DBRS Upgrades Royal Bank of Canada to AA (high), Changes Trend to Stable

DBRS, Inc. (DBRS) upgraded the long-term ratings of the Royal Bank of Canada (RBC or the Bank) and its related entities, including RBC’s Long-Term Issuer Rating, to AA (high) from AA. DBRS also changed the trend on all long-term ratings to Stable from Positive. The Bank’s Short-Term Issuer Rating was confirmed at R-1 (high) with a Stable trend. RBC’s Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA and Support Assessment of SA2, which reflect 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. Under the new Canadian Bank Recapitalization Regime (the Bail-In Regime), DBRS expects to eventually remove the uplift from systemic support, once the Bank has issued a sufficient level of bail-inable senior debt, which would thereby provide an adequate buffer for non-bail-inable obligations and is then expected to offset the removal of systemic support.

KEY RATING CONSIDERATIONS
The upgrade of RBC’s long-term ratings recognizes the Bank’s strong credit fundamentals, growing and significant franchise and consistently better-than-peer financial performance. Indeed, the Bank’s upgraded IA now ranks it among DBRS’s highest-rated banks globally. RBC operates a well-diversified franchise in Canada, a growing U.S. banking and wealth management business and a few businesses with global reach. Approximately 38% of total revenues are earned outside of Canada, contributing to geographic diversity. The ratings consider RBC’s business mix, including its significant capital markets business. The ratings also consider the length of the current credit cycle, increasing global economic uncertainty and the potential for a housing downturn in Canada, as well as the potential for a normalization of asset-quality trends from current relatively benign levels.

RATING DRIVERS
Given RBC’s recent rating upgrade and high rating level, upward ratings momentum is unlikely. Negative ratings pressure could arise if there is a perceived increase in risk appetite or a sustained deterioration in asset quality, especially from deficiencies in risk management. Additionally, an over-reliance on potentially more volatile earnings sources, such as capital markets, or a sustained weakening of profitability metrics could result in negative ratings pressure.

RATING RATIONALE
RBC operates a significant North American franchise, including a leading Canadian franchise that maintains top market shares across a number of products. In addition, City National Bank, which the Bank acquired in 2016, has been a steady platform for growth in the United States, particularly in private and commercial banking and wealth management. A few of RBC’s business lines also have global reach, especially capital markets and wealth management. RBC’s very strong franchise contributes to consistently robust profitability garnered through highly diversified revenue streams.

Despite a volatile capital markets environment, RBC reported strong earnings and returns for H1 2019, with net income increasing almost 5% year over year (YoY). The increase reflected revenue growth derived from both net interest income and non-interest income, partially offset by higher non-interest expenses and a higher provision for credit losses (PCLs). By segment, net income growth for H1 2019 included solid increases in all segments, except for Investor & Treasury Services, which declined due to lower funding and liquidity revenue, lower revenue from the asset services business and costs to support efficiency and technology initiatives.

Credit quality remains strong with the level of gross impaired loans (GILs) increasing modestly YoY, largely reflecting one account in the U.S. utilities sector. However, PCLs in H1 2019 increased sharply YoY by 56% to $957 million. This increase reflected higher provisions on impaired loans as well as a higher provision on performing loans due to unfavourable changes in macroeconomic variables, as required under International Financial Reporting Standards 9. DBRS expects that asset quality at current levels is likely unsustainable and expects both GILs and PCLs to revert to a higher, more normalized level over time.

DBRS remains concerned over the combination of Canadian household indebtedness and elevated housing prices, particularly in and around Vancouver and Toronto, and the potential impact of a housing downturn on the Canadian economy as well as to other consumer-related loan portfolios. Nonetheless, RBC’s residential-secured portfolio, like all the large Canadian banks, appears conservatively underwritten, with 37% of RBC’s Canadian residential mortgage loans insured. The average loan-to-value ratio of the uninsured portfolio is a conservative 57%, providing a substantial buffer for a decline in housing prices.

DBRS views RBC as having strong levels of on balance sheet liquidity and a very strong deposit franchise in Canada. Augmenting its substantial deposit funding, RBC enjoys ready access to diversified wholesale funding sources. The Bank’s liquidity remains strong with a liquidity coverage ratio of 127% in Q2 2019, which remains well above regulatory minimums.

RBC’s Q2 2019 Common Equity Tier 1 ratio increased 90 basis points YoY to 11.8%, primarily due to strong earnings generation. While overall capital levels remain well above regulatory minimums, they are at the low end of some global peers. However, DBRS views capital levels as strong given the Bank’s asset mix and ability to generate capital. The Bank has begun issuing Bail-inable Senior Debt as part of the Bail-In Regime. It is expected that the Bank will exceed the total loss absorbing capacity requirements issued by the Office of the Superintendent of Financial Institutions as it replaces maturing legacy senior debt.

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 December 12, 2019, to remove an unnecessary disclosure. The amendment was minor and would not impact the understanding of the reader.

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

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations (June 2019), which can be found on our website under Methodologies & Criteria.

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

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on June 26, 2018, when the Bank’s ratings were confirmed and the trends were changed to Positive.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: John Mackerey, Senior Vice President, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG
Initial Rating Date: 19 December 2005

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

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