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Analysts shrug at RBC downgrade

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Royal Bank’s (RY-T) reputation took a hit this week after it was the only Canadian bank to be downgraded by ratings agency Moody’s Investors Service. But, analysts responded to the downgrade with a shrug, saying it will have little impact on the bank’s operations.

“While the downgrade is larger than expected, our view on Royal Bank remains unchanged,” Peter Routledge, National Bank analyst, said in a note to clients. “It has a premier domestic franchise and strong risk management. Over the long-term we expect the bank to deliver attractive returns to shareholders.”

Routledge has a “sector perform” rating on the stock and a $60 price target.

Late Thursday, Moody’s lowered Royal Bank's long-term deposit rating two notches to Aa3 from Aa1. This was a part of a larger downgrade of 15 international banks with large capital markets operations.

The downgrade makes RBC the lowest-rated bank among Canada’s big six -- one notch below Bank of Montreal, CIBC and National Bank and two notches below Bank of Nova Scotia and Toronto Dominion. In the mid 2000s, RBC was the highest-rated bank in Canada.

But, analysts say the move will have little impact on RBC’s borrowing costs -- which typically increase as your credit rating goes lower -- and will also not impair earnings.

Many analysts also said RBC’s strong domestic business should help shield it from global uncertainty.

“We are surprised Moody’s proceeded with a two-notch downgrade given RBC’s diversified business model, solid Canadian franchise (#1 or #2 in all major segments), strong risk management (Capital Markets always remained positive throughout the financial crisis) and capital…and uninterrupted access to funding,” says BMO’s George Lazarevski. “We believe the rating action should not have a material impact on the bank’s funding costs given the deposit note and sub debt ratings are in line with S&P.”

Routledge from National Bank maintains that the ratings agency is ignoring the strong performance of RBC throughout the financial crisis.

“The paucity of capital markets related losses throughout the financial crisis of 2007-2009 stands as the most striking aspect of Royal Bank’s relative performance during that period,” he says. “Not only did Royal Bank avoid quarterly cash losses overall, but its wholesale bank…did not suffer a single quarterly net loss in that era or afterwards.”

And in a strange twist on the downgrade, RBC actually comes out as one of the stronger banks with large capital markets operations.

“Royal Bank was positioned among Moody's ‘first group’ of institutions, along with HSBC and JPMorgan,” Scotiabank’s Kevin Choquette says. “Moody's indicated that capital markets operations are significant for institutions in the first group; however, they have stronger buffers than many of their peers, including earnings from other, more stable businesses, strong risk management practices that lowered earnings volatility during the financial crisis, and their direct exposure to stressed European sovereigns and financial institutions is contained.”

He has a “sector outperform” rating and $68 price target on Royal Bank.

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