Royal Bank of Canada (RY) 2003 Q2 法說會逐字稿

Good afternoon ladies and gentlemen. Welcome to the Royal Bank 2nd Quarter Earnings Release Conference Call. I would now like to turn the meeting over to Miss Nabanita Merchant, Senior VP of Investor Relations. Please go ahead, Miss Merchant.

Thank you, Tina. Good afternoon everyone and thank you for participating in the one hour conference call regarding our second quarter results. We'll spend about 15 minutes describing our results and then take your questions. Gordon Nixon, President and CEO, will provide the highlights of our performance. Peter Currie, Vice-Chairman and CFO will give more details about the results, and Suzanne Labarge, Vice-Chairman and Chief Risk Officer, will outline trends in our asset quality. Five other members of our group management committee are available to take your questions. Elizabeth Bigsby, Sr Ex VP Human Resources & Public Affairs, and four heads of segments, James Rager, RBC Banking, [INAUDIBLE] of RBC Investments, Charles Winograd from RBC Capital Markets, and [INAUDIBLE] of RBC Global Services and our CIO.

Unfortunately, the [INAUDIBLE] head of RBC insurance couldn't be with us here today but we welcome questions in that business. Our EVP Finance is also with us. Please note that the comments we make in this call may include forward-looking statements that are subject to risks and uncertainties. In that regard, I will call your attention to the cautionary statement which is the first slide of our quarterly results slide document. I'll now turn it over to Gordon. Gordon?

Thank you, Nabanita, and good afternoon everyone and thank you for joining us with this call. We're going to try to keep our remarks fairly short so there will be lots of time for questions. We all have been down in North Carolina where we just completed our board meeting so unfortunately, with flights to catch, et cetera, we're going to have to end the call around 3:00. But we'll certainly be available for questions ongoing. But we'll have as much time as possible. In the second quarter of 2003, we certainly continued to experience a very competitive environment in our personal and commercial banking businesses.

Continued weak demand in brokerage and equity sales and trading in investment banking services and we're influenced or impacted by the strengthening of the Canadian dollar relative to the U.S. dollar which resulted in a lower translated value of our U.S. dollar denominated earnings. As is shown in charts 4 and 5, our second quarter net income under U.S. GAAP was 689 million, down 21%, 21 million, or 3% from the same period a year ago. And diluted earnings per share were 99 cents, down 2 cents or 2%. Under Canadian GAAP, net income was 697 million, which was up 3% and diluted earnings per share were $1 or up 4%. As is shown in chart 6, the 9% appreciation of the Canadian dollar relative to the U.S. dollar since the second quarter of 2000 resulted in a lower translated value of U.S. dollar denominated earnings and reduced net income by approximately $15 million, and diluted earnings per share by 2 cents.

Only I'll look to Peter Currie and Suzanne Labarge to discuss our revenue expense and asset quality performance in a few minutes. Chart H shows that our performance during the first six months relative to our objectives for the year was strong in the areas of portfolio quality, expense management and capital ratios, with provision for credit loss ratio below the target range, expenses down 1% and capital ratios above our medium--term goals. However, revenue growth was weaker, reflecting the significant strengthening of the dollar, the non-recurrence of a large net gain of 75 million on credit derivatives recorded a year ago, as well as competition in personal and commercial banks which we talked about, I referred to earlier. And continued challenging environment in capital market-sensitive businesses which we're certainly hopeful are going to start to pick up in the latter half, but have continued to be somewhat disappointing. In the face of these dynamics, we have accelerated efforts to identify new avenues for revenue growth, and ways in which we can be even more vigilant in terms of cost reduction.

The performance of our business segments are shown on charts 9 to 15. In the interest of time, I'll focus only on chart 9 which shows that excluding our capital market sensitive businesses, namely RBC Investments and RBC Capital Markets, the ROE's of the other three business segments were quite strong. We, as I said earlier, are confident that RBC Investments and RBC Capital Markets will benefit if, as and when we get a turnaround in Capital Markets in general. Turning to our U.S. operations, you'll note from chart 16 that our U.S. operations generated 28% of total revenues in the first six months of 2003, up from 27% in the first half of last year. Total U.S. net income was 194 million during the first six months accounted for 13% of total net income, up from 39 million or 3% during the same period a year ago. Our priority in the U.S. continues to be stronger performance from our U.S. acquisitions, RBC Centura, RBC Dain and RBC Liberty, in particular. As is shown in chart 17 net income from U.S. acquisitions increased to 58 million from 35 million a year ago, largely due to continued improvement in RBC Dain Rauscher which realized cost savings from the integration of Tucker Anthony Sutro as well as lower retention compensation costs, and continued good results from the fixed income side of that business.

U.S. dollar denominated earnings at RBC Centura were up slightly, while those at RBC Liberty Insurance were about unchanged. Compared to the first quarter of this year, RBC Centura's net income was down 12 million U.S. dollars, largely reflecting the fewer days in the second quarter, integration expenses associated with the acquisition of Admiralty Bank Corp. in Florida, and an increase in the provision for credit loss from an unusually low level in the first quarter. Chart 19 shows that retention compensation costs in the quarter and chart 20 shows our expectation for further reductions in the future. We recognize that to achieve our goal of being recognized as a investment class provider banking wealth management in the U.S., we must continue to increase the scale of our operations by making additional investments that add to our existing business base and by expanding our existing operations.

