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5 Years After the Crash, RBC is as Strong as Ever

It’s been 5 years since the world almost ended.  Well, financial world anyway.

Banks were at the epicentre.   I still remember exactly where I was when I heard the news that Lehman Brothers was bankrupt.  I’m sure I’m not alone with this memory.  While the US banking industry was brought to its knees, our banks emerged relatively unscathed and served as an example to the world on how a bank should be run.

Given that 5 year anniversaries are sort of special, we’re going to review how each of the Canadian banks has fared since the global meltdown occurred.  To kick it off, we’ve got the biggest of the bunch, the Royal Bank of Canada (TSX:RY,NYSE:RY).

RBC is Canada’s largest bank by assets ($360 billion) and market capitalization ($98.5 billion).  And while it stood tall during the financial crisis, the last 5 years have not exactly been easy.

In the fourth quarter of 2008, net income was $1.1 billion, down 15% versus the prior year.  Revenue was $5.1 billion, down 10% from the prior year.  The ROE of the bank went from almost 25% in 2007 to under 12% in 2009.  Tough numbers to swallow, but heavenly compared to the carnage that was going on with the banks in the U.S.

Though Royal Bank understandably stumbled during the crisis, it has roared back and is as strong as ever.  The bank’s Tier 1 capital ratio has risen from 9% in 2008 to over 13% currently, and ROE was back to almost 20% in 2012.  Accordingly, since bottoming in February 2009, the bank’s stock has climbed an impressive 146%.

Let’s now dig a little deeper into the bank’s different business segments.  As we can see from the following table, Royal Bank’s segmented revenue and net income has been shifting over the last 5 years.  Management has worked toward diversifying its income sources, and has effectively increased its wealth management business, its investor and treasury services business, and it is working on reducing its exposure to the volatile capital markets business.

Segmented Net Income

2013

2009

Personal & Commercial Banking

53.2%

49.0%

Wealth Management

11.0%

10.3%

Investor & Treasury Services

4.0%

Nm

Capital Markets

19.6%

31.1%

Insurance

7.8%

9.3%

Corporate Support

4.4%

0.3%

Source:  Company reports

Personal and Commercial Banking

Royal Bank’s Canadian banking segment essentially shrugged off the financial crisis.  Revenue has increased over 20% during the past 5 years, while net income has increased over 50%.  The ROE of this segment was 39.3% in 2012 compared to 36% in 2009.  Let’s pause on these figures as they nicely sum up how strong the Canadian retail banking business is.  In the face of global financial meltdown, RBC’s Canadian banking segment still clocked an ROE of 36%!  That’s astounding!

Its US retail banking operations, on the other hand, were essentially a money pit and in June 2011, Royal announced the sale of these assets, booking a loss of $1.6 billion in the process and stating that its US growth strategy from here in would focus on wealth management and capital markets.

Wealth Management

According to management, there is opportunity in the wealth management business as an aging population means more retirement services will be needed.  High net worth clients are growing significantly.  Also, management is investing in wealth management in international markets.  In the latest quarter, Wealth Management net income was a record $236 million, up 51% versus last year, mainly due to higher average fee-based client assets resulting from net sales and capital appreciation.  Higher transaction volumes also contributed to the increase.  Growth rates in this segment have been increasing dramatically since the crisis and Royal Bank is planning to benefit from this.

Investor and Treasury Services

Assets under administration have grown to $3.1 billion from $2.7 billion in 2011.  In April 2012 RBC purchased the remaining 50% of Dexia to take advantage of opportunities for growth in the global custodian business.  It’s an attractive business that generates stable revenue in a sector that is well positioned for long term growth.  The custodial business is scaleable as it is largely driven by technology and processes which are already in place.  According to management, this segment is well positioned to benefit from higher interest rates and an improvement in market asset values.

Capital Markets

Management’s goal in the capital markets segment is to increase its market share of the U.S. business, as well as shift from trading to loans and origination.  In the U.S., Royal Bank has just a 2.5% market share, yet this small share represents over half of the revenues generated from Capital Markets.  This speaks to the size and opportunity of the U.S. market. The big U.S. banks have on average, about 6% market share each.  There is opportunity for Royal to gain further market share.

Management also sees an opportunity to expand its international capital markets business.  Global peers have had to exit different markets and restructure.  Since Royal Bank withstood the crisis exceptionally well, it is financially strong enough to expand.  In 2008, the capital markets segments accounted for 25.7% of net income for the overall bank, but going forward, management does not want this business to exceed 25%.  It currently stands at just over 20% of net income.  This segment presents a good opportunity to generate strong returns, but is volatile.

Insurance

The insurance segment took a hit in the latest quarter, as the flooding in Calgary took its toll.  Prior to that, revenue from this segment has been steady.  Going forward, Royal Bank will work on the direct-to-consumer approach in its effort to make further inroads in the insurance business.

Bottom Line

A lot has changed for Royal Bank over the past 5 years.  After many challenges, write-downs, and shifts in strategic direction, Royal Bank looks set to embark on its new strategic plan.  The bank is in good financial shape, has a good track record, and a well thought out strategy, with promising opportunities ahead of it.

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Fool contributor Karen Thomas does not own shares in any of the companies mentioned above.  The Motley Fool does not own shares in any of the companies mentioned above. 

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