Earnings Call Transcript - RY Q3 2021

Operator, Operator

Please standby, your meeting is about to begin. Good morning, ladies and gentlemen. Welcome to RBC's Conference Call for the Third Quarter 2021 financial results. Please be advised that this call is being recorded. I would like to turn the meeting over to Nadine Ahn, Head of Investor Relations. Please go ahead, Ms. Ahn.

Nadine Ahn, Head of Investor Relations

Thank you. And good morning, everyone. Speaking today will be David McKay, President and Chief Executive Officer, Rod Bolger, Chief Financial Officer, and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions are Neil McLaughlin, Group Head Personal and Commercial Banking, Doug Guzman, Group Head Wealth Management Insurance and Derek Neldner, Group Head, Capital Markets. As noted on Slide 1, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially. I would also remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. To give everyone a chance to ask questions, we ask that you limit your questions and then re-queue. With that, I'll turn it over to Dave.

David McKay, President and CEO

Thanks, Nadine. And good morning, everyone. Today, we reported earnings of $4.3 billion, driven in part by strong client activity as we continued to attract new clients and deepen existing relationships across our market-leading franchises. Our performance reflects disciplined execution of our strategy, strong expense control, volume growth, higher fee-based client assets, and record investment banking revenue. This was partly offset by expected normalization in global markets revenue and continued pressures from low-interest rates. We also saw improvements in our macroeconomic outlook and credit quality, resulting in significant releases of reserves, which Graeme will speak to later. TCL on impaired loans and new GIL formations remain at cyclical lows. But our well-diversified portfolios continue to perform in these uncertain times, underpinned by strong underwriting and a well-defined risk appetite. Our CET1 ratio increased by 80 basis points to 13.6%, net of 15 billion in RWA growth. This was to support client demand and business growth across our platform. We leveraged our franchise and Balance Sheet strength to generate strong organic growth and an ROE of 19.6% this quarter, or 19.2% year-to-date, well above our global peers. We continue to create long-term sustainable value for our shareholders and support of our 17 million clients, as underscored by our 12% year-over-year growth in book value per share. And even though regulatory restrictions remain, we paid $1.5 billion in common dividends to our shareholders, the majority of which are based in Canada. I will now offer some perspective on the macro environment, which we view with cautious optimism in the near-term, but see it growing in strength into 2022. We remain cognizant of the near-term challenges to global growth posed by new variants, an inconsistent global vaccine rollout, supply chain disruption, rising geopolitical risks, and continued global travel restrictions. However, we are encouraged by the economy progressing as it reopens based on trends we're seeing in credit card spend on both goods and services and business investments in term assets and in working capital. All the momentum that's building could moderate in the near term by rising case counts, even with 75% of the eligible Canadian population being vaccinated. We believe the foundation of the economy remains solid, and we'll manage through the threat of the Delta variant. As I noted last quarter, we are well-positioned to leverage the scale and embedded profitability in our core franchises, to significantly grow earnings in a more favorable economic scenario, which would include rising interest rates, higher credit card revolve rates, and growth in business lending. With or without a rate hike, our diversified business model and scale by geography, channel, product or service is poised to generate strong growth, particularly asset growth, in cycles and with a consistent risk appetite. Our success comes from our investments in significant client data and geographic scale. This combined with our cross-sell ability, brand, and people have produced premium growth in average earning assets and market share gains in our core products. In Canadian Banking, we added a market-leading $37 billion in mortgages year-over-year, including over $9 billion this quarter. And we expect strong mortgage growth to continue, albeit at a lower rate than we've seen over the exceptional last 12 months. We are seeing green shoots of growth in our higher-yielding Canadian credit card and commercial loan portfolios, both up quarter-over-quarter. In the U.S., we are seeing particular strength at City National, where we've added $15 billion in loans over the last two years, including over $5 billion in mortgages. The recent launch of a new strategy supporting mid-corporate-sized companies across the U.S. is also proving to be successful, already