quarter Results Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Asim Imran. Please go ahead.

Asim Imran, Executive

Thank you, and good morning, everyone. Speaking today will be Dave McKay, President and Chief Executive Officer; Katherine Gibson, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions, Erica Nielsen, Group Head, Personal Banking; Sean Amato-Gauci, Group Head, Commercial Banking; Neil McLaughlin, Group Head, Wealth Management; Derek Neldner, Group Head, Capital Markets; and Jennifer Publicover, Group Head, Insurance. As noted on Slide 1, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially. I would also remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. To give everyone a chance to ask questions, we ask that you limit your questions and then re-queue. With that, I'll turn it over to Dave.

Dave McKay, CEO

Thank you, Asim. Good morning, everyone, and thank you for joining us. Today, we reported fourth quarter earnings of $4.2 billion, which includes $265 million from the acquisition of HSBC Canada. Our adjusted earnings reached $4.4 billion, marking an 18% increase year-over-year, or 9% when excluding adjusted earnings of $318 million from HSBC Canada. This quarter, we saw gains from market appreciation and strong client engagement in our largest segments. Notably, we achieved an all-bank operating leverage of 7%, or 4% on an adjusted basis. Provisions for credit loss on impaired loans remained stable quarter-over-quarter at 26 basis points. Looking back at our 2024 fiscal year, RBC generated earnings of $16.2 billion, with adjusted earnings exceeding $17 billion. We finished the year with a common equity Tier 1 ratio of 13.2%, resulting in $5 billion of excess capital above the 12.5% threshold. We are continuously enhancing our funding capacity and profile, aided by strong client-driven deposit growth. This year, we added over 600,000 clients in the combined Canadian banking business, benefiting from our leading distribution, strategic partnerships, and distinct products and services. This included RBC becoming the official financial services and ticket access partner for Taylor Swift's Eras Tour in Canada. Additionally, we are proud to have ranked highest in the 2024 J.D. Power Canada Retail Banking Satisfaction Study, for the fourth time in five years. In the U.S., we are witnessing increased client interest in RBC Clear, our cash management service, characterized by rising deposit inflows and a strong pipeline. The feedback from clients has been positive as we work towards building the next phase of our comprehensive multiyear initiative. City National’s loan-to-deposit ratio stood at 83%, primarily supported by a base of core deposits. We have upheld our prudent risk appetite. Adjusted credit loss on loans has increased to 64 basis points. We had no trading losses this year, and the operational risk multiplier remained steady at a ratio of 0.8. We concluded fiscal 2024 with a solid return on equity of 14.4% or an adjusted return on equity of 15.5% during a year when we completed our largest acquisition. Our strong return on equity facilitated internal capital generation of over 280 basis points this year, driving book value growth of 9% when excluding specific items. Now, regarding the macro environment: In Canada, inflation is moving toward targeted levels amid weaker consumer spending, a K-shaped economy, subdued business conditions, and rising unemployment, which is up 80 basis points from last year. Additional challenges include a more restricted immigration policy and the risk of increasing protectionism. However, there are offsetting factors, such as rising consumer income levels, solid savings rates, and 125 basis points of interest rate cuts by the Bank of Canada. These elements could help bolster demand and stabilize increases in credit losses in a rate-sensitive Canadian economy. In contrast, the economic environment in the U.S. has proven to be more resilient, with improvements in consumer spending and business expectations. While the potential for expansive U.S. fiscal policy may introduce uncertainty regarding the timing and scale of monetary policy actions, we anticipate that rate cuts by the Federal Reserve will foster constructive client engagement and activity levels across key markets. In this context, we are committed to our medium-term goals, including achieving a return on equity of over 16%, which we believe will be supported by earnings growth and effective capital deployment. Capital allocation is a careful process; disciplined client-driven risk-weighted asset growth remains a priority, and we anticipate seizing new opportunities to support our commercial banking and capital markets client financing needs. As part of our return to shareholders strategy, this morning, we announced a $0.06 or 4% increase in our quarterly dividend. We have taken a cautious approach to stock buybacks this quarter due to heightened volatility around election outcomes and monetary policy. Moving forward, we plan to utilize buybacks as a tool for capital deployment and will increase this activity strategically when opportunities arise. I would now like to update you on our multifaceted client-focused growth strategy, starting with our acquisition of HSBC Canada. This acquisition positions RBC as the bank of choice for newcomers and commercial clients with international needs. The adjusted earnings from HSBC Canada included realized run rate savings exceeding $400 million, roughly 55% of the targeted annual savings. We remain optimistic about achieving our expense synergy goal of $740 million, primarily within Personal Banking. We will disclose anticipated revenue synergy financial benefits in the upcoming quarters. Key drivers of our initial success include cross-selling RBC Personal Banking products to clients we acquired through HSBC Canada and our investments in new capabilities such as foreign currency accounts. The acquisition has strengthened our operational scale