Royal Bank of Canada
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Royal Bank of Canada
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Good morning, ladies and gentlemen. Welcome to RBC's Conference Call for the First Quarter 2019 Financial Results. Please be advised that this call is being recorded.I would now like to turn the meeting over to Dave Mun, Head of Investor Relations. Please go ahead, Mr. Mun.
Thank you, Elena, and thanks for joining us this morning. Speaking today will be Dave McKay, President and Chief Executive Officer; Rod Bolger, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Then we'll open the call for questions. [Operator Instructions] We also have with us in the room Neil McLaughlin, Group Head of Personal & Commercial Banking; Doug Guzman, Group Head, Wealth Management and Insurance; and Doug McGregor, Group Head, Capital Markets and Investor & Treasury Services.As noted on Slide 2, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially.With that, I'll turn it over to Dave.
Good morning, everyone. Thanks for joining us. We had a good start to the year. We delivered earnings of $3.2 billion, which was the second highest quarter on record. Against the backdrop of strong employment and resilient economic growth, we saw solid volume growth across our retail businesses. And our market-related businesses performed well given some of the market volatility during the quarter. We've been investing at our frontline in all businesses to grow volumes and market share, which led to record revenue growth of $11.6 billion. Our PCL was up as we continue to prudently build our Stage 1 and Stage 2 allowances on performing assets. And we also had 1 fallen angel in the utility sector. Overall, we view our credit position as strong.We continue to grow our balance sheet for clients across all businesses while maintaining a strong CET1 ratio of 11.4%, and we delivered a return on equity of 16.7%. In addition, I'm pleased to announce a $0.04 increase to our dividend this morning, bringing our quarterly dividend to $1.02 a share. Our results were driven by consistent client growth backed by solid GDP growth in Canada and the U.S. Business investment remains active, and unemployment rates remain near historic low. Although market activity took a pause in December and equity markets were down, sentiment has improved over the past 7 weeks.For our Canadian Banking business, this macro backdrop supported solid revenue growth and earnings of over $1.5 billion. Continued client activity drove volume growth particularly in deposits, credit cards and business lending. In cards, purchase volumes grew 7% driven by a number of factors including the value of RBC Rewards for customers coupled with strong alliances such as WestJet and Petro-Canada. We continue to foster partnerships to create more value for Canadians. In November, we worked with WestJet to create a unique offer for medical students entering residency given the extensive travel involved. The offer was very well-received. And this is part of our broader strategy to expand our relationships in the medical community by creating a differentiated offering for this high-value client group. We're also excited about RBC InvestEase, which we launched across Canada. Our robo-advising alternatives help serve our clients -- investing clients how and when they want and fills an important new channel in our full range of offerings to clients. In Business Banking, we added commercial bankers over the last couple of years, which helped us grow business loans by 12% and business deposits by 9%. This group is also starting to see new relationships through RBC Ventures. For example, 1 venture called Ownr has already digitally registered nearly 5,000 new businesses mostly on Ontario. And importantly, we've been able to convert over 40% of our recent Ownr users to Business Banking clients. We believe we can move that conversion higher as we optimize and scale this service nationally.In addition to Ownr, we have brought over 10 new ventures to market and have more on the way. We're excited about the momentum we've built with our ventures and new partnerships across Canada.In Wealth Management, our Canadian Wealth advisers supported our clients through the recent market volatility and grew fee-based assets by $16 billion year-over-year, which drove higher fee-based revenue. Our competitive recruiting strategy has been working, and we added 40 experienced high-producing advisers over the past year, which we expect will contribute to further growth. Our Global Asset Management business was impacted by the market volatility as retail clients shifted money from long-term funds to money markets and cash in the first 2 months of the quarter. Even with this volatility, we continue to experience better fund flows in the industry.I'm also proud of our innovative strategic alliance with BlackRock that we announced last month. Together, we created RBC iShares offering Canadian investors even more choice with over 150 ETFs. In U.S. Wealth Management, I'm really pleased with the integration between City National and our Wealth Management Advisory business to deliver client growth in each of their core segments. Having taken a methodical approach to building a dedicated team of bankers to cover RBC Wealth Management offices in key markets, including California and New York, we're seeing great client referrals into City National. In fact, last year, a quarter of the mortgage flow coming into City National branches in those markets were referred by RBC Wealth channels. And this year is already tracking well ahead of that. It's our focus on clients that won City National 11 awards for business banking from Greenwich Associates, including recognition for overall client satisfaction. Both our Insurance segment and Investor & Treasury Services segment posted solid results, each earning over $160 million in the first quarter while providing a diversified source of earnings in deposits. In both businesses, we have been investing in technology to grow and retain clients and to lower our cost structure. Our Capital Markets business generated strong earnings of over $650 million against the challenging market backdrop. Across the industry, clients were less active in the first 2 months of the quarter, but activity did pick up through January. Equities had a strong quarter and our fixed income business continued to perform better than the industry. We're also winning more lead mandates and landmark transactions. For example, RBC Capital Markets acted as sole adviser to BB&T on its announced $66 billion merger of equals with SunTrust. This was the largest bank merger in over a decade. And our role highlights the strength of our U.S. Capital Markets franchise. Overall, I'm pleased with our results. And we feel good about meeting our financial targets for the remainder of the year. Our credit position is strong against the solid macro backdrop. We're seeing our investments in client-facing, talent and technology paying off with higher volumes and market share gains. And notwithstanding a difficult December, our core business is strong and our outlook remains positive.And with that, I'll pass it over to Rod.
