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Royal Bank of Canada (NYSE:RY)

Q4 2013 Earnings Call

December 05, 2013 8:30 am ET

Executives

Karen E. McCarthy - Director of Investor Relations

Gordon M. Nixon - Chief Executive Officer, President and Not Independent Director

David I. McKay - Group Head of Personal & Commercial Banking

Morten N. Friis - Member of Advisory Board

Janice R. Fukakusa - Chief Administrative Officer and Chief Financial Officer

M. George Lewis - Group Head

Analysts

Robert Sedran - CIBC World Markets Inc., Research Division

Gabriel Dechaine - Crédit Suisse AG, Research Division

Peter D. Routledge - National Bank Financial, Inc., Research Division

Michael Goldberg - Desjardins Securities Inc., Research Division

John Reucassel - BMO Capital Markets Canada

Operator

Good morning, ladies and gentlemen. Welcome to the RBC 2013 Fourth Quarter Results Conference Call.

I would now like to turn the meeting over to Ms. Karen McCarthy, Director of Investor Relations. Please go ahead, Ms. McCarthy.

Karen E. McCarthy

Good morning, and thank you for joining us. Presenting to you this morning are Gord Nixon, President and CEO; Dave McKay, Group Head, Personal and Commercial Banking; Morten Friis, Chief Risk Officer; and Janice Fukakusa, CAO and CFO. Following their comments, we will open the call for questions from analysts.

The call will be approximately 1 hour long and will end just before 9:30. [Operator Instructions] We'll be posting management's remarks on our website shortly after the call.

Joining us on the call: George Lewis, Wealth Management and Insurance; Doug McGregor, Capital Markets and Investor & Treasury Services; Mark Standish, Capital Markets and Investor & Treasury Services; Zabeen Hirji, Chief Human Resource Officer; and Mark Hughes, Deputy Chief Risk Officer.

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

I will now turn the call over to Gord Nixon.

Gordon M. Nixon

Thank you, Karen, and good morning, everyone. As you've seen in the press release issued early this morning, we announced that I will be retiring on August 1, 2014, after 13 years as CEO. You will also have read that Dave McKay will take on the role of President at our annual meeting on February 26 and will assume the role of President and CEO on August 1, 2014.

I can't tell you how delighted I am by this announcement. Many of you on the call know Dave well. In my opinion, he is one of the best retail bankers in the world and has been recognized as such and is universally supported and respected across our organization. In addition, his risk management and international corporate banking experience round him out nicely. Dave is a strong leader and innovator. He is client-focused and collaborative and, like me, believes our employees are the core of this great organization.

So let me turn to the obvious question, "Why now?" I think that the time is right for a transition. When I retire, I will have been CEO for over 13 years. I'm very proud of what we have accomplished but feel it is a great time to look to the future and build for the longer term. When we presented our 5-year strategy to the board this summer, it was clear to me that someone else should take the lead, as they would ultimately have the accountability for its performance. Dave just turned 50. He's at the right age and stage of his career to hopefully have a good 10-year run at leading this incredible organization. Dave has earned the opportunity, and he has the full support of our management team, which is fully committed and has never been stronger.

I'd just like to remind people that Bruce Ross will be joining our management team. He is one of the most highly seasoned global technology executives in the world, and he'll be joining in a few weeks as Group Head of Technology and Operations. And we're excited to have him onboard.

Over the past decade, our earnings and market shares have grown, both in Canada and internationally. We have a diversified business mix that continues to deliver sustained shareholder value, as was evidenced this quarter. We have a strong brand and culture. Our culture of inclusion makes us a great place to work, where all employees have the opportunity to succeed, and I am very proud of our employees who put their clients first and work together to bring out the best of RBC.

There is no question that this is an -- that as an organization, we are poised for success and continued strong performance. All of our businesses ended this year in good shape, with strong momentum and solid growth plans. So while I'm excited about continuing to lead the organization into 2014, I do believe that succession is one of my primary responsibilities, and I feel it is the right time to pass the baton to the next leader to take this great organization to the next level.

Before I conclude, I'd also like to thank Mark Standish for his contributions over the last 18 years. Mark has made a significant contribution in building the business globally, particularly in the U.S., through some of the most challenging market conditions in recent memory. Mark provided strong leadership in growing the RBC brand in New York, which has helped to attract and retain new talent and clients. Part of that successful brand building was a result of Mark's personal commitment to make a difference in the community through his volunteer board memberships and other activities. So on behalf of the board and my colleagues, we look forward to working with Mark over the next several months as he works with some of our trading businesses to facilitate transition under the changing regulatory regime in the U.S.

I'd also like to congratulate Doug McGregor, who is assuming the role as Chair and Chief Executive Officer of RBC Capital Markets and Group Head of both Capital Markets and Investor & Treasury Services. Doug has helped Capital Markets and Investor & Treasury Services grow in the face of economic and market uncertainties and an evolving regulatory environment, and I know that he will continue to be a positive force for change.

Doug has led the expansion and rebalancing of Capital Markets, where a greater portion of our earnings are now derived from corporate and investment banking, origination fees and client-based activities in our trading businesses, and this was evidenced again this quarter. His strong leadership, deep knowledge of the business and client focus will continue to serve RBC exceptionally well into the future. I'm looking forward to continuing to lead group executive over the next 8 months, and I will be looking forward to working closely with Dave to ensure a smooth transition.

