RBC Chases Rich and Famous in U.S. Banking Do-Over

Royal Bank of Canada's decision to reenter U.S. banking with a focus on affluent customers says a lot about the overall industry's trajectory.

The Toronto company agreed Thursday to buy City National, a storied $33 billion-asset company that has spent decades serving the high-net-worth crowd in cities like Los Angeles, New York and San Francisco, while catering to the entertainment industry.

Royal Bank's bold move — the deal is valued at $5.4 billion — comes less than three years after management sold its retail banking operations in the Southeastern United States to PNC Financial Services Group. But in today's regulatory and technological environment, it is difficult to build a successful retail franchise, industry observers said.

So Royal Bank's admitted two-year courtship of City National, a highly specialized player, makes sense.

"If you want to enter the highly regulated U.S. banking market, you want to pick the right dance partner," said Brian Klock, an analyst at Keefe, Bruyette & Woods. "You want a strong management team, a strong franchise and a target that is in businesses where there isn't higher risk. Commercial banking and wealth management are businesses that don't bring the risk that consumer businesses do."

Royal Bank is paying 270% of City National's tangible book value, a high price, particularly for a deal that will likely face considerable regulatory scrutiny on both sides of the border. Still, several analysts returned to the same points: Royal Bank is paying a premium price for a premium franchise that will allow it to return to the United States with limited risk.

"It seems to make sense that Royal would target the West Coast," since Toronto-Dominion Bank is along the East Coast and Bank of Montreal is rooted in the Midwest, said Dan Werner, an analyst at Morningstar. This deal lets Royal Bank "ride the coattails of coastal growth, but in a targeted way."

City National "is a nice asset and it is not huge," Werner said, calling the deal a "measured foray back into the U.S."

Royal Bank's reentry possibly makes more sense than the routes other Canadian banks have taken in the United States, said Alois Pirker, research director in wealth management at Aite Group.

(Royal Bank also had an ill-fated entry into U.S. banking, buying Centura Banks in 2001, followed by deals in Alabama, Florida and Georgia. Those operations were part of the sale to PNC.)

"The deal clearly speaks to deep pockets of Canadian banks, and it speaks to the amount of opportunity they see in the U.S.," Pirker said. "Some of the others have such a complex construction, but this is much more focused on a specific product."

Royal Bank did not make any executives available for interviews, and City National did not respond to a request for an interview. During a conference call, Dave McKay, Royal Bank's chief executive, repeatedly noted that opportunities exist to leverage City National's expertise with RBC's existing U.S. wealth and asset management and investment banking operations. The deal also represents a chance to enter high-growth markets brimming with one-percenters.

City National "is strategically positioned in the largest and most attractive U.S. markets, such as New York, Los Angeles and the San Francisco Bay area," McKay said. "In fact, the combined high-net-worth population of these three markets is over 4.5 times the entire high-net-worth population of Canada."

A niche focus, combined with City National's geography, made the company a compelling acquisition candidate, said Jeff Davis, managing director of the financial institutions group at Mercer Capital.

"City National has the right mix and is blessed to be doing it where it does," Davis said. "It really speaks to the challenges of traditional banks. It is a very challenging environment for banks that are simply living on the spread."

Noninterest income made up 31% of City National's 2014 revenue, a percentage that is higher than many community and regional banks.

Still, analysts said City National's appeal involves more than just its wealth management prowess. The company is asset sensitive — 63% of its deposits are noninterest bearing — which has the potential to benefit Royal Bank greatly when interest rates rise.

"If those deposits are going to be held at zero, while you have the ability to reprice maybe 80% of the loans, you can see how they're going to benefit hugely — and probably quicker — than a lot of the U.S. banks," Werner said.

City National has also created a significant niche in the entertainment industry, which offers Royal Bank another opportunity to differentiate itself, said Tim Coffey, an analyst at FIG Partners.

"This is the bank where Frank Sinatra went to get the cash to pay the ransom when his son was kidnapped," Coffey said. "It has a rich history."