Royal Bank of Canada (RY) 2009 Q1 法說會逐字稿

Welcome to the RBC 2009 first 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 morning, everyone, and thanks for joining us. Presenting to you today are Gord Nixon, our CEO; Morten Friis, our Chief Risk Officer; and Janice Fukakusa, our CFO and Chief Administrative Officer. Following their comments, we'll 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 website shortly after the call.

Joining us for your questions are Barb Stymiest, our Chief Operating Officer; Dave McKay, our 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 2, our comments may contain forward-looking statements which involve applying assumptions that have inherent risks and uncertainties. Actual results could differ materially from these statements. I will now turn the call over to for Gord Nixon.

Thank you, Marcia, and good morning, everyone, and thank you for joining us on this earlier than usual conference call but with us in Vancouver and we know the analysts have a very busy day with all the reporting season. We thought that it would be good for everyone, and particularly our investors, to have the call earlier than usual. As you can see on slide 4, RBC once again displayed the strength of our Canadian businesses and demonstrated the value of our diversified business model. We earned this quarter over a billion dollars with earnings per share of $0.73. I would like to highlight items on slide 4 impacting our earnings, excluding these items are earnings worth $1.6 billion with earnings per share of $1.14. Our capital ratios remain strong. Our tier 1 ratio was at 10.6% and our tangible common equity to risk adjusted assets is at 6.8%. This reflects capital issuance in the first quarter as well as our continued focus on managing our risk adjusted assets and the earnings contributions from our businesses. Our solid financial profile should provide our shareholders and clients with additional confidence in the strength and stability of our organization and should support the continued growth of our businesses.

Before moving on, I would like to make a few comments about the roughly $1.3 billion of market-related charges that we took this quarter and describe our approach to valuing [illiquid] securities in the market. Unfortunately, fair value accounting, while well intended, have their limitations. Today, mark to market accounting rules did not anticipate a liquid market, and as a result of unintended consequences for bank earnings around the world. It has also given rise to a wide range of judgments that can be applied. The result has been significant disparity in how securities are valued and how changes in values are recognized in financial statements.

This does make comparisons more difficult. Some institutions have chosen to use a more models based approach to valuation while others have used a greater level of observable market inputs. This can cause the valuation of the same securities to vary. For example, the fair value of exposed hedge by model -- exposure hedged by model lines can be determined using market inputs such as credit default swap spreads or internal models designed to predict long-term recovery levels. These methods will result in different assessments at fair value. Moreover, even with credit default swaps using swap rates versus an average rate can cause different results.

Our approach has been to use market inputs and spot pricing where feasible. While this results in more income volatility than internal models, this is the approach that RBC has taken because we and our auditors believe it to be more transparent, conservative, and keeping with best practices. In addition, institutions have made different choices on the types of securities that are held in trading portfolios versus nontrading portfolios. Again, this makes comparisons difficult. As you know, changes in fair value of assets and available for sale are held to maturity portfolios generally will not flow through the income statement. We believe we have been very selective in determining which securities should be held in non-trading portfolios.

While both the use of observable market measures and the holding and securities in our trading portfolios causes greater volatility, we feel it provides better transparency in reflecting the current market conditions. While we don't like this volatility, over time there should be conversions between different methodologies as illiquid assets mature and realized values are determined. However, notwithstanding these charges as I said earlier, we had a very solid quarter and continue to manage the current headwinds effectively. I would like to give you an overview of our results.

Canadian banking continued to drive results with strong earnings reflecting volume growth across our businesses and effective cost management. However, the low interest rate environment impacted our margins and offset much of the volume growth. We have higher provisions for credit losses reflecting both higher loss rates and portfolio growth. This increase is not surprising as we see the weakening of the Canadian and global economies. In wealth management, earnings were down largely reflecting weak equity markets. We continue to have leading market share in Canadian mutual funds and full-service brokerage and will continue to focus on building our wealth management business by adding experienced consultants. This will position us well when we begin to see improvements in the equity markets.

Outside of Canada we have been particularly successful at recruiting advisers and teams who value RBC's competitive position and stability. Insurance generated solid business growth with net income up from last year. 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 in our investment portfolio. Once again, we continue to generate solid results in our capital markets business despite the market environment impacts. I keep referring to the diversity of our businesses, but it is really seen here when you look at how we continue to produce solid earnings from this segment during this extraordinary environment.

With respect to our dividend we are maintaining our quarterly common share dividend in the second quarter of 2009, which we believe is prudent in this environment. Over time, our objective is to grow our dividend. Stepping back and looking at overall results, the operating environment is certainly challenging but I am certainly also proud of how we have been able to manage through it. It's important that during these times we stay focused on our strategy to navigate through these challenging times that lie ahead. We will focus on maintaining a solid capital position. We will build on our solid risk management practices. We will manage costs aggressively and prudently, and we will utilize our flexibility to build our core earnings by investing in select areas where we generate value and can generate value for our shareholders.

