Monday, August 28, 2006

RBC Q3 2006 Earnings

Toronto Star
BMO Capital Markets, 28 August 2006

Details & Analysis

Royal Bank reported third quarter cash earnings of $1.18 billion, or $0.91 per share, compared to $1.13 billion, or $0.86 per share, in the last quarter, and $988 million, or $0.76 per share in the same quarter of last year. The previous quarters include one-time items and all three quarters include the negative impact of discontinued operations. As such, the appropriate comparison is $0.92 per share in this quarter, $0.86 per share in the last quarter, and $0.77 per share in the same quarter of last year. Results were ahead of our expectations of $0.85 due largely to lower loan losses and higher trading revenues.

Overall, Royal has again shown its great diversity. ROE was 23%, EPS grew 19% and credit was excellent. We are modestly raising our forecasts for 2007. The one weakness was the fact that much of the year-over-year earnings growth was driven by much higher trading and lower loan losses.

The bank's credit position remained strong. Gross and net impaired loans were essentially unchanged over the quarter. Loan loss provisions of $99 million were lower than expected and came from both the retail and wholesale operations. In Canadian Personal and Business Banking, after an extended period of higher loan losses, loan impairments in the personal book moderated markedly. This is a very positive development and, if sustainable, suggests a somewhat lower structural level of losses than we have forecast.

From a capital perspective, Royal's Tier 1 increased marginally from 9.5% in the last quarter to 9.6% this quarter. Risk-weighted assets increased by roughly $8 billion, offset by a $300 million preferred share issue in July. Royal was relatively aggressive in repurchasing its stock this quarter - 5.5 million shares under its normal course issuer bid. The bank also increased its quarterly dividend by $0.04 to $0.40, more than we had expected. Royal Bank, along with National Bank, has been most prepared to return excess capital to shareholders.

Projections & Valuation

We are increasing our Cash EPS estimates by $0.10 in each of 2006 and 2007 - to $3.55 and $3.75 respectively. The higher earnings this year principally reflect the earnings surprise this quarter, while the increase for 2007 is based on our assumption of more moderate loan losses in Royal's domestic banking business.

This was clearly a very solid quarter for Royal. Domestic retail earnings were up 9% over the year - 15% if we exclude the one-time items. This is another solid result from Canada's biggest retail bank, well ahead of the BMO where the comparable growth was 8% and the TD where growth was 22%.

The only issue this quarter was that much of the growth in earnings came from lower loan losses and better trading. In addition, tax rates were modestly lower.

We maintain our Market Perform rating and $52 target price. This quarter again shows the strength of Royal's franchises. Domestic retail was strong, the U.S. and International business continues to improve from a low base and the Capital Markets business was again robust. The Bank continues to manage capital aggressively, but prudently. At current levels, we prefer investment in TD or CIBC. The former is beginning to benefit from extensive restructuring over the past few years, while the latter is quite cheap.
Scotia Capital, 28 August 2006

Extremely Strong Third Quarter Earnings – 20% YOY Growth

• Royal Bank (RY) reported extremely strong earnings of $0.91 per share, up 20% YOY from $0.76 per share a year earlier, better than expected. Earnings were driven by a 4 basis point (bp) improvement in retail net interest margin and strong trading revenue.

• All business segments experienced solid growth, with U.S. & International P&B earnings up 32%, RBC Capital Markets up 31% and Canadian P&B earnings up 9%.

• Cash ROE is expected to be an industry high at 23.3% versus 20.5% a year earlier. Return on risk-weighted assets was 2.18% versus 2.06% a year earlier.

• The bank increased its common dividend 11% to $1.60 per share, with a payout ratio of 44% based on 2006E EPS.

Solid Retail & Wealth Management Earnings

• Canadian Personal and Business (P&B) earnings grew 9% YOY to $743 million supported by Canadian retail NIM which improved 4 basis points (bp) QOQ and 4 bp YOY to 3.26%, and despite a 22% decline in Global Insurance earnings.

• Underlying earnings for Canadian P&B would have increased 21% YOY excluding Global insurance earnings and an accounting adjustment from a year earlier.

• Operating leverage in Canadian P&B was negative 2% mainly due to the Global insurance business. Excluding Global insurance, operating leverage at Canadian P&B would be 3% with revenue growing 9% YOY and expenses growing 6% YOY.

