All participants, please stand by. Your conference is ready to begin. Good morning, ladies and gentlemen. Welcome to RBC's conference call for the first quarter 2019 financial results. Please be advised that this call is being recorded. I would now like to turn the meeting over to Dave Mun, Head of Investor Relations. Please go ahead, Mr. Mun.
Thank you, Elena, and thanks for joining us this morning. 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 re-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 two, our comments may contain forward-looking statements which involve assumptions and have inherent risks and uncertainties. Actual results could defer materially. With that, I'll turn it over to Dave.
Good morning, everyone. Thanks for joining us. We had a good start to the year. We delivered earnings of CAD 3.2 billion, which is the second highest quarter on record. Against a backdrop of strong employment and resilient economic growth, we saw solid volume growth across our retail businesses, and our market-related businesses performed well given some of the market volatility during the quarter. We've been investing in our front line in all businesses to grow volumes and market share, which led to record revenue growth of CAD 11.6 billion. Our PCL was up as we continued to prudently build our stage one and stage two allowances on performing assets, and we also had one fallen angel in the utility sector. Overall, we view our credit position as strong.
We continued to grow our balance sheet for clients across all businesses while maintaining a strong CET1 ratio of 11.4%, and we delivered a return on equity of 16.7%. I'm pleased to announce a CAD 0.04 increase to our dividend this morning, bringing our quarterly dividend to CAD 1.02 a share. Our results are driven by consistent client growth, backed by solid GDP growth in Canada and the U.S. Business investment remains active, and unemployment rates remain near historic lows. Market activity took a pause in December and equity markets were down, sentiment has improved over the past seven weeks. For our Canadian banking business, this macro backdrop supported solid revenue growth and earnings of over CAD 1.5 billion.
Continued client activity drove volume growth particularly in deposits and credit cards in business lending. In cards, purchase volumes grew 7%, driven by a number of factors, including the value of RBC Rewards for customers, coupled with strong alliances such as WestJet and Petro-Canada. We continue to foster partnerships to create more value for Canadians. In November, we worked with WestJet to create a unique offer for medical students entering residency, given the extensive travel involved. The offer was very well received. This is part of our broader strategy to expand our relationships in the medical community by creating a differentiated offering for this high-value client group. We are also excited about RBC InvestEase, which we launched across Canada. Our robo-advising alternative helps serve our investing clients how and when they want and fills an important new channel in our full range of offerings to clients.
In business banking, we added commercial bankers over the last couple of years, which helped us grow business loans by 12% and business deposits by 9%. This group is also starting to see new relationships through RBC Ventures. For example, one venture called Ownr has already digitally registered nearly 5,000 new businesses, mostly in Ontario. Importantly, we have been able to convert over 40% of our recent Ownr users to business banking clients. We believe we can move that conversion higher as we optimize and scale this service nationally. In addition to Ownr, we have brought over 10 new ventures to market and have more on the way. We are excited about the momentum we have built with our ventures and new partnerships across Canada.
In Wealth Management, our Canadian wealth advisors supported our clients through the recent market volatility and grew fee-based assets by CAD 16 billion year-over-year, which drove higher fee-based revenue. Our competitive recruiting strategy has been working. We added 40 experienced high-producing advisors over the past year, which we expect will contribute to further growth. Our global asset management business was impacted by the market volatility as retail clients shifted money from long-term funds to money markets and cash in the first two months of the quarter. Even with this volatility, we continue to experience better fund flows than the industry. I am also proud of our innovative strategic alliance with BlackRock that we announced last month. Together, we created RBC iShares, offering Canadian investors even more choice with over 150 ETFs.
In U.S. Wealth Management, I am really pleased with the integration between City National and our Wealth Management advisory business to deliver client growth in each of their core segments. Having taken a methodical approach to building a dedicated team of bankers to cover RBC Wealth Management offices in key markets, including California and New York, we are seeing great client referrals into City National. In fact, last year, a quarter of the mortgage flow coming into City National branches in those markets were referred by RBC Wealth channels. This year is already tracking well ahead of that. It is our focus on clients that won City National 11 awards for business banking from Greenwich Associates, including recognition for overall client satisfaction. Both our Insurance segment and Investor & Treasury Services segment posted solid results, each earning over CAD 160 million in the first quarter, while providing a diversified source of earnings and deposits.
In both businesses, we have been investing in technology to grow and retain clients and lower our cost structure. Our Capital Markets business generated strong earnings of over CAD 650 million against a challenging market backdrop. Across the industry, clients were less active in the first two months of the quarter, but activity did pick up through January. Equities had a strong quarter, and our fixed-income business continued to perform better than the industry. We are also winning more lead mandates and landmark transactions. For example, RBC Capital Markets acted as sole advisor to BB&T on its announced CAD 66 billion merger of equals with SunTrust. This was the largest bank merger in over a decade, and our role highlights the strength of our U.S. Capital Markets franchise. Overall, I am pleased with our results, and we feel good about meeting our financial targets for the remainder of the year.
Our credit position is strong against a solid macro backdrop. We are seeing our investments in client-facing talent and technology paying off with higher volumes and market share gains. Notwithstanding a difficult December, our core business is strong, and our outlook remains positive. With that, I will pass it over to Rod.
Thanks, Dave, good morning, everyone. Starting on slide six, first quarter earnings of CAD 3.2 billion were up 5% year-over-year, and diluted EPS was up 7%. Excluding last year's write-down of CAD 178 million related to U.S. tax reform, EPS would be up 1%. In addition, growth would have been higher if not for favorable items last year, which added CAD 50 million after tax to Q1 earnings. This year, we have small items which largely offset, including an accounting adjustment in Canadian Wealth Management and a write-down of deferred tax assets in the Caribbean. This quarter, our revenue growth was driven by solid client-driven volume growth and higher spreads in our retail banking businesses, partly due to the solid fund economic fundamentals that Dave mentioned. However, the market volatility in November, December reduced market-related revenue before improving in January.
