Royal Bank of Canada - Earnings Call - Q2 2025

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the RBC's 2025 Second Quarter Results Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Asim Imran, Senior Vice President, Investor Relations. Please go ahead, sir.

Asim Imran (SVP of Investor Relations)

Thank you, and good morning, everyone. Speaking today will be Dave McKay, President and Chief Executive Officer; Katherine Gibson, Chief Financial Officer; and Graeme Hepworth, Chief Risk Officer. Also joining us today for your questions: Erica Nielsen, Group Head, Personal Banking; Sean Amato-Gauci, Group Head, Commercial Banking; Neil McLaughlin, Group Head, Wealth Management; Derek Neldner, Group Head, Capital Markets; and Jennifer Publicover, Group Head, Insurance. As noted on slide two, 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.

Dave McKay (President and CEO)

Thanks, Asim, and good morning, everyone, and thank you for joining us. Today, we reported second quarter earnings of CAD 4.4 billion. Adjusted earnings were CAD 4.5 billion and included CAD 260 million of earnings from the acquisition of HSBC Bank Canada. This quarter, we generated strong pre-provision, pre-tax earnings of nearly CAD 7 billion as we continue to execute the strategies we shared at our investor day. Adjusted pre-tax pre-provision growth was up 16%, or CAD 971 million from last year, more than offsetting a prudent reserve build of CAD 568 million this quarter. Revenue growth of 11% year-over-year was underpinned by strong average volume growth in personal banking and commercial banking, as well as higher spreads in personal banking. We also reported robust fee-based revenue growth in wealth management and strong global markets revenue in capital markets.

Our results demonstrate the strength of our diversified business model and earnings power, as well as the value of the insights and advice we deliver for our clients as they navigate the uncertain macro environment. Our revenue growth is noteworthy considering the evolving market conditions. The strong performance was generated from a position of balance sheet strength, which continues to be through the cycle competitive and a strategic advantage for RBC. We continue to grow our core deposit franchises across our segments, including in Canadian banking, where the loan-to-deposit ratio improved to 97%, helping fund loan growth in an efficient and stable manner. We ended the quarter with a common equity tier 1 ratio of 13.2%, well above regulatory minimums, translating to excess capital of approximately CAD 5 billion relative to a mid 12% range.

Underpinned by a robust capital and earnings power, this morning, we announced a CAD 0.06, or 4%, increase in our quarterly dividend. We also announced our intention, subject to relevant approvals, to commence a normal course issuer bid to repurchase or cancellation of up to 35 million common shares. We also remain disciplined with respect to our risk management framework and risk appetite. The allowance for credit loss ratio increased to 74 basis points following a prudent reserve build, which included increasing weightings toward downside scenarios amidst heightened economic uncertainty. Our through-the-cycle approach to managing risk takes into consideration elevated market volatility. We did not have any trading loss days this quarter. Furthermore, over the last four years, we've only seen five days where we generated trading loss. Our strong balance sheet creates a resilient foundation that allows us to navigate uncertainty while creating value for clients and shareholders.

Turning to the macro environment, changes to longstanding U.S. and international trade policies have resulted in a volatile and uncertain operating environment, given the potential for structural disruptions to global supply chains and capital flows. These changes are taking place concurrently with other large secular forces of change, including the increased role of artificial intelligence and private capital, magnifying the complexity that businesses are facing. We saw market volatility through much of the quarter, evidenced by movements in credit spreads, the VIX, and bond market volatility indices. However, as the U.S. administration implemented a 90-day pause in reciprocal tariffs, the volatility of outcomes, sentiment, and markets narrowed significantly. While we can't say for certain where global trade policies will settle, we are cautiously optimistic about the path forward.

Reciprocal tariffs imposed on Canada are currently at the lowest end of the global scale, reflecting strong bilateral trade in the CUSMA Agreement. Although we are not projecting a recession in either Canada or the U.S., the prevailing uncertainty is dampening confidence, sentiment, and client activity in certain parts of the North American economy, including housing. North American consumers have remained resilient. They are continuing to spend, albeit less on discretionary items, and savings are growing. Businesses are in a holding pattern on large CapEx but have built inventory and shored up supply chains, moving consumption forward. It is under these complex circumstances that policymakers are looking to navigate the options to solve for inflation, unemployment, and growth. We expect the Bank of Canada will continue to take a more dovish stance to shore up consumer sentiment and growth.

Furthermore, we hope to see the increased political uncertainty in Canada drive structural improvements in the country's productivity and competitiveness, including more effectively leveraging our abundant natural resources and skilled workforce. With the Federal Reserve signaling a holding pattern on interest rates, given opposing forces, we similarly expect a more dovish stance in U.S. monetary policy, albeit on a lagged timeline. To reiterate what I said earlier, we believe we are in a strong position to navigate this period of uncertainty, given the strength of our balance sheet, our diversified business model, and our strong risk culture. With this context, I will now speak to the trends we're seeing across our businesses as we continue to focus on delivering advice, insights, and value to our clients, starting with our leadership position in Canada.

Personal banking, we have the leading distribution network in Canada with a full suite of award-winning products and solutions. Average deposits increased 13% year-over-year, or 8% excluding the acquisition of HSBC Bank Canada, led by outsized growth in our lower-cost core banking and savings products. As noted at our investor day, growing core deposits remains a priority. This provides us with data to support personalization, underpin risk models, and our interest rate hedging strategy while being an important source of funding. Residential mortgage growth was largely supported by stronger client renewals, higher origination volumes driven by strong mortgage switch-in activity, partly offset by higher paydowns. We expect housing resale activity and mortgage growth to remain contained in the near term as the uncertainty around tariffs outweighs lower debt servicing costs from lower interest rates.

