Royal Bank of Canada (RY) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Royal Bank of Canada, second quarter results conference call. During the presentation, all participants will be in the listen-only mode. Afterwards we'll conduct a question and answer session, at that time if you have a question, please press the one followed by the four on your telephone. As a reminder, this conference is being recorded Wednesday, May 22nd, 2002. I would now like to turn the conference over to Nabanita Merchant, Senior Vice-President, Investor Relations. Please go ahead.

Thank you, and good afternoon, everyone. We begin the call with Gordon Nixon, President and CEO, providing the highlights of our second quarter results. Peter Currie, Vice-Chairman and CFO, then will then shed further light and sudden elements about the performance. Susanne Labarge, Vice-Chairman and Chief Risk Officer, Will then we'll discuss our performance in the area of asset quality. We will then open the floor to your questions. The Vice-Chairman responsible for our five business platforms, who are members of the group management committee are also here today. We have Jim Raga from RBC Banking, our Personal Commercial Division Jim Westlake from RBC Insurance,[INAUDIBLE] RBC Investments our Wealth Management platform, Chuck [INAUDIBLE] RBC Capital Markets, and Marty [INAUDIBLE] RBC Global Services, our Transaction Processing Division. Marty is also our Chief Information Officer. Unfortunately, Irving Weiser, RBC [INAUDIBLE] has had [INAUDIBLE] removed and cannot join us for this call. Our SCD Financial, John Mariam is also here with us.I will now turn it over to go. Gordon Nixon, Gord.

Thank you, Nabanit, and good afternoon, everybody. I'm pleased to speak to you about our second quarter financial results. As you can see on chart four of the package, net income of $710 million was up 14% and earnings per share of $1.01 were up 6%, respectively, from a year ago. Excluding good will expense and last year's second quarter, which is detailed on chart five, net income rose 6% while earnings per share were about flat. ROE was 16.8% during the quarter. We're quite pleased to have achieved these reasonable results despite continuing challenges in particularly our capital markets-related businesses. We believe that our diversified earnings base, our continued cost management, and better results from our US acquisitions than in the second quarter of 2001 were all important factors. Results of our cost management efforts were reflected in a 3% decline in operating expenses compared to a 1% growth in operating revenues. Both excluding our recent US acquisitions. In area of asset quality, our non-accrual loans were down 7% from last quarter, while the specific provisions for credit loss ratio was .65%. The specific provision associated with the telecom account classified has impaired this quarter was partially offset by a $98 million gain on a related credit derivative recorded in other income due to the accounting rules. However, if the credit derivative gain were netted against the quarter's specific provision, the ratio would have been .45% this quarter and .50% for the year to date, which is in line with our 2002 target of .45 to .55%. Suzanne Labarge, our Chief Risk Officer will discuss our asset quality in more detail in a few minutes. As you can see on chart six, in the first six months of this year, we have met or exceeded most of our financial targets that we have set for 2002. In addition to our priority of strong fundamentals, we continue to pursue our three other objectives. International expansion, growth of high return, or high P multiple businesses, and cross platform leverage, which means working across our businesses to enhance both efficiency and grow the business with our customers. Charts eight and nine, mention just some of the initiatives undertaken by our business platforms during the quarter. While we are looking for RBC Banking, the personal and commercial banking platform and RBC Investments, The Wealth Management platform. To be the Main drivers of our operational and financial expansion over the long-term, we do recognize that our diversified business base reduces earnings volatility and represents one of our strengths. As a result, each of our business platforms has targeted priority areas for growth while also looking at opportunities for culling areas that do not meet our strategic or financial objectives. For example, we have reduced since 1998 our corporate lending book by a little under 20% and we continue to reduce the size of our corporate loan portfolio in order to enhance returns and reduce credit risks in RBC Capital Markets. We have segregated our loan book in a core and noncore and there continues to be a significant effort to reduces the capital utilized by that business. Chart ten provides the high-level summary of the earnings, economic profit and ROE's of our business segments. RBC Banking, RBC Insurance and RBC Investments, all grew net income over last year, reflecting higher contributions from our US acquisitions. However, RBC Capital Markets experienced higher loan loss provisions and lower trading revenues and RBC Investments, while up from a year ago is still experiencing disappointing results in brokerage as a result of challenging equity markets. We expect RBC Investments earnings contribution to the bank to rise, when equity markets strengthen and retention compensation costs for the recent US acquisitions fall considerably beginning in 2003. Further details of our business segment results are shown on charts eleven through sixteen. In the area of international expansion, you can see from chart seventeen, that 27% of core revenues for the year to date were from the US, up from 17% last year. Chart eighteen shows that recent US acquisitions generated net income of $35 million this quarter, up from a $22 million loss a year ago, largely due to the acquisition of Centura Banks in the third quarter of 2001 and better performance from RBC Dain Rauscher. These numbers exclude Dain Rauscher [INAUDIBLE], Whose operations have been fully integrated into RBC Capital Markets for the past two quarters. We announced two discipline and strategic platform extension acquisitions in the US, during the quarter, of Eagle BanK shares by RBC Centura and businessmen's insurance company by RBC Insurance. Both provide substantial cost synergies with our current US operations and should be accretive to cash earnings per share in the first and second years respectively. And this morning, we announced that we would be acquiring the assets of Barkley's private banking operations in the Americas, which represents a bolt-on acquisition in our global private banking key target markets. This business is located primarily in New York and Miami, with offshore fiduciary services in Cayman, London, Jersey and Geneva. And these offices together with our office in Toronto are where the clients will be serviced from. This deal will be accretive to earnings per share in the year '02 as well, and we continue to be committed to our strategy of tactical add-on acquisitions this year that will not exceed an aggregate amount of approximately a billion dollars. Before turning over to Peter Currie, I would like to make a comment about the subject of expensing stock options as some of our institutional investors have raised it over the past few months. As an adopter of US Gap, we have been complying with FAS-123 and since 1999, including disclosure about the impact on net income and earnings per share of stock options in the notes to our financial statements. In the 2000 -- in our 2001 annual report, our disclosure appeared on page 77 and showed an impact on net income of $20 million in 2001, $23 million in 2000, and $26 million in 199, representing approximately 1% of our earnings in those years I just point out that US Gap has required this disclosure for all options whereas the new CIC rules which came into effect January 2002 and applied 2003 fiscal years allow for option expenses to be disclosed only prospectively that is, for new option grants. We have also as now been expensing on our income statements the cost of stock appreciation rights which were granted in 2000 and 2001 in tandem with our options. The costs for those were $52 million before tax in 2000,$ 23 million in 2001, and $43 million in the first six months of 2002 under US Gap. So all in all, we have recognized the cost of options in our financial statement for some years now as if we had done with our SAR's which have gone through our income statement and incidentally, we have applied to Canadian Gap, even though it's not required by CICA. We have also disclosed on a proforma basis the remaining cost of all other outstanding options. With respect to any changes in 2003, it is our intention to monitor developments in both accounting and regulatory rules in order to ensure that we remain at the forefront with respect to disclosure. My personal view is that what is very important for all of us in the business community is that there be both consistency in terms of the reporting of stock option disclosure particularly through the income statements, so we don't have a situation where Investors are constantly comparing apples to oranges to lemons. So that is something that we are going to watch very carefully and we will certainly as we get closer to the year end make a decision with respect to how we proceed moving forward. I now turn it over to Peter Currie to give further details about our second quarter results. Peter?

