Royal Bank of Canada (RY) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the RBC and full-year 2008 fourth quarter results conference call. Please be advised 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.

Good afternoon, everyone. Thanks for joining us. Presenting to you today are Gord Nixon, our CEO, Morton Friis, our Chief Risk Officer, Janice Fukakusa, our Chief Financial Officer. Following their comments, we will open up the call for questions from analysts. The call will be one hour long and we will post management's formal remarks on our web site shortly after the call. Joining us for your questions are Bart 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, Doug McGregor, Chairman and Co-CEO, Capital Markets, and Mark Standish, President and Co-CEO, Capital Markets.

As noted on slide two, our comments may contain forward-looking statements which involve 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.

Thank you, Marcia and good afternoon, everyone. Thank you for joining us. I know it has been a long week for those analysts involved in the financial services industry. Without question, the tremendous volatility in the financial markets and weakening global economy have combined to make this a very challenging year for banks around the world. Fiscal 2008 and particularly the last quarter, were marked by unprecedented events, including the collapse of major financial institutions, a rise in funding costs, dramatic declines in equity markets and government bailouts of historic proportions. While we have had losses related to the market environment, RBC is one of the world's most profitable financial institutions, having generated approximately $4.6 billion of earnings in 2008 with a return in equity of 18%. Equally important is that we have generated these results and maintained a consistently strong capital position throughout the year. In aggregate, our earnings were down from last year mainly due to higher write downs and higher provisions for credit losses, primarily in the US banking business.

Slide 5 and other items that impacted our full-year and Q4 results, including gains related to fair value adjustments on RBC debt and the reduction of our Enron related provision. Our reported diluted earnings per share is $0.81 for the fourth quarter and $3.38 for the full-year. I would like to highlight that this is after items that had an $0.18 impact on the quarter and $0.77 impact on the year. Never has it been more important for us to focus on the fundamentals of our business. And I am firmly convinced that our relative strength in earnings performance is a direct result of a following a disciplined strategy adhering to sound risk management practices, maintaining a strong balance sheet, and insuring our business mix is well diversified. By following this course, we have withstood the market shocks over the past year better than most other financial institutions around the world, and we have grown our businesses. Our diversified business portfolio is a key foundation of both our stability and our success, and let me explain by giving you some highlights of our business segment performance.

Canadian banking continued to underpin our results with strong earnings over last year, reflecting solid volume growth across all businesses, and effective cost management, offset to some extent by margin compression and increased provisions. In wealth management, transactional volumes were lower than last year because of these market conditions, however, fee-based revenues were higher from growth in fee-based assets reflecting our PH&N acquisition and strong net mutual fund sales for most of the year. Insurance results were also reduced by investment losses and decline in equity because of the decline in equity market values. But we continue to grow our insurance business with premiums and deposits up 12% from a year ago.

In international banking, our US banking business continued to be impacted by the challenging environment, resulting in higher provisions for credit losses, and write downs on our investment portfolio. However, this was partially offset by earnings from our RBTT and ANB acquisitions and business growth in RBC Dexia. While some of our businesses in capital markets have been impacted by the write downs, it is significant that we earn through these losses every quarter by generating strong results in other capital markets businesses. In 2008, this segment generated return on equity of in excess of 20%, which is testament to the strength of our diversified businesses as well as our risk management practices. All in all I am pleased with our performance this year. Most of our businesses, with the exception of US banking, which was, which was certainly impacted by our builder's finance businesses, continued to perform well both on an absolute basis particularly relative to primary competitors.

Turning to slide six our capital position remained strong throughout 2008 and we ended the year with a tier 1 capital ratio of 9%. As you know, the Canadian and US dollar exchange rate changed significantly over the fourth quarter, which did have an impact on our ratios and businesses. One of the impacts is that it increased our risk adjusted assets and was the largest factor in decreasing our capital ratios from the third and fourth quarter of last year, which Janice will discuss in her remarks. With respect to our dividend, we are maintaining our quarterly dividend of $0.50 in the first quarter of 2009, which we believe is prudent in this environment. Over time, our objective is to grow our dividend.

Slide seven shows our total shareholder returns, demonstrating our long-term track record of outperformance as compared to our peers. Relative to our peers, over the three year period, we ranked second with an 8% annual return, and we ranked first in both five and ten-year periods, generating total shareholder returns of 12% and 14% per annum, respectively.

Our diversified business portfolio, strong risk management, and solid capital position have enabled us to remain focused on our three long term strategic goals, which are outlined on slide eight. They are in Canada, to be the undisputed leader in financial services. In the United States to be a leading provider of banking, wealth management, and capital market services, building on and leveraging RBC's considerable capabilities, and internationally, to be a premier provider of select banking, wealth management and capital services in markets of choice. In Canada, our retail business made significant strides during the year to enhance our market leadership positions, by making it easier for clients to do business with us. We have successfully increased market share across all Canadian banking businesses this year, and we intend to continue to grow our market shares. Our loan book increased by 13% as a result of strong growth in residential mortgage products, and the launch of new credit card offering. Also, we grew our deposit base by 5%, through the introduction of new personal and business products. We are open for business, our volumes are growing, and we continue to focus on growing our businesses and market share in our Canadian banking business.

