Royal Bank of Canada

TSX:RY

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, ladies and gentlemen. Welcome to the RBC 2018 Second Quarter Results Conference Call.I would now like to turn the meeting over to Mr. Dave Mun, SVP and Head of Investor Relations. Please go ahead, Mr. Mun.

[Dave Mun, Senior Vice President & Head]

Thanks, operator, and good morning. Speaking today will be Dave McKay, President and Chief Executive Officer; Rod Bolger, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. We'll open the call for questions following their comments. [Operator Instructions]In the room, we also have with us today 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.

[David I. McKay, President, CEO & Director]

Thanks, Dave, and good morning, everyone, and thanks for joining us today. A strong second quarter with earnings of $3.1 billion, up 9% from last year, and EPS was up 11%. Our franchise is driving growth with a focus on maintaining lowering volatility and a premium ROE, which reached 18.1% this quarter. We saw good results across our businesses as we benefited from strong volume and sales growth as well as higher interest rates. While uncertainty over NAFTA remains a concern on both sides of the border, clients and markets have continued to work through this uncertainty. We remain in close dialogue with governments, as with our clients, and we continue to remain hopeful for both sides to reach an agreement.We are transforming the bank, and our mission is to create more value for clients and to leverage our size and scale in everything we do. We are investing broadly for future growth, including in technology and the best talent.This quarter, we grew our leadership in fundamental and applied machine learning by opening another Borealis AI research lab, this time in Vancouver. The lab concentrates on computer vision, a subfield of machine learning, focused on training computers to see and understand the visual world.We also launched the RBC Developers portal, which allows eligible external software developers, industry innovators and clients to access select RBC APIs or application programming interfaces. This initiative will increase connectivity with developers and create new tools and experiences for clients. These are just 2 of the many projects in place as we transform RBC into a digitally enabled relationship bank.As we innovate and make banking easier for customers, we know that our clients' privacy is of utmost importance. And we'll continue to dedicate significant resources towards data protection and cybersecurity. So turning to the second quarter. Canadian Banking continued to benefit from a strong Canadian economy and healthy employment, which helped drive strong volume growth and low PCL. Notwithstanding monetary tightening and regulatory changes that affected some homeowners, we continued to see solid mortgage volume growth this quarter. We also saw momentum continue in business lending as a result of our focus on growing commercial client base.Our RBC Rewards program, combined with our partnership with WestJet and Petro-Canada, has created significant value for our clients and led to strong purchase volume growth in credit cards.We've been investing in our people to better serve our clients, and I'm proud that RBC was awarded Highest in Customer Satisfaction Among the Big Five Retail Banks by J.D. Power for the third year in a row. This speaks volumes about our employees, and I'd like to thank them for putting the client at the center of everything we do.This quarter, 2 of RBC's digital initiatives also won model bank awards from Celent. NOMI Insights and NOMI Find & Save won in the personal financial experience category, and RBC's digital employees activation strategy won in the employee productivity category. Turning to Wealth Management, we had another quarter of double-digit earnings growth with very strong operating leverage. In Canadian Wealth Management, we added client-facing advisers and grew net sales. RBC DS received the highest overall rating by investment advisers among all full-service brokerages in Canada in the 2018 brokerage report card by Investment Executive.In Global Asset Management, we continue to lead AUM growth, and 84% of GAM's Canadian retail assets are beating their benchmarks on a 3-year basis. I'm pleased that this quarter, GAM launched the only Canadian investment fund, which focus exclusively on board diversity in Canada.We also saw strong results in our U.S. Wealth Management business even as we made investments for future growth by adding new bankers and expanding into new markets. Our U.S. wealth franchise continues to grow its client base currently at over 480,000 clients. This has contributed to consistent loan growth of 13% to 15% at City National over the past 2.5 years, well above the industry average, as we continue to see strong margin expansion.Our Insurance business also continues to grow. This quarter, our term life business gained 7.5% market share, and we continue to be the market leader in individual disability insurance with 38% share of the market. Our Investor & Treasury Services business has seen the benefits of our technology investments made over the last 3 years, with increasing client growth driving revenue. This quarter, we saw notable client wins and renewals in key markets such as Luxembourg and Australia, which have driven higher revenue across our broad range of product offerings. We are committed to continued investment in our global platforms.Our Capital Markets performance was stable from last year. We saw strong corporate lending in Canada and in Europe, and continued momentum in European Investment Banking. However, the North American fee pool was down in the quarter, and we saw lower equities and FIC trading revenue in a more challenging trading environment. We made notable market gains in power and utilities, real estate and high-yield in the U.S. and M&A in Europe. And we continue to build our franchises in those geographies by adding investment bankers across sectors and products, which we expect will drive origination activity.This quarter, RBC acted as joint lead arranger and joint book runner on the $38 billion debt financing in support of T-Mobile's merger with Sprint, which is expected to close in the first half of 2019. This represents one of the largest U.S. wireless transactions and one of the largest M&A transactions globally. In conclusion, I'm very pleased with our second quarter results, which resulted from execution of our strategy and strong economic fundamentals. Looking forward, we expect strong earnings growth to continue into the second half of the year, and we are tracking well to meet our financial objectives for the full year. I'm also excited that we will share more details about our digital transformation and how we're creating more value for clients at our upcoming Investor Day on June 13.And now I'll turn it over to Rod to discuss our second quarter financial results.

