Royal Bank of Canada

TSX:RY

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to RBC's Conference Call for the First Quarter 2023 Financial Results. Please be advised that this call is being recorded. I would now like to turn the meeting over to Asim Imran, Head of Investor Relations. Please go ahead, Mr. Imran.

[Asim Imran, executive]

Thank you, and good morning, everyone. Speaking today will be Dave McKay, President and Chief Executive Officer; Nadine Ahn, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions Neil McLaughlin, Group Head, Personal & Commercial Banking; Doug Guzman, Group Head, Wealth Management and Insurance; and Derek Neldner, Group Head, Capital Markets.

As noted on Slide 1, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially. I would also remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. To give everyone a chance to ask questions, we ask that you limit your questions and then requeue. With that, I'll turn it over to Dave.

[David McKay, executive]

Thank you, Asim, and good morning, everyone. Thank you for joining us. Today, we reported first quarter earnings of $3.2 billion or $4.3 billion adjusting for the Canada recovery dividend and other items. Our results are a testament to our diversified business model underpinned by momentum from client-driven growth across our largest segments as well as the benefit from higher interest rates. Our performance this quarter also reflected record capital markets revenue driven by strong Global Markets results as well as market share gains in Investment Banking in what has been a difficult industry-wide environment for advisory and origination activities.

Reported expense growth was elevated to 17% year-over-year. However, Nadine will speak to shortly, expense growth included a number of notable drivers this quarter. Expense growth over the last 12 months has reflected strategic investments in client-facing roles and technology to enhance our value proposition and infrastructure, including artificial intelligence capabilities. A credit to these investments, RBC was recently ranked #2 amongst global banks and a recent benchmark of AI maturity in business.

While we're seeing the benefits of our strategic investments in talent and technology, the entire leadership team is committed to moderating expense growth from these elevated levels and driving efficiencies across the bank. Our results were also impacted by higher PCL this quarter. Although PCL on impaired loans remained well below historical averages, given strong employment and consumer balance sheets, we expect them to continue increasing from cyclical lows.

Correspondingly, we have added to our Stage 1 and 2 reserves this quarter, an important pillar and holistic strength of RBC's balance sheet, which includes strong capital and liquidity metrics, including our low-cost Canadian deposit base. We ended the quarter with a CET1 ratio of 12.7% and expect to maintain a CET1 ratio of at least 12% up to and following the close of our proposed acquisition of HSBC Canada. Our outlook includes a regular cadence of twice a year dividend increases, while also deploying capital to support further organic growth.

We continue to be well positioned to deliver a premium return on equity and compounding strong book value growth. This is underpinned by prudent growth in our many high ROE businesses, including Canadian Personal Banking, Global Wealth and Asset Management and Investment Banking. Before I provide context on our performance and growth strategies, I will speak to what remains a complex and fluctuating macro and market environment.

While central banks have successfully rained in peak core inflation, strong services demand, labor shortages, and the reopening of China's economy still present a challenge to getting firm control within stated target ranges.

While interest rates may be peaking, they may remain higher for longer as tight labor markets and other supply imbalances keep inflation high and constrained economic and market activity. The difficulty for central banks is forecasting a lagging impact that higher rates have on the economy, while also trying to assess the impact of further rate increases to control inflation.

Furthermore, the global economy remains susceptible to geopolitical shocks and regional political deadlocks. Overall, evaluating all the moving parts, we do forecast the softer landing characterized by a modest recession, largely underpinned by the impact of rising debt service costs on the consumer. This phenomenon has already been felt in the Canadian housing market, where home resales and prices have corrected since their peak last year.

Regardless of where we are in the cycle, RBC remains well positioned to support our clients while executing on our diversified growth trajectory. Starting on Slide 5, I will speak to these growth trends across our largest segments. I will then spend time focusing on our Canadian retail and global full-service wealth advisory businesses, which provide high ROE through the cycle diversified revenue streams.

Turning to our Canadian Banking business, where we earned record revenue of $5.3 billion this quarter, with strong volume growth highlighted the strength of our client franchise. We added $28 billion of mortgages over the last 12 months, up 8% from last year. And while mortgage origination activity has slowed from recent highs, it remained in line with pre-pandemic levels, offsetting a slowdown in activity, our retention rates of approximately 90% and midterm attrition rates at 5-year lows.

Looking forward, we continue to expect annual mortgage growth slow to the mid-single digits, given deteriorating affordability. In contrast, credit card balances were up 13% year-over-year, largely due to higher client spending, particularly in restaurants and travel, while balances have now surpassed pre-pandemic levels, partly due to lower payment rates, revolving balances will remain below Q4 2019 levels.

Business loans were up over 15% from last year. While utilization rates on revolving facilities remain below pre-pandemic levels, term lending for capital expenditures has been strong. We're seeing broad-based growth across sectors, including consumer services, manufacturing and auto finance. Our Global Wealth Management franchise generated record revenues of $4.6 billion this quarter, partly due to the success of our full-service advisory businesses, which I will speak to.

RBC Global Asset Management AUM increased over $25 billion from last quarter as equity markets picked up from the beginning of the fiscal year. Despite increased market volatility, RBC GAM remains an important high ROE profit generator for the bank. Loan growth at City National remained both diversified and robust, up 20%, including -- excluding the impact from PPP loans.

Going forward, we expect loan growth to moderate from these heightened levels, particularly in the jumbo mortgage space, where refinancing activity has pulled back. Capital Markets also generated record revenue, surpassing $3 billion for the first time. Pre-provision pretax earnings of $1.4 billion highlight the increasingly diversified nature of our revenue streams. The strong performance was underpinned by record results in Global Markets across most regions, driven by excellent execution on robust client activity through volatile market conditions.

Looking forward, we continue to identify growth opportunities in Global Markets, including an FX, an area of strength for HSBC Canada as well. Corporate Investment Banking results were down 11% from last year, amidst challenging markets. And while Investment Banking revenues were down 39% from very strong results last year, they outperformed global fee pools, which were down 55%. Consequently, RBC Capital Markets ranked seventh in global league tables this quarter, moving up 1 spot to ninth looking at the last 12 months.

Looking to the future, we continue to focus on diversifying revenue streams across higher ROE advisory and origination activities. We've been actively hiring managing directors across industry verticals and geographies while also expanding our client coverage. These have been factors in our move-up in global league tables. With that said, an uncertain macro and geopolitical backdrop, volatility across asset classes and higher financing costs remain the biggest challenges to M&A activity.

I will now double check on our differentiated and award-winning Canadian retail franchise where we welcome a further 130,000 clients this quarter on top of the 400,000 clients added throughout fiscal 2022. We continue to benefit from a number of strategic partnerships with partners such as ICICI Bank Canada while also leveraging investments made in our distribution network, including digital channels.

