Royal Bank of Canada (RY) 2011 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the RBC 2011 fourth-quarter results conference call. I would now like to turn the meeting over to Ms. Amy Cairncross, VP and head of Investor Relations. Please go ahead, Ms. Cairncross.

Good morning and thank you for joining us. Presenting to you this morning are Gord Nixon, our CEO; Morten Friis, our Chief Risk Officer; and Janice Fukakusa, our Chief Administration Officer and CFO. Following their comments we will open the call for questions from analysts.

Joining us for your questions are George Lewis, head of Wealth Management; Doug McGregor, Chairman and co-CEO, Capital Markets; Dave McKay, head of Canadian Banking; Mark Standish, President and co-CEO, Capital Markets; Jim Westlake, head of International Banking and Insurance; and Zabeen Hirji, Chief Human Resources Officer. The call will be approximately one hour long, and we will post management's remarks on our website shortly after the call. To give everyone a chance to participate, please keep it to one question and then re-queue.

As noted on slide 2 our comments may contain forward-looking statements which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements.

I will now turn the call over to Gord Nixon.

Thank you, Amy, and good morning, everybody. In 2011 we earned a record CAD6.7 billion from continuing operations, which was up 16% from last year and generated a strong return on equity of 18%. We also had record earnings in Canadian Banking, in Wealth Management, and in Insurance.

This quarter we earned CAD1.6 billion, up 43% from last year or 19% on a continuing operations basis, driven by record earnings in Canadian Banking and Insurance and good results from Corporate and Investment Banking. Within the context of a challenging environment we are very pleased with our 2011 operating results which, notwithstanding the tumultuous markets, exceeded our plan for the year.

While we did have a goodwill charge in the third quarter, as is reflected in our consolidated results, we believe our decision to sell RBC Bank in the United States was the right one for our shareholders and will improve results as we can deploy capital to generate better returns.

It should be noted that under IFRS, which we will begin reporting starting this quarter, there will not be any 2011 goodwill charge to earnings. This will be visible when we release our 2011 comparative financials in January, which will show consolidated earnings significantly higher under IFRS. Janice will elaborate more on IFRS in her remarks.

Moving to slide 5, within the context of an unstable economic condition in the United States and Europe, our objective is to ensure that RBC is well positioned to grow earnings and to take advantage of global dislocations while adhering to our strict risk-management practices and maintaining a strong capital position. To that end over the past year we improved our capital position and we strengthened our balance sheet by disposing of higher risk and lower return businesses that did not meet our financial risk-adjusted return hurdles. At the same time, we sustained momentum across our businesses and reinvested for future growth.

Our capital position remains strong, with a Tier 1 capital ratio of 13.3% and a Tier 1 common ratio of 10.6% at the end of the year.

In 2011 we also undertook a new cost management program to balance the investments required to strengthen our competitive position with the need to decrease the growth rate of our cost base. Janice again will expand more on this in her remarks.

With respect to risk management, we have always taken a disciplined approach to the client and counterparties we deal with, and this hold true for our dealings across Europe. We are a global investment bank and global wealth manager, and through our client-driven businesses we do have some European exposure.

I would note that our exposure to Europe or presents less than 10% of our total exposures. As part of our business, we transact with European financial institutions and corporations, and through our primary dealer activities we participate in auctions of government debt and act as a market-maker to provide liquidity to our clients.

The majority of our exposure is in large and well-rated countries, primarily the UK, Germany, and France. And our exposure to BRIC or European countries is minimal and mainly to investment-grade corporates. There is no question we continue to follow the events of Europe very closely and stress test against various outcomes. However, we are very comfortable with our exposures and remain committed to serving our global clients in these markets.

In fact, given the strength of RBC, we view the current dislocation as an opportunity to improve client penetration and enhance our risk-adjusted returns. We have provided very comprehensive disclosure on our exposures throughout Europe, and Morten will expand on these in his remarks.

Turning to our business performance in 2011 on slide 6, Canadian Banking had a record year with earnings of CAD3.5 billion, just over half of RBC's total net income. These record results were driven by strong revenue growth across all Canadian retail businesses, reflecting solid volume growth, which far exceeded our goal of growing volumes at a 25% premium to the market.

We continue to access more customers through the buildout of our multichannel strategy including branch, mobile, and online banking, and our superior cross-selling ability enables us to deepen our client relationships while profitably growing the business.

We are seeing success in our commercial loan book, and our initiative to refocus this business by leveraging our industry-specific expertise to win new business and grow market share is paying off. In the fourth quarter, we saw commercial loan growth of 8% from the prior year, the fastest rate of growth since 2008. With strong momentum in this higher-margin business, we believe we are well positioned to benefit from market trends that point to slowing consumer demand and a shift to more commercial activity. Our scale gives us an enormous potential to drive further growth and improvement efficiency.

Wealth Management had a record year with over 20% earnings growth. These results were driven by higher average fee-based client assets and increased transaction activity, reflecting improved market conditions in the early part of the year. We continued to invest and strengthen our business because we do see tremendous opportunity over the long term despite the current challenging conditions, including client uncertainty and ongoing pressure from low interest rates.