Thanks, Dave, and good morning, everyone. Starting on Slide 6, first quarter earnings of $3.2 billion were up 5% year-over-year and diluted EPS was up 7%. Excluding last year's write-down of $178 million related to U.S. Tax Reform, EPS would be up 1%. In addition, growth would have been higher if not for favorable items last year, which added $50 million after-tax to Q1 earnings. This year, we had small items which largely offset, including an accounting adjustment in Canadian Wealth Management and a write-down of deferred tax assets in the Caribbean. This quarter, our revenue growth was driven by solid client-driven volume growth and higher spreads in our Retail Banking businesses, partly due to the solid economic fundamentals that Dave mentioned. However, the market volatility in November and December reduced market-related revenue before improving in January. Given this temporary headwind, operating leverage in several businesses was negative in the first quarter. Nonetheless, we are still targeting to achieve positive operating leverage for the full year in our Canadian Banking, Wealth Management and Capital Markets franchises. Of course, this will partly depend on market conditions for our clients in some of these businesses.Expenses were up 5% year-over-year as we invested in our distribution network and other initiatives to grow our customer base, which supported our record revenue this quarter. Of that 5% expense growth, over 1/3 of that increase was from unfavorable impact of foreign exchange translation. Approximately 20% of the growth was due to investing in frontline sales and distribution to grow clients and revenue. 25% was due to digital data and ventures initiatives to add value and connect with more clients. And the remaining 20% was for other operating costs, including risk and regulatory costs as well as inflation. Although we added FTE year-over-year, we expect growth to slow down as we go through the year.Our PCL ratio on loans this quarter was 34 basis points including 6 basis points for Stage 1 and 2 PCL and performing loans due to both portfolio growth and the impact of higher near-term market uncertainty. We also had 1 utility account at 5 basis points Stage 3 PCL on impaired loans. In the last 3 quarters, we have prudently added over $220 million to our Stage 1 and 2 allowance on performing loans. On taxes, our effective tax rate was 19.5%, just under our expected range of 20% to 22% for the year. Turning to Slide 7. Our CET1 ratio remains strong at 11.4%. This quarter, regulatory changes reduced CET1 by 10 basis points. And our strong internal capital generation was offset by higher RWA due to client business growth. We are very comfortable with our capital position, which remains above our typical 10.5% to 11% target range and allows us to continue investing in organic growth and returning capital to shareholders.Moving on to our business segment performance on Slide 8. Personal & Commercial Banking reported earnings of almost $1.6 billion. Canadian Banking net income of over $1.5 billion was up 4% from a year ago. Excluding last year's $27 million after-tax gain related to the reorganization of Interac, net income was up 6% and pretax pre-provision earnings were up 8%. Revenue increased 6% from a year ago or 7% adjusting for that Interac gain. Underlying revenue was driven by solid loan growth as we gained market share in products such as credit cards, commercial lending without increasing our risk appetite. We also had strong loan growth in both -- as well as growth in both personal and business deposits.Net interest margin of 2.79% was up 11 basis points from last year and 2 basis points quarter-over-quarter, largely driven by higher deposit spreads. Going forward, without further interest rate hikes, we expect NIM to improve by a total of 2 to 4 basis points for the remainder of the year.Operating leverage in Canadian Banking was slightly negative, 0.2% this quarter or positive 0.6% adjusting for last year's Interac gain. This was partly driven by lower mutual fund distribution fees given challenging markets and lower client activity in our direct investing online brokerage business when compared to elevated activity last year. As I mentioned last quarter, we expect full year operating leverage to be in the 2% to 3% range, subject to some movement between quarters. And we are maintaining that view.Turning to Slide 9. Wealth Management earnings of $597 million were flat to last year. Quarter-over-quarter growth in fee-based client assets was muted in both Global Asset Management and Canadian Wealth Management. We also saw lower transaction volumes as many clients sat on the sidelines in the first 2 months of the quarter. Activity has improved since then.In U.S. Wealth Management, earnings were down 5% year-over-year in U.S. dollars or up 6% adjusted for last year's favorable accounting adjustment related to City National. Strong net interest income growth more than offset lower noninterest income. Loan growth at 15% at City National remained above the industry average as we benefited from our organic expansion strategy. We remain confident that our holistic funding strategy will continue to support strong loan growth at City National Bank.Moving to insurance on Slide 10. Net income of $166 million was up from $127 million a year ago as we benefited from life retrocession contract renegotiations as well as lower claims costs. First quarter earnings were lower quarter-over-quarter as the fourth quarter tends to be seasonably higher. As we have mentioned in the past, there will be some quarterly volatility, but our full year outlook has not changed.Slide 11 has Investor & Treasury Services results. Earnings of $161 million were down from last year's record quarter with lower funding and liquidity revenue. And although we saw higher client deposit margins, this was more than offset by global market volatility, which negatively impacted our asset services clients. Expenses were also up from last year due to our strategic technology investments to create efficiencies and enhance client experiences in this business. We expense -- we expect expense growth to moderate in this segment going forward. Finally, on Slide 12. Capital Markets had solid earnings of $653 million in spite of challenging industry-wide market conditions in November and December. Net income was down 13% from last year's record first quarter partly due to a credit provision related to a single U.S. account in the utility sector.Corporate and Investment Banking activity -- revenue declined amidst a smaller global fee pool as origination activity paused in the first 2 months of the quarter given the volatile markets. Global Markets revenue was flat year-over-year with higher North American equity trading revenue offset by lower fixed income results, largely in rates and credit. Given the market uncertainty and widening credit spreads, still, our trading businesses outperformed broader industry trends.Looking forward, higher markets and improving client sentiment should contribute to revenue growth across our businesses after the pullback earlier in the quarter. As a reminder, Canadian Banking gets impacted by fewer days in Q2. In Capital Markets, our deal pipeline remains solid across all regions. In our Canadian Banking and Wealth Management businesses, we've had good growth momentum underpinned by investments in sales capacity and technology. And we are confident that we will continue to create value for our growing client base. Overall, we expect solid economic fundamentals to underpin continued revenue and earnings growth. And we expect to continue benefiting from our cost scale and client focus across our businesses.And with that, I'll turn it over to Graeme.