Thanks, Gord and Good afternoon, everybody. Turning now to our revenue performance, you'll note from chart 23, the total revenues were $3.9 billion in the second quarter, up 12% from a year ago while non-interest revenues were 56% of total revenues. US acquisitions made in 2001 have resulted in this very strong top-line growth. Chart 24, shows the second quarter non-interest revenues were up 13% from a year ago. As Gord mentioned, there was and $89 million gain this quarter of, our credit {INAUDIBLE] recorded in non-interest revenues contributing to 34% of the revenue growth of a year ago. Driven by acquisitions, Capital market fees from full-service brokerage, discount brokerage and institutional businesses were up 10% and investment management and custodial fees up 1%. Securitization revenue were up 200%. Largely reflecting a $32 million gain on the sale of Government guarantee residential mortgage loans that were securitized during the quarter. Mutual fund revenues were up 4% while insurance revenues were flat. Mortgage banking revenue which relates to mortgages originated in the USA was down 7%, reflecting higher interest rates this quarter, while trade revenues were down 16% reflecting lower revenues from the equity derivatives and foreign exchange businesses. Turning to the net interest margin, you'll note from chart 26, that it narrowed by 11 basis points in the second quarter from the previous quarter. This largely reflects a higher proportion of low-yielding assets such as securities and narrowing of the prime core deposit spread as the average prime rate was lowered this quarter than last. As you can see on chart 27, our operating expenses which excludes special items, costs of stock appreciation rights and certain acquisition expenses such as retention compensation, were up 11% in the quarter. More than all this growth is due to the acquisitions made in 2001, which are positioning us for strong long term growth. As Gord mentioned and as you can see on chart 28, excluding US acquisitions, our operating expenses would have been down 3% in the quarter, while operating revenues would have been up 1%. You'll note from chart 30, that the cost of stock appreciation rights were up substantially over a year ago, $33 million on a US Gap and $62 million under Canadian. Now on to the balance sheet. As you can see on chart 31, consumer loans were up 1% over last quarter. The decline in business and Government loans is entirely consistent with our strategy to reduce the size of the corporate loan portfolio to enhance returns in RBC Capital Markets. You can see on chart 32, that our capital ratios improved from last year and last quarter. We bought back 2.3 million common shares for $118 million during the quarter, up from 1.7 million last quarter. Our buy-back program expires in June, and this morning we announced the intention subject to the approval of the TSX to renew the normal [INAUDIBLE] bid to repurchase up to 20 million common shares which represents about 3% of our outstanding common share float. We also generated $430 million in capital internally during the quarter as shown in chart 33. Our quarterly common share dividend was 38 cents per share in the first quarter as shown on chart 34, an increase of two cents, or 6% over the last quarter. This is our 6th increase in three years. Our dividend payout ratio is 37% in the quarter, and our medium term payout ratio objective remains in the rage of 30 to 40%. That concludes my summary remarked. Suzanne Labarge, our Chief Risk Officer to discuss our loan portfolio. Suzanne?