In wealth management, acquiring PH&N on May 1st together with our existing operations made RBC the largest discretionary manager in Canada and the largest fund company in Canada with a 16% market share. We continue to be a leader in the industry, this year with $8.8 billion in total mutual fund net sales. As Canada's largest investment bank and a leader in virtually every domestic ranking, we are distancing ourselves from our peers with our broad global capabilities and strong balance sheet.

Turning to the US, the significant challenges in the US banking environment impacted our banking operations. We are working hard to strengthen our business by managing our US loan portfolio, improving efficiencies, and reducing expenses to insure that we are well positioned when the environment improves. We are not happy with the current performance of our US banking business, and we will be extremely focused in 2009 in dealing with this underperformance. In US wealth management, we continue to build scale and extend our reach. In 2008, we acquired Ferris Baker Watts, which expanded our presence in key US regions.

In addition, we attracted a number of experienced financial consultants from the competition over the past year, demonstrating both the quality of our business and RBC's growing reputation in the United States. With over 2,000 financial consultants, we are the seventh largest national investment advisory firm in the United States. While market and economic events have negatively impacted some of our US capital markets businesses, we continue to capitalize on opportunities created by this market disruption. In addition, we are adding talent and resource that is are drawn to the strength and stability of the RBC name.

Turning to our third strategic goal, closing our acquisition of RBTT in the third quarter was the most significant development that we had outside of North America during the year. Combined with our existing Caribbean banking businesses, the acquisition made RBC the second largest banking group in the English Caribbean as measured by asset. International wealth management continued to expand its footprint, by opening new offices in Santiago, Chile and in Mumbai in connection with our capital markets business and by recruiting experienced private banking professionals. Also for the third consecutive year we were recognized by Euro Money as the number one provider of trust services in the United Kingdom.

Finally our capital markets operations continued to build international capabilities in areas where we have strength. For example we added a leverage finance team in London to support our investment banking business and we expanded the UK based infrastructure financing business into continental Europe and Australia and the United States.

Turning to slide nine, we look ahead with caution recognizing that the financial markets and global economies continue to face head winds. We believe a weak economic outlook, continued market volatility and general uncertainty on the timing of recovery will create a challenging environment in the short term but I would re-emphasize that we continue to see significant opportunities over the medium term. Because of high degree of uncertainty in the short term, we have established medium term performance objectives in place of our annual objectives. These objectives are aligned with our three strategic goals and we believe better reflect the new realities of the business and economic environment. Our medium term objective is to generate earnings per share growth of 7% or greater. Our focus on cost management relative to revenue growth is underlined by an operating leverage objective of over 3%. Our return on equity objective is 18% or higher, reflecting our commitment to delivering strong returns to shareholders, within the context of structural changes in the industry.

We will keep a keen eye on our capital base, maintaining a tier 1 capital ratio of at least 8.5% or higher. Finally, our continuing objective is to maintain dividend pay out ratio over the medium term of between 40 and 50%. We will continue to assess our progress on a quarterly and annual basis against these medium term objectives, and benchmark our total shareholders returns with our North American peers.

Looking forward, while cautious about the environment, we are confident in our business and committed to delivering long term growth to our shareholders. We will remain vigilant in managing our cost structure, efficiently using our balance sheet and managing risks. As I have said a number of times this year, we are open for business and proactively providing our clients with relevant and timely advice and the support they need during these difficult times. I will add that the dislocation in the markets continues to create opportunities for RBC to pull away from the competition or strengthen our leadership position. Across our businesses, we continue to find ways to deploy capital effectively in new products and new markets and our existing businesses.

In closing, I would like to thank our employee for their hard work, integrity and dedication. Through these remarkable times, what has struck me the most is the outstanding commitment of our employees to helping our clients around the world. With that, I will now turn it over to Morten.

Thanks, Gord. I will start with a review of the write downs and then provide an update on the credit portfolio.

As shown on slide 11, in the fourth quarter, we had writedowns in capital markets, corporate support, and international banking. These are covered in detail in our disclosure and totaled approximately $1 billion before tax, or $532 million after tax and related compensation adjustments. Approximately half of the write downs related to structured credit transactions in our capital markets segment which I have spoken about in previous quarters. This includes $248 million of write down related to the structured credit transaction that we hedged with MBIA. This amount represents declines from the fair value of credit default swaps with MBIA, expected recovery rates of the underlying assets and other parameter inputs. A further $204 million related to the value declines in subprimes CDOs and ABS and other subprime RMBS. The remaining write downs for capital markets total $153 million and related largely to our US insurance and pension solutions and US commercial mortgage backed securities businesses. Also, as Janice will discuss in her comments, we reclassified $6.9 billion of US auction rate securities and US mortgage backed securities from held for trading to available for sale. In corporate support and international banking, we had write downs of $154 million and $244 million respectively.

Turning to slide 12, you will see this quarter, trading had unusually high volatility, reflective of the markets. This volatility led to a number of days of both trading losses and gains. Seven of the largest days of net trading losses exceeded global VAR for their respective days, two of which were due to month end valuation adjustments. The remaining ten large net trading loss days this quarter did not exceed global VAR. We also had five days of significant trading gains across different businesses. Our global, global VAR is based on two years of historical data. Assuming market volatility continues, we can expect to see our global VAR trend higher as more months are incorporated into the historical data sets.