[Rod Bolger, Chief Financial Officer]

Thanks, Dave, and good morning, everyone.Starting on Slide 6. We had strong second quarter earnings of $3.1 billion. Earnings were up 9% from last year. And EPS of $2.06 a share was up 11%, reflecting the benefit of share buybacks. We had strong revenue growth in our retail bank and wealth management franchises as well as in Investor & Treasury Services. However, market-related revenues were down in some businesses due to less favorable market conditions.Our expense growth was contained at 3% from a year ago, even as we continued to invest heavily in talent and technology, including digital initiatives to support client business growth. Our credit quality was stable as the current economic environment and outlook remained favorable.Last quarter, we recorded a $178 million write-down due to U.S. Tax Reform, and we are still on track to earn that back by the end of the year. Given our business mix outlook, we are expecting our total effective tax rate to be at the low end of a 21% to 23% range.Turning to Slide 7. Our CET1 ratio of 10.9% remains comfortably within our target range of 10.5% to 11%. Our strong internal capital generation in the quarter was offset by higher RWA, reflecting good growth in client relationship business across our segments. We also had an update to our retail lending risk parameters, which was partly offset by the reversal of the Basel I floor adjustment. Consistent with our expectations, the new Basel II floor did not have an impact this quarter, and we do not expect it to impact our capital ratio in the foreseeable future.Then moving on to our business segments on Slide 8. Personal & Commercial Banking reported earnings of almost $1.5 billion, and Canadian Banking net income of $1.4 billion was up 8% year-over-year. This was driven by a 9% increase in revenue from solid volume growth across most products, including card purchase volumes and higher spreads from interest rate hikes. Business lending, in particular, was strong, up 12.8% from last year, as we continued to gain market share.Following the implementation of the B20 guidelines, we saw solid volume growth of 6% in mortgages amid a backdrop of lower average home prices in Toronto. Mortgage growth stayed relatively stable quarter-over-quarter. However, we did see a modest decline in HELOC balances as clients migrated variable-rate balances into fixed-rate mortgages in a rising rate environment.We continue to expect mortgage growth in the mid-single-digit range for the full year. And even if mortgage growth slows more than expected, over -- the overall NIM benefit from rate hikes more than offsets the revenue impact from slower growth. For example, if mortgage balances grow at half our expected rate, the impact on 2019 revenue would be less than the benefit we receive from one Bank of Canada rate hike.Net interest margins increased 12 basis points year-over-year and 6 basis points quarter-over-quarter, largely benefiting from higher interest rates. And we expect NIM will increase a further 2 to 4 basis points by the end of the year given the current rate outlook.We continue to make investments in talent and technology to support business growth and digital investments, putting our expense growth at 8% year-over-year. This led to positive operating leverage of 0.7%, just shy of our annual 1% to 2% target range. On a year-to-date basis, operating leverage was 2.1% after excluding last quarter's gain related to the Interac reorganization and last year's gain related to Moneris. For the second half of 2018, we expect our operating leverage to be in the 2% to 3% range.Turning to Slide 9. Wealth Management reported earnings of $537 million with double-digit earnings growth of 25% year-over-year. This was the second highest quarter on record in spite of choppy market conditions. Revenue in Global Asset Management and Canadian Wealth Management increased 6% and 7% respectively, primarily reflecting higher fee-based assets on solid net sales and capital appreciation. In U.S. Wealth Management, including City National, revenue was up 9% year-over-year in U.S. dollars due to strong 15% loan growth at City National, benefits from higher U.S. interest rates and higher fee-based assets.As a reminder, when comparing quarter-over-quarter results, last quarter included a one-time $23 million favorable accounting adjustment for City National.Moving on to Insurance on Slide 10. Net income of $172 million was up 4% from last year, largely due to favorable investment-related experience. Quarter-over-quarter figures were positively impacted by favorable investment-related experience and lower disability claims.On Slide 11, Investor & Treasury Services had double-digit earnings growth of 10% year-over-year to $212 million. This was driven by higher revenue in our asset services business, including custody, improving margins from recent rate hikes and growth in client deposits. In Capital Markets on Slide 12, we had stable net income year-over-year, and this was our third highest quarter on record despite less favorable market conditions. We benefited from a lower tax rate due to the U.S. Tax Reform and lower loan loss provisions. We also hired -- saw higher muni banking activity, a record quarter for European Investment Banking revenue and increased lending business largely in Canada and Europe.This quarter, RBC Capital Markets advised Melrose on its acquisition of GKN plc in Europe and also underwrote the associated debt financing. This transaction represents RBC's largest ever industrials advisory role in Europe and demonstrates our full service offering across all products to support clients on their highest profile transactions.Despite these wins, our results were lower in Global Markets and Corporate and Investment Banking, mainly in the U.S., partly due to comparables from strong prior periods. Global fee pools were down, which led to lower equity and debt origination and loan syndication in North America, as well as lower M&A in the U.S. as some deals were pushed to the third quarter. Now looking ahead, we have a very robust deal pipeline. We have some deals converting in future quarters, as reflected in our strong RWA growth, and expect our lending relationships to generate more ancillary fees. Although fixed-income trading revenue was down, we did see increased fixed-income trading in Canada due to higher client activity in our commodities business.In conclusion, we are pleased with our results this quarter as we continue to invest in future growth and create value for our clients.And with that, I'll turn the call over to Graeme.

