Earnings Call: Q2 2012

May 24, 2012

Good morning, ladies and gentlemen. Welcome to the RBC 2012 second quarter results conference call. I would now like to turn the meeting over to Ms. Amy Cairncross, Head of Investor Relations. Ms. Cairncross, please go ahead. Good morning, and thank you for joining us. Presenting to you this morning are Gord Nixon, our CEO, Morten Friis, our Chief Risk Officer, and Janice Fukakusa, our Chief Administrative Officer and CFO. 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 George Lewis, Head of Wealth Management, Doug McGregor, Chairman and co-CEO, Capital Markets, Dave McKay, Head of Canadian Banking, Mark Standish, President and co-CEO, Capital Markets, Jim Westlake, Head of International Banking and Insurance, and Zabeen Hirji, Chief Human Resources Officer. 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 Gord Nixon. Thank you, Amy, and good morning, everyone. As you can see from our results, we had a strong second quarter. Earnings from continuing operations were over CAD 1.5 billion, but more importantly, were CAD 1.8 billion, which is up 5% when you exclude the previously announced loss related to the acquisition of the remaining 50% of RBC Dexia. I would remind people that the lower the price that we paid for the other 50% of Dexia, the larger the accounting loss, or the reverse, if we had paid a premium, we would have reported a gain. These results, with the exception of the Dexia numbers, are very clean, and they reflect solid performance in Canadian banking, capital markets, insurance, and wealth management segments. Year-to-date, RBC has earned CAD 3.4 billion from continuing operations, or excluding the Dexia loss, CAD 3.6 billion, which is a return on equity of 19.3%. Our ability to continue to deliver strong results to our shareholders is a testament to the strength of our diversified business model and our ability to successfully execute on our disciplined growth strategy. Our results also reflect our strict discipline around managing costs and risks and our commitment to maintaining a strong capital position, all of which are key to RBC's operating philosophy and especially important in today's environment with market and economic uncertainty. Our Tier 1 ratio now stands at 13.2%, which is up 100 basis points from last quarter, primarily driven by the sale of our U.S. retail operations, which closed on March 2nd. As noted on slide six, we already meet the Basel III capital requirements, which become effective in the first quarter of 2013 for Canadians and 2019 for the rest of the world. Our estimated Basel III pro forma Tier 1 capital equity ratio is 8.3% based on our current interpretation of the rules, which of course have yet to be finalized. Our financial strength remains a clear competitive advantage in today's environment. We have financial flexibility. We continue to take a measured approach to capital deployment and strive for optimal balance between investing in our businesses for long-term growth, returning capital to shareholders, and pursuing select acquisitions. I'd now like to turn to our businesses. Canadian banking had another strong quarter, accounting for over half of RBC's total earnings. Our consistently strong results clearly demonstrate our continued ability to capture a disproportionate share of market growth by successfully leveraging our superior cross-sell ability and unparalleled distribution network to better serve our customers. While our target is to grow volumes at a 25% premium to the market, last quarter, Canadian banking delivered a 50% volume growth premium to our peers and achieved new highs in customer loyalty measurements. I'm pleased to note that Canadian banking was recently named best retail bank in North America by Retail Banker International, and Dave McKay won Retail Banker of the Year based on a criteria of exceptional performance and leadership, including our high levels of sustainable profitable growth. These prestigious awards are highly regarded within the industry and represents an exceptional level of achievement. RBC was the only Canadian financial institution to be shortlisted in five categories and the only Canadian financial institution to win an award. A key to RBC's success is our ability to provide customers with superior advice, convenience, service, and value for money. For example, in our commercial markets business, our focus on industry specialization and advice drove strong year-over-year growth in business loans of 9% and in business deposits of 11%. We are differentiating the customer experience through our focus on technology and innovation while continuing to drive efficiency. For example, our recently announced partnership with Shoppers Drug Mart, which has the number one loyalty program in the country, efficiently expands RBC's distribution through a unique bank offering. Additionally, we have improved our in-branch sales force productivity by 8% over the last 12 months while continuing to add new functionality to our online and mobile banking applications, such as our virtual Visa debit card. Overall, we believe the scale of our banking business provides an enormous potential to drive further growth and improve efficiencies, and Janice will comment on how we are effectively balancing costs as we invest to expand our leadership position. Moving on to wealth management, we had a strong quarter. We continued to extend our distribution and product strength, and we were recognized for many of those achievements. These included recognitions for our international wealth management business, specifically our world-leading trust capabilities, and for our Canadian business as well. Advisors rated our full-service Canadian wealth management business number one for the sixth year in a row, which underlines our success in increasing our share among high net worth clients in Canada. Our global asset management business continued its leadership at home with a strong RSP season and a record April for long-term fund sales in the face of volatile markets. This quarter, we continued to build on our existing strength in serving high and ultra-high net worth clients globally, including those from emerging markets, with the agreement to acquire the Latin American, Caribbean, and African international private banking business from RBS Coutts. Turning to insurance, we had another strong quarter. This business continues to make a consistent contribution to our diversified earnings