Earnings Call: Q4 2015

Dec 2, 2015

Good morning, ladies and gentlemen. Welcome to the RBC 2015 fourth quarter results conference call. I would now like to turn the meeting over to Ms. Amy Cairncross, VP and Head of Investor Relations. Please go ahead, Ms. Cairncross. Good morning, and thank you for joining us. Presenting to you this morning are Dave McKay, President and Chief Executive Officer, Janice Fukakusa, Chief Administrative Officer and CFO, and Mark Hughes, Chief Risk Officer. Following their comments, we will open the call for questions from analysts. The call is one hour long and will end at 9:00 A.M. To give everyone a chance to participate, please keep it to one question and then re-queue. We will be posting management's remarks on our website shortly after the call. Joining us for your questions are Doug Guzman, Group Head, Wealth Management and Insurance, Doug McGregor, Group Head, Capital Markets and Investor and Treasury Services, Jennifer Tory, Group Head, Personal and Commercial Banking, Sabine Hirzy, Chief Human Resources Officer, and Bruce Ross, Group Head, Technology and Operations. As noted on slide 2, our comments may contain forward-looking statements which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. I will now turn the call over to Dave McKay. Thank you, Amy, and good morning, everyone, and thank you for joining us. Today, we reported record Q4 earnings of over $2.5 billion, up 11% from last year. These results capped off a record year with earnings of $10 billion, up 11% from last year or 9% on an adjusted basis. I am very proud to say that we are the first Canadian company to earn over $10 billion in a given fiscal year. We met all of our financial performance objectives. We grew EPS by 12%, we delivered a strong ROE of 18.6%, and we exited the year with a very strong CET1 ratio of 10.6%. We increased our quarterly dividend twice during the year for an annualized dividend increase of 8%, all of which helped drive solid shareholder returns. I'm very pleased with these results, particularly since the macroeconomic environment was more challenging for us and our clients than we expected at the beginning of the year. I'd like to share my perspective on the full year performance of our business segments. Canadian banking had a solid year with earnings growth of 5% despite slowing economic conditions, particularly in the first half of the year, which prompted the Bank of Canada to cut interest rates twice. Clients took advantage of the historically low interest rates, and we saw strong growth in residential mortgages with balances up 6% from last year. While the overall market grew, we were able to capture a disproportionate share of the growth due to the success of our employee pricing campaign. In addition, we also saw clients switch out of secured lines of credit and into mortgage products to take advantage of better rates, which also contributed to our mortgage growth. As Mark Hughes will discuss, we continued to lend prudently, working directly with our clients to manage their debt. We also had excellent growth in our cards business this year, with balances up 7% as we continued to deliver a compelling value proposition to our clients. In fact, RBC ranked number one in four out of five categories in a recent Rewards Canada report on travel cards. With our strong product offering, including a flagship Avion and WestJet cards, we've opened over 1 million new client accounts over the past two years, and we've seen a growing number of clients switch over to RBC cards. As a result of technology enhancements we've made to our online sales platform, we've seen a 30% increase in the number of clients purchasing cards through digital channels. Turning to deposits, we have the number one franchise in Canada with an industry-leading market share of combined consumer and business deposits. Our successful marketing campaigns drove double-digit growth in core checking volumes this year and attracted a significant number of new clients to RBC. Core checking accounts are a key anchor product for us, and within the first three months, our clients typically expand their relationship with up to two or three additional products. On the business side, deposits were up 10% from last year. Given market uncertainty, many clients wanted to keep their excess funds liquid, and we've supported them through our range of savings products, including a new high-interest account. Moving to investment products, we continue to see strong client demand despite challenging market conditions this year. Client flows were strong as we leveraged the power of our distribution network and breadth of our product suite to drive 9% growth in mutual fund assets, and we acquired over 110,000 new clients. Our industry is changing, and we are increasingly interacting with our clients in the digital world. Currently, almost 5 million clients actively access RBC products and services using our online, mobile or tablet channels, a number which has grown more than 30% since 2012. We continue to design new products and services specifically for online and mobile channels and are excited about a number of digital product launches that we have planned for the coming year. Turning to Caribbean banking, we returned the business to profitability this year through a disciplined strategy, which included exiting non-core markets, taking out costs, and focusing on quality asset growth. I'm pleased that we've been able to achieve these results despite ongoing economic headwinds in the region. Moving to insurance, as expected, the impact of new tax legislation reduced earnings this year, but I'm pleased with the underlying performance of the business. We continue to see solid growth in new clients, and our strong client satisfaction scores have been increasing steadily over the years. Turning to wealth management, we had solid underlying earnings, though restructuring activities and market conditions impacted this segment's results. A year ago, we decided to realign and restructure our U.S. and international wealth business, and throughout the year, we exited certain regions. These were tough decisions to make but allow us to better serve ultra and high-net-worth clients from key centers where we have scale. Global capital markets were turbulent this year, with the volatility index up nearly 20% between May and October. This reflects uncertainty around the timing of a rate hike in the U.S., weakening domestic demand in China, Greece's debt crisis, and falling commodity prices. As a result, we saw significant repricing in equity markets, particularly in the fourth quarter, where we saw equity markets were down 7% in Canada over the prior quarter. Global Asset Management, our most profitable wealth management business, performed well despite the challenging market conditions. Over 75% of our assets under management outperformed