Royal Bank Of Canada at National Bank Financial Services Conference
Mar 26, 2014 AM EDT
RY.TO - Royal Bank of Canada
Royal Bank Of Canada at National Bank Financial Services Conference
Mar 26, 2014 / 05:10PM GMT
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Corporate Participants
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* Janice Fukakusa
Royal Bank of Canada - Chief Administrative Officer & CFO
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Conference Call Participants
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* Peter Routledge
National Bank Financial - Analyst
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Presentation
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Peter Routledge, National Bank Financial - Analyst [1]
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Welcome back everyone. Thanks very much for being back.
Beside me here is Janice Fukakusa, Chief Administrative Officer and Chief Financial Officer of Royal Bank of Canada. Janice, thanks very much for joining.
And welcome to warm Montreal. So we'll start with our standard what are the key messages you'd like folks to take away from today?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [2]
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Great, thanks Peter and thanks for having us here today. I think as you all know we had a pretty solid Q1 and we are off to a good start this year.
When you look at our earnings, if you exclude some of the specified items, we reported CAD2.2 billion of earnings and 7% earnings growth. And I think that's off the back of a very solid performance of art Canadian Banking platform. Volumes are growing in the mid-single digits and we are on the retail side and a little bit higher on the business side.
We are managing to hold our own on the cost side. Our Capital Markets platform had a pretty solid quarter. Strong growth on the corporate investment banking side so you see the impact of our shift in business mix to more corporate investment banking type of traditional wholesale activity and away from some of the trading activities.
Our Investor Services platform, very strong growth because you see the results of a lot of the retooling and resizing we have done around the cost base in that particular entity. Our wealth business is tracking high on the revenue side reflecting good growth in the markets. I think that we've had a bit of a one-time items with respect to some specific loan-loss provisions and some volatility in some of our stock-based comp that has caused the earnings growth to be a little bit lower than we expect and then what we should have going forward.
And then if you look at our insurance business, insurance is generally a solid performer. We have had some good performance there.
So I think if you look at the total basket of businesses, we think that we are off to a good start. We are still cautiously optimistic about the environment. It is fairly benign.
And I think one of the other things I would like to point out is our solid capital positions. We ended the quarter with 9.7% common equity Tier 1 ratio. We were building capital because of some of the new capital requirements around credit valuation adjustments and our new accounting for pension expense.
And we think that we are in a pretty strong capital position. You saw our affirmation of that in our declaration of a dividend increase. We increased it a little bit higher than I know market expectations were just to confirm our feeling about the solid results we had in Q1 and our pretty strong capital position.
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Peter Routledge, National Bank Financial - Analyst [3]
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Okay, maybe we'll kick off with a question about the CEO transition underway this year. I think if you look back over Gord Nixon's tenure you would see that he pretty much strengthened and solidified a pretty diverse array of franchises and leaves Dave McKay with a pretty good head start. What do you think Dave McKay's overriding challenge is and what do you think RBC looks like when he transitions?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [4]
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Those are pretty tough questions because you are asking me to predict the tenure of a person who hasn't started their job yet. But when you look at what we expect, I think that looking at where Dave McKay has come from and the fact that he is homegrown and he has worked at the bank in several divisions for a lot of his career, we are not expecting any exponential shift in anything we are doing.
Because I think it that if you look at our business strategy it has been supported by our diversified business model of making sure that through the cycle we always have a good businesses that carry us through and reduce any impact of potential earnings volatility. So when you look at what has happened over the 12 years since Gord has been there, you're right, he really solidified that. He created a lot more focus on cross platform leverage, cross platform synergy and making sure that we all serve the client with that single lens.
When You look at Dave McKay, I think it will be more of the same. There is the ability now in terms of where we sit with capital to look at capital allocation and to look at where we are investing. So I think that you will see tweaking of our strategy around recognition of the role of technology in what we do and what is happening in financial services.
I think that you will see a continued focus on the client in the near term because of the fact that we are in uncertain economic environments. And it's extremely important for us to maintain that lead that we have over our competitors in terms of serving the client, in terms of driving revenue and earnings growth.
I think that going forward putting Dave in there with a strong retail banking background is in recognition of the fact that technology and financial services are intimately linked. In order to get to that next playing field we need to really ensure that we're investing in all cylinders with respect to both our technology backdrop and are supporting the clients.
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Peter Routledge, National Bank Financial - Analyst [5]
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Okay. In thinking about Royal's earnings mix we do have a weighting of about 50% to Canadian Banking, in Capital Markets, roughly 25% in wealth and other businesses the remainder. And if you think about macro headwinds, Canadian Banking segment does face some macro headwinds, slowing household loan growth and tighter or at least tight margins that don't seem to be easing up that much.
