Monday, August 27, 2007

RBC Q3 2007 Earnings

  
Analysts' ratings and target prices for RBC:

• BMO Capital Markets maintains "outperform," 12 month target price reduced to $60.00 from $63.00

• Blackmont Capital maintains "buy,"

• CIBC World Markets maintains "," 12 month target price reduced to $57.00 from $64.00

• Desjardins Securities maintains "hold," 12 month target price raised to $61.50 from $60.00

• RBC Capital Markets maintains "outperform," 12 month target price is $63.00

• Scotia Capital maintains "outperform," 12 month target price is $75.00
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BMO Capital Markets, 27 August 2007

Royal Bank reported third-quarter cash earnings of $1.4 billion, or $1.08 per share, compared to $1.3 billion, or $0.99 per share, last quarter and $1.2 billion, or $0.91 per share, in the same quarter of last year. This quarter included various accounting adjustments that added $0.02 to EPS. Excluding unusual items in all three quarters, the appropriate operating comparison is $1.06 per share in this quarter, $0.99 in the last quarter, and $0.92 in the same quarter of last year. Results were slightly ahead of our forecasts of $1.03.

While Royal exceeded expectations, there was certainly fodder for both the 'bears and bulls.' On the negative front, overall earnings were inflated by lower tax rates and the retail business produced a lower than expected contribution. In addition, the trading results in the second half of July could be a worrying preview for the fourth quarter. However, we believe that this is too pessimistic a perspective. Expenses were somewhat elevated in the quarter and this should moderate by year-end. Furthermore, we have already assumed a fall-off in trading activity in the fourth quarter.

The bank boosted its dividend by 9% and its ROE was over 24% in the quarter. Royal continues to operate high quality retail and wholesale franchises.

The Canadian Banking segment reported earnings of $700 million, an increase of 13% over the second quarter and 6% over the year. On a quarter-over-quarter basis, results were largely driven by a stronger contribution from Insurance. The lack of growth in contribution from domestic banking was disappointing, with good revenue growth offset by higher expenses and loan losses. We believe the bank should be able to manage these expenses down over the next quarter.

Spreads declined both over the quarter and the year, but despite the spread compression, revenue growth was about 8%. Clearly, the retail operation remains as strong as ever. Wealth Management earnings were $183 million, down 8% over the second quarter but up a very strong 30% over the year. Good growth in fee-based revenue this quarter was offset by seasonally lower transactional revenues and relatively higher expenses. Asset growth remains strong across all businesses.

The U.S. and International Banking segment reported earnings of $101, up 23% over the quarter and in line with our expectations. Stronger results reflected an increase in contribution from Dexia as well as from the various recent acquisitions Royal has made in the U.S. Results were partially offset by the continued strength of the Canadian dollar and acquisition-related costs.

The Capital Markets segment reported earnings of $360 million, roughly flat over the quarter, but up 18% over the year. This was ahead of our expectations. Trading revenues were higher than we expected. Other investment banking and capital markets revenues were also strong. There was a falloff in trading revenues in the second half of July, and the conditions in August suggest that overall revenues will be lower in the fourth quarter. There is likely some flexibility in variable compensation accruals so we believe a fourth quarter contribution in the $250-300 million range is achievable.

The Corporate segment reported earnings of $73 million exceeded our estimates due to various tax-related adjustments which more than offset weaker securitization revenues. On the credit front, Royal's loan losses were roughly in line with our forecasts at $178 million. Gross and net impaired loans increased somewhat this quarter, but continue to be in line with our industry-wide expectation of a modest uptick as we move forward.

Royal's Tier 1 ratio remained stable at 9.3% this quarter. On the negative front, Royal has a modest unrealized securities loss position. The bank was somewhat less active than we expected in share buybacks this quarter but did announce a larger than expected 9% increase in its quarterly dividend.

Projections and Valuation

Our 2007 forecast of $4.25 is unchanged and we are reducing our 2008 forecast modestly to $4.45 from $4.50. We are also reducing our target price, to $60 from $63. Royal remains a very high-quality bank and its broad, strong retail and wholesale franchises ensure that it will benefit in the long term from the current market disruption.

