Royal Bank of Canada (RY) Q3 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and welcome to the RBC 2015 Third 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 9:00 a.m. To give everyone a chance to participate, please keep it to one question and then re-queue. We will be posting management’s remarks on our website shortly after the call. Joining us for your questions are George Lewis, Group Head, Wealth Management and Insurance; Doug McGregor, Group Head, Capital Markets and Investor & Treasury Services; Jennifer Tory, Group Head, Personal and Commercial Banking; Zabeen Hirji, Chief Human Resources Officer; and Bruce Ross, Group Head, Technology and Operations. As noted on slide two, our comments may contain forward-looking statements, which involve applying assumptions and have inherent risks and uncertainties. Actual results could differ materially from these statements. I will now turn the call over to Dave McKay.

Thanks Amy and good morning everyone. Thank you for joining us today. RBC had a solid quarter with net income of over $2.4 billion, up 4% from last year or 2% excluding the prior year's loss related to the sale of RBC Jamaica. Compared to last quarter, earnings were down 1% but were up 3% excluding the foreign exchange gain in Q2. I would highlight that this morning we announced a $0.02 or 3% increase to our dividend bringing our quarterly dividend to $0.79 a share. We had underlying strength across most of our segments while maintaining a strong credit and capital position. And I believe these results demonstrate the strength of our diversified model and solid execution in an increasingly uncertain environment. Before I provide my perspective on the performance of our business segments, let me share some views on the Canadian economy, oil prices and the housing market. Starting with the economy, in the recent months, we have seen mixed economic data and weaker than anticipated growth which led The Bank of Canada to cut interest rates for a second time this year. Looking ahead, we still forecast modest growth in Canada in the second half of the year as the strengthening US economy and lower Canadian dollar are expected to drive export growth, and consumer spending continues to be steady. Declining oil prices is causing economic uncertainty, particularly in the west with lower levels of investment. As we expected, lower oil prices are challenging for some of our clients. This quarter, we saw an uptick in impairments and Mark will discuss how we are managing our lending portfolios in this environment. Turning to the housing market, it's important to understand that Canada is a country of many regional housing markets, each of which has its own dynamics. The Greater Toronto and Vancouver regions are continuing to see strong levels of activity. The short supply of single-family homes in both cities coupled with strong demand fueled by household formation including net immigration has driven strong price growth. In July alone, home prices accelerated by 11% and 9% year-over-year in Vancouver and Toronto respectively, the fastest pace of growth since 2010. We are watching these markets very closely given price growth and the persistence of tight inventory. We continue to actively monitor key variables including sales to listings, rental capacity in the market, affordability and inventory level. And over the years we have enhanced our lending policies and property valuation strategies. Offsetting some of this growth is lower activity in oil exposed region. It's important to remember that many areas of Alberta are coming off several years of hyper growth. So the recent slowdown is in part a return to more normal growth levels but we do recognize these markets remain vulnerable to lower oil prices. In most other Canadian markets we're seeing generally balances conditions and fundament to the Canadian housing market continues to be supported by strong trends in employment, household income, population growth and low interest rates. What gives me confidence during this period of market and economic uncertainty is that RBC is diversified across different businesses, client segments and geographies as strict risk and cost discipline is backed by a strong capital position. With this foundation we are positioned to continue executing on our key strategic priorities. For example, we are working towards closing the acquisition of City National later this year which increases our leverage to a strengthening U.S. economy and creates a platform for long-term growth. Also, we have been heavily investing in technology for the past five or six years. We are focused on leveraging these investments to drive further efficiencies, deliver a differentiated experience and generally make it easier for our clients and employees to do business with us. Turning to the performance of our business segments. Canadian Banking had a record quarter with earnings up 5% from last year, and I'd like to highlight a few key drivers of our results. First, given the strong overall volume growth of 6%, a particular strength in our mortgage business as balances grew over 6% from last year. Both the seasonality of the summer mortgage season and historically low interest rates spurred a higher level of market activity for new originations and refinancing. In addition, the simplicity of our employee pricing campaign coupled with employee referrals helped drive sales. This quarter we also saw a client switch out of unsecured lines of credit into mortgage products to take advantage of lower rates which also contributed to mortgage growth. With this growth, we've remained disciplined from a risk perspective. I would point out that since we originate mortgages through our proprietary channels, we are able to work directly with clients that help to manage debt and we are seeing evidence of conservatism as many clients are committing to accelerated repayment plans and paying down lines of credit. We also saw strong growth in business financial services with business loans up 9% from last year and business deposits up 11%. This is a competitive space, however, we are the market leader in business financial services in Canada and continue to deepen our client relationships by