Earnings Call: Q1 2012

Mar 1, 2012

Good morning, ladies and gentlemen, and welcome to the RBC 2012 first 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 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 will be one hour long and end promptly at 8:30, as this call is followed by our annual general meeting. 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 of Capital Markets, Dave McKay, Head of Canadian Banking, Mark Standish, President and Co-CEO of 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 very much, Amy. Good morning, everyone. Thank you for joining us, and we hope that you're able to join us following this conference call at our annual general meeting. As you can see from our results, we had a very strong start to 2012, with first quarter earnings from continuing operations of over CAD 1.8 billion. We had a record quarter in Canadian Banking, with earnings of nearly CAD 1 billion. Capital Markets had a very strong quarter, and we also had continued strength in our insurance business and our wealth management platforms. I'm pleased to report today that we also announced a CAD 0.03 or 6% increase to our dividend, bringing the quarterly dividend to CAD 0.57. I should also mention that the sale of our U.S. retail banking operations is expected to close tomorrow, and in anticipation of this, we have converted our cross-border clients onto our new U.S. banking platform, which we're very excited about. Our results this quarter continue to demonstrate the strength of our long-term strategy based on generating approximately three-quarters of our earnings from retail and the balance from wholesale. Looking ahead, and based on our five-year strategic plan, our retail platforms should continue to deliver solid growth. While we expect the contribution from Capital Markets to continue to grow and be strong, the percentage of overall earnings from wholesale is forecasted to trend down from the mid to the low 20s. We are a premier investment bank with a leading position in Canada, a strong and growing presence in the United States, and a highly selective focus outside of North America based on our competitive strength, which include things like global energy, mining, and infrastructure. This focus strategy is working extremely well, and we believe that Capital Markets will continue to provide the right balance from both an earnings and risk diversification perspective. I point this out because, as you know, Moody's recently placed our long-term credit rating under review along with 16 other firms, simply because we are deemed to have significant global Capital Markets activities. In our view, we're being reviewed because of our profitability and success in this business rather than due to specific performance or risk concerns. Our credit ratings and capital base are amongst the strongest of all banks globally. Our ratings are amongst the highest of all institutions placed under review by Moody's, and our metrics and risk profile are entirely different. The relative percentage of our wholesale business is in the median of our Canadian peers and well below the others being reviewed. Over the past three years, our Capital Markets segment has been consistently profitable and has not incurred substantial losses, something that is not the case with other large global banks or even other Canadian banks. Our return on equity from this business has averaged 19% over the past three years and earned approximately 17% in 2011. While we were surprised to be included in the review, we certainly look forward to our discussions to assist Moody's in understanding our business today and the steps that we have taken to optimize our balance sheet to reduce risks, and as well, to adapt to the structural and regulatory changes that are occurring or have occurred in the marketplace. Turning to the first quarter, we saw improved Capital Markets conditions in the quarter, driven by some positive economic data, as well as the impact of coordinated efforts by global central banks, including the ECB, to provide additional liquidity to the market. Though we are encouraged by the improved market conditions, we believe the underlying global Capital Markets remain fragile, reflecting unstable economic conditions in the United States, and particularly Europe. Within this context, our objective is to ensure that RBC is well-positioned to continue to grow earnings while maintaining a strong capital position and adhering to our strict risk management practices. In the first quarter, we continued to deliver against those objectives. On capital, we generated a strong Tier 1 capital ratio of 12.2% and Tier 1 common ratio of 9.6%. With this strong financial position, we already meet the fully implemented Basel III capital requirements today, and Janice Fukakusa will expand on how we are transitioning over the next three quarters. With respect to Europe, we continue to follow the events closely and manage our exposures accordingly. Compared to Q4, our net exposure to Europe was down by approximately CAD 2 billion, primarily reflecting ongoing de-risking activities, as well as a shift of capital from trading businesses into the corporate and investment banking segment. On the domestic front, there has been considerable media coverage on consumer leverage, as well as the rapid rise of Canadian house prices over the last few years. I'd like to briefly provide our perspective on this issue. With respect to consumer leverage, while the absolute number is high by historical standards and is driving much of the media, it is important to look at consumer debt service ratios. These levels are within our historical and normalized range and clearly indicate that our clients have the ability to continue to service these debt levels. Overall, we believe the Canadian housing market continues to fare well, and we do not see any major cause for concern. Housing affordability remains at reasonable levels in most markets, and we're keeping a close watch on certain pockets where the price appreciation is above the long-term average. There may, for instance, be some vulnerability in the condo markets of Vancouver and Toronto, but as I have said before, we have very limited exposure to these markets. As Morten Friis will highlight