The current market conditions continue to create opportunities for RBC, given what has happened to a number of competitors around the world. We will continue to capitalize on our growing global reputation for strength and stability and I believe we will be in a stronger position when these markets start to return to a more normal environment, which we believe they will. With that, I will turn it over to Mort.

Thank you, Gord. I will start with an update on our credit portfolio. Looking at slides 11 to 16 we had $747 million in provisions for credit losses in the first quarter, up from $619 million last quarter. This quarter included a general provision of $149 million. This reflects deterioration in our corporate portfolio, higher loss rates and volume growth in our Canadian retail lending portfolio, and higher provisions in our US banking portfolio.

I will now review specific provisions for credit losses by geography. Starting in Canada, which represents 78% of our overall portfolio, we have higher specific provisions related to credit cards and personal loans, mainly unsecured credit lines. This reflects both higher loss rates and portfolio growth. Provisions for wholesale loans increased from the prior quarter, largely reflecting a provision in our corporate lending portfolio relating to a specific client in our prime brokerage business. This line item had a large impact on our specific PCL ratio this quarter.

There's no gross impaired loan or allowance of credit loss for this item because as the account became impaired we took a provision, wrote down the loan and took over the underlying securities within the quarter. Since taking over the portfolio securities, we have seen some recovery of losses and have taken steps to reduce the overall size and risk of the portfolio. We have no other prime brokerage accounts of this magnitude and have scaled down this business while adding further mitigation and controlled processes.

Turning to the US, which represents 15% of our overall portfolio, compared to last quarter, we had higher provisions for residential mortgages and personal loans reflecting the deepening recession and housing market decline. In the wholesale portfolio lower provisions related to our US residential portfolio were largely offset by higher provisions related to our US banking commercial loan portfolio. Finally, the remaining 7% of our loan book consists largely of our Caribbean banking operations. In general, our international portfolio continues to be stable.

Turning to slide 16, our total allowance for credit losses is 87 basis points as measured against total loans. This is up from 76 basis points in the prior quarter. In terms of coverage ratios, our total ratio is 73% and is approximately 107% if you exclude our US banking operations. The coverage ratio for our US banking operations is approximately 40%. This is mainly due to our US residential builder financed portfolio which has a coverage ratio of 20% as we believe underlying collateral values will give us reasonable recovery rate over time. Coverage ratios are a function of portfolio mix, underlying views on recovery rates and the overall quality of the portfolio. It is a [bottom up] process. The level of coverage is within our expectations based on previous cycles. We believe we are appropriately provisioned at this stage of the cycle.

Turning to slide 17, let's look at the global trading value at risk. You will see that there were six days with net trading losses in the quarter, four of which exceeded global trading VAR. Two of these were due to month-end valuation adjustments and the remaining two were due to significant volatility and equity and credit markets. We undertook some risk reduction actions in this quarter that I would like to highlight. As mentioned in the past, we have been winding down the risk in our correlation book. This is a trading portfolio containing CDOs of corporate default swaps. We have sold most of the positions in this book and are managing the residual exposure. In the first quarter, we undertook a series of risk reduction trades and trade assignments. These contributed through market related losses in this quarter.

I will finish off by spending a moment on bank-owned life insurance since we received some questions in this area. We have included some background information in Appendix B of our slides. We believe the probability that clients will sur render their insurance policies remains low. These policies are intended to hedge our long-term -- our clients' long-term benefit liabilities by providing a long-term tax-free income stream. If a client surrenders, they would lose their tax-free income unless paid taxes on accumulated tax-free earnings which we believe is a substantial impediment to surrender. Also, our payment obligations can be reduced by contractual protections relating to portfolio leverage and capital adequacy of the client. We have one policy with a notional value of $2.5 billion and a fair value of $900 million. After taking in to account contractual protections and provisions taken, we estimate that our payment obligation would be approximately $500 million if this contract had been surrendered on January 31.

Where appropriate, we proactively work with clients to restructure contracts. This further reduces the likelihood of surrender. While restructuring rather than surrendering, a client is able to preserve the tax benefits while improving returns. We are satisfied with the cumulative decisions we have taken are appropriate and we have not been doing any new business for some time. Our investor relations team would be happy to walk through the background information in our slides with you. At this point, I will turn the call over to Janice.

