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Royal Bank of Canada (NYSE:RY)
Q2 2018 Earnings Conference Call
May 24, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

All participants, please stand by. Your conference is ready to begin. 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 of Investor Relations

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. To give everyone a chance to ask a question, we ask that you limit your questions and then requeue. In the room, we also have with us today Neil McLaughlin, Group Head of Personal and Commercial Banking, Doug Guzman, Group Head, Wealth Management and Insurance, and Doug McGregor, Group Head, Capital Markets and Investor and 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 and Chief Executive Officer

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 lower-end 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 consumers to see and understand the visual world.

We also launched the RBC developer's portal, which allows eligible external software developers, industry innovators, and clients to access select RBC APIs for application programming interfaces. This initiative will increase connectivity with developers and create new tools and experiences for clients. These are just two of the many projects in flight 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 toward data protection and cybersecurity.

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, it 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 5 retail banks by JD 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, two of RBC's digital initiatives also won model bank awards from Celent. NOMI Insights and NOMI Find and 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 advisors and grew net sales. RBC DS received the highest overall rating by investment advisors among all full-service brokerages in Canada in a 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 three-year basis. I'm pleased that this quarter, GAM launched the only Canadian investment fund which focuses 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 two and a half 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 and Treasury Services business has seen the benefits of our technology investments made over the last three 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 a 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 in FIC trading revenue in a more challenging trading environment. We've 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 13th. And now, I will 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 at $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 Investor and Treasury Services.

However, market-related revenues were down in some businesses due to less favorable market conditions. Our expense growth was contained to 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 remain favorable. Last quarter, we recorded $178 million writedown due to the 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 [inaudible] 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.

Moving on to our business segments on Slide 8, Personal and 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 continue 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, 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 and 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 saw higher community 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 industrial 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 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. 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. With that, I'll turn the call over to Graeme.

Graeme Hepworth -- 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 on PCL on impaired loans of $7 million, mainly due to provisions in our Commercial and Personal Lending portfolios, which is partially offset by an increase in credit cards and a decrease in provisions for performing loans, mainly in our personal banking portfolios.

In Caribbean and 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 is 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 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 remain 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 ratios 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.

Questions and Answers:

Operator

Thank you, Mr. Hepworth. We will now take questions from our phone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press *1 on your telephone keypad. If at any time you wish to cancel your question, please press #. Please press *1 at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. Our first question is from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Director

Good morning. I wanted to start out with a big-picture question in terms of it sounds like you have a relatively constructive 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 anytime soon. I'm just wondering how you think about 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 and credit outlook?

David I. McKay -- President and Chief Executive Officer

It's a good question. Certainly, the uncertainty around NAFTA causes some investment decisions to go on hold, so it's 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 current economic activity to be strong, and I think the Bank of Canada is signaling very much the same.

When you think out three-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, the economy is still strong, and you saw from our comments that we're seeing healthy business pipelines both on the commercial and 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 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, as you heard in my comments, we're feeling good about the second half of the year.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Director

Got it. And, if I can tack to that, in terms of business banking, I think I heard you say some of the 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 few months.

David I. McKay -- President and Chief Executive Officer

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

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Director

Thank you.

Neil McLaughlin -- Group Head, Personal and Commercial Banking

The market share growth -- we've done about six quarters where we would view we're gaining share, and it's consistent with the strategy we talked about last quarter, which is looking at our policies about two years ago, and then, the addition of commercial account managers into our commercial business, just calling on more customers. So, that's really the source of the growth. In terms of where we're growing, as we've looked at it, it's across sector. We did have a couple 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.

David I. McKay -- President and Chief Executive Officer

Next question.

Operator

Thank you. Our next question is from Meny Grauman with Cormark Securities. Please go ahead.

Meny Grauman -- Cormark Securities -- Analyst

Hi, good morning. 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 the real question is why do you think that is? Thanks.