in his remarks, we have a strong adjudication process. We actively stress test our credit metrics and continue to demonstrate strength of our portfolio. In addition, we only originate through our proprietary channels. Turning to the performance of our businesses. Canadian banking had a record quarter with earnings of just under CAD 1 billion, which represent more than half of RBC's total quarterly earnings. These record results were driven by growth across most businesses, with volumes up 9% over last year, clearly demonstrating our leadership, even in a slow-growth environment. Once again, we achieved these results while demonstrating margin stability. We continue to expand our client reach and invest in technology and innovative solutions to improve the client experience. For example, we recently announced a banking partnership with Shoppers Drug Mart to offer a co-branded RBC Shoppers Optimum banking account and debit card with enhanced Shoppers Optimum rewards. We are continuing to prudently invest for the future with a strong focus on managing costs, and Janice Fukakusa will expand on this in her remarks. Overall, we believe the scale of our Canadian banking business provides enormous potential to drive further growth and improve efficiencies while extending our leadership position. Moving on, wealth management had a solid quarter given the continued challenges in the market and ongoing client uncertainty, especially in the early part of the quarter, which then improved as the quarter moved on. We are investing in the long term by building our brand and improving our client offering. The success of our strategy is evident in a couple of recent industry awards. RBC Global Asset Management and PH&N were recently awarded the top Lipper Awards for the sixth consecutive year, and we ranked top 10 in Euromoney survey for trust services globally. Turning to insurance, we had another strong quarter. This business continues to make consistent contribution to our diversified earnings streams and complements our overall retail offering. Moving to international banking. Although both businesses continue to face near-term headwinds in their respective operating environment, the long-term prospects remain favorable. In the Caribbean, we have a strong brand and continue to focus on integrating operations. In RBC Dexia, this business ranks among the top 10 global custodians, and we continue to expand our capabilities to strengthen and grow our client base. We remain committed to the investor services business as it is very complementary and fits with our long-term strategy and diversification. We continue to have discussions with our partner, Dexia, and we hope to conclude negotiations shortly. In capital markets, we had strong results in our fixed income trading businesses in the U.S. and Europe, driven by improved credit spreads and client volumes, particularly in the latter part of the quarter. We also had solid growth in our origination and loan syndication business, and we continue to add quality names to our loan book. Our investment banking pipeline remains strong, and we are hopeful that the stable market environment, which drove increased client activity this quarter, will continue. To conclude, our results this quarter demonstrate the earnings power of RBC, driven by our leading market position, diversified business mix, strong capital position, and our prudent focus on managing risk and cost. While many global banks are being forced to restructure and withdraw from certain markets, RBC is well-positioned from a competitive perspective, and our financial strength sets us apart and provides us with flexibility to continue executing our long-term strategy. With that, I'll turn it over to Morten. Thank you, Gord. Starting with credit on slide 8, overall credit quality improved compared to the prior quarter. Provision for credit losses on impaired loans from continuing operations improved 2 basis points, or CAD 8 million from the prior quarter to 29 basis points, or CAD 268 million. This improvement was largely driven by lower provisions in our Caribbean retail lending portfolio and our Caribbean and Canadian commercial portfolios. In our corporate portfolio, we had a provision on one account resulting in a net provision of CAD 17 million, a CAD 12 million increase over the last quarter. We also had a moderate increase in provisions in our residential mortgages and secured personal lending portfolios. Turning to our retail portfolio on slide 9, loss rates are relatively stable across all products, and the credit quality of our portfolio remains sound. As highlighted on slide 10, our mortgages are well-diversified across Canada, and approximately two-thirds are uninsured. The loan-to-value on our uninsured mortgage book is 50% based on outstanding balances and adjusted for the provincial housing price index. Our proportion of insured mortgages is lower relative to our Canadian peers, and there are a few reasons for this difference. Our mortgage loans are originated strictly through our proprietary channels, and we do not use the third-party mortgage broker channel, where you tend to see a higher proportion of high-ratio mortgages generated. Also, some of our peers make use of portfolio insurance sold by the Government of Canada-approved mortgage insurers for purposes related to credit risk, and this would increase their proportion of insured mortgages relative to ours. With respect to underwriting standards, we have a strong and disciplined credit adjudication approach, and we maintain a consistent standard throughout the cycle. Our mortgage portfolio continues to perform well as our loss rates remain low and are within our historical long-term range of 1 to 3 basis points. We stress test our portfolio for shocks in housing prices, unemployment, and interest rates. These tests confirm that Canadian residential mortgage portfolio, as well as the broader retail portfolios, can withstand even dramatic movements in these parameters. Moving on to condominiums, there may be some vulnerability in certain markets, as Gord commented. Our exposure here is modest. Mortgages on condos represent less than 8% of our residential mortgage portfolio. Our exposure related to high-rise condominium