offering personalized services and a full product suite. Another driver of Canadian Banking's results was our continued momentum in mutual funds and the credit card business. Our mutual fund assets grew by 13% over last year reflecting the strength and breadth of our distribution network and we are well positioned to capture the increasing client demand for savings and investment products. Growth in our cards business is being driven by our ongoing commitment to delivering a strong value proposition to our clients. For example, we have enhanced our redemption options for clients including our very popular Payback with Points option. To-date, this year, we have seen a number of new clients using our Avion and WestJet premium cards increase by 18%. Lastly, I am pleased with how the business has continued to manage costs and leverage investments in technology to further improve our industry leading efficiency ratio. For example, now virtually all of our mortgages are processed through our new system which is automated to end to end origination process from sales and adjudication due to fulfillment. Turning to Caribbean Banking, we had a particularly strong quarter. Our results reflect improved credit performance, progress from our restructuring activities and the benefit of a stronger U.S. dollar. Even as the region continues to experience economic headwinds, we believe we can continue to deliver solid core operating performance. Moving to Wealth Management, global asset management, our most profitable wealth management business continues to perform well. Solid net sales this quarter drove AUM growth of 12% from last year despite uncertain market conditions. We continue to invest in the business by attracting experienced portfolio managers and by enhancing our restructure to sustain our leading position in Canada and extend our global reach. In Canadian Wealth Management we hold the number 1 position in the high network segment. We continue to recruit experienced and high producing investment advisors to further grow market share with fee-based assets per advisor over two times our Canadian peer average. Our client relationships go beyond traditional investments as we provide a more holistic approach to wealth management. As we have discussed we have been particularly focused on business owners and the partnership between Canadian Banking and Wealth Management is enabling us to identify and help these clients plan for succession, from finding a buyer to financing the transaction and managing their new wealth. We plan to expand succession planning in the U.S. as a large portion of our U.S. wealth management clients are business owners. Through the acquisition of City National, we will be able to offer clients a broader suite of products. Moving next to insurance, we continue to focus on deepening relationships and simplifying products and processes making it easier for our clients to do business with us. As a result, we continue to gain new clients and we are seeing greater success in cross-selling other insurance products. Turning to investor and treasury services. As Janice will explain result were elevated impart because we align reporting periods in investor services and fundamentally the growth of this business continues to be driven by ongoing focus on our clients needs as well as exercising cost discipline. In fact RBC is consistently recognized for its excellent customer service in this quarter we receive the costly industry's top award for customer service and we were named Fund Administrator of the Year Developed Markets by Global Investor ISF magazine. And turning lastly to capital markets. We had a solid quarter, particularly in light of record results last year which included two large trades. Corporate investment banking had record revenue of over $1 billion mainly driven by strong M&A activity in the U.S and Europe. This achievement demonstrates our success in growing the business by focusing on traditional investment banking and origination activities as well as a diversification across products, industry sectors and geographies. Offsetting the strength was lower trading revenue reflecting the challenging market this quarter. And as you’ve seen, global capital markets have continued to be volatile driven by concerns related to China and have continued to decline in commodity prices. Looking forward, I remain confident in our capital markets strategy. We are maintaining our leading position in Canada. Our U.S business continues to drive growth and accounts for almost half of our capital markets earnings. The top 10 player in the U.S were well positioned to capitalize on the improving U.S economy. And in Europe while the economic environment remains challenging, I'm encouraged by the increase in client mandates that demonstrates RBC's strengthening market position. To wrap up, it was a solid quarter. I'm pleased with our year to date performance with earnings up 11% from last year or 8% on an adjusted basis and we remain on track to meet our performance objective. There is no question that we're operating in an uncertain economic environment, however given our diversified business model, our market leading position in Canada, a deepening platform in the U.S and a growing presence in Europe and other key markets, I'm confident we can continue delivering shareholder value by capitalizing on opportunities created by the changing market and economic environment. Now before I turn the call over to Janice I want to recognize George Lewis. As you know, we recently announced that Doug Guzman will succeed George as group head of our wealth management insurance business beginning on November 1st. George will continue to play a key role in global asset management but given that this will be George's last quarterly call. I wanted to take this opportunity to sincerely thank him for his contribution. Under his leadership we've established the number one position in Canadian Wealth and Asset Management, it grew to become the fifth largest wealth manger globally and greatly expanded and diversified our asset management business globally through some very challenging market condition. So thank you George and with that I'll turn the call over to Janice.