And then you look at the growth in the capital market segment and particularly in the US we've seen tremendous growth. 60% of your revenues now from the US capital market.
You have this 25%/75% guideline, let's call it, of split of earnings between Capital Markets and retail. How flexible would the bank be in allowing Capital Markets to take up a little bit greater share if the growth was there?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [6]
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I think, Peter, we are pretty comfortable with the 75%/25% split because it is served us well as a diversification strategy throughout the cycle. And Capital Markets is not constrained at all in terms of organic growth.
When you look at the organic growth that is there you see the difference in the business cycle manifesting itself in some of the other platforms. So in addition to the growth in Capital Markets, we see platforms like Investor Treasury Services; whilst when you look at core run rates is also growing.
So I think that there is enough, and Canadian Banking is still growing. It is growing at a less robust rate than it was last year but we still had a earnings growth of 4% to 5%. And it will continue to grow and it is over 50% of our earnings base.
So it takes a lot to shift that mix. We think that in terms of capital allocation, for Capital Markets it is about optimizing balance sheet. Because at the margin all of the Basel III capital that we have taken on, the balk of it has gone towards our Capital Markets platform. So we have a job to do in optimizing our returns there.
You've seen the shift in business mix to more traditional corporate investment banking business which has very non-volatile and solid return on equities. And we are hoping that as we work through the last vestiges of Basel III and some of the heavy lifting on implementation, we can continue to optimize and continue to deploy the existing capital and Capital Markets at higher return on equity.
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Peter Routledge, National Bank Financial - Analyst [7]
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At the last earnings conference call Gord Nixon lamented the rather expense evaluations in wealth management, for wealth management companies that might be acquired or potentially acquired. But that is a clear strategic focus for Royal.
So to what extent would the Board of Directors consider a transformational wealth deal that might be accretive on an EPS basis but was dilutive in terms of ROE? Is that off the table or is there situations where that might pass?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [8]
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I think that is a great question because that is the dilemma that we have in looking at acquisitions. It is what is the value of earnings growth? Because we believe earnings growth drives the organization and drives our valuation.
And how do we look at that earnings growth in contrast to return on equity dilution. So when we look at wealth management acquisitions, we know for sure there is return on equity dilution because of the large upfront investment. There is no usage of balance sheet or very nominal use of balance sheet and capital.
So that when we look at the business case, what we look at is not so much what happens on day one but how long does it take us to a accrete back into our return on equity benchmarks and our guidelines. So how long does it take us to accrete back into return of capital, say our 10% benchmark and then up to the 18% return on equity.
And we look at time frames of about three to five years because we think that is a reasonable period where we have EPS accretion and we can work on the synergies that are not just with growing the individual unit or platform that we buy but synergies across the bank and distribution in other areas in that. And by aggregating all of that returns grow back into the return on equity target of 18%.
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Peter Routledge, National Bank Financial - Analyst [9]
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I will go back to the audience in a second. Just one question, on the Canadian household. There are a vocal contingent of investors who continue to argue that the Canadian housing sector is due for a hard landing and then that will ripple into a credit crisis amongst at least a significant subsection of Canadian households. So I will be presumptive and ask why do you think these investors are wrong?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [10]
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I think they could be right in a different timeframe. And what we haven't seen any evidence of any excess of house price appreciation, really throwing out a lot of borrowers being in distress and defaults.
What I would say is the message about the over leveraging of the Canadian consumer has been heard loud and clear by the Canadian consumer. There is way more prudent activity and terms of areas like refinancing at fixed rates as opposed to taking variable rates mortgages to reduce any risk of interest rate increases.
Our portfolios are pretty -- anything negative is very benign. We know that in the business side you can have one off losses. It's the variability of what is happening but we haven't seen any buildups of nonaccrual loans, we haven't seen any charge up ratios increasing and we have seen prudence on the consumer side which is why the volumes are reducing.
I think that it is an area that we need to of course continue to watch. You never take your defenses down and at the margin look for areas where you see some decline and you can get in there before you get a negative experience. So I think we're watching all of us but we haven't seen anything.
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Peter Routledge, National Bank Financial - Analyst [11]
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Okay. And then related to that I mean mortgages is a secured product. RBC does have a fairly good weighting towards unsecured household debt.
Can you talk about your current credit risk appetite towards unsecured household credit? And how that might change if we started to see some weakening in the housing sector?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [12]
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When you look at unsecured credit, a lot of that is the credit card business that we have. And when you look at what our risk appetite is I would say that we are well below our risk appetite in terms of some of the loss ratios we are sustaining. And it is a brisk return dynamic.
