Royal Bank of Canada: Solid Franchise, But Valuation Raises Concerns

Royal Bank of Canada (RBC) is Canada's largest lender, founded in the 19th century, and operates in various financial services including banking, investing, and insurance. Despite its strong franchise, the author is not convinced to buy more shares at the current price. The latest quarterly report shows the bank's diversified business model and consistent performance.

Royal Bank of Canada Insurance Co. Ltd. (RBCICL), a subsidiary of Royal Bank of Canada (RBC), has received a negative outlook revision from S&P Global Ratings. The rating agency, which affirmed RBCICL's long-term issuer credit and financial strength ratings at 'AA-', cited concerns about the company's reduced product diversification compared to similarly rated peers [1].

Over the past few years, RBCICL has narrowed its product portfolio from a mix of creditor, longevity, and mortality business to just creditor reinsurance and longevity reinsurance. The company's reliance on a single business source, with creditor reinsurance ultimately sourced from its parent company accounting for the majority of earnings over the past five years, has raised concerns about its competitive strength [1].

S&P noted that RBCICL's expected growth in the U.K. longevity market has not materialized as anticipated, with longevity product growth slowing due to increased competition. The company's total net premiums have remained around C$2.5 billion, while net income has ranged between C$600 million and C$800 million over the past five years. The rating agency believes that this concentration in a single business source, combined with expected further deceleration in longevity business growth, could pressure the company's overall competitive strength [1].

Despite these concerns, RBCICL maintains strong profitability compared to peers, with a return on assets of 36.4% as of year-end 2024 under international reporting standards, including IFRS-17. The company benefits from its parent's extensive Canadian banking branch network, providing a steady source of creditor-life loan protection business [1].

S&P expects RBCICL to maintain capital adequacy at the 99.99% confidence level under its capital model. The company has updated its internal capital target requirements to at least 105% of capital required. The rating agency could lower its ratings within the next 12 months if capital adequacy falls below the 99.99% confidence level, if the competitive position weakens, if there’s a shift toward riskier business lines, or if S&P revises down its group credit profile on the Royal Bank of Canada group [1].

The outlook could return to stable if RBCICL demonstrates sustainable competitive position with appropriate diversification while maintaining profitability and capital strength [1].

References:
[1] https://www.investing.com/news/stock-market-news/sp-revises-royal-bank-of-canada-insurance-outlook-to-negative-93CH-4213602