Royal Bank of Canada (RY) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the RBC 2008 second quarter results conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Ms Marcia Moffat, Head of Investor Relations, please go ahead.

Thank you, operator. Good afternoon, everyone, and thanks for joining us. Presenting to you today are Gord Nixon, our CEO, Morten Friis, our Chief Risk Officer, Janice Fukakusa, our Chief Financial Officer. Following our formal comments we will open up the call for question from analysts and we ask that each of you please just ask one or two questions and then re-queue in order that everybody can participate. We recognize that there is another call by a bank immediately following ours, so we will be ending promptly at 1:30. We will be posting our formal comments on our website shortly after the call.

Joining us today for your questions are George Lewis, the Head of our Wealth Management segment, Marty Lippert, Head of Global Technologies and Operations, Doug McGregor, Co-President of Capital Markets, Dave McKay, Head of our Canadian Banking segment, Barb Stymiest, our Chief Operating Officer, Jim Westlake, Head of our International Banking and Insurance segment, and Chuck Winograd, CEO and President of Capital Markets. 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 will now turn the call over to Gord Nixon.

Thank you, Marcia, and good afternoon, everyone. Turning to our year-to-date financial performance on slide four, we are now halfway through our fiscal year and an interesting year it has been. But we have generated C$2.2 billion of earnings with an ROE of 18.5%. Earnings were down C$600 million from the first six months of ' 07, primarily due to the writedowns. Higher provisions for credit losses, primarily in our U.S. banking business, also attributed to the decline. Slide five shows items that impacted us this quarter as well as quarter one. As you know, we preannounced writedowns in our Capital Markets and Corporate Support segments on May 14th. As we stated then we believe a significant portion of the writedowns reflect liquidity pressures on assets that we continue to hold rather than underlying credit quality.

While we are not happy about these writedowns and we will continue to be impacted by higher provisions from credit losses in the U.S. banking business, we are confident in our fundamental strength of our operations and our risk management capabilities. We take a structured approach to defining the amount and type of risks we are willing to accept by establishing a risk appetite framework that we periodically measure against our risk profile. We look at several measures. These include debt ratings, liquidity and funding, capital ratios, earning stability relative to North American peers, exposure to tail events, potential impact of 100 basis points interest rate shocks and provisions for credit losses.

As Morton will speak to in greater detail in his contents, we have had higher provisions for credit losses, particularly in the U.S. builders finance business, which has increased our PCL ratio to 54 basis points this quarter and 49 basis points year-to-date. However, our overall risk profile remains within our risk appetite. Our strong risk culture, coupled with our diversified business mix and focus on performance management, enable us to stay very focused on building our businesses for long-term growth. I would like to give you some highlights in each segments. Our Canadian banking related operations continue to perform very well, generating volume growth across all businesses. We are working hard to meet the needs of our clients and we are continuing to develop new products such as our U.S. high interest rate savings account which we launched this quarter, last quarter.

Clients are rewarding us with their business and we are gaining market share. For example, in the past six months we increased market share in both personal core deposits and business deposits by 44 basis points and 78 basis points respectively. We are also maintaining our focus on performance management and effectively managing our costs in our Canadian banking related operations, as demonstrated by strong operating leverage. Insurance performed well this quarter and adds to our diversified business mix. As you know we will be highlighting insurance as a separate segment starting in quarter three. In wealth management we increased fee based client assets and continue to lead the mutual fund industry in net sales. RBC Asset Management continued to deliver top investment performance and recently received the Lipper award for best overall fund group for the second consecutive year.

As a result of market conditions, clients are continuing to show a preference for our money market funds over long-term funds. On May 1, we combined forces with Phillips Hager & North, making us Canada's leading private sector asset manager with a significant presence in all client segments and the largest fund company in Canada. We continue to add experienced advisors in RBC Dominion Securities, Canada's largest full service wealth management. In an annual survey completed by an independent trade publication, we received the highest rating of advisor satisfaction of any bank owned regional or national brokerage firm. In U.S. wealth management the Ferris Baker Watts shareholder vote is scheduled for June 20th and we remain on track to close in the third quarter of 2008 subject to regulatory approval.

This acquisition will expand our presence in the eastern, mid-western and mid-Atlantic region of the U.S. Our international wealth management business continues to grow, as reflected by increase in loans and deposits this quarter. We have expanded our presence by opening new offices in cities like Santiago and Mexico city. In U.S. and international banking our residential builders finance business continues to experience difficulties given the tough operating environment in the U.S. and the ongoing stress in the housing market. In an effort to manage this business more effectively, we decided that by and large we will no longer originate U.S. residential builders finance businesses outside of our U.S. southeast footprint, with one exception that being Texas. This allows us to prioritize for the greatest impact and concentrate our efforts on our strategic areas of focus in the U.S. southeast, where we do have deep client relationships and expanding client relationships.

