Royal Bank Of Canada And Its Dividend

| About: Royal Bank (RY)


Royal Bank of Canada has the second highest ROE of the majors.

The bank is, however, trading at a premium to its peers.

The bank is well capitalized and has the second highest leverage ratio.

Royal Bank of Canada (NYSE:RY) is one of the five biggest Canadian Banks (hereafter referred to as the majors) and has the second highest leverage ratio of the majors. The bank also has the second highest Return on Equity of the majors and is well capitalized.

The banks' dividend at around 3.7% is the third highest of the majors and it has uninterruptedly paid a dividend every year since 1870. Readers should note that all figures referenced are in Canadian Dollars unless the contrary is indicated or reference is made to the U.S. ticker symbol.

Asset Quality and Capital

The bank has a Capital Adequacy Ratio (CAR) of 14.7% which is well above the regulatory minimum of 11.5% set for Canada's six largest banks. Its CAR is, however, along with BMO (NYSE:BMO) the lowest of the majors.

(Source: Company Fillings)

The lower CAR does not, however, give rise to substantial concern particularly not when consideration is given to the leverage ratio. The leverage ratio can be regarded as the most conservative measure of Capital position as it essentially regards all assets, with a few exceptions, as equally risky. It thus strips out the benefit a bank obtains from holding government insured mortgages from the calculation. Royal Bank of Canada's leverage ratio at 4.4% is well above the regulatory minimum and the second highest of the majors.

(Source: Company Fillings)

The banks' Common Equity Tier 1 (CET1) CAR at 11% is also well above the regulatory minimum of 9.5%. It is again, however, at the lower end of the scale in comparison to its peers.

(Source: Company Fillings)

Considering the omnipresent fears of a Canadian housing bubble and potential mortgage meltdown it is worth noting that the banks' exposure to uninsured mortgages in the provinces of Ontario and British Columbia, in which the main problem cities are located, is lower than that of many of its peers. The banks total uninsured mortgage portfolio in these provinces amount to 1.3 times its total regulatory capital, indicating that a mortgage meltdown is unlikely to pose an existential threat to the bank.

(Source: Company Fillings)

It may also be worth noting that there are substantial differences between the U.S. and Canadian mortgage markets. Key amongst those being that Canadian mortgages are generally full-recourse, meaning the bank can seize other assets to cover the unrecoverable portion of the debt and limiting a 'throwback the keys' scenario, and Canadian mortgages are generally offered at much lower Loan to Valuation (LTV) ratios than other markets.

Royal Bank of Canada is no exception and has the second lowest LTV ratio, along with BMO, on its uninsured mortgages of the majors. Its LTV ratio on its uninsured mortgages is at 54% whilst its newly originated and acquired mortgages in the first quarter also had a low LTV ratio of around 70% highlighting the banks' conservative lending practices.

(Source: Company Fillings)

It is also worth noting that the banks' exposure to the oil and gas sector has been declining and now amount to a mere 1.1% of total loans outstanding compared to 1.6% in the first quarter of 2016.

Earnings and Dividend

The bank continues to earn more than 60% of its revenue from its home market, Canada, where growth has been slowing. In a recent interview with Bloomberg the CEO of the banks' rival BMO noted that

" the [Canadian] consumer is really- I think- at the limit of their capacity."

Considering this statement in conjunction with RYs high exposure to the Canadian markets it becomes clear why analysts have factored lower growth rates in for RY. The banks' earnings growth is expected to be the second lowest amongst the majors over the course of the next three years.


Weaker earnings growth is also likely to result in lower dividend growth rates. I do not, however, foresee a dividend cut in the near future as the banks' estimated payout ratio for 2017 remains below 50%. This is in line with the banks' targeted payout ratio in the region of 40-50%. It is, however, at the upper end of the banks' targeted scale leaving less room for dividend increases beyond earnings growth.

(Source: Reuters)

Valuation and Conclusion

The banks' stock is trading at a P/E ratio in the region of 13.51 which is above its 5-year average P/E ratio of 12.37. Its P/E ratio is also the second highest of the majors.

(Source: Ycharts)

The banks' price to book value at around 2.202 is also the highest of the majors and above its 5-year average of 2.143. The higher price to book value can in part be attributed to its higher ROE, but, when comparing its price to book value relative to ROE in comparison to that of its peers it becomes apparent that the stock is still trading at quite a substantial premium to its peers.

(Source: Ycharts)

(Source: Ycharts & Company Fillings)

I do not currently consider RY to be attractive from a valuation perspective either on a relative basis or in comparison to its peers. I do not, however, see any reason for existing holders to exit their position or any reason for the dividend to be reduced in the immediate future.

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Disclosure: I am/we are long TD, CM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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