Royal Bank of Canada (RY) 2008 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the RBC 2008 first quarter results conference call. Please be advised that this call is being recorded.

I would now like to turn the meeting over to Ms. Amy Cairncross, Director of Investor Relations. Please go ahead.

Good afternoon, everyone, and thank you for joining us. Presenting to you today are Gord Nixon, our CEO; Morten Friis, our Chief Risk Officer; and Janice Fukakusa, our Chief Financial Officer. Following our formal comments we will open up the call for questions from analysts. We ask that you please ask one or two questions and then requeue so that everyone has an opportunity to participate. In addition, I would like to thank our shareholders who e-mailed questions to us. Our management team will be addressing your questions in their remarks. The call will be one hour long and we will be posting our formal comments on our website shortly after the cal.

Joining us for your questions are Peter Armenio, head of our U.S. and International Banking segment; George Lewis, head of our Wealth Management segment; Marty Lippert, head of Global Technology and Operations; Barb Stymiest, our Chief Operating Officer; Jim Westlake, head of our Canadian Banking segment; and Chuck Winograd, CEO and President of our Capital Market segment. Please note that our comments may contain forward-looking statements which involve applying material factors and assumptions and which have inherent risks and uncertainties.

Slide two of today's presentation contains our caution regarding forward-looking statements which describes factors that could cause actual results to differ materially from what is expressed in these statements. I'll now turn the call over to Gord Nixon.

Thank you, Amy, and good afternoon, everyone. I will begin by reiterating some of the themes from my speech this morning at our annual meeting. I want to be clear about how I view the business and performance. Our approach to business is based on a few basic principles. Firstly, making it easier for our clients to do business with us, we also have a very diversified business mix which continues to protect against shocks to single businesses, products, or markets and finally, we want to ensure all of our activities are guided by defined strategic goals that are underpinned by a proactive approach to risk management and a rigorous operational discipline that make us, management, accountable for results. Our focus on doing these things well has helped us withstand the recent pressures and allowed us to build on our past performance and deliver solid results.

Almost all of our businesses within our four business segments, and we monitor 42 of them, delivered solid performance this quarter, and a couple as you know have been affected by the difficult market conditions. Each business pursues a mandate for growth which seeks to leverage the strength of others so that they can advise and satisfy all of our clients financial needs. This approach has helped us manage some of the challenges we faced in the first quarter as market volatility persisted and growth slowed in the U.S. and around the world.

Since last summer I've been consistent in saying that as a result of this correction, risk would be repriced and that market participants with financial strength, sound risk management and strong balance sheets will ultimately benefit. While I do believe there is still signs of further weakness and it will take years for some of these financial assets to recover, I certainly expect the aggressive action of monetary authorities will provide a floor for the markets and hopefully pave the way for a recovery in the latter half of this year. However, once that recovery takes hold I certainly expect the environment to be significantly different from what we had before this crisis.

I believe the damage to the global financial systems and the global economy will lead to a new normal. This will include a heightened sense of risk aversion, higher volatility, increased transparency, a move to simplicity, reduced financial leverage, and wider credit spreads. The period of leverage and bank disintermediation will for a time shift in favor of deleveraging more bank relationships, will increase in their importance. This competitive landscape is changing and it will reward those firms and I believe RBC is one of them that continue to demonstrate market leadership and balance sheet strength.

Turning to our financial performance in the first quarter of -- on slide four, the first quarter we had $1.245 billion of earnings and an ROE of 21%. Earnings were down $249 million from the record earnings of a year ago.

And on slide five, you will see items that impacted us this quarter as well as in Q1 and Q4 of '07. Taking these items into consideration, our earnings continue to be strong. We continue to make progress towards achieving our long-term goals and I would like to give some highlights in each business segment. In Canadian banking our banking related operations continue to build momentum and are running efficiently with an operating leverage of 4.1% and continued growth in key areas such as residential mortgages and personal deposits.

In Wealth Management we increased fee based client assets and RBC Asset Management continued to capture market share and we led the industry in overall net mutual fund sales gathering more than $4 billion of assets in the record first quarter. We're also very pleased and excited about our he recent announcement to acquire Phillips, Hager & North. Joining forces with PH&N will bring two asset management leaders together for the benefit of our clients and will form one of the largest private sector asset managements in Canada and we very much look forward to working with our new partners from PH&N. This acquisition will help us capitalize on the global growth that we expect in this sector over the next several years. At DS, our Canadian full service brokerage business we continue to attract experienced advisors and grow our fee based assets. Also we remain focused on growing our businesses outside of Canada as evidenced by our recently announced intention to acquire Ferris Baker Watts, which will add 330 financial consultants in key regions in our U.S. Wealth Management business.

Our international Wealth Management business which provides financial solutions to high net worth private clients in over 32 countries continues to grow and demonstrate an increase in loans and deposits this quarter. In U.S. and international banking our residential builders finance business caused a significant earnings setback in the profits of Centura. However, we are managing the current challenges, and I am encouraged by the work that is being done to strengthen our U.S. retail bank. As an example, of executing on this strategy is the acquisition of Alabama National which closed earlier this week. When the U.S. housing downturn begins to stabilize and rebound we do believe our U.S. banking operations will be well positioned. We have over 430 branches in a very attractive region in the U.S. Southeast.