And to this end, we continue to evaluate opportunities to continue to invest in the U.S. around our personal and commercial activities, and are moving forward with retail branch expansion and openings in the southeast U.S. I'd also like to announce our intention, subject to the approval of the Toronto Stock Exchange to renew our normal course issuer bid and to repurchase up to 25 million common shares, or 3.8% of our common shares outstanding through the Toronto Stock Exchange. The proposed share repurchase will enable us to balance the imperatives of maintaining solid capital ratios with the ongoing need to generate shareholder value. Our current normal course issuer bid expires on June 23 of this year. With that, I'll turn it over to Peter Currie who will provide some further detail on the financials. Peter?

Thanks, Gordon, and good afternoon everybody. Turning now to our revenue performance, you'll note from chart 22 that total revenues were 3.75 billion, dollars in the second quarter, down 163 million or 4% from a year ago. Noninterest revenues were 54.8% of total revenues compared to 56% a year ago. As shown in chart 23, the decline in total revenues reflected a $75 million net gain on credit derivatives relating to two telecommunications accounts that were recorded in last year's second quarter, and in $98 million decline in the translated value of U.S. dollar denominated revenues this quarter, due to the appreciation of the Canadian dollar relative to the American dollar. Were it not for these two factors, revenues would have been up $10 million from a year ago, and six months revenues would have been down 1% from the first half 2002. Turning to the net interest margin, you'll note from chart 24 it was down six basis points from last quarter and 16 basis points from a year ago, largely due to higher amounts and higher funding costs of low interest yielding assets such as securities, and lower lending spreads, largely in commercial and wholesale lending.

As shown in chart 25, second quarter noninterest revenue was down $136 million, or 6%, from a year ago, mainly due to lower capital market fees and the nonrecurrence this quarter of a $75 million net gain on credit derivatives reported in the second quarter of last year, which was included in other noninterest revenues at the time. Trading revenues were up significantly over a year ago. Chart 27 shows that excluding U.S. acquisitions, revenues would have been down 5% from the second quarter of 2002, but further excluding the Canadian dollar-U.S. dollar change rate change and the net credit derivative gains, revenues would have been down 2%. As shown on chart 28, noninterest expenses were largely unchanged from last year's second quarter. A $14 million decline in retention compensation costs was offset by a virtually corresponding increase in pension expenses. Chart 29 shows that were it not for the stronger Canadian dollar, noninterest expenses in the second quarter would have been up 3% and in the first six months, up 1%.

As shown on chart 30, excluding U.S. acquisitions, and the currency impact, noninterest expenses would have been up 3% as well over the second quarter 2002. Moving on to the balance sheet, you'll note from chart 31 that we registered strong growth in our consumer loans over the last year, residential mortgages up 6%, in fact, up 8% including amount securitized, revolving credit facilities up 19%, total personal loans up 2% and credit cards up 20%. As shown on chart 32, net loans increased by $1.3 billion or 1% from a year ago. While total consumer loans were up by $6.8 billion or 6%, business and government loans declined by $5.7 billion or 9%, reflecting our deliberate efforts to reduce the size of our corporate loan book in favor of lower-risk residential mortgages. Turning to chart 34, we hold leading market positions in total deposits which are comprised of personal deposits and mutual funds and in residential mortgages. Note the increase in our personal deposits and mutual fund market shares. As highlighted on chart 35, our capital ratios rose from a year ago reflecting our sizable internal capital generation of about $1.7 billion since the second quarter of 2002. And we show this on chart 36.

We used a portion of this capital to repurchase our common shares. During the quarter, we repurchased a total of 5.1 million common shares at a cost of $293 million. Since the commencement of the current one-year program on June 24 of 2002, we repurchased 15.8 million shares, leaving a balance of 4.2 million shares available for repurchase up to the expiration of this program on June 23 of this year. As Gordon Nixon mentioned we're in process of renewing our normal course issuer bid subject to the approval of the Toronto Stock Exchange. In terms of our quarterly dividend, as chart 37 shows, it has increased by 59% over the past three years as a result of six increases. The dividend payout ratio was 43% in the second quarter of this year. That concludes my summary remarks, I'll turn to Suzanne Labarge to discuss the loan portfolio. Suzanne?

Thank you, Peter, and good afternoon. I'll now take a few minutes to provide with you an update date on RBC Financial Groups asset quality. To get started chart 38 provides you with a current breakdown of our loan portfolio by section. Consumer lending now represents 63% of our loan book and the 37% in business and government loans down from 38% last quarter, is well-diversified. Turning to charts 39 and 40, you can see that non-accrual loans declined by $211 million in the quarter, driven by the return to performance status of international energy loans. This was partially offset by the classification of a domestic airline account as non-accrual in the quarter. Consumer non-accrual loans declined by a further 6% in the quarter and are now 19% lower than the same period last year.

Non-accrual loans in RBC Centura increased by $17 million, mainly due to the impairment of one commercial loan. As shown on chart 41, the provision for credit losses in the second quarter was $211 million compared to 186 million net of credit derivative gains in the first quarter. Included in this quarter's provision was a provision relating to the new non-accrual airline account. Despite the continued improvement in domestic consumer non-accrual loans, we did incur additional [INAUDIBLE] on our unsecured lending products well as student loans in the quarter. As shown on chart 42, we have recorded in noninterest revenues credit derivative gains of $120 million over the past five quarters, compared to credit derivative losses of 69 million. Chart 43 provides you with a status report on the level of credit protection that the bank has purchased and sold by sector.

