Earnings Call Transcript
ROYAL BANK OF CANADA (RY)
Earnings Call Transcript - RY Q3 2023
Operator, Operator
All participants please stand by, your conference is ready to begin. Good morning, ladies and gentlemen, and welcome to RBC's Conference Call for the Third Quarter 2023 Financial Results. Please be advised that this call is being recorded. I would now like to turn the meeting over to Asim Imran, Head of Investor Relations. Please go ahead, Mr. Imran.
Asim Imran, Head of Investor Relations
Thank you, and good morning, everyone. Speaking today will be Dave McKay, President and Chief Executive Officer; Nadine Ahn, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions, Neil McLaughlin, Group Head, Personal and Commercial Banking; Doug Guzman, Group Head, Wealth Management and Insurance; and Derek Neldner, Group Head, Capital Markets. As noted on Slide 1, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results could differ materially. I would also remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. To give everyone a chance to ask questions, we ask that you limit your questions and then re-queue. With that, I'll turn it over to Dave.
David McKay, CEO
Good morning, everyone, and thank you for joining us. Before we begin, I want to acknowledge the tragic events in the Northwest Territories, D.C., and Hawaii, with the ongoing wildfires. Our care and concern is with all those in these areas and we're supporting community relief efforts, and we are here to help affected clients and employees. Moving now to our results. Today we reported third-quarter earnings of $3.9 billion or adjusted earnings of $4 billion, up 11% from last year. Pre-provision pre-tax earnings were up 7% year-over-year. Revenue grew 19% to $14.5 billion, as our performance yet again demonstrated the strength of our diversified business model, which produced revenue growth across our businesses. Personal and Commercial Banking revenue increased 7% from last year. Capital Markets had another strong quarter with over $1 billion in pre-provision pre-tax earnings, gaining share across Global Markets and Investment Banking amidst declining fee pools. Wealth management revenues were up 10% from last year and Insurance Revenue, net of PBCAE was up 22% year-over-year. Expenses were up 23% year-over-year, largely due to acquisition-related costs, FX, and share-based compensation. Excluding these items and growth in variable compensation, expenses were up 9%. We also added a further $120 million of PCL on performing loans this quarter and we remain well-provisioned for a softer economic outlook. We ended the quarter with a CET1 ratio of over 14% while maintaining a diversified funding profile. Our strong balance sheet and premium ROE are important elements of our value creation model. Before I provide updates on our growth and cost strategies, I will speak to what remains a complex and challenging environment from a macro, operating, and regulatory perspective. On the macro front, consumer spending remains resilient. At the same time, it appears the magnitude of interest rate hikes is having its intended effect of reining in persistently elevated inflation. The increase in the price of goods and services has slowed to 2% and 4% respectively. While immigration levels and labor markets also remain strong, we are seeing evidence of slowing labor markets, as evidenced by slowing wage growth, lower job postings, and an increase in Canadian unemployment. Consequently, our base case forecasts a softer economic outlook. We expect slowing growth and lower inflation due to the lagging impact of monetary policy, combined with a slowdown in China and elevated climate in geopolitical risks. The length of time Central Banks will have to be in a hold pattern before decreasing interest rates will be a key determinant of the impact on consumers, businesses, and the economy. We are operating in a structurally uncertain macro backdrop. Furthermore, the operating environment is changing at a faster pace than we've seen for over a decade, particularly in the U.S. Banking sector. U.S. banks are facing increasing regulatory and funding requirements, which were exacerbated by quantitative tightening and other actions taking liquidity out of the U.S. banking system. Nearly $2 trillion sits in the Federal Reserve's overnight reserve reverse repurchase facility, including a significant increase in usage by money market funds. A higher cost of doing business is reducing profitability for U.S. regional banks but by higher funding costs and pressure to reduce lending capacity to protect capital and liquidity. City National is not immune to these factors, with both loan growth and profitability being impacted by the higher cost of attracting deposits and continued investments in its operational infrastructure. While we expect these cost pressures to continue for City National, we expect to drive future benefits from its asset-sensitive balance sheet. Furthermore, we are well positioned to benefit from our diversified U.S. business mix, including our top 10 Capital Markets and Wealth Management platforms, which generated over 90% of U.S. pre-tax pre-provision earnings over the last 12 months. Given the current operating environment and economic backdrop, I will now speak to the actions we are taking to optimize structural efficiencies to support our strategy of creating long-term value. While we have a strong foundation to do so, we have not been satisfied with our recent operating leverage, and so we've heightened our focus on expense control. We have acted by slowing discretionary spending, prioritizing investments, and moderating hiring to benefit from natural attrition. Our actions to date have resulted in a 1% reduction in FTE, excluding the partial sale of RBC Investor Services in our summer student program. We expect to further reduce FTE by approximately 1% to 2% next quarter, through attrition and targeted reductions. We will continue to monitor the changing landscape and are ready to accelerate further tactical actions as deemed appropriate. In addition, we're also maintaining our discipline around capital allocation as highlighted by the partial sale of RBC Investor Services. We remain focused on driving the bank forward including the planned acquisition of HSBC Canada. The transaction once approved and closed is expected to drive attractive financial returns, positioning RBC as a bank of choice for newcomers and commercial clients with international needs. We're also investing to create even more value including leveraging our leading Borealis AI Institute to expand our capabilities in artificial intelligence. We're expanding end market use cases and credit adjudication, cybersecurity, client offers, and through our Aiden trading platform. I will