As many of you have heard at our recent Investor Day, Wealth Management is an important focus at RBC. We have a strong foundation for growth and believe we are well positioned to benefit when market and economic conditions improve. Additionally, we are capitalizing on the current dislocation in the market to attract new clients with our recent global branding strategy, which highlights RBC's strength, stability, and global reach.

Insurance also had a record year, earning over CAD600 million. We continue to experience solid volume growth across all of our Insurance businesses and benefit from lower claims cost this year. Our Insurance business provides innovative and value insurance solutions to clients through our unique distribution strategy and continues to be a key complement to RBC's overall Canadian retail product offering.

Turning to International Banking, our results in the Caribbean continue to reflect some weakness in the tourism industry and local economies. But notwithstanding these pressures, we believe this is an attractive business with healthy margins over the long term. We have a strong franchise, and we are taking steps to strengthen the business for the future, including undergoing an extensive reorganization and branding initiative.

Turning to RBC Dexia, it is important to note that the joint venture has a strong financial position and is well capitalized, independent of its shareholders. Even though the business is operating in a challenging environment driven by low rates and volatile equity markets, it continues to execute its strategy effectively. We like this business and we believe it is well positioned to benefit from favorable demographic trends supporting long-term global growth in wealth management.

With respect to rumors in the market, we are assessing our options and have had ongoing discussions with Dexia, but we cannot comment further at this point.

Turning to Capital Markets, within the context of an extremely challenging market conditions we performed relatively well. I believe our results demonstrate the benefit of our diversified business mix and the increasing proportion of fee-based revenue. In our Corporate and Investment Banking business, revenue was up 20% over last year, demonstrating the growth initiatives in recent years, primarily in the US and more recently in Europe, are paying off. A key element of this strategy has been successfully expanding our loan book to develop new client relationships and deepen existing ones.

Our headcount in Corporate and Investment Banking was up this year, which mainly reflects a number of high-quality hires in the Investment Banking side. We will continue to strengthen our franchise with top talent, especially in the US and Europe, to roll out our client coverage model.

On the trading side, our global fixed-income business continued to be impacted by challenging market conditions. We did, however, take steps to reduce risk and scale the business in response to contraction in this market, and we are already seeing the benefits in this business from these actions. When there is more clarity around European sovereign debt issues and the state of the global economy, we believe improved market conditions will result in a more stable trading environment.

We also anticipate a more favorable competitive environment as some of our global and European banks have reduced their commitment to areas like the European fixed-income markets. In the interim and in response to structural changes in the markets, we are continuing to aggressively manage our balance sheet to optimize capital and to drive efficiencies across the Capital Markets businesses.

Turning to slide 7, while I am disappointed with our current share price, on a relative basis compared to our peers we have delivered top-quartile shareholder returns over the last five years. It is important to recognize that we have continued to deliver strong earnings over that period. As a point of reference, over the past five years our earnings from continuing ops are up over 40% and EPS 25%. But, unfortunately, the banking sector has been repriced by the marketplace, a trend that at some point should reverse itself.

Having said that, we have also seen a reduction in our premium valuation relative to other Canadian banks, largely as a result of a slowdown in earnings in the Capital Markets area over the last year. The strong growth in performance of this business was one of the drivers of a premium valuation during the '08 to 2010 period. And I would emphasize that over the longer term we continue to believe the returns from these businesses will continue -- will be strong relative to other areas of financial services and in line with our organizational objectives.

We remain committed to our goal of maintaining a diversified business mix and generating approximately 75% of earnings from retail businesses and 25% of our earnings from wholesale businesses through the cycle. We believe it is the right mix not only from an earnings perspective but also from a risk-diversification perspective.

In closing, 2011 was a strong year for RBC with record results from continuing operations. Notwithstanding the tremendous global uncertainty, especially in the latter half of the year, we executed well and we exceeded our financial operating goals.

Looking into 2012, we are confident about RBC's financial and competitive position. We expect global capital markets to remain volatile as a result of the European sovereign issues, coupled with US fiscal imbalance and political indecision. But on a relative basis, we believe RBC is well positioned to manage through this uncertain environment.

With respect to regulatory developments such as the new Basel III requirements, as we have mentioned before, based on our current interpretations we already meet the 2013 capital requirements today. In relation to other reforms like the Volcker Rule, the rules are far from finalized and there are many hurdles that have to be overcome from a political perspective. However, we are closely monitoring these developments and working to ensure the business impacts, if any, are minimized.

I believe our leading market position, diversified business mix, and prudent focus on managing risks and costs that drove our results in '11 will continue to be an advantage going forward. Further, our capital strength provides a great advantage over global competitors that face significant pressures to shrink their balance sheets and change their business strategies in response to regulatory change. With that, I will turn the call over to Morten.

Thank you, Gord. Starting with credit on slide 10, overall credit quality improved compared to the prior year and prior quarter. Specific provisions for credit losses from continuing operations of 31 basis points or CAD235 million were down CAD40 million from the prior quarter, largely driven by lower provisions in our Canadian and Caribbean commercial portfolios and fewer writeoffs in our Canadian card portfolio. Total provision for credit losses for discontinued operations of CAD29 million improved CAD63 million compared to the prior quarter due to lower provisions in the commercial loan portfolio.

