• CIBC World Markets raises target price from $44 to $47
• Desjardins Securities cuts target price from $50 to $46.50
• Dundee Securities raises target price from $36 to $38
• Genuity Capital Markets cuts target price from $56 to $54
• National Bank Financial raises target price from $43 to $44
• Scotia Capital has a target price of $58
• TD Securities has a target price of $43
• UBS Securities raises target price from $45 to $46
• Desjardins Securities cuts target price from $50 to $46.50
• Dundee Securities raises target price from $36 to $38
• Genuity Capital Markets cuts target price from $56 to $54
• National Bank Financial raises target price from $43 to $44
• Scotia Capital has a target price of $58
• TD Securities has a target price of $43
• UBS Securities raises target price from $45 to $46
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Scotia Capital, 1 June 2009
Q2/09 Solid Operating Earnings - Wholesale Stellar - Higher Credit Losses
• Royal Bank (RY) reported a decline in cash operating earnings of 6% to $0.97 per share, in line. Operating ROE was 18.6%.
• Reported cash earnings were $0.66 per share including net charges of $0.31 per share comprised of: writedowns of $556 million ($296 million after-tax or $0.21 per share) and a general provision of $223 million ($146 million after-tax or $0.10 per share). Reported accrual earnings were a loss of $0.07 per share including a goodwill impairment charge of $1.0 billion after-tax or $0.71 per share (previously announced) and amortization of intangibles of $55 million ($43 million after-tax or $0.03 per share).
• Earnings were driven by very strong earnings from RBC Capital Markets, which increased 80% to $559 million (excluding writedowns) due to very strong trading revenue. Canadian Banking earnings declined 4% to $582 million from a year earlier due to net interest margin decline. Insurance earnings were $113 million, an increase of 9%. Wealth Management earnings declined 25% to $139 million.
• U.S. & International Banking recorded a loss of $97 million due to the continued high level of loan losses. LLPs increased sequentially to $289 million from $200 million in the previous quarter and from $91 million a year earlier.
Canadian Banking Earnings Decline 4%
• Canadian Banking earnings declined 4% to $582 million from $606 million a year earlier due to a decline in retail net interest margin and higher loan loss provisions.
• Revenues in the Canadian Banking segment increased 3.7%, with non-interest expenses increasing 1.3% from a year earlier, resulting in positive operating leverage of 2.4%.
• Loan loss provisions (LLPs) increased 30% to $351 million from $270 million in the previous quarter, reflecting portfolio growth and higher impaired loans.
Canadian Retail NIM Declines 22 basis points
• Retail NIM declined 22 bp year over year and 3 bp sequentially to 2.78%.
Insurance
• Insurance earnings were $113 million versus $112 million in the previous quarter and $104 million a year earlier.
Wealth Management Earnings Decline 25%
• Wealth Management cash earnings declined 25% to $139 million from $186 million a year earlier due to large declines in AUM.
• Revenues were flat year over year with operating expenses increasing 11.6% for negative operating leverage of 11.6%.
• U.S. Wealth Management revenue improved 11%, with Canadian Wealth Management declining 16% and Global Asset Management revenue increasing 3%.
• Mutual fund revenue declined 19% from a year earlier to $311 million. Mutual Fund assets (IFIC) declined 10% from a year earlier to $97.8 billion including PH&N. U.S. & International Banking Remains in Loss Position
• U.S. & International recorded a loss of $97 million versus a loss of $22 million in the previous quarter and net income of $57 million a year earlier. The loss position was driven by the continued high level of LLPs. LLPs were $289 million in the quarter, up from the Q1 level of $200 million and up significantly from $91 million a year earlier. LLPs are at an extremely high level of 3.16% of loans and are expected to remain high throughout the remainder of 2009 and 2010.
• The weakness in the portfolio is primarily related to the bank's US$2.6 billion U.S. residential builder finance portfolio, of which 40% of loans are impaired. Our rough estimate is that RY has been taking $150-$200 million in provisions against this portfolio quarterly.
The run rate may not subside in the near term but we do not expect significantly more aggressive provisioning.
• Net interest margin increased 17 bp from a year earlier and 27 bp sequentially to 3.67%.
