Royal Bank of Canada (RY 0.99%), more commonly known by the acronym RBC, has a dividend yield of 3.8%. The yield has been higher in the past, notably during recessions, but it's still toward the high side of the historical range. There's a good reason for the lofty yield, but also a good reason to buy the stock anyway.
Nothing fancy about RBC
On the whole, RBC is a fairly simple business. As a bank, it takes in deposits and uses that cash to make loans. The bank makes the difference between what it pays for deposits and what it charges for loans. It has other businesses, but this is the core of the story, even if it is a purposely simplified view.
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The stock is down around 15% from its highs in early 2022, pushing the yield up to the current 3.8%. Nothing out of the ordinary happened at all, and there is a very logical reason for the price drop. Investors are worried about a recession. The precipitant for that is the move by central banks in the United States and Canada toward higher interest rates to combat elevated inflation. That's both good and bad.
On the one hand, higher interest rates allow RBC to charge more for loans. On the other hand, if rates get pushed too high, it can lead to reduced demand for loans, which are primarily made up of mortgages. And worse, if the rate hikes cause a recession, RBC might have to deal with an increased number of defaults on the loans it has in its portfolio. Fearing the worst, investors appear to be erring on the side of caution.
That's neither shocking nor illogical. However, it is more of a short-term view of things than a long-term view. History suggests that a recession will eventually be followed by a return to economic growth and, thus, better times for RBC.
Prepared for the hit
So, if you are a long-term-oriented dividend investor, the real question to ask is whether or not RBC can muddle through the tough times so it can benefit from the good times. There are a couple of reasons to believe that it can.
For starters, RBC, as its name clearly states, is based in Canada. The Canadian banking system is highly regulated. This created a situation in which the largest banks, which includes RBC, have entrenched positions. Simply put, RBC has a solid foundational business that is highly unlikely to be permanently impaired by even a deep economic downturn. For evidence of this, unlike some of the largest U.S. banks, RBC didn't cut its dividend during the Great Recession.
The strict banking regulation in Canada also created something of a conservative ethos throughout the country's banking industry. RBC is no exception, but that safety-first mentality isn't confined to its Canadian operations. RBC is generally fiscally conservative throughout all it does. So even the company's expansion into the U.S. market is undertaken with a bias toward reducing risk as much as possible. So RBC has a solid foundation and conservative operations.
The kicker today is that the bank's Tier 1 Capital Ratio, a measure of how well prepared a bank is for adversity, sits at a solid 12.6%. Higher numbers are better on this metric. For reference, U.S. banking giant Bank of America (BAC 3.35%) has a Tier 1 Ratio of 11.2%. To be fair, there are other banks with higher Tier 1 ratios, but RBC is still very well positioned to deal with any economic headwinds it may face.
RBC is a solid option
To continue the above comparison, Bank of America's dividend yield is 2.6%. So RBC is yielding more than a percentage point more even though it appears to be better positioned to handle an economic downturn. And then add the fact that RBC didn't cut its dividend during the last deep downturn, which is something that Bank of America had to do. If you are an investor that thinks in decades, Royal Bank of Canada is worth a deep dive even as the industry faces the risk of a recession.
