All participants, please stand by. Your conference is ready to begin. Good morning, ladies and gentlemen. Welcome to RBC's second quarter 2019 financial results conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Nadine Ahn, Head of Investor Relations. Please go ahead, Ms. Ahn.
Thank you, thanks for joining us. Speaking today will be Dave McKay, President and Chief Executive Officer, Rod Bolger, Chief Financial Officer, and Graeme Hepworth, Chief Risk Officer. We'll open the call for questions. To give everyone a chance to ask a question, we ask that you limit your questions and then queue. We also have with us in the room Neil McLaughlin, Group Head of Personal and Commercial Banking, Doug Guzman, Group Head, Wealth Management and Insurance, and Doug McGregor, Group Head, Capital Markets and Investor & Treasury Services. As noted on slide one, our comments may contain forward-looking statements which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially. With that, I'll turn it over to Dave.
Thanks, Nadine, good morning, everyone. Thanks for joining us. We delivered a solid second quarter. We earned CAD 3.2 billion, up 6% from last year. EPS was up 7%. We achieved continued growth in our core businesses, where we have been investing to create more value for our clients and our shareholders. As we grow our client franchises, we're focused on maintaining a premium ROE. Our ROE of 17.5% this quarter continues to exceed our medium-term objective. We ended the quarter with a robust CET1 ratio of 11.8%. This provides flexibility to fund organic growth opportunities and to return capital to our shareholders. Our results were supported by strong underlying economic fundamentals in our core markets. Though GDP softened the last couple of quarters, the Canadian economy remains resilient, and the unemployment rate is hovering near four-decade lows.
Regulatory changes have helped some of Canada's major housing markets stabilize, particularly in Ontario and to the east. Western Canadian markets remain under downward pressure, overall, making housing more affordable. In the U.S., we saw strong GDP growth and record low unemployment levels. Trade tariffs are expected to temper GDP growth. However, the underlying fundamentals of consumer spending and business investment remain favorable. Against this backdrop, we delivered solid volume growth and continued to increase our market share with the investments we've made across multiple business lines. In the first half of the year, we continued to invest, especially in client-facing talent and technology. In the latter half of the year, we expect to slow expense growth to drive better operating leverage. While there continues to be market and economic uncertainty, I remain confident in the diversity of our business mix and our focused growth strategy.
This quarter, we saw a PCL on a few accounts in our commercial book. While elevated from historical lows last year, we do not see this as a systemic trend. Our investments and our commitment to helping clients thrive and communities prosper have helped RBC maintain the number one brand in Canada. This year, we're the only Canadian company recognized in the top 100 global brands, an accomplishment we are very proud of. Turning to our business segments. In Canadian Banking, we saw increased market share and strong volume growth across a number of businesses. Higher revenue was driven by the strong execution of our growth strategy and the benefit of investments we made across our multi-channel distribution network, including our client-facing sales force and mobile banking platform. Business Banking saw strong deposit growth and client acquisition as a result of our highly engaged sales force.
Commercial growth remains strong and diversified across sectors, including commercial mortgages. Card volumes were also strong, and we're pleased to be recognized for our cards and reward platform with Best Loyalty Rewards Strategy at the Retail Banker International Global Awards. Our mortgage business also performed well, generating solid volume growth of 5% year-over-year in what continues to be a very competitive environment. We continue to innovate and create more value for our clients through a number of new digital offerings, including personalized AI-powered budgeting insights through NOMI. Turning to Wealth Management, we had strong earnings growth as the markets gained momentum and flows increased. We built on our leading position in Canadian Wealth Management, attracting new investment advisors, and leveraged our technology and investment performance to strengthen relationships and grow our clients.
Once again, RBC Dominion Securities was named the number one brokerage firm in Canada in the 2019 Investment Executive Brokerage Report Card. We continue to see strong AUM growth in Global Asset Management and industry-leading performance. 82% of our funds beat their benchmark on a three-year basis. This quarter, we expanded our alternative asset offerings by launching the RBC Canadian Core Real Estate Fund through an innovative partnership with BCI. Our U.S. Wealth Management franchise continues to perform well as we execute on our growth strategy in the U.S. Both U.S. Wealth AUA and AUM were up double digits as our U.S. Private Client Group continued to see great advisor recruitment. City National had yet another quarter of double-digit loan growth. Our results reflect the success of our organic expansion strategy, driven in part by attracting top talent from across multiple industries and geographies.
While our insurance results were down year-over-year, we still expect to see earnings growth for the full year. We continue to introduce innovative approaches to drive better outcomes for the increasing number of disability clients who are also facing mental illness. Through our exclusive Onward by Best Doctors program, we are better assisting clients by expediting their recovery through virtual access to healthcare experts. We are also exploring expansion of our virtual care programs to provide to more people who may be facing mental health challenges while still actively at work. Our Investor and Treasury Services business faced revenue headwinds in light of secular trends in the asset services industry. Our cost structure continues to improve through investments in technology initiatives, which are streamlining processes and creating efficiencies. Our Capital Markets business delivered record earnings this quarter.