Gross impaired loans from continuing operations of 78 basis points are flat to last quarter, reflecting improvements across all business platforms except for International Banking, where we had a small increase to the impaired loans in our Caribbean wholesale portfolio.

Turning to market risk, management VaR was down CAD3 million quarter over quarter, reflecting strategic risk reductions in the fixed-income trading portfolios. During the quarter, we had a total of 21 days with net trading losses, reflecting challenging conditions, in particular in August and early September, with improved stability over the latter part of the quarter. We saw higher daily trading revenue volatility as the market reacted to concerns over the European sovereign debt crisis and the US credit rating downgrade. The one day with a loss in excess of VaR reflected the US long-term sovereign credit rating downgrade in August.

Moving on to Europe, our net exposure to Europe is CAD43 billion, and we have provided extensive disclosure of the details on pages 46 and 47 of the annual report. The net exposure number differs from the gross credit risk exposure reported under the Basel II Pillar 3 framework in that undrawn commitments and potential future credit exposure on OTC derivatives have been excluded, and exposures to repo-style transactions and over-the-counter derivatives have been reduced by the amount of collateral held.

On slide 11, the gross drawn exposure of CAD37 billion provides the exposure calculated on a comparable basis for the gross funded exposure reported by a number of US banks. The net European exposure of CAD43 billion includes CAD11.8 billion of trading-related securities and also takes into account CAD5.5 billion of collateral held against derivatives, primarily in the form of cash and cash equivalents.

Our exposure also reflects approximately CAD1 billion of credit default swaps, which is modest, reflecting the fact that we do not make extensive use of these instruments for hedging purposes.

From a country perspective, 60% of our exposure is to the UK, Germany, and France. 3% of our net European exposure is to peripheral European countries. We have almost no exposure to Greece or Portugal; and our exposure to Italy, Spain, and Ireland is minimal, predominantly with investment-grade corporates with limited direct sovereign exposures.

Our exposure in Europe relate to client-driven activities in Capital Markets and to a smaller extent Wealth Management. The activities include loans to strong corporate and individual credits; trading securities related to client market-making activities; collateralized repo-style transactions and derivatives which are well collateralized and marked to market. Exposures also relate to securities supporting our funding and liquidity management.

We continue to monitor market developments and have taken action where we have deemed prudent. We have had a general reduction in the level of market risk and the size of our trading inventories, reflecting both active assistance to reduce risk and the general contraction in the market. We are comfortable with our current exposures and continue to transact in a prudent manner with well-rated counterparties. For our trading businesses, transaction is typically done in a Master Netting Agreement or on a collateralized basis.

With that I will turn the presentation over to Janice.

Thanks, Morten. Turning to slide 13, as Gord mentioned, fourth-quarter earnings were up 43% over last year, up 19% on a continuing operations basis driven by record earnings in Canadian Banking and Insurance. Moving on to the performance of our segments on slide 14, Canadian Banking earned CAD904 million this quarter, up CAD139 million or 18% from the prior year and 6% from last quarter.

These results were driven by continued solid volume growth in home equity products, personal and business deposits, business loans, and lower provisions for credit losses. Net interest margin remained relatively stable compared to last year and the prior quarter, as competitive pricing was largely offset by a favorable shift in our product mix.

Our efficiency ratio for the year was 47.8%. Excluding higher pension costs, our efficiency ratio was 46.2%, an improvement of 110 basis points over last year. On the same basis our operating leverage for the year was 2.4%, up 130 basis points over last year. We continue to strive towards an efficiency ratio in the low 40%s and under IFRS we expect to achieve our target sooner.

Wealth Management reported net income of CAD189 million this quarter. Excluding certain accounting adjustments in the current quarter, which are disclosed in our press release, net income was CAD157 million, down 10% from last year and 12% from the prior quarter mainly due to lower transaction volumes, reflecting challenging market conditions and reduced investor confidence.

Moving to Insurance, we had net income of CAD196 million up 58% from last year and 38% from last quarter, reflecting strong volume growth across most products including CAD26 million before and after tax related to the timing of a UK annuity reinsurance contract and lower claims costs.

International Banking earned CAD12 million this quarter compared to a net loss of CAD7 million last year, reflecting lower provisions for credit losses in Caribbean Banking, improved results at RBC Dexia, and net favorable tax and accounting adjustments. Compared to the prior quarter, earnings were down CAD19 million mainly due to increased costs and higher seasonal revenue in the prior quarter at RBC Dexia.

Capital Markets net income was CAD278 million, down CAD95 million or 25% compared to last year, largely reflecting significantly lower fixed-income trading results which were partially offset by continued growth in Corporate and Investment Banking. Compared to last quarter, earnings were flat, as fixed-income results were impacted by challenging market conditions and Corporate Investment Banking was down from a strong prior quarter, reflecting a weaker issuance and M&A activity.

