Royal Bank of Canada (RY) 2016 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the RBC 2016 first-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: Dave McKay, President and Chief Executive Officer; Janice Fukakusa, Chief Administrative Officer and CFO; and Mark Hughes, Chief Risk Officer. Following their comments we will open the call for questions from analysts.

The call is one hour long and will end at 9 AM. To give everyone a chance to participate, please keep it to one question and then requeue. We will be posting Management's remarks on our website shortly after the call.

Joining us for your questions are: Doug Guzman, Group Head Wealth Management & Insurance; Doug McGregor, Group Head, Capital Markets and Investor & Treasury Services; Jennifer Tory, Group Head Personal & Commercial Banking; Zabeen Hirji, Chief Human Resources Officer; and Bruce Ross, Group Head Technology and Operations.

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 Dave McKay.

Thank you, Amy. And good morning, everyone. RBC had a solid first quarter in an operating environment that was challenging for both us and some of our clients. We delivered earnings of CAD2.4 billion, flat from a strong first quarter last year.

Our results reflect strong execution of our growth strategy. We continue to build our core client franchises while managing expense growth. We closed City National which had robust first-quarter results. Even after making the largest acquisition in RBC's history we maintained a strong CET1 ratio of 9.9% through effective balance sheet management.

I'm pleased to report that this morning we announced a CAD0.02 or 3% increase to our dividend, bringing our quarterly dividend to CAD0.81 a share.

Before I comment on our business segment performance, let me share some views on the macro environment. Market conditions were volatile during the quarter given concerns about the outlook for global growth and the fluctuating price of oil. These periods of volatility are challenging for our clients but I would highlight that most major economies are expected to grow this year.

In Canada, we continue to believe that pressure from low oil prices will be largely contained to oil-exposed regions, and that strength in other regions will support modest GDP growth this year. In fact, we started to see the economic benefits of low oil prices and a weaker Canadian dollar on manufacturing and export activity. There's no question that the persistently low oil prices are tough for clients in the affected regions and are driving an increase in credit provisions in our portfolio. It's important to note the increase is off historic lows we've experienced in recent years and, further, I want to highlight that we've managed through many cycles and we plan our business based on expected losses rather than historic lows. Our experience this quarter was within the range of outcomes we had planned for.

Turning to the performance of our business segments, it was a record quarter for Personal & Commercial Banking. Canadian Banking performed well, notwithstanding the low interest rate environment and challenges in oil-exposed regions. We had solid volume growth across most products.

We extended our market-leading position in residential mortgages, and balances were up 7% from last year as clients continued to take advantage of historically low interest rates. In addition, our promotional programs drove customer activity to our channels. With this growth, we've remained disciplined from a risk perspective and our mortgage portfolio continues to perform well with provisions remaining at historic lows.

We've also continued momentum in business loans which are up 9% from last year. We've seen confidence rise among clients particularly in the retail sector as the weak dollar encourages Canadians to stay home to shop.

We also saw strength in the manufacturing sector as our clients take advantage of strong export conditions. In addition, we're seeing the benefits of investments we've made to grow in key markets.

Our margins held up relatively well in recent years but continue to be pressured by the low interest rate environment and competitive pressures, particularly given our relatively high proportion of fixed-rate mortgages and our strong and growing core deposit base. This quarter we also extended our lead as the number one deposit franchise in Canada with an industry-leading market share of combined consumer and business deposits.

We achieved 13% growth in core checking accounts, a key anchor product for us. Beyond deepening client relationships, deposit growth improves our funding position and provides leverage to higher rates in the future.

Our expense growth was well controlled this quarter, and we achieved positive operating leverage. Given the current environment, we continue to closely manage costs. At the same time we're continuing to invest in digitizing the bank but maintain the leading share of digital sales volumes in Canada, capturing almost half the market.

Turning to the Caribbean Banking, we delivered record results this quarter. This was our third consecutive quarter of solid core results following two years of significant restructuring, which demonstrates our ability to turn around an underperforming business and reposition it for long-term growth.

Moving to Wealth Management, this is our first quarter with City National, which closed on November 2, and is now part of our new US Wealth Management business line. I'm very pleased with the underlying performance. City National generated earnings of over CAD100 million this quarter, driven by double-digit loan and deposit growth.

Even with the accounting adjustments and integration costs that Janice will walk through, this business made a net positive contribution to earnings this quarter, which was ahead of plan. While it's early days, we're rapidly firming up plans to deliver on our synergies and I'm excited to tell you more about this great franchise at our City National Investor Day, which will be held here in Toronto on March 4, 2016.

Moving to Global Asset Management, as expected, lower market returns drove lower fees, but we still achieved positive net sales. However, in January in particular, we saw some clients move assets into cash products as they waited for market volatility to subside. This remains a key growth business for us and we continue to develop new investment solutions for our retail and institutional clients, including expanding our suite of US dollar investment solutions for Canadian investors.

Canadian Wealth Management had solid growth in client assets and we extended our number one position in the high net worth segment. While market conditions resulted in lower client transactions we saw good growth in insurance solutions, demonstrating that our clients value our holistic approach to wealth management.

