OIL CONCERNS ABATE, BUT HOUSING LOOMS
RBC POSTS RECORD QUARTER
Lower- than- expected provisions for energy loan losses helped propel Royal Bank of Canada to a thirdquarter profit that exceeded expectations Wednesday, but it was what some predict will bring the next wave of credit problems — a housing downturn — that generated the most noteworthy discussions with executives.
On a conference call with analysts, Royal Bank chief executive Dave McKay said Canada’s largest bank is underrepresented in the red hot Vancouver housing market and tends to have clients that are among the most credit worthy. He added that the markets are being watched closely, and said Royal could react quickly in the event of a sudden downturn.
“From what we can tell, we’re under-indexed to the growth in that marketplace right now. So I think that’s the best proof point that we’re being careful in the deals that we select and the business that we do,” McKay said on the morning conference call.
The underrepresentation “should be tangible evidence that we are reacting to potentially a heated housing price market where … higher unemployment rates would have a harsher impact on the potential portfolio,” McKay added.
Royal has also bolstered insurance on its portfolio with 48 per cent insured, up from 46 per cent a year ago, executives said.
In a note sent to investors after the call, National Bank Financial analyst Peter Routledge said high house prices in Vancouver and Toronto are acting as a “firewall” against deteriorating consumer credit in those markets, and cautioned that could change in a real estate downturn.
“Households generally do not default on their debts when their home values are up 15 per cent to 25 per cent year- over- year,” the analyst said, noting that strength in Royal’s consumer credit in Toronto and Vancouver more than offset weakness in Alberta in the third quarter as the western province continued to struggle from the fallout of low oil prices.
“When house prices in those two cities stabilize or, more problematically, decline, then we expect a material increase in loan losses,” Routledge wrote. He expects that a decline in real estate values would lead to lower consumption in those markets, which would in turn lead to higher unemployment, making it harder for people to pay credit card debt and other unsecured loans.
On the energy front, analysts said Royal Bank performed better than expected in the third quarter, which ended July 31. The bank set aside provisions for credit losses of $ 318 million, a 31 per cent decline from a year earlier and well below consensus analyst expectations of $442 million. This included a material decline in the amount set aside for energyrelated credit losses, which allowed for profit growth despite higher expenses in the quarter, according to John Aiken, an analyst at Barclays Capital.
On the conference call with analysts, Royal’s chief risk officer Mark Hughes said a modest increase in oil prices in the last quarter was helping clients tap the capital markets and take other measures to shore up their operations. Still, he said the industry and those who bankroll it are not out of the crisis because the oil price remains well below the level of a couple of years ago.
“We r emain c autious while the prices are where they are. … It has been a bit more of a sustained crisis than the previous one” in the 1980s, Hughes said. “If it goes above $60, it’s maybe a bit more of a positive environment.”
He said Royal Bank’s security and collateral positions should help the bank weather the energy environment.
“We may have impaired loans, we may have PCLs (provisions for credit losses), but we should see recoveries as the companies work their way through them,” Hughes said.
The lower- than- expected provisions for credit losses in the third quarter helped Royal post core cash earnings of $ 1.76, up five per cent from a year earlier, and above the consensus analyst estimate of $1.71.
Net income of $ 2.9 billion, which included a $ 235 million after- tax gain from the sale of Royal’s home and auto insurance business, was up 17 per cent from a year earlier.
The bank hiked its dividend by two per cent to 83 cents a share.
Royal was t he second bank to report financials this week, and the second to beat analyst expectations after the Bank of Montreal posted a four per cent jump in profit on Tuesday.
WE REMAIN CAUTIOUS WHILE (OIL) PRICES ARE WHERE THEY ARE.