Turning to credit on slides 13 to 16, we had $619 million in provisions for credit losses in the fourth quarter, up from $334 million in the third quarter. This includes a $145 million general provision this quarter reflecting portfolio growth in Canada, and a weaker credit quality metrics over prior periods. The balance relates to specific provisions for credit losses which I will discuss in more detail by geography. I'll start with Canada. Over 77% of our loans are in Canada and credit quality remains strong in the fourth quarter and most portfolios including residential mortgages. Canadian specific provisions as compared to the third quarter was primarily due to the few corporate accounts in our wholesale portfolio as well as volume growth and slightly higher loss rates in our retail portfolio.

Approximately 8% of our loan book is international, and consists largely of our Caribbean banking operations. In general, credit quality in the Caribbean remains stable with some signs of softening. The increase in provisions for credit losses over the third quarter largely reflects the inclusion of a full quarter results from RBCT. Finally, approximately 15% of our loan book is based in the US, whereas you know credit quality has continued to deteriorate. Gross impaired loans and provisions for credit losses in the US increased from the third quarter. I should note that part of the increase is due to the large change in the Canadian US dollar exchange rate from the third quarter, however we did also see credit quality deterioration. In the US banking business, the credit issues are primarily in the residential builder finance portfolio; however, our commercial and business banking portfolios have also experienced increased impaired loans and contributing to increased PCL in the wholesale portfolio.

In the retail portfolio, home equity lending and lot loans continue to weaken compared to the third quarter, also contributing to higher PCL. In the US retail portfolio, we have very little unsecured lending or credit cards and we have no subprime lending origination programs. Lastly, in capital markets, we had an additional $25 million provision in our US wholesale portfolio, related to impaired loans extended under liquidity drawn on by RBC administered multiseller asset backed commercial paper conduits. These are the same loans that we took a $35 million provision against in the second quarter of this year, and relate to a single security. Impaired loans extended under these facilities the amounted to $203 million at the end of the fourth quarter. Looking forward, assuming slower economic growth and higher unemployment in Canada, we would expect credit quality to weaken moderately in fiscal 2009. Based on this, we would anticipate modestly higher average provisions across consumer business and corporate credit portfolios. In the US, we expect that our US banking operations will continue to be impacted by a weak US economy, and the decline in the US housing market. We anticipate on going deterioration in our residential builder portfolio, as well as in our commercial retail and business banking portfolios.

At this point, I will turn the call over to Janice Fukakusa to discuss our fourth quarter result.

Thanks, Morten. Slide 18 provides an overview of our quarterly performance. Net income was down 15% from Q4, 2007, largely due to higher write downs, weaker results in our equity trading businesses, and higher provision for credit losses including the increase to our general provision that Morten discussed. These factors were partly offset by revenue growth in certain fixed income and foreign exchange businesses and reduction of the Enron related litigation provision, and gains related to fair value adjustments on RBC debt designated as held for trading. Noninterest expense declined 3% from a year ago largely because of the reduction of the Enron related litigation provision.

As Gord mentioned earlier, the significant change in the Canadian US rate had impacts across our businesses. Overall, it negatively impacted our fourth quarter earnings. As a reminder, most of the areas where we took write downs and a large portion of our provisions are from US based businesses. In terms of our balance sheet, the weaker Canadian dollar accounted for approximately one-third of total asset growth from the end of the third quarter to the end of the fourth quarter. And the impact of the change in the Canadian US dollar exchange rate was even larger for those balance sheet items that have a higher proportion of US dollar denominated assets.

Turning to slide 19, our capital position remains strong with a tier 1 capital ratio of 9%. The tier 1 capital ratio declined 50 basis points from the third quarter, primarily due to the impact of a sharply weaker Canadian dollar at quarter end on the translation of our foreign currency denominated assets. This change in foreign exchange rates accounts for approximately two-thirds of the increase in risk adjusted assets from the third to the fourth quarter. As Morton mentioned earlier, effective August first, we reclassified $6.9 billion from our held for trading to available for sale portfolios. This resulted in $478 million or $270 million after tax being recorded as a decline in other comprehensive instead of net income. We believe these securities are good quality, but given the significant lack of liquidity, their current market prices are well below our view of their long term recoverable value. We intend to hold these securities until their values recover.

Speaking generally about our available for sale portfolio, we conduct other than temporary impairment testing on our ASF portfolio to determine whether impairments to value are expected to recover. Our ASF securities remain quality assets and unrealized losses are viewed as temporary in nature. We intend to hold these assets and fully expect these assets to recover in value. I will now review the quarterly performance of our five business segments and corporate support.

Turning to slide 20, Canadian banking net income was down 15% through Q4 of '07 and 5% over the third quarter. Excluding the Visa gain and the adjustment to our credit card loyalty reward liability in Q4 '07, net income grew 11% from Q4 '07 on strong volume growth and effective cost management. Earnings decreased from last quarter, largely due to spread compression on lower mutual fund distribution fees offset by solid volume growth. On slide 21, you will see our retail net interest margin decrease over the year and the quarter. The decline over the previous year largely reflects the impact of sharply lower interest rates, as well as our client's continued preference for lower spread products, such as home equity lending and high interest savings accounts. The change from the previous quarter reflects narrower spreads between prime and spending costs in the fourth quarter. Competitive pressures also continue to impact our margins.