Thank you, Peter, and Good afternoon. I'd like to take a few moments now to provide you with an update on our asset quality. Turning to chart 35 and 36, you will note that growth impaired loans decreased $184 million from last quarter. In general, the level of new impaired loans has subsided and there is only one significant new impaired loan in the quarter which is the telecom account referred to by Gord and Peter. With respect to our domestic consumer loan portfolio, growth impaired loans improved to 34% over last quarter. Domestic business impaired loans decreased by $93 million or 8% due to the return to performance status of an account in the transportation sector. International impaired loans decreased by $68 million due to a lower level of new impaired loans, increased write-off and the return to performance status of about a third of our Argentinian loan portfolio. I will comment further on telecommunications and Argentina in a moment. The provisions for credit losses in the second quarter was $328 million, compared to $286 million last quarter, and $236 million last year. However, as noted on slides 38 and 39, the bank did realize a $98 million mark-to-market gain on a credit derivative established to mitigate losses directly related to the newly impaired telecommunication accounts, under US accounting principles, this gain cannot be directly netted against the provision for credit losses in the financial statements and has been recorded in other income. However, from a Risk Management perspective, the net provision of $230 million is down $56 million or 20% from last quarter. This improvement is attributable to lower loan loss provisions in both our corporate and commercial lending portfolios. Chart 40, shows the credit quality in the Canadian consumer loan portfolio remains stable. The provision for credit losses on this portfolio which includes residential mortgages but excludes student loans continues to range between 9 and 12 basis points. You will see on chart 41, that the specific provision for credit losses ratio net of the credit derivative gain was 45 basis points in the quarter, compared to 54 basis points last quarter. Our continued expectation for 2002, is that it will remain in the 45 to 55 basis point range. Chart 42, shows that during the quarter, net charge-offs were $346 million compared to $234 million last quarter and $230 million a year ago. The increase was due to significant write-offs taken on nine corporate accounts, mainly telecom, this quarter, compared to only two accounts last quarter. An update on our current exposure to telecommunications companies and Argentina is found on slides 43 and 44 respectively. Non-investment grade telecommunication loans outstanding at April 30th was 1.-- was $1billion, down marginally from $1.1 billion last quarter. Growth impaired loans up $300 million which are net of write-offs are well provided for as net impaired loans are now $97 million. Total [INAUDIBLE] exposure net of allowances is $89 million. With respect to Argentina, we completed a comprehensive review of all exposures which has resulted in the return to performance status of $50 million in loans, an increase provisions of $24 million on the remaining $108 million on accounts classified as impaired. Charts 45 and 46, a test to our positive trading performance. In conclusion, there's been an improvement in non-accrual loans, the telecom portfolio, and Argentina are well provided for, and our trading performance remains solid. Our Canadian portfolio remains in very good condition, benefiting from a number of changes we made in credit practices over the past eighteen months. The outlook for the remainder of fiscal 2002 appears more positive than negative and remains confident that the 2002 objectives for the specific provision for credit loss ratio of 45 to 55 basis points is achievable. At this point, I would like to turn the call over to the conference operator so we can begin the question and answer period.

Thank you. Ladies and Gentlemen, if you would like to register a question, please press the one followed by the four on your touch tone phone. You will hear a three tone prompt to acknowledge your request. If your question has been answered and would you like to withdraw your registration, please press one followed by the three. If you are using a speaker phone, please lift your hand set before entering your request. One moment, please, for the first question. Our first question comes from Jamie Keating from Merrill Lynch.

Thank you and Congratulations, team, on a good-looking quarter and particularly, Suzanne, if I might follow up with a couple of questions. Wonder if you could help us out on what the portfolio of credit default swaps or protection might look like at Royal Bank in aggregate or specifically relative to the Telco portfolio if you could help us on that. And I'm curious as a follow you talked about the 20% decline in corporate loans since '98. I wonder if you could quantify what that 20% has likely been over that period in dollar terms? and looking back, I'm curious to know if, any of the credit default swap that we saw in terms of profit or hedge this quarter, if there are any similar amounts in prior quarters that perhaps we could be aware of if they were taken in prior quarters at all? Thank you.