[Graeme Hepworth, Group Chief Risk Officer]

Thank you, Rod, and good morning. Happy to be here. Overall, the credit quality of our portfolio is strong as we continue to operate in a benign credit environment. The macroeconomic environment in Canada and the U.S. remains favorable with low unemployment and solid GDP growth. Starting on Slide 14. Total PCL of $274 million was down $60 million from last quarter. This includes PCL on impaired loans of $298 million, down $27 million from last quarter, mainly due to lower provisions in Capital Markets. Our total PCL ratio on loans was 20 basis points, down 4 basis points from last quarter; while PCL on impaired loans was 22 basis points, down 1 basis point from the prior quarter. Let me provide some additional color on our businesses. In Canadian Banking, PCL on loans decreased by $11 million from last quarter. This reflects a decrease in PCL on impaired loans of $7 million, mainly due to lower provisions in our commercial and personal lending portfolios, which was partially offset by the increase in credit cards and the decrease in provisions for performing loans, namely in our personal banking portfolios.In Caribbean & U.S. Banking, PCL on loans increased $5 million from last quarter, mainly due to higher provisions on impaired loans on a few accounts that were unrelated to the hurricanes last year. This was partially offset by lower provisions on performing loans in the Bahamas and Trinidad and Tobago.In Wealth Management, PCL on loans decreased $18 million from last quarter, primarily reflecting the lower provisions on performing loans in City National due to repayments and maturities, which was partially offset by volume growth. In Capital Markets, PCL on loans decreased $34 million from last quarter, primarily driven by lower provisions on impaired loans across multiple sectors.Turning to Slide 15. Gross impaired loans of $2.7 billion were up $128 million or 5% from last quarter. Our gross impaired loan ratio of 47 basis points was up 2 basis points from last quarter. The most sizable increase in gross impaired loans was in Capital Markets and was due to additional impairments on a few oil and gas loans.On Slide 16, we have more detail on our Canadian Banking portfolio. Overall, delinquencies remained relatively stable across our retail portfolios. PCL was largely stable across all Canadian retail products, with the exception of cards, which was seasonally higher. The credit quality of our Canadian residential mortgages continues to be strong with provisions at 1 basis point. We remain comfortable in our clients' ability to service their mortgage in this rising rate environment, given our strong underwriting and credit monitoring practices.Overall, we are pleased with the performance of our lending portfolios. While we expect to see some volatility quarter-to-quarter, we continue to expect our PCL ratio to be in the 25 to 30 basis point range for the balance of 2018.With that, operator, let's open the lines for question and answer.

[Operator]

[Operator Instructions] Our first question is from Ebrahim Poonawala with Bank of America Merrill Lynch.

[Ebrahim Huseini Poonawala, Director]

I just wanted to start out with a big-picture question in terms of -- it sounds like you have a relatively constructive macro outlook as you look out over the next 12 months. But at the same time, when we tie that with what's happening in the housing market and the slowdown we are seeing there, Dave, I think you mentioned about the NAFTA uncertainty, and it doesn't look like that's going to be resolved any time soon. I'm just wondering, how do you think about sort of the downside risk to GDP growth relative to current expectations? And how does that feed into your expectation for the bank, both in terms of business banking growth or in terms of credit outlook?

[David I. McKay, President, CEO & Director]

It's a good question. Certainly, the uncertainty around NAFTA causes some investment decisions to go on hold, so it is not without impact. But largely, we're seeing customers continue to work through that, find new markets, find new client segments. You're seeing business investment in machinery and equipment still on a healthy pace, so that points to productivity, increases in the economy and creates a business lending operation, as you've seen on the business banking side, and driving strong results. So we're still seeing the current economic activity to be strong, and I think the Bank of Canada is signaling very much the same. When you think out 3-plus years, are we doing all the right things to ensure this growth? There's more that we could be doing, and we've talked about that. But all in all, economy is still strong. And you saw from our comments that we're seeing healthy business pipelines both on the commercial and in capital markets side. You're seeing good deposit growth. You're seeing very strong results out of our U.S. Wealth Management franchise with very, very good margins, good lending volumes. Deposit volumes have come off a little bit, given sophisticated clients are looking at other opportunities with their deposit base. But you're still seeing good growth in the mid-single-digit range, and we're long deposits there as it is. So overall, a healthy environment. So I think those macro environments are causing some slowing of the economy, for sure. But overall, we're, as you heard in my comments, we're feeling good about the second half of the year.

[Ebrahim Huseini Poonawala, Director]

Got it. And just if I can tack to that in terms of business banking, I think I heard you say some of that growth is coming from market share gains. Would love any color that you can provide around who are we winning that market share from. Is it non-banks? Are certain banks pulling back? Just because it seems like it's pretty strong growth, and I'm trying to handicap the sustainability of that growth as we look out the next 12 months.

[David I. McKay, President, CEO & Director]

Yes, thanks, Ebrahim. Well, we will try to keep it to one question, but Neil will answer that question then we'll move on to the next.

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

Yes, the market share growth, we've been about 6 quarters where we would view we're gaining growth -- gaining share. And it's consistent with the strategy we talked about last quarter, which is looking at our policies about 2 years ago and then the addition of commercial account managers into our commercial business, just calling out to more customers. So that's really the source of the growth. In terms of where are we growing, it's really, as we've looked at it, it's across sector. We did have a couple of sectors that we targeted specifically where we thought there was opportunity, but the result has been across every credit segment in terms of loan size and well-diversified across geography and industry.