Nearly 60% of credit cards and almost 40% of core checking accounts are now open digitally. Our success is underpinned by a clear focus on doing what is right for the client. This is why we do not have a minimum balance requirement on our core checking account. Our continuum of offerings, combined with our insights and advice, allows us to help our personal banking clients make the best decision based on the prevailing macro backdrop.

In 2021, the continued low interest rate environment made it attractive for clients to shift liquidity into investment products such as mutual funds. In contrast, the significant increase in interest rates over the last 12 months has resulted in a shift of our core checking and savings into GICs and other high-yielding products. Personal GIC balances are up over $40 billion from last year, with nearly $15 billion this quarter alone.

While we recognize the trade-off to near-term margins, we attach greater long-term value to retention, deepening relationships and keeping our clients within the RBC value proposition. For example, clients enrolled in our highly successful Vantage product are twice as likely to cross-sell into credit cards and 3x more likely to stay at RBC. Furthermore, the profitability of our mortgage clients is 2x higher when retained for the second term.

The execution of our client-focused strategy is reflected in strong revenue growth. Despite clients moving to lower spread GICs, revenues in our Personal Banking Investments business were higher than last quarter. Turning to Slide 7. I will now speak to the strength of our global full-service wealth advisory platform, where we now have [ end ] market scale in 3 of the world's largest asset pools. We are seeing the benefits of our diversified revenue strategy with recent rate hikes driving strong growth in net interest income in both Canadian and Wealth Management -- in Canadian Wealth Management and in U.S. Wealth Management.

This offsets the impact of unfavorable markets on fee-based advisory revenues and transactional revenues this quarter. We are looking to expand our relationships with RBC Brewin Dolphin clients by offering core private banking, lending and payments products and services. This would leverage learnings from our successful U.S. wealth strategy, which is seeing growth in securities lending. We expect this to accelerate revenue growth in our businesses adding to our fee-based revenue streams, which I will now discuss.

RBC Dominion Securities continued to strengthen its #1 position in Canada, adding net new assets this quarter with Canadian AUA up over $20 billion quarter-over-quarter. Our position of strength is driven by a set of self-reinforcing competitive advantages, underpinned by winning advice, digital capabilities, holistic suite of solutions for a growing base of Canadian wealth planning professionals.

Canadian Wealth Management remains a highly profitable business, leveraging its scale to generate pretax margins in the mid- to high 20s. It's also important to have scale in the U.S., one of the largest fee pools globally. Our U.S. business added over $20 billion of AUA this quarter, adding to its position as the sixth largest full-service wealth advisory firm in the United States. Since early 2022, we've recruited 110 advisers, were expected to drive nearly $20 billion of assets under administration.

This recruiting will remain a key source of growth. We will also look to continue to leverage increasing RBC brand recognition in the U.S. to drive organic client growth. RBC Brewin Dolphin is one of the largest discretionary wealth managers in the U.K. and Ireland, offering in a market with significant structural changes, including moving from defined benefits to defined contribution plans. This market is expected to increase from approximately GBP 3 trillion today to GBP 4 trillion by 2026.

In conclusion, we look to continue executing on our through-the-cycle organic growth story, while maintaining a strong balance sheet across capital, credit and liquidity ratios. Furthermore, we look to deepen existing client relationships and attract new clients as we anticipate welcoming HSBC Canada's colleagues into RBC. Nadine, I'll now hand it over to you.

[Nadine Ahn, executive]

Thank you, Dave, and good morning, everyone. Starting on Slide 9, we reported earnings per share of $2.29 this quarter excluding the $1.1 billion impact of the Canada recovery dividend and other smaller items of note, adjusted diluted earnings per share was $3.10, up 8% from last year. Total revenue was up 16% year-over-year or up 7% net of PBCAE. Pre-provision pretax earnings were up 7% from last year as strong client-driven revenue growth more than offset elevated expense growth, which I will discuss shortly. The impact of higher provisions for credit losses was partially offset by a lower adjusted effective tax rate, resulting in adjusted net income growth of 5% year-over-year.

Before I discuss our segment results, I will spend some time on 3 key topics: capital; the outlook for net interest income and our related funding advantage; and finally, our expense outlook. Starting with our strong capital ratios on Slide 10, our CET1 ratio rose 10 basis points from last quarter, reflecting strong net internal capital generation of 39 basis points, net of $1.8 billion of dividends to our common shareholders. This was partially offset by the 20 basis point impact of the Canada recovery dividend and other tax-related adjustments.

Next quarter, we expect Basel III regulatory reforms to drive a 70 to 80 basis point benefit, largely reflecting the removal of the sector-wide credit risk RWA scaling factor under the new IRB framework. Furthermore, we expect to see RWA reductions reflective of our well-diversified portfolios and the conservatism of our wholesale risk parameters relative to the prescribed parameters under the new framework.

Moving to Slide 11. All-bank net interest income was up 18% year-over-year or up 29%, excluding trading revenue. These results reflect our earnings sensitivity to higher interest rates as well as the benefit from higher volumes. As a reminder, the cost of funding of certain transactions, particularly in Capital Markets, is recorded in interest expense while related revenue is recorded in noninterest income. All-bank net interest margin, excluding trading net interest income, was up 1 basis point from last quarter, largely reflecting trends in our Personal & Commercial Banking franchises.

On to Slide 12, where we walk through this quarter's key drivers of Canadian Banking net interest margin, which was up 3 basis points from last quarter and follows a significant 25 basis points expansion in the second half of last year. This quarter reaffirmed the benefits of our structural low-beta core deposit franchise, which drove a 10 basis point benefit to net interest margin in the quarter. We also saw benefits from higher credit card revolve rates, which were offset by continued competitive mortgage pricing.

Deposit growth outpaced loan growth this quarter, further improving our industry loan-to-deposit ratio of 103%, which points to a fully funded segment balance sheet. However, this was partially offset by rising deposit betas and a larger-than-anticipated shift in deposit mix, out of checking and savings accounts as clients sought higher-yielding GICs. Notably, we gained market share in GIC this quarter, which we view as an advantageous source of low-cost funding relative to wholesale sources.

Turning to City National. Net interest margin was down 5 basis points from last quarter, mainly; reflecting higher FHLB borrowings to support additional liquidity requirements at the end of the calendar year. This more than offset the significant benefits of Fed rate hikes on our asset-sensitive balance sheet. Going forward, we expect to continue to fund much of our loan growth through our core and sweep deposits, while supplementing these by accessing both broker deposits and FHLB funding.

Looking out to next quarter, uncertainty around implied rates and client activity impacting deposit mix are expected to put pressure on margins. Nonetheless, we expect margin expansion through 2023 for both Canadian Banking and City National. Our focus remains on growing net interest income. We anticipate mid-teen growth in Canadian Banking net interest income for fiscal 2023 and we expect even stronger growth for City National.