Thanks, Morten. As Gordon mentioned, net income for the quarter was just over $1 billion which was down 15% from the first quarter of 2008 and down 6% from last quarter. We remain focused on managing costs and have been able to manage our expense growth rate while continuing to support enterprise-wide business growth. Our expenses are relatively flat compared to last year if you take into account our acquisitions and the stronger US dollar. Our results were affected by market environment impacts and higher provision for credit losses, as Morten discussed. In terms of the market impact, we had both favorable and unfavorable impacts that collectively reduced revenue by $1.3 billion and net income by $646 million. The loss is related primarily to structured credit and unfavorable increased credit valuation adjustments. The credit valuation adjustment reflected both wider counterparty credit spreads and higher net derivative related credit exposure to certain of our counterparties.

Up to a year ago, valuations resulting from market and model driven inputs were generally the same. More recently, we've seen a divergence of the output from different valuation methods. Accurate valuation is important in managing risk and in properly pricing our trading activities. Our objective is to remain as current as possible in valuing exposures so that trading activities and our view of risks align. For this reason, we're using credit default swaps based on spot rates with respect to credit valuation adjustments. Provided there is no credit event, these credit valuation adjustments will flow back into income over time.

I will also briefly comment on MBIA's announcement last week to form separate structured finance and US public finance companies. Both MBIA's CEO and its insurance regulator have publicly stated that each legal entity is adequately capitalized with sufficient resources to pay all expected claims in a timely fashion. As a reminder, we have taken cumulative credit all of situation adjustments of $1.1 million against our MBIA exposure. We believe that in a realization scenario, we're more than adequately provisioned.

I will now review the quarterly performance of our five business segments. Starting with Canadian banking on slide 19, net income was up 3% from last year, reflecting volume growth across all businesses and a favorable adjustment to our credit card customer Loyalty Rewards program offset by spread compression and higher provision for credit losses and lower mutual fund distribution fees.

On slide 20, you will see net interest margin decreased over the year and the quarter. This reflects the impact of lower interest rates, product mix changes, and the competitive marketplace. Despite this decline we grew net interest income by 2% from last year on volume growth across all businesses. Looking at wealth management on slide 21, net income decreased 29% from a year ago due to the impact of capital markets on fee-based client assets and transaction volume.

Moving on to insurance on slide 22, net income was up 26% over last year. This largely reflects improved Canadian life and health policy holder experience and lower allocated funding costs on capital partially offset by lower favorable actuarial adjustments. As shown on slide 23, international banking had a net loss of $144 million, down $175 million compared to net income of $31 million last year. This decrease was mainly due to performance of our US banking business which had investment portfolio losses and higher provisions for credit losses.

Let me move on to our capital market segment on slide 24. Net income was down 26% from last year, largely reflecting the market environment impact and the provision for credit losses that Morten detailed. Certain trading businesses continue to benefit from the increased market volatility and the lower interest rate environment. Overall, despite market impact we generated solid results this quarter with strength in our Canadian banking and insurance segments as well as certain businesses and capital markets. At this point, I will turn the call over to the operator to begin questions-and-answers.

(Operator Instructions). Thank you. Our first question is from Jim Bantis from Credit Suisse. Please go ahead.

Good morning. Two questions. With respect to Canadian banking, when we adjust for the credit related -- credit card related gain, results were down 2% year-over-year, pretty consistent with the other large retail franchise in Canada. And I'm wondering if we can talk about the credit trends that we're going to face going forward with the sharp increase in unemployment and bankruptcies, and also just looking at potential offering leverage in this franchise, it doesn't look like 2008 really benefited from the cost control, and whether that can continue into 2009?

Okay. It's Morten. I will start with a couple comments on the credit trends. Clearly, the results this quarter actually are quite strong, reflecting very stable performance in the small business and commercial segments. So provision levels there actually remain stable at very solid levels while we continue to see decent growth in the portfolio. Where we have started to see some impact from the deterioration in the economy is in our unsecured consumer lending cards and unsecured credit lines but, again, the trend is relatively modest. You have seen -- my view on the impact of the environment is that the impact of unemployment hits first on our unsecured consumer lines and for a protracted period you also start to see this show up in the small business and commercial portfolios, but looking at the trends over Q1, which was a fairly difficult quarter from an economic standpoint, the impact on the portfolio has been fairly modest.

On the cost side, Jim, it's Gord Nixon speaking, as you are aware, we formed with our restructuring a month or so ago a new group operating committee which Janice Fukakusa is chairing. The top priority of our group operating committee at this point in time is a significant review of all of our processes and a cost reduction process. We have very ambitious internal reduction targets across all of our businesses, including the back end of our businesses which would, of course, impact our Canadian banking business, and we have not sized them at this point from a public perspective. We have internal targets for both 2009 and 2010, and there's a tremendous amount of work going on, on that front and, as I say, we have internal targets and we will be talking about more with respect to that in the future as we provide more -- do more detailed work and have more credibility with respect to the sizing of it. I don't know, Dave, whether you want to make a specific comment on branch network away from that?