Outside of the U.S. we remain on track to complete the acquisition of RBT Financial in the middle of '08 which will create one of the most expansive banking networks in the Carribean. Solid business growth from RBC Dexia Investor Services, and our U.S. banking operations combined to push earnings in this segment higher over the last quarter. As you know, Capital Markets had some challenges in the quarter but in spite of the write-downs we had broad based revenue growth across several capital markets businesses compared to last year with higher trading and fixed income, foreign exchange, and equity revenue. Our diversified portfolio has allowed us to capture, capitalize on the declining interest rate environment and the increased market volatility and even with the write-down Capital Markets still delivered a return on equity in excess of 20%. I'm pleased to say that we rank first in the Canadian mergers and acquisition equity underwriting and corporate debt financing lead tables according to Bloomberg's 2007 report.

In closing as I indicated last quarter, we anticipated early 2008 would be challenging and our first quarter results should be viewed in that context. We expect economic growth in the U.S. and Canada to pick up in late 2008 and we continue to drive towards achieving our objectives. Our capital market -- our capital position remains strong. Tier 1 capital comfortably above our target range. We are maintaining our quarterly common dividend at $0.50 in the second quarter as we feel it's just the prudent thing to do. And I would like to assure you that we remain focused on taking actions that will create value for our shareholders as well as serving our clients and growing our businesses profitably. We're watching our costs. We've got a lot of cost discipline programs in place and maintaining a risk profile and risk appetite that is commensurate with the overall organization. And with that I'm going to turn it over to our Chief Risk Officer, Morten Friis.

I will start with a review of the Capital Markets related areas and then provide an update on our credit portfolios. As Gord mentioned, as a result of continued deterioration in the credit markets this quarter we had write-downs in Capital Markets of $430 million pretax or $187 million after tax in compensation adjustments.

Slide 10 outlines these write-downs. $288 million of losses relate to U.S. subprime exposure. The balance of the $142 million reflects lack of liquidity in the U.S. asset backed paper, specifically in our investment portfolio supporting U.S. municipal GICs, U.S. auction rate securities and U.S. commercial mortgage backed securities.

With respect to subprime, the $288 million loss consisted of two components. First, $201 million of write-downs and protection with monoline insurers with the majority related to ACA that we have fully written down and a portion on MBIA. Second, we had $87 million of write-downs on other U.S. subprime exposures. As of January 31, 2008 our remaining net exposure to U.S. subprime is U.S. $639 million, including insurance with MBIA. Our gross exposure is U.S. $2.8 billion, which represents less than 0.5% of total assets.

Turning to slide 11, there was significant volatility in equity and credit markets this quarter. In total we had nine days of net trading losses with two days of large net trading losses reflecting write-downs related to U.S. subprime. The remaining net trading loss days did not exceed global VAR for its respective days.

Moving on to slide 12. In the last three months, the overall quality of our loan portfolio remained well within acceptable range for loss rates despite continued credit deterioration in some areas. We observed higher impaired loans in our U.S. and international banking wholesale portfolio, specifically in our U.S. residential build to finance business as well as our commercial and retail loan portfolios. These increases are triggered by the downturn in the U.S. housing market and slowing economic conditions. Higher impaired loans and residential builder finance particularly in California, Georgia, Arizona contributed to the increase in PCL in the segment.

As we said in Q4, our builder financed clients are reputable and well established. The deterioration of the portfolio was relatively short. And we previously reduced our business production in some of the less favorable markets across the U.S. The acquisition of Alabama National would add to the residential builder portfolio, while we have done extensive due diligence on this portfolio and are confident in the quality and performance. Also to give some perspective, the combined portfolios remain small in the context of RBC, representing approximately 1.5% of our total loan portfolio.

On slide 13, you will see total provision for credit losses by year and over Q4, 2007, largely reflecting trend up towards historical averages. The specific provision was up compared to the prior year, primarily reflecting the higher impaired loans in our U.S. banking business. The increase also reflected higher impaired loans and lower recoveries in our corporate lending portfolio. In addition, higher provisions in our Canadian credit card and business loan portfolios, primarily reflecting portfolio growth. We are not seeing any major quality issues within our Canadian loan portfolio.

In summary, our loan portfolio remains stable with stresses still confined to specific areas. As we mentioned last quarter, overall loan portfolio loss rates continue to trend higher, towards historical averages. At this point I'll turn the call over to Janice Fukakusa to discuss Q1 results.

Thanks, Morten. Slide 15 provides an overview of our quarterly performance. Net income was down $249 million from last year's record results, largely reflecting the items in Q1 2008 and Q1 2007, that Gord highlighted at the outset. Despite these items, we had solid performance in most of our businesses. Non interest expense rose 2% from a year ago from increased sales and service, staffing levels in our banking branch networks and higher systems development and processing costs. Expenses were up slightly from Q4, primarily due to higher variable compensation in Capital Markets and increased benefits costs due to seasonal impact.