stream and complements our overall retail offering by providing innovative client-focused solutions through our multi-channel distribution network. Moving to international banking, starting with RBC Dexia, we look forward to having 100% ownership as this is a strong business in an attractive sector, and we believe that we can leverage RBC's reputation, brand, and financial strength to win additional business, to improve the financial performance, and drive further growth. We expect this transaction to close in the middle of this year. In Caribbean banking, our performance continues to reflect the prolonged weak economic conditions, including reduced demand for business loans and a challenging credit environment, and Morten will discuss this later. We do believe that over the long term, this remains an attractive region for RBC, as we are the second-largest bank in the English Caribbean, and we have a strong brand presence. Additionally, the investments we have made in recent years to strengthen this business and integrate systems across the jurisdictions in which we operate is nearly complete and will enable us to improve the client experience and drive efficiencies. Finally, within the U.S. cross-border banking, we have now successfully transitioned our clients to our new banking platform in the United States, which was designed to meet the needs of clients following the sale of our U.S. retail banking operation. This foundation provides exciting opportunities as we believe that RBC has a competitive advantage being the only bank of scale that can offer cross-border clients the accessibility to seamlessly manage, view, and transact banking accounts on both sides of the border in a totally integrated manner. Moving to capital markets, we had another strong quarter of earnings. Our results were driven by increased client activity and favorable market conditions throughout most of the quarter, and we continue to see strong business activity. We are successfully leveraging the strength of both corporate and investment banking and global markets, including our loan book to deepen our client relationships, and we led a number of notable transactions this quarter. For example, we acted as lead financial advisor and book-runner in Apollo's $7 billion acquisition of Apache's exploration and production company, and joint book-running manager on the related credit transactions. This was one of the largest energy leveraged buyout transactions in history. We also acted as financial advisor to Switzerland-based Glencore International, the world's largest integrated producer and marketer of commodities, on its $7.5 billion acquisition of Viterra, Canada's leading grain handler, and provided the debt financing to Glencore as part of the transaction. The acquisition represents the largest Canadian M&A transaction since August of 2010 and the second-largest global M&A transaction in 2012 year-to-date. As many of you know, we are hosting a Capital Markets Investors Day on June 1, where you will hear directly from Doug and Mark on their strategy and their outlook for the business. To conclude, our results in this quarter continue to demonstrate RBC's earnings power, driven by our leading market positions, diversified business mix, strong capital position, and prudent focus on managing risks. Going forward, we are well-positioned to continue extending our lead in Canada and build strong client relationships in select U.S. and international markets while delivering long-term growth to our shareholders. Notwithstanding challenging issues around the globe, we have aggressively restructured our operations. We've reallocated capital away from underperforming assets. We've de-risked the balance sheet, and we feel all of our businesses are well-positioned, and for the most part, are performing very well. With that, I will turn it over to Morten. Thank you, Gord. Starting with credits on slide 9. While we saw a modest uptick in provisions this quarter, overall credit quality remains sound. Provision for credit losses from continuing operations increased 9 basis points or CAD 81 million from the prior quarter to 39 basis points or CAD 348 million. This increase is in part a reflection of seasonality and volume growth, and it was driven by provisions in our Caribbean wholesale and retail lending portfolios, as well as provisions on two accounts in each of our corporate and Canadian commercial portfolios. I want to emphasize that the watchlist is at a low for the corporate book, and we see no evidence of weakening in the wholesale books overall. With respect to the CAD 7 billion Caribbean loan portfolio, as we have previously highlighted, given the region's dependence on tourism from both North America and Europe, we believe that until we see a more sustained global economic recovery, the credit environment will likely continue to be challenging. With respect to gross impaired loans, the pace of new impaired loans formations at CAD 471 million increased compared to the last quarter but is at the low end of a recent historical range. Turning to our retail portfolio on slide 10, impaired loans are down CAD 40 million quarter-over-quarter. Overall loss rates remained relatively stable at 34 basis points of PCL, down from 35 basis points last quarter. Provisions on residential mortgages at one basis point are consistent with our historic performance, and we continue to actively monitor and stress test this portfolio. With the housing market discussion, while there's general concern over the pace and scale of condo development, I want to emphasize that RBC's total exposure to high-rise condo construction is spread across a significant number of projects and remains manageable at just under CAD 1 billion of outstanding loans, representing less than 3% of our commercial loan book. Turning to slide 11 on European exposures, we continue to follow market events very closely and manage our exposures accordingly. Compared to last quarter, our net exposure to Europe was down approximately CAD 1.7 billion, primarily reflecting ongoing risk management and balance sheet optimization. I will point out that our net exposures do not yet reflect the securities exchange related to the acquisition of the other 50% of RBC Dexia, as they report risk exposures on a one-month lag. The securities exchange announced at the time of the agreement to purchase the rest of the ownership of RBC Dexia has allowed us to effect the de-risking of the investment