their benchmarks over the most recent three-year period. Again, it's an important growth business for us, particularly as we expand beyond the Canadian retail market. Throughout the year, we added new investment solutions and professionals and expanded our distribution to U.S. and international institutional clients. We also continued to successfully integrate BlueBay funds into both the RBC distribution network and throughout the Canadian retail market. In Canadian wealth management, market conditions impacted client assets and results in lower client activity and fewer new issuances, particularly in the second half of the year. However, even in tough markets, we continue to extend our number one position in the high-net-worth segment as clients value our team of experienced investment advisors who collaborate with their partners in their retail and insurance businesses to provide a holistic approach to wealth management. Our U.S. wealth business is an important part of our franchise, serving 350,000 households south of the border. The U.S. is our second home market, which is why we made the decision to acquire City National and create a powerful platform for long-term growth. As the transaction just closed this month, our focus now is on integrating to bring the best of both organizations to our commercial capital markets and wealth management clients. We're excited to tell you more about this great franchise, and we're planning a City National Investor Day, which will be held in Toronto on March 4, 2016. We'll be excited to provide additional details in the coming months. Moving to Investor & Treasury Services, we had a record year, with earnings up 26% as market conditions were exceptionally favorable for our clients, particularly in our foreign exchange businesses. Even with a challenging fourth quarter, which Janice Fukakusa will discuss in more detail, I am pleased with the strong performance of this business this year. Turning to capital markets, we had a record year, with earnings up 13%. Our strong results demonstrate the success of our strategy to focus on traditional corporate and investment banking and origination activities. Corporate investment banking had a record revenue of $3.7 billion. Global M&A activity reached a record high this calendar year, as low borrowing costs and slow organic growth encouraged firms to expand through acquisitions. Against this backdrop, we advised our clients on $230 billion of completed M&A transactions and improved our U.S. market share by 200 basis points. We also underwrote more than $520 billion of deals across our equity, debt, and lending businesses, up 19% from last year. Debt issuance activity was also very strong as firms obtained funding in advance of a potential U.S. interest rate hike. We actively supported our clients' financing needs and had particularly strong results in our high-yield business, growing our global market share by 120 basis points. While equity origination revenues were down this year, it was against record results in 2014. Global markets had a very good year, with revenue up 15%. This business follows an originate to distribute model, and we leveraged our clients' strong issuance activity to drive trading revenue. Credit spreads widened significantly between July and October. As a result, client activity, particularly in fixed income, declined considerably. Equity trading continued to be strong but was down compared to exceptionally high levels in the first half of the year on lower issuance activity. Overall, capital markets had a strong year, and we continued to maintain our lead in Canada, grow our business in the U.S., and prudently expand our presence in Europe. To wrap up, I'm very pleased with our record results this year. We've grown our core client businesses, refocused some of our underperforming businesses, and enhanced our digital capabilities for our clients. Importantly, we've continued to invest for the long term, making the largest acquisition in RBC's history to accelerate our growth in the U.S. market. We met all of our financial performance objectives, and we remain committed to the same objectives going forward. I'm confident that we'll continue to deliver long-term value to our shareholders, given the strength of our diversified business model, our strong execution capabilities, and our disciplined approach to risk. I'll now turn it over to Janice to discuss our fourth quarter results. Thanks, Dave, and good morning, everyone. Turning to slide seven, we had a record quarter with earnings of over $2.5 billion, up $260 million or 11% from last year. Our results reflect solid earnings growth in capital markets and personal and commercial banking, and improved credit quality, partially offset by lower earnings in Investor & Treasury Services, insurance, and wealth management. This quarter, we benefited from tax adjustments, mostly in corporate support. While tax adjustments are normal course, they were larger this quarter than we have experienced in recent years. These adjustments reduced our effective tax rate for the fourth quarter and fiscal year 2015. If you add back these adjustments, our effective tax rate for fiscal 2015 would be at the low end of our target range of 22%-24%. We also had some tax adjustments in Capital Markets that related to our business mix in the current year, which I will explain shortly when I review that segment's results. Compared to last quarter, earnings increased CAD 118 million, or 5%, largely due to the tax adjustments I just mentioned, as well as higher earnings in insurance, partially offset by lower earnings in Investor & Treasury Services and Wealth Management. This quarter, our ROE was strong at 17.9%, although down from 19% last year, largely reflecting our capital build to fund our acquisition of City National, which closed on November 2nd. I will also note that this quarter, we incurred transaction costs of CAD 23 million after tax related to the acquisition. Turning to capital on Slide 8, our common equity Tier 1 ratio was 10.6%, up 50 basis points from last quarter, reflecting strong internal capital generation and lower risk-weighted assets from effective balance sheet management. As an example, in Capital Markets, we reduced securities inventory and derivatives in some trading portfolios. We also increased the granularity of data to allow for the correct risk weighting under the advanced approach. Looking ahead to Q1, we now expect that the closing of City National will impact our CET1 ratio by approximately 75 to 80 basis points, up slightly from our previous estimate, largely due to the impact of foreign exchange translation on risk-weighted assets. Moving to the performance of our business segments, starting on Slide 9, Personal and Commercial Banking reported earnings of over CAD 1.2 billion, up CAD 119 million or 10% from last year and down