now speak to key growth drivers across our segments. Starting with Canadian Banking, our largest business. We had our best-ever quarter for new-to-RBC client acquisition with record volumes from newcomers and new partnerships, including ICICI Bank Canada. Personal deposits were up 14% from last year. Our stable low-cost, low-beta deposit franchise allows us to efficiently fund our loan growth. Our attractive funding structure is also expected to provide a relatively smooth revenue stream, which Nadine will speak to shortly. We continued to see a shift in the deposit mix towards term products, as new and existing clients continue to value our higher yielding offerings. We also continue to enhance our franchise by expanding our offerings and partnerships, an important part of our client-centric model. We're excited to be the official financial services partner for the 2024 Taylor Swift, The Eras Tour in Canada. Earlier this quarter, we launched our new loyalty partnership with METRO in Quebec, while also opening our innovative ShopPlus platform and Avion rewards to all Canadians. Many of our Canadian Banking clients are members of our internationally recognized award-winning program. And we expect to grow this membership base by 50% in the next three to five years. On to mortgage growth, which moderated to 5% from last year and we expect industry origination activity to continue along this trend. We remain focused on the trade-offs between spreads and new mortgage originations as intense pricing competition is limiting expansion in asset betas. We will remain disciplined to ensure new originations continue to meet internal hurdles of economic value. Business loan growth remained strong, up 14% from last year, as we continue to see balanced growth including solid growth in agriculture and supply chain sectors. With inventory levels remaining below pre-pandemic levels, there is a continued runway for growth. Moving to our global diversified Wealth and Asset Management franchises, which are key contributors to our premium return on equity. Starting with Canadian Wealth Management, assets under administration were up 7% from last year, increasing to a record level of approximately $550 million. On Slide 30, we provide new disclosures on our leading adviser productivity, which remains significantly higher than peer averages. U.S. Wealth Management, AUA was up 7% from last year to a record level of approximately $575 billion. We also added over 20 new advisers this quarter, a key source of growth. RBC Global Asset Management, AUM increased 3% from last year despite unusual conditions where market outperformance was heavily weighted towards a narrow band of U.S. technology stocks. Our clients chose us as a trusted advisor, largely due to our performance in investment expertise. Nearly 85% of our AUM have outperformed the benchmark on a three-year basis, a challenging period for markets. Furthermore, we are confident that our leading money-in franchise is well-positioned for any client-driven reversal of GIC inflows back to investment products. We added to our alternative product suite this quarter by launching the RBC Global Infrastructure Fund, which exceeded commitment targets. Capital Markets had a strong quarter, as we benefited from the growing strength of our diverse business model. While industry-wide fee pools remain muted, our businesses showed continued momentum and delivered market share gains to drive outperformance. Our cross-platform teams are building undervalued positions as trusted advisors to our clients across geographies and products. In Corporate Banking and Investment Banking, we continued to advance the globalization of our business and deepen our sector and product coverage of our franchise. These investments are reflected in our participation in key mandates across diversified industry groups, translating into a move to ninth in global league tables on a year-to-date basis, up from 10th last year. Going forward, we are seeing increased client conversations and the buildup of a healthy pipeline. In Global Markets, we also delivered strong market share gains across several core products and focus areas for accelerated growth. Our strong market share in the spread business worked well for us this quarter. Furthermore, investments we've made in our macro business have also positioned us to support our clients. We are pleased that the strategic investments in talent and technology and the changes we've made to our organizational structure are producing results. In conclusion, our investments in our people, technology, products, and services continue to create more value for our clients. They are driving strong volume growth and client activity across our businesses. We also remain committed to delivering more value for our shareholders by efficiently allocating investments and capital within our stated risk appetite. Nadine, over to you.
Nadine Ahn, CFO
Thank you, Dave, and good morning, everyone. Starting on Slide 8. We reported earnings per share of $2.73 this quarter, adjusted diluted earnings per share of $2.84 was up 11% from last year, as broad-based revenue growth was partly offset by higher expenses and increases in PCL on impaired loans off of low levels a year ago. Before focusing on more detailed drivers of our earnings, I will highlight the continued strength of our balance sheet. Starting with our strong capital ratios on Slide 9, our CET1 ratio improved to 14.1%, up 40 basis points from last quarter, mainly reflecting net internal capital generation, share issuances under DRIP, and the impact of the partial sale of RBC Investor Services. Looking ahead, we do not expect there to be a material impact from the implementation of the fundamental review of the trading book or IFRS 17 in fiscal Q1 2024. We continue to expect that our CET1 ratio will remain above 12% following the close of the planned HSBC Canada transaction in the first calendar quarter of 2024 pending regulatory approvals. Moving to Slide 10. All bank net interest income was up 7% year-over-year or up 6% excluding trading revenue. These results reflect our sensitivity to higher interest rates, as well as the benefit from higher volumes, particularly in Canadian Banking. All bank net interest margin excluding trading results was down 1 basis point from last quarter as margin expansion in Canadian Banking was more than offset by NIM compression in other lines of business. On to Slide 11. We walk through this quarter's key drivers of Canadian Banking NIM, which was up 3 basis points from last quarter. The embedded advantages of our structural low beta core deposit franchise continue to come through this quarter. The latent benefit of recent interest rate hikes has resulted in a widening of deposit spreads. NIM