Thanks Dave and good morning everyone. As Dave said, it was a solid quarter with earnings of over $2.4 billion up $97 million or 4% from last year. Excluding last year's loss related to the sale of RBC Jamaica, earnings were up $57 million or 2%, compared to last year quarter earnings decreased $27 million or 1%. Excluding last quarter's foreign currency gain, earnings were up $81 million or 3%. Our results reflect record earnings in personal and commercial banking including solid growth in Canadian banking and improved results in the Caribbean as well as continued growth in investor and treasury services. As Dave noted capital markets were down from exceptionally strong levels last year and last quarter and reflect challenging market conditions in the quarter. Turning to capital on slide 7 our common equity Tier 1 ratio of 10.1% increased 10 basis points from last quarter. Strong internal capital generation was partially offset by higher risk weighted assets and the impact of a weakening Canadian dollar, particularly versus the British pound and the euro as we hedge the bulk of our U.S dollar exposure. In addition our capital ratio was positively impacted by a higher discount rate which decreased our pension obligations and increased our pension plan assets. I would note that our common equity Tier 1 ratio has increased 60 basis points from last year as we've continued to build capital in anticipation of closing the announced acquisition of City National in our first fiscal quarter of 2016. Moving to our business segment results starting on slide 8 personal and commercial banking reported record earnings of over $1.2 billion up $143 million or 13% from last year and up $81 million or 7% from last quarter. Canadian banking reported record earnings of over $1.2 billion up $54 million or 5% from last year. Our results reflect solid volume growth of 6% including loan growth of 5% and deposit growth of 7%. Our performance also reflects 10% growth in fee based revenue as net new sales and capital appreciation drove higher mutual fund distribution fees. In addition growth in credit card balances and purchase volume drove higher credit card revenue. Our solid revenue growth in Canadian Banking this quarter was partially offset by higher cost to support business growth as well as lower spread largely in business lending which continues to be highly competitive. Sequentially Canadian Banking earnings were up $48 million or 4% largely due to additional days in the quarter. Strong fee based revenue growth and solid volume growth across most businesses also contributed to the increase. These factors were partially offset by higher cost to support business growth and higher PCL which Mark will explain. This quarter our net interest margin in Canadian Banking was 2.66%, up two basis points sequentially or flat when you exclude last quarter’s cumulative accounting adjustments. Our efficiency ratio improved 30 basis points over last year to 43.5% and we generated positive operating leverage of 0.7% demonstrating our ongoing focus on managing the trajectory of revenue growth against expense growth. Caribbean and U.S. Banking had earnings of $42 million, up $89 million from last year. Excluding last year’s loss related to the sale of RBC Jamaica, earnings were up $49 million reflecting lower PCL and the benefit of cost management initiatives and foreign currency translation. Sequentially our earnings were up $33 million as last quarter included a $22 million after tax loss on the sale of RBC Suriname. Turning to Slide 9, wealth management had earnings of $285 million flat from last year. We had higher earnings from growth in average fee based client assets across all businesses. Assets under management and assets under administration were up 14% and 11% respectively over last year, due to FX net sales and capital appreciation. This growth was mostly offset by lower transaction volumes reflecting lower client activity and [seeing] new issuances due to the uncertain market conditions this quarter. In addition, our earnings were negatively impacted by a change in fair value of our U.S. share-based compensation plan. Sequentially earnings were up $14 million or 5% as the prior quarter had provisions for credit losses and higher restructuring costs related to the repositioning of our U.S. and international wealth management businesses. We’re about three quarters through the expected cost associated with this and expect to be largely finished by the end of the fiscal year. Moving to insurance on Slide 10, net income of $173 million was down $41 million or 19% from last year largely reflecting the negative impact of the tax change that I have previously discussed as well as higher net claims costs in our life retrocession business. Sequentially net income was up $50 million or 41% mainly due to lower net claims costs, the favorable impact of investments related activities on the Canadian life business and higher earnings from a new UK annuity contract. Turning to Slide 11, investor and treasury services had earnings of $167 million, up $57 million or 52% from last year. Previously investor services reported earnings on a one month lag, effective this quarter we aligned our reporting period and therefore the third quarter includes four months of result adding $28 million to the segment’s earnings. Growth from last year was also driven by higher earnings from our foreign exchange businesses and increased custodial fees partially offset by lower funding and liquidity revenue reflecting widening credit spread. Compared to last quarter earnings were up $8 million or 5% driven by the additional month of investor services results partially offset by lower funding and liquidity revenue. Capital markets had a solid quarter. Net income of $545 million decreased $96 million or 15% from a record last year and was down $80 million or 13% from a strong Q2. As Dave mentioned, we have a strong and growing presence in the U.S. We benefited from foreign currency translation which increased earnings by $37 million compared to last year. At the same time our effective tax rate has increased as the U.S. is a higher tax jurisdiction. Markets were more challenging in Q3 resulting in lower fixed income and equity trading and lower equity origination activity. I’ll also remind you that last year’s results included two trades which added approximately $100 million to trading revenue. While trading was down we had strong growth in corporate and investment banking driven by higher M&A activity in the U.S. and Europe and higher lending revenue mainly in the U.S. and Canada. With that I’ll turn the call over to Mark.