Amidst ongoing intense competition, we will maintain the disciplined mortgage growth strategy we articulated over the past year. In our credit card business, spending remained relatively resilient despite low consumer sentiment. Going forward, we expect spending to soften and revolve our balances to increase year-over-year should the current environment persist. Turning to commercial banking, we are a leading market share across all segments. Average deposit growth remains strong, up 15% year-over-year, or 10% excluding deposits acquired through the acquisition of HSBC Canada. This growth continues to be supported by investments in our people and capabilities, including digital client onboarding and transaction banking. Average net loans and acceptances were up 22% year-over-year, or up 9% excluding loans acquired through HSBC Canada. Adjusting for these acquired loans, larger commercial and corporate loans and small business loans grew at a similar rate. Utilization rates have remained largely unchanged.

While the lending pipeline and client activity remains solid across many parts of our diversified portfolio, we continue to see signs of cautious business sentiment in certain areas as clients assess how global tariffs could impact their strategies and investment plans. Loan demand was notably softer for companies in the automotive, consumer discretionary, and transportation sectors. Going forward, we continue to expect commercial banking loan growth in the high single-digit range for next year, but moderate to mid to high single-digit growth range in the back half. Turning to HSBC Canada, we are continuing to bring new capabilities to market as we've now completed the migration of the largest and most complex commercial clients acquired through the acquisition of HSBC Canada, pursuant to the Transition Services Agreement.

As we execute, too, the execution of cost synergy initiatives is largely complete, and we are increasingly confident of achieving our targeted annualized cost synergies by next quarter. Now to segments in which we are expanding our reach in global fee pools. Starting with capital markets, which reported strong pre-provision, pre-tax earnings of CAD 1.4 billion, or a record of CAD 3.1 billion in the first half of the year, reflecting its diversified business model. Global markets had a strong quarter driven by increased client activity amidst market volatility, which largely benefited our equities and broader macro trading businesses. This was partly offset by the impact of a challenging market backdrop on credit trading. The strong performance of both cash equities and equity derivatives was particularly notable as they are a key area of focus for market share gains over the medium term.

Like commercial banking, utilization in the corporate banking loan book remained relatively steady. We continue to pursue our strategy to moderately grow lending activity, with average loan balances up mid single digits year to date. In contrast, investment banking activity was muted this quarter, given the volatility in markets. Going forward, policy uncertainty could continue to impact activity as clients wait on the sidelines for clarity. While the second half of the year is seasonally lower or slower than the first half, client dialogue is robust, and we are well positioned to deliver as deal-making momentum improves. Moving to wealth management, where we reported assets under administration growth of 11% in Canada and 9% in the U.S. Our clients remain engaged, and we had solid net sales and transactional activity in our Canadian platforms, including in RBC Direct Investing.

RBC Global Asset Management assets under management increased by 11% to CAD 694 billion. Net sales were robust across asset classes, with client flows shifting from fixed income and equity mandates earlier in the quarter to more balanced funds in April, highlighting our clients' confidence in our wide range of investment strategies across geographies. As a leading asset manager, RBC GAM consistently delivers strong performance through our leading distribution network. This point was underscored with RBC GAM yet again being named the Top Gun Investment Team of the Year in Canada for 2025. To close, this quarter builds on the strong start we have had to fiscal 2025 amidst an evolving operating environment. While macro-related uncertainty remains, we are confident in our ability to pursue the ambitions of medium-term targets outlined at our investor day in March.

This includes our One RBC approach to extending our leadership in Canada, growing in global fee pools, and leveraging our strong balance sheet, data scale, and AI investments to create more value for clients. The key strategic initiatives designed to accelerate our ambitions are expected to continue to deliver leading risk-adjusted returns and long-term value for our shareholders through a wide range of economic cycles. Katherine, over to you.

Katherine Gibson (CFO)

Thanks, Dave, and good morning, everyone. This quarter, we reported diluted earnings per share of CAD 3.02. Adjusted diluted earnings per share of CAD 3.12 was up 7% from last year, driven by strong revenue momentum across our businesses and prudent cost management. The acquisition of HSBC Canada and foreign exchange translation impacts also benefited results. Turning to capital on slide 10, we demonstrated our through-the-cycle capital strength and resilience despite the market disruption. Our CET1 ratio came in at 13.2%, flat sequentially.

Solid internal capital generation, net of dividends, was partly offset by net credit migration, primarily in our wholesale portfolio. We also continued deploying organic capital across our businesses toward trading-related activities, as well as wholesale and personal lending. A key part of our capital deployment strategy is returning capital to our shareholders. This quarter, we repurchased 3 million shares for CAD 488 million, an increase from the 2.3 million shares repurchased over the last two quarters. We will continue to be tactical with the cadence of share repurchases while operating with a strong CET1 ratio. Next quarter, we expect a modest negative impact to our CET1 ratio as a result of changes to our retail capital parameters. Moving to slide 11, all bank net interest income was up 22% year-over-year, or up 14% excluding trading revenue and HSBC Canada.

All bank net interest margin, excluding trading revenue, was down two basis points from last quarter, partly due to the impact of higher investment securities balances in capital markets. Lower rates on our funding and securities portfolio and corporate support also impacted all bank NIM. As a benefit of certain hedging transactions this quarter was recorded in non-interest income, with a related offset reported in net interest income. These factors were mostly offset by a favorable product mix in personal banking. Canadian banking NIM was up five basis points from last quarter, benefiting from a favorable product mix, higher mortgage spreads, and continued benefits related to our tractor strategy, which provides protection in a declining rate environment. Benefits from changes in product mix were driven by strong growth in checking and savings accounts and seasonally higher credit card revolve rate, the latter of which we expect to reverse next quarter.

In addition to our client acquisition strategies, declining interest rates and uncertainty in the markets are driving clients to hold cash in non-maturity deposits as shorter duration term deposits mature. While we expect to continue benefiting from these tailwinds in the near future, we don't anticipate this level of margin expansion to continue. Looking forward, we are maintaining our 2025 all bank net interest income growth guidance of high single-digit to low double-digit net interest income excluding trading. Moving to slide 12, reported non-interest expenses were up 5% from last year. Our core expense growth was up 8% year-over-year. As a reminder, core expense growth includes run rate costs related to the acquisition of HSBC Canada, which contributed 1% to expense growth, but excludes the impact of foreign exchange translation and share-based compensation, which are largely driven by macro variables.