Given this temporary headwind, operating leverage in several businesses was negative in the first quarter. Nonetheless, we are still targeting to achieve positive operating leverage for the full year in our Canadian banking, Wealth Management, and Capital Markets franchises. Of course, this will partly depend on market conditions for our clients in some of these businesses. Expenses were up 5% year-over-year as we invested in our distribution network and other initiatives to grow our customer base, which supported our record revenue this quarter. Of that 5% expense growth, over a third of that increase was from unfavorable impact of foreign exchange translation. Approximately 20% of the growth was due to investing in frontline sales and distribution to grow clients and revenue. 25% was due to digital data and ventures initiatives to add value and connect with more clients.
The remaining 20% was for other operating costs, including risk and regulatory costs, as well as inflation. Although we added FTE year-over-year, we expect growth to slow down as we go through the year. Our PCL ratio on loans this quarter was 34 basis points, including six basis points for stage one and two PCL on performing loans due to both portfolio growth and the impact of higher near-term market uncertainty. We also had one utility account at five basis points stage three PCL on impaired loans. In the last three quarters, we have prudently added over CAD 220 million to our stage one and two allowance on performing loans. On taxes, our effective tax rate was 19.5%, just under our expected range of 20%-22% for the year. Turning to slide seven, our CET1 ratio remains strong at 11.4%.
This quarter, regulatory changes reduced CET1 by 10 basis points. Our strong internal capital generation was offset by higher RWA due to client business growth. We are very comfortable with our capital position, which remains above our typical 10.5%-11% target range and allows us to continue investing in organic growth and returning capital to shareholders. Moving on to our business segment performance on slide eight. Personal and commercial banking reported earnings of almost CAD 1.6 billion. Canadian banking net income of over CAD 1.5 billion was up 4% from a year ago. Excluding last year's CAD 27 million after-tax gain related to the reorganization of Interac, net income was up 6%, and pre-tax, pre-provision earnings were up 8%. Revenue increased 6% from a year ago or 7% adjusting for that Interac gain.
Underlying revenue was driven by solid loan growth as we gained market share in products such as credit cards and commercial lending without increasing our risk appetite. We also had strong loan growth as well as growth in both personal and business deposits. Net interest margin of 2.79% was up 11 basis points from last year and two basis points quarter-over-quarter, largely driven by higher deposit spreads. Going forward, without further interest rate hikes, we expect NIM to improve by a total of 2-4 basis points for the remainder of the year. Operating leverage in Canadian banking was slightly negative 0.2% this quarter or positive 0.6% adjusting for last year's Interac gain. This was partly driven by lower mutual fund distribution fees, given challenging markets and lower client activity in our direct investing online brokerage business when compared to elevated activity last year.
As I mentioned last quarter, we expect full-year operating leverage to be in the 2%-3% range, subject to some movement between quarters. We are maintaining that view. Turning to slide nine, Wealth Management earnings of CAD 597 million were flat to last year. Quarter-over-quarter growth in fee-based client assets was muted in both global asset management and Canadian Wealth Management. We also saw lower transaction volumes as many clients sat on the sidelines in the first two months of the quarter. Activity has improved since then. In U.S. Wealth Management, earnings were down 5% year-over-year in U.S. dollars or up 6% adjusted for last year's favorable accounting adjustment related to City National. Strong net interest income growth more than offset lower non-interest income. Loan growth at 15% at City National remained above the industry average as we benefited from our organic expansion strategy.
We remain confident that our holistic funding strategy will continue to support strong loan growth at City National Bank. Moving to insurance on slide 10, net income of CAD 166 million was up from CAD 127 million a year ago, as we benefited from life retrocession contract renegotiations, as well as lower claims costs. First quarter earnings were lower quarter-over-quarter, as the fourth quarter tends to be seasonally higher. As we have mentioned in the past, there will be some quarterly volatility, but our full-year outlook has not changed. Slide 11 has Investor & Treasury Services results. Earnings of CAD 161 million were down from last year's record quarter with lower funding and liquidity revenue. Although we saw higher client deposit margins, this was more than offset by global market volatility, which negatively impacted our asset services clients.
Expenses were also up from last year due to our strategic technology investments to create efficiencies and enhance client experiences in this business. We expect expense growth to moderate in this segment going forward. Finally, on slide 12, Capital Markets had solid earnings of CAD 653 million in spite of challenging industry-wide market conditions in November and December. Net income was down 13% from last year's record first quarter, partly due to a credit provision related to a single U.S. account in the utilities sector. Corporate Investment Banking activity revenue declined amidst a smaller global fee pool as origination activity paused in the first two months of the quarter, given the volatile markets. Global Markets revenue was flat year-over-year with higher North American equity trading revenue offset by lower fixed income results, largely in rates and credit, given the market uncertainty and widening credit spreads.
Our trading businesses outperformed broader industry trends. Looking forward, higher markets and improving client sentiment should contribute to revenue growth across our businesses after the pullback earlier in the quarter. As a reminder, Canadian Banking gets impacted by fewer days in Q2. In Capital Markets, our deal pipeline remains solid across all regions. In our Canadian Banking and Wealth Management businesses, we've had good growth momentum underpinned by investments in sales capacity and technology, and we are confident that we will continue to create value for our growing client base. Overall, we expect solid economic fundamentals to underpin continued revenue and earnings growth, and we expect to continue benefiting from our cost scale and client focus across our businesses. With that, I'll turn it over to Graeme.