Royal Bank has been more aggressive (and more successful) than its peers in capital markets. It is reasonable to assume that if the current malaise in fixed income markets continues into the fall, there is more risk to Royal's earnings than to that of its peers. We maintain an Outperform rating on RY shares, but for investors concerned by the current environment, CM and TD (both rated Outperform) are lower risk bets in our view.
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RBC Capital Markets, 27 August 2007

Earnings better than expected

RY's Q3/07 core cash EPS were $1.08, up 19% versus Q3/06, and ahead our consensus-like estimate of $1.03. All divisions did better than we thought, except for Canadian banking, where earnings were 4% below our expectations. The tax rate was 19.5% - about 2.5% below the average of last four quarters, which helped EPS by about $0.04. The quarterly dividend was increased $0.04 to $0.50, $0.01 higher than we expected.

Maintain Outperform rating

We believe that Royal Bank's premium valuation is sustainable (0.7x on 2008E P/E) and that the bank should grow earnings at a more rapid rate than its peers in 2008 (8% versus an industry median of 6%), based on: 1) Leading, and rapidly growing retail banking and wealth management franchises, the two highest multiple businesses Canadian banks participate in; 2) A more diversified capital markets business, which should lead to lower volatility in revenue and earnings than some of the other Canadian banks' investment dealers; 3) A superior outlook for near-term revenue growth, driven by a 15% increase in risk weighted assets in the last twelve months, a result of organic growth and acquisitions.

12-month outlook on RY positive; near-term risks remain

Our 12-month target price of $63 (unchanged) on Royal Bank is much higher than the current stock price and we maintain our Outperform rating. However, we remain concerned that Canadian banks could trade sideways or down in the near term on negative news flow out of world financials, as well as potential revisions to near-term earnings estimates. The increased risk aversion and tightening of liquidity, if it continues, could have a much larger impact on wholesale revenues in Q4/07 than Q3/07, in our view. Wholesale earnings represent 30% of earnings for the industry. The biggest risk to our outlook is that capital market issues become economic issues; a scenario that our economists do not envision at this time.
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Scotia Capital, 27 August 2007

Q3/07 Earnings Increase 19%

• Royal Bank (RY) reported Q3/07 cash operating earnings of $1.08 per share slightly above our estimate of $1.07 per share and consensus of $1.04 per share. Earnings increased 19% from $0.91 per share a year earlier. Earnings this quarter were aided slightly by a lower tax rate adding $0.02 to $0.03 per share.

• Return on equity was 24.9% versus 23.3% a year earlier. Return on risk-weighted assets increased to 2.24% versus 2.18% a year earlier.

• Earnings were driven by strong earnings growth of 30% from Wealth Management. RBC Capital Markets earnings were solid with 18% growth. U.S. & International Banking and Canadian Banking earnings growth was modest at 7% and 6%, respectively.

• The bank's performance was strong in Wealth Management and RBC Capital Markets but disappointing in Canadian Banking. Insurance earnings returned to more normal levels this quarter, however, underlying Canadian Banking earnings were weaker due to decline in retail NIM and higher non-interest expense due to heavy reinvestment. The bank has added approximately 1,500 branch sales personnel with a large portion of the additions taking place in this quarter.

Dividend Increased 9%

• RY increased its dividend by 9% to $2.00 per share from $1.84 per share as expected.

Canadian Banking Earnings Weak

• Canadian Banking cash earnings (including Global Insurance) increased 6% to $700 million from $662 million a year earlier. Excluding Global Insurance, Canadian Banking earnings were $597 million, a decline of 1% from $601 million a year earlier due to lower net interest margin, higher loan losses and higher non-interest expenses due to reinvestment (discretionary spending to grow platform).

• Revenues in the Canadian Banking segment increased 7.6% (excluding Global Insurance), with non-interest expenses increasing 8.1% resulting in negative operating leverage of 0.5%. • Global Insurance earnings improved to more normal levels this quarter with earnings of $103 million versus $52 million in the previous quarter and $61 million a year earlier. Earnings were driven by favourable disability claims and growth in the European life reinsurance business.