[Operator]

Our next question is from Meny Grauman with Cormark Securities.

[Meny Grauman, MD & Head of Institutional Equity Research]

The question is about B20. From the sounds of it, it doesn't look like it's having a real impact on your business, on your mortgage volume specifically. And I guess the real question is, why do you think that is?

[David I. McKay, President, CEO & Director]

Well, I think that the dynamics are consistent with what we've spoken about previously. We're still feeling the -- we're having deals closed that were part of some of these clients trying to get ahead of it. So this pull-forward effect had, as expected, pushed into Q2. And we had never really believed that this would be a significant impact on our mortgage business. So we continue to target mid-single-digit mortgage growth, which is what we're on plan for now. And the impact is just we're seeing minor SKUs to the portfolio, but nothing significant.

[Meny Grauman, MD & Head of Institutional Equity Research]

Can you just comment on your renewal pattern, if that's changing, and then just on originations as well?

[David I. McKay, President, CEO & Director]

Yes. So renewals, we have seen renewals with a nice increase year-over-year. Part of it we would attribute to B20, and part of that we would attribute to some process improvements we've made just to make it more seamless for customers to renew their mortgage with us. So we believe it's a combination, but that's definitely helping the business. In terms of originations, we're up year-over-year for the first half of the year. But we are looking for that trend to start to slow down in the back half of the year.

[Operator]

Our next question is from Gabriel Dechaine with National Bank Financial.

[Gabriel Dechaine, Analyst]

Actually, I just want to follow up on that question, a bit more granularity. I did some rough math, and it's consistent with what you're saying on the originations being up in the first half. Actually, more on Q2 specifically, they seem to be up year-over-year. Is that the case? And b, do you -- what do you expect for declines in the second half? And are you still comfortable with that, whatever, 5% decline in originations from B20?

[David I. McKay, President, CEO & Director]

Yes. I think we'll just connect those dots. Q2 was up more than Q1 in terms of originations. And when we look at that original estimate of 5%, we're still looking at that being probably in the target range, but skewed more to the back half of the year.

[Gabriel Dechaine, Analyst]

Okay, perfect. And if I could just throw something in there on the commercial side of things, commercial real estate, that portfolio in the wholesale book, it's about [ 33% ], $8.4 billion in the Canadian segment -- or in Canada, I should say, and about 80% of that, I think, is in PNC. But it's been growing at around 20% year-over-year. Can you give me some granularity in the PNC segment on what's driving that growth? And how do you see that playing out as the housing market slows down?

[David I. McKay, President, CEO & Director]

Sure. So it's, I guess, a continuation of the previous response on overall commercial lending. Our commercial mortgage business was a place that we did look at some policies, really took our time to understand where the market was, where we were. We got comfortable with the risk and made some policy changes more than a year ago. This is also a business where we have a specialized sales force that specializes in commercial mortgages. So we've grown that team somewhat, and the combination of those 2 things is what's really driving the commercial real estate growth. It's an asset class we feel very comfortable with. And at this point, it's really distribution-led in terms of how we're growing it.

[Gabriel Dechaine, Analyst]

So you were previously maybe dialing back and then you studied it a bit more, got more comfortable with it and then added -- allocated more capital to that business?

[David I. McKay, President, CEO & Director]

Yes, we had looked at where we were versus the market, understood what the incremental risk would be we'd be taking on by changing our policies. And once we got comfortable with that, we made the change and then couple that with additional commercial account manager capacity and commercial mortgage specialist sales forces.

[Operator]

Our next question is from Sumit Malhotra with Scotia Capital.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

Just a question on capital, to start. It was mentioned in the release that there was an update of risk parameters. I think that was on the retail portfolio, if I'm remembering correctly. Just hopefully, you can give us a little bit more detail on what exactly was being reviewed, and is there another component of this that will follow on other parts of the book?

[David I. McKay, President, CEO & Director]

I think Rod is going to answer that.

[Rod Bolger, Chief Financial Officer]

Yes. So we look at these every year, and part of this is looking at our own historical data, and part of it is looking at industry data. And on this one, our historical data was better than industry data. But we took our parameters up to the industry data, so it basically makes the risk weighting more conservative and also more conservative than what our historical loss data has been. So this is normal course of business in accordance with the Basel requirements. We undergo these annually. You would see these usually once a year or so, both in the retail book and the wholesale book. We're currently undertaking a look at the wholesale book right now. We don't expect significant changes coming out of that, but that would be an impact of less than 10 basis points in the future quarter, plus or minus.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

And just to be clear, Rod, was that Canadian consumer or was it across the -- I don't know if that's the bulk of your exposure, you have some U.S., some Caribbean, but it was Canadian consumer updates?

[Graeme Hepworth, Group Chief Risk Officer]

Yes, so this is Graeme. It was primarily at the Canadian consumer, the Canadian retail business.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

And this one is going to be for Neil. I'm sorry if I missed it in the prepared remarks, I was a little bit late coming on. Just on the expense growth in Canada this quarter, obviously, it looked a little bit -- I know timing of project spend can have an impact there, but I don't want to bury the lead. Your revenue was obviously very strong as well, and maybe that influenced some of the allocation of expenses. Anything specific from a project perspective that drove the larger increase? And what are you forecasting or what are you thinking about in terms of the level of expense growth going forward?

