Annual_Report_Ry

Background The Royal Bank of Canada (hereafter RY as it is known on the TSX and NYSE) has multiple US holdings, but it principle bank holding is RBC Bank is based in Raleigh, N.C. It has total assets of more than $30 billion, ranking among the five largest banks in North Carolina, and the 38th largest bank in the country. RBC Bank has approximately 5,000 employees across the Southeast. RBC Bank is especially fortunate to be a part of the RY family with its deep knowledge and experience. RY is one of North America's largest and most stable financial institutions, backed with a strong financial profile. RBC Bank clients enjoy the service, attention and relationships associated with a "hometown" bank, but with the depth of a global financial institution. At the same time, RY’s US operations have posed a challenge to the company that raises questions about its long-run commitment to the US market. Royal Bank of Canada (RY) and its subsidiaries operate under the master brand name RBC. RY is Canada's largest bank as measured by assets and market capitalization, and among the largest banks in the world, based on market capitalization. RY is one of North America's leading diversified financial service companies, and provide the following five segments; personal and commercial banking, wealth management services, insurance, corporate and investment banking and transaction processing services on a global basis. It employs approximately 77,000 full- and part-time employees who serve more than 18 million personal, business, public sector and institutional clients through offices in Canada, the U.S. and 53 other countries. RBC Bank itself is the product of more than 30 mergers and acquisitions since its founding in 1990. After beginning as a merger of between two regional bank holding companies with a combined century-long heritage, RBC bank has grown to become a leading regional bank over the past two decades. (6) Like every other major Canadian bank, RY entered the US market with its purchase of Centura Bank in North Carolina (in 2002). Since that time it has purchased small regional bank operations from Virginia to Florida and Alabama. It has also purchased mortgage companies and controls the full-service broker Dain-Rauscher. With the market meltdown in 2009, RBC has certainly taken a hit and this will be discussed later in the paper, but no major Canadian Bank has been bailed out, even during the Depression of the 1930's (7). This is in stark contrast to what happened in the US. In large part the stability of the Canadian market is related to the dominance of 6 major banks (accounting for 94 per cent of bank assts), tight regulation, higher capital reserve requirements and a distinctly conservative mortgage market and related tax provisions (e.g., no mortgage interest deductibility but no capital gains tax and mortgage insurance that carries hefty risk premiums.) Long Term Financial Objectives RY’s long-term goals can be organized by geographic location although they all have a common objective and that is to be the biggest and best in the financial sector. In Canada, RY continues to strive to be the undisputed leader in financial services sector. The financial service sector is jointly controlled by the federal and provincial governments. Under the Constitution, the federal government has sole jurisdiction for banks, for both prudential and market conduct under the Bank Act of 2006. The federal government has restricted the purchase of one or more of the six banks by a premier bank, thereby creating a slower growth opportunities within Canada. Although they have not been allowed to merge, they have been allowed to cross-sell products such as insurance via holding companies. With this brief background in mind, all Canadian banks have entered the US market with varying degrees of success (e.g. Bank of Montreal purchase Harris Bank in Chicago; TD Ameritade is a US operation of the Toronto-Dominion Bank, etc) Within the US, RY is copying its multi-product operations in Canada and is striving to be a leader in the capital market services, wealth management and banking by building and leveraging their current assets and strengths. Outside of North America, they are striving to be a premier provider of capital markets, wealth management and banking services. With the economies in the US and Canada starting to recover, RY is focusing on medium-term objectives based on improved growth in early 2010. Within each of the segments, they are dedicated to building there leadership position and continue to take steps to make it easier for clients to do business with them. Financial Performance For fiscal 2009, the company reported a net income of $3,858 million or $2.57 per share, which is a decline from $4,555 million, a decrease of 15%. This was mainly due to an impairment charge of $1 billion dollars on both a pre-tax and after-tax basis. This was a non-cash item and did not affect operations. The impairment charge reflected the deteriorating economy in the US especially the US housing market. At the same time, the market value of virtually all US banks. RY expects provisions for non-performing loans to decline in coming quarters as the US housing market establishes a bottom. Earnings per share (EPS) were 2.57 down 24% from a year ago. Excluding the goodwill impairment, adjusted net income was $4,858 million and EPS were $3.28. Despite a 5.7 annualized loan growth in the final quarter of FY 2009, RY net interest income declined for the first time in eight quarters. This was mainly due to lower returns form investment securities while the rate paid on liabilities increased. Total Revenue increased $7,524 million or 35% from 2008. In stark contrast to the situation several years ago,, revenues were positively impacted by shifts in the Canadian dollar relative to the US dollar. Income from operations was $11,506 million, up 27% from $9048 million in 2008. Investment related revenue decreased $427 million or 9% due to lower fee based client assets and lower mutual fund distribution fees (3). It is estimated that in FY 2010 and 2011 EPS will grow