RBC loses its luster as investors make TD Canada's premium bank

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Royal Bank's pain is TD's gain.

Shares of Royal Bank of Canada are losing ground to its biggest rival, Toronto-Dominion Bank, which rose to a record on Wednesday. Toronto-Dominion's returns more than doubled its Canadian competitor in the past year, eliminating the premium Royal Bank shares enjoyed for the better part of a decade.

"The pendulum has swung a bit more negative on Royal Bank," John Aiken, an analyst with Barclays, said in an interview. "There's no one definitive thing that says Royal's outlook is now being tarnished relative to TD's. It just looks like we're getting a shifting preference in the marketplace."

Royal Bank's stock valuation, measured by share price to tangible book value, has tended to carry a premium over other Canadian banks for the past decade. Toronto-Dominion did hold a higher valuation from the early 2000s up until the financial crisis — a period when it was buying U.S. banks. Since November 2012 it's been all RBC, until the past month.

Toronto-Dominion shares have surged 18 percent in the past 12 months while Royal Bank gained 7.1 percent. The eight-company S&P/TSX Commercial Banks Index rose 8.8 percent in the period. Royal Bank closed at C$100.44 in regular Toronto trading on Wednesday, while Toronto-Dominion hit a record C$76.74.

"Our strong performance is reflective of a consistent customer-focused strategy," Toronto-Dominion spokeswoman Alison Ford said in an emailed statement. "We continue to focus on investing in our transformation to deliver for our customers."

Royal Bank declined to comment on the relative stock performance and change in premium.

"It's just investors going to TD for the bigger U.S. exposure, not necessarily something against Royal," said Steve Belisle, a Montreal-based portfolio manager with Manulife Asset Management who helps oversee about C$7 billion ($5.3 billion) including banks.

Canada's two largest lenders dominate domestic banking, but differ in their strategies abroad. Royal Bank's U.S. strength lies with its capital-markets division based in New York and a wealth-management operation that houses City National, a private and commercial lender dubbed Hollywood's "bank to the stars." Toronto-Dominion bet on U.S. retail banking starting in 2005, spending $17 billion on takeovers to assemble a branch network from Maine to Florida.

Royal Bank's shares took a hit following its second-quarter earnings report on May 24, and fell for five straight days, even as profit exceeded analysts' estimates. Canaccord Genuity analyst Scott Chan called the earnings a "lower-quality beat." While they have since rebounded, shares remain below the record close of C$108.05 set Jan. 22.

"Usually when RBC beats by a lot it's because of the capital markets," Belisle said. "So far this year, it hasn't been a very strong year."

Eight analyst rate Royal Bank shares a buy, while another eight rate it a hold and two, including Aiken, say the stock is a sell. Aiken sees the stock's valuation as too high relative to its growth prospects. Twelve analysts rate Toronto-Dominion a buy, with four calling the stock a hold and one a sell.

Royal Bank's operations leave little to complain about, according to Aiken, though investors may feel that TD is a better bet on its U.S. strategy — especially following last month's earnings reports.

"You look at the resurgence of TD and we've seen some strength in their U.S. operations, which will always get people excited," Aiken said. "The market believes that TD's growth in the U.S. should be stronger over the next little while than at Royal."

Royal Bank may be getting penalized on its domestic strengths. As Canada's largest mortgage lender, it has a 16 percent market share when the nation's housing market is cooling and debt-laden consumers are starting to pare back borrowing.

At a June 13 investor day, Royal Bank sought to publicize new digital products and other innovations. Chief Executive Officer David McKay lamented that the firm isn't convincing as many Canadians as he'd like to switch banks.

"We've built an incredible franchise over time with all this sales power, yet we're frustrated," McKay said. "We're No. 1, the customer tells us we're No. 1, experts like Retail Banker say we're No. 1 in the world — yet we don't think enough Canadians are using our services."

As a further indignity, TD once again stole the crown of Canada's biggest bank by assets — a rank Royal Bank has held for most of the past century. Royal Bank is still larger by market value, though even that lead is shrinking.

For Manulife's Belisle, those are of little consequence — but he sees opportunity with the premium switch.

"It makes quite a bit of sense to shift some money potentially from TD into Royal just for the valuation gap," Belisle said.

Bank executives can find it hard to turn the tide on sentiment over the near term, but those who do things right eventually get credit, Barclays' Aiken said.

"You cannot scream from the hilltops and say, 'We are better than everybody else, why are we not trading at the best multiple?' — that just does not happen," Aiken said. "But if you run your businesses better than everybody else, ultimately you will be rewarded."

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