Moving to Slide 13. Noninterest expenses were up 17% from last year, with a few notable factors adding to expense growth this quarter. This includes the contribution from RBC Brewin Dolphin, which added 3% to the growth rate, as well as a prior year legal provision release, which added another 1%. Further to that, there was a 2% contribution from FX translation.

Beyond these factors, the biggest driver of expense growth was staff-related costs, which were inflated in part due to the U.S. Wealth Management, Wealth Accumulation Plan expense. As a reminder, this line is largely offset in other noninterest income using economic hedges, thus making the impact net neutral to pre-provision pretax earnings. The remaining contributors to expense growth were related to continued investment in our franchises through technology and business development costs as well as those driven off higher revenue, including trading execution costs.

For the remainder of the year, we expect noninterest expense growth, excluding variable and stock-based compensation to decelerate, reflecting the distancing from lower COVID [ area ] comparatives. We also expect a slowdown in FTE growth following a period of heightened investment in sales capacity. Strong client-driven revenue growth and a focus on cost control underpin our commitment to deliver positive all-bank operating leverage in fiscal 2023.

In Canadian Banking, we continue to expect operating leverage for fiscal 2023 to be in the mid-single digits, driving the full year efficiency ratio below 40%. Before adding color on segment trends, a reminder that this quarter, we announced a realignment of our business segment. Beginning on Slide 14, Personal & Commercial Banking reported earnings of $2.1 billion this quarter, with Canadian Banking pre-provision pretax earnings up 18% year-over-year.

Net interest income was up a record 23% from last year, due to higher spreads and strong growth in loans and deposits, which Dave spoke to earlier. Noninterest income was down 2% from last year as challenging market conditions weighed on average mutual fund balances driving lower distribution fees. This was partially offset by higher service charges and foreign exchange revenue driven by higher client activity. Strong revenue growth underpinned operating leverage of 5% and an efficiency ratio of 39%.

Turning to Slide 15. Wealth Management earnings were up 3% from last year. Revenues were up 14% year-over-year, aided by robust net interest income growth of 44%, reflecting the benefit of higher rates in both Canadian Wealth Management and U.S. Wealth Management. Global Asset Management revenue decreased, primarily due to lower fee-based client assets on the back of a challenging market condition and ongoing industry-wide pressures on net redemptions.

Turning to Slide 16. Capital Markets earnings were up 9% year-over-year, reflecting record revenue and the benefits of a lower tax rate. Record Global Markets revenue was up 17% from last year, reflecting a record quarter for macro products with strong results across all product lines underpinned by robust client activity across rates and FX. We also saw strength in muni products and investment-grade credit sales and trading.

Investment Banking revenue was down 39% from record levels achieved last year. Importantly, results outperformed a more significant decline in global fee pools. Lending and other revenue was up 23% from last year, reflecting strong results in transaction banking underpinned by margin expansion and higher lending revenue driven by volume growth.

Turning to Insurance on Slide 17. Net income decreased $49 million or 25% from a year ago, primarily due to higher capital funding costs, which impacted NIAT by approximately $50 million. This was partially offset by improved claims experience. To conclude, our leading money in franchise positions us well to continue seeing the benefits of higher rates while also funding strong client-driven growth. We also remain disciplined in balancing our investments and capital deployment to continue delivering value for our shareholders and clients. With that, I'll turn it over to Graeme.

[Graeme Hepworth, executive]

Thank you, Nadine, and good morning, everyone. Starting on Slide 19, I'll discuss our allowances in the context of the macroeconomic environment that Dave referenced earlier. While markets have already started to recover, the real economic impact of inflation and higher interest rates is just starting to influence credit outcomes. On the whole, we believe the probability of a more severe inflation and interest rate environment has started to reduce.

However, as Dave noted, we continue to expect a moderate recession in 2023. With this backdrop, we built reserves on performing loans for the third consecutive quarter. Provisions on performing loans this quarter were driven by 3 factors. First, from a macroeconomic perspective, we move closer to our forecast recession, bringing more of the associated expected credit losses into the IFRS 9 provisioning window. This was partially offset by a modest shift in our scenario weights, reflecting the lower probability of more adverse inflation and rate scenarios that I just noted.

Second, the credit quality of our portfolio continue to trend back to more normal levels with sustained increases in delinquencies and credit downgrades. And finally, we added reserves for ongoing portfolio growth. In total, our allowance for credit losses on loans increased by $268 million this quarter to $4.4 billion.

Moving to Slide 20. Gross impaired loans were up $400 million or 5 basis points this quarter with higher impaired loan balances across each of our major lending businesses. This was driven by an increase in new formations, which are returning to pre-pandemic levels. In our wholesale portfolio, new formations were up $220 million compared to last quarter, with the largest increases in the real estate related and consumer staple sectors. We do not expect to incur losses on a large majority of the new formations in the real estate-related sector as these formations related to loans that are well collateralized and current on their payments but have a financial sponsor in distress.

In our retail portfolio, new formations were up $61 million or 18% quarter-over-quarter, with increases across all of our lending products. Of note, new formations on residential mortgages more than doubled this quarter to $64 million, primarily due to variable rate borrowers who have seen payments increase after hitting their trigger rate. As you'd expect, delinquency rates on triggered variable rate mortgages increased during the quarter.

However, delinquency rates for the entire Canadian Banking mortgage portfolio were stable at 16 basis points. We remain very comfortable with our residential mortgage exposure. Clients continue to have excess savings and liquidity with deposit levels remaining elevated compared to pre-pandemic levels. High risk loans, which we consider as uninsured loans with the FICO score below 680 and a current loan to value over 80%, account for less than 1% of uninsured balances.

And we have prudently provisioned for the expected increase in losses, noting that we have increased reserves on performing mortgages by over 30% since Q2 of last year.

Moving to Slide 21. Provisions on impaired loans were up $103 million or 5 basis points compared to last quarter. Our PCL ratio of 17 basis points remains below pre-pandemic and historic averages. In our wholesale portfolios, higher provisions in Capital Markets and Wealth Management [ were more a function of reducing critic ] events and systemic issues while provisions of our Canadian Banking commercial portfolio were lower this quarter.

In Canadian Banking retail portfolio, higher provisions were primarily driven by personal lending and credit cards, which is consistent with our expectations as higher interest rates start to impact clients. In light of the higher interest rate environments and turning to Slide 22, I'll now provide some details on our exposure to commercial real estate. Our standing loan exposure to this sector represents 9% of our total loans and acceptances. The portfolio is well diversified and has been originated to our sound underwriting standards that stress test loans for more adverse capitalization rates and operating income.

Additionally, exposure is well rated and benefits from strong collateral, noting the on-balance sheet RWA density of our commercial real estate exposure is approximately 20% lower than the rest of our wholesale portfolio. That said, we do expect commercial real estate to be negatively impacted by higher interest rates. Higher rates will negatively impact property values and debt service coverage.