Thank you, Rod, and good morning. Starting on Slide 13. In Q1, we continued to see market volatility due to greater vulnerability to the macroeconomic outlook stemming from trade tensions, geopolitical uncertainty and revisions to global growth forecast from the downside. Given some unfavorable changes in near-term macroeconomic variables such as equity markets, oil prices and unemployment rates, but service input to our provisioning models PCL and performing loans exceeded our 3 basis point run rate associated with volume growth that I noted last November to reach $93 million or 6 basis points this quarter.PCL on impaired loans of $423 million or 28 basis points increased by 8 basis points from last quarter mainly due to higher provisions related to 1 wealth of our credit account in the utility sector. Excluding this account, PCL on impaired loans was in line with our expected range of 20 to 25 basis points at 23 basis points. In Canadian Banking, PCL on impaired loans of $292 million was up 1 basis point from last quarter. The credit performance for this business continues to be in line with expectations. In Wealth management, PCL on impaired loans increased $11 million or 3 basis points, mainly due to higher provisions at City National. In Capital Markets, PCL on impaired loans increased to $102 million, mainly driven by high provisions on the accounts I noted earlier.Turning to Slide 14. Gross impaired loans increased to $2.8 billion, up by 9 basis points from last quarter largely due to a new formation in the utility sector and seasonal factors in some of our retail products. Turning to Slide 16. PCL across all of our Canadian retail portfolios were generally stable quarter-over-quarter. In Alberta, however, we have seen a slight increase in impairments in our residential mortgage portfolio as the region continues to recover from the oil downturn and elevated unemployment level of 6.8%. The balance for our portfolio in this province was stable. For the retail portfolios overall, credit trends have generally remained stable and signs of straps -- stress have been isolated and manageable.Let me now provide some color on both our commercial real estate and leverage lending portfolios. Starting with commercial real estate, we have provided some new disclosures which can be found on Slide 17. Overall, this portfolio represents 7% of our total outstanding loan book. And it's mainly comprised of loans to owners and operators in established income-increasing properties. Development loans represent approximately 18% of our overall commercial real estate portfolio with condo developers representing about 1/3 of that. Over the past year, our commercial real estate portfolio has grown by 17% with Canadian Banking, City National and Capital Markets all contributing to that strong growth in line with our risk appetite. To the addition of City National and Capital Markets global focus, this portfolio is more diversified geographically and by industry segment than it has been historically. We are mindful of both the potential for adverse macroeconomic and secular trends in this sector and are closely monitoring our portfolio accordingly. Notwithstanding, we are comfortable with our underwriting practices which, together with our solid diversification, have contributed to its strong performance with PCL averaging 14 basis points over the last 4 years.Let me now touch on our leverage lending portfolio. Our leverage finance business, which include leverage loans and high-yield bonds, employs an underwrite to distribute model, which leaves us with 2 primary risks. Market risk in relation to the loans and bonds we distribute and credit risk in relation to the portion of the credit facilities we retain. Our market risk is managed to define risk appetite supported by well-established limits, build specific structure and pricing protections and speed to market with an average time from commitment to completion of syndication of less than 75 days. Our market risk framework has proven effective as we saw in November and December where we weathered the market volatility and decline extremely well. So we look to distribute the vast majority of loans and bonds in a typical transaction, we do end up retaining a residual amount of exposure in the senior secured revolving credit facility. While there is no standard market definition, non-investment-grade leverage lending exposure, as we define it in RBC, amount to $10.7 billion of outstanding exposure, which is less than 2% of our total loan book. Of that $10.7 billion, approximately 65% is rated BB with a balance rate of single B or lower. Also, 35% of this portfolio is for private equity sponsors with the balance to corporate clients. In addition to the senior secured nature of our exposure, the credit portfolio is very well diversified as relatively small single-name concentrations across over 400 unique borrowers. No sector represents more than 19% of this portfolio. We are monitoring this market segment carefully but remain comfortable with the size of its portfolio, risk framework we use to manage it and ultimately, the risk return profile.Briefly touching on market risk on Slide 26. Increases in fixed income holdings and volatile equity markets drove value at risk and stressed value at risk higher this quarter, particularly in December. Notwithstanding this volatility, we had no days with net trading losses in the quarter.To conclude, we are comfortable with the overall credit profile of our portfolios. Looking at the remainder of the year, we would expect our total PCL ratio to be in the 25 to 30 basis point range. Assuming the macroeconomic outlook remains unchanged, so we base season volatility in a given quarter.With that, operator, let's open the lines for Q&A.
[Operator Instructions] The first question is from Ebrahim Poonawala with Bank of America Merrill Lynch.
So I guess first, congratulations, Dave and Doug, on being the sole adviser to BB&T. I think it's notable for the RBC franchise for being there for the largest bank deal that we've seen in the U.S. in 15 years.
Thank you.
And with that, I think it's moving to, I think, the U.S. actually and City National. Like I'm looking at Slide 22 and net income contribution of City National, about 5% to 6% of earnings. Earnings growth has been about 5%. Deposit growth has actually -- deposits have been flat. And I've grown up looking at banking franchises and the value coming from deposits. So when I think of what we are doing with City National and appreciate all the investments we are making to grow that organically, can you talk a little bit strategically about how you view that contribution from U.S. retail banking playing out over the next 2 to 4 years? Where does U.S. M&A fit in given what we've seen and we could see more consolidation in the space? Because like I don't think of RBC as a fringe player and anything. And when I think about the U.S. strategy and the optionality for growth that the bank has, I'm just trying to wrap my hands around like what is it that is serving as a hurdle to go much more in a bigger way into the U.S?