Lastly, we're continuing to work through the restructuring of International Wealth Management. Given the complexity it's taking longer than planned but we're committed to optimizing this business for the long term.

Moving to Insurance, on January 21 we a announced that we reached an agreement to sell our home and auto insurance manufacturing capabilities to Aviva Canada, which will allow us to focus on underwriting products where we see the greatest potential for growth, including our life, health and wealth insurance offerings. In addition, we signed a 15-year strategic agreement with Aviva which will allow us to sell their broad product suite of property and casualty products to our clients under our own brand.

Investor & Treasury Services delivered a solid quarter. We continued to drive top-line growth by leveraging our leadership position in Canada and in the offshore fund markets of Luxembourg and Ireland to win new business and strengthen existing client relationships. We also increased investment in technology to enhance the client experience.

Capital Markets performed well in a difficult environment. Our results were solid compared to a very strong quarter last year, and the improvement of the prior quarter even with higher PCL, which Mark will expand on.

Corporate Investment Banking revenue was down slightly from very strong levels last year but up sequentially even with the significant slowing of new issuance activity. In fact, there were no IPOs both in Canada nor in the US in the month of January. There were also fewer debt instruments this quarter as credit spreads remained wide.

However, global M&A activity remained strong during the quarter and reached a record high in November. Against this backdrop, we advised our clients on over CAD29 billion of completed M&A transactions, including several high profile deals in the US. And we advised on the largest infrastructure deal in Australia's history. We also had double-digit revenue growth in Europe as our market position continues to strengthen and benefit from the investments we've made over time.

Turning to global markets, trading revenue was lower compared to the strong first quarter last year as market conditions impacted both originations and secondary trading. But trading revenue improved from the last quarter as client activity increased, particularly in our fixed-income business. Overall, our results in Capital Markets demonstrate the strength of our client-focused businesses and the value of our diversification across products, industry sectors and geographies.

To wrap up, I'm pleased with our performance this quarter. We had solid underlying results in our core client businesses, we continued to optimize some underperforming businesses, and we enhanced our digital capabilities for our clients, while demonstrating very good expense management. And the closing of City National creates a powerful platform for long-term growth in the US, RBC's second home market.

In the current environment, there is tremendous value in being a leader across a diverse set of global businesses. I'm confident that we'll continue to deliver long-term value to shareholders given the strength of our leading client franchises, our strong execution capabilities, and our disciplined approach to risk and cost management.

With that, I'll turn the call over to Janice.

Thanks, Dave, and good morning, everyone. As shown on slide 6, we had a solid first-quarter earnings of over CAD2.4 billion, flat from last year, despite the challenging operating environment and lower market returns. Our results reflect higher earnings in Wealth Management, which benefited from the inclusion of City National, record earnings in Personal & Commercial Banking, and higher earnings in Investor & Treasury Services, offset by lower results in Insurance and Capital Markets.

Provisions for credit losses increased from last year mainly due to the impact of sustained low oil prices, which Mark will discuss. Compared to last quarter, earnings were down 6%, mainly due to last quarter's net favorable tax adjustments recorded in Corporate Support. Higher earnings across most business segments were partly offset by lower insurance results.

We demonstrated good expense management. Net of the insurance fair value change, our operating leverage was negative 2.3%, or positive 1.3% excluding City National. This quarter our return on equity was 15.3%, down 260 basis points from last year, largely reflecting the additional shares we issued to fund half the purchase price of City National.

As we discussed last quarter, we've maintained our medium-term objective for return on equity of 18%-plus, based on our confidence that we will be able to build back up to that target level over time. We continue to focus on optimizing our balance sheet as we work towards this objective.

Turning to Capital on slide 7, our Common Equity Tier 1 ratio was strong at 9.9%, down 70 basis points from last quarter as the closing of City National was partially offset by internal capital generation. City National impacted our CET1 ratio by 94 basis points, slightly more than our previous estimates, largely due to the impact of foreign exchange translation on risk-weighted assets. In addition, our capital ratio was impacted by a lower discount rate which increased our pension obligation.

Let's move to the performance of our business segments, starting with slide 8. Personal & Commercial Banking reported record earnings. Canadian Banking had earnings of over CAD1.2 billion, up CAD11 million or 1% from last year. Our results were driven by solid volume growth of 6%, including loan growth of 5% and deposit growth of 7%, although the related revenue was impacted by lower spreads. Our net interest margin was 2.62%, down 6 basis points from last year, reflecting the low interest rate environment and competitive pressures.

Overall, funding costs have increased due to ongoing market volatility which has resulted in margin compression, particularly on our prime-based products. As we expect ongoing pressure from low interest rates and the competitive environment, we will continue to remain disciplined about managing our margins.

Our performance this quarter also reflects modest fee-based revenue growth. Expenses were up 2% from last year, reflecting higher costs in support of business growth, partially offset by our continued focus on efficiency management activities. We had positive operating leverage of 0.2% this quarter, and our efficiency ratio of 43.7% improved 10 basis points from last year.