Looking at wealth management on slide 23, net income was down $64 million or 36% from Q4 '07. Results this quarter were reduced from the combined impact of the provision related to the reserve primary fund and a charge related to auction rate securities settlement which are fully described in our 2008 annual report. We also had lower transactional revenue in our brokerage businesses, due to uncertainty in the global financial markets. These factors were partially offset by the earnings from PH&N's private counsel and asset management businesses, which we acquired on May 1st. Non-interest expense grew 18% from Q4 '07, primarily reflecting increased cost in business growth including acquisition-related costs, depreciation of the Canadian dollar relative to the US dollar and the provision for the reserve primary fund and ARF settlement I mentioned before.

Moving on to insurance on slide 25, earnings over Q4 of '07 and Q3 of '08 were reduced mainly due to the $110 million or $80 million after tax impact of losses related to the sale and impairment of securities as well as impacts from equity market movements. These factors were partially offset by strong growth in our reinsurance business and higher favorable net actuarial adjustments.

Let me go into some more detail on the losses. We had losses from the sale of bonds and impairments on preferred shares, and bonds of certain financial institutions. Similar to other life insurance companies, our earnings were also impacted by declines in equity values held to support our actuarial liabilities and universal life policy funds. These largely represent noncash charges on long-dated policy holder obligations. The decline in equity values was caused by significant market volatility and should markets improve, we would report gains in respect to these obligations. Unlike some life insurance companies, we have minimal exposure to products with embedded investment related guarantees such as segregated funds and certain types of annuities.

Turning to international banking on slide 27, earnings were down over Q4 of '07, the decline predominantly on our US banking business was mainly attributable to writedowns and losses on our investment portfolios of $244 million or $168 million after tax and higher provisions for credit losses, which Morten highlighted earlier. These factors were partially offset by earnings from our RBTT and ANB acquisitions. Noninterest expense increased over the fourth quarter of '07, mainly due to costs in support of business growth, including acquisition-related integration costs.

Turning to capital markets on slide 29, earnings were up over the fourth quarter of last year, reflecting stronger performance in certain fixed income and foreign exchange businesses, the reduction of the Enron-related litigation provision, and higher gains on credit derivative contracts used to hedge our corporate loan book. Offsetting these factors were weaker results in origination and equity trading, a higher effective tax rate, and significantly higher write downs. Noninterest expense was down significantly, mainly due to the reduction of the Enron-related litigation provision. On slide 31, you will see a break down of RBC's total trading revenue. Certain fixed income in foreign exchange businesses benefited in the quarter from the market volatility and interest rate environment, while equity training revenue declined.

At this point, I'll turn the call over to the operator to begin questions and answers.

Thank you. (OPERATOR INSTRUCTIONS). There will be a brief pause while the participants poll for questions. The first question is from Robert Sidran from National Bank Financial.

Good afternoon. I guess the first question today is for Morten. The coverage ratios dropped again this quarter, despite the addition to the general. Can you talk a little bit about where you think we are in the credit cycle, how comfortable you are with the reserves and what might cause you to strengthen them further?

Sure. So the coverage ratio, you're right, did fall. We're at 79%, in terms of total ACL to impaireds, and 26%, which is more stable, on specific ACL to reserves. It is the normal pattern as you go in through the cycle, that as impaireds grow, the provisions do not follow in tandem. That is because the root out of impaired is a combination of recovery back into producing status and provisions and write offs. So if you look at the historical pattern of coverage ratios, we are at a point in the cycle that is consistent with being early to mid cycle and from a, the combination of additional provisions and recoveries would expect coverage ratios to flatten out and move back up as the cycle turns up.

The other point I would make is the, the coverage ratio is, is an interesting number to look at, but it is a function of portfolio mix underlying views on recovery rates and the overall quality of the portfolio. So, I mean it is a bottom up process where we look at provisions on account by account basis, and we look at total coverage ratios, as a bit of a sanity check at the end of the process. So, where this takes us from here, as I said is likely to have a flattening out and improvement on coverage rates over time depending on how the cycle involves the mix of reduction to, increases in provisions and movements back into productive status will really drive exactly how that works.

so if it weakened a little or I guess went down a little further from here it wouldn't necessarily concern you all that much.

If you look this in an historical context, we're at a similar level to what we were at, in the early part of this decade, where there were some credit quality issues, but we were actually performing fairly well both in an absolute and a relative sense. And so to the extent that the, the downturn continues, there may be some ongoing deterioration of the coverage ratio. I mean I do think you have to look at the components and the part that is driving this is the, the size of the build to finance portfolio where the recovery rate over time on that will be relatively good. We are not a distressed seller of those assets, and while there have been significant reductions in the underlying asset values, recovery rates will over time will in be in fairly reasonable ranges and that, that kind of assessment does help drive the coverage ratio down when you have a large chunk of new impaireds with a projected good recovery rate.