construction is spread across a significant number of projects and is only CAD 800 million, or less than 3%, of our commercial loan book. These loans require sufficient qualified pre-sales to cover the risk of market acceptance of a project and minimum purchase deposits to ensure buyers close their purchases when buildings are complete. Moving on to Europe on slide 11. As Gord mentioned, our net exposure has declined by approximately CAD 2 billion or 5% from last quarter, mainly driven by a reduction in European trading securities this quarter, which largely reflected our ongoing de-risking and balance sheet optimization activities. Overall, we continue to transact in a prudent manner and remain comfortable with our exposure in Europe, which are with well-rated counterparties, mainly located in larger European countries. Turning to market risk, average management value at risk was CAD 40 million, down CAD 7 million from the last quarter, primarily due to strategic risk reduction activities during the quarter. This quarter, we have included disclosure on stressed VaR, reflecting the 2009 Basel Committee amendments which became effective in the first quarter. We have been using stressed VaR as a management metric and part of our limit structure since mid-2010. Stressed VaR is calculated using data from the most volatile historical period, which means that for this purpose, we're using data from the period that includes the Lehman Brothers default. The risk reduction activities I noted earlier have reduced stressed VaR over the quarter, resulting in a quarter-end number of CAD 55 million. During the quarter, we had a total of five days with net trading losses, with no losses exceeding VaR, as market conditions stabilized. With that, I'll turn the presentation over to Janice. Thanks, Morten, and good morning. Turning to slide 13, as Gord mentioned, we had a very strong first quarter with earnings from continuing operations of over CAD 1.8 billion, up 17% over last quarter. These results were driven by record earnings in Canadian banking, reflecting strong volume growth, higher earnings in Capital Markets, and continued strength in Insurance and Wealth Management. Overall, it was a very clean quarter. Compared to last year, earnings from continuing operations were down CAD 120 million or 6%, as business growth in Canadian banking and insurance and stable credit quality was more than offset by lower results in Capital Markets, which had a record quarter last year. Factoring in last year's gains related to MBIA of CAD 49 million after tax and comp adjustments, earnings for Q1 were down 4% over last year. As Gord said, we had a strong capital position with a Tier 1 capital ratio of 12.2%. As seen on slide 14, and consistent with the guidance we provided last quarter, our Tier 1 capital ratio was down 110 basis points sequentially, reflecting the regulatory changes in the treatment of investments in insurance subsidiaries, higher risk-weighted assets for Basel 2.5, and the phase-in of the transition to IFRS. I would like to point out that on a pro forma basis, as at January 31, we expect the sale of RBC Bank to add an estimated 100 basis points to our Tier 1 capital ratio. Building on Gord's remarks, we revised our capital allocation methodology effective this quarter to further align our process with new and evolving regulatory requirements. The new approach replaces the pro-rata allocation of unallocated capital that was used in 2011, and the impacts are being phased in over 2012 in anticipation of Basel III requirements in 2013. This resulted in a significant increase in capital being allocated to Capital Markets. We continue to take steps in this business to optimize capital and mitigate the impact of regulatory changes, including increasing the contribution from fee-based businesses, which are more favorable from a capital standpoint. Moving on to the performance of our segments on slide 15, Canadian banking had record earnings of CAD 994 million, up 5% from last quarter, largely reflecting solid growth in home equity products, personal and business deposits, and business loans. Compared to last year, net income was up CAD 61 million or 7%. Looking at slide 17, net interest margin remained stable as favorable product mix was largely offset by the impact of the continued low interest rate environment. Our efficiency ratio this quarter stood at 44.9%, an 80 basis point improvement quarter-over-quarter, primarily due to seasonally low marketing spend. Compared to last year, efficiency was up 80 basis points, largely driven by higher initiative spend. When you are looking at our expenses, approximately half of our expense growth was related to investments we are making for the long term, including increased technology spend to improve productivity and drive customer satisfaction. Another one-third of the growth was related to the timing of performance-related compensation and is not expected to recur in the coming quarters. The remainder of the increase came from costs associated with volume growth, including inflationary impacts. We remain firmly committed to our cost program and driving our efficiency ratio down to the low 40s over the median term. However, there will be fluctuations on a quarterly basis, including some seasonality and the timing related to investments we're making for the long term. We have a number of initiatives underway in Canadian banking to dynamically manage the trajectory of expense growth against revenue growth, and we believe we can generate a positive operating leverage in this business by the end of the year. Turning to wealth management, we earned CAD 188 million this quarter. Our business continued to be impacted by low transaction volumes, largely driven by a challenging market and continued investor uncertainty. We did, however, see some increase in client activity and capital appreciation in January as markets stabilized. Moving to insurance, net income was CAD 190 million, down CAD 10 million from the prior quarter, mainly due to higher claims costs and a new U.K. annuity reinsurance contract that was a little smaller than the contract last quarter. It's worth noting that relative to other products, annuity reinsurance involves a larger upfront recognition