Thursday, June 02, 2005

Analysts Puzzle Over RBC Numbers; Explanations Insufficient

Financial Post, Barbara Shecter, 2 June 2005

In an industry whose analysts frequently complain about murky financial disclosure, Royal Bank of Canada is making a name for itself as the bank least likely to be clear in explaining its performance.

The latest issue riling those who track the banking industry is Royal's level of disclosure about how the bank increased its market share and interest margins for personal loans and deposits.

Analysts are puzzled about how Royal was able to do this in an extremely competitive marketplace in which Canada's other big banks were unable to do the same.

All the banks have recently been offering discounts to posted mortgage rates and higher interest rates on short-term deposits to defend their market shares.

But the effect is to compress the difference between the two rates -- which is in other words the margin, or return, for the bank. For example, Bank of Montreal's retail net interest margin fell to 2.64% in its second fiscal quarter, from 2.68% in the first fiscal quarter. All the other banks showed declines as well.

Except for Royal, which showed an improvement to 3.20% from 3.16%, according to research from First Associates Investments Inc. It's all the more puzzling because Royal will not clearly explain why its numbers improved.

Explanations offered during the quarterly conference call "were many and they seemed mostly contradictory," said Quentin Broad, an analyst at CIBC World Markets, in a research note.

Royal's management said the mix of the loan and deposit portfolio had shifted to include more higher-margin unsecured loans. But Mr. Broad suggested Royal might have improved its numbers by taking on additional risk. It may have shifted the loan mix in favour of unsecured loans which are harder to collect on if they turn sour. This might lead to higher retail credit losses. "While we have not jumped to any conclusions, we will watch the migration of retail credit losses very closely."

Mr. Broad warned that investors will not reward Royal with higher valuations and that the stock may not rise further because of "the challenges of measuring the bank's performance given its current disclosure levels."

David Moorcroft, a spokesman for Royal Bank, said the needs of analysts must be weighed against the danger of disclosing the secrets of the bank's success to competitors.

But details about the trend in margins is just the latest disclosure issue at Royal that is troubling analysts.

Last quarter, Royal began reporting its results in three geographic divisions rather than the five used previously. Analysts complained the new disclosure made comparisons with previous results difficult, particularly for the U.S. operations.

Such comparisons are crucial because Royal has spent US$5.5-billion to buy companies in the U.S. in what now appears to be a stalled effort to build a full-fledged financial services company there. Analysts want to track the results to gauge the likelihood of Royal bulking up with additional assets or selling the operations.

The latest twist in this issue happened in last week's second-quarter results, where goodwill from U.S. acquisitions was shifted to the Canadian businesses, as an accounting consequence of the new reporting structure.

Just over 70% of the $3.1-billion of goodwill associated with the purchases of U.S. retail bank Centura and securities firm Dain Rauscher, is now attributed to the Canadian operations.

"We believe the return ratios [now] presented for the U.S. operations are not representative of reality since the common equity allocated to it is not representative of the money invested in these operations," Darko Mihelic, an analyst at First Associates, wrote in a note to investors. "Management appeared to agree with our view on this and assured us that they do not evaluate the returns of their divisions based on these accounting allocations (even though their [second quarter] report says that they do use these measures)."

Royal Bank executives have also cautioned against using regulatory filings. That may sound confusing, but what it means is the bank is "effectively suggesting there is no meaningful way to evaluate [the] U.S. results with published data," he said.

On a positive note for analysts, Royal recently joined Canada's other big banks in using Canadian accounting rules Generally Accepted Accounting Principles as the primary financial reporting standard. Analysts had criticized the use of U.S. GAAP because only a small portion of Royal's investors reside in the U.S.