Thank you, Rod, and good morning. Starting on slide 13, in Q1, we continued to see market volatility due to greater vulnerability to the macroeconomic outlook, stemming from trade tensions, geopolitical uncertainty, and revisions to global growth forecasts to the downside. Given some unfavorable changes in near-term macroeconomic variables, such as equity markets, oil prices, and unemployment rates, which serve as inputs to our provisioning models, PCL on performing loans exceeded our three basis point run rate associated with volume growth as I noted last November to reach CAD 93 million or 6 basis points this quarter. PCL on impaired loans of CAD 423 million or 28 basis points increased by 8 basis points from last quarter, mainly due to higher provisions related to one well-publicized account in the utility sector.
Excluding this account, PCL on impaired loans was in line with our expected range of 20-25 basis points at 23 basis points. In Canadian Banking, PCL on impaired loans of CAD 292 million was up one basis point from last quarter. The credit performance for this business continues to be in line with expectations. In Wealth Management, PCL on impaired loans increased to CAD 11 million or 3 basis points, mainly due to higher provisions at City National. In Capital Markets, PCL on impaired loans increased to CAD 102 million, mainly driven by higher provisions on the account I noted earlier. Turning to slide 14, gross impaired loans increased to CAD 2.8 billion, up by 9 basis points from last quarter, largely due to a new formation in the utility sector and seasonal factors in some of our retail products.
Turning to slide 16, PCL across all of our Canadian retail portfolios were generally stable quarter-over-quarter. In Alberta, however, we have seen a slight increase in impairments in our residential mortgage portfolio as the region continues to recover from the oil downturn and elevated unemployment levels at 6.8%. The balance for our portfolio in this province was stable. For our retail portfolios overall, credit trends have generally remained stable and signs of stress have been isolated and manageable. Let me now provide some color on both our commercial real estate and leveraged lending portfolios. Starting with commercial real estate, we have provided some new disclosures, which can be found on slide 17. Overall, this portfolio represents 7% of our total outstanding loan book, and is mainly comprised of loans to owners and operators of established and comprising properties.
Development loans represent approximately 18% of our overall commercial real estate portfolio, with condo developers representing about a third of that. Over the past year, our commercial real estate portfolio has grown by 17%, with Canadian Banking, City National, and Capital Markets all contributing to that strong growth in line with our risk appetite. With the addition of City National and Capital Markets' global focus, this portfolio is more diversified geographically and by industry segments than it has been historically. We are mindful of both the potential for adverse macroeconomic and secular trends in this sector and are closely monitoring our portfolio accordingly. Notwithstanding, we are comfortable with our underwriting practices, which, together with our solid diversification, have contributed to its strong performance with PCL averaging 14 basis points over the last four years. Let me now touch on our leveraged lending portfolio.
Our leveraged finance business, which includes leveraged loans and high-yield bonds, employs an underwrite to distribute model, which leaves us with two primary risks: market risk in relation to the loans and bonds we distribute, and credit risk in relation to the portion of the credit facilities we retain. Our market risk is managed through defined risk appetite, supported by well-established limits, deal-specific structure and pricing protections, and speed to market with an average time from commitment to completion of syndication of less than 75 days. Our market risk framework has proven effective, as we saw in November and December, where we weathered the market volatility and decline extremely well. Though we look to distribute the vast majority of loans and bonds in a typical transaction, we do end up retaining a residual amount of exposure in the senior secured revolving credit facility.
While there is no standard market definition, non-investment grade leveraged lending exposure, as we define it at RBC, amounts to CAD 10.7 billion of outstanding exposure, which is less than 2% of our total loan book. Of that CAD 10.7 billion, approximately 65% is rated B B, with the balance rated single B or lower. Also, 35% of this portfolio is to private equity sponsors with the balance to corporate clients. In addition to the senior secured nature of our exposure, the credit portfolio is very well diversified with relatively small single-name concentrations across over 400 unique borrowers. No sector represents more than 19% of this portfolio. We are monitoring this market segment carefully, but remain comfortable with the size of the portfolio, the risk framework we use to manage it, and ultimately, the risk-return profile.
Briefly touching on market risk on slide 26, increases in fixed income holdings and volatile equity markets drove value at risk and stress value at risk higher this quarter, particularly in December. Notwithstanding this volatility, we had no days of trading losses in the quarter. To conclude, we are comfortable with the overall credit profile of our portfolios. Looking at the remainder of the year, we would expect our total PCL ratio to be in the 25-30 basis point range, assuming the macroeconomic outlook remains unchanged, though we may see some volatility in a given quarter. With that, operator, let's open the lines for Q&A.
Certainly. Thank you. If you have a question and you're using a speakerphone, please lift your handset prior to making your selection. If you have a question, please press star one on your telephone keypads. 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 the participants register. Thank you for your patience. The first question is from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
Good morning. I guess first, congratulations, Dave and Doug, on being the sole advisor to BB&T. I think it's notable for the RBC franchise for being there for the largest bank deal that we've seen in the U.S. in 15 years.
Thank you.
With that, I think just moving to the U.S. actually and City National. I'm looking at slide 22 and net income contribution of City National, about 5%-6% of earnings. Earnings growth has been about 5%. Deposits have been flat, and I've grown up looking at banking franchises and the value coming from deposits. When I think of what we are doing with City National and appreciate all the investments we are making to grow that organically, can you talk a little bit strategically about how you view that contribution from U.S. retail banking playing out over the next two to four years? Where does U.S. M&A fit in, given what we've seen and we could see more consolidation in the space?