across all our businesses, especially in commercial banking, where we expect to gain revenue synergies from our trade finance and global cash management functionalities. In Personal Banking, we remain dedicated to acquiring clients, enhancing client relationships, and improving productivity. In Canada, we reported strong deposit growth of 19%, or 8% when excluding HSBC Canada. These deposits represent a core banking relationship. This quarter, we experienced growth in all three categories: core banking, term deposits, and investment accounts, as we capture the money in motion trend given the evolving interest rate and market outlook. Our One RBC client-first approach is reflected in the numerous awards and record Net Promoter Scores attained by our private bank. In the mortgage sector, we aim to sustain our disciplined growth strategy in a highly competitive environment. We have invested in technology to enhance our end-to-end digital renewal processes as we prepare for upcoming mortgage renewals. Furthermore, we are leveraging investments in technology and artificial intelligence to generate client value and improve productivity. For the third consecutive year, RBC was ranked among the top three global financial firms for artificial intelligence maturity according to the evident AI index. Shifting focus to our robust Commercial Banking franchise, we concentrate on cautious growth while capitalizing on our strong Canadian cash management and transaction banking services. In the fourth quarter, loans and deposits rose by 37% and 19% year-over-year, respectively. Excluding HSBC Canada, loans and deposits increased by 12% and 8%, respectively, primarily among existing clients. We have made significant investments in enhancing our frontline capabilities and coverage teams over the past few years, and we have further expanded our resources with talent acquired from HSBC Canada. We anticipate solid growth across our diverse sectors. In Capital Markets, we aim to ascend higher in the league tables across key categories. Including record fourth quarter revenue, pre-provision pre-tax earnings totaled $5 billion for the year, exceeding our guidance of $1.1 billion per quarter. Lending and other revenues rose by 14% year-over-year, benefiting from greater lending volumes and spreads. In Investment Banking, we gained 20 basis points in market share over the past year, particularly in equity origination and M&A advisory, which are focal areas. We have a strong pipeline that continues to grow as we advance through 2024, marked by active discussions across client segments. There are also signs of increased private equity activity as sponsors seek to invest their substantial unallocated funds. We will work towards enhancing banker productivity with a focus on securing multiproduct mandates and strategic senior hires in vital industry areas. Global Markets generated $1.3 billion in revenue this quarter, showcasing a constructive environment for fixed income products. We plan to continue investing in talent and technology to capture market share in this arena. In our Wealth Management segment, we aim to leverage our diverse product offerings and holistic solutions, enhance our technology, and expand our advisor base and distribution channels. This quarter, revenue grew by 20% year-over-year, driven by higher markets, asset accumulation, and client transaction-based revenue. RBC's Global Asset Management saw its assets under management increase by $139 billion, or 26%, compared to last year. GAM achieved Canadian retail mutual fund net sales of $3 billion in 2024, contrary to industry trends that reflected net redemptions. In this volatile landscape, clients have chosen us as a reliable advisor, partly due to our performance and expertise. Nearly 80% of our assets under management outperformed the benchmark on blended one, three, and five-year timelines. This quarter marked a significant achievement for our Global Wealth Advisory businesses, which reached $2 trillion in assets under administration for the first time. Canadian Wealth Management assets under administration rose 26%, or nearly $180 billion, compared to last year. In the U.S. Wealth Management sector, including City National Bank, assets under administration increased by 23%, or US$125 billion. We onboarded over 100 advisors this year. Additionally, our U.S. Wealth Advisory business reported robust growth in loans and deposits this quarter, as we enhance banking products to meet client needs. For the full year, City National reported net income of US$144 million. After adjusting for specific items, earnings amounted to US$391 million, as CNB continues to enhance its earnings profile. Though a relatively small contributor to our overall earnings, CNB remains a crucial element of our growth strategy in the United States. In our Insurance segment, which continues to yield high return on equity, we are focused on leveraging the strength of One RBC to deepen client relationships and offer a comprehensive suite of advice and solutions to both individuals and businesses. The year-over-year increase in contractual service margin, which reflects the future profit on our long-term products, was supported by growth in segregated funds and individual life and health products, laying a foundation for future revenue growth. In conclusion, we are well-positioned as we enter fiscal 2025. Our balance sheet provides a solid foundation for continued growth of our client base across our diverse lines of business in a prudent and efficient manner. I want to express my gratitude to our more than 98,000 employees who embody our purpose and create value for over 18 million retail, commercial, and institutional clients daily. This commitment to excellence is reflected in the strength of our brand. I am proud that RBC retained its top spot in the Kantar BrandZ Most Valuable Canadian Brands in 2024 ranking, outperforming financial peers in key areas like consumer trust and corporate reputation.