also benefited from changes in asset mix, including strong growth in credit card balances. Importantly, NIM headwinds associated with the flows from non-maturity deposits into GICs abated this quarter. However, we continued to be impacted by the tightening of mortgage spreads as competition remains highly intense. Going forward, we continue to expect to see the structural benefits of our latter deposit portfolio come through. The increase in swap rates seen over the past year should result in reinvestment rates that are higher than those rolling off, which in turn should provide tailwinds. However, as we've seen in past quarters, there are other factors that impact quarterly changes in margins, including changes in product mix both in assets and funding. With respect to competitive pricing, we assume intense competition for deposits and mortgages will continue. Any changes in the timing and extent of these assumptions could have an impact on the trajectory of net interest income. Turning to City National. NIM was down 11 basis points from last quarter, including the benefits from hedging, mainly reflecting an adverse funding mix shift into interest-bearing deposits as well as rising deposit betas. These headwinds more than offset the benefit of Fed rate hikes on City National's asset-sensitive balance sheet. Moving to Slide 12. Non-interest expenses were up 23% from last year. Approximately, 10% of this growth was driven by a combination of acquisition-related costs and macro-driven factors such as FX and share-based compensation. Beyond these factors, growth in variable compensation added a further 4% to the overall growth in expenses. The core drivers of organic expense growth were investments in people and technology. Salaries excluding the impact of RBC Brewin Dolphin were up 17% from last year as investments in our people reflected FTE growth of 6% year-over-year as well as inflationary impacts of salary increases announced last year. We also incurred a higher level of severance, which I will speak to shortly. The growth in FTE was prevalent in Canadian Banking where FTE was up over 1,500 year-over-year and up 2,500 from the end of fiscal 2021. Investments in product innovation also added to the segment's expense growth. In Capital Markets, expense growth was driven by higher variable compensation to measure with a rebound in revenues as well as ongoing technology investments and build-out of products. At City National, we continue to make investments in the operational infrastructure in support of the bank's next leg of growth, including higher professional fees and staff costs. On to Slide 13. I missed the ongoing challenging operating environment, I want to reiterate Dave's comments on our heightened focus on cost containment. Firstly, we are in the process of reducing our employee base. FTE excluding the impact of summer students is down 3% quarter-over-quarter. This was largely driven by the impact of the partial sale of RBC Investor Services operations. Excluding the sale, much of the FTE reductions to date have come in Canadian Banking, which was down 2% quarter-over-quarter, excluding the impact of summer students. As attrition and the slowdown in hiring are running their courses. Additionally, over the last two quarters, we have seen an aggregate severance cost of nearly $70 million. Moreover, we expect to further reduce FTE by approximately 1% to 2% next quarter resulting in additional severance costs being recognized in Q4. Another lever at our disposal is the managing of discretionary spend, which is already begun to slow. Looking forward, we see further opportunities to reduce discretionary spend across various work streams, including business development, advertising, and professional services. Moving to our segment performance beginning on Slide 14. Personal and Commercial Banking reported earnings of $2.1 billion this quarter, with Canadian Banking pre-provision pre-tax earnings up 5% year-over-year. Canadian Banking net interest income was up 9% from last year due to higher spreads and solid average volume growth of 7%. Non-interest income was down 1% year-over-year, partly due to a $66 million impact of retrospective HST on payment card clearing services announced in the Government of Canada's 2023 budget and enacted in Q3 2023. Excluding this, non-interest income was up 4% driven by higher service charges and foreign exchange revenue reflecting increased client activity. Year-to-date operating leverage for the segment was nearly 1%. Turning to Slide 15. Wealth Management's earnings were down 18% from last year, including the decline in profitability at City National on the back of the challenging expense environment, rising funding costs, and higher provisions for credit losses. The remaining businesses within Wealth Management saw combined earnings growth of 5% underpinned by higher net interest income in our International Wealth Management business, as well as solid asset growth in our North American Wealth and Asset Management businesses, amidst challenging market conditions. Wealth Management earnings also benefited from the gain on the partial sale of RBC Investor Services operations. Turning to Slide 16. In Capital Markets, we earned pre-provision pre-tax earnings of $1 billion reflecting the benefits of our diversified business model and market share gains across both Global Markets and Investment Banking. Corporate and Investment Banking revenue was up 74% from last year as the prior year included the impact of loan underwriting markdowns. Excluding this, revenue was up a strong 30% year-over-year underpinned by higher debt originations across all regions, share gains in M&A, and improved equity originations. Lending and other revenue was up 6% from last year, reflecting strong results in transaction banking supported by margin expansion as well as solid securitization financing activity. Global Markets revenue was up 18% from last year, reflecting an increase in fixed-income trading revenue on the back of good client flow, an improvement in the credit trading environment. These factors were partly offset by lower equity trading revenues amid lower volatility. Turning to Insurance on Slide 17. Net income increased $227 million, up 22% from a year ago, primarily due to favorable investment-related experience. The Insurance business generated gains related to movements on interest rates on assets backing reserves. To conclude, our results this quarter were largely underpinned by the strength of our leading Canadian deposit franchise as well as broad-based client-driven revenue growth. Looking forward, our full management team remains committed to rationalizing expenses with the goal of driving positive operating leverage. With that, I will turn it over to Graeme.