The main drivers of growth were higher staff-related costs, including higher-than-average severance, targeted amendments to our defined benefit pensions, and higher variable compensation to measure it with strong results in wealth management. Going forward, we continue to expect all bank core expense growth, which is off a base of reported 2024 expenses, to be at the upper end of our mid single-digit guidance range for 2025. We remain prudent in managing our cost base amidst an uncertain macroeconomic backdrop and have proactively identified levers to do so. Higher-than-expected core expense growth outside our guidance range for this year will likely reflect higher-than-expected variable compensation to measure it with higher revenues in our market-sensitive businesses. Consequently, we continue to expect positive operating leverage for the year. On taxes, the adjusted non-TAB effective tax rate was 20.6% this quarter, up from 19.8% last year.

The increase reflects the impact of changes in earnings mix and Pillar Two tax legislation, partly offset by the net impact of tax adjustment. Turning to our Q2 segment results beginning on slide 13, personal banking reported earnings of CAD 1.6 billion. Focusing on personal banking Canada, net income was up 15% year-over-year. Excluding HSBC Canada, personal banking Canada's net income rose 8% year-over-year as strong operating leverage of approximately 6% was partly offset by higher provisions for credit loss. Personal banking efficiency ratio improved to 41% this quarter, underpinned by strong revenue growth. Higher year-over-year revenues, excluding HSBC Canada, benefited from a 14% increase in net interest income and an 8% increase in non-interest income. We are maintaining the sub-40% efficiency ratio target noted at our investor day.

However, as a reminder, benefits from the purchase accounting accretion of fair value adjustments from the HSBC Canada transaction are expected to largely run off by Q2 2026. Turning to slide 14, Commercial Banking's net income of CAD 597 million rose 3% from a year ago. Results were impacted this quarter by an increase in stage one and two provision. On a pre-provision pre-tax basis, earnings were up 25% or 11% excluding HSBC Canada, driven by solid average volume growth offset by lower credit fees and higher expenses, mainly reflecting higher staff-related costs. Excluding HSBC Canada, average deposits and loan growth were strong at 10% and 9% year-over-year, respectively. Turning to Wealth Management on slide 15, net income of CAD 929 million rose 11% from a year ago, driven by strong growth in fee-based client assets across our businesses, benefiting from market appreciation and net new assets.

We added CAD 6.5 billion in net new assets across our Canadian Wealth Advisory business, reflecting the benefits of the holistic strategies we highlighted at our investor day. RBC Global Asset Management net sales were slightly negative this quarter as a result of net outflows from institutional clients, largely due to one client mandate. These outflows, however, were partly offset by a fifth consecutive quarter in positive retail fund inflows as we continue to grow our leading market share in Canada. Higher segment revenue was partly offset by higher variable compensation, measured with increased results and higher staff-related costs. City National generated $88 million U.S. in adjusted earnings, up 21% from last year. We are encouraged by the momentum we are seeing and remain focused on enhancing City National's profitability.

Turning to our capital markets results on slide 16, net income of CAD 1.2 billion decreased 5% from last year, reflecting a 1% decline in pre-provision pre-tax earnings off a strong second quarter last year and a higher effective tax rate this year. Global markets revenue was up 23% year-over-year as a volatile market backdrop drove higher client activity, particularly in our equity and FX trading businesses across all regions. Corporate investment banking revenue was down 7% from last year. Investment banking revenue was down 22%, reflecting lower M&A activity across all regions. The second quarter of last year was very strong due to the timing of several large M&A deals that closed in the quarter. Lending and transaction banking revenue was up 8%, underpinned by higher lending revenue, primarily in Europe.

Turning to slide 17, insurance net income of CAD 211 million was up 19% from last year, mainly due to higher insurance service results from improved claims experience. Results also benefited from higher insurance investment results on lower capital funding costs and favorable investment-related experience. Lastly, results for corporate support in the quarter included higher than normal severance costs, representing approximately half of the total severance incurred this quarter. As we look forward, we continue to expect corporate support to generate a net loss of CAD 100 million-CAD 150 million per quarter. Before closing, I want to note a couple of disclosure updates in our analyst slide. We have provided new disclosures related to the performance of our U.S. region, which we highlighted as a key geography at our investor day.

Secondly, while we commit to providing updates on synergies related to the acquisition of HSBC Canada, this is the last quarter we'll provide detailed financials as the acquired business becomes fully integrated into comparable periods. Lastly, we will look to provide annual updates on our investor day targets every fourth quarter. To conclude, despite the market and macroeconomic uncertainty, we delivered strong results this quarter. We are maintaining the annualized guidance provided last quarter on net interest income and core expense growth while continuing to drive towards the medium-term targets we outlined at our investor day. Our performance reflects the resilience of our diversified earnings stream and financial strength, all of which position us to navigate the quarters ahead. With that, I'll now turn it over to Graeme.

Graeme Hepworth (Chief Risk Officer)

Thank you, Katherine, and good morning, everyone.

I'll now discuss our allowances in the context of the current macroeconomic environment and ongoing trade uncertainty. After a stronger-than-expected start to the year, Canadian and U.S. economic indicators softened over the second quarter, with momentum stalled by global trade uncertainty. U.S. trade policy and bouts of market volatility are creating uncertain conditions, increasing the odds of a recession in North America. Although tariffs and flows on Canada were not as severe and broad-based as initially expected, global and sector-specific impacts are creating economic risks, including reduced trade, higher input costs, and supply chain disruptions. The final form of tariffs is still unknown, and it is too soon to know how they will work through the economy. Against this backdrop, we continue to lean on our robust credit provisioning process to inform our allowances. As a reminder, we are not managing to one scenario or forecast.