portfolio in that business, immediately reducing the level of European exposure and causing a general shift to lower-risk assets in that portfolio. Overall, we continue to transact in a prudent manner and remain comfortable with our exposures in Europe, which are with well-rated counterparties mainly located in larger European countries. Turning to market risk, average management VaR was $37 million, down $3 million over the last quarter, and stressed VaR, which is calculated using the data from the most volatile historical period, was $60 million, down $5 million over the last quarter. Both measures reflect ongoing risk reduction activities during the quarter. We had a total of four days with net trading losses during the quarter, with no losses exceeding VaR. The largest loss of $6 million occurred on April 30th, reflecting increased market volatility towards the end of the quarter. With that, I'll turn the presentation over to Janice Fukakusa. Thanks, Morten Friis, and good morning. Turning to slide 13, as Gord Nixon mentioned, we had a strong second quarter with earnings from continuing operations of over $1.5 billion. Excluding the RBC Dexia after-tax loss of $202 million, net income from continuing operations was $1.8 billion, up $83 million or 5% over last year. Overall, it was a very clean quarter, and I will briefly review the performance of our business segments. Canadian banking net income was $937 million, up $42 million from last year. Excluding the prior year gain on the sale of Visa shares of $21 million after tax, earnings were up 7%, reflecting continued strong volume growth of 9%, mainly driven by business and personal deposits and residential mortgages and business loans. Second quarter results in Canadian banking are impacted by seasonality, including fewer days in the quarter, and this was a key driver of the 6% decline in earnings over the last quarter. Looking at slide 16, net interest margin was down 3 basis points compared to last quarter, mainly due to the continued low-rate environment. Operating leverage this quarter strengthened. Excluding the prior year gain on Visa shares, operating leverage was positive at 1%, and we remain focused on costs to maintain this improving trend in the second half of the year. We are committed to driving our efficiency ratio down to the low 40s over the medium term, and we are seeing good progress from a number of initiatives underway in Canadian banking. For example, we are seeing continued savings from conversion to E-statements, with approximately 75% of the accounts converted. Turning to wealth management, we earned CAD 212 million, excluding the favorable accounting and tax adjustments of CAD 26 million after tax in the prior year. Earnings were up CAD 11 million or 5%, driven by higher average fee-based client assets, partially offset by lower transaction volumes, reflecting continued investor uncertainty. Compared to last quarter, earnings were up CAD 24 million or 13%, mainly due to higher transaction volumes on improved market conditions, particularly in the early part of the quarter, and higher average fee-based client assets from capital appreciation and increased net sales. Moving to insurance, net income of CAD 151 million was up CAD 28 million or 23% compared to last year, driven by volume growth across most products and lower claims costs in the Canadian insurance products. Compared to last quarter, earnings were down CAD 39 million or 21%, as last quarter's results included net investment gains. Lower results from our U.K. annuity business this quarter and unfavorable actuarial adjustments also contributed to the decrease. International banking had a net loss of CAD 196 million. Excluding the RBC Dexia loss, net income was CAD 6 million, down CAD 40 million from last year and down CAD 18 million from last quarter, driven primarily by higher PCL in Caribbean banking, which Morten discussed. In capital markets, net income was CAD 449 million, up CAD 43 million or 11% from last year, driven by higher trading revenue and solid corporate and investment banking revenues, reflecting favorable market conditions throughout most of the quarter. Earnings were flat from the prior quarter as strong growth in equity and debt issuance and higher equity trading was more than offset by lower loan syndication activity and a higher effective tax rate reflecting increased earnings in higher tax jurisdictions. Overall, we are very pleased with our strong performance this quarter. At this point, I will turn the call over to the operator to begin questions and answers. Please limit yourself to one question and then queue so that everyone has an opportunity to participate. Operator? Thank you. We will now take questions from the telephone line. If you have a question, please press star one on your telephone keypad. There will be a brief pause while the participants register. We thank you for your patience. Our first question is from Robert Sedran of CIBC. Please go ahead. Hi. Good morning. I just want a quick question on the loan loss side. I guess, you touched on the Caribbean losses, but I'm curious if you're seeing any We hear a lot about consumer debt. We hear a lot about the Canadian numbers. We're starting to see loan losses back up. I'm just curious if you're seeing any underlying trends in terms of stress in the Canadian portfolio beyond some of the larger commercial losses you saw this quarter. I would say the loan loss performance for this quarter in the Canadian portfolio is a combination primarily of seasonality and volume growth. As I commented, I think actually seeing on a basis point level the level of provisions remain constant quarter-over-quarter is indication of good credit quality. The level of total impairment is down for Canadian banking. We continue to see very strong and consistent performance in the retail portfolios. I think what all the attention is about is the risk of the impact of a stress event on the Canadian portfolios. The performance that we see given actual performance of the economy continues to be very strong. The residential mortgage book, in my view, gets a disproportionate amount of attention. Level of impairment there is relatively flat. The loan loss provision at one basis point is as good as you can expect it to get. I'm watching, frankly, more the unsecured portfolios, whether that's card or the RCL portfolios, which also continues to be stable from an overall quality standpoint. I would also add