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RY AT A GLANCE

P/E ► 17.7 AVG EV/EBITDA ► 4.34 AVG ROA ► 2.8% AVG ROE ► 14.6% AVG Debt to Equity ► 19.9 HIGH Current Ratio ► 0   Interest Coverage Ratio ► 1.41 AVG

 

 

 

 

 

 

While RBC tops Canada's Big Five, five banks that dominate Canada's banking system and control over 90% of all Canadian banking assets.^[5], its tier 1 risk-based capital ratio is the thinnest among its Canadian peers at 9.0%.^[6] Tier 1 is a measure of equity and retained earnings to risk-adjusted capital and generally is used to indicate a bank's financial health. RBC's tier-1 ratio is down 0.4% from the end of FY 2007, but at 9.0%, it is 2.0% above what Canada requires.^[7]. For FY 2008, RBC wrote-down C$2.79 billion related to U.S. investment losses,^[6] and in December 2008, the company announced it would issue C$2.3 billion in shares to ensure confidence in the stability of its operations.^[8] The largest losses during FY 2008 came from writedowns of U.S subprime (C$1,301m), U.S. adjustable-rate mortgages (C$243m), and U.S. non-agency mortgage-backed securities (C$273m).

Although RBC has suffered losses from the 2008 Financial Crisis, the bank competes in a highly regulated Canadian banking sector that has limited leverage and required conservative lending practices, which has left the Canadian Banks relatively unscathed through 2008.^[9] In fact, the Geneva-based World Economic Forum placed Canadian banks as the soundest in the World based on the likelihood and extent of government intervention necessary to support banks in each country.^[10] The US was ranked 40th in the survey of 12,000 corporate executives. Focusing on banks' balance sheets, Canadian banks fair much better than their US and European counter-parts. Canadian banks average a tier 1 risk-based capital of 9.8%, or twice that of the average American investment bank and three times greater than the mean of European commerical banks.^[7] The Canadian Government issued $75 billion in mortgage issuance to keep the international playing field level as other countries (especially the US and European nations) provided guarantees to bank assets.^[7]

Financial Highlights

The Canadian business segment showed the only improvement from 2007. The 2008 Financial Crisis weighed on U.S. loan portfolios and investment banking operations. Also, the insurance sector saw a decrease year over year as the investments that it holds against policies depreciated in value.^[11]

Total revenue for FY 2008 was C$21,582. The C$880 million decrease from 2007 resulted from a decrease in financial activity and writedown and losses stemming from the 2008 Financial Crisis.^[11] Net income did not fair much better as RBC reported C$4,555 billion, or C$937 million less than the prior year. For FY 2008, RBC had write-downs of C$2.79 billion primarily from US operations.^[8] Increasing loan defaults, illiquid markets, and widening credit risk spreads hurt the value of RBC's asset portfolio. The largest contributer to the write-downs were U.S. subprime mortgages, which dropped C$704 million in fair value.^[11] In addition, RBC had write-downs of C$421 million for collateralized debt obligations (CDOs) of asset-backed securities. Further deterioration in the health of the global economy would increase defaults on loans and require more write-offs.

RBC's largest business segment, domestic banking (43% of 2008 revenue^[11]), has provided a stable and growing revenue source for the largest of Canada's banks. This segment provided C$2.66 billion in profit for FY 2008 -- up from C$2.1b in 2006 and C$2.4b in 2007. Cost-cutting and growth across all domestic businesses (personal, business, and credit card services) boosted revenue and net income. Royal Bank of Canada's four other segments have been more variable in terms of revenue and net income. Wealth management had assets under management grow 37% in FY 2008 compared to 2007, but a decline in trading volume led to decline in revenue and a 13% reduction in net income for FY 2008 compared to the prior year. Capital markets and RBC's international divisions showed strong results until FY 2008, when the 2008 Financial Crisis applied pressure to its investment banking operations, as well as the bank's personal banking services in the Southeastern region of the United States. In 2006 and 2007, international business added C$303 million to net income; however, in FY 2008, the segment lost C$153.^[11] Similiar, capital markets earned C$1.355 billion on C$4.136 billion in revenue during FY 2006, while only making C$1.17 billion on C$3.935 billion in 2008.^[11] The fifth segment of RBC, insurance has had revenue decline steadily, but an increasing profit margin helped preserve net income. Fewer annuity sales hurt revenue, while an expansion in Canadian businesses and reinsurance provided support.^[11]