Our fixed income and currency business and equities businesses generated strong revenue in both primary and secondary trading as we saw markets recover from challenging conditions last quarter. While our corporate banking and investment banking revenues were relatively flat this quarter, we saw strong market share gains despite lower industry-wide fee pools. This highlights both the strength and resiliency of our franchise, as well as strong relationships with our clients through the cycle. In April, we issued our first green bond to fund a portfolio of new and existing businesses and projects that promote sustainability and the transition to a low-carbon economy. This transaction follows a series of environmental milestones at RBC, including our commitment to provide CAD 100 billion in sustainable financing by 2025.
In conclusion, our results over the first half of the fiscal year are testament to the strength of our diversified business and our disciplined strategy to grow our client franchises and deliver long-term value to shareholders. I would also like to comment on the floods in Eastern Canada. The difficult situation in Eastern Canada is impacting many families and communities. RBC remains committed to helping those affected by the floods, and we have launched a financial relief program to assist our clients and are proud to support the Red Cross, first responders, and volunteers in support of local relief efforts. Now I'll turn it over to Rod to discuss our financial results.
Thanks, Dave, and good morning, everyone. Starting on slide five, we had strong second-quarter earnings of CAD 3.2 billion, the second highest on record. Earnings were up 6% from last year, and diluted EPS of CAD 2.20 was up 7%. Before I discuss segment-level performance, I want to start with some perspective on key enterprise-wide performance drivers, and I'll start with cost management. Pre-provision, pre-tax earnings were up 7% year-over-year, even after absorbing an elevated expense growth of 8% as we continue to invest to create more value for our clients. A third of this expense growth was driven by higher variable compensation on improved results. Another third was related to investments to drive business growth in the form of additional sales force, distribution, transformational technology, and marketing spend.
While we remain confident in our client-focused growth strategy highlighted at our Investor Day last year, we are always mindful of risks to the macroeconomic environment. We will continue to manage our costs based on the revenue outlook and expect expense growth to slow to the low single digits in the second half of the year. We believe our scale and discipline positions us well to pull levers and prioritize discretionary projects if necessary. However, we will always balance any tactical cost measures with our commitment to creating long-term value for our clients and shareholders. Next, on taxes. Our effective tax rate of 19% was down from last year. Given our outlook for business mix, we expect our total effective tax rate to be in the 20%-22% range over the second half of the year.
Given our continued double-digit earnings growth in the U.S., we would expect our structural tax rate to increase modestly over the next year or so, given the relatively higher tax rate in the U.S. compared to other lower tax rate jurisdictions. I will talk about capital next on slide six. Our strong earnings allowed us to generate over 30 basis points of internally generated capital, while also distributing CAD 1.5 billion in common dividends to our shareholders this quarter. Credit risk, RWA, was up only 1% from last quarter, as client-driven growth in Canadian banking and City National were offset by runoffs in underwriting transactions. Market risk was down over CAD 3 billion quarter-over-quarter, largely due to lower fixed income inventory in capital markets and I&TS.
Going forward, we expect the effect of IFRS 16 and revisions to the securitization framework to impact our CET1 ratio in Q1 of 2020. Given our premium ROE, we expect to absorb this impact with less than one-quarter of retained earnings. As Dave noted, we remain well-positioned to fund organic growth opportunities and to return capital to our shareholders. Moving on to our business segment performance on slide seven. Personal and Commercial Banking reported earnings of over CAD 1.5 billion. Canadian banking net income of over CAD 1.4 billion was up 2% from a year ago, as 7% pre-provision earnings growth was partially offset by higher PCL on select commercial accounts. Strong volume growth was the largest contributor to the year-over-year increase in net interest income, driving over two-thirds of the growth, outpacing the benefit from higher interest rates.
Our strong growing deposit base, as well as solid loan growth, should continue to be the main driver of higher net interest income going forward. Deposit growth was strong, up 9% across both business and personal accounts. Put another way, we added over CAD 30 billion of deposits over the last 12 months. Given market volatility and higher interest rates, we saw double-digit growth in term GICs as our retail clients shifted into higher-yielding savings products. We also saw solid middle single-digit growth in non-interest-bearing personal deposit accounts as Canadians continue to choose RBC as their primary bank. Net interest margin was up six basis points from last year and one basis point from last quarter, largely driven by higher deposit spreads. Given the outlook for interest rates, we expect NIM to remain relatively flat over the next several quarters.
Operating leverage in Canadian banking was 1.7% this quarter as we continue to invest in client-facing staff, technology, and marketing to drive sustained business and client growth. Going forward, we expect operating leverage to be in the 2%-3% range, subject to volatility between quarters, as we slow the rate of expense growth. Turning to slide eight, wealth management earnings of CAD 585 million were up 9% from last year. Revenue, AUA, and AUM were up double digits year-over-year as North American equity and bond markets rebounded from challenging market conditions in Q1. While the majority of industry players are reporting net redemptions, RBC Global Asset Management generated mutual fund net sales of CAD 6 billion with over CAD 2.5 billion from individual investors. The majority of our retail flows were in long-term fixed income and balanced solutions as we continue to support clients through uncertain times.