We believe there's more we can do to drive further efficiencies and we continue to target operating leverage in the 1% to 2% range. Sequentially, Canadian Banking earnings were flat as solid volume growth, higher fee-based revenue, and lower marketing costs were offset by higher PCL and lower spreads.

Caribbean and US Banking had record earnings of CAD59 million, up CAD24 million from last year, largely reflecting the favorable impact of foreign exchange translation. Ongoing efficiency management activities also contributed to core earnings growth. Sequentially, earnings were up CAD16 million, largely reflecting higher fee-based revenue.

Turning to slide 9, Wealth Management had earnings of CAD303 million, up 32% from last year and 19% from last quarter. City National added CAD53 million to our earnings this quarter, or CAD107 million excluding amortization of intangibles of CAD31 million after-tax and acquisition and integration costs of CAD23 million after-tax.

As Dave mentioned, City National's performance reflects strong operating results with loan and deposit balances up 14% and 12%, respectively, from last year. Its credit quality also remained stable. Our integration is proceeding well and City National's results are ahead of plan, given strong core performance, helped by a favorable exchange rate.

Excluding City National, our Wealth Management results were impacted by challenging markets. We also incurred restructuring charges of CAD18 million after-tax related to the repositioning of our International Wealth Management business, mostly related to the announced sale of our Caribbean Wealth business, which is expected to close in the latter half of the year. As we've discussed, we're taking steps to improve our operating performance for this segment. We're pleased that focused expense management and savings from restructuring activities have helped drive 9% earnings growth.

Global Asset Management revenue was down 5% from last year largely due to lower performances fees. Assets under management grew 3% from last year even in challenging market question conditions, reflecting solid net sales. Canadian Wealth Management revenue was up 6% compared to last year, as higher earnings from growth in fee-based client assets was more than offset by lower transactional revenue given decreased trading volumes and fewer equity issuances.

Moving to Insurance on slide 10, net income of CAD131 million was down CAD54 million or 29% from last year, reflecting higher claims costs, largely in our life retrocession business, and lower earnings from a new UK annuity contract this quarter compared to two new contracts last quarter. Sequentially net income was down CAD94 million or 42%, reflecting favorable actuarial adjustments in the prior quarter and higher claims costs in the current quarter.

As Dave mentioned, this quarter we announced the strategic sale of our home and auto insurance business. We expect to record a gain of approximately CAD200 million after-tax when the transaction closes, which is expected in the third quarter of this year.

Turning to slide 11, Investor & Treasury Services had earnings of CAD143 million, relatively flat from last year. Earnings from better spread capture in our Treasury portfolio, the positive impact of foreign exchange translation, and growth in client deposits were offset by increased investments in technology.

Compared to last quarter, earnings were up CAD55 million or 63%. I'll remind you that last quarter credit spreads widened considerably and, as a result, we recognized mark-to-market losses on securities held in our Treasury portfolio. This quarter credit spreads stabilized which improved the performance of the portfolio.

Turning to slide 12, Capital Markets had a good quarter in a difficult market environment. Net income of CAD570 million was down CAD24 million or 4% from very strong results last year, driven by lower equity trading revenue and lower debt origination activity across most regions, and in addition we had higher PCLs. This factors were partially offset by lower variable compensation, the positive impact of foreign exchange translation, and a lower effective tax rate which helped to significantly improve our efficiency ratio.

Sequentially, earnings were up CAD15 million or 3%, driven by higher fixed-income trading revenue, reflecting stabilizing credit markets, as well as lower litigation provisions and related legal costs. We also benefited from higher M&A activity and equity origination in the US. These factors were partially offset by higher PCL. In addition, our results last quarter included a favorable income tax adjustment.

Before I hand it over to Mark, let me take a moment to discuss our allowance for loan losses because we've had questions about the accounting differences between Canada and the US. Our accounting for provisions follows an incurred loss model. As you can see in our disclosures, at the end of Q1 we had an allowance of CAD2.3 billion, of which CAD800 million was for specific losses and CAD1.5 billion was for our general allowance or losses that have been incurred but we haven't been able to specifically identify yet.

Depending on the type of loan, we typically allow 9 to 12 months for the losses to become identifiable to us. For residential mortgages, we extend this time frame to 18 months. Currently, the major source of potential new loan losses relates to the impact of low oil prices on our wholesale loan portfolio and possible impacts to our retail portfolio through lower employment and the wind-down of severance packages, mainly in oil-exposed regions.

During the past few quarters, we've scrubbed our oil-and-gas exposures with a bottoms-up, name-by-name analysis and macro stress tests, which Mark will discuss. We understand the portfolio extremely well. In the scenarios we have tested we believe that our general allowance is adequate to cover our losses over the next 12 months as it covers the unknown items.

This contrasts with US accounting, which is moving towards expected losses. We understand that a number of US banks effectively incorporate an expected loss model in their current provisioning. As we transition to new IFRS loan accounting, we will be closer to the expected loss model.

With that, I'll turn it over to Mark.

