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Key Takeaways for RBC Stock:
- Canadian banks are preparing for potential real estate losses in late 2024 and 2025, with RBC having one of the larger exposures to the domestic market.
- RBC is managing potential loan losses with a reported common equity Tier 1 ratio of 14.5% as of October 2023, which remains satisfactory compared with a current regulatory minimum requirement of 11.5%. Potential losses may occur over multiple years, allowing for the addition of funds to reserves if necessary.
- RBC's latest expansion into the U.S. high-net-worth and commercial banking space should provide additional high-margin growth for the bank.
Andrew Willis: Recently, we featured the most popular stock on Morningstar.ca in 2023: TD Bank TD. The bank took the spotlight in the sector with a great dividend and lower exposure to a leveraged domestic housing market.
Should RBC RY be concerned? They’re still number one in the sector with the largest amount of assets under management among the Canadian banks, however, that includes one of the largest exposures to our housing market.
Equity analyst Michael Miller says that mortgage debt levels in Canada have consistently increased for more than a decade now and he sees the state of leverage among Canadian consumers as a risk. That said, there’s risk – and then there’s managed risk.
Recently, the bank reported a 16% quarter-over-quarter increase in provisioning for loans as borrowers face greater credit strain. At the same time, the structure of the renewals can also provide some confidence for investors. Management expects peak losses towards late 2024 and 2025, and only 14% and 25% of all Canadian mortgages at RBC will renew in those years, respectively. And we note that the bank can continue to build reserves over the next two years, especially if credit strain increases.
RBC’s Investing Record Made it the Dominant Bank Today
We’ll admit that the rising mortgage risks have us leaning closer toward a Medium Uncertainty Rating on bank stocks, but we’re maintaining our Exemplary Capital Allocation rating for RBC stock. Calculated risks like RBC's latest expansion into the U.S. high-net-worth and commercial banking space should provide additional high-margin growth that bank investors look for… not to mention the change in risks when interest rates come back down.
For Morningstar, I’m Andrew Willis.
RBC Bulls Say
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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.
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The strength in its Canadian banking business, where returns on equity exceed 30%, should continue for some time.
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RBC's latest expansion into the U.S. high-net-worth and commercial banking space should provide additional high-margin growth for the bank.
RBC Bears Say
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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, and incur additional credit risk.
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Higher interest rates and rising amortization periods for mortgages show the Canadian consumer is set to come under increased strain for the foreseeable future.
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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.
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