DBRS Confirms Royal Bank of Canada at AA; Trend Remains Negative

DBRS, Inc. (DBRS) has today confirmed the ratings of the Royal Bank of Canada (RBC or the Bank) and its related entities, including RBC’s Issuer Rating at AA, Deposits & Senior Debt rating at AA and Short-Term Instruments rating at R-1 (high). The trends on the senior long-term debt, 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 (IA) continue to have a Stable trend. Confirmation of the ratings follows a detailed review of the Bank’s operating results, financial fundamentals and future prospects.

RBC’s ratings reflect its leading Canadian franchise as well as global capital markets and wealth management platforms. 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’s earnings are highly diversified both by product and by geography; however, DBRS notes that the potential exists for a material negative surprise or volatility from its large capital markets business, which represents about 25% of net income. However, reflecting RBC’s status as a growing and consistently out-performing franchise, DBRS views the Bank as one of the top banks in Canada as well as globally.

Despite weakness in energy and other resource-based sectors of the economy, the balance sheet remains strong and supportive of the ratings. DBRS continues to view RBC’s exposure to the oil and gas sector as manageable at about 1.5% of total loans. The ratings also consider the difficult operating environment highlighted by weak global growth, low interest rates and evolving regulatory and compliance burdens that are negatively affecting expenses.

RBC’s long-term Deposits & Senior Debt rating of AA with a Negative trend is composed of an IA of AA (low) and a support assessment of SA2, reflecting the expectation of timely, systemic support by the Government of Canada (rated AAA, Stable trend, by DBRS). The SA2 designation results in a one-notch benefit to the Deposits & Senior Debt rating. The maintenance of the Negative trend reflects DBRS’s view that ongoing changes in Canadian legislation and regulation still indicate that the potential for timely support for systemically important institutions is declining, leading to a likely change in DBRS’s support assessment to SA3 from SA2. The legislation enacting the bank recapitalization, or bail-in, regime is moving forward, but DBRS does not yet have sufficient clarity on the details of the implementation to remove the benefit of systemic support from the affected ratings.

RBC continues to report solid results with an adjusted return on equity in the 16% to 19% range. Specifically, RBC reported net income of $2.6 billion in Q2 2016 and net income of $5.0 billion for H1 2016. First-half results are up 1% on a reported basis and up 4% on an adjusted basis. Improved year-over-year results included the favourable acquisition of the Los Angeles–based City National Corporation (City National), a U.S. private and commercial bank, which boosted results in the wealth management segment.

DBRS remains concerned about the significant appreciation seen in housing prices, particularly in the greater Vancouver and Toronto areas. Nonetheless, RBC’s Canadian residential mortgage portfolio appears conservatively underwritten or is insured. Indeed, 46% of RBC’s Canadian residential mortgage portfolio is now insured, while the loan-to-value ratio of the uninsured portion is conservative at 56%. Alberta, the most exposed province to the energy sector, represents 16% of the total residential mortgage portfolio and is primarily insured.

The Bank has a good funding profile, has considerable access to capital markets and readily meets the Basel III liquidity regulations with a Liquidity Coverage Ratio of 133% for the quarter ended April 30, 2016. DBRS notes that the Net Stable Funding Ratio will not go into effect until January 1, 2018, which RBC should be able to adhere to, but likely at modestly higher funding costs.

The Bank’s financial risk profile remains robust as a result of solid internal capital generation, the quality of capital and strong capital ratios. The Bank reported a Basel III Common Equity Tier 1 Ratio of 10.3% at April 30, 2016. Additionally, RBC’s Basel III Leverage Ratio was 4.2%, which sits comfortably above the 3% minimum.

RATING DRIVERS
If support is removed, RBC’s long-term ratings may be downgraded. DBRS views the Bank’s current IA as strengthening. On an intrinsic basis, the Bank’s continued successful execution of its City National acquisition and continued outperformance in Canada could have positive rating implications. Conversely, sustained negative operating leverage, a material increase in impaired loans or an increased reliance or an elevated risk appetite in capital markets could 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 on the issuer page at www.dbrs.com.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (December 2015), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial LC. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.

Lead Analyst: John Mackerey
Rating Committee Chair: Roger Lister
Initial Rating Date: November 30, 1980
Most Recent Rating Update: July 16, 2015