RBC Capital Markets Earnings Stellar
• RBC Capital Markets earnings increased 80% (excluding writedowns) to $559 million, up from $310 million a year earlier due to very strong trading revenue.
Underlying Trading Revenue Very Strong at $1.4 Billion
• Trading revenue was very strong at $1,414 million (excluding writedowns) versus a record $1,748 million in the previous quarter and $786 million a year earlier.
• Trading revenue was extremely high in all products: interest rate, credit, equities, and foreign exchange.
Capital Markets Revenue
• Capital markets revenue was $568 million versus $520 million in the previous quarter and $472 million a year earlier.
• Securities brokerage commissions increased 15% to $355 million from $309 million a year earlier, with underwriting and other advisory fees at $213 million, increasing by 31%. Security Losses Negligible – Large Unrealized Deficit
• AFS security loss was $66 million or $0.03 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.01 per share a year earlier.
• Unrealized security surplus was a deficit of $1,786 million versus a deficit of $2,163 million in the previous quarter.
Securitization Revenue Increases
• Securitization revenue increased to $354 million or $0.16 per share versus $227 million or $0.10 per share in the previous quarter, adding $0.06 per share to earnings.
Loan Loss Provisions Increase
• Specific loan loss provisions (LLPs) increased to $751 million or 1.07% of loans from $598 million or 0.81% in the previous quarter and $349 million or 0.53% of loans a year earlier. LLPs in Canadian Banking increased 30% sequentially to $351 million from $270 million. LLPs in U.S. & International increased sequentially to $289 million (3.16% bp of loans) from $200 million. The bank recorded a $223 million general provision ($146 million or $0.10 per share). Total loan loss provisions were $974 million or 1.38% of loans.
• We are increasing our 2009 LLP estimate to $2,800 million or 0.97% of loans from $2,100 million or 0.70% of loans. Our 2010 LLP estimate is unchanged at $2,600 million or 0.86% of loans.
Loan Formations Decline QOQ
• Gross impaired loan formations declined to $1,800 million versus $2,648 million in the previous quarter but increased from $867 million a year earlier. Gross impaired loans increased 19% quarter over quarter (QOQ) to $4,217 million or 1.46% of loans versus $3,540 million or 1.20% of loans in the previous quarter.
• Net impaired loan formations increased to $1,467 million, up from $737 million a year earlier and from $1,134 million in the previous quarter. Net impaired loans increased to $1,341 million or 0.46% of loans.
Tier 1 Ratio Strong at 11.4%
• Tier 1 capital was strong at 11.4% versus 10.6% in the previous quarter and 9.5% a year earlier due partially to a 3% sequential decline in risk-weighted assets mainly from currency impact.
• Risk-weighted assets increased 7% year over year (YOY) to $265.6 billion. Market-at-risk assets increased a modest 2% YOY and 5% QOQ to $20.1 billion.
• The common equity to risk-weighted assets (CE/RWA) ratio was 11.2% versus 11.1% in the previous quarter and 9.5% a year earlier.
Additional Disclosure on High-Risk Assets
• The bank provided additional disclosure on its exposure to U.S. sub-prime CDOs of ABS, RMBS and U.S. insurance and pension solutions. The notional and fair value exposures to these areas as well as writedowns are detailed in exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.
Recommendation
• We are reducing our 2009 earnings estimate to $4.15 per share from $4.25 per share due to a higher loan loss provision forecast. Our 2010 earnings estimate remains unchanged at $4.65 per share.
• Our 12-month share price target is unchanged at $58 per share, representing 14.0x our 2009 earnings estimate and 12.5x our 2010 earnings estimate.
• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength-of-franchise and operating platforms, growth prospects from RBC Capital Markets, recovery in Wealth Management and higher than bank group ROE.
Q2/09 Solid Operating Earnings - Wholesale Stellar - Higher Credit Losses
• Royal Bank (RY) reported a decline in cash operating earnings of 6% to $0.97 per share, in line. Operating ROE was 18.6%.