So before I turn to our record results that we delivered, I'd like to ask Dave to say a few words, and I'm happy to come back to these issues during the Q&A. Dave?

David I. McKay

Thank you for your kind words, Gord. Let me start by saying how honored I am by the confidence the board has placed in me to take over the stewardship of this incredible organization. It is an exciting time to be asked to take on the role of President and then CEO. As Gord said, we have tremendous momentum. Momentum that I think is created not only by the success of our diversified business mix, but also by our 79,000 employees who are focused on our clients and deliver on our brand and our values each and every day.

I'd like to take a minute to thank Gord for his ongoing support and guidance throughout my career. He's played a very important role in providing me with development opportunities. He set a high standard for me and all of the senior executives to follow. Let me close by saying that I'm excited not only about this new challenge, but also by the fact that I will continue to work with an excellent senior leadership team.

I believe that together we can continue to build on our great success to date. Thanks.

Gordon M. Nixon

Thank you, Dave. And now to the more important matter of the morning, which is our record results for 2013. As you've seen, we reported net income of $8.4 billion, which was up 12% from last year. We delivered a return on equity of over 19% and our all-in common equity Tier 1 ratio remains strong at 9.6%. We achieved all of our financial performance objectives for the year.

Our results were underpinned by the strength and diversity of our businesses, led by record performances in Personal & Commercial Banking, Wealth Management and Capital Markets. During the year, we launched new products and partnerships, won new clients and gained market share in our key Canadian and global businesses, all while increasing efficiencies.

Looking at the fourth quarter, we delivered earnings of $2.1 billion, up 11% from last year. Our fourth quarter results were driven by strong growth in our corporate and investment banking businesses, solid volume growth in Canadian Banking, higher average fee-based client assets in Wealth Management and improved business performance in Investor & Treasury Services. We did have a charge, as was reported a couple of weeks ago, in our Insurance segment, which had an impact. But we also had a favorable tax adjustment this quarter related to prior periods, both of which Janice will discuss in her remarks.

Turning to our business segments. I will provide an overview of our annual segment performance, and following, Morten and Janice will comment more fully on our fourth quarter results. Starting with Personal & Commercial Banking, our Canadian Banking business delivered record earnings of over $4.4 billion, up 9% from last year, reflecting solid volume growth across all businesses, improved credit quality and our ongoing focus on efficiency and management activities. Our Canadian Banking fourth quarter earnings were $1.1 billion, up 7% from a year ago.

We closed our acquisition of Ally Canada back in February and completed the integration of this business this quarter. Overall, we are very pleased with Ally's performance, which has exceeded our objectives. The timing of this acquisition could not have been better. It not only gave us the leading market position in auto financing but enabled us to take advantage of growing market trends.

Across all other key product categories, we continue to be a market leader, with either #1 or #2 market share. Our results clearly reflect our ability to leverage our size and scale to take a disproportionate share of industry growth at, at least a 25% premium to the market over the last few years which, as you know, is our objective.

In personal financial services, we saw solid volume growth, reflecting the unparalleled size and scale of our multichannel distribution network, which allows us to reach more clients when and how they want. The breadth and quality of our product offering allowed us to grow faster than our peers, and we are also delivering innovative and differentiated products and services to capture a greater share of key high-growth client segments, such as retirees, business owners and newcomers to Canada, a key priority for us. In addition, RBC has a proven ability to cross-sell more effectively. We led the industry with close to 22% of our clients having at least 3 products or services with us, checking, investments and lending, compared to a peer average of 14%. This year, we were recognized for the second consecutive year as the Best Retail Bank in North America by Retail Banker International.

As well, our business financial services business was recently recognized as the Best Commercial Bank by World Finance. We have the leading commercial franchise with unparalleled industry specialization and the largest sales force in the industry. We continue to expand our sales force and strengthen our product and service offerings, including enhancing our mobile capabilities for business.

In cards and payment solutions, we have an extensive cards portfolio and grew both transaction volumes and loan balances this year. We pride ourselves on our long-standing relationships with our clients. They appreciate that we are constantly innovating and enhancing our cards portfolio, including entering into key partnerships this year with Target and WestJet. We are also at the forefront of emerging payments and mobile technologies, and in the last few months, we announced a number of innovations in this space, including the first cloud-based secure mobile payment solution in Canada.

While growing volumes in Canadian Banking is a priority, we are also committed to improving efficiency and productivity, particularly as we face a slower growth environment. For example, in early 2014, we will be launching a new mortgage origination system that automates and simplifies the end-to-end mortgage process to improve client response time. As you're aware, we've been working on this for quite some time. Our efficiency ratio of 44.5% leads the industry, and we expect to continue to drive this ratio to the low-40s over the medium term.

In the Caribbean, as we have discussed throughout the year, we continue to believe that the Caribbean remains an attractive region for RBC, and we are aggressively managing this business to drive improved performance, while in U.S. banking, we are focused on growing our cross-border business and serving the banking needs of our U.S. Wealth Management clients.

Turning to Wealth Management. We had record earnings of almost $900 million, up 18% last year, largely reflecting higher average fee-based clients and transaction volumes. We also generated strong earnings of $205 million in this quarter. While flat year-over-year, it was a result -- our underlying performance was very strong, but we were impacted by an unusual credit charge that Morton will discuss later on. Our client assets grew by 12% this year to reach over $1 trillion for the quarter. While the low rate environment persisted, our business capitalized on a moderate improvement in global economic market conditions.

