Royal Bank of Canada

Royal Bank of Canada reported solid fiscal third-quarter results. Adjusted earnings per share of CAD 4.28 grew 11% from the prior-year quarter. The results translate into an adjusted return on equity of 17.9%, above the bank's medium-term target of 17.0%-plus.

Why it matters: While net interest income growth of 5% (7% excluding trading) year over year was in line with RBC's full-year guidance for mid-single-digit growth, it was slower than the peer average of 8% in the quarter. RBC's net interest margin declined 2 basis points from the prior-year quarter, worse than most of its peers. Management said the purchase accounting accretion from HSBC Canada rolling off has created a headwind of around 4 basis points per quarter, which the bank should lap in the second quarter of fiscal 2027. Loan growth of 8% year over year was impressive, though, given the bank's size, and it was ahead of most peers in the quarter.

The bottom line: As we incorporate wide-moat Royal Bank of Canada's latest results, we anticipate increasing our CAD 235/USD 169 fair value estimate by a high-single-digit percentage. We continue to assess the shares as overvalued. The increase in our valuation will be primarily driven by higher fee income growth from the bank's wealth management and capital markets businesses in the near term, which will be partially offset by lower 2026 net interest income and higher expense growth.

Coming up: Similar to peers that have reported this cycle, RBC did not indicate any meaningful changes to its fiscal 2026 credit guidance amid the latest tariff announcements between the US and Canada. Its last guidance was similar to the 2025 level, which was 37 basis points of provisioning for impaired loans.

A prolonged and severe tariff situation would lead to higher credit costs and lower balance-sheet growth for Royal Bank of Canada as well as the other Canadian banks. That said, government-supportive measures for the tariff-affected sectors and the labor force would help alleviate the negative impact on profitability and returns for the Canadian banks. RBC also has a strong capital position to weather potentially higher credit costs, ending the third quarter at a common equity Tier 1 ratio of 13.5%, 240 basis points above its current regulatory minimum of 11.1%.

RBC's capital markets segment earnings were up 4% sequentially during the quarter, lower than some of its peers but still impressive, given that the bank's trading business has less exposure to equities trading. Within the segment, corporate and investment banking revenue rose 10%, while global markets revenue increased 5% sequentially.

After incorporating the latest results, we are increasing our fair value estimate of RBC to USD 169 per share from USD 143. Around 13% of the increase comes from the time value of money, around two-thirds from lowering our cost of equity assumption to 8.2% from 9.0%, and the remaining from higher near-term earnings and foreign exchange rate updates. The reduction in our cost of equity reflects our updated view regarding RBC's business mix and cyclicality. Our valuation is 3.0 times the tangible book value as of April 2026. We use an exchange rate of CAD 1/USD 0.72 in our valuation.

We have increased our trading income, underwriting and advisory income, and asset-based fees for RBC in the near term, and we now expect RBC to increase its fee income at a CAGR of 3.5% from 2025 to 2030, compared with our prior forecast of 3.0%. We acknowledge that predicting capital markets revenue is inherently challenging, and we still believe the capital markets business remains highly volatile. We caution investors that a reduction in the revenue base will lead to a much larger decline in profitability, given the business' high operating leverage.

We expect loan growth of 5.1% in 2026, with wholesale loan growth being the largest driver. This is a slowdown from the more than 15% growth in 2024 (mostly driven by the HSBC Canada acquisition) and around 6% in 2025. Overall, we expect RBC to increase its loan balances at a CAGR of 4.2% over the next five years. In terms of net interest margin, we expect a relatively stable margin for RBC between 1.56% and 1.60% from 2026 to 2030. Taken together, we forecast net interest income growth of 6.4% in 2026 and a five-year CAGR of 4.3%.

We forecast 2026 provisioning costs at 0.36% of total loans, lower than 0.43% in 2025 and similar to 0.35% in 2024. RBC has greater exposure than some of its peers to the Canadian housing market, where elevated home prices and consumer leverage are concerns. However, Canadian mortgage debt held up surprisingly well despite higher mortgage rates, and there was never a severe increase in mortgage defaults. We view this as more of a future risk to growth than an immediate risk to capital.