booking over $1 billion in new commitments over the last few months. On the other side of the Balance Sheet, our long-term strategy to grow our core deposit business and provide exceptional service and advice continues to succeed. Over the last year, we added $43 billion in personal and business deposits in Canadian Banking, and a further $14 billion in deposits at City National. Our North American wealth management businesses have also generated strong growth in fee-based client assets, both sequentially and a year-over-year basis. Canadian Banking assets under administration were up over $63 billion or 22% year-over-year, partly benefiting from strong equity markets and an increased client preference for investments, which I will speak to shortly. Furthermore, Canadian Wealth Management AUA increased 23% or 95 billion from last year crossing $500 billion in client assets for the first time. RBC Global Asset Management had $35 billion in total net sales over the last 12 months, increasing assets under management 13% or over $67 billion year-over-year to record levels. In U.S. Wealth Management, we added over $115 billion of AUA, growing client assets 27% year-over-year, and surpassing $550 billion for the first time. We're continuing to invest in our people to capture a greater share of growth, adding Managing Directors in core investment banking verticals, such as technology, healthcare, and aerospace. We're also adding ultra-high-net-worth private banking teams in City National on the East Coast, along with an expanded presence in our core California markets. In Canadian Banking, our team has added 1,700 employees year-over-year to capture strong client activity in mortgages, commercial banking, and investments. Another differentiated element of our strategy is building ecosystems that go beyond banking to enable RBC to participate in a broader part of the client journey and value chain. One example is in the increasingly competitive Canadian commercial and small business segment. Several of these capabilities are made in RBC proprietary solutions. Owner and RBC ventures has helped 45,000 entrepreneurs launch their businesses online, including 20,000 year-to-date. With RBC Insight Edge, our business clients can leverage aggregated data to gain relevant insights in their markets to enable them to attract more customers. We continue to make investments in building a digital platform with enriched payments and cash management capabilities for our business clients. RBC PayEdge helps our clients save time and money with a secure solution for their account payable process. We also launched RBCx, a platform to help entrepreneurs scale up their ideas through access to partnerships, capital, and advice in tech, clean-tech, and life sciences verticals. And to further support the Canadian tech ecosystem, RBC recently announced the Calgary Innovation Hub will be signing on to become the anchor financial sponsor for Hub 350, a new technology park near Ottawa. Both RBC PayPlan and Ampli allow us to increasingly partner with merchants across Canada to provide even more value for our retail and business clients. I've spoken a lot this morning about our asset-generating opportunities. Also core to our client strategies is a fundamental belief in reciprocity, which rewards clients for the depth and breadth of their relationship with us. Last quarter, we provided a number of metrics highlighting our multiproduct relationships. The recent launch of RBC Vantage further incentivizes the consolidation of our strong client relationships. Vantage offers a further retail banking value proposition to our existing investment capabilities, such as MyAdvisor, Direct Investing, and InvestEase. This expanded continuum of offerings allows us to support our clients with advice and solutions to help them make the best decisions based on the prevailing macro backdrop. The continued low-interest-rate environment is making it increasingly attractive for our Canadian Banking clients to shift out of lower-yielding GICs and savings accounts and putting their money to work into investment products, such as mutual funds. The related fee-based revenue along with higher client savings and card payment rates have been positive for credit quality and risk-adjusted revenue metrics, helping offset margin pressure. Even as we invest in our core client franchises to achieve premium asset growth, we remain committed to managing our costs as we've done in the past. This includes implementing a zero-based budgeting methodology where we judiciously and consistently reevaluate every cost and activity across the bank. To sum up, our diversified business model, scale, financial discipline, risk management culture, and robust capital position continue to provide the foundation for delivering differentiated client and shareholder value over the long term. We will continue to grow in an inclusive and sustainable way that enables our clients to thrive and our communities to prosper.