Starting with Global Asset Management. We are now a top 50 Global Asset Manager and the second-fastest [ph] growing asset manager in the world, having more than doubled our assets under management from 2007 to 2012, according to a global ranking published by Pension & Investments and Towers Watson. In Canada, we continue to lead in the mutual fund market share and captured the largest share of long-term fund sales in the industry. In addition, our institutional asset management business experienced positive flows from both our North American and BlueBay teams and consistently ranked #1 for fund assets quarter-over-quarter. Our Global Asset Management business is highly profitable and a significant contributor to RBC Wealth Management's earnings. This business continues to be the focus of our acquisition efforts, and we look for complementary international acquisitions to add to global equity capabilities, particularly given our success with BlueBay.

Turning to the Canadian and U.S. and international Wealth Management businesses. RBC is the largest and most comprehensive wealth manager in Canada. We were recognized this year as the Best Private Bank in the country for the second consecutive year by Professional Wealth Management and the Bankers magazine. Overall, RBC has a strong and industry-leading high-net-worth market share of 19%, and we continue to extend this lead by offering superior advice, best-in-class solutions and broad experience.

We continue to shift towards a more fee-based model. And in the U.S., our average fee-based clients' assets are up 9% from last year, contributing to an increase in earnings for the region. Beyond North America, we continue to invest in establishing scalable foundations in key financial centers.

In Insurance, although the results were negatively impacted by the fourth quarter charge related to the proposed legislation in Canada affecting certain individual life insurance policies, this business contributed almost $600 million of earnings this year. Factoring out the charge, our fourth quarter earnings were very strong compared to the prior year. We are transforming the way we sell insurance, as we are going directly to consumers more than ever before, given our comprehensive product offering. We are selling more insurance through our lower-cost channels, such as our retail insurance stores, proprietary sales force, contact centers and online presence.

In Investor & Treasury Services, our business performance continued to improve as we delivered higher revenue and benefited from our ongoing focus on efficiency management activities, generating annual earnings of over $340 million. Our fourth quarter earnings of $92 million were up 28% from the prior year. We are creating a specialist custody bank that provides excellence and asset servicing with an integrated funding and liquidity business for financial and other institutional investors worldwide. We're the leading Canadian custodian, with more than 40% market share of assets under administration. Our business is completed by offshore expertise, primarily based in Luxembourg, where we have the largest third-party asset service provider.

We are building revenue opportunities by leveraging RBC's strong reputation, brand, financial strength and cross-sell capabilities, opportunities we didn't have under our joint venture. I'm extremely excited about this business going forward. And for the third consecutive year in a row, we were voted the #1 overall custodian in the R&M global custodian net survey.

Turning to Capital Markets. We had a record year, with earnings of $1.7 billion. We finished the year with fourth quarter earnings of over $470 million. These results highlight the successful execution of our strategy to rebalance this business towards an originate-and-distribute model. We continue to shift to more traditional corporate and investment banking activities and are repositioning our trading businesses to focus on origination to achieve greater earning flexibility. We had strong growth in our corporate and investment banking business, particularly in lending and loan syndication activities, primarily in the United States, as we remain focused on extending our loan book to establish new client relationships and deepening existing ones by offering a fuller suite of products.

This year, our global markets businesses were impacted by a changing market environment, particularly due to the uncertainty pertaining to the direction of the U.S. fiscal and monetary policies in the latter half of the year. We lowered our compensation to revenue ratio to 37.8%, which is down 200 basis points from 2012, driven by our focus on improving productivity relative to compensation. Geographically, we produced solid results in Canada, where we are clear market leader. We remain focused on execution in building long-term relationships, increasing market share with small- and medium-sized companies and leveraging our global capabilities. And we continue to win significant mandates. We are advising Shoppers Drug Mart on their $13.8 billion sale to Loblaw's and Hudson's Bay Company on their $2.9 billion purchase of Saks, ranking us #1 -- ranking us #2 globally in retail M&A, as at October 31, according to Dealogic.

In the U.S., we are now generating over half of our Capital markets revenue globally, providing us both diversification and attractive growth opportunity, particularly as the U.S. economy improves. Recently, we have been involved in a number of high-profile U.S. deals, including the $49 billion offering of senior unsecured notes by Verizon, the financing of the $25 billion privatization of Dell and the $6 billion acquisition financing for Neiman Marcus. All 3 of these deals closed this quarter.

In the U.K. and Europe, we are selectively building our investment bank and continuously evaluating the performance of our business. We're also shifting from trading to more lending and origination, consistent with our North American strategy. While global capital markets continues to face regulatory reform, we believe we can continue to successfully adapt our business to this changing landscape.

As I mentioned earlier, we met all of our financial performance objectives for the year. Our strong capital position continues to provide us with the flexibility to find the optimal balance between investing in our business for long-term growth and returning capital to our shareholders. During the year, we raised our dividend twice for a combined increase of 12%, and we also repurchased 6.8 million of our common shares. We ended the year at the midpoint of our dividend payout range.

We are maintaining the same financial performance objectives for next year: diluted earnings per share growth of 7%-plus, return on equity of 18%-plus, strong capital ratios and a dividend payout ratio in the range of 40% to 50%. These key financial performance objectives help us measure our progress against medium-term objectives of maximizing total shareholder return by achieving top quartile performance. We generated strong total shareholder returns of 13% for both the 3- and 5-year periods. I would also highlight that in 2013, we generated a total shareholder return of 28%.