• Wealth Management revenue increased 21% YOY to $667 million with mutual fund revenue up 34% to $328 million, assisted by the Dexia transaction. Mutual fund assets (as reported by IFIC) increased 20% YOY to $64.3 billion.

• Personal Banking and Card & Payment revenues were up 6% YOY on solid volume growth, with residential mortgages up 14%, personal loan balances up 12% and credit card balances (including securitization) up 13%.

• Business and Commercial Banking revenue increased a modest 2% YOY to $541 million.

• Insurance revenue was $821 million, down 8% YOY from $888 million a year earlier due to the impact of the strong Canadian dollar on U.S. operations and lower annuity sales. Insurance policyholder benefits, claims and acquisitions expense also declined 8% YOY.

• Securitization revenue was $61 million, unchanged from the previous quarter and down 6% from $65 million a year earlier.

Canadian Retail NIM Improves 4 bp

• Canadian retail net interest margin (NIM) improved 4 basis points (bp) QOQ and YOY to 3.26% reflecting higher deposit and mortgage spreads.

U.S. & International P&B Earnings Increase 32% YOY

• U.S. & International P&B segment recorded strong growth at 32% to $121 million.

• Operating leverage was 1% with revenue flat YOY (although up 11% in U.S. dollars) and expenses down 1% (and up 10% in U.S. dollars). Wealth Management revenues were up 2% (or 13% in U.S. dollars) while Banking revenue declined 2% (although was up 8% in U.S. dollars).

• Loan loss provisions in this segment declined to $5 million from $18 million a year earlier, reflecting improved credit quality in the loan portfolio at RBC Centura.

RBC Capital Markets Earnings Exceptional

• RBC Capital Markets earnings were up 31% to $335 million reflecting higher trading revenue, and strong M&A activity.

• Operating leverage was 3% with revenues (teb) (excluding impact of VIEs) increasing 13% and expenses increasing 10% from a year earlier, mainly due to higher variable compensation.

Strong Trading Revenue

• Trading revenue remained strong at $537 million, only slightly below Q2 level of $586 million and compared to $376 million a year earlier. This quarter reflected extremely strong performance in equities offsetting some slightly weaker fixed income revenue versus the previous quarter.

• Equity trading revenue increased 27% QOQ to $171 million. Fixed income and foreign exchange revenues were weaker, declining 20% and 14% versus the previous quarter.

Capital Markets Revenue

• Capital Markets revenue was solid at $544 million, versus $606 million in the previous quarter and $525 million a year earlier with securities brokerage commission revenue up 6% to $291 million.

Total Bank Operating Leverage

• The Bank's total operating leverage was 1% with revenue growth of 6% and expense growth of 5%. Operating leverage was low mainly due to the weak results from Global Insurance. Excluding Global Insurance, operating leverage would be 4% with revenue growth at 9% and expense growth at 5%.

Security Gains Negligible

• Security gains were $11 million or $0.01 per share versus $22 million or $0.01 per share in the previous quarter and $33 million or $0.01 per share a year earlier.

• Unrealized security deficit improved in the third quarter to negative $49 million versus a deficit of $166 million in the previous quarter.

Loan Loss Provisions - Low at 18 bp

• Specific loan loss provisions (LLPs) remained low at $99 million or 0.18% of loans compared with $124 million or 0.25% of loans in the previous quarter and $128 million or 0.26% of loans a year earlier.

• We are reducing out 2006 LLP estimate to $425 million or 0.20% of loans from $450 million or 0.21% of loans. Our 2007 LLP estimate remains unchanged at $550 million or 0.26% of loans.

• Gross impaired loans (GILs) were $791 million compared to $793 million in the previous quarter and $866 million a year earlier. Net impaired loans (NILS) were negative $624 million versus negative $642 million in Q2/06 and negative $703 million a year earlier.

Tier 1 Ratio

• Tier 1 capital ratio was stable at 9.6% compared to 9.5% in the previous quarter.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.3%.

Share Buybacks

• During the quarter RY repurchased 5.5 million shares for $253 million or $46 per share. RY launched a new repurchase program on June 26, 2006 to repurchase up to 7 million or 0.5% of common shares outstanding, with 4.8 million shares already purchased.