Trading income grew by 34% in 2025, and we view 2025’s strong performance as over-earning from a midterm perspective. We now expect 2026 trading income to decline by 4.5% from the strong 2025 base, much lower than our previous forecast of a 20% decline. Excluding trading income, we forecast noninterest income to grow at 6.4% (prior: 4.7%) in 2026. We project total noninterest income to grow at a 3.5% CAGR from 2025 to 2030.

2024 core operating expenses grew 7.4% after adjusting for HSBC Canada-related expenses. 2025 core operating expenses accelerated to 11.8%, mostly driven by the strong performance in wealth management and capital market segments, as both businesses carry a large variable compensation component. We project expense growth of 5.3% for 2026, mostly driven by compensation and technology investments.

We forecast the bank's long-term efficiency ratio at around 55.2%, down from our prior forecast of 55.8%. Our forecasts indicate an average return on tangible common equity of 20.9% for the bank for the period 2026-30. We use an 8.2% cost of equity in our valuation.

We assign Royal Bank of Canada a Morningstar Economic Moat Rating of wide because it possesses durable cost advantages and switching costs that are consistent with our bank moat framework. In our view, RBC has a wide moat because it has superior market share in the advantageous Canadian banking environment, superior operating efficiency, and exposure to more-moaty nonbank businesses. We are confident that the bank will consistently earn returns that are comfortably above its 8.2% cost of equity through the cycle.

We believe bank moats are derived primarily from two sources: cost advantages and switching costs. We see switching costs in the Canadian system being driven by a tightly regulated oligopolistic market structure (Big Six Canadian banks control more than 90% market shares), which limits excess competition, therefore stabilizing product pricing and giving customers less incentive to switch banks. We see cost advantages as stemming from three primary factors: a low-cost deposit base, excellent operating efficiency, and conservative underwriting. Regulatory costs must also be considered, and we view the Canadian banking regulators as relatively favorable to the big Canadian banks. We view the Canadian banking environment as offering systemic cost advantages for the banks under its domain. These advantages manifest themselves in the form of lower operating costs, lower credit costs, lower regulatory costs, and lower absolute levels of and better diversification of risks, all of which allow the big Canadian banks to achieve greater risk-adjusted returns.

Royal Bank of Canada derives more than 60% of revenue from the Canadian market and the bank has consistently operated with one of the best efficiency ratios in Canada, partially through superior operational execution, and partially due to the highest noninterest income proportion among the Canadian banks. The bank is also one of the two largest banks in Canada (along with Toronto Dominion) and has dominant market share in many categories, including number-one or number-two share in all key retail and commercial banking products. It is also one of the dominant investment banks in Canada and a top-15 player worldwide. We think that the bank has a moat in investment banking built on intangible assets, which increases its probability of sourcing larger deals and generating better revenue share and economics from a deal with a lead advisor position. It also has the largest amount of assets under management and assets under administration among Canadian banks, giving it the largest exposure to this higher-margin, asset-light business and a larger share of clients’ overall wealth.

RBC’s Canadian Banking Business Has a Wide Moat

We believe the Canadian banking environment offers systemic cost advantages and switching costs that lead to returns above the cost of capital, allowing the big banks operating under its jurisdiction to possess moats. We view RBC’s Canadian banking segments (contributing around 40% of total RBC revenue as moaty. As the largest Canadian bank, Royal Bank of Canada accounts for more than 20% of domestic deposits and loans and holds number-one or number-two market share across all consumer and commercial banking products. The recent acquisition of HSBC Canada in 2024 added another 1%-2% Canadian market share in products such as deposits, mortgages, and commercial loans. The bank also has one of the best cross-selling capabilities and execution among all Big Six Canadian banks, enabling it to extract a larger share of its consumers' wealth. The strength of RBC’s Canadian banking franchise translates into superior efficiency ratios and returns over its peer Canadian banks.

