Yahoo Finance Should You Be Concerned About Royal Bank of Canada’s (TSE:RY) Liquidity?
Post-GFC recovery has driven major financial institutions’ return to health, increasing market confidence in these “too-big-to-fail” banks. As a large-cap stock with market capitalization of CA$143.95B, Royal Bank of Canada (TSX:RY) falls into this category. The recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks to vulnerabilities. Operating in CA, RY is held to strict regulation which focus investor attention to the type and level of risk it takes on. Investors are viewing RY with a more cautious lens and analysing these stocks using bank-specific metrics such as liquidity and leverage. Today we’re going to take a look at these metrics to gain more confidence investing in the stock. Check out our latest analysis for Royal Bank of Canada
Why Does RY’s Leverage Matter?
Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. Though banks are required to have a certain level of buffer to meet its capital requirements, Royal Bank of Canada’s leverage level of 17x is very safe and substantially below the maximum limit of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.
What Is RY’s Level of Liquidity?
Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Generally, they should make up less than 70% of total assets, which is consistent with Royal Bank of Canada’s state given its much lower ratio of 43.25%. At this level of loan, the bank has preserved a high level of liquidity but perhaps at the cost of producing interest income from illiquid loan.
Does RY Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. This mismatch between illiquid loans and liquid deposits poses a risk for the bank if unusual events occur and requires it to immediately repay its depositors. Compared to the appropriate industry loan to deposit level of 90%, Royal Bank of Canada’s ratio of over 67.08%is noticeably lower, which means the bank is lending out less than its total level of deposits and positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits. There is opportunity for the bank to increase its interest income by lending out more loans.
Next Steps:
Royal Bank of Canada ticks all the boxes for operational prudency in terms of liquidity and leverage. These factors often sideline next to other fundamentals but are equally important to consider as part of the investment thesis. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. We’ve only touched on operational risks for RY in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three important aspects you should further research:
Future Outlook: What are well-informed industry analysts predicting for RY’s future growth? Take a look at our free research report of analyst consensus for RY’s outlook.
Valuation: What is RY worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether RY is currently mispriced by the market.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
