Royal Bank of Canada (RY) 2009 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the RBC Fourth Quarter and full year 2009 results conference call. Please be advised that this call is being recorded.

I would now like to turn the meeting over to Ms. Josie Merenda, Head of Investor Relations.

Good morning and thanks for joining us. Presenting you today are Gordon Nixon, our CEO, Morten Friis, our Chief Risk Officer and Janice Fukakusa, our Chief Administrative Officer and CFO. Following their comments we will open up the call for questions from analysts. The call will be one hour long and we will post managements remarks on our website shortly after the call.

Joining us for the questions are Barbara 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 of Capital Markets, and Mark Standish, President and co-CEO of Capital Markets.

As noted on slide two, our comments may contain forward-looking statements which involve applying assumptions and having inherent risks and uncertainties. Actual results could differ materially from these statements. I'll now turn the call over to Gord Nixon.

Thank you very much, Josie, and good morning everyone and thank you for joining us again for this early morning call. We appreciated your feedback following last quarters early call and I think it was very positive so I think we'll continue with this format going forward. After another challenging year for banks worldwide, RBC stands apart as a globally significant strong and stable institution. In 2009, we generated cash net income of over CAD5 billion, up 8% from last year. Reported net income was CAD3.9 billion down CAD700 million mainly due to the CAD1 billion of goodwill impairment charge that was recorded in the Second Quarter. In addition, last years numbers included the reversal of the Enron related litigation provision of CAD250 million.

This quarter, we earned CAD1.2 billion, up 10% from a year ago reflecting strong performance from Canadian Banking, Capital Markets, Wealth Management and Insurance. Excluding our items the items on slide six our earnings were CAD1.5 billion or CAD1.03 per share. Our ability to deliver strong performance throughout 2009 demonstrates the value of our franchise, the strength of our diversified business mix, our disciplined approach to cost management and our commitment to maintaining a solid financial profile.

Like all institutions around the world, we face significant headwinds through the year from challenging economic and market conditions. Historically low interest rates, high credit costs, writedowns and accounting volatility made for an unusual environment. In response we undertook a number of initiatives to address these external challenges head on and fortify our financial position. We built up our capital base and closed the year with a tier 1 capital ratio of 13% up from 9% a year ago and tangible common equity ratio of 9.2% up from 6.5% last year. We executed on our cost initiatives by containing spend and discovering new ways to be more efficient while at the same time driving growth across our businesses. This is particularly evident in Canadian Banking where we grew our business while reducing costs by 1%.

We exited specific businesses to redeploy capital in areas where we could generate significant returns. For example, we quickly moved to contain certain non-performing capital markets businesses to focus our attention and resources on strengthening our core capabilities and expanding outside of Canada. We also reduced exposure in our available for sale portfolio and as a result our portfolio reflects a net unrealized gain compared to a net unrealized loss that we had in prior quarters. It's worth pointing out that the net unrealized losses in the portfolio peaked at CAD2.1 billion in the first quarter of 2009. Today we have a net unrealized gain of over CAD60 million.

We are now in an extremely strong competitive position relative to many financial institutions around the globe that are dealing with capital constraints, government ownership and new regulatory hurdles. Our strong balance sheet and diversified business model combined with our risk management and financial performance have given us an unprecedented range of opportunities to invest and grow our businesses while others are more constrained. Our pursuit of three long term goals shown on slide eight have guided the plans and activities of each of our businesses for several years and going forward. These goals are in Canada to be the undisputed leader in financial services. In the US to be a leading provider of capital markets, wealth management, and banking services by building and leveraging our considerable capabilities and outside of North America to be a premier provider of select capital markets, wealth management, and banking services in markets of choice. These seven key elements that are the foundation for our strategy. We believe these factors outlined on slide nine differentiate RBC as an organization and create a sustained competitive advantage that we will build on in 2009 -- will build upon our 2009 success and drive further momentum across our enterprise. I would like to briefly review our progress that we've made in 2009 in each of our businesses.

Canadian Banking performed extremely well and continued to underpin our results. Our ability to drive strong results during these current economic conditions speaks to the earning power and strength of our Canadian retail franchise. We generated double digit volume growth across many of our retail product lines. For example, we grew deposits by 11%, residential mortgages by 9% and business loans and personal loans by 8 and 21% respectively. This strong growth was muted by the rise in credit provisions resulting from a weakened economy as well as compressed margins reflecting historically low interest rates. I would once again remind you that each of our reported segments absorbs the full cost of running its business which not only provides an accurate picture of performance, it also incents the appropriate business decisions. Despite these headwinds we increased our market share, expanded our distribution capabilities, improved our overall operational efficiencies on a reduced cost base. I would note our core deposit market share was up 100 basis points and we had record net account openings.

We launched several significant transformational initiatives to enhance sales and service productivities while streamlining and automating processes. This drove an efficiency ratio of 47.8%, an operating leverage of close to 4% this year. Going forward we will continue to leverage our size and scale to grow and drive our efficiency ratio towards the low 40s which should fuel superiority leverage as the Canadian economy recovers. Our results in Wealth Management were down modestly from last year mainly due to lower average fee based client assets as well as spread compression. In this environment we leveraged our strength and stability to build our capabilities by attracting close to 160 client facing professionals across our US and international businesses and enhancing our product and service offering. Our growth in advisors was particularly strong in the US where we are the sixth largest full service brokerage firm at the present in 42 states. We had a record year of recruiting experienced advisors from competitors who were more challenged by market conditions. We continue to be the leading wealth management and asset management company in Canada. Our full service wealth management business continued to extend its lead extending the year with over CAD174 billion of assets under administration.