Thank you. I'll try to answer. I don't have all of the answers to your questions so I'll give you a try. We can do have portfolio swaps. I really don't have the total amount. I mean, it's probably close to a half billion dollars. But it's spread across a number of industries and I wouldn't be able off the top to say where it is. And let me explain where we use credit derivatives swaps. It's merely one of several tools we use for managing our portfolio. And one of the reasons is swaps can only be put into place on investment grade names. You can't find it on non-investment grade accounts which means you have to put it in place before a company deteriorates. What we try and do is we are trying to manage the size of any individual exposure in our portfolio. And there are sort of four tools we use. The first is not to make a big loan to any given name. The second is if you decide to do so for economic reasons or relationship reasons, is then you can either syndicate it, sell it in secondary market, or put a credit portfolio swap in place. We use all of those techniques in managing the portfolio, so it would be, you know, in this case, where we are talking, we did use a portfolio swap, but that's what we do. So I don't have any more precise information on that. I'm going to probably ask -- I think Chuck has -- Winigrad has the change in our corporate loan portfolio in the last couple of years, So, I'll let him speak to that in a moment. But back to credit default swaps, the FAS-133 rule really only surfaced this quarter so there is not an equivalent accounting in previous quarters but of that $98 million, that we took on the provision this quarter, $89 million is in the other income this quarter,$ 9 million was recorded in previous quarters under FAS-133, when we marked it up to mark-to-market at that point. So, Chuck, would you --

Yes. I would give a rough number of $15 billion in authorized.

Thank you, Chuck.

That's rough but I think that's close. [ indiscernible ]

Basically, when you look at our plan for the corporate loan book, we don't think as much in terms of the[INAUDIBLE] amount of the loan book as we think about the capital that we have allocated to it. The reason for that is what we are trying to do is improve our ROE And ensure that we have funds that can be reallocate to other areas of our business or the rest of the bank from the loan book. And when we think of this, we think of an opportunity really to reduce our equity by about 25%, which is roughly $700 million of equity that should come free looking at the beginning of this fiscal year which was October -- November 1st, 2002 and going to the end of 2003. And we think that we can do that primarily by running off what we call are non-core loan book. If you take a look at what we have done this year, that far I think that we would be between 2 to $300 million in terms of actually having run off equity in terms of the noncore loan book running off. So that's what we are basically looking at doing. Again, we don't think there's much in notional terms because basically there is such a difference in terms in the cap that gets allocated to double A loan versus a double D. JAMIE KEATING Thank you, again.

Our next question is from Heather Wolf of Goldman Sachs. Please proceed with your question.

Hi, Good afternoon. Two quick questions. One, just a clarification on the credit derivative. I assume that, $98 million gain is net of any costs that were used to implement that credit derivative.

Yes, that's true.

Okay. And, secondly, just a question on Centura Bank. The mortgage environment in the US , has been quite strong over the last couple of quarters and I'm curious if most of the strength at Centura over the last couple of quarters has come from mortgage banking or if there is -- if there are other strengths there that are driving the performance that you could highlight?

For sure. The mortgage business has been strong in Centura. That started to tail off a little bit here in the last month or so. But, you know, most of the -- or a lot of the earnings growth that we have seen in the United States has come from the mortgage business. That's not to say, though, that Centura has not delivered on all of the expectations that we had as we got into this acquisition with them. And if I could maybe just kind of reference some of those situations in the way that we have kind of gone about improving the retail banking capabilities of Centura, and added new business capabilities and how some of those areas have started to have a pretty good impact on their results. First of all, we put in as you know our kind of retail banking sales management and sales cultures. That has now been implemented in just about all of the branches. If you look at April of this year versus April of last year, they have had about a 13% growth in installment loans. Their equity lines are up 7.5%. Their deposit in money market volumes up over 10% over April last year and the fees are up 7%. So the retail banking execution of that strategy has started to have a very good impact. They have about 400 -- part of the response to the tailing off of mortgage refinancing activity in the US, Is that we will focus more on the purchase market and new homes being bought, on the cost structure of RBC Mortgage and on new products that we can now manufacture in Centura that they didn't have before. They have now about $500 million of new "R" product in the portfolio in Centura that had been originated by RBC Mortgage. Commercial banking, they picked up about 30 new accounts in April in RBC Centura, different kinds of accounts than they would have been before. It's about double what they normally would do in a given month. So you know, that started to have a very good impact on their results. And then a lot of North/South business. Commercial clients from Canada who have started to -- who have kind of been looking -- looking more and more to us to help them in the United States, where we have started to have some meaningful business results as a result of that. Back to the retail side, we are launching some new products, some new asset management, a wrap account, a no-load fund. We have consolidated all our asset management activities in the United States, now reporting into Dain Rauscher. And we have -- we will be launching some new CD's that will help the revenue growth, as well. So we have a lot of things going on, many of which have started to have a positive impact on results.

Great. That's great color. Thank you.

Our next question comes from Neil Mathewson of Standard Life Investments. Please proceed with your question.

