Royal Bank of Canada (RY) 2009 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the RBC 2009 second quarter results conference call. Please be advised this call is being recorded. I'd now like to turn the meeting over to Ms. Marcia Moffat, VP and and Head of Investor Relations. Please go ahead, Ms. Moffat.

Thank you. Good afternoon, 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 Chief Administrative Officer and CFO. Following their comments, we'll open up 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, Head of Strategy, Treasury and Corporate services, 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 applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. I'll now turn the call over to Gord Nixon.

Thank you, Marcia, and good afternoon, everyone. As everyone is aware our reported earnings this quarter were impacted by the goodwill impairment charge that we announce in the middle of April. As a result, we had a net loss of CAD50 million under GAAP but the charge of course is a non-cash item and does not affect our cash net income, our ongoing business or our capital ratios. Our cash net income was approximately CAD1 billion this quarter which is up 4% from last year.

Turning to slide five, our earnings were also affected by market related losses and the general provisions. These reduced our net income by CAD442 million and earnings by CAD0.31. As you can see, market related losses have been subsiding. Our underlying results are solid and we believe we have tremendous momentum in all of our businesses, with the exception of US retail banking that continues to operate in a very difficult industry.

Our capital ratios are extremely strong and significantly higher than historical levels. Our Tier 1 ratio is 11.4% and our tangible common equity ratio is 7.9%. Over the past two quarters, we have grown our Tier 1 ratio from 9%, which was among the lowest of our Canadian peers to a current level which places us among the highest of our peers. This is the result of both planned capital raising activities, targeted management of our balance sheet and growth in our cash earnings. In the short-term, we believe it is extremely important to be conservatively capitalized because our capital strength provides us with a competitive advantage in the marketplace and substantial flexibility.

We have tremendous opportunities to deploy capital in our existing businesses and toward other opportunities consistent with our strategy. Over time, our ratios will likely trend down, as we take advantage of attractive ways to deploy capital, and I must say, I have never been more positive in the ability to earn good returns on marginal capital as we begin to exit this difficult economic environment that we've been dealing in. We're also maintaining our dividend this quarter at CAD0.50 per share.

We believe that our businesses are well positioned for the current economic cycle. It's worth spending a few moments to talk about the environment and address the potential of our various businesses to perform through different points of the cycle. In the context of the global capital markets we are starting to experience stabilization. Credit spreads are beginning to ease, volatility has moderated from its recent peaks, and investor confidence is increasing. Global economic conditions, however, will be slower to recover as there is always a lag.

In the US, the rate of decline in the economy is easing which is a good sign but the economy remains in recession. The auto sector weighs on growth and the deleveraging by households and businesses continues to restrain activity. The Canadian economy is also in recession, but certainly to a lesser degree than the United States. I would expect the Canadian economy to perform differently than the US through this cycle. As I've mentioned in the past, there are important structural differences between the two markets. The underlying fundamentals with respect to the Canadian housing market, consumer debt levels, and fiscal policies better enable Canada to manage through this cycle and hopefully will result in a faster recovery. There are signs that the economy will bottom out in Canada in the first half of calendar 2009; however, we would expect the pace of any economic activity to recover very slowly.

In terms of RBC, I believe the diversity of our businesses gives us a tremendous advantage over many of our peers. We are the market leader in most of our businesses and each business performs differently during different stages of the economic cycle. For example, our capital markets capabilities have enabled us to take advantage of volatility in the current capital markets and will allow us to take advantage of further opportunities as global markets continue to recover and corporate activity, financing, M & A, et cetera. increases.

Next, our leading Wealth Management Business operations while stressed by the asset level declines over the last little, while can be expected to strengthen as these asset values begin to recover and investor confidence improves. And finally, it is well known that our retail banking tends to lag overall changes in the economy, but as the leading bank in Canada, we expect to be able to out pace the competition as we move through the cycle.

I've talked for several quarters if not years about the virtues and discipline of our diversified business model, because of its ability to generate good returns throughout the cycle. As you know, we focus on managing our Company for long term growth and remain committed to what we believe is proven to be an appropriate business mix. Our longstanding goal is to have 75/25, roughly 75/25 split between our retail banking, insurance and wealth management businesses on one hand and capital markets on the other. Of course, you will see some variation of this mix over the short-term reflecting stage of the cycle. For example, as you're aware, we are currently seeing higher contributions from capital markets. This business does have better short-term prospects in the banking business these days, particularly in the United States.

But I would point out this is a result of both strength in their businesses and also, of course, weaknesses in the earnings of our US banking business and wealth management businesses as well; however we would expect that that mix will revert to our long term range once these other businesses start to improve -- post improved results as the cycle progresses. Our strength, business mix and consistent execution against our strategy has translated into solid performance over the medium and long term. Our total shareholder returns compared to our North American peer group are on slide seven. We ranked first and out performed the markets over all periods.