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

Thanks for the question. Yes, this quarter, we had some lumpy expenses, partly due to the year-over-year comparison of a credit card credit -- credit in our credit card business that we received last year, which was a one-timer. So that made up about 2% of the growth. The rest of it was just timing of expenses, a couple of them in our sponsorships and donations line. And the rest of it would be sort of normal course expense growth related to FTE and technology, so talent and technology, as per Rod's comments. In terms of the outlook for Q3 and Q4, as Rod mentioned, we are targeting to the higher end of 2% to 3% operating leverage, and our NIE growth would be more into the range of 4% to 5%.

[Operator]

Our next question is from Robert Sedran with CIBC Capital Markets.

[Robert Sedran, MD & Head of Research]

Just to follow up quickly on that operating leverage comment. I remember last year, toward the back half, there were some fairly meaningful severance expenses that were affecting some of the year-on-year comps. Is that 2% to 3% confidence largely from those falling away this year? Or is there further expense control beyond those?

[David I. McKay, President, CEO & Director]

The 2% to 3% is we saw -- so that is an opportunity for us in terms of not expecting to have a severance expense of that size this year. It's also the benefit of the rate hikes that Rod had mentioned in his prepared comments. And then we're obviously making sure we keep an eye on where we're investing into the business.

[Robert Sedran, MD & Head of Research]

Okay. And I just wanted to follow up quickly on some of the mortgage commentary because the sequential growth in mortgages, and part of this may just be the way averages play out, but particularly with some of the pull-forward effect you've described, the sequential growth in mortgages is comfortably below the annual run rate. Are you expecting mortgage growth to accelerate in the second half? Am I -- I can't imagine that's the case, but is that why you're adjusting? I'm starting to think into '19, and I know it's early to talk about '19, it's still not even halfway through '18. But when you think about the trajectory of the mortgage growth, is it going to slow still further from what we saw in H1? Or are you expecting stability?

[David I. McKay, President, CEO & Director]

I think what we've -- how we're looking at the business is that we're benefiting right now from this pull-forward effect. We do believe there will be a modest slowing, partly due to B20. And so the back half of the year, we will see slowing growth. And in 2019, I think we're really still waiting to get the data points from what Q3 and Q4 are going to be before we start really putting out an outlook for 2019.

[Graeme Hepworth, Group Chief Risk Officer]

Refinance activity down, and resales are down across the country, right about 5%.

[David I. McKay, President, CEO & Director]

Yes, exactly.

[Graeme Hepworth, Group Chief Risk Officer]

I think that would be part of the slowdown you'd see.

[Operator]

Our next question is from Doug Young with Desjardins Capital Markets.

[Doug Young, Diversified Financials and Insurance Analyst]

Just in Canada on the credit card book, I just noticed the PCL sequentially did increase. Your balances were down sequentially. And maybe this is seasonality and maybe you can kind of elaborate on that. But Royal has a unique insight into the Canadian consumer, given your size. I'm just -- maybe you can talk about the sequential change in the credit card PCLs, and then what are you seeing from the Canadian consumer? Because obviously, every day, we read about the strained Canadian consumer. Can you give us any other data points that you're seeing to give us further comfort or suggest there's things that we should be watching?

[Graeme Hepworth, Group Chief Risk Officer]

Certainly. Thanks for the question. This is Graeme. On the card, certainly, what we see in Q2 is what we'll view as seasonality. We saw that tick up last year. It's very consistent in kind of following the holiday season to see that tick-up in Q2, so we do expect that to come back down in the future quarters. And we don't really see anything coming out of our cards portfolio that would indicate any concern at this point in time. I mean, overall, on the Canadian consumer, certainly, it's something everyone is very mindful of. I think we're trying to take a very consistent approach in our policies and in our risk strategy. So we haven't made any significant changes there and then continue to drive a very good origination profile. Certainly, our client base is a prime client base as well, and so that again is reflected in the originations you see. So at this point in time, between the macroeconomic backdrop that Rod reflected earlier where we are seeing rising rates, but that's consistent and offset, if you will, by strong unemployment environment and robust GDP. So certainly, in the near term, I think we continue to be quite comfortable with the profile of our clients.

[Doug Young, Diversified Financials and Insurance Analyst]

So in a nutshell, no real strain, nothing that's concerning at this point in time.

[Graeme Hepworth, Group Chief Risk Officer]

We don't see, I think, an early warning signal at this point in time, no.

[Operator]

Our next question is from Sohrab Movahedi with BMO Capital Markets.

[Sohrab Movahedi, Analyst]

Rod, you were talking about RWA growth as one of the reasons why the CET1 ratio was held back a little bit. We've seen the commercial loan growth in Canada, lots of talk about it over here. So I guess, I'm just trying to kind of get a sense of, are you trying to use the balance sheet a bit more now to win business and so that RWA growth is coming more through balance sheet leverage, whether it's in the Capital Markets business or otherwise? And is that RWA growth because you're adding new clients or is it largely because existing clients are going down, let's say, on existing lines?

