Royal Bank of Canada's (RY) CEO Dave McKay on Q4 2016 Results - Earnings Call Transcript

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Royal Bank of Canada (NYSE:RY)

Q4 2016 Earnings Conference Call

November 30, 2016 08:00 AM ET

Executive

Dave Mun - SVP and Head, IR

Dave McKay - President and CEO

Janice Fukakusa - Chief Administrative Officer and CFO

Mark Hughes - Group Chief Risk Officer

Jennifer Tory - Group Head, Personal & Commercial Banking

Doug Guzman - Group Head, Wealth Management & Insurance

Doug McGregor - Group Head, Capital Markets and Investor & Treasury Services

Analyst

Robert Sedran - CIBC

Gabriel Dechaine - Canaccord Genuity

John Aiken - Barclays Capital

Steve Theriault - Dundee Capital Markets

Doug Young - Desjardins Capital Markets

Mario Mendonca - TD Securities

Peter Routledge - National Bank Financial

Meny Grauman - Cormark Securities

Operator

Good morning ladies and gentlemen, welcome to the RBC 2016 Fourth Quarter Results Conference Call. I would now like to turn your meeting `over to Mr. Dave Mun, Senior Vice President and Head of Investor Relations. Please go ahead, Mr. Mun.

Dave Mun

Thanks very much and 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 Chief Financial Officer and Mark Hughes, Group Chief Risk Officer. Following their comments, we will open the call for questions.

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 or two questions and re-queue. We will post management’s remarks on our website shortly after the call.

Joining us for your questions in the room are our business heads. Jennifer Tory, Group Head, Personal & Commercial Banking, Doug Guzman, Group Head, Wealth Management & Insurance; and Doug McGregor, Group Head, Capital Markets and Investor & Treasury Services. Also Rod Bolger, CFO effective tomorrow is also with us.

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

I'll now turn the call over to Dave.

Dave McKay

Good morning everyone and thank you for joining us this morning. This morning we reported fourth quarter earnings of over $2.5 billion. This capped off a record year with earnings of $10.5 billion, up 4% from last year. I’m pleased with these results, particularly given challenges in the operating environment including sustained low interest rates and energy prices, as well as the subdued macroeconomic factor off across our key markets.

We continue to focus on prudently managing our cost; expenses were up 8% or down 1% excluding the impact to City National. We achieved this while incurring about $130 million of severance charges in 2016, higher than our typical run rate of about $90 million to $100 million, and this additional charge was taken in the fourth quarter.

Our results illustrate of our diversified business model, driving sustainable growth, a disciplined approach to cost management, and our commitment to maintaining a strong financial profile.

Turning to slide 4, we use key financial performance objectives to measure progress against our medium term goals, which we define as over 3 to 5 years. This year we did not meet our EPS growth and ROE targets. Both of these measures were impacted by the issuance of common shares related to the acquisition of City National.

On our capital objective, we exited 2016 with a strong CET1 ratio of 10.8%, four quarters after having closed the largest acquisition in our history. Our strong capital position continues to provide us with flexibility to investment in our businesses for long term growth, while also returning capital to our shareholders.

During the year, we repurchased 4.6 million of our common shares, and increased our quarterly dividend twice for a total dividend increase of 5%. We ended the year at the high-end of our dividend pay-out ratio of 40% to 50%.

Going forward, we’ve decided to revise our medium term objective for ROE to 16% plus, recognizing the pressure on returns in the markets including persistently low interest rates and uncertainty on regulatory capital requirements. This new level continues to give us flexibility to grow our business including abroad.

In 2016, we achieved an ROE of 16.3% which is in the top decile of global banks, in spite of the downward impact from the acquisition of City National, our revised 16% plus objective reflects a premium ROE that we continue to expect over the medium term. In all other aspects including EPS growth our financial objectives remain unchanged, and I’m confident we will achieve all of these over the medium term.

Let me share my perspective on the full year performance of our business segments. Canadian banking had a record year with earnings of over $5 billion, despite a challenging operating environment. Clients continue to take advantage of historically low interest rates, as we saw solid growth in residential mortgages with average balances up 7% from last year.

Our mortgage volumes continue to grow at a premium to the market, driven by expanded mortgage sales force, focused on key client segments such as newcomers, as well as the return of our successful employee pricing campaigns.

We also had excellent performance in our cards business this year, with strong growth in purchase volumes and balances up 6%. We continue to build our mobile capabilities including the release of the RBC Rewards mobile app this October and Apple Pay in May. The RBC Rewards app gives our clients the functionality of the online rewards platform, while they are on the go, including instant access to merchandize through partnership s with Best Buy and Saks for example. As well, our clients can use points to pay down their mortgage and credit card balances.

RBC Rewards is the largest and most flexible loyalty rewards program in Canada, reflecting our commitment to innovation and best-in-class mobile solutions. It is the core to our differentiated long term strategy, which also provides us with unique customer insights and data.

For 2016, we delivered an all-time low efficiency ratio of 43.4% in Canadian banking, reflecting our focus on cost discipline while continuing to invest in technologies for our clients and infrastructure. As we said before, we manage our business for long term sustainability. Our cost program to drive efficiencies is designed to what’s best for our clients and our employees.

