The general consensus in the Canadian market right now is that the Bank of Canada is more likely than not to continue a hiking schedule, reflecting the positive economic data flowing out of the Canadian economy. This year, Canada is projected to be one of the best performers among its peers in terms of growth and, as such, is aiming to return rates to at least the 1% level — a level previously held for approximately four years (2010-2014), until Bank of Canada governor Stephen Poloz cut rates to the 0.5% level following the drop in oil prices which sent Alberta (and the country) into a tailspin.
While economic growth appears to be inching higher, increasing the likelihood of additional rate hikes at a faster pace than economists initially predicted earlier this year, investors are now wondering how to combat rate increases which have hampered the stock prices of equities across staple Canadian sectors such as commodities, real estate, and utilities.
Enter Canada’s big banks. With the “Big Six” Canadian banks set to report earnings, I’m going to hone in on the first of the large Canadian banks to report earnings — Royal Bank of Canada (TSX:RY)(NYSE:RY) — and talk specifically about why this bank continues to be a great play for investors looking to take advantage of rising rates.
Interest rate increases boost profitability
This is a very general statement and tends to hold true in the long run for large financial institutions due to the fact that rising interest rates allow banks to increase their profitability margins. The increased profitability many banks experience is due in part to rising margins on lending due to increased spread (difference between cost of borrowing and revenue from lending), as well as improvement in the lender’s losses due to consumer delinquencies and defaults linked to economic strength (or lack thereof).
The improvement in RBC’s profitability seems to have trickled through to the company’s income statement this past quarter with the lender reporting an increase in adjusted net income of more than 5%, along with an increase in adjusted earnings per share of 7.6%, leading the bank to increase its dividend by 4.6% — a modest, yet meaningful increase.
Bottom line
Of the six largest Canadian banks, RBC remains the largest of the group and is widely considered to be one of the safest among its peers. With earnings continuing to improve, and the effect of higher interest rates not yet taking hold with RBC, investors can expect steady performance from one of Canada’s premier companies.
Stay Foolish, my friends.
