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Morningstar | RBC Continues to Grow Balance Sheet; Experiences Minimal Credit Losses in 3Q

Wide-moat Royal Bank of Canada reported solid fiscal third-quarter 2018 results, and our long-term thesis on the firm remains unchanged. We are increasing our fair value estimate for the Canadian shares to CAD 109 from CAD 107, due primarily to the time value of money, but we're maintaining our $84 per share fair value estimate for the U.S. shares, as exchange rates have moved some since our last update.

While return on equity of 17.3% during the third quarter was not quite as strong as the second quarter, we largely expected returns in excess of 18% to be unsustainable, so remain pleased with the recent quarter's result. Net income, at CAD 3.1 billion, was up 11% year over year, while diluted EPS grew 14% to CAD 2.10. The bank's common equity Tier 1 ratio increased to 11.1%, and credit quality remained excellent. RBC's gross impaired loan ratio remained below 50 basis points, its provision for credit losses, or PCL, ratio decreased even further to sub-20 basis points, and delinquency rates remained range-bound.

The only weakness we saw during the quarter was in the investor and treasury services segment, where net income fell 27% year over year due to decreased net interest income and rising expenses. This segment’s net income can be a bit volatile, so we wouldn’t read too much into the quarter. That said, we do think the overall trend of increased competition from larger competitors in some of the more niche areas where RBC has historically been advantaged is here to stay.

As for the other segments, personal and commercial banking was generally strong, with growth occurring in both the U.S. and Canada. The wealth management segment also performed well, with strong growth in the U.S. and Canada leading to a 3.9% sequential increase in managed assets, and 3.6% sequential growth in fee-based revenue, during the period. Insurance net income, which can be volatile, was roughly flat year over year, as well as during the first nine months of the year.

While we continue to expect mortgage growth to slow in the Canadian market, RBC still managed to grow Canadian residential mortgage loan balances by 1.7% sequentially during the third quarter. The bank's other consumer loan portfolios saw growth during the period as well, with RBC specifically noting that they've gained share in the cards space. Overall, we continue to expect growth to slow gradually for both residential mortgages and other retail-related portfolios over the medium term. While slower growth might be deemed a negative, we view this as a healthier trend for the Canadian market, and would note that small to medium changes in loan growth in any given year is not going to have much of a material impact on our overall assessment of RBC's value.