Earnings were up 41%, as we continued to realize the benefits from our cost management initiatives and lower provisions for credit losses in the Caribbean.

Moving to insurance, our net income of $900 million for 2016 reflects the $235 million gain from the sale of our home and auto insurance manufacturing business to Aviva Canada. The transaction not only broadened our ability to serve our clients, but also provided RBC with additional capital that we can deploy to advance other growth initiatives.

In wealth management, we had strong results with earnings of 1.5 billion, up 41%. City National performed very well and despite the challenging markets in 2016, wealth management earnings excluding City National were up 14%. In 2016, we saw solid net sales, particularly in the second half, benefiting from our cost management initiatives as well as lower restructuring charges.

While global capital markets were turbulent in the first half of the year, markets improved in the latter half and we were able to help our clients take advantage. In fact, RBC Global asset management captured one-third of industry sales in the fourth quarter and we expect our strong momentum to continue.

In Canadian wealth management, we achieved solid net sales of almost $20 billion or half of the growth in client assets, driven by strong advisor productivity. And in US wealth, our results were driven by the stronger than expected contribution from City National. City National delivered Canadian dollar earnings of 290 million or $465 million excluding the amortization of intangibles and integration cost of 175 million.

Our results also reflect the benefits of referrals and collaboration across our businesses. In 2016, our headcount at City National increased by 10%, which we expect will continue driving double-digit growth in loans and deposits. We’ve also invested in infrastructure and technology to support revenue growth going forward.

I am very pleased with City National’s performance in the first year, as we continue to execute on our strategy to be the preferred partner in the US corporate, institutional and high net worth clients and their businesses.

Moving to Investor and Treasury Services, we had a record year driven by favorable credit markets and interest rate movements. We achieved these results while making significant investment in the technology of our custodial business to enhance the client experience. In capital markets, we had solid underlying results in light of difficult markets. Net income was down only 2% from a year ago, despite higher provisions in our energy lending portfolio and lower client activity.

The resilience of our performance was helped by our ongoing discipline on efficient capital deployment to focus on traditional corporate and investment banking activities. On that, corporate investment banking had a solid year, with revenue in 2016 relatively in line with last year’s record levels.

Even as global deal volumes fell 22% during the first nine months of 2016, we had our best ever in M&A participating in significant mandates including Dell’s $67 billion acquisition of EMC. Looking ahead to 2017, our pipeline is strong and so far in Q1 we have seen continued momentum in our US investment banking business and good M&A activity.

To wrap up, I’m pleased with our record results this year, which reflects significant investment across all of our businesses, notwithstanding the more challenging operating environment. We’ve grown our core client businesses successfully integrating City National and continued to enhance our digital capabilities for our clients.

Looking ahead to 2017, we expect an operating environment characterized by moderate GDP growth in North America in the 1.5% to 2% range, low interest rates and evolving regulatory landscape and changing client preferences and demographics.

We believe we are well positioned to capitalize on opportunities created by the changing environment. Given our strong capital position and risk management, and ongoing investments in our business and technology, we will also leverage our top employee engagement and customer satisfaction scores across our businesses.

We also welcome recent actions by our regulatory and the Department of Finance that promote a healthy Canadian housing market, aimed at ensuring consumer debt remains at sustainable levels.

While the changes may weigh on mortgage growth for certain client segments, we see opportunities in others. We also believe these changes could ultimately help curb the tail risk associated with long term slow-down of economic growth.

And finally, just spoken before on how shifting demographics and growing digital expectations are changing the landscape of banking. We continue to transform how we serve clients by delivering a compelling digital experience and leveraging the scale of our data advantage to provide timely and personalized advice.

We believe we are uniquely positioned to achieve even greater client relevance in the digital world of the future. In 2017, our focus is on driving run-rate cost reductions to support these investments and technology, as well as deploying capital for earnings growth, all with a focus on maintaining a premium ROE.

I am confident that we will continue to deliver long term shareholder value, given the strength of our sustainable client franchises, leading culture of innovation and disciplined approach to risk and cost management.

Before I end my remarks, I’d like to take a moment to recognize Janice. As most of you know, she is retiring on January 31 after distinguished 31 year career with RBC. I would like to thank Janice for a partnership and for her leadership and dedication to our bank, our clients and the community throughout her career.

Rod Bolder will take on the role of Chief Financial Officer beginning tomorrow. Rod bring deep financial services experience and I have no doubt that his business knowledge and leadership positions him well for success.

And with that, I’ll now turn over the call to Janice to discuss our fourth quarter results.

Janice Fukakusa

Thank you Dave and good morning everyone. Starting on slide 7, our fourth quarter earnings of over $2.5 billion reflects solid underlying results across our businesses. Earnings were down $15 million or 2%, mainly due to the lower effective tax rate last year of 7.6%, which was driven by favorable income tax adjustments.

At the enterprise level, our effective tax rate for the fiscal year was 21.4%. Based on our forecast to the earnings mix, we expect our 2017 tax rate to remain with in the 22% to 24% range. Compared to last quarter, earnings were down 12% or 4% excluding the gain of $235 million after tax from the sale of our home in Auto Insurance business.