With the improvement in equity markets and investor confidence in the latter half of 2009 we began to see asset values recover and money flow back into long term funds. As the largest mutual fund company in Canada with 16% market share we continue to lead the mutual fund industry with close to CAD100 billion in mutual fund assets under administration as of October 31, 2009. With our strategic acquisitions over the past few years and the record growth of the number of experienced client facing professionals to more than 4500 worldwide, our Wealth Management segment is in excellent position to deliver strong organic growth. The current environment has also presented significant acquisition opportunities for this business and we will continue to consider suitable transactions outside of Canada in our global asset management and international wealth management businesses. Our Insurance business continued to make solid contributions to our diversified earnings stream and complement our retail product offering. We are unique in that we offer a full suite of solutions for both business and personal clients and we are the only Canadian insurer with an integrated manufacturing and distribution capabilities. In 2009 we had growth in all of our insurance businesses. We also recognize to be more responsive to client needs and added 14 Canadian retail insurance branches to our network. Going forward we will build on our insurance capabilities, deepen client relationships and streamline processes to make it even easier for our clients to do business with us.

In International Banking, our US banking business continued to be affected by the weak economic conditions. We are restructuring this business to improve client service and achieve greater operational efficiency and as Morten will explain, asset quality metrics are showing some signs of stabilization. In our Caribbean banking operation we are successfully integrating the RBTT acquisition with the goal of establishing a common operating platform for growth in the region. Our biggest opportunity in International Banking is a turnaround from this year's losses. Turning to Capital Markets our performance has been truly exceptional with net income increasing 51% from a year ago notwithstanding losses of about CAD650 million after tax from market related activities. While other banks have cut back the capital they commit to this business we have been prudently managing our balance sheet and have continued to invest by attracting almost 400 talented professionals and building teams to strengthen our global capabilities. We are now seeing the results of these initiatives including market share gains across a number of our businesses.

As Canada's only truly global investment bank we have taken advantage of opportunities around the world with approximately two-thirds of our capital market staff located internationally we are able to offer our clients the benefit of both our Canadian leadership and our global reach. In 2009 we increased clients in our investment banking and trading businesses. Most of these clients were outside of Canada which is in line with our global growth strategy. Further, our focused client approach is enabling us to increase our product penetrations with existing customers. Undoubtedly our trading businesses have benefited from favorable conditions throughout most of the year including market volatility and wider credit spreads. However, our success also reflects investments that we have made over the last 5 years that are paying off. We made investments in infrastructure and talent in the US and as a result we have increased market share across several businesses including investment banking, municipal finance and build a significant US dollar fixed income and currency business. In 2009 we became the only Canadian bank to be designated a US primary dealer by the Federal Reserve Bank of New York, allowing us to participate in US Treasury options. This status demonstrates the strengths of our US fixed income trading business and provides us with a broader product offering to better serve our clients around the world.

We are also gaining ground in a number of our global trading businesses and our global data origination franchise. Our fixed income and energy and mining businesses are global leaders. In the latter part of 2009 when markets stabilized and we started to see higher levels of origination activity our leadership position in investment banking was evident. This year we are the number one in Canada for equity and debt underwriting and M&A. Gross underwriting and advisory fees were up 20% from last year and we were awarded a number of key mandates. Looking ahead, trading results will likely moderate from 2009 as volatility subsides and spreads move closer to precrisis levels. Improving market conditions and economic conditions should result in lower writedowns however in our trading books and lower credit losses on our corporate loan book and should provide a better operating environment for investment banking activity. Overall our performance this year was strong and I'm certainly proud of the many accomplishments we have achieved. Nearly all of our businesses performed very well both on an absolute basis and a relative basis to their primary competitors.

Turning to slide 14, we measure our performance against a medium set of medium term objectives that align with our long term strategy. This year we continue to make progress towards these objectives and deliver strong shareholder returns although weak economic and market conditions and the actions to strengthen our capital position certainly hurt our EPS and return on equity. Our defined operating leverage for 2009 was 3.5% reflecting exceptional revenue growth and effective cost management. Overall we achieved strong value for our shareholders with top quartile performance with three and five year total shareholder returns at 8% and 16% respectively. We are maintaining our quarterly dividend at CAD0.50 which we believe is prudent given the current environment.

Looking ahead to 2010 we remain committed to these medium term objectives. With regard to our operating outlook we expect our businesses to benefit modestly from recovery in Canadian and global economies. Credit quality is expected to remain under pressure with some improvement in the latter half of 2010. We project global capital markets will continue to stabilize and credit spreads will tighten further as the global economic recovery continues and access to credit improves. In the next five years, leaders in the financial services sector in my view will be defined by their ability to successfully manage through regulatory reform. Our capital of strength, low leverage ratio and business mix combined to provide a great competitive advantage over other global competitors that will be required to shrink their balance sheets and change their business strategies in response to regulatory changes.

In closing RBC continued to produce positive results in a difficult environment and I'm proud of the way we managed and grew our businesses. I believe our leading market position, diversified business mix, and our prudent actions to address challenges head on and strengthen our balance sheet served us well in 2009 and will continue to be key advantages going forward. Additionally, our strong balance sheet and capital base will enable us to invest in key business areas as well as explore potential acquisitions that meet our strict economic, strategic and cultural criteria. We are now one of the better positioned financial institutions in the world but we are certainly not complacent. If anything our experience in 2009 has reinforced our sense of urgency about improving the way we deliver products and services and insuring our infrastructure is flexible to meet the needs of both our clients and our growing businesses. Throughout these remarkable times what has struck me most is the outstanding commitments of our employees around the world in helping our clients and I would certainly thank them for their efforts. With that I'll now turn the meeting over to Morten.