CAD 11 million or 1% from last quarter. Canadian Banking reported earnings of over CAD 1.2 billion, up CAD 17 million or 1% from last year. I will remind you that last year's earnings were favorably impacted by net cumulative accounting adjustments of CAD 40 million after tax. Excluding these adjustments, our Canadian Banking earnings were up CAD 57 million or 5% from last year, reflecting solid volume growth of 6%, including loan growth of 5% and deposit growth of 7%. Our performance also reflects continued growth in fee-based revenue as strong mutual fund asset growth resulted in higher mutual fund distribution fees, and volume growth drove higher credit card revenue. Solid revenue growth was partially offset by higher technology and staff costs to support business growth. We also had lower spreads, largely in business lending, which continues to be highly competitive. Sequentially, Canadian Banking earnings were down CAD 12 million or 1%. We continued to see strong volume growth across most businesses and had lower PCL. Our net interest margin was 2.65%, relatively stable from last quarter and down only one basis point. These factors were more than offset by expense growth, largely due to higher marketing and technology costs to support business growth. As I have said before, expenses in the fourth quarter are often seasonally higher due to the timing of marketing and other discretionary spend. On a full year basis, our efficiency ratio was 44%, 20 basis points better than last year, and our operating leverage was marginally positive. We remain focused on cost management and believe there's more we can do to drive further efficiencies in this segment. Caribbean and U.S. banking had earnings of $43 million, up from a net loss of $59 million last year, reflecting lower PCL and the benefit of cost management initiatives and foreign currency translation. Sequentially, earnings were flat. Turning to Slide 10, wealth management had earnings of $255 million, down $30 million or 11% on both a year-over-year and sequential basis. This quarter, we had lower transaction volumes, reflecting lower client activity and fewer new issuances against a backdrop of unfavorable market conditions, which Dave discussed. In addition, we had an after-tax restructuring charge of $38 million, largely related to the repositioning of our U.S. and international wealth management business, which includes the sale of RBC Swiss. The restructuring program is largely complete, although we expect to incur additional costs in Q1 of approximately $20 million-$25 million. Wealth management assets under management and assets under administration were up 9% and 4% respectively over last year due to net sales and capital appreciation, partially offset by the impact of business exits as part of our restructuring program. Moving to insurance on Slide 11, net income of $225 million was down $31 million or 12% from last year, largely reflecting the negative impact of a change in Canadian tax legislation, which I have previously discussed. Sequentially, net income was up $52 million or 30% due to favorable actuarial adjustments reflecting management actions and assumption changes resulting from our annual review, as well as lower net claims costs across most Canadian insurance product lines. Turning to Slide 12, Investor & Treasury Services had earnings of $88 million, down $25 million or 22% from last year and down $79 million or 47% from last quarter. As a reminder, this business provides asset services, custody, payments, and transaction banking for clients and also provides short-term funding and liquidity management for RBC. As Dave mentioned, credit spreads widened considerably during the fourth quarter, and as a result, we recognized mark-to-market losses on securities held in our treasury portfolio. Our treasury portfolio is approximately $70 billion in size. It's composed of high-quality liquid assets with strong credit profiles, and approximately 70% of the portfolio is held for trading. The losses in Q4 were relatively modest in the context of the overall portfolio. So far in Q1, we're seeing a stabilization and slight improvement in the spreads, which should improve the performance of the portfolio this quarter. Our client-focused businesses, particularly our foreign exchange business, performed well throughout the year and contributed to record full-year results. I'll also remind you that last quarter we aligned investor services reporting period and Q3 earnings included an extra month of results, which added $28 million to the segment's earnings. Turning to Slide 13, Capital Markets had a good quarter in a difficult market environment. Net income of $555 million increased to $153 million or 38% from last year, reflecting income tax adjustments related to the current year, strong trading revenue, and the positive impact of foreign exchange translation. In addition, results last year included a $51 million after-tax charge related to funding valuation adjustments and $46 million after tax of lower revenue and cost associated with our exit from certain proprietary trading strategies. Sequentially, earnings were up CAD 10 million or 2%, reflecting lower variable compensation, income tax adjustments, and higher equity trading revenues mostly offset by lower origination activity reflecting fewer client issuances and lower fixed income trading revenues due to unfavorable market conditions. Let me briefly discuss the tax adjustment this quarter. Our tax accrual process is based on a number of assumptions we make throughout the year, including business mix. in Q4, as we had full year earnings, the mix is known, and we determined that we had a higher proportion of taxable income in Canada compared to the U.S. than we did last year. Since Canada has a lower income tax rate relative to the U.S., this contributed to a lower tax expense for Q4. I would point out that our full-year tax rate of approximately 30% is in line with our expected run rate for 2015. Before I turn it over to Mark, I would like to briefly discuss a few priorities for next year. We continue to focus on managing the trajectory of expense growth against revenue growth in order to achieve full bank operating leverage of 1%-2%. Let me take a moment to talk about our approach. At RBC, we've had an ongoing focus on driving cost efficiencies for over a decade. As we've continued to evolve and mature these capabilities, they are now part of our business as usual activities. Our strategy is currently focused on three key themes. First, we're reinventing the client experience through digitization and process optimization. We have been investing in this area for a number of years, and as a result, we have been able to grow volumes and enhance our strong client service while keeping FTE relatively flat. Second, we are optimizing our business model by increasing the level of