[Rod Bolger, Chief Financial Officer]

Yes. I'll start, and I'll hand it off to Doug because most of the growth was in, when you strip out the retail parameter change which impacted Canadian Banking, most of the growth was in Capital Markets. And it mostly -- a lot of it -- I mean, there was across-the-board market risk, credit risk, but there were significant underwriting risk-weighted assets that were added, and that's some of the pipeline of the deal that Dave mentioned. But I'll hand it off to Doug.

[A. Douglas McGregor]

Yes. So in Capital Markets, the growth in RWA was sort of in the mid-teens. There was about 5 of it that was really underwriting-related, some of it in connection with the transaction Dave mentioned in his remarks, some from others. So that's good business. It's a -- we get well-compensated for those underwritings. And we have been putting on some loans in the U.S. and the U.K. to continue to build out the investment bank. And so we haven't really seen that loan book grow much the last couple of years. We're getting a bit more growth there now. And the balance is in some trading securities and in our repo business. So we have been putting more balance sheet to work over the last quarter, and we expect that we'll receive the benefits of that over the remainder of the year.

[Sohrab Movahedi, Analyst]

So Doug, and this would be all in -- I shouldn't say all, but given the nature of your business, usually in the U.S. and the U.K., this would be more in the high-yield end of the credit spectrum?

[A. Douglas McGregor]

Well, the underwriting is a combination. It's usually in the BB range on average, and so some LBOs and some corporate deals, like the T-Mobile deal that Dave mentioned earlier. In terms of the lending, the average credit is a BBB.

[Operator]

Our next question is from Scott Chan with Canaccord Genuity.

[Scott Chan]

Just switch to the U.S. side. When I look at the NIM at City National Bank, it's got really strong sequential margin increase and also year-over-year well above peers that seem to be slowing. What's different in National Bank that's driving more of an incremental increase? And how do we look at that going forward, I guess, with further rate hikes expected down there?

[David I. McKay, President, CEO & Director]

I'll give you the high-level kind of growth view, and then I'll hand it to Rod for any specific fill-in of more detail. Certainly, you're looking at our ability to not only benefit from the short end of the curve with the fed rate increases as we have a highly variable rate lending book and placing that -- those excess deposits into the market. But also, we're adding customers, we're growing and we're creating a little more duration of what -- as we land on the longer end and benefit from the steepness of the curve. So you've got both effects going on. And our client franchise is doing fantastically well. The operating environment in L.A. and California is very strong. Our expansion into New York and Washington is going very well. We'll be adding more to that. We invested significantly in more sales in private banking. In commercial banking, resources which we talked about, you're starting to see that. So it's that 14% to 15% loan growth creating some duration. It's also the short end of the curve creating a lift there. So when you combine that healthy loan growth with the significant deposit franchise we have, you get that type of effect.

[Rod Bolger, Chief Financial Officer]

And we've also -- we have a large amount of, basically, checking accounts that pay no interest rates. So as interest rates move up, it does accelerate the spread in improvement. And the forward markets are, call it, for 2 or 3 rate increases by next year. So if those do take place, we should see continued spread improvement in that business.

[Operator]

Our next question is from Nigel D'Souza with Veritas Investment.

[Nigel R. D'Souza, Investment Analyst]

I want to follow up on a comment Rod made on your HELOC book. So you mentioned that your HELOC book declined sequentially, and that was attributed to customers shifting from the variable floating exposure to the fixed kind of debt. And could you clarify what exactly is happening there?

[David I. McKay, President, CEO & Director]

I think Neil can take that question.

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

Yes. We just have customers, as they're watching rates increase, saying that their appetite for interest rate risk, they prefer to lock it into a fixed rate and just have the certainty of a payment. So we're seeing about $300 million a month move from the line of credit portion into a term portion of the HELOC.

[Nigel R. D'Souza, Investment Analyst]

Okay. Does your HELOC book include amortizing term HELOCs and floating consolidated? Is that captured in the $40.5 billion number? Actually, now because -- is the shift really what's driving the decline or are both those type of loan categories included in the total HELOC count?

[David I. McKay, President, CEO & Director]

Revolving credit piece.

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

Yes. Yes, no, our structure is a pure revolving credit line segment. The customer can have multiple segments, and then they could also have multiple segments of a fixed term or a variable term mortgage.

[Nigel R. D'Souza, Investment Analyst]

Okay, got it. And just the last quick question, if I could, just on your PCL guidance to clarify. You mentioned 25 to 30 basis points. I'm not sure if that was back half of '18 or over the full year, but it indicates an uptick in PCLs. And given the current benign credit risk environment, what do you see driving that uptick there?

[Graeme Hepworth, Group Chief Risk Officer]

Sure. This is Graeme, I'll take that. So that's the full year guidance I was giving there. Why I'm indicating that range is, I would say, twofold. One, certainly, in the kind of stage 3 piece is we saw lower levels this year, particularly out of Capital Markets, and that can be lumpy. But more so on the stage 1 and 2, we had some releases this year. And all being equal, we would expect that to kind of grow in line with the overall volume growth of the business, and so that could be a couple of basis points there. And so I think when you put those together, that's why we get back to that 25 to 30 basis point range because we had some factors this quarter, I think, that helped reduce that below our expectations.

[Operator]

Our next question is from Mario Mendonca with TD Securities.