• Loan loss provisions (LLPs) increased 57% to $190 million versus $121 million a year earlier due to volume increases in personal loans and credit cards and some deterioration in the business loan portfolio.

Canadian Retail NIM Declines 11 bp

• Retail NIM declined 10 bp sequentially and 11 bp from a year earlier to 3.15%. The decline in retail NIM was primarily due to change in product mix and lower spreads on mortgages and personal deposits. We also believe the bank's weaker deposit mix is placing higher pressure on spreads and transfer pricing is not as favourable.

Wealth Management Earnings Increase 30%

• Wealth Management cash earnings increased 30% to $183 million from $141 million a year\ earlier, reflecting strong net sales and growth in mutual fund assets.

• Revenue growth was an impressive 19.3% with operating expenses up 15.6% due to higher variable compensation. Operating leverage was a solid 3.7%

• Both U.S. Wealth Management and Canadian Wealth Management revenue growth was strong at 19% and 17%, respectively.

• Mutual fund revenue increased 7% sequentially and 17% from a year earlier to $385 million. RY led the industry in long-term asset (LTA) net sales with 18% market share in Q3. Mutual Fund assets (IFIC) increased 22% from a year earlier to $78.7 billion.

U.S. & International P&B Earnings Growth Modest at 7%

• U.S. & International P&B Q3/07 cash earnings increased 7% year over year to $101 million due to higher loan and deposit volumes and the impact of recent acquisitions.

• Revenue growth was strong at 21%, with expense growth high at 27% due to integration costs from recent acquisitions.

• Net interest margin declined 11 bp sequentially to 3.58% but declined 12 bp from a year earlier.

RBC Capital Markets Earnings Strong - 19% Growth

• RBC Capital Markets earnings were strong increasing 19% to $360 million from $304 million a year earlier due to robust M&A and equity origination activity.

• Operating leverage was positive 6.4% in Q3 with revenue increasing 13.3% from a year earlier and expenses increasing 6.9%.

Solid Operating Leverage

• Overall bank operating leverage was solid at 5% with revenues and non-interest expenses adjusted for insurance and VIEs increasing 12% and 7%, respectively.

Trading Revenue Solid

• Trading revenue on a tax-equivalent basis was $592 million versus $581 million a year earlier and $608 million in the previous quarter. Fixed income and money market trading revenue declined 2% with equity and foreign exchange contracts remaining relatively stable.

Capital Markets Revenue Increases 24%

• Capital markets revenue increased to $677 million from $657 million in the previous quarter and from $544 million a year earlier.

• Securities brokerage commissions increase 26% to $368 million from $291 million a year earlier, with underwriting and other advisory fees at $309 million, an increase of 22%.

Security Gains Negligible

• Security gains remain low at $34 million or $0.02 per share versus nil per share in the previous quarter and $0.01 per share a year earlier.

• Unrealized security surplus was $89 million at quarter-end (now contained in AOCI) versus the $112 million surplus at the end of the previous quarter and the $49 million deficit a year earlier.

Loan Loss Provisions Increase to 29 Bp

• Specific loan loss provisions (LLPs) increased to $178 million, or 0.29% of loans from $99 million or 0.18% of loans a year earlier. LLPs in Canadian Banking increased 57% to $190 million from $121 million due to higher provisions in credit cards and personal unsecured credit line portfolios. RBC Capital Markets net LLP recoveries remained unchanged from a year earlier at $7 million.

• We are increasing our 2007 and 2008 LLP estimates to $700 million or 0.30% of loans and $800 million or 0.34% of loans from $600 million and $700 million, respectively. Our forecast increase is based on higher volumes particularly in credit cards and unsecured personal loans.

Loan Formations Increase

• Gross impaired loan formations were $383 million versus $363 million in the previous quarter and $240 million a year earlier. Net impaired loan formations increased moderately to $275 million versus $227 million in the previous quarter and $158 million a year earlier.