Okay. Thanks. Gord I guess sticking with the balance sheet, I'm just curious to get your thoughts on capital. It seems like the definition of well capitalized has been taken away from the regulator and given to the market. With the asset growth, with the fact that every new preferred share issue seems to be pushing the price higher, would you be prepared today have the tier 1 ratio slide in the 8s, high 8s, if assets continue to come on?

Firstly if you look at our plan as we go forward we wouldn't expect that to happen. Our capital ratios, you know, as you know, they're strong to begin with, although you're absolutely right. The world has changed. I would make a couple of points on that, one of which of course is that we did add $525 million of capital right after our year-end. So that our capital ratio actually was, was higher on November 2nd than it was on, on November, or on October 31st. In addition to that, through a combination of managing our balance sheet which we have been doing quite aggressively again, I know it was lost in the foreign exchange side, but if you look at the capital markets balance sheet, they manage their growth adjusted assets quite if you look from peak to trough and that process is still continuing, and the good news is that the return on GAA is going up, at a very, very attractive rate which is one of the reasons you are seeing good performance in our capital markets business not notwithstanding that we are managing the balance sheet on the capital markets side quite aggressively.

So, you know, we do think we are well capitalized. Our earnings continue to be, to be strong. We are managing the balance sheet, and I would say that there is no question going forward, we will continue to work to maintain a strong capital position. It is a priority for us. We think it provides not only strength in terms of stability and credit rating et cetera, but we also think it is extremely important being able to take advantage of some of the opportunities that we do think are in front of us both in the short term and medium term because in this environment, there is an opportunity to, to deploy capital aggressively.

So, we will manage it very carefully and we will continue to make sure that we maintain a strong capital position and I think if you look at the trends going forward, there has been quite a change and but I would also, I would also just emphasize that when you look at the marketplace, there's a difference, I mean stated capital and capital going up temporarily to plug a hole is different than capital actually being, going up to grow a business, and I would like to think that we are in the business of growing our business not plugging holes.

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

Hi. Good afternoon. I have a couple of questions with respect to the US operations. I was surprised actually to see that there was not a goodwill or an intangible charge this quarter given that it is the year end, and I put in the context of a significant operating loss coming from the US this quarter basically not having very little earnings in 2008. And as by management's comments with respect to escalating provisions in the US for 2009, it is hard to imagine anything but minimal earnings, if not losses again in 2009. So, just wanted to get a sense on why there wasn't a charge there and kind of a realization that perhaps this asset is somewhat impaired.

Hi, Jim. It is Janice speaking and I will answer the question on goodwill. You are absolutely right. We test our goodwill impairment on an annual basis, and we go through an extremely complicated valuation methodology. One thing to point out to you is that with respect to the testing, the testing is done in reporting units that are a level below the segments, but for international banking for example, the reporting units include both our US bank and our Caribbean bank.

So, the testing of goodwill is against those two banks, that's number one, and the second thing is, that when we resegmented the bank of 2004 when we did that major reorganization, with respect to goodwill that arose on the acquisition of RBC Centura, two-thirds of that was left with the originating business platform that actually made the acquisition which was the Canadian bank. So we did do very robust goodwill testing and we came up with our valuations that supported our carrying value of those assets, but can definitely as we go through the next quarter or two, we will continue to monitor that, but I think the nuance is that it is not just about the US bank but our international banking operations. And their performance overall.

Thank you, Janice. I understand that. Perhaps when we think about the US operations, Gord, you just said a few minutes ago part of your strength with respect to capital is to opportunistically deploy it aggressively, and the US banking system seems to be in some sort of impairment and perhaps for a considerable time have had and we were actually seeing significant players come in and aggressively move deposits and I am just wondering at what point would the bank consider or yourself consider that perhaps the US retail banking environment is not for us and actually consider being a seller in this market?

Well, it's certainly not our intention to be a seller in this market for a variety of reasons, the least of which we do think there will ultimately be a recovery in the US banking business. And given our, our strength, we would like to take advantage of that as opposed to miss that opportunity. And particularly, at this point in the, in the cycle. There is no question, and I have been very clear to the marketplace, that we do not believe this is an environment, nor do we have the competitive advantage given what is happening in the US banking system in terms of capital being provided by the Government, in terms of the change of capital rules, goodwill, goodwill and accounting rules that you have seen in that marketplace, it is a market that we are going to continue to be extremely cautious in terms of deploying a capital aggressively in. But at the same time, it is not a market that we believe we should be, we should be exiting. It will turn.

There's a lot of good things going on in our US banking platform, and what we are very focused on in 2009 is one, insuring that we do everything we can to get the bank performing at a much better level and secondly, to make sure that we do explore our options in terms of, in making sure that well, we are well positioned as the, as the market place turns around. You know I would just emphasize and it is not an excuse by any means. We have been very candid. We are disappointed with our performance of our US banking business. Fortunately on a relative size basis, it is not a large business. But the vast majority of that is the result of their builders finance business. If you look at the core operations of RBC Centura, there are good things going on, in RBC. The old RBC Centura.

There's good things going on in RBC bank. Unfortunately, it gets overwhelmed by what is happening on the PCL side, primarily as a result of the builders finance business and if you remember, as I am sure you do, Jim. The builders finance business, originally was a business that was actually acquired before RBC Centura, it wasn't part of it but it is obviously part of the US banking reporting structure but if you back out builders, their core operations, there's some good strides being made, tThey've had good deposit growth in the last couple of quarters and there's some, a lot of initiatives underway. Jim Westlake might want to add to that because I would say for 2009, it is priority number one for Jim.