of profit on new treaties, as this product has lower acquisition costs and a longer term. Additionally, as we continue to build our reinsurance business, the timing and value of such contracts may fluctuate. International banking net income of CAD 24 million was up CAD 14 million from the prior quarter, primarily due to lower provisions for credit losses in Caribbean banking. Compared to last year, net income was down CAD 44 million, driven by continued spread compression in Caribbean banking. In capital markets, net income was CAD 448 million, up CAD 294 million from the prior quarter, driven by significantly higher fixed income trading revenue in the U.S. and Europe. Market conditions improved significantly over last quarter, and our fixed income trading business has benefited from tighter credit spreads and higher client volumes. Overall, corporate and investment banking saw positive trends this quarter, with solid growth in our debt and equity origination and loan syndication businesses. Our Q1 results also reflect net mark-to-market losses on CDS hedging our loan portfolio of CAD 25 million compared to a gain of CAD 30 million in the prior quarter. We're very pleased with our strong performance this quarter. At this point, I'll turn the call over to the operator to begin questions and answers. Please limit yourself to one question, then queue so that everyone has an opportunity to participate. Operator? Thank you. If you wish to ask a question, please press star 1 on your telephone keypad. If you're using a speakerphone, please lift the handset, then press star 1. You may cancel your question by pressing the pound sign. Please go ahead. Our first question is from Rob Sedran from CIBC. Please go ahead. Hi, good morning. Questions are on the Capital Markets side. I'm curious, with the usual caveats that the Capital Markets are going to do, that the conditions are going to be what they are. Is the old 700-900 guidance on trading revenue the new 700-900 guidance on trading revenue? On a related note or an unrelated note, I guess, the underwriting revenues, I was expecting a bit higher this quarter in terms of the bounce back. I know last year's Q1 was super strong for all kinds of reasons, but have we settled into a level where you think that is roughly the sustainable number on the underwriting side as well? Yeah. Hi, Rob. It's Mark Standish. I'll kick off on the trading market. Obviously, Q1 came off of two extremely difficult quarters where the markets basically, in particular in Europe, ground to a halt, and we just weren't seeing any activity at all. We're hesitant to suggest a range because I still don't believe that we're in markets that could be even remotely described as normal. Certainly, we saw a lot of pent-up demand in Q1 coming out as Europe stabilized and spreads started to come in. We saw a lot of new issue activity that had been held back waiting for markets to open up again. Clearly we benefited from that. There is a bit of a seasonal factor there where Q1 from a trading and new issue perspective is always a bit stronger historically. But looking forward, we certainly think that the read to the market and market activity is going to be good, but we're far from in a normal environment. Is it fair to say that much of the activity was in January and that pent-up demand showed up once the markets opened up a little bit, and the first couple of months were probably quite soft? Actually, no. We started to see a pickup really occurring in November, and I think we were probably seeing it before a lot of our competitors internationally. One of the things we've been very focused on is market share gains, doing more business with existing clients. I think that's where we started to see the pickup initially, and then it did accelerate and get better through the quarter. But yeah, initially it was market share gains that we saw ahead of the street. I'll make a comment on the underwriting revenues, Rob. As you mentioned, Q1 2011 was quite strong. The sequential quarters like this quarter we've just completed and the previous quarter are about the same. As Janice mentioned, there was an adjustment in the CDS that took this quarter down a bit and increased last. But in terms of where it's going, what we're focused on is really growing our relationship with clients, growing our loan book. We put on 93 new names in our loan book in the last quarter. There would be some natural runoff, but we continue to see good opportunities, especially in the U.S., to acquire new customers. We're really operating in a new issue environment that is constructive but not robust. If we see an improvement in markets, we'll see an improvement in M&A volumes and also IPO volumes. Let me just emphasize, primarily investment-grade customers. Yeah. It's 75% investment-grade on the loan book. Thank you. Thank you. Our next question is from Peter Routledge from National Bank Financial. Please go ahead. Yeah. A question for Dave McKay. It was a very strong quarter, another one. First of all, can you break out, you referenced favorable product mix in the steadiness in the NIM. Can you sort of give us a little more color behind that? Yeah. I think we're extremely pleased to grow our volumes at 9% and maintain stable NIMs quarter-over-quarter. As you noticed, they came off of a very strong quarter last year. Q1 were around 280 basis points. So, we've maintained our NIMs at 275 for three straight quarters. I think, as a part of what you're seeing is consumers are switching from variable rate mortgages into higher margin fixed rate mortgages. That is a trend that's really manifested itself in the last quarter as consumers try to lock in long-term rates. Right. Our variable rate book was running at a very low rate, and our fixed rate book is a better margin for us. You saw some price competition over the quarter in that fixed rate book, but overall, we are very happy with our ability to win clients and make good margins. I think that would be the primary driver, Peter. Thanks. That's helpful. Just a follow-up. You're growing your loan book very healthily. Overall, household credit continues to expand at a pretty much undiminished rate, at least for the last couple of years. How do you think about the marginal