We continue, Jim, it's Dave McKay, to invest for the future so we are looking at opening branches and to focusing on those core areas that drive our competitive advantage. Having said that, I think we've shown good cost discipline and we're going to continue to focus on making sure that we manage our costs closely. As an example, when we do open those 30 new branches, we are going to do [FT] neutral so employees will be transferred from other branches to stop those new branches. So there are areas to manage and, as Gord mentioned, we have an overarching program that we're focused on, but we feel confident that we can manage our costs closely.

Got it. Thank you. Just the second matter I wanted to address is the breakdown with respect to the prime brokerage business. Could you talk about what the issue was with respect to risk management and has -- how has it been rectified and how does it supply to your US business where you have been growing your prime brokerage business pretty aggressively over the past year and a half?

It's Morten. I'll take a stab at that. First of all to emphasize, this is -- the account that we've had the issue with is an account that is by far the largest that we have had in the prime brokerage business. So with that account in the position that it is in, the remaining business is significantly smaller and spread over a large number of account. The largest part of the business by volume remains in the Canadian market as opposed to US. You're right, there's been some growth in the US market. Fundamentally, the issue that caused the losses was the completely outsized move in the convertibles and some of the other markets where the fund had some positions and that caused the NAV of the fund to drop significantly. So what we have done since is obviously go back and look at the operational controls to ensure that we are on top of any that exhibit any similar moves, but at this point we're comfortable the controls will keep us on side and, as I said in my comments, the business has been downsized and we are basically operating at a reduced level while we're in this market condition.

Got it. Thanks, Morten.

Thank you. The next question is from Brad Smith from Blackmont Capital. Please go ahead.

Great, thanks. I have a quick question. First one just dealing with the impaired loan trends, I think I heard earlier we were talking about the unsecured portfolios in Canada but I was just observing in the (inaudible) on page 26 that the residential mortgage impairments are declining, I think they were about 23% in Canada. Wondering if you could provide us with some discussion as to what is happening there, and then, Gordon, a question for you. With government interventions increasing in the US, just wondering if you could give us some sense for how you view that opposite your US growth strategy, maybe give us an update on what you are seeing in terms of acquisition pipeline changes?

It's Morton. I'll start with a couple comments on the impaired loans growth. You are right that we have seen a noticeable increase in the impairments in the Canadian residential mortgage portfolio. What it reflects is the difficult market in Canada for residential real estate where prices are up somewhat. I would note that the loan to value levels that our mortgage business is underwritten on, what the impact of this is and, in my view will continue to be, is that we will just see some increase in impairment. If you go and look at the level of provisioning that's required for the residential portfolio, it has remained stable through Q1 and given the health of that mortgage portfolio, I do not see any change in that dynamic.

So in other words, you see recoverables remaining strong so you don't need to provide?

That's right. I think the underlying dynamic will be that relative to recent years and quarters, the length of time we have had to basically turn over properties could go where the mortgage goes into default might lengthen somewhat, but our ability to recover well within our mortgage levels remains very strong.

(inaudible) deterioration and most of it was in the insured mortgages, same situation (inaudible)?

Of course, number one would be in a sense not that surprising the insured is seeing a sharper run up in that the insured is where you have a higher loan-to-value ratio where the number is already 5% and ends up being off of our books. So it's not surprising that borrowers in that segment might have an average slightly higher problem rate, but if you are looking at it from a loss and recovery standpoint from RBC, the dynamic is actually very strong.

Okay, thank you.

Brad, to to answer your second question, the environment in the US continues to be tremendously uncertain. As I have said in the past, it's uncertainty with respect to balance sheet if one were to do anything in the acquisition front, but even more so the uncertainty with respect to TARP, the government intervention, how the whole environment is going to unfold puts us in a position where we're watching with interest but with tremendous caution the overall US marketplace. So there is -- we're following it closely. We are certainly following the activities and staying in touch and on top of what the various regulators are doing in the United States, but I would say it is clearly an environment of uncertainty and I do not think it's prudent to try to attempt to do anything when there is such a high degree of uncertainty.

Would you agree with those that do the interventions of US banks as first position to consolidate the better prospects in the market?

Sorry, you cut out halfway through. Brad, can you repeat the question?

Yes, I was just wondering if would you agree with those that view the interventions as putting US banks in a better position to consolidate the more attractive candidates going forward?

The answer is, it's very difficult to know because the rules are sown clear. I think that there is no question that a lot of integration and consolidation in the United States will be done with significant involvement from the regulators, whether it's FDIC or the fed or the treasury. And so the answer to your question is likely yes, but it's very difficult to tell in today's environment because there's been so little activity and there's so little clarity in terms of how it is all going to unfold going forward. As I said, I think it was in the last conference call, I do think that there will be significant opportunities over the next couple of years in all sectors, not just banking, in the United States, and -- but I don't believe there's any hurry in a marketplace like this with such a high degree of uncertainty where capital is such a scarce resource to try to catch a falling knife, as I describe it. So until there's a higher degree of clarity and certainty and things start to evolve, you are going to continue to see us operate with a high degree of caution.