Thank you Janice and good morning everyone. Turning to Slide 14, our credit quality remains strong this quarter as credit trends stayed near historic lows reflecting our strong risk management, low interest rates and strong employment trends. However given the headwinds Dave has highlighted, our outlook remains cautious. Provisions for credit losses on impaired loans of $270 million or 23 basis points this quarter remain near historical lows and decreased by $12 million or 2 basis points from last quarter. This decrease mainly reflects lower provisions in Wealth Management and in the Caribbean and U.S. Banking which were partially offset by higher provisions in Canadian Banking. Wealth Management's provisions were down $32 million sequentially as the last quarter included a provision on a single account in our International Wealth Management business. We had no new provisions this quarter. In Caribbean and U.S. Banking provisions were down $4 million from last quarter reflecting stable credit trends. In Capital Markets, provisions were flat sequentially at $15 million and largely related to one exploration and production account in Canada. In Canadian Banking we had provisions of $238 million or 26 basis points, up $26 million or 1 basis point from last quarter. I would point out that the increase was mainly due to the reversal in last year of a provision on a single account in our commercial lending portfolio. Turning to slide 15, our Canadian retail portfolio remains stable. Provisions in our credit card portfolio remained low at 243 million, down 19 basis points sequentially, primarily due to seasonality. In our small business portfolio, while we expect variability from quarter-to-quarter, we have seen a decline in provisions over the last few quarters. Provisions in our personal portfolio remain stable from last quarter. Our residential mortgage portfolio continues to perform well with provisions of 1 basis point this quarter, consistent with our historical performance. As seen on slide 16 this portfolio benefits from broad geographic diversification and a strong loan-to-value of 55% on our uninsured mortgages. Turning to gross impaired loans, as highlighted on slide 17, we saw an increase of $234 million this quarter, of which approximately 35% was due to foreign exchange translation. Capital markets gross impaired loans increased by $177 million largely related to four accounts, two of which were exploration and production companies, one in Canada and one in the United States. Only one of these accounts required to be provisioned for this quarter. Wealth management gross impaired loans increased by $39 million related to a single account in our international wealth business in the British Isles. Personal and commercial banking gross impaired loans increased by $18 million mainly related to two accounts in Canada, both unrelated to the oil and gas sector. To summarize, while our gross impaired loans increased this quarter, our total oil and gas portfolio only accounts for 8% of total gross impaired loans. Turning to slide 18, let me provide you with an update on our oil and gas exposure. Our drawn exposure to the oil and gas sector represents 1.6% of RBC's total loan book, up marginally from last quarter, mainly due to foreign exchange translation. The composition of this portfolio remains unchanged with approximately 65% of loans to exploration and production companies. Our undrawn exposure to oil and gas has increased from last quarter, also largely related to foreign exchange translation as well as the few new commitments. The undrawn book continues to be two-thirds investment grade. The aggregate drawn and undrawn book is approximately 50% investment grade and 50% non-investment grade. As the price of oil has continued to decline through the year we've updated our stress scenarios. From a wholesale perspective, we stress test on a name-by-name basis. Our most recent scenario assumes a $35 oil price for the remainder of 2015 and uses the forward price curve for 2016 which currently averages $45. Based on this scenario, we are now monitoring a handful of additional [lanes] compared to our prior scenarios. If the price of oil stays at current levels, we could see an uptick in wholesale provisions. However, we have seen a number of companies raise capital, delay capital spending or cut dividends which should help mitigate some of the impact. One factor we will keep a close eye on is this fall's borrowing-based redeterminations. Our price deck used for our spring redetermination expected the average annual price to be closer to $53 in 2015 with small increases to the mid $60 over time. Should the oil prices remain below $45, we would expect to see further challenges for these clients as our price deck would be reflecting these further depressed prices. Should this occur, our first impact will be an increase in gross impaired loans. I would stress that this may not play out in immediate increases in PCL as for the most -- for most of these borrowing-based financings we are secured and we are at the top of the deck stack. We take into account a view on loss in the event of default before we take provisions. Turning to our retail portfolios and the possible second order impacts, we are watching for changes in employment trends and consumer behavior as they are key leading indicators. In particular, we've seen the unemployment rate increase from 4.5% to 6.3% in Alberta, although it still remains below the national average of 6.8%. Delinquencies remain near historical lows and we have not seen an increase in delinquencies for Canada as a whole but have noticed a slight uptick this quarter in oil exposed provinces. This increase is insignificant at this point and it's too early to say that this is a trend. We stress the retail and commercial portfolio across a number of variables including higher unemployment rate a decline in house prices and slower growth across the country. Overall under these stress scenarios we continue to believe our PCL ratio will remain within our risk appetite of 40 basis points to 50 basis points through this cycle. But putting aside these stress scenarios and given what we are currently seeing across our portfolios we couldn’t visage our results moving from the benign to more normalized credit levels. Let me remind you the 23 to 26 basis points we have experienced over recent quarters represents in historically benign credit environment in a more normalized PCL environment we would see amounts in the 30 to 35 basis point range. Turning to market risk, this quarter while we saw a fairly volatile market conditions, our average value of risk decreased by $3 million and our average stress value at risk decreased by $14 million quarter over quarter, it is worth noting that both remain low at $31 million and $91 million respectively relative to our trading revenue streams. In addition we had no days of trading losses this quarter, in fact we have had no trading losses since January 2015 as shown on slide 20. To conclude while recent market and economic headwinds underpin a more cautious outlook, I am pleased with our overall credit and market risk performance which benefited from the diversification of our portfolios both in terms of geography and industry as well as our prudent risk management practices. With that operator, we'll open the line for Q&A.