As of April 30, we have bought credit protection totaling a billion dollars and sold credit protection totaling 252 million. Chart 44 shows that despite the Q2 increase in provisions, the credit quality in the Canadian consumer loan portfolio continues to remain stable. The quarterly provision for credit losses on this portfolio which includes residential mortgages, continues to fall within a range of 35 to 45 basis points. Chart 45 shows that during the quarter, net charge-offs were $228 million compared to 140 million last quarter, and 346 million a year ago. An update on our current exposure to power generation is found on slide 46.

Outstanding loans in this sector declined further by 3% in the quarter and the net impaired loans decreased by 85% to $33 million. Chart 47 provides an update on our current exposure to telecommunication company. Non-investment grade telecommunication loans outstanding at April 30 was $581 million and down a further 25% from last quarter. Net-impaired loans net of charge-offs taken to date are $23 million, which is unchanged from last quarter. Chart 48 provides an update on our exposure to airlines and aerospace as noted earlier, net impaired loans increased by 58 million and total loans of $1 billion was reduced by 1%. Our loans outstanding in hotels, restaurants and entertainment is disclosed on chart 49.

This sector has a large component of non-investment grade and much of our exposure is for small business and smaller commercial clients. The credit quality remains sound. Charts 50 and 51 attest to our continued positive trading performance. In conclusion, the Capital Markets non-accrual loan portfolio remains well-provided for. Exposure to challenged sectors continues to be reduced. The RBC Banking Canadian portfolio remains stable and our trading performance remains solid. The specific provision for credit loss ratio of 40 basis points in Q2 remains well-below the target range of 45 to 55 basis points we have set for our 2003 objective. We are certainly comfortable with the target range for 2003. At this point, I would like to turn the call over to the conference operator so that we can begin the question-and-answer period.

Thank you. We will now take questions from the telephone lines. If you have a question, please press one on your telephone keypad. If you are using a speakerphone, please lift the hand set and then press one. If at any time you wish to cancel your question, please press the pound sign. Please press one at this time if you have a question. There will be a brief pause while the participants register for questions. We thank you for your patience. Our first question is from Jamie Keating of RBC Capital Markets.

Good afternoon,everyone. How's the weather down in Rocky Mount today?

Fine. Sunny.

I'm curious about the retail business, if I could, domestic, I'm hoping to key in on, and I'm trying to reconcile some comments with what's going on in the NIM. I was looking at Slide 24 and noticed the NIM is down significantly, but most of the contraction appears to be related to commercial and wholesale lending. As the note implies, then looking over at the sub pack, I guess it's page 3, it looks like the RBC Banking margin relatively flat sequentially and I guess I was looking at that because I was hoping to see if that's where some of this competition was creeping into the numbers. But looking at the numbers, it looks more like it's noninterest expense that's had a bit of an influence on your year-over-year results. I wondered if, I don't know, Peter or Jim might comment on what's happening in the retail bank segment. And if it is an expense issue, if we could discuss what the bank's doing there.

Sure Jamie, it's Jim Rager here. Sequentially or year-over-year? You mentioned the net interest margin flat sequentially.

I agree, year-over-year you're down about seven basis points.

Right.

And again, relative to the group, that actually seems to show reasonably well.

Right.

And I was focussed on this as being a competitive environment, maybe I'm misinterpreting but the other side of the equation, Jim, is that the noninterest expense is up a fair bit.

Right. Year-over-year it's up like $47 million or so.

Right.

Yeah, the way we would explain that, we've been trying to protect our business in Canada and do a better job with our customers. So at about this time last year, we announced that we were putting about 450 people back into our branches. And those are just this first quarter year-over-year that they're there. As well, the -- you know, we had an increase in our pension costs during the quarter as compared to last year. So those two things are really the majority of that increase.

And I guess it leads to the question targeting the efficiency ratio in that area, do you have a sense as to what's achievable and where you'd like to be by year-end?

Our efficiency ratio in Canada is still below 60, closer to 55 than 60 in fact. About in the middle, about 58% in fact. Our target, if to get that down towards 50. But we've got to get the revenue coming back a little bit more strongly relative to the volume growth that we're getting for that to happen at this point. But if you look at our expenses, year-over-year, and you exclude the increased cost of pension and the FTE, we're pretty much flat.

So Jim one last question. If we're seeing all this residential mortgage rate war underway, should we brace ourselves for a little more erosion on the NIM in this area area?

The -- erosion on the NIM is a combination of things. A lot of pricing pressure on deposits as well. That, along with the rate wars on mortgages, is what really has contributed to the reduction on our net interest margin. You know, we are trying to be very selective in the way that we discount our prices. We're -- we want to make sure that we hold our market share and in effect that we build it back to where we would like to see it. But we very selectively use pricing as the need to do that. So we're hoping that the sequential, as you said, there's a bit of sequential flattening in the net interest margin at this point. We hope to see that continue.

Okay. Thank you.

Thank you. Our next question is from Jim Bantis of Credit Suisse First Boston. Please go ahead.