Our record results and accomplishments this year are in large part reflective of our strategic goals, as outlined on Page 6, which we have remained focused, consistent and build on our strength. These strategic goals drive our high-quality and sustainable earnings growth. While regulatory changes, prolonged low interest rates, market volatility and increased competition certainly have posed and will pose challenges, we also see great opportunities that are aligned with our view of global trends and build on our strengths.

We're committed to delivering the right strategy, business mix, culture and people to drive continued growth and take advantage of these opportunities; and our financial strength, diversified businesses and leading market share remain clear competitive advantages in today's environment. In closing, I am certainly pleased with our accomplishments this past year. We ended a record year, building on the strong momentum we had throughout 2013, and we believe this positions us very well going forward.

Before I turn the call over to Morten, as you would know, we announced back at the end of August that Morten will be retiring early next year after more than 30 years of service with RBC. Given this will be his last quarterly call, I wanted to take this opportunity to thank him for his exceptional contribution during his distinguished career at the bank. His strategic thought leadership, breadth of experience and deep understanding of the ever-evolving risk management landscape has made him an outstanding Chief Risk Officer. We're all extremely grateful.

So thank you for that, Morten. And with that, I turn it over to you.

Morten N. Friis

Thank you, Gordon. That's very kind. Maybe people are focused on other retirements than mine.

Turning to credit on Slide 8. We saw an uptick in provisions this quarter, overall -- but overall credit quality remained sound. Provisions for credit losses on impaired loans of $335 million, or 32 basis points, increased $68 million, or 6 basis points, from the prior quarter. With respect to gross impaired loans, while impairment provisions have increased this quarter, gross impaired loans are down $50 million over the year, and our impairment level is lower than our Canadian peers.

Looking at credit performance in more detail. Turning to Slide 9. Provisions in Canadian Banking were $250 million, up $37 million over last quarter, or 4 basis points. At 29 basis points, this remains at the low end of our historical range. The increase in provisions primarily reflected higher impairment on our personal lending portfolio and higher impairments in our business portfolio, as we grew volumes in both businesses. Provisions in our credit card portfolio decreased quarter-over-quarter, reflecting fewer bankruptcies. Provisions on our residential mortgages remained low at 3 basis points, consistent with our historic performance. Gross impaired loans increased slightly over the last quarter, but remained within our historical range.

Turning to the Caribbean. Provisions on impaired loans were $26 million, up $13 million from the previous quarter, largely related to a couple of accounts. While credit quality in our Caribbean portfolio has been stabilizing, challenges are likely to persist in the near term until we see sustained improvements in the regional economic environment.

We incurred provisions of $42 million in Wealth Management this quarter related to a few accounts. As I mentioned last quarter, growing the credit book forms part of this segment's long-term growth strategy and provisions at moderate levels are an expected outcome of that business activity. We expect loan loss provisions within Wealth Management to show some degree of variability from quarter-to-quarter, but this quarter's provisions fall outside of our expected range. We remain comfortable with the segment's overall credit quality, given our strict credit adjudication standards and the strong creditworthiness of the client base. With respect to Capital Markets, provisions were $11 million, or 8 basis points, down $17 million, or 12 basis points, compared to last quarter.

Turning to market risk. In 2013, average value at risk was $44 million and average stress VaR was $95 million, up $17 million compared to last year. The increase in stress VaR largely reflects the fact that our trading portfolio is more heavily weighted towards mortgage-backed securities and high-grade credit-sensitive fixed income debt, whose price behavior was particularly volatile during the financial crisis of 2008-2009, which is the historical period used for stress VaR calculations.

During the fourth quarter, we had no days with net trading losses. In 2013, we had 7 days with net trading losses, down from 20 days in 2012. The annual number of days with net trading losses was down for a second consecutive year.

Before I conclude my remarks, I want to take this moment to thank you all for your questions over the years and to officially welcome my successor, Mark Hughes, and wish him luck. Mark has been with RBC since 1981 and has both a broad and deep experience with our organization, which will make him an excellent Chief Risk Officer.

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

Janice R. Fukakusa

Thanks, Morten, and good morning. Turning to Slide 11. We had a solid fourth quarter with earnings of $2.1 billion, up $208 million or 11% over last year. Continuing our momentum, performance this quarter was underpinned by strong fundamentals.

I would note that while we had a relatively clean quarter, we had 2 items that largely offset each other. The first item is the $118 million after-tax charge in our Insurance segment discussed earlier. The second item is a favorable income tax adjustment of $124 million related to prior years. While this tax adjustment reduced our effective tax rate this quarter from 23% to 18%, we continue to expect our effective tax rate to be in the low 20% range going forward. Compared to the prior quarter, earnings were down $185 million, or 8%.

Moving on to capital. We completed our first year under Basel III with our capital ratios remaining strong and in excess of regulatory requirements. For 2013, our common equity Tier 1 ratio was 9.6%, largely driven by strong internal capital generation. This quarter, we also built our capital levels in anticipation of several notable regulatory and accounting changes scheduled to come into effect in the first quarter of 2014. As I mentioned on our last call, the first phase of the credit valuation adjustment, or CVA, is expected to negatively impact our common equity Tier 1 ratio by approximately 30 basis points.