David I. McKay -- President and Chief Executive Officer

Well, I think the dynamics are consistent with what we've spoken about previously. We're still feeling the -- we're having deals close 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. 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 impacts just -- we're seeing minor skews to the portfolio, but nothing significant.

Meny Grauman -- Cormark Securities -- Analyst

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

David I. McKay -- President and Chief Executive Officer

Yeah. 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 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.

Meny Grauman -- Cormark Securities -- Analyst

Thank you.

Operator

Thank you. Our next question is from Gabriel Dechaine with National Bank Financial. Please go ahead.

Gabriel Dechaine -- National Bank Financial -- Analyst

Hi, good morning. Actually, I just want to follow up on that question with 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, what do you expect for declines in the second half? Are you still comfortable with that 5% decline in originations from B20?

David I. McKay -- President and Chief Executive Officer

Just to 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 -- National Bank Financial -- Analyst

Okay, perfect. 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 $33.4 billion in the Canadian segment -- or, in Canada, I should say -- and about 80% of that is in P&C. It looks to be growing at about 20% year over year. Can you give me some granularity in the P&C 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 and Chief Executive Officer

Sure. So, again, it's a continuation of the previous response on overall commercial lending. Our commercial mortgage business was a place that we did look at some policies. We really took some 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 two 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 -- National Bank Financial -- Analyst

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

David I. McKay -- President and Chief Executive Officer

Yeah. 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 coupled that with additional commercial account manager capacity and commercial mortgage specialist sales forces.

Gabriel Dechaine -- National Bank Financial -- Analyst

Okay, thank you.

Operator

Thank you. Our next question is from Sumit Malhotra with Scotia Capital. Please go ahead.

Sumit Malhotra -- Scotia Capital -- Analyst

Thanks, good morning. 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. 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 and Chief Executive Officer

Rod's going to answer that.

Rod Bolger -- Chief Financial Officer

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. 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 a future quarter, plus or minus.

Sumit Malhotra -- Scotiabank -- Analyst

And, just to be clear, Rod, was that Canadian consumer or was it across the -- that's the bulk of your exposure in U.S. and Caribbean, but it was Canadian consumer updates?

Graeme Hepworth -- Chief Risk Officer

It was primarily at the Canadian consumer and Canadian retail business.

Sumit Malhotra -- Scotiabank -- Analyst

And, this one is going to be from 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, it obviously looked a little bit heavier. 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 on expenses. Anything specific from a project perspective that drove the larger increase, and what are you forecasting or thinking about in terms of the level of the expense growth going forward?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Thanks for the question. Yeah, this quarter, we had some lumpy expenses partly due to the year-over-year comparison of a 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 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%.

Sumit Malhotra -- Scotiabank -- Analyst

Thank you for your time.

Operator

Thank you. Our next question is from Robert Sedran with CIBC Capital Markets. Please go ahead.

Robert Sedran -- CIBC Capital Markets -- Managing Director

Hi, good morning. 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 and Chief Executive Officer

The 2% to 3% is -- 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 -- CIBC Capital Markets -- Managing Director

Okay, thank you. I just wanted to follow up quickly on some of the mortgage commentary because the sequential growth in mortgages -- part of this may just be the way averages play out, but particularly with some of the pull-forward effect you described, sequential growth in mortgages is comfortably below the annual run rate. Are you expecting mortgage growth to accelerate in the second half? I can't imagine that's the case, but is that what you're suggesting? 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 still slow further from what we saw in H1, or are you expecting stability?

David I. McKay -- President and Chief Executive Officer

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 modest slowing, partly due to the 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.

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Refinance activity is down and resales are down across the country, about 5%. I think that would be part of the slowdown you'd see.

Robert Sedran -- CIBC Capital Markets -- Managing Director

Okay, thank you.

Operator

Thank you. Our next question is from Doug Young with Desjardins Capital Markets. Please go ahead.

