Royal Bank of Canada
Annual Report 2016

Plain-text annual report

ROYAL BANK OF CANADA › › ANNUAL REPORT 2016 CMYK + PMS 286 11189_RBC DesignTYPESET_v12b_FA13a_covers only.indd 2 CMYK + PMS 286 2016-12-06 12:58 PM Who we are › › Royal Bank of Canada is Canada’s largest bank, and one of the largest banks in the world, based on market capitalization. We are one of North America’s leading diversified financial services companies, and provide personal and commercial banking, wealth management, insurance, investor services and capital markets products and services on a global basis. ›80,000 employees worldwide 16 million+ clients 38 countries Personal & Commercial Banking provides personal and business financial services in Canada, the Caribbean and the U.S. Wealth Management in Canada, the U.S. and internationally offers solutions to affluent, high net worth, and ultra-high net worth clients. Global Asset Management provides investment management to retail clients and directly to institutional clients. Insurance offers a full range of insurance products via proprietary channels and third-party distributors, and participates in reinsurance internationally. Investor & Treasury Services provides asset and treasury services, custody, payments and transaction banking for financial institutions and other institutional investors worldwide. Capital Markets is an investment bank that provides focused expertise in banking, finance and capital markets to corporations, institutional investors, asset managers, and governments. Contents Our strategy for success Our solid performance Innovating to help clients thrive Delivering to help communities prosper Message from Dave McKay Message from Kathleen Taylor Management’s Discussion and Analysis 1 2 3 4 5 7 8 Enhanced Disclosure Task Force Recommendations Index Reports and Consolidated Financial Statements Ten-Year Statistical Review Glossary Directors and Executive Officers Principal Subsidiaries Shareholder Information 115 116 206 207 210 211 212 To view our online annual report, please visit: rbc.com/ar2016 Our strategy for success Our strategy is deeply rooted in our commitment to clients and communities. Our vision and goals reflect our long-term focus, and our values guide our day-to-day actions. In a rapidly changing environment, we have capabilities, strengths and a diversified business model that position us well to achieve continued growth. PURPOSE DRIVEN Helping clients thrive and communities prosper PERFORMANCE FOCUSED Vision To be among the world’s most trusted and successful financial institutions Goals How We Will Win In Canada: to be the undisputed leader in financial services In the U.S.: to be the preferred partner to corporate, institutional and high net worth clients and their businesses In select global financial centres: to be a leading financial services partner valued for our expertise Sustainable Growth Exceptional Client Experience Best Talent Simplify. Agile. Innovate. Community & Social Impact PRINCIPLES LED Values Client First: We will always earn the right to be our clients’ first choice Collaboration: We win as One RBC Accountability: We take owner- ship for personal and collective high performance Diversity & Inclusion: We embrace diversity for innovation and growth Integrity: We hold ourselves to the highest standards to build trust Royal Bank of Canada: Annual Report 2016 1 Our solid performance In 2016, we delivered solid returns to shareholders. We grew earnings by 4%, increased our dividend by 5%, achieved return on equity of 16.3% and strengthened our Common Equity Tier 1 capital ratio to 10.8%. We are diversified by business and geography. $9.0 $10.0 $10.5 Solid Earnings Net Income (C$ billion) Diluted Earnings per Share1 (C$) $6.00 $6.73 $6.78 19.0% 18.6% 16.3% Profitable Growth1 Return on Equity (ROE) 14 15 16 14 15 16 14 15 16 9.9% 10.6% 10.8% Financial Strength Common Equity Tier 1 Capital Ratio Solid Returns to Shareholders Dividends Declared per Share $2.84 $3.08 $3.24 14 15 16 14 15 16 Annualized dividend increase of: 5% – one year 8% – ten year2 Earnings by business segment3 50% Personal & Commercial Banking 22% Capital Markets 14% Wealth Management 8% Insurance 6% Investor & Treasury Services Revenue by geography3 62% Canada 22% United States 16% International Financial Performance Metrics4 Total Shareholder Return5 Diluted EPS Growth1 Return on Equity1 Capital Ratio (CET 1) MEDIUM-TERM OBJECTIVES 7%+ 18%+ Strong Dividend Payout Ratio 40%–50% 2016 RESULTS 0.7% 16.3% 10.8% 48% Three-year Five-year Ten-year RBC 10% 16% 10% GLOBAL PEER AVERAGE 8% 13% 6% 1 Impacted in 2016 by our acquisition of City National Corporation (City National) due to the issuance of RBC common shares. 2 Compound Annual Growth Rate. 3 Excludes Corporate Support. 4 Our focus is to maximize total shareholder returns (TSR) through the achievement of top half performance compared to our global peer group over the medium term (3-5 years), which we believe reflects a longer-term view of strong and consistent financial performance. 5 Reflects annualized TSR and is calculated based on the TSX common share price appreciation plus reinvested dividend income. Source: Bloomberg, as at October 31, 2016. RBC is compared to our global peer group. The peer group average excludes RBC; for the list of peers, please refer to our financial performance objectives section of our 2016 Management’s Discussion and Analysis. 2 Royal Bank of Canada: Annual Report 2016 Innovating to help clients thrive Innovation is core to our thinking at RBC. We’re building a digitally-enabled relationship bank, and changing how we work. We’re also collaborating with a diverse set of partners to explore new technology, and investing in the digital ecosystem to help drive the future prosperity and economic success of Canada. We’re building a digitally-enabled relationship bank » Providing an exceptional and secure experience that’s available when, how, and where it’s most convenient for clients » Using digital channels to better understand our clients so that we can deliver solutions tailored to their preferences » We’re not just digitizing our existing products, but rethinking how we deliver services and advice We’re changing the way we work and becoming more agile » Seeking better, smarter ways of working across teams and fostering intrapreneurship within RBC » Using dynamic, agile teams to create and adjust offerings and bring them to market more quickly RECENT INNOVATION HIGHLIGHTS 2010 Launched mobile wallet First investment bank to introduce proprietary smart order router technology 2013 Launched mobile payments service First North American financial institution to bring person-to-person electronic money transfers to Facebook Messenger‡ 2015 First North American financial institution to introduce a fully cloud-based payment solution Launched SecureVoice conversational biometrics » Working together with our clients to build new