to $3.53 and $4.42 respectively (6). Segments Canadian banking total revenue increased 304 million or 3% from 2008. Net income was flat and average assets increased $27 billion or 11% due to home equity and personal lending. Wealth management net income for 2009 was $583 million decreased $82 million from 2008. Revenues increased to $93 million or 2% due to the weaker Canadian dollar relative to the American dollar. Insurance net income increased by $107 million or 28% compared to 2008. “Total revenue increase $3,105 million, which was mainly due to change value of investments and increase in annuity volumes in US and international insurance business”(3). International banking had a net loss of $1,446 million compares to a net loss of $153 million last year reflecting the goodwill impairment charge. In 2007 international banking had a $209 million positive gain, which was the last year before the economy started to decline. Capital Markets also showed a similar trend. From 2007 RY had their last positive gain of $209 million and then a loss of $178 million in 2008 and finally a loss of $206 million in 2009. Total revenue increased $489 million or 23% due to deposit and loan growth. Capital markets net income was $598 million or 51% from a year ago due to stronger trading revenue. Total revenues increased $3 billion or 76% also due to the strong trading revenue. Critical Areas to Improve Financial Performance RY’s main profit center is its Canadian banking operation which consistently accounts for more than half of the bank's profits. RY needs to finish its restructuring of the business to be more responsive to client needs and expand their Canadian retail network to achieve further operational efficiency. RY needs to focus on its US operations. Despite the positive results for the corporation as a whole, RY has over the last 8 years made minimal contributions relative to the initial investments. Many of changes that occurred in 2009 brought on many challenges for many financial institutions throughout the world. Some institutions adapted and survived and others have failed. In RY’s case, it is exemplified in the 1 billion goodwill impairment charge due to the decline of assets within the US market. The saving grace of the US operations, so to speak is that the bank’s U.S. loan portfolio represents less than 15% of RY’s total loan portfolio and the Canadian economy is on a better footing than the US. “The Canadian economy is currently forecasted to grow by 2.6% in 2010, reflecting increase spending, improvements in the US economy, continued low borrowing costs and the impact of government stimulus projects. Credit quality is expected to remain under pressure, although with some improvement in 2010 we expect unemployment in Canada to peak in 2010. The US economy is forecasted to grow by 2.5% and then stabilize.” (3) These are by many accounts optimistic forecasts but there is general agreement that it will take several years, and the absence of any further crises, before the US economy regains stability and then growth, Conclusion Even though there has been some minor improvement in the US economy, it will still take time for RBC Bank to position itself for growth. The next few years are going to be critical. So far, the stable and profitable Canadian operations have carried the US adventure but there are rumblings by Canadian shareholder about the scope and viability of the US operations. The $1 billion impairment charge reflects the decline in the value of US assets. RBS has kept it dividends relatively constant, but shareholders are asking that given the low return on US assets employed over the last 8 years, why didn't Royal Bank just stay home and pay even higher dividends' The US operations have consistently lost money or produced low returns. RBC share prices have certainly recovered since the meltdown, but once again it is on the strength of the Canadian operations rather than the US. There is no doubt that RBC had to undergo a pretty painful learning experience and discover that US notions of acceptable risk and mortgage market practices are certainly different in the US relative to Canada. The question is what to do now. You can be pretty sure that RBC will slow down its rate of bank acquisitions in the US, despite the fact that here are probably bargains out there, simply because the medium-term growth rate projections do not justify the expenditure. At the same time, there will need to be some serious cost-cutting in the US operations. Unlike the trend in Canada, the US market still demands "bricks and mortar" which is a relatively high-cost way of providing retail banking services. Investment services, commercial and wholesale banking is also going to be a lot slower until the economy recovers. Unless RBC is really in it for the long haul, one could expect some drawbacks and even consolidations/downsizing of US operations. As the Canadian economy improves relative to the US, and given signals that Canada's central bank is willing to start raising interest rates well before the Americans are prepared to do so, the interest rate difference, will result in even a stronger Canadian dollar which is almost at par now. Couple that with the size of the US deficit and the US dollar could certainly drop even further. Needless to say, RY is hoping and planning that both economies grow and prosper. References 1) http://www.hoovers.com/company/Royal_Bank_of_Canada/crccxi-1.html; 2010 Hoovers Inc. March 15, 2010. 2) http://investing.businessweek.com/research/stocks/snapshot/snapshot_article.asp' ticker=RY:US&page=; Business Week, March 15, 2010. 3) www.rbc.com/investorrelations/pdf/ar_2009_e.pdf; RBC Annual Report, March 10, 2010 4) http://quote.morningstar.com/stock/s.aspx't=RY&culture=en-US®ion=USA&r=155111&byrefresh=yes; Morning Star, March 18, 2010. 5) http://www.eluta.ca/top-employer-rbc; Eluta.CA, March 15, 2010 6) ,'http://www.rbc.com'); Royal Bank of Canada, March 3, 2010. 7) Boone, Peter and Johnson, Simon; http://economix.blogs.nytimes.com/2010/03/25/canadian-banking-is-not-the-answer/. The New York Times ‘Business’, March 25, 2010