RBC Centura to Acquire Flag Financial Corporation

• On August 9, RY announced that wholly owned subsidiary RBC Centura will acquire Flag Financial Corporation (Nasdaq: FLAG) and its bank subsidiary, Flag Bank for US$456 million, or US$25.50 per share. FLAG has 17 branches and 370 employees, serving Atlanta, central and western Georgia. RBC Centura already has 30 banking centres in Georgia, primarily in the Atlanta area.

• This acquisition is expected to be neutral to RY's EPS in Year 1. The transaction will be financed with cash, and is expected to close by the end of 2006, subject to regulatory and shareholder approval.

Earnings Estimates Increased

• We are increasing our 2006 and 2007 earnings estimates to $3.60 per share and $4.00 per share from $3.45 per share and $3.85 per share, respectively, reflecting strong earnings momentum in all business segments, strong trading revenue, and net interest margin improvement.

• Our 12-month share price target is unchanged at $58, representing 16.1x our 2006 earnings estimate and 14.5x our 2007 earnings estimate.

Reiterate 1-Sector Outperform

• We reiterate our 1-Sector Outperform rating on the shares of Royal Bank based on a high relative ROE, and strength in its retail, wealth management, and capital market platforms. RY is expected to produce the strongest core earnings this quarter and we believe its P/E multiple is on track to expand to a 10%-15% premium to the bank group.
Financial Post, Duncan Mavin, 26 August 2006

Royal Bank of Canada will not be rushed into buying up more banks in the United States to add to its RBC Centura franchise, chief executive Gord Nixon said yesterday after announcing record third-quarter profits at Canada's largest bank.

RBC reported earnings jumped 20% to $1.2-billion compared with $1-billion for the same period last year, while revenue grew 6% to $5.2-billion.

Cash earnings per share were 91 cents, compared with an average estimate of about 85 cents among Bay Street analysts.

Mr. Nixon said the bank's strong performance was a reflection of the successful execution of growth initiatives in North America.

Net income at RBC's U.S. operations increased 39% to $168-million compared with a year ago, and now represents more than 14% of total earnings. Also, during the quarter RBC announced the US$456-million acquisition of Atlanta-based Flag Financial Corp. However, Canada's largest bank is taking a cautious approach to further growth in the United States.

"I think we want to continue to grow patiently as opposed to grow aggressively," said Mr. Nixon, who explained that RBC's U.S. strategy involves opportunistic acquisitions and limited new branch openings.

RBC Centura has opened a fairly conservative 32 new branches in the past three years and is planning 12 or 16 more in the next 12 months.

The approach contrasts with that of rival Toronto-Dominion Bank.

Many U.S. banking industry observers have predicted a wave of consolidation in the sector as a difficult interest rate environment and intense competition takes its toll on smaller, regional banks in particular. TD executives have said the bank intends to take advantage of the tough conditions by targeting one or two regional banks each year to add to its Banknorth franchise in the north east U.S.

But Mr. Nixon warned that "the key issue" is how to achieve market share growth in the U.S. without impairing shareholder value, and he is prepared to bide his time for the right deal.

"There will continue to be opportunities in the United States for a long time," said Mr. Nixon. "The challenge will be opportunities that are reasonably priced and strategically attractive. They are few and far between."

Meanwhile, RBC's record third quarter was broadly in line with heightened expectations, coming after TD and Bank of Montreal had already reported strong results earlier in the week.

"At this point, TD's results stand as the strongest we have seen so far this quarter," said UBS Investment Research analyst Jason Bilodeau in a note.

RBC's earnings from core domestic retail banking grew an impressive 9% compared with last year but that fell short of the 14% growth reported by TD, he noted.

RBC also followed in the footsteps of TD and BMO by hiking its dividend, by 4 cents, or 11%, to 40 cents a common share.
The Globe and Mail, Sinclair Stewart, 26 August 2006

The trading team at Royal Bank of Canada produced huge numbers for the second consecutive quarter, surprising analysts and helping to power the bank to a 20-per-cent increase in profit.

RBC, the country's largest company by market capitalization, is viewed as the bellwether for the Canadian banks, and its results suggest the sector is well positioned to continue its impressive performance.

