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RBC’s fourth-quarter earnings mark subdued finish to solid year

Corporate logos for the Royal Bank of Canada are displayed on their office buildings in downtown Toronto, in this file photo.

Norm Betts/Bloomberg

Royal Bank of Canada ended a solid year on a subdued note, reporting fourth-quarter earnings that missed expectations and lowering a key return target for the next few years.

In the final quarter of its fiscal year, Canada's largest bank reported a $2.54-billion profit, down 2 per cent from the same period in 2015. Adjusted to exclude one-time items, RBC earned $1.69 per share, missing analyst expectations of $1.72 a share. For the full year, RBC's headline figures were encouraging, with total revenues rising 8.7 per cent and profit hitting $10.5-billion despite a Canadian economy troubled by plummeting energy prices and the Alberta wildfire.

However, the bank missed two key performance targets in 2016. RBC's earnings-per-share grew by only 0.7 per cent, largely because it issued equity to help fund its $5.4-billion (U.S.) acquisition of City National Bank, and its return on equity (ROE), one of the top metrics in the banking industry, dropped to 16.3 per cent from 18.6 per cent in 2015.

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Related: Scotiabank spurs optimism as big quarter caps bumpy year

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Read more: Will Canadian banks' blowout profits silence skeptics?

Focusing solely on these figures can be misleading, because RBC has delivered a string of strong profits over the past few years and it gets harder to keep beating good results. The City National deal is also the largest in the bank's history, which distorts comparisons with older metrics.

But on Wednesday the bank said it expects lower ROEs for the medium term, revising its target to "16 per cent-plus." On a conference call, chief executive officer Dave McKay said the new level accounts for the "pressure on returns in the market including persistently low interest rates and uncertainty on regulatory capital requirements," adding that achieving it would still rank RBC in the top decile of global banks.

The new target reflects a different outlook. A year ago, RBC's executives were rather optimistic about growth. "We had a way more bullish outlook at this time last year on interest rate increases," chief financial officer Janice Fukakusa said in an interview, adding that there was hope that the U.S. Federal Reserve would soon hike its benchmark rate multiple times.

All banks benefit from such increases because they then earn better margins on loans, but RBC would get an extra lift because City National's earnings are particularly sensitive to rate changes.

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Ultimately, interest rates barely budged, but investors haven't cared much. Canadian bank stocks are on fire, and RBC is one of the leaders. Although the stock was down 2.5 per cent in midday trading Wednesday, it closed at a record high of $90.12 (Canadian) the day before. The dividend was unchanged at 83 cents a share.

Across the bank's divisions, wealth management was the standout in the fourth quarter, reporting a $396-million profit, up 55 per cent from the year prior. Much of that rise came from the City National acquisition, but even after stripping it out earnings jumped 20 per cent thanks largely to lower restructuring costs and a growth in fee-based assets.

Capital markets earnings dropped 13 per cent from the same quarter in 2016, yet the headline profit clouds what is happening on the ground. Much of the drop was attributed to a higher tax rate this year, while corporate and investment banking as well as fixed-income trading delivered strong results. Global equities and repo trading, though, saw their profits drop 26 and 20 per cent, respectively.

Corporate lending to oil and gas companies, which falls under capital markets, also continues to weigh on results. Gross impaired loans from this business grew by $185-million in the fourth quarter.

Canadian personal and commercial banking, which accounts for the bulk of RBC's profits, reported a $1.25-billion profit, up 2 per cent from the year prior. Much like its rivals, RBC has needed to invest in new technology across the division to keep pace with clients' digital preferences, which raises expenses.

Loan growth in the unit was encouraging, with the value of residential mortgages climbing 6 per cent from the year prior – a solid jump in a tougher lending market. But it's getting harder to make money off mortgages. "We've seen continuing pressure on our margins," Jennifer Tory, who runs RBC's personal and commercial banking, said of the mortgage portfolio.

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Such pressure is a chief reason RBC decided earlier in November to significantly boost the rate on its five-year fixed mortgage by 30 basis points, to 2.94 per cent. Bond yields have spiked since Donald Trump was elected president in the United States, and that means RBC's borrowing costs to fund mortgages have climbed.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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