U.S. tax cuts weigh on RBC results, but also lifting U.S. business

U.S. tax cuts weighed on the Royal Bank of Canada's first-quarter profits, but the lender also saw early benefits for its business south of the border from the reforms it expects will have an longer-term positive impact.

The Toronto-based bank delivered better-than-expected profits in the three months ended Jan. 31 and increased its quarterly payment to common shareholders by three cents to 94 cents per share.

"RBC had a strong start to the year, with robust client activity across our businesses... while we absorbed a writedown related to the U.S. tax reform," chief executive Dave McKay told analysts on a conference call Friday.

"Overall, we believe that tax reform will be positive for the broader U.S. economy and our businesses."

The bank reported net income of $3 billion, relatively unchanged compared with a year ago, but beating market expectations.

After adjustments, Canada's biggest lender by market capitalization earned $2.05 per diluted share, exceeding the $1.99 expected by analysts surveyed by Thomson Reuters.

'Good momentum'

"It's another strong quarter," said DBRS's vice-president of global financial institutions, John Mackerey. "They showed pretty good momentum against most business lines, and I think they're getting some tailwinds from higher interest rates both in the U.S. and Canada."

Excluding RBC's $178 million writedown primarily related to an adjustment of deferred tax assets stemming from U.S. tax changes, including a corporate tax rate cut from 35 per cent to 21 per cent the lender generated $3.2 billion.

Deferred tax assets can occur when a company has paid taxes in advance that are held on its balance sheet. When tax rates fall, so does the value of those assets and banks must recognize a non-cash charge adjustment. Several of Canada's lenders with U.S. exposure have indicated they expect to record a writedown in the first quarter to reduce the value of deferred tax assets, but are expecting a long-term, sustainable boost to their earnings from the tax cut.

Rod Bolger, RBC's chief financial officer, said Friday that the lender is expecting an annual benefit of roughly $250 million due to the U.S. tax reforms.

"We expect to earn back the tax writedown in the first year through the lower tax rate on U.S. earnings," he told analysts on a conference call.

In turn, Bolger added, the bank's effective tax rate after one fiscal year will move to the lower end of its range of 22 per cent to 24 per cent.

Some of RBC's other divisions have also begun to see the early benefits of U.S. tax reform. RBC's wealth management division reported a 39 per cent increase in net income to $597 million from $167 million in the same quarter one year ago, in part reflecting a lower effective tax rate.

Los Angeles-based City National, acquired by RBC in 2015, contributed US$114 million in net income in the latest quarter, more than double the US$58 million in the first quarter of 2017.

"We continue to organically invest in all three of our major businesses in the U.S... And it makes that investment more attractive now, with the lower tax rate," Bolger said in an interview.

RBC's capital markets division saw a 13 per cent jump year-on-year in net income to $748 million, primarily due to a lower effective tax rate largely due to U.S. tax changes and higher results in corporate and investment banking and global markets.

At home, RBC's Canadian personal and commercial banking arm reported net income of $1.52 billion, down $71 million or four per cent from the same period a year ago. However, the year-ago results included a gain related to the $212 million sale of the U.S. operations of Moneris.

Mortgage growth

RBC's Canadian residential mortgage portfolio was $258 billion in the latest quarter, up 5.7 per cent from $244 billion in the same quarter a year ago. For comparison, RBC saw a 4.7 increase in mortgage growth in the first quarter of 2017, up from $233 billion in the first quarter of 2016.

The banks' mortgage portfolios are being watched for any impact from new stricter underwriting rules for uninsured mortgages introduced on Jan. 1. The revised rules require would-be homebuyers with a 20 per cent down payment or larger to prove they can continue to service their mortgage payments if interest rates rise something the banks have signalled could act as a headwind to the business.

Neil McLaughlin, RBC's group head of personal and commercial banking, said Friday it is too early to assess the impact of the new rules and the bank continues to forecast mid single-digit mortgage growth for 2018. However, RBC saw an uptick in mortgage demand at the end of calendar 2017 as people scrambled to get loans before the changes took effect, he noted.

"So we are expecting some slowing in the second quarter, but we're maintaining our outlook."

RBC's provisions for credit losses, or money set aside for bad loans, increased 13 per cent in the latest quarter to $334 million, compared with $294 million a year earlier. However, the quarter was the first to reflect a new accounting standard that puts a greater emphasis on a banks' expected losses over the life of the loan. That, in turn, introduces more volatility to the measure.