The bank reported third-quarter profit yesterday of $1.16-billion, or 90 cents a fully diluted share, up from $968-million or 74 cents a year ago.

Credit provided a big lift to RBC's bottom line, with loan-loss provisions accumulating at a far slower clip than Bay Street had been expecting. Provisions for soured loans were just $99-million, down from $128-million a year ago.

Domestic retail banking was also strong, much as it was for rival Toronto-Dominion Bank, thanks to a combination of improving profit margins and a heady appetite for consumer and business borrowing.

This was somewhat expected, however, given TD's results on Thursday. What was more of a surprise was the continued strength in RBC's trading platform, which is generating more than half a billion dollars' worth of revenue every three months.

In the third quarter, total trading revenue reached $537-million, an increase of 43 per cent from the same period in 2005. The results dipped from a record $586-million that RBC's trading operations produced during the second quarter, but not nearly as much as some analysts had forecast.

"Trading was extremely high," said one analyst who tracks the company. "$586-million is a monstrous number, $537-million is just a really, really huge number."

On a conference call with analysts yesterday, RBC said the trading unit benefited from increased market volatility during the quarter, as well as "business expansion."

The bank has taken pains to dismiss suggestions it could be assuming more market risk with its trading, and said that despite the stellar results, it is no more reliant on this business than it has been historically. Trading accounted for a little more than 10 per cent of the bank's total revenue in the first nine months of the year, the same percentage as three years ago.

RBC chief executive officer Gordon Nixon told analysts he was pleased with the performance of the U.S. retail bank, RBC Centura, which has rebounded following a period of poor performance, caused in part by a troubled mortgage unit. Its profit increased 39 per cent during the quarter to $111-million. "We think Centura has turned around," he said.

The improvement reignited RBC's U.S. expansion earlier this month when it acquired Flag Financial Corp. for $510-million. Mr. Nixon said the bank will continue to look for acquisitions, but acknowledged that reasonably priced, strategically situated targets are "few and far between."

On a cash basis, which analysts use to forecast profitability, RBC made 91 cents a share -- about 7 cents better than consensus estimates. The Canadian personal and business division made $742-million, up 9 per cent, while the investment bank made $329-million, up 29 per cent.

Even so, RBC shares sank yesterday amid a general selloff among the banks, as investors took money off the table following a two-month rally in the sector. RBC also raised its quarterly dividend yesterday by 4 cents a share to 40 cents.
RBC Capital Markets, 25 August 2006

• RY Beats Consensus Again. RY posted $0.92 cash EPS (excludes -1¢ from discontinued ops) for ~21% growth YoY, and well ahead of the $0.85 consensus. While the positive EPS variance was driven by stronger trading revenue and the low loan loss, it was acceleration in underlying domestic retail business that caught our attention upon deeper analysis. We estimate 9% reported YoY domestic retail profit growth was 16%, excluding a Q3/05 accounting gain, and was 22% excluding the decline in insurance contribution. This was an excellent result, matching TD.

• EPS and Price Target Adjustments. For the 6¢ Q3/06 variance, we are raising our EPS 2006 cash EPS estimate to $3.54 from $3.46 – our Q4/06 estimate is also up 1¢ to 87¢. Our 2007 estimate remains $3.94, and we are introducing a 2008 $4.41, indicated up 11-12%. Our price target remains $55.00 (target P/E remains 14x, at a 1 point premium to our sector target P/E of 13x). Reiterating Outperform rating.

• Credit Impressed Again. RY’s loan loss provision at $99MM this quarter compared to our estimate of $140MM and consensus of $150MM (nearly 3¢ EPS benefit versus consensus). Impaired loans were stable and the reserve-to-impaired loan coverage ratio was steady at 179%.

• Domestic Retail Bank Up 16% YoY, 22% Excluding Insurance. This was a solid result despite the specific market-sensitive weakness in retail insurance. Core retail product sales momentum remained very strong. Lower retail credit losses, down $28MM, tipped RBC divisional earnings growth positively. Expense growth at 6% YoY appeared to be high, but excluding the insurance operation, the retail bank actually generated 3 points of positive underlying operating leverage.