Thank you, Gordon. Turning to credit on slide 17 to 21, overall provision for credit losses increased CAD113 million over last quarter. Specific provision for credit losses remain elevated reflecting economic the environment but were stable compared to last quarter. The slight increase this quarter relates primarily to our corporate lending portfolio and provisions of CAD28 million was helping from the reclassification of certain impaired available for sale debt securities to loans which I will discuss in a moment. In the Fourth Quarter we added CAD156 million to the general provision predominantly relating to our US banking and Canadian unsecured and business portfolios . This compares to CAD61 million last quarter largely in US banking. The increase in the general provision reflects ongoing weakness in the economies in which we operate despite stable specific provisions this quarter.

This quarter we reclassified certain available for sale and held for trading debt securities to loans in accordance with amendments to the CICA Section 3855. Available for sale debt securities held at year-end that are not quoted in active markets have an estimated fair value of CAD11 billion and includes certain auction rate securities, US non-agency MBS, and government and corporate debt. The majority of the debt securities that aren't coded in the inactive markets remain in available for sale debt securities and fair value exceeds book value or intent to hold until their fair values recover to book value. The fair value of reclassified securities was CAD871 million and are primarily non-agency US mortgage backed securities in our international banking segment. These securities were reclassified as they are not coded in active markets, have previously incurred significant non-credit related losses and we intend not to sell for in the foreseeable future.

As a result of the reclassification these securities will be assessed using the impairment model for loans thereby eliminating accounting volatility related to liquidity discounts. With these changes our reporting is now more closely aligned to US GAAP accounting standards. The reclassification had an impact on our credit quality metrics, most of which are shown on slide 19. Specific provisions increased by CAD28 million in the Fourth Quarter and [CAD67] million for the year. Specific PCL ratio was four basis points higher in the Fourth Quarter and two basis points higher for the year under the reclassification. Gross impaired loans at the end of the year were CAD1.14 billion higher and gross impaired loans as a percentage of average loans was 38 basis points higher. Our total coverage ratio at the end of the year was 61% after the reclassification down from 72% on a pre-reclassification basis. Further details on the reclassification can be found in our 2009 annual report.

Before I go into credit performance by business segment, let me touch on a couple of items I've addressed in prior quarters. Our US insurance and pension solutions business in capital markets provides stable value contracts on bank owned life insurance policies purchased by banks on groups of eligible employees. We no longer originate these policies. For the year, we recognize losses of CAD111 million, almost all of which were related to one contract that is invested in both leveraged and unleveraged strategies. This contract was restructured to remove the economic consequences of an early surrender of the policy by establishing a fixed maturity base and the notional value. The fair value of our estimated payment under the restructured contract at maturity is CAD250 million which has been fully recognized with the loss.

This quarter we also refined our valuation on the specific Monoline insurer to insure we are appropriately served despite near term positive volatility and credit spread and underlying asset values. The near term positive movements resulted in a gain in the Fourth Quarter. To date we have taken significant cumulative credit valuation adjustments against our exposure and believe that we are adequately provisioned.

Turning to credit performance overall this quarter asset quality metrics in most of our US portfolios and Canadian credit card portfolios continue to show signs of stabilization, however our corporate loan portfolio particularly in the US continues to be impacted by the economic environment. In our Canadian banking segment the decrease of CAD26 million in provisions from last quarter was largely due to lower provisions in our business lending portfolio. Performance in the remaining portfolios was consistent with last quarter. Credit card specific provisions as a percentage of average loans remained flat at 467 basis points as loss rates due to bankruptcies remained high but stable over last quarter. In international banking, provisions were flat from the prior quarter reflecting lower provisions in our US banking commercial and residential builder finance portfolios as a result of stabilizing asset quality. Early signs of US economic recovery and lower new impaired loans resulting from a general reduction in the residential builder finance portfolio contributed to the stabilization of provisions. These decreases were largely offset by increased provisions of CAD27 million related to the impaired available for sale securities reclassified as loans I mentioned earlier.

In the Caribbean, provisions increased slightly as the economy continued to be negatively impacted by slowing tourism and rising unemployment. Capital market specific provisions increased CAD43 million from the prior quarter primarily related to a few impaired loans in our US corporate lending portfolio. Looking to 2010, credit quality will likely be driven by economic conditions and will continue to impact our consolidated results as credit losses historically come off the peak one year after the trough of the economic cycle. In Canada, we expect credit quality to remain under pressure with some improvement in the latter half of 2010 as we anticipate the unemployment rate will peak early in the year. Credit quality is expected to be -- to continue to be weak in the US, but should improve through 2010 as we are coming off a high level of credit losses in 2009 and anticipate improvements in consumer and business spending and modest gains in labor and housing markets in 2010.

Further detail on our economic and market outlook is discussed in detail in our 2009 annual report. Turning to market risk, we had one day of large net trading gains which arose primarily from credit valuation adjustments. This reflects improvements in global capital markets and moderated volatility in the latter part of the year. I'll now turn the presentation over

Thanks, Morten. As Gord mentioned our Fourth Quarter net income was up 10% over last year, reflecting strong revenue growth and our ongoing commitments to prudent cost management. We look at our expenses net of variable compensation. Compared to last year our expenses were relatively flat after taking into account the impact of foreign exchange reflecting average depreciation of the Canadian dollar, the full year expenses from acquisitions, and last year's reduction in the Enron related litigation provision. All of our businesses currently have initiatives under way spanning two to three years to reduce our discretionary costs and transform our cost base. Examples of these initiatives include reducing complexity in the organization through process redesign, streamlining work flow to enhance efficiency, and improve the client experience and simplifying sales and service processes through automation.

