RBC completes ‘milestone’ deal for U.S.-based bank City National

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Royal Bank of Canada has completed its $5-billion (U.S.) acquisition of Los Angeles-based City National Corp., setting into motion RBC's ambitious strategy for building a much larger presence in the United States and Britain.

The deal with City National, a private and commercial bank focused on high-net-worth customers in California and New York, brings $35-billion in assets that have been growing at a double-digit clip.

But the acquisition is not without challenges, largely related to the health of the U.S. economy, the direction of interest rates and the impact on RBC's capital requirements.

Since the deal was announced in January, RBC has gone to great lengths to explain to investors that the acquisition – the bank's largest to date – is by no means an effort to revisit its failed U.S. retail-banking strategy, which it sold in 2011.

Instead, it sees City National as a strategy focused on high-net-worth and commercial clients, with a strong potential for expansion. RBC expects that the bank can generate significantly stronger growth in the years ahead with assistance from RBC's larger assets and strong capital-markets capabilities.

"They've nurtured and grown a number of high-tech and entertainment franchises that have grown up and gone to Goldman Sachs and JPMorgan for that larger, full-service universal bank capability," said Dave McKay, RBC's chief executive officer.

With RBC's assistance, he believes, City National can now hold on to these clients and win some back. It can also expand into more U.S. cities as well as into Britain, making it a powerful vehicle for expansion as RBC seeks to diversify its earnings beyond Canada, where economic activity is slow.

"When you bring those two franchises together, we really do believe that this is an opportunity to create a new leader in private banking, wealth, high-net-worth and commercial segments in the U.S. marketplace," Mr. McKay said

These longer-term ambitions come with near-term costs, though.

RBC said the deal, valued slightly below the original price tag of $5.4-billion announced in January, will reduce its common equity tier 1 ratio – a measure of financial strength watched closely by regulators – by 70 basis points or 0.7 percentage points.

RBC believes that its profits can rebuild capital over the coming quarters to return the ratio back toward its target of 10 per cent, but it would have to hold off on share buybacks.

"When I talk to our shareholders, and particularly our large shareholders, they have a long-term view," Mr. McKay said. "They're thinking in years, and therefore they look at the opportunity for RBC to grow in the U.S. market. This is an exciting transaction that transcends what's going to happen over the next two quarters."

RBC is scheduled to report its fiscal fourth-quarter results on Dec. 2. Since the start of the year, its shares have slumped more than 7 per cent, which is in line with its peers.

Apart from its fast-growing high-net-worth client base, City National has also been seen as an ideal play on rising interest rates, with profits expected to rise when the U.S. Federal Reserve starts to normalize monetary policy.

However, the Fed has maintained its key rate at close to zero per cent for much longer than economists had expected, because of uncertainty about the U.S. economic recovery. It held off on rate hikes at the conclusion of its most recent policy meeting, putting into limbo any hopes that rates will rise soon.

"City National does have significant leverage to higher rates; it's very much a part of their financial profile," Mr. McKay said. "As rates normalize within Western markets, there is a significant earnings opportunity that is certainly factored into our overall evaluation."