Royal Bank of Canada (RY) 2004 Q2 法說會逐字稿

Good afternoon ladies and gentlemen. Welcome to the Royal Bank of Canada's second quarter earnings release conference call. I would now like to turn the meeting over to Ms. Nabanita Merchant, Senior Vice President, Investor Relations. Please go ahead, Ms. Merchant.

Good afternoon, everyone, and thank you for joining us for this conference call regarding our second quarter 2004 results. The call will last till about 3:15 PM to allow adequate time for your questions. We'll begin the call with an overview of our results by Gordon Nixon, President and CEO. Then a discussion of personal and commercial banking performance by Jim Rager, Vice-Chairman. Following that, Peter Currie, Vice-Chairman and CFO, will provide more details of our financial results. And Suzanne Labarge, Vice-Chairman and Chief Risk Officer, will discuss asset quality trends. We will then take your questions.

Also with us here, to take your questions are other members of our group management committee -- Elizabeth Bigsby, our Senior Executive Vice President, Human Resources and Public Affairs; and heads of our four remaining business segments, Peter Aermenio from RBC investments, Chuck Winograd from RBC Capital Markets, Jim Westlake from RBC Insurance and Martin Lippert, who is also our Chief Information Officer, from RBC Global Services. Janice Lugar (ph), our Head of finance, is also here with us.

I will now turn over to Gordon Nixon. Gordon?

Thank you very much, Nabanita. We are actually all here in New York, so we're hoping that this teleconferencing system is effective and clear. We had a bit of a tough time hearing the operator. But hopefully, going the other way, it's working well.

I'm pleased to report another quarter of what we believe are very good results which reflect much stronger performance in our investments, capital markets as well as our Canadian banking and insurance operations. As shown on charts four and five, second-quarter net income was $774 million, up 12 percent from a year ago, and diluted earnings per share were $1.16, up 17 percent.

You will note from charts six, that our second-quarter results were impacted by four items, and Jim Rager will discuss the valuation allowance on certain mortgage loans.

As you can see from chart seven, a nine percent appreciation of the Canadian dollar relative to the U.S. dollar from the second quarter of 2003 resulted in a lower translated value of U.S. dollar-denominated earnings, reducing net income by approximately $20 million and diluted EPS by three cents. Peter Currie will discuss our revenue and expense performance, and Suzanne Labarge our asset quality in the second quarter, in just a couple of minutes.

As shown on chart nine, our performance during the first six months relative to our objectives for 2004 was strong in the areas of earnings growth, ROE, portfolio quality and capital ratios. With solid EPS growth of 11 percent and ROE of 17.7 percent, both are within our target range. The allocated specific provision for credit loss ratio was well below the target range, and our capital ratios above our medium-term goals.

Revenue growth during the first six months was 2 percent, which is below our target range, reflecting the effect of the strong Canadian dollar on the translated value of our U.S. dollar-denominated revenues and the impact of the lower interest rate environment on our margins. We're encouraged by the 7 percent growth in revenues achieved in the second quarter of this year, which reflected strong growth and capital markets-related revenues other than trading in Canadian banking revenues. The 9 percent expense increased for the year-to-date largely reflects the cost of the Rabobank settlement last quarter, higher variable compensation costs and higher pension and post-retirement benefit costs.

The performance of our business segments is shown on charts 10 to 31. In the interest of time, I will focus only on chart 10, which shows the very strong performance in four of our five business segments which recorded double-digit earnings growth in the second quarter. The strongest growth was recorded in our capital markets-related businesses, RBC Investments and RBC Capital Markets. Net income for RBC Investments more than doubled from a year ago due to higher earnings in the U.S. in Canadian brokerage businesses and Canadian asset management operations. Earnings at RBC Capital Markets increased by 85 percent, largely due to strong performance in the investment banking and equity businesses and a decline in the provision for credit losses. Net income at RBC Global Services and RBC Insurance grew by 51 percent and 16 percent, respectively. As for RBC Banking, the 1 percent decline in earnings reflects good growth in Canada which is more than offset by a significant decline in the United States. However, compared to the first quarter of this year, if you put aside two large items, the $18 million net loss on certain mortgage loans in the second quarter and the $21 million after-tax gain on the sale of Centura's merchant card acquiring portfolio in the first quarter, U.S. banking results are starting to show signs of improvement. We're confident that the results on our U.S. banking operations will continue to improve over the balance of the year, and Jim Rager will be discussing RBC Banking results in more detail.

Turning to our total U.S. operations -- as shown on chart 32, they generated 26 percent of total revenues in the first six months of 2004, down slightly from the same period last year, reflecting a reduction in the translated value of U.S. dollar-denominated revenues due to the appreciation of the dollar. As shown in chart 33, RBC Investments and RBC Capital Markets recorded much higher earnings in the U.S. compared to a year ago, despite the dollar. RBC Investments benefited from higher revenues in the full-service brokerage business and a $3 million after-tax decline in retention compensation costs, while RBC Capital Markets benefited from higher equity underwriting and other revenues. Our number-one priority for the U.S. remains returns, and any further expansion will be very focused and geared on improving distribution in high-growth markets via branch openings, as an example.

We remain committed to the U.S. and will focus on strong execution to ensure that we generate acceptable returns. We will also continue to deploy our internally generated capital through a combination of disciplined growth, good dividend payout and share repurchases. In that connection this morning we announced 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 percent of our common shares outstanding through the facilities of the exchange. Our current normal-course issuer bid expires on June 23rd.

Just before closing, I would just reiterate the strong performance in virtually all of our businesses and emphasize that even in banking, notwithstanding the U.S., our Canadian operations continue to perform exceedingly well with good growth, in terms of performance and market share which we are very pleased with.

I would now like to turn it over to Jim, who's going to discuss in a little bit more detail the results across banking.

