Royal Bank of Canada (TSX:RY)(NYSE:RY) is a long-term favourite among the dividend crowd, but new investors are wondering if the stock is still a safe pick.
Why?
Analysts have become a bit skittish over the past year as energy exposure, economic headwinds, and threats imposed by non-bank mobile payment firms risk hitting the bottom line of the Canadian banks.
Energy woes
Pundits are concerned that exposure to oil and gas companies will result in higher loss provisions. Royal Bank has some loans tied to the energy sector, but the overall amount is relatively small compared to its total loan book.
At the end of fiscal Q3, Royal Bank had $7.5 billion in oil and gas industry exposure. Wholesale loans to the energy group represent just 1.6% of total loans, and management says it has not yet seen any material trouble in the portfolio.
A further slide in energy prices will certainly increase loss provisions, but the impact on Royal Banks’s results should be minimal.
Housing bubble
Housing is another source of stress for bank investors. A meltdown in the energy sector risks sending a wave of trouble right across the country, and that could hit employment levels. With Canadian residential property being overpriced by 10-50%, and homeowners stretched to the limit on debt payments, there is definitely cause for concern.
Royal Bank has about $200 billion in Canadian residential mortgages on its books. The latest quarterly statement says 40% of the portfolio is insured and the loan-to-value (LTV) ratio on the other 60% is about 55%.
Royal Bank’s insured mortgage percentage is lower than its peers and the LTV is pretty much in line with the rest of the group. The Canadian market would have to see a significant pullback for Royal Bank to take any serious losses, but it is at a higher risk than some of the other banks.
Most analysts expect a gradual deflation of the bubble and Royal Bank can easily navigate through that scenario.
The company is well capitalized with a CET1 ratio of 10.1%.
Technology threats
The emergence of FinTech disruptors is probably the number one thing that keeps bank executives up at night. Customers want their banking activities to be fast, efficient, and convenient, and that is posing some challenges for the banking industry.
Royal Bank realizes it has to stay ahead of the curve and is investing in new technology and partnering with FinTech start-ups to ensure it is capable of defending its kingdom.
Earnings and dividend strength
Royal Bank remains an immensely profitable company. The firm reported fiscal Q3 2015 net income of nearly $2.5 billion despite operating in a challenging environment.
Management is fully aware of the headwinds, but the executive team can’t be too concerned about the earnings outlook because the quarterly dividend was just increased to $0.79 per share. That translates into a 4.1% yield at the current stock price.
Should you buy?
Royal Bank has survived every financial crisis of the past 150 years, so there is reason to believe the company will continue to be successful. If you have a buy-and-hold strategy, Royal Bank remains a solid dividend pick.