I don't think of RBC as a flinch player in anything, and when I think about the U.S. strategy and the optionality for growth that the bank has, I'm just trying to wrap my head around what is it that is serving as a hurdle to go much more in a bigger way into the U.S.
Got it. Yeah. Let's go back to Investor Day. We laid out a path for the combined entity to grow to CAD 1.5 billion. Strategically, as we think about this, as we've grown this from a lot more than 5%, we'll send you the compounded growth. It is double digit. It's grown very well to over CAD 1 billion of profit in our U.S. Wealth franchise. We've been investing significantly in the infrastructure to grow. We've been investing in frontline commercial bankers. We've been investing in private bankers. We've been opening offices in Boston and New York, Washington, Nashville, trying to fill out California. With this growth has come
A fair amount of investment for the future to continue this momentum. As I've said over and over, that we see a significant opportunity given the market segment that we're in, the markets that we're focusing on in high net worth markets for organic growth. We continue to look at the marketplace to see if we can grow geographically through an acquisition of a bank that would have a cultural fit, that would have, obviously, a similar segment approach to what we're doing. We are looking at making sure we earn a return on investor money. Prices are still high, and we look at the synergy playbook, as I said before, and we continue to think, but we've got a great franchise that can grow organically at double digits, which it will continue to do with the investment that we've had.
We unfortunately took one charge-off in the quick service restaurant space this quarter. It surprised us obviously. We may recover it. That book has been very, very strong. If you take that out, it's again, very strong performance year-over-year from the City National franchise. The storyline hasn't changed. Organic growth, expansion of bankers, expansion of markets. The franchise is really strong. Kelly Coffey has just taken over as a leader. He's incredibly excited to take this bank to the next level. Michael Armstrong in Minneapolis has done a great job for us. We really think that the playbook stays the same, that we're going to grow this business as we talked about in our investor day three years ago.
Thank you.
Thank you. The next question is from Meny Grauman with Cormark Securities. Please go ahead.
Hi, good morning. Just hoping you could give a little bit more color on the specific variables that are driving the increase in the performing loan provisions. Graeme, I think you mentioned a few variables. I didn't really catch it. Could you just go into a little more detail on what really pushed this up this quarter?
Sure. Yeah, I can definitely take that question. This quarter, I think as we noted the last analyst call, we were kind of entering a downturn in both equity markets and oil markets, those were really the two biggest factors that we saw driving our models and our provisions this quarter. Those factors really impact the wholesale portfolios more so, which is why you saw the increases in Capital Markets and C&D specifically. Most notably, the oil prices. Our baseline forecast there had been in the $70s last quarter, now reduced down into the CAD 50s. Equity markets, while certainly we saw a bounce back in January, quarter-over-quarter, we did reflect what, an 8% decline there in our baseline scenarios as well. Those are the key variables that we're driving.
I would say unemployment, particularly in Alberta, where we moderated our forecast there a little bit, had a more minor impact. Overall, I would say those are the key variables this quarter.
Is there anything that's less sort of formulaic that's driving things that you could highlight?
I think those were pretty much the drivers this quarter. There wasn't anything beyond that in the models. I mean, I think as we indicated last quarter, the starting point each and every quarter is really growth in stage one and two consistent with growth in our loan portfolio. We saw that this quarter with about three basis points or about half of the stage one and two allowances consistent with our volume growth, and the other half is largely due to these macro factors that as we rebaselined our models in the quarter.
Yeah, Meny, it's Rod. What you might be asking also about is just the credit quality within that Stage 1 and Stage 2. As Graeme pointed out, it's really the volume growth and the macro factors. It's not a degradation of credit quality within that you might see in future periods if there is an economic downturn. That's not the case now.
Okay. That's very helpful. Just as a follow-up, I noticed the uptick in the real estate book as well, in impaired provisions in real estate. Just wondering if you could give a little more detail on what region of the country that is and what gives you confidence that it's an isolated incident?
Sure. I'll maybe make some initial comments there. I'll turn it over to Doug to add further to that. That was an account out of Capital Markets in the U.S. It was in the retail segment of commercial real estate, if you will. It was largely one particular account there. Overall, as I think we provided in our disclosure, I think we see a very well-diversified portfolio in real estate. Retail is one of those segments that we do monitor carefully. That's not been a big source of our growth, and we're just monitoring it carefully consistent with some of the secular trends we're seeing there. The parts of retail that we're concerned about don't form a big part of our portfolio. We will face some bumps on that.
Maybe we'll turn it over to Doug, maybe just give a bit more specifics in his book on that space.
Yeah. The book in investment banker Capital Markets, the largest borrowers are the largest real estate asset managers in the world, like Blackstone, Brookfield, would be examples. There is very little development risk in the book. It is diversified across mostly the U.S. and Western Europe. If I had to look at concentrations, I would say we have a bigger concentration, for instance, in office and industrial, far bigger than we would against retail. We have been careful around retail. In this particular instance, we are hopeful we can work this out. We are working with the borrower, and we should sort it out one way or another over the next couple of quarters.
Thanks for that.
Thank you. The next question is from Robert Sedran with CIBC Capital Markets. Please go ahead.
Hi, good morning. Graeme, you seem to be all warmed up, why don't we maybe stick with the loan loss line. On your slide, you say higher provisions in Canadian business lending offset by lower provisions in Canadian personal, I'm wondering if that is just the seasoning of a portfolio that has been growing quite rapidly over the last little while, or if there's something more interesting going on than that?
