Royal Bank of Canada has given City National a lifeline, but the U.S. bank’s future remains uncertain

Royal Bank of Canada moved to prop up City National Bank on Friday as its Los Angeles-based subsidiary continues to struggle under the weight of the U.S. regional banking crisis.

RBC said it injected an undisclosed amount of capital into City National and transferred some of the American bank’s debt holdings to the Canadian parent. The goal of those transactions, RBC said in a statement, is to stabilize City National’s balance sheet and improve its profit margins after the U.S. bank posted a US$38-million net loss in its most recent quarter.

“Royal is basically right-sizing the business,” Keefe, Bruyette & Woods analyst Mike Rizvanovic said in an interview. “What happens here is City National reports a loss, but Royal doesn’t actually report a loss because they are not going to sell those securities. They will just hold them on their balance sheet.”

The lifeline from RBC could be considered an “internal bailout,” Mr. Rizvanovic said, and it should help City National maintain its operations for the time being. But he stressed that the cash injection and asset transfer to RBC would only be temporary solutions.

“This is indicative of a very tough environment for City National,” he said. “Things could easily get even worse.”

“If interest rates are going to be higher for longer, as everybody seems to be saying they will be, then that is a very challenging situation for City National,” Mr. Rizvanovic said.

The collapse of Silicon Valley Bank, Signature Bank and First Republic Bank earlier this year laid bare the risks facing mid-sized U.S. banks in a higher interest-rate environment. Many of their assets consist of low-interest loans and bonds. Research from Northwestern University’s Kellogg School of Management estimates that up to 186 U.S. regional banks remain at risk of insolvency, as the shrinking value of their assets raises the odds of depositors withdrawing their holdings en masse in a bank run.

“It is not like City National has lost all of its deposits, and it is not suggestive of a deposit run, per se,” Mr. Rizvanovic said. “If they keep losing those deposits and the funding side keeps getting more challenged then it is harder to lend.”

Since being acquired by RBC for US$5.4-billion in cash and stock in 2015, City National has tripled its total assets to US$96.1-billion from US$32-billion as of July 31, 2023. It has also, however, faced increasing scrutiny.

In January, the U.S. Justice Department fined City National US$31-million for discriminating against predominately Black and Latino communities in its mortgage underwriting business. The fine represents the largest-ever penalty issued in relation to a practice known as “redlining,” which refers to companies drawing symbolic red lines on maps around communities where they refuse to offer services “because of race, colour or national origin of the residents of those communities,” according to a Justice Department definition.

RBC chief executive officer Dave McKay tried to pro-actively address concerns about City National’s balance sheet during an Aug. 24 conference call with analysts held to discuss his bank’s third-quarter results.

In his prepared remarks, Mr. McKay said “a higher cost of doing business is reducing the profitability for U.S. regional banks” and “City National is not immune to these factors.” But analysts were skeptical.

“When you look at City National, the business isn’t profitable any more,” TD Securities analyst Mario Mendonca said during the question-and-answer portion of that call. “It seems as though the issues are much bigger than can be addressed by an incremental move on expenses.”

In his response, Mr. McKay acknowledged that “everything went against us this quarter with City National,” and that the business “is well below our expectations for this year.”

Two weeks later, at the Sept. 6 Scotiabank Financials Summit, Mr. McKay struck a more optimistic tone.

“We thought we’d have a record year in City National this year, and everything got turned upside down,” he said. “But you’ll see it start to stabilize in Q4 and improve next year and we still see enormous opportunity for the City National franchise.”