[Operator Instructions]. The first question is from Steve Theriault at Bank of America Merrill Lynch. Please go ahead. Your line is open.

I had a question for Janice but maybe just a quick follow up from Mark if I could. You gave us a bunch of numbers there on your oil and gas stress test. So do I have it right that you're telling us the average throughput cycle PCL loss rate 30 to 35 bps and under the stress case that you outlined for us PCL don’t go any higher the net 40 to 50 basis points range? Is that correct?

What I said was the 30 to 35 basis points would a more normalized PCL that we would have experienced overtime and the stress test are not seeing us test our risk appetite of 40 to 50 basis points.

I wanted to just focus on capital for a second for Dave or maybe for Janice. The global [CC] review is coming up in a couple of months wondering to what extent you’ve maybe had discussions with the regulator, as to whether you expect to be maybe regulated with more intensity or subject to higher buffers or whether things like buybacks or acquisitions would be more scrutinize carefully or more scrutinized if in fact you make the list this year.

So I'll answer that for you to the extent I can. We recognize that given the metrics that we may be classified as G50, of course it all depends on the euro and the performance of the other banks. So we have had discussions specifically with all three about the prospect of being a G50 and we've had discussions about capital and they've indicated to us that they will get back to us towards the end of September or mid-October. The discussions have centered around the fact that we already have a domestic CC buffer and if you look at tearing of G50 we recognized the fact that domestic CC buffer will be replace by G50 but the range as you know is anywhere from a low of 1% up to 2.5%. And currently when you look at our capital levels we're running at 10.1% we have a bit of a prudential minimum we look towards of maybe 9.5% so that's 250 basis points. So those are the discussions we're having and we're assuming that as oft it comes to the conclusion they will let us know slightly prior to when it's announced to the market. When you look at our capital planning and capital attribution and allocation, our critical driver on capital accumulation today is [defend] our City National acquisition. So we think that will take about 70 basis points so we are building capital towards that. With the close in our first fiscal quarter and given our solid capital and earnings generation, we feel that once we close City National, we'll be in more of a business as usual capital allocation and usage time which will mean funding of course as usual all organic growth looking at dividends increasing at the rate of growth of earnings and looking at buybacks or other acquisitions at the margin recognizing of course that we are committed to effectively integrating and getting City National off to an excellent start in terms of its earnings generation. So that's sort of the way we’re looking at capital.

So just to be clear on if you do get classified clearly it will be in the bottom bucket which is the equivalent to the 1% domestics -- you give some color on that so can I translate that into -- there is at least some risk that the -- if you're in the 1% category that it isn’t additive additional CET1 or not?

I don’t think that the way the metrics work it will be additive, but I would say that if you look at how we’re running our capital, as I said we are running capital at a 250 to 300 basis points buffer at this point in time over the 7%. We think that’s a prudent level to run our capital at.

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

Hi, good morning. Just want to better understand the flat year-over-year wealth management earnings and I know there is a restructuring going on, but can -- Janice just to start, can you quantify that U.S. share based comp issue that was called out on the slide?

Yes, Rob I would say this about the U.S. comp issue too, it is episodic. So it relates to the value of the -- our ROI shares some of it and the fact that while we’ve hedged our stock-based compensation it's an economic hedge and not accounting hedge. So the mark-to-market moves around and then I am going to turn it over to George to make some comments on unusual earnings trajectory.

Thanks Janice and thanks Robert for the question. Yes, and we disclosed this in the supplemental, the impact of the U.S. wealth accumulation plan and if I recall on a year-over-year basis the differential is around 14 million, so roughly 5%. I'd say we also had a couple of other minor unusuals, but just on the international wealth restructuring as a follow-on to Janice’s comments, we had some modest amounts this quarter, we are about 75% [relate] through that program. So you will see an item in the fourth quarter as we largely complete that by year-end and that we are very focused then on letting the results of our larger businesses that Dave highlighted flow through to bottom-line to a greater extent.

So the -- I mean the restructuring costs are going to follow next year, I mean you had revenue growth from what I can tell across all three of your business lines and it was 8% year-over-year. So I mean is this still a business that should be a high single low double-digit earnings contributor or is there something -- are you making investments in the international businesses elsewhere that’s going to slow that growth rate as we look into next year?