Thanks for the question. I think I'll just be reiterating some of the comments we made earlier. When it comes to commercial, I think this is just a bit more normal quarter-to-quarter volatility that we're seeing. When we look through the fundamentals and not just some of the kind of stage one, two model outputs, as Rod indicated, we're not really seeing any material shift in the risk profile of our portfolio there. The growth that we've seen in commercial has really been related to existing clients where we're doing more with our best clients. The quality of our originations has been very consistent this past year with what it has been in previous years. Our watch lists have been fairly consistent. We aren't seeing any trends in our downgrades there.
In the near term, again, we feel pretty comfortable with the nature of that portfolio and aren't really seeing any real macro shifts. I wouldn't use that as an indication that something is materially changing there right now.
These provisions on impaired are just things that happen from time to time.
Right now, yeah. That's what I would say.
Okay. Just as a follow-up to the Capital Markets provision, are you comfortable that the provision you've taken deals with it or is there a chance that there may be yet more to provide on that same loan?
Yeah. On the utility account, subsequent to quarter end, we have exposure to two different borrowers within that name. One part of that we view to be much higher risk or at risk of the kind of significant liability uncertainty there. We sold off that exposure partly due to that risk. We found a strong bid in the market, so we did sell off that exposure and have reduced the overall risk there by about a third. That's monetized part of the provisions that we've taken with there. The remaining exposure we now have, we feel much more comfortable with. It's going to be a long and complex workout. I think we've taken the majority of the risk off the table there now.
Okay. Thank you.
Thank you. The next question is from Sumit Malhotra with Scotia Capital. Please go ahead.
Thanks. Good morning. First questions are on City National, probably going to be for Rod. Rod, first off, when we look at the provisions in the wealth segment, is it fair to say that those are almost exclusively City National related?
Yeah. They have been since the acquisition. The loan book and the rest of the wealth business is quite small, and we haven't had any chunky losses there. What you're seeing is due to City National, yes.
About 20 basis points this quarter.
It represents one account, right?
Yeah.
I just referenced, yeah.
Okay. That's fine. Just wanted to make sure that that's the only thing there. Rod, staying with you on that business. Last quarter, you had mentioned that the run rate for net interest margin for City National this year, you were expecting 5- 10 basis points a quarter based on what the Fed did. You did better than that this quarter. Just to tie two things together and get an update on your outlook, obviously, the commentary from the Federal Reserve has been somewhat more dovish, if you will, in terms of how rate hikes look. At the same time, your deposit growth, which you've talked about as a key focus point for that business, was flat sequentially. Kind of putting those things together, how are you thinking about the NIM trend going forward?
Yeah. Thanks for that. Yeah, the guidance that I gave last quarter, as you rightly pointed out, was based on a Fed outlook, which was much less dovish, if you will. It was anticipating two to three increases. We had the one which benefited this quarter. I'd say the rest of the next three quarters, we're likely going to see a little bit of a bump up in Q2. Two elements of that. One is the days in the quarter. The math just works out. It doesn't add more revenue, it just adds more NIM on a basis point perspective. Also, we're expecting a little bit of a recovery on some legacy loans back from the FDIC era that will boost that by about 5-1 0 basis points.
I would expect it to come back to these levels for Q3 and Q4 within 2 - 4 basis points higher or lower, depending on mix and depending on competitive pricing, depending on Fed outlook. Consider these levels pretty much appropriate for the rest of the year, absent the nuances I mentioned in Q2.
I'll jump in and kind of reinforce the messages I did at the conference in January around growing our deposit base and making sure we're in a range that we're happy with long term of our loans deposits. We have three avenues to raise deposits that we haven't really pursued given we were so long deposits. One is to use our transaction capability that we acquired with Exactuals and our rollout of improved data faction and a new cash management bundle that we're rolling out should improve our core low beta deposit gathering, which has stalled a bit. The second one is we can roll more sweep deposits in from our Wealth Management franchise and from the City National wealth franchise that are off balance sheet, so we can utilize those to fund growth.
The third one is, as I mentioned before, because we're so long deposits, we haven't been aggressive in bidding up non-standard deposits. We always have the opportunity, albeit it comes with some margin give, but overall, there's a deep market with that type of client base that we're serving to go after deposits. Those are 3 strong avenues that we're continuing to build up. We haven't had to use them for a while, and now given the strong loan growth and the gapping to deposits, we're going to have to pick up our effort.
Last one for me is probably for Doug, maybe Rod as well. You had mentioned, or you had certainly indicated on the call last quarter that you were expecting a tougher revenue environment for Capital Markets. Obviously, your trading result today, a very positive surprise. Just to maybe put two things together that maybe they belong together, maybe they don't. Your equities number from a trading perspective was quite strong, and we've seen this tie up from time to time. Your tax rate in Capital Markets continued to decline. I know last year when we had the benefit of Tax Reform, we expected that to move lower, but it's down to something like 10% in Q1. I know a lot of these tax advantage trades had run their course, or at least I thought so.
Am I wrong to tie the decline in the tax rate to the strength in equity trading? Maybe you can just help me understand what's going on there.
Yes, you're wrong. It's not related to the equity trading. The equity trading numbers were good because the cash equities businesses did well, especially in the U.S. and Canada. We did very well in our equity derivative, our options business, facing clients and hedging risk for them. That team's just continued to improve and do well. In terms of the tax rate, that's more about where we're making money, both in terms of tax advantage geographies and also in terms of having some assets that are tax advantaged as well. The earnings mix changed a bit this quarter. That tax number's a little bit low, but I think that we'll continue to have better tax cash pay in this business than we had, say, a year ago.