products and platforms in an agile lab environment1 2016 We’re bringing the outside in to RBC » Welcoming students through work-integrated learning programs to help solve some of our toughest problems » Building innovation labs, partnering with startups and conducting proof of concepts and pilots » Investing in FinTech focused venture funds and startups to access emerging trends We’re a leading partner in the Canadian digital ecosystem » Investing in innovation which will help drive Canada’s future prosperity and economic success » Working with leading universities to partner with the best, brightest and boldest minds » Supporting the advancement of machine learning and artificial intelligence in Canada Introduced our new mobile banking app Joined the first interbank group for global payments based on blockchain technology Used blockchain technology to improve functionality for our loyalty program2 Executed 60% of all financial transactions through digital and mobile channels3 1 Advanced Client Experience Program 2 RBC Rewards® 3 Personal & Commercial Banking, excluding cash withdrawals Royal Bank of Canada: Annual Report 2016 3 Delivering to help communities prosper Our social and environmental initiatives and investments will deliver a positive and lasting impact to shape the future. Our expertise, efforts and energetic employees are the foundation of our leadership in corporate citizenship. WHAT WE’RE FOCUSED ON Creating value for society through our commitment to young people Supporting the development of a clean economy Using our capabilities as an engine for public good Creating value for employees and fostering diversity & inclusion HOW WE EMBED CITIZENSHIP Innovating new products and services that create positive social and environmental impact Making it easier for employees to get involved in their communities Committed to unlocking the potential of young people to be better prepared for the future of work and pursue their path to success Sharing our learnings to advance the social and environmental sectors Deepening our expertise in the way we measure, track and report our impacts Launched a one-stop digital platform that enables employees to identify volunteer opportunities, apply for volunteer grants and donate to the charity of their choice PERFORMANCE HIGHLIGHTS $90 million+ Cash donations and community investments through more than 11,500 donations to support communities around the world1 LEADERSHIP IN CITIZENSHIP $2.3 billion Green bonds underwritten in 2016, bringing our total to $7.4 billion since 2014 200,000+ hours Volunteered by employees who took part in our volunteer grant programs in 20162 1 Includes employee volunteer grants and gifts-in-kind, as well as non-profit contributions to non-registered charities. Figure does not include sponsorships. 2 Includes non-work time volunteer hours reported by employees globally and pensioners in Canada. For more information, please visit: rbc.com/community-sustainability/index.html 4 Royal Bank of Canada: Annual Report 2016 Dave McKay President and Chief Executive Officer We believe that we are uniquely positioned among our competitors to achieve even greater client relevance in the digital world of the future. Message from Dave McKay We live in an uncertain and changing world. 2016 offered continuing challenges for the financial services industry, from a subdued macroeconomic outlook to political and technological disruption, to name just a few. Amid this uncertainty, RBC moves with a clear purpose, helping clients thrive and communities prosper. This is our north star that guides everything that we do. Our performance-focused and principles-led strategy enables us to navigate with conviction, to spot and create opportunities for our clients and ultimately to create sustainable value for shareholders. Our 2016 results demonstrate that this strategy continues to deliver success. Our record earnings of $10.5 billion were up 4% from last year, driven by strong results in Wealth Management, higher earnings in Insurance, solid results in Personal & Commercial Banking, and record earnings in Investor & Treasury Services. We earned $6.78 per share on a diluted basis, delivered a return on equity of 16.3% and strengthened our Common Equity Tier 1 capital ratio to 10.8%. During 2016, we returned $5.2 billion to shareholders as we raised our dividend twice for a combined increase of 5% and repurchased 4.6 million common shares. We delivered compound annual Total Shareholder Returns of 10% and 16%, over the three- and five-year periods. These results, delivered against the backdrop of a challenging economic environment, show how RBC continues to bring our strengths and capabilities to bear: strong client relationships; scale; an internationally-respected brand; prudent capital and risk management; a client- focused culture and highly-engaged employees. We also continue to be well positioned given the strength of our diversification, by business and by geography, and our ability to effectively manage costs. In addition, we believe that we are uniquely positioned among our competitors to achieve even greater client relevance in the digital world of the future. As our clients increasingly move online, we are quickly transforming our business to build a truly digitally-enabled relationship bank. This focus on digitization will ultimately help us realize our vision to be among the world’s most trusted and successful financial institutions. Our strategic goals remain unchanged: to be the undisputed financial services leader in Canada; the preferred partner to corporate, institutional and high net worth clients and their businesses in the U.S.; and a leading financial services partner valued for our expertise in select global financial centres internationally. In all of these markets we are targeting high growth and high value client segments to achieve sustainable growth. Achieving sustainable growth We believe our focus on innovation and technology will help enable us to extend our lead in Canada. In 2016, we maintained our number one or two market position in all key retail categories and we remain the leader in business banking. Our scale in Canada affords us the opportunity to leverage unrivalled digital and data insights. It provides our clients with an improved experience, leading to increased loyalty and improved profitability, despite the challenging macroeconomic environment. Looking forward, as Canada’s top wealth and asset manager, we also see an opportunity to further grow our business serving high net worth clients, including assisting our many business owner clients with their succession and ownership transition plans. We will also continue to focus on building our business with newcomers to Canada, an increasingly important and growing market. And we expect to prudently grow our Capital Markets business segment, currently the number one investment bank in Canada and the 10th largest