Monday, March 03, 2008

RBC Q1 2008 Earnings

• RBC was cut from Market Perform to Underperform by BMO Capital Markets
• RBC target price was cut from C$58 to C$52 by CIBC World Markets
RBC Capital Markets, 3 March 2008

RY's Q1/08 GAAP diluted EPS of $0.95 were ahead of our estimate (by $0.06). Core cash EPS was $1.11 versus our estimate of $1.06, which was the same as consensus.

• Domestic banking net income was close to our expectations, wholesale was much better than expected and wealth management was slightly below.

• Trading revenues were stronger than expected; $461 million of revenues was down from $652 million in Q1/07, but Q1/08 figures included $430 million in pre-tax writedowns related to U.S. sub-prime exposures, U.S. municipal finance, U.S. CMBS and U.S. auction rate securities.

• Credit quality continued to deteriorate as we expected, as specific loan losses rose to $281 million compared to $250 million in the prior quarter and $162 million a year ago.

Maintain Outperform rating

We maintain our Outperform rating, 12-month target price of $55 per share and 2008 and 2009 EPS estimates. We believe that Royal Bank's premium valuation is sustainable (1.1x on 2008E P/E) and it should grow earnings at a more rapid rate than its peers in 2008 (7% versus an industry median of 4%), based on:

• Leading retail banking and wealth management franchises, the two highest multiple businesses Canadian banks participate in. We also expect bottom line growth in retail banking to benefit from slower expense growth.

• A more diversified capital markets business, which should lead to lower volatility in revenue and earnings than some other Canadian banks' investment dealers. The resiliency of revenues in Q1/08 and disclosure on "topics of interest" also give us comfort that Royal Bank's greater exposure to non-Canadian capital markets businesses does not put the bank's earnings growth or capital strength at risk relative to its Canadian bank peers.

• Credit quality is deteriorating for all banks, and we believe Royal Bank is more exposed to the early stages of deterioration in its loan book (i.e. U.S. retail/construction lending). We estimate that, following the acquisition of Alabama National, Royal Bank will have 2.3% of its total loan portfolio in U.S. construction lending, highest of the Canadian banks (TD and BMO would also have exposure, representing about 1.6% and 1.2% of their loan portfolios).
Scotia Capital, 3 March 2008

Q1/08 Earnings Solid

• Royal Bank (RY) reported Q1/08 cash earnings of $0.97 per share. Underlying operating earnings declined 3% YOY from record Q1/07 to $1.12 per share excluding $0.15 per share in write-downs. The $430 million in write-downs included $201 million on U.S. sub-prime with monoline insurers (ACA), $87 million on other sub-prime and $142 million on U.S. asset backed paper. These charges reduced earnings $187 million after-tax and related compensation adjustments or $0.15 per share. These charges were in line with expectations.

• Earnings were driven by extremely strong trading revenue offset by earnings drag from 16% appreciation in the Canadian dollar, lower Insurance earnings, flat earnings from Wealth Management and weak US & International earnings. Return on equity was 24.7% versus 27.5% a year earlier. Return on risk-weighted assets was 2.32% versus 2.55% a year earlier.

• Canadian Banking earnings increased 8% from a year earlier on a comparable basis led by Canadian Retail earnings up 15% with Insurance declining 26%. Wealth Management earnings declined 14%. RBC Capital Markets increased 24% (excluding CDO write-down). Wealth Management earnings declined 14%, U.S. & International earnings were weak.

• We are disappointed the bank did not increase its dividend although the bank did repurchase $55 million in shares at an average price of $49 per share.

High Operating Leverage

• Overall bank operating leverage was solid at 9%, with revenues (excluding write-downs) and non-interest expenses adjusted for insurance and VIEs increasing 10% and 1%, respectively.

Canadian Banking Strong

• Canadian Banking (excluding Global Insurance) increased 8% on a comparable basis. Earnings were led by Canadian Retail earnings increasing 15% to $674 million from $588 million a year earlier due to robust domestic demand and solid Canadian housing market activities.

• Revenues in the Canadian Banking segment increased 8% (excluding Global Insurance), with non-interest expenses increasing 4%, resulting in positive operating leverage of 4%.

• Global Insurance earnings were weak this quarter at $89 million versus $102 million in the previous quarter and $185 million ($120 million excluding unusual items) a year earlier due higher costs and less favourable disability claims.

• Loan loss provisions (LLPs) increased 18% to $214 million versus $182 million a year earlier due to higher provisions in credit cards and business loan portfolios.

Canadian Retail NIM Declines 2 bp

• Retail net interest margin (NIM) declined 2 basis points (bp) sequentially and 11 bp from a year earlier to 3.08%.