In all the businesses we are in, we set our risk appetite at the beginning of the year and it's part of our five-year planning process. And we do not have any areas that we are looking at in terms of having to expand the risk appetite to generate the returns that we expect that we will be continuing to generate and to hit our medium-term targets.
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Peter Routledge, National Bank Financial - Analyst [13]
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Okay. Go out to the audience and we have a hand up here.
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Questions and Answers
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Unidentified Audience Member [1]
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I'm sorry if this question appears to come from left field but I was wondering the application of the Volcker Rule, how will that affect your ownership of assets management businesses, if it will affect you at all?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [2]
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That is a good question and it is a topic of our studying and doing a lot of work around that for our US business. It will not have any effect on our retail asset management businesses or what sits in wealth. Where it will have an impact is in our global arbitrage trading business, where we have some proprietary trading capability in the US.
And so we are in the process of looking at how we restructure around that business and basically adhere to the rules and ensure that we are not violating and doing proprietary trading in the US. So that is something that we are working on. And just from a sizing perspective, if you look at our prop trading revenues, they are about 1.5% of total revenues and so it is not a significant thing for us.
And we're just talking about the US component. Our other platforms outside of the US are fine.
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Unidentified Audience Member [3]
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I was under the impression that if you were contaminated in the States it moved up to your other platforms, number one. And number two I was also under the impression that your asset management business for institutions, not for individuals but for institutions, was also affected.
Perhaps my impressions were wrong but nevertheless I would still like to hear you on the subject. Thank you.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [4]
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I think one of the things that happened through the many iterations of Volcker was that the extraterritorial nature of what was happening was fairly contained. So our interpretation, which seems to be the interpretation of the market, is it is about that US business as well as our discussions with some of the regulatory bodies and our counsel. And with respect to what you are saying on the institutional asset management, we are not aware that -- and I guess it depends on the definition of institutional but -- and we can have that conversation later but we are not aware of any impact on that.
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Unidentified Audience Member [5]
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In relation to Mr. McKay's description, you referred to his background as being fairly strong on the retail side and the current importance of technology. I am just curious could we see Royal use technology and its retail expertise to enter other geographies other than Canada?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [6]
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That is a good question. And it is on the strategic side something that we do talk about and examine and more in partnership with other companies in that.
So I think that what technology is an enablement across the board so when we're talking about technology it is really about serving what our clients want. And so we have been looking at the potential for partnerships around that.
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Peter Routledge, National Bank Financial - Analyst [7]
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Okay, I will come back to maybe a question about RBC Capital Markets. I mentioned this earlier but RBC Capital Markets now gets 60% of its revenues from the United States.
The first question I have noticed, the revenue stream is much less volatile than what we have seen at other US investment banks. So maybe you can help us understand why that is so wired, why aren't we seeing more volatility in the revenue line?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [8]
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Will I think it is the mix and the composition and the fact that you see a lot more of that revenue coming from the corporate investment banking business. So it is spread income and CE income.
I think that from a trading side, we have taken a lot of time to optimize our capital usage and focus on volatility. And while there is still some volatility arbitrating side I would say that is less pronounced now because a lot of the trading activities are focused on client flows to support our corporate investment banking business.
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Peter Routledge, National Bank Financial - Analyst [9]
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Okay. And then I wonder if you could also sort of give us an update and compare and contrast the US strategy to the strategies RBC Capital Markets has in Europe and Asia.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [10]
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That is a good question. And I think that the strategy are the same in terms of long-term focus but what you see in the US is that there is a lot of activity there in the market in terms of what is happening with corporates and building and M&A.
So you see us leveraging more of the capability we have to put business on there. And we are in a pretty good spot because it took us 10 years to build the capability in the sectors that we're really good at and we are able to actually capitalize on that.
Europe is a different environment because the economy is not robust. It is not growing. So while we have capability on the corporate investment banking side, we are carefully trying to ensure that we are not deploying too much and spending too much on the capability in advance of revenue streams.
And I think in Asia on the corporate investment banking side we are more of a fixed income product distribution bank. And it is nascent in terms of developing but we are still trying to get their industry sector coverage and getting into more traditional corporate investment banking.
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Peter Routledge, National Bank Financial - Analyst [11]
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Okay. In wealth management, you know, obviously, one component of that business is your high net worth business. And it does at least from my perspective tend to fly under the radar.
And it is a business where RBC has grown this presence pretty steadily and it is a fast growing business. I think it is fair to call it a growth market.