Sure. When we get into the actual bank, Jim we are doing what you would expect. We are very aggressively managing expenses, we're focused on getting the kind of operating leverage we have been accustomed to here in Canada. we are focused on taking advantage of the marketplace in the south, where some big players such as Wachovia have gone through changes and we think it represents some good plan opportunities. So, trying to build the business while we deal with the current economics of the situation we find ourselves in.

Got it. I appreciate that and it sounds like you have a cautionary tone toward capital deployment in that area for the year.

I would say that's fair.

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

Hi. My two sets of questions. The first one relates to the PH 36 of the annual report, which I think gives us concept of level one, level two and level three. As I look at it, a significant increase of the, is a significant increase in the assets that are being valued for internal models. And Janice, can you talk as to what assets are in there, it looks as if the majority of them are in the trading book outside of derivatives.

Right. The majority of the increase are in securities like auction-rate securities, and municipals where we, the market was totally illiquid and some of the bank paper. So the that you is why you see the increase in the other than derivatives in the top category and also classified in our available for sale because as you know, we reclassified the auction rate securities portfolio largely to available for sale this quarter. So it is basically, it is kind of comparable to level three but not exactly because as you know, level three is the US GAAP concept. But what that does is tell you that we used a lot models valuations in these sure to turn money market products.

So, of the, as I look back through it, it is about $23 billion, how much of it is o auction rate securities valued that and how much are other things?

Well, the auction rate securities that we reclassed were about 6, just over $6 billion, I think. Just over 3, the total was 3, just over $3 billion, and working back from that, the rest would be, there's a small portfolio that's left in house for trading and the rest would be other bank paper.

So this would be, you say other bank, what other bank would there not be, would you have to use models on?

Bank paper that was relatively illiquid where the spreads widened out so much that we couldn't get close on.

Okay. And the, second question related to the conduits, page 78 of the annual report. As you can tell I have been busy since this morning. And Morten, this relates , to loans. You have got loans of $1.9 billion which was a conduit drawing on liquidity backstop. Is this assets that you have taken back? And that's where the loan comes in or is the $1.9 billion

No, Ian. The top of page 78 that helps you navigate through. If you see the, the line that we are looking at here is the $2.36 billion of asset-backed securities.

Right.

That is the commitment about 75% of that is outstanding. So, what has been funded is the asset-backed securities or some of the asset backed securities as a subset of that. The $1.9 billion, and the loan with the provision that we refer to as a further subset of the only asset back related security we had have had any evidence of real quality deterioration.

What happened is you took the asset backed securities from the conduit and through a loan.

I think -- and others may want to help me out but I believe we are actually just funding it by way of a loan to the conduit. We have not taken the asset back as such. It might be a nuance, but it is rather than being funded in the CP market, given that the, the commercial paper holders have a clear preference for simple assets, however well, however high the quality might be, funding more exotic assets through the CP market, we just decided was, was less efficient and it was more cost effective to bring the funding back through a loan from the bank. But the assets remain in the conduit.

It also looked as if you sold some auction rate securities to a conduit as well? Is that right? The 465 of auction rate that was sold to the conduit during the year?

Ian, it's Janice, and yes, during the year we restructured some of the auction rate securities and put them into conduits so that we could get more liquidity on that particular product. We had talked about that in Q2 and Q3. As the auction rate security market was seizing up, we were restructuring them. We have done that.

You put them into the conduit.

We put them into a separate conduit. They're not in our.

Separate, okay.

They're not in our other conduits. It is not mixed in. Not into the monthly sellers, it is a conduit for those securities.

Thank you. I will requeue.

Okay.

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

This is either for Janice or Morton, it relates to page 19 of the set back. Morten, in your prepared remarks you alluded to why the VAR will increase, by how much should it increase and ball park is fine? By how much would affect that $17 billion of market risk weighted assets?

Well, this is first of all how much it will continue to increase is a function of how much the on going volatility continues. If you look at the value at risk methodology, we have a 500 day data center, two years of trading P&L, that determines this and we update this roughly on a monthly basis, every time you, at the moment every time you drop off a month, it's a month of quite benign, stable data and then as you add, as you add a new volatile month, that changes the mix. So the longer the degree of high volatility continues, the more you will see value at risk increasing assuming that we keep a similar mix of business in the trading business. So how much it will go up will be a function of the, number one what kind of mix of business that we are doing, and then number two, of what the future looks like.

So, but I mean you can see I think you can see with us and a number of other institutions that the VAR has been trending upwards, and there will be, single digit millions of VAR added assuming we keep the same kind of portfolio on, on each additional month of new volatile data. But it is hard to be more precise than that and obviously we are adjusting our trading businesses to take a view on where are the opportunities for return relative to what appears to be increased risks, I think the good part of this story at the moment is that there are a large number of areas where, while the risk is moving up, the, the returns in those businesses, in a majority of those businesses is actually very, good to so the return on risk that we're seeing is actually excellent. It is just calibrating the amount of risks we taking against the return. So it is more a stand on Doug's question probably in terms of how we have value those pieces.

