Increased Trading Defines RBC's New Normal

Dec. 7.09 | About: Royal Bank (RY)

By Andrew Willis

Last year saw iconic Wall Street names relegated to the dustbin, as the likes of Bear Stearns and Lehman Brothers closed massive trading desks.

We’re still coming to grips with just what this means for trading of all stripes - fixed income, currencies, derivatives and equities. No one really knows what the new normal looks like on Wall Street. What we do know is that Royal Bank of Canada (NYSE:RY) is scooping up an impressive amount of market share in global trading. And that creates a degree of uncertainly, and even trepidation, over the prospects of the country’s largest bank.

RBC Dominion Securities, the investment dealer arm at Royal Bank, is doing an admirable job of picking up global clients in the aftermath of the financial meltdown. The volume of bond, stock and currency trading is up, and so are the margins on this business. In the final three months of fiscal 2009, RBC Dominion posted an impressive $1.4 billion of trading revenues. Just two years ago, in the final quarter of 2007, RBC Dominion’s global trading revenues were $347 million.

“Clearly, the old pre-crisis level is not the new run-rate for any Canadian bank – but especially for Royal Bank,” said a report on Friday from National Bank Financial analyst Robert Sedran. He noted that just 28% of RBC Dominion’s trading revenue in the quarter came from Canada, while 42% was from the U.S. market, and 30% was from clients in Europe and Asia.

This diversification shows the impressive growth in the platform over the past few years as the bank has taken advantage of displaced staff and damaged global competitors to step up its capital markets activities,” said Mr. Sedran.

Looking ahead, analysts are struggling to project just how much Royal Bank will earn from trading, and what sort of multiple should be assigned these earnings. This is an issue that divides the Street, as some analysts and institutions discount the profits earned from capital markets, on the ground these earnings lack the quality of profits thrown off by retail bank networks.

At National Bank Financial, Mr. Sedran predicts RBC Dominion’s trading revenues will decline slightly, to $1.1 billion a quarter. The analyst said Royal Bank “management expressed confidence that their numbers have already started to normalize – though they never even approach guidance – which provides a measure of support to that forecast.”

What do continuing robust trading revenues mean for this bank as a whole? Mr. Sedran's veiw is that Royal Bank will outperform peers, and justify a premium valuation, as the bank is in a “strong relative position both in the current environment and once the economy begins to recover.”