Graeme Hepworth, Chief Risk Officer
Thank you, Nadine, and good morning, everyone. Starting on Slide 19, I'll discuss our allowances in the context of the macroeconomic environment. As Dave noted earlier, during the quarter, we saw labor market start to soften. However, unemployment rates remained exceptionally low, which has contributed to persistent consumer demand, economic growth, and inflation. Accordingly, the Central Bank continued to tighten monetary policy, and the markets are now contemplating a higher for longer interest rate environment. With this backdrop, we added provisions on performing loans for the fifth consecutive quarter. This quarter's provisions reflect increasing levels of delinquencies and credit downgrades, a higher weighting ascribed to our more pessimistic scenarios, and ongoing portfolio growth. Provisions on performing loans were predominantly in City National and Capital Markets, reflecting the more challenging conditions in the United States. Allowances on performing loans for our retail portfolios were largely unchanged this quarter, as negative drivers were offset by an improvement in our baseline forecast for housing prices. In total, our allowances for credit losses on loans increased by $182 million this quarter to $5 billion. Moving to Slide 20, provisions on impaired loans were up $58 million or 2 basis points relative to last quarter. While provisions continue to normalize from pandemic lows, our PCL ratio of 23 basis points remains below historical averages. In Canadian Banking, provisions were stable this quarter with lower provisions in the commercial portfolio offset by modestly higher provisions on personal loans and residential mortgages. Expected losses in the retail portfolio continued to be delayed due to strong employment and elevated levels of consumer deposits. We do expect credit trends in retail to weaken as the labor markets soften and more clients are impacted by higher mortgage payments. These credit trends will be led by credit cards and unsecured lines of credit consistent with the traditional credit cycle. In Capital Markets, provisions of $158 million were up $45 million compared to last quarter. Given the relatively large size of our client's loans and Capital Markets, loans can vary from quarter to quarter. I'm sorry losses can vary from quarter to quarter. This quarter, we took a large provision on three related financings in the commercial real estate sector and a large provision on a loan in the transportation sector. In Wealth Management, provisions were also higher this quarter and included a larger provision in City National on a commercial real estate loan secured by an office property. The office segment remains challenging, given the fundamental change in demand for office space post-pandemic. However, challenges within the commercial real estate sector are not exclusive to the office segments; any property facing multiple headwinds is a greater risk in the current high rate environment. For example, the larger provision in Capital Markets this quarter was on loans secured by multifamily properties. The segment of commercial real estate that continues to perform very well in the aggregate. In this instance, the properties were now impacted by the higher rate environment, but also by elevated unemployment rates and negative socioeconomic change in the region. But we are seeing the impairments and losses we have been expecting in this sector; we remain comfortable with our commercial real estate exposure. As I noted last quarter, the portfolio is well diversified and has been originated to sound underwriting standards in support of a strong client base. Additionally, loss rates on impaired loans are typically lower in commercial real estate as they benefit from the value of the properties held as tangible collateral. And finally, losses are expected to be manageable relative to the size of the portfolio, and the portfolio is well-provisioned. Over the last several quarters, we have significantly increased reserves on performing loans; our IFRS 9 downside scenarios reflected a decline in commercial property values ranging from 15% to 40%. Moving to Slide 21, gross impaired loans were up $391 million or 4 basis points this quarter. The increase was primarily driven by capital markets, where new formations were higher, largely due to the impairment of the commercial real estate loans I noted earlier. We've now seen four consecutive quarterly increases in gross impaired loans. However, our GIL ratio of 38 basis points remains below pre-pandemic levels. So to conclude, we continue to be pleased with the ongoing performance of our portfolios. Our retail portfolio continues to outperform expectations supported by low unemployment rates and elevated consumer deposits. Despite some larger impairments during the quarter, our GIL and PCL ratios remain below long-term averages, highlighting the size and diversification of our loan portfolios. We are still expecting PCL-impaired loans between 20 basis points to 25 basis points for the year, consistent with the guidance I provided last fall. Looking forward, the impact of inflation and higher rates is expected to play out over a number of years, and we are still in the early stages of the current credit cycle. As we move further into the credit cycle, we expect to see losses driven by more systemic factors arising from the anticipated economic slowdown. Ultimately, the timing and magnitude of increased credit costs continue to depend on the Central Bank's success in contributing to inflation while creating a soft landing for the economy. We continue to proactively manage risk through the cycle and we remain well capitalized to withstand plausible and even more severe macroeconomic outcomes. 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. Our first question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.
Sohrab Movahedi, Analyst
Okay. Thank you. Neil, last quarter, I think in your segments, you were probably a little bit unpleasantly surprised by the movement from non-interest rates to term deposits. This quarter, I guess a little bit pleasantly surprised maybe not surprised, but that's what it looks like to me. I mean, when you think about this, are we stabilized or do you expect some variability around these types of net interest margins, at least on the funding side? When you look ahead over the next couple of quarters anyway.
Neil McLaughlin, Group Head, Personal and Commercial Banking
Thanks for the questions, Sohrab. Yeah, I mean, last quarter we had commented that the GIC book for personal deposits has grown $15 billion quarter-over-quarter. So, you heard Nadine comment about that trend is starting to lessen. In this quarter, it was about half of that. So, that's I think the trend we're on. Overall, I think we feel very comfortable that we continue to win in gathering deposits, where the rates are? They're still incentives for that retail investor to place that in a term investment. So, I think that's the trend. We are seeing across into those term deposits really everywhere as we monitor the flow of funds; really every category of deposits are flowing in there. But I think it's important to call out that about half of that growth is coming from external deposits. So, again, that strength of the platform to be able to gather those deposits.
Sohrab Movahedi, Analyst
Okay. Can I just ask you on the asset side? I think you've maybe noticed the intense competition on mortgages and mortgage spreads in particular. I wonder if you could just share how mortgage spreads were in the quarter compared to, I don't know, recent quarters. And then I don't know if this is a stat that you could share with us Neil, but if you had to think about the stock of your mortgage book between kind of existing mortgages and kind of net new mortgages if you are actually seeing an improvement in the LTV of one versus the other or maybe put differently are we seeing faster pay downs from savings on existing stock of mortgages. Thank you.
Neil McLaughlin, Group Head, Personal and Commercial Banking
Sure. So, I'll start with the profitability question, the margin question on mortgages. Obviously, mortgages are a key relationship product for us, but we do price our mortgages to make sure we're meeting the hurdle. And I think you heard that in the prepared comments at the top. Despite the competition, the rapid volatility in swaps has impacted mortgages, I think across the street. We said the market is competitive, but we do look at it and expect some normalization as we saw that volatility and swaps start to abate. When we look at it overall in terms of profitability, we do look at the levers we have in the short term and long term, and I think we feel very confident that we have levers over the medium term if we need to pull them to manage the profitability there. In terms of your second question around LTV and pay-downs, we are seeing I'd say some trends there where clients are saying I'm going to make some lump sum payments upon renewal to take down the impact of that payment shock. And then on LTVs, I'd say at origination, we are seeing a slight decrease of LTVs at origination, but not something I would say worth calling out the portfolio overall.
Sohrab Movahedi, Analyst
Okay. Thank you.
Operator, Operator
Thank you. The following question is from Doug Young from Desjardins Capital Markets. Please go ahead.