Wealth Management Earnings Decline 14%

• Wealth Management cash earnings declined 14% to $186 million from $217 million a year earlier.

• Revenue declined 4% primarily due to the strong Canadian dollar impacting the U.S. denominated portion of revenue. Operating expenses declined 2% for negative operating leverage of 2%.

• The revenue decline was concentrated in transactional and other which declined 21% due mainly to lower retail brokerage activity.

• U.S. Wealth Management revenue growth was strong at 13% with Canadian Wealth Management modest at 2%.

• Mutual fund revenue increased 6% from a year earlier to $375 million. Mutual Fund assets (IFIC) increased 11% from a year earlier to $81.6 billion.

U.S. & International P&B Earnings Decline

• The operating performance in the U.S. was disappointing as earnings declined to $47 million from $80 million a year earlier but improved from a disappointing $36 million in the previous quarter. LLPs increased sharply to $71 million from $10 million a year earlier but were flat from the previous quarter of $72 million relating to U.S. residential builder finance.

• Revenue growth was 9%, with expense growth high at 9% due to higher processing and staff costs.

• Net interest margin declined 20 bp from a year earlier to 3.41% but in a positive development improved 1 bp from the previous quarter.

RBC Capital Markets Earnings Strong – 24% Growth

• RBC Capital Markets earnings were strong, increasing 24% (excluding $187 million in write-downs) to $492 million from $397 million a year earlier. Including write-downs earnings declined 23% from a year earlier. Trading revenue was a major driver this quarter.

Underlying Trading Revenue Extremely Strong

• Trading revenue was a record $891 million (excluding $430 million in write-downs) versus and $517 million in the previous quarter and $652 million a year earlier. Interest rate and credit trading revenue was particularly strong.

Capital Markets Revenue Declines

• Capital markets revenue declined to $549 million from $625 million in the previous quarter and from $611 million a year earlier.

• Securities brokerage commissions increased 3% to $333 million from $323 million a year earlier, with underwriting and other advisory fees at $216 million, declining 25%.

Security Gains/Losses Negligible

• Security gains/losses remain low at a loss of $20 million or $0.01 per share versus a loss of $0.01 per share in the previous quarter and a gain of $0.02 per share a year earlier.

• Unrealized security surplus was not available versus the $105 million surplus at the end of the previous quarter and the $135 million a year earlier.

Loan Loss Provisions Increase to 45 Bp

• Specific loan loss provisions (LLPs) increased to $293 million or 0.45% of loans from $162 million or 0.28% of loans a year earlier. LLPs in Canadian Banking increased 18% to $214 million from $182 million due to higher provisions in credit cards and personal unsecured credit line portfolios. RBC Capital Markets LLP provisions were $28 million versus recoveries of $8 million a year earlier.

• We are increasing our 2008 and 2009 LLP estimates to $1,000 million or 0.40% of loans and $1,200 million or 0.47% of loans from $900 million and $1,000 million, respectively.

Loan Formations Increase

• Gross impaired loan formations increased to $715 million versus $589 million in the previous quarter and $311 million a year earlier. Net impaired loan formations increased to $604 million versus $435 million in the previous quarter and $237 million a year earlier.

Tier 1 Ratio Solid at 9.8%

• Tier 1 capital under Basel II was 9.8% versus 9.2% under Basel I. Tier 1 in the previous quarter was 9.4% and 9.2% a year earlier.

• Risk-weighted assets were flat at $241.2 billion from a year earlier under Basell II. Market at risk assets were also flat at $19.1 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.5%, versus 9.0% in the previous quarter and a year earlier.

Additional Disclosure on Monolines and Credit Derivatives

• The bank provided additional disclosure on its exposure to U.S. Insurance monolines and credit derivatives. The exposure to these areas is in line with expectations with the quality slightly better.

• Mark to market losses on the RMBS/CDO portfolios if counterparty (high quality monoline - MBIA) fail is estimated at approximately $900 million or $585 million after tax or $0.45 per share versus our previous estimate of $0.50 per share.

Share Buybacks

• This quarter RY repurchased 1.1 million shares at an average price of $49.11 per share for a total of $55 million.


• Our 2008 earnings estimate remains unchanged at $4.50 per share. We are trimming our 2009 earnings estimate to $5.00 per share from $5.20 per share based on our higher LLP forecast and slightly lower retail NIM.

• Our 12-month share price target remains unchanged at $75, representing 16.7x our 2007 earnings estimate or 15.0x 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 and higher than bank group ROE.
The Globe and Mail, Tara Perkins, 29 February 2008

After reporting a 17 per cent drop in first-quarter profits, the Royal Bank of Canada is battening down the hatches as it waits for what it hopes is a sunnier second half of the year.

