Royal Bank of Canada (RY) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the RBC 2008 third 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, Ms. Moffat.

Thank you, operator. Good afternoon everyone and thanks for joining us. Presenting to you today are Gord Nixon, our CEO, Morten Friis, our Chief Financial Officer, and Janice Fukakusa, our Chief Financial Officer. Following their comments, we will open up the call for questions from analysts. The call will be an hour long and we'll post Managements formal remarks on our website shortly after the call.

Joining us for your questions are Barb Stymiest, our Chief Operating Officer, Dave McKay, Head of Canadian Banking, George Lewis, Head of Wealth Management, Jim Westlake, Head of International Banking and Insurance, Chuck Winograd, CEO of Capital Markets, and Doug McGregor and Mark Standish, Co-Presidents of Capital Markets. As noted on Slide 2 our comments may contain forward-looking statements which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. I'll now turn the call over to Gord Nixon.

Thanks very much, Marcia, and good afternoon, everybody. We're now three quarters through this fiscal year and we've generated $3.4 billion of earnings and an ROE of just under 19%, which we think are very impressive results when you consider the performance of financial institutions around the globe and the state of the overall marketplace. We performed solidly through difficult market conditions which I think demonstrates the strength of our people as well as the organization. We've effectively managed our cost and our risks while taking advantage of market opportunities and continuing to invest for future growth across our diversified businesses. Most importantly, we are staying very focused on our three strategic goals: To be the undisputed leader in financial services in Canada, to build on our strength in the United States and to be a premier provider of selected financial services globally.

I'd like to give you some highlights with respect to our first quarter. We earned $1.3 billion this quarter which is down $133 million from a year ago and up $334 million from the second quarter of this year. Our reported diluted earnings per share were $0.92 and I would highlight that this is after write-downs of $0.20 and the impact of that. Even with these write-downs our revenues are at record levels and our underlying earnings are very strong reflecting continued success of our diversified businesses. Canadian Banking had record results with net income of $709 million which was up 19% from last year. There were no unusual items and we grew volumes across all businesses and generated strong operating leverage through revenue growth as well as effective cost management. Personal core deposits have grown 15% over last year and home equity lending is up 17%.

We continue to work hard to enhance our clients experience by opening new branches, adding ATM's and renovating our existing branches. We are not only earning more business from current clients, we are attracting new clients. Over the last year we increased our market share in personal core deposits and mortgages by 54 basis points and 19 basis points respectively. Consistent with our strategy of expanding services for clients we recently announced the acquisition of ABN AMBRO's Canadian Commercial Leasing Division.

Our Wealth Management results were also strong. We increased fee-based client assets and continue to lead the Canadian Mutual Fund industry in total net sales. Our results include the contribution from PH&N, which combined with our existing business makes us the largest Canadian Mutual Fund Company with a leading presence in all client segments of the Asset Management Business in Canada.

We also continue to grow our Global Asset Management capabilities with the acquisition of a 10% interest in O'Shaughnessy Asset Management, a long time partner for RBC, and the acquisition of Access Capital Strategies, a US independent investment advisor that expands our capability into social responsible investing.

Within our Canadian Wealth Management Business, RBC Dominion Securities, Canada's largest full service wealth management-- manager continued to recruit experienced and successful investment advisors from our competitors across the country. They are attracted to the merits of RBCs financial strength and stability, our dedicated focus on Wealth Management as well as the value they can offer their clients through our broad product and service offerings.

We continue to grow our US Wealth Management Business with the acquisition of Ferris, Baker Watts, bringing our total number of financial consultants to over 2100. Our International Wealth Management Business continues to grow as reflected by the steady increase in loans as well as deposits. Both our US and International Wealth Management Business have been successful in attracting experienced advisors and other client basing professionals from our global competitors during this period of volatility.

In our International Banking Segment our US banking operations continue to experience difficulties particularly in residential builders finance, because of the ongoing stresses in the US housing market and the tough operating environment. That said the relative size of these issues is manageable in the context of RBC and we have dedicated professionals focused on systematically managing our US banking loan portfolio. Morten will speak more about the US credit environment during his comments. Performance in other areas of our US banking operations continues though to be acceptable and stronger than most of our US peers. We're making good progress on integrating Alabama National, we're-- and we are working through the current environment and we are focused on having the best bank possible and a good earnings recovery when the credit environment starts to improve.

In our Caribbean Operations, this quarter we completed the acquisition of RBTT, which has significantly expanded our presence throughout the Caribbean. RBC is now the second largest bank in the English-speaking Caribbean and the fourth largest overall. We will be integrating this acquisition in the months to come and improving access and choice for our Caribbean clients.