that when you look at the wholesale portfolios, if you look at the Canadian wholesale commercial book, we had two accounts that really represented the increase in provision with the specific provisions. One was a real estate-related Western Canadian project that's been problematic for quite some time for reasons entirely related to the project itself and not housing demand. The other account was a fraud. Losses are losses, but the point is there's nothing systematic about this. The size of the watchlist, as I commented on, is at a stable and a low level. I would say that for the corporate book, again, we had two accounts generating the overall PCL for the quarter. The overall level of provisions, I think 27 basis points of the Capital Markets book is low and consistent with previous quarters. Again, we do not see any evidence of inflow of new problem accounts in that book. So it is a very active market. These things can turn quickly. Based on current stats, I would say outside of the Caribbean, the portfolio quality is strong, sound, entirely consistent with our expectations and I think very encouraging. The Caribbean performance is disappointing. I would emphasize it is a small portfolio of CAD 7 billion. We probably have another quarter or two of issues to work through there. Assuming that we can see a resurgence in economic activity in that region, it is a region that has very good earnings, high margins from that portfolio. We hope that the level of impairment losses will reduce there over the coming quarters. But it remains the one source of some disappointment for us. Is it fair to say that the number this quarter, overall provision number this quarter is just you are comfortable it is quarter-over-quarter volatility and you are not too concerned that things are turning? If you see that overall provisions at 39 basis points for the total loan book is very strong performance. We would expect in a normal environment to be in the 40-50 basis points. If we are better than that reflects very strong performance in my view. Great. Thank you. Thank you. Our next question is from Peter Routledge of National Bank Financial. Please go ahead. Thank you. We are reading this morning European officials are reported to be developing contingency plans for a Greek departure from the European Monetary Union. Realizing that is probably an unprecedented event and Royal has operations in Europe, what sort of contingency plans specific to a Greek exit has RBC taken or is thinking about putting in place? It is Morten. Maybe I can at least start with a response to that. We, and I think like a lot of other large financial institutions, have had a specific contingency planning effort underway to deal with the potential breakup of the Eurozone. We have, this is run out of London with the risk and business leaders in that market driving the effort. It is working through. We have a playbook, if you like, of all of the various options that we need to work through in the event of a Eurozone breakup. The process that team has gone through is to make sure they have identified all the various steps that need to be gone through in the event of us going from uncertainty to an actual exit. I would say that there is good clarity on the steps that we need to go through. And we have, as part of the crisis management process, the team there fully engaged. If you look at the actual risks that we are dealing with, I would put it in a couple of different buckets. First of all, if you look at our Capital Markets activity, our direct exposure to Greece, as you can see from our disclosure on the European exposure, is minimal. And our direct exposure to peripheral countries overall is quite small and very manageable. So for Greece exit, specifically, the first order impact that we have to deal with out of our Capital Markets business is actually fairly small. The other businesses in Europe that have some degree of activity, whether they have a modest amount of peripheral country exposure related to wealth management, entirely manageable, and I think small enough that we can deal with that on a one-off basis. Obviously, the investor services business under RBC Dexia has activities throughout the region. And again, they are part of the crisis management process and the contingency planning for dealing with that. So I hope that answers your question. How long have you been looking at this in depth? The effort for a specific crisis contingency management process has been ongoing since the fall of last year. It might be a little bit of an unfair question, but you could do everything right, Royal could do everything right, and then you just got to hope your counterparties have done the same amount of diligence on this. What is your thinking on that? Well, so I guess two points. Part of the process here is trying to make sure we have a contingency management process that allow us to respond to developments as they occur. I think one of the things that people have to understand is you cannot plan in advance the specific steps you go through because there are too many uncertainties about exactly how this will develop. So our approach to this is to make sure we have a thorough process to deal with all of the possible twists and turns this can take. I think from an exposure management standpoint, one of the more important points to deal with is to try to make sure that you identify areas of wrong way risk, so that to the extent that you have got direct exposures to counterparties that are most likely to be caught by this in a negative way, that you have reduced your exposure to those counterparties so you can manage both the first and the second order impacts of such an event. Just maybe for Mark. Mark, do you have any thoughts on how prepared or what Royal needs to be watchful for over the next couple of months? We've been reducing the balance sheet that's been applied to the trading businesses for some time. If you look at Q2 versus Q1, we've reduced VaR by about 7%. We've reduced stress VaR by 9%. A lot of that reduction has come in the European business. As Morten said, we've been stressing our counterparty exposures to breakup scenarios. We remain very cautious with respect to Europe, but it's not the same stress environment that we saw on a funding side this time last year. As I said, we remain extremely cautious. We've been reducing risk-weighted assets that we've been employing in the trading business and really focusing our activity