Turning to slide 16 our Tier 1 capital ratio this quarter was 9.8% under the new BASL 2 reporting framework. Under the old BASL 1 framework our Tier 1 ratio was 9.2%. We have a strong capital position and our access to liquidity has not been impacted by the market conditions this quarter. We continue to be a regular issuer in a variety of markets and have access to both short term and long-term funding.

I'll now review the quarterly performance of our four business segments. Starting with Canadian banking, on slide 18, net income was down slightly from last year and down 15% from last quarter. Net income was up 8% over last year, excluding the favorable impact of adjustments recorded in Q1 '07 in global insurance. Excluding the gain related to the Visa restructuring and the charge to increase our credit card reward program liability reported in Q4 '07 net income increased 7% over last quarter. Looking at our banking related businesses, earnings increased 15% over last year. Compared to last quarter, earnings decreased 16% or increased 11% excluding the Visa gain and the credit card charge. Volume growth was strong across all our businesses over both periods due to the successful execution of growth initiatives. Banking related operations are running very efficiently with operating leverage of 4.1%.

Compared to last year, expenses were higher, reflecting higher costs supporting business growth but were lower quarter-over-quarter, mainly due to lower seasonal marketing and occupancy costs. Global insurance earnings were down $96 million over last year, and down $13 million over last quarter. As highlighted earlier, our prior year's earnings include the favorable impacts of an adjustment related to the reallocation of foreign investment capital of $40 million and a cumulative valuation adjustment of $25 million related to prior periods. The prior quarter included a gain related to the sale of securities in our U.S. insurance operations.

On slide 19, you will see that we experienced some margin compression compared to the previous year, largely due to the impact of changes in product mix and lower spreads on credit cards and personal deposits. Margin compression was minimal quarter-over-quarter.

Looking at Wealth Management on slide 22, net income was down 14% or $30 million from a year ago. Favorable items in the prior year impacted our results including a $14 million foreign exchange translation gain on certain deposits and a tax reversal. Also, appreciation of the Canadian dollar against the U.S. dollar reduced earnings by 5% or $11 million compared to last year. These factors aside, we had strong revenue growth in client assets across our businesses and solid deposit and loan growth in our international Wealth Management business. Non interest expense decreased from last year, mainly due to the favorable impact of the strong appreciation of the Canadian dollar against the U.S. dollar. Quarter-over-quarter, NIE decreased mainly due to the lower stock based and variable compensation in our U.S. brokerage business.

Moving on to U.S. and international banking on slide 24, earnings decreased $36 million over last year, due to increased provisions for credit losses and higher cost in support of business growth. Earnings increased $10 million over last quarter on solid business growth in RBC Dexia and our U.S. banking business. Non interest expense was up 9% or $30 million from the prior year, reflecting higher processing and staff costs at RBC Dexia on business growth and the full quarter of expenses of Flag, the inclusion of AmSouth branches and our U.S. de novo branch openings. These costs were largely offset by the impact of a stronger Canadian dollar against the U.S. dollar denominated expenses.

Slide 25 shows revenue in our banking businesses was flat for the year, primarily reflecting the impact of the strong appreciation of the Canadian dollar. In U.S. dollars, banking related operations grew 12% and deposits 18% over last year. Reflecting a full quarter of a results from Flag and the inclusion of the AmSouth branches. Our prior year results also reflected a loss on the restructuring of the investment portfolio in our U.S. banking business. RBC Dexia revenue was up 24% from last year, due to growth in custodian and securities lending activities, higher foreign exchange transaction fees and business growth from new and existing clients.

Turning to Capital Markets on slide 26, net income was down from record results last year, largely reflecting the write-downs that Gord and Morten discussed. Also, appreciation of the Canadian dollar against the U.S. dollar and British pound reduced earnings by $24 million over last year. Revenue was down from last year due to these items. However, several of our businesses performed very well compared to last year including trading in fixed income, foreign exchange and equity derivatives driven by declining interest rates and increased market volatility. Compared to last quarter, our earnings were up primarily on solid revenue growth. Non interest expense was down slightly from last year, mainly due to a favorable impact of foreign exchange. NIE was up over the previous quarter, mainly due to higher variable compensation, and higher benefit costs due to seasonal impacts.

On slide 28 you'll see a breakdown of RBCs total trading revenue. Despite the charges we had strong trading revenue and our results demonstrate the benefits of our diversified platforms. At this point I'll turn the call over to the Operator to begin the questions and answers.

Thank you. We'll now take questions from the telephone lines. (OPERATOR INSTRUCTIONS) Our first question is from Jim Bantis of Credit Suisse. Please go ahead.

Good afternoon. I've got two questions. One, if we could chat a little bit about the CDO exposure related to corporates. You've provided us with some additional disclosure, which we appreciate, $2.8 billion coming from corporates. I'm wondering if you could just talk about the underlying securities related to that, how do these transactions come to fruition? Should we look at these similar to other corporate debts that you would have on balance sheet? And then my second question is perhaps for Chuck and Janice, just if we add back the one-time items related to Capital Markets, $400 million plus revenue, almost $200 million in earnings, we come up with a quarter that was at record proportion. So I wanted to be able to find out what the true operating run rate was from the wholesale operations as well.