Additionally, certain asset classes like office properties are being impacted by changing fundamentals as companies have adopted hybrid working models post-pandemic. As a result, we expect to incur some losses in the commercial real estate sector moving forward. We've been proactive in provisioning for these expected losses. For example, our IFRS 9 downside scenarios reflected a decline in commercial property values ranging from 15% to 40%.

As such, our ACL ratio on performing commercial real estate loans has increased 40% since Q2 of last year and has more than doubled relative to pre-pandemic levels. To conclude, we continue to be pleased with the ongoing performance of our portfolios. Our PCL ratio on impaired loans remains below pre-pandemic levels, but we have seen the normalization of delinquencies and impairments as higher interest rates start to impact credit outcomes.

We expect PCL and impaired loans to increase through 2023 as we head into a forecast recession. And ultimately, the timing and magnitude of increased credit cost continues to depend on Central Bank's success in curbing inflation while creating a soft landing to the economy. We continue to proactively manage risk through the cycle, and we remain well capitalized with [indiscernible] yet more severe macroeconomic outcomes. With that, operator, let's open the lines for Q&A.

[Operator]

[Operator Instructions] And we will take the first question from Meny Grauman, Scotiabank.

[Meny Grauman, analyst]

Dave, for a number of quarters now from the outside looking in, it sounds like you're focused on getting expenses more under control. And then we have a quarter like this one where it still looks like that's not mission accomplished yet. And I'm wondering, are you frustrated by that? And how do we interpret that in terms of -- are we just seeing more of a persistency of inflation coming through, what's really the challenge in terms of -- what seems to be like a key focus for you for quite a while now?

[David McKay, executive]

Yes. Thank you, Meny. I guess you could hear that in my comments -- my prepared comments. There's a couple of factors at play. One, there is persistent inflation out there that just doesn't come through only on salary and benefit line as we -- as all companies across the world increase base pay and compensation to match the inflationary environment, but also comes through our third-party strategic sourcing line of all our partners, all the companies that we work with from technology, to advisory, to consultants, all those inflationary costs come through other lines of business. So there's -- we are in a hyperinflation environment.

The second area that all companies are struggling with is the productivity from a hybrid workforce, and we -- lots of discussion around how are we working, how efficiently are we working as an economy? And I think we're working through that uncertainty as well. I think Nadine did a good job in kind of walking back some of the headline numbers to a more reasonable number. But that volatility, I think, has caused us to have to refocus on different areas of our cost opportunity.

We do see opportunity. We did invest significantly in growth. As I talked about, I think the last time, if we aren't going to see that growth, then we're going to have to kind of reposition some of our capacity, but we are still forecasting a relatively mild recession and a softer landing and then opportunities to continue to access good growth. So I think we're on it. I think it's a volatile market. There's a lot of things going on.

We're repositioning the bank for a very different world going forward as far as technology capabilities across the board. It's a very complex operating environment. Having said that, we got to do better, and we're going to do better.

[Meny Grauman, analyst]

And just as a follow-up, I know you've been very vocal, Royal have been very cautious about taking restructuring charges historically. But is the environment different now? And again, given the persistence of this issue, does it change your view on that tool?

[David McKay, executive]

No. We think we have the tools with doubling down in different areas to manage this in the normal course right now as we normally do. And you'll see our expenses get under control.

[Operator]

Next question is from Ebrahim Poonawala, Bank of America.

[Ebrahim Poonawala, analyst]

I guess maybe a question for Graeme. You mentioned higher interest rates impacting credit or credit normalization. At what point -- and I hear you in terms of expectation for a mild recession. But at what point do we start worrying about credit normalization actually leading into a more pronounced deterioration that looks a lot recession-like?

Like what are the indicators? Is it all about jobs and what the job market does? And give us a sense of across the customer segment, commercial, consumer, where are you seeing the most pronounced pain due to the higher interest rates?

[Graeme Hepworth, executive]

Yes. Thanks, Ebrahim. Maybe just to provide a little bit more color on kind of how we're thinking about the environment. I think as we've guided earlier, we certainly continue to expect that credit outcomes. Negative credit outcomes will rise through the year as we progress through the year heading back towards more historic norms kind of expecting that to start to peak out towards the end of this year and to the first half of next year.

As you said, there's different aspects we look at that. And these are the things that really factor into our models in IFRS 9. And so as you said, it's debt servicing costs, certainly, that directly impacts things like our mortgage portfolio. But we do worry about and think about the overall kind of wealth effect and how that's going to squeeze out discretionary income -- discretionary expenses as well. And so that's kind of the things that factor into why we forecast GDP the way we do and why we're forecasting unemployment to increase over the course of this year.

Right now, we're at exceedingly low levels there, but we do expect the unemployment to graduate up to kind of more in that 6.5% to 7% range at the tail end of this year before kind of coming back to more historic norms. And so those are the factors that we think really go into our models and how we assess kind of the overall loan losses. Having said that, we continue to see in the near-term kind of very significant outperformance, particularly on the job space.

We've continued to expect unemployment to rise. We've continually been surprised by the strength of the job market in Canada and the U.S. And so that's kind of always like continues to push back the timing of this normalization a little further than we've anticipated. But -- so yes, jobs is a big one here. And what you see -- when you think about the retail side, maybe to break into that a little bit further, certainly, we're seeing the delinquency trends kind of move up. But the insolvency side of it, which is kind of the other half of the equation, is very much tied to the labor market.

And we have seen insolvency start to tick up a little bit, but they're still well below pre-pandemic norms. And so until we really start to see that kind of job situation, labor side move, it's going to continue to be a near-term benefit to the overall credit outcomes.

[Ebrahim Poonawala, analyst]

And just on that, Graeme, higher rate structurally, when we look at the commercial real estate market, C&I borrowers were seeing their cost of capital go up, no material pain there.

[Graeme Hepworth, executive]

Commercial real estate is, certainly, as I noted, I mean, that is one of the portfolios that we are most focused on for sure. I would say it's a sector that I think the underwriting standards have been very strong that have been very disciplined on for some time. If you look at portfolios, we were doing a deep dive review on our Canadian commercial portfolio, for example, looking at the mortgage side of that. I mean, a, we have had a strategy very focused on kind of your top-tier clients. And so these are clients that I think are very seasoned, very capable to weather kind of a through-the-cycle set of challenges.

And two, again, the underwriting standards have been very, very strong there. You look at our mortgage portfolio on that side. We've got guarantees or partial guarantees on 95% of those commercial mortgages. It's just an indicator of, again, the strength of the underwriting standards. And so things will trend up, but they're going to trend up from what's been near 0 numbers in that portfolio for a long time.

