Royal Bank of Canada has set aside more money to absorb loans that could default, as borrowers increasingly fall behind on real-estate and credit-card payments as a result of higher interest rates and inflation.
While the country’s largest lender posted a first-quarter profit on Wednesday that beat analysts’ expectations, it also signalled that borrowers are likely to struggle to manage their debt until rates fall later this year.
With Canada’s economic growth lagging the United States, however, there could be relief coming for consumers. RBC chief executive officer Dave McKay said that the Bank of Canada is likely to start cutting interest rates earlier than the U.S. Federal Reserve this year.
“Growing consumer demand and rising unemployment points to a softening in the Canadian economic backdrop,” Mr. McKay said during a conference call with analysts. “In contrast, the U.S. is showing continued strength in labour markets, above average wage growth, a resilient U.S. consumer and higher corporate profits.”
Over the past year, RBC has faced significant hurdles with its Los Angeles-based bank City National. Mr. McKay said the latter bank had a “tough year last year” because of its torrid growth since RBC acquired it in 2015. In 2023, the lender failed to turn a profit and drew the ire of a U.S. banking regulator.
Canada’s largest lenders have been increasing provisions for credit losses – the funds banks set aside to cover loans that may default – as clients struggle with higher borrowing costs. RBC set aside $813-million, which was higher than analysts anticipated, and included $133-million against loans that are still being repaid.
Provisions for losses in Canadian personal and commercial banking were increased largely by rising risk in credit cards, but also rose across all products.
The increase in provisions flowed from rising risk in real estate, particularly commercial properties. In its capital markets division, RBC booked large reserves on an impaired office loan and a multi-family residential loan, both of which were in the U.S.
While gross impaired loans – debt that the bank believes will not be repaid – in real estate more than doubled since the same quarter last year, the bank’s provisions for the sector jumped to 182-million from $16-million in the first quarter a year prior.
“While you’re seeing the stresses you would anticipate related to increases in the sector, we have been providing for those sufficiently,” said Nadine Ahn, RBC’s chief financial officer, in an interview.
“We have been building reserves commensurate with that, but given the diversification of our portfolio, we do feel that it’s within our risk appetite and we are comfortable overall with our exposure.”
National Bank of Canada, which also reported first-quarter earnings Wednesday, set aside $120-million in provisions for credit losses, higher than analysts anticipated. Provisions were boosted by increased risk from loans in Canadian personal banking.
“Significant uncertainties still remain in the forward path of economic growth and interest rates,” said William Bonnell, National bank’s chief risk officer, during a conference call.
On Tuesday, two banks reported first quarter earnings, with Bank of Nova Scotia beating analyst expectations and Bank of Montreal missing estimates. Toronto-Dominion Bank and Canadian Imperial Bank of Commerce will close out the week on Thursday.
National Bank reported higher first-quarter profit as a revenue boost in Canadian banking and capital markets offset higher provisions. It posted adjusted earnings per share of $2.59 per share, topped the $2.36 per share analysts expected, according to data from the London Stock Exchange Group.
Adjusted to exclude certain items, including transaction and integration costs related to its proposed takeover of HSBC Bank Canada, RBC earned $2.85 per share. That beat the $2.80 per share analysts expected.
“A decent quarter for [RBC] overall at first look, although the [earnings per share] beat was driven predominately by a strong result in capital markets, which we expect to moderate in the coming quarters,” said Mike Rizvanovic, a Keefe, Bruyette & Woods analyst, in a note.
Better-than-expected profit in capital markets and wealth-management units helped prop up RBC’s results, in part offsetting costs from an industry-wide special assessment by the U.S. Federal Deposit Insurance Corporation, as well as investments in City National.
In the U.S., RBC is working on rebuilding the profitability of that bank. Last year, the Canadian bank injected nearly $3-billion into its U.S. division to reinforce its capital, and City National was fined by the U.S. Office of the Comptroller of the Currency for failings in many of the lender’s internal controls and risk-management processes.
“I think our growth outstripped our operational capability,” Mr. McKay said. “We emphasize maybe growth over the profitability of the growth a little too strongly.”
RBC is also on the cusp of closing the largest-ever domestic banking deal. Its pending $13.5-billion takeover of British-based banking giant HSBC Holdings PLC’s Canadian unit received approval from Finance Minister Chrystia Freeland in December. The deal, which was initially set to be completed last year until it faced delays with approvals, is expected to close at the end of March.
The bank updated its financial expectations for the deal. RBC anticipates pre-tax acquisition and integration costs of about $1.5-billion, up from $1-billion when it announced the deal in late 2022. But it also expects to close the deal with a higher capital tier one (CET1) ratio – a measure of a bank’s ability to absorb losses – at 12.5 per cent, up from the previous 11.5-per-cent estimate.
HSBC’s Canadian subsidiary has 780,000 retail clients, of which 40 per cent are considered affluent. Its loan portfolio is focused on commercial and mortgage lending, but RBC said that the credit quality of those loans are largely held by larger businesses and high-net-worth clients that have withstood the economic slowdown.
“We got very comfortable with their portfolio and, if anything, it skews a little bit better than some of our portfolios,” said Graeme Hepworth, RBC’s chief risk officer.
Stefanie Marotta