Rod Bolger, Chief Financial Officer

Thanks, Dave, and good morning, everyone. Starting on Slide 8, we reported quarterly earnings per share of $2.97, up 35% from $2.20 per share a year ago. Pre-provision, pre-tax earnings of $5 billion were up a solid 6% year-over-year with strong client-driven performance in Canadian Banking and Wealth Management, non-U.S. along with record investment banking revenue, more than offsetting a moderation in capital markets trading revenue as client activity decreased across the industry. Excluding the impact of foreign exchange and lower interest rates, pre-provision, pre-tax earnings were up a strong 10% from a year ago. These results yet again highlight the resilience of RBC's diversified business model. Moving to Slide 9, our CET1 ratio of 13.6% was up 80 basis points sequentially, including the benefit of model parameter updates, net of the increase in SVaR multipliers guided through last quarter. This quarter saw a further $2 billion of net credit upgrades, lowering the cumulative net credit downgrades since the start of the pandemic to $8.5 billion. Strong internal capital generation net of dividends added nearly 50 basis points of capital. This was partially offset by strong client-driven business growth across our largest segments. Going forward, we expect RWA to continue to grow given the client-driven organic opportunities Dave highlighted earlier. I also wanted to give an update on our initial analysis of the impact of the upcoming Basel changes. We expect a net impact of the reforms to be moderately favorable as the benefits from the implementation of the guidelines in 2023 are partly offset by adverse market risk impacts under the fundamental review of the trading book coming into effect in 2024. Moving on to Slide 10. Net interest income was down year-over-year. Excluding trading revenue, net interest income was up 6% from last year as strong client-driven volume growth in Canadian Banking and City National more than offset continued margin pressures. Canadian Banking NIM decreased by 4 basis points from last quarter, largely due to competitive pricing pressures in mortgages and changes in asset mix. City National NIM was down 10 basis points relative to last quarter, largely due to the dilutive impact of a lower loan-to-deposit ratio with excess deposits being deployed into low-yielding short-term securities. Although NIM was lower in each business due to mix, more importantly, net interest income was up at least 5% year-over-year in each business. Going forward, we expect all bank net interest income, excluding trading results to continue to increase year-over-year as strong volume growth more than offsets moderating margin pressures. Turning to Slide 11. While we don't anticipate short-term rates to increase in the near-term, both Canadian Banking and City National are well-positioned to benefit when they do rise, partly because nearly half of the deposit base has near 0 rates. Looking forward, we expect a 25 basis point increase in the short-term interest rates, with the long-end of the curve unchanged, would increase Canadian Banking net interest income by $90 million and U.S. Wealth Management revenue would increase by another $80 million in this scenario, including the benefits from our sweep deposits. Turning to Slide 12. Higher non-interest income, net of insurance fair value change was largely driven by strong growth in our higher ROE investment management and mutual fund revenue streams. This quarter also saw a shift in the revenue mix in capital markets. Strong loan syndication and M&A fees boosted underwriting, advisory and credit fees. This was offset by a decline in global markets revenue. Higher service charges and card service revenue reflected the benefits of higher client activities in Canadian Banking. On Slide 13, non-interest expenses were well controlled, up only 1% year-over-year, largely due to higher variable compensation on stronger wealth management revenue, partly offset by lower compensation on reduced capital markets revenue and market-related movements in our U.S. wealth accumulation plan. Excluding growth in variable and share-based compensation and the impact of FX, expenses were up 1.5% year-over-year, partly due to higher salary and benefit costs. Non-compensation costs declined largely due to lower facility and cleaning costs. This was partly offset by higher technology and equipment costs, as well as higher marketing and travel expenses from prior year lows. We're cognizant that some of these discretionary costs could start to increase as economies begin to open back up and as we implement new client acquisition strategies. As Dave noted, we will continue to execute on the zero-based budgeting program while continuing to invest in our people and technology to drive revenue growth. Moving to our business segment performance beginning on Slide 14, Personal Commercial Banking reported earnings of over $2.1 billion, up 55%, mainly on lower PCL. Canadian Banking pre-provision, pre-tax earnings were up a strong 13% from last year. Canadian Banking revenue was up 8% year-over-year, partly due to volume-driven growth in net interest income. Non-interest revenue was up largely due to higher mutual fund distribution fees underpinned by very strong AUA growth. Well-controlled Canadian Banking expenses were up 2% from last year combined with strong revenue growth drove operating leverage of 6% this quarter and 3% year-to-date. On average, we expect operating leverage to remain at or above the higher end of our annual 1% to 2% historical guidance over the next 4 to 5 quarters based on current economic projections.