Before discussing our segment results, I'll touch on a few points. This quarter, we had losses related to available for sale securities which reduced earnings by CAD150 million. Also, a provision related to the restructuring of certain Caribbean banking mutual funds reduced earnings by CAD39 million. As background, these funds were trading at a fixed par value despite changes in the underlying asset values and are now being transitioned to a floating net asset value which is more in line with international standards. We injected cash and provided a guarantee to the funds to allow unit holders sufficient time to adjust to these revised practices.

Notwithstanding these items, we witnessed the continued stabilization of capital markets this quarter with improved investor confidence and more favorable funding markets. As a result, credit spreads for us and many issuers continued to tighten. Credit spreads are now close to pre-crisis levels and going forward we expect to see more normal levels compared to the extraordinary volatility of the past 18 months.

Let me now move to slides 23 and 24 for a look at the performance of our five business segments. Starting with Canadian banking, net income was up 6% from last year and 7% from last quarter, mainly driven by revenue growth across most businesses and very strong operating leverage of 5.6%. Specific provisions were up from last year mainly due to weaker economic conditions but were down from last quarter as Morten mentioned.

Looking at slide 25, you can see we experienced margin expansion from last quarter, largely reflecting improved lending spreads. When the absolute level of rates increases, we should benefit from further margin expansion. Further, we were the last bank to reprice our unsecured lending portfolio so we would expect to see some impact in our margins in the Second Quarter. Moving on to wealth management, net income was 39% higher over last year as last year included provisions related to the reserve primary fund and the auction rate security settlement with US regulators. Higher transaction volumes reflecting improved market conditions were partially offset by spread compression and lower average fee based client assets. Net income was down 4% compared to last quarter mainly due to a lower gain on our stock based compensation plan in our US brokerage business. This was largely offset by higher average fee based client assets and higher transaction volumes reflecting improved market conditions.

Insurance net income was CAD104 million up CAD45 million over last year as last year included investment losses. Business growth largely in our European life reinsurance business also contributed to this quarters increase. Net income decreased CAD63 million from last quarter largely due to unfavorable actuarial adjustments in the current quarter reflecting management actions and our annual assumptions changes. International banking net loss of CAD125 million compares to a net loss of CAD206 million last year reflecting lower market environment related losses on our available for sale portfolio. This compares to a net loss of CAD95 million last quarter reflecting current quarter provision relating to the restructuring of the Caribbean banking mutual funds I mentioned earlier. This was partly offset by lower market environment related losses on our available for sale portfolio and a decrease in FDIC costs due to the special assessment levied against all US banks in the prior quarter.

Net income for capital markets was CAD561 million, down CAD23 million from last year as last year included the CAD252 million reduction of the Enron related litigation provision net of related compensation adjustment. This quarter, capital markets generated stronger trading revenue compared to last year particularly in our US based equity and global fixed income businesses. We also recorded total market environment related gains as compared to losses last year and higher equity origination fees. These were partially offset by higher variable compensation and increased specific provisions. Compared to last quarter, net income was flat. We had lower trading revenues in certain businesses which were impacted by the lower volatility in credit spreads. Offsetting these factors were market environment related gains compared to losses in the prior quarter, improved equity origination activity, and higher M&A fees. In fact our equity new issue and M&A fees in Canada were at near record levels in the quarter.

Slide 26 illustrates RBC's total trading revenue. We continue to have strong trading revenue in traditional less structured fixed income products such as bonds, money-markets and interest rate derivatives driven by favorable market conditions, increasing client activity and tighter credit spreads. Our equity and foreign exchange revenues were lower than last year due to decreased volatility and volume.

At this point, I'll turn the call over to the Operator to begin questions and answers. Please limit yourself to two questions and then requeue so that everyone has an opportunity to participate. Operator?

Thank you. (Operator Instructions) Our first question is from Steve Theriault from Banc of America Merrill Lynch. Please go ahead.

Thanks very much. A question for I think for Mark Standish. Some of your peers in Canada as well as in the US have felt some pretty dramatic normalization effects and interest rate trading but your number held quite steady in Q4 so can you give us an update on your thoughts on sustainability specifically for the fixed income trading division, I saw that the equity number was down a fair bit this quarter. Is it a foregone conclusion that we should see a fair bit of weakness here in 2010, and separately, can we read anything into the higher levels of trading assets in Q4 versus the third quarter? Thanks.

Yes, hi, Steve. Let me take those one at a time. In terms of sort of distribution of trading revenues, probably if I give you some numbers it might help. If I look at the last quarter, trading revenues came from 28% in Canada, 42% in the US, and 30% in Europe and Asia, so I think we've got tremendous geographic distribution in our trading business in particular in our FIC business, as Gord mentioned obviously we expect some moderation in trading revenues. Q4 was a great quarter for us. During the quarter, July was a stronger month relative to October as things have clearly sort of tailed off, but they seem to have, levels seem to have sort of normalized for us and clearly it's going to be a new normal level for us. We continue to see very strong market gains and that is as I said that's a geographic thing, not just a Canadian market thing.

Another way of explaining I think or demonstrating where we are today versus where we were a couple of years ago is since we became a primary dealer in the US in July of '06, we've seen our volume in US Treasuries up over 71% and that's really opened a lot of doors for us with respect to new clients. In the UK for example,, we've seen a tremendous growth in our various trading businesses there in particular, guilt business and we know the market volume numbers, we get those from the Bank of England and the debt office but we're not allowed to disclose them but we can clearly see significant gains. I think a good way of demonstrating that is in October, the British government issued a 2060 gilt issue that was a 7 billion sterling issue and we were one of only four book runners on that deal and that's clearly a huge success for Canadian Investment Bank and clearly gives I think a good indication of where we are in that marketplace, and then in terms of sort of inventory levels, because we are more active today in government securities be it gilt, be it US Treasury to support both of those businesses, clearly we're carrying higher inventories specifically in government securities, be it gilt and be it US Treasury so I think that would explain that.