We also recently completed the acquisition of Alabama National, which expands our network in the U.S. southeast. Our pending acquisition of RBTT received shareholder approval and is scheduled to close in the third quarter of ' 08, subject to regulatory approval. This acquisition will significantly expand our presence in the Caribbean. RBC Dexia continued to generate solid business growth and was recently recognized by Global Investor and R&M Consultants in two global custody surveys, where we rank number one and number two overall respectively. Looking at capital markets, our results were significantly impacted, as you all know, by the writedowns I mentioned earlier. We do have a very diverse capital markets platform that serves clients around the world.

Some businesses benefit in the second quarter from the market volatility and declining interest rate environment, including certain fixed income, foreign exchange and equity derivatives trading businesses. We continue to invest across our core capital markets businesses and are capitalizing opportunities that have been and will be created by the market dislocation to recruit top talent. We added equity options sales and trading capabilities in the United States and a leverage lending team in London. We also added significant new talent in our global fixed income and currency businesses in the United States and expanded our product and geographical depth in this area with an emerging market team in London and expansion plans for Hong Kong. We continue to build out our North American energy focused commodities team.

Turning to our year-to-date performance versus objectives, progress towards our objectives has been affected largely by the writedowns, higher provisions for credit losses in U.S. banking and spread compression. We are maintaining our quarterly dividend at C$0.50 in the third quarter. Our capital position remains strong with Tier 1 capital ratio of 9.5% and we expect it will remain well above our objective of over 8% for the balance of the year. However, market conditions have impacted our ability to meet other annual performance objectives. We expect the financial markets will continue to remain under stress, reflecting liquidity and pricing pressures. That being said, we have many businesses that are performing well. In Canada consumer fundamentals are strong, housing prices continuing to perform reasonably well and our consumer debt is relatively low.

Our core strength in Canadian banking and wealth management are a significant advantage and position us better than many North American and global peers. We have many advantages, market leadership, diversified balance sheet, excellent access to funding, a disciplined approach to risk, strong capital ratios and strong senior debt ratings. I am confident that we also have the best people and the best capabilities to serve our clients across these businesses. In the face of near-term challenges, we have not lost sight of the future and we are continuing to build our businesses for long-term growth. And with that, I will turn it over to Morton.

Thanks, Gord. I will start with a review of the writedowns and then provide an update on our credit portfolio. As Gord mentioned, market turbulence continued through the second quarter resulting in writedowns of C$854 million before tax or C$436 million after tax and related compensation adjustments. As shown on slide 10, these were in capital markets and also in corporate support, which includes our corporate treasury activities. Full details are provided on pages five through seven of our second quarter report to shareholders. In our corporate support segment, we had writedowns of C$140 million related to U.S. sub-prime and Alt-A. Of this C$73 million related to declines in the fair value of Alt-A residential mortgage backed securities and training portfolios and C$67 million related to available for sale holdings of ALT-A and U.S. sub-prime RMBS that were determined to be other than temporarily impaired.

In our capital market segment we had writedowns of C$714 million in total, of which C$204 million related to declines in fair value of credit default swaps with MBIA, that represent credit protection we purchased to hedge our credit exposure to super senior tranches of structured credit transactions. A further C$87 million related to declines in fair value of sub-prime CDOs of asset backed securities and other sub-prime RMBS. Unrelated to U.S. sub-prime, we had writedowns in four other areas in capital markets. First we had C$148 million -- C$184 million of writedowns on U.S. auction rate securities. These were due to a decline in the fair value of our trading positions based on market prices and a model's approach to valuation. U.S. auction rate securities are long-term debt that trades at short-term debt prices with an interest rate reset every week to 35 days. These securities are issued by municipalities, student loan authorities and other sponsors through bank managed auctions.

We acquired our inventory of auction rate securities primarily in the first quarter and to a lessor extent early in the second quarter in support of providing liquidity to the market. During the second quarter we sold or are committed to sell C$1.3 billion of auction rate securities at fair value into off balance sheet special purpose entities to which we may provide liquidity facilities. As at April 30th, the fair value of the auction rate securities we hold on our balance sheet is C$3.6 billion. The average yield on our holdings is above our funding costs. Approximately 90% of our inventory is rated triple A and approximately 85% are senior positions. In terms of student loan auction rate securities that we hold, over 85% are guaranteed under the U.S. Government Federal Family Education loan program. Also, over 85% of our student loan auction rate securities inventory has a ratio of trust assets to liabilities of greater than 100%.