cost of credit? At some point in this cycle, the credit cost of an additional loan to an additional household will be a lot higher than the historic average. How close are we to that inflection point where the additional marginal cost of credit suggests you want to pull back from your origination activity? First, I'd say we do price for marginal credit risk, and we do look at the credit risk of a borrower and the ability to repay and charge a variable pricing grid based on that customer risk. Once you look at consumers and the distribution of risk across consumers in general in Canada, not just our portfolio, but in Canada in general, you haven't seen a proportion of higher risk borrowers in Canada increase. So on average, the industry's been lending to the healthiest customers in Canada. So you're seeing customers, and we use TDS as our primary measure, the same measure that Gord referred to in his speech, Total Debt Service. We feel over cycles and over 20 years now, we've used TDS as our primary mechanism. It served us well through cycles. As you look at Total Debt Service ratios, and you look at the percent of customers over 40% that the industry's lending to, has not really changed over a longer period of time. We're actually lending to consumers who are in the middle of that distribution, you might call it, around 20%-25% Total Debt Service. So they're strong, healthy borrowers with the capacity, as Gord said, to repay. I wouldn't characterize this that we're near a tipping point, that we've got very prudent standards, that if there's shocks to the system, you could see customers migrate to higher risk categories as there's disruption of income. But I wouldn't characterize it as a tipping point coming. And so you feel that TDS at 20%-25%, there's a margin of safety to a 100 basis point shock? There is. And we stress our portfolio across all the dimensions, obviously, and we're comfortable with our stress tests. And we stress them under severe scenarios with significant housing price declines, and we look at the Case-Shiller index in the U.S. We use that as a proxy. We use unemployment north of 13% as our proxy. So when we stress the portfolio, when we look at where we're lending to the average consumer while debt is growing, and I would just counteract one of the points you're saying is, we are seeing a slowing in credit growth. We are seeing a slowing in housing price appreciation. So I think all are good signs, and I would say that stressing the portfolio, looking at who we're lending to, we remain confident we're making good, solid long-term decisions. Okay. Thanks very much. Very helpful. Thank you. Our next question is from Gabriel Dechaine from Credit Suisse. Please go ahead. Hey, good morning. Just a quick one on the trading. How much of that big pickup in trading was attributable to mark-to-market gains versus some flow type activity? Then in the Canadian retail business, the P&C segment, I just want to clarify some of Janice's comments, and I'd like to hear from Dave as well. What you mean by achieving positive operating leverage by year-end. Are we saying like Q4, or you want the full year to have positive operating leverage? Because the way I look at it, you had 3% revenue growth and 4.6% expense growth, negative 1.6% operating leverage. You're going to need a 300 basis point swing in operating leverage for the next three quarters to make it modestly positive for the year. I'm just wondering, am I misinterpreting the comments or Let me walk you through how we see the year rolling out, and then I'll hand it over to Doug and Mark Thanks to make a comment. As we look at operating leverage, we had a tough year-over-year comparison. When you said you saw 9% volume growth and only earning 3% revenue growth is extremely low on the range of relationship between volume growth and revenue growth. We certainly expect to see in Q3 and Q4, revenue growth and volume growth come closer together. So, 3% volume growth, I think, is understated based on the volumes that we're doing. So you'll see some uptick in revenue growth in Q3, Q4. As Janice referenced, of the 4.6% NAE growth, a third of that, or 1.5%, was related to one-time Q1 compensation costs. So we expect to move, and we are managing our costs very carefully. We also expect to move our NAE growth rate into the 3%-4% range. The combination of the two, slowing expense growth, getting rid of the one-times, having revenue growth more closely approximate volume growth going forward, you can see we expect a fairly sizable shift, particularly in Q3 and Q4, into positive operating leverage, where you will have higher revenue growth and lower expense growth. We do not see it as that big a challenge in Q3, Q4. Having said that, in Q2, we are still going to come off a very high comp from last year. We had NIMs last year of 279 in Q2. Even if you just assume you hold your NIM constant at 275 this year, we have NIM pressure coming at us in Q2 just looking at the historic numbers. It may be a challenge to get the positive operating leverage in Q2, but certainly Q3, Q4, we expect that, and we certainly expect to be positive for the year. Oh, that is very helpful. In terms of your question on trading, I mean, clearly we benefited from credit spreads improving, but we run primarily flow trading businesses, so the improvement we saw was primarily in client activity. If you go to page 30 of the Report to Shareholders, you can actually see the daily net trading numbers, and I think just to look at how smooth they are really shows you that this really is a flow trading business. In terms of aging activity, we very closely monitor the length of period the positions remain on a trader's book. They turn over continuously. And obviously, in periods of good activity, that turnover accelerates. It is a very good question. I think the one area where we benefited from credit spread narrowing that we haven't separated, so obviously we've identified CVA, is in our central funding business where we do run within Capital Markets the liquidity portfolio that we manage for the entire organization. That is in extremely high quality, predominantly sovereign debt. So there was a little bit of improvement there, but given the high-quality nature of that, it's not