Our industry-leading net sales resulted in our all-in Canadian retail market share increase to 15.5%, up 40 basis points from a year ago. Adding to our strong growth, our non-U.S. wealth management efficiency ratio improved 80 basis points year-over-year. In U.S. wealth management, earnings were up 8% year-over-year in U.S. dollars as strong growth in our U.S. private client group more than offset higher PCL at City National. City National continued to generate strong growth in net interest income, up 14% year-over-year. In U.S. dollars, City National pre-tax, pre-provision earnings were up 10% year-over-year. With deposit competition remaining intense, we utilized select wholesale funding this quarter to meet increasing client demand, resulting in margin compression quarter-over-quarter. We remain confident that our wide range of deposit initiatives will enable us to support strong, prudent loan growth at City National.
Furthermore, recoveries on legacy loans that we guided to last quarter were delayed and should now provide a boost to margins in Q3. We maintain our guidance from last quarter and expect City National NIM to be range-bound from year-to-date levels, assuming no rate cuts for the rest of the year. Moving on to insurance on slide nine, net income of CAD 154 million was lower as last year benefited from more favorable investment-related experience driven by new investment strategies. This quarter also had higher disability and life retrocession claims costs. We expect some quarterly volatility from the timing of longevity reinsurance sales. Over the last three years, approximately 60% of RBC insurance earnings have been earned in the second half of the year, given annual actuarial updates generally take place in Q4. We also expect to keep expenses well controlled.
We highlight Investor & Treasury Services results on slide 10. Earnings of CAD 151 million were down from strong results in the first half of 2018. Funding and liquidity revenue was down largely due to the impact of lower mark-to-market gains from lower short-term interest rates. In addition, the prior year also benefited from higher realized gains from the disposition of certain securities. Lower client activity, as seen across the industry, negatively impacted our asset services business, particularly in our global foreign exchange market execution services. We kept expenses fairly flat to last year and, going forward, we expect expense growth to remain modest in this segment. Turning to Capital Markets on slide 11, the segment generated record net income of CAD 776 million, up 17% from last year, benefiting from both strong revenue growth and a lower effective tax rate.
Global markets revenue was up 13% year-over-year, largely driven by strong fixed income trading revenue. Credit trading was higher with improved client activity reflecting more favorable market conditions, including the narrowing of credit spreads. Our equities trading businesses also performed well, largely from momentum in equity derivatives and deeper client engagement. Corporate Investment Banking revenue remained flat despite lower global fee pools. Constructive market conditions, including narrowing credit spreads, benefited both debt and equity origination. Looking forward, while we closed on some headline deals this quarter, our pipeline remains strong in the upcoming quarters. Overall, we are pleased with our performance against our financial objectives. We continue to execute on the strategy that we outlined at last year's Investor Day, namely delivering more value to our clients while driving premium growth in a prudent manner. With that, I'll turn it over to Graeme.
Thank you, Rod, good morning, everyone. Starting on slide 13, our total PCL on loans was CAD 441 million this quarter, equivalent to 29 basis points, which was comprised of CAD 435 million in provisions on impaired loans, as well as CAD 6 million in provisions on performing loans. PCL on impaired loans increased by CAD 12 million from last quarter, mainly due to higher provisions in Commercial Banking, which were partly offset by lower provisions in Capital Markets. PCL on performing loans decreased by CAD 87 million from last quarter. Here, provisions necessary to support volume growth were more than offset by the impact of more favorable macroeconomic variables such as equity markets, oil prices, as well as interest rates and unemployment rates relative to Q1. I'd now like to provide some color on three businesses, starting with Canadian Banking.
PCL on impaired loans of CAD 363 million increased seven basis points from last quarter, largely due to losses associated with two borrowers in our commercial lending portfolio, one in the public works and infrastructure sector and the other in the information technology sector. In Wealth Management, PCL on impaired loans increased by CAD 6 million from last quarter, mainly due to higher provisions on a couple of accounts at City National. In Capital Markets, PCL on impaired loans decreased by CAD 54 million, as we had a large provision on one account in the utility sector in Q1. Turning to slide 14, gross impaired loans increased to CAD 3 billion, up three basis points from last quarter, largely due to new formations, which were partially offset by a number of impaired loan sales.
Most notably this quarter, we saw an elevated level of new formations in the oil and gas sector, mainly in the U.S. While headline oil prices have strengthened in recent months, there are still critical headwinds impacting a number of our clients. These include weakened financial situations persisting from the 2015 downturn and continued low natural gas prices. Impaired loans in this sector continue to be well-structured, with our seniority and collateral providing us good protection against loan losses. Despite the elevated level of impairments, we believe we are adequately provisioned. We do not expect new oil and gas formations to persist at this level going forward. Aside from oil and gas, new impairments and loan losses in our wholesale portfolios have been relatively limited in number and widely dispersed across geographies and sectors.
Turning to slide 16, our Canadian retail portfolios were generally stable both in terms of provisions and new formations this quarter, with the exception of our cards portfolio, where seasonal factors led to higher provisions in the quarter. Overall, the performance of our retail portfolios is as expected, and we anticipate performance will remain so for the remainder of the year. In closing, we continue to be well-disciplined in our loan underwriting process and are comfortable with the credit profile of our portfolios. While we have seen elevated levels of impairments and provisions in our wholesale portfolios relative to the exceptionally low levels experienced in 2018, we do not see that as indicative of a material credit trend.
As we look to the remainder of the year, we expect our total PCL ratio, including both impaired and performing loans, to continue to be in the 25 to 30 basis point range based on the current macroeconomic environment. We do expect to see some quarter-over-quarter variability in our provisions. With that, operator, let's open the lines for Q&A.