But it is clear that in the near term you will likely to see a, a gradual increase in VAR. I would add that by our risk appetite measures, , from the overall risk we are taking in the trading businesses, whether you measure it in a value at risk or sort of expected loss-like fashion or if you look more at sale events, we are at levels that we continue to be quite

I guess perhaps a more fair question would have been, let's say VAR increases 25%, by how much would your market risk risk-weighted assets increase?

I don't carry that calculator in my head. So, we will get back to you with that but I mean that's fairly easy to arrive at. Why don't we get back to you after with those answers.

Thank you. Appreciate it.

Thank you. The next question is from Mario Mendonca from Genuity Capital Markets. Please go ahead.

Good afternoon, along the same lines as Ian's questions regarding the US multisellers you make reference to weighted average first loss protection of 35.7%. If you can talk about what form that takes, is that a first loss protection note or some other form and that is an awfully high number, but only if the weighted average is arrived at from a rather diverse pool where there aren't any major extremes. Can you provide some commentary on the US multisellers, that pool in the context of the effectiveness of the first loss protection.

Hi. This is Mark Standish. As you point out we have an average weighted average first loss buffer of 35.7%. That essentially is additional credit enhancement. So over and above that, we have a small additional first loss provider, but that nearly 36% credit enhancement is made up of a mixture of additional collateral, some in the form of cash, some in the form of additional receivables, we run an extremely diversified, a full 95% of our conduits are made up of cards, order receivable, trade receivables, student loans, equipment leases et cetera. And probably just add to that, that 90% of these assets are run on a cost of funds plus basis. So, that relates to how we fund them.

So when you say that there's, the credit has a weighted average 35.7 there must be a number of tranches within there and can you give us a sense, any, I guess what I am really getting at is cards are a big part of that. $12.3 billion, and I think everybody can appreciate that cards are softening in the US pretty abruptly. I want to be comfortable that there isn't a tranche out there that's all cards with a low first loss protection on them.

Mario, it's Morten. Really, averages do not tell a complete story obviously but the point is that the degree of subordination or overcollateralization in the various transactions is driven in large part by what tranche we are looking at. The vast majority of the business is very high in the capital structure and still carries a large amount of subordination to the extent we have piece that is are not at the top, the degree of overcollateralization increases. And using your example of credit card receivables, you're right that the, the performance is -- we have seen some softening in the US market and given the current environment we are likely to see some more but we are, as we have indicated here, able to take a multiple deterioration of what we are currently seeing, seeing given the amount of overcollateralization of credit support we have in these structures. And for the various issuers, whether it's credit cards or other asset classes, we have tracked performance going back years and in some cases, decades, we have clear evidence of underwriting practices, collection practices, and the ability to track this very accurately. So the history we have to base it on goes back through several cycles, the structuring reflects that. So this is a good business for us, it has got very nice returns but the risk protection actually is very good.

That was very helpful maybe then in the context of that $1.9 billion loan, that you made to the conduit and I understand it is more semantics as to whether you pulled the assets out or made the loan, why would there be a $65 million provision on that particular loan, just given the level of credit enhancement on the pool?

Okay. So if the provision we have is against a single security, which has some mortgage product in it, so if going back to the $1.9 billion, that is a mix of asset-backed securities that have been funded through loans from the bank, the one loan in there that has, we have seen a quality deterioration of in any measurable sense is the one loan we have the provision against. It is a mortgage-related product, where there is, where there is real deterioration, the rest of the asset backed are a less, are more complicated story to tell than the credit cards or trade receivables or other receivables. But they remain at a level from a quality standpoint where we have no concern in the near term over impairment or provisions on any of those assets.

Why wouldn't those asset-backed securities also have a level of credit enhancement that would limit Royal's exposure.

They do have a level of credit enhancement. I would say the difference between the more structured assets and credit cards or auto receivables is that they are structures that are slightly more complex. The degree of subordination actually is very large, but as we have seen over the last year and a half the subordination in some of the more complex structures gets, gets eaten up more quickly than in a plain vanilla credit card or other type of transaction. So, if we were to quote numbers they would actually sound similar or more comfortable than the credit card receivable transaction but I think the reality is that those structures have more complex story and we feel comfortable with the quality. But y the reason we fund them by a loan is exactly the reason why we are having this conversation here, where it is a little bit complex and confusing, but the quality actually is strong on those assets as well.

So I think just a, we will get off this, it sounds like the ABS were leverage structures, that is what sort of drove the loss even though you had protection, and would I be right in saying that outside of that ABS, that you had to make the loan for, there are no other structures that have that level of leverage that would cause you problems.

These are, as a broad statement, we do not have outside of that loan, we do not have asset backed securities category any assets with leverage incorporated into the conduit business.

That's all. Thank you. One other quick thing then, growth in US earning assets and I understand clearly that currency had a big effect here, but earning assets in the US business or international up 25% sequentially, loans and acceptances up 21% sequentially. I think currency would account for half of that but it is still a big number. Anything you can point us to?

I think we will have to get back to you on it. I don't have a quick come back. It is largely driven by currency-related things and opportunities or movement in assets driven by currency, but we will get back to you on the details.

Thanks.

