Earnings Call Transcript - RY Q4 2023

Asim Imran, Head of Investor Relations

Thank you, and good morning, everyone. Speaking today will be Dave McKay, President and Chief Executive Officer; Nadine Ahn, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions are Neil McLaughlin, Group Head, Personal & Commercial Banking; Doug Guzman, Group Head, Wealth Management and Insurance; and Derek Neldner, Group Head, Capital Markets. 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. With that, I'll turn it over to Dave.

David McKay, CEO

Thank you, Asim, and good morning, everyone. Thank you for joining us. Today, we reported fourth quarter earnings of $4.1 billion. We also announced a $0.03 or 2% increase in our quarterly dividend, continuing our policy of increasing dividends every other quarter. Our revenues were up 4% from last year, reflecting the strength of our diversified business model, including market share gains in both Investment Banking and Global Markets, solid volume growth in Canadian Banking, and higher fee-based revenue from Wealth Management. Reported expense growth of 13% year-over-year was impacted by several factors, which Nadine will speak to later. Importantly, core expense growth declined to 5% year-over-year or about 2% sequentially. This is a trend that underscores our heightened focus on expense control and includes higher-than-normal severance costs. Our results were also impacted by higher provisions for credit losses on impaired loans. We added a further $194 million of provisions on performing loans this quarter in recognition of the evolving macro environment and more challenging credit conditions. Our allowance for credit losses now covers three times the Stage 3 provisions for credit losses that we incurred over the last 12 months. Looking back at the 2023 fiscal year, RBC delivered earnings of nearly $15 billion in a very challenging operating and macro environment. We met all our medium-term objectives while investing to further strengthen our core businesses. As part of our regular strategic review, we also simplified our business model by exiting our Investor Services franchise in Europe. We ended the year with a strong CET1 ratio of 14.5%, nearly 200 basis points higher than last year. Furthermore, we generated a return on equity of 14% this year or 16% when we consider the capital we are holding ahead of closing the proposed acquisition of HSBC Canada. We remain confident in our ability to continue meeting our medium-term objectives, including delivering a premium return on equity of over 16%. Our balance sheet is diversified by both industry and geography, underpinning our all-weather franchise. The strong balance sheet, combined with our premium return on equity, enables RBC to create value for our clients and shareholders through the cycle. This includes growing book value per share by 10% compounded annually in the recovery following the global financial crisis from 2012 to 2019 and by a similar rate from 2019 to 2022 during the uncertainty of the pandemic. Before I discuss the strategic initiatives that will drive our next leg of value creation, I will provide my perspective on the macro environment where a slowdown in economic activity is already being observed. The rapid nature, size, and accumulation of interest rate hikes is reigning in elevated inflation. Higher interest rates are having a more immediate impact on the cost of living in Canada relative to the U.S., partly due to the stark difference in the duration of mortgage terms. Consequently, discretionary consumer spending in Canada is down, with October marking the largest monthly decline in six months. Higher interest rates are also cooling housing markets across the country, with sales to new listings ratio falling to 49% in October. Furthermore, we are seeing signs of slowing labor markets as evidenced by rising unemployment, slowing wage growth, and lower job postings. We're also seeing declines in global trade even before the recent escalation of geopolitical risk. Following recent peaks in September and October, we are seeing declines in both yields and oil prices, further signs of an economic slowdown. Given the easing pricing pressures, we believe central banks have reached the end of the tightening cycle and will pivot to rate cuts in 2024, albeit rates are expected to remain higher than pre-pandemic levels. With this context, we expect Canadian mortgage growth will continue to moderate to the low to mid-single digits as immigration-driven demand more than offsets the impact of higher interest rates on the cost of capital.

Nadine Ahn, CFO

Thank you, Dave, and good morning, everyone. Starting on Slide 11. We reported earnings per share of $2.90 this quarter. Adjusted diluted earnings per share of $2.78 was flat from last year as the benefits of higher rates, solid volume growth, strong market-related revenue, and a lower tax rate were largely offset by higher expenses and increases in provisions for credit losses from low levels a year ago. I will first highlight the continued strength of our balance sheet before focusing on more detailed drivers of our earnings. Starting with our strong capital ratios on Slide 12. Our CET1 ratio improved to 14.5% and is up 40 basis points from last quarter, mainly reflecting internal capital generation net of dividends and the benefits of share issuances under the DRIP. This was partly offset by unrealized losses on OCI securities. Risk-Weighted Assets growth, excluding FX, was largely flat this quarter. Business growth in Canadian Banking and Capital Markets as well as an unfavorable wholesale credit migration was offset by lower loans in City National and RWA optimization initiatives driven by improvements in data quality and collateral management. We expect that our CET1 ratio will remain comfortably above 12% following the close of the planned HSBC Canada transaction pending remaining regulatory approvals. We do not expect a material impact from the implementation of IFRS 17 or FRTB next quarter. Furthermore, based on our initial estimates, we do not expect RWA floors to be binding in 2024. We will look to revisit the DRIP and the reintroduction of share buybacks in the second half of the year.