Hi, good afternoon, two questions, please. On the supplemental, looking at page 5 in terms of RBC Investments, we're seeing the noninterest expenses over the last three-quarters kind of stabilize in the $730 million range after some real progress in the last half of '02, but revenues continue to erode clearly. Can you tell me if, have we hit a wall in terms of expense reductions in Dain Rauscher and Tucker Anthony in the U.S.? I've noticed that the head count, the FTE's are down considerably over the past two quarters. Is there a level of termination and severance costs built into that number and maybe we'll see a drop going forward?

This is Peter Arninio. The question is for Dain, our do you want it overall? Do you want it on both?

Yes, that would be great.

Basically from a Dain perspective, the way we feel about our expenses, we did accelerate the synergies between Tucker Anthony and Dain at the time, and we are now sort of enjoying that part of it. They're going now to the next phase of expense reduction which will be much more related to a kind of a initiative that is north-south between the two organizations whereby we will look at our technology, our operations, our HR, our finance, and those kind of things. And that's where our next focus will be. So we've gone at this by phases, whether it be in Canada or the U.S., the first phase in Canada was making sure we accelerated the synergies between the two organizations. We now feel we have enough of a dialog going on between the north-south that we can now start to accelerate the expense reduction in that regard. So by no stretch of the imagination are we hitting a wall, we are definitely making sure that we're now getting into the next phase of that. In Canada, you're right, from quarter one to quarter two, it has sort of dragged a bit. There again I would say we've done these things in phases, we've done a lot of the cost initiatives in quarter 4 of '02. We're now started re-accelerating, we did a lot in quarter one of '03 which hopefully will start to hit to some degree starting in the month of May, June and July. So to answer your question, no [INAUDIBLE] from my perspective, we're not hitting the wall, we're definitely looking at re-energizing ourselves on the cost side.

Great, thank you. The second question is probably to Gordon or Peter, in the respect of the last conference call in recent statements had really talked about the U.S. expansion strategy being perhaps accelerated post-clarity coming from the federal government in terms of mergers and it seems that that is happening. Could you talk about -- and the M&A activity in the U.S. has started to pick up on the retail side, albeit slowly and smally. Could you talk about where you take your tier one ratio and the respective of transaction in the U.S.? You know, how low, Peter, are you willing to go in terms of tier one ratio? Are you more focussed on tangible common equity at this point? I'm trying to get a sense of the excess capital in terms of the cash component of any transactions.

I'll kick it off and turn it over to Peter to specifically answer with respect to how far we would take our tier one capital to, although I would say that we would structure a transaction to stay within our objectives, and to the extent that we needed equity to achieve that, we would certainly stay in that range. I think generally the -- I think you're right. I think the -- certainly the lack of clarity that we've had around mergers in Canada appears to be disappearing, although never say never. But certainly I think it's more clear to us that we're probably looking down the road a couple of years as opposed to in the near term. And if that is the case, I think we will start to see an acceleration or certainly from our perspective, an ability to look at more aggressively investing in our platform in the U.S., particularly, as I said earlier in the personal and commercial banking businesses in the southeast and certainly with the flip side of the negative impact of a strong Canadian dollar on our earnings, that does provide some benefit in terms of looking at investment opportunities in the U.S. So we are certainly accelerating our plans in terms of investment in the U.S. marketplace. Peter, I don't know whether you want to add specifically to the capital question?

Sure. There's no question that given our current capital ratios that we're in a very, very strong position, up 9.6% and 12.8% tier one in total capital respectively. And there's also no question that we're looking for opportunities as Gordon has indicated, we think we're in a strong position to move forward if and when we find the right partners. If the question really is getting at are we prepared to substantially reduce our capital ratios, we're very, very conservative in that regard. We believe very strongly in the maintenance of strong capital ratios. So we've indicated our medium term goals are 8 to 8 1/2% for tier one and 11 to 12% for total capital, certainly that remains at the forefront of our minds as well. So we've -- I don't know what else I can tell you. Other than that we remain very vigilant to continue to grow the business, very selectively but we also don't want to impair the capital strength of the company.

Thanks, Peter, I appreciate that. To what extent are you concerned about the tangible common equity ratio?

It's obviously -- tangible common equity has become a much more visible ratio with the rating agencies and others. And it's something that we're keeping more and more in the forefront of how we track our businesses.

I appreciate your time, safe flight.

Thank you.

Thank you. Our next question is from Steve Cawley of TD Newcrest. Please go ahead.

Hi, I'd like you to respond to the quality of the earnings and the sustainbility of the earnings in three areas: One is the other division; the other is the insurance division and specifically there I'd like to know if there was any reserve releases or any changes in the assumptions that you used, price or policies; and then finally, in the investment securities, there was a gain which is very different from the rest of the banks. So if you could speak to those three topics, I'd appreciate it.

Okay. It's Peter it's Peter Currie, let me talk to those, and not necessarily in the order you asked. In terms of insurance, we're actually very pleased with the performance of our insurance operation. It's performing strongly across virtually all it's product lines. I can tell you that the results have not emanated from any change in operating assumptions. So to the extent that it's sustainable I think traces itself back to the underlying vitality of the general insurance markets and as you recall, we're in several of those markets. We're in creditor, we're in travel, we're in life in Canada, and property and casualty in Canada, and to a lesser extent, life in the U.S.A.