Thank you. We will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions. We thank you for your patience. Our first question is from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead.
Thank you. Good morning. I guess, I had a two-part question for Rod on expense and operating leverage. One, I heard you in terms of expense growth slowing down in the back half. Was wondering if you could put some numbers around that. We see first half expense growth of about 6.5%. I was just wondering, does low single digits mean more like 1%-2%? Secondly, in an environment where revenue growth could probably slow to low single digits next year, can you talk about additional potential to reduce expenses? Could we have a period where expense growth could be flat or lower in a low single-digit revenue environment? Thank you.
Sure. Thanks, Ebrahim. Thanks for that. As I mentioned, the low single-digit expense growth, as I mentioned, a third of our growth or a little more than a third of our growth this quarter was on variable compensation. That does accommodate slightly lower revenue growth going forward than the 9% that we were able to achieve this quarter. If our revenue growth does go back to that 9%, you'd see us more towards that mid-single-digit growth. Otherwise, low single digits is somewhere in the 1%-4% range, all else being equal. Your question in terms of the slowing revenue growth, absolutely.
Operating leverage does scale to revenue growth typically on a longer-term or medium-term basis. If we just go back to 2016, when we acquired City National, if you strip out City National, you may recall that we had revenue growth of only 1% across the rest of the business that year, and we were able to decrease expenses by 1% in that year. That was a period where we did see the slower revenue growth, and we were able to curtail the expense growth. We have been investing. We have been investing for the future. We have been investing in our talent. We have been investing in our technology, in our marketing, in our clients, and in solutions for clients. Our growth is at an elevated level, so the rate of growth should come down.
Crystal clear. Thank you so much.
Thank you. Our following question is from Meny Grauman from Cormark Securities. Please go ahead.
Hi, good morning. Also on the expense side, interested in you expanding a little bit on what you mentioned in terms of not wanting to trade off long-term investment needs for shorter-term considerations. Just wondering, is it becoming tougher to manage that, to invest what you need in the business, and make sure that you have the expense control that you need in a slowing revenue environment? Is that becoming tougher? Are there any practical implications to that statement that you made?
Meny, maybe I'll start. I'll hand it to Rod. Certainly, as you've heard us comment over a number of quarters that we plan on a number of factors. We felt that over the last couple of years, we've gotten ahead of the curve on a number of large program technology investments. You've seen the announcements we've made in the retail bank, on our mobile platform, on our back office capabilities. You've seen us invest in capital markets and trading platforms and in I&TS. We felt, as you heard us say, that we timed a lot of our large investments to the revenue tailwinds that we've had from interest rate increases and strong economy, and we've been planning for an environment where things slow, as you would expect in a normal economic cycle.
We have a number of programs that we're working on that we feel we can slow investments without sacrificing the good work that we've done. We feel that we're well positioned, and that's been consistent with our strategy for an extended period of time, and we feel we're in a good position.
Just as a follow-up, in terms of the guidance of slowing expense growth in the second half, if you take that forward, that kind of slowdown, is that sustainable over a longer-term period, or is that really based on an assumption that things will normalize on the revenue side of the equation in a year or in two years? Is there a time limit here where it does become tougher again to keep that expense growth slow?
Given the size of our organization, this is where scale really plays to our strength. We have significant scale. We have a significant ability to absorb, whether it's an AML program or regulatory requirements or building out a client-facing platform. Our scale allows us to invest simultaneously across a number of platforms. Again, back to my previous comment, we've been doing this for a number of years. We knew we had strong economic winds behind us. We are planning to manage in a number of different economic environments. If we're continued positive economic growth in the market, we're prepared to balance our revenue expense growth. If we see slower volume growth and slower revenue growth as we hit a cycle, we have plans to manage, as Rod mentioned, in that type of cycle too, knowing how much we've invested already.
We feel given our scale and our historic investments, we're well positioned to manage that.
Thank you.
Thank you. Our following question is from Gabriel Dechaine from National Bank Financial. Please go ahead.
Good morning. I want to talk about ITS first and just take a crack at understanding the revenue trend there, where NII has been negative for the past couple of quarters. You talked about funding its cost. Just wondering if there's anything in the balance sheet mix of that business that's maybe detracted from profit growth there. I see the deposit growth has been, in dollar terms, much larger than the asset growth over the past couple of years.
Yeah, it's Doug McGregor. The issue with that part of the business, the treasury services part of the business is we were getting much better spreads on our high-quality liquid asset portfolio. That portfolio invests in Europe and Canada, and it has to invest in sovereign and sovereign agency securities, and the spreads have really come off in the last couple of years. It's really about what we can earn on the liquidity book that we hold for the bank in various places.
Presumably that liquidity helps you in other areas of the bank.
Well, it's necessary, it was just that we were earning twice the spread on that book a couple of years ago than we are now, we've kind of positioned ourselves short I guess reasonably conservatively in anticipation we'll get another opportunity to earn more on that book going forward.