Business Overview

Personal financial services accounted for more than half of RBC's Canadian banking revenue. RBC is Canada's largest bank in terms of total assets and market capitalization^[11]

RBC's 80,000 employees provides Financial Services to 17 million clients in primarily Canada (70% of 2008 revenue), Southeastern US(17%), and the Caribbean.^[4][11] Over 2006-2008, retail banking, wealth management, and insurance accounted for between 70 and 80% of earnings, while capital market operations formed the remainder.^[4] The company divides its business into five business segments.

Business Segments

Canadian Banking (43% of 2008 Revenue^[11])

Canadian Banking is the largest business segment of RBC. Canadian Banking, which earned C$2.662 million during FY 2008, provides personal and business services to over 10 million customers in Canada.^[11] Personal financial services include taking deposits and originating loans. RBC profits on the net interest rate spread, or the difference between what it pays to borrow money and the revenue earned from lending money. In 2008, RBC increased its Canadian loan book 13% by expanding home equity loans and its credit card offerings.^[11] The increase in money lent helped increase revenue 3%, or C$257 million, and net income 5% over 2007; the growth in revenue and net income partially were offset by a contraction in margins.^[11]

Wealth Management (18%)

Assets Under Management is a key driver to growing revenue. Despite large growth in 2008 from 2007, decreasing trading activity in managed accounts led to revenue being flat year over year.^[11]

As RBC's second largest business segment, Wealth Management contributed C$3,987 million, or 18%, to RBC's total revenue.^[11] Using a network of 4,000 financial consultants, wealth management provides financial advice, asset management, estate, and trust services to high net worth individuals (HNIs) and affluent clients. In 2008, 37% of the segments revenue was generated in Canada, and the remainder was scattered over 23 other countries. A key driver to growing revenue is assets under management (AUM), which grows by either attracting new funds or capital appreciation of underlying assets. More assets translates to higher management fees collected. Through the acquisition of PH&N and strong mutual fund sales, RBC increased AUM C$61 billion, or 38%, over 2007's $C161 billion. RBC led the industry with $8.8 billion in net mutual fund sales in FY 2008; RBC is the largest fund company Canada with a 16% market share.^[11] Offsetting this gain was lower transaction activity resulting from uncertainty in the global financial markets. Revenue was flat year over year and net income decreased C$97 million, or 13%, from 2007.

Insurance (12%)

Using third-party and propreitary channels, RBC offers life, health, travel, home, auto, and creditor insurance services to individuals and business clients in Canada and the United States. Outside North America, RBC manages a specialty reinsurance business. RBC Insurance makes money when the premiums collected and investment returns exceed its insurance payouts. Total revenue for 2008 was C$2,610 million, which decreased 18% from 2007. The decline resulted from losses in financial assets that RBC uses to back insurance policies and fewer annuity sales in the United States.^[11]

International Banking (9%)

The C$2,101 million generated in 2008 stems primarily from U.S. and Caribbean banking operations, but also includes global custody and investor services. RBC operates 439 full-service banking centers in the Southeast region of the United States. Headquartered in Raleigh, RBC Bank focuses on six states; North Carolina, South Carolina, Virginia, Georgia, Alabama, and Florida). According to the 2007 US Census Bureau and the US Bureau of Economic Analysis, this region accounts for 1/5th of US Gross Domestic Product, or twice as big as Canada. Also, the population is growing faster and employment has been more stable compared to the national average.^[4] RBC ranks in the top 7 for total deposits in each of these six states.^[11] Through a network of 127 branches, RBC operates banking services in 17 countries and territories in the Caribbean. Despite the growth potential in international banking, this segment lost money for RBC in FY2008; higher provision for credit losses, writedowns, and losses in its investment portfolio contributed to a C$153million net loss of income.^[11]