Thanks for your time.
Thank you. The next question is from John Aitken with Barclays. Please go ahead.
Good morning, Graeme. I think you've had a bit long of enough of a break. Wanted to just circle back on the leveraged loans. Thank you very much for the disclosure. That was quite interesting. Wanted to ask, though, what's the typical retention rate on your originations? Secondly, did you have any losses or hung deals in the first quarter?
The retention rate, we don't typically retain anything in the term loan B or bond piece. Those are fully distributed. All we're retaining is a portion of the revolving credit facility that really is held by the banks and the underwriting banks. That's what I referenced when we say that you can roughly calculate the average hold there by taking the amounts we gave you and dividing it by the borrowers there. Our holds there are relatively small. It's a fairly granular portfolio, so we don't get the same chunkiness because of that. When we go to the market conditions, certainly we saw in the markets in November, December the pricing protections I referred to were certainly of value to us in that period. We typically get 125 , 175 basis points of protection.
We continue to see a market that operated though and got deals off our books. In the end we had a few deals that we were hung with, we've gotten those off the books now, and I don't think we basically have a very small residual portfolio there. I don't know if Doug has got anything further to add on that.
Very small. Certainly less than a billion. In the hundreds of millions.
It's like under CAD 200 million, I think, at this point.
Yeah. We got through. I think it's a good test of the business, actually. We've said for years now that we've got tight limits on our underwriting of single B credits, in particular LBOs. We had a very significant downdraft in single B and in credit generally in December. We managed our risk. We sold it off. We continue to operate in that market, and we think that it's a good business for us as long as you manage the risk, you diversify the credits, and you have the discipline to sell.
Great, thanks for the color. Doug, if I can keep on with-
I think we're going to go to one question just to get through everybody's first. We only have 20 minutes left. Sorry.
No, go ahead. I'll re-queue.
Please re-queue. Yeah, thanks.
Thank you. The next question is from Gabriel Dechaine with National Bank Financial. Please go ahead.
Okay. Well, now that I got one question, I'll do my big picture one. Dave, you had some comments the other day in the paper about the under-tap potential of the resource economy and framing it in a broad context of Canada's economy. I'm wondering if you can tie that back to your business. We can guess what the impact is of weak energy activity on the Capital Markets business, but more on the P&C business. Like how is that, I guess, weak market backdrop for the energy industry affecting your retail business? If I want to play devil's advocate, I say you're still going quite well in P&C. Is it really that big of an issue?
I would say we're going real well in P&C.
Yeah. No, you are.
Great volume growth. We're investing in the future growth at the same time with expansion of our sales force and our service force and new channels like InvestEase. We're feeling really good about P&C. You're absolutely right. Economic activity, as Doug has mentioned a number of times, client activity in the energy sector is low. Generally activity in the capital market sector is low in Canada right now, and our U.S. business is strong. Overall, Canada continues to perform very well for us. We're gaining market share across most categories. I'm going to pass it to Neil to talk specifically about Alberta in that context. As we see generally a strong Alberta, we're seeing a little bit of weakness at times. Neil, do you want to comment? Overall, Canada looks really strong, Alberta perspective.
Yeah. I think to Dave's point, a strong Canadian economy obviously is going to support a mass retail business. I think there's the obvious linkage there. In terms of Alberta, I think just a couple of years ago, we would've looked at our retail business, our small business clients, our personal clients, and even into commercial, and said there was incredible resiliency as oil prices started to come off. I think that they had been through that cycle before, and they knew the levers to pull. At some point, you do start to worry about that economy. I think longer term, that's where I think some of the broader comments come from. In terms of, I guess just the broad strength. We're seeing across the country good unemployment underpinning Graeme's comments about the credit performance of the book.
We think we could actually do better in Alberta, strong performance there. We are not pulling back from Alberta at this point at all. We think we could actually do better in the mortgage business there. It hasn't been an updraft market, obviously. We're seeing prices come off, but our share there isn't one of our strongest, and our momentum could improve somewhat. Our commercial business similarly performing really well. We have lots of appetite for the type of entrepreneurs we're supporting in the Alberta market. We continue to feel really good, and we're investing in Calgary and Edmonton, in a very similar way we're investing across the country. I think the comments are more broad-based about the support for the Canadian economy, and we do have concerns just about the energy impact as it relates to the health of Canada.
Right now we feel strong about Alberta, and we'll continue to compete hard there.
No big credit concerns at this stage, or you found it a little bit like?
No, we're seeing very modest uptick in delinquencies in early stage, really nothing that gives us cause for concern.
Thank you.
See that from our gross impaired loans across Canada and our performance. The retail credit book is very strong across the country.
I alluded to earlier, I think we see pockets like Alberta, it's been offset by the broader strength of the national portfolio and the strong unemployment numbers overall. I think it's very well managed in a broadly diversified portfolio.
Thanks for the question.
Thank you. The next question is from Scott Chan with Canaccord Genuity. Please go ahead.
Good morning. Maybe just going back to Graeme on the commercial real estate. In your disclosure, you talked about growth last year being 17% year-over-year. It seems like a lot higher than what we kind of track with peers. Perhaps maybe you can give an outlook of what you're seeing for perhaps the next few years, and if there's any growth differences between the U.S. and Canadian markets.
Well, I think on the growth side, maybe I'll defer to Neil and some of the business partners around the table so they can speak on kind of the forward side of that.