collaboration globally and across segments to achieve economies of scale. For example, in Europe, we have created centers of expertise that now support all three of our business segments operating in the region: wealth, capital markets, and Investor & Treasury Services. Third, we are simplifying our organizational and operational structures to make them more agile. As part of this initiative, we're running development workshops in which employees across business, IT, and functional areas prototype a new product or system within 16 weeks. There are both cost savings and revenue generation opportunities associated with these initiatives as they enable a more agile, cost-efficient, and innovative organization. Also, across all of our businesses, we're focused on balance sheet management to optimize capital allocation and improve our competitive position and returns. I will point out that as a result of issuing equity to fund half the purchase price of City National, we expect return on equity dilution of approximately 1%-2% in the short term. However, we've maintained our medium-term objective for ROE of 18% plus based on our confidence in building back up to that target level over time. With that, I'll turn the call over to Mark. Thank you, Janice, and good morning. We are pleased with our fourth quarter credit market risk performance. It reflects the diversification of our portfolios, both in terms of geography and industry, low interest rates, strong employment trends, as well as our prudent risk management practices. Turning to slide 15, provisions for credit losses on impaired loans of $275 million, or 23 basis points this quarter, were relatively flat sequentially, as higher provisions in Capital Markets were largely offset by lower provisions in Personal and Commercial Banking. Gross impaired loans decreased $94 million or 3 basis points this quarter, largely due to lower impairments in Personal and Commercial Banking and a write-off in Capital Markets, partly offset by higher impairments in Wealth Management. In Canadian Banking, credit trends were stable. We had provisions of $228 million or 25 basis points, down $10 million or 1 basis point from last quarter due to lower provisions in commercial lending. Gross impaired loans decreased $55 million from last quarter, reflecting lower impaired loans in commercial lending and residential mortgages. In Caribbean and U.S. Banking, credit trends improved slightly this quarter, with provisions down $7 million and gross impaired loans down $55 million, reflecting higher collections. Wealth Management's provisions were relatively flat, though gross impaired loans increased $48 million sequentially due to a single account in International Wealth Management, which is fully collateralized. We do not anticipate a provision will be required. In Capital Markets, provisions increased $21 million sequentially, spread across five accounts, with two of these five accounts in the oil and gas sector, one in the U.S. drilling and services sector, and the other in the Canadian E&P sector. Gross impaired loans decreased $32 million from last quarter, mainly due to a partial write-off of an account in the oil and gas sector. Let me provide you with an update of our oil and gas exposure. As you can see on slide 16, our drawn exposure to the oil and gas sector remained at 1.6% of RBC's total loan book, with our exposure to E&P companies down slightly from last quarter. The majority of this E&P portfolio is borrowing-based facilities. Over the past couple of months, we have been going through our fall redetermination, and it is now largely completed. The price deck we used for the redetermination was down 10%-15% from the spring. Borrowing bases have reduced on average 1% in Canada and 6% in the U.S. This has resulted in reduced credit availability for some clients, while others have remained flat or even increased due to asset acquisitions, incremental hedging, or the addition of further proven reserves to the borrowing base. During the quarter, we added eight new names to our energy watch list for closer monitoring. While the energy watch list has increased over the year, primarily as a result of our stress testing earlier in the year, our enterprise watch list has been relatively stable as a number of clients have been removed from the list when loans are repaid or clients are upgraded. Overall, our portfolio is performing as expected, and we continue to work closely with our clients to help them manage through this sustained period of low oil prices. Turning to slide 17, our Canadian retail portfolio remains stable, but we've noticed some early signs of stress in Alberta, particularly in communities that are more dependent on the oil and gas sector. The unemployment rate in Alberta reached 6.6% in October, and while it remains slightly below the national average of 7%, it is up 2.2% from last year. Our total retail portfolio in Alberta represents 16% of our total Canadian retail portfolio and is largely secured. We've noticed a slight, and I would stress the word slight, upward trend in auto and credit card delinquencies in Alberta, and while they haven't translated into write-offs, we are monitoring the performances of these portfolios. Combined, these two portfolios account for less than 2% of our total Canadian retail portfolio. In our Canadian credit card portfolio, provisions have steadily improved to 234 basis points, down nine basis points sequentially. In our small business portfolio, as we expect variability from quarter to quarter, we've seen a slight increase in provisions, mainly in Ontario. Provisions in our personal portfolio remain stable from last quarter. Our residential mortgage portfolio continues to perform well, with provisions of two basis points this quarter, consistent with our historical performance. Turning to slide 18, our portfolio is geographically diversified, and our clients' credit profiles are strong and have remained stable over the past year. Also, many clients are committed to accelerated repayment plans, and the debt service ratio is low, reinforcing our confidence in our clients' ability to repay. We've seen strong house price growth in a few markets, notably Vancouver and Toronto, driven by the short supply of single-family homes, coupled with strong demand. We are monitoring these markets closely. The credit trends of our portfolios have remained stable, and signs of stress remain isolated and manageable. Turning to market risk on slide 19, global market volatility had a considerable impact on the first half of the quarter, which resulted in six days of trading losses totaling $17.6 million. In addition, due to the impact of a weaker Canadian dollar and higher equity market volatility, our average VaR increased $4 million, and our average stressed VaR increased by $23 million from last quarter. So far in Q1, we've seen