RBC Dexia continued to perform well through these challenging markets. Insurance also performed well this quarter and continued to add to our business mix. Capital Markets delivered a return on equity this quarter of 18% and net income of $269 million despite the impact of the write-down. This is a testament we believe to the strength of our diversified businesses. We are continuing to invest across our Capital Markets businesses and capitalizing on opportunities created by the market environment to win business as well as recruit top talent.

For example, we added significant new talent to our municipal finance practice, which we are growing in select target areas, including healthcare and housing, and we also added to our US leverage finance team. We're continuing to buildout our North American energy focused commodities team. Consistent with this we recently closed the acquisition of Richardson Barr & Co., a leading Houston-based energy advisory firm specializing in acquisitions and divestitures in the exploration and production sector.

Turning to our year-to-date performance versus objectives on Slide 7. Our ability to meet our objectives has been impacted by the write-downs as well as higher provisions for credit losses in US banking. However, our capital position remained strong with Tier 1 capital of 9.5% and we expect it to remain well over our objective of 8% for the balance of 2008 and of course that incorporates the acquisitions. We're maintaining our quarterly dividend at $0.50 in the fourth quarter.

As I've mentioned several times over the past year, RBC has historically pulled away from the competition in times of turmoil, and I can tell you that we are certainly seeing that today. We have market leadership, client focus, a good balance sheet, strong capital ratios and strong senior debt ratings and excellent access to funding and we will continue to leverage these strengths to take advantage of market opportunities. We believe we have the right strategies and the right people in place for our business to succeed and we'll continue to work hard to execute against the three strategic strategies that I outlined before. With that I'd now like to turn it over to Morten Friis. Morten?

Thanks, Gord. I'll start with a review of the write-downs and then provide an update on our credit portfolio. As Gord mentioned we had write-downs in the quarter of $498 before tax or $263 million after tax and related compensation adjustments. As shown on Slide 10, these were in Capital Markets, Corporate Support and International Banking. Full details are provided on Pages 5-8 of our report to shareholders.

Starting with Capital Markets we had $173 million of write-downs related to the structured credit transaction that we hedged with NBIA. This amount reflects the declines in the fair value of credit default swaps with NBIA, expected recovery rates on the underlying assets and other parameter inputs. A further $97 million related to declines in the fair value of subprime CDOs of asset backed securities and other subprime residential mortgage backed securities. Unrelated to US subprime, the remaining write-downs in Capital Markets totaled $72 million and related to auction rate securities, our US Municipal GIC Business, US commercial mortgage back securities, and our US Insurance and Pension Solutions Business. These are all areas that I've discussed in previous quarters and are covered in the report to shareholders.

Turning to Corporate Support, $88 million of write-downs related to available for sale holdings of Alt A and US subprime RMBS that we determined to be other than temporarily impaired and 18-- and $15 million related to the declines in the fair value of Alt A RMBS in trading portfolios. In International Banking we had write-downs of $39 million on preferred stock of Freddie Mac and Fannie Mae held in our US Banking Business that we deemed to be impaired due to recent events. We also had $14 million-- had a $14 million write-down on available for sale holdings of Alt A RMBS that we determined to be other than temporarily impaired.

Turning to Slide 11, two of the largest days of net trading losses and the single day of large gains at the end of the quarter were primarily due to month end valuation adjustments. The remaining two large net trading loss days this quarter were largely attributable to significant volatility in the equity and credit markets and did not exceed global VaR for each respective day.

Turning to credit. Pages 30 to 31 of our report to shareholders discuss credit quality and include a break down of the loan portfolio in our US Banking Operations. Over 80% of our loan book is based in Canada and credit quality in Canada remains stable. Increases in Canadian gross impaired loans and provisions for credit losses mostly relate to portfolio growth. You can see from Slides 12 and 13 that GIL and PCL ratios in Canada continue to be low and comparable to prior quarters. About 6% of our loan book is International. The increase in gross impaired loans that you see from the second quarter is largely due to our June 2008 acquisition of RBTT. Finally approximately 13% of our loan book is based in the US, whereas you know credit quality has been deteriorating.

As shown on Slides 12 and 13, gross impaired loans and provisions for credit losses in the US have increased compared to last quarter. The credit issues are primarily in residential builder finance, though our Commercial Banking portfolio is also showing deterioration in some areas. In the retail portfolio, home equity loans and lot loans have also weakened compared to last quarter. US residential builder finance loans consists of our ongoing builder finance business and RBC Real Estate finance Inc, a wholly-owned subsidiary set up to manage the rundown of builder finance loans from the out of footprint states as well as certain other impaired US residential builder finance loans from the in footprint portfolio. Builder finance loans account for over half of the PCL in the US this quarter.

