Press Release

DBRS Morningstar Confirms Royal Bank of Canada Rating at AA (high) With Stable Trends

Banking Organizations
May 12, 2023

DBRS Limited (DBRS Morningstar) confirmed its 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 trends on all ratings are Stable. RBC’s Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA and a Support Assessment (SA) of SA2, which reflect 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 to the Bank’s IA.

KEY RATING CONSIDERATIONS
The ratings and Stable trends recognize RBC’s leading and highly diversified franchise in Canada, combined with a growing U.S. banking and wealth management business. RBC also has global capabilities and reach through a number of other strong businesses, including capital markets and wealth. RBC is geographically diverse with one fourth of its F2022 earnings outside of Canada. While historically well-managed, the Bank’s large capital markets business creates the potential for earnings volatility. However, RBC continues to exhibit solid through-the-cycle financial performance and has historically exhibited strong risk management and credit fundamentals. Further, RBC’s planned acquisition of HSBC Bank Canada in a $13.5 billion transaction is expected to close in the first quarter of 2024 (subject to required regulatory approvals) and will further strengthen the Bank’s already leading Canadian business.

The ratings also consider the challenging macroeconomic and geopolitical environment, which could lead to an adverse impact on profitability and asset quality. DBRS Morningstar remains concerned about the combination of highly leveraged Canadian consumers; elevated home prices, particularly in the greater Toronto and Vancouver areas; and materially higher borrowing costs and inflation levels that are eating into consumers’ disposable income. DBRS Morningstar believes that housing prices remain somewhat vulnerable and, as a result, views RBC, like its Canadian bank peers, as susceptible to any significant adverse changes in the Canadian residential real estate market. Positively, DBRS Morningstar views RBC’s residential real estate portfolio as conservatively underwritten and, historically, the Bank’s focus on retail lending has been a source of lower credit risk.

RATING DRIVERS
Given RBC’s high rating level and current risk profile, a ratings upgrade is unlikely. DBRS Morningstar would downgrade the ratings if there were a sustained deterioration in asset quality, especially caused by deficiencies in risk management. Additionally, material deposit outflows or a prolonged decline in profitability metrics would also result in a ratings downgrade.

RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Very Strong
RBC is the largest bank in Canada by both total assets and market capitalization. The Bank operates a significant North American presence, led by its dominant Canadian banking franchise with first or second market positions across its core products. In addition, City National Bank (CNB), 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 broad distribution channels and brand, which continue to provide growth opportunities outside Canada. Indeed, RBC closed its $2.4 billion acquisition of Brewin Dolphin Holdings PLC on September 27, 2022, making the combined business the third-largest wealth manager in the UK and Ireland by assets under management.

Earnings Combined Building Block (BB) Assessment: Strong
RBC has a diversified earnings base, driven by Personal and Commercial Banking (53% of F2022 earnings), Capital Markets (19%), and Wealth Management (20%). RBC consistently produces robust profitability, garnered through its highly diversified revenue streams (F2022: 46% net interest income/54% noninterest income). F2022 earnings of $15.8 billion decreased 1.5% year-over-year (YOY) as strong growth in net interest income was more than offset by a large drop in noninterest income, along with higher provisions for credit losses (PCL) and noninterest expense. Q1 2023 net income (excluding $1.05 billion related to new income tax measures that became effective in Q1 2023) increased 10% quarter over quarter (QOQ) to $4.3 billion, as solid net interest income growth (ex-trading) more than offset higher expenses and PCL. Net interest margins (NIM) have expanded as a result of higher interest rates, loan volume growth, and a low deposit beta. However, DBRS Morningstar expects a more challenging F2023, with negative operating leverage, continued normalization in credit quality metrics, and moderating NIM expansion as interest rates stabilize and funding costs increase in both Canada and the U.S.

Risk Combined Building Block (BB) Assessment: Very Strong/Strong
DBRS Morningstar views RBC’s risk profile as somewhat elevated relative to its peers because of its relatively large capital markets presence and adjusted leveraged lending exposure (but well diversified by industry/sector, representing roughly 10% of the corporate banking loan portfolio at Q3 2022). These concentrations have historically been well managed. Credit quality remains strong as credit metrics continued to normalize in Q1 2023 from unsustainably low levels. The PCL ratio increased 7 basis points (bps) QOQ to 25 bps, while allowance coverage of 53 bps was up 3 bps QOQ and flat compared with pre-Coronavirus Disease (COVID-19) pandemic levels. RBC’s real estate secured lending (RESL) portfolio represents approximately 54% of total gross loans and acceptances (GL&A), the highest among Canadian large bank peers. The Bank’s RESL portfolio is of high quality with an uninsured average FICO score of 805 and an uninsured current loan-to-value ratio of 50%, providing a substantial buffer if property values declined. Positively, RBC does not permit negative amortization but nonetheless, amortization periods greater than 30 years in Canada have materially increased since Q2 2022 (27% for RBC at Q1 2023), illustrating the impact of higher interest rates on variable rate mortgages with fixed payments. We will continue to monitor the ability of Canadian consumers to handle higher payments once their mortgages reset, although all mortgages are stress-tested at higher rates at origination. Meanwhile, CRE exposure represents a manageable 9% of GL&A and is well diversified across geographies and subsegments (i.e., office represents 1.9% of GL&A).

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 20% of total assets) and a very strong deposit franchise in Canada that is diverse and broad-based (personal deposits represent approximately one-third of total deposits). In recent periods, however, the deposit mix has been notably shifting from demand to higher-cost term deposits as clients search for yield. 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, 2023, with a liquidity coverage ratio (LCR) of 130% and a net stable funding ratio (NSFR) of 112%. 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, 2023, RBC’s CET1 ratio was solid at 12.7% and up 10 bps QOQ, as net internal capital generation (net of dividends) was only partly offset by the impact of the Canada Recovery Dividend and other tax related adjustments along with organic RWA growth. Unrealized losses on RBC’s amortized cost portfolio would have an approximate 66 bps negative impact on the CET1 ratio. Furthermore, RBC will be deploying a portion of its excess capital when the HSBC Bank Canada acquisition closes (late 2023/early 2024), with the Bank expecting the CET1 ratio to be approximately 12.0% post-close. As of January 31, 2023, the Bank's total loss-absorbing capacity as a percentage of RWA increased 180 bps QOQ to 28.2%, well above the regulatory minimum of 24.5%. The Bank also reported a leverage ratio of 4.4% in Q1 2023, flat QOQ, and above the regulatory minimum of 3% and in line with its Canadian bank peers.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/413935.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations; June 23, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.

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:

The last rating action on this issuer took place on May 13, 2022, when DBRS Morningstar confirmed the Bank’s ratings.

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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Carl De Souza, Senior Vice President, North American Financial Institutions Group
Rating Committee Chair: William Schwartz, Senior Vice President, Credit Practices Group
Initial Rating Date: December 19, 2005

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

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