markets stabilize. I would note these VaR and stress VaR levels have reduced back again this quarter. In summary, our risk performance in Q4 in fiscal 2015 has remained strong, with metrics still reflecting a benign environment. Looking ahead, recent market and economic headwinds continue to underpin a more cautious outlook. Should oil prices remain depressed and the unemployment rate rise, we could expect credit provisions to reach more normalized levels in the 30 to 35 basis point range. However, we would also anticipate some positive impacts from low oil prices, a weaker Canadian dollar, and our well-diversified portfolio should help offset some of the possible deterioration in the oil and gas loan book and retail loan book of oil-exposed provinces. With that, we'll open lines up 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 a selection. If you have a question, please press *1 on your telephone keypad. If at any time you wish to cancel your question, please press the # sign. Please press *1 at this time if you have a question. There will be a brief pause while the participant registers. We thank you for your patience. The first question is from Steve Theriault at Bank of America, Merrill Lynch. Please go ahead. Your line is open. Thanks very much. A couple questions on capital. After some somewhat stubborn CET1 trends, you got a nice lift this quarter. When I look at the RWA schedule, there seems to be a lot of categories that are down. Admittedly, some of the larger drivers look to be the repo line, the derivative line. You touched on that, Janice. Thanks for that color. Could we get a little bit more detail, and maybe split it out? Were there any model assumption changes or model enhancements or approvals? Pretty unusual to see RWA going down. Then maybe more importantly, is there anything on slate for next year on the horizon in terms of model enhancements or anything you expect to help you on the RWA front going forward as you absorb City National? Hi, Steve. Thanks for the question. I think that it was pretty straightforward this quarter in terms of all of our efforts around balance sheet optimization. When you asked about potential for other than looking more carefully at what is happening with our various categories like securities and derivatives, if there are any model changes, we have not had anything of significance. What you saw is a data cleanup. We had some of the items that were lumped all together, and we actually cleaned it up into the various underlying categories so that we could get advanced Basel 2.5 treatment for those particular exposures. Going forward, we expect the ongoing back and forth about credit models and model review that we do from time to time. But what you see here is the results of very solid balance sheet optimization and balance sheet management across all of our businesses. On the derivative side, is any of the derivative component related to unwinding any of the dividend rental trades? No, not at all. Okay. Just on capital as well, the SIFI announcement obviously came and went in November. Are you in a position at this point to provide the SIFI score for the year that I think we got Q1 last year? Wondering if you have that any earlier. We don't have that information available from Basel, but the minute that we have it, we'll definitely provide it. Obviously, we were below the 130 cutoff- Yeah that Basel was using. Okay, thanks very much. I'll leave it there. Okay, thanks Steve. Thank you. The next question is from Sumit Malhotra at Scotiabank, Scotia Capital. Please go ahead. Your line is open. Thanks. Good morning. Just to piggyback off that question regarding some of the decline in RWA. It did seem to be in part related to what I would consider to be more capital market type items. Probably for Doug, when we think about some of this balance sheet repurposing, if I can use that term, do you foresee this having any impact on revenue trends for the bank going forward? If not, I guess the natural question would be, what was the benefit of having these assets in the first place? It's Doug. I think, first of all, I'll take you through where some of the reductions came in Capital Markets. It came in fixed income, and some of the portfolios that we were looking at were credit portfolios in the U.S. in particular, and some of our securitization portfolios. When Janice talks about optimization, what we're really doing is trying to figure out where we're getting proper returns on GAA and RWA, and we looked at those portfolios in particular and took some assets off. I would say also in the leveraged lending part of our business, we weren't as active last quarter as we have been over the last year or so, and frankly, that worked out pretty well for us given the performance of credit markets. I think going forward, we have a business plan. We obviously work with Janice and the rest of the bank on capital allocation, and the bank expects to generate more capital as the year goes on through retained earnings. We think that we'll have the capital we need to grow the business. The question regarding net income, in your view, the pullback from some of these businesses, should we contemplate any kind of material change in the earnings profile of your segment? No. One of the reasons we took assets off where we did, in the fixed income business in particular, things are reasonably difficult in certain parts of those trading books. I wouldn't expect that that's going to have a significant run rate change to our business. The other thing that's happened, and I think it might be in the supp, is that the legacy book has been running off pretty vigorously. Some of the old Level 3 type stuff? Yeah. There's been a significant runoff over the course of the year in the last half of the year. Thanks for your time. Thank you. The next question is from Rob Sedran at CIBC. Please go ahead. Your line is open. Hi, good morning. Janice touched on all bank operating leverage and the hopes for next year. I wonder if we can get a little bit more color perhaps from Jennifer on the Canadian segment specifically. I am curious on the quarter, how much of it was just seasonally elevated expenses versus structural spending that has to happen, and perhaps what the prospects are for your segment in particular as we look into next year. Thanks, Rob, for the question. Overall, we are pleased with the progress we have made managing expenses. On a full year basis, our efficiency ratio was 44%, and actually we have improved the ratio by 70 basis points over the past two years. Operating leverage was 0.4, notwithstanding margin compression. I think that is an important thing to note. In addition, we reduced our headcount Canadian banking by 528 FTE this year, mostly through attrition and a similar number last year. The expenses this quarter were up 3%, largely driven as was pointed out by some of