DBRS Limited (DBRS Morningstar) confirmed the ratings on 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 (IA) of AA and a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). As a result of the SA2 designation, the Bank’s Long-Term Issuer Rating benefits from a one-notch uplift.
KEY RATING CONSIDERATIONS
The ratings and Stable trends recognize the Bank’s leading and highly diversified franchise in Canada, combined with a fast growing U.S. banking and wealth management business. In addition, RBC has global capabilities and reach through a number of other businesses, including capital markets and wealth. RBC has exhibited better-than-peer, through-the-cycle financial performance and has historically exhibited strong risk management and credit fundamentals. Additionally, the Bank earns just under one-third of its earnings outside of Canada, contributing to RBC’s overall geographic diversity. The ratings also consider RBC’s Capital Markets business that can contribute to earnings volatility and, at approximately 25% of total Bank earnings, is a larger contributor than most Canadian peers.
The ratings also consider that government support measures have largely mitigated the negative economic impacts of the Coronavirus Disease (COVID-19) pandemic. Positively, economic performance has rebounded, and the labour market is essentially at full capacity; however, headwinds persist from a potential aggressive interest rate tightening cycle to combat inflation, geopolitical tensions related to the Russia-Ukraine conflict, supply chain disruptions, and the pandemic. Furthermore, DBRS Morningstar remains concerned about the combination of Canadian household debt levels, which have reached an all-time high, and elevated home prices (particularly in the greater Toronto and Vancouver areas), which have been driven by housing market imbalances and robust demand during the pandemic. Housing prices remain vulnerable and, as a result, RBC and its Canadian peers are susceptible to adverse changes in the Canadian real estate market. However, DBRS Morningstar views RBC’s retail exposure as manageable given its conservative underwriting and strong risk culture.
DBRS Morningstar views RBC as well placed in its rating category. Given RBC’s high rating level and current risk profile, a ratings upgrade is unlikely. Ratings would be downgraded if there were a sustained deterioration in asset quality, especially if caused by deficiencies in risk management. Additionally, a prolonged decline in profitability metrics would also result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Very Strong
RBC is the largest bank in Canada by market capitalization and the second largest by total assets. The Bank operates a significant North American franchise, including a leading Canadian banking franchise that maintains top market shares across a number of core products. In addition, City National Bank, which RBC acquired in November 2015, has been a steady platform for strong organic growth in the United States, particularly in private and commercial banking as well as wealth management. A number of RBC’s business lines have global capabilities and reach, especially capital markets and wealth management. The Bank benefits from its wide distribution channels and brand, which continue to provide growth opportunities outside Canada. Indeed, RBC announced the $2.6 billion acquisition of Brewin Dolphin Holdings PLC (Brewin Dolphin) on March 31, 2022. The transaction is expected to close by the end of Q3 2022 and will enhance and expand RBC’s existing UK and Ireland wealth management offering.
Earnings Combined Building Block (BB) Assessment: Strong
RBC consistently produces robust profitability, garnered through its highly diversified revenue streams (40% net interest income/60% non-interest income in F2021). With higher interest rates and volume growth, net interest income is expected to rebound in F2022, driven by the Bank’s retail franchises as non-interest income growth moderates. The Personal and Commercial Banking segment represented nearly half of F2021 earnings (49%), followed by Capital Markets (26%), Wealth Management (16%), Insurance (6%), and Investor and Treasury Services (3%). For F2021, earnings increased 40% year over year to $16.1 billion, primarily reflecting a total provision for credit loss (PCL) reversal of $753 million, reducing elevated pandemic-driven PCL levels from the prior year. In Q1 2022, RBC’s reported earnings increased 5% quarter over quarter to $4.1 billion, as higher revenues were partially offset by an increase in PCL. Additionally, the Bank's adjusted efficiency ratio improved to 48.8% in the quarter compared with 52.1% in the prior quarter, driven by positive operating leverage. The earnings outlook for F2022 remains cautiously optimistic, noting the near-term challenges given the scale of the aforementioned headwinds.
Risk Combined Building Block (BB) Assessment: Very Strong/Strong
DBRS Morningstar views RBC’s risk profile as somewhat risker than its peers because of its relatively large capital markets presence and leveraged lending exposure although these concentrations have historically been well managed. RBC, like others in the banking industry, benefitted in F2021 from PCL reversals on performing loans, which resulted in a total PCL reversal and a total PCL ratio of -12 basis points (bps). PCL in Q1 2022 showed some modest deterioration quarter over quarter with total PCL of $105 million compared with -$227 million in Q4 2021, although total PCL ratio at 5 bps and PCL on impaired loans ratio at 9 bps remain well below historical levels. Moreover, gross impaired loans remained low in Q1 2022 at a manageable 0.28% of gross loans and acceptances.
DBRS Morningstar expects a modest deterioration in asset quality metrics from the current unsustainably low levels as credit conditions normalize. DBRS Morningstar remains concerned about the high household debt levels and the potential impact of a housing-related downturn in the Canadian economy and its knock-on impact on consumer-related loan portfolios. However, RBC’s real-estate secured lending portfolio, like that of all large Canadian banks, appears to be conservatively underwritten with 27% of these loans being insured at Q1 2022 and the low uninsured loan-to-value ratio of 48% providing a substantial buffer.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views RBC as having strong levels of on balance sheet liquidity (high-quality liquid assets represent approximately 21% of total assets) and a very strong deposit franchise in Canada (personal deposits represent approximately one-third of total deposits). Augmenting its substantial deposit funding, RBC enjoys extensive access to wholesale funding sources that are well diversified across a variety of markets, products, and currencies. RBC’s liquidity profile remains strong as at January 31, 2022, with a liquidity coverage ratio (LCR) of 124% and a net stable funding ratio (NSFR) of 113%. The NSFR, unlike the LCR, looks at funding resilience over the medium to longer term and both the LCR and NSFR comfortably exceed the regulatory minimum thresholds of 100%.
Capitalization Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views RBC’s capitalization as strong, supported by significant internal capital generation. At January 31, 2022, RBC’s CET1 ratio was solid at 13.5% but down 20 bps quarter over quarter, as growth in risk-weighted assets and share repurchases were only partly offset by internal capital generation. At this CET1 level, the Bank maintained a sizable cushion of $17.3 billion over the minimum regulatory requirement. RBC will be deploying a portion of this excess capital when the Brewin Dolphin acquisition closes in Q3 2023, which is expected to reduce the CET1 ratio by approximately 40 bps. As of January 31, 2022, the Bank's total loss-absorbing capacity as a percentage of RWA was 26.4%, well above the regulatory minimum of 24.0%. The Bank also reported a leverage ratio of 4.8% in Q1 2022, above the regulatory minimum of 3% and in line with its Canadian bank peers. DBRS Morningstar notes that this metric remains somewhat weaker than many global peers.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/396821.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262). Each of the methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision.
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.dbrsmorningstar.com.
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 for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision, Specifically, the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021) was used to evaluate the Issuer, and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) was used to assess ESG factors.
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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Carl De Souza, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: December 19, 2005
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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