Thank you, Janice, and good morning. Turning to slide 14, as a result of sustained low oil prices and a rise in unemployment in oil-exposed regions, provisions for credit losses on impaired loans increased from last quarter's low levels of 23 basis points to 31 basis points this quarter. For context, this time last year the price of oil was around [$50] a barrel, a level that we noted challenged the profitability of the sector.

Throughout 2015 many of our clients in the oil-and-gas sector raised capital, delayed capital spending, cut dividends or sold assets to help mitigate the impact. The extended duration of low oil prices which averaged [$37] a barrel in Q1 has put additional pressure on some of our clients. Given the challenging environment, our credit performance this quarter was in line with our expectations.

As seen on slide 15, provisions of CAD410 million increased by CAD135 million this quarter, mainly driven by higher provisions in Capital Markets and Personal & Commercial Banking. In Capital Markets, provisions were CAD121 million or 53 basis points, up CAD84 million or 36 basis points from last quarter, primarily due to losses on four oil-and-gas accounts and one utility account.

Wholesale provisions can be lumpy and this quarter we had one large provision on a syndicated exploration and production company which accounted for approximately two-thirds of the Capital Markets provisions. The remaining oil-and-gas provisions are related to two drilling and service accounts, one in Canada, and one in the United States, and one exploration and production account in the United States.

In Personal & Commercial Banking, provisions were CAD284 million or 30 basis points, up CAD44 million or 5 basis points from last quarter. Provisions in Canadian Banking were CAD266 million or 29 basis points, up CAD38 million or 4 basis points from the prior quarter, due to higher provisions, mainly in our personal lending and cards portfolios. As expected, a rise in unemployment in oil-exposed provinces is affecting retail clients and largely explains the increase in provisions this quarter.

Provisions in Caribbean and US Banking were CAD18 million, up CAD6 million from last quarter, reflecting higher recoveries in Q4. Provisions in Wealth Management were CAD5 million or 4 basis points, up CAD4 million or 2 basis points sequentially due to the addition of City National.

Turning to slide 16, gross impaired loans increased CAD835 million from last quarter, largely due to credit impairments of CAD657 million acquired with City National. These impairments consist mainly of FDIC covered loans which should not result in any material losses. Excluding City National, our gross impaired loan ratio was up only 2 basis points sequentially, reflecting new impairments in Capital Markets and the impact of foreign exchange translation.

Now let me provide some additional color on what we're seeing in our portfolio as a result of the sustained oil prices, starting on slide 17. Our drawn wholesale loan book to the oil-and-gas sector, while continuing to represent only 1.6% of RBC's total loan book, has increased by CAD693 million this quarter. This largely reflects the impact from foreign exchange translation as well as higher drawings on some existing facilities.

Approximately 60% of our drawn exposure is to exploration and production companies, typically governed by borrowing bases and sized to the proven reserves of the borrowers, which provides good protection against credit losses. Our total drawn and undrawn exposure to the sector, excluding the impact of foreign exchange, was flat sequentially with no significant change in mix.

Over the past few months, we ran an updated name-by-name wholesale stress test assuming a [$30] oil price, flat throughout 2016, followed by a discounted futures price curve thereafter. Based on this stress test we added nine new names to our energy watch list for closer monitoring and anticipate our PCL to fall within a 30 to 35 basis point range.

We also ran an enterprise-wide macro stress test based on oil at [$25] a barrel in 2016, which looked at the impact on our retail and wholesale portfolios in Alberta and the contagion effect on the rest of Canada should this cause a Canadian recession. In what we believe to be an unlikely scenario at this point, provisions based on this macro stress test would increase to 40 to 50 basis points, which is within our historic average through a cycle.

As we've seen this quarter, we expect the current environment will likely result in further liquidity challenges for some of our clients, causing increased drawings on committed lines. Further, as we look ahead to the spring redetermination, we expect a further decline from the price deck we used last fall, which will likely result in reduced credit for some clients. These conditions will likely lead to continued losses, although they won't necessarily materialize in a linear fashion.

I would add that in this environment, we work with our clients to assess their situation on a case-by-case basis. This includes assessing covenants in relation to cash flows. In some cases we may provide covenant relief as our goal is to help support our clients while also minimizing our losses. As for our commercial clients, so far they have remained relatively isolated from the impact of low oil prices, given the strength of their balance sheets and geographic diversification.

Let's now turn to our retail exposure on slide 18. As I mentioned earlier, sustained low oil prices have led to increasing unemployment rates. Alberta's unemployment rate increased from 4.6% to 7.4% over the past year and severance packages have started to wind down. The unemployment rate now exceeds the national average.

We are also seeing similar trends in other oil-exposed regions such as Saskatchewan and Newfoundland and Labrador. As a result, provisions in these regions have increased, largely in our personal lending and cards portfolios, where the first signs of stress typically occur.

Against this backdrop, we continue to actively monitor shifts in our clients' financial patterns to ensure we maintain visibility into early signs of stress. We did see delinquencies move up this quarter from historical lows in our residential mortgage portfolio in Alberta and are proactively working with these clients. Overall, however, our mortgage portfolio continues to perform well given our strong underwriting practices and geographic diversification, with provisions of 2 basis points this quarter.