Within our IFRS 9 framework, we employ five separate scenarios: a base case, an optimistic scenario, and three downside scenarios of varying severity. This allows us to better handle forecasting uncertainty and incorporate a larger range of potential risks. Compared to last quarter, our base case reflects a greater slowdown in the North American economy from tariffs already known and imposed, which we expect will be in place for at least six months before easing. We expect Canada and the U.S. will narrowly avoid a recession as higher inflation and unemployment are expected to be offset by interest rate reductions in both countries, providing relief to borrowers and stimulating investment. Given the trade-related uncertainty, we implemented a new trade disruption downside scenario this quarter, which replaces our previous oil and gas downside scenario.

This new scenario reflects the potential for a severe North American recession driven by an escalating global trade war and rising geopolitical risks that translate into a rapid rise in unemployment, higher inflation, disruptions in supply chains, and a sharp decrease in asset prices. The trade disruption scenario and other downside scenarios help us evaluate risks that we have not yet observed. Given the height of geopolitical and economic uncertainty, we have reduced the weighting on our base case and reallocated it to our trade disruption scenario. We would expect to decrease the weighting on our downside scenarios as and when there is greater clarity of tariff-related outcomes, and those are captured in our base case scenario. In the retail portfolio, clients continue to demonstrate resilience, with credit performance improving as interest rate cuts and wage growth have made it easier to service debt.

Mortgage renewal pricing and refinancing risk have played out better than we anticipated. Housing prices have also generally held up well. While we are seeing more balanced conditions in the Canadian housing market, with improving home portability due to lower interest rates and rising inventory levels, we are monitoring risks, including risk of further slowdown in the condo segment and certain regions harder hit by economic weakness. We remain well provisioned on performing loans in the home equity finance portfolio, and we have built higher allowances in segments of the housing market where we see higher risk. We also continue to monitor our condo developer portfolio as new condo sales cool off. For context, our exposure to high-rise condo developers represents only about 1% of total loans and acceptances.

This portfolio has a very strong credit profile that reflects our focus on top-tier developers, supported by prudent underwriting standards such as minimum pre-sales backed by buyer deposits, minimum borrower equity, and outside recourse carrying sufficient liquidity to support a project. Turning to slide 19, we took a total of CAD 568 million, or 23 basis points of provisions on performing loans this quarter, an increase of CAD 500 million from the prior quarter, mainly reflecting unfavorable changes to our macroeconomic scenario weights, our macroeconomic forecasts, and credit quality. This significant increase in provisions on performing loans is meant to capture a broad range of potential outcomes due to the heightened uncertainty I spoke to earlier. As a reference point, the ratio of ACL to total loans and acceptances is 74 basis points, while we reached a COVID peak of 89 basis points in 2020.

This marks the 12th consecutive quarter where we added reserves and performing loans, resulting in a total ACL of CAD 7.5 billion. Moving to slide 20, gross impaired loans of CAD 8.9 billion were up CAD 1.1 billion, or 10 basis points, from last quarter, primarily driven by commercial banking and capital markets. In capital markets, we saw new formations in the U.S. commercial real estate office portfolio, reflecting continued softness in the U.S. office market conditions. In commercial banking, while new formations increased CAD 512 million quarter-over-quarter, the majority of this increase was driven by administrative factors that have subsequently been resolved. The largest ongoing impairment this quarter was related to the insolvency of a large retailer in Canada, where we had related commercial real estate exposure.

Turning to slide 21, PCL and impaired loans of 35 basis points was down 4 basis points, or CAD 133 million quarter-over-quarter, with lower provisions across most segments. In personal banking, provisions were down CAD 17 million, driven by lower provisions in other personal lending and residential mortgages. Consumer clients continue to show resilience, but higher employment is expected to lead to higher losses in our unsecured portfolios. In our commercial banking portfolio, provisions were down CAD 22 million, reflecting a moderation of PCL from the HSBC Canada commercial portfolio, as we had anticipated. Overall, the commercial portfolio continues to be impacted by softer economic conditions and consumer spending in Canada. We expect PCL in the commercial segment to remain elevated in the coming quarters, considering the added uncertainty from tariffs.

In capital markets, provisions were down CAD 100 million, as we had a large provision on one account in the other services sector in Q1, which is partially offset by a few new impairments in the U.S. office real estate this quarter. Within our broader commercial real estate portfolio, headwinds still exist and will continue to play out over an extended period. As we have seen, impairments can be uneven and less predictable on a quarterly basis. However, realized losses have been well contained on the back of our strong client base and underwriting standards. To conclude, despite the uncertainty in the macroeconomic and policy environment, we are pleased with the overall diversification and performance of our portfolios. While sustained trade uncertainty could create recessionary conditions, the range of outcomes are well within the stressed and downside scenarios we currently consider, giving us confidence in our financial resilience through the cycle.

We are navigating this uncertainty from a position of strength, with PCL expected to be manageable under multiple scenarios. Our lower PCL and impaired loans this quarter was positive and within our expectations. We are prudently building reserves to account for the uncertainty ahead. Today, we are seeing some slight pull forward of losses because of trade-related uncertainty, which, if sustained, may push full-year losses to the higher end of our previous guidance. However, we expect the impact of tariffs to play out mostly in 2026, potentially pushing out peak stage three credit losses into fiscal 2026. Moving forward, the likelihood, timing, and direction of allowances and peak PCL will continue to be dependent on the extent and duration of tariffs, retaliatory measures, availability of fiscal support measures, magnitude of change in unemployment rates, the direction and magnitude of changes in interest rates, and commercial and real estate prices.

As always, we continue to proactively manage risk through the cycle, and we remain well capitalized to withstand a broad range of macroeconomic and geopolitical outcomes. With that, Operator, let's open the lines for Q&A.

Operator (participant)

Thank you. We will now take questions from the telephone lines. If you have a question, please press star one on the device's keypad. You may cancel your question at any time by pressing star two. Please press star one. At this time, if you have a question, there will be a brief pause while the participants register. We thank you for your patience. The first question is from Gabriel Dechaine from National Bank Financial. Please go ahead. Your line is open.