It's Rod. I'll jump in on your comment on the net interest income because that's a function, unfortunately, of the accounting where our cash desk does a series of transactions a U.S. dollar, then swaps into other currencies. Unfortunately, the payments that go out are booked into net interest income, then the revenue that comes in from the hedging is in the other revenue line, which is what you'll see when you notice that that dropped off after Q2. That activity increased given our position in the marketplace. So you would've seen a corresponding increase in that other line and a decrease in the net interest income line, specifically in I&TS. That also impacts our all-in bank NIM, which is why that appeared to start going down starting in Q3 of last year because of that structural change from the accounting.
Okay. Well, back to Doug, the trading, Rod had talked about trading and credit being a driver of the fixed income results that we saw. How much of an influence was the improved dynamics in the high yield market this quarter? If you have any thoughts on the Fed's recent statements on the high yield market and raising some concerns of how you're positioned versus what they're worried about.
Well, there has been a very active high yield new issuance business over the last couple of months, in particular. I think as investors saw term interest rates back off and anticipated they would come down, they were buying fixed income products. There was some money moving out of the loan market into high yield. We've been active as a book runner in a number of high yield deals. That has helped. I think really, credit products, including investment grade, leverage loans, high yield, all improved dramatically in the second quarter, and we participated. I would say fixed income credit is a business that we really work to be continuously better and better in. I think that's where the opportunity is, in fact. I think it's paying off. I think we did a good job.
In terms of our participation in high yield, it's really around just doing new issues. Our participation in leveraged finance, which I think is what the Fed is more concerned about.
Oh, yeah.
we would be a ninth or tenth market player. We've been quite consistent in terms of our underwriting risk right through the cycle. We're very comfortable with it.
Thank you.
Thank you. Our following question is from John Aiken from Barclays. Please go ahead.
Good morning. A couple of quick questions on the domestic residential mortgage growth, if I may. Was there any geographies that provided outsized growth, or was it basically the inflows were pretty much in line with the current portfolio as it stands?
Thanks, John. It's Neil McLaughlin. Across the book, we would say Ontario is leading the way. Softer out west, both in Alberta and the Prairies. Quebec is a little bit slower. Everything else is kind of about the average.
Thanks, Neil. How would you characterize the competition in the quarter, and how did it change? I guess one of the things is that the growth that you received on the residential mortgage side was a little bit higher than I had anticipated.
Yeah. We always would say the competition's quite fierce this time of year. We were really getting into the heavy spring market. I think we do expect we will compare well versus some of our competitors. We made some changes in the business, both in terms of operational efficiencies, getting back to customers more quickly, just being more competitive on price. There has been a fragmentation in the market that we needed to adjust to. Then I'd say the last part is, we mentioned in a couple of calls, we made some changes last year, both in terms of process as well as a new digital tool. That's really helped our retention, and we're seeing all-time highs in terms of the retention of the mortgage book. It's all coming together to give us a little bit of premium growth.
Great. Thank you. I'll recue.
Thank you. Our following question is from Steve Theriault from Eight Capital. Please go ahead.
Thanks very much. If I could start on City National. Rod, you talked a bit about the margin. We were surprised to see it go down after what we talked about last quarter, but it sounds like there's a delay there. You also mentioned unexpected wholesale funding. Can you give us a bit more detail around that? Was that just around stronger loan growth, or was it around, I see the deposit balances were down in the quarter. Did you just have to maybe use some short-term wholesale funding? Just some color on that. You mentioned the go-forward margin. Should we think of it as it's between 348 and 356 for the next few quarters? Just some detail around that would be great.
Sure. Yeah. We had planned for the wholesale funding that we tapped into. I'd say we expect deposit growth to resume again on a go-forward basis. We have been growing the loan book faster than the deposit book. We had enjoyed a very favorable loan-to-deposit ratio. Now we're getting back towards market levels at about a 90% level. The wholesale funding, there's plenty of opportunity there and very low usage of that. Our margins continue to be quite strong on a relative basis to our peer group. With the Fed now more likely by October or December to decrease than increase, we just don't see the expansion that we've been able to enjoy over the last year or two. The deposit pricing has been intense in the U.S. as the value of those deposits has gone up.
Now that the interest rate increases have paused, that is expected to pause as well. We think we're well positioned. We also plan to continue growing the loan book and resume growth of the deposit book.
Did I hear you correctly that the sort of the accounting adjustment that was going to favorably impact in this quarter, do you still expect to see that in half 2?
Yes. It's actually not accounting. It's an actual recovery on some old FDIC loans that were coming out of the financial crisis. We thought we were going to close on the deal in Q2. We're going to close on it in Q3. It's going to give a one-time benefit. It's not a PCL item. It goes through net interest income. That's a one-time bump up, we would expect to be back to the levels that we've been at in Q1 and Q2.
Got it.
Absent a Fed decrease.
Right. Okay.
Dave here. Just a little comment around some of the outcomes from our new deposit strategies are taking a little longer to materialize, but we do have ability to move more sweeps on. We are working actively to build out low cost, low beta transaction account momentum in a number of different ways. We're competing harder for mid-beta deposits with our customers. These are all taking time to come to fruition. As Rod pointed out, we expect to see better traction with that going forward and a better opportunity to fund the double-digit loan growth that we expect to continue.
Okay, just last thing for me, Rod, I missed what you said, or maybe didn't understand what you said on Q1 2020. Did you size that RWA impact from some of those anticipated changes?