Katherine Gibson, CFO

Thanks, Dave, and good morning, everyone. Starting on Slide 11, we reported diluted earnings per share of $2.91 this quarter. Adjusted diluted earnings per share was $3.07, up 16% from last year, benefiting from the acquisition of HSBC Canada. Each of our businesses exhibited strong double-digit revenue growth this quarter, which underpinned robust adjusted all-bank operating leverage of 4.3%. Turning to capital on Slide 12, our CET1 ratio improved to 13.2%, up 20 basis points from last quarter, mainly reflecting internal capital generation, net of dividends. This was partly offset by business growth and net credit migration mainly in the wholesale portfolios. We also repurchased approximately 408,000 shares this quarter or $67 million. We will continue to prioritize capital allocation towards client-driven organic growth and dividend increases in line with earnings. In addition, we will be opportunistic in our use of buybacks. Moving to Slide 13, all-bank net interest income was up 17% year-over-year or up 15% excluding trading revenue. These results were largely driven by the addition of HSBC Canada as well as higher volumes and spreads in both Personal Banking and Commercial Banking. The all-bank net interest margin, excluding trading revenue, was up 6 basis points from last quarter, largely due to a favorable funding cost adjustment and improved lending spreads in capital markets. Favorable tailwinds in Canadian Banking also contributed to the increase. Canadian Banking NIM was up 2 basis points from last quarter as the benefits from our tractor deposit strategy and changes in product mix were partly offset by ongoing competition for term deposits, which we expect to persist throughout the year, as well as the dilutive impact of the BA/CORRA migration. We hedge our low-cost non-maturity deposits in a laddered strategy of three- and five-year duration. Going forward, with five-year swap rates up approximately 140 basis points from five years ago, our core deposit portfolio is well positioned to provide an offset to the impact of lower short-term interest rates. In the past, we have highlighted that there are many variables that impact NIM, including changes in client and competitive behavior and the forward curve, which are difficult to predict in the current dynamic environment. Looking forward to 2025, we are providing new guidance with net interest income ex trading revenue expected to grow in the mid- to high-single-digit range. Moving to Slide 14. Non-interest expenses were up 12% from last year on both a reported and adjusted basis. The bulk of the year-over-year core expense growth was driven by higher variable compensation to match with higher revenue. Higher volume-driven costs, investments in technology and discretionary costs also contributed to the growth. Looking forward, given the uncertain macro environment, we will continue upholding a disciplined approach to cost management. We expect all-bank core expense growth, including run-rate HSBC Canada costs to be in the mid-single-digit range for 2025, off a base of reported 2024 expenses. Core expense growth in the first half of the year is expected to be in the high-single-digit range, reflecting the inclusion of HSBC Canada results and, to a lesser extent, investments for our next phase of growth. While we anticipate volatility within our guidance range to be largely driven by movements in variable compensation, we ultimately expect to drive positive operating leverage throughout the course of the year. As a reminder, core expense growth excludes the impact of FX and share-based compensation, which are largely driven by macro factors. Reflected in this guidance is the expectation of 1% to 2% operating leverage for the combined Canadian Banking businesses. Turning to taxes, the non-TEB effective tax rate was 19% this quarter or 19.5% on an adjusted basis. As we look to 2025, we expect the adjusted non-TEB effective tax rate to be in the 20% to 22% range, reflecting the impact of Pillar 2 income taxes, which arise in jurisdictions where our operations have an effective tax rate below 15%.