the seasonal timing of marketing and particularly higher technology related costs. We are continuing to invest in our digital channels, as Dave mentioned, and also to invest in automating and simplifying our processes to improve the pain points for our clients and our employees. We are obviously continuing to manage our overall costs given the margin conditions as we want to continue to invest in the business. We are going to continue to target operating leverage of 1%-2% for the full year and drive our efficiency ratio further down over the medium term, notwithstanding the challenging interest rate environment. But a reminder that through the year, the seasonal factors impacting revenue and expense trends can create fluctuations in operating leverage and efficiency ratio. Do you think that kind of operating leverage is attainable over a medium term when you have already got a 44% efficiency ratio? How far down do you think that ratio can go? Yes, because as even Janice Fukakusa pointed out, we think there are more efficiencies through technology investments that we can gain. The challenge is really going to be on the revenue side given margin compression. Rob Sedran, it's Dave McKay here. I would add that you look at the interest rate environment of absolute low rates, but very high prime BA spreads. That plays against the construct of our balance sheet more than any other bank on the street given the very high core deposit base that we have and the relatively high proportion of fixed rate mortgages that we have. That creates a more difficult revenue environment. As you start to see that shift in the last couple of months towards slightly higher base rates as BAs go up and compression, as Jennifer Tory just mentioned of your prime BA spreads, which really affects your variable rate lending book. That plays a little bit more into our strength than others. It's been a difficult year balance sheet-wise as far as margin compression for Jennifer Tory's business, as she mentioned from an overall macro environment, rates environment, but also from a competitive environment, and that should alleviate a little bit going forward. That was one of the reasons why revenues compressed. We like the structure of our balance sheet with very strong core deposits and our deposit funding ratios being the strongest among the banks. It just didn't play into the rate environment as well, a fairly unique macro rate environment last year. Thanks for that. Thank you. The next question is from Gabriel Dechaine at Canaccord Genuity. Please go ahead. Your line's open. Good morning. Just wanted to ask a quick one of Doug. We got some color from Janice, but if you can talk about the current quarter trading conditions, how those are progressing compared to the quarter we just had. The next one would be for either Dave or Janice. A few of your peers with big U.S. businesses have quantified the sensitivity of their earnings to increases in U.S. rates. As you've acquired City National and roll that, you gave some guidance when you acquired City National about their rate sensitivity, but how does it fit into the overall business? Is there like a broad sensitivity you can give us that we can. Yeah. There. Okay. It's Doug. I'll start with the current quarter. I would say that the business environment overall is much more constructive than it was last quarter. I mean, last quarter we had an equity market where very difficult to issue into. We had clients' shares reducing in value. They weren't interested in selling at levels that the shares got to, and probably more importantly, credit markets, especially high yield in the U.S., was quite difficult. We're seeing a nice repairing in equities and firming up on the credit side. The new issue business is going better. Hydro One being an example. We've also had some good wins on the M&A side. We've had a nice win in the U.S. and Australia over the last 2 or 3 weeks. Yeah, it's considerably better than it was in August, September. Hi, Saif here. We've had a month now with City National, and we're really excited about the momentum that the business had coming into the close of the transaction on November 1st with their balance sheet growth and their client growth has been absolutely exceptional, and we spent the better part of the month starting to launch our synergy programs. As you point out, one of the largest synergies in this transaction, we'll spend a lot more time on this in the City National Investor Day in March, is the asset sensitivity of the balance sheet to a higher U.S. rate environment. That was a big part of the trajectory of the earnings that we saw. I can refer you back to a September disclosure by City National, where they disclosed some of the asset sensitivity of their current balance sheet that they had at the end, I believe of, at least it was Q2. They disclosed that in a rate environment that goes up 200 basis points. As you bleed those higher rates into that portfolio, by the end of the second year, they disclosed an asset sensitivity of U.S. $279 million. So very significant sensitivity. I think that's beyond what we disclosed in January. Again, reflecting both the accelerated growth of the balance sheet and the client success they're having, and the short duration of their asset profile leads to very significant asset sensitivity in the context of their overall current earning structure. So a very exciting part of the synergies and the trajectory of this business, U.S. $279 million. How would that compare to the existing Royal Bank business? Is it similar? Is it more? Just trying to get a sense of the full picture, not just City National. Right. Great question. We do have a significant amount of sweep deposits on our U.S. wealth management franchise that would, as we unlock the value of those, and again, we require the City National acquisition to really get after the use of those deposits and unlock the true value of those sweeps over time. But certainly that deposit base would have an asset sensitive. I don't think we've disclosed that and calculated that. Again, it's a meaningful part of the overall earnings potential of our existing U.S. wealth franchise. When you combine the two business together, they both bring fairly material asset sensitivity and interest rate increase earnings potential to RY. Okay. I think it would be helpful if once it is settled down the integration a little bit, you can give us a bit of a picture there and some rules of thumb for 25 or 100 basis point shift that keep it simple, stupid stuff. We like that. Thanks. Thank you. The next question is from Doug Young at Desjardins Capital Markets. Please go ahead. Your line is open. Hi, good morning. Just on the wealth management business, and I think Janice, you mentioned just a few points. I think you mentioned there is a CAD 21 million, correct me if I am wrong, restructuring charge