I will now go through each of our business segments in more detail. Our Canadian banking segment remains our foundational strength and has allowed us to continue to invest and grow in other businesses and geographies over time. We continue to generate solid volume growth, reflecting our ability to attract new clients and new businesses from existing clients. Our Canadian banking results compare favorably to all of our peers and are exceptionally strong given the economic and interest rate environment. As a reminder, each of our reported segments fully absorbs the impact of the interest rate environment and charges in interest rates in their respective businesses. Our philosophy is that this provides a more accurate and transparent picture of each segment's performance and also incidents the right behaviors and decisions within those businesses. Margins continue to be affected by the low interest rate environment, particularly spread on deposits.

In terms of credit performance, our provisioning levels are within our expectations in banking, and consistent with the current economic environment. Our residential mortgage portfolio continues to perform very well and reflects Canada's solid housing fundamentals, and our conservative lending practices. Wealth management, as I said earlier, has been impacted by market conditions including the impact of low interest rates on spread income from client deposits. The business is very well positioned for the future and we see significant opportunities and growth as equity markets continue to improve and investor confidence returns. We are expanding our product line and remain focused on attracting top Advisors both in Canada and outside, who are able to leverage the strength and stability of RBC for the benefit of their customer.

Insurance generated consistent earnings in the quarter, adding to our diversified earnings stream. International banking was largely impacted by the non-cash goodwill impairment. As I mentioned, the US economy is still experiencing many difficulties and the business remains challenged as a result of the provisions for credit losses reflected by the weak environment. We are focused here on refining our operating models to improve efficiencies and enhance our competitiveness in our US banking business. Our Caribbean banking business is a good contributor to earnings and RBC Dexia continues to execute in the global custody services arena.

Capital Markets produced solid results once again, demonstrating our ability to take advantage of market conditions and our overall strength as a counterparty. We had strong trading results in the UK and the US fixed income and money-market businesses and US-based equity businesses. Market environment related losses, as I said earlier, are beginning to subside, reflecting improved conditions in the financial market. Through these uncertain times, it is clear to me that clients are choosing to do more business with RBC because of our brand, our financial strength and our expertise. Across our enterprise, our people are providing advice to help our clients create what is important to them as they plan for their future. We will continue to take advantage of opportunities in the marketplace, building on our client base, recruiting key talent and enhancing our efficiencies.

With that, I'll turn it over to Morten Friis.

Thank you, Gord. Looking at slides 10 to 14, specific provisions for credit losses increased by CAD153 million over the last quarter. We also added CAD223 million to the general provision, which relates primarily to our US banking operations. The impact of sustained recessionary conditions in the US has been significant across our US banking portfolios, particularly residential builder finance. Housing and commercial real estate markets remained weak although there were signs emerging that the pace of home prices and housing starts is moderating.

In our international banking segment, the increase in provisions by CAD89 million from last quarter is mainly attributable to our US banking operation. This quarter, we saw further deterioration in residential building finance as well as lot loans, home equity and residential mortgages. Provisions in our commercial and business portfolio remained roughly level with last quarter, including commercial Real Estate loans. Our experience within individual portfolio categories has been consistent with that of our US peers; however our portfolio mix is different with a higher concentration in residential builder finance. The homebuilding business is one of the first portfolios impacted when the housing market has a downturn and economic conditions slow. As a result, residential builder finance portfolios in the US, including ours, has been at the front end of the credit deterioration and has been impacted more quickly than other portfolios.

Outside of residential builder finance, credit losses typically peaked one year after the trough of the economic cycle has been reached and our US banking portfolios will remain under pressure until a definitive bottom or term occurs in the markets. Looking at the Caribbean, as expected we are seeing some softening, but it's moderate and the portfolio is small. Our portfolio is primarily retail and commercial with nominal direct exposure to hotels and resorts. In Canada, the economic region has been less severe than in the US and not a direct result of the housing market.

In our Canadian banking segment, the increase in CAD81 million in provisions from last quarter is mainly due to higher impaired loans and credit card write-offs. Credit cards specific provisions as a percentage of our average loans is 437 basis points this quarter. The level of provisions is consistent with what we would expect at this point of the economic cycle and reflects a sustained recessionary conditions as well as increased personal bankruptcies. Our Canadian residential mortgage portfolio continues to perform well and with a specific PCL ratio of two basis points, which is consistent with last quarter. The uninsured portion of the portfolio, including secured lines of credit has an average loan to value of 55%. The rest of the portfolio is insured.