Second, we had C$142 million of writedowns from declines in the fair value of trading positions in our portfolio supporting our U.S. municipal GIC business. This is a business where we issue guaranteed investment certificates for cash received from municipalities and invest the cash received primarily in agency and non-agency mortgage backed securities. As at April 30th, the fair value of the investment portfolio supporting our U.S. municipal GIC business was C$3.3 billion, down from C$4.4 billion at January 31st, due to net maturities, sales and a decline in value of certain positions. Third, we recognized a loss of C$21 million related to our U.S. commercial mortgage backed securities business due to both credit deterioration and reduced liquidity. And fourth, we had a C$76 million writedown in our U.S. insurance and pension solutions business, of which C$6 million represents real life losses on a surrendered policy. Let me provide some background on this business.

Our U.S. insurance and pension solutions business provides stable value contracts on bank owned life insurance policies purchased by banks on a group of eligible employees. The purchaser pays premiums to the insurance company and the premiums are then invested in a portfolio of eligible assets. While the insurance is in place, the purchaser receives tax exempt earnings linked to the performance of the underlying assets and also receives death benefits as they arise. The stable value ramps provided by our U.S. insurance and pensions solutions business reduced the volatility of the tax free earnings stream received by the purchases on the assets in their portfolio. If a purchaser were to surrender its insurance policy prior to maturity, the terms of the stable value contract generally require us to make up the difference between the notional and fair value of the assets inside the policy.

The purchaser would receive a payment for this difference in value, but would also be taxed on the surrender value, forfeit the tax exempt income stream and may be exposed to unhedged long-term tax deferred liabilities. As at April 30th, the difference between the notional value and fair value of our bank owned life insurance contract was C$1.1 billion. This represents the loss that would be recognized if all the insurance contracts were surrendered on that date. Turning to slide 11, we had three days of large net trading losses which related primarily to the writedowns and month end valuation adjustments on instruments with limited liquidity. The remaining net trading loss days this quarter were largely attributable to the significant volatility in credit markets and did not exceed the global value at risk for each respective day.

Turning to credit, on slide 12, the overall quality of our loan portfolio remains within an acceptable range for loss rates, despite continued credit deterioration in some areas. We observed higher impaired loans in our U.S. wholesale portfolio, specifically in our U.S. residential builder finance business, particularly in California, Georgia and Arizona. Residential real estate gross impaired loans in our U.S. retail portfolio also increased, but to a lesser extent. The year-over-year trend in gross impaired loans primarily reflects the downturn in the U.S. housing market and slowing US economic condition. As Gord mentioned earlier, we recently exited most of the out of footprint portion of our residential builder finance business, with the primary exception being the business in Texas. The existing portfolio of out of footprint loans will be unwound and managed down in an orderly fashion over the next three to four years to avoid a sale of loans at a deep discount in the mist of what is currently a distressed market.

At the end of Q2 our U.S. residential builder finance loan portfolio was approximately C$3 billion, including the additional -- the addition of the Alabama National portfolio. Our total portfolio at RBC Bank -- our total loan portfolio at RBC Bank is now approximately C$22 billion, with approximately two-thirds in commercial loans, including business banking and builder finance, and one-third in consumer loans. On slide 13, you will see that the -- so that total specific provision for credit losses in the specific PCL ratio increased relative to the prior year. Provisions were up primarily reflecting higher impaired loans in our U.S. residential builder finance portfolio. Higher write-offs on retail loans in our U.S. banking business also contributed to the increase in provision, reflecting the challenging operating environment.

The increase also reflected a C$35 million provision related to loans extended on the liquidity facilities drawn on by RBC administered multi-seller asset backed commercial paper conduits, categorized in U.S. wholesale. Impaired loans extended under these facilities amounted to C$172 million at the end of the quarter and are secured by the super senior tranch of a CDO asset backed securities. In addition we also had lower recoveries in our capital markets corporate loan portfolio than in previous quarters. I would like to note that structured products make up a very small component of our total back stopped liquidity programs. 98% of the assets in the conduit that we provide liquidity to are un-leveraged, plain vanilla, traditional asset classes such as credit card and auto receivables. Higher provisions in our Canadian business loans and retail loan portfolio, primarily reflecting growth, also contributed to the increase. To date there have been no major issues with our Canadian loan portfolio. At this point I will turn the call over to Janice to discuss our second quarter results.

Thanks, Morten. Slide 16 provides an overview of our quarterly performance. Net income was down C$351 million from last year because of the writedowns highlighted earlier. Earnings were also impacted by higher PCLs primarily in our U.S. banking business. Canadian banking continued to perform well and underpin our earnings. Non-interest expense was down 6% from a year ago, reflecting lower variable compensation due to weaker results and the impact of a stronger Canadian dollar on the translation of U.S. dollar denominated expenses. Turning to slide 17, we have maintained our strong capital position. Our Tier 1 capital ratio this quarter was 9.5% under Basel II. The decrease from last quarter is largely due to higher risk adjusted assets and a higher goodwill deduction due to the acquisition of Alabama National Bank, which was partially offset by capital issuances.

