Monday, December 08, 2008

RBC Q4 2008 Earnings

  
• BMO Capital Markets cuts target price to $43.50 from $53.50
• Dundee Securities cuts target price to $38 from $43
• Genuity Capital Markets cuts target price to $44 from $52
• RBC Capital Markets target price is $47
• TD Securities cuts target price to $40 from $55
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Scotia Capital, 8 December 2008

Q4/08 Operating Earnings Solid

• Royal Bank (RY) cash operating earnings were flat at $1.01 per share slightly better than pre-released numbers. Operating ROE was 20.0% versus 22.9% a year earlier. Reported earnings were $0.84 per share after writedowns with ROE a solid 16.3%.

• Positives this quarter were operating results in Canadian Banking and RBC Capital Markets with negatives being gross impaired loans and credit losses especially in U.S. home builder portfolio.

• Reported earnings of $0.84 per share included net writedowns of $242 million after-tax or $0.18 per share, gains on CDS hedging corporate loan book of $105 million after-tax or $0.08 per share, and a general provision of $145 million ($98 million after-tax or $0.07 per share). Reported ROE for fiscal 2008 was solid at 18.2%.

• Earnings were driven by strong Canadian Banking earnings which increased 11% YOY followed by 16% growth at RBC Capital Markets (excluding writedowns) with Insurance increasing 36% to $139 million. Wealth Management earnings declined 10%. The operating performance in the U.S. was disappointing as earnings declined to a loss of $13 million (excluding writedowns) from net income of $36 million a year earlier due to higher loan loss provisions.

Positive Operating Leverage Continues

• Overall bank operating leverage was a positive 1.0%, with revenues (excluding writedowns) increasing 12.6% and non-interest expenses adjusted for insurance and VIEs increasing 11.6%.

Canadian Banking Earnings Increase 11%

• Canadian Banking earnings were up 11% to $679 million from $611 million a year earlier due to strong volume growth and cost control.

• Revenues in the Canadian Banking segment increased 3.7%, with non-interest expenses flat from a year earlier, resulting in positive operating leverage of 3.7%.

• Loan loss provisions (LLPs) increased 6% to $225 million from $212 million a year earlier, reflecting portfolio growth.

• Fiscal 2008 Canadian Banking earnings increased 13% to $2,669 million from $2,364 million a year earlier.

Canadian Retail NIM Declines 6 bp

• Retail net interest margin (NIM) declined 6 basis points (bp) sequentially and 21 bp from a year earlier to 2.89%.

Insurance

• Insurance earnings were strong this quarter at $139 million (excluding writedowns) versus $137 million in the previous quarter and $102 million a year earlier.

• Insurance earnings in fiscal 2008 were $469 million versus $442 million in fiscal 2007.

Wealth Management Earnings Decline 10%

• Wealth Management cash earnings declined 10% to $166 million from $185 million a year earlier.

• Revenue increased 4%, with operating expenses increasing 9% for negative operating leverage of 5%.

• U.S. Wealth Management revenue improved 1%, with Canadian Wealth Management flat and Global Asset Management revenue increasing 25%.

• Mutual fund revenue increased 4% from a year earlier to $387 million. Mutual Fund assets (IFIC) declined 9% from a year earlier to $93.2 billion including PH&N.

• Wealth Management earnings for fiscal 2008 declined modestly to $739 million from $784 million in fiscal 2007.

U.S. & International Banking Records a Loss

• U.S. & International recorded a loss of $13 million versus net income of $36 million a year earlier due to a 175% increase in loan loss provisions. LLPs continued to rise, increasing to $198 million from $72 million a year earlier and up from $137 million in the previous quarter, relating primarily to U.S. residential builder finance. LLPs are at an extremely high levels of 2.32% of loans.

• Net interest margin improved 38 bp from a year earlier and 6 bp sequentially to 3.78%.

• Fiscal 2008 U.S. & International Banking earnings declined by half to $128 million from $299 million in fiscal 2007 mainly due to higher loan loss provisions.

RBC Capital Markets Earnings Increased 16%

• RBC Capital Markets earnings increased 16% (excluding writedowns) to $403 million from $346 million a year earlier due to strong capital markets revenue.

• RBC Capital Markets earnings in fiscal 2008 increased 11% to $1,620 million from $1,453 million in fiscal 2007.

Underlying Trading Revenue Solid

• Trading revenue was solid at $588 million (excluding writedowns) versus $717 million in the previous quarter and $517 million a year earlier.

• Fiscal 2008 trading revenue increased 28% to $2,982 million from $2,321 million in fiscal 2007.

Capital Markets Revenue

• Capital markets revenue was strong at $643 million from $588 million in the previous quarter and $625 million a year earlier.

• Securities brokerage commissions increased 20% to $390 million from $324 million a year earlier, with underwriting and other advisory fees at $253 million, declining by 16%.

• Capital Markets revenue declined 12% in fiscal 2008 was $2,252 million versus $2,570 million in fiscal 2007.

Security Gains Negligible - Large Unrealized Deficit

• Security gains were a loss of $15 million or $0.01 per share versus nil per share in the previous quarter and a loss of $0.01 per share a year earlier.