But right now, these are still, I would say, forward expectations. We're not seeing a lot of real negative outcomes in that portfolio at this point in time.

[Operator]

Next question is from Doug Young, Desjardins Capital Markets.

[Doug Young, analyst]

Just on the CET1, specifically on RWA movements. It looked like market risk RWA was down 8% quarter-over-quarter. Counterparty RWA down 11%. Just hoping to get a little bit of color of what drove this? And should there be a reversion down the road?

And Nadine, the Basel is going to be 70, 80 basis points positive come Q2. I think there's further changes coming from a regulatory perspective, specifically around the trading book and maybe next year. Can you talk a bit about what the offset would be? Or is there any other negative items that are coming down the pipe on the CET1 ratio side?

[Derek Neldner, executive]

Thanks for the question, Doug. It's Derek Neldner. I'll maybe start addressing your RWA question from a business perspective, and Graeme can chime in and Nadine may want to add as well. But in terms of the trading businesses, we obviously saw very, very strong levels of client activity in the quarter. It was a very robust environment. And against that, we were able to drive good velocity and turnover in our trading book inventories and also bring down some of those inventories, in particular, in our credit trading businesses where, as you know, it was a tougher environment in 2022.

Our inventory levels went up a little bit, and we were able to bring those down against a very strong trading environment in Q1. And so that really was the largest contributor to a decline in our market risk RWA. As you noted, we also did see a decline in our counterparty credit risk RWA. That was really, again, a function of improving credit environment, but as well some FX movement that helped bring RWA down.

And then finally, we did see a moderation in commodity prices. And so that did bring down our counterparty RWA against some of our commodity trading positions.

[Nadine Ahn, executive]

Go ahead, Graeme.

[Graeme Hepworth, executive]

No, I think -- I mean on that part, I think Derek has absolutely captured it right. It's -- this is a quarter with good liquidity. It allowed us to be much more in the moving business and not in the storage business by trading side of it. So I think those are absolutely right factors. But I guess better pieces were on overall 70, 80 basis points.

[Nadine Ahn, executive]

Yes. Just as it relates to on the horizon, we will be implementing the remaining components of Basel IV that are coming into effect next year. So that's related to FRTB and DBA. We don't expect those to have material impacts overall, Doug, in terms of our CET1 ratio.

[Operator]

Next question is from Mario Mendonca, TD Securities.

[Mario Mendonca, analyst]

Could we first go to the margin? I was a little surprised to the margin, but it clearly relates to that dynamic you described where the expense was reported in NII, but the income in -- noninterest income. Is there any way you can help us understand what effect that had on the all-bank margin in the quarter? It would be helpful to understand what that margin might have looked like, was it up 5 basis points sequentially if that dynamic hasn't played out? That's something you can quantify, Nadine?

[Nadine Ahn, executive]

Sure, Mario. So if I just start from the total bank NIM of down 9 basis points, as you commented, a lot of that relates to the Capital Markets business, where we have the cost of funding, which obviously has gone up with interest rates going up, showing up in the NII line and then their offsets are in other income. So when I break out the 2 main drivers of that primarily attributed to the repo business as well as some of our equities derivatives businesses, that takes our number down and what you're getting from a capital markets perspective than on a total bank level, that would take that number down, which is roughly about 12 basis points down to 1 or 2, which is mainly on the loan book as margin impacted by higher funding costs.

When I look at it at the all-bank level then, so if you take out a substantial portion attributed to that, you're looking at the increase of 1 basis point. Within that number, we are down a few basis points as it relates to our increased liquidity position. That relates, as we commented in terms of our LCR increase, but also we've increased our funding. That will get absorbed as we go through the year and the loan book growth contributes to the margin.

[Mario Mendonca, analyst]

Okay. So Nadine, maybe let me -- I may have misunderstood it then. The 1 basis point lift in the margin all-bank already appropriately excludes that effect that you referred to, that effect of expensing in one area of revenue in another. Is that true?

[Nadine Ahn, executive]

That is correct. What I would say was it represented a bit under where we would expect it to be is because of the higher liquidity position. In addition, there was one movement of anomaly between quarters, another couple of basis points.

[Mario Mendonca, analyst]

Okay. So that really gets -- that's helpful. So now I think I understand why the margin -- I think I understand these margin dynamics a little bit better. So it really does lead to my second question, which is the overall margin sensitivity and improvement for an asset-sensitive bank like Royal, it appears to be diminishing over time. And it's for all the reasons I think you offered, deposit betas, migration, maybe even deposit attrition.

And that disclosure you provide in your presentation where you break out costs, funding costs and like the income where that breakout you do in your presentation, that's awfully helpful. But the message I'm getting here is that, that asset sensitivity that Royal has benefited from like we're in the final innings of that. Would you agree with that, that we're in the final innings of the benefit for these asset-sensitive banks?

[Nadine Ahn, executive]

No, we do expect to -- I think if we go back to our structural deposit benefit that we have, which continue -- which drives our asset sensitivity to higher rates, and we continue to expect to benefit from that going forward. I think what you're seeing in terms of what you commented on the near-term movements, as it related to the deposit migration, we expect that, that will have slowed given that the interest rates have gone up and they expect to level up. So a lot of that movement will have slowed down. We will continue to see the margin expansion benefit for our structural deposit base.

And that is going to be a bit sensitive, Mario depending upon what happens to the longer end of the yield curve. And we've seen it move quite significantly just gave some perspectives on where we're at with rate increases. So it's obviously, we're dealing with a bit of an inverted yield curve right now. That has been moving around to the tune of 30 to 50 basis points over the last quarter. And so that's where the value driver as we start to think about that margin expansion coming from that structural deposit base.

[Mario Mendonca, analyst]

Okay. And then I'll stop here. The guidance you offered for mid -- I think you said mid-teens growth in NII in Canadian Banking in 2023. The math is pretty simple. It would imply that the domestic -- or that Canadian banking margin will be essentially flat or maybe marginal, maybe up slightly going forward. That's what the math tells me just by plugging in your mid-teens. Is that right? Is that essentially what you're telling us that margins could be kind of flat from here in Canadian Banking?

[Nadine Ahn, executive]

I think what you could expect in the next quarter is continue to see a bit of that pressure as it relates to the deposit mix movement, but we do expect to see the margin expansion still continuing through the latter half of 2023, Mario.

[Operator]

Next question from Scott Chan, Canaccord Genuity.

[Scott Chan, analyst]

Nadine, just a follow-up to that line of questioning. You talked about the Canadian P&C, but I think you offered comments on the U.S. side as well on City National Bank being better in 2023. And just wondering the factors in context that relative to kind of the deposit base declining and likely decline through a [ few years ] as well? .