Chuck, why don't you take the second one first while Morten takes the first one.

In terms of the second one, with respect to trading, it is just many factors. It's like we have a big trading business and it's diversified, both from a product standpoint and geographically and so the answer is just not one any single factor. The other thing I'd say is that it's two edges of a sword. Basically the things that in some respects cause some of the write-downs that we took in credit markets have also created the spreads in the overall trading market with respect, liquidity, and other things that allow you to make more money in your day-to-day trading business and you also get some advantage from the standpoint of funding cost accounting. But effectively when you look at it, we had a very good quarter in fixed income. Remember, we've got a fixed income business in the U.S., Europe, and Canada and they're all significant businesses. We did well in each of those. We did have the theme right. We were working on lower rates and a steeper curve and that helped us, but basically it wasn't -- certainly isn't a huge part of the explanation. We had very good results from the standpoint of the way we set ourselves up for funding. We had a very strong period in 4X. We had a good equities -- good equities performance just in our day-to-day equities business. We also had good prop results especially from equity related businesses. So it was a combination of just a whole number of factors and I would point out that the environment that has created the write-downs also is creating an environment where you can trade and make some money and in some respects it's a race between these two factors for us.

Got it. So it certainly sounds like you can have it both ways in terms of adding back $400 million in revenue related to let's say Stan's area, the global markets, just doesn't work that way given that there were some offsetting factors that wouldn't have existed otherwise; right?

I think that if somebody waved a magic wand and made the world right from the standpoint of subprime and the housing business in the U.S. and some of the corporate credit issues and we went back to where we were we wouldn't be making as much money on daily trading business.

It's Morten, with respect to the $2.8 billion corporate related that you quoted, these are the facts highlighted on slide 37, and page five of the report to shareholders. This is part of our log in structures. They're CDOs of investment grade corporates. Synthetically structured, performing as that combination of names, you would expect them to perform over the last little while.

So Morten, when I think of these structures there's not unusual level of leverage within them, as you said, it's all investment grade so the asset quality we shouldn't be too worried about?

Well, they are typical for those structures and as I said, they are investment grade names, selected at the outset. Given the environment that we've had over the last six months, there have been widening of credit spreads and some down grades, but it's not a portfolio that from a credit standpoint in itself is performing abnormally to the market.

Given the structure of those transactions, would you be required to take an adjustment to valuation based on liquidity as opposed to credit standards?

Jim, it's Janice speaking. We, within these structures, to the extent they're on balance sheet, they're fair value, just the same way we fair value a lot of this. But the reason that you have -- if you go through the MD&A and the little bit complex explanation, the reason it's set out this way is that you'll see that when we're looking at our monoline insurers to the extent that they are wrapping those CDO exposures, that's how you have to look at it. So it's more sorting through the different layers and analyzing the structure.

Got it. Thanks very much.

Thank you. The following question is from Andre Hardy of RBC Capital Markets. Please go ahead.

I also have two questions and they're probably both for Chuck. A lot of the write-downs were related to credit, if not all, and credit spreads have continued to deteriorate. I'm just wondering if you can talk about February and what you've seen so far in your businesses. And my other question relates specifically to auction rate securities. It looks like the bank would have exposure of around $4 billion and correct me if I'm wrong with my numbers. If that's the case that's a market that I understand has run into a lot of difficulty. Can you talk about the risk that there is and the Royal Bank related to those securities.

First of all, I'm not going to talk about February. You've talked about February but I'm not going to talk about it. With respect to the auction rate securities, we had, at the end of the first quarter, I think it was -- it was over 4 billion, $4.5 billion I think, approximately of auction rate securities. We also had about $850 million of ZRDN. Those auction rate securities were focused in one business where we are a top five player in the U.S., which is in the student loan business and they're called SLARS, another acronym for student loan auction rate securities. They are trusts effectively which are underpinned by student loans that are 97% guaranteed by the U.S. Government as to principle. And so that is where our focus is in the auction rate securities business. I think 85% or 90% of our AAA securities and effectively that is our position. I mean, it's a business where there's different types of them and everything else and you've got to look at them but effectively the collateral that underlies them is 97% guaranteed by the U.S. Government.

Okay. Thank you.

Thank you. The following question is from Sumit Malhotra from Merrill Lynch. Please go ahead.

Good afternoon. Looking at the U.S. and international banking segment, gross impaired loans, 3.37% GL ratio this quarter continues to move up. Yet we didn't see too much of a move on the provisioning side. Can you talk a little bit about that dichotomy, especially it sounds like with the information you've given us home builder portfolio is good 10, 15% of the total portfolio here so why didn't we see provisions move up accordingly?