Doug Young, Analyst
Good morning. Maybe this is for Dave, but big picture question, you talked a bit about interest rates and the impact at the beginning of your comments. Can you talk about the key impacts on Royal's results and NIMs or credit or whatever metric you want to talk about from a higher for longer rate environment and generally as the impact more positive, as the impact neutral or negative? Just love to hear your thoughts. I get this question a lot; I'd love to hear your thoughts on this.
David McKay, CEO
Yeah. Thank you for that question. It was an important part of the overall economic construct trying to forecast what type of lending we might have. And Canada differs from the United States in the construct of higher for longer. And if you look at the U.S. style mortgage when you have so many U.S. mortgage holders who are in 30-year fixed open mortgages, it gives them enormous flexibility in times of rising rates and persistently high rates; those interest yields that they're paying on their mortgage are kept low, and they have disposable income to spend in the U.S. economy and you're seeing why the U.S. economy has had this persistent inflation challenge more so than Canada. The reverse is true in Canada because we have five year terms, four or five year terms. We reprice that the amount of disposable income that's being pulled into debt servicing of mortgages slows the Canadian economy down more quickly, which is why Canada is a little bit ahead of the curve in most western countries in getting inflation under control. But going forward, the period of time that the Bank of Canada has to hold at these rates then to make sure we've brought inflation down to our targets is critical as you know, we have the industry has a significant portion of mortgages maturing in '24, '25; the rate resets if rates hold will pull more disposable income out of the economy and slow it even faster. So, it's hard to predict how much spending will slow; we're starting to see spending slow right now. So, it's important to contrast a bit the two economies and the amount of disposable income that will go to service mortgages given the structure of the industry. And therefore, for that reason, for business investment and community, it's more important for Canada to start easing than it is for the U.S. for those factors. So, we watch closely inflation rates are coming down, core inflation rates are coming down nicely, and if we can start to ease in 2024 that's going to really help the economy get through this to a soft landing. Does that help?
Doug Young, Analyst
It does. I'm more interested in how you think that kind of flows through your results? And I’m sure you get these questions internally and from the board and what not, but I'm just curious as to if we don't have that easing what types of pressures like obviously there's benefits in certain aspects of your business pressures and other like what's the ultimate impact on your business if we stay higher for longer? Isn't it more positive, neutral or negative? That's kind of where I was hoping to go.
David McKay, CEO
Certainly. The emphasis is on medium to longer-term rates rather than short-term rates, as we're analyzing how the market anticipates rate changes. Our mortgage rates are based on swap curves, particularly the five-year and four-year curves. With the market expecting inflation to remain elevated, we've seen a recent increase in rates across various markets, which will influence mortgage resets for clients. As Nadine mentioned, the rise in rates has positively impacted our deposit book by increasing our earnings from it. This influx of customers into our deposit offerings is a significant factor in our net interest margin growth. We need to find a balance between the short-term benefits from our strong deposit portfolio and potential challenges our clients may face on the credit front due to higher rates. Our bank continuously navigates these two dynamics. Additionally, it's crucial to consider our asset betas. I noted that U.S. regional banks have effectively passed on cost increases to customers through higher asset betas, outperforming Canada in this regard. The competitive landscape in Canada has hindered our ability to do the same, particularly in the mortgage sector, although we are seeing some progress in transferring increased costs to GICs. However, the U.S. remains ahead in managing higher deposit betas alongside asset betas. We are optimistic that Canada will eventually adopt a similar approach, which would enhance our performance as we continue addressing the increased costs discussed in previous quarters. Now, I’ll pass it over to Nadine for further insights.
Nadine Ahn, CFO
Thank you. I want to highlight our interest rate sensitivity as detailed on Slide 26, which shows that we benefit from rising interest rates. This is reflected in the expansion of our net interest margin this quarter, thanks to our structural deposit base. As interest rates remain high or continue to rise, we will see sustained benefits from this deposit base in terms of margin expansion. Additionally, as Neil noted, we are focusing on managing our margins on the asset side, which will lead to overall margin growth for the retail bank. We've also discussed the implications regarding our U.S. operations, specifically whether we can leverage our asset sensitivity. City National is indeed poised to benefit from asset sensitivity. Though deposit betas are increasing, our growing interest rate sensitivity on the liability side will enable us to capture advantages on the asset side as well. Therefore, we anticipate that our core banking segment will benefit from higher interest rates, and we can further discuss how inflation has already impacted our cost structure. Overall, it’s going to result in a net benefit despite some societal impacts.
David McKay, CEO
Thanks, Doug.
Doug Young, Analyst
Okay. Appreciate the color. Thanks.
Operator, Operator
Thank you. Our following question is from John Aiken from Barclays. Please go ahead.
John Aiken, Analyst
Good morning. Graeme, I wanted to leave a nitpicking on commercial real estate to others but on Slide 33, you go through the past-due delinquencies in Canadian Banking. And not surprisingly, we're seeing personal start to uptick, but a little bit unusual is the decline that we've seen in credit cards over the last couple of quarters. Can you talk to that? Is this just noise in the system or is there something fundamentally different that's happening in cards versus mortgages, HELOCs, and other personal lending?
Graeme Hepworth, Chief Risk Officer
Yeah. Thanks, John, for the question. I wouldn't say there's anything specifically happening in cards; I mean cards do have a seasonal effect to it, and so you're going to see it ebb and flow through the year. But overall, what's driving all of this right now is a very strong employment backdrop. But the unsecured products overall, we do expect those to trend negatively. Why you see something like the personal lending, in particular, the RCL product trending more negatively now is it more rate-sensitive and directly rate-sensitive, right? So there is a direct impact that flows through to the consumer on that. And as interest rates rise, you'll see that kind of continue to trend that way. We do expect cards to trend more negatively as we kind of work our way through this year and into next year because there's an unsecured client base that we think will be most impacted as we work our way through this cycle.