Effective November 1, we adopted a new accounting standard related to pensions and other post-employment benefits, which is expected to negatively impact our ratio by approximately 10 basis points. As we transition to the new standard, we will be restating our financials next quarter, including an increase in pension expense of $70 million for 2012 and $125 million for 2013. Going forward, we anticipate a modest increase in pension expense. We will continue to prudently manage our capital levels going forward, given the evolving regulatory environment.

Let me now turn to the quarterly performance of our business segments on Slide 12. Personal & Commercial Banking generated strong earnings of over $1 billion in the quarter, representing an increase of $47 million, or 5%, from last year, largely due to earnings growth of 7% in Canadian Banking, reflecting solid volume growth of 7%, which includes the contribution of our Ally Canada acquisition. Sequentially, earnings decreased $99 million, or 8%. Higher volume growth across all our Canadian Banking businesses was more than offset by higher PCL, a provision related to post-employment benefits and restructuring charges in the Caribbean and moderate spread compression.

Margins in Canadian Banking were down 7 basis points from last quarter, as the prior quarter was favorably impacted by fair value purchase accounting adjustments related to our acquisition of Ally Canada and the reversal of accounting volatility from the second quarter. Factoring out these impacts, margins were down 2 basis points, in line with our expectation of 1 to 2 basis points of sequential compression. Looking ahead, we expect margins to remain under pressure, given the continued low interest rate environment, slowing growth in consumer lending and competitive pricing pressures.

Our reported operating leverage and efficiency ratios this quarter were 0.2% and 44.8%, respectively, with growth in noninterest expense remaining well contained. I would remind you that expenses in the fourth quarter are often subject to a degree of seasonal elevation due to true-up of marketing and other discretionary spend. Going forward, we continue to manage the trajectory of expense growth against revenue growth and are adjusting the pace of our investments in response to a slower growth environment.

We remain committed to driving our efficiency ratio down to the low-40s over the medium term and are seeing good progress from a number of initiatives under way in Canadian Banking, including the launch of our new mortgage origination system early in 2014, as Gord mentioned. Also with the acquisition of Ally Canada now fully integrated, we believe we are on track to generate meaningful synergies, further contributing to steady improvements in our efficiency ratio, as well as generating positive operating leverage.

Turning to Wealth Management on Slide 13. We earned $205 million this quarter, relatively flat compared to last year, as higher average fee-based client assets resulting from net sales and capital appreciation were offset by higher PCL of $42 million on a few accounts, as discussed by Morten, and lower transaction volumes as we continued to shift our business towards more recurring fee-based revenue. Noninterest expense also increased this quarter compared to last year, reflecting higher variable compensation, driven by higher commissionable revenue, as well as increased staff levels and infrastructure investments, as we support the growth of our wealth and asset management businesses. Compared to the prior quarter, earnings were down $31 million, or 13%, driven by higher PCL.

Moving to Insurance on Slide 14. Net income of 170 -- $107 million was down $87 million, or 45%, compared to last year and down $53 million compared to last quarter, primarily due to the previously disclosed charge of $118 million after tax discussed previously. Let me take a few moments to explain the charge more fully. Under Canadian IFRS, the present value of the expected profit for a life policy is recognized at the time the policy is sold. Subsequent to initial recognition, changes in assumptions as a result of updated experience or new regulations impacting these life insurance policies are recognized in net income when the changes are made.

While the legislation remains proposed, from an accounting perspective, we consider the measures to be substantively enacted. Therefore, as a result of the legislative changes, the current expected profit on these policies is lower than what we initially expected. The charge is based on our assumption that we expect a significant portion of affected clients to select one of the revised offerings we are offering, and we will update the charge, if necessary, to reflect any changes in policyholder experience or regulations. Excluding this charge, net income increased $31 million, or 16%, compared to last year and $65 million, or 41%, compared to last quarter, reflecting favorable actuarial adjustments and a gain on the sale of our Canadian travel agency insurance business.

Turning to Slide 15. Investor & Treasury Services earned $92 million, up $20 million, or 28%, from last year, reflecting improved business performance in Investor Services and continued benefits from our ongoing efficiency management activities. Compared to the prior quarter, earnings were down $12 million, or 12%, as the prior quarter has seasonally higher securities lending fees.

Turning to Capital Markets on Slide 16. We had strong earnings of $472 million, up $62 million, or 15%, from last year. This reflects strong growth in our corporate and investment banking businesses, primarily loan syndication and lending activities in the U.S., and the favorable impact of a stronger U.S. dollar. We also had lower PCL, due largely to a provision taken in the prior year on a single account, which also contributed to the increase. This impact was offset in part by higher litigation provisions and related legal costs. Compared to last quarter, net income was up $84 million, or 22%, largely driven by strong growth in loan syndication activities across all geographies and higher debt origination, mainly in the U.S.

Our results this quarter highlight our strong momentum in corporate and investment banking, and our performance was positively impacted by a number of large notable transactions that Gord highlighted, which closed at the end of the quarter. Looking ahead, we have a strong deal pipeline, which continues to grow both in Canada and the U.S.

To wrap up, we are very pleased with our solid performance this quarter. We have a diverse and strong portfolio of businesses. And as Gord noted, we believe we remain well positioned to continue delivering sustainable earnings growth.