Got it. Yes. So let's go back to Investor Day. And we laid out a path for the combined entity to grow to $1.5 billion. But strategically, as we think about this, we've been -- as we've grown this from a lot more than 5%, we'll send you the compounded growth, it is double digit. It's grown very well to over $1 billion of profit in our U.S. Wealth franchise. We've been investing significantly in the infrastructure to grow. We've been investing in frontline commercial bankers. We've been investing in private bankers. We've been opening offices in Boston and New York, Washington and Nashville, trying to fill out California. So with this growth has come a fair amount of investment for the future to continue this momentum. So as I've said over and over, that we see a significant opportunity given the market segment that they're in, we're in, the markets that we're focusing on and high net worth markets for organic growth. We continue to look at the marketplace to see if we can grow geographically through an acquisition of a bank that would have a cultural fit, that would have obviously a similar segment approach to what we're doing. And we are looking at making sure we are on a return on investor money. And prices are still high. And we look at the synergy playbook, as I've said before, and we continue to think. But we've got a great franchise that can grow organically at double digits, which it -- we'll continue to do at the investments that we've had. And we, unfortunately, took 1 charge-off in the quick-service restaurant space this quarter. It surprised us, obviously. We may recover it. But that book has been very, very strong. If you take that out, it's, again, very strong performance year-over-year from the City National franchise. So the storyline perhaps changed, organic growth, expansion of bankers, expansion of markets. The franchise is really strong. Kelly Coffey has just taken over as the leader. She's incredibly excited to take this bank to the next level. Michael Armstrong in Minneapolis has done a great job for so -- we really think that the playbook stays the same, that we're going to grow this business as we talked about in our Investor Day 3 years ago.
The next question is from Meny Grauman with Cormark Securities.
I was hoping you could give a little bit more color on the specific variables that are driving the performing -- the increase in the performing loan provisions. Graeme, I think you mentioned a few variables. I didn't really catch it. Could you just go into a more detail on what really pushed this up this quarter?
Sure. Yes, I can definitely take that question. This quarter, I think as we noted in the last Analyst Call, we are just -- we're kind of entering downturn in both equity markets and oil markets. And those were really the 2 biggest factors that we saw driving our models on our provisions this quarter, which -- and those factors really impact the wholesale portfolios more so, which is why you saw the increases in Capital Markets and CMB specifically. So most notably, the oil prices, our baseline forecast there have been in the 70s last quarter. Now that have been -- now were down -- reduced down into the 50s. In equity markets, well, certainly, we saw a bounce back in January. Quarter-over-quarter, we did reflect a more than 8% decline there in our baseline scenarios as well. So it's those -- those are the key variables that we're driving. And I would say unemployment, particularly in Alberta where we moderated our forecast there a little bit, had a more minor impact. But overall, let's say, those were the key variables this quarter.
And is there anything that's less sort of formulaic that's driving things that you could highlight?
No, I think that's a -- those are pretty much the drivers this quarter. There wasn't anything beyond that in the models. I mean, as we indicated last quarter, I mean, the starting point each and every quarter is really growth associated -- growth in Stage 1 and 2 consistent with growth in our loan portfolio. And so we saw that this quarter with both 3 basis points or about half of the Stage 1 and 2 allowances consistent with our volume growth and the other half is -- are largely due to these macro factors that we -- as we baselines our models in the quarter.
Yes. Meny, it's Rod. What you might be asking also about is the credit quality within that Stage 1 and Stage 2. And as Graeme pointed out, it's really the volume growth and the macro factors. It's not a degradation of credit quality within that you might see in future periods if there is an economic downturn. But that's not the case now.
Okay. That's very helpful. And then just as a follow-up. I noticed the uptick in the real estate book as well in impaired provisions in real estate. Just wondering if you could give a little more detail on what region of the country that is and what gives you confidence that it's an isolated incident?
Sure. I'm going to give additional comments there, and I'll turn it over to Doug to add to this to that. That was an account in -- out of Capital Markets in the U.S. It was in the retail segment of commercial real estate, if you will. So it's largely 1 particular account there. Overall, as I think we provided in our disclosure, I think we see a very well-diversified portfolio in real estate retail is one of those segments that we do monitor carefully. And that's not been a big source of our growth. And we're just monitoring that carefully consistent with some of the secular trends we're seeing there. The parts of retail that we are concerned -- more concerned about don't form a big part of our portfolio, but we will face some bumps on that. And -- but maybe let me turn it over to Doug to maybe just give us more specifics in his book on that space.
So the book in the investment bank in our Capital Markets, the largest part was the largest real estate asset managers in the world like Blackstone, Brookfield would be examples. There's very little development risk in the book. It's diversified across mostly the U.S. and Western Europe. And if I had to look at concentrations, I would say, we have a bigger concentration, for instance, in office and industrial far bigger than we would against retail. We've been careful around retail. In this particular instance, we're hopeful we can work -- or work this out. We're working with the borrower, and we should sort it out one way or another over the next couple of quarters.
The next question is from Robert Sedran with CIBC Capital Markets.
Graeme, you seem to be all warmed up, so why don't we maybe stick with the loan loss line. On your slide, you say higher provisions in Canadian business lending offset by lower provisions in Canadian personal. And I'm wondering if that is just the seasoning of a portfolio that has been growing quite rapidly over the last little while or if there's something more interesting going on than that.