• Reported cash earnings were $0.66 per share including net charges of $0.31 per share comprised of: writedowns of $556 million ($296 million after-tax or $0.21 per share) and a general provision of $223 million ($146 million after-tax or $0.10 per share). Reported accrual earnings were a loss of $0.07 per share including a goodwill impairment charge of $1.0 billion after-tax or $0.71 per share (previously announced) and amortization of intangibles of $55 million ($43 million after-tax or $0.03 per share).
• Earnings were driven by very strong earnings from RBC Capital Markets, which increased 80% to $559 million (excluding writedowns) due to very strong trading revenue. Canadian Banking earnings declined 4% to $582 million from a year earlier due to net interest margin decline. Insurance earnings were $113 million, an increase of 9%. Wealth Management earnings declined 25% to $139 million.
• U.S. & International Banking recorded a loss of $97 million due to the continued high level of loan losses. LLPs increased sequentially to $289 million from $200 million in the previous quarter and from $91 million a year earlier.
Canadian Banking Earnings Decline 4%
• Canadian Banking earnings declined 4% to $582 million from $606 million a year earlier due to a decline in retail net interest margin and higher loan loss provisions.
• Revenues in the Canadian Banking segment increased 3.7%, with non-interest expenses increasing 1.3% from a year earlier, resulting in positive operating leverage of 2.4%.
• Loan loss provisions (LLPs) increased 30% to $351 million from $270 million in the previous quarter, reflecting portfolio growth and higher impaired loans.
Canadian Retail NIM Declines 22 basis points
• Retail NIM declined 22 bp year over year and 3 bp sequentially to 2.78%.
Insurance
• Insurance earnings were $113 million versus $112 million in the previous quarter and $104 million a year earlier.
Wealth Management Earnings Decline 25%
• Wealth Management cash earnings declined 25% to $139 million from $186 million a year earlier due to large declines in AUM.
• Revenues were flat year over year with operating expenses increasing 11.6% for negative operating leverage of 11.6%.
• U.S. Wealth Management revenue improved 11%, with Canadian Wealth Management declining 16% and Global Asset Management revenue increasing 3%.
• Mutual fund revenue declined 19% from a year earlier to $311 million. Mutual Fund assets (IFIC) declined 10% from a year earlier to $97.8 billion including PH&N. U.S. & International Banking Remains in Loss Position
• U.S. & International recorded a loss of $97 million versus a loss of $22 million in the previous quarter and net income of $57 million a year earlier. The loss position was driven by the continued high level of LLPs. LLPs were $289 million in the quarter, up from the Q1 level of $200 million and up significantly from $91 million a year earlier. LLPs are at an extremely high level of 3.16% of loans and are expected to remain high throughout the remainder of 2009 and 2010.
• The weakness in the portfolio is primarily related to the bank's US$2.6 billion U.S. residential builder finance portfolio, of which 40% of loans are impaired. Our rough estimate is that RY has been taking $150-$200 million in provisions against this portfolio quarterly.
The run rate may not subside in the near term but we do not expect significantly more aggressive provisioning.
• Net interest margin increased 17 bp from a year earlier and 27 bp sequentially to 3.67%.
RBC Capital Markets Earnings Stellar
• RBC Capital Markets earnings increased 80% (excluding writedowns) to $559 million, up from $310 million a year earlier due to very strong trading revenue.
Underlying Trading Revenue Very Strong at $1.4 Billion
• Trading revenue was very strong at $1,414 million (excluding writedowns) versus a record $1,748 million in the previous quarter and $786 million a year earlier.
• Trading revenue was extremely high in all products: interest rate, credit, equities, and foreign exchange.
Capital Markets Revenue
• Capital markets revenue was $568 million versus $520 million in the previous quarter and $472 million a year earlier.
• Securities brokerage commissions increased 15% to $355 million from $309 million a year earlier, with underwriting and other advisory fees at $213 million, increasing by 31%. Security Losses Negligible – Large Unrealized Deficit
• AFS security loss was $66 million or $0.03 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.01 per share a year earlier.
• Unrealized security surplus was a deficit of $1,786 million versus a deficit of $2,163 million in the previous quarter.
Securitization Revenue Increases
• Securitization revenue increased to $354 million or $0.16 per share versus $227 million or $0.10 per share in the previous quarter, adding $0.06 per share to earnings.