Barriers to entry are very high for the Canadian banking system. Existing regulations prevent foreign competition: non-Canadian residents may not own more than 25% of a bank's shares unless approved by the government (preventing foreign takeover), and foreign banks can operate in Canada only under certain restrictions (preventing significant direct foreign competition). Domestic competition is also controlled, as Canada’s banking system historically developed to favor a few large banks controlling the majority of the domestic market, and this is actively enforced through the exclusive federal government control of chartering. Additionally, the rejection of merger proposals in 1998—between Royal Bank of Canada and Bank of Montreal, and between Toronto Dominion and Canadian Imperial Bank of Commerce—set a precedent that no further consolidation among the main Canadian banks would be accepted by regulators.

Having larger banks helps spread fixed costs across a larger operating base, increasing operating efficiency, as the four largest Canadian banks are all larger than the largest US regional bank. Canadian banks, because their branch networks are spread throughout Canada, arguably have some of the most powerful distribution networks in the country. This offers cost advantages via lower customer acquisition costs. In addition, the banks are involved in nearly every major financial product, including asset management, wealth management, insurance, investment banking, and a variety of other consumer and commercial banking products and services. Bigger scale, powerful distribution networks, a multitude of products, and diversification of business lines lead to economies of scope in addition to the economies of scale already achieved.

We believe a more protective and efficient regulatory system also leads to cost advantages, primarily through risk reduction. More consolidated and well-integrated banking systems, like the Canadian system, have tended to be more stable over time, reducing risk. Also, the Canadian regulators must only primarily monitor and develop relationships with the Big Six Canadian banks, which is much easier than trying to monitor the thousands of banks that exist in the US, for example. This leads to more collaboration and cooperation between regulators and banks, as well as greater institutional memory and more coordinated and easily implemented responses if strain begins to appear in the system. Regulators also help to control pricing in the market at times, such as on mortgage products, helping to reduce the potential for pricing wars to gain market share at the expense of underwriting standards. Canadian regulation also makes it more difficult for bad credit to be issued in many ways, including mandatory insurance and standards on riskier mortgage loans, not having a GSE-like government-subsidized mortgage securitization market, and forcing banks to hold more of the risk on their own balance sheets. These factors help contribute to better absolute risk reduction in the system as well as regulatory economies of scale.

Canadian banks are also more geographically diversified on average than, for example, most US regional banks, which often have concentrations in individual states or local economies. This diversifies credit risk, lowering the overall risk for each individual bank. Canada’s system of higher taxes, more social safety nets, and other complex factors has also led to a more robust and stable middle class that contributes to economic and political stability, further reducing systemic risk.

Combine all of these factors, along with explicit government subsidies on deposit insurance and mortgage insurance, as well as the implicit subsidy of being too big to fail domestically (all Big Six Canadian banks are labeled as domestic systemically important banks at a minimum), and we believe an environment exists where excess returns for banks are almost certain to exist in Canada.

Wealth Management Segment Benefits From Switching Costs

We think the primary moat for wealth management and asset management businesses is switching costs, and we view Royal Bank of Canada as moaty in both businesses. Royal Bank of Canada is the largest Canadian wealth manager and the largest retail fund manager. The wealth management segment accounts for about 30%-35% of Royal Bank of Canada’s total revenue and 16%-20% of its earnings. Within its wealth management segment, Canadian wealth management contributes around 30% of revenue, while US wealth management (including City National Bank) contributes around 45%. Global asset management contributes around 15% of wealth management revenue. The remaining 10% of wealth management revenue comes from its international wealth management and investor services business.

Royal Bank of Canada’s Canadian wealth management clients are mostly in the high-net-worth and ultra-high-net-worth tiers, with around 2,000 advisors and CAD 856 billion AUA by the end of fiscal 2024. RBC’s HNW and UHNM focus makes its advisors much more productive. The brand of RBC is also very attractive in recruiting top talent and retaining advisors. RBC’s US wealth management includes its US wealth advisory business (around 2,200 advisors and CAD 930 billion in AUA) and City National Bank (commercial banking and HNW wealth management).

As the largest bank in Canada, RBC is also one of the largest distributors of mutual funds in Canada. Of Royal Bank of Canada's CAD 1.6 trillion of assets under management at the end of fiscal 2025, approximately 5% are in money markets, 14% in equities, 20% in fixed income, and 61% in multi-asset and other investments.