Graeme Hepworth, Chief Risk Officer

Thank you, Rod, and good morning, everyone. Starting on Slide 20, the allowance for credit losses on loans of $4.9 billion was down $658 million compared to last quarter. This includes a $638 million release of reserves on performing loans primarily in capital markets and the Canadian Banking cards and personal lending portfolios. The release reflects improvements in both our macroeconomic outlook as well as the credit quality of our portfolios during the quarter. We have now released about 40% of our pandemic-related reserves. Our ACL is now 0.67% of loans and acceptances down from its peak of 0.89% in Q4 of last year. Our level of allowances remains well above pre-pandemic levels, given the ongoing uncertainties associated with the COVID-19 Delta variant, and the conclusion of the significant government support that has benefited both consumers and businesses. Turning to Slide 21, our gross impaired loans of $2.6 billion were down $216 million or 5 basis points during the quarter. Impaired loan balances decreased across all our major businesses, and new formations of $293 million were at a 9-year low this quarter. Muted new formations in Canadian Banking are due in part to ongoing government support programs. As noted earlier, in corporate markets, clients continued to benefit from active debt and equity markets providing strong access to capital in the improving macroeconomic environment. Turning to Slide 22, PCL on impaired loans of $146 million or 8 basis points was down 3 basis points from last quarter and has trended lower in each of the last 5 quarters. In the Canadian Banking retail portfolio, PCL of $136 million was down $25 million from last quarter, with decreases across all products with the exception of our residential mortgage portfolio. Our PCL was flat quarter-over-quarter and remains at its lowest level in more than 5 years. In the Canadian Banking commercial portfolio, PCL of $25 million was down $9 million from last quarter. The credit quality of the commercial portfolio is strong with sustained low delinquency rates, positive net credit migration, and reductions in our watchlist exposures. In capital markets, we had a net recovery for the second consecutive quarter. The net recovery of $16 million was due to PCL reversals in the real estate and related, and oil and gas sectors, partially offset by a provision in the transportation sector. Our strong performance on credit continues to be a reflection of the quality of our client base, the diversification of our portfolios, and our prudent underwriting practices. With government restrictions easing and companies starting to return employees to premises, I'd like to provide an update on our commercial real estate portfolio on Slide 23. Our portfolio is well diversified by geography, business segment, and property type. As I noted in prior quarters, the retail segment of this portfolio has been most impacted by COVID-19 restrictions. Rent collection has been most challenged for enclosed malls which have faced closures and reduced foot traffic. However, our exposure to closed malls is limited and the loans were well-structured heading into the pandemic. As for the office segment of this portfolio, we have not seen material changes in rent collection or occupancy rates. However, the outlook for the office segment remains uncertain as companies will need to balance work capabilities with physical distancing requirements and the need for more space per employee when in the office. The remaining segments of this portfolio, where a majority of our exposure sits, have not been materially impacted by COVID-19. We continue to monitor the portfolio and are carefully managing exposure to the retail and office segments. To conclude, we are pleased with the positive trends in our credit portfolio that we're seeing as the economy recovers. We have seen pandemic-related government restrictions easing and significant progress on vaccine distribution, which has contributed to the strong credit performance this quarter. While pandemic credit uncertainty has declined, translating into a large release of reserves on performing loans this quarter, uncertainty does remain elevated due to a rise in cases of the COVID-19 Delta variant. This could impact the timing and pace of the economic recovery. We do, however, remain adequately provisioned for an expected increase in delinquencies and impairments in 2022. We believe this will result in 2022 PCL on impaired loans trending above our long-term average. However, as I noted last quarter, we expect to draw down on the remaining balance of our nonperforming loans built in 2020, such that our total PCL across all stages will remain below long-term averages. And with that Operator, let's open the lines for Q&A.

Operator, Operator

Thank you. We will now take questions from the telephone lines. If you have a question and are using a speakerphone, please press your handset before making your selection. If you have a question, please follow the operator's instructions. There will be a brief pause for participants to register. Thank you for your patience. The first question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Good morning. I was wondering if we could maybe, Dave, just get your view on the housing market. It's become a big election issue with the ban on foreign buyers being promised. Just talk to us in terms of how, given your mortgage business being very strong, how you see the housing market today. And do you see the appropriate policy responses coming through to kind of make housing affordable, especially in the metro markets?