Thank you very much.

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

Two questions. First, the (inaudible) MBIA (inaudible). Can you help us understand the duration of the CDOs? That would help us understand --

Andre, could you pick up your phone? You're cutting out. I think you might be on a conference phone.

Okay. I was asking about the MBIA hedges on page 7 of the report. What is the rough duration of these assets? Then I have another one while you look for that which is related specifically to the equity, there is an unrealized loss position of $658 million. How does the impairment process work for equity (inaudible) how about equities?

Andre, it's Janice speaking. I'll answer your question about the impairment process on equity first. The equity in our available for sales portfolio are mainly Canadian banks, and the reason we have that portfolio is to hedge our stock-based compensation expense. When we look at the impairments and test for potential impairment with respect to equities, and I think that we put a lot of detail in the MD&A about our process, we look at the underlying earnings power and earnings quality of the banks that we're invested in. We look at the past stock history with respect to longer term over the cycle in assessment of those particular impairments. So it is a judgment, but we look at it from the perspective of the fact that, A, it's a long-term investment we intend to hold it for the long term and, therefore, we need to look at the investment across many cycles, and B, from our other perspective those securities are being used to hedge our comp plan, so in essence from an expense perspective, although there's timing differences, it's somewhat of an offset. They're not investments just to earn income on them. Morten, I'll turn it over to you for the MBIA.

Just a quick -- Janice, so the price of the securities or how long (inaudible) is not (inaudible).

We also look at the aging of the securities and the price fluctuations and how long they've been underwater or above water, those sorts of things. There is quite an extensive process and, Andre, we know that in US GAAP there is more discipline around that particular process, and the one we're looking at, at reporting on US GAAP, we're also going to be reviewing that from a US GAAP perspective because there are more stringent rules based approaches to generally the equities portfolio.

Andre, this is Morten Friis. I'll try to take a stab at the question you left us with here. In terms of the MBIA hedges and the underlying CDOs, the thing I would focus on is not so much the maturity of the underlying assets as the timing of defaults and payouts from MBIA as the assets show losses. If you look at the portfolios we hold, we will see defaults generating claims and payments starting as early as later this year. And so in terms of the MBIA hedges, I think that is where we should focus.

Thank you.

Can I just make a request? We recognize that the telephone system at the hotel we're at is not quite as effective as we're used to, so we apologize for -- I know there's some challenges with respect to the quality of the system. But it would be very useful if analysts asking questions would pick up their phones, because it's a lot easier for us to hear if people speak directly into the phone rather than a speakerphone. Thank you.

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

Thank you. Can you hear me okay?

We can hear you well, Michael.

Okay. Could you explain why your gross formations shown on page 27 of your sub pack are up to $2.6 billion, primarily on the wholesale side? And then you've got offsetting that about $1.5 billion of secured sales and repayments. Again, elevated on the wholesale side. Can you explain what went in and what went out, the amount, what it's related to, and was there a direct offset between the two numbers?

Michael this is Morten Friis. The large swing here relates to the prime brokerage account that I referenced in my comments at the outset. So you will see that there is, and as I explained, it ended up not affecting the impaired balance at quarter end but as the loan became impaired you would you see it then on the formations here flowing through the total impaireds and being offset by an equal movement out. So the -- in terms of the wholesale impaireds and the formations, that one account caused a set of numbers that is significantly different from previous quarters.

So if an equal move in both the gross formation and the cured sales for payment?

Yes. So in effect what was done was the loan went impaired. We took a provision, we took over the assets, so that the assets so that the assets now are managed as part of the RBC portfolios within our trading businesses because the loan had defaulted. It ends up moving into impaireds and then out of the impaired loans because the assets are now RBC assets but we manage the underlying portfolios.

Okay. Just for clarity, can you tell us how much of the -- how much is included? What's the number?

What's the number. Which number are you referring to? You see, when you see the large formation and what moves out, the majority of that number, both in terms of formation and movement out, you can you can figure out how it balances off is represented by the prime brokerage account.

Right. I understand that. What I'm wondering is what that amount is. In other words, I would like to know what the gross formation would be excluding that prime brokerage account.

So we're not providing that level of detail but, I mean, you can get fairly close by just -- you will get a pretty good idea when you look at the total numbers here between the various pieces on the supplementals. Let me put it this way, the level of formation outside of this account is not off site what we've had in previous quarters. It's consistent with the trend you see in the rest of the portfolios.

So if I was to assume --

Let's move on to the next question, Michael, and we'll take this off line because we can walk you through this in IR. Thanks.