Also, our total capital ratio remains strong at 11.5% and our assets to capital multiple is well within off-seas requirements at 20.1 times. We continue to have excellent access to both short and long-term funding and have a modest amount of debt maturing over the next 18 months, which positions us well. I will now review the quarterly performance of our four business segments. Starting with Canadian banking, on slide 19. Net income was up 15% over last year on higher results in global insurance and volume growth across all banking related businesses. Looking at our banking related businesses, earnings increased 7% over last year due to 17% and 18% growth in volume in our home equity lending and personal deposits respectively. As you know, home equity products are secured loans and supported by low loan to value ratios. Canada's housing market continues to perform well in today's environment with solid consumer fundamentals.

Our year-over-year earnings comparison is impacted by a C$29 million loss, C$35 million pretax on redemption of our Visa IPO shares in the second quarter of this year. Our banking related operations are running efficiently with operating leverage of 3%. Compared to last year expenses were lower, mainly reflecting our effective cost management efforts. On slide 20 you will see net interest margin decreased over the year -- over a year ago, reflecting the changing portfolio mix as clients continue to display a preference for products, such as home equity and high interest savings accounts, which are lower yielding to us. I will point out that our online only high interest savings account is a low cost channel for us and the net interest margin metric does not factor this in. Despite the challenging low interest rate and competitive environment, we were able to grow net interest income in our Canadian banking business by 5% over last year, based on our sustained volume growth.

Global insurance earnings were up C$52 million over last year, reflecting lower disability claims, costs, and improved universal life experience in our Canadian insurance business, as well as growth in our reinsurance business. Looking at wealth management on slide 23, net income was down 6% or C$12 million from a year ago. Impacting this comparison was a foreign exchange translation gain on certain deposits that increased second quarter earnings in 2007 by C$8 million. Also appreciation of the Canadian dollar against the U.S. dollar reduced earnings in the second quarter of this year by C$7 million over last year. In global asset management we grew assets under management by 10% and revenue by 5% over last year. In our brokerage businesses we had lower transactional volumes reflecting market conditions. Non-interest expense increased slightly from last year, mainly due to the inclusion of JB Hanauer and increased costs in support of business growth.

Moving on to our U.S. and international banking platform on slide 25, earnings decreased C$29 million over last year, largely due to increased provisions for credit losses related to our U.S. residential builder finance and retail loan portfolios. This was offset by growth in RBC Dexia IS and our U.S. banking business. Non-interest expense was up 12% or C$47 million from the prior year, reflecting higher costs associated with the Alabama National acquisition, which closed in February, a full quarter of expenses [from AmSouth] branches and higher processing and staff costs at RBC Dexia IS in support of business growth. Slide 26 shows revenue in our banking businesses was up C$40 million for the year. In U.S. dollars revenue was up US$70 million and our banking related operations grew loans 30% and deposits 33% over last year. This reflects the Alabama National acquisition and a full quarter of revenue from the AmSouth branches. We also had a C$15 million gain related to the Visa IPO shares.

RBC Dexia revenue was up 17% from last year due to higher net interest income from deposits and growth in custodian and securities lending activities. Turning to capital markets on slide 27, net income was down from last year largely reflecting the writedowns that Gord and Morten discussed. Non interest expense was also down due to lower variable compensation attributable to the writedown. On slide 29 you will see a breakdown of RBC's total trading revenue. Despite the writedowns, some of our trading businesses did benefit during the period from the market volatility and declining interest rates, as Gord mentioned at the outset. In conclusion I would like to confirm that we have provided additional disclosures in our report to shareholders this quarter and with these additional disclosures we are substantially in compliance with the overall substance of the financial stability forum's recommendations for disclosure in areas that are significant to RBC. At this point I will turn the call over to the operator to begin the questions and answers.

(OPERATOR INSTRUCTIONS) Our first question is from Jim Bantis from Credit Suisse. Mr Jim Bantis, you line is now open. You may proceed with your question.

Thank you, good afternoon. Just a couple quick questions. One for Morten, looking at the U.S. builder portfolio, could you just recap some of those numbers that you provided with respect to that portfolio. How much is actually in footprint and that you are keeping and how much is out of footprint that is going to be wound down?

The overall portfolio as of the end of the quarter, I have the number in my space and I'm just trying to flip to the page here. From memory roughly C$3 billion overall, that includes the addition of the Alabama National portfolio. In terms of the out of footprint business, we are looking at a part of the portfolio in excess of C$1 billion that is being liquidated over time as markets permit. The speed of the disposition of the portfolio will be driven by market condition. These are generally fairly well collateralized and in a more stable market the recovery rate of the loan should be reasonable. Clearly at current market it will take us some time to get out of those positions.

Morten, that C$1 billion you quoted for out of footprint is included in that C$3 billion or is on top of?