To date we have not seen widespread problems in our general US commercial and business banking portfolio, however, we have seen higher impaired loans in PCL and areas related to supplying or providing services to the US housing market such as building supplies. While our US retail portfolio experienced higher impaired loans in PCL, particularly in home equity and lot loans we believe the portfolio is generally of good quality. In the retail portfolio we have very little unsecured lending or credit cards and no subprime origination programs.

To conclude, while we do have some challenges in our US loan portfolio this represents a relatively small portion of our overall loan book. The remainder of our loan book continues to perform very well. At this point I'll turn the call over to Janice Fukakusa to discuss our third quarter results.

Thanks, Morten. Slide 16 provides an overview of our quarterly performance. We had strong results in Canadian Banking, Wealth Management, insurance, and certain businesses in Capital Markets. Net income was down $133 million from last year reflecting the write-downs and higher PCL primarily in our US Banking Business that Morten highlighted earlier. Non-interest expense was up 3% from the year ago reflecting higher cost and supporting business growth, acquisitions and infrastructure investments.

Stepping back a little here, we constantly evaluate internally how we are doing in terms of expense management. When we do this, we look at expenses net of variable compensation. Looking over the last several quarters in this context, we have been able to carefully manage our expense growth rates while continuing to support enterprise wide business growth. The notion of revenue growth is part of all cost management discussions at RBC. We have added many points of access and advisors allowing clients to get advice when and where they need it while continuing to become more cost efficient.

Turning to Slide 17, our capital position is strong. Our Tier 1 capital ratio this quarter was 9.5% under Basel II. This was unchanged from last quarter even with the acquisitions of PH&N and RBTT which were partly funded with equity. Our total capital ratio was 11.7% and our assets to capital multiple was 19.4 times.

I'll now review the quarterly performance of our five business segments. Starting with Canadian Banking on Slide 19. Net income was up 19% over last year on strong volume growth across all our businesses. Operating leverage was 8% with revenue up 5% and NIE down 3% through effective cost management. On Slide 20 you'll see that our net interest margin decreased over the year and the quarter. This reflects our clients continued preference for lower spread products such as home equity and high interest savings accounts as well as the lower interest rate environment. Lower credit card spreads due to higher volume of low rate offers also contributed to the decrease from last year. However due to excellent volume growth we grew net interest income in Canadian Banking by 6% over last year.

Looking at Wealth Management on Slide 22. Net income was up 5% or $9 million from a year ago. We had higher fee based revenue including the contribution from our PH&N acquisition and higher loan and deposit balances in our International Wealth Management Business. Transaction volumes across our full service brokerage businesses were lower due to weak market conditions. Non-interest expense increased 1% from last year mainly in support of business growth including the PH&N and FBW acquisitions.

Moving on to Insurance on Slide 24. Earnings increased 33 % or $34 million over last year. This is largely due to favorable actuarial adjustments reflecting Management actions and assumption changes, improved universal life experience and business growth, mostly in our reinsurance business. Total revenue was up 45% over last year, primarily reflecting mark-to-market impact on investments backing our life and health policy holder liabilities which is largely offset in policy holder benefits and claims.

Turning to International Banking on Slide 26. We had a net loss of $16 million which compares to net income of $87 million last year. This is mainly due to higher provisions for credit losses reflecting higher impaired loans in our US residential builder finance commercial and retail loan portfolios and a write-down of $53 million or $33 million after tax on the investment portfolio in our US Banking Business. This was partially offset by contributions from the A&D and RBTT acquisitions and business growth at RBC Dexia. Non-interest expense was up 25% from the prior year reflecting the A&D and RBTT acquisitions and higher staff costs at RBC Dexia in support of business growth.

Turning to Capital Markets on Slide 28. Net income was down 25% from last year largely reflecting the write-downs that Gord and Morten discussed. Notwithstanding the write-downs we had strong results in some trading businesses including fixed income, equity derivatives and foreign exchange where we were able to take advantage of the market volatility and the interest rate environment. We also had higher gains on credit derivative contracts used to economically hedge our corporate lending portfolio. Non-interest expense increased 3% over last year, which reflects infrastructure investments in certain businesses. At this point I'll turn the call back over to Marcia.

Thank you, Janice. We'll now take your questions. What I would ask is that each of you please limit yourself to two questions and then requeue so that everyone has an opportunity to participate. Operator?

Thank you. (OPERATOR INSTRUCTIONS). The first question is from Brad Smith from Blackmont Capital. Please go ahead.

Thanks very much, Gord, this is a question for you. I was just wondering if you could update us with respect to your thinking about the US growth opportunities that you're seeing? And maybe just touch a little bit on how you look at the return potential there relative to the risk and contrast that against your Canadian opportunities which seem to be growing?