At this point, I'll turn the call over to the operator to begin the Q&A. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Robert Sedran from CIBC.

Robert Sedran - CIBC World Markets Inc., Research Division

Not sure if the question is for Morten or for George, but I wanted to come back to the issue of the Wealth Management loan losses. I know, George, you've talked in the past about wanting to grow the loan book. And I guess with -- there's no such thing as a riskless loan, as we found out this quarter. But can you maybe give us a little more color in terms of what the security is behind these kind of loans, what kind of lending this is and whether we should expect these kind of provisions to kind of now bounce in and out of the segment, as the odd one goes impaired?

Morten N. Friis

So it's Morten, Robert. I'll start and Gord may want to fill in a few business details. But -- so if you look at the supplementals, you'll see on the Wealth Management breakdown that we got about $13 billion in loans for this segment. There's another $3 billion or so letters of credit that represent the total amount of credit risk that we have in that business. More than half of those loans are in North America. The majority of them are traditional margin loans that you'd find in a broker-dealer or private banking operation. So the vast majority of the loans are secured by liquid collateral. There is a small portion of less than 10% that is secured by commercial and residential real estate, and a tiny fraction of 1% or so that is unsecured. So the nature of this portfolio is one where you should not expect ongoing significant provisions. I would say if you look at the chart that we're having this quarter, it reflects a small number of loans with a large concentration in a small number of securities, where there was a significant fall in value, and that's what drove the significant provision. So as I was saying in my comments, this is very much outside of the range of losses that we'd expect to see in the portfolio and does not affect our view of the credit quality of the portfolio as such. I would say that our historical experience is way more indicative of what you should expect than what you've seen in the last quarter or 2. But when you have a $16 billion portfolio, you have growth objectives, obviously, you will have losses here and there, but at more modest levels than we've seen this quarter, would be my expectation.

Robert Sedran - CIBC World Markets Inc., Research Division

So, Morten, when you talk about having the traditional margins secured by highly liquid securities, I'm assuming then that you're able to run numbers in terms of how much concentration you might have in a specific asset class or a specific security in terms of what's backing these loans. Is that -- is it just that this was an abnormal quarter that it just happened to be in a pocket of the book? Or is it that maybe we're still developing the infrastructure to support some of this business?

Morten N. Friis

No. So this is a business we've been in for a long time. And there's a -- it's a daily mark-to-market process. There are securities listed on public exchanges with daily margin calls and so on. I mean, what was unusual this time was we had, as I said, a small number of loans with similar securities backing them up and large concentrations in specific securities, where those securities saw a large drop in value.

Robert Sedran - CIBC World Markets Inc., Research Division

Okay. And, Janice, just a very quick numbers question. The Q4 Insurance segment is, you mentioned, actuarial adjustments plus a gain. Is that pretty much responsible for all of the year-on-year increase? Or is there actually something else in there?

Janice R. Fukakusa

That's what it is. And you'll recall that, once a year, we formally revise all of our actuarial adjustments, so you get a bit of volatility in the fourth quarter related to that. And then, of course, the gain on the sale of our travel business this quarter.

Operator

The next question is from Gabriel Dechaine from Crédit Suisse.

Gabriel Dechaine - Crédit Suisse AG, Research Division

Just a clarification for Janice. First of all, on the -- you said the pension expense would have a modest impact, so I get to -- after tax, it works to about $0.07 in 2014. I'm just wondering if you're thinking of offsetting that item somehow with savings in other areas. And then, second one, first of all, Dave, congrats on the promotion. Just want to talk about your pattern every 3 years, and this is across the bank, but it impacts Canadian Banking, of undergoing big initiative spending to generate better efficiency down the road. Is 2014 going to be one of those years? And should we expect some softer operating leverage as a result in the near term until you yield those savings?

Janice R. Fukakusa

So, Gabriel, it's Janice. I'll start first with the pension explanation. So what I said is that it would be relatively flat in 2014. And just for -- you should recall that we are restating 2012 and 2013 because the pension accounting is -- it's a retroactive accounting. That's why there's an immediate hit to the common equity Tier 1 ratio. And the -- so the ramp-up in expense that you see, what we're saying is it will be relatively flat year-over-year. And of course, on a cash basis, we are generating a higher expense rate, and we look at all the expenses when we look at our efficiency programs and our investment programs. And, Dave, you can comment on some of the investment efficiency programs?

Gabriel Dechaine - Crédit Suisse AG, Research Division

Actually, if you don't -- the $125 million, is it pretax or post tax?

Janice R. Fukakusa

It's pretax. It's an actual expense number.

David I. McKay

Gabriel, it's Dave. We're still targeting an operating leverage of 1% to 2%. As this large program comes to a successful conclusion and we deploy it across our network over the coming quarter, we

[Audio Gap]

systems and our technology, and we will do so going forward, focusing on our commercial systems, particularly our commercial deposit systems, but not to the level that you've seen historically with the retail credit transformation. So it will be a smaller project, but it's something that we continuously invest in our back-office capabilities, our front-office technology capabilities. And we are watching our costs and our revenues very closely and driving positive operating leverage.

Gabriel Dechaine - Crédit Suisse AG, Research Division

So there is a program taking place in Q1, but it's going to be smaller than prior years?

David I. McKay

Yes, it's in the normal course of business for us.

Operator

The next question is from Peter Routledge from National Bank Financial.

