• BMO cuts price target to C$53 from C$63; rating outperform
• CIBC cuts price target to C$56 from C$62; rating sector performer
• KBW cuts price target by C$2 to C$58; rating outperform
• Macquarie cuts target price to C$56 from C$60; rating neutral
• UBS cuts price target to C$66 from C$68; rating buy
__________________________________________________________
Scotia Capital, 27 August 2010
Event
• Royal Bank (RY) cash operating earnings declined 28% YOY to $0.87 per share significantly below expectations due to lower-than-expected trading revenue and lower net-interest margin, which offset strong earnings from Canadian Banking and Wealth Management. Operating ROE was 14.8% with RRWA of 1.95%.
Implications
• RBC Capital Markets earnings declined 68% YOY to $202M as trading revenue collapsed. Trading revenue plummeted to $188M from $1,022M in the previous quarter and $1,656M a year earlier. Canadian Banking earnings were strong increasing 14% YOY to $766M.
• We have reduced our 2010 and 2011 earnings estimates to $3.85 per share and $4.40 per share from $4.15 per share and $4.80 per share, respectively, due to lower earnings from wholesale banking, lower economic growth outlook, and moderating net interest margin as the prospect for higher interest rates is delayed.
Recommendation
• We have reduced our one-year share price target to $60 from $68 based on our lower earnings estimates. We maintain our 2-Sector Perform rating.
Canadian Banking Earnings Increase 14%
• Canadian Banking earnings increased 14% to $766 million from $671 million a year earlier, due to solid loan volume and revenue growth and lower LLPs. Canadian Banking average loans and acceptances increased 8% YOY and 2% QOQ.
• Revenue growth was solid at 5.9% although muted by a 1 bp YOY decline in retail net interest margin to 2.70%. Retail NIM declined 6 bp sequentially. Expenses increased 6.3% reflecting higher performance related compensation, higher pension costs, and investment in business growth. Efficiency ratio was flat at 47.3%.
• Loan loss provisions (LLPs) declined 6% to $284 million from $302 million in the previous quarter.
Overall NIM
• The bank's overall net interest margin declined 18 bp from the previous quarter and 35 bp from a year earlier to 2.01%.
RBC Capital Markets Earnings Plummet
• RBC Capital Markets earnings declined 68% YOY and 60% QOQ to $202 million from $622 million a year earlier and $502 million in the previous quarter due to a collapse in trading revenue.
Trading Revenue Collapse
• Trading revenue in RBC Capital Markets plummeted to $188 million versus $1,022 million in the previous quarter and $1,656 million a year earlier. This is the lowest operating trading revenue since the third quarter of 1997. Trading revenue was negatively impacted by losses on MBIA and BOLI and difficult market conditions. The impacts of MBIA and BOLI were a loss of $100 million and $73 million respectively, which negatively impacted earnings by $0.05 per share.
• The major weakness in trading revenue was in interest rate trading, which had a loss of $19 million versus positive $650 million in the previous quarter and $1,056 million a year earlier. The weakness in interest rate trading was centered in the bank's U.K./European trading operations.
• On the conference call, RBC guided that it is reasonable to expect annual trading revenues to be in the $3 billion to $4 billion range.
Wealth Management Earnings Improve
• Wealth Management cash earnings increased 20% to $197 million from $164 million in the previous quarter and increased 10% from $179 million a year earlier.
• Revenues increased 2.6%, with operating expenses increasing 3.7% from a year earlier for negative operating leverage of 1.1%.
• U.S. Wealth Management revenue declined 5%, with Canadian Wealth Management revenue increasing 9% and Global Asset Management revenues increasing 15%.
• Mutual fund revenue increased 7% from a year earlier to $388 million. Mutual Fund assets (IFIC) declined 1% from a year earlier to $101.1 billion, including PH&N.
Insurance
• Insurance earnings were $153 million versus $107 million in the previous quarter and $167 million a year earlier. Strong premiums and solid investment income helped offset higher claims in the quarter.
International Banking Remains in Loss Position
• International Banking continued to report a loss at $52 million versus a loss of $3 million in the previous quarter due to weaker net interest margin, higher LLPs, and operating expenses.
• LLPs were $192 million, up slightly from $185 million in the previous quarter but down from $230 million a year earlier.
• Net interest margin declined 8 bp from a year earlier and 28 bp sequentially to 3.78%.