In the capital markets, specific PCL increased CAD87 million from a year ago and decreased CAD15 million from last quarter. We took an additional provision related to impaired loans through an RBC administered conduit. These were the same loans I've spoken to you about in the past, most recently in the fourth quarter of 2008. The impaired amount is CAD201 million and we've taken aggregate provisions of CAD121 million against these loans. We also had a few additional impaired loans in our US corporate lending portfolio. Finally, you'll recall that last quarter we took a provision related to a specific prime brokerage client in our Canadian corporate portfolio. This quarter, we recovered approximately CAD100 million, 75% of the provision taken in the first quarter.

Turning to slide 14, let's look at trading value at risk. During the quarter there was one day with net trading loss, which exceeded VaR for that respective day. Both the loss date and the large profit at the end of the quarter arose primarily from credit valuation adjustments, including those for MBIA.

I'll now turn the presentation over to Janice Fukakusa.

Thanks, Morten. As Gord mentioned, we reported a net loss for the quarter of CAD50 million as a result of goodwill impairment we announced on April 16th. Cash net income was CAD993 million, up 4% over last year, mainly attributable to higher trading results, lower market environment relate the losses and higher securitization gains, offset by higher provisions for credit losses and higher non-interest expense. The rise in non-interest expense was attributable to higher earnings based variable compensation, driven mainly by higher trading results and capital markets, increased expenses due to our prior year acquisitions and the stronger US dollar. The capital markets began to stabilize partly through the quarter and resulted in lower market related losses and a lower net unrealized loss position in our available for sale portfolios.

Tightening credit spreads had both negative and positive implications. We had negative adjustments on RBC debt designated as held for trading and on credit default swaps used to economically hedge corporate loans. Positive credit valuation adjustments on derivative trading activities partially offset these amounts. Several new US GAAP standards became effective in November of 2008. These standards require enhanced qualitative and quantitative disclosures regarding our use of derivatives and hedging activities and our continuing involvement with assets for which we've obtained off balance sheet treatments. These disclosures can be found in the US GAAP reconciliation notes of our second quarter consolidated financial statements.

Let me now move on to the performance of our five business segments. Starting with Canadian banking on slide 16, net income was down 4% from last year, reflecting higher provisions for credit losses, continued spread compression, and lower mutual fund distribution fees. We continue to grow volumes across all businesses. Lower interest rates impacted margins on deposits. Slide 17 shows net interest margins decreased over the year and the quarter.

Moving on to wealth management on slide 18, net income decreased 31% from the year ago due to lower fee based and spread revenues. As shown on slide 19, insurance net income was up 9% over last year. This largely reflects lower spending charges, growth in most businesses and an ongoing focus on cost management. Partially offsetting these items were unfavorable actuarial adjustments. Let me move on to international banking on slide 20. The net loss was mainly due to the goodwill impairment and higher provision for credit losses in our US banking businesses that Morten highlighted.

Looking at capital markets on slide 21, net income was up CAD407 million from a year ago, primarily due to higher revenue from our trading businesses along with lower market environment related losses. These factors were partially offset by higher variable compensation, commensurate with the higher trading results as well as higher loan loss provisions in taxes. A large portion of our capital markets variable compensation is based on profits rather than revenues. Revenue only pay outs are more than normal in the investment banking industry. We believe our incentive compensation structure strikes a better balance of risk and payout for our shareholders and employees.

Slide 23 illustrates RBC's total trading revenue. Our strong trading results were increased much of volatility, declining interest rates, wider bid offer spreads and increased client flow. We have higher trading volumes in more traditional, less structured fixed income and currency products such as FX spots, forwards, bonds, money-markets, and interest rate derivatives. At this point, I'll turn the call over to the Operator to begin the question and answer.

Through. (Operator Instructions.) There will be a brief pause while participants register for questions. Our first question is from Jim Bantis from Credit Suisse. Please go ahead.

Hi, good afternoon. A few questions on credit. Morten, one of the ways we continue to look at credit quality and trends is the coverage ratio and I know each banks' reserve coverage ratio is not apples-to-apples comparison and yours slipped to about 68%. Of the GILs you've got, the CAD4.2 billion, how much of that do you think is fully recoverable, i.e. that you won't lose a cent on, to kind of put your coverage ratio in perspective?

Well, let me try to put some light on that. As we talked about in previous quarters, the coverage ratio that we have reflects the asset mix that we've got and our view of ultimate recoverability. The biggest driver of the reduction in coverage ratio continues to be our US banking portfolios and specifically the residential builder finance portfolio, and maybe what I should do is just speak a little bit to the process we have for setting provisions and allowances for that portfolio. It is driven off current view of market appraisal for all of the properties that are impaired. The appraisals are down to industry standards reflecting what's recoverable, assuming disposition for a reasonable time which is not instantaneous for months rather than years, and the resulting provision is one that gets a fair amount of scrutiny internally from our regulators and from our auditors and so the outcome is, to look at RBC Bank portfolio overall, we have a 16% coverage ratio, so when you take that off the total, our coverage ratio gets North of 100% again.