• Unrealized security surplus was a deficit of $1,729 million versus a deficit of $546 million in the previous quarter and a surplus of $105 million a year earlier.

• RY reclassified its $6.9 billion in securities including U.S. auction rate securities and U.S. agency and non-agency mortgage backed securities from Held for Trading (HFT) to Available-for-Sale (AFS) effective August 1, 2008.

Loan Loss Provisions Increase

• Specific loan loss provisions (LLPs) increased to $474 million or 0.63% of loans from $334 million or 0.47% of loans in the previous quarter and $263 million or 0.42% of loans a year earlier. LLPs in Canadian Banking increased 6% to $225 million from $212 million a year earlier. LLPs in International Banking continue to rise, increasing to $198 million from $72 million a year earlier and up from $137 million in the previous quarter relating to U.S. residential builder finance.

• RY added $145 million ($98 million after-tax or $0.07 per share) to general reserves. Therefore total loan loss provisions were $619 million or 0.82% of loans.

• Loan loss provisions in fiscal 2008 were $1,450 million or 0.48% of loans versus $791 million of 0.32% of loans in fiscal 2007.

• We are increasing our 2009 and 2010 LLP estimates to $1,800 million or 0.58% of loans and $2,000 million or 0.62% of loans from $1,500 million or 0.51% of loans and $1,800 million or 0.59% of loans, respectively.

Loan Formations Increase

• Gross impaired loan formations increased to $1,091 million versus $753 million in the previous quarter and $573 million a year earlier. Net impaired loan formations increased to $1,192 million, up from $605 million in the previous quarter and $424 million a year earlier, reflecting mainly higher impaired loans in the U.S. residential builder finance portfolio.

Tier 1 Ratio Declines to 9.0%

• Tier 1 capital (Basel II) declined to 9.0% from 9.5% in the previous quarter due to 10% sequential increase in risk-weighted assets with 2/3 due to depreciation in the C$.

• Risk-weighted assets increased 13% at $278.6 billion from a year earlier. Market-at-risk assets increased 5% to $17.2 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 10.1%, versus 10.4% in the previous quarter and 9.0% a year earlier.

Additional Disclosure on High-Risk Assets

• The bank provided additional disclosure on its exposure to U.S. sub-prime, auction rate securities, municipal GICs, CMBS, U.S. insurance and pension solutions, and U.S. MBS and other securities. The notional and fair value exposures to these areas as well as writedowns are detailed in Exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.

Recommendation

• We are reducing our 2009 and 2010 earnings estimates to $4.20 per share and $4.80 per share from $4.70 per share and $5.20 per share, respectively.

• Our 12-month share price target is unchanged at $60 per share representing 14.3x our 2009 earnings estimate and 12.5x our 2010 earnings estimate.

• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength of franchise and operating platforms, particularly Retail Banking and Wealth Management, growth prospects from RBC Capital Markets, and higher than bank group ROE.
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Financial Post, Eoin Callan, 5 December 2008

Royal Bank of Canada's bank branches in the United States has turned into a money-losing enterprise, in a sign of how worsening economic conditions are starting to compound the damage being inflicted on banks by volatile financial markets.

Having pushed deep into southeastern states such as Florida and Alabama when local housing markets were soaring, Canada's largest bank now finds itself losing money amid plunging home prices and heavy job losses.

The reversal is only one of many headaches for chief executive Gord Nixon, who is also grappling with ongoing exposures to complex credit instruments and mortgage-backed securities that have already cost the bank $2.8-billion this year.

Yet the setback at the retail chain is significant because it suggests new sources of losses are arising for banks as market turmoil fuels an economic nosedive.

RBC predicts that financial "volatility will continue to dampen both consumer and business spending and will likely cause the U.S. recession to deepen."

The bank also suspects the Canadian economy has already slipped into a recession, while official figures Friday showed job losses were the worst in a quarter century last month.

This means Bay Street is likely to find more Canadians will struggle to pay back loans after years of record borrowing, which in turn means banks may be forced to set aside increasing amounts to cover credit losses.

This combination of investment losses and exposures to worsening credit conditions means bankers are increasingly resigned to tough times next year.

In its end-of-year update Friday, RBC declined to provided guidance on how its business would perform next year, choosing instead to guide investors toward a time horizon of three to five years from now.

With persistent uncertainty about how long it will take for world stock indices to settle and the wider economy to recover, RBC's chief executive said Friday his bank would rein in risky bets and shrink the balance sheet it uses to trade in international markets.

While this will do little to address RBC's already-substantial exposure to highly-impaired credit markets -- a major source of concern for investors -- it may help the bank preserve capital so it can better deal with losses lurking in its books.

This is a top priority for executives, who Friday confirmed RBC's reserves had fallen to the lowest level of any bank in the country after four quarters of falling profit and trading losses.

This means RBC has a thinner capital cushion than its peers to absorb future losses, which analysts said Friday were highly probable.

Mr. Nixon said the bank would manage its books "prudently" and pointed out the bank "earned over $4.5-billion for our shareholders in 2008," as analysts underlined the bank's ability to re-balance its reserves over time from incoming cash.

The bank also eased pressure on its capital base by taking advantage of looser accounting rules to shift almost $7-billion of assets out of its trading book.
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