It is included in the C$3 billion and I would add that if you go back historically we had about C$2.5 billion in the legacy RBC Bank or Centura business and we have seen some reductions in that and then we have had the addition of Alabama National bringing us up to the C$3 billion level.

The next question is for Chuck. Looking at some guidance with respect to your flavor on the second half of 2008 for capital markets. We have got C$1.2 billion in writedowns at this point. Not sure how much of that is going to come back. But maybe while Doug is there as well to talk about his business and what you can see on some of these structured product businesses going forward. Typically you are about C$1.1 billion revenue run rate per quarter and I'm wondering if you have got the capabilities to get back there.

I certainly don't consider this guidance, but we have the capability of getting back there. Basically, not from the structured products areas and not even necessarily from recovery, but I mean we have a broadly diversified business that in a trading environment without write-offs and with a normalized investment banking and investment banking origination environment, certainly has the capacity to do that and more.

Do you want to comment on the U.S. investment banking?

Sure. Jim, I would just say that the origination of business in the U.S. has come along reasonably well. In fact the U.S. is year-to-date performing almost at the level financially as the Canadian business, which is much better than it has in the past. But I think in terms of Chuck's comments, it is going to be largely dependent on markets continuing to improve.

Thank you. When you see that C$1.2 billion bucket in terms of year-to-date losses, perhaps Morten, how much of that do you think is actually written off and how much of that do you think actually can be recovered? I put it in the context of you had assets at the beginning of January and some of these losses are related to that, but you have had sales in those businesses. I'm trying to get a sense of some of the comments made in terms of holding assets because of liquidity issues.

It is probably inappropriate and impossible to comment specifically on how much would come back. But I think it is very clear from a valuation standpoint that a good part of the valuation is driven by liquidity issues rather than underlying fundamental values. And so with improvement in markets, some portion of that should come back. I don't think I should comment beyond that.

I can appreciate that. You would feel comfortable about saying that about the auction rate securities and municipal bond business but probably less so with respect to sub-prime or CMBS.

Just from a business standpoint I would think that the more difficult areas are the structured products areas and the areas where they should come back would be more on the trading related products that don't have the leverage and the structuring that the structured products have. I would also add that two things. First of all, you are not going to wait for a full recovery. It all depends on how quickly it comes and what other opportunities exist in terms of whether you are going to sell these assets or not. Secondly, there are assets on the other side, which is the future value that has been recognized with respect to our liabilities that in normal course would also offset the recoveries. Partially offset the recoveries, not by no means fully offset the recoveries. When I look at it, and I'm not going to be imprudent because I mean to use these phrases not to project preciseness because it is anything but, but I think there is considerably more than half of our losses, more than half aren't coming back and less than half are, considerably less than half.

That's great. Thanks, Chuck. I appreciate that.

The following question is from Ian de Verteuil from BMO Capital Markets, please go ahead.

Thanks. Question for Morton. The facility, I think you have taken on a loan back from the -- one of the multi-seller ABCP conduits. Can you give us some detail on that. Is it the US, what is the total size of the loan brought back, and what is the potential for more of this occurring?

The detail I did provide some of these numbers in my comments and I'm just flipping to find the right -- .

I apologize. There were a lot of numbers, Morten.

To get back to what it is. As I commented in my comments, we have 2%, or less than 2% of the total assets in our conduits represent structured products. The loan that we have had the C$35 million provision on was C$172 million in total. That is a related to a CDO of asset backed securities. That is the -- of that particular type of structured product, that is the only product of that particular type. But in the 2% number there is a range of other structured products, none of which at the moment show any sign of having quality problems, but the future, obviously, remains uncertain on that. So that begins to provide an answer to what you were looking for.

So the 2% is a 2% of the C$42 billion in maximum exposure through the conduits.

Yes, 2% of the C$40 billion, C$41 billion. 42 -- that's the size of the structured products within our con do you wits overall.

Okay, so that's 840.

That's the size of the structured product within our conduits overall. The specific loan from memory is C$172 million where we have the -- .

The answer to Ian's question, for clarification, is C$172 million.

I got you. The second question is related to the gross impaired. Obviously the big area, and I'm looking at page 22 of your sup-pack for clarity. Obviously the gross impaired on the real estate piece kicked up, which would be the builder finance piece. There is some other area that seem to be rising as well. The other category is up a couple hundred million dollars and it does seem as well as if the Canadian res mortgage piece, which I'm surprised by, is tracking up a bit. Could you talk to those, Morton.

Maybe the page 23 with the impaired loan formation is, the 22 and 23 together probably provide you the best picture of this. In terms of speaking to impaired loan formation, you will see that out of the total, the vast majority is U.S. wholesale related, which again is dominated by the U.S. builder finance business but with a couple of other wholesale loans thrown in. The increase in the Canadian portfolio is roughly equally split between residential and business. And again, the growth there I would emphasize that relative to our internal plans we are on plan for our provisioning in our Canadian portfolio. From a credit quality standpoint, given the good growth that we have seen, it is actually where we had expected it to be and so where we continue to be pleased with that performance. In terms of the business portfolio, it actually continues to perform relatively well although we had one or two commercial loans that have moved into the impaired category, which has helped drive those numbers up somewhat.