Loan Loss Provisions Increase
• Specific loan loss provisions (LLPs) increased to $751 million or 1.07% of loans from $598 million or 0.81% in the previous quarter and $349 million or 0.53% of loans a year earlier. LLPs in Canadian Banking increased 30% sequentially to $351 million from $270 million. LLPs in U.S. & International increased sequentially to $289 million (3.16% bp of loans) from $200 million. The bank recorded a $223 million general provision ($146 million or $0.10 per share). Total loan loss provisions were $974 million or 1.38% of loans.
• We are increasing our 2009 LLP estimate to $2,800 million or 0.97% of loans from $2,100 million or 0.70% of loans. Our 2010 LLP estimate is unchanged at $2,600 million or 0.86% of loans.
Loan Formations Decline QOQ
• Gross impaired loan formations declined to $1,800 million versus $2,648 million in the previous quarter but increased from $867 million a year earlier. Gross impaired loans increased 19% quarter over quarter (QOQ) to $4,217 million or 1.46% of loans versus $3,540 million or 1.20% of loans in the previous quarter.
• Net impaired loan formations increased to $1,467 million, up from $737 million a year earlier and from $1,134 million in the previous quarter. Net impaired loans increased to $1,341 million or 0.46% of loans.
Tier 1 Ratio Strong at 11.4%
• Tier 1 capital was strong at 11.4% versus 10.6% in the previous quarter and 9.5% a year earlier due partially to a 3% sequential decline in risk-weighted assets mainly from currency impact.
• Risk-weighted assets increased 7% year over year (YOY) to $265.6 billion. Market-at-risk assets increased a modest 2% YOY and 5% QOQ to $20.1 billion.
• The common equity to risk-weighted assets (CE/RWA) ratio was 11.2% versus 11.1% in the previous quarter and 9.5% a year earlier.
Additional Disclosure on High-Risk Assets
• The bank provided additional disclosure on its exposure to U.S. sub-prime CDOs of ABS, RMBS and U.S. insurance and pension solutions. The notional and fair value exposures to these areas as well as writedowns are detailed in exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.
Recommendation
• We are reducing our 2009 earnings estimate to $4.15 per share from $4.25 per share due to a higher loan loss provision forecast. Our 2010 earnings estimate remains unchanged at $4.65 per share.
• Our 12-month share price target is unchanged at $58 per share, representing 14.0x our 2009 earnings estimate and 12.5x our 2010 earnings estimate.
• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength-of-franchise and operating platforms, growth prospects from RBC Capital Markets, recovery in Wealth Management and higher than bank group ROE.
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Financial Post, John Greenwood, 30 May 2009
According to Gord Nixon, chief executive of Royal Bank of Canada, the world that emerges when the current recession finally ends will be a much happier place for banks, with fatter margins, higher interest rates and less competition from the shadow banking system that in recent years has been muscling in on the lending business.
"I think you're going to see a lot of very positive things for the industry generally," said Mr. Nixon, commenting on a conference call after Royal reported its second quarter yesterday.
"You're going to have a repriced balance sheet and a much better pricing of credit. You'll see margin expansion because you'll naturally see that happen as interest rates start to move up. In addition to that, given all the things that have occurred in the marketplace, competitors have exited, particularly the shadow banking system, the pricing of assets has become more attractive."
But those happy days have not arrived yet. RBC yesterday posted its first lost since 1993 after taking a previously announced $1-billion writedown on goodwill associated with the declining value of loans held by its U. S. operations.
In the three months ended April 30, Canada's largest bank had a net loss of $50-million, or 7¢ a share, compared with a profit of $928-million (70¢) last year.
Excluding the goodwill charge and other one-time items, RBC came out ahead of analysts' expectations with a profit of 97¢ a share.
Royal was the last of the big six banks to post results and, as with its competitors, analysts were concerned about its exposure to the United States, where the economy is slowing more quickly than in Canada.
RBC, like Bank of Montreal and Toronto-Dominion Bank, has been expanding in the United States and in recent years has bought several banks in southeast states such as Alabama which are significantly exposed to the troubled real-estate market.