Thank you, Gordon. Good afternoon, everyone. I would like to review RBC Banking's Q2 performance, looking briefly at the overall results and then delving more deeply into our performance in Canada and the U.S. First of all, in terms of overall earnings, as you can see on chart 13, net income and in Q2 for RBC Banking was down $5 million or 1 percent from the same quarter last year, while return on equity was 20.1 percent, up 130 basis points. For the first half of 2004 net income was up 2 percent. Turning to Canada, as shown on chart 14, in Canada Q2 earnings increased 18 percent, driven by solid revenue growth and lower taxes. Canadian revenues grew 6.1 percent from a year ago, with strong growth in loan and deposit balances and foreign exchange, credit card and mutual fund revenues. Net interest income in the quarter was up 4 percent compared to a year ago, while non-interest income was up a strong 12 percent. Sequentially, revenues improved by just about 1 percent.

Overall, domestic product volume growth rates in Q2 were ahead of our very solid Q1 growth performance. Residential mortgage volumes were up 10 percent. We continue to improve our service offering, including the introduction of RBC Vacation Home Mortgages and RBC Homeline Plan -- a home equity borrowing solution that combines a credit line and multiple mortgage tiers.

Personal loan volumes were up 12 percent. Excluding student loans from the base, volumes were up over 17 percent, largely due to the continued success of our Royal Credit line.

Credit card balances, up 16 percent, continued their very strong growth. Personal deposits and mutual funds were up 5 percent and 22 percent, respectively. We had a very strong RFP season, with contributions to registered investments up 8 percent over last year's season.

Sales of long-term and mutual funds were at their highest levels since 1987. Business loans to our small and medium-sized clients increased 5 percent over a year ago, while business deposits increased 11 percent. Our Canadian market share position as of February 2004 is shown on chart 15, -- this is the most recent information available and is compared to our position a year earlier. Overall, we made good inroads in strengthening our market share with gains of 21 basis points in residential mortgages, which reinforces our lead position, and 39 basis points in personal loans and credit cards. While our mutual fund market position strengthened by 34 basis points, personal deposits share was down nine basis points.

As seen in chart 16, RBC Banking's net interest margin is stabilizing in both Canada and the U.S., although at lower levels than a year ago. Our total and Canadian net interest margin improved slightly compared to Q1 2004, as lower net mortgage breakage costs in Canada more than offset spread compression from lower interest rates in Canada.

Turning to the U.S., as shown on chart 17, the U.S. recorded a net loss of C$17 million or US$13 million in Q2. As noted in the press release, earnings were impacted by a C$18 million, U.S. $13 million after-tax loss from certain mortgage loans that are believed to have been fraudulently originated. These loans were originated back in 2001 and 2002. The alleged fraud was discovered last year, and the loans were returned by the investors in January of this year. We're cooperating with all of the appropriate authorities and have filed claims with our insurance carrier. Liquidation of the underlying property is ongoing. Most of the properties have been sold at a loss, and the valuation allowance was established in Q2 for the loans. Given that sufficient information was available to reasonably estimate the loss. As I mentioned, we do have insurance, and although an insurance claim has been filed regarding this matter, no benefit from this insurance claim had been reflected in the financial statements at this time, due to the uncertainty surrounding the timing and final amount of the recovery.

Finally, we have taken steps to enhance technology, and modification of the origination process to prevent recurrence of this type of fraud.

As shown on chart 18, compared to Q1 of this year, U.S. revenues increased $8 million, despite last quarter's $35 million pre-tax gain on the sale of RBC Centura's merchant acquiring portfolio, Moneris Solutions. Excluding that gain, revenues in the U.S. were up $43 million Q2 over Q1, or almost 19 percent.

Starting with RBC Mortgage, as you can see on chart 19, origination volumes picked up over Q1 2004, driven partially by a decline in long-term rates, and we succeeded in meeting our objective of originating more purchase versus refinance business. The margin improved as well, reflecting better pricing and changes in branch manager compensation. This resulted in $30 million of higher revenues, which is shown on chart 20. We also made good progress in improving back office execution and reducing the backlog of greater-than-90-day loans to 280 million US$ at the end of April 2004. This resulted in savings in hedging costs.

At RBC Centura, revenues declined $22 million or 10 percent from Q1, due to last quarter's $35 million gain on the sale of Centura's merchant-acquiring portfolio. Volume growth continues to contribute to revenue with loans and deposits up 4 percent and 5 percent over Q1 -- not annualized, but Q2 over Q1, of the last quarter. A larger investment portfolio and improved yield also added to revenues. As shown on chart 21, we increased the portfolio by U.S. $500 million quarter-over-quarter, while the yield improved 12 basis points as we extended the portfolio duration. So in all, excluding the $35 million gain, revenues at Centura were up 7 percent, Q2 over Q1.

As shown on chart 23, we continue to take steps to improve U.S. performance. At Centura our de novo branch build continues with 17 branches open so far this year. Deposits in these branches more than doubled from March to April. Nonetheless, they are not yet at breakeven, and they represented a $3.5 million drain on earnings during the quarter.

Consumer and business loans and deposits, as I mentioned, are growing well organically, showing 4 and 5 percent growth which respectively. We continue to make progress on our strategy of targeting specific customer segments like the snowbirds, business owners, professionals and executives. Returns on the investment portfolio improved in Q2, and we remain focused on cost containment.

Turning now to the costs in general in the business, as you know, tight control over discretionary expenses remains a priority. Back on chart 13 you can see the noninterest expenses in Q2 for total RBC Banking were up $51 million or 4 percent from last year. In Canada expenses grew $33 million or 4 percent, reflecting higher pension plan and other compensation costs partially offset by increased in GSP recoveries. U.S. expenses increased $19 million or 7 percent. The cost on the mortgage loans that I spoke of increased expenses by $33 million, and a stronger Canadian dollar reduced expenses by 24.