[Nadine Ahn, executive]

Sure. So for City National, we had commented, I believe, in Q4 towards the end of the quarter, we had increased our liquidity position related to some changes around parameters. That was funded through FHLB. So the impact of that fully in the Q1 is what you're seeing in terms of a lot of the decrease from the 5 basis points. As we look forward for City National, we did comment that we are expecting to continue to see benefit from our loan growth through the funding of both our deposit sweeps and our low-cost deposits.

However, we will potentially need to supplement that for FHLB, which would put some further pressure on margins, I would think, into next quarter, similarly to what you saw this quarter. However, we do expect to see the expansion of that as we start to stabilize that deposit level through the latter half of 2023.

So we have [indiscernible] sensitivity on the asset side, so that can still benefit significantly.

[Scott Chan, analyst]

Okay. So the comment was that you expect NII in 2023 on the U.S. side to slightly outpace Canada this year from what you see right now?

[Nadine Ahn, executive]

Correct. .

[Operator]

Next question is from Sohrab Movahedi, BMO Capital Markets...

[Sohrab Movahedi, analyst]

I just wanted to maybe ask a question of Neil. I appreciate the additional detail you provided around customer behavior when it comes to savings accounts, deposits, GICs and the like. Can you also talk a little bit about what's happening on the loan side when it comes to mortgages, variable mortgages, what sort of behaviors you're seeing?

And maybe comment a little bit about how those mortgage holders, variable mortgage holders, I guess, how many of them would have credit cards with you? And what sort of insights, I guess, are you seeing from a credit quality perspective that might be for talent here?

[Neil McLaughlin, executive]

Sure. So thanks for the question. So on the variable rate mortgages, I guess there's a couple of themes. Not surprising, we're seeing percentage of originations really drop, really getting down to kind of 15% of originations. Keep in mind that the entire portfolio, about 1/3 of the portfolio is variable rate. So we're seeing a very dramatic shift there. We're also seeing a shift overall to basically fewer first-time homebuyers. You can imagine not a product that first-time homebuyers are going to take on.

And then we've already commented on this. But just in terms of trigger rates, we have seen a good portion of that variable rate portfolio go through that process around trigger rates. The earlier cohorts that went through it saw bigger increases. The ones that have been more recent have had smaller increases. Graeme commented, those are embedded in the credit performance.

One of the things just to add to Graeme's comments is that, overall, those variable rate mortgages did start from a lower delinquency level than average. So we're starting to see the move up to be average, and we're seeing the more recent cohorts actually have lower incremental payments. So a real focus around the category, reaching out, talking to those clients, and we do break it down and look at a couple of factors, including what's the collateral those customers have, what are the FICO scores.

And then Graeme touched on just seeing the excess deposits, so whether it's excess deposits or we have seen wage inflation over time from when many of those mortgages were taken out, and that is helping those clients deal with the increased payments. So that's maybe a little bit of color on variable rate mortgages. And Graeme, do you want to -- anything you want to add?

[Graeme Hepworth, executive]

No, I think you touched on some key points. I think the one I think you do draw out there, which I think is important is that we are seeing delinquencies rise in that segment, as I noted. But as you know, Neil, that they're starting from a position of strength again, and that's true of our client base as a whole. Again, the strong employment situation, the strong liquidity situation in that portfolio -- segment of that portfolio in particular kind of was starting from a better-than-average situation and then that's trending up but that's why the overall delinquencies in the mortgage book are relatively stable quarter-over-quarter.

[Neil McLaughlin, executive]

And then in terms of your second question, just about the percentage of mortgage holders with credit cards, it's over 50%. So we have obviously a very strong credit card lineup. We do have a relationship-based model. So the majority of our mortgage holders do hold other products and over half of that portfolio also hold a credit card with us.

[Sohrab Movahedi, analyst]

Okay. And just a quick, I guess, housekeeping item. Nadine, you didn't mention any impact of the DRIP discount on the CET1 ratio. Was the uptake not what you expected? Or any sense as to how that DRIP discount is.

[Nadine Ahn, executive]

Yes. No, we do -- our uptake in the DRIP has been what we expected, Sohrab, and we do expect to get about 10 basis points a quarter as it relates to that.

[Sohrab Movahedi, analyst]

Okay. So included -- would there have been about a 10 basis point benefit this quarter? .

[Nadine Ahn, executive]

In terms of this quarter impact, the DRIP was just started, so it's going to be smaller than the 10 that we had in -- but we expect full 10 for next quarter.

[Operator]

[Operator Instructions] The next question is from Joo Ho Kim, Credit Suisse.

[Joo Ho Kim, analyst]

Just one on Capital Markets. There was a commentary that the bank outperformed the global fee pool from Corporate and Investment Banking side. I'm curious if that outperformance was the same on the Global Markets side as what you have some commentary there? And more importantly, would you have a sense of what the PTPP earnings capacity might look like from Capital Markets this year? Obviously, it will ebb and flow with the market. But curious if you have a baseline sort of expectation similar to the guidance that you provided back in early 2022.

[Derek Neldner, executive]

Sure. Thank you for both those questions. From a market share perspective, as you noted, in our advisory and origination businesses in Investment Banking, we can get very real-time market share data. And so as you pointed out and as Dave highlighted in his comments, we did have a very strong quarter in what was a tough environment, we did gain share and moved up in our rankings. .

To your question on Global Markets, the data that we can get is not quite as real time. There's a little bit of a lag, and so we'll be waiting to get some of that data. But when I look at a variety of different information we can access and just anecdotal data points, I do think that our performance this quarter reflected both a benefit from some of our business mix. We are, as we've talked about in the past, have a larger credit business. That business performed very well and a very large rates, FX and commodity business.

And those businesses all had a constructive environment. But away from the mix, I do think we picked up share in a number of businesses in Global Markets, which I think is a reflection of a number of the new strategic initiatives we've been implementing in that business over the last couple of years, but in 2022, in particular.

To your question on pre-provision pretax, obviously, we've discussed in the past that we think, in a normalized environment, we could contribute $1 billion plus a quarter. When we look at the resegmentation and the addition of treasury services and transaction banking plus combined with our ongoing growth initiatives, we do think that we can lift that bar to $1.1 billion.

And so again, I would caveat that we are in a cyclical business and that depends on a normalized quarter. But in a relatively normal environment, that's the goal that we'll continue to be shooting for is $1.1 billion plus.

[Operator]

The next question is from Mike Rizvanovic, KBW Research.

[Mehmed Rizvanovic, analyst]

Derek, if I could just follow up, I wanted to ask a question about the trading line. Obviously, a great quarter for you guys. I'm wondering, in an environment like this, did you just get paid better for your transactions on the trading side just given some of the numbers that we track just to try to get a look ahead in terms of the volume that comes into the market overall? It seems like this is still an outsized quarter.

We really see the volatility spike. We didn't see trading volume spike and yet here you are sitting at $1.4 billion trading, which was a great number. Anything to suggest that maybe it was outsized a little bit because you're just getting paid more or maybe not as much volume.

