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Report on Business RBC’s third-quarter profit sets the tone for healthy earnings for Canada’s largest banks

Royal Bank of Canada shrugged off concerns about trends in consumer credit and the global economy to report higher third-quarter profit and revenue, even as it set aside more cash to prepare for a rainy day.

Each of the bank’s core divisions – retail banking, wealth management and capital markets – pitched in to propel profit 11 per cent higher than a year ago, despite less stellar results from investor and treasury services, and the bank’s insurance arm.

RBC is the first bank to report third-quarter results and its solid performance sets the tone for another quarter of healthy earnings for Canada’s largest banks, which have routinely outpaced estimates this year. The bank also enjoyed rapid growth from its expanding U.S. operations, fuelled by improving margins on loans, which bodes well for Toronto-Dominion Bank, Bank of Montreal and Canadian Imperial Bank of Commerce – all of which also have sizable U.S. footprints. CIBC is scheduled to report on Thursday, with other banks following next week.

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Robust economic conditions and low unemployment across North America have been crucial to RBC’s success, but the bank’s risk managers are keeping a wary eye out for storm clouds gathering on the horizon. Uncertainty about the fate of the North American free-trade agreement, compounded by tariff wars and instability in Turkey and Venezuela, continue to weigh on confidence. And it remains to be seen how well consumers can withstand rising interest rates that make debt more costly, while adjusting to tougher stress-testing on some mortgages that was introduced in January.

Expected loan losses swelled to $338-million, up 22 per cent from the previous quarter, as RBC set aside more money to cover loans that are performing but could go sour. But executives attributed the increase largely to accounting changes, and the bank’s provisions for loans considered to be impaired decreased amid a strong labour market.

So far, there are scarcely any signs of stress in the bank’s credit portfolios. Delinquencies are low and consumers appear to be tempering their borrowing habits, according to Neil McLaughlin, head of RBC’s personal and commercial banking group. “We were expecting to see customers be a little bit caught off guard and our front-line advisers really aren’t sharing that,” he said. RBC has seen a modest uptick in a metric measuring how much of a client’s income is needed to service their debts, but it “wasn’t as high as we were expecting, and again we attribute that back to customers really self-adjusting.”

Under new accounting rules, banks must earmark money to cover potential losses both for loans that are still performing fairly well and those that have already been labelled as impaired. The new model emphasizes expected losses over the life of a loan, which can be subjective and vary from bank to bank.

In the third quarter, RBC added $90-million in provisions for performing loans in an effort to be “prudent,” anticipating “potential storm clouds that aren’t there now but could be there in the future,” chief financial officer Rod Bolger said in an interview. “That is what the accounting standards would have us do. And there is no deterioration in our mind, over all, from a macroeconomic standpoint or a credit perspective.”

At the same time, provisions for impaired loans decreased sharply to $248-million, from $298-million in the second quarter and $320-million a year ago – owing in no small part to Canada’s low unemployment rate, which sits at 5.8 per cent. “Credit trends continue to be very favourable, and I’d encourage people to weight that more,” Mr. Bolger said, adding: “We’re no more worried than we were three months ago or six months ago.”

For the three months that ended July 31, RBC reported profit of $3.1-billion, or $2.10 a share, compared with $2.8-billion, or $1.85, a year earlier.

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Adjusted to exclude for one-time items, RBC earned $2.14 a share, ahead of the $2.11-a-share consensus expectation among analysts, according to Bloomberg LP.

Revenue was $11-billion, up 9 per cent from a year ago, although expenses rose 6 per cent to $5.9-billion as RBC continues to invest in technology and new ventures.

RBC also hiked its quarterly dividend by 4 cents, to 98 cents a share.

In RBC’s core personal and commercial banking arm, profit rose 8 per cent to $1.5-billion, helped by wider spreads from rising interest rates and good growth in mortgages, commercial lending and deposits. The bank’s residential mortgage portfolio expanded by 5.9 per cent compared with a year ago, despite new regulations that make it tougher for some borrowers to qualify for loans. And its renewal rate for existing mortgages climbed to 92 per cent, which Mr. Bolger attributed mostly to a new online tool that cuts down on paperwork.

Capital markets profit rebounded from a sluggish second quarter, up 14 per cent year over year to $698-million, driven by higher revenue from corporate and investment banking, as well as lower loan losses.

In wealth management, bullish equity markets and brisk client activity helped propel profit to $578-million, up 19 per cent year over year. The U.S. wealth-management arm was a major contributor, with profit up 44 per cent to $202-million, as loans made by the City National subsidiary grew by 15 per cent.

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The two blemishes on RBC’s earnings came from investor and treasury services – which caters to institutional investors – where profit fell 13 per cent because of lower funding and liquidity revenue, and 2 per cent lower profit from the bank’s insurance arm, owing mostly to rising costs.

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