So I'll purposely avoid answering the question directly, because I'll do it indirectly. The provisions we set reflect our best view of the losses that we expect to take, but to the extent that you expect continued deterioration in the economic conditions, there is likely to be additional provisions on loans that are already impaired and the current provisions and allowances reflect our view as of today's market and we actually think it is appropriate, it follows the GAAP and regulatory requirements. To the extent that we end up having a bonding out of the credit conditions and an improvement in overall economic conditions, chances are we will then see coverage ratios improve through increased ability to dispose of assets and a more positive view on what allowance is appropriate for the portfolio as a whole.

But I suspect in the near term your ability to dispose of assets remains difficult?

In the near term, the movement is relatively slow, but I would emphasize that we continue to sell modest amounts out of our build to residential portfolio I guess is the area that people tend to be the most interested at values relatively close to par and we expect to continue to sell assets at discounts that are not excessive but it will be at a modest rate and to the extent the markets continue to deteriorate, really that continues to stay difficult, if it improves, those conditions should become somewhat better. I mean, I think just overall, if you look at coverage on a portfolio by portfolio basis, we are actually comfortable that the provisions and allowances are appropriate and reflect the appropriate level.

Got it. And I remember last quarter you suggested your coverage ratio on the US home builders portfolio was roughly 20%. Is that pretty well the same ratio at the end of this quarter.

What's the question again?

You had stated last quarter, Morten that the reserve coverage ratio on the home builders portfolio was 20%, and has that dramatically changed?

It has fallen somewhat. It's about 16% as we speak.

And is that against the total portfolio or the impaired portfolio?

That's against the impaired. Just for the record I know that is the ratio that the industry looks at. It is theoretically and if you like the wrong metric, I mean this could be the specifics against the impaired and the general against the total portfolio given what the allowance is supposed to reflect, but quarter-over-quarter, there has been some further slip age just given the fact and maybe I should just add, if you look at our US portfolio overall, we had a net increase in impaireds of about 280.

We have taken specific, this is the US wholesale portfolio, you can see it in the supplementals, we've taken provisions of about CAD507 million on the US wholesale, and of the CAD223 million increase in the general, 173 of it was associated with international banking platform and as a result of the in flow and out flow through writeoffs, the net increase to the allowance is about CAD18 million. If you look at our total general of 1.9, something in the order of 30% of that is attached to our international banking portfolio in total, where the largest piece of it would relate to RBC Bank.

Got it. Thanks very much. I'll requeue.

Thank you. Our next question is from Sumit Malhotra. Please go ahead.

Good afternoon. My first question has to do with risk weighted assets. If I go back to the Q4 call, we were told at that time that two-thirds of the sequential RWA growth was due to the depreciation of the Canadian Dollar which fell about 15, 16% in that quarter. If I think about where we are right now in Q3, quarter to date the dollar is up, Canadian Dollar is up 9%. How should I think about the impact on risk weighted assets and how that would further benefit your already strong Tier 1 ratio?

This is Janice speaking so I'll answer that. If you look at the strength of our Tier 1 ratio, about 40 basis points of that was related to the capital issuance, the lower RAA, about 30 basis points was related to lower RAA, and as Gord said in his opening remarks, a significant portion is 20 basis points due to our cash earnings, and if you drill down on RAA, of the 30 basis points, about a third of that would be related to--

30%.

Right, 30% would be related to FX, and with the balance being related to the reduction in RAA, and the effect of RAA management, so that pretty much gives you an idea.

So that 30% number you just quoted, that's for Q2?

Yes.

And the dollar move in Q2 if I'm looking at this right wasn't that much. It was about 3% on spot, so thinking about obviously we've got a long way to go here in Q3, but we've already had a very strong move this month, so theoretically, your capital ratios here look even better if this holding going out. It does work the other way just like it did in Q4 against you?

Just one thing though, I think it's 30% of 30%, right?

I'm with you.

Right. 30 basis points.

Right, 30% of the RAA component which was 30% of the total.

Okay, that's helpful, thank you. One more if I could. I very much understand the loss rate or provisioning rate on Canadian residential mortgages is quite low and certainly still remains that way. When I look at Royal Bank over a longer period of time, the proportion of mortgages on the balance sheet that are insured fit about 25% today. If I go back to the beginning of this decade, it was almost half. I can understand then and correct me if my numbers are wrong there, I can understand lately there's been an uptick in securitization activity that would affect that number but it seems like it's been for quite some time that the proportion of insured mortgages have been dropping on the bank's balance sheet. Can you talk to me a little bit about what the mindset has been in that regard? Is it NIM related? Is it the fact that you don't think the actual default rates are going to be that low so you haven't needed the insurance? Maybe just an idea on what your thought process has been.

