RBC on Sidelines for Takeovers, Buybacks After City National

  • Deal may push Royal Bank's capital level to lowest among peers
  • RBC may be named global systemically important bank by FSB

Royal Bank of Canada’s $5 billion purchase of City National Corp., its largest-ever takeover, is forecast to put the lender on the sidelines for further acquisitions and share buybacks until it can rebuild capital to levels that satisfy regulators.

Royal Bank, the country’s second-largest lender by assets, will have the lowest capital strength among the biggest Canadian banks after its takeover of Los Angeles-based City National, analysts including Scotia Capital’s Sumit Malhotra said. The Toronto-based lender could face further capital requirements if global regulators designate Royal Bank as systemically important this week.

"We’ve got a plan to rebuild our capital to that target ratio that we had before," Royal Bank Chief Executive Officer David McKay said in a Monday phone interview. "It’s going to take us quarters, not years, and it’s a very reasonable plan and it will have, hopefully by the end of 2016 -- which is very soon -- all the capital deployment capabilities that we have today."

Takeover Closed

Royal Bank, which today closed its City National takeover, said in September its common equity Tier 1 capital ratio could be about 9.5 percent after completing the deal, compared with 10.1 percent as of July 31. Canada’s six-largest lenders averaged 10.2 percent as of July 31. Tier 1 capital consists of a bank’s common equity, including cash reserves, and qualifying preferred stock, all of which absorb losses when a bank is in financial stress.

The final price for City National, which was paid with $2.6 billion cash and 41.6 million of RBC shares, is lower than the announced value of $5.4 billion in January, according to a Monday statement. The transaction is expected to reduce its capital level by 70 basis points for the quarter ended Jan. 31 and the bank “continues to forecast a strong capital position going forward,” Royal Bank said.

“To make a strategic acquisition of this magnitude and be back to where we are two or three quarters from now" would be outstanding, McKay, 51, said.

‘Selective Acquisitions’

Royal Bank Chief Financial Officer Janice Fukakusa said in an Oct. 30 e-mailed statement that after City National’s close and “over the next number of quarters" the lender aims to lift its capital back up to approximately a 10 percent level. Royal Bank may look at buybacks or “selective acquisitions” after hitting that target, she said at a Sept. 17 banking conference.

“Buybacks and acquisitions would, in my view, be limited until Royal organically builds up its capital," Scotia Capital’s Malhotra said in a phone interview. "They would be somewhat hamstrung relative to peers in terms of capital deployment when the sector is already growth challenged."

Canadian banks have earned international recognition for their capital strength and for sidestepping the financial crisis, with the World Economic Forum ranking them the world’s soundest for eight straight years. That’s partly due to Canada’s banking regulator, which pushed lenders to bolster capital buffers ahead of deadlines by international watchdog agencies.

Capital Deployment

Canada’s Office of the Superintendent of Financial Institutions told banks in March 2013 that they’re systemically important domestically and need to reserve an additional 1 percent of risk-weighted capital by 2016 to safeguard against failure. That added to OSFI’s requirement that lenders hold at least 7 percent core Tier 1 capital by January 2016.

"Whatever the official rules are, there seems to be a moving buffer in terms of what the actual level required is to actually be able to undertake capital deployment," Malhotra said. "Ten percent seems to be the magic level -- for now."

Royal Bank also faces the prospect of being named a globally systemically important bank, or G-SIB, by the Financial Stability Board, which may require the lender to hold an additional 1 percent of capital or more above Basel levels.

“Irrespective of whether we are or aren’t on the list, we do not believe it would have a material impact to our capital ratios," Royal Bank’s McKay said.

OSFI Impact

OSFI hasn’t said if such a designation would mean additional requirements above the Canadian regulator’s demands. Annik Faucher, spokeswoman for the regulator, said in an Oct. 22 e-mailed statement that if a Canadian bank was designated a G-SIB, OSFI would communicate additional requirements, if any.

Royal Bank shares fell 0.4 percent at 12 p.m. trading in Toronto, on par with the decline of the eight-company Standard & Poor’s/TSX Commercial Banks Index.

Running too close to regulatory requirements -- especially amid stock market volatility -- prompted National Bank of Canada to sell C$300 million ($227 million) of shares last month to bolster its balance sheet. The Montreal-based lender’s stock dropped 5.3 percent the day after announcing the share sale. Canada’s sixth-largest lender said the sale would increase its regulatory capital ratio to 9.8 percent at the end of October.

‘Wiggle Room’

Royal Bank will face pressure to boost its balance sheet since a 9.5 percent capital ratio over time will be viewed as low by creditors and regulators, said David Beattie, a senior vice president for Moody’s Investor Services.

“It doesn’t leave a lot of wiggle room,” Beattie said in an Oct. 22 phone interview. “We would not be surprised if there were various regulatory pressures to increase that level of common equity Tier 1 over the medium term."

Halting further acquisitions wouldn’t be a bad thing for Royal Bank, said Barry Schwartz, chief investment officer at Baskin Wealth Management in Toronto.

“A year of hibernating and growing earnings and plowing that into the share capital is not the worst thing in the world,” Schwartz said in a Oct. 23 phone interview.

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