07 December 2009

RBC Q4 2009 Earnings

Scotia Capital, 7 December 2009

RY cash operating EPS increased 4% YOY to $1.06/share in line with our estimate and slightly above consensus. Operating ROE was 18.9%, with RRWA of 2.45% and Tier 1 Capital at 13.0%. Fiscal 2009 EPS was $4.45, an increase of 4% from $4.30 per share in 2008.


• Canadian Banking earnings increased 6% YOY. Insurance earnings declined 25% YOY with Wealth Management earnings increasing 4% and Capital Markets increasing 42% due to strong trading revenue. International Banking recorded a loss of $46M due to high loan losses.

• Our 2010E EPS remains unchanged at $4.80. We are introducing our 2011E EPS at $5.50. Our one-year share price target remains unchanged at $75 per share representing 15.6x our 2010E EPS and 13.6x our 2011E EPS.


• We maintain our 1-SO rating on the shares of Royal Bank based on its superior earnings growth given the strength of its retail and wealth management businesses and its uniquely positioned capital markets platform (U.K. and U.S. presence). In addition, the bank has significant earnings recovery potential from its U.S. retail business. RY has no meaningful premium despite its high ROE, and high capital bank.
The Globe and Mail, Tara Perkins, 4 December 2009

Royal Bank of Canada is now sitting on nearly $15-billion more than it needs to meet regulators' minimum capital requirements, and it's money that chief executive officer Gordon Nixon is in no rush to spend.

RBC is receiving more deal pitches than ever before from CEOs and investment bankers with businesses to sell, Mr. Nixon suggested Friday. But he has other ideas.

Canada's largest bank, which just posted a $3.86-billion profit for the fiscal year ended Oct. 31, has made more than two dozen acquisitions since Mr. Nixon took the top job in 2001.

But only three deals have been done since the financial crisis peaked, even though banks and other financial companies have become much cheaper – and Mr. Nixon is unlikely to increase the pace of acquisitions any time soon.

Why? Because as the banking sector moves from crisis to recovery, his strategy is to try to anticipate what regulators will demand, and stay ahead of the curve. And he knows that he could plump profits just by making more loans down the line, when conditions improve.

While he doesn't know exactly what the new capital requirements will be, he's confident RBC already exceeds them. That, he suggests, will give it an edge, because banking should become a lot more profitable in the next few years.

In fact, Mr. Nixon foresees a heyday for banking, complete with fatter lending margins. He wants to have plenty of funds to lend when that time comes, so RBC is content to sit on money that some analysts think should be put to use now.

“In the next five years, leaders in the financial services sector – in my view – will be defined by their ability to successfully manage through regulatory reform,” Mr. Nixon said Friday on a conference call with analysts after RBC reported fourth-quarter profits of $1.24-billion, topping the Street's estimates.

“Our capital strength, low leverage ratio and business mix combine to provide a great competitive advantage over other global competitors that will be required to shrink their balance sheets and change their business strategies in response to regulatory changes.”

The key measure of RBC's financial cushion, called the Tier 1 capital ratio, now sits at a whopping 13 per cent, up from 9 per cent a year ago. It's nearly double the Canadian regulator's minimum requirement of 7 per cent, and the highest of the big banks. And the proportion of RBC's capital that comes from plain vanilla common equity, the strongest form of capital, is higher than many peers.

Comparing Tier 1 ratios among banks in different countries is a bit of an apples-to-oranges issue, but Barclays Capital analyst John Aiken said he thinks RBC's capital position is arguably the strongest on a global basis as well.

“Navigating the regulatory environment over the next couple of years is going to be a major undertaking for all banks around the world, and we want to go into that in as ‘fortressed' a position as we possibly can, because we think it will provide us good opportunities to deploy capital in the future,” Mr. Nixon said, borrowing a phrase from Manulife CEO Don Guloien, whose strategy is also to build “fortress” capital levels.

Mr. Nixon expects RBC will be able to pick up new market share in Canadian, international, and investment banking down the line as a result of this strategy.

The crisis has damaged competitors, with a number of global banks exiting certain countries and businesses. Many financial institutions will be forced to shrink their loan books further to meet new capital and leverage rules, Mr. Nixon predicts, and the global flood of government stimulus money will dry up.

Prices for the bank's corporate loans have already risen significantly, with new loans being made at better prices than RBC could charge before the crisis.

The last couple of years have been characterized by aggressive pricing, “and I do think that we'll be settling into a different environment that will be very favourable going forward,” Mr. Nixon said.

That's not to say the bank isn't growing its loan portfolios right now. It holds $146.4-billion worth of mortgages, up from $136.2-billion a year ago.

And Mr. Nixon's still looking at potential wealth management acquisitions outside Canada. But he's not in any hurry.

“Our strong balance sheet and capital base will enable us to invest in key business areas, as well as explore potential acquisitions that meet our strict economic, strategic and cultural criteria,” he said.