Turning to slide 19, the vast majority of our clients' credit profiles are strong and have remained stable over the past year. In fact, the average FICO score in Alberta is in line with the national average. Also, the debt service ratio in Alberta is stronger than the national average and we have a greater percentage of insured mortgages in that region. While we do expect to see further credit deterioration in our retail portfolio in oil-exposed regions, we did not see any signs of deterioration outside of these regions this quarter.

Turning to market risk on slide 20, our average value at risk increased by CAD5 million from last quarter due to foreign exchange translation and higher equity market volatility. This was partially offset by lower interest rates and credit-spread exposures from reductions in our fixed-income portfolios which also impacted our average stressed value at risk, reducing it by CAD8 million sequentially. Both remain low relative to our revenue stream.

This quarter we had three days of net trading losses totaling CAD13 million, largely due to higher market volatility in Q1, driven by uncertainty over China's economic growth which adversely affected commodities and equities globally. This is down from six days of net trading losses last quarter.

To conclude, while the ongoing market and economic headwinds underpin a cautious outlook, and we are continuing to monitor for any signs of contagion, we do expect to continue to benefit from the diversification of our portfolios, both in terms of geography and industry, as well as our prudent risk-management practices.

With that, we will open the lines for Q&A.

(Operator Instructions)

The first question is from Sumit Malhotra from Scotia Capital. Please go ahead.

Thanks. Good morning. I just want to start with Mark, please, and specifically on the wholesale portfolio. A two-parter here. It was in January David made mention about, I think, 40 basis points being a reasonable outlook as far as the loss rate in the Capital Markets or wholesale segment was concerned in the interim. I wanted to check with you as to whether under this scenario you're now envisioning that still holds.

And maybe related to that, we've talked a lot about the oil and gas portfolio but we did note and you mentioned there was a utilities provision booked in the quarter, as well. How should we think about your utilities exposure as it relates to the current oil and gas environment?

Thank you for the question. I'll answer the first one on the 40 basis points. Obviously, as I did mention in the capital market situations, they tend to be lumpy. And we did have the one loan PCL which caused that to jump to the 53 basis point. We do believe that the 40 basis points would still hold over a number of quarters.

On utilities, I would stress that the loan that we had the PCL on was an individual situation that is not really an industry problem. It was a situation where a parent company outside of Canada and the United States has had difficulties and has caused some investment issues in terms of building the operation. So I would call that certainly unique and not an industry issue.

I just want to clarify something here. So, we're focused mostly, or we have been anyway, on the direct oil and gas portion of what you break out on energy. When we think about that utilities component, in some of the scenarios you've described in your stress testing, does that come into play in a major way in terms of your forecast of losses? Or is it more on the P&P and services component that you're still focused?

The majority of our expectation under stress would be in exploration and drilling and services.

All right. I have one on capital but I'll requeue and try it later in the call.

Thank you. The next question is from Doug Young from Desjardins Capital. Please go ahead.

Hi, good morning. Just further on the oil and gas portfolio, we saw that the undrawn facility increased, I think, from CAD13.7 billion from CAD11.7 billion. So I'm just trying to get a sense of the quantity of increase that was more FX related. And about the increase, where that's related to, what type of clients and so forth. Thank you.

The undrawn increase was solely related to foreign exchange.

So, it's 100% foreign exchange. Okay. Since I was fairly quick maybe I can just redouble back on another question here. In Canadian Banking, obviously the NIM compression down 3 basis points, and there was a number of drivers of that given in the prepared remarks. Just wondering, when you look at through FY16 what sense do you have in terms of other contractual -- what do you think the impact of the full year will be in NIMs considering nothing else changes in the environment that we're in right now? Or is this a NIM where we should see stabilization? Thank you.

Thank, Doug. It's Jennifer. Obviously the current environment is challenging our margins, given low interest rates and the competitive pressures. We also have a fully loaded funding model so the cost of hedging, et cetera, are all reflected in our NIM. This year-over-year decrease was actually in line with the 1 to 2 basis points per quarter that we expected, given the current environment. And going forward, we expect to continue to guide to compression of 1 to 2 basis points per quarter, but we will remain disciplined about managing our margins.

This is Dave, too. As we talked about in the last call, asset mix has an impact given the ratio between fixed-rate consumer lending and variable-rate consumer lending. We still continue to see very high, by historic terms, margins on the variable rate book, which has a lower component in our overall portfolio than many of our other peers.

Great. Thank you very much.

Thank you. The next question is from Steve Theriault from Bank of America-Merrill Lynch. Please go ahead.

Thanks. I had a quick question on City National. But if I could just ask Mark a follow-up question. I was going to ask if you think the 31 basis points this quarter is a reasonable run rate or if we might see some reversion to the down side. Obviously that number can bounce around a lot. I'm sure it will depend on if there are any lumpy charges. But it seemed from your prepared remarks, Mark, that you think that -- my interpretation anyway -- was that 30 to 35 is probably what we should expect in the near term, and there is going to be some noise through the oil and gas portfolio unless oil rises meaningfully from here. So, maybe just your thoughts on that, please.