Thanks very much for that follow-up. We are very focused as we go into 2016 Doug and myself on a more modest revenue growth outlook given market conditions. And so the completion of our international wealth restructuring program is allowing us to accelerate our expense program. So we are bringing that expense profile in line with our revenue growth, so that we are able to deliver positive operating leverage even in a more modest revenue environment. But the underlying flow performance, the client flows in our three large businesses remain positive. And so we feel good about 2016 in terms of momentum of our businesses now that we largely completed our restructuring.

Thank you. The next question is from John Aiken at Barclays. Please proceed. Your line is open.

Good morning, Mark, you did an excellent job in your prepared commentary. But unfortunately you're still going to get some questions on credit. In terms of when you're characterizing normalized environment of 30 or 35 basis points, what in terms of the macro environment over the next little while would get you there? And could you I guess frame your answer around the fact that we’ve seen ongoing improvements within the Canadian consumer portfolio over the last 12 months, but actually deterioration on the business side which I guess would even if we’re looking at year ago is probably counterintuitive?

Thank you, John. I guess normalized goes to some of the macroeconomic metrics, I mean do we expect interest rates in Canada and United States to stay at the levels that they are? Obviously depending on how some of the current market conditions are there, they may do for a period of time. But I think in a more normalized situation we would be expecting interest rates to move, unemployment is obviously a big factor that would come into play and then GDP growth. So those macroeconomic factors I think need to normalize a little bit from where we are and we would then expect to see that move from the lower -- the mid-20s up to the 30 to 35. Now when those conditions occur, is I guess anyone's guess, but those are the things that I would bear in mind.

And then in context the evolution of the Canadian consumer book versus a Canadian commercial book versus the wholesale book?

Well we’re certainly seeing on the commercial book, a good business growth as Dave reported in his comments. We did see as I think I reported a couple of gross impaired loans but they were very name specific and situation specific. So we're not really seeing a deterioration in credit trend in that portfolio. On the retail side, across all of the portfolios as I reported we're not seeing deterioration in our impairment rates and in fact in some cases we are actually still seeing some improvements. So I am not really seeing either in retail or commercial significant concerns at this point, it's just -- I overlay of course, the market conditions that we're operating in and so that's why I've tried to express a cautious view.

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

Hi, good morning. My question is for Dave or Janice. Just a follow-up on Steve's questions on the GCIB nomination potential later this year. Let's say things don’t go out of -- turn out as you hope they do, and obviously require another buffer to be layered on and the target goes to 11%, and that's a few billion dollars of incremental capital. I assume you will earn your way there for the most part and have some flexibility in that regard, however, the market always want higher capital ratios to grow faster. Would you look at selling some assets to speed up that progression?

Well I can take that. I don’t think we can comment on that. Now that there's lot of options for us, we'll come up with a plan with OSFI to meet that new target if they set it there. We have no idea if they would or not but there's a number of ways we can get there and I think it would be prudent to hypothesize which avenue it would take. But certainly the plan would be to work with OSFI towards the time we would get to that target.

Okay. Next question, a couple of quick ones here. If you can comment on the current trading commissions and you have seen in August volumes will probably be lower but just what you are seeing? And also, if we get another bank account at the rate cut, what are you doing to prepare for that? I know the first one we saw earlier this year was a bit of a surprise but the most recent one was expected and maybe another one will be expected. What can you do to kind of offset any additional NIM pressures there?

I can start with the trading conditions currently. I think starting with fixed income, we are seeing because of the recent market volatility high yield for instance in the U.S. new issue flows is down, investment grade credit is steady but down a little bit, and in rates trading I would say it hasn’t changed. In the equities trading side of the business, it's really just agency trading. We are not really putting capital to work for to offer liquidity. So the equities trading business has actually been as you might imagine reasonably robust especially over the last several days. In terms of preparing for a rate cut?

Great, thank you Doug. What I would say about preparing for the rate cut is as you've seen when we look at a potential for a bank accounted rate cut, we look at a variety of factors including impacts on our clients and also looking at other rates in the market and what's happening to our funding spreads. So I would say that when we are approaching, we look at the actual conditions in the market before we determine the direct response. And just as with other areas of net interest margin pressure, in our Canadian Banking platform, we are also focused on driving on efficiencies and ensuring that despite the revenue environment we can still drive very solid earnings growth. And I think those builds that programs have been started and are well underway and will continue to focus on the both earnings growth as well as some top-line growth.

Thank you. The next question is from Meny Grauman at Cormark Securities. Please go ahead. Your line is open.

Hi, good morning. I wanted to ask a question about the mortgage market. You are putting up good mortgage growth, 6.5%, that looks quite a bit better than the market overall based on the aggregate data that we have and I am just wondering if you think that kind of outperformance is sustainable and what do you attribute it to?

