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Andrew Willis: After the fate of a few banks in the U.S., and one in Europe, investors up North are putting the Big Six under the microscope.
But instead of concentrated deposits or unprofitable trading businesses, they’re finding discussions of capital requirements and liquidity coverage ratios. This might be less exciting but makes for a low uncertainty rating and one of the more stable baking systems in the world. Which makes what RBC’s been doing stand out.
Morningstar strategist Eric Compton says RBC (RY)’s capital markets segment has been arguably overperforming lately. In particular, it’s trading and foreign exchange businesses. We expect this segment to continue to be a strong contributor to net income and note its countercyclical behaviour as earnings soared during the pandemic.
RBC’s capital markets business is the icing on the cake of superior market share and operating efficiency, which we believe will allow it to remain a steady player in retail and commercial Canadian banking. But investors should be aware that ‘steady’ can also involve a decline – in areas like loan growth or net interest margin.
By 2024, if Canadian GDP growth slows, we expect RBC will experience a decline in margins as interest rates fall. Given the state of leverage in the domestic real estate market, however, it might be a good thing for stability.
For Morningstar, I’m Andrew Willis.
Bulls Say
- Royal Bank of Canada's worldwide scope in capital markets and wealth management provides a powerful and diversified stream of revenue. This should lead to outsize fee income versus peers.
- The strength in its Canadian banking business, where returns on equity exceed 30%, should continue for some time.
- RBC's latest expansion into the U.S. high-net-worth and commercial banking space should provide additional high-margin growth for the bank.
Bears Say
- The bank has one of the larger exposures to the Canadian housing market, and as the Canadian consumer's ability to borrow becomes constrained, RBC may struggle to achieve loan and revenue growth.
- The Canadian housing market is heating up again, potentially increasing the risks for the economy and the banking sector.
- The latest announced acquisition of HSBC Canada may not add much value for shareholders if some of the risks of the deal end up materializing.
Editor's Note: All images are courtesy of Unsplash.com and AP Images.