Capital Markets Revenue Stable
• Capital markets revenue was $608 million versus $565 million in the previous quarter and $636 million a year earlier. Securities brokerage commissions declined 7% to $313 million from $337 million a year earlier, with underwriting and other advisory fees at $295 million, declining by 1%.
Security Gains - Modest Loss
• AFS security gains were a loss of $14 million or $0.01 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.03 per share a year earlier. Unrealized security surplus was a surplus of $188 million versus a surplus of $125 million in the previous quarter.
Securitization Loss Declines
• Securitization net income impact declined to a loss of $10 million, or $0.00 per share, versus a loss of $55 million, or $0.03 per share, in the previous quarter.
Loan Loss Provisions Decline
• Specific loan loss provisions (LLPs) declined to $432 million or 0.58% of loans from $477 million or 0.67% in the previous quarter and from $709 million or 0.98% of loans a year earlier.
• We have reduced our 2010 LLP estimate to $1,850 million or 0.63% of loans from $2,000 million or 0.69% of loans, due to lower-than-expected loan loss provisions in the third quarter. Our 2011 LLP estimate is reduced to $1,600 million or 0.53% of loans from $1,800 million or 0.59% of loans.
Gross Impaired Loan Formations Decline Modestly
• Gross impaired loans were unchanged at $5,020 million or 1.69% of loans versus $5,064 million or 1.74% of loans in the previous quarter. Net impaired loans were flat at $1,841 million, or 0.62% of loans, versus $1,841 million, or 0.63% of loans, in the previous quarter.
• Gross impaired loan formations declined to $868 million from $1,131 million in the previous quarter. Net impaired loan formations increased slightly to $519 million from $475 million in the previous quarter.
• Average loan and acceptances increased 3% YOY and 2% QOQ. International Banking average loans and acceptances declined 13% YOY and were flat QOQ. RBC Capital Markets average loans and acceptances declined 19% YOY but increased 1% QOQ.
Tier 1 Ratio 12.9%
• Tier 1 capital declined to 12.9% from 13.4% in the previous quarter due to higher risk-weighted assets.
• Risk-weighted assets increased 4% sequentially and 6% YOY to $258.8 billion. Market-at-risk assets increased 55% YOY and 21% QOQ to $27.3 billion. The common equity to risk-weighted assets (CE/RWA) ratio was 13.0% versus 13.3% in the previous quarter and 12.8% a year earlier.
;
Event
• Royal Bank (RY) cash operating earnings declined 28% YOY to $0.87 per share significantly below expectations due to lower-than-expected trading revenue and lower net-interest margin, which offset strong earnings from Canadian Banking and Wealth Management. Operating ROE was 14.8% with RRWA of 1.95%.
Implications
• RBC Capital Markets earnings declined 68% YOY to $202M as trading revenue collapsed. Trading revenue plummeted to $188M from $1,022M in the previous quarter and $1,656M a year earlier. Canadian Banking earnings were strong increasing 14% YOY to $766M.
• We have reduced our 2010 and 2011 earnings estimates to $3.85 per share and $4.40 per share from $4.15 per share and $4.80 per share, respectively, due to lower earnings from wholesale banking, lower economic growth outlook, and moderating net interest margin as the prospect for higher interest rates is delayed.
Recommendation
• We have reduced our one-year share price target to $60 from $68 based on our lower earnings estimates. We maintain our 2-Sector Perform rating.
Canadian Banking Earnings Increase 14%
• Canadian Banking earnings increased 14% to $766 million from $671 million a year earlier, due to solid loan volume and revenue growth and lower LLPs. Canadian Banking average loans and acceptances increased 8% YOY and 2% QOQ.
• Revenue growth was solid at 5.9% although muted by a 1 bp YOY decline in retail net interest margin to 2.70%. Retail NIM declined 6 bp sequentially. Expenses increased 6.3% reflecting higher performance related compensation, higher pension costs, and investment in business growth. Efficiency ratio was flat at 47.3%.
• Loan loss provisions (LLPs) declined 6% to $284 million from $302 million in the previous quarter.
Overall NIM
• The bank's overall net interest margin declined 18 bp from the previous quarter and 35 bp from a year earlier to 2.01%.
RBC Capital Markets Earnings Plummet
• RBC Capital Markets earnings declined 68% YOY and 60% QOQ to $202 million from $622 million a year earlier and $502 million in the previous quarter due to a collapse in trading revenue.
