DBRS Limited (Morningstar DBRS) confirmed its credit ratings on Royal Bank of Canada (RBC or the Bank) and its related entities, including RBC's Long-Term Issuer Rating of AA (high) and Short-Term Issuer Rating of R-1 (high).
The trends on all credit ratings are Stable. RBC's Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA and a Support Assessment of SA2, which reflect the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend). As a result of the SA2 designation, the Bank's Long-Term Issuer Rating benefits from a one-notch uplift to the Bank's IA.
KEY CREDIT RATING CONSIDERATIONS
The credit ratings and Stable trends recognize RBC's leading and highly diversified franchise in Canada, further strengthened by its acquisition of HSBC Bank Canada (HSBC Canada). Additionally, RBC has a U.S. presence through City National Bank (CNB; wholly owned U.S. banking subsidiary), along with global capabilities and reach through a number of other strong businesses, including capital markets and wealth. RBC is geographically diverse with approximately one-third of its F2023 earnings outside of Canada. While historically well managed, the Bank's large capital markets business creates the potential for earnings volatility. Additionally, CNB recorded an unexpected net loss in F2023, with profitability headwinds resulting from the rapid increase in interest rates, which drove higher deposit funding costs aside from its already elevated level of noninterest expenses. Although RBC has historically exhibited strong risk management and credit fundamentals, CNB's risk management and compliance capabilities have not been commensurate with its rapid growth. As a result, remediation efforts are currently under way at CNB to address the operational risk management and internal controls deficiencies noted as part of the cease-and-desist order from the Office of the Comptroller of the Currency (OCC) issued on January 31, 2024. Nonetheless, RBC recently fortified CNB's balance sheet and Morningstar DBRS believes the Bank has ample liquidity and sufficient capital to rectify the identified issues at this important growth vehicle for the Bank.
The credit ratings also consider the challenging macroeconomic and geopolitical environments, which could lead to an adverse impact on profitability and asset quality. Morningstar DBRS remains concerned about the commercial real estate (CRE) market, particularly the U.S. office sector, along with the combination of highly leveraged Canadian consumers, elevated home prices (particularly in the greater Toronto and Vancouver areas), persistent inflation, and materially higher borrowing costs that are eating into consumers' disposable income. Morningstar DBRS believes that the CRE office sector and housing prices remain somewhat vulnerable and, as a result, views RBC, like its Canadian bank peers, as susceptible to any material adverse changes in these markets. Positively, RBC has maintained its prudent underwriting standards, reflecting the Bank's strong credit risk culture.
CREDIT RATING DRIVERS
Given RBC's high credit rating level and current risk profile, a credit ratings upgrade is unlikely. A credit ratings downgrade would occur if identified operational risk challenges and systemic deficiencies in internal controls and risk management at CNB endured extended remediation timelines or became more pronounced across RBC. A sustained deterioration in earnings or asset quality would also result in a downgrade of the credit ratings.
CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Very Strong
RBC is the largest bank in Canada by both total assets and market capitalization. The Bank operates a significant North American presence, led by its dominant Canadian banking franchise with first or second market positions across its core products. In the U.S., RBC has multiple platforms for growth; however, RBC will be moderating growth at CNB while it looks to optimize the risk/return profile of its customer relationships while making investments to strengthen its operational infrastructure and remediate certain nonfinancial risks. A number of RBC's business lines have global capabilities and reach, especially capital markets and wealth management. The Bank benefits from its broad distribution channels and brand, which continue to provide growth opportunities outside Canada.
Earnings Combined Building Block (BB) Assessment: Strong
RBC has a diversified earnings base, driven by Personal and Commercial Banking (53% of F2023 earnings), Capital Markets (26%), Wealth Management (16%), and Insurance (5%). RBC consistently produces solid profitability, garnered through its highly diversified revenue streams (F2023: 45% net interest income/55% noninterest income). F2023 earnings (as initially reported under IFRS 4) of $14.9 billion decreased 6% year-over-year as strong growth in net interest income and noninterest income was more than offset by higher provisions for credit losses (PCL) and noninterest expense. Q1 2024 net income decreased 9% quarter-over-quarter (QOQ) to $3.6 billion, as solid noninterest income growth was more than offset by a reduction in net interest income and higher PCL. In F2024, Morningstar DBRS expects an improvement in operating leverage with moderating net interest margin expansion.