Our growth in adjusted earnings from the prior quarter reflects higher results in insurance, investor and treasury services and wealth management. These factors were more than offset by lower earnings in capital markets and personal and commercial banking, which were largely impacted by seasonality.

Turning to slide 8, our common equity tier one ratio was strong at 10.8%, up 30 basis points from last quarter, driven by internal capital generation. In November, the sale of Moneris USA to Vantiv was announced and is expected to close in the first quarter of 2017. We estimate the transaction will result in an after tax gain of approximately $200 million, with an expected impact to our CET1 ratio of about 8 basis points.

Our strong capital ratios and focus on balance sheet optimization provide us the flexibility to fund all growth in all of our businesses and manage pending regulatory capital changes. As Dave mentioned, we will balance our capital deployment with returning capital to the shareholders through dividends and share buybacks.

Please turn to slide 9, for the performance of our business segment. Personal and Commercial Banking reported earnings of almost of $1.3 billion, which was relatively flat compared to last year. Canadian banking had earnings of over $1.2 billion, up $19 million or 2% from last year. Results were driven by volume growth of 6% across most of our businesses, partially offset by lower spreads as well as higher fee based revenue. This includes strong deposit growth of 8%, which was driven by momentum in both business and personal deposits.

Loans increased by 4%, reflecting solid growth in commercial lending and higher volumes in both residential mortgages and credit cards, partly offset by lower balances in auto lending. These results were largely offset by higher PCL, primarily in oil exposed regions, higher technology spend, and higher cost in support of business growth.

The fourth quarter was also impacted by seasonally elevated levels of expenses due to the timing of certain marketing activities. For example, we ran a successful National Deposits Campaign with iPad incentives and this quarter also included costs associated with our 2016 Summer Olympics campaign.

For 2016, operating leverage was 1.4%, which is within our annual target of 1% to 2%. Compared to the prior quarter, Canadian banking earnings were down 3% largely driven by higher initiatives and technology spend and higher marketing costs partially offset volume and fee based revenue growth.

Caribbean and US banking had earnings of $29 million, down $14 million from a year ago, mainly reflecting higher cost to support business growth. Sequentially, earnings were down $9 million.

Turning to slide 9, wealth management had earnings of $396 million up a $141 million from last year. Results continued to benefit from the contribution of City National earnings of $89 million or a $127 million, excluding the amortization of intangibles and integration cost of $38 million.

Excluding City National, wealth management earnings were up 20% from last year, reflecting higher results in Canadian wealth management and asset management as well as lower international restructuring charges. In fact Canadian wealth achieved record revenue this quarter, driven by growth in average fee based client asset and higher transaction volumes on improved markets. Compared to last quarter, wealth management results increased by 2% or $8 million.

Moving to insurance on slide 11, net income of $228 million was relatively flat from a year ago. Higher results from new UK annuity contract were offset by the reduction in earnings as a result of the sale of our Home and Auto Insurance business last quarter.

The reduction to earnings this quarter from the sale was in line with the $10 million to $15 million range that we provided previously. Compared to last quarter, earnings were down a $136 million. Excluding the gain on sale, net income was up $99 million, mainly due to favorable actuarial adjustments resulting from our annual review and higher earnings from two new UK annuity contracts.

Turning to slide 12, investor and treasury services had record earnings of a $174 million, up $86 million or 98% from last year. Compared to the prior quarter, net income increased $17 million or 11%. Results were mainly driven by higher funding and liquidity earnings.

As you may recall, credit spreads widened significantly in the fourth quarter of last year, causing our funding and liquidity portfolio to realize mark-to-market losses. Throughout the current year, results have benefitted from the subsequent tightening of credit spreads, which drove funding and liquidity earnings up.

Turning to capital markets on slide 13, net income of $482 million was down $73 million or 13% compared to a year ago, as the prior year benefited from favorable tax adjustments, contributing to an effective tax rate of 12% last year. This quarter, our results included unfavorable tax adjustments that contributed to a tax rate of 30% which was higher than the full year tax rate of 28%.

Looking ahead to 2017, we expect our tax rate in capital market to be in the 27% to 29% range. Pre-tax earnings were up 10% in the current quarter and results were solid, reflecting higher revenue in both our corporate and investment banking and global markets businesses.

In Corporate and Investment Banking, we experienced strong debt and equity origination revenue, driven by increased client activity and increased loan syndication particularly in the US in advance of the potential US rate hike in December. In global markets, fixed income trading revenue strengthened across all regions and we had higher equity trading revenue in Europe. This was partially offset by lower equity trading in Canada.

Sequentially, earnings were down a $153 million or 24%. Fixed income and equity trading results were lower compared to robust levels last quarter. These factors were partially offset by higher loan syndication revenue largely in the US.

In 2016, our compensation ratio for capital markets was 34.9%, down from 37.2% last year. A primary driver of this variance was related to a change in the bonus deferral policy that aligns us with industry practices. As a result of this change, the compensation ratio will continue to be impacted in 2017 and 2018, but to a lesser extent than in the current year.

Before I turn the call over to Mark, it has been a privilege to work with such a talented team here at RBC, and I truly value the connections I’ve made with our investors and analysts over the year.