[Derek Neldner, executive]

Sure. Thank you for that. A few different comments. I mean, overall, I would say, it was a very strong quarter for our trading businesses, and I would describe it as a very clean quarter. So there weren't any notable onetime items or anything. It was just really good client volume, a constructive market backdrop. And I think our teams managed risk and executed very well against that backdrop.

A few observations, though, I think, one, fiscal Q1 for us always tends to be a seasonally strong quarter for the trading businesses. We do get some benefit from the calendar year-end and how some of our clients are managing their balances and how other banks are managing their balances. So Q1 always tends to be seasonally a stronger quarter for us. This year, there was a constructive backdrop as I think a lot of our clients were repositioning their portfolios around year-end and for the year ahead with what continues to be a wide array of views for how 2023 may play out. So that drove heightened client volume.

And then as I mentioned, I think our mix did play to our favor a little bit. In 2022, our mix created some natural headwinds for us because of challenges in the credit business. Repo spreads were still quite depressed. None of those have been dramatic changes. But obviously, it was a more constructive quarter for credit. We have continued to see some moderate improvement in our repo spreads. And so I think our mix has helped.

And then importantly, I think our team has just executed really well on a number of strategic initiatives that we've been investing in and focused on over a number of quarters. So -- all to say, it was a very robust quarter. I certainly wouldn't expect that kind of run rate to continue through the balance of the year. But at the same time, there were no one-off items or anomalies. It was just a really good solid backdrop and our team executed well against it.

[Mehmed Rizvanovic, analyst]

And then maybe just quickly for Neil. On your residential mortgage lending in Canada, I'm not sure if you want to provide any guidance on where you think your growth level could drop. It looks like you're up about 50 bps quarter-over-quarter. What I'm wondering is just given the dynamic of potentially higher rates for longer, so -- like is there a possibility that the mortgage book starts to shrink here, not materially, but maybe by a few percentage points.

Is that something that you think is a possible outcome if you do get this dynamic of higher rates for longer and obviously, the origination volume seems to be very weak right now. Home sales are very weak. Is that something that's a possibility in your view?

[Neil McLaughlin, executive]

Yes. Thanks for the question. To your point, originations are down materially, probably about in the range of 40% in terms of transactions. And then you overlay the -- just the HPI decrease, and that further takes it down in terms of the actual dollars hitting the balance sheet. So right now, Q1 is not really the heavy origination period of the year. We are getting reports in the market that some inventories are coming online. Some properties are actually staying on the market for shorter periods of time. So it's probably too early to tell.

Our outlook for the mortgage business for the full year would be mid-single digits is where we see it getting to. But there isn't anything when we look through the portfolio based on what we would see where negative growth in the quarter would be something we would expect.

[Operator]

Next question is from Lemar Persaud, Cormark Securities.

[Lemar Persaud, analyst]

I want to turn back to expenses, specifically at the all-bank level. And looking at your Slide 13, is there any element of investment either in terms of technology or FTE related to enhancing collection processes, related to the tougher credit environment perhaps in Canadian Banking? Or is the growth in tech and comp all kind of strictly related to growth initiatives?

[Neil McLaughlin, executive]

Yes, I'll take the question. No, there isn't technology that we would need to put in, in terms of the collection activities. I mean it is -- we -- if you look at our largest increase in expenses year-over-year is compensation that's partly due to wage inflation, Dave spoke to, but also bringing on additional complement of FTE, mostly in front of the client, where we're looking to really build volumes. But we have started to build up that collections group in terms of just capacity, but it's not a technology driver at all.

[Lemar Persaud, analyst]

Got you. And then maybe coming back to an earlier comment from Dave on expenses and the ability, I think, to pull back expense growth at the top line slows. If I look at your bucketing and waterfall on your Slide 13, what are some of the areas you can pull back on expenses if the revenue growth environment kind of slows?

[Nadine Ahn, executive]

Yes, sure. I'll take that question. Thank you. So in terms of when you look at the bucketing, I would say on the investment in people, we've obviously ramped that up quite significantly over the latter half of 2022 as we were investing for growth, and you see that with our strong volume. So that was one of the buckets I commented will start to taper off as we absorbed some of that hiring that we've seen early part of the year.

I would say, also, when you look at the discretionary and other, David commented that, that is also a bucket that's being impacted in inflation. And that's one area that if we start to see any headwinds coming from the economic downturn that we can pull back on that. That's primarily driven off of not only increase in terms of marketing but also travel, business development that has started to pick up, particularly given where we were on the lows from Q1 in '22.

And from a technology standpoint, what you're seeing there is a lot of the investments that we've done not only from a client perspective and driving a lot of our growth in terms of our applications for Canadian Banking, for Wealth Management and for Investment in the Capital Markets business. And part of that also would drive further efficiency savings as we look out into latter years, as we've talked about how we've been focused on our zero-based budgeting.

[Operator]

The next question is from Paul Holden, CIBC.

[Paul Holden, analyst]

I apologize, I missed a portion of the call. So if you've already addressed these, I do apologize. But two questions. I guess the first one is on regulatory deal risk. You've done transactions, both south of the border and Canada. So wondering if you can provide any insights on what you think the primary differences are between the regulatory process in the U.S. versus Canada? And then also, just remind us sort of your current confidence in the timing of the HSBC transaction?

[David McKay, executive]

Yes. Maybe I'll take that, it's Dave. Certainly, there's a time period difference between when we went through City National 8 years ago in the current environment. We are going through that process, an orderly process with the Competition Bureau, OSFI, and the finance department. Now we're providing information to them. We still remain confident that this is a good transaction for Canada, a good transaction for HSBC clients and employees and a good transaction for our shareholders.

And therefore, we're going through that process now. It's a normal process, doesn't feel any different than the last process we went through in the United States, where you provide a lot of information on your business, and we're confident the numbers tell the story. So that's how I can comment so far as we're early days. But everything is proceeding according to what we expected.

[Paul Holden, analyst]

Okay. That's helpful. And then second question is just with respect to the outlook for commercial loans. Are you seeing any indications of slowing demand, whether that's in -- or I guess in the Canadian business specifically?

[Neil McLaughlin, executive]

Yes. Thanks for the question. We actually have seen our commercial lending pick up over the last couple of quarters. And I'd say overall sentiment from commercial clients is probably a little bit mixed. We see some of them who feel -- they waited long enough, they need to start to pull a lever to invest in the business and they're deploying capital and starting to lean into revolvers or taking out term debt.

And you have others who I think are a little more cautious. But overall, that growth that we're talking about, we do see that growth continuing to be fairly -- quite strong throughout the year. And it's underpinned by a change in strategy and levers we pulled last year, we resegmented the business and we put more experienced and additional FTE against our larger commercial clients in the one segment we didn't feel we were really capturing our fair share. And that's playing out exactly how we wanted.