Yeah, I mean, I think that as everybody is aware, the-- certainly valuations in the US have dropped very dramatically, although the US marketplace is not without its challenges and particularly as it relates to the real estate sector. When you look at the retail banking, our Personal and Commercial Banking Business in the United States, there's equity market values and then there's real value when you look at the balance sheets and the loan books and the mark-to-markets. And I would say that we look at the US with a tremendous amount of caution given the current operating environment but we also want to be positioned to take advantage of opportunities. Which sounds a little bit wishy washy, but I think it's very consistent with where we've been for quite some time, where we're willing to look and to explore opportunities, but we certainly don't want to do anything that's going to compromise the financial strength and the performance of the organization. And there's still a lot of challenges when you look at investment opportunities in that marketplace.

And I would also say, which I've said many times before, is while US banking gets a lot of attention because of what's going on there, we continue to look at opportunities across all of our businesses. And a lot of businesses are finding opportunities to invest capital at very good rates of return, and whether that's in banking outside of the United States like RBTT, PH&N, some of the smaller investments we've made this past quarter, the acquisition in Houston, the leasing business from ABN AMRO, I mean we-- we've got a pretty, I think, aggressive but disciplined approach in terms of looking at ways where we can invest capital wisely and take advantages of opportunities given the turmoil and it's not all related to US banking. So I would say we will continue to be very cautious well respect to that market but at the same time we're paying a lot of attention to what's going on.

But you also mentioned, I believe in your introductory comments, that you're building on your domestic retail brokerage distribution network. Can you put any numbers on that for us and give us any indications as to what the implications are for your platform here in Canada?

Well I'll let George Lewis answer that and I don't think it's just the retail platform but that's certainly one that we've highlighted. But George, perhaps you'd like to talk about Canada Wealth Management?

Sure, thanks, Gordon. The growth of our full service brokerage business here in Canada has been driven really by the attraction, retention of experienced advisors from our competition. As Gord highlighted they are attracted to the fact that we do have a dedicated focus on Wealth Management here at RBC. They're attracted by what is the broadest and deepest product and service offering. And I think certainly here in Canada but also in the US and internationally they're attracted to the strength of the overall institution in these times as well. So just to pick Canadian Wealth Management, which was the focus of your question, we've moved from 1300 advisors a couple years ago to over 1400 today, while continuing to actually improve the productivity of those advisors as well.

Can you just talk a little bit about the productivity in terms of how you measure it and how it's changed over that same time period?

Sure. I think we've include some overall information for our Wealth Management Business in terms of revenue per FC on our supplementary slides. But that's an average and a blend of our advisors across Canada in the US and internationally. Speaking of Canada in particular, Dominion-- RBC DS here would have roughly 50% larger if I recall, 50% larger revenue per FC or booked per FC compared to our nearest competitor. That's continued to extend over time. Last year we were the first business here in Canada past the $150 billion mark in assets under administration with again a force of 1300 to 1400 IA's here.

Okay. Terrific, thanks so much.

Thank you, Brad.

Thank you. The next question is from Jim Bantis from Credit Suisse. Please go ahead.

Hi, good afternoon. Questions for Chuck and Doug. I remember the last call we were trying to find a road map how to get back to $1 billion in revenue coming from the Capital Markets Business and you've done it pretty quickly this quarter. And I guess if I add back the charge of about $350 million this looks to be one of the highest record quarters in terms of Capital Markets particularly coming under Global Markets. And I'm wondering if you can just give us a little bit of details and flavor for what's coming out of Global Markets? Is it-- it's got to be I imagine bank positioning in terms of certain product areas as opposed to client volumes that are driving this very strong revenue growth in Global Markets. If you could just talk about that, that would be great.

Okay, Chuck. I mean basically Global Markets is, is-- are fixed income and derivatives business as well as got a number of other business in it, but basically it's been very broad based. I mean the fixed income business has been attractive and remember when we're talking about the fixed income business we're talking about the Canadian business which is the core but not necessarily the biggest part of it anymore. But the US-- what we have in the US, which is really the most recent edition and what we have in Europe. And just as an example, both the US and Europe, the US we've totally restructured over the last two years and we basically are starting to see some substantial benefits from that restructuring and we've developed a Capital Markets Business out of what was a regional business and it's really started to hum. Europe had some major change in it over the last 18 months and that's starting to come forward. So it's not just, it's not just a matter of the markets or volumes or pricing, although pricing is clearly better this year, but it's a matter of investment in two parts of the business over the last couple of years that are starting to pay off.

In addition to that as you know the 4 X Markets have done very good and we've done well in them. And in addition to that we've got a strong proprietary business in [GAT] which has done well this year. And I would just add that we manage short-term money in that business. Our short-term flows and that's been a very good business to be in. So I think, Stan you would know but I think I've covered most of--.