Capital Markets (18%)

Ranked 12th on Bloomberg's Largest Global Investment Banks,^[11] the capital markets business segment of RBC added C$3,935 million, or 18.2%, to RBC's total revenue in 2008.^[12] Capital Markets structure and provide capital financing to help businesses achieve growth objectives. RBC especially is focused on Canada and U.S. mid-markets, as well as natural resource companies.^[4] As such, growth and an increase in mergers and acquisitions (M&A) among natural resource businesses tends to boost RBC's bottom-line.

Key Trends and Forces

2008 Financial Crisis

Illiquidity, rising defaults, and decline in financial investments have stemmed from the 2008 Financial Crisis. These factors have led to large losses in the investment community and have battered the financial services sector. Royal Bank of Canada was no exception; the bank wrote down C$2.79 billion for FY 2008^[6]. U.S. subprime losses at C$1.3 billion was the largest contributor.^[11] U.S. competitors such as Bear Stearns Companies (BSC), Lehman Brothers (LEH), and Washington Mutual (WM) failed. While not immune, Canadian banks, including Canada's largest bank, RBC, have managed better than European and American counter-parts.^[7] The Bank of Canada, which is the "Federal Reserve" of Canada, reported in December of 2008 that more conservative lending practices sheltered the industry more so than competitors in outside countries.^[9] Nevertheless, Canadian banks are not sheltered from investment write-downs and a slowing global economy can stall the demand for Canadian exports. RBC operates 439 banking offices in the Southeastern region of the United States. A substantial collapse in housing prices have contributed to an increase in defaults and a decrease in value of asset-backed securities.^[4]; as of September 2008, previously owned single-family homes in Miami were off 28.3% from a year ago.^[13] Canada is starting to see a spillover affect as well. For October 2008, sales of existing homes fell 14% to a six-year low and prices collapsed 10% compared to a year ago.^[14] However, a smaller subprime market and homeowner's equity averaging 70%, compared to the US at 48%, provides a cushion against losses from Canadian mortgages.^[15]

Increase growth in energy and mining supports RBC

RBC's capital markets are focused on mid-market energy and mining markets.^[16] RBC wants to build its junior energy sector and grow its commodities trading business.^[4] As such, flucuations in the global energy and mining sectors will influcence the success of RBC. Increasing growth in the sector and a flurry of mergers and acquisitions (M&A) activity supports RBC, but a decline in business transactions decreases revenue for RBC's capital market. As prices of natural resources plunged, RBC Capital Markets saw net income fall 16.6% for Q4 2008 compared to the year ago.(excludes the addition to income resulting from a reduction in expected litigation provision for Enron)^[17] The orgination and equity trading business activity decreased year over year.^[17]

RBC sells common shares to increase tier 1 capital ratio

The financial crisis has led to a 40bp reduction in RBC's tier-1 capital ratio over the past year. Tier-1 is a guage of a bank's financial solvency. In order to maintain a healthy ratio, RBC announced that it would sell shares to increase equity. While this offering helps sure up capital, it dilutes the current shareholder base.^[11]

RBC has seen its tier-1 ratio fall from nearly 10% in 2006 to 9% in 2008. At 9%, RBC is the lowest amongst its peers and below the industry average of 9.8%.^[7] RBC has taken measures to sure up equity by announcing in December of 2008 a $2.3 billion share offering.^[8] While adding shares will add capital, it also dilutes outstanding shares. Canada requires banks to maintain a tier-1 capital ratio of at least 7%. The ratio is a measure of equity and retained earnings to risk-adjusted assets and provides a general guide for determining a bank's financial health.^[7] As a bank approaches the regulatory limit, it becomes retstricted in originating loans and making investments with higher potential returns, which impacts operating income negatively. Further, the bank risks regulatory intervention.

The USD/CAD relationship impacts operating revenue and net income.