Risk Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views RBC's risk profile as somewhat elevated relative to its peers because of its relatively large capital markets presence and adjusted leveraged lending exposure (but well diversified by industry/sector). These concentrations have historically been well managed. Credit quality has normalized and is now beyond pre-coronavirus pandemic levels. In Q1 2024, the PCL ratio increased 3 basis points (bps) QOQ to 37 bps, while the allowance coverage (ACL) of 64 bps was up 3 bps QOQ and remains elevated. CRE and the U.S. office sector represent a manageable 9.7% and 0.6%, respectively, of total loans and acceptances (L&A). CRE exposure is well diversified by geography, business, and property type, with CRE ACL on performing loans approximately three times higher than pre-pandemic levels and four times higher in the U.S. than in Canada. RBC's Canadian real estate secured lending (RESL) portfolio represents approximately half of total L&A, at the higher end of the peer range. The Bank's RESL portfolio is of high quality with an uninsured average FICO score of 806 and an uninsured current loan-to-value ratio of 50%, providing a substantial buffer if property values declined.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views RBC as having strong levels of on balance sheet liquidity and a very strong deposit franchise in Canada that is diverse and broad-based (personal deposits represent approximately one-third of total deposits). However, the deposit mix continues to experience a shift from demand to higher-cost term deposits as clients search for yield in the higher for longer interest rate environment. Augmenting its substantial deposit funding, RBC enjoys extensive access to wholesale funding sources that are well diversified across a variety of markets, products, currencies, and investor segments. RBC's liquidity profile remains strong as at January 31, 2024, with a liquidity coverage ratio of 132% and a net stable funding ratio of 113%, both comfortably exceeding the regulatory minimum thresholds of 100%.
Capitalisation Combined Building Block (BB) Assessment: Strong
Morningstar DBRS views RBC's capitalization as strong, supported by significant internal capital generation. At January 31, 2024, RBC's CET1 ratio was solid at 14.9%. However, the CET1 ratio is expected to reduce to approximately 12.5% in Q2 2024, reflecting the HSBC Canada acquisition, partly offset by net organic capital accretion and benefits from the dividend reinvestment plan (DRIP). Following the payment of the dividend on February 23, 2024, the 2% DRIP discount was stopped. As of January 31, 2024, the Bank's total loss-absorbing capacity as a percentage of risk-weighted assets increased 40 bps QOQ to 31.4% and the leverage ratio was 4.4%, both well above the regulatory minimums and in line with its Canadian bank peers.
Further details on the Scorecard Indicators and Building Block Assessments can be found https://www.dbrsmorningstar.com/research/432635.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Governance (G) Factors
Morningstar DBRS finds the Corporate/Transaction Governance factor is relevant to the credit rating but does not change the assigned credit ratings or trends. On January 31, 2024, the OCC imposed a U.S. $65 million fine against CNB, along with a cease-and-desist order, related to 'systemic deficiencies in operational risk management and internal controls.' CNB is actively working on corrective actions to improve its strategic plan, operational risk management, compliance risk management, and investment management practices. This was preceded by an administrative fine of $7.475 million on November 3, 2023, from the Financial Transactions and Reports Analysis Centre of Canada related to noncompliance with anti-money laundering and terrorist financing measures following a compliance examination in 2022. As a result, this factor is incorporated into RBC's Risk Profile grid grades. This factor is new and was not present in the prior credit rating disclosure and reflects the material developments following the previous credit review.
There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.
Notes:
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (April 15, 2024; https://dbrs.morningstar.com/research/431155). In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024; https://dbrs.morningstar.com/research/427030) in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at https://dbrs.morningstar.com.
The credit ratings were initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for these credit rating actions.
Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.
These are solicited credit ratings.
These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed credit ratings:
The last credit rating action on this issuer took place on May 12, 2023, when Morningstar DBRS confirmed the Bank's credit ratings.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.
For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
Lead Analyst: Carl De Souza, Senior Vice President, Sector Lead, North American Financial Institution Ratings
Rating Committee Chair: Michael Driscoll, Managing Director, North American Financial Institution Ratings
Initial Rating Date: April 1, 1976
For more information on this credit or on this industry, visit https://dbrs.morningstar.com.
DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577
ROYAL BANK OF CANADA 