Turning to IFRS, as Gord mentioned we will be pre-releasing our 2011 comparatives in January. For now, let me highlight some general impacts of IFRS. We have also provided a more detailed summary on slides 15 and 16 of the impacts upon transition, as well as the ongoing impacts to earnings.

From a net income perspective, 2011 consolidated earnings under Canadian GAAP were CAD4.9 billion, which includes the goodwill charge related to the sale of RBC Bank. Under IFRS, the goodwill associated with RBC Bank has been written down through a transition adjustment.

Our 2011 earnings from continuing operations are approximately CAD6.9 billion under IFRS, or 3% higher than Canadian GAAP earnings of CAD6.7 billion, primarily as a result of our election related to employee benefits. Also, our shareholders equity is estimated to decrease on transition by CAD3.6 billion or approximately 9%. Going forward, we have revised our medium-term ROE target upward to 18%-plus to reflect this change.

From a Tier 1 Capital perspective the transition impact will be minimized, as it will be phased in over a five-quarter period beginning in the first quarter of 2012; and our quarterly earnings over this period could also serve to offset the impact.

In addition to IFRS, I want to highlight two items that will impact our capital in Q1 of 2012. The first item relates to changes to the trading book capital rules under Basel 2.5, which many of you are aware of. Based on our current estimate, the resulting impact to risk-weighted assets will be an increase of approximately CAD14 billion.

The second item relates to the capital deduction for investments in Insurance, which will move to 50% Tier 1, 50% Tier 2 deductions from 100% Tier 2 deduction today, as prescribed by Basel II. As a result, we expect these two changes combined will decrease our Tier 1 Capital ratio by approximately 120 basis points in Q1.

Before we open the call for Q&A I would like to make a few remarks on cost management. As Gord mentioned, expenses are a key area of focus, and earlier this fall we announced a new cost program. To provide some context, let me explain how our cost program is different from programs we have undertaken in the past.

With Client First in 2004, we focused on front-office productivity and flattened our organizational structure. In 2009 we took a bottoms-up approach with individual businesses and platforms. With our new program, the goal is to reduce our expense growth both at the enterprise and segment level.

We have had a large buildup in investment across our businesses, so the focus is getting our run rate of expenses down to where we have always targeted -- an operating leverage of about 3%. There will be some fluctuations on a quarterly basis, but that is our intention over the next three to five years.

We believe this program will provide the necessary levers to dynamically manage the trajectory of expense growth against revenue growth, while making prudent selective choices that balance the investments needed to foster future growth.

At this point I will turn the call over to the operator to begin the questions and answers. Please limit yourself to one question and then re-queue so that everyone has an opportunity to participate. Operator?

(Operator Instructions) Robert Sedran, CIBC.

Hi, good morning. Gord, when I think about your earnings power, the first quarter of this year seems like a bit of an anomaly against the rest. But the last three quarters, CAD1.03 to CAD1.11, do you see that as a -- on a core basis I guess, do you see that as a reasonable run rate from which to grow?

And if I missed it in the materials I apologize; but is there any earnings target growth rates that you are disclosing for next year?

The only one that we would provide is our medium-term objective, Robert. I think in terms of run rate, I think when you look at the year and you segment the various businesses, as I referred to in my comments I think the one business clearly that was impacted by the markets more than others was the Capital Markets business. I think to some degree the growth rate of that business will be reflected based on how markets stabilize and unfold going forward.

As we highlighted in our remarks we have taken some pretty aggressive steps to restructure that business. If you look at the mix of revenue -- trading versus investment banking, etc. -- we have made quite a shift over the last year or a year and a half. I think going forward that positions us very well in terms of the dynamics of that business.

I think when you look at the other businesses, we provided a detailed breakdown with Wealth Management on the Wealth Management day. When you look at where we are with respect to Insurance and particularly Canadian Banking, I think our projectile going forward is pretty strong and consistent with where we ended the year.

Of course, International Banking will change as a result of the transaction in March. I am not sure whether I have answered your questions specifically, but --

Well, maybe I guess to look at it a different way, with the 18% ROE target, interesting to see an ROE target going up. Are we basically saying that you're comfortable that capital regulations will not be far beyond the 7% minimum that Basel III is requiring?

Yes. No, the ROE target going up is reflective of the fact that under IFRS our capital levels go down slightly. So it is more of a mathematical change as opposed to an objective change. We want to maintain consistency with where our objective was.

In terms of the capital levels going forward, if I -- again if you are asking what do we think we'll -- where do we think we will end up relative to Basel? I mean I think the Basel minimum of 7%, that is the requirement of the Canadian banks by 2013. As you look out to 2000 -- going forward from that it will be the minimum plus some degree of cushion and some degree of increment, reflecting the fact that the Canadian banks will be, quote unquote, national SIFIs, however that is defined. Our expectation is that that buffer is probably going to be somewhere around 100 basis points.

Thank you.

John Reucassel, BMO Capital Markets.

Thanks. For you, Gord or maybe Doug or Mark, could you talk a little bit more about the changes in your approach to Capital Markets? I assume you're particularly talking about Europe.