Wealth management firms benefit from both client asset stickiness and advisor stickiness. On the one hand, clients are often hesitant to switch advisors because of existing relationships with their current advisor, uncertainty about the potential cost-benefit trade-off of a switch, and inertia with financial management decision-making. On the other hand, we believe advisors tend to stay with their current firm due to the threat of losing client assets if they switch.

We believe the asset-management business is conducive to the creation of economic moats, with switching costs and intangible assets being the most durable sources of competitive advantage for firms operating in the industry. Although the switching costs might not be explicitly large, inertia and the uncertainty of achieving better results by moving from one manager to another tend to keep investors in place for extended periods. As a result, money that flows into asset-management firms tends to stay there. For the US fund industry, the average redemption (retention) rate for long-term mutual funds (which excludes money market funds) has been around 25% (75%) annually the past three decades. Redemption (retention) rates have been much lower (higher) in the Canadian market, where the average annual redemption (retention) rate for long-term funds has historically been closer to 15% (85%). This is more a product of how funds are distributed in the Canadian market than a reflection of superior investment performance or some other attribute.

We believe asset managers can improve on the switching costs inherent in their business with organizational attributes (such as depth and breadth of product mix and distribution channel concentration and geographic reach) and intangible assets (such as strong and respected brands and manager reputations derived from successful records of investment performance), which can provide them with a degree of differentiation from their peers. We generally refer to all these things—the organizational attributes and the more common intangibles—as intangible assets that can either add to or subtract from the switching cost advantage that might be inherent in and asset manager's business model.

For example, firms that offer niche products with significantly higher switching costs—such as retirement accounts, alternative funds with lockup periods, and tax-managed strategies—that allow them to hold on to assets longer are generally viewed as having intangibles that clearly separate them from peers. Meanwhile, the depth and breadth of the product mix, distribution channel concentration, geographic reach, and successful records of investment performance are all visible attributes, but it is harder to make a direct connection to their influence on switching costs. In the Canadian market, we have seen another attribute—a greater preponderance of fund manufacturers with their own in-house distribution arms—that aids redemption (retention) rates. All Big Six Canadian banks have their branch network and financial advisors as distribution channels, which helps retention rates.

A superior redemption (retention) rate is good only if you can do something with it, as the key to generating positive organic AUM growth is to keep fund redemption rates at/below historical averages (which is generally aided by producing average to above-average investment performance) and selling products that customers want to buy. Firms that have demonstrated an ability to gather and retain investor assets during different market cycles have been less reliant on market gains to generate AUM growth and have tended to produce more-stable levels of revenue profitability, with returns exceeding their cost of capital for longer periods.

We have watched the balance of power in the Canadian market shift more toward the Big Six banks—Royal Bank of Canada, Toronto-Dominion Bank, Scotiabank, Bank of Montreal, Canadian Imperial Bank of Commerce, and National Bank of Canada—and the Canadian life insurers. The non-bank-affiliated pure-play asset managers that we cover—IGM Financial, CI Financial, and AGF Management—have struggled with both organic and overall growth of their AUM, primarily due to increased competition for fund sales. The Big Six banks and life insurers in the Canadian market have used their position as the largest distributors of mutual funds, as well as expansions of their fund manufacturing operations, to compete more heavily with the independents on price, allowing them to take share. We've seen instances where Canadian banks have charged management fees that are 10% lower than those charged by non-bank-affiliated pure-play asset managers, with trailer fees that are 15%-25% lower than the industry average. As their fund manufacturing and distribution operations are one of many different products and services they provide customers, pricing can be a bit more fungible for the Big Six banks than it is for the non-bank-affiliated purer-play asset managers.

Capital Markets Segment Has a Narrow Moat From Intangible Assets

Royal Bank of Canada derives around 20% of its revenue from the capital markets business. We think Royal Bank of Canada has brand recognition that provides a competitive advantage for garnering investment banking deals and recruiting top talent. It is one of the dominant investment banks in Canada and a top-15 player worldwide. Around half its capital markets revenue is from its investment banking business, and half is from its market/trading business.