• Valuation for RY. Our $55 price target is set at 14x our 2007 cash EPS estimate of $3.94. Our premium target P/E is based on high-quality EPS revisions potential, what we believe to be best-in-class ROE and excellent credit performance. Our price target is indicated at ~3.0x our projected book value of $18.63 (as at Oct 31/07). RY continues to face some execution risk in its US operation as it undertakes ambitious cost savings and operating leverage programs. An over-sized Enron provision could pose a short-term risk to price performance, though we expect this risk is fairly well contained with the Q4/05 litigation reserve of US$500 million (pre-tax).
Report on Business Television, 25 August 2006

Click here for the ROBTv video clip,
of Janice Fukakusa (CFO, RBC) speaking about RBC's Q3 2006 Earnings.
Bloomberg, Sean B. Pasternak, 25 August 2006

Royal Bank of Canada, the country's biggest bank, said profit rose for the seventh straight quarter, led by its U.S. and international consumer bank.

Net income for the period ended July 31 rose 20 percent to a record C$1.18 billion ($1.07 billion), or 90 cents a share, from C$979 million, or 74 cents, a year earlier, the Toronto- based bank said today. Revenue rose 5.6 percent to C$5.21 billion.

Chief Executive Officer Gordon Nixon turned around the money-losing U.S. business by selling a mortgage unit and cutting about 500 jobs. Royal Bank is the third Canadian lender this week to beat analysts' estimates because of a surge in trading income and higher profit from consumer lending and capital markets.

"It looks to have been a smart move to get rid of the U.S. mortgage business," said Gavin Graham, director of investments at Guardian Group of Funds in Toronto, which manages about $5.3 billion including Royal Bank shares. ``The retail business is booming.''

Profit from U.S. and international consumer banking, which includes Raleigh, North Carolina-based RBC Centura, rose 39 percent to C$111 million. RBC Centura cut costs and targeted business clients in North Carolina, Florida and Georgia after a slowdown in the U.S. led to Royal Bank's first annual profit decline in four years in 2004.

"We've overhauled our business strategy," RBC Centura Chief Executive Office Scott Custer said in an Aug. 9 interview. ``We think we're on the right track, but in many ways, we've still got a long way to go.''

This month, the bank announced its first U.S. consumer bank acquisition in almost three years, agreeing to buy Atlanta-based Flag Financial Corp. for about $456 million. Royal Bank could make future purchases once Flag has been integrated, Chief Financial Officer Janice Fukakusa said.

"Our immediate focus is developing a banking platform that we can leverage," Fukakusa said today in a telephone interview.

Royal Bank shares fell along with other Canadian banks after rising 10 of the past 14 sessions. The stock fell 90 cents, or 1.8 percent, to C$49.80 in 4:10 p.m. trading on the Toronto Stock Exchange. They've risen 9.7 percent this year, double the gain for the 39-member S&P/TSX Financials Index. Bank of Nova Scotia and Bank of Montreal also declined.

Excluding one-time items, Royal Bank earned 91 cents a share, topping the 84-cent median estimate in a Bloomberg News survey of seven analysts. Robert Wessel, an analyst at National Bank Financial, also expected 84 cents a share on that basis. Trading fees were 8 cents to 10 cents a share higher than expected by Jason Bilodeau, an analyst at UBS Canada.

Canada's economy is benefiting from record prices for commodities such as oil and nickel, helping cut the jobless rate to a 30-year low. Transactions on the Toronto Stock Exchange rose 42 percent this year as the value of mergers in Canada climbed to a seven-year high. That contributed to a 29 percent increase in investment banking profit for Royal Bank, to C$329 million. Equity trading revenue rose 76 percent to C$171 million.

RBC Capital Markets leads all lenders in advising on Canadian mergers this year, according to data compiled by Bloomberg. The bank is working with Inco Ltd., the world's second-biggest nickel miner and the target of three takeover bids. The firm also ranks first for managing new stock sales this year.

Consumer banking profit in Canada rose 9.3 percent to C$742 million, driven by higher revenue from mutual funds, credit cards and mortgages. Insurance revenue declined 7.5 percent to C$821 million.

The bank boosted its quarterly dividend 11 percent to 40 cents a share, the fourth increase in two years.