Okay. My other question is could you give us some idea of how much revenue you generate from prop trading excluding facilitation?

Michael, the bulk of our trading activities are with clients and counterparties, and specifically when you look at trading revenues, we really don't split them that way because we're a client-led business and so we look at the trading revenues on both sides so we don't look at our trading revenue using that lens.

I think, Michael, I remember Chuck Winograd tried to answer that question a bunch of times and it is very difficult to separate out when you are in a flow business customer versus proprietary trading when you are taking positions. But, as Janice says, most of our businesses are customer-based businesses. If you are asking which businesses are specifically prop trading, I'll turn it over to Mark, but I think it's primarily our JAT business would be viewed as a prop trading business.

Hi, Michael, it's Mark Standish. To give you a sense of the balance, just going back to Morten's comments that we had in the quarter only six trading days of net losses and two of those were month-end valuation. That really points to the significant diversification that we had in our trading businesses, both in terms of the nature of the books but also in terms of the geography, and as you can see, given the volatility that we've seen in the quarter, we are running a very disciplined, very diverse business on the trading side and, as Gord said, it is very heavily focused on clients.

Next question, please.

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

A couple really quick questions. First, Gord, can you highlight or give us some rationale for the drip plan and why some (inaudible) were removed to the drip plan?

I'm going to ask Barb to answer that question.

Darko, it was simply that it's easy to do. We think there's a demand there that being able to issue shares from treasury to augment capital ratios in an environment where there's a huge focus on capital was an easy fix, and we think our shareholders will take advantage of it.

How much do you expect to general rate in terms of capital from this switch? What would be a rough guesstimate?

If we have a take up, looking at some historical information, 20% to 30% of our shareholders may choose to take advantage of this. So 20% to 30% of our dividends that would be paid in a particular quarter over time. It is going to take awhile because people are going to have to go through the process of making the amendments to how they receive their dividends.

Thanks, that's helpful. One last question if I can sneak one in here on the write-downs with respect to the credit default swaps and the correlation book. Can you walk me through why the write down was the size that it was, and given that you have exited this business, can we expect to see more of in this future quarters, and can you give me a handle on how could I go about tracking that?

This is Mort. I will start with the final piece. I think, as I said in my comment, we've done significant risk reduction trades. This has -- so we've taken most of the risks in the correlation book off the table, so that to eliminate as much as possible future volatility from the source. I would note, though, that there is some piece of the book remains, so we obviously have a risk of some volatility there but significantly reduced from what it was, and the size of the write down really is a reflection of our desire to move as much of that volatility off as possible.

So what's the size of the book and can you give us -- can you outline that for us?

I don't have the size at my fingertips. We'll have to get back to you with a little bit more background through IR after the call.

We do have, you can see in there that we've got the notion, right?

Okay.

Just to reinforce Morten's comments, because they are important, the reason we did that this quarter is we made the decision to the extent to get out -- to move out of this business. So it's -- this was an intended step to basically exit to a large degree the correlation trading business.

It's Mark Standish. To answer Gord's comments, we've been very aggressive at exiting this and other businesses because the opportunities elsewhere in the business to generate revenues with capital is just so great right now that we've been very focused and very aggressive.

It also frees up risk adjusted assets as well.

Thank you very much.

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

I'm not sure the funny accent is going to help with the hearing too well here. Gord, your opening comments were very interesting. You talked about something that has been a problem, and that is that mark to market is creating such tremendous volatility in reported earnings. When I look at that your earnings this quarter, do you think that mark to market accounting helped your earnings or do you think it hurt your earnings this quarter?

Well, it hurt our earnings significantly because most of the write-downs that we have taken with respect to the adjustments, the roughly $1.3 billion, are all related to mark to market accounting. I think that the -- as I said in my comments, ultimately there will be convergence, but it creates a tremendous amount of volatility relative to the way banks have traditionally reported, if you go back to previous cycles. If you do a comparison between '91, '92, for example, when banks were in Canada these were in a lot worse shape than they are through this cycle, the accounting impacts are dramatic, and dramatically to the negative in the current environment because the -- you are marking to very, very illiquid levels and the reason that we highlighted in Janice's comment, the MBIA example is because there's sort of three -- there's various outcomes with respect to that.

One, of course, is which everything is paid out. Another is that they don't pay out generally, and then you've got the mark to market, and then you've got your realized value or expected realization and they're very different numbers, and you are marking to a credit default swap which is a market determined with a high degree of illiquidity, and it pushes institutions to the lowest level to some degree because of what has happened in the marketplace. So it's -- I don't want to become a pundit on accounting policy and accounting rules but there is no question that it has created unintended consequences, and you are taking marks in theory on assets where there will be realized values. Now, things could get a lot worse in those marks could get worse and the realized values could get lower, but at any point in time, you are marking to levels which generally are below potential realized values. That's an issue. I think from -- in terms of comparison. One of the points we've tried to make what we have done is tried to use the most conservative approach, which means we are using, as opposed to internal models, we are using observable market inputs.