global investment bank by fees. Wherever we operate, our brand strength, breadth and scale enable us to bring the best we have to offer for the benefit of our clients. In the U.S., our acquisition of Los Angeles- We continue to be well positioned given the strength of our diversification, by business and by geography. Royal Bank of Canada: Annual Report 2016 5 Wherever we operate, our brand strength, breadth and scale enable us to bring the best we have to offer for the benefit of our clients. based City National provides us with significant opportunities to deepen our relationship with high net worth and mid- market commercial clients. In its first year as part of RBC, City National has generated $290 million of additional earnings, complementing our existing U.S. Wealth Management and Capital Markets franchises, and underlining the value of City National to our U.S. strategy. This helped us generate 24% of revenue in the U.S. in 2016. Across our businesses in Canada, the U.S. and internationally, we continue to invest in areas where we see the greatest potential for sustainable growth, focusing on specific markets and client segments where we can be a leader. In select global centres in the U.K., Europe and Asia, we continue to prudently grow our wealth management, asset management, capital markets, and investor and treasury services businesses. Meanwhile in the Caribbean, we’ve continued to strengthen our retail business, following our decision to exit non-core regions last year. In Canada, we made the decision this year to sell RBC General Insurance Company, our home and auto insurance business to Aviva Canada, for $582 million. Under the distribution agreement entered into as part of the sale, we maintained our deep relationships with our clients, while continuing to offer a full suite of property and casualty insurance products. Providing exceptional client experience We are continually working to provide an exceptional client experience to our personal, institutional, and commercial clients, whether they choose to interact with us in person, on the phone, or digitally. This year, we were immensely honoured to have been awarded the rank of ‘Highest in Customer Satisfaction Among the Big Five Retail Banks,’ by J.D. Power’s 2016 Canadian Retail Banking Satisfaction Study. This recognition speaks to our commitment to clients and our 6 Royal Bank of Canada: Annual Report 2016 ongoing efforts to put them first and is further evidenced by the fact that our net promoter score, an indicator of client loyalty and satisfaction, has doubled over the last 15 years. Our focus on innovation Thanks to our focus on efficiency, we are able to reinvest in innovation and technology in ways that others can’t. This innovation will itself drive further efficiency, enabling us to simplify how we work and digitize our operations. Today within Personal & Commercial Banking, 60% of all financial transactions, excluding cash withdrawals, come through digital and mobile channels. The insights that we are deriving from these channels are helping us to provide an exceptional and secure experience that is available to our clients when, how and where it is most convenient for them. In developing the technologies of the future, we know that we don’t hold all of the answers. We are partnering with and investing in start-ups and universities to tackle some of the most interesting opportunities in financial technology, bringing the outside in to RBC. While many of these ideas are being incubated through our innovation labs in Canada, the U.S. and Europe, we are also increasingly seeing innovative ideas emerging from new and exciting avenues, including from students working with RBC. As an example, this year, our new Amplify internship program within our technology and operations division, challenged students to take on projects in agile teams. All of the projects have been funded for further development and two have been submitted for patent approval. This is just one way that we believe our investment in innovation will not only support future business opportunities, but will also help drive the future prosperity and economic success of Canada and benefit each of the communities in which we operate. Our colleagues continue to drive results Our success this year would not have been possible without the dedication and professionalism of our colleagues, whose high engagement and client focus continues to drive our results. We will ensure that we evolve for uncertain times and a digital age. We are creating a culture that nurtures innovation and collaboration, and is increasingly fast-paced, adaptive and execution-focused, in order to meet clients’ needs. We are building a better workplace for our colleagues that harnesses diversity and inclusion and where everyone has the opportunity to realize their full potential. Helping our communities prosper That potential is more likely achieved thanks to our colleagues’ pride in working for an organization that is confident in its role in building a future for clients, their families, their businesses and their communities. As a purpose-driven company – and as Canada’s largest corporation by market capitalization – we understand the important role that we play in addressing societal challenges that could impact our business over time. That is why this year we announced a new commitment aimed at unlocking the potential of young people to thrive and drive Canada’s future prosperity ahead of Canada’s 150th anniversary year – #make150count. We are passionate about making a positive social impact in all of the communities in which we live and work. Our thanks to you In a changing world, I’d like to thank all our clients for putting their trust in RBC. I also want to thank our colleagues whose commitment enables our ongoing success. And finally, to you, our shareholders, I would like to reiterate our focus on delivering high- quality and sustainable earnings growth and moving with clear purpose in 2017 and beyond. David McKay President and Chief Executive Officer Message from Kathleen Taylor Dear fellow shareholders, The key responsibility of your Board of Directors is to keep RBC focused on delivering strong and positive outcomes for shareholders, customers, employees and the communities we serve. This means engaging actively with the Bank’s outstanding management team to ensure we have the right strategy, talent and risk management to identify suitable opportunities for growth and continue to create long-term value. The right strategy The Board of Directors and management share a vision for RBC: to be among the world’s most trusted and successful financial institutions. To help realize this vision, the Board oversees the organization’s strategic direction, maintaining its focus on markets and segments where RBC can apply its strengths to win business and deepen relationships with clients and our communities. Your Board is well suited