David McKay, President and CEO

Thanks for that question. I'll say a few comments, and Neil, who is also very close to the issue, I'll ask to make a few comments. So we look at the structural elements of the housing industry in Canada on a monthly basis. We have a lot of stats we track on supply-demand imbalances. Those obviously continue to persist where you have a shortage of supply and highly stimulated demand marketplaces from all the factors we discussed: low rates, consumer preference changes, and a lack of general supply. So obviously, price increases are part of this. As an employer in the major metropolitan areas, we certainly worry about the cost of housing and the effects on our employees, and our ability to attract talent to the country and to the cities where we operate. One of the reasons why we created the Calgary hub for technology is to diversify our employee base across the country and access talent in different markets. To your question, the rising cost of housing impacts all employers, our cost of operating, and our ability to operate the way we want to. We’re starting to make moves, as you saw in Calgary, to diversify our areas. We don't worry about the quality of our credit book; it's well adjudicated. There's a good equity position. Still, one-third of it is insured. Therefore, we're confident in the cash flows and the stress test, and the policies that have gone into changing those stress tests to ensure good adjudication. This is more of a long-term macroeconomic issue. Where I do worry, Ebrahim, to your point, is the more cash flow that consumers are putting into housing stock, the less that is available to drive the economy. Policymakers across Canada are worried partly about the long-term economic drag from that much cash flow going into servicing housing. It’s crucial that we look at policy initiatives that try to balance the needs of Canadians and the prosperity and happiness of Canadians. And with that, I'll pass it to Neil.

Neil McLaughlin, Group Head Personal and Commercial Banking

Thanks, Dave. The only other thing I would add is, if we focus on our mortgage business and the underwriting in that business, I think B20 has been a positive for the industry, providing a lot more granularity on the different segments and transactions in the book. The stress test has built-in confidence that there is resiliency there. In terms of the supply-demand imbalance, maybe just a couple of other points to build on Dave's comments. Recently, you've started to see the supply side start to get more airtime. I would say that does need a lot more focus. We have a very strong immigration policy, but a big portion of new household formation comes from newcomers, so we see what's driving it. Beyond some macro elements, there are shorter-term issues too. We get a lot of feedback from some of Canada's largest developers, and a more cooperative municipal set of policies could help them actually increase supplies in the market. So that could be a tactical move that could be beneficial, but the supply side is something we need to talk more about.

Meny Grauman, Analyst

Hi. Good morning. Dave, you touched on the macro outlook in your opening remarks, but to put a finer point on it, if I think back to the call last quarter, you made a very bullish case for the recovery and for Royal's ability to take advantage of that recovery. I'm wondering, given the Delta variant, if there is any change in your outlook, anything you would highlight that's different now than it was in early June?

David McKay, President and CEO

Net, when you think of the medium-term, as I said, through 2022, we're still equally as positive about the opportunity for the economy to grow and to accelerate beyond where it was in 2019. We're seeing that economic activity progress nicely. We look at our credit card spending. We look at the activity levels, which are now above 2019. We're starting to see draws on our operating working capital lines. That was the green shoot that pointed to all symbols of confidence returning. We're seeing term asset lending start to grow. We're seeing our authorized credit book increase almost 10%. You're seeing all the signs of economic confidence. What will happen with the Delta variant? It may pause things for a month or two as we have to work through and ensure we don't overwhelm the health system. It's a little concerning to see the numbers, but we see a little bit of a turn on the Delta variant in other parts of the world. We'll manage through this with 75% of vaccination rates. We don't expect we will need to shut down the economy the way it was last year or early in 2021. So we should have every ability to manage through this, given what we've achieved so far. Therefore, I think you're looking at months of maybe slowing returns to work and the full reopening of some of our service sector until we deal with this, but I don't think that will upend the majority of the momentum we have. So I'm still very positive about the continued progress in reopening the economy over the next 12 to 24 months.

Scott Chan, Analyst

Good morning. I'm just looking at the new Canadian Banking slide that you provided on slide 6. On the revenue yields showing stable, the NIE offsetting the NIM pressure. So just on the NIE side on the yield, what kind of factors are driving that? Is the message that the NIE is more stable or that could potentially increase over time?