Are these tactical changes or strategic changes? Talk more about it and just give us some idea; are you pruning traders, hiring bankers? What exactly is happening?

Well, what we have been doing really is we have been hiring bankers. So that if you look at our headcount we are up about 200 bankers; about 130 of them are in the US and the balance are in the UK.

Really, the theme is we came into this market with a reasonably small loan book, and we have been resizing the loan book based on the size of the Investment Banking capability and also the capability of the trading platform. Really what we are trying to do is add new borrowing names.

And in terms of borrowing names, we have got an increase of about 20% year-over-year on our loan book of borrowers, and a similar increase in our authorizations. We are really focusing on strong customers in the US, a smaller number of strong corporate customers in the UK, and really just trying to grow the origination business so that we can bring new issue debt, equity, M&A and other business.

So the traction in the US has been extremely good, and I would say that the opportunity is still quite good. Because it is just a very good time to be a Canadian bank trying to expand your business in this area in the US and the UK.

So are trading functions more -- trading activity more closely aligned with origination as opposed to standalone function? Is that --?

It's Mark Standish. That's exactly right. That has been part of our strategy for the last three years is -- as we grow the origination to concentrate sales and trading resources around those names and around those clients. We have been reducing headcount in London and to a lesser extent in New York; but we have been adding headcount in Asia, specifically in Hong Kong.

We have made very significant reductions to inventory levels and to the value-at-risk that we have in the various centers, mainly because obviously the current environment and because the nature of the markets are changing.

In London, for example, the primary dealership model seems to be moving more from an auction-type model to a syndicate model, and that requires less inventory to support trading activity.

So as I look at the past quarter, August was extremely weak and we have seen quite significant improvement through the quarter in part because of the changes that we have made. And it is more of an agency model today, and that is how we see it going forward.

Okay, great. Thank you. Janice, last is -- the market risk-weighted assets look like they were down about 20% in the quarter. Did you move to some new models there, or what happened?

What we have done in RWA is we have reduced on the trading side in our rates and credit business, we have reduced it by about 25%, and then elsewhere around the globe by about 21%.

Thanks, Mark.

Steve Theriault, Bank of America Merrill Lynch.

A couple of follow-ups maybe then for Mark and Doug maybe to start. Clearly the environment can turn on a dime; but given the changes that Gord alluded to and then Morten alluded to, and then I think you expanded on, is it still reasonable to expect that CAD700 million to CAD900 million of quarterly trading is reasonable in a relatively well-functioning environment, whatever that means these days?

Then just to Gord, to follow up on Rob's question, did you mean to imply that you foresee managing towards a Tier 1 Common? Or that 8% you would see as a minimum targeted level, and you manage at some sort of buffer above 8%? Sorry to be picky there.

Yes, in terms of Q1, which is where we came out with that range, we're in a totally different environment today than we were there. Obviously, the increase of issues around the sovereign debt crisis, but also we have experienced in the markets issues around the US debt ceiling, and a lot of uncertainty and deleveraging of bank balance sheets globally, and clients have stepped back.

So it's a very difficult in this environment to predict what it's going to look like in the short or medium term. So therefore coming up with a range I think would be somewhat meaningless.

All I would say is that because of the changes that we have made we have seen through Q4 a significant improvement from the beginning of the quarter to the end of the quarter, which looks like it is continuing. And on the positive side, what we are finally seeing is our competitive position in markets improve. So we are finally starting to see some of our competitors now finally pulling back.

So while I expect to see the environment remain very difficult I would expect to see our competitive positioning improve as we go forward.

Yes, I think to follow up on the other question, I think we are managing today towards the 7% -- which we already exceed -- 2013 minimum. And then whatever the buffer will be on top of that as imposed by the regulators I think is a pretty good number to manage towards. You know, you may have a slight buffer above that just to ensure you have got some flexibility; but when you look at the conservative nature of those numbers, our expectation and indications are certainly that that is -- we are not going to be managed towards significantly above that number.

Peter Routledge, National Bank Financial.

Thank you. And thanks for the detailed disclosure on Europe in your annual report. You have set the standard for that.

Just on Europe, I am hearing maybe some pruning and some prudence in the interim period in Europe, which I understand why you are doing that. But I guess my question is more why would Royal Bank at this time stay as committed to Europe as it appears to be.

We've got more volatility ahead probably. And the marginal incremental earnings, if things all play out as hoped, seems to be, well, marginal. Yet there still remains a fairly asymmetric downside if things go wrong, just given the scale of your operations there -- notwithstanding the fact that you are managing it down in the interim.

So I guess the question is just -- why stay as committed? Why not just make a bigger strategic pullback, go to the US or Asia?

Well, firstly, I would say that one of our biggest businesses in Europe is Wealth Management, and the competitive position of that business in some respects has never been stronger. Because Europeans are looking -- if you look at that business, we manage capital and trusts and investments for people around the world, including Europeans. And when you look at the strength and stability of RBC, we see that as a very large growth opportunity, and we are seeing inflow of funds and opportunities as a result of what is going on in Europe.