That's great. Thanks very much.

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

Good morning. Just wanted to follow-up with respect to Morten's comments and I'm looking at page 29 of the sit pack and looking at the acceleration with respect to impaired formations on wholesale and Morten, I'm wondering if you can elaborate a little bit more. You seem constructive on credit cards and certain parts of US banking but the wholesale portfolios both in Canada and in the US continue to have accelerating impairments and I'm wondering if you can give us a little bit of color on maybe sectors that are coming into your watch list, any kind of help here would be helpful.

Sure. I'll give that a shot. I mean if you look at impaired formations, we are up slightly this quarter from last quarter but down from the peak earlier in the year so I think the underlying economy having shown some signs of having hit the bottom, my anticipation is that impaired formations should be stable to hopefully slightly improving as we go through 2010. If you look at the various parts of the wholesale portfolio starting with the positives first, if you look at the Canadian commercial portfolio is actually performing extremely well and if you look at the underlying stats you can see business bankruptcies across the country I guess with the exception of Ontario are actually still showing a downward trend and quite a contrast to what you see on the personal side and I think that has been driving very strong performance both in terms of impairments and loss rates on our Canadian commercial portfolio, so most of the issues that we've had both in terms of impairments and provisions in the wholesale portfolio relates to the US and I think the story on our RBC Bank portfolio is fairly well worn. I think the facts there I think are well understood but we are seeing, we've seen significant improvement quarter-over-quarter in the commercial portfolio within RBC Bank, but overall impairments obviously remain high and I think we've got some quarters to go before we can see significant overall improvements in that book.

The biggest driver of the quarter-over-quarter performance in wholesale has been issues in our corporate book, as I said primarily in the US. I mean the nature of that book is that it's fairly lumpy. We've had as you saw an overall increase in provisions of CAD43 million quarter-over-quarter, paralleling a fairly significant jump in the impaired category in that business. You can actually see on the sector pieces here where from a real estate standpoint, you're seeing better overall assets are down quarter-over-quarter driven primarily by fairly focused efforts within RBC Bank of driving down real estate assets. You've got some issues in non-bank financial services reflecting a couple of quite large loans having gone impaired and I would say as a footnote, some of those have actually been close to fully hedged but obviously we have taken the gains on the hedges prior to that and starting to write the provisions this quarter so from an economic standpoint, you end up getting a slightly distorted view of how lumpy the issues are.

In terms of in flow to our watch list and impaired in corporate banking, it's dangerous to work off snapshots if you like but in the Fourth Quarter, we had a reasonable number of new loans going impaired. The pipeline behind those particular assets is actually very skinny so making a judgment based on an end of October, early November snapshot, the corporate portfolio actually looks like it actually is not showing any signs that they continue to perform at the kind of levels you've seen in this quarter or the previous quarter but given the economic conditions is obviously a fair amount of uncertainty on that. It doesn't take a large number of loans for both provisions and impaired levels to bump back up again but I would say overall, the performance on wholesale in terms of impaireds and provisions reflect a much more negative scenario than my personal outlook is for the next couple of quarters.

Gordon, I appreciate that color. Janice? I just wanted to follow-up, I may have missed this on your comments with the AFS Securities losses during the quarter. I think we're in an environment where spreads have tightened and asked values have increased so I was very surprised to see the losses and you're highlighting it due to market environment so if you can give us a little bit of color on the underlying assets?

Sure, Jim. If you look at our AFS portfolio you'll see we had a category called equities that was significantly under water for an extended period of time and so when we look at the equities in particular some Canadian securities that were under water because of the duration they were under water and the fact they're in liquid markets we made the accounting call to impair those securities so we've significantly taken down the equity risk in our AFS portfolio and that's why you see net unrealized gains there because of the spread tightening on a lot of the fixed income securities and taking down the equity risk.

Got it. Okay, thanks for that.

Okay.

Thank you. The following question is from John Aiken from Barclays Capital. Please go ahead.

Good morning. It looks like in the US banking outside of residential mortgages we're seeing a bit of an uptick on lending volume and Jim, I was wondering if you wouldn't mind giving us what your outlook is for lending in the US on the retail side outside of real estate?

Yes, thanks, John. While certainly we think that most of the sectors have bottomed out and we are seeing modest improvements and I think that Morten's comments are pretty reflective of our view of the market, we certainly think that modest growth would be our expectations, that there's still some underlying economics there that need to improve before we'll see substantial gains.

Great. Thank you, and if I may, Gord, we're sitting at 13% Tier 1 capital ratio and tangible common equity ratio which probably would have been acceptable two years ago as a Tier 1. Is this Royal being ultra conservative heading into a period of regulatory change or is this also an environment where it's difficult to deploy capital as we're seeing risk weighted assets on the credit side actually decline sequentially for the past couple quarters?

John, I think the answer is it's a combination of both. I think that as I said in my comments that I think navigating the regulatory environment over the next couple of years is going to be a major undertaking for all banks around the world and we want to go into that in as fortressed a position as we possibly can because we think it will provide us good opportunities to deploy capital into the future. In terms of that deployment today, as we've said in the past, we're certainly looking to deploy capital in each of our businesses. We potentially would look to make investments if we found ones that were attractive and met our various hurdles and our various criteria. It is a challenged environment to do that given not so much the lack of availability. I would say in terms of opportunities there's probably never been more incoming calls than there are today but given the regulatory uncertainty, given the capital uncertainty going forward in terms of bank measurements, we certainly are going to maintain a very cautious position as we sort of look at different opportunities.

