Royal Bank of Canada reported solid profits on Wednesday for the ninth straight year, and, like clockwork, the bank’s executives were rewarded with skeptical questions from analysts about the odds of future success.
Such scrutiny is almost automatic for Canada’s largest public company by stock-market value. Canadian banks have faced one obstacle after another over the past decade. There was the financial crisis, the slow economic recovery, the fears of a housing bubble, the collapse of energy prices from 2014 to 2016. Now, the price of Alberta heavy oil is tumbling again.
But through it all, the country’s biggest banks have remained sturdy – and RBC has been one of the most dependable. Its total profit in fiscal 2018, which ended Oct. 31, hit $12.4-billion. That’s 38 per cent higher than the earnings announced five years before.
For all that growth, RBC can’t shake the questions about its resilience. Before Wednesday, its shares had fallen 4.9 per cent in the past 12 months, despite delivering better earnings in each consecutive quarter over the past year.
The latest results did persuade buyers to push the stock the stock 2.7 per cent higher on Wednesday, to $98.10. But the broader market also rose sharply. Winning over investors is expected to remain tough.
“The market is pricing in substantial headwinds for 2019,” Eight Capital analyst Steve Theriault wrote in a research report on Wednesday. RBC’s stock trades at less than 12 times last year’s earnings.
What is the root of the market’s skepticism? On top of regular hiccups such as commodity price swings, which threaten to bring higher loan losses in Alberta, the 2008 crash still lingers in some investors' minds. There have been continuous political, economic and market disruptions in the decade since – everything from the unexpected election of U.S. President Donald Trump to the quantitative easing that lasted longer than many thought it would and suppressed interest rates.
Still, by now, RBC’s continued strength is tough to overlook. On Wednesday, the bank reported that its Tier 1 capital ratio is 11.5 per cent, a full percentage point higher than RBC’s target level, and much higher than it was before the financial crisis. That means the bank has loads of money tucked away to serve as a buffer when a downturn comes.
RBC’s return on equity, one of the industry’s most closely watched metrics, also sits at 17.6 per cent. To put that in perspective, JP Morgan Chase & Co. is constantly praised as one of the world’s best-run banks, but its ROE is 14 per cent.
This return largely stems from a stellar personal and commercial banking (P&C) business that contributes nearly 50 per cent of RBC’s bottom line. The division remains highly profitable, despite a recent housing slowdown. In fiscal 2018, the bank’s residential mortgage portfolio grew 5 per cent, but total P&C revenues rose 8.6 per cent in the fourth quarter, compared with the previous year.
“Companies are investing. Employment is strong. There are a number of tailwinds from an economic perspective," chief financial officer Rod Bolger said in an interview.
The strong economy means interest rates are rising at last, and that has been a major boon to lenders, allowing them to charge more for mortgages and many other loans. The rates banks pay on deposits are also rising, but not as quickly.
Of course, nothing lasts forever, and lately there are growing expectations of a U.S. recession, or at least a sharp slowdown. Asked about the largest systemic threats that RBC faces, Mr. Bolger, the CFO, cited trade tensions and the risk of higher unemployment. At the moment, this threat is most imminent in Alberta, because the province is wrestling with low prices for oil and gas.
As for RBC’s own oil and gas exposure, chief risk officer Graeme Hepworth brushed off the questions on Wednesday, noting that the sector amounts to only 1 per cent of RBC’s total loan book and calling the risk “pretty small, pretty manageable.”
RBC must also demonstrate that its U.S. City National division will deliver better profits. The bank has invested in it this year, and that has taken the steam out of profit expansion. The American market dynamics are also changing, with many affluent and high-net-worth clients moving their money out of deposits and into better-yielding assets, which makes it harder for banks such as City National to find cheaper ways of funding their loans.
RBC’s executives, though, are not sweating it. “We’re feeling good about the outlook for the economy and for the bank," chief executive officer Dave McKay said on a conference call on Wednesday.
Investors that trust them could see big gains. “If RBC can in fact deliver, we believe there is meaningful upside for [its] shares as the bank continues to do a lot of the right things," Mr. Theriault, the analyst, said in his report.
Tim Kiladze