the same as owning lower quality paper, which clearly did see an improvement. Thank you very much. Thank you. Our next question is from Mario Mendonca from Canaccord Genuity. Please go ahead. First, sort of related question. Did trading benefit, or maybe let me rephrase this. Did the bank participate in the ECB term loan facility? Did that make a contribution to trading revenue? The reason I ask the question that way is recently, senior executives at JP Morgan have referred to that as a pretty attractive carry trade. Did Royal participate? No, we did not. The fact is, though, that that extremely significant facility really is what created the stability generally in the marketplace, not just in Europe, but in North America. That's where we sort of pick up in activity. But no, we do not and have no intention of participating. Or going forward, I suppose. Is that fair? No, that's correct. Just a quick follow-up. Going back to domestic retail, the HELOC growth has been very strong, and HELOCs in particular are where a period of rising interest rates can really throw off your debt servicing ratio. So what I'm interested in understanding is why the sort of the push in HELOCs, and how does that sort of square up against your emphasis on the debt servicing ratio? Is that enough information to go with, Dave? Yeah. I'm not sure how you get to your conclusion that HELOCs necessarily push off your debt servicing ratio. You mean compared to a fixed rate mortgage? For sure. That's exactly what I'm referring to. Within our HELOC structure, customers can opt for a fixed rate mortgage or a variable rate mortgage or revolving credit segment. I would say you're probably seeing. We'll go back and check it for sure for you, but I'd be surprised if we're not seeing the same customer behavior within the HELOC as you are outside the HELOC, and that customers are opting to go for four- and five-year fixed rate mortgages within the HELOC to lock in their credit costs. I mean, it's certainly a trend we're seeing inside and outside the HELOC, so we can go back and confirm that for you. I don't expect to see an increased shock to that book for a material shock to that book that's different than a non-HELOC book, just because a large proportion of the borrowings within a HELOC structure are conventional mortgages. That sort of throws me off a little bit. I would've thought that your HELOCs would've been essentially, they almost have to be variable. No. No, they don't. Okay. You can choose any segment you like, a HELOC, a variable rate mortgage, a fixed rate mortgage, and a revolving. What's different about the HELOC is as a consumer repays a principal, they can redraw it through the open-to-buy on the revolving credit line. You don't necessarily, on your interest-only segment, continue to amortize that portfolio. From that perspective, you're right. You don't necessarily reduce your credit outstanding. And in a higher interest rate environment, that revolving variable piece would be subject to higher interest rate costs. But it may be a small proportion, depending on the customer. It's hard to characterize the typical customer. We can go back and say it, but I would guess that less than 20% of those loans would be on a revolving credit basis. Bottom line, Dave McKay, you don't see the HELOCs as presenting any additional risk in this environment relative to, say, a fixed-rate mortgage. Exactly. We're in an extremely low-rate environment. Customers are locking in. The material risk of a shock comes more from unemployment than it does from an interest rate increase. We've stressed all these variables, and when you look at where material risk occurs, it's a long-term shift in unemployment into that mid-double-digit range. That's where job loss and income disruption is the primary risk to consumer lending, not so much an interest rate increase. Thank you very much. Thank you. Once again, please press *1 on your telephone keypad if you wish to ask a question. Our next question is from John Reucassel from BMO Capital Markets. Please go ahead. Thank you. Just back to trading for a second. Janice, I just want to confirm the CAD 12 billion increase in market risk-weighted assets in the quarter. That was all Basel 2.5 related? Most of it was. We had some parameter changes, but most of it was Basel 2.5. Okay. Mark, you talked about aligning your business more with client flow. Is a way to track that, I guess you see revenue up and VaR down, and presumably stressed VaR is down, too. Is that a good way to measure that, or how can we externally track the closer alignment and the less risk you're taking in the business? I think that is the easiest and most visible way of tracking it. Obviously, the adoption of Basel 2.5 is making carrying inventory, carrying market risk extremely expensive. So it's driving significant behavior changes for institutions that have adopted it. Going forward, as other institutions have to adopt Basel III, and this will roll out over the next couple of years, then we expect to see how markets trade change. Inventory will be more expensive to carry. So yeah, I think that's exactly right. That is the best way to watch it going forward, and I think that as the new capital regime comes into effect, institutions with a strong capital base will be in a very good position to benefit their corporate clients. That behavioral change, can you give us some examples? Maybe they're not tangible, but does the balance sheet accelerate? Do you just trade more often, or what is the behavioral change? Yeah, it will. Turnover will increase quite significantly. What we've been doing is we've been redeploying balance sheet that historically was supporting new issue activity where we would typically carry larger trading inventory. We've been reducing that and redeploying it into our secured financing business. So I think you're going to see that shift continue in the marketplace. From an earnings perspective, that's, I think, a very high-quality shift that's occurring. But over time, I think turnover on certainly bank dealer books will continue to accelerate. Just the stressed VaR, you've followed it since 2010, but you haven't disclosed it. Would the trend in stressed VaR be the same as VaR? It's Morten, so it parallels