Not directly. I said it would be covered by one quarter of retained earnings, which, just looking back historically, our internal capital generation net of dividends has been in the 30 basis points. I basically said it was less than 30 basis points. It's probably in the middle to higher end of that. It's going to be more than 15 and below 30, I'll say that much.
That's helpful. Thank you.
Thank you. Our following question is from Robert Sedran from CIBC Capital Markets. Please go ahead.
Thanks. Good morning. Rod, I guess sticking on the risk-weighted asset question, I didn't fully appreciate in your answer whether some of the items you discussed that moved the risk-weighted assets down a little bit were timing related and might kind of go back the other way. I'm trying to understand the 11.8% CET1 ratio. Is there a chance in the next quarter that that edges down rather than the continued capital generation, or have we kind of rebased here at 11.8?
I don't know that we're rebased. I'd say we enjoyed our internal capital generation of 33 basis points. Excluding foreign exchange, our RWA went down by almost CAD 2 billion. That was four basis points. I would not expect a repeat of that. I would expect our trailing four-quarter growth has been in the CAD 10 billion range versus the CAD 2 billion decrease. CAD 10 billion is usually 20 basis points. I don't know that we're going to get back to that level, although historically Q3 has been higher from a retail bank growth standpoint, given the mortgage market. Our City National growth has been strong as well. That will flip around. Then this quarter, we enjoyed some unrealized gains in securities, given the markets, and kind of everything else added about four basis points, and that can be anywhere from plus or minus four basis points.
I would not expect us to grow at this level, but I would expect us to be range bound within a -10 or +10 over the next quarter. I would not expect another growth of 40 basis points.
Just thematically, leaving aside the Q1 impact of IFRS changes, is that sort of 15 basis points a quarter of capital generation, 15-20 basis points of capital generation still in play going forward, or does business mix and business mix evolution shift the way we should think about the ability to generate excess capital?
Yeah. I'd say we've been in that mix shift already. We've been growing in City National, where we're on the standardized approach and not the advanced approach. We've been growing the uninsured mortgage book much faster than the insured book, given the change in the regime there. We had been growing until this quarter capital markets, which tends to carry higher risk-weighted assets. That growth has slowed. Part of that was the pipeline was so robust over the previous year. I would not expect that to structurally change. I'd say that 30 basis points guidance would hold.
Okay. Thank you.
Thank you. Our following question is from Doug Young from Desjardins Capital Markets. Please go ahead.
Hi, good morning. Just on City National. I think, Rod, you mentioned pre-tax, pre-provision earnings were up 10%, and then I look at your supplement, the adjusted earnings were down 16%. I'm just trying to get some sense of how much of that related to credit, and how much of that related to expense growth, because I think, and maybe you can give a little more color on the credit side, because I think you had a few accounts impaired this quarter. I think there was one account that was impaired last quarter. Just hoping to get some color on the divergence between that.
Sure. I'll start, and then I'll hand it over to Graeme to give more color on the credit. In terms of US dollars, in terms of the revenue and expense growth, when you look through it all, we're around 10% growth on revenue and expense. As Dave mentioned, we continue to invest organically in that business, and we plan to continue to invest organically in that business. We haven't done a bolt-on acquisition, so we will invest some of our earnings there for long-term strategic value. But the PCL in US dollar terms had a recovery last year of $13 million, given the intricacies of IFRS 9. This year was a charge of $23 million in US dollars. That's a $36 million swing year-over-year. I'll hand it over to Graeme to give a little bit more color on that.
Yeah. I was going to reiterate where I left off there. One is, last year they were in a net recovery, which is not a norm by any means, both on Stage 1 and 2, and had very low levels of impairments and some significant recoveries on Stage 3 side in 2018. We look at 2019 year-to-date there, City National is running, I think, in the kind of 24, 25 basis point range. About half of that is coming from the performing loan side, the IFRS 9 Stage 1, Stage 2. That's probably running at a higher level than I'd expect. As we've indicated overall, there is an amount there that would and should grow consistent with their overall loan growth there, their loan growth is obviously higher than overall RBC.
Stage 1 and 2 has been impacted there due to some macro forecast changes and other components in their portfolio. Over time, that should grade down to be more consistent with their overall portfolio growth, assuming the macro environment doesn't change. Stage 3 has been running in the 12-13 basis point range. I don't think that's outside of a normal amount for them. We have had a handful of accounts. When you look at their portfolio, they've got a commercial portfolio that I think is a good quality portfolio. We haven't changed the nature of the credit profile, we expect that to operate at a consistent, steady level going forward.
I think overall, the other piece we have in their portfolio is a growing resi mortgage portfolio, which is a very high-quality portfolio that shifts the overall balance there as well a little bit down. I think those two portfolios over time would look similar to the Canadian portfolios, that would be a bit of the guidance I'll give you there.
It just sounds like more abnormal bumps than anything that you're getting overly concerned with at this point in time, and some of it related to IFRS 9.
That's correct. Yeah.
Okay. Just maybe second on the City National, I think the U.S. jumbo mortgage market, I think has been an area that you plan to use to drive cross-sell. It sounds like, and correct me if I'm wrong, that market has slowed considerably this year. Is that the case? Has that changed your strategy in new client acquisitions? Maybe just if you can flesh that out. Thanks.