Canada's biggest bank is reining in its expenses and did not increase its dividend this quarter.

“We're watching our costs,” said chief executive officer Gord Nixon. Not increasing the dividend was the “prudent thing to do” given the current environment, he added.

It's the first time since 2004 that Royal Bank has gone three quarters in a row without boosting it, making RBC's dividend “the first official casualty of the more difficult environment facing the banks,” Dundee Capital Markets analyst John Aiken wrote in a note to clients.

Royal's earnings were hit by $430-million in pre-tax writedowns related to U.S. subprime mortgages, the bank's municipal GIC business, its U.S. commercial mortgage-backed securities business and its U.S. auction rate securities portfolio. The hit will result in a $132-million reduction to employee bonuses at the bank.

“Some of the businesses, there have certainly been shrinkage and changes,” Mr. Nixon said of the work force in areas of the bank where problems arose.

He said the bank remains committed to its capital markets business. “As a bank, you can't pack your bag and go home because the market is competitive and rates are low and so forth,” he said. “What you have to do is try to manage your business with good overall risk standards and processes.”

Mr. Nixon cautiously predicted an economic recovery in the second half of this year.

“There's so much uncertainty in the marketplace that if you're an economist you could be bullish or bearish and you'd have a 50 per cent chance of being right,” he cautioned. “While I do believe there are still signs of further weakness, and that it will take years for some of these financial assets to recover, I do expect the aggressive action by monetary authorities will provide a floor for markets and eventually pave the way for a recovery, hopefully, in the latter half of this year.”

The bank is still working to try to meet its profit goals for 2008, he said.

Mr. Nixon even suggested that, eventually, some of the charges that are hurting the banks now could be reversed. Accounting rules require the value of many assets to be ratcheted down on paper even if their value should recover in the long term, he suggested.

Meanwhile, Royal Bank's loan loss provisions rose more than 80 per cent from a year ago because of weakness in its U.S. corporate loan book and its U.S. home builder portfolio, noted Credit Suisse analyst Jim Bantis. “Higher provision levels are likely to persist given the continued deterioration within the residential and commercial real estate markets in the U.S. Southeast and the incremental risk from the recent Alabama National acquisition,” he wrote in a note to clients.

On Friday, Royal Bank reported first-quarter profit of $1.245-billion, 17 per cent less than a year ago. The cash earnings of 97 cents per share fell short of analyst forecasts of $1.06 per share.

The profit, which was $249-million lower than a year ago, was hurt by $430-million (pretax) in writedowns related to U.S. subprime mortgages, the bank's municipal GIC business, its U.S. commercial mortgage-backed securities business and its U.S. auction rate securities portfolio.

The charges amount to $187-million after taxes and the resulting lower bonuses for employees are factored in.

“Almost all of our businesses within our four segments delivered solid performance this quarter and while a few have been affected by the difficult market conditions, our diversified business mix, proactive approach to risk management and rigorous operational discipline continue to underpin strong earnings,” Mr. Nixon said. The bank's profit one year earlier had been a record high.

The investment banking, or capital markets, division of RBC saw profit fall $92-million to $304-million primarily as a result of the writedowns. The stronger Canadian dollar also took a $24-million bite out of its earnings.

RBC's core Canadian consumer banking division showed no growth from a year ago, contributing $762-million to the bottom line, but profit was up 8 per cent once insurance gains a year ago are excluded.

Profit from the bank's insurance operations dropped by $96-million, or 52 per cent, to $89-million. Wealth management was down 14 per cent, or $30-million, at $181-million.
Financial Post, Duncan Mavin, 27 February 2008

A recent observation from Canada's banking industry watchers is that the sky-high Canadian dollar coupled with depressed U.S. bank stocks could make now the ideal time for the big Canadian banks to do a deals south of the border.

But, according to one U.S. report, Royal Bank of Canada at least is not looking to add to its U.S. operations any time soon.

RBC's U.S. retail banking operation — which recently announced it is changing its name from RBC Centura to RBC Bank (USA) this spring — closed its acquisition of Alabama National for US$1.6-billion last week. That deal came at the end of somewhat of a spending spree — in the past 14 months, RBC has also picked up Flag Financial Corp. of Atlanta and 39 branches of the former AmSouth Bancorp.

But the focus for RBC Bank (USA) is now on consolidation according to comments made by the unit's chief executive Scott Custer to American Banker.

"We have to be careful to get our own health in order," Mr.Custer is reported to have said. Acquisitions would be hard to value right now, he reportedly said. "This is a time for patience and prudence, which we feel is the better course here."