Gabriel Dechaine (Managing Director and Senior Equity Analyst)

Hey, good morning. I didn't expect to be first anyways. I'd like to ask about your increase in gross impaired loans.

You did mention that a big chunk of that was tied to a large Canadian retailer. Thanks for that. How much discretion are you using to classify loans as impaired? Because one perspective is that maybe this is a Royal-specific issue. We've seen a couple of quarters of higher GIL. Maybe the bank is just being a bit more proactive in how they classify something as impaired. They could still be paying you, but you're assessing the risk and deciding, "Well, let's classify those as impaired." You are more conservative in a sense than maybe another bank might be.

Graeme Hepworth (Chief Risk Officer)

Yeah, hi, Gabriel. It's Graeme. I'll take that. Thanks for your question. Some broader context on the GIL build this quarter. We just were over CAD 1 billion increase quarter on quarter.

As I noted in my speech, about 40% of that was related to some administrative concerns, and those have all been resolved subsequently. The overall build is not quite maybe as large as the headline relates to. To your question on kind of discretion, I mean, I cannot speak to what others do in their processes. I would say we have very well-defined processes and rules in how we determine when something is impaired. Those rules on when we impair something are not strictly driven on when a company stops paying or not. It would be on our forward views of that company as well. Some of the companies we have put into impaired loan status over the last two quarters are still paying interest to us. We then, in turn, take that and just build that into our reserves as we receive that interest.

There is some discretion in that regard, but I would say we're very consistent in our processes. We certainly haven't changed our approach on that in recent quarters. I would just also note maybe on the impaired. Again, the wholesale, it just can be a bit more episodic. Quarter to quarter, it's not quite as consistent in the way retail is. I think if you go back to the latter half of last year where we had, I would say, very low impaireds in PCL in our wholesale businesses, we noted at the time that that was probably not representative of the cycle either. I think, again, just kind of a quarter to quarter and maybe how this trends over a longer period. I don't think we saw this quarter with something unique or kind of newly indicative of where we see things trending.

Gabriel Dechaine (Managing Director and Senior Equity Analyst)

Okay.

Can you clarify that administrative comment? Forty percent of the billion increase is administrative in nature or technical, and they've been resolved. That is going to go in the other direction next quarter? Is that how it could work?

Graeme Hepworth (Chief Risk Officer)

Yeah, that seems to go. This relates directly and indirectly to us just kind of finalizing some of the final pieces of integrating HSBC into our processes. As we worked through the final kind of credit elements of that, there were some cues, particularly related to some term loans that were up for renewal that just did not get renewed on our normal timelines. Those tripped into impaired. None of those were credit issues. Those have all been subsequently renewed and resolved. Yes, those will go the other direction next quarter.

Gabriel Dechaine (Managing Director and Senior Equity Analyst)

Got it. Thanks for that clarification.

Operator (participant)

Thank you.

The next question is from Ebrahim Poonawala from Bank of America. Please go ahead. Your line is open.

Ebrahim Poonawala (Head of North American Banks Research)

Good morning. I wanted to follow up, actually, Graeme, with you on credit. Sorry if I missed this. I'm not sure if you talked about what your expectations were on impaired PCLs for the back half of the year. Just talk to us, as you think about peak PCLs being pushed into 2026, are there new areas of stress within the book? Are there areas within sort of the commercial book where you're seeing stress, maybe due to tariffs or a prolonged kind of a slow economy that are emerging, which are informing that view?

I'm just trying to think about, as we think about all these macro reserve builds, is it just conservative management of building reserves, or do you have a sense of a line of sight on how this plays out and the stress areas are maybe already beginning to emerge where future losses could come through? Thanks.

Graeme Hepworth (Chief Risk Officer)

Yeah, thanks, Ebrahim. Just to maybe provide a few different pieces on that. In our slide there on the ACL build, we really try and break down the drivers of what's building that ACL, right? And so the three really big component parts there, one is credit migration. So that's a direct reflection of what we're seeing with our clients, their risk profiles, if you will, their financial profiles.

This quarter was about 20% of that build, and that's kind of in line, in fact, quite a little bit lower than what we've been seeing in prior quarters. I wouldn't say at this point we're seeing newly emerging kind of credit pockets of concern, at least directly to our client base. 80% of the build is really more on kind of our go-forward view and just the uncertainty around that go-forward view, right? Our base case was weaker this quarter. Not hugely weaker, but certainly we've increased our views on unemployment going forward. We pulled back a little bit of our views on HPI and GDP. That's contributing to it. That's just reflecting the current uncertainty in the market right now. There are some real direct economic impacts of that. The third part was just really increasing the weights.

We introduced this new scenario to really try and target kind of the uncertainty we're seeing. That by itself didn't really increase our reserves because we already had some fairly pessimistic scenarios in there, but it was really attributing more weight to that. The more weight is just, again, just us trying to, I think, address this uncertain environment and get ahead of that to some degree.

Ebrahim Poonawala (Head of North American Banks Research)

Understood. Maybe I guess just one for you, Katherine, around rate sensitivity as we think about on a go-forward basis. I appreciate you're sort of guiding to NII growth. Perhaps if you can tell us what would drive NII into that low double digits versus high single digits. Is it balance sheet growth? Loan growth needs to pick up to get us there.

As we think about future sort of Bank of Canada rate cuts, how do you sort of think about the direct impact on NII relative to what the Bank of Canada or the Fed does? I see the disclosure on slide 26, but would love some color around that. Thank you.

Katherine Gibson (CFO)

Good morning, Ebrahim. Thanks for the question. In relation to, I guess, our outlook on the NII excluding trading, we have all just taken you through our underlying assumptions on how we arrived at that guidance. As I go through that, you will get a sense of what could move us in that range. If I start off with volume, our volume, we are holding to the guidance that we disclosed actually back in Q4. On a mortgage basis, we are still targeting low single digits.