Thanks for the question. And I'll just -- I think I'll just be reading some of the comments we made earlier. Within commercial, I think this is just a bit more normal quarter-to-quarter volatility that we're seeing. We're not really seeing any -- we look through the fundamentals and not just some of the kind of Stage 1, 2 model output, as Rod indicated. We're not really seeing any material shift to the risk profile of our portfolio there. The growth that we've seen in commercial has really been related to existing clients where we're doing more with our best clients. The quality of our originations has been very consistent this past year with what it has been in previous years. Our watchlist have been -- has been fairly consistent. We aren't seeing any trends that are downgrades there. So in the near term, again, we feel pretty comfortable with the nature of that portfolio and aren't really seeing any real macro shift. And so I wouldn't use that as an indication that something is materially changing there right now.
So these provisions on impaired are just things that happen from time to time?
Right now, yes, that's what I would say.
Okay. And just as a follow-up to the Capital Markets provision, are you comfortable that the provision, you've taken deals with it? Or is there a chance that there may be yet more to provide on that same loan?
Yes, on the utility account, subsequent to quarter end, we have exposure to 2 different borrowers within that name. One of them we view -- one part of that we view to be a much higher risk or at risk of the significant liability uncertainty there. We sold off that exposure -- partly due to that risk, we found the -- a strong bid in the market. And so we did sell off that exposure and have reduced the overall risk there by about 1/3. And that's monetized part of the provisions that we've taken with that. But the remaining exposure we now have, we feel much more comfortable with than -- it's going to be a long and complex workout, but I think we've taken the majority of the risks off the table there right now.
The next question is from Sumit Malhotra with Scotia Capital.
First questions are on City National. This is probably going to be for Rod. Rod, first off, when we look at the provisions in the Wealth segment, is it fair to say that those are almost exclusively City National related?
Yes. I mean, they have been. Since the acquisition, the loan book and the rest of the wealth business is quite small, and we haven't had any chunky losses there. So what you're seeing is due to City National, yes.
So about 20 basis points this quarter.
It represents 1 account, right?
Yes.
For -- okay, that's fine. I just wanted to make sure that that's the only thing there. And then Rod, staying with you on that business, last quarter, you had mentioned that the run rate for net interest margin for City National this year, you were expecting 5 to 10 basis points a quarter based on what the Fed did. You did better than that this quarter. And just to tie 2 things together and get an update on your outlook, obviously, the commentary from the Federal Reserve has been somewhat more dovish, if you will, in terms of how rate hikes are looking. At the same time, your deposit growth, which you've talked about as a key focus point for that business, was flat sequentially. Kind of putting those things together, how are you thinking about the NIM trend going forward?
Yes, thanks for that. And so yes, the guidance set I gave last quarter, as you rightly pointed out, was based on a Fed outlook, which was much more much -- but much less dovish, if you will. So it is anticipating 2, 3 increases. We had the 1 which benefited this quarter. I'd say, the rest of the next 3 quarters, we're going to -- we're likely going to see a little bit of a bump up in Q2, 2 elements of that. One is the days in the quarter, which is if the math just works out, it doesn't add more revenue, it just adds more NIM on a basis point perspective. Also, we had -- we're expecting a little bit of a recovery on some legacy loans from back -- from the FDIC era. That will boost that by about 5 or 10 basis points. But then I would expect us to come back to these levels for Q3 and Q4 within 2 to 4 basis points higher or lower depending on mix and depending on competitive pricing, and then depending on fed outlook. But consider these levels pretty much appropriate for the rest of the year absent the nuances I mentioned in Q2.
The last...
Maybe just...
Oh, sorry.
I'll jump in and kind of reinforce the messages I did at the conference in January around growing our deposit base and making sure we're in a range that we're happy with long term of our loans to deposits. We have 3 avenues to raise deposits that we haven't really pursued given we were so long deposits. One is to use our transaction capability that we acquired at Exactuals and a rollout of improved Datafaction. And a new cash management bundle that we're rolling out should improve our core low beta deposit gathering, which has stalled a bit. The second one is we can roll more suite deposits in from our Wealth Management franchise and from the City National wealth franchise that are off balance sheet so we can utilize those to fund growth. And the third one is, as I mentioned before, because we're so long on deposits, we haven't been aggressive in bidding up nonstandard deposits. And we always have the opportunity, albeit it comes with some margin give. But overall, there's a deep market with that type of client base that we're serving to go after deposits. So those are 3 strong avenues that we're continuing to build up. We haven't had to use them for a while. And now given the strong loan growth and the gapping to deposits, we're going to have to pick up our effort.
Last one from me is probably for Doug and maybe Rod as well. You had mentioned or you had certainly indicated on the call last quarter that you were expecting a tougher revenue environment for Capital Markets. Obviously, you're trading result today, a very positive surprise. Just to maybe put 2 things together that -- maybe they belong together or maybe they don't, your equities number from a trading perspective was quite strong, and we've seen this tie up from time to time. Your tax rate in Capital Markets continue to decline. I know last year when we had the benefit of tax reform, we expected that to move lower. But it's down to something like 10% in Q1. I know a lot of these tax-advantaged trades had run their course or at least I thought so. Am I wrong to tie the decline on the tax rate to the strength in equity trading? Or maybe you can just help me understand what's going on there.
Yes, you're on.
No, it's not related to the equity trading. The equity trading numbers were good because the cash equities businesses did well, especially in the U.S. and Canada. But we did very well in our equity derivative, our options business, facing clients and hedging risks for them. And that team's just continued to improve and do well. In terms of the tax rate, that's more about where we're making money both in terms of tax-advantaged geographies and also in terms of having some assets that are tax-advantaged as well. So the earnings mix changed a bit this quarter. That tax number's a little bit low, but I think that it will continue to have better tax cash pay in this business than we had, say, a year ago.