So overall, the Q2 results are encouraging in Canada with domestic volume growth and stabilized margins accelerating revenue growth. In the U.S., the financial results, putting aside the $18 million loss and last quarter's gain on sale of the merchant acquiring portfolio demonstrate that both RBC Mortgage and RBC Centura has made some progress. However, the U.S. results are currently not meeting our expectations, and we are targeting earnings similar to those achieved in the second and third quarter of 2003. We're working hard to trend towards this level of earnings over the next few quarters. I will now turn it back over to Peter Currie. Peter?

Thanks, Jim, and good afternoon, everybody. Turning now to our revenue performance, you'll notice on chart 36 the total revenues were $4.4 billion in the second quarter. That's up $291 million or 7 percent from last year. Noninterest revenues were 64.2 percent of total revenues compared to 60.1 percent a year ago.

Chart 37 indicates that the appreciation of the Canadian dollar relative to the U.S. dollar reduced the translated value of of our U.S. dollar-denominated revenues by some $130 million. Were it not for this, revenues in the second quarter would have been up $421 million or 10 percent from a year ago.

Turning to the net interest margin, you will note from chart 38, it was down 27 basis points from a year ago, due to growth in capital markets-related assets that generate noninterest income, despite compression on domestic deposits resulting from lower interest rates and lower returns from RBC Centura's investment portfolio.

As shown on chart 39, second-quarter noninterest revenue was up $354 million or 15 percent from a year ago, despite a $90 million reduction due to the appreciation of the Canadian dollar. The increase was largely driven by a much stronger capital markets-related revenues other than trading. You will note that the very significant growth in securities brokerage commissions, which reflect higher client trading volumes due to improved equity market conditions, underwriting and other advisory fees due to higher new issue volumes, mutual fund revenues, which reflect higher assets under management and administration, again due to improved market conditions as well as higher net sales of mutual funds, and investment and custodial fees -- investment management and custodial fees, which reflect increased fees from the market appreciation of equities and higher volumes. Insurance revenues also rose due to the acquisition of Businessman's Insurance Company on May 1 of 2003 and higher revenues from the Reinsurance, Home and Auto and Canadian Life divisions.

Foreign exchange revenues other than trading, securitization and card revenues were up as well. However, trading revenues declined in money market and fixed income businesses, and securities gains were down.

As shown on charts 40 and 41, noninterest expenses were up $215 million or 9 percent in the second quarter of last year, largely reflecting a $127 million increase in variable compensation. Now, these costs relate to stronger capital markets-related revenues in both RBC Capital Markets and RBC Investments, and the $33 million valuation allowance relating to certain U.S. mortgage loans that Jim Rager discussed a few moments ago, and the $23 million increase in pension costs.

Moving to the balance sheet, as shown on chart 42, in accordance with FIN 46R, which deals with the consolidation of variable-interest entities, since January 31 of 2004 we have included in our consolidated balance sheet assets owned by certain multiseller, asset-backed commercial paper conduit programs that we administer. To avoid overstating the growth in the loan categories impacted by FIN 46R we have excluded these amounts from the analysis that follows on the next chart.

You will see from chart 43 that we registered strong growth in our consumer loans over the last year, some 9 percent, with Personalized up 13 percent, Credit Cards up 11 percent and residential mortgages up 8 percent. Business and government loans were up by $4.6 billion. That's after securitization and commercial mortgages, largely due to the growth in securities borrowing activity.

As shown on chart 44, our Tier 1 capital ratio is 9.3 percent, and our total capital ratio is 12.9 percent at the end of the quarter. These compare very well to our goals of 8 to 8.5 percent for Tier 1 capital and 11 to 12 percent for total capital. Our Tier 1 and total capital ratios in the first quarter were reduced by 14 basis points and 16 basis points, respectively, for the reasons noted on this chart.

On the next chart, which is 45, you'll see that we generated over $420 million in capital internally during the quarter. We used a portion of this capital to repurchase some of our common shares. As shown on chart 46, we repurchased a total of 3.8 million common shares in the second quarter at a cost of $238 million. As announced this morning and referenced to by Gordon a few minutes ago, we're in the process of renewing our normal-course issuer bid, subject to the approval of the Toronto Stock Exchange.

In terms of our quarterly common share dividend, it was up 13 percent in the second quarter of the first, and our dividend payout ratio was 44 percent this quarter, at the midpoint of our new payout goal of 40 to 50 percent. You may recall that we had raised his payout goal from 35 to 45 percent about a quarter ago.

That, that concludes my summary remarks. I would like to turn it over to Suzanne Labarge to discuss our loan portfolio. Suzanne?

Thank you Peter and good afternoon. I will now take a few minutes to provide you with an update on RBC Financial Group's asset quality. To get started I would like to put out some of the key highlights for the quarter. Overall, we experienced strong growth that was well balanced and diversified across the consumer and business portfolios. Our business and government portfolio grew 6.5 percent, yet we continued to manage and strategically reduced exposures in challenge sectors. Our overall credit quality continued to strengthen with non-accrual loans reaching their lowest levels since the first quarter of 2000. Our specific PCL ratio continues to remain well below our medium-term goal, and in our trading businesses, performance continued to remain solid, despite a marginal dip in revenue.

As you can see on chart 49, our portfolio grew by $14 billion or 8 percent over the same period a year ago, with the majority of this growth occurring in fiscal 2004. The portfolio mix now reflects a more normalized state for business and government, which had reached historic lows at the end of 2003 as a result of strategic reductions in the portfolio and lower demand for credit. The next chart shows the high level of diversification in our business and government loan portfolio. In comparison to a year ago we have significantly decreased our exposures to sensitive sectors such as telecommunication and energy, and have increased our exposure to counterparties in other sectors, most notably financial services. Our non-accrual loans of 1.6 billion at the end of the quarter represents the lowest level since Q1 2000. This reduction, in combination with the growth in the portfolio, underscores the level of improvement in credit quality in our portfolio.