A weakening Canadian dollar helps support the Canadian economy, which relies heavily on exports. With 70% of revenue being generated in Canada, RBC relies on the health of the Canadian economy to grow revenue and limit losses on loans and other investments.^[18]

Fluctuations in the U.S. Dollar (USD) and the Canadian Dollar (CAD) impact RBC’s business operations and its ADR share price. On one hand, a rise in the US Dollar boosts values of its American portfolio of loans, but also reduces the dividend paid on the ADR all else equal. On the other hand, the Canadian economy is largely linked to exports of natural resources.^[19] As the CAD depreciates, it boosts domestic revenue for Canadian resources. For instance, if oil trades for $50USD/bl, and the USD/CAD is 1, then a Canadian exporter receives $50CAD/bl for his oil. Now if the CAD depreciates 20% relative to the USD and oil does not move, he would then receive $60CAD/bl for the same oil; thus, improving his return. In a nutshell, a weak Canadian dollar can boost the domestic economy and cushion the impact of falling natural resource prices. Therefore, Canada's economic health is dependent on the USD/CAD relationship. As of December 21, 2008, the Canadian dollar is worth 82 cents of the US dollar. In early December 2008, the Bank of Canada expressed concern that a strengthening Canadian dollar could hurt Canadian banks by leading to a worse recession in Canada.^[9] Higher unemployment and decreasing natural resource prices would lead to lower repayment of loans and decreasing financial activity among energy and mining companies, which RBC focuses its capital markets division.

The Canadian Banking System

Please view the Canadian Banking System page (link at bottom of article) to see a general outline of the Canadian banking structure and a comparison between US and Canadian banks. A few highlights include that the Big Five, which RBC tops in terms of total assets, control 90% of Canadian domestic banking assets, while the five largest banks in the United States only accounted for 9.7% of total American banking assets in 2002.^[5] Another stark contrast that impacts RBC is the ability and/or willingness of Canandians to pay back loans. 70% of RBC's revenue is earned in Canada, so Canadians financial strength is an important determinant of net income.^[4] Loan delinquency rates in Canada is 0.29% compared to 2.20% in the US as published by the CBA, Mortgage Bankers' Association in July 2008.^[15]

Competition

Comparing the Big Five

Data as of latest Quarterly/Annual Report December 24, 2008:

Write-downs

According to the Bank of Canada and a survey by the World Economic Forum, Canadian banks weathered the 2008 Financial Crisis better than peers in outside nations.^[9] Nevertheless, they are not immune. Between 2007 and as of quarter ended Oct 31 (4Q FY2008 for most banks), Canadian banks had written down C$16.17 billion compared to global banks and brokers having written down USD$720 billion.^[24] Canadian Imperial Bank of Commerce (CM) has written down the largest amount in 2008 at C$4.969 billion,^[25] while RBC made C$2.79 billion of writedowns as of December 2008. Bank of Nova Scotia (BNS) took an after-tax writedown of C$595 million for its 4th quarter of fiscal year 2008.^[26] The remaining two of Canada's big five are not unscathed as well. Between the third quarter of 2007 and November 19, 2008, Bank Of Montreal (BMO) has written down C$899 million and Toronto-Dominion Bank (TD) C$65 million.^[25]

Ranking RBC to Competitors

As Canada's largest bank in terms of total assets and market capitalization,^[2] RBC is larger than the remaining four banks, Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM), Toronto-Dominion Bank (TD), and Bank Of Montreal (BMO), included in Canada's Big Five. These five banks, all included in Forbes Top 200 Banks, dwarf the remaining 14 domestic banks in terms of assets.^[27] RBC's total assets are C$200 million larger than its closest Canadian competitor, Toronto-Dominion Bank (TD). Royal Bank of Canada also has the largest investment banking presence in Canada in terms of transactions and ranked #1 on Euromoney's Global Canadian Dollar Dealer list.^[4]

RBC's operations are not limited to Canada. With 18% of 2008 revenue being generated in the United States, RBC competes for everyday banking services in the Southeast with regional banks, such as Regions Financing Tr I (RF) and also national ones like Bank of America (BAC). RBC is the 5th biggest deposit taker in North Carolina and Alabama.^[4] RBC's operations in Canada, the United States, and the Caribbean make it the 5th largest financial institution in North America in terms of revenue.^[2]. RBC also competes against American investment banks, like Goldman Sachs Group (GS), for mostly mid-market energy and mining business.^[16] For 2007, Bloomberg ranked RBC #13 in U.S. Equity Offerings and #16 in U.S. M&A Transactions.^[4]. In terms of total fees, RBC is the 12th largest investment bank in the world.