The next question is from John Aiken with Barclays.
Graeme, I think you've had a bit longer enough of a break. I wanted to just circle back on the leverage loans. Thank you very much for the disclosure, that was quite interesting. I wanted to ask though, what's the typical retention rate on your originations? And then secondly, did you have any losses or hung deals in the first quarter?
The retention rate, we don't typically pertain anything in the term loan B that are bond pieces. Those are fully distributed. So all we're retaining is a portion of the revolving credit facility that really is held by the banks, the underwriting banks. And so that's what I referenced when we say that as you can roughly calculate the average hold there by taking the amounts we gave you and dividing it by the borrowers there. So our holds there are relatively small. It's a fairly granular portfolio so we don't have the same chunkiness because of that. When you go to the market conditions, certainly, we saw in the markets in November, December, the pricing protections I referred to were certainly available to us in that period. We typically get 125, 175 basis points protection. And so we continue to see a market that operated there and got deals off our books. And in the end, we had a few deals that we were hung with, so we've got those off the books. And they don't basically have a very small residual portfolio there. And I think Doug has got I think further to add on that.
Very small. Like -- certainly, less than $1 billion, in the hundreds. I mean...
Oh, it's like -- yes, under $200 million I think at this point.
Yes. So we got through -- I think it's a good test of the business, actually. We've said for years now that we've got tight limits on our underwriting of single B credits, in particular LBOs. And we had a very significant downdraft in single B and in credit, generally, in December. And we managed our risk. We sold it off. And we continue to operate in that market. We think that it's a good business for us as long as you manage the risk, you diversify the credits and you have the discipline to sell.
Great. And Doug, if I can keep on with...
No, I think we're going to have to...
Let's go one question just to get through...
But remember this first, sir, we have to 20 minutes left, sorry.
No, go ahead. I'll requeue.
Please requeue, yes. Thanks.
The next question is from Gabriel Dechaine with National Bank Financial.
Okay. Now I've got one question, I'll do my big picture one. Dave, you had some comments the other day in the paper about the under-tapped potential of a resource economy and framing it in a broad context of Canada's economy. I'm wondering if you could tie that back to your business so we can guess what the impact is of weak energy activity on the Capital Markets business. But more on the PNC business, like how was that, I guess, weak market backdrop for the energy industry affecting your retail business? I mean, if I want to play devil's advocate, I'd say, you're still growing quite well in PNC. Is it really that big of an issue?
I would say, we're growing really well in PNC with great volume growth. And we were investing in the future growth at the same time with the expansion of our sales force and our service force and new channels like InvestEase. So we're feeling really good about PNC. And you're absolutely right. I mean, economic activity, as Doug has mentioned a number of times, client activity in the energy sector is low. Generally, activity in the capital market sector is low in Canada right now. And our U.S. business is strong. But overall, Canada continues to perform very well for us. We're gaining market share across most categories. I'm going to pass it to Neil to talk specifically about Alberta in that context as we see generally a strong Alberta, but we're seeing a little bit of weakness at times. So Neil, do you want to comment to the overall Canada looks really strong but Alberta perspective?
Yes. I think the -- yes, I think to Dave's point, a strong Canadian economy obviously is going to support a mass retail business. So I think there's the obvious linkage there. In terms of Alberta, I think there's a couple of years ago, we would have looked at our retail business, our small business clients, our personal clients and even into commercial and said there was incredible resiliency as oil prices started to come off. And I think that they had been through that cycle before and they knew the levers to pull. But at some point, you do start to worry about that economy. And so I think longer term, that's where I think some of the broader comments come from. In terms of, I guess, just the broad strength, I mean, we're seeing across the country good unemployment underpinning Graeme's comments about the credit performance of the book. The -- in the terms of -- we think we could actually do better in Alberta, strong performance there. So we are not pulling back from Alberta at this point at all. We think we could actually do better in the mortgage business there. It's -- it hasn't been an updraft market. Obviously, we're seeing prices come off, but our share there isn't one of our strongest and our momentum could improve somewhat. Our commercial business, similarly, performing really well. We have lots of appetite for the type of entrepreneurs we're supporting in the Alberta market. So we continue to feel really good. And we're investing in Calgary and Edmonton. In a very similar way, we're investing across the country. So I think the comments are more broad-based about the support for the Canadian economy. And we do have concerns just about the energy impact as it relates to the health of Canada. But right now, we feel strong about Alberta and we'll continue to compete hard there.
No big credit concerns at this stage or -- you sounded a little bit like...
No, we're seeing a very, very modest uptick in delinquencies in early stage, but really nothing that gives us cause for concern.
You can also see that from our gross impaired loans across Canada in our performance. The credit in retail credit book is very strong across the country.
Yes, I think that's -- well, generally, I think, as we see pockets like Alberta, it's been offset by the broader strength in the national portfolio and the strong unemployment numbers, overall. So I think it's very well-managed and a broadly diversified portfolio.
The next question is from Scott Chan with Canaccord Genuity.
Maybe just going back to Graeme on the commercial real estate you disclosed. You talked about growth last year being 17% year-over-year. It seems like a lot higher than what we kind of track with peers. Perhaps maybe you can give an outlook of what you're seeing for perhaps the next few years and if there's any growth differences between the U.S. and Canadian markets.
So I think on the growth side, maybe I'll defer to Neil and some of the business partners around the table so they can speak on the forward side of that.