It's Dave McKay here. Certainly as we look at our current balance sheet, it would be along the ratios that you mentioned it but when we look at our originations and assets under management, it certainly reverts back to that ratio around 45%, so really, it is. You pointed to the answer yourself. It really is the fact that that is the asset category that normally gets securitized and we originate at the 45% level but we tend to take them off to securitization so when you add back the securitized and look at the total residential book it comes back to that ratio. But there's nothing going on for specific targeting or changes in business that we're targeting. It's all around securitization.

Okay, so that would suggest to me that, well maybe it's just that you use more securitization over time that's driven that ratio lower so I'll check back on that. One more if I could, Marcia if that's okay?

All right, one more.

Okay, thank you. On the call last quarter, I believe it was Gord mentioned an internal cost reduction mandate that was happening within the bank and specifically in the context of Canadian banking. Doesn't look like we saw too much flow through on the expense side this quarter. It was talked about that it was a lot of work being done. We might get some sizing of that in the future. Are you in a position to offer us anything in that regard, how that's progressing or what we can look for on the back half of the year?

This is Janice and I'll talk a bit about that. We're currently in the process of up sizing what we're looking at in terms of being more efficient. The actual initiatives involve simplifying a lot of the process, getting closer to the client and then looking at all of our discretionary spend and including real estate and effectively taking our cost base down but we're currently in the process over the next few months of actually getting everyone to commit to it because the critical thing about this whole cost management initiative has to do with the fact that it's being very business like and all of our businesses are signing up to all of the efficiency targets.

Yeah, but it's Dave McKay. Maybe I'll make a comment about the current quarter, because we are actually quite happy with our performance across cost in the second quarter. They're up 1% year-over-year, just under 1% but we actually drove 12 to 13% volume growth in assets with that 1% growth so we had a very productive quarter with operating leverage around 3%, so in our view, we are managing costs very carefully. We're actually down in FTE from our peak in October from 350 to about 400 FTE, so we're actually driving higher volumes, good revenues with excellent expense control with less FTE and we're managing it very prudently along a number of lines including opening branches without increasing FTE, we're looking at performance management and attrition and managing down our employee base and we'll continue that going forward so I think our cost to revenue performance was very good and showing all of the right trends.

What I would add to that, because just to provide flavor, we aren't going to size it at this point in time but I also don't want people to be left with the impression that this is just a statement that we're going to be more efficient or take costs down and we have a major undertaking going on across the organization. We have some support on some specific initiatives from the consulting side and as Janice says, this is very much business driven and it will bedded into our budgeting process which is finalized to the Board, it will go to the Board this Summer for 2010 and 2011, so while there will be some of it this year, when you look at the magnitude of what we have, what we intend to do over that period of time, this is a very very significant project for the organization.

Thanks for your time.

Thank you. Our next question is from [Steve Hera] from Merrill Lynch. Please go ahead.

Thank you, a couple of questions if I may. The first one, another question on capital on page 21 of the supplementary package. Looking at bank credit risk, if I look at bank credit risk it's down about two-thirds in quarter or getting up on CAD7 billion or if you'd like to look at it this way about three quarters of the total risk weighted asset decline in the quarter so the number had been unchanged for well over a year it looks like, so could you tell us a bit about what's going on in that line, please?

Why don't we take that off line, because I'm having a bit of trouble following what line you're on. You're on page 21?

Page 21 right at the bottom of the bank credit risk with exposure of 43 billion and risk weighted assets of 2.9 billion.

Why don't we take that offline, Steve. We'll get back to you on that.

Okay, that's fine. And another then if I may, again on the set pack on page 26, the non-bank financial impaireds which had been pretty steady uptick quite a bit there to CAD279 million. Didn't see a bump in provisions at all there, so I was wondering if you could get a little color on that, please?

It's Morten. It is on Page 26 where we show non-bank financials impaired for 279?

That's right.

So that relates to one of the larger US capital markets related accounts that was taken through the quarter, and if you flip to the next page on page 29, you see the allowance has also moved up. The reason why the provision on page 28 where you show a net recovery of 10 is showing up is that there are a few moving parts and one of the larger elements is the recovery that I mentioned around the prime brokerage accounts that where we have the provision in the first quarter and about 75% of that moved back during the second quarter and you then have one of the larger provisions for the portfolio move the other way, so net-net, you ended up having in addition to the allowance, saying that provision last quarter was written off, but on the provision line, you don't see the specific number move through because of the other movements back and forth.

Okay, great. Thanks, Morten.

Thank you. Our next question is from Michael Goldberg from Desjardins Securities.

Thanks. How much of the US builder finance portfolio is now impaired, and how big is that portfolio? Can you remind us?

It's Morten Friis again. So the US builder finance portfolio in terms of both what's in the RBC Bank legal entity and what's outside of the legal bank entity itself is currently about CAD2.6 billion. I don't have the precise impaired number in front of me but it is, give me a second, I might be able to get it. So on an impaired basis, we are at around 400 basis points overall in terms of impaired for that portfolio.

