DBRS Morningstar Confirms Royal Bank of Canada at AA (high) with a Stable Trend

DBRS, Inc. (DBRS Morningstar) confirmed the ratings of Royal Bank of Canada (RBC or the Bank) and its related entities, including RBC’s Long-Term Issuer Rating of AA (high) and Short-Term Issuer Rating of R-1 (high). The trend on all ratings is Stable. RBC’s Long-Term Issuer Rating is composed of an Intrinsic Assessment of AA and a 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 Morningstar). The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating. Under the Canadian Bank Recapitalization Regime, DBRS Morningstar 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 ratings confirmation and Stable trend recognize the Bank’s strong, highly-diversified franchise in Canada with a growing U.S. banking and wealth management business and a few businesses with a global reach. RBC has historically exhibited strong risk management and credit fundamentals and better-than-peer financial performance. Approximately 39% of total revenue is earned outside of Canada, contributing to geographic diversity. The ratings also consider RBC’s business mix, which includes a significant capital markets business that may contribute to increased earnings volatility.

The ratings also reflect the likely impact of the wide and growing scale of the economic disruption caused by the Coronavirus Disease (COVID-19) pandemic. While RBC has entered this downturn with a strong balance sheet, DBRS Morningstar will continue to monitor this developing situation and its potential impact on the Bank's revenue, earnings, and asset quality. Nevertheless, DBRS Morningstar notes that unprecedented support measures have been put in place by governments and regulators around the globe, which will mitigate some of the negative impacts of this crisis.

RATING DRIVERS
Given RBC’s high rating level and the current economic environment, an upgrade of the ratings is unlikely. Ratings would be downgraded if there is a prolonged adverse impact from the coronavirus pandemic resulting in a sustained deterioration in asset quality, especially due to deficiencies in risk management. Additionally, a sustained weakening of profitability metrics would also result in a downgrade of ratings.

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 number of RBC’s business lines also have a global reach, especially in capital markets and wealth management. RBC’s very strong franchise has historically contributed to consistently robust profitability garnered through highly diversified revenue streams.

Like its Canadian bank peers, RBC reported a sharp drop in earnings for 2Q 2020 as it built reserves to reflect weakening economic conditions, with net income dropping 58% compared with the linked quarter. Strong performance in Investor & Treasury Services, stemming from higher funding and liquidity revenue, partially offset weaker results in the other business segments. Lower card service revenue and spreads affected Personal & Commercial Banking revenue, while market volatility adversely affected Wealth Management's results. Insurance revenue was flat sequentially, and Capital Markets saw a decline in fixed-income trading revenue from loan underwriting markdowns, lower merger and acquisition activity in the United States, and lower equity trading in Canada and Europe. DBRS Morningstar expects revenue to remain pressured while credit costs remain elevated in the current environment, which will negatively affect RBC’s earnings for the remainder of F2020.

The Bank's provision for credit losses (PCL) rose substantially to $2.8 billion from $419 million in the previous quarter. The majority of the increase was comprised of PCL on performing loans, which stood at $2.1 billion, and was a result of changes in forward-looking macroeconomic indicators related to the impact of the pandemic and lower oil prices. Meanwhile, PCL on impaired loans grew 81% quarter over quarter (QOQ) to $613 million as a result of higher provisions in Capital Markets and Personal & Commercial Banking. RBC's exposure to sectors directly affected by the pandemic is manageable at 7% of total loans and acceptances. While PCL levels are elevated, it is uncertain whether these higher levels of provisions will translate into higher loan losses and will be driven by the duration of the economic downturn.

DBRS Morningstar 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 130% in Q2 2020, which is well above regulatory minimums. During the quarter, the Bank supplemented its funding by using some of the new programs offered by the Bank of Canada, including the Standing Term Liquidity Facility. RBC also has access to central bank programs in other jurisdictions in which it operates, including the Bank of England's U.S. dollar swap facility. The Bank currently holds $289 billion in high-quality liquid assets, a 15.7% increase sequentially.

RBC's CET1 ratio declined 30 basis points sequentially to 11.7%, largely due to higher risk weighted assets reflecting drawdowns on credit facilities, net credit downgrades, and securities losses. RBC has historically generated strong internal capital; however, capital generation may be lower as earnings remain under pressure in the current environment. On March 13, 2020, the Office of the Superintendent of Financial Institutions (OSFI) lowered the Domestic Stability Buffer (DSB) requirement for Domestic Systemically Important Banks (D-SIBs) to 1.0%, which effectively reduces the CET1 regulatory minimum to 9.0% for D-SIBs. As the DSB was intended, OSFI is providing the D-SIBs with more flexibility to extend loans to their customers during the coronavirus pandemic. Simultaneously, OSFI announced that it expects all D-SIBs to halt any new common share dividend increases and buyback activity. During the quarter, the Bank's total loss-absorbing capacity as a percentage of risk-weighted assets was flat QOQ at 19.7%.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (June 8, 2020) https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar 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 (DBRS Morningstar) 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 18, 2019, when the Bank’s ratings were upgraded.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar 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
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: 19 December 2005

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

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