In April, Royal said it planned to take a $1-billion goodwill charge associated with those deals, but some analysts worry that given the state of the U. S. economy, there could be more writedowns to come.
"Trends continue to worsen," said Jim Bantis, an analyst at Credit Suisse, who noted that the bank's impaired loans had increased considerably over the first quarter and that loan-loss provisions had risen for the third consecutive quarter.
Mr. Nixon conceded that "the environment remains challenging," but said the bank's capital ratios are strong. RBC is prepared for a downturn, he said, and will emerge on the other side in a position to take advantage of the opportunities he expects to be there.
Mario Mendonca, an analyst at Genuity Capital Markets, said the crux of the problem is RBC's operations in the U. S. Southeast, where the housing-market meltdown has been particularly harsh, including the recently acquired AmSouth Bank and Flag Bank.
In the second quarter, RBC's U. S. operation had about US$3.3-billion of mortgages, US$4.6-billion of home-equity loans and a US$1-billion of loans to buy homebuilding lots.
In the event that the downturn in the United States is worse than expected, those assets could prove troublesome, Mr. Mendonca said.
"If U. S. unemployment moves higher, if you're going to see problems down the road, that's the stuff to be worried about," he said.
BMO and Toronto-Dominion both have U. S. branch networks, but most of their operations are not in states that have been hit hard by the housing meltdown.
;
According to Gord Nixon, chief executive of Royal Bank of Canada, the world that emerges when the current recession finally ends will be a much happier place for banks, with fatter margins, higher interest rates and less competition from the shadow banking system that in recent years has been muscling in on the lending business.
"I think you're going to see a lot of very positive things for the industry generally," said Mr. Nixon, commenting on a conference call after Royal reported its second quarter yesterday.
"You're going to have a repriced balance sheet and a much better pricing of credit. You'll see margin expansion because you'll naturally see that happen as interest rates start to move up. In addition to that, given all the things that have occurred in the marketplace, competitors have exited, particularly the shadow banking system, the pricing of assets has become more attractive."
But those happy days have not arrived yet. RBC yesterday posted its first lost since 1993 after taking a previously announced $1-billion writedown on goodwill associated with the declining value of loans held by its U. S. operations.
In the three months ended April 30, Canada's largest bank had a net loss of $50-million, or 7¢ a share, compared with a profit of $928-million (70¢) last year.
Excluding the goodwill charge and other one-time items, RBC came out ahead of analysts' expectations with a profit of 97¢ a share.
Royal was the last of the big six banks to post results and, as with its competitors, analysts were concerned about its exposure to the United States, where the economy is slowing more quickly than in Canada.
RBC, like Bank of Montreal and Toronto-Dominion Bank, has been expanding in the United States and in recent years has bought several banks in southeast states such as Alabama which are significantly exposed to the troubled real-estate market.
In April, Royal said it planned to take a $1-billion goodwill charge associated with those deals, but some analysts worry that given the state of the U. S. economy, there could be more writedowns to come.
"Trends continue to worsen," said Jim Bantis, an analyst at Credit Suisse, who noted that the bank's impaired loans had increased considerably over the first quarter and that loan-loss provisions had risen for the third consecutive quarter.
Mr. Nixon conceded that "the environment remains challenging," but said the bank's capital ratios are strong. RBC is prepared for a downturn, he said, and will emerge on the other side in a position to take advantage of the opportunities he expects to be there.
Mario Mendonca, an analyst at Genuity Capital Markets, said the crux of the problem is RBC's operations in the U. S. Southeast, where the housing-market meltdown has been particularly harsh, including the recently acquired AmSouth Bank and Flag Bank.
In the second quarter, RBC's U. S. operation had about US$3.3-billion of mortgages, US$4.6-billion of home-equity loans and a US$1-billion of loans to buy homebuilding lots.
In the event that the downturn in the United States is worse than expected, those assets could prove troublesome, Mr. Mendonca said.
"If U. S. unemployment moves higher, if you're going to see problems down the road, that's the stuff to be worried about," he said.
BMO and Toronto-Dominion both have U. S. branch networks, but most of their operations are not in states that have been hit hard by the housing meltdown.