With that I’ll turn it over to Mark.

Mark Hughes

Thank you Janice and good morning. Turning to slide 15, total provisions for credit losses of $358 million were up $40 million or 13% from last quarter and our PCL ratio of 27 basis points increased 3 basis points quarter-over-quarter. We believe these results reflect the strength of our diversified portfolio and benefited from low interest rates, stable employment trends and improved backdrop to the oil and gas sector and prudent risk management.

Let me discuss the performance of each segment on slide 16. In personal and commercial banking, provisions of $288 million increased by $17 million from last quarter. Canadian banking provisions of $276 million increased by $11 million from last quarter largely in our retail portfolios. Caribbean and US banking provisions were up $6 million from last quarter, due to the impact of hurricane Matthew.

Wealth management provisions of $22 million increased by $8 million from last quarter, mainly reflecting higher provisions of City National due to new normal loan growth and a single account in international wealth. Capital markets’ provisions of $51 million increased by $18 million from last quarter, largely reflecting higher provisions in the oil and gas sector.

Turning to slide 17, gross impaired loans of $3.9 billion were up $187 million or 5% from last quarter. Our gross impaired loan ratio of 73 basis points was up 3 basis points from the prior quarter. In Canadian banking, the reduction and formations was due to a number of commercial accounts returning to performing status. This was offset by higher formations in Caribbean banking due to hurricane Matthew.

In wealth management, we had an increase in formations in City National’s technology portfolio, largely offset by a reduction in the credit impaired loans acquired by City National after the financial crisis. In capital market, we had higher impairments largely related to a few UK and US oil and gas accounts and one consumer goods account.

Let me elaborate on our oil and gas portfolio on slide 18. Our drawn exposure to the oil and gas sector of $6.3 billion or 1.2% of RBC’s drawn loan book decreased by 11% from last quarter, driven by higher repayments from exploration and product companies, as they benefited from improved performances, improved balance sheets and increase M&A activity driven by higher oil prices.

We are approximately 40% through our fall redetermination and so far we are seeing that borrowing basis in both Canada and the United States are largely flat from their spring levels. At current oil prices, our portfolio has performed as we expected, while the increase in oil prices has provided some relief to certain of our clients the price remains well below 2014 levels, which continue to challenge the profitability of the sector and its ability to reinvest for future growth. We are monitoring this portfolio closely.

Outside of our direct oil and gas portfolio exposure, our commercial portfolio in Alberta continues to demonstrate resiliency.

Let’s now turn to our Canadian retail exposure on slide 19. We had an increase in provisions in a few of our retail portfolios this quarter, which was partially offset by lower write-offs in our cards portfolio. The higher PCL is due to an increase in the allowance in our residential mortgage and personal lending portfolios following our review of loss rate assumptions applied to collectively assess impaired loans which we conduct annually.

Normally, we make these changes in Q1, but since our retail review was completed, we elected to apply them this quarter. Next quarter, we will be reviewing our wholesale parameters. This year’s change for our residential mortgage portfolio primarily reflects the termination of valuation insurance provided by a third party. It is a one-time change and does not reflect any change in the underlying credit risk of our portfolio.

Nationally, our mortgage delinquencies are flat quarter-over-quarter, but we note a modest deterioration in our personal lending and residential mortgage portfolios in oil and gas exposed regions. Delinquencies for our cards and auto portfolios declined even in oil exposed regions, as they benefited from stable unemployment rates both nationally in Alberta and a strong unemployment in Ontario.

Turning to slide 20, overall we remain comfortable with the risk profile of our residential mortgage portfolio. Our client’s credit profiles remained strong, with low LTVs and high FICO scores. Many clients are also committed to increase down payments, fixed mortgage rates and accelerated repayment plans, reinforcing our confidence in our client’s ability to repay.

Our impaired rates remain low, especially in Greater Toronto and Vancouver. However, given the elevated house prices in both Greater Toronto and Vancouver areas, as well as the recent announcements by the Department of Finance, we continue to actively monitor this portfolio. Overall, I’m pleased with our credit performance this year, with total annual PCL of 29 basis points, which is slightly below our historical range of 30 to 35 basis points.

Looking ahead, the outlook for PCL relative to our historical range remains contingent on both the duration and level of macroeconomic drivers such as interest rates, unemployment and commodity prices. Also as I’ve mentioned in the past, both loan loss provisions and recoveries within our wholesale book could show some degree of variability which in turn may drive our total PCL to fall outside of our historical range from quarter-to-quarter.

Turning to market risk on slide 21, average VAR of $25 million decreased by $10 million from last quarter due to inventory reductions in fixed income and securitized product portfolios. We had one day of trading loss this quarter, largely driven by market conditions that negatively impacted trading activity across major business lines.

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

Question-and-Answer Session

Operator

[Operator Instructions] our first question is from Robert Sedran from CIBC. Please go ahead.

Robert Sedran

When I look at the full year adjusted operating leverage at the all bank level in the sub-packets. It’s the negative reach of the last three years. So does that reflect the bank that is sort of at peak efficiency considering all the different areas in which you need to invest, or should we expect to see that flipping deposit of operating leverage in the next couple of years?