Yeah. Maybe I'll start, then I'll pass it to Doug. It's Neil. When we look at commercial real estate, the vast amount of our growth is coming in commercial mortgages. The developer book is a much smaller portion. We've only started to grow that in about the last year. It was relatively flat for about the 24 months before that. In terms of the commercial mortgage segment, it's growing double digit. It's what's powering that number on the retail side. Most of these, or that book is really targeted in kind of the CAD 1 million-CAD 10 million loan segment. Broad-based across the country, very diversified by asset and by region. These are income producing properties, loans made to owner operators. We've liked the risk. Over the cycle it's performed really well.
We mentioned before, we have a dedicated team who sells this product to these type of entrepreneurs, that's part of what's growing it. In terms of the forward-looking view, we don't expect this to continue at this pace, we'll start to see that slow over the next couple of years.
I would say in the investment banking book, the majority of the growth has been in a few very large cross-collateralized portfolios for some of the large asset managers that I talked about earlier. Some of those will roll off, we'll continue to work with them to try to replace the assets. I would say going forward, the growth would be maybe mid-single digits, but it would be slower than what you saw over the last 12 months.
Great. Thank you very much.
Thanks for the question.
Thank you. The next question is from Mario Mendonca with TD Securities. Please go ahead.
Good morning. Can we go back to Capital Markets, the growth in the balance sheet there. Essentially, I'm looking at page 14 of your supplement.
Yep.
The numbers have been pretty substantial, especially this quarter, adding over CAD 1 billion of assets, the trading book growing. I've been surprised by that kind of growth. If this ties in in any way to the growth in the equity trading you saw this quarter, if you could tie those in, if in fact those are related.
No, they're not really. It's not related to equities. There's a couple of things going on on that page in the sup. One of them is the growth in the loans and acceptances. About half that growth that you see year-over-year in the loans and acceptances is actually coming from loans. The balance is securitizations. We had a reclassification from securities to loans over the course of the quarter that just increased that number. We took it off the trading balance sheet and put it in the lending balance sheet. I would say the loans year-over-year have grown about 13%, whereas that category in total grew 21%. Half that growth is actually in the conduits and securities that we've reclassified.
In terms of other growth, we had some significant growth in our repo books, and we planned for that over the quarter. We had significant balance sheet demand, and it's almost entirely less than three months repo against government securities. We're looking at that. I think you can look forward to us sort of managing that much more tightly. You won't see that kind of growth over the course of the year.
Just going to equities just for a moment. I appreciate your answer to Sumit's question that the equity derivative trading isn't what caused the tax rate to go down.
But were the strategies essentially tax-driven?
No.
No, they weren't. It's about risk. It's about customers who have exposures, where we, in the equity derivatives business, hedge them and charge for that. It's not about tax.
Thank you.
Thank you. The next question is from Sohrab Movahedi with BMO Capital Markets. Please go ahead.
Thanks. Rod, a few quarters ago, you had talked about some of capital being tied up in the underwriting businesses, generally speaking, in Capital Markets. Any chance you can give an update as to how much basis points of CET1 is still tied up in underwriting activity?
It would be negligible. As Doug mentioned, a lot of that book has come down. I think the underwriting has come down by 50% versus what it was three, four months ago. That has actually freed up some capital. It's negligible impact.
Nothing material coming from here?
No.
Okay. Thank you.
Thank you. The next question is from Doug Young with Desjardins Capital Markets. Please go ahead.
Hi. Good morning. Just back to City National, I guess my question is fairly simple. You do have a target to hit $1 billion pre-tax earnings, I think, by 2020. When I look at your slide 22, I think that implies a fairly sizable growth from where we stand today. I'm just trying to get a better sense as to, I understand the PCL bumpiness and higher expenses and the investments you're making. I'm just trying to see, is that still a doable target? Then how do you get from where you stand today to that target? Thank you.
As we go back to our investor day, we talked about the combination of wealth, the synergies between the two are getting booked on each of the P&L sides. We look at the business in a combined fashion, obviously, given that they're the same client base. Again, seeding that growth, we've invested, I think, over CAD 230 million. We'll double-check that number. It's the number I've got in my head. Expanding into new markets, expanding the sales force. It takes a commercial banker and a private banker 12 to 24 months to really get going. Therefore, there's a lag to that growth. We're expecting more growth. We just opened in Boston, as I imagine. We're expanding in Washington. We're expanding significantly in New York. Therefore, we're expecting that organic growth to continue to play out.
We've got strong expansion into new markets on the national credit side of the business. We brought a team in on the food and beverage side that's about 18 months, two years in now that's really starting to produce. It really is to continue to expand. The other component of that growth that's been a bit slow in going, but we're starting to see it, and you saw it in my comments, is the jumbo mortgage growth. As we're referring more businesses, we're expanding, and one of Kelly's clear focuses is to use jumbo mortgage to accelerate our organic expansion in existing and new markets. That is just starting to lift off.
We saw, I think, 17% growth in our consumer mortgage portfolio, that's going to be a strong source of organic growth for us and a really strong customer who we can cross-sell once they come in as a new client. We do not contemplate doing acquisitions to get to that number. Acquisitions should be net additive to the number that we're targeting to get to. I think we've gotten a good source of profit increase from the interest rate environment. We're not expecting a whole lot more right now. It will continue to work its way in over time as it would normally do, as you move your deposits to loans and you reprice old loans. I think that's the trend. It's the same playbook, we're continuing to execute very well.
It doesn't sound like page or slide 22 has all of the, I guess, earnings that you would apply towards that CAD 1 billion target. I guess some of it is in the rest of the Wealth Management. If that's the case, can you provide where you stand with that on pre-tax earnings relative to that CAD 1 billion target? If we can take that offline, I'm just curious. Thanks.
Yeah, we'll take it offline.
Thanks.