John Aiken, Analyst
Thanks, Graeme. And I know that your U.S. book is dramatically different than the Canadian book, but are we seeing similar trends on the U.S. delinquencies as we are in Canada?
Graeme Hepworth, Chief Risk Officer
We don't really have much of a retail book in the U.S. Our retail book in the U.S. is really tied to a high net worth affluent client base, and so it's largely a mortgage book, and we really haven't seen any indicators of any negative trends there at all.
John Aiken, Analyst
Perfect. Thank you.
Operator, Operator
Thank you. The following question is from Gabriel Dechaine from National Bank Financial. Please go ahead.
Gabriel Dechaine, Analyst
Good morning. My daughter wanted me to ask if the Avion card really helps you get the Taylor Swift ticket, but I'll stick to a couple of questions on the Canadian bank here. The deposit flows, and we've all seen the improvement there and stabilization of pricing and mix. I'm just wondering, one of your major competitors seems to be playing catch-up on GIC pricing in the last couple of months, and I'm wondering if that could be at all disruptive to what has been an improving trend? And then my second question is on the mortgages. And correct me if I'm wrong, but I don't believe your floating rate fixed payment mortgages negatively amortized. I'm wondering if that is correct; is there an accounting or capital impact because if I'm trying to simplify things, those borrowers aren't actually paying you as much as they should, but should otherwise be negatively amortizing.
Neil McLaughlin, Group Head, Personal and Commercial Banking
I'll take the questions in order. First, your daughter is correct. The Avion program allows you to enter the queue for Taylor Swift tickets. Regarding GIC pricing, there has been increased competition recently. One competitor has re-entered the market, but competitive pressures are strong overall. However, pricing is just one aspect; having access, a capable sales force, and a platform to connect with depositors sets us apart, and we are optimistic about our ability to succeed in that area. Over the past year, we have seen a rise in market share in the GIC sector, so we feel confident there. As for your question about mortgages, our variable rate mortgages do not allow for negative amortization, which is what our contract specifies. I hope that clears things up. There are various structures out there, but we don't operate that way. Also, it's important to note that our GIC product is attracting new clients, contributing to our overall client growth from GIC originations.
Gabriel Dechaine, Analyst
Just to follow up on the negative aspect. If it did occur, you would see the loan balances increase due to the excess payments that are not being received. I just want to clarify that there is no accounting or capital impact related to your specific product line.
Nadine Ahn, CFO
To be clear, the reason it doesn't go negative amortizing is the client actually has their payment reset.
Gabriel Dechaine, Analyst
Okay. All right. That makes sense.
Nadine Ahn, CFO
We’ll take the next question.
Operator, Operator
Thank you. The following question is from Meny Grauman from Scotiabank. Please go ahead. And I just want to remind participants to limit yourself to one question. Please go ahead.
Meny Grauman, Analyst
So the question is just for Neil, going back to the GIC trend that's improving or that growth is slowing. Just trying to better understand what is driving that from a high-level perspective, is it just that the clients that have moved money have moved it already? And so that's the fundamental question. Whether there's a risk that changes, if the rate environment continues to move higher, is there still a risk here that you could see a reacceleration?
Neil McLaughlin, Group Head, Personal and Commercial Banking
Thank you for the question. There are a few factors to consider. When we monitor flows from different products, we notice that in our core checking accounts, there has been a softening of balances. The current high-rate environment has been in place for quite some time, and for those looking to make a switch, much of that has likely already occurred. Additionally, when analyzing this category, we see movement primarily from individuals with very high balances, over $100,000, which seems to be diminishing. Another trend is the level of confidence among retail investors. We have observed negative net sales in our mutual fund platform, but now it's nearly flat. As investor confidence increases and these individuals re-enter the market with their funds, this will represent another trend we are watching.
David McKay, CEO
It's Dave. To expand on that, as we examine how customers in the U.S. and Canada maintain their core balances, we notice that the average balance across most customer segments remains higher than it was before the pandemic. While growth has stalled, customers are still maintaining higher balances for various reasons, including a sense of safety and security due to past economic shocks and inflation. In Canada, consumers are carrying about 19% to 20% higher average balances. This stability is crucial. In the U.S., the ratio of non-interest bearing balances to total balances, which has historically been around 15%, is currently close to 25%. This indicates that U.S. consumers are holding a significant amount of surplus liquidity in their core balances, although this is declining faster in the U.S. than in Canada, where it remains stable. This surplus savings provides a cushion during downturns and assists in debt servicing even when individuals experience shocks to their financial situations. However, there is still the question of how this money will transition back into mutual funds, GICs, or remain in core checking accounts, and we are trying to anticipate these movements, which is a crucial point to understand.
Meny Grauman, Analyst
Thanks for that, Dave.
Operator, Operator
Thank you. Following question is from Ebrahim Poonawala from Bank of America. Please go ahead.
Ebrahim Poonawala, Analyst
Good morning. Nadine, could you provide an update on time and expenses? Slide 12 is very helpful in illustrating the path to the $7.861 billion this quarter. As we consider the strategies you've outlined for Q4, and with HSBC Canada set to open in the first quarter of next year, could you share your thoughts on future expense growth and the potential for positive operating leverage? I'm uncertain whether we should expect the $7.8 billion figure to decrease or remain the same as we look towards 2024 and the HSBC Canada closing, or if there might still be some upward momentum for that number.