It's Morten here, if I could speak to that, he charge, the size of the provisioning is really a function of the inflow of impaired loans and while the first quarter continued to be negative, it was actually slightly better than the previous quarter. We are -- we do have a portfolio here that will be a drag on performance through 2008 and the size of the provisioning reflects the size of the current impaireds and our view on value and recoverability on those assets. So I don't know whether that gets close to answering what you were asking about.

Well, just to be on the same page there, it looks like impairments are a lot higher than they were last quarter?

Well, if you look at the impaired formation in our supplementals, I mean, part of what's driving the impaired formation on the U.S. side is that we this quarter for the first time in a number of quarters have had some provisioning in the Capital Markets portfolio. One of the assets was a U.S.-based borrower, hedged, I might add, so the income from the hedge shows up in other income. So part of the growth in the impaired on the U.S. side of the portfolio is actually not in the builder finance portfolio but part of the corporate banking portfolio. I don't know whether that helps explain what appears to be a dichotomy.

Okay. I understand that. Just a second part to that. I haven't seen a 10-K or a 10-Q for Alabama filed yet, it's closed, I guess we can talk about it. I did get a chance to look at some of the FDIC information. I'm not sure if that's completely comparable. But it looks like non-performings there are close to doubling quarter-over-quarter. Is that, first off, accurate in terms of the numbers you have? Are we going to see a filing from Alabama for their fourth quarter?

I'll speak to the asset quality and the trends that we're seeing. Prior to the close of the transaction, we did have a second round of due diligence and had a clear scrub of the portfolio. Historically, chargeoffs and provisioning in that portfolio has been very low with the developments in the market, they too have had a negative trend. But I think on the net basis, their portfolio continues to perform well. I mean, one of the issues we've got with the overall, with the combined portfolio, try to make sure we manage the concentration and any further deterioration actively. At this stage, we think we have captured the -- any assets that are weak at the time of closing of the transaction and we just continue to watch any deterioration from that. I mean, our conclusions out of ANB's performance during the period running up to the closing of the transaction is their risk management practices have actually served them extremely well. Their chargeoff rates have been low, both in an absolute sense and on a relative sense. But they are in markets that are in part some of the weaker markets. I would note that the Alabama market is actually relatively stable and less affected by the current downturn. The Florida market obviously is a little bit more challenging but their assets in that market have actually been not as deeply affected as you might expect from the overall strain on the Florida market in general.

Okay. Thanks. That was helpful. One more from me and this is probably for Janice. In Canadian banking only, expenses after the last two quarters we did see a decent sized decline. I saw some commentary in the press release, talking about seasonal trends. What do we look for here in terms of a run rate and expense growth? Do you think that that higher trend that we saw in year over year increase has normalized now? I was thinking that would probably be in the back half of the year but it looks like it came through a little early. Have you started to prepare for softer revenue here? Is that why we're seeing expenses trend down? Is that what we should look for going forward?

It's Jim Westlake. I might comment first. I think that we are going to see it trend down. We've been talking about that and expecting it. We kind of peaked out on a year-over-year in the last two quarters of last year with the extra spending we had done on branches and staffing. So as each quarter comes along we expect that to moderate even a little more.

And Sumit, just to add to Jim, what we're focused on is of course on an annual basis, the solid operating leverage that's there in Canadian Banking. So while there's some seasonality, if you look at it over the course of the next four quarters, we should hit the run rate operating leverage that you've seen for the past two years.

Okay. Thanks very much.

Thank you. The following question is from Ian de Verteuil from BMO Capital Markets. Please go ahead.

First question is just a clarification. Chuck, so the $430 million of write-downs, was that all taken in the trading line? So if we think about the trading line of 600 million, X these trading close to 1 billion, is that right?

Yes.

Good trading numbers. And the second question, just to clarify, the exposure to monolines, am I right in saying slide 37, forgive me, I spoke to Amy, that confuses me always, slide 37 which gives exposure to monoline, does that include any credit default swaps where monolines would be on the counterparty?

Yes, so the -- it's Morten here. On the information on slide 37 relates to the various buckets of monoline related securities or risks that we've got and so it does include the collateral, the CDSs with other monolines, which from a fair value standpoint is actually a very modest number outside of the MBIA position.

So the 1.1 billion, I think you mean it's in that bucket there, Morten, is that right, the 1.1 billion?

That's right.

And that's notional or is that -- that's fair value?

That's notional.

That's notional. Right. Thank you.

The line below says fair value, 48.

Thank you.

Thank you. The following question is from John Aiken from Dundee Securities.

Swinging back to the U.S. international, we, I guess focusing in on what Sumit was getting at, we see the second quarter very high provision levels, is there any offset that you see possibly coming over the next quarters or are we stuck with low single digit ROEs until the credit cycle begins to abate?

I'll take a stab at that and Peter might want to fill in. In terms of the size of the builder financed portfolio in a Centura context at $2.6 billion is relatively significant and the size of the impaired and the fact that we will be at best through 2008 and into 2009 before we start to see things recover in that market, we will over the next quarters continue to have a drag from the impaired portfolio and some risk of further increases to provisions at levels above what would be considered normal. I don't know whether that helps.