Thanks. It's Dave here. Certainly, as we think about growing our business over the next four or five years and diversifying our client base, diversifying by geography, the jumbo mortgage product and acquisition ability that it has is very much integral to our expansion in New York and Boston, Washington, and maybe other areas in the South. It's proven to be a very successful product for us. As Graeme mentioned, with the client segmentation that we're targeting is a low risk, low volatility product and one that we can cross-sell from. You've seen that product grow year-over-year at around 20%. We expect that to continue, if not accelerate. We've got a good foundation to do that, and we're hiring bankers out there to really target clients with that product. We think it's integral to our overall expansion and growth strategy.
Is that 20% your growth? Is that the industry growth?
That's our growth.
That's your growth. Okay, great. Thank you.
Thank you. Our following question is from Sumit Malhotra from Scotia Capital. Please go ahead.
Thank you. Good morning. I will start with Dave, please, as I wanted to ask maybe a more philosophical question around the expense commentary. I think, Dave, one of the factors the market has appreciated with Royal has been the consistency of the investment spend the bank has worked with for a number of years now. Certainly, you've avoided taking any of the restructuring charges or one-time factors that some of your peers may have benefited from in the short term. The commentary on expenses, I get certainly the tie-in to revenue.
As far as the enhancements that you have communicated to us for a number of years, the RBC Ventures build-out and the professionals you've brought aboard, should we also read this reduction in expense growth going forward as some commentary on you've made the progress or you've built the systems and advantages out that you were looking for, and now it's going to be a reduced level of allocation required? I get the tie into revenue, just kind of thinking bigger picture about where you wanted to take the bank and whether this reduction speaks to that as well.
I think you're absolutely on the right track. If you look at each of the functional and business heads, very much a renewed focus on incrementally what is really important given all the accomplishments that we've had over the previous five years. We're very focused on what we need net new, and we're constantly looking for opportunities to recycle a spend that in our significant cost base to new initiatives. We're actively working on it, and when you're an organization of our size, you have to get ahead of these things well before a cycle turns. We're, as a management team, actively thinking about this all the time, where our priorities lie in planning for a potential environment. We don't know the timing, but you have to plan to get ahead of these things.
We feel that we're able to accomplish our regulatory needs, our safety and soundness around AML, our customer-facing needs, our re-platforming of a number of areas in capital markets, and manage into a potentially unknown timing, a lower revenue environment. This is actively how we're managing the business and how we talk about the business. The faster you can get ahead of it, the easier it is to manage.
To relate this to maybe the here and now for Neil. Your segment, it would sound like, is the primary beneficiary of a lower level of expense growth. At least from the comparisons we do, it seems like the operating leverage for Canadian P&C or Canadian banking at Royal has been lower than industry levels. It's been consistently positive, but lower. Are you of the view that with this step-down in costs, we will see the operating leverage performance in Canadian banking now trend decently higher than what we've seen for over a three-to-five year basis?
Yeah, thanks for the question. The operating leverage to date, to your point, has been positive. We do expect it to improve in the second half of the year. One of the things we've been investing in is in our people and in technology, to Rod's point earlier. On our people, we're going to start to see a flattening of the FTE profile. We've made the investments where we felt we needed to, whether that's in our commercial business or mortgage business. We're feeling confident that we've targeted the right roles in the right markets, and you'll start to see that level off. In terms of the other comment I'd make, in terms of technology, we're also benefiting now from just the economies of skill.
The platforms we've put in place and the people we've hired, they're actually able to put out more productivity per FTE in those technology initiatives than we did two or three years ago. A good example would be our mobile team. They'd be able to put out about a third more productivity this year versus two years ago in terms of the amount of code they're putting into the app. That helps in terms of the efficiency around technology.
Thanks for your time, guys.
Thank you. Our following question is from Mario Mendonca from TD Securities. Please go ahead.
Good morning. One specific question and one more broad-based. First, the specific. You folks referred to narrowing credit spreads on a few occasions as the reason why, say, unrealized gains were a little higher and why underwriting was a little stronger. Did the narrowing credit spreads have any effect on the trading revenue, which looked awfully strong this quarter in terms of mark-to-market gains or any other accrual adjustments?
Yes, Doug. Certainly improving credit spreads helped the fixed income business. It wasn't so much mark-to-markets on inventory as it was just really trading activity with clients and even more so, new issue activity and investment grade and high yield credit. Yeah, a better credit environment was a lot of the source of much better FICC results for the quarter.
To the extent that there was some mark-to-market adjustments, that was not the driver of the strong results then?
No. It wasn't this quarter. The mark-to-market results we're talking about earlier in the Treasury Services business was a year, a year and a half ago, where we had some longer-dated sovereign securities in a held-for-sale book, and we sold them and marked them. It contributed to the earnings a year ago.
Okay. Just a broad-based question, Dave and Rod. You folks have referred to guidance for the year at 7%+ on the first half of the year. Challenging in Q1, a little better now, but you've come awfully close at about 6%, 7%. There are just so many moving parts here, including what you said about expenses, PCLs, margins. Can you offer any outlook on what you think 2019 looks in totality from prospective EPS growth?
Yeah, I think for the latter half of the year, we're feeling that we've got good momentum, that we're, as you say, going to bring our expenses down. We're operating in a strong economy with strong employment. Therefore, we feel the ability to continue to grow the business. We're not moving off of our medium-term objective.