Chart 52 shows that our non-accrual loans decreased 158 million in the quarter and 525 million or 24 percent from a year ago. The decrease is mainly due to fewer new impaired loans and higher charge-offs in the business and government portfolios in the quarter. Improvements in the domestic consumer portfolio also contributed to the reduction in non-accrual levels.

The total provision for credit losses of 153 million in the quarter compares favorably to 211 million a year ago, due to the lower level of new problem loans in the business and government portfolio realized in the current period. The increase from the previous quarter is mainly due to the reversal of $150 million of the general allowance in Q1.

As you can see in chart 54, while our specific provision increased in the quarter, our loss ratio continues to be significantly below our medium-term goal. The quarterly increase was driven largely by a combination of growth in a number of consumer portfolios and seasonality associated with the student loan portfolio.

Chart 56 shows we have credit protection totaling $794 million and sold 846 million of credit protection as of April 30th. The level of protection held decreased by 236 million or 30 percent year-over-year, consistent with the general improvement in the credit quality of our portfolio.

Trading revenues continue to be strong despite dipping slightly in the quarter due to low returns in the money market and fixed-income trading businesses. Our global VaR trend remained stable quarter-over-quarter with a slight decrease over the prior year, further attesting to the stability of our trading book.

At this point I would like turn the call over to the conference operator, so we can begin the question-and-answer period.

(OPERATOR INSTRUCTIONS). Rob Wessel from National Bank Financial.

Good afternoon. By the way, it's echoing quite a bid for the speakers. I have what I think is a fairly difficult question. National Commerce got acquired, as you know, by SunTrust not that long ago, and you know that bank had really strong management and the exact geographic footprint of your subsidiary was the right size. I guess my question is I was quite surprised that you weren't a serious bitter, and I guess my question is, given that you lack scale in the U.S., it almost seems like you are a bit paralyzed here, too afraid to buy something to build scale, but you can't build branches fast enough to get scale. I guess my question is, do you see that you have a strategic challenge ahead of you, and how do you see yourself resolving it?

Rob, hi, it's Gordon Nixon speaking. We have made it very clear, I think, to the marketplace that our first priority with respect to the U.S. is to ensure that we get our operating performance to a level that we are comfortable moving forward from. And from that base, we will continue to look and acquisitions -- to look at smaller acquisitions and potentially to look at larger acquisitions. But certainly in the short-term the priority is to get the returns up to, as I say, more acceptable returns. The other comment that I would like is that we are, if you will, cautious with respect to the valuations in the United States from a buyer's perspective. Yes, National Commerce did trade -- it traded at an exceedingly high-price, and in our judgment for us to compete at those kinds of price levels in the current environment as essentially a cash buyer in the U.S. with no U.S. currency is a real challenge. Now, a lot can change in a marketplace over time -- a shift in valuations, opportunities as a result of consolidation. A whole bunch of things can occur. But in the interim we're going to the patient and we're going to wait for the opportunity that we not only think is right strategically but makes sense from a shareholder perspective as well. And we just can't get comfortable -- that's from a shareholder perspective, even in the medium-term, that that would be an attractive transaction from our perspective. And one can take an exceedingly strong long-term view, but if you look at economics of that type of transaction -- and I'm trying to remember what the multiple --

2.5 times book.

What was it?

2.5.

Oh, it was higher than that.

It was not. I have it right on my screen!

Yes; it was a much higher multiple of tangible book, I do believe, than that.

I have the presentation right on my computer, Gordon. Price to stated book, 2.5 times.

Still, as I say, it was very difficult to make the numbers work from our perspective.

Fair enough. Just a quick follow-up, though. Given that consolidation in the U.S. is ongoing, are you at all concerned that some of the more attractive properties might sort of get acquired away or consolidated away in the intervening period?

There's always that risk, Rob. There's also opportunity that potentially could arise from consolidation as well. So, as I say, we're going to be patient and wait for what we believe to be the right opportunity. So consolidation provides some benefit from our perspective, we believe; but it also does eliminate potential future opportunities. But if you look at that Southeast marketplace with respect to a lot of sort of the smaller and mid-size properties, there has been some activity, like the Union Planters and the National Commerce. But there is still potentially lots of opportunity, in our view, for growth in consolidation in the future.

Jim Bantis from Credit Suisse first Boston.

You showed some -- sorry, the echo is quite prevalent. You show some details regarding the RBC Mortgage revenues on slides (sic) 20. Do you have similar type of information in terms of the expense line -- whether some hedging costs are still relevant, things of that nature, that should alleviate itself going forward, is my first question.

First of all, overall, the noninterest expense in general in RBC Mortgage is coming down. They did a lot in the first three months of this year, in fact, to rationalize a lot of their activity. So they are operating at a lower cost base.

With respect to the hedging costs, if you look on page 20, chart 20, you see there that the hedging costs improved by $3 million in the second quarter over the first quarter of this year. So, in fact, that reflects -- you know, as I mentioned, the loans in the warehouse that have been there for a long time, we've reduced from about $650 million to 280 million or so, and as a result of that, the hedging costs related to those mortgages have dropped. There will always be hedging costs, though, associated with the business because the loans that are in the warehouse are hedged.

Thanks Jim. Along those lines, could you refer to the branches expansion, the 17 branches, when the payback for them typically is? Historically, is it a two-year payback, 18 months?

It's 18 months is kind of the target that we have, as a general kind of benchmark.