As Dave would have mentioned in his remarks, we're cautious on the outlook on that front, but we're still seeing progress in that low single digits. As it relates to commercial for the full year, looking to still hold volumes at high single digits. For the second half, again, given the cautiousness that we are seeing from some clients, we're expecting that to be more towards mid to high in the second half of the year. On our corporate banking, continuing to see moderate growth and expecting that to hold as we go through the second half of the year. Overall, in the volumes, those are our expectations. Where it could shift is really around the client behavior for the second half of the year and around the cautiousness and how we see that play out.

As we move to NIM, that was obviously another key part of our guidance. A couple of items there. On the tractor front, continue to see that positive moving through. What could continue to underpin that is the strong growth in deposits that we are seeing, which is obviously key to our overall deposit acquisition strategy. What we are seeing with that higher growth is we are putting more into tractors, not an immediate impact, but it is positive overall. As I said in my remarks, we have the seasonal movement, so that will impact NIM as we go forward. I guess a couple of the unknowns that I have spoken about before really ties into the mixed shift as well as competitive behaviors. On the mixed shift, we have been seeing that as a positive tailwind as we are seeing GICs start to come down.

We're seeing the non-term maturities continue to grow, and clients are holding their funds there. That is accretive to NIM. As we go throughout the rest of the year, if we continue to see that trend, that would be accretive. On the competition front, we continue to see pressures on the GIC front. A little bit on the mortgages, it is starting to pull back. Depending on how that plays out through the second half of the year, that is another item that could move us in our guidance on the net interest income excluding trading.

Ebrahim Poonawala (Head of North American Banks Research)

Thank you.

Operator (participant)

Thank you. The next question is from Mario Mendonca from TD Securities. Please go ahead. Your line is open.

Mario Mendonca (Managing Director and Senior Research Analyst)

Good morning. Graeme, you sound a little bit more cautious on credit than I am hearing from other banks. Like your point about PCLs peaking in 2026 is a little different.

We're hearing slightly different sentiment from the other banks. This morning, you probably would have seen that the U.S. Court of International Trade has sort of struck down the reciprocal tariffs, the 10% baseline tariffs. I know this is hot off the press, but does that change your outlook? If in fact this whole tariff scare was just one giant head fake, would that build greater confidence for you on PCLs for oil?

Dave McKay (President and CEO)

Mario, it's a fair question. Dave, and I'll start on the macro side and hand it to Graeme. Obviously, when we set our scenarios, a number of things, we set our scenarios well over a month ago. The world is evolving and continues to be volatile. That's part of our challenge and part of the reason we build formations is the uncertainty in the world around us.

We still have to go through a CUSMA renegotiation with the U.S., and we still don't know the impact on the auto industry. We don't know the impact on the dairy industry and agriculture and forestry. Yes, while the short-term reciprocal tariffs appear to be illegal, it doesn't mean that we have an overall extended agreement with the United States on future trade. Therefore, very much involved in that, and we have to kind of manage that going forward. I think our uncertainty still applies in the medium term that we still have to progress through a number of other elements. I think it's fair, some of the shorter-term volatility and reciprocal tariffs and the cost of that, all of this is creating uncertainty, right? It's creating uncertainty in allocating capital from mortgages right through to M&A.

Therefore, while this cloud overhangs the Canadian economy, it's having a real impact in, we think, the momentum and the potential of the economy going forward. I still don't think we're shaking the overall uncertainty level just because of that ruling last night. It helps. It helps set the stage for kind of renegotiation of USMCA that we expect will happen over the coming six months. Thank you, Graeme.

Graeme Hepworth (Chief Risk Officer)

I think they've covered a lot. Certainly what transpired in May, there would be some positive signals in May that didn't exist in April. I would also say I'm not sure those positive signals are taking us anywhere towards the conclusion on kind of where this is going to land, where it's going to land, or quite frankly, when it's going to land either.

I think, yes, we'd have a degree of caution with that, Mario, and we'll certainly evaluate kind of what we learn in the coming months and adjust accordingly. If we feel a lot stronger that this is going to land sooner and better than we are thinking right now, then that will lead us to kind of adjust our weights and reserves accordingly. They are intended to be dynamic, but I think at this point in time, it was prudent to be building against that uncertainty.

Dave McKay (President and CEO)

I think just back to Dave here. I think it's just important that this is a stage one and two provision. We haven't spent it. It's in our pocket, right? And happily, if we're wrong, then we will release it. There's no downside in being cautious given this uncertainty and how we feel.

Mario Mendonca (Managing Director and Senior Research Analyst)

Thank you.

Operator (participant)

Thank you.

The next question is from Paul Holden from CIBC. Please go ahead. Your line is open.

Paul Holden (Equity Research Analyst)

Thank you. Good morning. Two quick questions, or hopefully they're quick. First one, maybe for Derek and sort of dovetailing off what Mario just asked. Given your pipeline for, say, M&A, ECM, etc., and maybe some improvement in certainty around tariffs, how quickly do you think IB activity can bounce back if the market gets more comfortable with the tariff outlook?

Dave McKay (President and CEO)

Sure. Thanks for the question, Paul. I'd really break into two things. Sort of how quickly does activity bounce back, and then how quickly does activity actually lead to consummated transactions and revenue in the business? Because there obviously is a time lag depending on the nature of the transaction.

I think if you look at where we were sitting in April at the peak of uncertainty around tariffs and the economic outlook, we saw a very short but very pronounced slowdown in activity. As Dave alluded to, there was a lot of uncertainty, and clients really hit pause, whether that be on financing activity or longer-term strategic capital allocation decisions, including M&A. As we have seen more signs of optimism, including obviously some of the announcements last night and this morning, we certainly are seeing a pickup in activity as we've come through recent weeks. You tend to see that in different phases. The first is you see that pickup in your flow financing activity, whether that be DCM, ECM, high-yield issuance, term loan issuance. Already in May, there has been a reasonably healthy improvement in that regard, both in terms of activity, but also just client dialogue.