So Meny it's Jennifer here. We were very pleased with how our spring and summer markets performed with strong volume, and the seasonality is and the low rate environment has spurred a higher level of market activity for new originations and refinancing as Dave mentioned. We also had a very successful employee pricing campaign. But we will also note that some of the growth is due to client switching out of unsecured lines of credit and some early renewals as clients are taking advantage of the better rates offered on mortgage products. And as far as outlook is concerned, we continue to have a strong pipeline but there is that seasonality to the business that we expect will moderate somewhat in the fall.

And it doesn’t touch you directly per se but definitely there was a lot of talk this quarter about some issues of active verification in the broker channel. I'm wondering if you have any insight into that and what's your take on that segment of the market?

First of all we don’t originate through brokers but income verification is a key component of our adjudication process and our application [growing] taken by branch lenders and our proprietary mortgage salesforce. And for each application we verify income, we have various ways of doing that and our policies require documents to be retained. We have underwriting in our credit adjudication center and application review process that's undertaken in that group particularly for our mortgage specialist salesforce and needs credit professionals to income verification that is confirmation to employment with close employers, document review. And so we have good processes on new clients. We originate many of our mortgages from our existing client base and so we have multiple ways to verify income including news of our internal RBC information and generally we find clients are prepared to provide other forms of documentation which are actually easier for them [such] statements or income tax forms which are readily available. And prior to that we have ongoing fraud monitoring of our application process to help the tax and prevent more [fixed] fraud.

Just as a follow up do you see those issues as being a risk to the market as a whole or contained? Do you have a view on them?

I did the commentary at the time that this was [indiscernible] I can't really comment on the industry overall, but I think just the comments on those involved were that they were contained but from our point of view we feel that we contained that risk for [indiscernible].

The next question is from Mario Mendonca at TD Securities. Please go ahead. Your line is open.

When you offered the 30 to 55 basis points the normalized outlook, what I want to confirm is that, that was just purely information only, you weren't really guiding us there in the near term. Is that a fair statement?

Yes that’s correct.

And then going to the 40 to 50 basis points for a stress PCLs. I think we can all appreciate that the banks can manage that certainly from a capital perspective. But the more challenging thing to gauge is what that would do not just to PCLs but the overall effect on the bank what will that do to earnings. And the broad question is can the bank grow their earnings year-over-year in an environment where PCLs are approaching the 40 to 45 basis points and all the other things are happening to revenue and expenses as a result of that stress scenario you offered us.

Well certainly in all of these stress scenarios you do factor in the PCLs. You factoring the impact on earnings, you factor in the impact upon how RWAs growths et cetera. We do see RBC in those scenarios still producing solid earnings through that period. I think the diversity of our portfolios across industries and geographies still retain a very sound and solid earnings growth potential.

So I couldn’t possibly imagine the bank losing money, bank generates $2.4 billion in earnings, there is no way that’s going to go in the quarter. So I appreciate this is going to solidly positive but do you think it grows in that environment?

I think that depends on the situation at the time.

I would agree, I mean there is one thing you do see in more troubled times is more draw down. So sometimes you see your NII going up in that case. But you do have higher impairments and higher PCLs. So the number of variables that go into that, make it hard to predict whether you go up or down but I think as you look at how Mark's frame the overall risk profile, you should be confident in our core earnings ability through that period.

And the next question is from Peter Routledge with National Bank Financial. Please go ahead. Your line is open.

Looking at the page 18 in the presentation, wondered if you could give us a sense of what last given default would be in the oil and gas loan categories.

Slide 18 did you say?

Yes so for E&P or drilling.

Well what we do with our portfolios, I think the industry does is we provide withdrawn exposures. And then the way we categorize on drawn exposures is the exposure at default and then we provide you with a fair amount of detail in the supplemental as to how that exposure default is calculated. It is a fairly complicated mathematical equation because it takes into account many different levels of borrower risk ratings as well as historical analysis on loss across those risks ratings that we apply to our exposures.

I guess the reason I was being more specific is the [indiscernible] LGD just by business loans overall. Can I just impute the LGDs from your broad business portfolio on to your oil and gas portfolio or is there a difference for oil and gas?

There is not a different for oil and gas.

And then you’ve got 13.3 billion roughly in undrawn, what is your exposure default? How much of that gets drawn as borrowers approach default and how much degrees of freedom do you have to cut lines before they can draw?

So the way the exposure at default is calculated is in a default scenario that is the potential that we would be expecting could be drawn, each loan of course is specific and different in terms of the characteristics of its drawing capability, some loans have covenants, some do not or that would restrict drawings. I would also acknowledge that in many instances over the past years as a client is experiencing difficulties, they do draw down the loans before they get to the fault. So what I think we’ve come up with as the industry has is with the exposure default numbers are the calculations that are based upon historical data.

Okay. And did general business exposure default is applicable to oil and gas without any adjustment?

Yes.