to the transformational nature of our industry, remaining agile and responsive to the evolving marketplace. At every board meeting we examine and discuss aspects of enterprise and business segment strategy to identify opportunities for organic growth. We also spend time analyzing prospects for the Bank’s long-term growth plans. Earlier this year RBC completed the acquisition of City National, which is already proving to be the right platform to complement our existing U.S. presence, advancing RBC toward our long- term strategic goal of becoming the preferred partner to corporate, institutional, and high net worth clients and their businesses in the U.S. The right talent The continued superior performance of RBC, including the ongoing, successful integration of City National demonstrates that having the right strategy is critical to our success. But equally essential is the leadership of a talented executive team and dedicated employees to execute our strategy with excellence. A key responsibility of the Board is talent management and succession planning for the top executive team, in order to ensure we have a strong pipeline of leaders to drive both short and long-term performance. This includes an in-depth evaluation of the strengths and opportunities for high-performance executives who are key candidates in both the near and medium term. Building diverse teams at every level is a priority that we embed into our talent management strategies, recognizing that a diversity of viewpoints, backgrounds and experience is an important driver of innovation and profitable growth. Prudent risk management In overseeing the ongoing operations and strategic direction of RBC, the Board carefully assesses whether management’s plans appropriately balance business opportunities with sound risk discipline. We seek to instill and support a strong risk culture, monitoring the alignment of risk conduct with our enterprise-wide framework. The Board ensures that the Bank’s risk management function is independent from the businesses. We approve Risk Appetite, oversee strategic risk management and regularly meet with regulators to discuss the Bank’s control environment. Fostering a culture of integrity and good governance Your Board also champions the strong corporate values that are entrenched in the culture of RBC. We recognize that integrity and accountability are the foundation for the Bank’s strong reputation and brand. We establish standards of integrity designed to promote ethical behaviour throughout the organization, and foster a business approach in which we work to make a positive impact on society, the environment and the economy. Beyond the setting of prudent structures and strong policies, corporate governance at RBC is a matter of board culture where active engagement and open and productive debate are not only encouraged but expected. We regard certain characteristics and behaviours as essential for board members. Directors must be dedicated to the needs of RBC, engage fully, appropriately challenge the status quo, assess opportunities from a strategic context, exhibit sound business judgment and uphold RBC values. Our governance approach continues to receive recognition, with RBC winning Best Overall Corporate Governance – International at the 2016 Corporate Governance Awards in New York. Kathleen Taylor Chair of the Board Creating long-term value for our shareholders and other stakeholders We place strong emphasis upon board renewal, assessing the strengths of candidates for the Board against the evolving needs of the Bank. We were pleased this year to welcome Andrew Chisholm, the recently retired Advisory Director and Senior Strategy Officer at Goldman Sachs & Co., who brings to the Board extensive experience in strategic advice, mergers and acquisitions, and capital markets, as well as risk and capital management. I would like to thank the members of your Board for delivering valuable advice and oversight throughout the year. In turn, the Board extends its thanks to Dave McKay and his leadership team for their dedication to helping clients thrive, communities prosper and employees succeed. And finally, thank you to all RBC employees, whose daily commitment to our clients and communities continues to drive our success. Kathleen Taylor Chair of the Board Royal Bank of Canada: Annual Report 2016 7 Management’s Discussion and Analysis Management’s Discussion and Analysis (MD&A) is provided to enable a reader to assess our results of operations and financial condition for the fiscal year ended October 31, 2016, compared to the preceding two fiscal years. This MD&A should be read in conjunction with our 2016 Annual Consolidated Financial Statements and related notes and is dated November 29, 2016. All amounts are in Canadian dollars, unless otherwise specified, and are based on financial statements prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB), unless otherwise noted. Additional information about us, including our 2016 Annual Information Form, is available free of charge on our website at rbc.com/investorrelations, on the Canadian Securities Administrators’ website at sedar.com and on the EDGAR section of the United States (U.S.) Securities and Exchange Commission’s (SEC) website at sec.gov. Information contained in or otherwise accessible through the websites mentioned does not form part of this report. All references in this report to websites are inactive textual references and are for your information only. Table of contents Caution regarding forward-looking statements Overview and outlook Selected financial and other highlights About Royal Bank of Canada Vision and strategic goals Economic, market and regulatory review and outlook Defining and measuring success through Total Shareholder Returns Key corporate events of 2016 Financial performance Overview Impact of foreign currency translation Total revenue Provision for credit losses Insurance policyholder benefits, claims and acquisition expense Non-interest expense Income and other taxes Client assets Business segment results Results by business segment 8 9 9 10 10 11 12 12 13 13 13 14 15 15 16 17 17 19 19 How we measure and report our business segments Key performance and non-GAAP measures Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Results by geographic segment Quarterly financial information Fourth quarter 2016 performance Quarterly results and trend analysis Financial condition Condensed balance sheets Off-balance sheet arrangements Risk management Overview Top and emerging risks Enterprise risk management Credit risk 19 20 22 27 32 35 36 40 41 41 41 42 43 43 44 46 46 47 49 54 Market risk Liquidity and funding risk Insurance risk Operational risk Regulatory compliance risk Strategic risk Reputation risk Legal and regulatory environment risk Competitive risk Systemic risk Overview of other risks Capital management Additional financial information Accounting and control