Trading Revenue Collapse
• Trading revenue in RBC Capital Markets plummeted to $188 million versus $1,022 million in the previous quarter and $1,656 million a year earlier. This is the lowest operating trading revenue since the third quarter of 1997. Trading revenue was negatively impacted by losses on MBIA and BOLI and difficult market conditions. The impacts of MBIA and BOLI were a loss of $100 million and $73 million respectively, which negatively impacted earnings by $0.05 per share.
• The major weakness in trading revenue was in interest rate trading, which had a loss of $19 million versus positive $650 million in the previous quarter and $1,056 million a year earlier. The weakness in interest rate trading was centered in the bank's U.K./European trading operations.
• On the conference call, RBC guided that it is reasonable to expect annual trading revenues to be in the $3 billion to $4 billion range.
Wealth Management Earnings Improve
• Wealth Management cash earnings increased 20% to $197 million from $164 million in the previous quarter and increased 10% from $179 million a year earlier.
• Revenues increased 2.6%, with operating expenses increasing 3.7% from a year earlier for negative operating leverage of 1.1%.
• U.S. Wealth Management revenue declined 5%, with Canadian Wealth Management revenue increasing 9% and Global Asset Management revenues increasing 15%.
• Mutual fund revenue increased 7% from a year earlier to $388 million. Mutual Fund assets (IFIC) declined 1% from a year earlier to $101.1 billion, including PH&N.
Insurance
• Insurance earnings were $153 million versus $107 million in the previous quarter and $167 million a year earlier. Strong premiums and solid investment income helped offset higher claims in the quarter.
International Banking Remains in Loss Position
• International Banking continued to report a loss at $52 million versus a loss of $3 million in the previous quarter due to weaker net interest margin, higher LLPs, and operating expenses.
• LLPs were $192 million, up slightly from $185 million in the previous quarter but down from $230 million a year earlier.
• Net interest margin declined 8 bp from a year earlier and 28 bp sequentially to 3.78%.
Capital Markets Revenue Stable
• Capital markets revenue was $608 million versus $565 million in the previous quarter and $636 million a year earlier. Securities brokerage commissions declined 7% to $313 million from $337 million a year earlier, with underwriting and other advisory fees at $295 million, declining by 1%.
Security Gains - Modest Loss
• AFS security gains were a loss of $14 million or $0.01 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.03 per share a year earlier. Unrealized security surplus was a surplus of $188 million versus a surplus of $125 million in the previous quarter.
Securitization Loss Declines
• Securitization net income impact declined to a loss of $10 million, or $0.00 per share, versus a loss of $55 million, or $0.03 per share, in the previous quarter.
Loan Loss Provisions Decline
• Specific loan loss provisions (LLPs) declined to $432 million or 0.58% of loans from $477 million or 0.67% in the previous quarter and from $709 million or 0.98% of loans a year earlier.
• We have reduced our 2010 LLP estimate to $1,850 million or 0.63% of loans from $2,000 million or 0.69% of loans, due to lower-than-expected loan loss provisions in the third quarter. Our 2011 LLP estimate is reduced to $1,600 million or 0.53% of loans from $1,800 million or 0.59% of loans.
Gross Impaired Loan Formations Decline Modestly
• Gross impaired loans were unchanged at $5,020 million or 1.69% of loans versus $5,064 million or 1.74% of loans in the previous quarter. Net impaired loans were flat at $1,841 million, or 0.62% of loans, versus $1,841 million, or 0.63% of loans, in the previous quarter.
• Gross impaired loan formations declined to $868 million from $1,131 million in the previous quarter. Net impaired loan formations increased slightly to $519 million from $475 million in the previous quarter.
• Average loan and acceptances increased 3% YOY and 2% QOQ. International Banking average loans and acceptances declined 13% YOY and were flat QOQ. RBC Capital Markets average loans and acceptances declined 19% YOY but increased 1% QOQ.
Tier 1 Ratio 12.9%
• Tier 1 capital declined to 12.9% from 13.4% in the previous quarter due to higher risk-weighted assets.
• Risk-weighted assets increased 4% sequentially and 6% YOY to $258.8 billion. Market-at-risk assets increased 55% YOY and 21% QOQ to $27.3 billion. The common equity to risk-weighted assets (CE/RWA) ratio was 13.0% versus 13.3% in the previous quarter and 12.8% a year earlier.