And the final question regarding RBC Banking in the U.S. -- has the next (ph) margin in the 2.7 percent range -- are we had a short-term lull here, or do you see further deterioration?

I think that with -- two things, the things we're doing in the investment portfolio as well as just anticipation of a rising rate scenario in the U.S., we could expect better net interest margins.

Michael Goldberg, Desjardins Securities.

I have a couple of questions. First of all, could you give us a little bit of color on how these fraudulent mortgages that you describe arose? And you said that you put in an insurance claim. What was the amount of the claim, even if it's uncertain that you will recover it? And my second question, and I forget where I saw it, is there was some reference to an SEC subpoena. Can you elaborate on what that is about?

Sure. First of all, I will take the question on the mortgages. Essentially, the situation of fictitious borrowers with inflated appraisals and inaccurate or fraudulent information with respect to income levels and that sort of thing of the borrowers was the way that the fraud was perpetrated. You have always got to be on-guard for that sort of thing in this business.

The insurance issued, though, -- our claim was for the full amount of the loss, and we're just not sure at this point in time what the expected recovery will be.

So what is that on a pretax basis?

Whatever it was.

Michael, it's Nabanita -- the loss that we disclosed in the quarter was $33 million before tax.

Michael, it's Peter Currie here. I'll try to answer your question on the subpoena. You did notice that was in the press release. Let me just give you some background on this. RBC received a subpoena from the U.S. Securities and Exchange Commission recently, related to documents pertaining to the auditor independence matters, including the September 2003 resignation of PriceWaterhouseCoopers as one of our auditors. The provision of nonaudit services by our auditors and our company's policies and procedures for ensuring compliance with auditor independence rules -- you may recall or not. But in our policy circular issued in relation to our 2003 results, we did disclose the fact that we had moved from two auditors to one, and that was single auditor being Deloitte & Touche. But PriceWaterhouseCoopers had resigned as a result of certain auditor independence issues.

We're providing documents in response to the SEC subpoena. We don't believe the SEC's investigation to be material to our operations. But many standard requests for proposals from various customers and potential customers ask our businesses questions related to any subpoenas received by it or any of its affiliates. The reason we put this in our press release is, we wanted to avoid selective disclosure. So we decided to the information about subpoena in our earnings release. As I just mentioned, PriceWaterhouseCoopers' resignation arose because of nonaudit work that that Company had done on behalf of an RBC subsidiary, and this is what the SEC apparently is looking into. Certainly we take seriously all matters related to the independence of our auditors, and we're cooperating with the SEC's investigation in every way. And one more point I would just add, Michael, we also discussed this with the SEC at the time.

One other question, if I could, for Jim Rager. You mention that you have confidence in further improvement in U.S. bank contribution over the balance of the year. Do you want to give us some color as to what gives you that confidence?

I believe that we have cleared out all the problem issues that we have been working on. I look at the very good growth rates that are being now achieved during the second quarter to the first quarter of this year, in loan growth, in core deposit growth, and expect that to continue. The pipelines are good, so I think we can count on that sort of core business performance -- organic business performance, to continue. We have cost management plans in-place that will improve our cost structure.

And the mortgage business, as I mentioned, was profitable in the month of April. And we have no reason to believe at this point that will not continue to be so for the rest of the year. If interest rates backup in the U.S. and, as a result of that, say mortgage financings slowdown, we have built up a lot -- the percentage of our core deposits to total is higher than it has been. So as rates backup, there will be more value to those deposits, and we'll benefit in that way as well. As well, the new strategy for RBC Mortgage is being implemented at this point. Pricing has improved. Our margin now -- you remember when we talked about our focus on improving margins in RBC Mortgage, in the second quarter our margins margin was 62 basis points. So we're kind of at a higher level of profitability as well.

Susan Cohen Thank you. this will be an easy one, compared to some fiber-optic the others. You have noticed that business and government loans have been growing. What do you see for the demand for credit on both sides of the border at this point?

It's Suzanne Labarge. I'll answer some of it. What we are seeing is our utilization rate on authorized credit is finally beginning to increase. We hit an all-time low at the end of 2003, in terms of draw down under facilities, just as demand dried up. We are seeing across the board -- and then Jim could comment about specific stuff -- but across the board, the demand for credit has increased. We are seeing more transactions in the capital markets that require financing. And there just seems to be an increased demand both north and south of the border for general operating loans that should stand us in very good stead for growth over the next year. Jim, did you want to add anything to that?

Right, the -- if you look at our Canadian business banking, as we call it, loan growth is starting to pick up there. We had some things we were working on to improve our performance. Those are now starting to gain momentum -- in addition to which, as Suzanne said, companies are starting to borrow. The same thing is happening in the US. But in addition to that, we have been pretty aggressive. We've got a real good group of commercial and business banking account managers in the southeast and they are good business developers and so, we are starting to pick up a lot of good loan growth in that respect as well.

Heather Wolf, Merrill Lynch.

Two questions. First, one 5/19, you gave us the breakdown of refi versus purchase and that percentage has shifted quite a bit in the quarter. I'm just curious how sustainable that is. The second quarter is with respect to the margin increase in Canada -- I'm wondering if we could get some more color there and how sustainable that is?

The sustainability of purchase versus refinancing -- our strategy in our business in the US is to have a heavy weighting toward the purchase markets. That's what we focus on. We're signing up more builders in these associated business arrangements that we have there. And so, we expect that the percentage will be weighted towards the purchase market, as you have seen here in the improvement that we have shown. And, especially if rates lift up and go up I mean, refinancing will slow down. Our focus is one the purchase market, through the expertise that Sterling has brought us, in fact, I think will stand us in good stead. In terms of Canadian margins, we -- I think that the focus that we have put on managing our pricing and aggressively going after loan growth and deposit growth has now become a kind of core part of how people carry on their daily activities. So, I think we are in pretty good shape, in terms of sustainability of those kind of margins. If rates move up, that will help us.