If you look at any global wealth report, you will probably draw that conclusion. So can you talk about in what particular geographies the bank is strong and where is the bank focusing its efforts?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [12]
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I think we are very strong in Canada because we have the benefit of our whole franchise. And we have taken the capability in investment management that we had when we acquired PH&N and put that together with our own high net worth capability in private banking.
So you will see some growth in the marketplace in Canada. In the US, we are targeting that sector. We do not have as full of product breadth but we are targeting more on the assets under management side and getting some of the flows there.
And I would say that in Europe, the European economy is not that robust but we have seen because of our AA rating and our Canadian bank posture as being pretty safe, lots of deposit flows from high net worth and that is what we target into our banks there and through our Channel Islands operation. And even into Canada because of that whole quest for diversification of dealing with financial institutions and the view that Canada is pretty safe.
So I think that sort of sums up where we are growing. So you are right, it is all organic and it is for the markets going so we do have more investment at the margin there.
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Peter Routledge, National Bank Financial - Analyst [13]
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Okay. We are closing down to the end of the interview so we've got a question out here.
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Unidentified Audience Member [14]
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Can you share with us maybe your thoughts on NVCC and the bail-in debt?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [15]
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On NVCC?
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Unidentified Audience Member [16]
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And in bail-in debt.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [17]
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Okay so we -- NVCC it is a recovery estimate. So you saw that in January we issued the first NVCC pref share issuance and that is good capital. That is good Tier 1 capital.
From a leverage perspective it is usable and we think that there is demand and that was sort of proven out when we issued in the Canadian marketplace for pref. And we were in the process of redeeming some of our pref instruments.
So it was a good thing for us. We wanted to -- it took a long time to get there with our regulators in determining conversions and triggers and we really wanted to get there quickly because there was a demand in the marketplace and acceptance.
I mean some of the issues around ratings, potential ratings from the rating agencies were solvable from our perspective. And we think that we had a pretty successful issue. We targeted CAD250 million to CAD300 million, demand was over CAD600 million and we closed out at CAD500 million.
And I think the good news after we closed the deal is that two other banks issued and it was readily taken up. So of course we are now focused on sub debt. And we need to get there with our regulators in terms of looking at triggers and dilutions.
When you look at bail-in, bail-in is really a resolution tool. So with respect to bail-in we believe it should be more of a statutory sort of capability as opposed to being built into the actual documents as NVCC is for pref and sub debt. And we are still waiting for regulatory guidance on the balance side.
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Peter Routledge, National Bank Financial - Analyst [18]
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Do we have any others? And I will just one follow-up on bail-in.
I think bail-in is this new concept that the market is probably just getting its head around both on the fixed income and equity side. However it ultimately looks, and I won't ask you that because you can't predict what the regulatory authorities will do but is there any concern in your mind that this might be disruptive to the system? That it will introduce a new form of funding that the market will gravitate towards maybe less quickly than you would like?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [19]
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I think that if we can get the bail-in provisions into the actual law as it is in other jurisdictions, it will not be disruptive. Because it is a resolution tool, it is not a recovery tool. I think where we get a little bit of the issue is if you're looking at recovery tools and you are setting unrealistic sort of metrics and stuff on conversion and that that could be disruptive but I think the solution that we have for the prefs in NVCC was pretty well managed by everyone and I think it is pretty well understood.
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Peter Routledge, National Bank Financial - Analyst [20]
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And then just one final question on the regulatory front, next year we will have leverage ratio and the liquidity ratios coming in, where does Royal stand on those? You do not have to give me the exact numbers but any concerns about beating the minimum standards and then any issues with managing your business in the context of those new rules?
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [21]
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Those are good questions Peter. And I think with both the metrics we are well above the regulatory minimums today because we have been working towards that for the last, especially liquidity, for the last two years.
When we look at balance sheet optimization, the optimization is about capital usage, impact on leverage and liquidity characteristics. And more prevalent in the capital market side but across the board in all of the products.
So, it is in our routines now. That is how we optimize in terms of making sure that we are targeting and focusing our capital on the highest return, most liquidity and leverage friendly products. So that is the construct we use.
And I think it is good discipline to have because I know that that there are multiple guidelines. The one thing we do know for sure is that the metrics shift and sometimes they will shift favorably. So if we get everyone in the routine of looking at all the triage between the three, we have a better chance of sustaining the business in our business model and not being disruptive by changes in the metrics.
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Peter Routledge, National Bank Financial - Analyst [22]
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Okay. Well we are out of time.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [23]
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Okay.
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Peter Routledge, National Bank Financial - Analyst [24]
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Thank you very much and all the best.
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Janice Fukakusa, Royal Bank of Canada - Chief Administrative Officer & CFO [25]
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Great, thanks Peter.
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