[Mario Mendonca, Managing Director and Research Analyst]

Before I get into the question I want to ask on capital, Rod, if I could just follow up on something you said about margins in the U.S. You referred to the potential for 2 to 3 more rate hikes and how that would continue to benefit the margin. That caught me a little off guard largely because of some of the comments I'm hearing in the U.S. from U.S. banks on how deposit betas have moved materially higher and how the benefits just won't accrue the way they have in the past. Are you seeing anything on deposit betas that would cause you to revisit that guidance?

[Rod Bolger, Chief Financial Officer]

No, I think it's the construct of the book of business and the construct that we have is that we generally don't pay up for deposits for large deposits like that because we don't get the liquidity value, and we have more deposits than loans. So we're really looking for the transaction accounts and payment accounts, which tend to have a lower interest rate and a lower beta. So yes, we are seeing that competition. We are seeing deposit pricing being much more competitive than it was in the past. But at the same time, because of the construct of our book, it doesn't have the same impact that it might have on other institutions.

[Mario Mendonca, Managing Director and Research Analyst]

That explains it. And then to my actual question, this might be for Rod and Doug. The bank's CET1 ratio is perhaps the lowest in the group right now, which throws me off in part because you're the only global SIFI. Where I'm going with this is, could there come a time, and perhaps this is for Doug, where that lower CET1 ratio relative to global peers, and I understand there are differences in the way these things are calculated, does it ever -- does there come a time when that puts you at a disadvantage relative to some of these other large global players in big capital markets decisions?

[A. Douglas McGregor]

Well, in terms of the CET1 ratio at 10.9% versus 11% or 11.1%, I think, really, that's affected by a number of things, including how much stock we buy back. And so I think that's a capital allocation that Rod and Dave make, and we bring forward investment opportunities in our business and to date, we've always upped and supported. And so I'm not in a place where I'm concerned about finding capital to do attractive business. It's more of a counter-party rating, I think, Mario.

[Rod Bolger, Chief Financial Officer]

I mean, we have very strong debt ratings, and we have -- we're seen as a strong counter-party in the global industry. And when you look at the buffers above the local minimum plus the G-SIB buffer, we're at stage 1 versus some that are higher. The average is right around 300 basis points, and we are currently at 290. Last quarter, we were at 300. So we're right in there. And we also believe that we tend to have lower risk. Graeme talked about our non-prime. We don't play in that space. We tend to have lower-risk trading activity. So we're quite comfortable with this level. In fact, we had previously stated that our capital ratio objective was 10.5% plus. I think because of the market competition and kind of the upward escalation of some of the peers, we upped that to 10.5% to 11%. So we are carrying capital above what we would need in a stress scenario. So we're quite comfortable with our capital ratio.

[Mario Mendonca, Managing Director and Research Analyst]

So one final quick point on this. Could you stomach CET1 ratio of 10.5% to do it to make an acquisition as long as you knew that would only be a temporary condition? Could you stomach 10.5% for a deal?

[David I. McKay, President, CEO & Director]

Yes, this is Dave. Absolutely, and I think we've taken it down there in other instances over the past 18 months, then they grew at 10.6% when we had some -- an opportunity to buy back some shares. So returning capital or investing in inorganic growth, absolutely, we would take it down to 10.5% and rebuild it from there.

[Operator]

Our next question is from Steve Theriault with Eight Capital.

[Stephen Theriault, Principal & Co]

Just a quick one from me. Neil, you flagged earlier this year initiatives you expect to help personal lending in the back half of the year. So maybe, is that under way? Can you give us a little color here on what you're doing, what you're working on? Is that in full flight yet? Should we be expecting personal lending to show some meaningful growth in half 2 after being pretty flattish for the last little while?

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

Thanks for the question. I'll break it down into the 2 segments. Our auto lending business is actually up 6% year-over-year. So we're feeling quite good about how we're competing in that category. The strategy, as we spoke to last quarter, were really around our branch unsecured lending. Those strategies are under way. There are things like refreshing our preapproved credit offers that we'll put out to customers and a second one just to reengage our branch based account managers. So they're under way. I think it will take us a while to really start to grow that branch unsecured lending channel. So auto right now, we're feeling good about. We've had a longer run to really drive competitiveness, but we are well under way with the strategies.

[Stephen Theriault, Principal & Co]

When you say take us a while, does that feel like more of a next year when we'll start to see it actually come through the growth numbers or sooner rather than later? Go ahead.

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

We'll start to -- my expectation is we'll start to see some of this pull through, especially from the preapproved offers as well as some of the work we're doing around digital loan acquisition into the Q4 range, and then build from there into 2019.

[Stephen Theriault, Principal & Co]

And so you -- last thing. You mentioned auto lending was 6% up. So ex auto lending, is it -- are we sort of 3-ish percent down year-on-year?

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

A little less than that. We're about 1.5% down in branch-based unsecured lending.

[Operator]

Our next question is from Sohrab Movahedi with BMO Capital Markets.

[Sohrab Movahedi, Analyst]

Dave, I just wanted to get a reminder on when you think about capital allocation and mix of business, how big Capital Markets can get?