Overall in terms of watch list and assets that look like they are in danger of moving into impaired, the inventory of that remains remarkable small. When you look at overall credit metrics in the Canadian portfolio, they remain strong. The signs of weakness are in some extent in delinquencies at the very small end of our business banking portfolio where you can see some growth in problem assets, but it doesn't translate into real dollar numbers. If you look at the retail portfolios, we can see some increases in delinquencies in the mortgage book, but because of our very conservative loan to value pieces there are write-off experienced remains solid and exactly where it has been. So you have some very small signs of weakening of the economy translating into some of the metrics we measure in the portfolio. But I would emphasize, and on the retail portfolio it actually does not translate into any real deteriorating trend in performance. Most of the growth you have seen in both impaireds and in provisioning relates to growth of the portfolio overall.

Thank you.

The following question is from Robert Sedran from National Bank Financial. Please go ahead.

Hello and good afternoon. Apologies, if I can just return to the builder finance issue for a minute, I have a couple of questions and the first is, I guess, what is it about Texas that you like? Is it the market or is it your exposure in that market that continues to make it attractive to you. And second, would you like to make Texas part of your footprint at some point or would you prefer to build scale within the existing footprint?

It is Morton. I will start with the first part of the question and I will let Jim tackle the second one if he feels like it. In terms of Texas I think there are two pieces related to that. The historical base of the builder finance business was in Texas. The Texas market continues to perform quite well. In the near-term, there is little benefit in moving out of that -- from a portfolio standpoint it was not an area that really warranted the attention of the rest of the out of footprint business. But I don't know, Jim, whether you want to speak to the overall Texas market.

We have no plans at this time to expand our core banking into Texas, Robert. I would just add one little bit to what Morten had to say. We do do some out of footprint lending, which are extensions of very strong Canadian clients who operate in the U.S. We do that business, so that's why we are not quite as categorical to say all out of footprint.

Thank you.

The following question is from Michael Goldberg from Desjardins Securities, please go ahead.

My first question is about the dividend. There was no increase this quarter and I'm wondering whether that is a reflection of the current weak earning power or more of a reflection of concern about the outlook?

Michael, it is Gord. I'm not sure it is concern about either rather than it is just a reflection of where we are with respect to our earnings at this point in the year and our dividend payout ratio objective and it is very much a reflection of that. I think it's -- we look at the dividend as something that we want to continuously grow and to increase, but we also want to do it on a prudent basis in the context of our objectives and our payout ratios and given the write-offs in the first quarter, we've just make the decision to, we the board has made the decision to take a more prudent perspective. I'm sure it is a reflection of either of those things rather than just a reflection of the reality of our earnings today versus where they would have been without the writedowns.

Okay. Also returning to the Ian's question. I just want to make sure, C$172 million loan, is that a single loan that is non-performing?

Michael, it is Morten. The answer is yes, it is a -- it is the financing of one of our conduits has one asset to it. So the way it functions is there is a single loan associated with a transaction which is a senior tranche of a CDO of asset backed securities.

Okay. And was that loan actually taken out of the conduit and put into the bank?

The funding for that and most of the rest of that conduit is actually on balance sheet and has been since late last year.

The funding for the loan?

The conduit, the funding for the conduit is done on balance sheet at this stage and has been. If you look at our C$40 billion plus of conduit activity, because of the nature of the assets in that conduit, which is the conduit with the structured products activity, it is less amenable to financing in the commercial paper market. So we had prior to this provision being recognized taken the funding for the conduit on balance sheet.

I'm sort of confused. So not all of the C$40 billion conduit is on the balance sheet?

No, no, this is in the order of C$1 billion or less. So just to actually answer a question you haven't asked but to make sure we don't have confusion here. Out of our C$40 billion plus in securitization conduits continue to fund well in the CP markets. The U.S. market has continued to operate well for most of the period. The Canadian market, while has been funding throughout the period and has improved over recent quarters, so with the exception of this very small piece of our total securitized assets that are more structured, which are therefore less appropriately funded in the CP market, everything else continue to fund through on a normal basis in the commercial paper market at levels that have been improving?

So all of the loans related to structured products have been put onto the balance sheet or effectively --

This particular conduit it is funded currently entirely on balance sheet. It can be funded in the CP market, but we have not been doing that for the last several months.

I think I understand. It is funded on the balance sheet but it is not on the balance sheet itself?

Rather than funding through the commercial paper market, is being funded by a loan from RBC to the conduit.