Doug Young -- Desjardins Capital Markets -- Analyst

Hi, good morning. 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 elaborate on that, but Royal has a unique insight into the Canadian consumer given your size. Maybe you can talk about the sequential change in the credit card PCLs. And then, what have you seen from the Canadian consumer? Obviously, every day, we read about the strained Canadian consumer. Can you give us any other data points that you're seeing for the comfort or suggest there's things that we should be watching? Thank you.

Graeme Hepworth -- Chief Risk Officer

Certainly. Thanks for the question. On the cards, certainly, what we see in Q2 is seasonality. We saw that tick up last year. It's very consistent in following the holiday season. You 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.

Overall, on the Canadian consumer, certainly, it's something everyone's very mindful of. I think we're trying to take a consistent approach in our policies and our risk strategy, so we haven't made any significant changes there and continue to drive a very good origination profile. Certainly, our client base is a prime client base as well, so again, that's 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 a 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 -- Desjardins Capital Markets -- Analyst

So, no real strain? Nothing that's concerning at this point in time?

Graeme Hepworth -- Chief Risk Officer

We don't see anything in our early warning signals at this point in time, no.

Doug Young -- Desjardins Capital Markets -- Analyst

Okay, great. Thank you.

Operator

Thank you. Our next question is from Sohrab Movahedi with BMO Capital Markets. Please go ahead.

Sohrab Movahedi -- BMO Capital Markets -- Managing Director

Thanks. 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'm just trying to get a sense of are you trying to use the balance sheet a bit more now to win business, 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 drawing down on existing lines?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

I'll start, and then I'll hand it off to Doug. 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 a lot of it -- across the board, there was market risk, credit risk, but there was significant underwriting risk-weighted assets that were added, and that's some of the deal that Dave mentioned, but I'll hand it off to Doug.

A Douglas McGregor -- Group Head, Capital Markets and Investor and Treasury Services

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. I think it well compensated for those underwritings. We have been putting on some loans in the U.S. and the U.K. to continue to build out the investment bank. So, we haven't really seen that loan book grow much in the last couple years. We're getting a bit more growth there now, and the balance is in some trading securities, and then, 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 -- BMO Capital Markets -- Managing Director

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 on the more high-yield end of the credit spectrum?

A Douglas McGregor -- Group Head, Capital Markets and Investor and Treasury Services

Well, the underwriting is a combination. It's usually in the double-B 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 triple-B.

Sohrab Movahedi -- BMO Capital Markets -- Managing Director

Okay, thank you.

Operator

Thank you. Our next question is from Scott Chan with Canaccord Genuity. Please go ahead.

Scott Chan -- Canaccord Genuity -- Director

Hi, good morning. Just to 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. It seems to be slowing. What's different at City National Bank that's driving more of an incremental increase and how do we look at that going forward for the rate hike expected down there?

A Douglas McGregor -- Group Head, Capital Markets and Investor and Treasury Services

I'll give you the high-level growth view, 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...at the short end of the curve, with the Fed rate increases, as we have a highly variable-rate lending book and placing those excess deposits into the market, but also, we're adding customers, we're growing, and we're creating a little more duration of book as we lend out at 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 well. We'll be adding more to that. We invested significantly in more sales and private banking and commercial banking resources, which we talked about, so 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

Yeah, and we've also -- we have a large amount of what are basically checking accounts that pay no interest rate, so as interest rates move up, it does accelerate the spread improvement, and the fuller markets are calling for two or three rate increases by next year, so if those do take place, we should see continued spread improvement in that business.

Scott Chan -- Canaccord Genuity -- Director

Great, very helpful. Thank you.

Operator

Thank you. Our next question is from Nigel D'Souza with Veritas Investments. Please go ahead.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Thank you. Good morning. I wanted 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 debt. Could you clarify what exactly is happening there?

David I. McKay -- President and Chief Executive Officer

I think Neil is going to take that question.