reasonably closely. When you go back over to the 2010 period, at that point as we were starting to use it, we actually had the Lehman default period in our regular VaR, so there was less of a gap between stressed VaR and VaR than you have today. But generally speaking, if you look over the last year or so, the trend line for the two has been similar. But the real point with stressed VaR is that it allows you to see the market risk expressed using the most volatile data we have in our historical database as opposed to the current period. So if you go through a longer period of less volatile markets, you'll see a bigger gap between the two. Okay, thank you. Last, just clarification from Janice. The sale of RBC Bank in the U.S. is 100 basis points to Tier 1. Would that be the same for Tier 1 common under Basel III? I don't know about the 100 basis points because the percents are a function of the base, but it is the exact same adjustment because it is pure return of its RWA reduction, those sorts of things. Okay. It would be directly impacting both Tier 1 common and Tier 1 equally. Okay. Thank you. Thank you. Our next question is from Cheryl Pate from Morgan Stanley. Please go ahead. Hi, good morning. I just wanted to touch on the trading results again. I understand the comments on the increased client activity. I guess, can you help me reconcile that when I look at the increase in trading in the quarter versus a non-conventional increase on the comp and expenses within the investment bank and how sustainable is the current expense base within the Capital Markets business? All right. The variable comp quarter-over-quarter has increased. I think that it's split out so that it's in the expenses there. Is that the question you have, is that have the expenses increased? Yeah. I guess, we don't get the comp numbers by segment, but just sort of even looking at the expense increase within the wholesale banking relative to the revenue pickup. Right. The variable comp is calculated as a percentage of net income before bonuses and taxes. It's formulaic, and so it did increase over the quarter as the fixed income trading increased. It's in the numbers. Okay. Cheryl, the one nuance would be that as we restated for IFRS accounting last quarter, you know that we had a significant mark-to-market on an SPE that we no longer have. We've eliminated that exposure. So remember, there's a delta in Capital Markets earnings of what we reported in Canadian GAAP versus what we reported under IFRS. That mark-to-market wouldn't have attracted the variable comp piece because it's theoretical, right? It's a restatement of actual results. So if you're looking at trailing quarter, there's a bit of a nuance in looking at expense basis that way, simply because of the restatement to IFRS. So I think a better proxy for Capital Markets looking trailing quarter is to look at the Canadian GAAP expense base. Okay, thanks. That's helpful. Just one follow-up there. In terms of how you're thinking about the non-compensation related expenses, particularly within the U.S. Capital Markets, and how we should think about that going forward in light of some of the regulatory changes still to come. Yeah. So bank-wide, we're addressing expenses. I guess in the U.S., the operating margins are lower than they are in Canada in our business, in the investment bank and in the trading business. We have a higher tax rate in the U.S., and we have a more expensive platform. So we're trying to balance keeping our expenses in line, obviously, and trying to continue to ramp up our revenues to get better margins. So we're pretty focused in terms of keeping our headcount stable, our expenses down, and trying to get our productivity up. Have you sort of sized potential impact for Volcker, things like that? Very difficult to size Volcker because it will have an impact, and Mark will talk about it, but it will have an impact on some of our trading businesses. But those businesses that are directly affected are a less substantial part of our business than they would've been a few years ago. No, that is correct. Gord talked about the contribution of Capital Markets in our forward plan. But within that, we do see growth in Capital Markets in the U.S. What is happening is we are seeing a very significant global deleveraging of financial institutions, and that is creating very good opportunity for us in the U.S. marketplace. Doug mentioned the increase of lending that we have been enjoying primarily to investment-grade clients. What goes along with that is a pickup in ancillary business. So we are doing a much better, much higher quality business now with better-rated U.S. issuers, and that is something that we see continuing. Okay, great. Thank you. Thank you. Our next question is from Steve Theriault from Bank of America Merrill Lynch. Please go ahead. Thanks very much. A couple questions. First, a couple follows for Dave. Dave, just in terms of some additional numbers, fixed versus variable, you said fixed has been picking up and that is consistent, I think, with what we are hearing from others. Can you speak to the mix of new origination, fixed versus variable, how that compares to a year ago, and where your total book stands presently? Then you spoke a little bit about stress test. Are you able to speak at all to how high consumer loss rates get in some of your more draconian stress cases? Then lastly, for Doug or for Mark, I am hearing anecdotally that the swap business is becoming somewhat more expensive for you. Is there anything specific to Basel 2.5 or the regulator's view on liquidity that is driving any changes in the swaps business? Anything you could tell us there would be great. Thank you. I'll answer that quickly. I'm not sure I fully understand the question. The vast majority of derivatives that we're involved with support new issue activity and are relatively straightforward plain derivatives, roughly 85% of which will move on to exchanges going forward. No, I think if anything, the support of that activity gets better as they move on to regulated exchanges. Steve, it's Dave. I'll give you the quick numbers, and I'll hand it to Morten to talk about our stress testing work. On the new volumes, roughly 75% fixed, 25 variable. And on the