matters Critical accounting policies and estimates Regulatory developments Controls and procedures Related party transactions Supplementary information Enhanced Disclosure Task Force recommendation index 66 72 82 83 84 85 85 85 87 87 87 89 99 99 99 106 107 107 108 115 See our Glossary for definitions of terms used throughout this document. Caution regarding forward-looking statements From time to time, we make written or oral forward-looking statements within the meaning of certain securities laws, including the “safe harbour” provisions of the United States Private Securities Litigation Reform Act of 1995 and any applicable Canadian securities legislation. We may make forward-looking statements in this 2016 Annual Report, in other filings with Canadian regulators or the SEC, in other reports to shareholders and in other communications. Forward-looking statements in this document include, but are not limited to, statements relating to our financial performance objectives, vision and strategic goals, the economic and market review and outlook for Canadian, U.S., European and global economies, the regulatory environment in which we operate, the outlook and priorities for each of our business segments, and the risk environment including our liquidity and funding risk. The forward-looking information contained in this document is presented for the purpose of assisting the holders of our securities and financial analysts in understanding our financial position and results of operations as at and for the periods ended on the dates presented, as well as our financial performance objectives, vision and strategic goals, and may not be appropriate for other purposes. Forward-looking statements are typically identified by words such as “believe”, “expect”, “foresee”, “forecast”, “anticipate”, “intend”, “estimate”, “goal”, “plan” and “project” and similar expressions of future or conditional verbs such as “will”, “may”, “should”, “could” or “would”. By their very nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties, which give rise to the possibility that our predictions, forecasts, projections, expectations or conclusions will not prove to be accurate, that our assumptions may not be correct and that our financial performance objectives, vision and strategic goals will not be achieved. We caution readers not to place undue reliance on these statements as a number of risk factors could cause our actual results to differ materially from the expectations expressed in such forward-looking statements. These factors – many of which are beyond our control and the effects of which can be difficult to predict – include: credit, market, liquidity and funding, insurance, operational, regulatory compliance, strategic, reputation, legal and regulatory environment, competitive and systemic risks and other risks discussed in the Risk management and Overview of other risks sections of our 2016 Annual Report; global uncertainty, the Brexit vote to have the United Kingdom leave the European Union, weak oil and gas prices, cyber risk, anti-money laundering, exposure to more volatile sectors, technological innovation and new Fintech entrants, increasing complexity of regulation, data management, litigation and administrative penalties; the business and economic conditions in the geographic regions in which we operate; the effects of changes in government fiscal, monetary and other policies; tax risk and transparency; and environmental risk. We caution that the foregoing list of risk factors is not exhaustive and other factors could also adversely affect our results. When relying on our forward-looking statements to make decisions with respect to us, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. Material economic assumptions underlying the forward-looking statements contained in this 2016 Annual Report are set out in the Overview and outlook section and for each business segment under the heading Outlook and priorities. Except as required by law, we do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by us or on our behalf. Additional information about these and other factors can be found in the Risk management and Overview of other risks sections of our 2016 Annual Report. 8 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Overview and outlook Selected financial and other highlights (Millions of Canadian dollars, except per share, number of and percentage amounts) Total revenue Provision for credit losses (PCL) Insurance policyholder benefits, claims and acquisition expense (PBCAE) Non-interest expense Income before income taxes Net income Segments – net income Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Net income Selected information Earnings per share (EPS) – basic – diluted Return on common equity (ROE) (1), (2) Average common equity (1) Net interest margin (on average earning assets) (3) Total PCL as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances Gross impaired loans (GIL) as a % of loans and acceptances (4) Liquidity coverage ratio (LCR) (5) Capital ratios, Leverage ratio and multiples Common Equity Tier 1 (CET1) ratio (6) Tier 1 capital ratio (6) Total capital ratio (6) Assets-to-capital multiple (6) Leverage ratio (6) Selected balance sheet and other information (7) Total assets Securities Loans (net of allowance for loan losses) Derivative related assets Deposits Common equity Total capital risk-weighted assets Assets under management (AUM) Assets under administration (AUA) (8) Common share information Shares outstanding (000s) – average basic – average diluted – end of period Dividends declared per common share Dividend yield (9) Common share price (RY on TSX) (10) Market capitalization (TSX) (10) Business information (number of) Employees (full-time equivalent) (FTE) Bank branches Automated teller machines (ATMs) Period average US$ equivalent of C$1.00 (11) Period-end US$ equivalent of C$1.00 $ $ $ $ $ $ 2016 38,405 $ 1,546 3,424 20,136 13,299 10,458 $ 5,184 $ 1,473 900 613 2,270 18 10,458 $ 6.80 $ 6.78 16.3% 62,200 $ 1.70% 0.29% 0.28% 0.73% 127% 10.8% 12.3% 14.4% n.a. 4.4% 2015 35,321 $ 1,097 2,963 18,638 12,623 10,026 $ 5,006 $ 1,041 706 556 2,319 398 10,026 $ 6.75 $ 6.73 18.6% 52,300 $ 1.71% 0.24% 0.24% 0.47% 127% 10.6% 12.2% 14.0% n.a. 4.3% $ 1,180,258 $ 1,074,208 $ 236,093 521,604 118,944 757,589 64,304 449,712 586,300 5,058,900 215,508 472,223 105,626 697,227 57,048 413,957 498,400 4,683,100 1,485,876 1,494,137 1,485,394 3.24 $ 4.3% 83.80 $ 124,476 1,442,935 1,449,509 1,443,423 3.08 $ 4.1% 74.77 $ 107,925 2014 34,108 1,164 3,573 17,661 11,710 9,004 4,475 1,083 781 441 2,055 169 9,004 6.03 6.00 19.0% 45,700 1.86% 0.27% 0.27% 0.44% n.a. 9.9% 11.4% 13.4% 17.0X n.a. 940,550 199,148 435,229 87,402 614,100 48,615 372,050 457,000 4,710,900 1,442,553 1,452,003 1,442,233 2.84 3.8% 80.01 115,393 75,510 1,419 4,905 0.755 $ 0.746 $ 72,839 1,355 4,816 0.797 $ 0.765 $ 73,498 1,366 4,929 0.914 0.887 $ $ $ $ Table 1 2016 vs. 2015 