around the origination side of the business. It's not the balance sheet trading business that we used to run pre-crisis. Given our focus today on origination, it's much more sales and trading around the origination effort with a smaller balance sheet. Where we do use balance sheet, it's much more focused around individual names that we support. Yeah, I would just add from a macro perspective, you've heard me say before, in terms of the management of our businesses, we manage these businesses hoping for the best, but expecting the worst, and we feel pretty comfortable about that. I think the real question is what would the impact be of European fallout on markets like the U.S. and global economic growth and those secondary impacts. Those are things that are much less predictable at this point in time. A lot remains to be played out. All right. Thanks for that color. I appreciate it. Thank you. Our next question is from Steve Theriault of Bank of America Merrill Lynch. Please go ahead. Thanks very much. Gord, you told us today that your Basel III Tier 1 common is up to now 8.3%, and thanks for that disclosure. So a couple of related questions. Yes, I would just add based on the current interpretation. Fair enough. Yeah. So a couple of questions. Does that include the full effect of IFRS phase-in? Secondly, how are you feeling with respect to returning capital to shareholders? Are you starting to get into the territory where you're thinking about activating something like a buyback program, or is it too early to even be discussing that at this point? Yeah. As you know, we increased our dividend in the last quarter, and I would say that I would, in today's environment, probably favor repatriation of capital through dividends, although buybacks are certainly things that we will factor into our long-term capital plans. I think that, as you've heard me say in the past, we've tried to take a very disciplined approach towards ensuring that we're deploying capital across our businesses in an effective manner where we're generating appropriate levels of return. As a result of that, as you've seen us restructure parts of our business, sell some businesses, reallocate capital from trading businesses towards investment banking businesses, et cetera, as well as continue to repatriate through dividends. I think going forward, you'll continue to see more of the same. I think it will, to some degree, depend on how quickly our businesses are growing and whether there are acquisition opportunities that enable us to deploy capital in that fashion as well. What I can assure you is we're going to remain very disciplined, and we will factor all three, business growth, acquisitions, and repatriation of capital, into our plans going forward. I think they will be adjusted accordingly based on operating environment and opportunity. The IFRS phase-in, does that 8.3 fully account for IFRS? It is without the phase-in, Steve. It is Janice. Okay. Can you quantify the phase-in at all for us? Well, I think it is quantified if you look at our annual report disclosure of the deductions, and it is a five-quarter phase-in, so effectively we will be earning into it by the time we get to Q1 of 2013. Okay. Gord, just to maybe interpret what you are saying, probably not buybacks this year, but maybe revisiting the dividend a little more frequently in that I think it has been sort of every third quarter since we have emerged from the abyss. Yeah. I would say that we will keep them both as options rather than to suggest we wouldn't necessarily utilize one. Okay. That's fair. Thank you. Thank you. Our next question is from Michael Goldberg of Desjardins Securities. Please go ahead. Thank you. Can you comment, Gord or Mark, on trading results since the end of the second quarter? Has weakness in Europe since then had any impact? Do you also expect any regulatory impact of the JP Morgan trading losses? I'll let Mark specifically address the trading business. In terms of our overall Capital Markets business, the calendar continues to be pretty solid, and as you know, most of our business is client flow-based and client-based business, and we've shifted more and more towards that over the last year or so. It continues to feel okay, although obviously these developments provide a high degree of unpredictability. But the overall environment remains okay. Specifically on trading, Mark? Yeah. Hi, Michael. Specifically to trading, we certainly saw strength in the first 2 months of the quarter, and April was certainly a little bit softer as Europe came back onto people's watch lists, and we started to see more of a risk-off type of mentality, which slowed the origination calendar down. However, having said that, we've seen a pickup certainly as we go through this month in origination activity. Our sales and trading focus, as I said earlier, is very much around supporting origination, and we see quite a significant multiplier effect coming out in sales and trading activity against new issue activity. So we've certainly seen a modest pickup from where we were in April. Having said that, going forward, certainly the second half of the year historically seems to be a little bit weaker than the first half of the year, but I think our business is different today than it's been in the past given the origination focus and the fact that we're continuing to use the loan book, and we're seeing good activity around that, not just in DCM, but also ECM activity as well. With respect to JP Morgan, Michael, it's certainly not helpful. I would hope that there's pretty unique circumstances, and I won't comment on JP Morgan, but they're very specific, and I would hope that public policy would not necessarily be simply directed because of one event within one institution. But as you know, this is a highly politicized environment in which we operate. But we continue to be very engaged in those discussions, and hopefully, smart policy will trump potentially good politics. But that remains to be seen. Okay. Just a brief comment. Can I suggest that in the future you hold another conference call, maybe a week after, when no other banks are reporting? Because frankly, with the huge amount of information you've released in the short time between the release and the call, it is really hard to ask any intelligent questions. Michael, I think that you might have an opportunity to actually do that in particular for Capital Markets during our Investor Day, which is Next Friday. I