Dominion Bond Rating Service confirmed its debt ratings on Royal Bank of Canada today, and all trends are stable. But, it says, bigger investments, or further divestitures, may be needed to right its U.S. strategy.
DBRS reports that the bank generated record earnings in 2004, excluding unusual items, and continues to do well into 2005, despite issues being experienced in its U.S. operations. “Royal’s core strengths remain unchanged; its strong, diversified domestic franchises with leading or near-leading market shares in many domestic businesses provide the foundation of a strong financial institution,” it says. “Royal remains among the strongest of its peers in terms of consistency of credit quality, and current asset quality ratios are at or near all-time bests.”
The rating agency adds that Royal’s reduction in business lending exposure positions it to maintain strength through the next cycle. “However, like its competitors, Royal has limited growth potential in its domestic operations, an industry that is competitive and likely to become only more so in the future,” it notes, adding that with a string of acquisitions beginning in 2001, Royal expanded into a diverse range of businesses in the U.S. to address this issue.
Yet, “Since that time, several of these businesses, including the mortgage operation, have experienced difficulties.” So, it says, one of Royal’s shorter term challenges is to improve the return on these investments. “Shorter term initiatives such as improving the return in RBC Centura’s securities portfolio, improving infrastructure, and reducing branch expansion plans have increased profitability in 2005, although the operations as a whole continue to generate a low return on equity.”
Royal recently announced the sale of certain assets of its mortgage brokerage operation; which is a step in the right direction, in DBRS’ opinion, because it was a poor fit with the other operations.
“The longer term and more difficult challenge with respect to U.S. operations is to mould the businesses into a complementary set of business units that can effectively compete in the tough U.S. business environment; a goal that DBRS believes will eventually require substantial additional investments and possibly some further divestitures as well,” it concludes.