Around-- so what do you mean, 4% of it is impaired?

Yes.

Okay.

And that was the legal entity numbers. It's somewhat bigger when you end up including the pieces that are outside would be a bigger percentage, so we would have to get back to you on the total.

It will be much different, because the vast majority of it would be outside the legal entities.

About half of it.

Yeah.

Yeah, Michael, we'll get back to you on that number.

What I'm really trying to get at is how much is already impaired, how much more could potentially go impaired? When I look at your formations, it looks like about half of the CAD1.2 billion of wholesale formations in the quarter came from the United States? Is that correct?

If you look on page 27, you got CAD1.8 billion total new impaired and a CAD1.2 billion o that is wholesale and out of that, you end up having net impaired, well that would be about right.

Okay.

But I would emphasize that we had some additional impaired loans in our corporate portfolio, so not all of it is related to rbc bank or the builder finance portfolio.

Okay. Can you give us some further granularity about those wholesale formations? You know, maybe by Canada, US, US builder, and other international?

So I would say in terms of impaired formations, the more significant growth has been in the US relative to its portfolio size. In the Canadian portfolio, we have seen some movement overall but it's relatively modest, relative to the size of the portfolio. We ended up having a small number of accounts with predictable chunkiness that had a slightly larger provision in our commercial portfolio than we've had in recent quarters although frankly quite consistent with the economic environment, and in the corporate banking portfolio, I spoke to that in my comments and I said we've had a small number of significant accounts with provisions, the securitization conduit and a couple of other corporate connections that had generated provisions from an impaired standpoint. It is a slight negative trend but no dramatic shift from recent quarters.

Okay. And a separate question, Gord, you described the U.S. Retail banking environment to be difficult and given the goodwill impairment, you can't be thrilled with your franchise. Is it realistic for us to believe that you can create a better franchise among the opportunities that are out there in the U.S.?

Yeah, I mean the first thing I'd say, not that I'd end the franchise, but this is obviously a very difficult business, I think with Sheila Blair of the FDIC who says the business model for banking in the United States is broken, and unfortunately, the region we're in which is where there's a lot of real estate component to it, it is a very very difficult environment, so if you look at the performance of our banking business from a PCL perspective, it's pretty much in line with what's happening as you go through sector by sector, and now we have a higher percentage of real estate because of our builders finance business but if you go through the portfolio, Morten has said this, that we're pretty much in line with the industry so it remains a very difficult industry, and hopefully that will change, but one of the challenging parts about the US banking industry when it comes to investments, acquisition investment in particular, there's been very few dollars invested really over the last 15 years in that business, originally because of valuations versus returns and more now because of compounded by the recent crisis, which has been a good return from a shareholder perspective. It's just been a very difficult business.

Now will that change as we move out of this crisis? It will certainly be opportunities for both business models to shift and then they will be investment opportunities as a result of what is happening in the United States as well, but it remains I would say a very stressed industry from a business model perspective, given just the nature of the industry of the high loan loss rate across the industry, margin compression across the industry, it remains challenged, but we do have a major restructuring under way which Jim Westlake may want to comment on, with respect to the existing business model, and then I think in terms of building on that model, as I've said in the past, we want to remain very-- have lots of optionality as the industry starts to restructure, consolidate and unfold going forward, but we've literally been in an 18 month holding pattern and certainly we don't see coming out of that very quickly given the overall environment in terms of opportunities, consolidation, et cetera. But there's a lot of attention being paid to the existing business model and frankly because of some of the stability we are seeing stability provided by RBC relative to some of the other competitors, we are seeing some positive things on the deposit side, the customer side, et cetera, but you're on a treadmill trying to keep up with the credit experience. Jim, do you want to comment on some of the specific things going on in the existing business?

Sure, Gord. I think the one I would add is in addition to being overweight on builders we're a little overweight Florida relative to some of the competitors which has seen some of the toughest stats coming out and I think that it's safe to say that as the US model goes forward there are going to be significant differences in terms of credit availability, in terms of reliance on builder finance, the residential mortgage business, and when you spend so much time talking about PCL, it doesn't ask a lot of those individual initiative toss retool and make sure that we are structured appropriately for what we think the market will look like as we come back up the economic cycle, so we're focusing a lot of attention on our products, on the offerings we have on credit cards, residential, small business, and refining our branch network and bringing our costs in line, so as we go back up the economic cycle we'll have a much better performance.

Thank you.

Michael before you go, it's Morten. I have my sheet here, so the answer is 40% rather than 4%.

I thought it sounded strange.

It was too good to be true but I was reading the number off the sheet.

And that's just the legal entity?