portfolio at large, 54% fixed, 46% variable. As Morten, on the stress testing, we do a variety of stress tests. Just to focus on the residential mortgage related portfolio, when we looked at The sort of 20% down across the country in terms of housing prices and the associated unemployment and other economic statistics that go with that. You see the loss rates on the residential mortgage portfolio move up in the 30 basis point on an average basis. Obviously, as you have more severe stresses, you can have in local markets, certainly loss rates in the 50-100 basis point range if you overlay very severe stress scenarios. I would say that the way we approach stress testing is we do it both on a portfolio specific basis, and we have a fairly comprehensive enterprise-wide stress testing program where we look at the impact on the overall bank performance of a variety of macroeconomic shocks, and we look at the sort of one in 20-year event, one in 50-year event. Through that process really demonstrate our ability to withstand extremely severe shocks. The portfolio specific pieces I think are very instructive. But overall, you have to keep in mind that the first order effect on a single portfolio will likely be accompanied by effects across the institution. When you look at the benefit of our diversified business mix, it speaks very favorably to our ability to withstand significant economic shocks. Those figures that you gave are on the mortgage book, I think you said. On the mortgage book specifically. I just happened to have some of those recent tests in my head in terms of the specifics. We've also looked at the broader retail portfolios as well as the full bank enterprise-wide stress testing program, where it's more difficult to provide the issues. If you look at our most severe macroeconomic stress test that we use for the enterprise-wide program pushes PCL up in the 80 basis point range. So demonstrating that fairly significant macroeconomic shocks will have impacts across the portfolio, but still keeping loss rates on the credit books within what historically would be quite acceptable ranges. Thanks for that color. Thank you. Our next question is from Brian Klock from Keefe, Bruyette & Woods. Please go ahead. Good morning. I apologize if you answered this question already, Dave, but early in the call I was a little tied up. I was not sure if you answered this question on the strong growth that you guys did see in this first quarter within the Canadian banking segment, especially driven by, again, residential mortgage growth. Maybe you can kind of comment about what you expect for the growth for the full year. Last year was a 7% growth for that industry. Do you expect that to start to slow? I know you guys talked about the Total Debt Service and how you feel comfortable there, but I guess what are you thinking about as far as the loan pipeline and what you think that the total pool could grow and what you think your share could grow within that residential mortgage pipeline? Certainly. I did talk about certainly the debt service side off the first question. So I will just reference your question around volume growth. Our volume growth occurred across the board. We had very strong volume growth in our deposit business as Gord referenced both on the consumer and business side, along with very strong upper single digit growth in our consumer and commercial lending side. So strength across the board, which highlights the strength of the overall franchise in each of our businesses. Going forward, we are seeing consumers are more cautious out there. We are seeing slow to negative growth in the credit card business on the unsecured lending side. So there will be a modest slowing, I think over the year. We have been calling for that for about 18 months now, and it is slowly been coming off. We continue to target a 25% premium to the marketplace. I think you'll see, and we'll see how all the other results come out, but you'll see us, I would expect us to beat that at 9% based on the market share numbers that we see gaining market share in every business that we're competing in. Again, a bit of a slowing growth that we will fully expect to maintain our 25% volume performance premium and translate that into net income performance. Hopefully that helps. Okay. Just a quick follow-up, I guess when you think about the residential mortgage growth, what are your thoughts about the CMHC and its rationing of MI here just within the last month or so, and what do you think the longer-term impact of that could be? Certainly, they're making available that coverage for individual consumers who are looking to make purchase mortgages. It doesn't really affect the individual consumer who we deal with prominently. As you heard Morten Friis reference in his speech, we haven't used the bulk insurance facilities of CMHC nearly as much as some of other players in the marketplace as they use it for funding reasons and other reasons, credit risk funding and capital. We haven't made use of those as we have different vehicles with how we've approached the market and a diversified funding model. It won't materially impact consumer. It won't materially impact our operations. There are other providers out there that have capability to originate this business, whether it's Genworth or Canada Guarantee, a new player. There's capacity in the marketplace to do this business, and I don't expect it to be a major disruption. Okay. So really if anything, you think it's more macro events that would drive the demand, not the MI capacity or ability. Yes, it will be macro conditions around interest rates, consumer disposable income growth, their appetite to buy a home. Okay. Thanks. Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Nixon. Thank you very much. I think for the record, this is the first time in my 11 years as CEO where I have not been asked to answer a question. I do not know whether that is a good thing or a bad thing. Hopefully that will remain throughout our annual meeting. We appreciate everybody's participation. As I said, we hope some of you will join us for the annual meeting, and if not, we look forward to presenting to you next quarter. Thank you very much. Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.