Janice Fukakusa

Hi Robert its Janice speaking. I would say that one of the functions of mix weighs heavily on the operating leverage. So I would say that if you look at our all bank operating leverage and look at, for example, NIE there are things that like restructuring charges that are embedded in that NIE run rate, and also the revenue variability depending on where we’re earning revenue if it’s capital market sensitive of course then those particular revenues have a higher cost in terms of compensation or commissions associated with them, so they impact our run rate.

So I would say that at the all bank level, we’re striving for 1% to 2% operating leverage, but it depends on mix. What’s more relevant for us from an operating leverage perspective is to look at our banking platforms and efficiency ratios as well as operating leverage at that level. I think if you want to do a comparison year-over-year, you should look at our annual run rate of expenses, because I think it demonstrates how we are managing our expenses and spend vis-à-vis a the large investments we are making in technology. And we would have seen that.

If you at our run rate on NIE excluding City National’s impact, we are down year-over-year. And I think that year-over-year is a good metric because it eliminates some of the seasonality that happens. So I would start with that.

Robert Sedran

Okay. So when you think about the banking outlooks and Janice and maybe I’m asking you to put your successor on the spot. But when you think about the coming years, even there the efficiency ratio is at the low end of the group. Is there room to still take the banking efficiency ratio lower?

Janice Fukakusa

I think Jennifer will answer that Rob.

Jennifer Tory

We continue to target a low 40s efficiency ratio, and as Dave mentioned, this year we’re at a historic low. We continue to reduce expenses across the board; both with changes we’re making in our infrastructure in terms of technology spend on the back office. In fact we’ve reduced our FTE base by 1100 in 2016, mostly through attrition, and we continue to have opportunity in that area, as well as continuing to look at our branch network and gain efficiencies on the service side as we spend on digital technology to enhance the client experience.

But we’re investing through all of that in our sales capacity, as well as increasing our spend on technology. So I think our guidance on operating leverage for 2017 continues in the 1% to 2%, and in fact I would say at the higher end of that range just as we finish that this year as well.

Operator

Our following question is from Gabriel Dechaine from Canaccord Genuity. Please go ahead.

Gabriel Dechaine

My first question is on the mortgage business and you said Mark that you’re reviewing that portfolio for obvious reasons. We’ve seen some of the numbers coming out of [DC], volumes down, prices down and I know you see the trend in your mortgage Brooks and Alberta, who are nearing negative growth at some point. At what point do we start to wonder about the indirect impact of the mortgage business similar to what we were doing at oil earlier in the year, where you got the job losses tied to the construction sector instead of the oil and gas business?

Dave McKay

Gabriel it’s Dave. Are you talking about the GDP impact from slower housing?

Gabriel Dechaine

Pretty much, yes.

Janice Fukakusa

On the quality?

Dave McKay

Well if you look at it I think housing starts, they are off just a bit, but housing starts are just annualized in about 170,000 to 180,000 range. So you’re seeing purchase activity down in Vancouver. You’re not seeing a lot of purchase activity change in GTA that’s for sure. So there are definitely policy impacts that you’re seeing in Vancouver from the taxes and from the Department of Finance Changes, still have to work their way through the system. So I would separate - the markets are different. There are certainly demand formation that’s continuing in core markets in Canada, whether total formation or immigration in to the city continued to have demand formation.

There continues to be supply constraints in a number of key markets particularly the GTA which is giving prices support and price inflation, which you’re not seeing as demand starts to fall off in Vancouver, and some of that is actually shifting in to the GTA. So you’re seeing healthy demand creation, you’re still seeing relatively healthy housing starts; you’re seeing good capacity uptakes. So there will be a moderation in supply and therefore will be somewhat of a moderation on the impact in GDP going forward, I think you should expect that.

But I think it’s going to be gradual and it won’t be a shock to the system.

Gabriel Dechaine

Just wondering when Mark was talking about the review of that book, what are the areas of concern here you’re looking at in particular?

Dave McKay

No, it’s wasn’t a concern that we do the review. We do this particular review of lost rates both annually for both the retail and the wholesale books. We normally do them in Q1, that’s sort of then allows us to take the prior years’ performance in to account to add it to our historical performance. With the retail books, we actually had the results finished in this quarter, and so we bought them forward and took them in Q4.

And the primary change, as I mentioned in my remarks, is a one-time change that is related to a valuation insurance program we had with the third party which has been terminated. We do not expect that change to go forward, and we expect to revert back to the PCL performance for the residential mortgage book that we would have had in prior quarters.

Gabriel Dechaine

And my next question’s for Dough, in the trading performance discussion looks like three out of the four main regions indicated that equities trading was down and I’ve seen the numbers as well. Equities trading was pretty weak, can you give me a sense of what was going on there that my kind of business or some of the more esoteric stuff and depending whether that’s reversed in Q1 or if there’s any other tailwinds that have emerged in Q1 in the wake of the US elections?

Doug McGregor

The cash equities business in particular is quite influenced by new issue activity and new issue activity has been pretty slow really throughout the year. But there was actually a month last quarter where we didn’t book run a deal in Canada which hasn’t happened for many years. So we saw significant slowdown in new issue activity and declines just prior to the elections were stopped repositioning if you will. So those businesses were weak quarter-over-quarter and year-over-year.

