DBRS Confirms Royal Bank of Canada at AA; Trend Changed to Positive

DBRS, Inc. (DBRS) 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). Additionally, the trends on all long-term ratings have been changed to Positive while the short-term ratings at the Bank remain Stable. RBC’s Intrinsic Assessment (IA) remains at AA (low) and the Support Assessment (SA) is 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 one notch of uplift from the IA to the Long-Term Issuer Rating. However, following the finalization of the Canadian Bank Recapitalization Regime (the Bail-In Regime), DBRS eventually expects to remove the uplift from systemic support. This will be actioned once a sufficient level of bail-inable senior debt is issued, thereby providing an adequate buffer for non-bail-inable obligations, which is then expected to offset the removal of the systemic support (see the press release “DBRS Takes Rating Actions on Six Canadian Banking Groups after Finalization of Bail-In Regime,” April 19, 2018).

KEY RATING CONSIDERATIONS
RBC’s ratings reflect its leading Canadian banking and global wealth management franchise as well as its strong capital markets platform. In Canada, RBC ranks number one or two in most aspects of personal and business banking and wealth management. Additionally, RBC has steadily increased its global footprint, most notably in wealth management and capital markets. This expansion was accelerated by the 2016 acquisition of Los Angeles-based City National Bank, which has been the platform for strong growth in U.S. private and commercial banking and wealth management. The ratings also consider the longevity of the current credit cycle and the potential for a housing downturn in Canada, as well as the potential for increased volatility in its large capital markets business.

The Positive trends reflect the strong momentum RBC has exhibited building its diversified franchise that has delivered consistent earnings growth, while maintaining a sound risk profile. DBRS believes these traits distinguish the Bank from its Canadian as well as many global peers. Overall, DBRS views RBC as one of the top banks globally.

RATING DRIVERS
If RBC continues to show strong credit fundamentals, franchise momentum and better-than-peer performance, the ratings would likely be upgraded. DBRS does not see any near-term negative rating pressure; but, sustained negative operating leverage or an increased reliance on capital markets could result in a negative rating action. Additionally, a severe downturn in the real estate market that leads to a sustained deterioration in asset quality, especially from deficiencies in risk management or underwriting, could pressure the ratings.

RATING RATIONALE
RBC’s earnings remain very strong with H1 2018 net income increasing 4% year over year (YoY), or 8% on an adjusted basis, excluding a gain on the sale of Moneris’ U.S. operations in the prior year. Results reflect improvement in each business segment apart from the Insurance segment, which was flat. Overall, RBC’s H1 2018 return on equity was a strong 17.7%. Given the expectation for solid gross domestic product growth in both Canada and the United States, DBRS views RBC as well positioned to continue to deliver strong results over the next year, reflecting higher short-term interest rates in both Canada and the United States and a lower corporate tax rate in the United States following tax reform.

DBRS views RBC as having well-established and prudent risk management practices, which have contributed to relatively stable credit trends. Asset quality metrics remain sound and have improved over the past year. As of April 30, 2018, gross impaired loans were at a manageable 0.47% of gross loans and acceptances, an improvement of 12 basis points (bps) YoY, while the annualized H1 2018 provision for credit losses (PCL) as a percentage of average net loans and leases was 0.22%, remaining well below the Bank’s historic range of 30 bps to 35 bps. DBRS notes that RBC adopted IFRS 9 starting in FY2018, which may lead to more volatility in the PCL. While current asset quality metrics reflect the benign credit environment, DBRS views these levels as cyclical lows and likely not sustainable over the longer term.

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, especially given the level of Canadian household indebtedness. Nonetheless, RBC’s residential-secured portfolio, like all the large Canadian banks, appears conservatively underwritten or is insured. Specifically, 42% 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 122% for Q2 2018. RBC maintains a highly liquid balance sheet with liquid assets representing about 43% of total assets.

During Q2 2018, RBC’s CET1 ratio declined by ten bps quarter over quarter to 10.9%, primarily reflecting higher risk-weighted assets due to business growth and an update to retail lending risk parameters, partially offset by internal capital generation. DBRS views RBC as a top-tier capital generator although absolute capital levels, as with the other large Canadian banks, remain at the low-end of the global bank peer group.

With $1.3 trillion in assets as of April 30, 2018, 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; Capitalisation – Very Strong/Strong.

DBRS notes that the above press release was amended on January 17, 2019, to add disclosures regarding the primary sources of information and the initial and previous rating dates. The amendment was minor and would not impact the understanding of the reader.

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 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.

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on our website under Methodologies.

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

Lead Analyst: John Mackerey, Vice President, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: November 30, 1980
Last Rating Date: April 19, 2018

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

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.

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