Basically, Jim, there's the four points. We did restructure in the US, it's gone well. We continue invest in that platform because it's performing very well. As Chuck said we've seen very significant increases in spread in the marketplace which we've been able to take advantage of, and obviously we've enjoyed significant market volatility. So you put those four things together and it's great for a disciplined, well focused cash business.

And it spreads not only in the Global Market side but in what we call our given side, which Doug can add comment on. I mean last year, we-- two years ago we basically brought Carlin on board and we've dramatically changed our US Equity Business over the last two years, we're seeing pay back on it. As an example, our Investment Banking revenues this quarter, Canada has been a tough place to be. US has been quite strong for us over the year but the third quarter was, as you seen in just the Business has suffered, but we-- over the last couple years we've built a very nice business in energy and mining in London, and we have a, we have quite a sizeable operation up there now and it happened to contribute quite substantially, particularly in the energy side, in the third quarter and so it covered some of the difficulties that were in some of the other markets. And it's just a matter of over a long period of time we've tried to steadily invest in our businesses and we've got pluses and minuses all over the place, but we've just steadily invested and this year we've continued to steadily invest. And you're seeing this within as much investment spending as we've really had in the last couple of years. I would think if you added the things most of which came as a result of market opportunities and we didn't think we would be doing when we started the year.

Got it, okay. Well I guess we're putting this in the framework of US and global brokers just getting estimates slashed across the board. But I mean from the explanation you've just given me it sounds like a lot of these gains, while there is some market volatility involved, a lot of this is sustainable given the investments you've made?

Yeah, I think that we are growing and building our business. I shouldn't, shouldn't under state the fact that volatility is just helped all trading business this year.

Some of the agency businesses have also benefited, Jim. I mean, as Chuck pointed out on the cash equities business our market share has gone up quite dramatically. I mean some of the people that we're competing with aren't financing their clients anymore or can't finance them, and the Carlin acquisition did give us, as it turned out, a very good product to rollout. So where we're just in agency cash businesses, our market share has gone up and hopefully that will sustain itself.

I'd also add that if you were a client looking at the world you would not have hard time concluding that we are a better counter party on a relative basis by a long shot than we were 12 months ago, and we were good then.

Great, okay, thank you. Just a quick follow-up question. Looking at interback-- sorry, International Banking revenue, down quarter-over-quarter despite the RBT acquisition. I think there was some mention with respect to write-downs in the banking business, but find it hard to see that what type of CDO products might be in there. Could you just describe that a little bit, Janice?

Sure, there were some write-downs in their available for sale portfolio. There were some agency preferred shares that we wrote down and in addition to that, some of the Alt A MBS where we wrote it down to market values because we determined that it was other than temporarily impaired, I think that is-- was about $50 million, so that really is why you see that drop in revenue.

Janice, were those assets in the RBTT portfolios?

No, they were in the RBC Bank US portfolio. As you know they run an investment portfolio. The agency prepped for example, were legacy investments that had been there for quite a while, so-- and then MBS, because they do run about a $5 billion portfolio.

I guess I'm just surprised that this charge coming this late in the game regarding those portfolios, I mean particularly if it's in the Centura, Alabama.

Well I think, Jim, that we look at all of our available for sale which is under the oversight of our Corporate Treasury Group and what we're looking at is that determination of other than temporarily impaired. So at this point in time given the aging of some of those securities, and you know that we also in our disclosure show the unrealized gains and losses in those portfolios, that we made the assessment this quarter that those securities would probably not recover and that's why you see that write-down reflected there.

You're also starting to see it now in terms of the, perhaps the agencies Fanny and Freddie prep issue has sort of hit the press recently, and I would say we're actually quite early in terms of making our adjustments with respect to that although it was just recently announced in our quarter, but I think there were a couple of announcements that came out yesterday.

Right.

But from our standpoint it's not a material number. I think we sized it in our--.

Right, and so it's the $50 million write-down for the agency press plus the MBS.

Okay, thank you. I'll requeue.

Thank you. The next question is from Robert Sedran from National Bank Financial. Please go ahead.

Hello. Good afternoon. Janice, I know the Treasury revenue tends to get allocated to the segments. Was it in any way a meaningful contributor positive or negative to year-over-year growth in Canadian Banking this quarter?

I would say that there was nothing unusual about the contributions from Treasury. The core banking results in our Canadian Banking platform were pretty clean. They're pretty clean and so there's no-- nothing from Treasury is causing any unusual revenue bump or revenue decrease.

Okay, great. And Gord, just to follow-up on Brad's earlier question, I know you can never rule it out, but is it fair to rule out a wholesale acquisition in the US? I mean you've added a number of displaced professionals in the last while. It just seems you can get the business without getting the balance sheet problems?

