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Fitch Affirms Royal Bank of Canada at 'AA/F1+'; Outlook Revised to Stable
October 27, 2017 / 6:03 PM / a month ago

Fitch Affirms Royal Bank of Canada at 'AA/F1+'; Outlook Revised to Stable

(The following statement was released by the rating agency) CHICAGO, October 27 (Fitch) Fitch Ratings has affirmed Royal Bank of Canada (RY) Long- and Short-Term Issuer Default Ratings (IDRs) at 'AA' and 'F1+', respectively. The Rating Outlook has been revised to Stable from Negative. This rating action follows Fitch's periodic review of the Canadian Banks Peer Group, which includes Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Federation des caisses Desjardins Quebec's (FCDQ), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). For additional information, please see "Fitch Affirms Canadian Banks; Fundamentals Outweigh Persistent Housing Risks" at www.fitchratings.com. KEY RATING DRIVERS IDRS, VR's, AND SENIOR DEBT Today's rating affirmation reflects RY's strong domestic franchise, consistently good operating performance, sound funding and liquidity position, and adequate capital ratios. Additionally, the Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks. At their current level, RY's ratings remain at the top of Fitch's global bank universe. Today's rating actions incorporate Fitch's belief that uncertainties remain regarding the potential impact of recent mortgage reform announcements on the broader mortgage market. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. This would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch expects the Canadian banks' ratings would be sensitive to these changes. RY's ratings are supported by its strong market share positioning in Canada across various product segments. The bank has a leading deposit market share throughout Canada, strong lending market share across multiple products, high league table positioning in its investment bank in Canada, as well as a strong wealth management franchise in Canada and the U.S. The Outlook revision to Stable from Negative incorporates Fitch's view that growth in RY's capital markets business has not translated into increased revenue and earnings volatility. Moreover, RY has generally kept capital markets revenues at around 25% of total revenue. As such, Fitch does not believe that RY's capital markets businesses will have an outsize impact on operating performance volatility over the medium term. To support its already strong franchise in wealth management, RY completed the acquisition of City National Bank (CNB) in late 2015. This gave RY a solid presence in the U.S. market in both wealth management to ultra-high net worth individuals and in commercial lending. Fitch believes that RY has done well integrating CNB into its operating platform and that CNB should continue to provide RY with good growth opportunities particularly compared to business more tied to the slower-growth Canadian markets. While Fitch views this transaction positively, given regulatory and capital requirements in the U.S. relative to the Canada, the CNB business may be modestly dilutive to RY's operating performance metrics over time. RY's historical earnings performance continues to remain strong. Over the last 10 years, RY's operating performance as measured by operating income dividend by risk weighted assets (Op Income/RWA) averaged 2.93%, the highest of the peer group, with a standard deviation of 0.45%, well below the peer group average over that time period. Fitch attributes RY's performance track record to its strong market share in Canada, the contribution from its growing wealth management businesses, and the contribution from its growing capital markets businesses. Additionally, the CNB acquisition provides some capacity for incremental capital markets revenue growth to support operating performance, as management has stated that it does not want capital markets revenue to exceed 25% of total revenue. RY's capital markets businesses accounted for 20.87% of total revenue as of the fiscal third quarter of 2017 (3Q17). Fitch also considers RY's funding and liquidity profile to be a rating strength. RY's Fitch adjusted loan-to-deposit ratio compares favorably to peers and to similarly rated entities. Additionally, the company's Liquidity Coverage Ratio (LCR) of 121% as of 3Q17, while lower than some peers, is considered strong. RY also has a sizable and diverse wholesale funding mix with access to investors in multiple geographies. RY's Fitch Core Capital (FCC) to risk-weighted asset ratio of 11.12% is lower than the peer group average of 12.37%. This lower ratio is offset by a higher than peer average RWA density of 38.1% as of 3Q17, due in large part to higher risk weighted assets in the U.S. relative to the Canadian market, as well as the company's superior internal capital generation abilities via retained earnings. SUPPORT RATING AND SUPPORT RATING The affirmation of the RY's SR of '2' and SRF of 'BBB-' reflect Fitch's view that the likelihood of support remains high for Canadian Banks due to their systemic importance in the country, significant concentration overall in of Canadian banking assets amongst the institutions noted above, which account for over 90% of total banking assets, the large size of the banking sector with banking assets at 2.1 times Canada's GDP, and the Canadian Banks' position as key providers of financial services to its local economy. In Fitch's view, Canadian banking authorities through the CDIC Act, have wide latitude to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors. Nonetheless, bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch recognizes that the Canadian government's willingness to provide support for D-SIFI's in Canada has been reduced demonstrated by Department of Finance