Minimal Sub-Prime, CDO and Non-Bank ABCP Exposure

• Management indicated that RY does not originate sub-prime mortgages and only has minimal exposure through RMBS and CDOs (collateralized debt obligations). At the end of the quarter, exposure for RMBS and CDO securities was $1.1 billion, less than 0.2% of assets, with CDO squared exposure nominal. The bank also disclosed its LBO exposure at $2 billion in commitments, of which $1.3 billion, representing 0.2% of assets, were priced and committed to before the market correction. No single commitment represents more than $250 million.

• At quarter end, RY had approximately $40 billion in liquidity backstop facilities for bank asset-back commercial paper (ABCP). Of this amount 94% was reserved for RY sponsored conduits. The bank has no exposure to non-bank ABCP.

Tier 1 Ratio Stable at 9.3% – RWA Growth 15%

• Tier 1 capital was 9.3% unchanged from the previous quarter but declined from 9.6% a year earlier.

• Risk-weighted assets increased 15% to $250.2 billion. Market at risk assets increased 23% to $19.0 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.0% unchanged from the previous quarter but down from 9.3% a year earlier.

Share Buybacks

• This quarter RY repurchased 1.0 million shares at an average price of $58.00 per share for a total of $58 million.

Recommendation

• Our 2007 earnings estimate remains unchanged at $4.32 per share. We are trimming our 2008 earnings estimate to $4.80 per share from $4.90 per share based on our higher LLP forecast and slightly lower retail NIM.

• Our 12-month share price target remains unchanged at $75, representing 17.4x our 2007 earnings estimate or 15.6x our 2008 earnings estimate.

• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength of franchise and operating platforms, particularly retail banking and wealth management, higher than bank group ROE, and only a slight valuation premium.
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Financial Post, Duncan Mavin, 25 August 2007

The volatility of capital markets has put Canada's wholesale banks on the defensive for now.

But in the longer term, recent upheavals will increase margins and open up new opportunities, Chuck Winograd, the head of RBC Capital Markets, said yesterday.

"Be clear. We are right now playing defence and trying to make sure we get ourselves through this situation," Mr.Winograd said.

Once the volatility settles, the drying up of liquidity in the market could benefit higher-rated banks and liquidity providers such as RBC, he said on a conference call to discuss the bank's third-quarter earnings.

"A lot of what is going on is just repricing of risk," Mr. Winograd said.

"And repricing of risk is just another phrase for higher spreads, and higher spreads gives us a lot of leverage."

RBC's earnings for the quarter jumped 19% to $1.4-billion, compared to $1.2-billion in the same quarter last year.

Profits from RBC Capital Markets also increased 19% to $360-million on revenue of $1.2-billion.

Despite Mr.Winograd's assurances about the long-term outlook, some analysts said the capital markets group will likely not be able to sustain its

recent growth in the quarters to come.

"Given our moderating outlook for the capital markets, we are forecasting a moderate decline in the level of capital markets revenue," said John Aiken, a Dundee Securities analyst.

Market volatility should help trading revenue, but it will likely be offset by lower fees for underwriting and advisory work as fewer transactions take place.

Overall, RBC's performance for the quarter was steady, said Credit Suisse analyst Jim Bantis.

Revenue increased 9% from $5.2-billion last year to $5.7-billion. But top-line growth was more than offset by an 11% increase in operating expenses, from $2.9-billion last year to $3.2-billion in the current quarter.

Nevertheless, the results showed "strong underlying trends," Mr. Bantis said.

The bank earned $103-million from insurance, double its profits from that segment in the second quarter.

Global wealth management profit of $177-million was up 30% from last year.

The bank also increased its quarterly dividend by 4¢ per share or 9% to 50¢.

The bank confirmed it has "minimal" exposure to hedge funds and the U.S. subprime mortgage market, and "nominal" exposure to Canadian non-bank sponsored asset-backed commercial paper conduits with general market disruption liquidity facilities.
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The Globe and Mail, Tara Perkins, 24 August 2007

Shares of the Royal Bank of Canada fell Friday morning, after its third-quarter earnings came in only slightly ahead of analysts' expectations and its CEO said it has minimal exposure to a number of problem areas.