Gord, to the same extent, your rules with respect to marketing are applied to everything, whether it's these books or your regular trading books. So if I remove these, you had $1.7 billion in trading revenues, which presumably you could make the same point on that you had realized gains from blow-out in credit default swaps which may not actually translate into gains down the road. Isn't that right? I think that would be a fairly small -- I mean, there would be some truth to that. We've always been very clear that if you look at capital markets trading revenues there's no question that there is some benefit that we are getting or the marketplace is getting as a result of the volatility that is occurring in the marketplace, but if you look at our trading revenues, they tend to be well diversified across various books, fixed income, foreign exchange, interest rate derivatives, equities, GAT. So I think to some degree you're comparing apples and oranges, although there is some value to the trading businesses, given the high degree of volatility and some of the margin increases that has come from the illiquidity.

Ian, it's Doug Mcgregor. I think the other issue that we have discussed in these calls is on CDS, we use CDS to hedge our loan portfolio primarily and the gains, the CDS gains in the quarter were not significant. We don't trade CDS for the sake of trading CDS. I think in terms of the trading numbers, as Mark has said and as Gord has said, the trading environment, the spreads in the trading environment, the fact that many counterparties in Europe, in the US, and in Canada that were active a year ago aren't active now has really allowed us to take market share in our closed trading business and they are producing very well.

We're doing business with customers that we've never dealt with before because we have the liquidity and balance sheet and given what has happened in the marketplace. And that's one of the opportunities that I think is from the turmoil in the current marketplace.

I've heard things like your [muni] bond business, I've heard you end up being one of the last men standing in a business that is going to be a business long-term. Does that mean that your trading revenues on a quarterly basis we should assume are going to exceed a billion dollars a quarter?

Yes, you know we won't answer that question. But as we have said all along, from a strategic perspective, this is not a business that we're abandoning. We actually have been shrinking our risk adjusted assets in this business. We've had head winds of currency because 62% of the assets I think it is in that business are US dollar-based but we have been reducing, attempting to reduce our risk adjusted assets for obvious reasons, but this is a business that we are going to continue to invest in. So the answer is yes, we do like our prospects in businesses like the muni business and others, given the change in landscape because I think coming out of this, I think it will be -- it will be a business in which margins have expanded, and as long as we operate with a high degree of prudence from a risk management perspective. And on that front, as you know, we've learned some lessons over the last year.

Thank you.

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

Following along from that question. As retail slows a little bit because of higher PCLs and maybe slower revenue loan growth throughout this year, and let's assume for a moment that maybe Royal can generate a billion plus this quarter, maybe 1.7, 1.8, if the bank can generate that kind of revenue going forward, what do you envision the change in mix to be for the bank in terms of retail versus wholesale earnings? Do you see at least for a period of time, perhaps a couple of years, while you benefit from this, the bank shifting aggressively toward wholesale earnings from the retail business?

I don't think so. I think that we have been very, very disciplined to try to maintain that the appropriate ratio, and our stated strategic objective is 75% retail or retail related which, of course, includes insurance and Wealth Management and other businesses and 25% wholesale. What I've always said is there's a wholesale range, and it will be slightly higher than that range during a good part of the wholesale cycle and slightly lower than that range during a weaker part of the wholesale cycle, and 20 to 30 is roughly the range that we have used in the past, and going forward we want to maintain that. It may -- from an earnings perspective, it would be nice if it trended up because that would be a good thing. And -- but in terms of strategically managing the business we are going to remain very disciplined on that front because we think it's a model that the market is going to accept as being an appropriate level because margins will be good in the wholesale side of the sector. But to the extent that people are overweighted in that sector, there will be a -- I think a valuation issue, there will risk perspective. So we're going to remain very disciplined on that front. So could earnings creep up? I would love to see it happen, because that, as I say, that would be a positive. In terms of managing the business, we want to remain 75% strategically in banking, insurance, Wealth Management and less volatile businesses.

Would I be right in adjusting that for this quarter, adjusting for everything that the bank has highlighted as an item of note that that capital markets business was something like 40%, maybe 45% of total bank earnings?

You mean with all the adjustments, yes. We wouldn't expect the banking earnings in the United States, for instance, to be as negative for an extended period of time, so you can look at it at any point in time. If you had looked at it a couple quarters ago you would have had a much, much lower number. So I think it's a little bit risky to look at it on a specific quarterly basis because, as I say, some of the weaker earnings in areas like US Bank and even an area like Wealth Management where earnings continue to be solid but clearly are down dramatically because of what has happened in the equity markets. So I think as those businesses come back you'll see more of a reversion of the norm.

