The report on Royal Bank of Canada is updated and rated (higher) Buy at $130.08 or US $96.33.
The bottom line is that it looks attractively valued but banks are always highly leveraged and dependent on sophisticated risk management systems and models. The outlook appears good but there are headwinds in terms of possible higher loan losses and businesses and individuals struggle to pay higher interest rates and due to the projected mild recession.
It was surprising to see how quickly RBC’s loans and other assets have adjusted upwards to higher interest rates. Apparently they do not have that much in assets locked into low rate loans and investments (unlike Silicon Valley Bank) that had way too much locked in (invested) at low interest rates. RBC’s interest income rocketed up a shocking 162% year-over-year in the latest quarter. They collected $19.3 billion in interest versus $7.4 billion a year earlier.
It’s a bit scary to think about who was on the other end of that paying an extra $12 billion in interest. That’s $48 billion annualized just at this one bank! This would include governments, institutions, businesses and individuals. We have not seen reports yet of businesses going under due to higher interest rates but that seems a possibility.
It was less surprising to see that RBC’s interest expense on deposits and other funding has repriced to higher interest rates. They paid out $13.1 billion in interest versus $2.1 billion the prior year. Many individuals and institutions and businesses are benefiting from that but they are not usually or certainly always the same ones that are paying higher interest.
One group that is falling behind due to higher rates is residential mortgage payers. Many are on variable interest rates but with temporarily fixed payments. 26% of RBC’s Canadian mortgages now have amortizations over 35 years. A year ago there were none over 30 years. And these appear to be mostly uninsured mortgages. Strangely, this was not mentioned at all in the management discussion in Q1 it was just noted in a table without comment. And I searched through the the Q1 analyst call transcript and it appears there were no questions about this.
Interestingly, NONE, of RBC’s U.S. mortgages have amortizations over 30 years. This may be one time where the Canadian system is not in fact safer than the U.S.
I bought a few shares of RBC today on the basis that it looks attractive although there are some risks here.