While Royal Bank of Canada’s net interest margins and expenses disappointed in its second quarter, National Bank Financial analyst Gabriel Dechaine thinks the outlook for the second half of the fiscal year is “more constructive.” On Thursday, shares of RBC, the country’s largest bank by market capitalization, slid 1.8 per cent after it reported its profit fell 14 per cent from a year earlier to $3.6-billion, or $2.58 per share. After adjustments to exclude certain items, it said it earned $2.65 per share, missing the consensus forecast on the Street of $2.80, according to Refinitiv data.
“RY’s all-bank NIM (excl. trading) fell 7 basis points quarter-over-quarter,” said Mr. Dechaine. “The Canadian business (NIM down 8 bps Q/Q) was the primary driver of this performance and, once again, the main issue revolved around funding mix/costs. On mix, total Canadian P&C deposits were up 8 per cent year-over-year, with chequing/savings accounts falling 9 per cent and term accounts jumping 81%. On costs, the two categories have increased 100 bps and 244 bps, respectively, over the past year.
“Looking ahead, we are reasonably confident in guidance for NIM stabilization/improvement by Q4/23 given: 1) the sequential pace of term funding cost increases fell to a quarter of the pace set over the prior two quarters; 2) 14-per-cent sequential growth in GIC balances was down from 18 per cent over the prior two quarters; and 3) higher spread commercial loan growth outpaced mortgage growth for the eighth consecutive quarter. While we continue to expect some NIM pressure to arise during Q3/23, we are hopeful for a strong finish to fiscal 2023.”
The analyst also attributed the underperformance to “another quarter of (very) elevated expense growth.”
“RY’s expense growth was a negative surprise for the second consecutive quarter, with both quarters delivering expense growth around 16 per cent,” he said. “The biggest driver of this growth has been the Brewin Dolphin acquisition that, to be fair, has also contributed to revenues. Otherwise, the biggest growth driver of RY’s fixed cost base is compensation, which has risen 16 per cent this year (and is the biggest component of fixed costs). This growth represents a lagged impact of aggressive hiring over the past few years, along with base salary increases. Expense growth should moderate to the upper single digits by Q4/23 as comps become more favourable and as RY implements cost-cutting measures that have just begun to be implemented.”
Reducing his estimates to reflect lower NIM and higher expenses, Mr. Dechaine cut his target for Royal Bank shares to $136 from $142 with an “outperform” rating. The average target on the Street is $137.05.
Other analysts making target adjustments include:
* Credit Suisse’s Joo Ho Kim to $141 from $149 with an “outperform” rating.
“RY’s Q2 results were disappointing, given the wide miss on our PTPP earnings, with another quarter of elevated expenses and lower than expected NIMs impacting results,” he said. “We see near-term (Q3) pressure on expenses, as the impact of efficiency initiatives is expected to take some time to show. The bank’s guidance for low double-digit NII growth from Canadian Banking for F2023 does suggest modest NIM improvement for the remainder of the year, while we believe margins could remain under pressure at CNB given the increasing intensity in the deposit/funding market south of the border.”
* Desjardins Securities’ Doug Young to $140 from $155 with a “buy” rating.
“Adjusted pre-tax, pre-provision (PTPP) earnings were 5 per cent below our estimate,” said Mr. Young. “Clearly, the focus and pressures related to lower net interest margins (NIM) and higher non-interest expenses (NIX). While controlling NIX growth is a focus for management, scaling this back could take a few quarters. We adjusted our estimates, lowered our target price.”
* Scotia Capital’s Meny Grauman to $143 from $146 with a “sector outperform” rating.
“If the first step to change is admitting your mistakes then Royal Bank is on the road to recovery as Management openly admitted two key missteps that have weighed on results over the past few quarters,” said Mr. Grauman. “These missteps included not realizing how quickly core demand deposits would move in the search for yield, and over-hiring through the pandemic without appreciating the approaching inflationary and revenue headwinds. While Royal spoke openly about these issues, it is important to emphasize that they are not just RY specific issues but in fact sector-wide wide problems. However, the fact that Royal Bank is struggling with these challenges is significant given that investors tend to assume that it is better positioned to manage expenses and margins than many peers. So far this year that has not been the case, but the bank did commit to aggressively dealing with its expense run-rate by the end of the year, and pointed to a better outlook for both expenses and margins in 2024, when the company will also be able to begin to harvest the synergies from the acquisition of HSBC Canada.”
* CIBC’s Paul Holden to $139 from $142 with a “neutral” rating.
* Canaccord Genuity’s Scott Chan to $128.50 from $133.50 with a “hold” rating.
* Barclays’ John Aiken to $122 from $142 with an “underweight” rating.