Right. Can I ask you -- what is the amount -- on the C$40 billion in the conduit what is the amount of risk weighted assets that that represents and what would it be if you did consolidate the C$40 billion conduit?

You want to try to answer that, Janice?

Michael, it is Janice speaking. The C$40 billion that we are talking about are the backstop liquidity facilities to fund the conduit. And with respect to the exposures, I think that in some of the financial stability form disclosures, you will see a disclosure to loss by client asset type. So it would be the securitized assets and the type of loans or the credit quality that is in there.

I'm sorry --

I think that our disclosure is actually in a variety of pieces here in our report to shareholders. Why don't we get back to you and we can point out where it is so that you can piece it together.

Okay. Lastly, I guess this would be a question for Gord or Chuck, do you think that you can get the market to fairly value your more volatile trading businesses and if not, given the capital that you have got supporting those businesses and other possible uses for that capital where you might get more fairly valued, why stay in those businesses?

Well, I will answer it and then Chuck may want to add his comments as well. The first point I would make is that we have been pretty steadfast. That was businesses we are comfortable representing approximately 25% of the overall earnings of the bank. And we think that is a good objective for us and we think it is one that allows us, from a risk reward valuation perspective, to be in a very strong position. And frankly, even those organizations which have de-emphasized that business, most of them are pretty close to that range as well, to be perfectly honest. In addition to that, I would also say that if you look at that business, even this year thus far, which has been in a very, very unusual period, which everyone is familiar with, this is still a business which has had a return on equity, I believe, of about 12% roughly, which is not acceptable or up to standard.

But there are certainly other parts of the financial services businesses globally where a 12% return would be viewed to be strong and when we look at this business going forward, the ability as long as we maintain it, as I said, at a low relative risk compared to -- low relative size compared to the overall organization, the returns that will be available in this business, we believe, are going to be very, very attractive and very difficult to replicate by investing in other parts of the financial services industry whether it is banking or elsewhere. So I think that from a strategic perspective, we want to keep that balance because we think at the margin it will be -- there will be very attractive returns and frankly, I think very difficult for those organizations who are exiting some of these businesses to replace the returns and to replace that value and I think over time that will play out in the share prices.

Isn't that return though a function of the internal transfer price that you have for funds that support that business?

Yes, but you can make any adjustment to that number you want, it is still going to be within that range. There is a lot of good methodology in returns of how capital is allocated internally.

Michael, we are going to move onto the next question.

I just want to add a quick comment.

Okay, Chuck is going to add one comment and then we are moving on.

One quick comment and that is that we are not proud of it, but we really have never made any significant money in the businesses that we lost a lot of money in over the last 12 months, nothing we are proud of. If you look at our history with respect to our trading results, and I'm knocking wood while I say it, they have been over a long period of time quite stable and growing and basically, fortunately, we are not going to lose very much by having really shut down most of the businesses where we have lost a good amount of money. So the picture I think has good value.

We are going to move on to the next question just to give others an opportunity. Thanks, Michael.

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

Good afternoon. First for Janice or Morton, staying with gross impaired loans and specifically looking at the U.S. The C$400 million change this quarter, how much, if any, of that relates to the first time inclusion of Alabama National or was that marked down at close?

It is Morton. The answer is the loans that -- any assets that were criticized were marked down at close, so the Alabama National portfolio that is captured is in essence clean at this stage.

So I think 172 relates to the gross impaired loan relating to the conduit you talked about and the rest is in the legacy, Centura and home builder business?

There is a mix of loans in the impaired category. The one structured transaction we talked about is the large part. I believe there is one or two other smaller loans out of our U.S. corporate loan portfolio and most of the rest is in RBC Bank with a majority of the RBC Bank impaired being the builder finance business.

And on that note, Morten, it certainly feels like and it looks like that two of the numbers at the nonperforming rates for the bank have been growing a lot quicker than the provisioning rates in recent quarters. I think the historical run rate you have or target you have is 40 to 50 basis points. Even at 55 today, when you look at some of the geographies you are in and the state -- your own cautious commentary on the state of the U.S. banking economic system, what do you think is reasonable? Is 55 basis points enough of a cushion right now, given the coverage ratios falling and the impairments continuing to grow at a rapid pace?

Let me try to give you a couple of answers to that. First in terms of specific provisions, if you look at the assets that we are providing for, while the U.S. builder finance business is clearly -- the market is in distress, the collateral value for all of the assets that we got in there are actually relatively strong. So from an economic standpoint over time the recovery rates will be -- in other words, we will have provisions for way less than 100% of the notional because of the secured and structured nature of this and the underlying economic values. As impaired loans grow, the specific provision is going to by definition grow at a slower rate and that is appropriate because of the recovery rate associated with that.