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Yeah. We just have customers -- as they're watching rates increase -- saying that their appetite for interest rate risk -- they prefer to just lock it into a fixed rate and 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 D'Souza -- Veritas Investment Research -- Analyst

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

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Our structure is a pure revolving credit-line segment. The customer can have multiple segments and they can also have multiple segments of a fixed-term or variable-term mortgage.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Okay, got it. And, just a last quick question if I could, 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 for 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 -- Chief Risk Officer

I'll take that. That's a full-year guidance I was giving there. Why I'm indicating that range, I would say twofold. Certainly, in the Stage 3 piece, we saw lower levels this year, particularly coming out of Capital Markets, and that can be lumpy, but more so, on Stages 1 and 2, we had some releases this year, and all else being equal, we would expect that to grow in line with the overall volume growth of the business, so that could be a couple basis points there. So, 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 that helped reduce that below our expectations.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Okay, great. Thank you.

Operator

Thank you. Our next question is from Mario Mendonca with TD Securities. Please go ahead.

Mario Mendonca -- TD Securities -- Analyst

Good morning. 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 two to three 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 the 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 -- TD Securities -- 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 there come a time where that puts you at a disadvantage relative to some of these other large, global players in big capital markets decisions?

A Douglas McGregor -- Group Head, Capital Markets and Investor and Treasury Services

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 been supported. And so, I'm not at a place where I'm concerned about finding capital to do attractive business. But, counterparty rating merit --

Mario Mendonca -- TD Securities -- Analyst

What I was getting at --

Rod Bolger -- Chief Financial Officer

We have very strong debt ratings, and we're seen as a strong counterparty in the global industry, and when you look at the buffers above the local minimum-plus-fee G-SIB buffer, we're a 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 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 -- TD Securities -- Analyst

One final, quick point on this: Could you stomach a CET1 ratio of 10.5% 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 and Chief Executive Officer

Absolutely, and I think we've taken it down there in other instances over the past 18 months. I think we were at 10.6% when we had 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.

Mario Mendonca -- TD Securities -- Analyst

Thank you.

Operator

Thank you. Our next question is from Steve Theriault with Eight Capital. Please go ahead.

Steve Theriault -- Eight Capital -- Principal, Financials Research

Thanks very much. Just a quick one for me. Neil, you flagged earlier this year initiatives you expect to help personal lending in the back half of the year. So, 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 the second half after being pretty flattish for the last little while?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Thanks for the question. I'll break it down into the two 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 strategies we spoke to last quarter were really around our branch unsecured lending. The 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'll 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.

Steve Theriault -- Eight Capital -- Principal, Financials Research

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

Neil McLaughlin -- Group Head, Personal and Commercial Banking

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.

Steve Theriault -- Eight Capital -- Principal, Financials Research

And so, last thing, you mentioned auto lending was 6%. So, ex auto lending, are we at 3%-ish down year on year?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

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

Steve Theriault -- Eight Capital -- Principal, Financials Research

Okay, thank you.

Operator

Thank you. Our next question is from Sohrab Movahedi with BMO Capital Markets. Please go ahead.

Sohrab Movahedi -- BMO Capital Markets -- Managing Director

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 and Chief Executive Officer

As you're seeing greater diversification in our global businesses, particularly with our U.S. wealth franchise, if you extrapolate the first half of the year, we'll approach -- if not exceed -- $1 billion of earnings, which wasn't the case. You're seeing greater diversification in our earnings. 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 and diversifying that growth, and 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 will 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 -- BMO Capital Markets -- Managing Director

Okay. And, for Neil, just one clarification. You talked about commercial, and six quarters of good growth, and picking up market share. Can you just talk 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, Personal and Commercial Banking

No, we're not competing on prices. The lever we're pulling to generate that volume -- it's the two things we had referenced earlier, making sure we are in market on policy and risk appetite and 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 competitor 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.

Sohrab Movahedi -- BMO Capital Markets -- Managing Director

Thank you.

Operator

Thank you. Our next question is from Gabriel Dechaine with National Bank Financial. Please go ahead.