Hi, it's really for Susan. It's one concerning the telecom side. Year to date roughly, what sort of provisions has the bank taken on the telecom portfolio? Can you tell us?

If you could move to the next question, I can come back hopefully to that one. I have the information, I'll just have to see if I can pull it out.

Okay. Thank you.

Our next question is from Quinton Brott of CIBC World Markets.

To follow up on RBC Centura, just the net income Q1 '02 is $358 million, in Q2 '02 it's $42 million, thats using slide eighteen, Can you break out for me the Prisma /SS&B contribution to that 42 and 58 versus the cure RBC Centura that you have purchased?

No, Sir. We don't go into that level of detail. We are just -- we are going to report and will continue to report RBC Centura as a total package.

So the 10-Q filings of RBC Centura, you would suggest cannot be reconciled to the numbers that you are now reporting as RBC Centura?

I will just make kind of give you my own version of that and then maybe, Peter would like to comment. Centura is a statutory entity in the United States that we will preserve and use as an important part of RBC Financial group's activities in the US, That will or may be different from the actual RBC Banking activities in the US, that could have a different -- somewhat of a different look to it because it may or may not include things that are in the statutory entity.

This is Peter Currie here. That's exactly right, Neil. What we are talking about here is the difference between management and statutory reporting which you'll see on the 10-Q's under Centura is a very narrow statutory interpretation of the Centura entity whereas what you're looking at here is our banking business, our banking platform in the US, which is the way we run the business.

I can answer your question. Your question is about the drop in earnings in Centura in the second quarter. As you would expect, there is seasonality to that business as there is here. Fewer number of days, Christmas and all of that sort of thing, not being in the second quarter We had some security gains in the first quarter, you know, just kind of as we cleaned up everything, you know, post-acquisition, some businesses and parts of businesses that we disposed of that had a one-time impact in the first quarter. And then slightly less mortgage revenue.

Okay. Then if I could with -- for Peter, what I'm trying to actually drill down to on slide eighteen, the total US acquisition contribution of $35 million versus the sub pack disclosure of US, income in the quarter of minus $4 million, I guess trying to understand the difference there. Is it simply Dain Rauscher or Wesles which you note rise on slide eighteen as not included in that number? Is that the difference of minus $39 million? And then just then to follow that is, how do that relate to Royal Bank generating an adequate return on the you know, you know, almost $8 billion or $8 billion canadian of invested capital in the US, given the current run rate results?

Well, there are a couple of questions there the first one pertains to what we are showing on chart 18, which is the specific contributions from the US acquisitions that we have made and I'll come back to that in a moment. But otherwise, if you look at the geographic contribution, you are going to see elements in the US, results that don't relate to the acquisitions. For example, certain loan provisions we may take in the United States, that's appropriate. That wouldn't pertain to the acquisitions, therefore you get some skewing. -- some apparent skewing of the results in that context.

Okay.

Now, specific to the acquisitions themselves, I can tell you that they're all on track to deliver a cretion on exactly the schedule that we have disclosed when we made those acquisitions whether it's Centura or Prisma or Liberty or, you know, the one we announced today, or, you know, any of the other ones at all. Dain Rauscher the same sort of story. They're all on track. You know, I can't be any more explicit than that because we don't line them up against acquisition parameters in the public domain. But that's the essence of the story, Quinton.

Sorry, are they generating your internal rate of return hurdles?

They are meeting their hurdle rates that we anticipated and disclosed when we made the acquisitions.

Thank you.

That we -- yeah, that the trickle rates that we had set for ourselves in the early the first year and the second, the third year forecasts, most of these acquisitions were about a year into with respect to performance. As we -- as everyone is aware, the one that has been the most challenging from a performance perspective hasn't been the Dain acquisition because of the performance of the equity capital markets in particular. And the impact that that has had across their businesses and in the retail brokerage side. And there's been a lot of changes and steps that have been taken in that business. And it continues to be a challenging business, but one that we certainly would anticipate to start to turn around as we move into the latter part of this year and next year.

Great.

Perhaps I can come back to the question about telecom's. If you take a look at the total bank provisions for the first six months, only 20% of it would be related to telecom. If, of course, you apply it strictly to our corporate loan book, then it then is somewhere between 60 or 70% depending on how you want to allocate any recoveries we have made on previously impaired loans.

Our next question is from [ INAUDIBLE] Please proceed with your question.

Two questions. The first one is Suzanne, page 43, the net exposure of $2.6 billion to telecom cable, Am I right that includes exposure to equipment manufacturers, telecom companies but it excludes committed undrawn lines?

That's correct.

So like for example, if there was someone who made equipment like, you know, Nortel, Lucent, whatever, it's not in here?

No, that would not be included as telecom per se.

Can you -- I think most of the other competitors include equipment manufacturers. Do you have a number that you can provide us with that gives you a sense of exposure to equipment manufacturers?