References

1. ↑ RBC Company Homepage
2. ↑ ^{2.0 2.1 2.2} RBC Capital Markets “RBC Capital Markets Expands International Oil and Gas Team”
3. ↑ Forbes.com "The Global 2000" April 2, 2008
4. ↑ ^{4.00 4.01 4.02 4.03 4.04 4.05 4.06 4.07 4.08 4.09 4.10 4.11} RBC Company Presentation (Fall 2008)
5. ↑ ^{5.0 5.1} Wikipedia.org "Canadian and American economies compared" Accessed 1-Jan-09
6. ↑ ^{6.0 6.1 6.2} Seeking Alpha “Canadian Banks’ Q4 Better Than Expected – TD Newcrest” October 2008
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5} Time Magazine "Why Canada's Banks Don't Need Help" Erik Heinrich Nov 10, 2008
8. ↑ ^{8.0 8.1 8.2} Yahoo Finance! Canada “Royal Bank of Canada to raise up to C$2.3 billion in share offering” “The Canadian Press” December 8, 2008
9. ↑ ^{9.0 9.1 9.2 9.3} Bank of Canada “Financial System Review “Highlights – December 2008”
10. ↑ Reuter’s “Canada rated world’s soundest bank system: survey” October 2008
11. ↑ ^{11.00 11.01 11.02 11.03 11.04 11.05 11.06 11.07 11.08 11.09 11.10 11.11 11.12 11.13 11.14 11.15 11.16 11.17 11.18 11.19 11.20 11.21 11.22} RBC Annual Report – FY 2008 –
12. ↑ RBC Capital Markets Homepage
13. ↑ New York Times, "Pangs of Seller's Remorse in Miami Market" By Damien Cave, August 31, 2008
14. ↑ Times Colonist "Canadian housing sales plunge as crisis deepends" By Eric Beauchesne, Friday, November 14, 2008
15. ↑ ^{15.0 15.1} “RBC Company Presentation” “December 2008 Facts” December 2008
16. ↑ ^{16.0 16.1} RBC Corporate Website “About Us”
17. ↑ ^{17.0 17.1} “Fourth Quarter 2008 Earnings Release” RBC Investor Relations
18. ↑ FutureSouce.com Commodity Quotes and Charts
19. ↑ Library of Parliament, "Energy Resources: Boon or Curse For the Canadian Economy" By Philippe Bergevin, 31 March 2008
20. ↑ [http://www.scotiabank.com/images/en/filesaboutscotia/19551.pdf Bank of Nova Scotia FY 2008 10-K]
21. ↑ [http://www2.bmo.com/content/0,1089,divId-3_langId-1_navCode-3198,00.html Bank of Montreal FY 2008 10-K]
22. ↑ [http://www.td.com/ar2008/pdfs/ar2008.pdf TD FY 2008 10-K]
23. ↑ [http://www.cibc.com/ca/pdf/investor/2008-financial-results.pdf CIBC FY 2008 10-K]
24. ↑ Bloomberg "Royal Bank Drops Forecast as Writedowns Cut Profit" By Doug Alexander, Dec. 5, 2008
25. ↑ ^{25.0 25.1} FP Trading Desk, "The year of bank writedown", By David Pett, November 19, 2008
26. ↑ Morningstar.com "Bank Nova Scotia To Take C$595 Million in 4Q Writedowns" Dow Jones Newswires 11-18-08
27. ↑ Statistics Canada "Canada's Banks" August 2002