The stock was down about 1 per cent at $54.89 on the Toronto Stock Exchange in early morning trading.

The country's biggest bank reported profit of $1.395-billion for the three months ended July 31, up 19 per cent from a year ago.

On a cash basis, the earnings were $1.08 per share. Analysts had expected the bank to earn $1.04 per share.

Market expectations for the bank's earnings rose on Thursday after Toronto-Dominion's profits blew past analyst expectations. Earlier this month, the Canadian Imperial Bank of Commerce pre-announced that its results would be significantly higher than analysts' expected, despite a $290-million hit it will take on its investments related to the U.S. subprime mortgage market.

RBC chief executive Gord Nixon said Friday that Royal has “minimal” exposure to U.S. subprime residential mortgage-backed securities and collateralized debt obligations.

The bank said its exposure amounts to less than 0.2 per cent of its total assets of $604.6-billion, or about $1.2-billion.

Woes in the U.S. subprime mortgage market have rippled through the world's financial markets as investors become more fearful of risks. Subprime mortgages are those given to prospective homeowners with a poor credit record.

Mr. Nixon said RBC's exposure to hedge funds and its underwriting commitments to leveraged buyouts were also “minimal.”

The bank's hedge fund trading and lending exposure, including prime brokerage, is less than 0.3 per cent of its assets. Its underwriting commitments to leveraged buyouts is less than 0.2 per cent of its assets.

The bank did not quantify its exposure to the sector of the Canadian asset-backed commercial paper market that has fallen into turmoil in recent weeks, but indicated that it is “nominal.” Mr. Nixon stressed that RBC does not hold this paper in any of its mutual funds or private client accounts.

The bank also said on Friday that it is raising its dividend by 4 cents per share, or 9 per cent, to 50 cents.

While its quarterly results were helped a bit by a lower tax rate, they showed strength in capital markets, wealth management, and basic Canadian banking. “I am very pleased with the results this quarter across all of our business segments,” Mr. Nixon said.

RBC's biggest division, Canadian banking, saw profit rise 6 per cent.

The bank has experienced higher amounts of bad loans on its credit cards and unsecured credit lines, and so its provision for bad loans rose to $178-million from $99-million. Small business loans and commercial loans also contributed to the higher provision.

RBC cautioned that “while credit growth of both consumer and business lending in Canada was solid, credit quality weakened moderately during the period as conditions appear to be reverting to more normalized levels.”

The bank's capital markets division saw profit rise 19 per cent, while wealth management profit rose 30 per cent.

Total revenue rose 5 per cent to $5.48-billion.
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Bloomberg, Doug Alexander, 24 August 2007

Royal Bank of Canada, the nation's biggest lender, reported profit that beat analysts' estimates as the country's banks sidestepped most of America's subprime-loan fallout.

The company said third-quarter net income climbed 19 percent to C$1.4 billion ($1.33 billion), or C$1.06 a share, from C$1.18 billion, or 90 cents. The Toronto-based bank raised its dividend 9 percent to 50 cents a share.

Royal Bank benefited from a 30 percent profit gain at its asset-management unit, and higher fees from arranging mergers and underwriting stocks and bonds. The stock declined after trading revenue fell and the bank set aside more money for bad loans.

``Everybody was really nervous about the subprime business and some of the banks were hit quite hard,'' said John Kinsey, who helps manage $1.9 billion at Caldwell Securities Ltd. in Toronto, including Royal Bank stock. ``You kind of hear things that the economy is slowing, but their main banking business seems to be very solid.''

The bank said profit for the quarter ended July 31 was C$1.08 a share excluding one-time items, topping the median estimate of C$1.03 a share from nine analysts polled by Bloomberg News.