Yes, maybe I'll start and then I'll pass it to Doug. It's Neil. Yes, when we look at commercial real estate, the vast amount of our growth is coming in commercial mortgages. The developer or the developer book is a much smaller portion. We've only started to grow that in about the last year. It was relatively flat for the -- about 24 months before that. In terms of the commercial mortgage segment, yes, it's growing double digit. It's what's powering that number on the retail side. Most of these are -- that book is really targeted in the kind of the $1 million to $10 million loan segment. So broad-based across the country, very diversified by asset and by region. These are income-producing properties, loans made to owner operators. We've liked the risk over the cycle. It's performed really well. And we have -- we mentioned before, we have a dedicated team who sells this product to these type of entrepreneurs. So that's part of what's growing it. In terms of the forward-looking view, we will -- we don't expect this to continue at this pace, and we'll start to see that slow over the next couple of years.
I would say in the investment banking book, the majority of the growth has been in a few very large cross-collateralized portfolios for some of the large asset managers that I talked about earlier. Some of those we'll roll off and we'll continue to work with them to try to replace the assets. But I would say going forward, the growth would be maybe mid-single digits, but it would be slower than what you saw over the last 12 months.
The next question is from Mario Mendonca with TD Securities.
Can we go back to Capital Markets? The growth in the balance sheet there, some -- essentially, I'm looking at Page 14 of your supplement. The numbers have been pretty substantial and especially this quarter, adding over $1 billion of assets, the trading book growing. I've been surprised by that kind of growth. And if you could -- is this ties in, in any way to the growth in the equity trading you saw this quarter? If you could tie those in if in fact those are related.
No, they're not really. It's not related to equities. There's a couple of things going on, on that page in the sup. One of them is the growth in the loans and acceptances. And about half that growth that you see year-over-year in the loans and acceptances is actually coming from loans that balances securitizations. And so we had a reclassification of some -- from securities to loans over the course of the quarter. They just increased that number. So we took it off the trading balance sheet and put it in the lending balance sheet. So I would say, the loans year-over-year have grown about 13% whereas that category in total grew 21%. Half that growth is actually in the conduits and securities that we've reclassified. In terms of other growth, we had some significant growth in our repo books. And we planned for that over the quarter. We had significant balance sheet demand. And it's almost entirely less than 3 months' repo against our government securities. So we're looking at that. I think you can look forward to us sort of managing that much more tightly. Like you won't see that kind of growth over the course of the year.
And just going to equities just for a moment. I appreciate your answer to someone's question that the equity derivative trading isn't what caused the tax rate to go down, but were the strategies essentially tax-driven?
No.
No, they weren't. It's about risk. It's about customers who have exposures where we, in the equity derivatives business, hedge them and charge for that, but it's not about tax.
The next question is from Sohrab Movahedi with BMO Capital Markets.
Rod, a few quarters ago, you had talked about some of capital being tied up in the underwriting businesses, generally speaking, in Capital Markets. Any chance you can give an update as to how much basis points of CET1 is still tied up in underwriting activity?
It would be negligible. I mean, as Doug mentioned, a lot of that book has come down. I think the underwriting has come down by 50% versus what it was 3 or 4 months ago. So that has actually freed up some capital. And so it's negligible impact.
So nothing material coming from that?
No, no.
The next question is from Doug Young with Desjardins Capital Markets.
Just back to City National, and I guess my question is fairly simple. You do have a target to hit USD 1 billion pretax earnings I think by 2020. And when I look at your Slide 22, I think that implies a fairly sizable growth from where we stand today. I'm just trying to get a better sense as to -- and I understand the PCL bumpiness and higher expenses and the investments you're making. I'm just trying to see, is that still a doable target? And then how do you get from where you stand today to that target?
As we go back to our Investor Day and we talked about the combination of wealth and -- the synergies between the 2 are getting booked on each of the P&L side. So we look at the business in a combined fashion, obviously, given at the same client base. So again, seeding that growth, we've invested like over $230 million. We'll double check that number. It's the number I've got in my head. And expanding into new markets, expanding the sales force, it takes commercial banker and a private banker 12 to 24 months to really get going. And therefore, there's a lag to that growth. So we're expecting more growth. We just opened in Boston. As I imagine, we're expanding to Washington. We're expanding significantly in New York. And therefore, we're expecting that organic growth to continue to play out. We've got strong expansion into new markets on the national credit side of the business. We've brought a team in on the food and beverage side that's about 18 months, 2 years and that is really starting to produce. So it really is to continue to expand. The other component of that growth that's been a bit slow in going but we're starting to see it and you saw it in my comments is the jumbo mortgage growth. So as we're referring more businesses, we're expanding. And one of Kelly's clear focuses is to use jumbo mortgage to accelerate our organic expansion in existing and new markets. And that is just starting to lift off. We saw it at 17% growth in our consumer mortgage portfolio. And that's going to be a strong source of organic growth for us. And it really is a strong customer who we can cross-sell once they come in as a new client. So we're -- we do not contemplate doing acquisitions to get to that number. Acquisitions should be net additive to the number that we're targeting to get to. And I think we've gotten a good source of profit increase from the interest rate environment. We're not expecting a whole lot more right now. It will continue to work its way in over time as it would normally do as you move your deposits to loans and you reprice old loans. So I think those are -- that's the trend. It's the same playbook, and we're continuing to execute very well.
So it doesn't sound like -- Page or Slide 22 has all of the, I guess, earnings that you would apply towards that $1 billion target. I guess some of it is in the rest of the Wealth Management. And if that's the case, can you provide what -- where you stand with that on pretax earning relative to that $1 billion target? And if we can take that offline, I'm just curious.
Yes, we'll take it offline.
