Royal Bank profit dips to $3.6B as bank set aside more money to cover bad loans

Rising interest rates gave a boost to RBC's earnings in the third quarter, but the benefits were outweighed by a significant pullback in capital markets and the deteriorating economic outlook that higher borrowing costs have also triggered.

Canada's biggest bank said Wednesday it earned profit of $3.6 billion or $2.51 per diluted share for the quarter ended July 31, down from a profit of $4.3 billion or $2.97 per diluted share in the same quarter a year earlier, as it booked provisions for potential loan losses ahead and took a hit on a loan underwriting markdown because of market conditions.

"Our market-sensitive businesses reported a challenging set of results, against the backdrop of one of the toughest environments for financial markets," said chief executive Dave McKay on an earnings call Wednesday.

"This was underpinned by increased uncertainty, heightened volatility, lower asset valuations and widening credit spreads impacting client sentiment and activity."

The company's shares lost about 2.5 per cent of their value to close at $123.20 a share on the Toronto Stock Exchange, as investors digested the underwhelming financial numbers from Canada's biggest lender.

McKay pointed to the now familiar challenges of inflation, supply chain constraints, geopolitical tension, tight labour markets. He added that droughts related to climate change are becoming an additional constraint.

Revenue totalled $12.1 billion, from $12.8 billion a year ago.

Provisions for credit losses affected earnings

The bank's earnings were affected by having to set aside a larger amount of money to cover bad loans. Known as provisions for credit losses, RBC set aside $340 million for the quarter. That compares with a release of $540 million from those provisions in the same quarter last year.

McKay said the provisions were prudent given the weaker macroeconomic forecast, including the likelihood of a recession across North America, while rising central bank rates push the economy even closer toward the end of a cycle.

The capital markets division was also a drag, where net income of $479 million was down 58 per cent from a year ago. A major factor in that fall was a $385 million loan underwriting markdown caused by market conditions.

Personal and commercial banking saw earnings dip $90 million, or four per cent, to $2 billion, on loan provisions, while the division saw a 14 per cent jump in net interest income as it recorded 10 per cent loan growth, including double-digit mortgage loan growth. Credit card spending was 30 per cent above pre-pandemic levels.

McKay said that while mortgage growth was strong he doesn't expect it to last as interest rates hit the housing market.

"We expect mortgage growth to slow over the coming quarters given the decline in housing activity and prices, and a return to a more balanced sales-to-listing ratio."

He said that given the economic challenges there will likely be fewer people qualifying for loans ahead as the bank stays disciplined with its risk appetite.

"You can expect that with inflation, with challenges to consumers, with potential job loss coming at us, that more and more customers will fall out of that risk appetite."

Chief risk officer Graeme Hepworth said rising rates and declining home prices is increasing the risks of the bank's mortgage portfolio, but that the most leveraged borrowers — who originated mortgages in the heady housing market of the pandemic — don't renew until 2025 or beyond.

"This puts our clients in a strong position to deal with rising rates and declining home prices … clients will also have time to adjust behaviour and benefit from wage and income inflation to moderate the impact of higher payments."

He said the bank has also seen credit card delinquency rates start to increase towards pre-pandemic levels, but the bank noted that deposit rates were still 30 per cent higher than pre-pandemic levels.

Overall, the bank reported total revenue of $12.1 billion, from $12.8 billion a year ago. On an adjusted basis, RBC says it earned $2.55 per diluted share for the quarter compared with an adjusted profit of $3.00 per diluted share a year earlier.

Analysts on average had expected an adjusted profit of $2.66 per share, according to financial markets data firm Refinitiv.