Royal Bank shares fell 43 cents to C$55 at 4:14 p.m. in trading on the Toronto Stock Exchange. The stock has fallen 1 percent this year, compared with a 1.7 percent decline in the Standard & Poor's/TSX Banks Index.

Canadian banks have so far not been buffeted by the credit crunch sparked by rising defaults in U.S. subprime loans. Toronto-Dominion Bank said yesterday that profit rose 39 percent, beating estimates, on higher investment-banking fees. The six-biggest lenders will probably post average profit increases of 13 percent before one-time items, according to Kevin Choquette at Scotia Capital in Toronto.

The credit crunch is having more of an impact than previous market downturns in 1998 and 1987, RBC Capital Markets Chief Executive Officer Charles Winograd, 59, said today on a conference call with analysts.

``It's more complex, deeper and broader than 1987 was,'' Winograd said. ``1987 was really in one product, which was equities.''

Royal Bank doesn't originate U.S. subprime loans and had investments of about $1.04 billion linked to the subprime market at July 31. Most of the holdings are in mortgage-backed securities and collateralized debt obligations, CEO Gordon Nixon said in a statement. The investments are equal to less than 0.2 percent of bank assets, Nixon said.

By comparison, Canadian Imperial Bank of Commerce said on Aug. 13 that its holdings in the U.S. residential mortgage market were about $1.7 billion before it took a writedown of C$190 million to reflect a decline in the value of the investments.

Royal Bank also has ``nominal exposure'' to Canadian non- bank asset-backed commercial paper funds, which have been unable to roll over most debt since last week. The bank backs some of these funds for emergency financing.

Trading was hurt by concerns over the U.S. subprime market, and reduced ``liquidity'' in late July, the bank said. Trading revenue fell 20 percent to C$546 million, led by fixed-income and equities. Royal Bank had six days of trading losses in the quarter, five of which were in the latter part of July, Chief Operating Officer Barbara Stymiest said in an interview.

``Both the gains and losses that we've been experiencing through this period of volatility have been significantly in the fixed-income area,'' Stymiest said.

Royal Bank's wealth management group earned C$177 million, up 30 percent from a year ago. Royal Bank had C$1.42 billion in mutual fund sales in the quarter, up from $720 million a year earlier, according to preliminary figures from the Investment Funds Institute of Canada.

Profit from the consumer-banking unit in Canada rose 5.9 percent to C$699 million from C$660 million, the slowest growth in at least five quarters. Profit from U.S. and international consumer banking, which includes Raleigh, North Carolina-based RBC Centura, rose 6.1 percent to C$87 million, the highest in at least nine quarters.

Royal Bank set aside C$178 million for soured loans, compared with C$99 million a year ago, as provisions for credit cards and consumer and small business loans rose. Loan-loss provisions for Canada's six main banks are projected to rise an average of 55 percent this quarter, according to estimates from Credit Suisse analyst James Bantis.

Profit from global insurance rose 69 percent to C$103 million as insurance claims fell 59 percent from a year ago.

Royal Bank and other lenders also benefited from higher fees from investment banking. Profit at the RBC Capital Markets investment banking unit rose 19 percent to C$360 million from C$303 million a year ago. Underwriting and other advisory fees rose 22 percent to C$309 million, the bank said.

The firm ranked No. 1 for advising Canadian firms on mergers and acquisitions, which surged 46 percent to $53.9 billion in the fiscal quarter. RBC Capital worked with Thomson Corp. on the $7.75 billion sale of its education unit.

Total market-sensitive revenue, which includes trading and underwriting fees, rose 16 percent to C$2.01 billion, Merrill Lynch analyst Sumit Malhotra said today in a research note.

``Sentiment on the stock will likely be challenged by the fact that a large proportion of the growth came from areas that the market does not appear to believe are sustainable,'' wrote Malhotra, who rates Royal Bank a ``buy'' and doesn't own the stock.

CIBC, the No. 5 bank, said last week it expects profit to top forecasts, even with the debt writedown. Bank of Montreal and Bank of Nova Scotia report results on Aug. 28, while Canadian Imperial and National Bank of Canada report on Aug. 30.
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