Fitch Ratings has affirmed Royal Bank of Canada's (RY) Long and Short-term Issuer Default Ratings (IDRs) at 'AA' and 'F1+' respectively. This affirmation reflects RY's good earnings performance over multiple operating cycles, strong funding and liquidity position, and adequate capital ratios.
The Rating Outlook for RY remains Stable.
This rating action follows a periodic review of the Canadian Banking sector. Fitch will publish the main findings of this review in a report 'Canadian Banks: Nearing a Tipping Point' available at www.fitchratings.com
KEY RATING DRIVERS - IDRs, VR's, AND SENIOR DEBT
The affirmation of RY's ratings reflects good earnings performance, strong market shares in Canada, a good liquidity position, and adequate capital ratios, which compare reasonably well to similarly rated international peers. These strengths help support RY's already high ratings, which are at the highest of Fitch's global rating universe for financial institutions.
Additionally, RY recently helped augment its earnings diversity with announcement the acquisition of City National Bank (CYN), which is expected to close in the fourth calendar quarter of 2015. This will provide RY some additional wealth management and banking earnings from the U.S., especially considering that RY has previously exited U.S. banking from a mass market perspective in 2011.
Further, given Fitch's concerns related to the growing contribution of capital markets earnings on the company's overall results, such that it could increase the volatility of RY's earnings particularly as consumer banking in Canada slows, this acquisition should help to keep the proportion RY's capital markets earnings have on RY's overall earnings below 25%.
However, to the extent that the contribution from capital markets earnings including advisory, underwritings, trading, and related lending earnings still creeps above 25% of overall earnings, there is likely to be some pressure on overall ratings.
Today's rating action is further supported by the RY's good and robust liquidity position. 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 to name a few.
Fitch believes that RY's earnings performance remains adequate for its rating category, but it also notes that earnings for RY, as well as the rest of the Canadian banks, is likely at a cyclical peak given that it has been supported by low provision expense over the last several years.
Similarly, Fitch believes that credit quality for RY, as well as the rest of the Canadian banks, is likely at a cyclical trough, and that modestly higher provision expense is likely at some point over the next 12 - 24 months. This will likely weigh on the company's overall earnings, partially offset by any incremental earnings that are realized by the CYN acquisition described above.
RATING SENSITIVITIES - IDRs, VR's, and SENIOR DEBT
Given RY's already high level of ratings, Fitch does not expect any upside to RY's ratings over a medium-term time horizon.
Alternatively, ratings could be downgraded to peer levels should RY's credit performance deteriorate at a faster rate than other similarly rated entities on a global basis.
Fitch believes that all Canadian banks, including RY, are vulnerable to credit deterioration in their domestic loan portfolios given high levels of consumer indebtedness in Canada, combined with Fitch's view of some overvaluation in the Canadian housing market. This limits housing affordability and makes consumers particularly susceptible to negative shocks to their income levels. Should the rapid decline in global oil prices cause an economic slowdown in Canada that impacts employment levels, this could hasten potential credit deterioration.
While Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks, RY has less of a preponderance of CMHC insured mortgages than other Canadian Banks. This means that potential losses in consumer loan portfolios would have a bigger impact on RY's credit metrics, earnings, and risk-weighted assets than some other Canadian banks. Should this risk become more evident a downgrade to peer levels is possible.
Fitch considers RY's capital ratios to be adequate, particularly given its earnings generation. However, the overall Basel III Common Equity Tier 1 (CET1) ratio of 9.9% is in the middle of the pack. Additionally Fitch would note that RY's risk-weighted assets (RWA) on its uninsured mortgage portfolio under the Basel III Advanced Approach is less conservative than some other peer Canadian banks who given their business model have a higher proportion of standardized RWA, and therefore total RWA, relative to their common equity.
This potentially makes RY's overall RWA more sensitive to any credit migration, should credit quality deteriorate, particularly in its uninsured mortgage portfolio. To the extent that this scenario pushes overall capital ratios lower, this could lead to a ratings downgrade to at least peer levels.