Any of that kind of flow activity also then results in transactions being completed quite quickly. The second part then is longer-term, more strategic M&A activity. We certainly are seeing an improvement in sentiment and more dialogue and lots of client dialogue going on. Where there still is uncertainty is how quickly does that actually translate into announced transactions, and then what is the period of time through closing? I think in the month of May, across all of our geographies, we have seen some very nice transaction activity and some deals being announced. There is a lot where boards and executive management teams are still evaluating what the world is going to look like over the next 12-24 months. There will be a delay in some of that coming to fruition.

Obviously, depending on the sector, the nature of the transaction, closing can be anywhere from three months to 18 months, depending on regulatory approvals or otherwise. Overall, certainly the outlook is notably improved from where we were six weeks ago.

Paul Holden (Equity Research Analyst)

That is very helpful. Thank you. I will just sneak in that second quick one, if you do not mind. For Sean, just very strong growth in commercial banking. We heard from Kathryn sort of the outlook, somewhat slowing the second half. Just maybe a reminder on where you are growing in commercial, because it looks like you are picking up some share based on what we have seen from your peer banks. Two, quite a big difference in the net interest margin, QoQ, in commercial banking versus the personal bank.

Maybe I just want to better understand why the NIM is going lower in commercial banking given the strong loan growth. Thank you.

Sean Amato-Gauci (Group Head of Commercial Banking)

Maybe I'll start with, thanks for the question, Paul. Maybe I'll start with the second one. It is primarily driven by the VA migrations and the shift between NIM and other income. It is mostly offset on the other side of the other contributor to revenue. On a year-over-year basis, that starts to have less of an impact as that completes in the next quarter. With respect to growth on the portfolio, your first question, this is the continued execution of a multi-year strategy to invest in coverage and underwriting expertise and structured banking expertise to drive growth in the larger segments of the portfolio, our senior commercial and corporate client group segments. That has been executed really well.

It is also returning off of a base of underperformance in the early part of this decade. On a five-year basis, our growth rate is actually very close to the industry average at about 1% greater. In terms of recency of growth, as Dave mentioned, through all the uncertainty there, we are definitely seeing sequential growth slow. On a rolling four-quarter basis, for example, our quarterly sequential growth was averaging about 2.5%. In Q1, that was 1.8%. In this quarter, relative to Q1, it was 1.6%. As Katherine highlighted, our outlook is sort of in the mid-single digits to low end of high single digits on a full-year H2 basis this year, which would imply about a 1%-1.5% sequential growth on a quarter-over-quarter basis for the next two quarters.

Paul Holden (Equity Research Analyst)

All right. That is it from me. Thank you.

Operator (participant)

Thank you.

The next question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead. Your line is open.

Sohrab Movahedi (Managing Director and Banks Analyst)

Okay. Thank you. Graeme, roughly half of the performing build looks to have been kind of charged to the commercial bank. Can you talk a little bit about the industry sectors there that were targeted by the build?

Graeme Hepworth (Chief Risk Officer)

Yeah. Thanks, Saohrab. Yeah. I mean, so commercial, again, this is all about kind of the go-forward macro and how we are playing out going forward. I would say in some sense, it is kind of continuing to put pressure on some of the same sectors that have been under pressure to date. Very much that supply chain sector, the industrial, the manufacturing, the transportation sectors. That is really, I would say, the core components of where we see that being hit there.

We have done bottom-up analysis here to really kind of try and assess which sectors overall we think are going to be hit most directly by tariffs. I mean, that's, again, a challenging exercise because those tariffs seem to change day to day, week to week, both in their magnitude and where they're going to be applied. We go through the book really looking at those sectors that have kind of the biggest import-export kind of dependencies. Within that, kind of refine which of those we think have the most challenged abilities to absorb costs or not. That is kind of the analysis we do that kind of supports that. I'd say there's significant chunks of that really kind of point back to some of those same sectors that have been kind of challenged to date.

Sohrab Movahedi (Managing Director and Banks Analyst)

Okay.

Just with Sean, staying with the commercial, your ROE obviously reflecting the reserve build lower than Capital Markets' ROE this quarter. You have an 18% type target out there. How long do you think before you hit that 18%?

Sean Amato-Gauci (Group Head of Commercial Banking)

Yeah. As we articulated in our investor day presentation, it is a three-year target. To your point, there is a number of contributing factors that has driven it lower than the recency. Obviously, the reserve build this quarter, as Katherine highlighted last quarter, the allocation of the capital methodology into the businesses was about 70 basis points. Then about 90 basis points of the reductions also the Goodwill allocation from the HSBC acquisition. Our projections are to rebuild to 18% in three years.

Sohrab Movahedi (Managing Director and Banks Analyst)

It would be very hard for this year anyway, right?

Sean Amato-Gauci (Group Head of Commercial Banking)

Yes. That is not the.

Sohrab Movahedi (Managing Director and Banks Analyst)

Thank you.

Operator (participant)

Thank you.

The next question is from Mike Risvanovic from Scotiabank. Please go ahead. Your line is open.

Mike Rizvanovic (Managing Director and Equity Research Analyst of Banks and Insurance)

Hey, good morning. Question for Graeme. This is more of a qualitative question. When I look at your GIL ratio on the mortgage book, I get it that it's relatively low among your peers, but it's actually deteriorated the most over the past year. I'm sort of wondering if that's largely related to the HSBC client base coming in. I do think there's a perception in the market that Royal's customer base, including on the retail side, tends to be of better quality, lower risk, probably better FICO score. Are you still sticking with that narrative if you do agree with it? Is this largely HSBC related?

Graeme Hepworth (Chief Risk Officer)

Yeah. Thanks, Mike. No, I do not think that's HSBC related.