Yes, I think if oil continues at the level it is, the 30 to 35 is what I would think is our more normalized PCL for going forward.

Okay. Thanks. And just on City National, you go into some he detail around the rise in gross impaireds from the impact of City National. Can you give just a little detail on the FDIC covered loans that I saw mentioned, just in terms of their nature and the size? Is it from a portfolio or an acquisition or a book of business that's running off or something that's being built on?

It's a book of business that's being run off. Coming out of the financial crisis a number of financial institutions in the United States purchased FDIC-covered loans as essentially investment opportunities. These were impaired loans that are FDIC covered. This is a portfolio that's winding down quite satisfactorily. It's been, I think, a very good investment for City National. But it was a once-in-time opportunity but they still had some left as we acquired them.

Got you. It was a loan sale, not a bank acquisition, per se?

It was a purchase of the loan portfolio.

Got you. Thanks very much.

Thank you. The next question is from Gabriel Dechaine from Canaccord Genuity. Please go ahead.

Good morning. I have a two-pronged one for Mark, just a quick numbers one. When you do your stress test, what's the impact of credit downgrades on your RWAs and, therefore, on your core Tier 1 ratio?

And then I just want to talk about the range of PCLs that you quote for your stress scenario, 40 to 50 basis points. If I look at your capital disclosures, page 42 of the supplement, I see a average historical actual loss rate of 43 basis points. That's within that range, but that's a historical average going back to 2003, which included some very good years and two or three really bad ones that were -- I don't want to downplay the financial crisis but it was brief in retrospect. I'm just wondering how come that number is within your stressed range. It doesn't make sense to me. We're apples to oranges here a bit but I'm looking for a connection.

If I answer the first question, in the stress scenarios, I think you were asking what would be the impact on RWA. Is that what you were asking?

Yes. Or if you just want to summarize in core Tier 1 terms.

I think the thing I need to stress is the exposure in oil and gas still is only 1.6% of our total loan portfolio. So, while we would expect some increases in RWA, and I think it would be in the region of CAD1 billion to CAD3 billion, that in the overall scheme of our capital management that is still a relatively small number.

So a CAD1.3 billion --.

CAD1 billion to CAD3 billion of incremental RWA.

CAD1 billion to CAD3 billion, okay.

I'm also having a little bit of trouble understanding your question with respect to the 40 to 50. So let me try and then if I don't quite get it, get back to me. What we do is we do a macro stress across all of the portfolios, and that stress has shown that our PCL would increase in that Canadian recession type scenario to 40 to 50 basis points.

What we then say is that an increase that would be within what we call our risk appetite. And we define our risk appetite is that we look at our historical through the cycle loan losses and determine is this going to be outside of that historical through the cycle experience. If it's beyond that, then that would suggest a stress test that's beyond our risk appetite. If it's in our results in this macro stress that I'm quoting are actually within that historical through-the-cycle. Does that answer your question?

Yes, it does. So the results of your stress tests lead to a PCL ratio that is essentially your historical average, not like as we think of it as a stress scenario where PCLs really spike. That's what it sounds like.

I think what I'm trying to say is that it's a positive in a sense of, what we're trying to say is that even when we construct a Canadian recession scenario, we do not see PCLs going beyond our historical through-the-cycle PCL.

Okay. But that's the point here, is that how is that possible if -- and I'm being very simplistic here, not as detailed as what you guys are doing -- but all the stuff that goes in these stress tests -- unemployment spikes, oil for CAD25 for a number of years, and interest rates doing whatever -- and all that does is result in your historical loss rate. That's what you're saying?

Yes.

Okay. Thank you.

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

Good morning, Mark. Apparently you're very popular this morning. I wanted to circle back on the consumer side of the loan portfolio. The increase in charge-offs on the credit card portfolio, not terribly surprising. But the uplift on the personal lines was a little bit higher than I would have expected at this stage in the game. Can you tell us what type of products are driving this? Was this almost completely on the unsecured lines or were some of this secured by auto or other products?

That would include some auto, some unsecured revolving credit lines, as well there is also some student loans in that grouping.

And that is principally out of the provinces that are impacted by the energy crisis.

That's correct.

Are you as a bank doing anything at this stage going forward to try to mitigate the growing losses that are emanating out of the consumer book?

Certainly -- and Jennifer may also want to join in here -- but in Alberta certainly we're looking at our policies, our programs. And essentially I think the easiest way of saying it is, where we had exceptions to grants credits, those exceptions are not being given. We're sticking to our disciplined policies and I think that's proving to be a good way to at least manage the portfolio at the moment.

What I'll add to that, John, is that obviously we're continuing to work with our clients through these difficult times. But we're constantly updating our credit strategies, and those credit strategies with used for both origination and for monitoring our portfolios.

So, we've added some additional dimensions in the oil-exposed provinces to be able to mitigate some of the rising concerns. And also, we've got very well-developed strategies to support our clients through the difficult times where we give them advice on restructuring their credit.

