Royal Bank of Canada Executive Insights: Loan Loss, Greece

On Thursday, Royal Bank of Canada (NYSE:RY) reported its second quarter earnings and discussed the following topics in its earnings conference call. Here’s what executives shared.

Loan Loss

Robert Sedran – CIBC: I just wanted a quick question on the loan loss side. I guess, you touched on the Caribbean losses but I am curious if you are seeing any – we hear a lot of our consumers that way hear a lot of other Canadian members who are starting to see loan losses back up. I am just curious if you’re seeing any underlying trends in terms of stress in the Canadian portfolio beyond some of the larger commercial losses you saw this quarter?

Morten N. Friis – CRO: I would say the loan loss performance for this quarter in the Canadian portfolio is a combination primarily of seasonality and volume growth. As I commented, I think actually we’re seeing on a basis point level the level of our provisions remain constant quarter-over-quarter is indication of good credit quality. The level of total impairment is down for Canadian Banking. So we continue to see very strong and consistent performance in the retail portfolios. I think what all the attention is about is the risk of the impact of a stress event on the Canadian portfolios. The performance that we see given actual performance of the economy continues to be very strong. The residential mortgage book in my view gets a disproportionate amount of attention. The level of impairment there is relatively flat. The loss loan provision at one basis point is as good as you can expect it to get. I am watching frankly more the unsecured portfolios whether that’s card or the RCL portfolios which also continues to be stable from a overall quality standpoint. I’ll also add that when you look at the wholesale portfolios, if you look at the Canadian commercial book, we had two accounts that (reveal) represented the increase in provision of the – with the specific provisions, one was a real estate related Western Canadian project that’s been problematic for quite some time for reasons entirely related to the project itself and non-housing demand, the other account was a fraud. So I mean, losses are losses, but the point is there is nothing systematic about this. The size of the watch list as I commented on is at a stable and on a low level, and I would say that for the corporate book, again we had two accounts generating the overall PCL for the quarter. The overall level of provisions, I think 27 basis point of the Capital Markets book is low and consistent with previous quarters and again, we do not see any evidence of inflow of new problem accounts in that book. It’s a very active market, these things can turn quickly, but based on current stats, I would say outside of the Caribbean, the portfolio quality is strong, sound, entirely consistent with our expectations, and I think really encouraging. The Caribbean performance is disappointing. I would emphasize, it is a small portfolio of $7 billion. We probably have another quarter or two of issues to work through there and assuming that we can see a resurgence in economic activity in that region, it is a region that has very good earnings, high margins from that portfolio. So we hope that the level of impairment of losses will reduce there over the coming quarters, but it remains the one source of some disappointment for us.

Robert Sedran – CIBC: Is it fair to say that the number this quarter, overall provision number this quarter is just – you’re comfortable with its quarter-over-quarter volatility and you’re not too concerned that things are turning…

Morten N. Friis – CRO: If you see that overall provisions of 39 basis points for the total loan book is very strong performance. I mean we would expect it in a normal environment to be in the 40 basis points to 50 basis points. If we’re better than that, that reflects very strong performance in my view.


Peter Routledge – National Bank Financial: We were reading this morning European’s officials are reported to be developing contingency plans for a Greek departure from the European currency union. So realizing that’s probably an unprecedented event and where others have operations in European, so what sort of contingency plans specific to Greece exit has RBC taken or is thinking about putting in place?

Morten N. Friis – CRO: It’s Morten. Maybe I can at least start with the response to that. So I mean we, I think like a lot of other large financial institutions, have had a specific contingency planning effort underway to deal with the potential breakup of the eurozone. So we have this was run out of London was the risk and business leaders in that market driving the effort. So it’s working through. So we have a playbook, if you like, and of the various options that we need to work through in the event of a eurozone breakup. The process that that team has gone through is to make sure they have identified all the various steps that need to be developed, that need to be gone through in the event of us going from uncertainty to an actual exit. I would say that there is good clarity on the steps that we need to go through and we have as part of the crisis management process the team there fully engaged. If you look at the actual risks that we’re dealing with, I’ll put in a couple of different buckets. I mean, first of all, if you look at our Capital Markets activity, our direct exposure to Greece as you can see from our disclosure on the European exposure is minimal and our direct exposure to peripheral countries overall is quite small and very manageable. So for Greece – for Greek exit specifically, the first order impact that we have to deal with out of our Capital Markets business is actually fairly small. The other businesses in Europe that had some degree of activity was we have a modest amount of peripheral country exposure related to Wealth Management entirely manageable and I think small enough that we can deal with that on a one-off basis. Obviously, the investor services business under RBC Dexia has activities throughout the region and again, they are part of the crisis management process and the contingency planning for dealing with that. So, I hope that answers your question.

Peter Routledge – National Bank Financial: How long, I mean, have you been looking at this in depth?

Morten N. Friis – CRO: The effort for a specific crisis contingency management process has been ongoing since the fall of last year.

Peter Routledge – National Bank Financial: Just it might be a little bit of an unfair question, but how comfortable – I mean, you could do everything right, the (world) could do everything right and then you just got to hope your counterparties have done the same amount of diligence on this. What’s you’re thinking on that?

Morten N. Friis – CRO: I guess, two points, I mean part of the process here is trying to make sure we have a continuous demand of the process that allow us to respond to developments as they occur. Today, I think one of the things that people have to understand is you cannot plan in advance the specific steps you go through, because there are too many uncertainties about exactly how this will develop. So our approach is to make sure we have a thorough process to deal with all of the possible twist and turns those can take. I think from an exposure management standpoint, one of the more important points to deal with is to try to make sure that you identify areas of wrong way risks, so that to the extent that you’ve got direct exposures to counterparties that are most likely to be caught by this in a negative way, but you have reduced your exposure to those counterparties. So you can manage both the first and the second order impacts of such an event.

Peter Routledge – National Bank Financial: Just maybe for Mark, do you have any thoughts on how prepared or what Royal needs to be watchful for over the next several months?

Mark A. Standish – Co-Group Head, Capital Markets: We’ve been reducing the balance sheet that’s been applied to the trading businesses for some time. If you look at Q2 versus Q1, we’ve reduced VaR by about 7%, we’ve reduced stressed VaR by 9%, a lot of that reduction has come in the European business. As Morten said, we’ve been stressing our counterparty exposures to breakup scenarios. We remain very cautious with respect to Europe, but it’s not the same stress environment that we saw on our funding side this time last year. But as I said, we remain extremely cautious, we’ve been reducing risk-weighted assets that we’ve been employing in the trading business and really focusing our activity around the origination side of the business. So, it’s not the balance sheet trading business that we used to run pre-crisis, given our focus today on origination, it’s much more sales and trading around the origination asset with a smaller balance sheet and where we do use balance sheet, it’s much more focused around individual names that we support.

Gordon M. Nixon – President and CEO: Yeah, I would just add from a macro perspective, you’ve heard me say before, in terms of the management of our business, as we’ve managed these businesses hoping for the best but expecting the worst, and we feel pretty comfortable about that. I think the real question is what would the impact be of European fall out on markets like the United States and global economic growth and those secondary impacts, those are things that are much less predictable at this point in time. But a lot remains to be played out.