DBRS Confirms Ratings of Royal Bank of Canada, Negative Trend

DBRS Limited (DBRS) has today confirmed the ratings of Royal Bank of Canada (RBC or the Bank) and its related entities, including the Bank’s Deposits & Senior Debt at AA and Short-Term Instruments at R-1 (high). Trends on senior long-term debt ratings, short-term instruments and older-style subordinated debt remain Negative, while other capital instruments whose ratings are notched down from the Bank’s intrinsic assessment continue to have a Stable trend. The Bank’s ratings are underpinned by its highly diversified business model, strong Canadian retail franchise and well-positioned capital markets business, while noting the potential for material negative surprises from so large a capital markets business.

RBC’s long-term deposits and senior debt rating, at AA, is composed of an intrinsic assessment of AA (low) and support assessment of SA2 (reflecting the expectation of systemic and timely external support by the Government of Canada). The SA2 ranking results in a one-notch benefit to the senior debt and deposits ratings. The Negative trend reflects DBRS’s view that anticipated changes in Canadian legislation and regulation mean that the potential for timely systemic support for these systemically important institutions is declining and is likely to eventually result in a change in DBRS’s support assessment to SA3 from SA2 for this institution.

At the same time, DBRS notes that additional protection for non-bail-in-able debt and deposits may eventually be provided by bail-in-able senior debt under the anticipated bail-in debt regime. DBRS will assess the impact of the Taxpayer Protection and Bank Recapitalization Regime rules as more details are made available by the authorities.

RBC is the largest bank in Canada. Its highly diversified business model and strong performance, even in difficult market situations, is reflected in its strong return on common equity. The Bank has generated solid earnings growth across its business segments. RBC continues to dominate all facets of the banking landscape in Canada and is gradually increasing its global footprint, most notably in wealth management and capital markets. The Bank has been increasing its market share among the top global banks.

In January 2015, RBC announced an agreement to acquire Los Angeles-based City National Corporation (City National, rated “A”), the parent of City National Bank. DBRS views the acquisition as on-strategy for RBC and considers City National as having a solid franchise with strong asset quality. The addition of City National significantly increases the Bank’s wealth management reach in the United States and builds its targeted high net worth and commercial lending client base. In a commentary published on January 22, 2015, DBRS noted there are clear integration risks as RBC incorporates the more entrepreneurially driven City National while trying to extract the projected expense synergies.

As with other Canadian banks, RBC has notable exposure to the Canadian residential mortgage market. Any slowdown in this market may slow earnings generation, while a downturn in the residential mortgage market could hurt asset quality indicators and ultimately have an impact on provisioning levels. Direct exposure to oil and gas (O&G) is manageable within a well-diversified portfolio. Asset quality within the Canadian market will be determined by the extent to which any deteriorating consumer credit quality trends materialize in the Canadian market, including potentially as an indirect result of volatility in O&G. At this point, there are no material observable problems.

The Bank has strong asset quality and appears to have appropriate controls to manage these risks. While the Bank’s Capital Markets segment generally produces roughly one quarter of the Bank’s earnings, this is a business which can be volatile and comes with risks which must be managed very carefully, particularly since losses in such businesses can appear quickly with the potential to be very large.

The Bank’s financial risk profile remains robust as a result of solid internal capital generation, quality of capital and strong capital ratios. The Bank has a good funding profile, considerable access to the capital markets and meets the new liquidity regulations.

RBC’s rating could be positively influenced if the Bank were to demonstrate stable earnings and superior loan quality metrics through an economic downturn or major decline in Canadian residential real estate prices. Also, successful execution of the pending City National acquisition and increased traction in global wealth management would be viewed positively. In addition to the support and other considerations noted earlier with respect to the negative trend, other factors with negative rating implications include an increase in risk appetite, particularly in Capital Markets, or notable weakening of asset quality, or franchise. Evidence of Capital Markets risk outside of risk appetite expectations may also have negative rating implications.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2015), Rating Bank Capital Securities - Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015), and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2015), which can be found on DBRS’s website at www.dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.