2023-03-28 06:29:20 ET
Summary
- Royal Bank of Canada has seen growth in net interest income.
- However, this has been accompanied by a higher provision for credit losses.
- I do not take a bullish view on RY stock at this time.
Investment Thesis: I do not take a bullish view on Royal Bank of Canada at this time.
When I last wrote about Royal Bank of Canada ( RY ) in May 2021, I made the argument that while the bank had seen impressive growth in Personal & Commercial Banking as well as Capital Markets, short-term consolidation in the stock could lie ahead.
My reason for making this argument was that while previously low interest rates and a spike in loan demand by consumers and businesses due to the economic effects of COVID-19 had led to an increase in net income across Personal & Commercial Banking - further growth in credit demand was not necessarily a given going forward.
Since then, the macroeconomic environment has changed quite substantially - with higher interest rates, inflationary pressures and higher energy prices being the biggest economic concerns at present.
Since my last article, Royal Bank of Canada is down by just over 10% overall:
investing.com
The purpose of this article is to assess whether Royal Bank of Canada could have scope to rebound from here.
Performance
When comparing net interest income performance for Q1 2021 and Q1 2023 - we can see that overall net interest income has increased, from $5.035 billion in Q1 2021 to $6.202 billion in Q1 2023.
Q1 2021 Net Interest Income
Royal Bank of Canada Q1 2021 Results
Q1 2023 Net Interest Income
Royal Bank of Canada Q1 2023 Results
It is particularly noteworthy that the contribution of trading net interest income to overall NII has decreased greatly - from 14.69% in Q1 2021 to 2.99% in Q1 2023.
This reflects the contribution of higher interest rates to higher net interest income, but such higher rates have also contributed to a decline in equity markets - evidenced by a much lower contribution of Trading NII to overall net interest income.
With that being said, it is also noteworthy that the growth we have been seeing in Personal & Commercial Banking has been decreasing - from growth of 13.01% between Q2 and Q3 2022 to 2.71% between Q4 2022 to Q1 2023.
Additionally, diluted earnings per share were down by 19% on that of the previous year (while adjusted diluted EPS showed growth of 8% over the same period, this was on a non-GAAP basis):
Royal Bank of Canada: Q1 2023 Results
We can see that one of the contributors to this drop in net income has been a higher provision for credit losses. In other words, Royal Bank of Canada has needed to set more funds aside in anticipation of needing to provide a buffer against bad debts.
For Personal & Commercial Banking, PCL on performing loans had increased to $173 million from $(80) million last year which largely reflected a change in credit quality across the Canadian retail banking portfolio. This was also accompanied by PCL on impaired loans increasing by $177 million. As such, while net interest income has seen growth from higher interest rates - this has also come with the risk that a higher number of loans will see defaults due to the added expense of repaying such loans on the part of customers.
Risks and Looking Forward
Going forward, while Royal Bank of Canada could see net interest income grow from here - continued growth in provision for credit losses could place further pressure on earnings growth.
When looking at the company's 10-year return on equity - we can see that while this metric saw a significant recovery heading into 2022 - it has subsequently fallen significantly since then:
ycharts.com
Additionally, when looking at the ratio of deposits to liabilities as according to the Supplementary Financial Information Q1 2023 (as a proxy for how well-capitalized the bank is), we can see that the ratio fell slightly from 68% in 2021 to 66% in 2022.
Royal Bank of Canada Supplementary Financial Information Q1 2023
The ratio was calculated as follows:
2022 | 2021 | |
Deposits | 1,208,814 | 1,100,831 |
Liabilities | 1,809,044 | 1,607,561 |
Deposits to Liabilities ratio (%) | 66.82% | 68.48% |
Source: Figures sourced from Royal Bank of Canada: Supplementary Financial Information Q1 2023. Figures provided in millions of Canadian dollars, except the deposits to liabilities ratio. Deposits to liabilities ratio calculated by author.
While the decrease is slight, a further decrease in this ratio going forward could make investors apprehensive that the bank's level of capitalization is deteriorating.
Conclusion
To conclude, Royal Bank of Canada has seen growth in net interest income, but a higher provision for credit losses and slowing growth in NII across the Personal & Commercial Banking segment could place downward pressure on the stock. Until Royal Bank of Canada can demonstrate the ability to bolster earnings growth once again - I would not take a bullish view on the stock at this time.
For further details see:
Royal Bank Of Canada: Higher Net Interest Income, But Earnings Still Under Pressure