We do think there's an ability to deploy capital as I said, in each of our existing businesses although again, we're doing it each business is slightly different. Capital markets we've had the opportunity to expand and grow our businesses but we've actually shrunk our balance sheet over the last year in that business and again that's been really more a story of redeploying capital. We freed up a lot of capital from aggressively managing our balance sheet particularly in areas like structured credit and so forth where we had -- where we were chewing up a lot of capital in under performing businesses and we've aggressively managed our balance sheet down in those areas, so as we look at the environment today, I think it will be a combination of deploying capital in each of our businesses. Hopefully seeing some good asset growth in Canadian banking and international banking as well as in our capital markets platform. We will look at opportunities but again, we're going to maintain a position of caution simply because we think in today's environment, it's the prudent thing to do and as these regulatory rules start to come into form, as I said in my comments, it is going to force a lot of banks around the world to change their business strategies. We don't think we're going to have to change our business strategy and we think there will be opportunities in each of our businesses to pick up share and to grow opportunities as a result of that restructuring so we want to go into it in a very cautious position.

Thanks. I appreciate that.

Thank you. The following question is from John Reucassel from BMO Capital Markets.

Thanks. Gord, maybe I could ask that question in a little different way. When you look at potential acquisitions out there and whether to do them or not, you're probably going to have to make some implicit assumption on what the new rules are going to be from OSFI. So do you want to share what kind of the higher capital requirements are going to be, your impact on your Tier 1 is 8.5 the new 10.5 or how should we look at that?

Well, I would never speak for OSFI but what I will tell you is that certainly every expectation we have is that there will be greater consistency between standards across the various countries and various regulators around the world and I think that OSFI has made it very clear that as these new international standards are formulated whether it's the new Basel rules, the new Financial Stability Board rules that Canada will be consistent with what happens elsewhere, I think the CAD64,000 question which is difficult to answer is what are those new standards going to be. We are very confident that whatever they are we are going to be very well positioned because of our strong capital position and our low leverage position.

I think there's no question that you'll see a significant increase in the capital cushion required under the new rules, whether that's 2 or 3% incrementally from where it was in the past, very difficult to judge and I would say that there's not necessarily full agreement between international regulators or perhaps more appropriately governments around the world on that issue. I think we'll also see a leverage cap, probably 25 times or in that range but again I would stress that there's certainly not international agreement as to whether there even should be a leverage cap let alone what that cap should be. What we've been emphasizing is that the most important thing from Canada's perspective and I think from a global safety and soundness perspective is level playing field, consistency and simplicity around the world. We should have clearly higher tangible common equity ratios than we've had in the past and I think that will be a new critical ratio going forward because I think both the market and the regulators will pay much more attention to tangible common than they will to Tier 1 from what they've done in the past. We should have a Tier 1 ratio which is obviously significantly higher from where it was in the past but it should be established hopefully with a degree of clarity and hopefully simplicity because it's not just what the Tier 1 ratio is, it's what is the definition of Tier 1 and what's the definition of risk adjusted assets because there's so much discussion going on around whether it's goodwill, whether it's deferred taxes, whether it's counter cyclical capital ratios. The list just goes on in terms of the different things that are being looked at so it's not just the ratio itself, it's the makeup of that ratio.

What we've been emphasizing to governments and regulators is simplicity, consistency and a level playing field around the world and I think extremely important that we have some kind of leverage cap placed on banks around the world because in my judgment, that's probably the single biggest differentiator between those banks who performed well versus those that struggled in the crisis, so that's a long winded way of saying there's still a high degree of uncertainty. The one thing we can assure you is that the world will be operating with much higher capital ratios, lower from where we are today we believe but much higher capital ratios from where we've been and probably a leverage limit somewhere around 25 times and I think on that basis, we consider ourselves well positioned.

And Gordon, it also seeps the regulators are going after things that aren't necessarily capital ratio either. They talk about liquidity, so keeping more liquid assets around the issue of solo capital and I guess the only thing I can come to is that means tax rates may go up because you are going to have less capital in tax efficient jurisdictions. There's systemic risk. Is there also the possibility that you just are going to have lower spreads or lower earning assets or higher taxes and stuff that falls outside of the capital ratios?

Yes, I think the answer is and I actually gave a speech in London a couple weeks ago, it's on our website. I encourage you to look at it. Your question, the fall out from all that and this is the issue that governments are going to be dealing with is it's all, it's great to say that we're going to have significant rule changes around liquidity, solo capital, counter cyclical capital ratios, higher capital, lower leverage, et cetera but ultimately the cost of that would be passed on to borrowers and to the marketplace if banks are going to continue to generate the kinds of returns that are necessary to maintain their credit ratings and to maintain their confidence in the marketplace and I think that's where you're going to see this overreaction and then sort of a pullback to the middle and I'm quite confident we will end up with different liquidity rules, and we will end up with different capital rules and we will end up with different leverage rules, but I think we'll be pushed into more reasonable position simply because if you were to move too far in any of those fronts, I think it would constrain capital on a global basis and clearly that's not what governments would like to see, so I mean, you're right.