coming in Q1. Just wondering because I thought that was going to be done at the tail end of this year. Just wondering what is dragging into next year, and then are we done? Then more broadly on wealth management, if I exclude the restructuring charge, I think, and correct me if I am wrong, earnings increased 3% year-over-year, but obviously your assets were up quite nicely, and I think you have had less transactional activity and issuance activity or something as such. If you can just enlighten me and maybe kind of guide me in terms of how to think about modeling out or thinking about earnings growth. Then maybe in the same context, what does City National add to that potential in the wealth business? Thank you. Okay, great question, Doug. What I said about the remainder of the restructuring, it would be about CAD 20 million to CAD 25 million of additional expense after tax that we would be taking in Q1. It is in relation to the fact that we are going as fast as we can, but it is a big and complex project, so there was some overhang into the next fiscal year. If you look at our core wealth management earnings and to some degree, adjust out a lot of the noise that's happening, we do believe that despite the fact that markets did turn down towards the end of the year, there was earnings growth in our core businesses in wealth management, and we think that as we go through the next year, you'll see more of that core earnings growth because less of a preoccupation on what we've been doing around international wealth management. Yeah. It's Doug Guzman. I can add to Janice's comments as well. I think what's been previously disclosed in relation to the restructuring program is that we were largely complete, and so this is moving along that spectrum. And is consistent with our expectations for the overall execution of the program. If you'd look back to when we started at our estimate of the cost and timing has been very accurate. It's been quite well executed. You shouldn't view the 20 to 25 as additional to what was anticipated before, but rather, as Janice says, the sort of completion of the last set of activities that are currently contemplated. Part of my job is to come in and take a fresh look at things. So I'll be doing that, at the whole business, but you should regard that program as having been well executed in the last bit, is pretty much the completion of what we talked about before. And Doug, with respect to your question, how does City National fit into overall wealth management? We decided to organize around one client, which is the high net worth, ultra high net worth client in the U.S., putting together our existing U.S. wealth franchise with the City National franchise, who serves a very similar customer on the wealth side. In addition, City National serves a very strong commercial customer and links those two together. And that organizing philosophy around one bank, one client is consistent with how we think about our franchise globally, particularly in Canada. So given the client they serve, it belongs in the wealth franchise and will roll up overall to our global wealth business because of the customer franchise that it serves. So that's where it belongs for now, and that's how it's going to be managed. Russell will report into myself directly, but the results will show up in the consolidated global wealth segment. When I think about looking forward, should we expect the margins that have to, and I believe it's the case, but is there potential for margin improvement in wealth as you integrate City National? Is that the way to think about it? Certainly with respect to our U.S. wealth business, as we look to expand our client wallet and increase the revenue, for sure. Then we look at cost efficiencies from the functional side across the two businesses are both primary opportunities. But this is first and foremost a revenue growth strategy and a cross-sell and deeper client relationships with a larger product shelf. Secondary, it's leveraging the sweep and cash deposits that are in the wealth franchise. Tertiary, it's a cost opportunity across the infrastructure side. So yes, in that order. Okay. Thank you. Thank you. The next question is from Sohrab Movahedi at BMO Capital Markets. Please go ahead. Your line's open. Thank you. Maybe Dave or Janice, when you look at the financial targets that you have, and as we think ahead, what is the basis, for example, for the EPS growth target? Is it the CAD 10 billion, or is it an adjusted number that is lower? How should I think about the atypical movements in the business mix this quarter of Capital Markets and the Corporate segment? Right. Good question, Sohrab. I think that when you look at our target for EPS growth, it is obviously going to be impacted by the share issuance we did on acquisition of City National. We also look at sort of EPS growth target as a proxy for earnings growth target going forward in the medium term. It would be growth based on where we sit today and what is achievable in the medium term. So that would be the basis given our current trajectories and how we look at the medium term in terms of our outlook, our business mix, taking into consideration the things Dave talked about the growth potential we have with, for example, City National and our solid performance in all of our underlying segments. We believe we can achieve the medium-term objectives as set out in our annual report. But there will be some pressure on EPS definitely in the short run because of the issuance. Right. Just to be clear, Janice, I am not suggesting this is an annual target, but if we were going to start the measurement period today and look ahead, the starting point is the CAD 9.9 billion adjusted net income? Mm-hmm. Yeah. That's how we're looking at it, and these are absolutely not annual financial targets. They are about the medium term. As you know, there is movement without, and that's why we look at a medium-term objective and not setting annual guidance. Perfect. That's very helpful. Now, maybe this one's, again, for Dave or Janice. When you think about this medium-term target, if you think over the next, I don't know, couple of years, where do you think the primary driver of the leverage is going to come from? Is it going to be on the revenue line, or is it going to be on the expense line? I would say it'd have to come from both. It's a good question. We're certainly excited about the growth opportunities of our Capital Markets opportunity, Capital Markets franchise, and our Wealth franchise with City National in the U.S. and capitalizing on a strong U.S. market. That presents a very strong revenue growth opportunity. We have a very balanced and strong Canadian franchise that whether the growth is in the Wealth side, Commercial side, Capital Markets, or Consumer, we are poised from a business perspective, from a geographic perspective