[PAUSE}

Should I go on to another question while you --

Yes, please.

Sure. Peter, I'm sorry to sort of micro-question here. Page 8 of the sub pack, I must admit I'm sort of from the old school on Canadian Gap here, but the other segment which I don't think that had an unusually strong result, and I know it flips around a fair amount but this quarter it flipped very positive. Am I right that the [ INAUDIBLE ] is not in here, it's in RBC Capital Markets so this had something else? And what could that be?

You're correct on the credit derivative and what it could be is we had the proceeds from securitization transaction in there and we also had the proceeds from a realignment in some of our strategic investment portfolio in there, as well.

Gotcha.

If I could come back to communications equipment, our standing amount in that category is under $400 million.

Thanks, Suzanne. That's net I presume?

Yes. It's our out standings in that category.

That's gross?

That's gross amount.

Okay, thanks.

Gross and net are the same in that category.

That's good to hear. Thanks.

Our next question is from Jack [INAUDIBLE] of Salomon ,Smith, Barney. Please proceed with your question.

Thank you very much. And I have a question for Suzanne, as well. Suzanne, when you say that you are comfortable with the provision of guidance of 45 to 55 basis points, is it correct to assume that unlike on chart 39, you are including actually either provision what will be going through the P&L rather than netting any potential, income from derivatives of which I'm sure you are going to have a lot?

We have come to the 45 basis points, what we have done is try and do it on the terms that we have looked at, which is from a Risk Management perspective which is take out of the calculation any gains on a credit derivative that is directly associated with a loan loss. When we started and set our goal, we had not expected FAS-133 to have this impact on recording our credit derivative transactions.

Okay. So this credit would be definitely in a separate line and the absolute provision will be based on this 35 to 55 basis points?

That is correct.

Okay. And then also --

Just a note for one sec, it's as I understand it, it's under Canadian Gap, the numbers would be -- we would be able to net the numbers. It's because of US Gap --

That's right. And that's why there may be some sort of variation here which indeed can be a little bit ambiguous.

I'm sorry, could you repeat that comment?

No, no. That's okay. I understand that you will be basically showing the provision in the income statement based on the Canadian Gap, which will definitely not have the offsetting from the derivatives book.

It's Peter Currie. I think that's a value judgment. I don't think it would be better or worse but cleaner. The net result on the reporting would be the same.

Then also a separate question. This question is on the net interest margin in your personal and commercial banking by 10 basis points. Is it possible to split it between the US And Canada? Because I would assume that the pressure is mainly coming from the Canadian operation. Is it fair?

Yes. Our spread was enhanced marginally a couple of basis points by the US, so you're absolutely right, that that -- it's 10 book basis points sequentially, Q1 to Q2 and 28 year-over-year. So I mean, that has a big impact on our revenue.

Okay, thank you very much.

Mostly canadian.

Yup, thanks.

Our next question is from Jim [INAUDIBLE] with Credit Suisse First Boston. Please proceed with your question.

Good afternoon. First of all, thank you for the breakdown of the net income per segment between total and US. It leads me to my first question regarding RBC Capital, where we are seeing some series of negative contributions coming from the US And I recognize a portion of that is coming from the retention compensation. But I'm wondering if I can get some color on, is it a broad-based business issue in terms of all market businesses that are suffering right now coming from Dain and the US. and is the cost structure appropriate given the current market levels?

There are a number of questions. I think if you took a look at the single largest contributor to what has happened in the US ,in the second quarter, I think loan losses would probably be the single biggest element of it because again, most of our telecom problems have come in the US And with both loans booked in the US. I think that it also is the case that the US, Underwriting business has been very weak in sectors where we're strong. And, that does unquestionably hurts our profitability. But that impact hasn't been as significant as the [INAUDIBLE] elements will be, In terms of, the compensation in the market on of the things clearly happening in the market place is compensation is adjusting to performance and I think you'll see that continue as the year goes on. As you know, the compensation in this business is something that happens once a year. In addition to that, you know, we have a pool structure which combines the profitability of our organization on a global basis. It's not tied to any one specific geographical area or business and therefore, this is something that the overall partners in that pool are going to have to deal with as the year progresses.

But the short answer, Chuck, the bulk of the negative is a result of loan losses, not as a result of the operations.

No, the biggest part of it, whether it's 80%, the biggest part of it would be loan losses, correct.

Okay, got it. Chuck, when you move towards optimizing your loan book in limiting the noncore portion and you free up the excess capital, where do you see more of a longer term ROE , for the capital markets business?

About 20%.

You like to get back to the 20% range?

Absolutely. I mean, I think that's a reason why we have always had an objective around here of 25%. I think that's going to be very hard, with the still -- with the size of the loan business that we are going to continue to have. But again, over the course of the cycle, 20% may be a bit rich but it's something we are going to aim for.