Rod Bolger, Chief Financial Officer

Thanks for that question, Scott. The NIM is obviously a factor of what you're paying on deposits and what you're receiving on the loan. The mix has been a significant driver of our overall NIM. As we continue to grow mortgages at an elevated rate, that will naturally bring it down because those products, since they’re secured and well underwritten, tend to have a lower rate with the client. But as the green shoots you mentioned start to emerge, and we begin seeing credit card balances and commercial balances come up, we would expect that to start to bottom out and then increase again. That will help NIM overall bottom out and increase again. Importantly, because volume growth is strong, and deposit growth is strong and low-cost, net interest income has bottomed out and is growing and will continue to grow.

Neil McLaughlin, Group Head Personal and Commercial Banking

Got it. It's me on the block, and I'll jump in. What we're trying to get across there is the other income side has seen really good growth year-over-year, reflecting the diversification and what we have within the retail bank. There's been strong growth in mutual fund trailer fees. Our new client acquisition over the last couple of years is paying off in higher service charges. We're starting to see a bit of a bounce back in FX. Our direct investing business is also benefiting from the overarching macro trend. The message here is there's a strong contributor in other income, which strengthens our overall revenue contribution.

Sohrab Movahedi, Analyst

Yes. Thanks. That's actually a great segue to my question. I guess, Neil, there is also a slide that talks about beyond banking for the Canadian business. So you're not attributing any of the fee income or other income results in your segment to these initiatives, are you?

Neil McLaughlin, Group Head Personal and Commercial Banking

Yeah. What we're really trying to get to there, in terms of our strategy, is two things. Our continual focus is the value for money we provide clients and our ability to distribute more clients year-over-year. We're starting to play upstream and downstream in terms of the client's value chain. An example would be what we think of as our owners with the investment we're making. We're seeing an increase in new small business accounts related to our investment and really pleased with the trajectory, really pleased with our ability to turn those new business registrations into RBC customers.

David McKay, President and CEO

This is Dave. The key is both attracting new clients and existing clients. We could demonstrate an ecosystem like this in home equity and everyday payments and shopping. So we gave you an example of a well-constructed ecosystem on our business and commercial side, but this is obviously a big part of the strategy we articulated at Investor Day 4 years ago, that's really coming to life to drive both client acquisition and an expansion of fee opportunity and new revenue streams for the bank.

Gabriel Dechaine, Analyst

Good morning. A couple of quick ones here. One on the expense outlook there for Rod, up 1%, down 1% in the non-comp, variable comp category? Is that the focus on that number? Like is that one where you're continuing to grind it down over the next year-and-a-half, or do we start to see a ramp-up?

Rod Bolger, Chief Financial Officer

I'll start on the expense and then hand off to Neil for direct investing. So on the expenses, this is a continuation of the cost management program of our efficiency initiatives. We look to spend dollars where it makes sense to continue to grow market share, to continue to invest in distribution. We think that's one of the key reasons why we're growing market share in our core businesses. That’s not only people but also technology, and we will continue to do that, but we're also going to continue to focus to grind down other costs in an effective way as we digitize and leverage that technology, expecting other cost growth to moderate. It's unlikely that it would be negative or 0 for 5 straight quarters after it's been that way for the last 5 quarters. It's probably going to have a little bit of uptick, but it's not going to grow wildly. It's not going to get up to mid-single-digits, but it is likely to be lower single digits. The rest of the expenses will flow in accordance with variable compensation for our Financial Advisors and other employees at large.

Neil McLaughlin, Group Head Personal and Commercial Banking

Sure. Thanks, Gabriel. Regarding competition, we’ve seen one more player go to 0 on commissions while another player in the market is already there. The announcement this week was some from a player who has very little market share. We believe there's good value in the RBC Direct Investing platform in terms of the toolsets, top-tier research, and providing free streaming quotes. The difference is we look at the investment market holistically. A large portion of our direct investing customers are also banking customers. The value also comes from what they're paying for trade, but many also participate in the RBC Vantage program, receiving discounted banking fees for that. That's another way we're delivering value, so we're focusing on having a strong proposition in all areas of that market.