So when you look at the Wealth Management space, which as I say is a relatively big business over there, the environment is extremely positive.

When you look at -- I'm going to turn the Capital Markets question over to Mark and Doug, but as I say, we have significantly restructured our business over there to reflect, if you will, the dynamics of that marketplace. There are good opportunities in certain areas, like the Capital Markets side. But on a relative basis, if you look at the size and scale of our North American business it is significantly higher and we have been investing in it.

Yes, in terms of the Capital Markets business, most of the growth has been in the US. We have been building out the European equity sales and trading and Investment Banking origination capability. But I would say 95% of that is UK-centric, first of all; and second of all, in terms of our revenues, it is still a small part of our business.

But the competitive opportunity we see as reasonably good. I mean there are a number of competitors in the UK that are just struggling and not able to provide capital to investment-grade customers who do business around the world, and it is a window for us.

So I wouldn't say we are particularly aggressively growing in that market. And as Stan or Mark just said, we have been taking some capital off the trading desk there and things have come around nicely. But on the origination side I think we will stick with what we have; and we may grow it a little bit more, but over the last couple of years it has improved dramatically for us.

Put differently, if you weren't as big in Europe -- I mean every bank has asymmetric exposure to Europe, whether they are there or not right now. If you weren't in Europe or if your operations there were much smaller, would it change much of that asymmetry? Or is it just not an incremental difference maker?

Well, for us two of our core businesses are energy and mining. We have always had a global -- or we have had for a number of years a global energy and mining business. I think it's important to be represented in Europe on the sales and trading, research, lending side to service those customers.

In addition, we've had a legacy strong infrastructure business that we have supported. So now really the incremental growth is just a couple of other industry sectors.

Yes, in terms of Fixed Income, over the last six months we have dramatically refocused that business, really narrowed its focus around the origination activity.

In terms of the SSA business -- the sovereign, super-nationals, and agency businesses -- obviously right now that is extremely quiet, but we do expect that to return at some point. And distribution of that product is a very global business.

So we do think that will come back; and as I said earlier, I think that is going to back in a more dealer-friendly mechanism than it has been in the past.

I do think it is really important to, in that question, to emphasize how the business is changing over there. As Doug alluded to, when you look at the businesses that we are growing, they are largely lower risk related businesses. I mean advisory, new issues, etc.

As I say, the Wealth Management business is our largest business by headcount across Europe and, again, very much geared or benefiting to some degree from that dislocation. So it's very important in terms of answering that question that you put it in context, the areas where you are seeing growth relative to the areas where we are paring back such as the trading side -- which as I said last quarter, part of that market will return, but part of it is a permanent structural change.

Thank you very much.

Mario Mendonca, Canaccord Genuity.

Good morning. Looking at your Basel III ratio, the pro forma Basel, you have told us that it is above the 7%. Even if we put in the CAD14 billion or so in Basel 2.5, it would still appear that that ratio is bumping up against 8%. And you can certainly correct me if I am wrong on that, but it seems plausible.

What I am getting at is, when the bank sits down, when the senior folks sit down and look at your bank three or four years out, you can make a reasonable argument that that ratio starts to look -- would be well above the national SIFI buffer that you alluded to earlier, Gord.

Right.

So when you think about your bank, how do you absorb that capital? I don't mean this to be a softball, but it's a real practical issue.

How do you absorb that capital? Is it organic RWA? Is it acquisitions? Or even do we start talking about buybacks again one day?

You know, it's a nice question in that I would rather answer that question than the flipside of it. To some degree you have answered it. I think it is a combination of all three.

We have always said -- and I have said this for 11 years now -- that part of our primary responsibility is to deploy our excess capital in an effective manner -- and there is essentially three ways.

Into our existing businesses, and that remains a very strong priority because historically we have always been able to generate very high returns by investing into our existing businesses. Acquisitions is another alternative; and we are going to remain very conservative on the acquisition front because of the uncertainty that exists around the world. As I said before, we might do something in an area like Wealth Management which carries very low risk and we believe good opportunity, as George talked about a month or so ago given the brand and the nature of what is going on around the world.

And then finally, repatriation of capital, which is dividends and potentially share buybacks. Again, we have been operating in this environment; it has been a bit of a catch-up game because while I would arguably have always been on a relative basis very well capitalized, you have had this bar going higher and higher as a result of Basel and as a result of regulation. So all of the banks have been, if you will, accumulating capital to get to whatever the new levels are.

As you said, we are pretty much there as we sit today; so going forward we will invest in our businesses. We may make some acquisitions and we will look at repatriation of capital as an alternative to that as well going forward. I think we will be in a much better position over the next couple of years than we have been over the last couple of years, where we have had this catch-up required from a regulatory perspective.

So in making that call, the allocation call between those three items, what metric is an important one to look at? Is a ROE, wanting to maintain something like 18%-plus? Or does that factor in? Would you be content to see that drift lower?

You know, from an acquisition perspective in the short term, we would always accept a slightly lower return than our 18% ROE threshold provided it was strategic and continued to generate long-term growth and got you back to those sorts of levels over a long period of time. Obviously if we only looked at investments that generated those kinds of returns we wouldn't be looking at a lot of investments.