Yes. And just real quickly, mean, we have been growing since the acquisition. We've been growing earnings in the mid-teens, we had 3 onetime adjustments last year in 3 different quarters. If you adjust for that and adjust for the PCL this quarter, which I know you can't always do, I mean, the earnings are earnings. But we've maintained that mid-teens earnings growth trajectory. And if we maintain that for another 2 years, that would take the 800 up to 1 billion, just doing some simple math for you. There's a lot of ups and downs and nuances to get there, but we are tracking towards that.
So we're in there.
And the next question is from Nigel D'Souza with Veritas Investment.
This question's for Neil. If I look at Slide 19 of your deck here at the loan balances for Canadian Banking, the HELOC line item there is down year-over-year in terms of the balance of HELOCs and that's what you incurred last quarter as well. So the industry seems to be growing at fairly, let's say, robust rate for HELOCs. So how do we square that divergence? What's driving the difference there? How should we think about it?
Yes, thanks for the question. I guess the first thing would be what's driving our numbers is, when we started to see interest rate started to go -- starting to go up, we saw clients move balances from the HELOC at the revolving portion of that product into the fixed portion, the traditional mortgage segment of the product. It's good advice for the customer. It takes on interest rate risk for them, provide some certainty. So that started. It was a little bit higher when interest rates started to go up, but we're seeing it level off. But that's the swap of where those loan balances are going. In terms of our HELOC book versus our competitors, one of our competitors, in particular, really hasn't brought that product to market in the way we have. We've had this product in the market for, I think, about 14 or 15 years. So our customers have been offered the product for more than a decade. And some of the competitors are just getting around to really growing it. We've enjoyed what we believe is higher retention rates and renewal rates because of the product construct. And I think those are the 2 real drivers of that trend.
Okay. And if I understand it correctly when the shift happens from revolving to amortizing, that goes in your res mortgage book. Just from my -- just to understand the directionality here, if we back out that conversion with your residential mortgage balances, would that be up sequentially or lower sequentially? How should we think about it?
So it would still be up, but it would be just over right around more like 4% or just over 4% when you combine them together.
The next question would be a follow-up from Sohrab Movahedi with BMO Capital Markets.
Just Graeme, when you think about your total PCL outlook in that 25 to 30 basis point range, can you just provide some color as to what, if any, expectations you have around the impact of Brexit on the lending portfolio of the Capital Markets has out there?
Yes, I think certainly, when -- in the opening remarks, we talked about some of the geopolitical uncertainty, Brexit is one of those events that we're thinking about. And certainly, the kind of the trade uncertainty that we see in the U.S. with Asia increases uncertainty. I think for us on Brexit, our operations aren't as significant in Europe as some of the other global banks out there. We've been actively working for some time now to ready for potential negative outcomes there. And so there's an operational side to that, that I think we feel comfortable with as best we can given the uncertainty there. And then there is the macro side of it. And I would say the macro side of it, I don't -- I wouldn't see that being -- something that translates kind of in a 9-month time frame -- time line like we're kind of articulating in that outlook. But I think that presents more uncertainty as we go forward into 2020 and beyond. So it just creates a broader slowdown in the U.K. economy. But I wouldn't be quantifying that in that 25 to 30 at this point in time.
But would it be something that at some stage would be noticeable in that PCL rate?
Well, I mean, we're not going to speculate in an event where we really don't know what that negative outcome looks like. And this is really -- if that is an uncertain event, the impact it's going to have on the economy is as uncertain. I mean, our loan book is generally a higher quality loan book of any of our regions we have. It's a -- it's much more balanced than an investment-grade book than it is in our other regions. So we have a better starting spot, if you will, than we do with another spaces. But it's really going to depend on what that -- how that evolves and what that economic situation looks like.
Do we have time? Or is that...
We have time for one more. That's it. Hi, operator. I assume there's no more questions.
We do have one last question. Did you wish to take it?
Yes, we'll take one more.
Yes, we'll take the last.
Certainly, so the last question is from Gabriel Dechaine of National Bank Financial.
I'll make it quick. The leverage loan balance you gave, the $10.7 billion. How do you classify that in your wholesale loan book -- breakdown in the industries? Is it in a specific category? Or does it go by industry?
No. As I said, those are across all of the industries. I think in my comments, I made reference to the fact that no industry, no sector there represents more than 19% of the portfolio. So leverage lending is a product. And it -- we engage with clients across all the sectors there, so that's why and say it's a very diversified portfolio. It's not specific to any one sector.
Okay. Because there's one category, investments. But I was wondering if that one's not -- what is in that any way?
No, that's a -- that is unrelated to the leverage lending, specifically. I think the -- there was an uptick in investments, but that was more to do -- due to a recent classification, we were cleaning up some SIC codes on the other category and realigning those to the other categories more appropriately.
Yes, we have holding companies, investment offices high net worth and some occasional conglomerate in there. So...
Right. But I think it's important also that people understand that, that $10 billion number isn't all private equity buyout loans. That, that is leverage lending definition.
Yes. We said, there is -- 35% of it would be, what we would call, a private equity financial sponsored backed activity.
Right.
We want to thank everyone for their questions. I would characterize it as a strong quarter that's -- diversification -- the diversity of our franchise really showed through in a quarter that had significant volatility, particularly in December that impacted our Capital Markets activity levels, it impacted -- certainly impacted our AUM, AUA, AUC levels across our I&TS and Wealth Management franchises. But underlying all that is a significant client momentum, market share gains and great core activity that we were able to earn through. So we feel, as we pointed out, very good about the activity levels in our business and the momentum our business has heading to the rest of the year. And we kind of remain our -- are confident in our medium-term outlook for the business. So thanks for your questions, and we'll talk to you next quarter.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.