CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Royal Bank of Canada's (RY) long- and short-term Issuer Default Ratings (IDRs) at 'AA' and 'F1+', respectively. The Rating Outlook has been revised to Negative from Stable.
This affirmation reflects RY's consistently good earnings performance, sound funding and liquidity position, and adequate capital ratios in the wake of the closing of its acquisition of City National Bank (CNB).
At the same time, Fitch has revised the Rating Outlook for RY to Negative from Stable. This Outlook revision is driven by Fitch's view that RY's credit performance and future earnings volatility may be higher than Canadian bank peer averages as well as in comparison to similarly rated global financial institutions. In addition, RY's tangible capital ratios, while satisfactory and supportive to the rating, compare less favorably to other similarly rated financial institutions.
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), Caisse Centrale DesJardins (CCD), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD).
For further discussion, please refer to the Canadian Banks Peer Review Special Report to be published shortly.
KEY RATING DRIVERS
ISSUER DEFAULT RATINGS (IDRS), VIABILITY RATINGS (VRS) AND SENIOR DEBT
The affirmation of RY's ratings reflects historically good earnings performance, strong market shares in Canada, good liquidity position, and satisfactory regulatory capital ratios. These strengths help support RY's high ratings.
RY's historical earnings performance has remained consistently good for a number of years. This operating performance has been supported by low provision expense, as credit losses have been minimal despite net interest margins under pressure amidst low interest rates in Canada. This performance has also been supported by growth in other businesses such as Capital Markets and Wealth Management.
RY's ratings are also supported by a comparatively good liquidity position. Fitch notes that the bank has a leading deposit market share throughout Canada, and attractive access to multiple funding sources globally. This includes senior debt issuances, senior deposit notes, securitizations, and covered bond issuance. In addition, RY is also in compliance with the Liquidity Coverage Ratio (LCR) standards.
A further driver of today's rating action is the closing of RY's acquisition of CNB, which Fitch views favorably, as it should provide good growth opportunities for RY in the U.S. markets. That said, over time the CNB acquisition may be modestly dilutive to RY's overall return on equity (ROE), as CNB has historically operated at lower ROEs than typical Canadian banking operations.
Given that capital markets revenue has also been growing, the acquisition provides some capacity for incremental capital markets revenue growth, although this is not expected to exceed 25% of earnings. However, Fitch believes that future growth for RY in the capital markets businesses may necessitate incrementally higher risk appetite as the company competes more against larger global players. Fitch believes that this could introduce higher levels of volatility to RY's overall earnings profile relative to both global and Canadian peers.
Fitch notes that the closing of the CNB transaction is expected to reduce RY's pro forma 1Q16 Basel III Common Equity Tier 1 (CET1) ratio by 70 basis points, but Fitch expects this ratio to increase over time through the retention of more earnings and potential further risk-weighted asset (RWA) optimization. Even so, relative to similarly rated global peers, RY's tangible capital ratio compares less favourably.
The Rating Outlook for RY has been revised to Negative from Stable given Fitch's view that there is likely to be higher levels of earnings volatility for RY than for domestic peers. Fitch believes this will be driven by higher provisioning in Canadian Banking and capital markets (primarily the wholesale businesses), as well as some increased volatility in overall results from capital markets revenues.
Given the recent decline in oil & gas prices RY, as well as some other peer banks, may be exposed to additional credit pressures. For RY at the end of 2015, gross impaired loans in Capital Markets increased to $296 million from $50 million in 2014. The increase was largely driven by higher impaired loans exposed to oil and gas, utilities, and consumer goods sectors.
Given that RY's pro forma regulatory capital ratios after completing the CNB acquisition may be slightly lower than domestic peers, and its tangible capital ratios are lower than some similarly rated global peers, potentially higher earnings volatility may not be consistent with the company's current rating level.
Additionally, it is worth noting that RY's RWA on its uninsured mortgage portfolio, which is proportionately larger than for other Canadian Banks, under the Basel III Advanced Approach, is less conservative than some global jurisdictions. This could indicate the denominator of RY's regulatory capital ratios is less conservative than some other global peer banks.
SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
The affirmation of 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 Canadian banking assets among the institutions noted above, which account for over 90% of total banking assets, the large size of the banking sector with banking assets at 2.1x Canada's GDP, and the Canadian Banks' position as key providers of financial services to its local economy.
In Fitch's view, with the CDIC Act, Canadian banking authorities have wide latitude to resolve a troubled bank situation, including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors.
Fitch recognizes that the government's willingness to provide support for D-SIFIs in Canada has been reduced, demonstrated by Department of Finance consultation paper which outlines the proposed bail-in regime as banking regulators seek to protect taxpayers from the risk of a large financial institution failing. This is evidenced by the issuance of non-voting contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress in reducing the propensity of state support for banks going forward.
RY's IDRs and senior debt ratings do not benefit from support because their VRs are all currently above their SRFs.
City National Bank's (CNB) SR of '1' reflects institutional support, as CNB is a wholly owned subsidiary of RY.
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.
The preferred securities of RBC Capital Trust are non-cumulative preferred securities which are notched five below the VR, made up of two notches down for non-performance and three notches down for loss severity.
RATING SENSITIVITIES
IDRS, NATIONAL RATINGS AND SENIOR DEBT
RY's ratings are at the top of Fitch's Global Bank Rating Universe, and as such, there is very little upside to current ratings.
As indicated by the revision of the Rating Outlook to Negative from Stable, potential risks to RY's ratings are higher earnings volatility in the context of its slightly lower than Canadian peer group pro forma regulatory capital ratios after the closing of the CNB transaction as well as lower tangible capital ratios that similarly rated Global peers.
Specifically, RY's ratings are primarily sensitive to Fitch's view of potential earnings volatility as measured by return on assets and equity (ROA and ROE) relative to domestic and highly rated international peers. Over the Rating outlook horizon (typically 12-18 months), RY's ratings could be downgraded one notch should earnings measures exhibit significantly higher volatility. For example, a 25% change in the standard deviation of earnings measured over multiple quarters, absent an increase in both regulatory and tangible capital ratios could be indicative of heightened volatility outside of Fitch's expectations for the company's ratings.
Alternatively, should RY be able to manage future provisioning and capital markets volatility with minimal standard deviation of ROA or ROE, all while retaining internally generated capital to boost both regulatory and tangible capital ratios, the Rating Outlook could be revised back to Stable.
SUPPORT RATING AND SUPPORT RATING FLOOR
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.
Fitch's assessment of continuing support for Canadian D-SIFIs 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 implementation. Furthermore, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks.
CNB's support rating of '1' is sensitive to any change in Fitch's views of RY's propensity to provide institutional support to CNB.
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).
Fitch has affirmed the following ratings and revised the Rating Outlook to Negative from Stable.
Royal Bank of Canada
--Long-term IDR at 'AA'; Outlook 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 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'.
Additional information is available on www.fitchratings.com
Applicable Criteria
Global Bank Rating Criteria (pub. 20 Mar 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863501
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