Peter D. Routledge - National Bank Financial, Inc., Research Division

A couple of questions for Dave. First of all, Dave, I noticed, just in loan growth generally in Canadian Banking, but retail loan growth in particular, Royal is a little bit slower than peers, which -- over the last couple quarters. Wonder if you have any thoughts over why that might be.

David I. McKay

Yes. Certainly, if you look at where the source of growth is in the marketplace, we do not book any mortgage whole loans from third parties nor brokers. So -- but particularly, if you were to extract whole loan mortgage purchases from the growth of our peers, you would see a dramatically different number, I would believe. So our growth is core proprietary channel growth. And if you look at the -- in the appendices of the slides, I think the first appendix, we're gaining market share in all our core segments, with the exception of commercial deposits. But when you look at commercial and consumer lending growth, market shares are up. So our core channels are continuing to perform, we believe, at a premium to the market.

Peter D. Routledge - National Bank Financial, Inc., Research Division

The uptick in third-party and broker channel originations, in your view, is that classic end-of-cycle adverse selection? I mean, are folks just gathering up weak credits at the end of a turn and -- at the end of a long credit cycle?

Gordon M. Nixon

I'll answer that one. It's Gord. Because personally, I don't think we should comment on what other financial institutions do. But what I would say is we -- as Dave reiterated, John (sic) [Peter], I mean, as you know we've been a long-time believer in core originations and not buying third-party mortgages. And we think, through the cycle, that's going to be positively reflected in terms of both margin and performance. So I don't think we should say it's end-of-cycle behavior on behalf of competitors, but it's something that we just don't -- have never subscribed to.

Peter D. Routledge - National Bank Financial, Inc., Research Division

And just, Dave, on the mobile payment strategy, can you talk about how that aligns with your Avion strategy? And how do the economics compare?

David I. McKay

They're somewhat distinct strategies. I mean, Avion is a credit card product. The mobile payment strategy encompasses all payment products, including debit, in particular debit. We were the first bank to launch a mobile debit payment with McDonald's this year, which we're extremely proud of. So I wouldn't link, necessarily, Avion specifically to a mobile payments because it's a multi-card, multiproduct umbrella strategy. We're very proud of our mobile strategy, particularly the innovation around our secure cloud, which we announced this year, which we feel is the strongest customer offer in the marketplace, particularly around security and ease of use. We'll be deploying that over the next 30 to 60 days in the marketplace. So we are extremely happy where we are in mobile payments, but I wouldn't necessarily link our Avion strategy, which is very much about building on, we believe, Canada's #1 premium credit card, taking advantage of the mild disruption that's in the marketplace and acquiring more customers.

Peter D. Routledge - National Bank Financial, Inc., Research Division

I guess where I was going with that is a certain part of the Avion clientele uses the card for just a transactional basis, does the mobile payment strategy risk cannibalizing that revenue stream?

David I. McKay

And the fact that a customer might choose debit over credit? I would say no. I think the #1 driver of a consumer, particularly in Canada, in choosing which payment vehicle to use, is loyalty. Canadians are very attached to the loyalty programs on their credit cards, particularly the Avion loyalty program, and that is the #1 driver of which payment card, debit or credit, you choose to use. So whether that fits in a digital wallet or it fits in your physical wallet, that same driver should -- will cause you to pull it out and use it either through your phone or direct at the terminal.

Operator

The next question is from Michael Goldberg from Desjardins Securities.

Michael Goldberg - Desjardins Securities Inc., Research Division

First of all, congratulations to all of the people on the changes in your careers. My first question is for Morten. As Royal grows its lending in the U.S. and Europe, are you comfortable that credit discipline among banks there has become comparable to Canada and that discipline will continue in the future?

Morten N. Friis

So, I mean, a couple of comments. First of all, I guess, we're driven by our discipline more than the market discipline. And where we have been able to grow the business on the lending side is where there's enough of an overlap between how we are prepared to do business and what allows us to win business in the market. I would certainly say that the -- it is -- it's been fairly good expansion in those areas from an overall market standpoint. If you look at the leveraged lending business, in particular, we've had great success there and worked very hard to do that within our credit standards. I would say the regulatory wins would suggest that some of the aggressive practices in that business are likely to diminish somewhat over the next year or 2. And as for Europe, I think it's -- the question, from my standpoint, is a question of whether you have a decent risk-return relationship. I think for the kind of credit transactions we're looking at, we have not been going after business that's been outside of what we can do within our risk appetite and our standards. And I'm sure -- just as a footnote, I mean, so Mark is coming out of having managed a lot of that business. I mean, so you've got a guy in the chief risk officer chair who's extremely well equipped to deal with those credit issues going forward.

Michael Goldberg - Desjardins Securities Inc., Research Division

Okay. Another question I have is -- this is about Insurance and the charge that you took. Is there any reason that we should think that there's anything different about your 10/8 product and the policyholder behavior that you expect that, that should be different from anything else in the industry, in terms of resulting policyholder behavior?

M. George Lewis

Thanks, Michael. It's George Lewis here. I think given our focus on high-net-worth clients and business owners, we are a significant player in the 10/8 market. Because of that, these policies were sold as part of financial plans, and we expect a high degree of conversion to our replacement product because of that.

Michael Goldberg - Desjardins Securities Inc., Research Division

That being said, among other sellers of the 10/8 product to affluent customers, was there anything different about your product that would result in a different policyholder behavior in response to the changes that are taking place?