Nadine Ahn, CFO
Thanks for the question, Ebrahim. A very important conversation. So we've been very vigilant and you see on Slide 13 where we started to break down some of the actions we've been taking since we had our conversation on the call last quarter. We are not done. We were moving forward, as we indicated in Q4 to further reduce our headcount by the 1% to 2%. Obviously, there's going to be some severance costs that come with that in the fourth quarter. And so you're going to start to see the benefits of that run rate pushed through into 2024. We are looking to continue to moderate on our discretionary expense, and you saw that come down in terms of the increase in Q3, and then we're going to look to do that more as we go into 2024 as well. And we're going to evaluate where we're at from our headcount and look at where we can address our structural cost base more explicitly as well into 2024. So the expectation is that we are going to look to slow down significantly our growth in NIE into next year, just coupled with the actions we've been taking to date as well as what we're planning on a go-forward basis. Sorry, HSBC, obviously we've been outlining our cost base, and we outlined in terms of the $1 billion as part of the integration there.
Ebrahim Poonawala, Analyst
Understood. And just as a follow-up, when you think about operating leverage, was the response to the earlier question that we should see the Canadian NIM drift higher in this backdrop if the Bank of Canada holds rates?
Nadine Ahn, CFO
Correct. Yes. We start to see the benefits of that structural deposit base and the rates continuing to persist up, marshalling any other shifts in mix we've been discussing.
Ebrahim Poonawala, Analyst
Thank you, guys.
Operator, Operator
Thank you. Following question is from Paul Holden from CIBC. Please go ahead.
Paul Holden, Analyst
Thank you. Good morning. So I want to continue with the interest rate conversation a little bit of a different angle versus Doug's question because this is an important one. Just as we're heading into 2024, I think the market expectation for central banks, both in Canada and the U.S., is to reduce rates, which traditionally would be a negative, I think, on NII. Is there anything different in this scenario just because of the dynamics we've seen over the last six, nine months that might mean central bank rate cuts are less of a negative than you've historically seen?
Nadine Ahn, CFO
I believe it's important to focus on the impact of rising interest rates we've experienced so far and the ongoing benefits for our margin expansion. When we discuss potential interest rate decreases, we highlight the immediate effects on the overall curve. We're still benefiting from the interest rates that have already increased, and while we face a risk from potential decreases, we've managed our interest rate exposure and have taken measures to mitigate that through our hedges. Additionally, the advantages of lower interest rates would likely relate to refinancing in the mortgage sector and easing some of the refinancing burdens for our customers.
Paul Holden, Analyst
Okay. So if I understand you correctly, Nadine, then central bank rate reductions in 2024, if the long end of the curve stays where it is, is not necessarily that much of an NII or earnings negative?
Nadine Ahn, CFO
Correct. You can tell us on our sensitivity that particularly for Canadian Banking, more of their interest rate sensitivities on the longer end of the curve past two years, yes.
Paul Holden, Analyst
Got it. Okay. I’ll leave it there. Thank you.
Operator, Operator
Thank you. Following question is from Mario Mendonca from TD Securities. Please go ahead.
Mario Mendonca, Analyst
Good morning. Dave and Nadine, as I go through your presentation, it appears that the steps the bank is taking to address expenses, they seem incremental, like taking FTE down another 1% or 2% talking about marketing and travel. That's my impression from the outside looking, and this seems very incremental. And part of the reason why I'm offering that is when you look at City National, the business isn't profitable anymore. I mean, a business you paid over $5 billion for in 2015 didn't make any money this quarter. So, it seems like the issues are much bigger than can be addressed by an incremental move on expenses. So, I guess what I'm asking here is, is there something in place for a more drastic move to take expenses down to address City National, for example, or just the bank as a whole? I mean, do you agree with me that the steps are incremental?
David McKay, CEO
I will begin, and then Nadine will elaborate. The overall reduction in FTEs takes time to receive the necessary regulatory approvals, especially for a large bank. I agree that FTE reduction is part of a larger expense reduction strategy that is significantly more extensive. As we aim for slower growth in Q4 and into next year, it is due to the various actions we are undertaking related to discretionary items that haven't been detailed in the slide. This is indeed part of a broader and more ambitious program that we will discuss further in the upcoming quarter. We initiated the first phase of FTE reduction through natural attrition and by slowing down operations. In Q4, we accelerated this process now that we have the necessary approvals, and we will keep pursuing it. It's important to remember that we have to manage one of the most complex transitions with HSBC next year, which is why we have additional non-interest expenses. This gives you the bigger picture: it is part of a larger cost reduction initiative designed to have a significant impact on our cost trajectory, so don’t focus solely on the FTE aspect. Regarding City National, we faced numerous headwinds this quarter, including credit losses related to a real estate issue Graeme mentioned, the considerable impact of deposit betas, FHLB borrowings, and rising costs to meet various expectations. However, this business is poised to benefit from asset repricing significantly in the next quarter and year. Unfortunately, it has fallen short of our expectations for this year. This drastic change has been noticeable since the financial difficulties in the U.S. banking system in March, which led to liquidity issues faced by all regional banks, resulting in similar challenges with NIM decreases and expenses. We do have a plan to address these expenses, and you will see an improvement in City National's performance moving forward.
Mario Mendonca, Analyst
One quick thing about the Basel III end game. You mentioned that the higher capital requirements could be a negative for the bank. My impression is that while it may impact U.S. banks, our Canadian banks, particularly their intermediate holding companies, might actually benefit from this. What's your perspective? Is the Basel III end game a negative for the Canadian banks operating in the U.S.?
Nadine Ahn, CFO
Thank you, Mario. I'll address that. You're right. It won't have a broad impact on RBC as the results indicate we have managed well from a regulatory capital perspective. The question may be more about how we finance operations in the U.S. regarding our legal entity there to ensure our capital ratios are intact. However, the implementation timeline is lengthy, and there will be ongoing discussions to ensure the U.S. doesn't feel unfairly penalized compared to the rest of the world. So, this will take time to implement. But specifically for Canada and RBC, it won't affect us from a regulatory standpoint.
Operator, Operator
Thank you. Our following question is from Lemar Persaud from Cormark Securities. Please go ahead.