Yeah, I think that's exactly right. I mean I think Chuck and Mark and Doug's response to the previous question I think was just indicative of what we've been trying to do for awhile. We really like that strategy. We think we can deploy our capital and get very attractive returns by choosing areas where we can compete, where we can be competitive and a major wholesale acquisition I don't think-- you never say never, which I would repeat, but it's just not something that strategically we think makes sense for our organization. We really like the mix between our retail wholesale, 75/25. We are not dramatically shrinking capital in wholesale but we're certainly charging the wholesale bank more and more for it, and I think they're managing the business effectively on that basis.

And taking on someone else's headaches, we just think is not as an attractive way to deploy capital as we can do on our own and as you know we have a few headaches of our own as well. So the likelihood is very, very remote. I think you'll see us continue to do more from a mix perspective of what we've been doing over the last couple of years. And as I say we really like this sort of 75/25 if I can lump insurance and Wealth Management in with the 75 split between our businesses, we think it's a really nice model for the future.

Thanks.

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

Question for Morten. Page 30 of the note to shareholders, very good disclosure on the US banking assets and the ones we worry about. The two categories, the home equity and the lot loans. I look at that that's sort of $4.5 million and yet when you look at the, the impaired loan formation and the provisioning on the retail side, they just don't look as high as we see other people having. Can you talk to, is there something in that book that you think sets it apart from a typical HELOC or lot loan business?

Well let me start with the HELOC, so if you look at the, I mean the underwriting standards are actually quite high. I mean, this is like the rest of us that we've never had any subprime origination and these have been appropriately done on a loan-- a conservative loan to value basis. And the reality is that given where the US market has gone, notwithstanding those underwriting standards, we're seeing some deterioration in the home equity loan business and we never highlighted the negative trend there, they still continue to perform reasonably well. And I would suggest compared to a number of our peers the HELOC performers we're seeing is probably better than a number of those. So that's why that might be slightly better than what you'd expect.

In terms of the lot loan portfolio, I mean it's with the addition of the Alabama National Portfolio we're at $1 billion as you can see here. It is one that's, up until the last year, year and a half has actually performed extremely well. It is a small portfolio where we're seeing a consistent number of loans get into trouble. But the degree of provisioning that you can kind of read in, if you'll read all of the various pages of the supplementals to figure out roughly what the size is, is all that we see coming out of it. I mean the-- there is part of the issue here is that even for lot loans, while a lot of these where properties were people who had probably bought them in anticipation of ongoing increase in value, the ultimate recovery from the property itself is enough that you don't have provisioning to a huge proportion of the total loan. You just have to recognize that there's going to be a significant hair cut on this position and provisions are being set accordingly. So--

Is the HELOC book, is it first lien or second lien?

Yes, there are second charges basically exclusively.

And is the lot loans are they secured just by property or is there-- ?

They're secured on the property. But because they are lot loans, they are properties that we may or may not be-- and they're generally serviced, but they are properties that may or may not be easy to sell or you can see this position of in the near term.

Because if I add up these past four quarters it's sort of $60 million of provisions you've taken in the entire retail book and given $4.5 billion portfolio, that's just an excellent performance.

And I mean if you look at the proportions of it, the home equity piece is by far the largest piece and while we're not happy with the performance relative to what we hoped for in normal conditions, is actually-- but it's not, it's just performing sub par. It's not a terrible performance and the provisioning reflects the performance as we see it. And while there have been negative trends, the negative trends are actually relatively modest. They're just at levels we're not entirely happy with.

Thanks.

Thank you. The next question is from Sharon Cowherd from Citi. please go ahead.

Hi. Would you comment on the Canadian Banking growth in non-interest income? It's-- other-- your competitors have reported sort of like declining, in their home equity products, declining market share and Royal growing this business is it better pricing or is it product differentiation or is it a combination of both?

If I understand your question correctly, it's how we are achieving our outstanding 17% growth in home equity?

Yeah, especially the non-interest income piece. Is it fees on the home equity products?

No, non-interest income would not be attributable in Canada to home equity, so our non-interest income is largely driven by our deposit accounts and the revenues that we get and the fees that we get on our accounts. And we've had a big push in the last year to really improve the competitiveness of our core deposit accounts introducing multi-product rebate, introducing a whole new line up of accounts and we're achieving significant success in that field, along with some price increases this year. So those two factors are really driving our non-interest income.

And then yet could you speak to the home equity lending piece being up 17%?

Sure. Coming back to the investor presentation in April we talked about the collaboration that we have across our channels and how we work together on behalf of the client. And that's really paying great dividends across our mortgage specialists working with our branches, really able to go out and source new business across a number of channels is contributing largely to that great success we're having.