There's probably 10 or more different components of capital makeup that are being discussed and looked at by the Basel committee and the FSB committee and various regulators around the world, and it's tough to comment on them with any degree of certainly rather than as I say our encouragement is to move to something in the middle that's reasonable and insure that you've got a level playing field around the world so that the general markets aren't sort of held hostage to the lowest common denominator from a government or banking perspective in one particular jurisdiction. So I do think you'll move somewhere to the middle on this front, but there's a lot of discussions currently under way and this process isn't going to be resolved in two or three months, it's going to be an ongoing process for the next couple of years.

Thank you.

Thank you. The following question is from Darko Mihelic from CIBC. Please go ahead.

Hi, good morning. Just a couple of real quick clarification questions. Morten, I couldn't remember, I didn't hear it. I'm zeroing in on the gross impaired loans in the US division. Can you just remind me how much of that is the builder finance in terms of gross impaired loans?

Sure. So gross impaired loans, you've got in RBC Bank overall, from a legal entity standpoint CAD2.2 billion. In terms of the builder finance, it's 352 within the RBC Bank legal entity and another CAD486 in the real estate finance so whatever the sum of those two numbers are. From an impaired standpoint, it equates to about 45% of our builder finance assets are in the impaired categories instead of roughly stable, slightly up from the previous quarter.

Okay, so what I'm trying to zero in on is when I look at the amount of the impaired loans you have in the entire US international division it's about 2 to 3 times that of say regions BB&T and SunTrust and what I'm trying to sort out and you also have a very low coverage ratio. Now you mentioned that you have stabilization in the builder finance. Should I take that to mean that there were fewer impaireds this quarter or that you're actually getting recoveries?

Well, it's a combination of factors. I mean let me give you a couple of statistics because if you look at the coverage ratio for the builder finance portfolio, it's at about 14% but it's 14% of a written down amount so if you look at our performance in terms of we continued to sell loans or gradually get retainments of loans in the builder finance category so the reduction you've seen in the real estate related assets in international banking is largely a result of all of that. We've been selling, the loans that are going off the books have been going off the books at CAD0.90 on the CAD1 or thereabouts is now creeping down more in the CAD0.75 to CAD0.80 on the CAD1. If you look at where we're carrying these loans, we have written them down significantly so that between writedowns and current provisions, the value on the loans relative to original loan amount is in the mid 60s.

So in other words in terms of where we're currently seeing assets move off the books, we've got CAD0.20 or thereabout of cushion before we run out of room so to speak, so this is a decision that we took some time ago that we are not a distressed seller. We have a focused and fairly deliberate and mildly aggressive approach trying to move the assets off the books. We move them off the books at values that are not to distressed sellers and that's been quite successful and the coverage ratio that we've got we think actually given the written down amount of the loans is appropriate.

Okay, fair enough. I think I'll follow-up with you a little bit later. Just working a theory with respect to the US, but one last question I'd like to sneak in is do you care about anything that's happening in Dubai?

Well, we're naturally interested. I mean we're in the fortunate position of not having any exposure that's affected by this, so from a Dubai standpoint, we have a de minimus amount of bank related exposure which we don't see as at all problematic and we have no direct exposure to the entities that are involved in and restructuring and obviously if it should spread to other parts of the world I would be interested but I don't see that as likely at this stage.

Okay, thanks very much.

Thank you. The following question is from Mario Mendonca from Genuity Capital Markets.

Good morning. Also a quick clarification. On page 29 of your supplement. Looking at the increase in your gross impaired loans I want to make sure I understand what proportion of that increase from Q3 to Q4 relates to the reclassification and I know you've restated it historically because I can see the supplement has changed. What I'm getting at is how much of that relates to those specific securities that were reclassified? Is it that reference you make on page 11 in your press release to CAD164 million?

I think that it is, and I know that the disclosure is a little bit complex on all of the, it's Janice speaking by the way, on all of the transfers because it was retroactive to Q1 for the loan restatement, so why don't we actually take you through that, take this off line and take you through it because we do have a bit of a disclosure map that will sort out all of the numbers for you.

And just real quickly does it go through that line referred to as real estate and related on page 29? Is the 164 I suppose in that line real estate and related? Because that's a meaningful move.

Yes, we'll have to get back to you on that because I don't know the details of that but we'll get back to you, Mario.

Another quick question. Someone referred to maybe perhaps it was you Janice referred to a gain on the monoline in the quarter. Was that a pretty small number I presume?

It was. It's in our disclosure under market environment so what happened with respect to the market environment we referred to a couple of things. We referred to the fact that with the BOLI contract that we had that we have restructured the contract and then the monoline exposure that we have taken effectively gain and if you look at those two being the significant items, they net down to a pretty de minimus market environment impact.

Is that in the press release? Or is that in your MD&A?

It's in the annual MD&A and again, why don't we give you a disclosure map on that because it's in the annuals and it involves a little bit of taking what's disclosed last quarter and taking it but why don't we go through that offline.

We maintain a pretty conservative approach.

Yes, and I think that the point we were making on the evaluation of that monoline is that we've used a modified spread basis based on our own estimate of realization value so we have a fairly conservative valuation methodology in looking at the value of that coverage, given that when you look and you're looking at indicative market spreads you may think that there's a different answer there.

I just want to make sure there wasn't some kind of gain in the quarter that wasn't specified or highlighted but you're suggesting that the BOLI and the monoline issues offset each other?

Yes, all of the market environment issues were pretty de minimus this quarter.

And then very quickly, on expenses, you referred to moving to the low 40s in domestic retail from an efficiency perspective, I think Janice you referred to two to three year project, the bank is on to reduce expenses. What would be helpful to understand is is this one of those situations where the bank works on cutting costs and at some point down the road a year or two years from now we see the expense line change significantly as in drop significantly, kind of like the way it did early in 2005 or is this much more of a gradual thing? Do we see all expenses sort of gradually decline?