Sorry, Peter, the disclosure that you guys provide there on page 4 of the supplement, is lacking pretty badly and I hope that we can get some better disclosure over time, even just to see gross premiums every once in a while would be useful. Like this really isn't what I'd call an income statement reflective of an insurance company.

You're right. What it is is an income statement conformed to a bank because that's, in fact, what we are. And as a result, we wanted to maintain some consistency among the various divisions so people could compare relative performances.

Maybe in the notes of the financials that would be useful.

Steve, if I may add to Peter's comment, if you look at page 7 of our press release, we do indeed provide a breakout of our premiums and deposits and our earned premiums and policy benefits and acquisition costs and a few other lines that are perhaps a little more comparable to insurance companies. But your point is well-taken and we will consider perhaps adding those in the supplementary information.

It's just getting to be a meaningful division for you, on a profitability basis.

Right. Well, thanks for that suggestion.

Your other question, as I recall, dealt with the "other" category, the other business segment as it were and your question was -- I think your question was what is the prognosis for this in terms of net income and what's in there? I can tell you obviously by definition, it includes a lot of miscellaneous items. This quarter, probably the major item that affected its result was a realization of securities gains on discretionary investment that we had. That was disposed of during the quarter. We've indicated in the past that items of that nature tend to flow through this category on a one-time basis.

So that would have also been in your "other" income line under the securities gains, is that the same number?

Yes, yes.

Yes.

That's a net number in your other income. Can you tell me what the actually gain was in this discretionary investment?

No, I guess I can't.

And so what are you -- to me, that doesn't look like a regular operating type number and I wouldn't be giving it let's say the same sort of evaluation that I'd be willing to give a regular stream of income. Am I thinking that the wrong way? Is there anything that you could add to dispel that criticism?

Let me respond, by definition, as I said a moment ago, it's not a regular operating item in any event. You can assign whatever weighting you want to it. That's your call. But I guess my suggestion is that we're a big, complex business and engaged in a number of activities. And experience has shown that over time, we tend to get items flowing through this category that individually may be nonrecurring, but as we said we're big and complex and lots of things that flow through that category.

I think quarter over quarter, other was flat or up marginally, I have a

Up about 60.

Quarter -- sorry, quarter over quarter -- year-over-year, yes, it's 84 versus 63, versus the same quarter last year.

Thanks, Peter.

Okay.

Thank you. Our next question is from Rob Wessel of National Bank Financial. Please go ahead.

Hi, good afternoon. Most of or actually indeed almost all of my questions have been asked and answered but just a quick clarification on the acceleration of the U.S. expansion strategy. Is it right to think about it this way, which is that the finance minister will come out with some sort of statement, whatever that may be, let's assume it's somewhat muted on the idea of bank mergers, and that that is sort of a catalyst and then at that point in time, it's almost like a starters' gun going off?

For U.S. expansion?

Yes.

No, I don't think so. I mean no, we have not stopped in terms of our investment -- looking for opportunities to expand in the southeast, although, as I said at one of the investment dealer conferences, which was webcast, there's no question that your mindset as an organization is influenced if there's a view that potentially there's a miniature domestic merger two months down the road. I think if that is eliminated, I think the - as a general statement, the ability to focus a little more in terms of medium-term or longer-term plans is increased somewhat. But I certainly wouldn't want to leave anyone with the impression that we've had a whole bunch of opportunities that that we've put on the shelf and we're going to bring them back once we have clarity around mergers. We have never stopped having discussions with people, looking at opening branches, looking at real estate. And we're going to continue with that plan but certainly that -- the clarity issue is one that we want resolved one way or the other.

Great. And just one more follow-up. With respect to the extremely weak markets we've had, and let's assume that revenue growth remains challenged in this area for a while, would the bank consider using declines and incentive comp as a lever for earnings growth or at least in order to preserve earnings erosion?

Well, I mean, our variable comp is very formulated-driven. So to the extent there continues to be or there is further erosion in the areas of the business, whether it's variable comp, you will see that translated immediately into the cost reduction line. I mean, there's no -- I mean, we don't move those numbers around. They're driven very much by formula and commission structures. So you'll see a direct impact regardless of which way the business goes.

That's great. Thank you very much.

You're welcome.

Thank you. Our next question is from Susan Cohen of Dundee Securities. Please go ahead.

Thank you. You commented that the foreign currency translation costs about 2 cents a share. Going forward, are you going to be able to do anything to hedge foreign currency translation so that it won't have the same kind of impact on your bottom line?

Susan, it's Peter Currie. Let me address that on two fronts. First of all, let me tell you that we follow a consistent policy of converting our actual U.S. dollar earnings to Canadian dollars in the spot market at the end of each month of the quarter. We don't hedge U.S. -- expected U.S. earnings at the beginning of a quarter or at the beginning of any period. The only time that will end up really working against you is in a period of rapid -- the only time it will create volatility is in a period of rapid change in the relative currencies. We saw that in the last quarter. We don't think that's a typical environment, therefore, we don't plan to change our policies in that regard. In terms of the balance sheet, we lever our U.S. dollar equity investments and hold both U.S. dollar assets and liabilities, the Canadian dollar value of the American assets liabilities and equity change with the exchange rate. Hedging just that equity investment would only reflect a portion of the exposure to changes in exchange rates, so in effect, what we do is we try to minimize the effective changes in exchange rate on our capital ratios, not the Canadian dollar value of the investment and we don't anticipate changing that position either.

