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RBC profit buoys outlook for Canadian banks

An RBC Financial Group sign featuring the current lion and globe logo, and the first Royal Bank of Canada logo, created in 1962, are photographed on July 10, 2017. (Fred Lum/The Globe and Mail)

Fred Lum/The Globe and Mail

Neither interest-rate uncertainty nor hot-and-cold Canadian housing markets could shake Royal Bank of Canada from a steady path toward stronger growth.

Canada's second-largest lender by assets showed such trust in its trajectory on Wednesday that it kicked off the third-quarter reporting season for big banks by hiking its dividend by 5 per cent, to 91 cents a share – twice the increase most analysts expected.

Encouraging results from RBC's key retail-banking arm, which posted a 6-per-cent bump in profit to $1.4-billion and 5-per-cent growth in domestic earnings, bolster the case for cautious optimism amid a flurry of changing economic conditions.

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Several hopeful signs are emerging for RBC and its fellow banks. The Canadian economy is projected to grow faster than any other Group of Seven country in 2017, providing relief after a prolonged period of slower progress. The prospect of a second interest-rate increase from the Bank of Canada in October, coming on the heels of the first hike in about seven years in July, could lift some of the pressure on margins. And after months of hand-wringing over skyrocketing Toronto-area housing prices, federal Finance Minister Bill Morneau now says changes to mortgage rules have helped curb high-risk borrowing.

RBC boosted its underlying profit by 5 per cent in the third quarter, overcoming headwinds from higher costs and weaker trading revenue in capital markets. In absolute terms, net income dipped by 3 per cent, but only because last year's third-quarter results included a $235-million after-tax gain on the sale of an insurance business.

"We had a solid quarter," president and chief executive officer Dave McKay said on a Wednesday conference call with analysts. "All our business segments performed well."

The bank's adjusted earnings per share of $1.89, which excludes last year's gain on sale, topped analysts' consensus estimate by 2 cents, according to Bloomberg LP.

Unadjusted earnings per share were $1.85, down 2 per cent from a year earlier, while revenue fell 2.6 per cent, dipping just below $10-billion.

RBC's net interest margin, which tracks the difference between what it earns on loans and pays on deposits, was unchanged from a year ago. But as interest rates begin to rise, "we expect to see benefits next year," chief financial officer Rod Bolger said.

Yet, the third quarter wasn't without its challenges for RBC. Profit from the capital-markets arm dipped by 4 per cent to $611-million, as less-volatile markets led to lower fixed-income trading returns. During the same period last year, investors were caught off guard by the Brexit vote, roiling financial markets.

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And the bank's costs climbed higher as it invested heavily in new digital capabilities, exploring fields such as artificial intelligence. To free up cash for new initiatives, RBC increased its cost-cutting, slashing several hundred jobs, many of them from its head office. (By contrast, the bank has hired more than 450 new staff at its United States arm.)

So far this fiscal year, the bank has paid $175-million in severance, including $120-million in the third quarter. "We found ourselves a need to accelerate our transformation," Mr. McKay said. "We moved kind of two years of work into two quarters."

Other parts of RBC's business have responded. The wealth-management division was a bright spot, with profit rising 25 per cent to $486-million. So far, the 2015 acquisition of Los Angeles-based lender City National Bank is providing the shot in the arm that RBC had anticipated. The U.S. lender contributed $79-million in profit in the third quarter – 26 per cent more than a year ago – helped along by rising American interest rates.

"If [RBC's] quarter could be defined in one word, resilience is the one that comes to mind," Gabriel Dechaine, an analyst at National Bank Financial Inc., said in a research note.

Looking ahead, the biggest risk to the bank's momentum comes from global political pressures, according to Mr. Bolger. "It would be beneficial if a trade deal could be solidified," he said in an interview, one day after U.S. President Donald Trump mused that he would "probably" terminate the North American free-trade agreement.

Housing is also still a source of uncertainty. RBC reported healthy credit metrics in its residential mortgage portfolio, which grew by 6 per cent and had low delinquency rates in Vancouver and Toronto. Mr. McKay praised an array of government measures to cool price increases. "We welcome the changes that have happened so far, and the slowing."

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He also voiced his support for draft changes to the federal policy on mortgage underwriting – known as the B-20 guideline – proposed by Canada's banking regulator. New rules would introduce tougher stress testing for uninsured mortgages, making it harder for some borrowers to qualify. But Mr. McKay called the proposed measures "prudent."

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