But, you say in the press release that spread compressed again, but that that was offset by lower mortgage breakage fees?

Yes. Yes; the lower net breakage cost. We had an increase in the prepayment penalties that we received during the quarter that were higher than we saw in the first quarter or over last year, and that helped our spread on our mortgage business as well.

But the underlying spreads ex-batters (ph) is still compressing?

The underlying spread on deposits is compressing, yes.

Quentin Broad from CIBC World Markets.

Couple of questions for Gordon, perhaps. Gordon, you mentioned not wanting to pursue acquisitions in the U.S. without hitting a trigger point of returns or improving the returns in the U.S. business. What would those returns look like? Do they reflect more of what Jim was talking about for Centura, returning it to kind of Q2 2003? Or is it something different?

And then secondly, just looking strategically, given the experience you have had with U.S. acquisitions, could you give us your take on undertaking future acquisitions, specifically when it comes to hurdle rate of return expectations that you might have now, due diligence activities around the acquisitions' necessity, for cost synergies and reliance, if at all, and implication for revenue synergy expectations? I'm just trying, in terms of acquisition strategy in the U.S. wants this thing is right-size -- ?

That's a big question to answer. I think the first thing, as I said earlier, is, our short-term priority is to get back to those -- the returns that we have been earning with respect to RBC Centura. But when you look at our expectations going forward -- if you look at the asset levels and growth that we are generating in that business, if we can get the return on assets up to industry levels, then we will ultimately generate earnings significantly higher than 2003 second and third-quarter numbers. And clearly, our objective is to get that platform operating at that level. What I don't want to do is give sort of time-frames with respect to how and when we are going to get there. But clearly, that's the objective and what we're working toward.

I think, with respect to the acquisitions -- and you know, Rob was right -- the magic of Blackberries or blueberries -- 2.5 was the price to book on the national commerce transaction. But it was 4.4 times tangible book and over 18 times earnings. If you flow that through to the economics of a transaction with the Royal Bank, with reduced synergies relative to a buyer like a SunTrust, it's very, very difficult to make a numbers work and hit any kind of return thresholds that we would establish for ourselves, which sort of brings me to the second part of the question. I don't think our return thresholds with respect to U.S. growth will change from what they have been in the past. We have had what we believe are appropriate expectations in terms of earnings per share, accretion and internal rate of return thresholds. Our experience in the U.S. has been mixed. We have met our targets with respect to some investments and acquisitions. And we have not met them with respect to other ones. And clearly, when you look at the current banking platform in the U.S., as I said, we recognize we have some improvement to achieve, in terms of getting to those kinds of returns. So, that's where the focus and attention is.

I think, as we go forward and look to continue to grow in the U.S., one of the things that we do want to make sure that we are is focused, in terms of going to businesses where we really feel we have competitive advantage, where we can compete and where we want to continue to make a long-term commitment to. And we remain very committed to the wealth management and the retail and consumer businesses in the Southeast. And we think that over the long-term we're going to be able to invest and create value for our shareholders. So it's a strategy that we remain committed to, and we think that execution is where the value is ultimately going to lie. And that marketplace will change and create opportunities, and our objective is to make sure that we take advantage of them when they occur.

I think, around your questions with respect to due diligence, et cetera, we think that the process and standards that we have in-place are reasonable and quite strong. And I wouldn't suggest that we would make dramatic changes around that area. I hope that has answered most components of your question.

It did indeed, Gordon. But just on the last one, in terms of due diligence -- so, it's your sense, then, that the challenges you have run into at Banking have not been due to oversights or shortsightedness with respect to the operations going into the transaction? It's just evolved due to, let's say, market conditions? Or, i.e., this wasn't an issue going in -- it's been involving issue evolving as you have owned the business?

Yeah, I think it's a combination of a number of things. And I would hate to say that it's one thing, because it just wouldn't be the case. I think it's a combination of some of what you say, with respect to our initial expectation of the nature of the organization relative to what it is. I think part of it lies with respect to the strategies that we have implemented and some of the shifts that we have made with respect to RBC Centura, that we have significantly shifted the nature of that organization. We have reduced significantly the asset mix with a significant reduction in the percentage of commercial real estate loans from what it was going in. We have expanded the retail banking network and expanded the emphasis on the personal side of the business, which has been a much more significant build than we might have expected going in. So we have shifted the mix of the investment portfolio which we have talked about. And that has had an impact on earnings as well, as we have expanded the branch network. As Jim said, on a quarterly basis it's costing us about $3 million a quarter in terms of the branch expansion. We are meeting our targets with respect to those branch expansions. But there is a cost in the short-term. So I would say it's a combination of a number of things. And I am not trying to hide from the issue of execution. I mean, we have some execution issues that we're dealing with. But I wouldn't sort of point it as a due diligence issue or an expectation issue. It's a combination of a number of things, including the marketplace, where spread compression has had an impact on margins. And as the investment portfolio, as an example, has matured and runoff or, in our case, shifted significantly, it's difficult to replicate the kinds of returns at such low absolute levels of interest rates. So it's a combination of a number of things.

Ian de Verteuil from BMO Nesbitt Burns.

The first question relates to slide 17. The 33 million valuation allowance, Jim -- these are for loans that were originated in 2001 and 2002. Wouldn't, in the normal course, those have been securitized and pushed back off the balance sheet? What is the process by which these end-up coming back to Royal Bank?

These loans were in fact sold to investors. In those sales, though, there are certain representations and warranties and undertakings with respect to accuracy and legitimacy of documentation. And in the event that those things don't prove to be true and there is, for example, a fraud underneath, those loans can be returned. And that in fact is what happened.