The client base we absorb from HSBC is of very high quality and actually skews higher than the rest of our consumer book and mortgage book. No, that is not what's driving that narrative. I think partly what's driving that is a mixed question and the markets that are most challenged by kind of the higher payment environment. This would be the GTAs of the world that are really driving our impairments these days. I think, again, overall, the quality of our client base continues to be very strong. The performance there continues to be very strong. We feel very good about that book and the structure there. The ultimate write-off, if you follow that through, have been very low because of that. We are seeing impairments as more clients are facing more challenges in this higher rate environment at the end of the day.

Mike Rizvanovic (Managing Director and Equity Research Analyst of Banks and Insurance)

Okay.

That's helpful. Just one quick one probably for Erica. Just in terms of the mortgage business in your segment, are you able to provide at least maybe a high level of what the revenue contribution is? To the extent that you might have that handy. If you look at the spread and the fees related to originations and any activity in the reso book or just the mortgage book per se, could you ballpark that? Is it 10% of revenue? Is it closer to 20% in your segment?

Erica Nielsen (Group Head of Personal Banking)

I think what we do in the, if I think about where we've been over the last 12 months in that mortgage book, what we're seeing is the balance that we talked about and how we think about the volume that we're putting on the books and the margins that we're putting that business on at.

On a year-over-year basis, we are seeing our ability to continue to have the mortgage business start to come back from low levels of profitability when we saw our spreads really degrade to levels that probably from an ROE perspective, we need to be back up to a higher degree of ROE in the business. I think on a year-over-year basis, we continue to see green shoots in that business contributing more in the profitability of the aggregate earnings of the personal bank. We are certainly not at the levels of profitability that we would have seen 24 months ago, 36 months ago in terms of the contribution of that mortgage book back to the earnings of the personal bank.

We still are balancing our growth expectations and how we are pursuing growth in that market with the returns in that business and taking a calculated march to getting back to higher earnings from the aggregate mortgage business.

Mike Rizvanovic (Managing Director and Equity Research Analyst of Banks and Insurance)

Just again, I am not sure if you are comfortable providing a ballpark number or we can take it offline, but is 10% a reasonable number? Would the mortgage business contribute roughly 10% of the segment revenue, or is it something a bit higher or lower than that?

Erica Nielsen (Group Head of Personal Banking)

Yeah. Let us take that. Let us take that question offline, and we can discuss post.

Mike Rizvanovic (Managing Director and Equity Research Analyst of Banks and Insurance)

Okay. All right. Thanks for the insights.

Operator (participant)

Thank you. The last question is from Lamar Purcell from Carl Marks Securities. Please go ahead. Your line is open.

Yeah. Thanks. My question is for Graeme.

I guess going back to last quarter, I guess the bank felt the downside scenario appropriately accounted for trade uncertainty. Can you walk me through what drove your decision to introduce another scenario? Because I would have thought that with a sufficiently conservative downside scenario before, the ability to shift weights between scenarios and layer in ECJ, there would have been a very compelling reason to introduce a whole new scenario. I guess walk me through why you decided you needed to go through the trouble of introducing a new scenario rather than using some of the levers I mentioned, because those seem to me much simpler than introducing a new scenario. Does it feel like perhaps a trade war has a real risk of persisting far longer into the future than perhaps the banks are messaging this quarter?

Graeme Hepworth (Chief Risk Officer)

Yeah. I mean, thanks.

I would say where we were after Q1, you remember, I mean, things had just started to play out literally in the early days of February after we closed our quarter. And so while we had been doing analysis and using this scenario kind of in the background, as we kind of persisted through Q2 and things really amped up, I mean, really at the beginning of April with Liberation Day, this kind of went to a whole different level of concern and uncertainty. We had a pessimistic scenario that was kind of broad in nature and of similar severity. We really wanted to kind of invoke something that really addressed the current kind of concerns and what bad might look like and the risks we're facing here now. And so it did not by itself change the overall numbers.

It certainly does change where we're allocating reserves and really highlights the pockets of risk that we'd be more concerned about. That just, again, allows us to directly leverage our framework as opposed to just kind of using overlays and management judgment in, I would say, a little bit more subjective ways, if you will. I think we just like the framework we have, and we like to use that framework rather than just override it with our judgment.

Thank you.

Dave McKay (President and CEO)

Okay. I think that's our last question, and I will wrap things up. We appreciate your comments. As we went through the quarter and we prepared for the call today, we knew that your focus would be on our reserve build and the GILs in the portfolio. Let me just take us back to the top, though.

We did show very strong pre-tax, pre-provision growth, very strong client levels, activity levels, particularly in personal and commercial banking and on the deposit side. We delivered really good revenue growth. We had very strong operating leverage. As you heard in the credit side, as we went through these scenarios in our stage one and two reserve build, we knew there is conservatism. We did not know it would be that different than our peers at the end of the day, but we do these things obviously in isolation. We knew that would cause us at the top of the house to miss expectations, but we still took them at the end of the day because that is what the scenarios advised us. They are a conservative scenario where 80% of that reserve build is macroeconomic estimates of the future. Everyone can have a different view, but we took that.

It's not like we spent that money that goes into an ACL, and if we're wrong, we'll release it. We knew that conservatism may cause the types of questions you asked today. The other fair questions you've asked is on our gross impaired loan build. You heard Graeme say 40% of that build was administrative, right, and matured credits that had to get renewed. You offset that and you get a 60% build. We didn't even talk about how we're confident in our allowances for that GIL build because of collateral and structure and the types of clients that we know we have. We expected kind of your conversations to come back to that. Don't forget the very strong overall performance we saw execution on HSBC. We saw execution on City National.

All that led to very strong overall revenue and pre-tax, pre-provision profit results and strong net income results. I'll remind you again, we increased our dividend by CAD 0.06, showing our confidence. We continue to do buybacks because we know where the intrinsic value of the firm is, and we'll continue to buy back shares even at these elevated evaluations. All that signifies, notwithstanding, we took some prudent reserves that you're reacting to our confidence in the future. Thanks very much for your questions, and we look forward to seeing you next quarter.

Operator (participant)

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