Gabriel Dechaine -- National Bank Financial -- Analyst

Hi. I just had a follow-up on the capital questions there, and specifically on buyback. Last year, we saw you at almost 30% of your earnings were returned to shareholders via buybacks. We saw that pace again in Q1. This past quarter, it fell below 10%, I believe. Given your relative positioning -- not versus global, but versus other banks -- do you feel pressure to retain more and not buy back as much stock so that you don't fall too far behind some of the other Big 6 banks?

Rod Bolger -- Chief Financial Officer

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 -- National Bank Financial -- Analyst

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

Rod Bolger -- Chief Financial Officer

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

David I. McKay -- President and Chief Executive Officer

It's always been that way. We've commented that way for the last three or four years.

Gabriel Dechaine -- National Bank Financial -- Analyst

Okay. Then, the other one on the unsecured -- the branch strategy unsecured lending -- you lumped in auto lending with unsecured lending, and I'm just wondering about the branch strategy. Are we talking about selling more auto loans to the branches or the unsecured personal loan?

David I. McKay -- President and Chief Executive Officer

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

Gabriel Dechaine -- National Bank Financial -- Analyst

Okay. Could you remind me how big that portfolio overall is? I don't have that in front of me right now -- the non-auto bit and how big it is in the branch.

David I. McKay -- President and Chief Executive Officer

Our branch-based is about $22 billion.

Gabriel Dechaine -- National Bank Financial -- Analyst

Excluding auto?

David I. McKay -- President and Chief Executive Officer

That's right.

Gabriel Dechaine -- National Bank Financial -- Analyst

Okay, thank you.

Operator

Thank you. Once again, please press *1 at this time if you have a question. Our next question is from Nigel D'Souza with Veritas Investments. Please go ahead.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Hi. Thank you for taking my follow-up. I just wanted to circle back on the HELOC question. Correct me if I'm wrong here, but my understanding is that your HELOC book includes revolving and non-revolving HELOC lines. So, when that shift happens from variable to fixed, is that portion then included in your res mortgage book? Can you walk me through what's happening there on the balance side?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

That's exactly what would happen. If a customer went from having a tranche of a secured revolving credit line and decided to take a fixed segment, it would move from the secured credit line reported segment into the residential mortgage line.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Got it. Did that have any material impact on the sequential increase you saw in Q2 versus Q1 -- that shift?

Neil McLaughlin -- Group Head, Personal and Commercial Banking

The migrations have actually been happening for a while 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.

Nigel D'Souza -- Veritas Investment Research -- Analyst

Okay, got it. Thank you. That was very helpful.

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 and Chief Executive Officer

I want to thank everyone for their questions. I think the themes that you've heard over the last hour are consistent in 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 -- so, Canada, the U.S., and Europe -- we still are forecasting, as you saw, from our 25% to 30% in the fairly benign credit environments. We're feeling good about the operating momentum we have and look 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.

Duration: 57 minutes

Call participants:

Dave Mun -- Senior Vice President, Head of Investor Relations

David I. McKay -- President and Chief Executive Officer

Rod Bolger -- Chief Financial Officer

Graeme Hepworth -- Chief Risk Officer

Neil McLaughlin -- Group Head, Personal and Commercial Banking

Doug Guzman -- Group Head, RBC Wealth Management and RBC Insurance

A Douglas McGregor -- Group Head, Capital Markets and Investor and Treasury Services

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Director

Meny Grauman -- Cormark Securities -- Analyst

Gabriel Dechaine -- National Bank Financial -- Analyst

Sumit Malhotra -- Scotia Capital -- Analyst

Robert Sedran -- CIBC Capital Markets -- Managing Director

Doug Young -- Desjardins Capital Markets -- Analyst

Sohrab Movahedi -- BMO Capital Markets -- Managing Director

Scott Chan -- Canaccord Genuity -- Director

Nigel D'Souza -- Veritas Investment Research -- Analyst

Mario Mendonca -- TD Securities -- Analyst

Steve Theriault -- Eight Capital -- Principal, Financials Research

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