No, that's the overall portfolio. The legal entity is somewhat better than that, but not massively.

Thank you.

Our next question is from Mario Mendonca from Genuity Capital Markets. Please go ahead.

Good afternoon. The increase in PCLs and the domestic business retail I think we can all understand what's happening there. A little bit more on international banking. Jumping to CAD289 million this quarter after it had been level at about CAD200 million, was there something specific this quarter as in the bank, maybe being a little more aggressive and pushing through files or what was it specifically that would cause that sort of 50% bump from one quarter to the next?

Well, nothing specific in terms of actions on pushing things through. It's simply how the portfolios have developed. I mean if you look at the piece that doesn't get a whole lot of attention in this, and you end up having the provisions in the Caribbean moving up slightly, but not significantly, and essentially in international banking, the whole story on the increase is in the RBC Bank portfolio.

So taking that just one step further, if you look at the what you referred to as the troubled areas, you talk about the builder finance which is the CAD2.6 billion, you talk about lot loans of CAD1.1 billion. Is that essentially where like of that CAD289 million, how much of that CAD289 million essentially relates to that call it CAD3 billion or CAD3.5 billion that we just went through the lot loans and builder finance?

We don't provide that level of detail and disclosure and I don't really have it easily available but I mean, if you look at the outside of the builder finance related areas, the largest dollar numbers associated with our commercial and business banking of around CAD50 million, the rest are in the 20s and 30s per portfolio, I mean what has happened over the quarter is that we have seen some further deterioration and particularly in both home equity and residential mortgages and the lot loan portfolio which is in Canadian dollar terms and the fact that we had CAD1 billion which is a loan to individuals that was for purchase for largely home development or vacation home development had also a further deterioration there so those are the more significant areas, but from a file process standpoint, there's no change in how we manage the process. It's reflecting the flow of files that become problematic and how we view them at the time.

Is there anything you can offer in terms of does this take another step function up in the next few quarters or does this--

I try to reflect in the comments at the beginning, if you look at our builder finance portfolio, it is clearly the portfolio that saw the deterioration the earliest and where we're now seeing charge-offs picking up and where the slowdown in deterioration is likely to come first, if you look at the rest of the portfolios, it's largely dependent on the economic environment. If the economic environment is in fact stabilizing you will likely have another few quarters of high PCL, with the possibility of some deterioration, but the level of overall provisioning is going to be driven primarily by the economic conditions that we're facing but if you look at what started out as a CAD3 billion and now CAD2.6 billion finance portfolio, it is the part that is going to see the most of the pain, but therefore will also cease to contribute large numbers the soonest.

And then just finally, in the wholesale segment where you took the PCL related to the multi-seller conduits, I think it's CAD60 million or so this quarter. Is that what you referred to?

I forget the precise number. The order of magnitude, that's about right. I'm sorry, let me see here. Yeah, it's about 60 yes.

Now you referred to CAD2.7 billion of asset backed securities in the US multi-seller along with about CAD1.8 billion. Is there anything you can tell us that would put to rest the notion that there could be a few more shoes to drop at least as far as this CAD2.7 billion of asset backed securities are concerned in the multi-seller conduit?

If you look at our multi-seller conduit business, we've talked about this in previous quarters, this loan of CAD200 million, it is the only facility of its type in this particular type of mortgage related CDL type exposure so in a multi-seller conduit context, we have out of the CAD30 billion plus in total assets, we have I think no more than about CAD1 billion of structured assets of which this particular loan is the only significant loan with mortgage related type CDL exposure.

CAD200 million and it's written down to about what, 100 now?

We've taken cumulative of 121, if you look at my comments in there.

I see it. Thank you.

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

That was a great pronunciation. Morten, just to make sure you're on your game here, so we've got those various pages in the supplemental and the disclosure is very good. When I look at page 28 and you look at the provision, so just to understand this issue on the prime brokerage in and out here, so in Q1, the client filed, you seized the assets, you impaired the loan, you took a charge, so it was 142. It didn't show up in the allowance, so that meant it went straight to write-off and then the next quarter which is this quarter, you had more non-bank financial services credits go bad which drew up the gross impaireds. You reversed some of the previous provision. Is that broadly what happened?

Well, first of all, I'll don't comment on client names but you're right that in the first quarter we had provisions of around 142 of which the majority was related to one specific account.

Right.

So we took the provision, had the write-off, so the provision did not cause an increase in the allowance, and then this quarter, we had recoveries of close to CAD100 million or around CAD100 million on that particular account that showed up as the recovery and all that's written off I guess in accounting language, and then moving against that, we had in what shows up in the same sector on page 28, we had one of the provisions that we took on the US corporate portfolio happened to be in the non-bank financial services sector, so that offset the recovery.