Is there a particular underwriting office that was where these things related to? Or is it across the board?

All of these things took place in one location. So, in fact, we learned of this in May of 2003. We immediately did an investigation. We determined that it was in fact isolated to that single location, identified the extent of the problem and started to deal with it at that point. The loans were not returned to us, though, until January of this year.

So in May of 2003, it was not clear that you would be in -- the difference, between the carrying value and the underlying real estate was in deficit. So you needed to sort of get those back, liquidate it, and then you knew the reserve. Is that right?

That's right. That's exactly what happened.

The second question relates to Chuck. The investment Banking pipeline -- can you give us any color? We have had different views from some of the other competitors on what the pipeline looks like going into Q3.

The pipeline is mixed. I think it's certainly way better than it was this time last year and probably a bit worse than it was coming into the second quarter. Now, having said that, you have to, from our standpoint, take a look at versus can the United States -- in the U.S., there is a huge pipeline of what we call EIS transactions that is waiting with respect to what would be an income trust product in the U.S. marketplace. And that would really skew -- if we get those executed in the third and fourth quarter, that would certainly be a big help.

And in Canada?

Pardon me?

And in Canada?

In Canada, there are things happening. As you know, the income trust market is backed up, although we have been working on a large transaction in the last couple of days that's in the marketplace. And there are things happening. But as I say, it's a bit weaker than it was coming into the second quarter. And I think that interest rates will drive a lot of what is happening. There's a lot out there waiting to get done if it can get done.

Jamie Keating from RBC.

Ian actually asked the question. Thanks.

Steve Cawley from TD Newcrest.

On the Dain Rauscher front, can you give us an update on where your broker numbers stand right now?

Steve, they are running around 1850 at this point.

1850. Can you give me a sense of what the retention rate's been like?

The retention has been, actually, pretty positive. We have net gained on the retention side, in terms of folks that have come in, versus the people leaving. But we are running at around 5 to 6 percent loss. But on the lower end of our business.

Can you remind me of where things stand in terms of retention? Like I know you've got a table that shows the evolution of retention compensation costs. But, is there -- like the percentage of brokers no longer have handcuffs right now?

It was a four-year -- I think there is one year left, on the broker one -- on the Tucker. On the Dain, it will be finished this year; and then there was one year left on the Tucker.

So when exactly does Dain come off?

January of 2000 -- we started in 2001, so it's going to be January of 2005.

This morning TD announced a $300 million legal reserve charge, and CIBC has given us disclosure that they have taken 109 million of charges and have insurance. Can you remind me, has Royal given us any disclosure, in regards to these types of charges?

Steve, it's Peter Currie. We've given disclosure in terms of our financial statements in the context of various litigation matters. And our practice and in fact accounting convention is that you take a reserve when you can appropriately quantify it. In the context of what Charter Dominion has done, to my knowledge, they took a reserve. I have no details on what supports that or whenever. And if you are referring to something related to Enron, we continue to believe that the transactions that we may have undertaken -- related to Enron over the years were all very much aboveboard and so forth. So we're confident in our position on that.

And in the context of any reserve, we will take a reserve as and when we can appropriately quantify it. We don't believe we can appropriately quantify it at this stage of the game, so we've not taken a specific reserve in that regard.

Does the city settlement provide you with any sort of benchmark? If not, why not?

It provides us with an interesting number. But -- I will be honest with you -- I have got no idea as to how they arrived at their data point. And they are in a substantially different situation than RBC is, I believe.

Could you may be described how different situation is, beyond obvious?

Well, there are others in the room who can speak more eloquently about it. But I'll start off that Citi was in essentially a lead position, from my understanding, with that customer. We were not.

I would just say, I don't think it's our job to comment on other peoples' roles or responsibilities. I think that the Citi provision, 2.6 of it was rated to WorldCom. The rest was related to the balance, of which they have said they've got, I think the word was hundreds of various -- numerous class-action suits or litigation against various things in the security side. And ours is primarily related to one issue, which is, of course, the Enron transaction. So it's just a very different mix of business and different issues and so forth. I don't think there is any information that has quantified anything specifically around Enron for them or, frankly, even with respect to TD, based on what I read from TD's disclosure.

Maybe one for Jim Rager, then. Jim, you were mentioning that April was very good, in terms of the U.S. mortgage business. I think you were saying in terms of -- I can't remember, actually, if it was on the purchase side or on the refi side. Can you just remind me of what you said for April it was strong?

What I said about April -- what I said was that in the mortgage business, in the U.S., in February we lost money. We broke even in March, and we were profitable in April. So that for the quarter, we broke even.

Can you give a sense of what your perspective is right now, in terms of volumes? We have understood volumes have come down quite significantly of late.

Just in the last few weeks there has been a reduction in the pipeline as a result of rates backing up. But as I said, as that happens we are pretty active in the purchase market. So we're hoping that we can buffer that out somewhat. And at the same time, we reduced our costs considerably, so that we can maintain profitability at lower levels of volume.

And is a $280 million backlog roughly what you will be operating with on a quarterly basis? Are you comfortable with that level?

No. The target is to get that down to the kind of $100 million level at July-August.

(OPERATOR INSTRUCTIONS). Heather Wolf from Merrill Lynch.

Just following up on the two questions that I asked earlier, on Canadian margins you mentioned that spreads on deposits are still compressing. And hopefully, that eases once interest rates start to go up. Can you talk a little bit about spreads on the assets side?

We're focusing, obviously, on growing our asset product areas, because spreads are better, credit card spreads are better. We have had significant growth in our credit card balances. The secured RCL -- the revolving credit line -- tends to have higher spreads than we see on the deposit business. Homeline -- we will do the same thing. So as we focus more of our attention right now -- and, I think, for the foreseeable future -- on the asset side of our balance sheet, we should be able to hold our net interest margins.

