Monday, March 06, 2006

RBC Maintained Outperform at Scotia Capital

  
Scotia Capital, 6 March 2006

Strong First Quarter Earnings - Better than Expected

• Royal Bank reported Q1/06 cash operating earnings of $1.76 per share, an increase of 16% from $1.52 per share a year earlier, ahead of expectations. Cash operating ROE was 23.6% with RRWA of 2.27%.
• Reported cash EPS was $1.80 which included a number of other items that are highlighted in Exhibit 2.
• First quarter earnings were driven by strong although not exceptional trading revenue and strong operating performance in retail and wealth management. We view RY as having the strongest core earnings of the bank group.
• The bank announced a 13% increase in its common dividend to $2.88 per share from $2.56 per share with payout ratio of 41% on first quarter earnings.
• RY also announced a stock dividend which has the same effect of a two-for-one stock split. RY's common shares are expected to begin trading on a post-stock dividend basis on the Toronto Exchange on March 23, 2006.

Strong Retail & Wealth Management Earnings

• Canadian Personal and Business (P&B) earnings increased 3% QOQ and 22% YOY to $731 million (excluding hurricane-related charges of $61 million) The year over year increase in Q1 earnings reflected higher revenue growth across all business lines and strong volume growth in mortgages, personal loans, and credit cards.
• Insurance revenue increased 11% YOY and 8% QOQ to $858 million.
• Mutual fund revenue increased 16% to $261 million from a year earlier and was flat quarter over quarter. Mutual fund assets as of the end of the first quarter, as reported by IFIC, increased 28% YOY to $61 billion.
• The 6% increase in Canadian P&B non-interest expenses was mainly due to higher variable and stock based compensation.

Canadian Retail NIM Declines 2 bp Sequentially

• Canadian retail NIM declined 2 bp sequentially to 3.19% with competitive mortgage pricing and lower mortgage prepayment interest penalties. However, the retail margin actually improved 5 bp YOY reflecting the stabilization of the margin over the past seven quarters.

US & International P&B Earnings Muted By Higher Expenses and Strong Canadian Dollar

• US & International Personal and Business earnings declined 14% QOQ and 2% YOY to $111 million. Solid growth in wealth management revenues was offset by higher stock based compensation expenses which contributed to an 11% increase in non-interest expenses QOQ. The strong Canadian dollar also reduced earnings contribution.

RBC Capital Markets Earnings Increase 20% YOY

• RBC Capital markets earnings increased 20% YOY to $317 million (excluding the $50 million general allowance reversal and $16 million charge for the transfer of Institutional and Investor Services to RBC Dexia IS). Strong earnings growth was driven by trading revenue.

Trading Revenue Strong But Not Exceptional

• Trading revenue was solid, increasing 45% QOQ to $465 million but was down from high trading revenue of $506 million a year earlier.
• Trading revenue averaged $433 million in the previous eight quarters. Trading revenue in the quarter was $32 million or 7% higher than the average of the previous eight quarters adding an incremental $0.03 per share to earnings.
• Trading revenue was strong but not as exceptional as it was at BMO and BNS.

Capital Markets Revenue

• Capital Markets revenue was $528 million, flat from the previous quarter and down 5% from a year earlier.

Strong Operating Leverage

• Revenue growth for RY was 5% on a year over basis while expenses grew by 2% with loan loss provisions down 10%.

Security Gains Modest

• Security gains were $43 million or $0.04 per share versus $0.01 per share in the previous quarter and $0.01 a year earlier.
• Unrealized security surplus was $62 million, versus $70 million in the previous quarter and $389 million a year earlier.

LLPs Decline

• Specific Loan Loss Provisions (LLPs) declined to $97 million (excluding $50 million general allowance reversal) or 0.19% of loans, versus $103 million or 0.21% of loans in the previous quarter and $108 million or 0.24% of loans a year earlier.
• We are reducing our 2006 LLP estimate to $450 million or 0.22% of loans from $550 million or 0.27% of loans.
• Gross Impaired Loans (GILs) increased to $800 million from $774 million in the previous quarter but were down from $1,053 million a year earlier.

Tier 1 ratio

• Tier 1 Capital was 9.5% at quarter end versus 9.6% at previous quarter end, and 9.2% a year earlier.
• The common equity to risk weighted assets (CE/RWA) ratio was 9.6% compared to 9.7% in the previous quarter, and 9.7% a year earlier.

Share Buybacks - Modest

• RY repurchased 2,200,000 shares in the quarter at an average cost of $87.73 per share for $193 million. Its current repurchase program of 10 million shares commenced on June 24, 2005, and expires on June 23, 2006.

Earnings Estimates Increased

• We are increasing our 2006 and 2007 earnings estimates to $6.80 per share and $7.50 per share from $6.60 per share and $7.25 per share, respectively, reflecting strong earnings momentum in retail, wealth management, higher trading revenue, and lower loan loss provisions.
• We are increasing our 12-month share price target to $115 from $110, based on our higher earnings forecast, representing 16.9x our 2006 earnings estimate and 15.3x our 2007 earnings estimate.

Maintain 1-Sector Outperform

• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on relatively high ROE, strong capital levels and strength in its retail, wealth management and capital market platforms. We believe that RY produced the strongest core earnings of the bank group in the first quarter and its P/E multiple will return to a 10-15% premium, the level it traded at prior to its U.S. expansion difficulties.
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