And secondly, if I may, you mentioned that there were some integration costs associated with Admiralty. Is that a second quarter item only? Or will this continue for the balance of the year?

That's second quarter item, we closed on the transaction, we did the systems conversion in April, and the costs related to that took place in that month. And are gone. You won't see those again.

And can you put any kind of a number around it?

Sorry?

Can you quantify those costs in any way?

No, we don't quantify those costs.

Okay, thank you.

Thank you. Our next question is from Heather Wolf of Merrill Lynch. Please go ahead.

Hi, good afternoon. Just a couple of follow-up questions. First, on the retail banking margin, as Jamie, I think, indicated, you posted a sequential increase and I'm guessing if it weren't for the three-day count, you probably would have had even more of an increase, it's a little inconsistent with the commentary in the press release about the pricing pressure in the Canadian market. I'm wondering -- I'm guessing there's a lot going on behind the scenes in that margin, I'm wonder to go you can flush out some of the contradicting trends?

I think the comment in the press release related to year-over-year compression in margin. And, in fact, that did take place as Jamie said, we were down seven or eight basis points overall in the business in Q2 of last year. But we have watched that throughout and adjusted our pricing policies accordingly. And what you see is from the first quarter of this year, a little bit -- or at least a stabilization of that drop in spread. So I don't think that there's anything complicated going on there, except that as we go -- as we look at our business growth, as we look at what we have to do to hold market share in some of these areas, we will adjust our pricing accordingly and that worked to our benefit, I think, as we compared Q2 to Q1 of this year.

And can you give us any flavor on what was happening in Canada versus the U.S. in terms of margins? Were they both pretty stable quarter over quarter?

The U.S. improved a little bit whereas Canada dropped slightly. In fact, that's the way the overall-- but because of the relative weighting, it ends up showing the picture that you see there.

Okay, great. Thanks. Just a couple of other questions. First, on the financial target that looks like the EPS target might be a little bit difficult for you this year. Do you have any intent on revising the targets? And then the second question is a follow-up on the U.S. acquisitions. Have you specified a size range in which you would be willing to complete a transaction?

Heather it's Gordon speaking speaking. With respect to the first question, we don't provide targets. And we haven't in the past and will not in the future. We publish each year our objectives in our annual report. And then we report to our shareholders the following year in terms of meeting those objectives. And our objectives for the next year. And so I would just put in perspective that those are objectives and we will do that again at year-end. So we certainly don't have any intention of providing a target. Sorry, the second question was with respect to the size of acquisition?

That's right.

No, I mean, I've said many times in the past that we could certainly manage an acquisition comfortably given our capital ratios in excess of that which we have invested over the last year or two in acquisitions, which has been about a billion dollars a year roughly in new investments. So when you look at our current capitalization, we could certainly make an investment significantly higher than that. But we're always hesitant to qualify because we could make a large acquisition if it was a good acquisition, both strategically and fundamentally. Because we not only have a strong capital structure, but if need be, we could raise equity to complete the acquisition. We could handle a couple billion dollars of investments pretty much given our existing capital structure, as you know, you can calculate the numbers when you look at our capital ratio objectives. But we could certainly go larger than that if there was a transaction that made sense. But we're going to continue to be very disciplined in terms of not compromising our fundamentals for the sake of a larger acquisition. Or quicker growth. So we're trying to manage that balance. But there's no question that comfortably we could invest significantly more than the billion dollars range that we've had over the last couple years.

That's very helpful. Thank you.

Is that a gray enough answer for you?

That was actually helpful. Thank you very much.

Thank you. Our next question is from Ian de Verteuil of BMO Nesbitt Burn.

2 sets of questions. First of all for Jim. Jim, I was wondering if you could articulate the rationale for the Royal Bank, both posting mortgage rates and detailing best rates to consumers. It seems that they're relatively new phenomenon, and I was wondering why, isn't that a real problem in dealing with consumers at the branch level?

In fact, we were having a lot -- kind of customer satisfaction issues with consumers at the branch level because our pricing was different in different channels. And folks were confused. In fact, what they would end up doing is arbitraging us by customers would see that, would understand that, and would not understand why the price was higher in one channel than in another. So that, plus the fact that the competitiveness of this marketplace for residential mortgages is very high right now, and one of the strategies we took there to kind of dig in and protect our position was to post the same rates, our best rates, in all channels. And, in fact, that's been very effective.

Doesn't the consumer who doesn't get the best rate sort of feel like a second-class citizen?

Sorry?

Doesn't the consumer -- I mean, presumably if it's a best rate, you cannot actually offer a better price to anybody than what you've detailed just for truth in advertising. So I mean, some consumers must get less than the best rate, doesn't that create a problem?

What we said there is that we will post our best posted rate in all channels.

I see. So that would be like the mortgage broker channel.

That doesn't mean -- that's right, that doesn't mean that that's the best rate we would give all the time. There's still room for discretion based on customer value and those other kind of things.

Thanks. The second question for Jim, if -- I think you mentioned to get the expenses down you figured the right thing was to get the revenue line working again. How are you going to get the revenue line working again without taking down spread some more?