So, if spreads are improving on assets side, does that mean that the price competition is less or that Royal Bank just isn't quite as aggressive?

I didn't hear the last part of your question, Heather.

If spreads are improving on asset side, does that mean that price competition in the industry is declining? Or does that mean that Royal Bank isn't as aggressive as it has been over the last few quarters?

I think that competition is as aggressive as it has been. I think that we have had a lot of operational and other kinds of issues to work through with respect to retention, with respect to marketing on the card side and that sort of thing. And now that we have gotten those things resolved, we're able to be less aggressive on pricing and still be able to hit our volume targets.

Heather, it's Gordon speaking. That's a really tough question, because Jim is answering it with respect to certain asset classes. And when you look across the whole mix of the business, there are certain businesses where asset spreads are getting tougher and tougher in the competitive market -- I mean Chuck, I think if you were to respond with respect to the corporate side, spreads have been continuing to decline and get narrower.

So you really have to go through the mix of all of the various asset classes and I think you would see variation, depending on the asset class.

And also, just following up on the U.S. mortgage revenues, they did essentially double in the quarter. And most of that is indicated here driven by volumes and margin. I'm curious if you can give us any more information on how much the margin improvement drove the revenue.

I don't have the exact breakdown of that. When I can say, though, is that our margin in the second quarter was 62 basis points. I think, when we spoke to you in March we were showing numbers around the 42-basis-point level.

Quentin Broad from CIBC World Markets.

Just a follow-up for Chuck on the trust pipeline. Is there anything in particular that might be roadblocks from a legal perspective going into U.S.? And then secondly, you mentioned, obviously, if that pipeline goes ahead, it's a great time. I guess the quarter would be, what if it doesn't? What if the pipeline lagged that product?

Well, I don't know whether there are legal roadblocks are not. But this is a product that is an innovative product. So the process of getting it to market -- forgetting about selling it, is just time-consuming, for reasons that you would expect to be the case, the regulators are being very thorough with respect to these transactions. Innovation is hard work, and that is exactly what this is, as you know.

It's a very efficient method of sale, and there is a very interested arbitrage in it for both the sellers and the purchases. So that the market, if in fact the two can come to a price, could be very deep. And as you also know, the opportunities for the Canadian firms, because they have got such good experience with the product, is very good. And I think there -- and I could be wrong when these numbers, but say there's 15 deals filed in the U.S. marketplace. I think that we are in ten of them, and we are slated to be book runner in four of them, which is a much higher share then we would have of the U.S. market on a daily basis, needless to say. So it's a very important market. If it works, it could be very strong, not only from our profitability. But in some respects -- not that anything is that much more important and profits. But basically from a franchise issue. And so it's quite important to us. But it is still a market that there is has been one deal -- one relatively small deal done. And it's depth has yet to be tested. But if it's deep, I don't believe supply will be the issue.

What stands behind it, Chuck, if for whatever reason the structuring can't make it through the process?

Well, basically, it doesn't work. If it can't make it through the process, you will go through your one regular -- try to find something that can that works, and if you can't do that, the deals will die.

Sorry, I'm obviously not making myself -- in terms of the rest of your pipeline that is non-trust-structured deals, what does that pipeline looked like? So if that is the fallback position --

In the U.S. that pipeline is, again, way better than it was this time last year. And it's been pretty steady in the U.S.. We are very pleased with our progress in the investment bank side. We have got a lot of stuff to come -- market contingent.

Michael Goldberg from Desjardins Securities.

My question was answered.

Ian de Verteuil from BMO Nesbitt Burns.

The supplemental pack Canadian GAAP, slide -- page 19 -- the mortgage-backed security is retained. Is that -- probably a question for Peter. Is that mortgage-backed securities that you have originated out of the U.S. mortgage business, but not sold? If it is, why is that number up?

I'm sorry -- say the last part of that again.

It looked as if the mortgage-backed securities retained up. I would have thought that number would have been coming down as you had moved things through on the mortgage origination business.

Ian, it's Nabanita, if I may. This does not have anything to do with our U.S. mortgage business, because those we outright sell. And what these relate to is a securitization activity in Canada. And if you can see the amount of new mortgage-backed securities increased during the quarter, and that's the reason for it.

And is that why the income statement impact of securitization was quite a bit bigger this quarter? This is the next two lines down on that slide 19; it looks as if the total impact of securitization is about 18 million.

It's not really a direct securitization impact as much as it is sort of like an opportunity cost. In other words, because we had securitized, our net interest income is $50 million lower than it would have been, had it stayed on the balance sheet. And similarly, because it has been securitized, we have got 58 million more of other income than we would have had, had it not been securitized. So really, that's what it's saying. It's sort of -- what would the impact have been, had we not had the securitizations is essentially what it's saying.

That's very helpful. The second question relates to page 21 of the Canadian sub-pack again -- the market risk -- the risk-adjusted balance on market risk was up in the quarter. Peter, how should I -- what should I take from that? Or should I take anything from that?

Which number are you looking at?

The market risk within the capital account -- the risk we within associated market risk.

That's the 10.6 versus 9.1?

Yes.

I don't think you should necessarily take anything negative from that prospectus. Suzanne, do you want to make a comment on it?

As I remember, a lot of that is just extra activity that we had of going slightly longer in the fixed-income market. So it's really just sort of within the normal range of trading, so I wouldn't make anything out of it. It's just that there was a position taken that was there when we did the average -- that was just the nature of the trading over the last quarter.

There are no further questions registered at this time. I would now like to turn the meeting back over to Ms. Merchant.

Well, on behalf of everyone here we thank you very much for your participation. So thank you very much, once again, and if you have any further questions, do call me at work. Thanks again. Bye-bye.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation, and have a nice day.