Okay. Sort of related question, again, if you go through the exercise of reversing all the adjustments the bank highlights items of note, salaries and employee benefits this quarter, it was a large number, $2.6 billion is what I'm coming up with and that's up maybe -- that's up $600 million, $650 million from last year and up maybe $500 million quarter over quarter. And I guess what I'm struggling with is, I understand that on a cleaned up basis, an adjusted basis, the bank's revenue was up in a huge way. And that might explain why the variable comp would be up. But ultimately, what shareholders got was the reported number, not the adjusted number. So why is it that salaries and benefits would be up so significantly because of this higher trading revenue when ultimately the bank didn't really earn that because there was a loss there that we're excluding?

Well, I can tell you the on the losses, we are one of the few investment banks in the world that actually has a bonus pool based on earnings, not off revenue. So there is no correlation between the revenue growth and the -- in other words, the capital markets bonus pool, if that's what you are talking about, is not up because it is driven by -- it is impacted by earnings, not revenue. So, I don't know, Janice, if you --

The question, maybe if you could answer on a quarter over quarter basis salaries and employee benefits, $2.6 billion, up 22% and up 32% year-over-year.

Some of it is US currency, then some of it does have to do with the fact that we have top-line bonus pool on the trading books, and so you will see shifting of that in and out until we get to the end of the year. The way we account for that expansion is we like to accrue it as current expense in the quarters and we adjust it as we're going through the year to reflect the longer term performance. And it is a lot of the expenses US dollar based, so there is that ramp-up. So if you look at our total expenses, there is that bump in variable comp. If you look at the rest of the expenses, our expenses outside of variable comp have actually gone down about 7% quarter over quarter. So we are maintaining that cost discipline. The variable comp, in trading businesses, is more like a cost of goods sold and a top line pool as opposed to a profit sharing.

It just seems to me like the shareholders are eating the losses but the capital markets people continue to get rewarded. It feels like that just by looking at these results but that's more a comment than a question.

It's just not -- that is just not correct, because that's not how the pools work.

Okay.

Ian, this is Doug Mcgregor.

Mario.

Janice's explanation is correct. What we have is a revenue and a (inaudible) based bonus pool and the accrual you are seeing, the portion of it that's relevant to the capital marks business is formulaic, and I think probably the good news is that we have accrued a good amount of bonus this quarter. As we get to the end of the year we'll see where the bonus pool is and we'll allocate it amongst the businesses accordingly. So what's driving that accrual is just the top line -- in portion, the top line revenues from those businesses.

And it's important, and I reiterate this I think it is a real source of differentiation in how we run our business compared to what you have seen elsewhere. If you look at our capital market bonus pool last year, it was down pretty proportional with their earnings reduction. In other words, it's driven by bottom line earnings, the bonus pool was down, I think it was 30% roughly, and earnings were down roughly 30% and that is very unusual, and I think it's a trend, frankly, that the whole industry will move towards for precisely the reason you are mentioning, which is that if you're paying bonuses off revenues, then you can have results that you've had in markets like the United States that you read about every day where you have bonus pools being paid out when revenues were there that earnings weren't. If we don't have earnings, we don't have bonus pools.

I understand. Thank you.

We'll take one more question because we're already at the end of the hour. So we'll take one more question and then we need to move on because of our AGM. Thank you.

Next question is from Rob Sedran from National Bank Financial. Please go ahead.

Thank you. I guess I better make it a good one. Gord, you mentioned staying very cautious on the acquisition front and US [PNC]. Is it also the case for organic capital deployment in that business or can you make loans at a better spread with little risk so you're happy to pick up the slack from competitors that may be pulling back?

I am going to let Jim Westlake answer it. It is a good question. There is a lot of attention to be paying. I would say a macro perspective, capital allocation internally across our businesses is priority number one. I think that is the biggest area that we should be focusing on in terms of creating value for our shareholders. What businesses we allocate capital in, where the returns are most attractive, and where we can deploy it most effectively. That's forcing us to make decisions like getting out of the correlation trading book and moving capital in to other areas where we think there are returns. I would say within US banking they are going through that exercise very much internally as well so I will let Jim speak specifically to that.

Thanks, Gord. I think that when you look at the U.S., we're definitely seeing a lot of opportunities, and so where it makes sense and where we can make money, particularly on the lending side, there's been a lot of consolidation in the southeast market. We're in the heart of what was Wachovia country. And so we are seeing lots of those. Very tight on the deposit side but great opportunities in lending.

I think we're done then, Gord.

Okay. I think with that we do have our annual general meeting which starts in about 55 minutes, so if people want to hear more from us, you are more than welcome to listen in to our AGM, but I would like to thank everyone once again for their participation and for joining us on this call, and we look forward to presenting at our next quarterly results. Thank you very much.

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