Graeme Hepworth, CRO

Thank you, Katherine, and good morning, everyone. Starting on Slide 21, I will discuss our allowances in the context of the macroeconomic environment. Over the course of 2024, actions taken by central banks to curb inflation have largely been successful. However, the economic impacts of a higher interest rate environment have varied across the core geographies in which we operate. As Dave mentioned earlier, in Canada, the economy has been underperforming, and we expect relatively slower growth and weaker labor market to result in the Bank of Canada continuing to cut interest rates more aggressively than the U.S. Federal Reserve. In the U.S., GDP growth remained strong, but labor markets have started to show signs of softening, prompting the Federal Reserve to start cutting rates, with focus shifting from managing inflation to managing strength in the labor markets. While interest rate cuts are certainly constructive for credit outcomes, it takes time for the benefits of rate cuts to flow through the economy, and interest rates remain elevated relative to the low rates following the pandemic. Our clients continue to feel the effects of prolonged higher interest rate environment, and we continue to see net credit downgrades, moderate increases in delinquency rates and watch-list exposure and drawdowns in savings and deposits for clients impacted by higher rates. These outcomes are in line with our expectations for where we are in the credit cycle, and we continue to build allowances that provide strong coverage relative to current and anticipated PCL on impaired loans. For the quarter, we took a total of $208 million of provisions on performing loans across our portfolios, reflecting unfavorable changes to credit quality, including the downgrade of a large exposure to a previously investment-grade rated company in the other services sector. This was partially offset by a favorable change to our macroeconomic forecast, driven by lower interest rates, better-than-expected house prices and the continued strength of the U.S. economy. This marks the 10th consecutive quarter where we added reserves on performing loans, resulting in a total ACL of $6.4 billion. Moving to Slide 22, gross impaired loans of $5.9 billion were up $182 million or 1 basis point this quarter. Higher impaired loan balances in Commercial Banking and Personal Banking were partially offset by lower gross impaired loans in Capital Markets and Wealth Management. In Commercial Banking and Personal Banking, new formations remain elevated, reflecting the weaker economic conditions in Canada compared to the U.S. that I noted earlier.

Ebrahim Poonawala, Analyst

Good morning. I guess maybe just to start with, Dave, I think you talked about the ROE and you laid out on Slide 6. Now this in a context where Royal has one of the best ROEs among global banks, period, but how should we think about that 16%-plus ROE in the context of where the capital requirements are today? Is that 16%-plus aspirational, or as a shareholder, do I expect Royal to be delivering a 16% ROE year in and year out on a consistent basis as we look forward?

Dave McKay, CEO

Thank you, Ebrahim, for your question. This is a crucial aspect of our investment thesis, and we are dedicated to achieving it with confidence. It's not just a goal; it’s very practical at this stage. We have several initiatives planned that we believe will help us reach this target without needing additional capital, including improvements at HSBC and significantly enhancing profitability at City National, as we've discussed. While we are aware of the challenges we face, we are also optimistic about the numerous initiatives in our pipeline that will support our long-term and medium-term goal of over 16% ROE. Our scale allows us to leverage our client base, brand, and balance sheet effectively. We are confident in our strategy and approach, which is a key component of our plan. We wouldn't express this level of confidence if we didn't believe we could achieve it.

John Aiken, Analyst

Good morning. Graeme, I understand your commentary on the macro and completely on side with that, but one of the things that's standing out this quarter is the ongoing uptick in terms of residential mortgage impairments. I was hoping we could get underneath the hood on that a little bit, particularly with when we take a look at what's been going on in terms of the mortgage. The past due has seen a steady incline over the last couple of quarters where we've seen a bit of a more mixed approach with some of the other consumer lending products. Can you give us a sense in terms of what you're seeing in terms of the residential mortgage market? What's causing the increase in impairments? And hopefully, some sort of outlook in terms of what you expect for 2025 on residential mortgage in terms of credit quality?

Graeme Hepworth, CRO

Thank you for the question, John. For that reason, we provided an update that addresses the period we're entering, particularly 2025 and 2026, which is the peak renewal phase. This is a key factor as we begin to see more of our fixed-rate clients affected. Previously, we faced the impact of variable rate clients feeling the pressure from higher rates quite quickly. Now, we're witnessing the start of the effect on fixed-rate clients, many of whom secured their original mortgages during the low-rate phase and are now refinancing amidst higher rates. This will likely lead to an increase in delinquencies over the next few quarters and throughout this year. However, with rates beginning to decline slightly, we feel more optimistic about this risk compared to a year ago when rates were at peak levels. Our clients are well-equipped to navigate this situation. Although we're observing a rise in impairments, it hasn’t yet resulted in significant write-offs. The reason our provision for credit losses was low this quarter is due to a reassessment of our coverage ratio for newly impaired mortgage loans, which we evaluate annually. Last year, we anticipated a softer housing market and took a cautious approach, but most clients hold considerable equity in their homes, giving them various options. As a result, the workout outcomes have been strong, prompting us to adjust our coverage ratios accordingly. We're still cautious and will continue to support our clients. While we expect impairments to rise, and there will be some related provision for credit losses, we don't foresee it being as significant a factor in 2025 as the unsecured products, which we have pointed out previously.