Investment banking moats (equity underwriting, debt underwriting, merger advisory, restructuring advisory) are primarily built on intangibles. Intangibles for an investment bank are in the strength of its reputation, relationships with investors, history with company executives, industry expertise, research analyst coverage, track record of successful deals, and distribution capabilities. Having strong intangibles, an asset-based moat increases the probability that the investment bank will be hired for the coveted lead advisor position on an investment banking deal that comes with superior revenue share and economics compared with other investment banks in the underwriting syndicate, or that provides lower-value services, such as a fairness opinion on the valuation of a deal. A strong brand can also position the firm as an employer of choice for productive bankers. High-level indicators of an investment bank’s intangible assets can be seen in its investment banking league table position, participation in high-profile transactions, and revenue production of its bankers.

We see little evidence of moats in developed financial markets for institutional securities trading by investment banks and broker/dealers. Financial instruments in developed markets often have fairly transparent pricing and high liquidity (the ability to trade without significantly affecting the instrument’s price). The tight trading spreads in equities on financial exchanges and the increased electronification of fixed-income trading are examples of the decreased profit potential for institutional broker/dealers. Increased profits may be had in more-opaque areas of trading, such as bespoke derivatives or block trades, but they often come with greater risk for the broker/dealer. For example, a close-to-ideal situation for a broker/dealer would be to execute two offsetting trades simultaneously, such as buying shares from a client who wants to sell out of a position and immediately selling those shares to another client who wants to buy them. However, in a block trade where the investment bank buys a large chunk of shares from a selling shareholder, those shares would sit on the investment bank’s balance sheet while it looks for investors to buy them. In the time that the shares are on the investment bank’s balance sheet, the value of the shares could decrease and produce a loss on that block trade.

Even high revenue and operating margins in institutional trading do not necessarily indicate an economic moat that generates excess returns on capital. For a couple of global investment banks with USD billions in institutional trading revenue and operating margins that can be 10 percentage points higher than smaller investment banks, they can have returns on capital that are volatile and in the high-single digits to low-double digits, which is not significantly different from the cost of capital needed to support the business. Broker/dealers often have to hold an inventory of financial instruments on their balance sheet to facilitate client transactions, such as fixed-income securities. Financial regulators have increased the amount of generally more-expensive capital, such as shareholders' equity or long-dated corporate bonds, that are used to fund the inventory of financial instruments at large banks with trading operations to reduce their solvency risk and liquidity risk. So, even if the revenue and operating margins of an investment bank’s institutional trading business are high, returns on capital can be low, which signals the lack of a moat that generates excess economic returns.

Insurance Segment Is a No-Moat Business

We don’t view Royal Bank of Canada’s insurance business as having a moat, which is around 5% of total RBC’s earnings. Of its insurance revenue, around 55% is from Canada and the remaining 45% is from international markets (mostly reinsurance). In general, insurers do not benefit from favorable competitive positions. Customers generally won’t pay a sizable premium for brand, and products are highly replicable, making cost structure the key differentiator. Insurers often do not know their cost of goods sold for a number of years, allowing them to potentially underprice policies without knowing it. Firms have an incentive to chase growth at the expense of long-term profitability and can be forced to match low prices or risk losing business. Of the main insurance segments, we view life insurance as less moaty than property-casualty insurance. It is more difficult for life insurers to differentiate themselves in underwriting, as mortality rates are relatively predictable and life insurers are more exposed to capital market conditions.

RBC's worldwide scope in capital markets and wealth management provides a powerful and diversified stream of revenue. This should lead to outsize fee income versus peers.

RBC's execution in deepening client relationships and cross-selling in the Canadian banking business can improve its return profile even higher.

The acquisition of HSBC Bank Canada has strengthened RBC's position in Canada, more revenue synergies from this acquisition could boost RBC's return profile.

The bank has one of the larger exposures to the Canadian housing market, and as the Canadian consumer's ability to borrow becomes constrained, RBC may struggle to achieve loan and revenue growth and incur additional credit risk.

If tariffs are implemented for a prolonged period, the Canadian economy could enter a recession and make the bank see lower growth and higher credit costs.

The bank's US commercial banking business, City National Bank, remains a drag on overall bank returns despite some improvement in the efficiency ratio.