Lemar Persaud, Analyst
Thank you for the additional slides on NIE growth. Considering the 1% to 2% reduction in FTEs for next quarter, how should we anticipate that affecting human resource costs? This quarter, FTE numbers decreased by 1% sequentially, but human resource costs, which encompass salaries and variable costs, increased by 4% sequentially. Is it correct that there's a lag effect due to higher severance costs? When can we expect to see the benefits of that?
Nadine Ahn, CFO
So correct, Lemar. I think in terms of the headcount reduction that you saw in this quarter to Dave's comment, it was primarily managed through attrition. So that will start to play out one quarter's impact is not going to be as significant. You'll start to see that play out more on Q4. Related to the 1% to 2%, we will have severance that would overwhelm any benefit as it relates to an actual reduction in salaries in the fourth quarter. So, the run rate benefit will that start to persist in Q1 of 2024.
Lemar Persaud, Analyst
Okay. So we're going to see more of an impact as we move forward into next year. I think that's the...
Nadine Ahn, CFO
Correct.
Lemar Persaud, Analyst
And then just following on that, more broadly, I think you guys are clear suggesting Q3 would be a transitional quarter in your actions to reduce expense growth. But how should we think about Q4? Because is there anything you guys are doing to limit the seasonal bump we typically think of in Q4?
Nadine Ahn, CFO
Yes. I mean there are things that obviously are going to come in play from a timing standpoint in Q4 that we will not be able to avoid. However, we are very focused on our spend and particularly our discretionary spend, which sometimes you do see tick up in the fourth quarter. There are some types of fees, for example, as well as some marketing that may come through. But we are focused on reducing our overall growth trajectory in the fourth quarter based on the actions we've taken to date. And you will expect to see that come down to more the mid-single digits in a growth trajectory.
Lemar Persaud, Analyst
Thank you.
Operator, Operator
Thank you. Once again, we ask that you limit yourself to one question and then come back on the queue. The following question is from Nigel D'Souza from Veritas Investment Research. Please go ahead.
Nigel D'Souza, Analyst
Thanks, guys. Good morning. I wanted to circle back on City National and maybe get some more insights on the deposit trends. When I look at the loan-to-deposit ratio, that's moved up substantially over the last two years. Deposits are pretty much back to where they were in 2021, but your loans have increased. Trying to get a sense of the runway here for that mix to shift? Could you give us a sense of how much non-interest-bearing deposits are remaining in terms of the mix at City National? And is there a need to continue to offer higher interest rates on interest-bearing deposits to maintain the liquidity at City National given that the loan-to-deposit ratio has moved higher?
Nadine Ahn, CFO
Thank you for your question. Overall, we have seen stability and a slight increase in our deposits, which is encouraging as we manage to hold them. You are correct that there has been a shift in our deposit mix. Specifically, the percentage of non-interest-bearing deposits has decreased from 45% in Q1 to 37%. This change is contributing to the compression in our net interest margin. We are taking steps to rebalance our deposit mix by increasing our sweep deposit balances, which come at a lower cost compared to the recent increases in CDs. Additionally, loan growth has slowed down, and we anticipate this trend will help us manage our funding levels without having to rely more on higher FHLB funding moving forward.
Nigel D'Souza, Analyst
Okay. But fair to say that you kind of have to give up some margin there to maintain?
Nadine Ahn, CFO
I would say that we've already given up some margin in our trajectory, but we are looking to improve that moving forward as we bring in more lower-cost deposits in the sweep balances. While these are high beta, they are less expensive compared to some of the increases we've experienced throughout 2023.
Nigel D'Souza, Analyst
Okay. That’s it for me. Thank you.
Operator, Operator
Thank you. Following question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.
Sohrab Movahedi, Analyst
Hey. Thanks for squeezing me. Last one from me. Nadine, I've just looked at the last four quarters anyway, the effective tax rate on the adjusted at the total bank level, I don't think has ever been below 20%. How would you like us to model this over the next few quarters?
Nadine Ahn, CFO
I appreciate you getting your last question in, Sohrab. Regarding the tax rate, I can provide some guidance. Most of it was influenced by capital markets, and we expect this trend to continue into Q4. Moving forward, you can likely estimate the effective tax rate for RBC to be in the range of 19% to 20%.
Sohrab Movahedi, Analyst
I appreciate you squeezing me. Thank you.
Operator, Operator
Thank you. That's all the time we have for questions. I would now like to turn the meeting back over to Mr. McKay.
David McKay, CEO
Thank you, operator, and thanks, everyone, for your questions. Just to kind of sum up the quarter, I think very strong performance from our customer franchises on revenue growth, as you saw, strength of diversification, whether it was in Canada and our ability to grow our commercial and consumer businesses, our wealth businesses and combined with our global businesses, we didn't talk at all any of the questions about the real strength in capital markets this quarter, particularly in global markets and trading, credit trading was very, very strong. We saw good market share gains in investment banking, as well as our advisory businesses are really kicking in and strong corporate banking performance. So I think from that perspective, very strong capital markets operations, fairly strong U.S. wealth, and our advisory and broker in the U.S. as well. So those global franchises were very strong. And the importance from all the questions on our deposit franchise, where it's U.S. dollar deposits and particularly Canadian dollar deposits, how they move, how do consumers behave, has a big impact on all banks, including ourselves. It's a core strength of ours and are generally low beta, and particularly in comparison to peers. And that strength has led to NIM expansion, very important this quarter and will continue to benefit as a tailwind over the coming quarters and years. So very, very important to talk about that. And then I would say balance sheet strength. Diversification of our balance sheet, the global diversification of our balance sheet, customer diversification of our balance sheet. You saw some strong credit performance in a volatile world. I think continued strong performance and very, very excited about HSBC as we move forward and continue to plan for and wait for to hear on approvals but also plan for conversion and close in the coming quarters. So we feel very good about our customer momentum and what's in store for the coming quarters. Thanks very much and we look forward to seeing you next quarter.
Operator, Operator
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.