Increase (decrease) $ $ $ $ $ $ 3,084 449 461 1,498 676 432 178 432 194 57 (49) (380) 432 0.05 0.05 n.m. 9,900 n.m. n.m. n.m. n.m. n.m. n.m. n.m. n.m. n.a. n.m. $ 106,050 20,585 49,381 13,318 60,362 7,256 35,755 87,900 375,800 42,941 44,628 41,971 0.16 n.m. 9.03 16,551 2,671 64 89 (0.042) (0.019) $ $ $ $ 8.7% 40.9% 15.6% 8.0% 5.4% 4.3% 3.6% 41.5% 27.5% 10.3% (2.1)% (95.5)% 4.3% 0.7% 0.7% (230) bps 18.9% (1) bps 5 bps 4 bps 26 bps – bps 20 bps 10 bps 40 bps n.a. 10 bps 9.9% 9.6% 10.5% 12.6% 8.7% 12.7% 8.6% 17.6% 8.0% 3.0% 3.1% 2.9% 5.2% 20 bps 12.1% 15.3% 3.7% 4.7% 1.8% (5.3)% (2.5)% (1) (2) (3) (4) (5) (6) (7) (8) Average amounts are calculated using methods intended to approximate the average of the daily balances for the period. This includes Average common equity used in the calculation of ROE. For further details, refer to the Key performance and non-GAAP measures section. These measures may not have a standardized meaning under generally accepted accounting principles (GAAP) and may not be comparable to similar measures disclosed by other financial institutions. For further details, refer to the Key performance and non-GAAP measures section. Net interest margin (on average earning assets) is calculated as net interest income divided by average earning assets. Average amounts are calculated using methods intended to approximate the average of the daily balances for the period. GIL includes $418 million (2015 – $nil) related to the acquired credit impaired (ACI) loans portfolio from our acquisition of City National, with over 80% covered by loss-sharing agreements with the Federal Deposit Insurance Corporation (FDIC). ACI loans added 8 bps to our 2016 GIL ratio (2015 – n.a.). For further details, refer to Notes 2 and 5 of our 2016 Annual Consolidated Financial Statements. LCR is a new regulatory measure under the Basel III Framework, and is calculated using the Liquidity Adequacy Requirements (LAR) guideline. Effective in the second quarter of 2015, LCR was adopted prospectively. For further details, refer to the Liquidity and funding risk section. Capital and Leverage ratios presented above are on an “all-in” basis. Effective the first quarter of 2015, the Leverage ratio has replaced the Assets-to-capital multiple (ACM). The Leverage ratio is a regulatory measure under the Basel III framework. The ACM is presented on a transitional basis for prior periods. For further details, refer to the Capital management section. Represents period-end spot balances. AUA includes $18.6 billion and $9.6 billion (2015 – $21.0 billion and $8.0 billion; 2014 – $23.2 billion and $8.0 billion) of securitized residential mortgages and credit card loans, respectively. Prior period figures have been revised from those previously disclosed. Defined as dividends per common share divided by the average of the high and low share price in the relevant period. (9) (10) Based on TSX closing market price at period-end. (11) Average amounts are calculated using month-end spot rates for the period. n.a. not applicable n.m. not meaningful Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 9 About Royal Bank of Canada Royal Bank of Canada is Canada’s largest bank, and one of the largest banks in the world, based on market capitalization. We are one of North America’s leading diversified financial services companies, and provide personal and commercial banking, wealth management, insurance, investor services and capital markets products and services on a global basis. We have over 80,000 full- and part-time employees who serve more than 16 million personal, business, public sector and institutional clients through offices in Canada, the U.S. and 36 other countries. For more information, please visit rbc.com. Our business segments are described below. Personal & Commercial Banking operates in Canada, the Caribbean and the U.S., and comprises our personal and business banking operations, as well as our auto financing and retail investment businesses. Wealth Management serves affluent, high net worth and ultra-high net worth clients from our offices in key financial centres mainly in Canada, the U.S., the U.K., the Channel Islands and Asia with a comprehensive suite of investment, trust, banking, credit and other wealth management solutions. We also provide asset management products and services directly to institutional and individual clients through our distribution channels and third-party distributors. Insurance provides a wide range of life, health, home, auto, travel, wealth, group and reinsurance products and solutions. In Canada, we offer insurance products and services through our proprietary distribution channels, comprised of the field sales force which includes retail insurance branches, our field sales representatives, advice centres and online, as well as through independent insurance advisors and affinity relationships. Outside Canada, we operate in reinsurance markets globally offering life, accident and annuity reinsurance products. Investor & Treasury Services serves the needs of institutional investing clients by providing asset services, custodial, advisory, financing and other services to safeguard assets, maximize liquidity and manage risk in multiple jurisdictions around the world. We also provide short- term funding and liquidity management for RBC. Capital Markets provides public and private companies, institutional investors, governments and central banks with a wide range of products and services. In North America, we offer a full suite of products and services which include corporate and investment banking, equity and debt origination and distribution, and structuring and trading. Outside North America, we offer a diversified set of capabilities in our key sectors of expertise such as energy, mining and infrastructure, and we have expanded into industrial, consumer and healthcare in Europe. Our business segments are supported by Corporate Support, which consists of Technology & Operations and Functions. Technology & Operations provides the technological and operational foundation required to effectively deliver products and services to our clients, while Functions includes our finance, human resources, risk management, internal audit and other functional groups. The following chart presents our business segments and respective lines of business: ROYAL BANK OF CANADA Insurance O Canadian Insurance O International Insurance Investor & Treasury Services Capital Markets O Corporate and Investment Banking O Global Markets O Other Personal & Commercial Banking O Canadian Banking O Caribbean & U.S. Banking Wealth Management O Canadian Wealth Management O U.S. Wealth Management (including City National) O International Wealth Management O Global Asset Management O Technology & Operations O Functions Corporate Support Vision and strategic goals Our business strategies and actions are guided by our vision, “To be among the world’s most trusted and successful financial institutions.” Our three strategic goals are: • • • In Canada, to be the undisputed leader in financial services; In the U.S., to be the preferred partner to corporate, institutional and high net worth clients and their businesses; and In select global financial centres, to be a leading financial services partner valued for our expertise. For our progress in 2016 against our business strategies and strategic goals, refer to the Business segment results section. 