Doug Young, Analyst

Good morning. Just on the credit card business, balances are up quarter-over-quarter but still down year-over-year. I'm curious about the percent of clients paying down balances monthly today versus pre-pandemic. And so how much of the growth is coming from the revolver side? Given the higher liquidity, might the rebound on the net interest income from higher card balances lag? Is that a fair assumption? And could you discuss what you're seeing from a buy-now-pay-later trend perspective, and if you feel that's a threat?

David McKay, President and CEO

In terms of the card book, I think breaking it down into the two large segments is appropriate: the transactors paying their credit card bills in full each month and the revolvers. Those transactors are driving disproportionate increases in spending and balances. The percentage of revolvers has decreased versus pre-pandemic due to the stimulus in the economy. The average Canadian has more money in their deposit accounts. Predicting the timing of revolvers returning is challenging, but I'm confident you'll see revenues lag. Overall, spending is up even compared to 2019 levels. We discussed categories where everything is improving except travel and dining. Dining is approaching 2019 levels; while travel isn't there yet, it has spiked since mid-May, providing positive signs. The effective yield on the portfolio has decreased, impacting NIM. Regarding buy-now-pay-later, we see this trend as a value proposition for merchants that they want to include, but it’s not a significant threat to our lending business.

Lemar Persaud, Analyst

Thanks. I have a big-picture question. I didn't think I'd be here talking about Royal delivering a near 20% ROE while holding 30.6% in common equity Tier One capital. Any thoughts on whether a 20% ROE is sustainable going forward? Can you comment on where you see the ROE for Royal playing out over the long term?

David McKay, President and CEO

Thanks for that question. It's something we also consider. I can share some of the bigger drivers affecting ROE. We can talk about the ranges. Our ROE is well above our medium-term objectives. Some positives are higher-yielding asset growth, such as credit card revolving rates, credit card spending, all positive for ROE. You can't underestimate the impact of interest rate sensitivity on our City National Balance Sheet - as rates come back, those are positive drivers for existing ROE. Our strong fee-based revenue generation and the mix we have will also be positive for ROE, alongside strong banking pipelines. As we've discussed, returning capital to shareholders through dividends and buybacks will also enhance ROE. We have significant opportunities to enhance revenues from existing capital and RWA deployment. In sum, we expect our ROE will remain in high teens, with an upward bias.

Rod Bolger, Chief Financial Officer

Dave covered the key core business drivers. One thing I look at is our book value per share growth of 12% year-over-year and tangible book value of 17%. Our organic client-driven growth means our RWA has had an annual CAGR of 3% since acquisition. As long as we continue to grow earnings and client relationships faster than capital, we will be positioned for improved ROE. However, we won't see big reversals every quarter on PCL, so after stripping that out, we should expect ROE in the high teens, with some upward bias.

Mario Mendonca, Analyst

Graeme, can you revisit your comment earlier about impaired loan PCL in 2022 potentially being above long-term average for Royal? The long-term average for Royal impaired is approximately 25 to 30 basis points over the long term. This year, impaired loans might only be about 10 basis points, suggesting a near tripling in PCL for 2022. What encourages you to call for that increase, and did I get my numbers right?

Graeme Hepworth, Chief Risk Officer

Thanks for the question. Your numbers are generally correct. We talked about three key areas to assess: vaccine progress, reopening of the economy, and government support levels. Progress has been great on the first two points, but the third point will inflect loan losses heading into 2022. The degree of government support impacts how we view losses in the future. Many portions of our portfolio could see loan losses trending toward long-term averages in 2022, particularly significant government-supported areas like consumer and commercial. We've noted the lowest levels of new formations in a long time, which are positive in the near term but not expected to persist. Our wholesale PCL has benefited from recoveries, keeping our near-term stage three reserves low, but we expect changes moving forward as conditions evolve.