We’ve seen a significant impact on new issue activity and trading, as people are new repositioning after the elections. So yeah its better now, and hopefully that will sustain itself.

Gabriel Dechaine

Quite a bit better or do you feel if it’s shaping up there will be a good quarter for trading?

Doug McGregor

Yeah, I would say there’s a number of things going on in terms of the business, and one of them is that we’ve gone through a period of significant weakness in energy. We went through a period of not terrific credit market and so it was hard to issue leverage finance in high yield. And these are all big businesses for us, and so now through November, we’ve been doing a lot more business in the loan syndication business especially in the US.

You’ve seen some large energy infrastructure clear Canada over the course of this week and earlier in the month. So, yeah activity is up and those are really very big businesses for us that have seen much better markets.

Operator

Our following question is from John Aiken from Barclays. Please go ahead.

John Aiken

I’m trying to square some of the commentary about City National versus the disclosure that you had in terms of US dollar revenues in AUA in Wealth Management segment. So if the contribution from City National was up strongly on a sequential quarter basis, yet we actually had a decline in AUA and essentially flat revenues.

Does this mean that we’re getting incremental efficiency at City National, or was the US business in wealth management outside of City National facing some headwinds in the quarter?

Doug Guzman

I can start with that. As we look back one of our business is convergent, we sold, so you would have seen a decline in AUA from that largely, but all other kind of core volume drivers in the business are very strong with loans up double digits, with deposits up double digits. AUM is strong, but the AUA would have been our ultra-high net worth family office that we sold over the quarter. Very small operation, but it neutralized any type of growth.

John Aiken

And then carrying on with wealth management, the rising PCLs that we’re seeing coming through this, is this a seasoning of the portfolio and should we expect this to carry on for a little while or should we - essentially what are the expectations that we’re going to see for provisions going forward?

Mark Hughes

Basically as you know when we acquired City National, we used the purchase price accounting. So as we’ve now are growing the business, we are essentially rebuilding the reserves that we have, and as loan growth grows, we take incremental reserves on PCL. So it’s not really a credit quality aspect, it is a growth aspect typical of every US bank operation.

Janice Fukakusa

And you can see that John through the purchase accounting adjustments. Just see that, they’re all related to City National loan.

Operator

Our following question is from Steve Theriault from Dundee Capital Markets. Please go ahead.

Steve Theriault

Couple of questions, one on rates, but starting with capital markets. It’s been highlighted in some past quarters the strength and positive trajectory in Europe. But with the sequential decline after a very strong Q3 on the back of Brexit tailwinds, can you talk a bit about your outlook for the European component of capital markets now that Brexit tailwinds have passed. Do you still view this as an area of potential strength looking out over the next year or two or has Brexit or European turbulence generally amended your expectations at all?

Mark Hughes

I was over there a week before last, and spent several days with all the people around the businesses over there. I would say the big improvement has really been in our fixed income business in Europe and just a new leadership and it’s just better people doing the right things there. They are doing reasonably well as we started the quarter, and so I expect that they will continue to improve that business and they certainly have plans to.

In the equity or in the investment banking business, the numbers have been improving year-over-year and they are starting off with reasonably decent backlog of business. So, I expect that that will be okay. I would say that Europe is more difficult than say the United States in terms of margins and growth rates of the European economies. So I think we have more leverage certainly in the US right now. It’s a much bigger business, the US versus Europe.

But overall I would say that we’re just better in Europe than we were and we expect we’ll continue to do get better.

Steve Theriault

Do you think if you think of your plan over the next couple of years, I think Europe’s been running about maybe 14%, 15% of revenue, would you expect that to change?

Mark Hughes

No. I think really what we’re focused on is sustaining our leadership in Canada doing all the business we can do in Canada. But we do expect the growth opportunity and margin opportunity is to continue to grow our business in the US. And so that will be the focus. So it would be difficult for Europe to take a significantly bigger share of our business over the coming couple of years especially given what’s going on in the US right now.

Steve Theriault

And then my second question probably for Janice. I think it was last quarter you talked about de-risking and shortening duration in your funding and liquidity portfolio. So I’m wondering how you were positioned rates wise in to the US election, should we expect to see a noticeable lift in treasure revenue or margin in Q1 if the curve’s deepening holds?

Janice Fukakusa

I would feel that we were positioned the same way for the election that we had positioned for Brexit. So we took maturities longer and we always plan for the worst, but hope for the best. The actual last quarter part of the de-risking and part of the reduction in our LCR had to do with the fact that we had a buffer that we thought was too large, vis-à-vis what we needed. And so that was more of a one-time step and you’ll see us run investors around where we are today, where we reported.

Steve Theriault

So maturities being longer, does that help you with the steepening curve, will we see that at all through the revenue line next quarter?

Janice Fukakusa

No, I think that what you’ll see is more of a neutral position, because the longer maturities were in response to the two significant events and we would have gone on to a normal run rate at this point. Although you can’t tell what happened in the credit spread end market volatility. I would say that‘s the caveat.

Operator

Our following question is from Doug Young from Desjardins Capital Markets. Please go ahead.