And then quickly --

It's Morten Friis, if I could just quickly add. Just so we're sure that we understand the dynamic of the home equity product in Canadian market versus what you see in the US. So unlike what we just talked about in our US banking platform the structure of the product in Canada is that such-- is such that it is a first charge on the property so it's a -- it's done to the same loan to value standard as we've talked about. But it's the first charge on the property and from a risk profile standpoint, a way superior product to what you see in the US market and consistent with the risk profile of our residential mortgage product historically. The average loan to value on our portfolio, again going back I think to what we disclosed in the investor day a few months ago, is around 69% on our overall book counting the impact of the fully drawn home equity piece.

We do not charge the customer a fee to originate a mortgage. We originate in and hold it on our balance sheet and our income stream from mortgage is the interest earned.

Okay. And then real quickly I noticed in the, on the subpac where you list the changes to reporting, you reclassified certain trading revenues from interest income to non-interest income this quarter that you sort of changed in the reverse in the first quarter. Could you just tell me why?

That was a misclassification in both of those quarters. It has to do with some of the trading revenue we have that is spread related if it's on the balance sheet versus off balance sheet hedges that are in other income. So it was basically a correction to more properly reflect the splits. That's why when we look at overall trading revenue, we look at both the net interest income and the non-interest income portion together.

Thank you.

Okay.

Thank you. The next question is from Darko Mihelic from CIBC World Markets. Please go ahead.

Hi, thank you. I have a number of questions for Janice. I'll try and simplify it and make it as quick and dirty as we can. I'm looking at the International Banking segment and noticing that RBTT is now in the results, but--

Can you speak up Darko, please?

Sorry can you hear me now?

That's better.

Looking at International Banking, Janice, can you explain how much of an impact if at all RBTT had on revenue expenses, PCLs? And if I'm looking at it correctly, also I'm wondering why deposits really didn't jump up as much as they should have for the RBTT inclusion? Thank you.

Thanks, Darko. RBTT, the actual P&L, it was two weeks because they're, they're-- we're reporting them on a non-coterminous basis, so we're reporting them on calendar quarters. So what you would basically see in RBTT two weeks of earnings which would be modest revenue and expense. The International Banking, the major acquisition there that we have a full month of run rate is Alabama National. So that would be driving some of the metrics in terms of revenue and expense growth, and that's why you see for example, the expense base increasing on a run rate basis about 25% from where it's seen over not last quarter but the quarter before when we had no acquisitions in. In terms of the overall balance sheet, we have-- we of course we've consolidated what's in there in the balance sheet and what-- I have to take it off line because I'm not quite clear on exactly how much in deposits went in with respect to RBTT versus what was happening with respect to the other acquisitions. And the other thing to note is that in our RBC Dexia segment we do proportion a consolidation there so there might be some impact on deposits there, but we'll get back to you on that.

Okay, thank you.

Thank you.

Oh, yeah, that's true. And so the other thing to note on the acquisitions is with respect to the NIE, there are some one-time charges related to RBTT which would also be in the NIE. So if you look at NIE growth of say from a normalized without acquisitions to this quarter of about 25%, about 20% of that 25% would represent one-time charges.

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

Hi, Janice, part of my question was a follow-up on that last point you made. So we had integration charges in this quarter. How long do you expect integration charges to affect expenses at both Alabama National and RBTT, or was that all capitalized in this quarter?

We-- Andre, we basically capitalized most of the integration charges, but as you know in terms of the purchase price equation, they're open for a year on all of our acquisitions. So there may be some other non-capitalized acquisition expenses we could have in RBTT, because we only have the two week period. We think that we've picked them all up but as we get into the next reporting period we might have some there. With respect to Alabama National, I think that we're through in terms of any one-time charges there.

Okay, and the other quick one, on Insurance, it looks like there were some unusual gains this quarter, I guess (inaudible) business has roughly $100 million quarterly run rate business. Would that still be accurate?

Yeah, Andre, it's Jim Westlake. I wouldn't describe them as unusual. We did have a series of separate positive gains from reserve releases. I would continue to look at it as approximately $100 million or so. We think that we are very conservatively reserved in that over time as we do studies and actuarial trending that we will tend to see more positive than negative, but that's not a bad spot to start from.

Thank you.

Thank you. The next question is from Michael Goldberg from Desjardins Securities. Please go ahead.

Thanks. Had a couple of questions. First of all, if the conditions that caused the $0.20 of markdowns during the quarter hadn't been present, could I conclude that earnings per share would have been $1.12? In other words, do you have trading positions on it materially benefit from the conditions that cause the markdowns on the other side?

I mean, I don't think you can say that. In the end, the markets are still quite volatile and I think our trading operations benefit from volatility and the fact that in this type of an environment you get paid more for putting up your capital. So there has-- there clearly is some double-edged sword here. I would--

But no direct offsets.

No, no there's no direct-- no, there's no major direct offsets in there but in terms of the environment it's there. I would describe sort of the third quarter as certainly being less, that phrase would apply or that description would apply less to the third quarter than the first quarter with the second quarter being somewhere in between.

