On Friday, Barclays analyst John Aiken downgraded Royal Bank of Canada (TSX:RY)(NYSE:RY) to “underweight”. In response, the bank’s shares are down by 2.3% (as of this writing), and are down by nearly 10% so far in 2015.
So what’s going on with Canada’s largest company? And why does Mr. Aiken think things will get worse? Below we take a look at three reasons to sell RBC.
1. Declining oil prices
The decline in oil prices affects RBC in a number of ways, most of them negative.
First of all, the Albertan economy will struggle. And this will lead to depressed loan demand, as well as higher defaults on loans. Consumer spending will take a hit, impacting RBC’s credit card business. The real estate market in places like Calgary is not doing well, which does no favours for the bank’s mortgage business. And there are legitimate concerns these problems could spread to the rest of Canada.
Making matters worse, RBC is more directly affected by the oil plunge than its main competitors are. The bank has a big Capital Markets business, with a specialty in energy, and that business could easily dry up. Wealth management revenues also could take a hit, thanks to falling stock prices. Roughly 8% of corporate loans are made to energy companies — this is higher at RBC than it is at other banks.
2. Slowing loan demand
It’s no secret that Canadian homes are expensive, and the Canadian population is heavily indebted. For years numerous experts have been saying that this cannot last, that house prices will fall, and Canadians will stop borrowing.
It hasn’t happened yet. But the oil plunge, along with its economic side effects, could easily be the trigger that proves these experts correct. This would be a big negative for RBC, since slowing loan growth will depress margins. Consequently, Mr. Aiken is predicting only “low single digit” earnings growth for RBC and its peers.
Perhaps this is partly why RBC spent US$5.4 billion on an American private bank. The transaction will shift RBC’s earnings mix towards the United States, and away from a troubled Canadian market.
3. Declining interest rates
A struggling Canadian economy comes with yet another nasty side effect for the banks: lower interest rates. We’ve already seen the Bank of Canada lower its benchmark rate from 1% to 0.75%, and some economists are predicting further cuts.
Yet again, this would be bad for the banks’ margins, since they would have to charge lower rates on loans. We’ve already seen the banks lower their prime rates by 0.15% after the last cut.
So are any of the Canadian banks worth buying? Well, there are pros and cons for each one. You’ll find more information in the free report below.