Graeme Hepworth, CRO

Thank you, Nadine, and good morning, everyone. Starting on Slide 21, I'll discuss our allowances in the context of the macroeconomic environment. As Dave noted earlier, higher interest rates are causing growth to slow and unemployment rates to soften. Markets now believe the rate hiking cycle has concluded. Interest rates have been elevated for over a year and credit outcomes have normalized from pandemic lows. Delinquency rates and impairments are at or above 2019 levels and insolvencies have been steadily climbing. In our retail portfolio, higher interest rates and rising unemployment are now the primary drivers of credit outcomes. Clients who have yet to be impacted by our higher rates, such as fixed-rate mortgage borrowers, continue to perform well with stable delinquency rates and elevated levels of savings. However, clients who have experienced a material increase in their mortgage payments are more likely to be showing signs of stress with increasing delinquency rates and decreasing savings levels. To date, less than one-third of mortgage clients have seen their payments impacted by higher rates, with the majority of mortgage renewals still over a year away. Over half of our Canadian Banking residential mortgage balances renew in 2025 or 2026. The fixed-rate borrowers in those cohorts currently pay an average rate of 3.1% and 3.5%, respectively. As more people renew at higher rates and more of their income is used to service mortgage debt, we expect delinquencies and losses to increase in the retail portfolio. Our mortgage exposure benefits from strong credit quality of our clients, significant borrower equity, and our clients' capacity to make higher payments. Higher rates and rising employment are expected to have the largest impact on credit cards and unsecured lines of credit, consistent with the traditional credit cycle. In our wholesale portfolio, higher interest rates have not been the main driver of credit deterioration. However, higher rates have exacerbated headwinds stemming from rising costs and changing consumer spending and behavioral patterns. This quarter, in our wholesale portfolio, we continue to see a growing number of credit downgrades, increased watch list exposure, and more accounts being transferred to our special loans team. With this backdrop, we added CAD $194 million of provisions on performing loans this quarter. Provisions were predominantly on commercial real estate loans in the wholesale portfolio and on credit card and personal loans in the retail portfolio. We have now added provisions on performing loans for six consecutive quarters, increasing our allowance on performing loans by 33% over that period.

Neil McLaughlin, Group Head, Personal & Commercial Banking

Yes, thanks, Gabe. It's Neil. I'll take the question. To provide some context, in Canada, our discussions are primarily about NSF fees and ensuring that both low and no-cost deposit accounts are available to Canadians. On these two main points, we include an NSF charge as part of our core deposit account offering. We also have fairly generous go-pay, no-pay processes, where we analyze the client's liquidity and may cover charges to prevent NSF fees. Furthermore, we have the lowest NSF fee in the country, and we plan to collaborate with the government to advance this policy direction. Regarding the potential for a significant decline in other income within the retail bank due to this, we do not foresee that happening. Lastly, concerning low and no-cost accounts, we already offer this product as it is required by regulation, and the government is focused on ensuring that larger financial institutions also provide access to these accounts.

Gabriel Dechaine, Analyst

I have a question about overdraft fees. I've covered that off in the U.S. quite a bit over the past few years, but it's becoming an issue in Canada as well. Would you be able to share what percentage of your Canadian revenues come from overdraft fees? I ask this because your core deposit business is quite substantial.

Meny Grauman, Analyst

I wanted to follow up on commentary you made about revisiting the DRIP buyback issue in the second half of the year. I'm just wondering, first of all, if the buffer goes up by 50 basis points, did that change your guidance on this issue? And also wondering about the expectations for rates that's built into that comment that outlook?

Derek Neldner, Group Head, Capital Markets

Sure. Thanks, Sohrab. Yes, for Q4, just to touch on it, it was a record revenue quarter for Q4 and was a record revenue year for '23 overall. So obviously, we're very pleased with the results, and I think it reflects headway we've been making on a number of the strategic initiatives we've undertaken. As we look forward to 2024, right now, I would say we're cautiously optimistic on the outlook. Obviously, there still is a fair bit of uncertainty on the economy and rates and the implications that may have on markets and client activity. But overall, I think we feel quite constructive in terms of the macro and then obviously, some of the specific things we're driving to grow the business. Investment Banking has obviously had a difficult two years with fee pools down 30% plus each of 2022 and 2023. I think, again, as we see greater confidence in the outlook over the next few years, we're starting to see corporate and sponsor activity pick up, which is reflected in obviously a good quarter you saw and improving visibility on our backlog. So I think we feel good about the outlook for the Investment Banking franchise next year.

David McKay, CEO

Yes. I'll just take the call from here. This is Dave. So thanks very much for all your questions, very good questions, as always. Just to summarize kind of my takeaways from the messages through your Q&A today and what I'd like you to focus on: enormous balance sheet strength and liquidity strength with capital at 14.5%. You can see the clear path towards being able to absorb HSBC, continue to build capital, and allocate capital for growth and to start returning capital to shareholders in the near future. So that strength of capital build and organic growth is core to one of our investment themes, as you know, and the return on that capital. You've heard us and you've asked a lot of questions about cost control. You've seen us move core expenses down to that 5% mark which we are committed to continuing in 2024. We feel very good about that, a number of initiatives that we've already executed and more that will make to continue to manage that.

Asim Imran, Head of Investor Relations

Thank you for your participation.