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High Expectations For Royal & Toronto Dominion

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If Royal Bank of Canada (NYSE: RY) were based in the United States, it would rank as this country's fifth largest bank by assets, with some $760 billion. It is the largest bank in Canada. Global Finance ranks Royal Bank as the 10th safest banking company in the world; the highest ranking American bank being Bank of New York Mellon (BK) at 25th. The highest ranking non trust bank in the United States in the survey was 36th ranked JP Morgan Chase.

 

If the American banking industry nearly died in 2008 through 2009, the Canadian banking industry scarcely hiccupped. Royal Bank's worst year in the last five was 2008, when it still managed to post earnings of $4.56 billion, for a 0.63% return on assets. If that was the low point, things have improved. In its fiscal 2011, when ended October 31, 2011, Royal Bank posted earnings of $6.65 billion, or $4.45 per share. Both figures are all time records, and the per share represented a 29% advance from 2010. Also of interest is the 2011 profits provided a 16% return on shareholders’ equity, and provided a return on assets of 0.88%. Royal Bank's efficiency ratio in 2011 was 51%.

 

In 2011, Royal Bank's biggest deal was to get out of the retail American banking market by selling its RBC unit to PNC Financial Group for about $3.5 billion. It seems Royal Bank never really got a handle on how to make money in America, though it certainly makes up for it in the 57 other countries in which it has operations.

 

The sale of the American branch network aside, Royal Bank is clearly in growth mode. Quarter by quarter, Royal Bank's loans outstanding increased throughout all of 2011 slowly but surely. Just this week, Royal Bank announced the acquisition of Royal Bank of Scotland's Latin American, African and Caribbean Private Bank, Coutts.

 

Royal Bank's retreat from the American market brings it back to the problem Canadian banks have long had. With Tier One Capital of over 12% of assets, and minimal debt, what is it going to do with all the excess capital? The Canadian economy is pretty much saturated by a handful of national banks. And culturally, the easiest expansion avenue is the United States. I believe that Royal Bank was invested here, in the Southeast, at just the wrong time.

 

Analysts estimate Royal Bank with earnings of $4.88 per share in 2012, and $5.21 per share in 2013. The bank recently raised its annual dividend to $2.30 per share, for a yield of 3.9%. With its tremendous financial strength, and well above average yield, Royal Bank is a fine choice for income investors who seek some growth as well.

 

The Toronto Dominion Bank (NYSE: TD) is Canada's second largest bank, only slightly smaller than Royal Bank with about $690 billion in assets, which would again rank fifth among American banks. It is well known in this country as the owner of TD Ameritrade Brokerage Services, and TD Bank, the latter of which is American's tenth largest bank by assets with about $190 billion.  Overall, Toronto Dominion posted record 2011 earnings of $5.9 billion, or $6.41 per share. This was up 26% over 2010, and represented a 0.86% return on assets. This growth was brought on by a $1.3 billion increase in net interest income, along with a $750 million increase in non-interest income. Meanwhile, non-interest expenses rose $850 million year to year. This folks, is how to grow a bank. Sure, it helped some that the provision for loan losses fell $200 million from the 2010 total, but unlike American banks, that was a small component of the income hike.

Toronto Dominion raised its dividend in 2011 to $0.68 quarterly, for an annual yield of 3.3%. Its earnings are forecast to grow in the 8% to 10% range for the next several years, and there is no bank I see more suitable for growth and income investors as this.

Let’s point out what makes Royal Bank and Toronto Dominion far wiser investments than say, Citigroup (NYSE: C) and Bank of America (NYSE: BAC)Combined, the two Canadian banks increased their profits in 2011 by about $2.8 billion from the 2010 level. But combined, their provisions for loan losses decreased $1.1 billion. The bulk of the profit growth came from growing loans and net interest income, increasing fees and non-interest income, and holding expenses in check. The two large American banks had a much different story. Citigroup set aside about $26 billion for loan losses in 2010, and about $12.8 billion for loan losses in 2011, a difference of over $13 billion. Citigroup's net income in 2011 was about $11 billion.

Bank of America is even more curious, or rather, pathetic. It set aside $28.4 for loan losses in 2010, and $13.4 billion in 2011, a difference of $15 billion. Despite that, it managed only to report earnings of just under $1.5 billion in 2011. Even that modest profit amount is further compromised as Bank of America divested billions of dollars in assets in 2011, giving it some $5 billion of one time benefits in the fourth quarter of 2011 alone. Yet, it has a return on assets of just .07%. Those one time benefits and ability to dramatically reduce provisions for loan reserves will not be anywhere near as available in 2012 as they were in 2011, and I just have seen no proof that current Bank of America management knows how to run a bank profitably. Neither Citigroup nor Bank of America is allowed by the Federal Reserve to pay a meaningful dividend at this time either.

2012 will be an important year not just for Bank of America and Citigroup, but for all American banks that have relied upon credit improvements, and in some cases, shrinking balance sheets to shore up capital. I want to see if, as a group, American banks can earn money on something other than loan loss provision reductions. Meanwhile, for large Canadian banks, it appears 2012 to be another in a long line of relatively smooth and profitable years.

 


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