Right.

Having said that, as I said, I think discipline around returns is extremely important and going to be rewarded by the marketplace. Some of the decisions we made around things like US banking was driven very much by a view of what sort of future returns could we generate from investing capital in those businesses versus other businesses.

So when we look at investment opportunities we use the obvious metrics that you would expect -- internal rate of return, are we earning our cost of capital, what is it doing in terms of generating earnings per share growth over the next 12-month or 24-month period. We have certain internal metrics, and we will continue to use those and, I would like to think, be very disciplined around that process.

Thank you.

Gabriel Dechaine, Credit Suisse.

Good morning. Just on the FIC and the strategy there, can you list the activities or businesses that you are pulling out of?

And will I notice a beneficial impact on your ROE or Basel III ratios because of this pullback? Because it certainly looks like the trading assets, the decline quite substantially in this quarter, I am wondering how much of that was attributable to the pullback in certain activities and what is left to pull back on as well.

Then on the Europe exposure, thanks again for that disclosure. Would you be willing to tell me the unrealized loss or gain position on the CAD9.5 billion of AFS securities in that securities portfolio?

Okay, so on the FIC side we have been doing a number of things. Globally we have been looking at where we can consolidate activities. So where we might have been trading certain products in different centers we've been pulling that into one center, which has had an impact primarily in London but to a lesser extent in New York.

We have taken a fair amount of RWA out, as I mentioned earlier. A couple of things have happened. Firstly, as I said earlier, we don't need as much inventory to support what we believe the new model is, to support our clients. So whereas before, where you take down primary product, as you distribute that you would have to take back in secondary product. So you would end up building up spread positions on your balance sheet. Going forward, we see less of that.

And then secondly we have narrowed the focus of our business. So in the credit space, we are trading a lot less names than we did before, and I would describe that now as being much more narrow but much deeper in the trading of those names. So we are able to turn over product much more frequently with clients, and we are seeing actually very good results from the change in strategy.

So will there be a beneficial ROE impact to these adjustments?

Yes, I mean we believe that going forward, even though the overall level of capital has increased under Basel 2.5 against trading businesses, we believe that going forward running the business this way will require less capital in a higher capital environment than we had before.

Right. That trading asset level now, is that somewhat what you expect to be running at on a normal basis? Or does it have further downside?

It might have a little downside, but a lot depends on really the overall market environment. But if we stay in this sort of environment we are today there might be a small amount of additional further reduction. But I think we are probably at levels that make a lot of sense and recent performance is justifying that.

Okay.

It's Morten. On the available-for-sale portfolios, I think if you look on page 103 of our annual report, you see the reported total AFS portfolio. So I don't have the detailed breakdown on the European subset; but if you note there we have gross unrealized gains of CAD646 million and gross unrealized losses of CAD503 million. So we are in a net gain position.

The European component of that would be a relatively small portion of the total, but I don't have the specific breakdown for you.

Directionally, is it a net loss position, or do you even know that?

Off the top of my head, I don't, but I believe it is fairly balanced between gains and losses even for that portfolio.

Okay, thank you.

Michael Goldberg, Desjardins Securities.

Thanks. A couple of questions. First of all for Janice, how are you planning to implement the expense management program? Is there a productivity improvement plan, hair-cutting expenses at the outset? Or is it more along the lines of continuous improvement?

Thanks, Michael. It's a bit of all of the above in that to implement the program, depending on where we sit with respect to the platforms, the expense mix is different. So when we look at our core retail platforms like Canadian Banking, it is a longer-term goal of looking at improving efficiencies end to end, requiring some investment and a lot of simplification of processes. So that is a longer-term program, but there is a line of sight at the initiative level on each step we need to take to get the benefits.

If you look at some of our capital market sensitive platforms like Capital Markets and like Wealth, in addition to that longer-term structural takeout, you will see more takeout and belt tightening across-the-board in terms of rightsizing some of the businesses. Some of that is taking place in connection with the some of the economic environment that we are operating in the different geographies.

So it is all of the above. There are defined targets. And the program is all about reducing the rate of growth of expenses, so it is about getting our run rates down to a reasonable expense growth. that is more responsive to how our revenue flows are taking place.

So it is more about reducing the growth and getting agility in our expense base to mirror the flows of revenue, so that we can continue to drive very solid earnings growth.

Okay. I have a second question on slide 24 from the presentation, the various components of Capital Markets trading revenue. This past quarter you had CVA and DVA contributing to the improvement, as well as BOLI I guess coming down.

Could you -- I can figure out what drives the DVA component, but can you just clarify the factors that would drive the BOLI and the CVA?

Yes, I will answer certainly on BOLI. As you know, we restructured our contract two years ago with a seven-year life, so we have five years left to go. We have essentially a forward in place. The assets supporting that forward contract are performing very well and are very stable.

But what you are seeing here is P&L that is reflective of a fall in the reinvestment rate as cash flow comes out of those assets. So there is some exposure to falling rates here.