would reiterate, Michael, that we moved this call after our release early in the morning at the request of the analysts originally. I am not sure your views are consistent with your peers, and we always think your questions are intelligent. Thank you. Thank you. Our next question is from John Reucassel of BMO Capital Markets. Please go ahead. Thank you. Just for Gord, just on the JP Morgan. He was, right or wrong, widely viewed as one of the best credit or risk managers in the business. The loss just gives people a bad feeling about trading revenue. So can you quantify for us what percentage of the trading or mark is actually client flow related? Is it 99% or is it 60%? Or can you help us understand? Yeah, but before doing that, I think it's very important to clarify differences. Firstly, our Capital Markets business represents less than 25% of our overall activity. In the case of a bank like JP Morgan, it's not only a higher number. Where this trading loss occurred wasn't even in their Capital Markets business. It was in their CIO office, which we don't have the equivalent of. So if you actually add those two together, it's a very, very different relative size and profile. In addition to that, and again, I won't comment on JP Morgan, but the current claim is this is not trading. This was a hedging activity against their loan exposure. We don't undertake those types of activities. We don't have that similar type of business. So I think from a comparable basis, there's sort of no direct comparison. Our trading business is relatively small compared to our overall balance sheet and activities. As Mark said, the vast majority of it is client flow. On a percentage basis, Mark? Yeah. Most of the equity revenues is agency style income on the fixed income side of the business. It's probably in the range of 80%-85% is direct client flow versus carry on inventory. That's a significant change over the last few years. In terms of our global arbitrage and trading business, it's still within the 2%-3% range of revenues. That business is not comparable in any way. It's focused on extremely liquid short-term instruments and has seen quite consistent smooth results. I would reiterate, unless I understand this incorrectly, and I'm not an expert, but this was in their treasury, not in their capital. Absolutely, Gord. It was, and the distinctions you draw are important. It's just the trading business continues to get a bad reputation wherever it's located, right? I agree with that. But remember, every bank in the world runs a treasury. Yep. Fair enough. Okay. Thank you. Thank you. Our next question is from Gabriel Dechaine from Credit Suisse. Please go ahead. Hi, good morning. Just to go back on the excess capital issue, excuse me. Why not get rid of the DRIP, first of all? It seems like unnecessary dilution at this stage, given your capital levels. Alternatively, your name, Royal's been attached to a few asset management deals, potential deals during the quarter. Wondering how we should think of funding for acquisitions. Is it safe to assume that a fairly significant proportion could be excess capital deployment as opposed to new shares issued? Then last one on deposit growth. I'm just looking here in Canadian retail for Dave. It's positive. I look on a linked quarter basis. Maybe that's the wrong way, but that's how I look at it. It was positive, but it was the weakest level of deposit growth in the past four quarters. It was 4%, 4%, 3%, then 1% this quarter. Is that a reflection of anything in particular as in higher deposit gathering competition? What are you seeing out there? Thanks. Thank you for that question. With respect to the DRIP, I believe we are getting rid of it. I do not know whether we have announced that or whether we do announce it, but we appreciate your suggestion, but we are already there. Okay. With respect to the funding and the rumors, I would just emphasize a couple of things. Firstly, our priority with respect to any acquisitions or investment, as you say, is in the wealth management space very much geared towards the asset management business as opposed to the brokerage business per se. I say that just because there were certainly some speculation around non-asset management businesses. I would also say that when you look at our strategy and what we would be looking at, we have targeted acquisitions that would really be bolt-ons, if you will, and add to areas. We think we have got a very strong global platform in global wealth and asset management. There are some holes that we would like to fill if there were attractive investment opportunities. They would tend to be, I would say, on the reasonable sized spectrum. Therefore, our expectation is that we would, in all likelihood, fund anything simply out of our current capital and current earnings generation. By bolt-on, because one of the deals I saw $70 billion of assets. I assume you don't consider that a bolt-on. I'm not sure which one that would be, but I don't believe everything. Bank of America International. George, do you have any comments? Yeah, just on that, Gordon. I just echo Gordon's comments. To put CAD 70 billion in context, I am not sure what it is in reference to. We have over CAD 500 billion of AUA in our wealth distribution businesses and CAD 250 billion AUM in our global asset management businesses. What I would emphasize is if you look at our acquisition record over the last five years, which is a little over CAD 3 billion, that is basically been the earnings contribution from the wealth management platform. So we would anticipate going forward, adding to our existing businesses, using acquisitions to bolster our already strong organic growth, which we had a very strong quarter of CAD 11 billion of flows into wealth and CAD 6 billion in asset management, and would look to self-fund out of the wealth management segment any acquisition activity. That is helpful. Hi, Gabriel. It is Dave McKay here. Just to answer your deposit question, I think you have to be careful looking at quarter-over-quarter comparisons in Q2. As you know, seasonality, even in deposit gathering and in volumes, affects our quarter with less days. So it is really important to focus on the year-over-year momentum. And if we look at our deposit business, our year-over-year growth momentum Q2 to Q2 is accelerating across most categories, particularly GICs and our savings accounts. So you cannot really take the quarter-over-quarter growth in deposits