M. George Lewis

Michael, not that we're aware of, no.

Michael Goldberg - Desjardins Securities Inc., Research Division

Okay. I also have, I guess, a couple of people questions. First, could you give us some background on Bruce Ross and why is he being brought in and what are his objectives?

Gordon M. Nixon

Sure. I'd be happy to. It's Gord, Michael. To be honest, when you -- I think when you look at our industry going forward, technology is going to be an equally important part of strategy of just about any other part of the industry. I would describe Bruce as one of the top technology people, particularly as it relates to financial services in the industry globally. As you know, he ran -- not only was he of IBM Canada a ways back, but most recently ran their business in North America and prior to that, Europe. He has great experience in the financial services sector and has a tremendous understanding of not only technology from an engineering perspective, but technology from a strategic perspective. And we have been, for a while, looking for the right individual to take on responsibility for technology and ops. As I say, extremely important part of the backbone of banking but also an extremely important part of strategy for banking going forward. And in Bruce, we think we have an absolutely -- not only a world leader, but a remarkable GE partner, who's going to be instrumental in terms of leading this section of the bank for us going forward. Remember, tech and ops has -- Janice, how many people in our technology and operations?

Janice R. Fukakusa

8,000 people.

Gordon M. Nixon

8,000 people, and it's a big part of banking going forward. So we're very excited to have Bruce on board as an addition to GE.

Michael Goldberg - Desjardins Securities Inc., Research Division

Okay. And lastly, for Dave McKay, again, congratulations. What would you like to do -- or how would you like to further increase RBC's business diversity? And aside from that, how should we expect that RBC's strategies may evolve, given your different background from Gord's? And please don't say no change because, invariably, there's always differences.

David I. McKay

Thanks, Michael, for your comments. The first thing I'll say is our success has been driven by our diversified business model, and that will continue to be the tenet of our success going forward. And if you look at each and every one of our existing businesses, they're undergoing enormous change as it is. The Canadian Banking business model is evolving through technology, the Capital Market's model is evolving and the Wealth Management model is evolving. So when you say no change, we're already going through an enormous amount of change, as each individual leader looks to the future and builds a competitive model. So the world changes and our models will change going forward. But the tenet of our success is diversification across those core businesses, including Insurance.

Operator

The next question is from John Reucassel from BMO Capital Markets.

John Reucassel - BMO Capital Markets Canada

Just a clarification for George or Morten on this Wealth Management loss. Was this in Canada or the U.S. or internationally? And was it through the broker-dealers? Or was it through the private banking? Could you just qualify that a bit more for us?

Morten N. Friis

It's Morten. It was through a private banking unit internationally. I mean, in terms of from an operational standpoint, whether it's a broker-dealer or the private banking unit, the operational infrastructure is pretty much identical and the processes are the same.

John Reucassel - BMO Capital Markets Canada

Okay. So was it outside of North America?

Morten N. Friis

That's correct.

John Reucassel - BMO Capital Markets Canada

Okay. And then for Gord and Dave, just -- since we're running out of time here, just could you talk about your medium-term EPS guidance of 7%? Are you going to stick with that? And in the transition period here, would you say that the balance between acquisitions or buyback is likely to sit with buybacks in the transition period?

Gordon M. Nixon

Yes. I mean, I wouldn't say that, John. I would say that during the transition period for the bank, generally speaking, it's business as usual. As I said in my comments, I think we exit this year with all 5 businesses performing well. They've all got strong growth objectives and plans going forward and, as I say, they're all in pretty good shape. There's not a lot of issues with respect to them. In terms of our strategic agenda, going forward, there is nothing major on the front burner, but I would say it's business as usual. We continue and will continue to look at opportunities to deploy capital between repatriation to shareholders, investing in the business, which, as you know, is my favorite way to invest capital and I'd love to give the businesses even more, but they can only take so much, and investments through acquisitions. And our program around that front is not going to be any different over the next 8 months than it would otherwise have been other than -- obviously, we're not going to do anything that Dave doesn't 150% subscribe to because, ultimately, he's going to be accountable for the execution and performance of that. But as I say, I think it's business as usual. I mean, I'm -- one thing that I am certainly very pleased and happy about is sort of our whole succession process. We've got, as I say, businesses firing well. But in place -- the GE is very strong, very established. The transition process, I think, will go very, very smoothly. And as I say, pretty much, it's going to be business as usual. I mean, I guess I would disagree a little bit with Michael Goldberg's sort of last comment that don't say it's business as usual. I think one of the things we're trying to make sure that it is, is that it's business as usual. And I think you can expect more of the same going forward at least during the transition period that we've had in the past.

John Reucassel - BMO Capital Markets Canada

The 7% still stands, Gord?

Gordon M. Nixon

Yes, absolutely. I mean, our midterm objectives are midterm objectives, and it's what we use to measure our benchmark. They are minimum objectives, as you know. And we have tended to exceed them, and I hope that will continue to be the case. But they are what's as described. They are midterm objectives. They're not an 8-month or a 1-year forecast.

Okay. I guess that brings this call to a conclusion, and we appreciate everybody's participation. And we look forward not only to the next quarterly call but, hopefully, everybody's participation at our annual meeting, which is where it will take place from. So thanks very much, and we'll see everybody soon.

Operator

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

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