Okay, great. And my last question, just regarding broker retention, we notice you closed Dain Rauscher [ indiscernible ] this past quarter and you know, there were 990 brokers from Tucker Anthony and about 1100 from Dain. Maybe you could update us on what the retention ratios were for that broker channels acquired.

The retention has been excellent. We are above the retention levels that we built into plan when we did the Tucker Anthony sutro acquisition and I think that the Dain obviously retention continues to be very good. I think that obviously --the key issue on the Tucker Anthony Sutro was going through conversion, which is now passed. Because we were at most risk as we walked up to no man's land on the conversion date. We are no past that so we are feeling much more comfortable in terms of the go forward.

Ray, could you provide me with a bit of a percentage in terms of what the retention has been?

I think the retention has been close to well North of 95% -- North of 90%.

Got it. Thank you.

Our next question is from Susan Cohen of [ indiscernible ] securities. Please proceed with your question.

Thank you. Your trading revenues in the first quarter were exceptionally strong and relative to some of the other banks that have reported, they continued quite strong in the second quarter, as well. Can you perhaps comment on, what you're doing right and is this level likely to continue going forward?

Well, I think that, again, this is very hard to project trading revenues, even harder than most of the other revenues we have. I think that secret to our trading side is that we are well diversified. We have a large number of books and we have strong trading in fixed income and in derivatives and in money market and foreign exchange. As you are well aware, the fixed income revenues certainly were much weaker on a quarter-to-quarter basis, but we had other things that were offsetting and more stable, I think that the existing rates of revenue are sustainable but I really hate to project trading revenues because they really -- they are really very day to day. Again, they actually been except for and this always happens in the trading business except for a couple of weeks here and there, quite steady this year. There have been some real good weeks and, you know, some bad weeks but basically they have been reasonably steady and it's more diversification than anything else.

Thank you very much.

Our next question is from Ron Vessel of National Bank Financial. Please proceed with your question.

Most of my questions were asked and answered but I just have one quick one. Can you comment on the pace of realization of cost reductions on the Tucker Anthony acquisition?

Yes, I can. It's Ray Mikie. We are on the plan that we are actually a little bit ahead of the cost reduction process and plan that we put in place when we did the economics for the deal. And I see no reason why we won't continue to basically take those costs out slightly ahead of the timetable that we had in the original plan.

Sorry, the same amount of cost just realized faster? Or a larger amount of cost reductions realized?

Probably a little of both.

A little of the both?

I think the costs are coming out faster and we probably will have -- we will probably realize slightly more costs.

Would you venture an estimate as to how much you have realized to date?

No.

Okay. Great. Thank you very much.

Our next question is from Trevor Bateman of CIBC World Markets. Please proceed with your

Hi, Thank you. I just have a question that relates to Moody's negative outlook on your credit rating. It has recently published its opinion that it is comfortable with the level of non-performing assets in your domestic business portfolio, but it did identify the Canadian auto suppliers sector as a potential risk to its comfort level. If you could just, please, comment specifically on that sector in terms of its performance around outlook on it.

It's Peter Currie. I'd like to make a comment on Moody's negative outlook and then I'll pass it to Suzanne to talk to their observation on the auto sector. Moody's has had us on negative outlook since we undertook our [INAUDIBLE] strategy in the United States. And actually, what they were diversification.

What they were communicating was they had doubts on our ability to ex-skult on the series of platform extensions into the US Market. In the context of meet that is we had with moody's, I'm confident over the next medium term they are going to reevaluate that position. Certainly, we have been executing on our strategy. They acknowledge that we have been executing on our strategy and I'm confident that's going to get reflected in our rating evaluation at some point in the foreseeable future. Suzanne, do you want to comment on the auto sector?

Yes, while we deal with the auto secretary to the automotive parts sector is not a major part of our commercial lengthing portfolio. We did a fairly serious leading out of a number of those accounts a couple of years ago. And so although there have been problems there, we have not had -- I think we have had only one small account in that sector that has any problems over the last couple of years. So from my perspective, although the whole automotive industry and obviously -- has been under some stress, and therefore the suppliers have been as well, it is not a major part of our portfolio and as I say certainly none of ours have deteriorated to an extent that we are worried about them.

Thank you.

Our next question is a follow-up question from Jamie Keating of Merrill Lynch. Please proceed with your question.

Thank you very much. Just probably a follow-up for Jim Rager if possible. I wonder if I get a little color on the domestic retail and commercial operations on the revenue front and perhaps talk about some of the high and low points on market share to the extent you can.