Yes, thanks. And Jennifer thanks for your comments on your underwriting procedures in mortgages and you mentioned, you gave us a lot of examples of quality assurance. I guess the question I -- so even if you check documentation, documentation can be misrepresented or altered. How do you -- what sort of checks do you run to ensure that the actual documentation you're getting, the employment letters, other forms of income verification are accurate?

Well there are a number of ways you can do that including calls to employers, also as I mentioned a good percentage of our new mortgages originated from existing RBC clients and so often that payroll will be going into their account with RBC. So we feel quite comfortable with the processes that we have in place, plus knowledge that we have of the customer that we can verify that income adequately and of course you got income tax returns which are often what a client will provide to us as evidence of their income levels.

Thank you. The next question is from Sohrab Movahedi of BMO Capital Markets. Please go ahead. Your line is open.

Okay. Thank you. Couple of quickies, Mark you mentioned you had two formations and you actually took specifics against one of them, that level of specifics that you took on that account, how would it have compared to when you're stressing scenarios?

Actually, pretty good actually, so for example that particular client was identified earlier in the year when we were doing our original stress testing and we identified the challenges the client would have and the amount was ended up taking in line with our expectations were through the year.

Okay and a lot of the commentary you’ve provided suggests that higher loan losses are inevitable, they are not imminent and I wonder if you could just comment what happens to the credit cycle if we stay more or less 2% GDP growth environment in Canada, plus or minus either side of that, will that have the net effect of lengthening the credit cycle?

I guess if I had that much of a crystal ball -- I really can’t tell you, I mean possibly.

So as a Chief Risk Officer would you rather have a 4% growth environment next year or 2% growth environment?

That’s a very good question. I guess I would then actually want to understand what the other aspects are wherein interest rates would be to go with that. So if you give me a combined package I could certainly see some higher growth being very positive even for our risk books, but continuing on of the benign credit environment I would be very happy with it as all.

Okay, so just

And in terms of what the source of growth is you could still have 4% growth driven by manufacturing and exports and other struggling commodity energy cycle. So you’ve got to look at it holistically…

Fair point and just one last one, when you run the stress scenarios, do you then assume interest rates are down to 0%?

Actually in some of the scenarios we increase interest rates as well which you could argue the -- whether that’s actually plausible or not, but part of the stress scenarios is actually to try to replicate what could really be a bad situation. So we do have scenarios where interest rates are kept very low while all of the other factors are weakening significantly, but then we also do scenarios where we also add in increased interest rates.

Thank you. Our last question will be from Sumit Malhotra at Scotia Capital. Please go ahead. Your line is open.

Thanks, good morning. My questions are likely for Doug McGregor. Doug starting with your corporate loan book, you’ve indicated for some time that we were likely to see the pace of growth start to decelerate from what have been very strong levels, yet they continue to run quite strongly this year. I know there's been some FX noise. But when you look at the underlying trends in corporate lending, do you envision that starting to slow on a core basis as some of the macro headwinds take shape here or do you have growth in other geographies that is making up the difference?

Yes, almost all of that growth is in the U.S. and so to your comments about half the growth is FX but we are seeing frankly a pretty robust demand, and I think it's really just a function of the fact that we're expanding our client base. And there is a lot of M&A activity going on in the U.S. and frankly we are not seeing that abating, although we have been in a rough markets for the better part of a couple of weeks here in terms of the real volatility, so we'll see how that plays out. But the demand is quite high. I think really the longer term growth is high single-digits. So yes, it's mostly U.S. and we are seeing pretty good demand.

What about the energy portfolio in particular? Mark mentioned that you are heading into this period of credit redetermination reviews. Again, I know the FX might be skewing things here. But it does look like you've got about a 500 million quarter-over-quarter increase in your energy balances. Has that been -- well let me just ask you, do you anticipate the outright energy portfolio declining as you go through this period of fall review?

If there's any significant decline, it will be on the difference between committed and drawn, so that as you go through the redetermination, the availability could drop if we're using a new price deck. So that's where you will see the reduction. And in terms of servicing the industry, we continue to participate in the industry. We are obviously, we have been in this business for a long time. We think that we have good processes in terms of determining company's ability to pay. And I think to Mark's earlier comments, we are usually a senior lender and yes will continue to be in the business.

Yes, hi, it's Mark here, I would just echo that. In terms of the increase that we had in the quarter, certainly some of it was foreign exchange related but some of it was actually from new clients that were put on in the wholesale book. As Doug has sort of said, we are not afraid of this industry sector, we have dealt with it for a decade. I think we have a lot of people that are very strong in their understanding of how to deal with this sector. And so the right client opportunities come along, we will take advantage of them.

Thank you. This is all the time we had for questions. I would like to turn the meeting back over to Mr. Dave McKay

I just want to thank everybody for attending our Q3 call today and your questions and participation. And we look forward to seeing you next quarter in Q4. Have a good day. Thank you.

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