Doug Young

Just on the ROE medium target reduction to 16% from 18% plus, I believe Dave maybe you said and correct me if I’m wrong that part of that reduction is the result of potentially more cumbersome regulatory capital rules or any. And I’m hoping if that’s the case you can elaborate a little bit about that, and if you can give any further updates maybe on the changes that potentially could come from Basel.

Dave McKay

I think what drove this is, as we - a year in to our acquisition with City National we had significant rate uncertainty leading up to the close and then in the past year. So our expectation on rates and rate outcomes have the largest impact on our ROEs as far as tailwinds go and earnings lift in that continued uncertainty of that trajectory in the US and in Canada, I think weighs heaviest on our decision to move it down in addition to the expected mix.

But I think tertiary to that is, as we await the decision, I think they’re making this with, the FSB and the regulators to go through training with final treatments any capital floors that may come out. And we have enormous flexibility with a 10.8% CET1 ratio; we’re running at the high end of where we thought we’d be. So we’ve got a flexibility there.

So I don’t think there’s anything specific honestly Dough that I can articulate right now. It’s just we’re carrying a little bit more capital for the uncertainty of all of those aspects and we’re reducing our expectations of ROE, given that uncertainty going forward, but our goal and so our strong goal is to continue to drive a premium top decile ROE growth we expect to grow back to that 18% plus, but it’s going to take a little bit longer to do that with a capital and interest rate environment.

Doug Young

So what was the big change last quarter to this quarter that made you move, because rates have moved up a little bit obviously and the outlook looks a little bit more optimistic. So the delta of last quarter to this quarter is it just its not moving up as much as you anticipated, just wondering if there is something else I’m missing.

Dave McKay

No, it’s an annual process we go through to reaffirm our medium term objective. So we wouldn’t have made the change in Q2, Q3 or Q1 even. So as we go through that with our Board and we sit down and talk about our expectations going forward, we do that each year. So we would not have made that change anywhere else and at Q4 and heading in to a new fiscal year.

Doug Young

And then just secondly, in capital markets it just looked like net interest income was down and that was up relative to what we were looking for. Just wondering on the corporate banking side, because I didn’t see significant change in loan balances that would account for that is there reduction in fees or just wanted to see if there’s additional color you could provide?

Dave McKay

At the start of the year in particular there was an increase in funding cost of that book that obviously gets netted off, and some decrease in margins. We’ve seen some relief in terms of the funding cost issue in the latter part of the years. And the balances in that business were pretty stable during the course of the year. We expect and given the business activity that we’re seeing right now, we expect to grow the balances of that book this year, but it will be in the sort of low to mid-single digits.

Doug Young

Do you expect further margin pressure, is that been the biggest impact?

Dave McKay

I have seen margin stabilizing over the course of the last several months. And a lot of the growth in the book or most of the growth in that book is in the US and we have seen some stabilization there. So I’m hopeful that will continue.

Operator

Our following question is from Mario Mendonca from TD Securities. Please go ahead.

Mario Mendonca

Dave the extent to which a close call on being labeled a G-SIFI, did that inform your decision to reduce the ROE guidance at all?

Dave McKay

No, because I think as we’ve talked about before if the G-SIFI was in Canada where we look at where level one G-SIFI’s are; we’re always going to maintain in our commentary that we do not expect it’s a major capital issue for us. There are obviously cost of compliance and there’s resolution planning requirement that would change, but we never felt that in our dialog with our regulator that where we’re capitalized and where level 1 G-SIFI’s are capitalized that was going to be a capital issues. So that didn’t factor in to our expectation going forward.

Again it’s a medium term objective and we’ve revised that every year, but we’re really trying to look forward and anticipate the rate environment and where growth’s going to occur and where the returns are for that growth for all industry players and our view is that over the next three plus years it’s going to take us a little longer to get back to where we thought we’d be when we entered in to the year about 18 months ago.

Mario Mendonca

Okay, so when you refer to regulatory uncertainty, you’re not suggesting uncertainty associated with being labeled a G-SIFI or not, and you’re referring to all the other factors that could play in 2017?

Dave McKay

Exactly, correct.

Mario Mendonca

A slightly different question related to Royal's mortgage mix. Can you speak to any observed changes in fixed rate mortgage margins, and if you could discuss that in the context of the recent move in the five year - the Government of Canada five year bond yield?

Dave McKay

Yeah, certainly, I think I’m going to hand it to Jennifer. We’re seeing margin compression in our roll-over of our fixed rate mortgages, as we’re seeing lower spreads in the environment we are competing in. But Jennifer do you want to comment on your margins and the decision to change your fixed rate to pricing?

Jennifer Tory

So we’ve seen continuing pressure on our margins, and so if you saw on November 16, we revised our variable and fixed rate to have mortgage pricing. We consider a number of factors and we’re making changes to mortgage rates in concluding, finding costs in market conditions and I think that we’re comfortable for the moment that we review on a daily basis our rate to make sure we continue to grow our business and meet client expectations.

The prices changes are only on newly originated loans, so I think that as opposed to the much larger existing portfolio, we’re on renewals and so we don’t anticipate an uplift in NIM in the near term, but we did want to address some of the pressure that was in the rate environment.