Sure. Earnings for our domestic business pretty much flat year-over-year. The revenue was -- obviously, our revenue performance was challenged. Three reasons for that really. First of all, business credit volumes in our small, medium size and commercial portfolios were down. It wasn't because we weren't out there pitching business. Our pipelines were good. Our authorizations were up. Customers just were not drawing down on those lines of credit. And that had an impact. But that started to pick up in the month of April for the first time in our SME portfolio, we saw some growth in loans. So that was good. Personal credit was down as well for a couple of reasons. You know, we have a fairly sizable car lending activity. Zero percent cap to finance offers were -- you know, did have an impact on us during the quarter. Our student loans are running off and in fact they are running off a little bit faster than we had anticipated, and the performance of that troubled portfolio has been pretty much on expectations. Then finally, we tightened up about a year and a half ago, you remember us at some of these meetings talking about a credit quality in our personal loan portfolio and how we were seeing some trends that we didn't like so we adjusted. And that did have an impact, as well. So, -- But there again, we think we are in pretty good shape. We have changed our score cards and improved them so that we can launch some new initiatives here and hope that that will pick up in terms of business. And then spread compression. As I said, that was about 28 basis points year-over-year. The -- if you take an average business basis of $100 billion, that's meaningful in terms of revenue loss. We -- even though our deposit balances were up, our revenues for deposits were down. So you know, all of those -- those are the kind of key areas, major areas, for the revenue challenge that is we experienced in the second quarter. The good news, I think, though is that our credit quality is good, that we have continued to reduce our costs and not lost that discipline, had an improvement in fraud performance year over year and our sales culture I think is in good shape as we kind of come out of this and hope to grow in the future. We have lost some market share some market share, we are We have a cognizant of that and have a number of initiatives under way in our credit card business and in our deposit business for the most part to help us improve that.

Thank you, Jim.

Our next question is from Michael Goldberg of [ indiscernible ] securities. Please proceed with your question.

Thank you very much. You have given us some idea of the net impact of the telecom loan classified and the transportation declassified. Could you tell us what might have been individually, sort of each of the two of them? And secondly, what would be the impact of -- on your net interest revenue of moving to flatter yield curves?

I'll comment on the first thing and then I guess pass it to Peter Currie. We won't comment on the individual amounts for either of those names so you'll have to go with the general information we have provided you. Pete, do you want to comment on the yield curve?

In terms of the yield curve we're pretty well balanced right now. So the flattening of the yield curve doesn't pose us any particular problems. We're not making a play either on an increase or decrease in it, steepening or shallowing of it.

To a degree, it depends on the yield curve flattens, whether the short rates go up or long rates come down.

Yeah.

The opposite of the impact of rates going up would be slightly beneficial with respect to our interest --

The prime -- the positive spread is important to us, however the yield curve looks.

Right.

Our next question is from Heather Wolf of Goldman Sachs. Please proceed with your question.

I just had a quick question on variable compensation. You indicated that in the US., there is a trend to manage variable compensation down in line with the weak revenue environment. Two questions. Number one, is that -- is the US a primary driver of the decrease in variable comp that you posted this quarter? and number two, what kinds of trends are you seeing in the Canadian markets with respects to variable comps in the capital markets.

I hope I didn't get the impression that -- this is something that was being, quote, managed down as much as it was something that was being marketed down. You know, except in very specialized areas of the US market, what we have seen is that compensation is going down. I mean, there are places where that is not happening. But in general, we see it is happening. And in Canada, the same is occurring. Just from a natural supply demand there, more people leaving the market than there are coming in, in terms of new competitors. It's not that there aren't people that are dealing in the spot market but in general, the market is working the way -- and I use the word it should, advisedly, but the market is working. And in Canada, it's happening pretty well in the same -- in the same pattern, although it's a market that is more constrained.

Having said that, the -- it's being -- it's coming down naturally because the performance of the business is coming down and the bonus pools are driven directly by the performance of the business. So there is a direct correlation if the system is working the way it should.

Right --

And I wouldn't hesitate to say the way it should. With respect to -- to our variable [ INAUDIBLE ] in that business, Chuck, I think it's important to recognize that we essentially have won worldwide compensation structure for that business unit. So that it's you know, by and large there is very little variation between the various geographies because it's managed in one pool.

In our case, what we do is we basically have a bonus pool and at the end. Year we take what is in that bonus pool and allocate it amongst the various businesses. Depending on how they performed, what the market values are, and any number of other variables that use the determined compensation. It's not something that we're -- where we basically have accrued a certain amount. We actually have a formulaic basis of doing it and we do it on a formulaic basis.

Just a quick follow-up. It appears to me that your variable comp is being managed down more quickly than at your Canadian competitors. Can you comment on that at all, or, are you -- am I reading the trend incorrectly?

Yeah. Well, it's just not -- yeah, it's -- I don't know what's happening at the other competitors but it's not an issue of being managed down. We have a formula that we use. And it's just driven by the profitability of the various businesses.

We would prefer that number to be being managed up. But that's not the way the market is moving.

Okay. Thank you.

There are no further questions at this time.

Thank you all very much for your participation. On behalf of everyone here, and if you have any questions, please give me a call at 416-955-7803. That's for your follow-up questions. Thank you, bye bye.

Ladies and Gentlemen, that does conclude the conference call for today. We thank you for joining and ask that you please disconnect your line.