10 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Economic, market and regulatory review and outlook – data as at November 29, 2016 The predictions and forecasts in this section are based on information and assumptions from sources we consider reliable. If this information or these assumptions are not accurate, actual economic outcomes may differ materially from the outlook presented in this section. Canada The Canadian economy is expected to grow by 1.3%1 during calendar 2016, which is below our estimate of 2.2%1 as at December 1, 2015 and consistent with our estimate as at August 23, 2016. Growth over the first half of the calendar year was supported by solid consumer spending and housing activity, reflecting low interest rates and a resilient labour market. Business investment remained weak as firms in the energy sector continued to reduce capital spending. Weakness in the energy sector was compounded by wildfires in Alberta that resulted in temporary shutdowns by oil and gas producers, destroyed over 2,000 buildings and displaced 80,000 individuals. The economy has rebounded in the second half of the year as oil and gas production normalized and non-energy exports recovered from earlier weakness. The unemployment rate rose to 7.0%, slightly higher than July’s rate of 6.9% as labour force participation increased. The Bank of Canada (BoC) has held the overnight rate steady in calendar 2016 amid persistent slack in the economy, due to slower-than-expected growth in non-energy industries, as well as inflation results that were below target. In calendar 2017, we expect the Canadian economy will grow at a 1.8%1 rate, driven by firm consumer spending, fiscal stimulus, stronger export growth and a modest recovery in business investment. Due to federal and provincial policy changes announced in 2016, we expect housing market activity will soften in calendar 2017. The BoC has maintained a cautious tone recently amid uncertainty surrounding the economic outlook; however, we expect the overnight rate will be held steady throughout 2017 as growth moves in line with the BoC’s latest projection. U.S. The U.S. economy is expected to grow by 1.6%1 in calendar 2016, which is below our estimate of 2.8%1 as at December 1, 2015 and slightly above our estimate of 1.5%1 as at August 23, 2016. Consumer spending growth was strong over the first half of the year, reflecting solid job growth, rising wages, elevated consumer confidence and low interest rates. However, declining inventory investment and a reduction in business investment, partially reflecting further weakness in the energy sector, had an adverse impact on growth earlier this year. The unemployment rate of 4.9% has been relatively stable this year amid rising labour force participation, falling within the range that the Federal Reserve (Fed) views as consistent with full employment. The Fed has noted that the case for higher rates continues to strengthen with growth having rebounded in the second half of the year and inflation picking up gradually. Barring an extended period of market volatility following the recent U.S. election result, we expect the Fed will raise the federal funds target range to 0.50%-0.75% in December from its current range of 0.25%-0.50%. In calendar 2017, we expect the U.S. economy will grow at a 2.2%1 rate as consumer spending growth remains firm and business investment picks up in both energy and non-energy industries. As growth continues at a solid pace, the labour market improves further and inflation rises toward the Fed’s 2% target, we expect the gradual withdrawal of monetary policy stimulus to continue, with the Fed raising rates by another 50 basis points in calendar 2017. The recent U.S. election could result in policy changes that impact the economic outlook though any revisions to our expectations await further details being announced by the new administration. Europe The Eurozone economy is expected to grow by 1.6% in calendar 2016, which is below our estimate of 1.7% as at December 1, 2015, but slightly above our estimate of 1.5% as at August 23, 2016. The steady economic recovery has continued over the last year and the threat of deflation has subsided, although inflation remains well below the European Central Bank’s (ECB) target. Growth has been driven by consumer spending and business investment, reflecting a gradually improving labour market and rising business sentiment. The unemployment rate of 10.0% in September matched the lowest level since July 2011. The ECB left monetary policy unchanged in October, awaiting the results of a review of its asset purchase program that will be available in December. In calendar 2017, we expect the Eurozone economy will grow by 1.3% as political uncertainty, including evolving Brexit negotiations, weighs on business sentiment. We expect the ECB will continue to provide substantial monetary policy stimulus with monthly asset purchases likely to be extended beyond March 2017. Financial markets Global equity markets recorded minimal gains this year amid several periods of heightened volatility related to global growth concerns and political uncertainty related to Brexit and the U.S. election. Central banks have maintained highly stimulative monetary policy and some governments are increasing fiscal stimulus. Yields on Canadian and U.S. long-term government bonds generally declined over the first half of the year but increased more recently as inflation expectations rose. Oil prices hit year-to-date highs of around $50/barrel in October but declined more recently on concerns that the Organization of the Petroleum Exporting Countries (OPEC) would have difficulty reaching a consensus to cap output. The macroeconomic headwinds discussed above, such as the volatility of oil prices, the potential for greater uncertainty or financial market instability related to Brexit and the U.S. election, and greater global economic uncertainty may alter our outlook and results for fiscal 2017 and future periods. These continuing pressures may lead to higher PCL in our wholesale and retail loan portfolios and impact the general business and economic conditions in the regions we operate. Regulatory environment We continue to monitor and prepare for regulatory developments in a manner that seeks to ensure compliance with new requirements while mitigating any adverse business or economic impacts. Such impacts could result from new or amended regulations and the expectations of those who enforce them. Significant developments include continuing changes to global and domestic standards for capital and liquidity, over- the-counter (OTC) derivatives reform, initiatives to enhance requirements for institutions deemed systemically important to the financial sector, and changes to resolution regimes addressing government bail-in and total loss-absorbing capacity. We also continue to implement reforms enacted under the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act including those related to the Fed’s enhanced prudential standards for Bank Holding Companies and Foreign Banking Organizations. For a discussion on risk factors resulting from these and other regulatory developments which may affect our business and financial results, refer to the Risk management – Top and emerging risks section. For further details on our framework and activities to manage risks, refer to the Risk management and Capital management sections. 