or loans and annualize it to a new sustained rate. You have to be very careful about seasonality. So our deposit growth is still exceptionally strong, and our business investment in deposits business is growing at 12.9% right now, and that is up from 7.5% a year ago. So we are seeing very strong growth. Okay. Thanks for that. Thank you. Our next question is from Mario Mendonca of Canaccord Genuity. Please go ahead. Good morning. Two quick points to clarify. Janice, 8.3% common equity Tier 1 ratio Basel III. I suppose what you are saying is you have only accounted for the two quarters of phase-in but not the remaining three. Is that right? Yeah, that is right. I think your response to the question was you would expect to maintain the 8.3% by, say, early 2013 because you can earn into that amortization. Right. Exactly. Is the amortization per quarter something like 25 or 30 basis points? I think it could be closer to the 20, but I would have to get back to you because I cannot recall exactly. Okay. Thank you. The other clarification I wanted to go through is Mark Standish, you said that April was slightly, those are the words you used, slightly weaker than the previous two months. Can you help put some meat around that? Slightly came as a bit of a surprise to me. I would have thought that April would be, and not to put too fine a point on it, more like half of what any of the previous months would have been. Is that a fair characterization? No, it's not. We've continued to see through the quarter and into this current month, strong origination that's been driving our sales and trading results. If you look at slide 23, where you've got the geographic breakdown of revenues, you can actually see the improvement that we've seen coming out of our U.S. business in particular. That is where we continue to see some good business growth. I think when you look at that slide, you'll see where we've seen, I think, a bit of a pickup relative to others in the market is because we're enjoying, certainly in the case of the high yield market, strong activity in the U.S. You wouldn't want me to assume that April would be half of what the previous months would be. That might be a bit extreme, but I also get the sense you don't want to put a number around that either. That's correct. Okay. Thank you. Thank you. Our next question is from John Aiken of Barclays Capital. Please go ahead. Good morning. A quick question for Dave McKay. We have seen some fairly strong lending growth in the wholesale portfolio both year-over-year and quarter-over-quarter. Are we seeing a sentiment shift out there from businesses willing to borrow? As well, what impact is this having on the competitive environment that you are seeing? Yeah. Thanks, John. It is Dave. Absolutely, we are seeing very strong growth in our commercial and small business lending portfolios up 9% year-over-year, and we have seen growth accelerate in that portfolio over the last five quarters. I think the sector composition of that growth is really important and supports your question that we are seeing a very balanced growth across our portfolio, across all sectors. The growth that we have achieved year-over-year really reflects the overall average composition of our portfolio. So it is not over-indexed to commercial real estate lending. Commercial real estate would have comprised a third of that growth year-over-year, and roughly commercial real estate lending is a third of our commercial lending portfolio. So we are seeing good growth in wholesale, public sector, manufacturing, and ag across the board. So I think it does indicate an overall strengthening of commercial sentiment in the marketplace. Dave, the competitive factors that you are seeing? As you see, all banks have targeted this sector for growth. If you look at their disclosures, it is a competitive sector. Our market share that we provide in those slides is dated and reflects business results, I think one or two quarters ago. The last market share we have updated, I believe it is December market share. When we get the market share reflecting our 9% growth, we are hopeful that we have stabilized and turned around our market share, and we will wait to see those results over the next month. But it is a competitive marketplace on structure. Less on price, but more on structure. A very competitive marketplace right now. Great. Thank you very much. Thank you. Once again, please press star one if you have a question. Our next question is from Sumit Malhotra of Macquarie. Please go ahead. Good morning. First question is probably for Janice. Just to come back on the Basel III disclosure, wanted to make sure the 8.3% number, does that include the impact of the RBC Dexia transaction closing? If it does not, can you remind me what the number would look like with that in? Sumit, it's Janice. It does not include the RBC Dexia because it's as of Q2, and that would be, I think 20-30 basis points. Of course, it depends on the base. Right? We had sized it when we did the acquisition and the disclosure of the impact at, I think it was sized at about somewhere 20-30, but it's a ratio. Okay. It'll be incorporated when we close. We intend to close in Q3, then you'll see that dilution then. Okay, so we're probably looking, if you wanted to do a pro forma right now, it'd be closer to 8, I think is what you're telling me. Right. If we included that. Okay. For Dave McKay, I apologize if this came up previously, but just wanted to circle back on expenses in your business line. Two consecutive quarters of outright decline in expense is a very impressive result. If you could, and if I look at the year-over-year number, down to something like 3%. If you could just give me an update on what you're thinking here. Is the view that you still have the capacity to hold costs in line? I think your operating leverage is going to improve just because of some of the comparisons. Are there some investment spending requirements that we may need to see in the back half of the year? Great question. Certainly we're extremely happy where our cost controls come in to be able to generate a 1% positive operating leverage in a challenging margin environment. Our strong volume growth helps a lot too around those challenges. We're still targeting that 3% to 3.5% range. We may be able to keep it under 3%, but we have more leeway going forward as you referenced, in Q3 and Q4, our margin comps year-over-year become quite a bit easier. We saw that trend