Rod Bolger, Chief Financial Officer

Let me add perspective, Mario. Graeme referenced somewhere in his comments that we still have a substantial stage-1 and stage-2 reserve based on the pandemic, and roughly 60% of what we added to our Balance Sheet during this time remains. Implicit in that is the expectation that we will incur losses on those, leading to higher stage 3 than observed. If we don’t see losses, we will expect to release some reserves, but if we do, we will utilize stage 1 and stage 2 against those.

Ebrahim Poonawala, Analyst

Thanks for taking my question. Just a follow-up, Dave: you spent time discussing RBC Ventures and how they're acquiring new clients. One concern from longer-term investors has centered on open banking in Canada. What does that mean for your grip on client wallet share? Is there a risk to Royal? Also, looking outside Canada, are there opportunities in the U.S. and Europe for RBC to engage as a disruptor due to the rise of FinTech?

David McKay, President and CEO

That's a great question, thanks for asking. I'll discuss strategically while Neil, who is very active on strategy and policy, can provide further details. We're anticipating a more open market, disruptive tech platforms we’ve discussed for the last five years, and ensuring our ventures and ecosystems are built for competition in this landscape. When we think about open banking and attracting clients through our ecosystems, we feel prepared for competition. We're well equipped to create value for customers, making it challenging for clients to leave, through RBC Vantage and partnerships with businesses like DoorDash. We expect open banking will create significant opportunities for RBC rather than fears of losing customers. Neil, you’ve worked on this policy and strategy.

Neil McLaughlin, Group Head Personal and Commercial Banking

Yes, the open banking initiative in Canada has been open for years, and the advisory committee just submitted recommendations to the government. The industry is working collaboratively to implement this faster than anticipated. We've established a standard for data safety and privacy as we exchange information more compliant with clients' requests. Open banking is something clients want; it's about ensuring data portability rather than being mandated. It's important to note that in other regions, particularly in the UK, competition didn't spike significantly. Canada could play out differently, but we see it as more of an opportunity than a risk, enhancing our value propositions. We believe we can consolidate customer relationships through open banking.

David McKay, President and CEO

Yes, it's a great question, and we've been considering that for a while. The key capability required is a partner that provides access to those clients. Creating a direct-to-consumer deposit bank is straightforward, but the high costs make it challenging. Thus, having an asset generator along with deposit-takers is essential for effectively going to market. We've been speaking with potential partners, and while it's still on the table, we're prepared for direct-to-consumer strategies. For now, our long deposit position means launching direct-to-consumer offerings isn't worth it, but we have plans ready to move forward if needed.

Nigel D’Souza, Analyst

Thank you. I wanted to discuss the risk-weighted assets and PCL reversals in the quarter. Should we expect those two items to move in tandem? As you lower probability of default assumptions, should we anticipate PCL reversals affecting RWA and consequently lower risk weighting?

Graeme Hepworth, Chief Risk Officer

It's Graeme. They should have a correlation, but not a one-to-one relationship. The probability assessments influencing RWA meet regulatory standards and are long-term averages. While they will be reassessed annually, the changes won’t be drastic. IFRS 9 tracked is more of a real-time impact that will play through more immediately. Directionally, yes, they correlate, but they don't match one-to-one.

Rod Bolger, Chief Financial Officer

I would expect upward bias for RWA as we continue to grow our client business and for allowances to have a downward trajectory as we move through the pandemic reserves we built. I’ll turn it back to Dave.

David McKay, President and CEO

Thanks, Rod. I just want to wrap up by stating that we appreciate today's comments and questions revolving around our growth strategies and our adaptability to changes in policies and economies. We see promising growth in Canadian Banking from cards and commercial segments. One element we didn't highlight earlier is that one-third of our mortgage volumes come from new clients, providing unique opportunities for cross-selling RBC Vantage and various investment products, exemplifying growth across City National aimed at mid-corporate areas. Although we didn't cover Wealth today, we have outstanding results and growth opportunities in asset management businesses. It's imperative to maintain a strong pipeline and manage expenses while ensuring risk management is up to par. We're optimistic about future growth, especially in investment banking opportunities, and our overall risk management will sustain quality in our portfolios. We didn't address the Ventures questions earlier, but these initiatives will not only drive client acquisition but also illustrate new revenue streams. Thank you for your great questions today, and I look forward to the next quarter.

Operator, Operator

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