No, not just focusing in on the risk from credit but is there other areas like, you know, expense reductions or other areas of revenue where we might be able to see some bottom line growth and offset some of the potential risk that provisions face?

John, that's what I was going to add. Peter Armenio here. We have taken several initiatives to strengthen the business going forward and the earnings of course and so we continue to grow our revenue quarter-over-quarter. But there is a cost management program that's on the go right now which is important and has got several initiatives on the go. Obviously, from our integration with ANB, we also look to cost savings over there and we are reconstructing our builder finance business which also will provide us with some cost saves as well. There are several initiatives on the go to strengthen the business and its earnings.

Thanks, Peter. Does Alabama national, does it represent a possible relief or is this going to be another incremental headwind when it comes on board?

From everything we've seen so far, it makes the bank stronger. So whether it's on their credit side, whether it's on the management side, whether it's geographies that we're in, the scale that we're getting in certain places, everything that we've done in terms of the strategic expansion is making it a stronger and better bank.

I would just emphasize that the -- I mean to the extent that you can in an environment like this, to repeat Morten's comment, we scrubbed this portfolio very, very closely before closing and obviously that's where the headwinds would come from if there was a deterioration on the credit side and with the acquisition, we certainly took advantage of that to do the best we could in terms of providing for anything that we think could deteriorate. But who knows where the market is going to lead.

That's great. Thanks for the clarification.

Thank you. The following question is from Michael Goldberg of Desjardins Securities.

I have a few questions. First of all, if I look at your non-performing loans, net of both specific and general allowance, your total allowance is still greater than your gross non-performing loans. But this surplus allowance has shrunk to just $97 million from $579 million a year ago, and $353 last quarter. Has your loss provision been far below your net formations. So my questions are do you expect gross and net formations to continue to trend higher? Are you prepared to allow your surplus allowance to shrink further? And would you even be prepared for gross non-performing loans to be greater than the total allowance?

Michael, it's Morten, I assume you're referring to RBC as a whole here, are you.

Yes.

In terms of the expectations on formations, I think as Gord commented at the annual meeting and the following calls, that our expectation continues to be for the market to continue to deteriorate somewhat overall. The Canadian portfolios are actually performing quite well, in terms of it's within very acceptable ranges, good risk return balances and no evidence yet of deterioration there. There's some risk that we will see additional formation of impaireds in those portfolios but there's no evidence that that will happen. In terms of the US&I and the Centura portfolios specifically, the big question in terms of formations I think is to what extent the impaired formation and the provisioning will be required for in any volume for portfolios outside of the builder finance piece. In terms of the allowance, I mean, the provisioning methodology is relatively straightforward. We provide for our wholesale portfolio essentially on a specific name by name basis and so the overall allowance reflects our view of the collection of the files. Having said that, as we then look at our overall allowance, taking into account our general as well, the degree of coverage is obviously one of the things we look at and with respect to the US&I piece specifically, I would also add that when you add in Alabama National to Centura, the coverage ratios for Centura will actually improve somewhat and that might be a minor reflection of the overall numbers. I don't know whether that helps.

I guess what I'm getting at is, as I said your surplus allowance has almost disappeared over the past several quarters, as you've ran with a provision that's been a lot lower than your formations. So should I be looking for your provision to be closer to the level of your net formations going forward?

Well, I mean, I think it's fair to say that impaired formation in the long run is likely to give an indication of future allowance developments, but it is -- it's frankly, it's hard to say anything more helpful than that. The other piece that I would say that in terms of our general allowance, the size of the general allowance is driven by a combination of our views of the portfolio and the specific accounting requirements for the general allowance, and if you look at our portfolios overall, the corporate banking portfolio we've had a couple of impaired loans but I would emphasize it's only a couple and the overall portfolio quality there remains strong, not really justifying provisioning to any real extent. The Canadian Banking portfolios have grown and there's some growth in provisioning as a result of growth but not really quality deterioration of any magnitude, at least. And outside of Centura, the rest of the US&I portfolios also remain at quite strong levels. So given the methodology for looking at allowance and coverage ratios, the overall allowance actually reflects the quite strong health of the portfolio outside of the couple of pockets that we have identified.

Okay. Just to turn to a different subject, what's your take on the prognosis for Canadian non-bank ABCP in light of problems facing BMO, Apex, and [Sitka] conduits, and I'm talking about the Montreal Accord. Do you think it's going to fly?

Michael, I don't think that we're in a position to be able to answer that. As I said at the press conference following the annual meeting, firstly, we were a very small participant in that marketplace. All six Canadian banks have been asked to support the margin funding facility but at very different levels and suffice to say that we're at a very low level because of our participation but we have indicated that we are supportive because it's important to the Canadian marketplace. In terms of its success, you're just asking the wrong group. As I say, we've committed our support but you'd have to ask the committee and the people involved in the restructuring.

Okay. One other question. Just on a clarification of the gross and net subprime exposure. Is the difference between the two the insurance provided by MBIA now?

This is the information on page five, I guess.

Yes, it is. Slide 10, the 639 and the 2.8 billion.