But we're at the point where we are unlikely to see, I think, rates fall much further. So I would be surprised to see more negative numbers there; and obviously if rates increase we would see that turn around a bit.

Michael, it's Morten. On the CVA, I guess I'd just make a couple comments. In addition to whatever risk-management actions we have taken during the quarter, the one management action that had some impact on CVA was that we did have a change to some of the parameters in the CVA calculations that were implemented in September. This was a modification to modify the recovery rate assumptions in the CVA calculation, basically setting those parameters to be identical to the loss in event of default parameters that we use for Basel II purposes, with the exception that we do have a higher floor than what the Basel II parameters set for sovereign and related risks.

This is really recalibrating the -- and getting better granularity and consistency with how we do the broader risk calculations across the bank for the CVA. So that had the effect of reducing the volatility somewhat and improving relative to previous quarters the CVA number.

But I would emphasize that that actually is a methodology improvement that is -- it puts us better aligned to how we do the broader calculations across the firm.

But just to clarify, did that methodology improvement increase in the CVA? And if so, by how much?

If you look across the book, the impact was to increase the CVA for some subsectors, improve it for others. Net-net methodology-over-methodology it is a slight improvement quarter-over-quarter.

So it's only -- well, so the sequential change is about CAD80 million. How much of the CAD80 million would be that methodology change in total?

It is not a large amount. I think if you want to pursue it further, I think we should take that discussion off-line.

Okay, thank you.

Darko Mihelic, Cormark Securities.

Hi, there. Thank you. I just went to try and handicap the worst-possible case for the Volcker Rule implementation. Gord, you once mentioned that proprietary trading was about 3% of total revenues. Is that still an accurate gauge?

What kind of efficiency ratio would I use against that, to handicap where you would come out if Volcker Rule worst-case were to come to pass?

When you look today -- and again, part of this is restructuring -- proprietary trading represents less than 2% of revenues; earnings represent less than 1% of earnings -- or proprietary earnings represent less than 1%. And even with the Volcker Rule there's parts of those businesses that will be and won't be impacted.

So we try to -- Doug and Stan can elaborate, but we have tried to manage to a level where we think we -- as I said in my comments, it could have a minimal impact and there may be some things that we'd have to restructure.

But it is much less significant than perhaps it would have been a couple years ago. I don't know whether you want to elaborate on that, Doug or Mark.

Well, I think to your earlier comments, we have had -- just as an example, we have had an increase in the run rate of our loan book revenue that is roughly equivalent to -- the increase to the loan book revenue is roughly equivalent to what we -- our revenues in the prop book. So the business mix has definitely shifted. I think, Stan, you want to comment on --?

Yes, there is a lot of uncertainty out there. And to Gord's comments earlier, I think we just have to wait and see how this plays out. The initial draft from the Fed had a lot of issues in there that were clearly significant to every bank in capital markets given the extraterritoriality of the way they have laid it out.

There were 400 questions in the release, so I think it is going to be some time before we get a better handle on it. And quite frankly, not just the impact to proprietary trading -- which at this point, as Gord said, is a small number for the firm overall -- but its impact to the customer flow businesses -- fixed income and currencies, for example. So we will just have to wait and see.

Okay, thanks a lot.

Cheryl Pate, Morgan Stanley.

Hi, good morning. Thank you for the disclosure on the European exposure. I just have a couple clarification questions.

First, if you are looking at, for example, the financials exposure in the UK, for example, would that relate to foreign branches that have a foreign bank within the UK? Or should we think about it more holistically as UK bank exposure regardless of location?

It's Morten. It is predominantly UK financial institutions as opposed to foreign branches of UK. We have classified this on a country of risk basis for the net exposures. To the extent we are dealing with non-UK financial institutions through our London operations, it would show up in the respective countries.

Okay. So it should roll up to where the parent entity is.

Yes.

Okay. Then just secondly on the Belgian exposure, can you help us think about how much of that is Dexia-related versus other financial institutions?

For Belgium, the securities-related exposure, a large portion of that would be Dexia related. But there is some through our other -- through our fixed-income trading and our lending activity. You will see some small numbers there as well. And the derivatives exposure would be largely non-Dexia.

Then in terms of the Dexia-related exposure through RBC Dexia -- or direct, for that matter -- a large part of that is in fact government guaranteed Dexia securities or exposure.

Okay, thanks. That's helpful.

Thank you. This concludes today's question-and-answer session. I would now like to return the meeting over to Mr. Nixon.

Thanks very much. I will just wrap up quickly. I am going to take a liberty here. Poor old Dave McKay feels like the Maytag repair man, having not received a question. I would just like to close by highlighting the fact that this has been a spectacular year in Canadian Banking, a record by all measures. And as I say, our primary objective in that business -- to outgrow the marketplace by 25%, and to have achieved that with stable NIMs is something that we are particularly pleased about.

Certainly when you look at that business and you factor in some of our other retail businesses like Insurance and Wealth Management, it is a very strong story. So I am taking the liberty and closing on that note.

Appreciate everybody's participation and look forward to next quarter. Thank you very much.

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