Yeah. Just real quickly, we have been growing since the acquisition. We've been growing earnings in the mid-teens. We had three one-time adjustments last year in three different quarters. If you adjust for that and adjust for the PCL this quarter, which I know you can't always do, earnings are earnings. We've maintained that mid-teens earnings growth trajectory. If we maintain that for another two years, that would take the CAD 800 up to CAD 1 billion, just doing some simple math for you. There's a lot of ups and downs and nuances to get there. We are tracking towards that.
Thank you.
Great.
Thank you. The next question is from Nigel D'Souza with Veritas Investments. Please go ahead.
Good morning. Thank you for taking my question. This question's for Neil. If I look at slide 19 of your deck here at the loan balances for Canadian banking, the HELOC line item there is down year-over-year in terms of the balance of HELOCs, and that I think occurred last quarter as well. The industry seems to be growing at fairly, let's say, robust rate for HELOCs. How do we square that divergence? What's driving the difference there? How should we think about it?
Yeah, thanks for the question. I guess the first thing would be what's driving our numbers is when we started to see interest rates starting to go up, we saw clients move balances from the HELOC or the revolving portion of that product into the fixed portion, the traditional mortgage segment of the product. It's good advice for the customer, takes down interest rate risk for them, provides some certainty. That started, it was a little bit higher when interest rates started to go up, but we're seeing it level off. That's the swap of where those loan balances are going. In terms of our HELOC book versus our competitors, one of our competitors in particular really hasn't brought that product to market in the way we have. We've had this product in the market for I think about 14 or 15 years.
Our customers have been offered the product for more than a decade, and some of the competitors are just getting around to really growing it. We've enjoyed what we believe is higher retention rates and renewal rates because of the product construct. I think those are the two real drivers of that trend.
Okay, if I understand correctly, when the shift happens from revolving to amortizing, that goes in your res mortgage book. Just to understand the directionality here, if we back out that conversion, would your residential mortgage balances, would that be up sequentially or lower sequentially?
No, it would still be up, but it'd be just over right around more like 4%, just over 4% when you combine them together.
Thank you. Appreciate the color.
Thank you. The next question is a follow-up from Sohrab Movahedi with BMO Capital Markets. Please go ahead.
Just, Graeme, when you think about your total PCL outlook in that 25-30 basis point range, can you just provide some color as to what, if any, expectations you have around the impact of Brexit on the lending portfolio the Capital Markets has out there?
Yeah, I think certainly when in the opening remarks, we talked about some of the geopolitical uncertainty, Brexit is one of those events that we're thinking about. Certainly the kind of the trade uncertainty that we see in the U.S. with Asia introduces uncertainty. I think for us on Brexit, our operations aren't as significant in Europe as, say, some of the other global banks out there. We've been actively working for some time now to ready for potential negative outcomes there. There's an operational side to that I think we feel comfortable with as best we can given the uncertainty there. There's the macro side of it, and I would say the macro side of it I wouldn't see that being something that translates kind of in a nine-month timeframe timeline like we're kind of articulated in that outlook.
I think that presents more uncertainty as you go forward into 2020 and beyond if it just creates a broader slowdown in the U.K. economy. I wouldn't be quantifying that in that 25-30 at this point in time.
Would it be something that at some stage would be noticeable in that PCL rate?
Well, you're asking me to speculate on an event where we really don't know what that negative outcome looks like, and it's an uncertain event. The impact it's going to have on the economies is uncertain. Our loan book there is generally a higher quality loan book of any of our regions we have. It's much more balanced with investment grade book than it is in our other regions. We have a better starting spot, if you will, than we did with other spaces. It's really going to depend on how that evolves and what that economic situation looks like.
Okay. Thank you.
We have time or is that it? We have time for one more?
That's it.
Hi, operator. I assume there's no more questions.
We do have one last question. Did you wish to take it?
Yeah, we'll take one more.
Yeah, we'll take the last.
Certainly. The last question is from Gabriel Dechaine with National Bank Financial. Please go ahead.
Thanks. I'll make it quick. The leveraged loan balance you gave, the CAD 10.7 billion, how do you classify that in your wholesale loan breakdown the industries? Is it in a specific category, or does it go by industry?
I was going to say those are across all those industries. I think in my comments, I made reference to the fact that no industry, no sector there represents more than 19% of that portfolio. Leveraged lending is a product, and we engage with clients across all sectors there. That's why I say it's a very diversified portfolio. It's not specific to any one sector.
Okay. There's one category, investments, that I was wondering if it was that one. What is in that anyway?
No. That is unrelated to the leverage lending specifically. I think there was an uptick in investments, but that was more just due to reclassification. We were putting up some SIC codes on the other category and realigning those to the other categories more appropriately.
Yes. You have holding companies, investment offices, high net worth, and some occasional conglomerate in there so.
Right. I think it's important also that people understand that that CAD 10 billion number isn't all private equity buy-out loans.
Right.
That is leverage lending definition.
Yeah. As we said, 35% of it would be what we would call private equity or financial sponsor backed activity.
Right. Well, thank you everyone for their questions. I would characterize it as a strong quarter that's diversification or diversity of our franchise really showed through in a quarter that had significant volatility, particularly in December that impacted our Capital Markets activity levels. It certainly impacted our AUM, AUA, AUC levels across our I&TS and Wealth Management franchises. Underlying all that is significant client momentum, market share gains, and great core activity that we were able to earn through. We feel, as we pointed out, very good about the activity levels in our business and the momentum our business has heading to the rest of the year. We remain confident in our medium-term outlook for the business. Thanks for your questions, and we'll talk 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.