So we're quite confident in the strategy. And then the second comment I would make is we're just really pleased with the diversification. So we see essentially very even growth across all sectors. We see very consistent growth across all regions. So we're not seeing anything -- any one sector really overweighted. And we -- I think that's the strategy and provides good diversification in terms of our risk profile.

[Operator]

The next question is from Mario Mendonca, TD Securities.

[Mario Mendonca, analyst]

Can we go to two comments you made during your opening that caught my attention. When you said that the hybrid working model -- hybrid working force model, you question sort of productivity. And then you in a separate comment, that seemed unrelated, but is related in my mind, you talked about how losses could emerge in commercial real estate.

So what I'm getting at here is if the world really is going to -- if we're going to function in this hybrid working model where a bunch of us working at a home, is the message here that big occupiers of commercial real estate like Royal, like the rest of our banks, need to revisit their commercial real estate needs and address the productivity and address the inflation by actually unloading this commercial real estate. Is that why you're sensitive to commercial real estate losses going forward?

[David McKay, executive]

No, I think it would be almost the opposite. I think that the absence of working together in many ways has led to productivity and innovation challenges and society isn't back together enough and working enough. So it actually [ marries ] the opposite. Now -- there's been a lot of dialogue among CEOs globally now about what is the productivity and creativity of your workforce in this hybrid world and what is the future hybrid world. And we're in this discovery area and trying to find balance with employees.

You hear a lot of commentary about it. I think most CEOs would tell you that there is a productivity loss. I think we can identify both in our organization productivity gains and productivity losses depending on the group you're looking at from operations to head office to sales. So we're working through that as an organization. We're working through that as an economy and a society. And I think there's opportunity for improvement. So it's actually the opposite.

I'm trying to say that we likely need more people back at work, not permanently, like not 5 days a week, but more than we're seeing today. We're [indiscernible] some of the demand for commercial real estate and hence, our balanced approach -- I don't think I said there's a heightened commercial risk.

[Mario Mendonca, analyst]

Sorry, what Graeme did offer is that commercial real estate was an area of risk going forward. Maybe, Graeme, is that true? Did you say that? Or was I...

[Graeme Hepworth, executive]

That's right. I mean so commercial real estate has got 2 headwinds, right? You've got the overall headwind of a higher interest rate environment, which is affecting the asset class as a whole. And then certainly, sub portfolios within that like office have the additional headwind that companies are implementing hybrid models. And -- but as Dave is saying, how that plays out over time is uncertain, right?

And so certainly, if it goes down a more negative path as you're articulating, where companies choose to be in a more permanent state in a hybrid model, that will impact the kind of the demands and needs around that footprint. But as Dave is pointing out, we've also got companies saying that we see negative impacts on productivity on that front. And so this is going to play out over time. But certainly, it's a portfolio because of that, that we're more focused on, and we're cautious with them.

[Mario Mendonca, analyst]

And I'll talk about this now. But the point I'm thinking through here is if Royal sends out an e-mail tomorrow to its 80,000 employees saying, everybody come back to the office, it certainly seems to me that commercial real estate risk is diminished because you're using it again. Is that not the right way to look at it?

[David McKay, executive]

Yes, that's part of the reason, but it's not going to be returned to pre-pandemic levels either. So there is going to be some dislocation. But I think we're probably edging back to a better balance than we saw in '21 and '22. So we're finding our way, I think, as a society. I think all CEOs in every sector I talk to are struggling with the balance of attracting, retaining, developing talent, promoting talent, building culture, creating productivity, it's tough. It's really tough.

We don't have the final model yet. So I'm trying to highlight there's opportunity to be better at this. There's opportunity to be more productive about it. I think that provides a support level under some commercial real estate, but there will be companies like us that [ re-lease ] some real estate, I don't think we'll have 100% of the portfolio we had before.

So we're finding our way towards that. And I think it's a balance that creates an overall environment that I think is constructive. So I think we're just trying to highlight that perspective that we're confident of our portfolio. We're evolving as a society, and we'll manage it.

[Mario Mendonca, analyst]

That's helpful. I think the answer is we just don't know yet, but I appreciate you trying to put some texture around it. So I am a little further along in my understanding.

[David McKay, executive]

So maybe -- I know we've run over there. Maybe I'll -- operator, I'll cut it off there. I think we only had one question in the queue given that we've gone a fair bit over. So maybe I'll summarize some of the thematics that came out in the questions and maybe some of the deltas that happened over the quarter.

And I think the first takeaway I'd like everyone to have is our franchises built over putting the customer first. That helps us create high ROEs, sustainable growth over time. And very much, as you saw on the deposit and filtered into the margin questions, but it's really building a solid client franchise, building a solid funding franchise with a strategic advantage for RBC, leveraging the money in and money out and keeping it within the RBC ecosystem is all part of the strength of our client franchise.

And that really was put on, I think, strong exhibit today and the money flow, money in and out, it came at lower margins, but that's the right thing to do for a client. It may have surprised you a little bit, but that's how the client is reacting to a higher interest rate environment, and it's the right thing to do. And therefore, that helps create higher ROEs, high retention, higher cross-sell, creates a funding strategy for us as we've termed out some of that money with term GICs, creates a good liquidity profile. That levers into a very strong balance sheet with CET1 of 12.7%, higher liquidity than you've seen funding strength.

So again, from that perspective, I think this is overall enhancing the high ROE franchises in Wealth and Canadian Banking, U.S. Wealth that we have. The second thematic is certainly on cost. And as I mentioned, we hired -- and Neil mentioned, we hired aggressively into the year-end. We're kind of walking the talk that we're expecting a softer landing. We're looking for future growth, and we had a lot of client-facing employees. We've also invested heavily in technology to adapt to a rapidly changing world, whether it's AI, whether it's back office, front office, across the board when you have #1 franchises, we've been investing.

Having said that, there is an opportunity to pull back. There is an opportunity to focus. And you have my commitment and my management team's commitment that we can do better on cost side, and we can do better on driving operating leverage. Having said that, you see Neil's business had a 39% efficiency ratio with a significant gap to the competition. So we're already at kind of market and industry-leading numbers.

But I mean, having said that, we can do better, and we will do better. So I think from that perspective, we feel good about the trajectory going forward. You heard Nadine comment on margin expansion still going forward and leveraging our very strong core banking capability in the United States, in Canada. So I think those are the thematics on top of the strong growth, very strong performance in Capital Markets. Good performance in our U.S. and Canadian Wealth franchise, albeit in a volatile market, and I think we've produced a strong quarter.

So thank you for your questions. They're all on the right themes. We appreciate your insights and look forward to seeing you next quarter. Thanks, operator.

[Operator]

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