recent Resolution Framework, which has received parliament approval. The proposal seeks protect tax payers from the risk of a large financial institution failing through the guidelines recently published by OSFI for issuing non-viability contingent capital (NVCC) instruments and defining securities that could be used for "bail-in". In Fitch's view, bail-in proposal enhances resolution powers given to regulatory authorities under the CDIC Act. SUBSIDIARY AND AFFILIATED COMPANY All of the subsidiaries and affiliated companies including City National Bank and Royal Bank of Canada, Sydney Branch are reviewed as part of the Canadian Bank peer review factor in a high probability of support from parent institutions to the subsidiaries. This reflects that performing parent banks have very rarely allowed subsidiaries to default. It also reflects the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by RY and its subsidiaries are all notched down from the common VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. RY's subordinated debt is notched one level below its VR of 'aa' for loss severity in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR. LONG- AND SHORT-TERM DEPOSIT RATINGS City National Bank's uninsured long-term deposit ratings are rated one notch higher than RY's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default. RATING SENSITIVITIES IDRS, VR, AND SENIOR DEBT With the Rating Outlook revision to Stable from Negative, RY's ratings are solidly situated at their current level, which is at the top of Fitch's global bank universe of ratings. Today's rating action incorporates Fitch's view that uncertainties remain on what the impact of recent mortgage reform announcements will be to the broader mortgage market. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. Further, these changes would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch notes that the Canadian banks' ratings are sensitive to negative pressures in the housing market. Downside risks to RY's ratings include higher overall earnings volatility in the context of its slightly lower FCC ratios, relative to similarly rated Global peers, though Fitch views this risk as modest over the medium term. Fitch believes RY's ratings are primarily sensitive to potential earnings volatility as measured by the volatility of op income/RWA relative to domestic and highly rated international peers. Negative rating pressure could eventuate should capital markets revenue as a percentage of total revenue consistently exceed management's threshold of 25% or should there be a 25% change in the standard deviation of RY's annual op income/RWA metric measured over two years without a corresponding increase in the company's FCC ratio. While overall impaired loan ratios for RY and its peer banks have declined as potential losses to energy related credits have abated as oil prices have increased and troubled assets have been able to be restructured, overall impaired loan ratios remain near troughs. As such, Fitch believes impaired loan ratios will likely increase over time. Modest rating pressure could ensue should RY's credit performance deteriorate evidenced by impaired loans and loan losses trending to levels significantly above its 10-year average of 0.45% and 0.83%, respectively. This could potentially become more severe should macroeconomic risks continue such as unexpected increases in interest rates, a severe housing price correction as well as macroeconomic weakness in the overall Canadian economy that leads to a material rise in unemployment SUPPORT RATING AND SUPPORT RATING FLOOR RY's SR of '2' incorporates Fitch's expectation that there could be some level of support for the Canadian banks going forward, although it has been weakened given bail-in legislation. Although Canadian authorities have taken steps to improve resolution powers and tools, they intend to maintain a flexible approach to bank resolution. Therefore, SRs and SRFs are sensitive to the implementation of TLAC requirements. To the extent that these are deemed more than sufficient to recapitalize a non-viable bank, SRs and SRFs may be lowered. Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC and TLAC implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks. SUBSIDIARY AND AFFILIATED COMPANY The subsidiary and affiliated company ratings including City National Bank and Royal Bank of Canada, Sydney Branch are primarily sensitive to any change in the VRs of the banks. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt and hybrid capital ratings are primarily sensitive to any change in the VRs of the banks (or bank subsidiaries). LONG- AND SHORT-TERM DEPOSIT RATINGS The ratings on long- and short-term deposits issued by City National Bank and its subsidiaries are primarily sensitive to any change in RY's IDR. Fitch has affirmed the following ratings: Royal Bank of Canada --Long-Term IDR at 'AA'; Outlook to Stable from Negative; --Viability Rating at 'aa'; --Short-Term IDR at 'F1+'; --Short-Term debt at 'F1+'; --Senior unsecured debt at 'AA'; --Subordinated debt at 'AA-'; --Market-Linked Securities at 'AAemr'; --Support Rating at '2'; --Support Rating Floor at 'BBB-'. City National Bank --Long-Term IDR at 'AA-'; Outlook to Stable from Negative; --Short-Term IDR at 'F1+'; --Long-Term Deposits at 'AA'; --Short-Term Deposits at 'F1+'; --Subordinated debt at 'A+'; --Support at '1'. Royal Bank of Canada, Sydney Branch --Long-term senior unsecured debt at 'AA'. Contact: Primary Analyst Justin Fuller, CFA Senior Director +1-312-368-2057 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Doriana Gamboa Senior Director +1-212-908-0865 Committee Chairperson Sean Pattap Senior Director +1-212-908-0642 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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