DBRS Confirms Royal Bank of Canada at AA; Trend Changed to Stable from Negative

DBRS, Inc. (DBRS) has today confirmed the ratings of Royal Bank of Canada (RBC or the Bank) and its related entities, including RBC’s Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). RBC’s Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, reflecting the expectation of timely, systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. The trends on RBC’s short-term ratings, as well as the Long-Term Issuer Rating, Long-Term Senior Debt, Long-Term Deposits and older-style subordinated debt, have been revised to Stable from Negative, while other capital instruments whose ratings are notched down from the Bank’s IA remain Stable.

The revision of the trend to Stable reflects DBRS’s view that RBC’s long-tenured track record of strong fundamentals and growing franchise points to an improving IA, which may offset the anticipated regulatory reform support-related downward pressure on the rating. Therefore, the expectation of a ratings downgrade following the removal of support is less likely.

RBC’s ratings reflect its status as a leading Canadian franchise as well as its strong capital markets and wealth management platforms. RBC is the market leader in many facets of the Canadian banking landscape and is steadily increasing its global footprint, most notably in wealth management and capital markets. The Q1 2016 acquisition of Los Angeles-based City National gives it a strong platform from which to grow its U.S. private and commercial banking and wealth management business. RBC’s earnings are highly diversified both by product and by geography. DBRS views RBC as one of the top banks in Canada, as well as globally, reflective of the Bank’s steadily growing and consistently out-performing franchise. The ratings also consider the challenging operating environment that is constrained by sluggish global growth, low interest rates, heightened regulatory and compliance expense burdens and the potential for a housing downturn in Canada. Additionally, DBRS also notes that the potential exists for volatility in its large capital markets business, which represents over 20% of net income.

DBRS continues to believe that changes in Canadian banking legislation and regulation point to a declining potential for timely support for Canada’s systemically important banks. Eventually, this decline is expected to result in a change in DBRS’s SA to SA3 from SA2. Currently, for these banks, the SA2 results in an uplift of one notch above their IAs. This regime primarily affects the six big Canadian banks that have been designated as domestic systemically important banks (D-SIBs). While this bail-in regime is expected to come into force in H1 2018, the proposed new bail-inable debt will only begin to be issued by D-SIBs at that time and no existing debt will be subject to bail-in retroactively. Thus, DBRS considers that there would not be sufficient bail-inable debt initially to reduce the likelihood of systemic support from its current level in Canada. DBRS expects to maintain the current notch of support until the D-SIBs build up sufficient new bail-inable senior debt such that the likelihood of systemic support has declined to a level at which this uplift is no longer warranted. The timing of such action depends on the finalization of the bail-in regime and the extent to which the D-SIBs build up their bail-inable senior debt. Two factors pressuring the D-SIBs to issue new bail-inable senior debt are the maturing of their existing senior debt and their need to meet the newly established requirements for total loss absorbing capacity (TLAC) by November 1, 2021. DBRS continues to evaluate the impact of the proposed regulations and will comment further as the proposals are finalized. For more detail, please see “DBRS Comments on Proposed Implementation of Bail-in Regime in Canada; Bank Negative Trends Unchanged” published July 11, 2017, on dbrs.com.

RBC results remain very strong with H1 2017 net income increasing 16% year over year, or 12% on an adjusted basis, excluding a gain on the sale of U.S. operations of Moneris. Results reflect improvement in each business segment with the exception of insurance. Overall, RBC’s H1 2017 adjusted return on equity was a strong 17.0%. DBRS views RBC as well positioned to continue to deliver strong results over the next year despite concerns over housing and highly indebted households in Canada.

Asset quality metrics remain sound and have been improving over the past year with gross impaired loans (GILs) at 0.59% of gross loans and acceptances, while the annualized H1 2017 provision for credit losses as a percentage of average net loans and leases was 0.22%. GILs have decreased due to lower impaired loans in the capital markets portfolio, predominately in the oil and gas portfolio. DBRS views current asset quality metrics to be at cyclical lows and likely not sustainable.

DBRS remains concerned over the significant appreciation seen in housing prices, particularly in and around Vancouver and Toronto and the potential impact of a housing downturn to the Canadian economy as well as to other consumer-related loan portfolios. Nonetheless, RBC’s residential-secured portfolio, like all of the large Canadian banks, appears conservatively underwritten or is insured. Specifically, 48% of RBC’s Canadian residential-secured portfolio is insured, while the average loan-to-value ratio of the uninsured portion is a very conservative 51%.

Augmenting its ample deposit funding, RBC maintains ready access to diversified wholesale funding sources. The Bank’s liquidity remains strong with a Liquidity Coverage Ratio of 123% for Q2 2017. DBRS notes that the net stable funding ratio will now not go into effect until January 1, 2019, but expects that the Bank is well positioned to adhere to the rule.

During Q2 2017, RBC’s CET1 ratio declined by 40 basis points (bps) quarter over quarter to 10.6%. Although internal capital generation during the quarter was strong, contributing 33 bps to the ratio, a combination of factors, such as share repurchases, an update to risk parameters, the impact of lower rates in determining pension and other benefit obligations and higher overall growth in risk-weighted assets, contributed to the decline. DBRS views RBC as a very strong capital generator although absolute capital levels are at the low-end of the global peer group.

With $1.2 trillion in assets as of April 30, 2017, RBC is the second-largest Canadian bank by assets while the largest by market capitalization.

The Grid Summary Grades for RBC are as follows: Franchise Strength – Very Strong; Earnings Power – Very Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Strong; Capitalization – Very Strong/Strong.

RATING DRIVERS
When support is removed, RBC’s ratings could remain at their current levels reflecting an improving IA that could offset the removal of the uplift currently derived from support. On an intrinsic basis, if the Bank continues to show strong fundamentals, franchise momentum and continued better-than-peer performance in Canada, there could be positive rating implications. Conversely, sustained negative operating leverage, a material increase in impaired loans or credit risk, an increased reliance or an elevated risk appetite in capital markets or a severe downturn in the housing market leading to significant earnings deterioration 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 principal methodology is the Global Methodology for Rating Banks and Banking Organizations (May 2017), which can be found on dbrs.com under Methodologies.

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

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

Lead Analyst: John Mackerey
Rating Committee Chair: Lisa Kwasnowski
Initial Rating Date: 31 December 1980
Most Recent Rating Update: 28 July 2016

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.