Canadian banks are also taking advantage of a decline in bad loans. Royal Bank set aside C$99 million for soured loans, a 23 percent decrease from the year earlier.
Dow Jones Newswire, Monica Gutschi, 25 August 2006

Royal Bank of Canada appears to have done everything right in the third quarter - easily roaring past analyst estimates.

But it made the mistake of issuing its financial report a day after rival Toronto-Dominion Bank delighted investors with record-breaking numbers. So Royal suffers in the comparison.

While most of the lift in Toronto-Dominion's numbers came from its cornerstone domestic-banking operations, Royal Bank was helped along by low loan-loss provisions, a lower tax rate and strong (but unsustainable) trading revenue.

Royal Bank net income rose to C$1.18 billion or 90 Canadian cents a share from C$979 million or 74 Canadian cents a year earlier. On a cash basis, third-quarter earnings were 91 Canadian cents a share, well above the Thomson First Call mean estimate of 84 Canadian cents a share.

Return on equity soared to 23.1% and revenue grew 6%. Provisions for credit losses dropped to C$99 million from C$128 million a year earlier. All of the bank's business units performed well, especially its U.S.-based retail bank as the makeover of the past few years bore fruit.

As expected, Royal Bank also raised its dividend.

Nevertheless, "we don't think these results are as good as TD's results," Ian de Verteuil, analyst at BMO Capital Markets said in a note. And UBS' Jason Bilodeau suggested that, while the headline earnings number was good, it "may fall short against heightened expectations in wake of TD's numbers."

In Toronto Friday, Royal Bank is down 90 Canadian cents to C$49.80 on nearly 2 million shares. After rallying in the period since central banks in Canada and the U.S. stood pat on interest rates, the shares nudged close to record highs this week.

Shares in other Canadian banks are also lower Friday, with the exception of Toronto-Dominion.

Net income at Royal Bank's Canadian retail unit rose 9% to C$742 million, representing 58% of total profits. Net interest margins widened, and the bank saw strong volume growth in a number of businesses, including residential mortgages, credit cards and business deposits. However, insurance revenue sagged.

Net income at the U.S. and International banking division rose 39% to C$111 million. Better credit performance played a strong role, further confirming the turnaround at RBC Centura, the company's U.S.-based retail bank.

Earlier this month, Centura announced that it had purchased Flag Financial of Georgia for US$456 million, the first U.S. buy since 2003.

Chief Executive Gord Nixon said the purchase "was very opportunistic as opposed to driven by the desire that we have to grow." He noted there would continue to be acquisition opportunities in the U.S. although the bank would only consider targets that met strategic and financial parameters.

Net income at the Capital Markets division rose 29% to C$329 million, driven by strong trading revenue.

"It's all pretty good if you look at it in isolation," said Bruce Campbell, of Campbell-Lee Investment Management, who holds Royal Bank shares. However, "it's not quite as good as TD's."

Part of the problem, Campbell said, is that the bank is "a little more at risk as far as loan losses go" if the North American economy weakens next year.

De Verteuil at BMO agreed: "RY's loan losses in a downturn will need to rise much more meaningfully than TD's loan losses," he wrote. Additionally, he noted that earnings at Toronto-Dominion's domestic retail bank rose 22%, compared with 15% at Royal Bank.

And Campbell also said the stock's recent rally has a role in the market reaction Friday. "The upside on it is less," he said. "I prefer TD at the relative prices."

Andre Hardy of Merrill Lynch noted that both banks have "better momentum" than their peers to grow Canadian-based revenue. However, he also said in a note that Royal Bank's "relative risk profile has risen," as its leading loan growth has come primarily from unsecured loans. Tellingly, personal core deposits rose only 1% in the quarter.

BMO Capital Markets, UBS and Merrill Lynch all have investment-banking relationships with Royal Bank and own its securities. It wasn't immediately clear if the analysts own shares.

Royal Bank is the third Canadian lender to report quarterly results. Bank of Montreal, the fourth-biggest bank by assets, said on Aug. 22 that profit rose 30 percent to a record C$710 million. Toronto-Dominion, the second-biggest, said yesterday that profit almost doubled to C$796 million on higher trading fees and increased earnings from its U.S. discount brokerage.