As I've said, one of the things we've tried to do here is to be selective in the way we've taken -- we've used pricing as a strategy. For example, rather than offering a high interest savings account, which causes significant cannibalization that is there for a long time, we'd use rate sales so that we could target that to particular customer segments to help us build our deposit market share back. We used money market funds and other things to do that. We could be selective in the way we offer those things and in the way we price them so that as we see things stabilizing, we can modify once again our pricing strategy to improve revenues.

We also -- it's Gordon Nixon speaking -- believe very strongly that we can continue to build value proposition for our customers by providing them broader variety of services across our various platforms. Personal and commercial banking products through other distribution channels and vice versa. And as you know, one of our priorities is cross platform leverage and there are a lot of initiatives across the organization where we do think we will start to see some increased revenue by basically minding more from our existing customer base by providing them a better package of value and services. And there's a number of initiatives in the credit card businesses, for example, across all of our businesses. We have a number of cross-platform initiatives related to specific products or specific customer base at different customer segments. And we think that those initiatives are going to be very important to us in the future. So there is a lot of activity in those areas.

Second set of questions relate to loan losses. Don't want to let you off too easy, Suzanne. We started to see - we've seen the net impaireds continue to improve but the loan losses and the provisioning hasn't come down in the quarter the way we've seen with some other institutions. I guess -- I know you do it on a specific basis, but is there any -- as you look out, is there a sense that provisioning should start to decline or are you going to keep running at this level and building net impaireds?

Uhm I guess it's always sort of hard to get where it's going, first of all, I remind you that we didn't have unfortunately if you want to call it fortunately or unfortunately, the ability to massively improve our credit provisioning from year-over-year. But I think more importantly, I mean, we look at it on a specific count that will always be names that come out that are surprises. We're still not through the worst of uncertainty, which is what makes it very hard to estimate where we're going forward. I mean, the impact of what we have more or less the uncertainty around the world, there's still enormous amount of uncertainty in the U.S. economy about what's going to happen to a number of industry sectors. And there are companies that are always on the edge and they may or may not go over, depending upon what happens in the economy. In Canada, it depends upon what happens to the macro economic level, if SARS or Mad Dow disease or something else went on for a very long period of time. Our goal is obviously to get back to better times when we have better loan loss provisions but it's hard to predict just when the economy is going to allow us to do that.

The last question relates to your slide 46, your net impaireds and power fell by about 170 million. Was the reclassification of the power loan that went performing, was it about 150 million?

It was largely one account.

It was about 150 million?

That sound like about the right amount.

Thank you.

Thank you. Our next question is from Quentin Broad of CIBC World Markets. Please go ahead.

Good afternoon. A couple of questions, just one technical. In the other income, other 56 million sequentially down about 94 million, what was in there? I mean, we've had an explanation year on year, but I may have missed what might have been on a sequential basis.

Quentin, your voice is coming through very softly. Could you repeat that? Were you referring to the supplementary?

Page 15 and I'd be referring to Canadian GAAP supplementary.

The other income?

The other other income on a sequential basis down $94 million. And I think all of your U.S. GAAP slides and your commentary have talked about year-on-year and there isn't any material credit derivative activity that would have gone through that line in Q1 that you --

Yeah, I think we have some sort of an explanation for that. Last quarter, we had reported in our press release that we had a gain on sales of the TSX shares of about $35 million. That had been included in the number last quarter. As well as indicated in the footnote 4 there was a gain on credit derivatives of $29 million last quarter so that accounts for a sizable chunk.

54 of the 95.

Yeah, of the reduction, right.

Okay. Secondly, and this is I guess a fairly wide-ranging question, but if I look at -- and if I take all of your individual SUPs on the reporting groups and back out the U.S. income, which is part and parcel of your reporting, and I go through each operating unit, the Canadian reporting, RBC Banking delivered lowest income in 10 quarters, RBC Investment lowest income in 10 quarters by almost 20%, RBC Capital, second lowest in 10 quarters. We're seeing a very weak Canadian contribution, if you will. And I'm just wondering, can anything be explained on a more macro basis? Is there any concern whatsoever that as you've expanded into the U.S., perhaps a little bit of the eye of the ball in Canada? Is it what we've heard from Jim in terms of competitive pressures? I'm trying to get a sense. The results were weaker than I expected and I would say the culprit is probably a weak Canada. In this quarter. Any thoughts on that?

Yeah. It's Gord speaking. There's no question that I think if you look at the mix of our businesses in Canada there's been some weaknesses, particularly in those that relate to the equity business. And I guess the view that you hope for is that in terms of the equity -- overall equity market performance that we're at a level where it doesn't get much worse. But it's impacted all of our businesses from wealth management through -- I mean, there's very new issue activity, there's very little large lending activity that is driven by acquisition and bridge financing, there's very little activity in general. Our outstandings are significant, but the draw-downs are very low across our commercial markets. The corporate market in Canada -- or the markets in Canada from a balance sheet perspective are quite strong because most companies, small and large, are building up their balance sheets, they're not investing significantly, and there's just relatively a low level of activity. So we certainly would anticipate that that is going to start to turn, and pick up. And but it's -- there's not a lot of general growth cross the marketplace in most of our product areas. Even transaction processing in the equity side of the business, there just is less overall activity than there is in -- than there are in normal times. So we would certainly anticipate that that is going to start to turn, but it continues to be fairly new to growth.