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

Good afternoon, Morten. Just one more time on the conduits, did you say of that $60 million provision, that had been taken against that book of loans it was 200 million or so on the, on the gross impaired so that is the total size of the loan that relates to this problem asset you said.

It is $203 million Canadian at the end of the dollar, it is a US $170 million asset.

So that $200 million is the part of the $1.9 billion that would be $60 million in provisions relate to.

You got it.

The remainder of the assets you just went through you are comfortable with what you are seeing there.

That's correct.

If I bring that back to RBC Capital Markets the loan portfolio in that segment, so $25 million this quarter, relates to the can the number is still, obviously it has been low for a few years still a little high in provisions for what we're seeing there. Can you talk about specifically, in the corporate book what you are seeing maybe in terms of watchlist or sector concentration as the economy here shows some signs of weakening what are the areas of concern at this point for Royal in the corporate book?

In the corporate book, the PCL in the quarter is, we have got the, the $25 million that we just talked about, and a small a number of other loans that have taken provisions. We have got gross impaired at 199. And as you were saying, foreign exchange is driving some of the increase in both impaired and provisions here in that if it is sort of half and half in terms of where we have Canadian and US borrowers. In terms of impaireds, we don't actually have any particular sector focus in the wholesale portfolio. The run up in real estate is dominated by the, the wholesale portfolio coming out of RBC Bank. So the corporate banking portfolio, we have, like I said, no particular sector focused in terms of where the problems are. We are focusing obviously on any of the sectors that are being impacted in the current environment. But the watch list in the corporate bank is, we are seeing some increase in, in the number of accounts coming into the watch list. I would add that a fair number of them move off the watch list without going into impaired. There is not a dominant theme on any of that activity, and the Canadian environment tends to be mid size, more commercial-like accounts that end up on the watch list, the majority of which we so far have not seen the need to take provisions on and in the US, it is really one account at the time at the moment without any clear sectoral trends.

If I just bring this back it has been a few years now since Royal would talk about a loan loss range of 40 to 50 basis points, and depending on how you view the general this quarter we are somewhere in the 65 to 85 range. As you look out to 2009 right now, and obviously we have seen an acceleration in non-performing loans, do you view the level of provisioning this quarter, with or without the general as something or maybe that's the question is 600 maybe a number that we should get used to from Royal in terms of getting that coverage ratio a little bit higher and having the reserves built up for any kind of surprises that could occur as the economy weakens?

The big unknown here is the speed and location of the deterioration. I mean if you look at the current quarter, the specific PCL ratio is 65 and that is, I mean the one that to the extent we have talked about a 40 to 50 basis point target for where we should at worst be in a normal credit environment, that is the reference point. If you take out builder finance, and I appreciate we can't take out any of the portfolios without starting to dilute this conversation but if you take out builder finance we are well within the 50 basis point area. As we go forward with the kind of change in unemployment and economic growth that is being forecast, we would expect some deterioration in the Canadian book but not massive whether or not further addition to the general is required is obviously something that we will look at as the quarters move forward, but I would suggest that in the current environment, seeing us in the 50 plus basis point range for a specific provision is entirely possible. We are shooting to be better than that. Thanks very much.

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

Hi. Thank you, just a quick question actually I'm not sure if this is for Gord, or Barbara, or Janice. So if anyone can give me a hand for this. You achieved operating leverage by having expenses fall faster than revenues, what happens if you have another year of declining revenue? Can you bring expenses down again? You have a large expense base, I'm just curious how much expense save you can find in there and if you can, just curious which business unit you think punch above its weight in reining in expenses in a period of falling revenues?

It is Janice. Why don't I answer that for you. Definitely operating leverage is a function of both revenues and expenses and where it totally engaged on the cost management side. It is not about targeting certain businesses that will come down. For example, Capital Markets is constantly retailing their businesses, and for some of their businesses that are not performing, they're taking out expenses there. We are doing some business process outsourcing, we are accelerating on that front, managing our discretionary expenses across the board, and really trying to maintain our expense run rates at a very low core, and not putting on any additional projects, and things like that until we see revenue coming on stream. So it is a balancing act between looking forward and seeing when we are going to get more revenue stream and layering on some of the projects that are more focused toward cost containment versus revenue growth. So, it is across the board in all of our businesses.

I would just emphasize, Darko, that as we build our plans, we have our plan for 2009, as we stress test our plan, there's a number of initiatives across all of our businesses including the back end of our business that are will be put into place to react to any revenue impact as a result of the, of what is going on across the economy. So as Janice says, it is not so much a specific business as it is a number of initiatives across, across all of our businesses, both in the front and back end.

And we had one discretionary spend was about $1 billion. Is that still a round about and how fast can you pull that in, Janice?

It is still around about $1 billion so the, the speed what we were focused on initially was not growing it. So the speed is more related to looking at travel entertainment and all that sort of stuff. We are actively managing that spend down at this point.

I understand. Thank you.

Thank you. I would now like to turn the meeting over to Mr. Nixon.

Thank you, everyone, again for joining us. As I said at the start, I know it has been a long week with a lot of bank numbers and noise in those numbers. We would like to thank you for joining us, we hope everyone has a somewhat more relaxing holiday season, and we look forward to talking again at the end of the next quarter following our annual general meeting. So thank you very much.

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