Great. Thanks for the color.

Thank you. The next question is from Meny Grauman for Cormark Securities.

I thought maybe I'd just follow up on Gabe's question, just maybe from a different angle. You talk about PCL staying in historic range. From someone looking in maybe more cynically, how can we talk about historical range when we're looking at the kind of oil shock that we're seeing? It seems like we're not in normal times. So I'm just wondering what's your perspective on that in terms of how do we define normal?

Again, maybe what I would try to maybe say here is, what we're looking at is how do our stress tests reflect from where we were. If you look at 2015, our PCL was in the 24 basis point level, which was a very benign credit environment. When we do our name-by-name wholesale stress test, we believe that would purchase our PCL back up to what we would call a more normalized 30 to 35 basis point range.

If we then do the macro stress test, which is essentially trying to assume that there's a contagion effect across all of our portfolios into a Canadian recession, that would push our PCL up into the 40 to 50 basis point range. While I think you're struggling that 40 and 50 doesn't seem to be that high in a stress scenario, it is actually working off a base of 24. So, it is a fairly stressful situation relative to the experience we've been having over the last 12 months or so. Does that help?

Yes, that definitely helps. I'm not sure if you mentioned it but what real GDP growth are you assuming in your more extreme stress case scenario ex Alberta? Is that something you can mention or you've talked about?

We have multiple stress tests. I'm struggling to remember. We do actually have some where we actually have decreases in GDP, 3% to 4%, and unemployment going up 4% to 5%, and house prices coming down 20% to 25%. So, those are the three. Oil price is obviously a big variable in this particular situation. But we do see GDP was down in a stressed scenario, we see how prices down, and we see unemployment up.

Thank you very much.

Thank you. The next questions is from Sohrab Movahedi from BMO Capital Markets.

A quick question for Janice. Janice, it was very helpful the color around generals and specifics. I'm trying to get a feel for, is there any flexibility on the part of the management to think beyond the 12-month time frame that seems to be the norm re identifiable losses and specific to the general allowance?

That's a great question, Sohrab. I think that when we look at accounting, like general allowance and that, it's all about what the accounting guidance is. And I think that's a different case. When Mark talks about looking at borrowers on a case by case basis and looking at how we're evaluating losses in that, that's a different perspective. That is a working perspective.

From an accounting perspective, we can't really deviate from the accounting without having broad discussions around why we're different. So, that's why I think the IFRS has addressed this whole issue by moving more towards expected losses, which, from our perspective, is probably reasonable, given the cycle, and it would be a little bit closer to what's happening in the US provisioning. But at this point in time, there's no point in switching around what we're doing, given that the IFRS accounting change is happening in the next couple of years.

That is tremendously helpful. And I'm happy to take this offline but with IFRS new accounting rules, does that essentially mitigate the need to have general allowances?

There's nothing called a general allowance in IFRS.

Collectives or unidentified or --.

Exactly. And I think what you will see with a move towards expected loss is less of a reason to have an unassigned allowance. But the collective losses on portfolios may have a little bit more volatility. And there may be more front ending of portfolio losses with an experience coming in and revising the assumptions. But it's hard to say.

Thank you very much.

Thank you. The next question is from Mario Mendonca from TD Securities.

If I could first go back to something Dave McKay said, and this is something you've talked about in prior calls, as well, that Royal's more heavier weighting to fixed-rate mortgages puts it at a bit of a disadvantage with the wider prime BA spread. I think that's something you've talked about. That prime BA spread has really narrowed recently. So, is it your view that disadvantage narrows over time?

I think if you expect a reversion to the mean of 166 over time, we're in this unprecedented territory for four or five quarters now. I think, while it has narrowed, it's still slightly up year over year. If it holds where it is now with around 180, 185, you'll see Q3, Q4 would be actual decrease from 195. I think it reached that peak.

Right now it's still stable year over year to slightly up. But certainly given we're 75% fixed, our margins are fixed there, we don't get the same lift on our variable rate mortgage books and the impact on our P&L that you did if you had the reverse of 25-75, variable-fixed. When you're talking about a CAD250 billion book it's quite a significant margin shift.

My only observation is that it did seem to be narrowing somewhat. But I guess time will tell.

It had has sequentially, absolutely. But, still, if you look year over year, I think January 15 was around 182 or I think roughly or 183.

Okay. Can we go to the ROE discussion because I feel like I'm missing something here. Perhaps, Janice or Dave again, you talk about maintaining the 18%-plus ROE. When I think about that in the context of potentially being a G-SIFI, the 9.9% Basel III Common Equity Tier 1 ratio, potentially higher risk weights on mortgages, although in a more modest way, standardization, there's so many reasons why capital requirements would be going higher. So what am I missing?

When you talk about 18%, are you talking about managing the capital lower? Are you talking about managing earnings materially higher? Or am I just looking at this over a period of time that's different from yours? Are you thinking 5, 10 years out when you think 18%? Can you help me think through that, Janice?