Great. Okay, and I guess one other question, could you provide some color on the decision to again hold the dividend flat at $0.50?

Yeah. I mean, I would say that certainly it was Managements recommendation and I think that ultimate that the Board decision, I don't think there was any disagreement. I mean I think we've got a stated objective with respect to a pay out ratio. And given the year and where we are to date and where we are with respect to that range, it wasn't I think something that we gave a lot of consideration to at this juncture and it's something that we'll review at year-end. But I think it just relates very much to our stated objective and where we are today.

Okay, and if I could, a couple of number questions. First of all how much gross impaired loans came with RBC-- RBTT? And can you also give me some idea of the amount of level three assets and liabilities that you have at the end of the third quarter?

Why don't I take that last question first, Michael. We don't follow US GAAP level one, two, and three but what I can tell you is overall in our portfolio, about 1% of our securities are valued using models where there are no market observable inputs or no market observable referencable direct securities, so that would be sort of equivalent to level three.

So that's 1% of all securities?

Yes.

Okay, and liabilities? And what about derivatives?

That would include the derivatives, so I'm counting all of our securities positions including derivatives.

So I'd have to add your securities and your derivatives together?

Right.

Okay and what about liabilities?

That includes the liabilities too. So of course, in certain different categories like in derivatives categories, there would be a slightly higher waiting towards models than other securities, so I'm giving you a blended estimate of the total. And Morten, do you want--?

And Michael in terms of the impaired that came with the acquisition, we don't actually provide that level of granularity in our disclosure. I don't have the number at hand, so I'll have to get back to you off line. But I mean suffice it to say that it's quite a small number but I don't have the precise detail with me.

Okay. Just-- I'm just trying to follow the impaired loan continuity and this impact that--

I mean if you go through the supplementals, there is a lot of detail provided so you could probably triangulate on something that comes fairly close, but we'll take a look at it and get back to you.

Thanks, Morten.

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

This question relates to the other-other income statement. Marcia, and I know you sent around some-- you tried to clarify this for us, but the spike up, how do I think of that? I mean is it that because of the swap business that the revenues were very good and does that feed through into the trading revenues that Chuck is talking about and-- that may or may not reoccur? How do I think about extra couple hundred million of earnings? Sorry, of revenues?

Right. The-- Ian, if you look at the trend line on a quarterly basis, that-- those particular, there are two aspects to that. First of all 2/3 of the change relates to mark-to-market gains on cross currency swaps that hedge our funding. And so with respect to-- and then the end part of it of course relates to the widening of our own credit spreads. So because this is not a perfect hedge, it's an economic hedge that doesn't qualify in terms of an accounting hedge, there would be to some degree an offset in spread income for the other side of this because this is on our structural book. So if you look at that part of that is already offset in our income statement another part of it would be winding down depending on where interest rates are as we reach the end of the contract.

With respect to the rest of that volatility, it relates to the gains on our credit default swaps and as you know, those credit default swaps are in place to hedge credit risk. So to the extent there's another side on those, there's a timing issue with respect to how we recognize potential provision for credit losses versus the mark-to-market gains on these credit default swaps. So that's accounting volatility.

So effectively as the spread blows out on something that you've hedged you book a gain on it?

Right.

The-- it's likely though that there hasn't actually been a provision set up because it's probably not impaired?

Right.

So the question is to the extent the name did default, how would that-- you pick up a PCL in the future and how would that reverse?

Well we-- what we would have is some matching. So as we would have-- if the credit spread was widening at a faster rate than as when the loan deteriorated, we would have picked up the gain in a period prior to when we're recognizing the provision. So that's, that's the offset.

What percentage of that number is the credit default versus the other?

About a third of the growth change is credit default swapped and the 2/3 has to do with our own hedging on our debt, yes.

I'll follow-up off line. Busy day today so let me follow-up off line tomorrow. Thanks a lot guys.

Thank you. The next question is from Michael Goldberg from Desjardins Securities. Please go ahead.

I-- that's a question that I often wonder about also and just on the ACS 3855, and I just wonder why don't you just disclose that number since it is noise, it has no economic impact on what's going on and it's just distorting the results. And if it's 2/3 of the $200 million roughly, it's not an immaterial amount just in looking at changes, so can I suggest you just split it out like TD does?

We'll look at that, Michael. I think that what-- it's always been our practice to speak to the reasons of that volatility and so we'll look at that. And we'll get back to you.

Thank you.

Thank you. This concludes the question-and-answer session. I'd like to turn the meeting back over to Mr. Nixon.

Okay, I'd just like to thank everyone for participation and we look forward to your questions next quarter.

Thank you. The conference has now ended. Please disconnect your lines at this time and thank you for your participation.