Right. So really, the way to think of it is the 142 provisions in Q1 really should have been, let's say 20, and then this quarter it should have been 120 or something like that or 100, so really, it was in and out where you provided too much, or you were able to get out of the securities that you seize and unwound them when you booked at least this quarter?

I'll let Janice comment on the accounting niceties here but the provision that we took as of the first quarter reflected our view of the market at the time and then working with the portfolio, we then were able to recover the amount that showed up in PCl recovery for the second quarter.

I would have thought that would have been a trading game because it was in and out of the loan book, I mean the impaired loan book and then it became a securities position.

Ian, what we looked at is the fact that we had actually had a change in estimate on the PCL, and that's how we recorded it, so basically, we made an estimate on the PCL last quarter based on prices of securities among other things. We looked at that again and reestimated it this quarter, so from that perspective, the 20/20 hindsight we would have provided less in Q1.

But it's a function of what happened in the market with the portfolio during the quarter. It's a very unusual item but it's because of the nature.

Because of the nature of the portfolio. Yes. The second quick question is it looks as if your credit default swap book is declining dramatically and is there some strategic initiative I don't know if Gord or Morten, it looks as though you're really taking down credit default swaps. Am I right on that?

Hi, Ian, it's Mark Standish. I mean, the answer is yes. What you're seeing there actually is reflective of what we did in the first quarter and any P & L impact from that and that was primarily selling the correlation book up in the first quarter. What you saw in the second quarter is having neutralized the risk, we then went through the fairly labor intensive process of matching off and assigning all of the individual trades, so the reduction of notional you see in the second quarter, there was no P & L impact positive or negative in the second quarter from that reduction. It was all the P & L impact was the first quarter.

And is there an RWA impact from commuting these things?

Absolutely, we've freed up capital and this is part of the ongoing process to put CSAs, netting agreements and just keep cleaning up the balance sheet.

Thank you.

This will be the last question I think we have.

Thank you. The last question is from John Aiken from Dundee Capital Markets. Please go ahead.

Good afternoon. I guess I'll be forced to make this entertaining but you mentioned in your prepared comments about when you talk to your capital levers the opportunities that you saw in the marginal deployment capital, and based on commentary around the US platform, I'm assuming that you're not about to pull the trigger on something down there, but could you give us some insight as to where you think opportunities may lay over the next quarter or two to deploy the capital that is arguably beginning to depress your profitability of an ROE basis?

Yeah, well, John, I mean the first comment I'd make is that I don't know whether it will happen over a quarter or two. We have made the decision that being one of the best capitalized banks in the world is a competitive advantage for all of our businesses, and so in terms of reduction of capital levels, I think that will to some degree be dictated by the environment so I don't want to give anyone the impression that we're going to drive that capital ratio down immediately. I mean, we want to remain extremely well capitalized because we think it's a competitive advantage, but to answer your question specifically, and I'll take a slightly broader answer. I mean, I think that I don't know when we're going to come out the other end of the valley and but at some point as we start to move in that direction, I think you're going to see a lot of very positive things for the industry generally. I mean you're going to have a repriced balance sheet at a much better pricing of credit. You'll see margin expansion because you'll naturally see that happen as interest rates start to move up, and you'll obviously see a very different environment and even potential reversals when it comes to things like marks and provisioning, et cetera.

But in addition to that, given all of the things , given all of the things that have occurred in the marketplace, competitors have exited the shadow banking system. There are evaluations have clearly come down, the pricing of asset levels has become more attractive, and so as you look at each of our businesses, whether it's our banking business here in Canada as well as in the United States, whether it's our wealth management business, whether it's our capital markets businesses, we do think there will be very attractive ways to deploy that marginal capital in each of our businesses and generate much higher returns than perhaps were available over the last number of years where you had significant margin compression, whether it was because of excess liquidity, competition, more competitors in the marketplace, et cetera. So, it's not just that there will be one opportunity out there to buy a bank or to buy an asset manager. I think it will be very much across each of our businesses but I think as we start to come through the valley, having the ability to invest that excess capital will I think put us in a very strong position, and because we think there will be lots of opportunities, as I say even through acquisition or directly in our existing businesses, just because margins will be more attractive, and one of the things that we've intentionally tried to do is make sure that we're well positioned to take advantage of that.

What I can't tell you is when we're going to start to see those or sorry, when we're going to start to get to that point in the cycle where we're very comfortable taking down our capital position, but I do believe that the industry over the long term will not revert to the capital levels that it was at going into this crisis but it will certainly come down from where we are today and I'd rather be in a position of over capitalization today going into the future and the ability to invest and be in a position of

Great, thanks guys. Good to hear your confidence.

Thank you. That concludes our question and answer session for today. I'd like to turn it back over to Mr. Nixon. Please go ahead.

Well, thank you very much, everyone, for participating in the conference call, and we'll look forward to hearing from everybody next quarter. Thank you.