throughout Q2. When we went through February, March, April, we saw revenue growth grow throughout the quarter, giving us greater operating leverage as we moved through the quarter. As our NIMs move from 279 last year in Q2 2011 down to 275, that composition allows our revenue growth and our volume growth to move closer in tandem going forward. To generate positive operating leverage, we're going to have, hopefully, if all things hold, a greater opportunity to grow revenues a little bit higher than they were in Q2. And give us a leeway to potentially move up our operating costs. But again, we are very much targeting to keep it as close to 3% if we can. The reason I asked it in that way is that if you recall, Dave, and perhaps for Janice as well, in Q3 a year ago, I, and I suspect the market was somewhat caught off guard by a pretty sizable increase sequentially in expenses in the segment. At least from the tone I'm hearing from you, it doesn't sound like there's going to be anything that material that should surprise us, so to speak, in the second half of 2012. Fair statement? No. We don't see a lumpiness to the cost trajectory. You may see costs vary within a band. It's tough to maintain costs closely quarter to quarter in that sense. But we certainly see them in that band of around 3, maybe up to 3.5. But they could be down below 3, depending on the various marketing tactics and what the market bears. So quarter to quarter they vary, but we don't see a wide volatility going forward where they would bounce by 200 or 300 basis points or anything like that. I think last year, though, over 50% of that expense number was pension. If you back the pension out, it was down to closer to 3%-4%. So isn't that the case, Janice? Yes. I remember having a recollection here of you folks talking about a HELOC campaign you were running at that time as well, which boosted the advertising spend. Right. But as Gord mentioned, last year, the majority of the volatility occurred around pension expense running through our NIE. Without that impact this year, certainly the volatility will decrease. But we do not see, whether you launch a marketing campaign or not, we just do not see that type of volatility going forward. But we are watching our expenses closely in the face of more challenging business environment. Thanks for your time. Thank you. Our next question is from Darko Mihelic of Cormark Securities. Please go ahead. Hi. Thank you. Good morning. A question for Dave as well. There is an awful lot of consternation about the residential real estate market in Canada. Just wanted to get your view, what are you seeing on the ground with respect to values of the homes, your more recent appraisals on mortgages that you are underwriting? Are you seeing anything on the ground that would suggest that a lot of this rhetoric No, you can't generalize across the country. There are a couple of hot spots that are well documented in the market that we're watching closely. Everyone looks at the mainland Vancouver market and a little bit at the Toronto market for some hot activity on the ground. Obviously, we tailor our lending practices to those hot spots, and we watch them very carefully. But you can't really generalize across the country. It's very important that you maintain kind of a regional and, at times, city-specific strategy. We watch those markets carefully. There is a lot of rhetoric. There is a lot of anecdotes of foreign money coming into the marketplaces that are creating strong bidding wars. There's a lack of supply issues, particularly on single-family homes in the GTA that are driving up prices as land's not being released or service land's not there. The starts aren't there. You're driving people into bidding wars on single family and into starts on multi-family residential. They're all part of a number of planning exercises that cities go through to densify cities like Vancouver and Toronto. The activity you're seeing is not inconsistent with the market stimulus out there and what's happening on the ground. But it is demand-driven. I mean, it really is demand-driven, whether it's foreign money or lack of supply. But when you lend in today's environment, your appraisal process is not coming back to you. You're not looking at the appraisal process today and saying, "You know what? These houses today, we should take a haircut." Nothing like that has crept into your thinking. Is that- No, we have tightened our appraisal process and made sure that we're getting an accurate read because you're absolutely right. When you think you have an 80% loan-to-value ratio, you want to make sure you have an 80% loan-to-value ratio. We have reviewed our appraisal practices and processes and have tightened in certain areas. Whether that's increasing more drive-by appraisals or full appraisals on properties is all part of the options that we have in looking at how we manage the valuation of the properties we're taking as collateral. Has the tightening of the appraisal process, and sorry to dig away at this, but has the tightening of the appraisal process had an impact? Off the top of my head, I can't tell you. I'd have to go back and look at that. When you look at our volumes and our approval rates and the quality of customers that are coming in, I would say that the average quality of our applicants has been increasing in the mortgage portfolio, and that's some of the stress testing that we've done around that, too. There doesn't seem to be any sign of that, but I'd have to go back and look at the appraisal question specifically. Nothing's come to my attention. Okay. That's helpful. Thanks very much. Thank you. This concludes the question-and-answer session. I would now like to return the meeting over to Mr. Nixon. Okay. I would just like to thank everyone for their participation. I would also just quickly come back to Michael Goldberg's question. I do not mean to slough it off quickly. We did move this meeting at the request of analysts because so many of the banks get backed up one after the other. If people have views with respect to its timing and ways to improve it, we are certainly prepared to listen to that, and Amy Cairncross will follow up with a few, and perhaps anyone who would like to is free to follow up with Amy Cairncross as well. But we appreciate everybody's participation, and we look forward to speaking with you at our next conference call. Thank you very much. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.