Finally, and as previously noted, Fitch continues to expect a slowdown in consumer banking and lending in Canada, which will likely reduce earnings from this segment. Given RY's growing contribution from its expanding capital markets business, , Fitch would expect capital markets revenue and earnings to proportionally become a larger part of RY's overall earnings mix partially offset by the CYN acquisition noted above.
While Fitch acknowledges that this could help to support earnings and benefit equity holders, the volatility of capital markets related earnings, would introduce higher levels of volatility to overall earnings, which Fitch views negatively from a credit perspective.
KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS
The affirmations of the RY's SRs and SRFs reflect Fitch's expectation that there remains an extremely high probability of support from the Canadian government ('AAA'; Stable Outlook) if required. This expectation reflects Canada's extremely high ability to support its banks especially given its financial flexibility, though propensity is becoming less certain.
Specific to RY, Fitch's view of support likelihood is based mostly on RY's systemic importance in Canada, significant concentration overall Canadian banking assets amongst the institutions noted above, which account for over 90% of banking assets, the large size of the banking system with banking assets at 2.1 times Canada's GDP, and the Canadian banks' position as key providers of financial services to the Canadian economy. The RY's IDRs and senior debt ratings do not benefit from support because its VRs are all currently above the SRFs.
However, in Fitch's view, there is a clear intention to reduce support for D-SIFI's in Canada, as demonstrated by commentary and actions from Canadian banking regulators seeking to protect tax payers from the risk of a large financial institution failing. This is further supported by the issuance of non-viability contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch believes this increases the likelihood of NVCC and potential senior debt losses if one or more of the Canadian Banks run afoul of solvency assessments.
RATING SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
Fitch is classifying Canada as a Path 2 country as defined in its September 2013 report, 'Bank Support: Likely Rating Paths', and given the factors noted above, Fitch expects there to be some level of support for the RY going forward, and as such does not expect the SR to be impacted.
The SRF ratings are more likely to be impacted and are sensitive to progress made in completing NVCC issuances and any additional regulatory initiatives that may be imposed on the Canadian D-SIFIs. 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 implementation.
Fitch expects that the continued regulatory action to ensure sufficient contingent capital will be implemented for all Canadian banks in the near term, but regardless of its finalization, Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to revise RY's SRFs to 'BBB-' at some point over the next twelve months.
Absent a material in change economic conditions or the companies' stand-alone credit profile, a revision of the SRFs to 'BBB-' would mean no change to RY's Long-term IDR and debt ratings because its viability ratings are all above the SRF.
KEY RATING DRIVERS - SUBORDINATED DEBT AND TRUST PREFERRED SECURITIES
Subordinated debt and trust preferred securities issued by RY and by various issuing vehicles, RBC Capital Trust are notched down from the banks' (or bank subsidiaries') VRs in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles.
Fitch notches these securities five notches from the RY's VR given management and regulatory authorities powers to suspend dividends.
KEY RATING SENSITIVITIES - 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:
Royal Bank of Canada
--Long-term IDR at 'AA'; Outlook Stable;
--VR 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 '1';
--Support Rating Floor at 'A-'.
RBC Capital Trust
--Preferred stock at 'BBB+'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (January 2014)
--'The Evolving Dynamics of Support for Banks' (September 2013)
--'Bank Support: Likely Rating Paths' (September 2013)
--'2015 Outlook: Canadian Banks' (December 2014)
--'Assessing and Rating Bank Subordinated and Hybrid Securities' (January 2014).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
The Evolving Dynamics of Support for Banks
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000
Bank Support: Likely Rating Paths
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715001
2015 Outlook: Canadian Banks (Stable Rating Outlook, Negative Sector Outlook Remains for 2015)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=810389
Assessing and Rating Bank Subordinated and Hybrid Securities Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732137
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978298
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