Hold on a second. I've got the information here. Let me just make sure I get it for you straight here. So the net exposure, the gross exposure relates to the various held for trading portfolios, 2.4 in Capital Markets and 4.02 in available for sale. And the net is then 237 of other exposure in Capital Markets and the -- and again, the available for sale portfolio.

Okay. And just a couple of questions for you, Gord. Can you elaborate on why no dividend increase?

Well, firstly, we don't -- I know that market gets used to the dividend being automatically increased every second quarter but I would say that if you go back over the last number of years, it hasn't been that linear and that there have been quarters where we have increased twice in two quarters and there's been other quarters where we have waited three quarters to make an increase. We just assessed the overall -- where our earnings were in the quarter, where our payout ratio was in the quarter and the uncertainty in the marketplace and the yield on our stock and as I say our current payout ratio which is at the high end of our range and we just felt that from a prudent perspective, it wasn't something that we should do and we'll evaluate it as we look at the next quarter. So I'd say it was a combination of things but it is not something that we, as I say, have always been linear in terms of an automatic every second quarter increase. And as I say, you look at the payout ratio and the environment and we thought we would wait a quarter to see.

Last question, Gordon, what gives you comfort of expecting a recovery later in 2008?

Well, I'm not sure there's anything that gives me comfort. There's so much uncertainty in the marketplace that it's -- if you were an economist, you could be bullish or bearish and you would have a 50% chance of being right. I do think that so much of what is occurring in the marketplace today relates to financial assets and it's very much compounded by mark-to-market accounting rules which are making it more challenging because losses are being recorded and taken in portfolios, even where there is no impairment. And I think it's causing a lot of transparency issues in the marketplace, it's causing a lot of balance sheet and income volatility. I think that at some point here, and I can't tell you when, but at some point here we're going to start getting some degree of stability back into the financial assets. Whether it's because there's so much value there with respect to opportunity. And I think if we get some stability back in the financial side of the marketplace, with the money that has been put into the system by the various central banks around the world and with the low level of interest rates, I think that -- and certainly our forecast is that as we look at the second half of the year, we should be facing a better environment both in the financial markets and in the U.S. economy than we sit with today. That's our forecast and as I say, I think we're certainly confident. But I think the sooner that we get some stability in these financial assets and a bit back into the U.S. real estate market, that will be what will be the defining difference.

Would you be a buyer of these assets?

Yes, I mean, that's a -- that's a very difficult question. I think there is certainly value in the marketplace with respect to some assets and there are some which are going to continue to be very challenging and that's what makes a market.

Thanks a lot.

Thank you. The following question is from Darko Mihelic of CIBC World Markets.

My question is for Morten. Just with respect to, you mentioned there was a file in the quarter that went impaired and you had credit derivatives that provided revenue. I wonder if you could normalize your loan loss provision for me to X out that impact?

In round numbers, the size of the provision that was hedged was about $20 million.

$20 million. How would that compare to, say, last quarter? Was there anything like that in last quarter's results?

No. I mean, as a rule, I mean, we do use credit derivatives for hedging our loan portfolio but we are not a big user of credit derivatives for that purpose and we have not had a significant volume of recovery on hedges over the last few years, in part because we've had so few impaired loans.

Could you remind me how much protection you have against your loan portfolio?

Did we disclose that? I think it's--.

Darko, it's in the credit derivatives chart that you see.

But the ALM part, I can get that myself.

Because it is disclosed there.

What about overall revenues from widening credit spreads, do you guys talk about that?

No, but it wasn't a particularly large number. I mean, I think it was 50 million-ish, 60 million-ish.

Okay, perfect.

Including the situation that Morten was referring to where we had PCL offsetting it. In total it wasn't substantial at all.

That's very helpful. Thank you.

Thank you. The following question is from Mario Mendonca of Genuity Capital.

A question for Chuck Winograd. The current replacement costs on the credit derivative, there was a rather significant increase year-over-year and sequentially. And I understand that this is a matched book because the liabilities also increased pretty much in lock step. What I'm trying to get a flavor for is, one, what sort of assets are we referring to here? What underlying are we referring to that would deteriorate so quickly? And secondly, if you could tell us who the counterparties are or perhaps you're not talking about counterparties, perhaps you're talking about indices?

This particular amount, $3.6 billion, was made up primarily of structured credit.

I'm not -- sorry, just to be clear. It's not 3.6. I'm referring to the current replacement cost, credit derivatives, page 23 of the press release, 2.1 billion, 15.8.

2.1.

And to be clear, when the replacement cost increases so significantly, year-over-year, or even quarter-over-quarter, it can only mean that the reference assets are declining.

Yes, I just don't have a good answer to give you. I can get back to you offline. Again, as you said it's a matched issue and not open exposure.

The reason why this is important, though, is you've explained that you have $2.8 billion of subprime exposure and that's it. But there's no asset that's declining to my knowledge at that pace, like the underlying from one quarter to the next was off 52%. You disclosed that yourself, 10 billion to $15 billion. And I'm not sure how that could happen if in fact the underlying is not subprime.