Mario Mendonca

So despite the changes in mortgage rates, you’re saying you would not guide us to any improvement in NIM in the near term?

Jennifer Tory

Not in the near term, no.

Mario Mendonca

Okay, then any update on wholesale funding costs, this is just a more generally for the bank? Are you seeing anything there, again in the context of higher rates?

Dave McKay

In our wholesale funding --?

Mario Mendonca

Yes wholesale funding cost. Just generally for the bank.

Dave McKay

On a five year spread or --.

Janice Fukakusa

I’ll answer that Mario and I don’t think we haven’t seen any significant movement and you know that when we do our funding, we try to fund in advance in all durations and period. So we try to fund type B, so we try to minimize any of those types of spread intact, but we haven’t seen anything significant.

Dave McKay

I would say Janice one of the other things we’ve done this year or we did earlier in the year, throughout the year its extended term when we saw quite a flat yield curve in that wholesale book, and so I think that will benefit us going forward in terms of the certainty and the cost of funding.

Operator

Our following question is from Peter Routledge from National Bank Financial. Please go ahead.

Peter Routledge

Dave, I guess a question for you just on the ROE target change, certainly, City National probably put a little bit of a downward pressure on the bank's ROE. So in your opening comments you seem to identify other future acquisitions as something you might look at. To what extent will you limit the bank's acquisitions to only those that are ROE accretive or not materially dilutive?

Dave McKay

No, I don’t think our strategy is changed in how we’re going to deploy our capital. We’ve got enormous flexibility with a 10.8 CT1 ratio. We see significant organic growth potential. So our capital first and foremost is going to be deployed organically across all our businesses. And one of the themes that really do want to make sure comes out is that, we feel we’re exiting here with enormous organic momentum cross all our businesses.

Doug referenced the momentum that we’ve got in our capital markets business after a bit of a slow choppy Q4. We’ve exited the year across our investment banking business, our lending businesses and our trading businesses in a better shape.

Doug Guzman referenced the significant momentum we have on the flow side in our asset management business and in our wealth franchise. If you look at Jennifer’s numbers, as we exit Q4 with strong momentum now across almost all our product categories, from mortgages to business deposits to better business loan performance, you’ve got INTS and insurance. So we’ve got significant momentum across all those businesses that we feel really good about, and continuing that momentum will consume some of that organic capital going forward. So I think we feel good about that.

We continue to look for opportunities to return capital to shareholders. As a core tool we’ll have - and then my view on inorganic growth remains the same. We will look for selective small tuck-in opportunities to grow City National in the US if it makes sense. We’re looking for a wider range of synergies that’s more accretive to the shareholder and will not be as dilutive as the City National move.

Now valuations in the U.S. are quite unattractive right now with the run-up in banks. That will obviously play to our mind despite our own strong currency. So the answer to your question is yes, we’re being very prudent and we will look to drive strong shareholder returns and with the strong organic momentum we have and organic growth opportunities that our priority.

Dave Mun

And Operator we’ll take one more question before handing it back to Dave for final remarks.

Operator

Our last question is from Meny Grauman from Cormark Securities. Please go ahead.

Meny Grauman

Dave in your opening remarks, you talked about some of the impacts of mortgage rule changes, and you mentioned that you see opportunity in some segments of the mortgage market. And I was wondering if you could just elaborate on that comment specifically?

Dave McKay

In the absence of any monetary tightening in Canada, we welcome the rule changes. We want a sustainable long term mortgage market in Canada. It matches with our sustainable long term growth strategy within the organization. So in the absence of any monetary tightening, we need the policy changes that we’re seeing to slow down some very hot markets out there.

We continue to grow our sales force to continue to target premium clients. We’ve had enormous success with new comers and first time home buyers. We continue to rely on a proprietary channel so we can control the credit risk in those incoming into the bank, and I think we feel good about our business model and we feel good about our scale and the growth in our investment of that business. We feel good about the credit we’ve taken on a little bit more insurance.

So I think as you look at how we’ve invested prudently in that business, where we’re positioned for growth geographically, we feel good about the business going forward and we had very strong results in 2016 with 7% plus growth. We had market share gain, the quality of our book is strong, Mark articulated, and the one-time change that we went through in Q4 due to our valuation insurance changes. But we continue to expect that portfolio to perform strongly. We’ve got 47% insurance on the portfolio now. So we feel good about how we’ve grown and our ability to continue to grow.

Meny Grauman

Just as a follow-up on that, would you say that the rule changes benefits you maybe at the expense of some of the smaller players? Would you say that there's an element of that going on or what's your view on that?

Dave McKay

It’s hard to say. Certainly there are smaller players in the market whose funding model will be impacted and you should expect to see some channel shifts. And we would hope to be the beneficiary of that with our expanded sales force. How that plays out is hard to predict, but certainly there are more challenges to some of the smaller players in the market who’ve relied on traditional funding models.

Operator

Thank you. I would now like to turn the meeting back over to Mr. Mun.

Dave McKay

Maybe I’ll take it. Thanks everyone for your questions this morning and your participation, and we look forward to seeing you again in another three months. Thank you.

Operator

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

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