RBC is confident it can turn around City National, but not right away

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Royal Bank of Canada's business fortunes are a tale of two countries: strong growth in Canada and significant challenges in the United States.

But RBC executives expressed optimism Wednesday that new leadership will turn around the unit that's been the source of the company's U.S. struggles — its City National Bank franchise, which has recently fared much worse than its stateside wealth management and capital markets operations.

Los Angeles-based City National eked out an $88 million profit last quarter after removing some one-time items, such as increased deposit-insurance payments to help pay for the failure of three regional banks last year. Including those items, the bank lost $22 million, which was still a significant improvement from a $247 million loss three months earlier.

After RBC acquired City National in 2015, the U.S. unit may have emphasized growth over profitability "a little too strongly," RBC CEO Dave McKay acknowledged during an earnings call Wednesday.

"I think our growth outstripped our operational capability," McKay said while reflecting on City National's "tough year" in 2023.

To underline that point, the Toronto-based company's earnings presentation highlighted that City National's assets grew from $39 billion in 2016 to $96 billion this year.

In November, RBC demoted Kelly Coffey from her role as City National's CEO and hired veteran bank CEO Greg Carmichael as City National's executive chairman. Carmichael is the former head of Cincinnati-based Fifth Third Bancorp, and prior to joining City National last year, he was tapped to run the remaining operations of the failed Signature Bank.

At City National, Carmichael has very quickly "built a strong team," McKay told analysts. The benefits may not be fully visible this year, but McKay said RBC is "feeling really good" about the medium-term prospects.

"When we look at our cost trajectory, revenue opportunities, repositioning of assets, we feel confident of generating strong returns out of this business again in 2025," McKay said.

The story was different in RBC's Canada operations, where the company had a "strong start to the year," Jefferies analyst John Aiken wrote in a note to clients. The bank is poised for further growth due to its still-pending acquisition of HSBC's Canadian banking unit.

Aiken wrote that RBC's effort to turn around City National "appears to be bearing fruit, relieving one of the few negatives that could be pointed to within its operations."

City National's problems stem partly from its decision to buy up a sizable amount of bonds when ultra-low interest rates meant bonds paid very little. As soon as interest rates started rising, those low-paying bonds became far less valuable, and the bank racked up significant "unrealized" losses. 

In October, the Canadian bank reworked City National's balance sheet and pumped capital into its struggling U.S. bank. The bank has also bought new bonds at today's much higher interest rates, helping to improve its profitability.

City National's net interest margin rose to 2.98% last quarter, up from 2.78% a quarter earlier, as higher interest payments from the new bonds boosted its interest income. Even so, RBC Chief Financial Officer Nadine Ahn said that rising deposit costs at City National "continued to be a headwind," with the bank needing to shell out more money to its depositors and thus seeing its interest expenses rise.

City National has long been known as the "bank to the stars" due to its Hollywood ties. But its well-heeled clients proved to be a pain point when rising rates prompted depositors to either demand higher payments or take their money elsewhere.

First Republic Bank, another California bank that catered to a similar clientele, failed last year after experiencing major deposit outflows during the springtime banking crisis. City National did not suffer from similar deposit flight, but it did have to borrow from more expensive funding sources last year.

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Adding to the bank's troubles is its standing with regulators. The Office of the Comptroller of the Currency recently hit City National with a $65 million fine, citing wide-ranging deficiencies in its risk management and forcing it to make a series of upgrades. 

Those issues contributed to higher expenses at RBC, which said Wednesday that it was spending more money to "enhance City National's operational infrastructure."

City National's spending on "professional fees" has roughly tripled since 2021, the bank said in an earnings presentation. Notwithstanding recent layoffs at the U.S. unit, staff in City National's risk management, compliance and internal audit functions have doubled to more than 800 full-time employees.