I'll start, and maybe Janice can jump in. We certainly spend a lot of time talking about our targets. We look at, these are medium-term objective. So, they're not in-year objectives. And we certainly made a large strategic acquisition which has reduced us from our target range back down.

We sit down as a management team, and we says, as we look at where the growth is going to come from in the future and how we're going to grow our business, are we going to grow back to that ratio, and we sit here today saying there's a number of positives. And, you're right, there are headwinds around uncertain regulatory environments, around market trading risk, and around potential Basel IV capital. It's all uncertain where we are in the future.

But, having said that, we're in record low margins for a, very large business. If you project where the net neutral rate is in the economy, and if you assume we can get back to some type of net neutral rate, which the Bank of Canada forecast to be in the 300 basis point to 350 basis point, if you can get your head to the net neutral rate, which is a lot lower than it's ever been in the past, and you look at the impact on our wealth businesses, on our ITS businesses, on our very significant core deposit book, you can see a benefit that's not realized in current margins that really helps you.

Along with the growth trajectory of the acquisition we made and others, you can see a path forward. So, I think those are some of the things that you think about as you balance off the headwinds and you look at the path of your business.

Mario, Dave's talked about, really, the numerator. And the flip side of that is that you see a lot of very effective capital management through balance sheet optimization. We are constantly at it. So, you saw there was effectively, the RWA growth was because of the add of City National plus FX this quarter. So, our businesses are still expanding but we are trying to use capital more efficiently. It's about more earnings, and at the margin adding less capital to support the earnings growth that we have.

So time, rates and management actions around capital, that's what gives you the confidence to talk about 18%.

Yes.

Thanks.

Thank you. The next question is from Robert Sedran from CIBC. Please go ahead.

Hi. Good morning. Sorry if I missed it, just a quick clarification. That large loan loss in the Capital Markets segment, that was a US credit?

No, it was outside both Canada and the United States.

Okay. And then just returning to Jennifer, Jennifer, you talked about the margin pressure continuing. Thoughts on operating leverage in that environment? I know Janice mentioned still targeting 1% to 2%, but is that a likely or a possible outcome in an environment where revenues are sluggish? Or should we assume flat operating leverage for the balance of the year?

No, we're still targeting 1% to 2%, given the cost management initiatives that we have under way. A lot of those are, first, through reducing cost you through digitization and optimizing our processes, but also we're looking to achieve economies of scale by putting things through [in-home avestit], and some organizational and operational structures that we're using to be able to make things happen a little more quickly. We've reduced our headcount in Canadian Banking by 500 year over year, most of which was through attrition, and we still see a way to continuing to maximize the use of efficiencies to be able to continue to get at that in some of our larger environments.

Was there anything unusual or seasonal about this quarter in terms of the expense base?

This quarter there was actually just staff costs, which at this time of the year, in the first quarter given timing of salary and benefit increases, and also our eligible-to-retire, we had some higher occupancy costs. But overall, other than that, just normal.

Okay. Thank you.

Thank you. The next question is from Peter Routledge from the National Bank Financial. Please go you ahead.

Thanks. A question for Mark. Thank you for the data on the enterprise-wide stress test. I think the clarity of it sparks 100 different questions in my mind, so that's your reward for doing a good job. But the most important question I have is what do you assume about house prices in that scenario.

In the macro stress test, I think it was 25% down.

That would be nationwide, peak to trough?

Yes.

Okay. And then would that be uniform across the country or are you saying Vancouver and Toronto might be more --?

In that stress test it was uniform across the country. We do other stress tests that look at different regions and variations. But in the one that I've been quoting relative to what could oil do, that's been across the country.

Thanks. A question -- I think Gabe touched on it -- that perplexes me anyway. I appreciate the 40 to 50 basis point guidance range. But if I look back, even with Royal we see the PCL ratio going well above that for isolated short periods of time. So, how do we reconcile that 40 to 50 guidance with a historic record where occasionally we did see that ratio well above 50? How should we think about that?

All we're trying to do with the stress test is to give you information as to what we could see could happen if the variables that we put into the stress test occur. Obviously if any of those variables are different, then the numbers and the output would also be different. So, it could be less, it could be higher.

But we are using our best management judgment on what could happen if oil prices cause a greater contagion across the country into a Canadian recession. All of those variables is really what brings you to a result.

Are there one or two variables that would particularly drive it higher, assumptions you think might be more volatile?

Out of them, if you look, again at our portfolios, the biggest portfolio that we have is residential mortgages. So, if our assumptions around house prices and the consumer ability to service those debts is worse than what we put in our scenarios, that would have a material impact.

Our corporate lending is based on a more individual type industry basis. We're assuming a recession that would be across all of the industries. That generally isn't how it occurs. It tends to be more individual industries that are affected than others. So, it could be either one of those.

Thanks. That's very helpful. Appreciate it.

Thank you. This concludes the question-and-answer session for today. I would now like to turn the meeting back to Mr. Dave McKay.

Thanks, everybody, for joining this morning and your questions. We certainly understand your interest in the oil and gas in the portfolio, and appreciate your questions, and look forward to talking to you again next quarter. Thanks very much.

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