Mario, I'm going to ask Dave to answer.

Mario, it's Dave McKay. It's a good question and I think we're focusing really on that productivity ratio and not specifically on the cost line per se, and as we've talked about we have a couple of objectives. One, maintaining positive operating leverage so we do focus very much on cost in relation to our revenue trajectory but as we go through a multi-phase transformational program in Canadian banking where we are looking at our end-to-end business, we're trying to drastically simplify our end-to-end business so it should reduce and lower costs but we always looked at saying can we get that upside in sales productivity so our first objective obviously is to take it in the top line and revenue growth and salesforce productivity but certainly we look at the optimization of our network over time and you can see from our numbers we are down FTE year-over-year as we try to optimize that so it's going to be a combination of both but that's why we're really focused on our productivity ratio and not actually the bottom line cost line as the sole objective.

And do you feel like this is a gradual thing or do you figure the benefits hit at some point?

It will be a gradual trajectory. We've got a multiphased approach. We're well into Phase I. It's going to look at some technology implementation so there will be step downs as we implement new technology that simplifies and takes out some of our manual processes, so I would say it's going to be kind of a step wise process over the next three to four years. But we have a real focus on that low 40s target.

Thank you.

Thank you. The following question is from Sumit Malhotra from Macquarie.

Good morning, this isn't my direct question but just following on what Mario was saying originally, Janice for the gross impaired loans on the debt securities reclassification, you have a slide in the presentation slide 19 that indicates it was 1.1 billion that got added because of the AFS. I thought the 168 or 164 was the amount of the formation. Is that accurate? Am I on the right track here?

Sumit, I think that the gross amount we transferred was actually the face amount of the securities at I'm thinking November 1, right, 2008?

Yes.

So we back that up there and then the GIL formation you would have to look at its spot at the end of Q4, right? So we'll take you through that too. I realize this is a bit complex on the 3855 and some of the disclosures in the earnings release. Some of it is in the annual report so I think that what I'm learning from this is that we need to give you guys a map of what's happening and also address Mario's questions.

Rather than take it off line with one or two we should provide it to everybody.

We definitely will provide everyone with a bit of a disclosure map on every single piece of our disclosure including the sub pack.

Okay I won't go into this but the pre reclassification number 4319, that doesn't tie to where you ended Q3, so I was under the impression that that was where you would have ended Q4 if it wasn't for moving these securities over. Is that--?

That's what it was designed to do but it's because we did restatements in both Q1 and Q4 that there may be a lack of continuity but why don't we get back to you all on that.

Okay then my actual question probably for Gord or Mark Standish might want to chime in on this as well, we certainly all accept and acknowledge and realize the fact that capital requirements for banks are going higher. The biggest surprise to me this year has been the ability of the group to reprice their cost of capital for customers so quickly. We can look at your net interest margin which is up 20, 25 basis points in a couple of quarters. Mark, if you look at something like a trading ROA on that business, you're running at levels that are two times wider than you did in the last six years. As even your largest peers in capital markets are now regulated as banks globally, how much do you think of these wider spreads we've seen whether it's in the credit, whether it's in the market oriented businesses are actually structural more than just a function of low interest rates or wider spreads?

Well, I'll start off Sumit and then Doug will add to my comments. I think this is very much structural and I think that while we're seeing a contraction right now, it's contraction driven by a huge amount of global government stimulus that's come into the market. At some point, that stimulus will have to be removed so I think we're in a new environment where the sort of last couple of years has been taken off in terms of overly aggressive pricing and I do think that we'll be settling into a different environment that will be very favorable going forward. If you look around the globe and that's one of the reasons why I highlighted the distribution of our business geographically, we're extremely well positioned in many markets where there will be a very significant amount of debt issuance and equity issuance as well as advisory work so I think what's happening is playing to our strengths and it's very much structural.

It's Doug. I would just add as well that we're seeing a fairly significant repricing of the loan book and how sticky that will be we'll have to wait and see but I would say that the pre-2007 lending spreads I don't see them coming back any time soon, so there's been significant pick up on the loan credit side in the corporate loan book.

And that's really the take away for me and Gord mentioned the potential impact on risk weighting on their call last week, BMO talked about market RWA being two to three times higher and I think we all get that. The interesting phenomenon here is how quickly the banking system as a whole is particularly obviously I can talk to Canada has been able to reprice that risk capital this year and from what you're saying if your costs are going to be higher, it's probably going to make its way to the end customer as well.

Right. The average term of these loan books is sort of in the 2.5 year range and we've been in a higher spread environment for going on two years now, and so it is largely repriced and any new business we're doing is at more favorable pricing than we saw pre the Summer of 2007. I would say going forward we'll see how that sticks but it feels pretty good now and the customers aren't having, I think, a lot of trouble with it because overall, nominal rates are quite low.

But the structural issue too again coming back to what I said earlier, it's Gordon speaking, is that you still have a world where the banking system has too little capital and too much leverage and in that environment, it's pretty hard to argue that this isn't a structural change that's going to last for a considerable amount of time because a tremendous amount of equity either has to be raised or balance sheet has to be reduced in order to sort of live in the new normal world as we move forward and those dynamics point to a permanency to the structural changes that we've seen happen over the last year or two.

Thanks for your time.

Thank you. This concludes today's question and answer session. I will now turn the meeting over to Gord Nixon for his closing remarks.

I would just conclude by thanking everyone again for their participation and if there are any further follow-up questions, please don't hesitate to call one of us and Janice and others will be getting back on the issue that we discussed earlier. Thanks very much and we look forward to speaking to everybody after our annual meeting in February. Thank you.

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