Sorry, somebody's whispering in my ear. I mean, I just can't give you an answer right now because I don't have it. But it's not -- I could tell you that it's not subprime in terms of any net exposure to subprime.

But I'm not talking about net exposure. I'm talking about gross exposure.

Well, in terms of gross exposure either. I mean, you can think of examples where we may be trading at a particular period of time and we've got matching trades outstanding that are either with counterparties that are collateralized or we're doing business with and have lines with where we may have trades that are derivative trades and if that's what would be reflected in that we wouldn't see that as risk because they're offset by the credit of the people that we're trading with. And we generally would have collateral if we were worried about it. So I'm just not -- I don't see that as a -- we don't see that as an exposure.

The bank had I think Ian pointed this out. The bank explained that the trading was almost $1 billion and that if you remove the 430 from interest rate and the fixed income trading, then the bank had an enormous credit trading quarter as well and I can't help but believe this is precisely what we're seeing.

I can tell -- if you -- we did not have an enormous credit trading quarter at all. We didn't even have a good credit trading quarter.

Would the $430 million come out of the $132 million that you referred to as interest rate and credit trading in the subprime?

The 400--?

I can be specific. Page of the supplement, and the only reason I'm making a fuss about this is because the bank's comment about $2.8 billion in subprime exposure, I'm having a lot of trouble reconciling that with the decline as evidenced by the sharp increase in the replacement cost. It doesn't -- I don't know of an asset that is declining 50% in a quarter. Other than subprime. And that's why I'm sort of like a dog on a bone, it doesn't make sense.

Mario, I think what Chuck is saying is that when we look at the overall business, what you see in that disclosure around the gross is that the business is run on a net basis. So that what we've looked -- what we've looked at in terms of outlining the exposures is our net increase in that exposure and so I think that what would probably be more helpful is if that -- if we could have a little more time to talk you through how we look at the credit derivative of the business.

In addition to that, I mean, credit spreads have widened quite dramatically so these numbers would change in any event and they would probably change just from credit spread widening. But from our standpoint, we've got two sides of the trade when we do a trade, we basically are handing off the liability to somebody and with that individual -- with that counterparty we're either collateralized or we're dealing with them on a credit basis or we're doing a netting with respect to our overall position with that counterparty and we just don't look at it in the fashion you're looking at it. It has nothing to do with an individual asset decreasing by 50% as far as I can see it. But the problem is, Mario, I just don't think of it that way so it's very hard for me to adjust.

I'll wrap it up here. The only reason why this is important is there are examples in financial history, one not very long ago, where there are companies that have been long and short certain indices on the presumption that the correlations, historical correlations they have observed would hold. When they didn't hold, they blew up. That's why I'm asking the question.

In terms of the indexed trading we do, and we do do some index trading, basically that is being done almost entirely as a market maker. And we would not go home with significant net positions. Now, we do have trades that we've done with two sides here and we -- we have opposite liabilities with those, assets and liabilities with those two sides. But we ourselves do not have a substantial position in that. It's in our counterparty exposure.

Thank you.

Which are all governed by our--.

Which basically come under limits and it's the way we run it. We just don't look at it like that.

This is Morten, just in terms of the credit derivatives trading, I would also add that a large volume of that is collateralized and to the extent that it isn't, it is with very high quality counterparties. The majority is collateralized.

I'm not entirely sure I've expressed the concerns appropriately but I think you're right, it's something we should take off line.

It's something we should take off line and we're happy to deal with it. I could sit around thinking about a lot of risk and this is just not one of them I think about except in the sense of counterparty credit.

Just in terms of subprime, we have disclosed all of our subprime exposure. So if the question is, is there some other subprime exposure that we have not disclosed, the answer is no, as of January 31, there is not.

But you could theoretically trade subprime indices?

We do do some trading of subprime. It is a small business. If you basically saw the way we handled it, it is basically a market making business in every sense of the word. I'm not saying we have absolutely no (inaudible), but it's just not material whatsoever. Our positions are with the counterparties that we're doing trading with, post op.

Got it. Well, not really. If we could just follow up.

Almost full stop.

One thing I can assure you is we'll give you as much time as necessary.

Yes, and incidentally, the disclosure you guys provided this quarter was top notch and I appreciate it.

Well, thank you for that. And I can tell you that Janice and her team have many hours, have logged many hours to get us there and they have done a very good job.

Appreciate it.

Well, thank you everyone. I would just like to clarify one point from a question earlier and that is that ANB will not be filing a final 10-K as they're not required. So let me just turn it back to Gord briefly, just to make some final comments.

I would just conclude by thanking everybody for attending the call. It has been an interesting quarter, to say the least, and a very different market than we faced a year ago but we're certainly, as I say, ensuring that we provide as much disclosure as we possibly can and we think we're positioning our businesses well to face these headwinds as we go into the next quarter and hopefully a slightly better latter half of the year. So thanks everyone for joining us and we'll talk to you again in three months' time.

Thank you. This concludes today's conference call. Please disconnect your lines and thank you for your participation.