to capture that growth in Canada. We've demonstrated that over a decade now, and we feel strongly about that. When you look at our ability to grow where we see pockets of growth globally, we feel very strongly, particularly with our North American franchise and an emerging business that Doug is building with I&TS and Capital Markets in Europe, albeit that could be a more prolonged play of economic recovery. But we're certainly investing for that long-term play. That really is where we look at the revenue side, there is an enormous opportunity digitally to look at efficiencies, to streamline customer processes, to redeploy our employees into higher value-added activities. That's an ongoing, longer-term secular opportunity to become more efficient. The last thing I would add is, you look at the delta on earnings from interest rate increase on our Canadian balance sheet, it's significant. With the largest, as I talked about in my speech, core deposit franchise on the consumer and business side that is seeing historically low compression in margins. As that accelerates in an eventual rising rate environment, that also gives us confidence in our long-term trajectory to meet those earnings objectives. I think you look at diversification, you look at our growth strategy in the U.S., you look at our ability to use technology, and you look at our balance sheet and our core deposit franchise are all reasons to be positive about these medium-term objectives. Thank you. The next question is from Meny Grauman at Cormark Securities. Please go ahead. Your line is open. Hi. Good morning. During the prepared remarks, you noted signs of stress in Alberta, and I am not sure if I missed it, but I am wondering if you could clarify what you are referring to, what you are seeing in the province. Yes. Certainly. It is Mark here. Thank you. I guess I would point to two things. One, as I have said throughout the year, one of the early warning signals we monitor is unemployment, and unemployment has moved up. That is obviously an economic impact for all of us in the province. The second point I mentioned is we did see some slight uptick in delinquencies in our card portfolio. I would say that is quite slight. It is less than 1% of our outstandings in our Alberta card portfolio. But because we are watching so closely, we did notice it, so we will now continue to monitor that going forward. Thanks for that. I am wondering, going to the expense side, a lot of discussion there. Definitely technology spending is in focus for Canadian banks and globally. I am wondering from your perspective, do you have any sense that Royal Bank has an advantage when it comes to technology spending in the current environment? We tend to think of scale as being important here. Do you believe that that is still an important factor in terms of being able to handle these expenses better relative to peers? Are there any other factors that would suggest that Royal has an advantage when it comes to meeting these significant challenges when it comes to technology spending? I would say there are two things that favor us. One, we started this journey probably earlier than many of our peers almost 7 or 8 years ago, and have been on a legacy system replacement technology build over a prolonged period of time, whether it is the retail credit transformation project, commercial projects. We started this a while ago, so we sequenced this over a period of time and got some of the big projects out of the way and are enabled to focus more on the digital projects now. I think I have talked about that many times over the last 5 years, and we feel that we have gotten a lot of heavy lifting done, but we have got a significant amount of work to do where others may be playing catch up on both those fronts. The second thing is scale. Technology costs for all of us is probably less for us with our purchasing power, but let us say it is even the same when the size of our income statement and our revenue line allows us to spend more than our competitors, and it is going to cost us the same to deliver many of these apps in the digital world or back office technology integrations or digital processes. I would say timing and scale are advantages. Thank you. The next question is from Peter Routledge at National Bank Financial. Please go ahead. Your line is open. Hi. Thanks. Probably a question for Janice. There is always a lot of talk about level of capital, but I want to ask a question about the cost of capital, particularly non-equity capital. You may have noticed there was a preferred issuance by one of your peers where we saw widening by about 2 times on spreads. NVCC sub debt spreads are wider by 90 basis points. Next couple of years, we will have bail-in. That is probably going to raise your long-term deposit funding cost by 20 to 40 basis points. I guess you are either going to pass this along to customers or shareholders, and I suspect more of it will go to customers. Do you think that is right? Am I right in that assessment? Secondly, if so, what are the implications for Canadian credit quality as loan yields move up? That is a good question, Peter, because you would have seen from our perspective that we do a lot of funding in the markets, and when we do funding, we try to fund 3 to 6 months ahead of our requirements so that we do not get caught in pricing pressures and have to replace that funding. When we look at our own funding spreads, because of where credit markets have been, they have widened out, but with our base book, we are still funding pretty much below the AA- equivalent of other financial service companies. I think that as we get more clarity around bail-in, we will have more clarity around the debt ratings. I think that that is a bit of an overhang for all of the Canadian issuers in terms of determining what the bail-in triggers are and that sort of stuff. But from our perspective, we are well aware of the potential for funding costs to creep up, and that is why we are totally focused on balance sheet optimization, looking at the correct returns, and making sure that we are never caught short in terms of our own funding needs and that we can satisfy them well in advance of when we have the requirements. I think that is how we look at the funding equation with all of the uncertainties. Thank you. This concludes our question and answer session today. I would like to turn the meeting back over to Mr. McKay for final remarks. I want to thank everyone for joining us this morning and also for your support and engagement over the past year as we've had very constructive dialogue, and certainly appreciate your questions. I'd like to take this opportunity at this part of the season to wish you and your families all the very best for a safe and happy holiday season. We'll see you in Q1. Thanks very much. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.