Thank you.
Thank you. Our following question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.
Thanks. Just two quickies here, hopefully. Rod, on page 20 of your slide deck, you have a breakdown of the U.S. earnings or the U.S. operations, 17%, I think, over the last 12 months of earnings and 23% of revenue. When you think two, three years out, where do you think those percentages will go to, and where will they converge on? Do you think the revenue and the earnings will kind of converge on some number, presumably with earnings going up as opposed to revenues coming down? Do you see just the higher growth outside of Canada or inside Canada?
Well, thanks for that. I would expect the share of revenue to be higher than the share of earnings because while we're growing scale in the U.S., we're not going to match the scale we have and the market share and market position that we enjoy in Canada. While that delta might narrow, I would not expect to see it be eradicated. In terms of the growth rate, though, we continue to see higher growth prospects in the U.S. Again, given the inverse of scale, we don't have the same market share, we're able to grow market share, and we have been across all of our businesses in the U.S., and that comes with higher growth rate than what we would expect in Canada, where we do have a number one or number two market share in most of our businesses.
Although we might continue, and we expect to continue to grow market share as we outlined at our Investor Day, that growth rate won't be at the double-digits if the overall economy on a nominal basis isn't growing at that sort of level.
Is it safe to say that the driver of the medium-term EPS growth is going to have to come from outside of the U.S.?
I wouldn't say that. Our medium-term objective is 7%+, and we should be able to achieve that in Canada and outside of Canada. Just might be higher outside of Canada.
Okay. Maybe for Neil, I don't know. Neil, when I look at the wholesale bank or the wholesale loan book breakdown, two industry groups that seem to be delivering pretty robust year-over-year growth are financial services and investments. What would be included in those and what businesses would they be supporting, and in which geographies?
It's Rod, I might take that. I think that had been the growth in our repo book. That's where a lot of that is flowing into. We would expect that growth rate to slow down.
Okay. Thank you.
Thank you. Our following question is from Scott Chan from Canaccord Genuity. Please go ahead.
Good morning. Just following up on the previous question. On the U.S. wealth management side, assets are pretty strong relative to what I track with U.S. peers. You kind of called out private client as one of the areas of growth, but is there anything outside of market appreciation that we should think about that's driving this outside asset growth in the U.S.?
Yeah. Scott, it's Rod. We've been adding advisors. We've been growing that business significantly. Our margins in that business have improved off of relatively low levels versus the industry to now industry levels. We've been investing in technology. We've been adding advisors who are being attracted to the RBC culture, the RBC brand. As a result, our margins have more than doubled in that business. That's been attracting new AUA as well as credit growth, where we've been leveraging the City National franchise and the partnership between City National and the U.S. wealth business, the legacy business out of Minneapolis, the Dain Rauscher business, has been quite strong, as has been the partnership with the capital markets business with the manufacturing and then the distribution through the U.S. wealth business. That business is firing on all cylinders right now.
What is the biggest driver of that double of the margin? Is it just the scale or is it something else?
Well, we have a very strong sweep balance down there, which as interest rates increase, we've been able to benefit from. That's been a big driver. Also the broker, the financial advisor productivity is up substantially. We've been driving strong operating leverage through that business. Again, back to Dave's earlier comments on scale, that's a business where we've been able to drive up good revenue growth with modest expense growth. That's a business where we've significantly increased the technology spend. We had been under-investing in that business until the last two years, and the result is that we have better tools for our advisors and for our clients.
Great. Thank you very much.
Thank you.
One more call, operator.
[inaudible] I would now like to turn the meeting back over to Mr. McKay.
Thought we could take one more call. Before I conclude, I'd like to welcome Nadine Ahn, who is our new Head of Investor Relations. Nadine brings a wealth of experience gained over 20 years at RBC, including in her current role as CFO of Capital Markets and I&TS. Prior to this, Nadine held a number of positions of increasing responsibility in our corporate treasury group. Nadine's capacity for building trusted relationships, coupled with her strong business and financial acumen, will serve her well in her new role. Welcome, Nadine, to your first call.
Thank you.
At the same time, I'd like to sincerely thank Dave McKay, who you all know well, who has moved on to another role, continuing on his 20-year journey at the bank. We've all greatly valued Dave's insights over the years, and his leadership was critical to both the success of our 2018 Investor Day and for RBC being recognized as having the best investor relations team in the Canadian financial sector for two years running. Congratulations to Dave, and he's going to do great work for us in another role. Just summing up, I think you heard a story today and our results around great customer momentum and flow across all our businesses, market share gains. Our investments have really produced growth that's stable to growing margins in most cases. We have great activity and success in our Capital Markets business and our trading businesses.
I think that is one of the headline stories. Our NIE was elevated to drive some of that growth, but positions us well for the future. I think you've heard a number of questions and comments that we are going to bring that NIE down quite significantly as we've achieved a number of our objectives going forward and our run rates become a little easier. You've seen a few credit spikes. We don't think it's systemic, but it's part of the diversification of our book that we've got a globally diversified book, a customer-diversified book, and diverse across businesses, and you're going to see a credit here and there that's going to go the wrong way. Overall, we're feeling good about the business. Thank you for your questions, and I look forward to talking to you next quarter.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.