So in terms of -- we don't provide guidance on provisioning, but I would say that if you look at -- I did go through a little bit of a commentary around the impaired portfolios in both Canadian banking and the U.S., I would say that what we have seen over the last quarter in the U.S. builder finance business is consistent with what we have been expecting since the early part of this year. The Canadian portfolio continues to perform at a level where the impaired formation is actually consistent with what we would expect and the provisioning level is not something I expect to see increasing over there. So performing, I think, it is entirely realistic for us to expect to perform within our general historical averages.

Okay, thanks.

The following question is from Mario Mendonca from Genuity Capital Markets, please go ahead.

Good afternoon. Page 22 of the report to shareholders, when you are referring to your corporate segment, you make reference to the C$140 million charge in the corporate segment, then you indicate that the losses were largely offset by income taxes amounts related to enterprise funding activities. Two-part question, the tax if you can just describe what you are referring to here in terms of these tax items. Are they unusual tax gains? Is this something you would expect to repeat? And then secondly, were they contemplated in providing those items of note if you will?

Mario, it is Janice speaking. Every quarter, if you will look at the corporate support section, we do make reference to the enterprise funding activities where we received favorable tax advantage. These are ongoing. This is funding activity that we have in the center to fund all of our various operations off-shore. From our perspective in terms of why it is here, it is here because it is for general funding purposes and we allocated across the various businesses. It is not anything unusual from an ongoing basis.

Okay.

What was the second part of your question.

I think you have actually addressed it. I just wanted to understand if there was something unusually large about these tax items this quarter and it sounds like the answer is no.

No.

Okay. The securitization gain about C$51 million this quarter, it seems to be a pattern, perhaps not a pattern, but at least I have seen it one other place. What was it about this quarter that allowed the banks to generate a little more in securitization activity than they have generally.

What it is is interest rates went down, so these are securitizations from our perspective of our Canadian residential mortgage books, 3CMHD. So we assembled the mortgages and when rates go down, we mark them to market as we put them into the vehicles and that particular gain is amortized over the life of the funding. It is really a bit of a timing difference, but it is totally linked to where interest rates are.

And then finally, throughout the report to shareholders reference was made to parts of the trading business that did particularly well and I think you referred to certain trading businesses or certain trading strategies, fixed income and volatility. Could you offer anything else in that? The reason why I'm focusing on this is again, if you were to -- if we were content to reverse all the charges that were highlighted for us, this becomes an astounding quarter on the trading side. Is there anything you can point to.

No. There were a couple of various -- we did well in geographical parts of our fixed income side. We had some strength in parts of the equity crop businesses we had and other areas. I've said this many times before, the trading results are part, I think in terms of looking at the place we made money, good trading and part the fact that these days if you are operating globally you can make more money on the trading business because basically there is higher value paid for capital and risk has been repriced.

Perhaps maybe for both Gord and Chuck. Last quarter you made the point that it would not be entirely appropriate to isolate the gains from the losses in trading because the two are some how related. Is that a comment you would offer for us again this quarter?

I mean, generally, yes. I think that probably like last quarter there are some things that went for you in trading. Particularly with respect to you made more money on your hedges, not on the product but just your general hedges against long positions than you would have this quarter. But basically, I think that generally the phrase still applies. You can't separate what is going on in the losses from some of the way profits are made on an overall industry basis.

But I would say that would have been more the case the last quarter, Chuck. I think you would agree with that. I think this quarter was a little bit more normalized from that perspective.

And then finally, Chuck, on basis risk, anything special you can offer us this quarter?

No, I think that we are in pretty good shape with respect to basis risk. That's one of the reasons why we have lost money along the way, is not wanting to fully deal with it. But basically it is an issue that I think is going to have to be faced in the industry over this quarter for people.

Did it result in losses for the bank this quarter?

Not net.

Not, sorry.

Not net.

Not net. Got it, thanks.

We have time for just one more question.

The following question is from Andre Hardy from RBC Capital Markets, please go ahead.

Just a quick one on that C$3 billion builder portfolio in the U.S., how much has already been classified as impaired and how much has been taken in allowances on that?

I don't think we provide disclosure down to that level of detail. I'm not sure to what extent I can really comment on it.

Is it fair to assume that the majority of the delta in the last year in gross impaireds and the allowance related to real estate would be that portfolio?

Absolutely, if you look at provisioning over the last several quarters, the vast majority and other than a couple of things we have highlighted this quarter, is related to builder finance and if you look at the supplementals and see where the growth, what the growth in impaireds in our U.S. wholesale portfolio has been and what the provisioning in that segment of the book has been, it is predominantly U.S. builder finance. I think that would give you a pretty good indication of how to answer your question.

Thanks.

Thank you.

Okay, it's Gord just thanking everyone once again for joining us for this quarterly call. I know it is, again, a noisy quarter and certainly we are all available for follow-up questions and discussions. Thank you for joining us and we look forward to next quarter

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