Doug Young, Analyst

Hi, good morning. Just wanted to go back to the ROE discussion, because by my math, it's really difficult to get the cash ROE to breach 16%-plus without bringing the CET1 ratio down to 12.5% or lower, but it sounds like you would disagree with this. I guess I'd like to hear more about like what are two to three drivers that would help push you towards that target if you are going to sit at a 13% CET1 ratio? Just trying to get a little bit more detail.

Dave McKay, CEO

Yes, that's a valid question. As we evaluate our options, we're considering the remaining cost reductions from HSBC and the potential to enhance profitability towards our goals. So far, we have only realized $4 million out of the $750 million in costs. We haven't addressed revenue synergies yet, many of which may not require capital investment, particularly in the wealth sector. Looking at CNB, we see opportunities for greater efficiency, and many of the charges we are incurring in CNB are aimed at simplifying the business and enhancing operations, which entails a more straightforward risk management framework and operational processes that are manageable and adaptable over time. As we streamline City National and aim for horizontal improvements across the business while leveraging RBC more effectively, there are significant opportunities for cost reductions without capital expenditures. Furthermore, we anticipate growth in City National, which requires us to establish a stronger operational infrastructure, and we are making progress in that area. We believe our expenses have peaked and will begin to decline in 2025 and extend into 2026. Additionally, we are noticing net movements in deposits and GICs into our wealth franchise, which has led to an increase in NIMs without needing capital investments. This ongoing trend is beneficial as we effectively capture those flows, as highlighted in our prepared comments. These are three key areas we are focusing on, alongside strong capital generation that we plan to continue. This will provide us with the ability to conduct share buybacks as another strategy. Considering all these factors, our plans do not necessitate a reduction of the CET1 ratio to 12.5%. If executed well, we have significant flexibility and multiple pathways to achieve over 16%, and this gives us confidence in our strategy.

Paul Holden, Analyst

Thank you. Good morning. So, I've heard the message on building pipeline for commercial and in capital markets. Wondering what you're seeing on Canadian residential mortgages. Have heard a few others comment that they're seeing higher application rates and are expecting better volumes in '25. So, just maybe you can provide an outlook there.

Erica Nielsen, Segment Head, Personal Banking

Yeah, thanks, Paul, for the question. It's Erica. I think as we look to the next year, we would see some more activity in the residential mortgage market. As we came through the last part of this cycle, a lot of buyers have been sitting on the sidelines just given the affordability impact to them of thinking about a new house purchase. And so, as we see prices come down for the consumer, we expect to see more of those thinking about home purchases. So that should increase activity inside the market a little bit over next year. The other side for us as an organization, and Graeme and Dave mentioned it, would just be that we would expect to see a lot of renewal activity. And inside that, there's obviously an opportunity for us to gather switch business from our competitors and likewise to shore up our own business. So, we would expect strength or growing mortgage volume over this past year as we go into 2025.

Dave McKay, CEO

Great. So, thank you for the questions, everyone. I think we're going to bring this to a close and maybe just a few summary comments. So, we're very proud of the quarter and proud of the year, a year in which we made our largest acquisition and went through a very complex transition. I think you can see HSBC is well on track to deliver on the bottom-line impact of $1.4 billion and with upside from the revenue that we'll get from cross-sell that we'll disclose more fully in the beginning of the year. So, HSBC is a big part of the overall theme. But an important theme is that we did not lose momentum. We gained momentum in all our core businesses. The wealth growth was outstanding. The capital markets building pipelines had very strong performance this year. And the business has exited the year in Q4 with momentum, the client volume play. And there's a couple of businesses that can improve as well on that, which we talked about, certainly as we look to do a bit better in the mortgage business, if the market allows that as far as a profitability perspective. So, very strong client volumes, prudent risk management. You heard of maybe a bit of a cautious outlook, it's just a macro call. It's hard to make a macro call right now with so many variables, but we're cautiously optimistic, and we think that's the prudent way to do things, and we haven't changed our forecast. And we could be wrong. It could accelerate it. It could be on the schedule we said. Whatever it is, we will adjust to that, and that will play out as it does. And certainly, you think about our commitment to being good stewards of capital. We've got enormous strategic optionality. We know 16%-plus is a very important investment thesis. We have a very strong tactical plan with a number of levers. We can do more of this, less of this in the short and medium and long term, and therefore, we're confident we can deliver on our EPS and ROE commitments and drive premium TSR performance as we did over the last year plus. So, thank you very much for your questions. I wish you all a great holiday season. We look forward to seeing you at the RBC Capital Markets Conference in January. Have a great break, and thank you for all your attention.

Operator, Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.