[David I. McKay, President, CEO & Director]

I think as you're seeing immigrated diversification in our global businesses, particularly with our U.S. wealth franchise, if you extrapolate the first half of the year, we'll approach it, not exceed $1 billion of earnings, which wasn't the case. You've seen greater diversification in our earnings. We still -- from an overall revenue and earnings and capital allocation mix, we're still targeting Capital Markets to be in that 20% to max 25% range. I think you're seeing downward thrust on that given the success of the U.S. wealth franchise in diversifying that growth. And that's still our objective is to diversify and grow our wealth franchise, and our retail banking capital markets has lots of room to grow as we've been able to build other business lines, and we'll continue to do so. So I think it fits with how much capital we want to put in the business. It fits with the volatility we're trying to drive through a cycle and what our investors are looking for. And therefore, it remains a core tenet of our strategy.

[Sohrab Movahedi, Analyst]

Okay. And for Neil, just one clarification, Neil. You talked about commercial and 6 quarters of good growth and picking up market share. Can you just talk a little bit about the pricing, if you will, of new deals versus the back book and how competitive that is and whether or not market share is being picked up based on pricing?

[Neil McLaughlin, Group Head of Personal & Commercial Banking]

No, we're not competing on prices. The lever we're pulling to generate that volume, it's the 2 things we had referenced earlier: really being making sure we are in market on policy and risk appetite; and really leading with distribution strength, hiring up 80 new commercial account managers, including some more specialists. So that's where it's really coming from. In terms of spreads, I think the spreads are more from -- we're seeing more spread impact from the mix of business rather than competitive pressures. We had felt a lot of competitor pressure in commercial about a year ago. It feels like that has started to become a little bit more reasonable.

[Operator]

Our next question is from Gabriel Dechaine with National Bank Financial.

[Gabriel Dechaine, Analyst]

Just had a follow-up on the capital question there and specifically on buybacks. Last year, we saw you -- about 30% almost of your earnings were a return to shareholders to be a buyback. We saw that at pace again in Q1. This quarter -- or this past quarter, it kind of fell below 10%, I believe. Given your relative positioning, not versus global, but versus other banks, do you feel pressure to maybe retain more and not buy back as much stock so that you don't fall too far behind some of the other Big Six Banks?

[Rod Bolger, Chief Financial Officer]

Yes, it's Rod. I think you saw that this quarter a little bit where we didn't do a lot of buybacks, and that's largely because our preference would be to allocate the capital to client-driven business. And we had that opportunity this quarter. We saw good markets, and we saw good activity and good relationships from our client-facing teams. And that's where we allocated the capital, and we would expect to do so in the future as well.

[Gabriel Dechaine, Analyst]

Okay. So more organic opportunities, less buyback -- or supporting organic growth, less buyback.

[Rod Bolger, Chief Financial Officer]

Yes. So in the hierarchy, client-driven organic growth would always be above share buybacks.

[David I. McKay, President, CEO & Director]

It's always been that way, and we've commented it that way for the last 3 or 4 years.

[Gabriel Dechaine, Analyst]

Okay. Then the other one, on the unsecured, the branch strategy, unsecured lending, you lump in auto lending with unsecured lending. And I'm just wondering the brand strategy, are we talking about selling more auto loans to the branches or the unsecured personal loans type of thing?

[David I. McKay, President, CEO & Director]

Yes, no, we're not targeting branches to be a real source of auto loans. No, that would be auto loans really are being sold through our dealer relationships, and the branches are unsecured installment loans or unsecured revolving lines of credit.

[Gabriel Dechaine, Analyst]

Okay. Do you have any idea how big that portfolio overall is? Like, don't have that in front of me right now. But [indiscernible] and how big it is in the branch?

[David I. McKay, President, CEO & Director]

Our branch base is about $22 billion.

[Gabriel Dechaine, Analyst]

Excluding auto?

[David I. McKay, President, CEO & Director]

That's right.

[Operator]

[Operator Instructions] Our next question is from Nigel D'Souza with Veritas Investment.

[Nigel R. D'Souza, Investment Analyst]

I just wanted to circle back on the HELOC question. You can correct me if I'm wrong, but my understanding is that your HELOC book includes the revolving and non-revolving HELOC lines. So when that shifts out from variable to fixed, is that portion then included in your res mortgage book or can you just walk me through what exactly is happening there on the balance side?

[David I. McKay, President, CEO & Director]

Yes, that's exactly what happens. So if a customer went from having, let's say, a tranche of revolving secured -- a secured revolving credit line and decided to take a FIC segment, it would move from the credit line reported segment -- secured credit line reported segment into the residential mortgage line.

[Nigel R. D'Souza, Investment Analyst]

Got it. And did it have any material kind of impact on the sequential increase you saw in Q2 versus Q1, that shift?

[David I. McKay, President, CEO & Director]

It's been our -- the migrations have actually been -- it's been happening for a while really since interest rates started to go up. So it hasn't been -- that this quarter has been out of line with what we've seen since rates started to move.

[Operator]

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. McKay.

[David I. McKay, President, CEO & Director]

I want to thank everyone for their questions. I think the themes that you've heard over the last hour are consistent that we're feeling good about our growth, we're feeling good about the pipeline of growth and continuing that momentum. We have seen good margin improvement, and we're expecting to see a little bit better margin improvement over the year. You're going to see a little bit better cost control and better operating leverage out of the bank going forward. And with the constructive economies that we're working in, in our primary markets of Canada, the U.S. and Europe, we still are forecasting, as you saw from our 25 to 30 range, there's a fairly benign credit environment. So we're feeling good about the operating momentum we have and love to continue to perform.So thank you, and we'll see you again in Q3.

[Operator]

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