Gordon, as you look at that, then, you mentioned that you thought you had pretty good expense control but it - revenues are down 3% and expenses only down 1% and I don't know what the [INAUDIBLE] impact was but do you -- is there -- if the markets stay where they are, is there more aggressive actions required on the expense side, Number 1? And if you look at the net economic profit contribution, and I appreciate seeing it all on one page, 13 in the SUP, if I look at RBC Capital Markets and the net economic profit contribution, if markets don't change, do we have to see more significant changes in terms of whether it be variable comp bringing whole grids down, or cutting people? I mean or is this as someone said earlier, you've hit a wall on some of this stuff and you absolutely need the markets to come back to get this back generating reasonable economic profit?

Yeah, I mean, I'll let Chuck speak specifically to the Capital Market side. But as a general statement. we can and will continue to do more if need be in terms of reducing our overall expense structure. But I would reiterate that we are in a lot of these businesses at a low in terms of general activity levels. And we would certainly anticipate that some of these businesses are going to start to show some better signs of life as we move forward. It is generally a very, as I say, anemic environment up there. With respect specifically to the Capital Markets business, Chuck, do you want to make a comment?

My comments would be basically as time goes on, if the market doesn't become more profitable, the share between effort and capital will just naturally reallocate. But basically the bigger issue in the ROE and the economic profit is just the amount of cash you have in the business which in our case is being largely dictated by credit capital, which is largely dictated or a lot of it is dictated by basically the models that we use that allocate capital and [INAUDIBLE] environment. So as things get better, that should improve. In fact there will be more leverage in that type of a phenomena then -- and, in fact, getting rid of capital in our loans that basically do not create sufficient revenues and there would be from any other single thing I can think about. From a cost standpoint, in Canada particularly, the cost of actually laying off people is such that you have to be very careful that you -- that you're not taking a wholesale move that doesn't make sense from an economic standpoint. And we didn't build our Canadian business that substantially over the course of the cycle and we brought it down somewhat but not greatly.

Thank you, gentlemen.

Tina, we can take one last question, as we're approaching 3:00.

Certainly. Our next question is from Nick Solelli of Bincore. Please go ahead.

Let me expand quickly on the cost-cutting initiative. Could we talk about the timing of that? Is it more of a next quarter type of item that could see some reductions or more long-term, probably an '04 or '05 more longer term restructuring to bring down your cost? Secondly, just on the U.S. expansion, I was wondering if you could just comment if you're seeing more favorable prices, or the currency seems to have gone on your side, your stock price, except maybe for today, has been increasing as well but nonetheless good valuation, could you comment if you're seeing better prices these days? And lastly, I don't know if you commented on the Air Canada exposure, could you give us your gross exposure and how much of that has been provisioned, please?

Suzanne would look after the Air Canada question, but I don't think she'll have a comment with respect to specifically on Air Canada itself. With respect to your question on cost cutting initiative, we don't have currently a cost-cutting initiative that we have announced in place. I hope you haven't assumed that. I think that in terms of our general cost reduction program, as I have said in the past, on many occasions, it is really something that is ongoing, we have a number of programs and initiatives across the organization, some of them longer term and some of them shorter term in terms of our improving our efficience ratio and our cost structure in all businesses. With respect to personal and commercial banking, we have provided a target of getting down to the low 50s in terms of efficiency and we certainly intend to continue to move in that direction. And there's a number of programs that will get us there. We've talked in the past about our E-squared committee that's looking at all of our functional costs, all of our technology costs across the broader organization and ways to improve the overall efficiency of the organization. We have a number of longer term projects that relate to straight-through processing and technology efficiencies that we think will generate significant longer term productivity improvement. So there will continue to be an ongoing program of productivity and efficiency improvement across the organization. I think with respect to specific short-term ones, some of our businesses and in particular the Capital Markets-related businesses have to react very quickly to volatility in their markets which tend to be very volatile by nature. And there's been a number of specific initiatives in our Capital Markets in a our wealth management businesses and they will continue, as I say, to adjust to the marketplace. And if need be, we'll take action. But I would emphasize, there's no across the organization initiative, it's more a question of a series of ongoing programs. With respect to U.S. acquisitions, I think your question related to the price of investment opportunities given the appreciation of the Canadian dollar, given the strength of our share price relative to financial institutions. And the picture has improved somewhat and that's a positive. It hasn't improved as dramatically as one would expect because the areas where we tend to be interested, specifically in the first loan commercial banking businesses in particular, tend to be those financial institutions that have been able to maintain higher multiples in this environment. So there has been somewhat of an improvement but it has not been as dramatic as one might think. Suzanne, do you want to add anything to Air Canada other than to say no comment?

We have a policy of not giving information on specific accounts.

Thank you very much.

Thank you.

Thank you. At this time, I would like to turn the meeting back over to you, Ms. Merchant.

Thank you very much, everyone, for your participation. Please if you need to get in touch with me, leave me a voice mail message at work and I will pick up my messages when I get back at about 5:15 this afternoon and will be available to take calls through the weekend as well. Please keep leaving me voice mail messages. Thank you very much.

Thank you.