1 Annualized rate Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 11 Defining and measuring success through total shareholder returns Our focus is to maximize total shareholder returns (TSR) through the achievement of top half performance compared to our global peer group over the medium-term (3-5 years), which we believe reflects a longer-term view of strong and consistent financial performance. Maximizing TSR is aligned with our three strategic goals discussed earlier and we believe represents the most appropriate measure of shareholder value creation. TSR is a concept used to compare the performance of our common shares over a period of time, reflecting share price appreciation and dividends paid to common shareholders. The absolute size of TSR will vary depending on market conditions, and the relative position reflects the market’s perception of our overall performance relative to our peers over a period of time. Financial performance objectives are used to measure progress against our medium-term TSR objectives. We review and revise these financial performance objectives as economic, market and regulatory environments change. By focusing on our medium-term objectives in our decision-making, we believe we will be well-positioned to provide sustainable earnings growth and solid returns to our common shareholders. The following table provides a summary of our 2016 performance against our medium-term financial performance objectives: 2016 Financial performance compared to our medium-term objectives Table 2 Diluted EPS growth of 7% + ROE of 18% + Strong capital ratios (CET1) (1) Dividend payout ratio 40% – 50% (1) For further details on the CET1 ratio, refer to the Capital management section. 2016 results 0.7% 16.3% 10.8% 48% Both our diluted EPS and ROE were impacted by our acquisition of City National due to the issuance of RBC common shares, as noted below. For 2017, we maintained our financial performance objectives relating to diluted EPS growth, strong capital ratios and dividend payout ratio. We have revised our ROE financial objective to 16%+ to reflect higher ongoing regulatory capital requirements and the impact related to the issuance of RBC common shares on the acquisition of City National. We compare our TSR to that of a global peer group approved by our Board of Directors. The global peer group remains unchanged from last year and consists of the following 10 financial institutions: • Canadian financial institutions: Bank of Montreal, Canadian Imperial Bank of Commerce, Manulife Financial Corporation, National Bank of Canada, Power Financial Corporation, The Bank of Nova Scotia, and Toronto-Dominion Bank. U.S. banks: JPMorgan Chase & Co. and Wells Fargo & Company. International banks: Westpac Banking Corporation. • • Medium-term objectives – three and five year annualized TSR vs. peer group average Table 3 Royal Bank of Canada Peer group average (excluding RBC) Three year TSR (1) Five year TSR (1) 10% Top half 8% 16% Top half 13% (1) The three and the five year annualized TSR are calculated based on our common share price appreciation as per the TSX closing market price plus reinvested dividends for the period October 31, 2013 to October 31, 2016 and October 31, 2011 to October 31, 2016, respectively. Common share and dividend information For the year ended October 31 Common share price (RY on TSX) – close, end of period Dividends paid per share Increase (decrease) in share price Total shareholder return $ $ 2016 83.80 3.20 12.1% 16.8% $ 2015 74.77 3.04 (6.5)% (3.0)% $ 2014 80.01 2.76 14.3% 19.0% $ 2013 70.02 2.46 23.0% 28.0% Table 4 2012 56.94 2.22 17.1% 22.0% Key corporate events of 2016 RBC General Insurance Company On July 1, 2016, we completed the sale of RBC General Insurance Company to Aviva Canada Inc. (Aviva), which was previously announced on January 21, 2016. The transaction involved the sale of our home and auto insurance manufacturing business and included a 15-year strategic distribution agreement between RBC Insurance and Aviva. As a result of the transaction, we recorded a gain of $287 million ($235 million after- tax) in our 2016 results, which was recorded in Non-interest income – Other. For further details, refer to Note 11 of our 2016 Annual Consolidated Financial Statements. City National Corporation On November 2, 2015, we completed the acquisition of City National Corporation (City National), the holding company for City National Bank. Total consideration of $7.1 billion (US$5.5 billion) was paid with $3.4 billion (US$2.6 billion) in cash, 41.6 million RBC common shares and $360 million (US$275 million) of RBC first preferred shares. City National has been combined with the U.S. Wealth Management business within our Wealth Management segment. For further details, refer to Note 11 of our 2016 Annual Consolidated Financial Statements. 12 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Financial performance Overview 2016 vs. 2015 Net income of $10,458 million was up $432 million or 4% from a year ago. Diluted earnings per share (EPS) of $6.78 was up $0.05 and return on common equity (ROE) of 16.3% was down 230 bps from 18.6% last year. In 2016, both our diluted EPS and ROE were impacted by our acquisition of City National due to the issuance of RBC common shares as noted above. Our Common Equity Tier 1 (CET1) ratio was 10.8%, up 20 bps. Our results were driven by higher earnings in Wealth Management, Insurance, Personal & Commercial Banking, and Investor & Treasury Services, partially offset by lower earnings in Capital Markets. Our results include the after-tax gain of $235 million on the sale of RBC General Insurance Company to Aviva and the favourable impact of foreign exchange translation. Results in 2015 included a gain of $108 million (before- and after-tax) from the wind-up of a U.S.-based subsidiary that resulted in the release of foreign currency translation adjustment (CTA) which was recorded in Corporate Support. Wealth Management earnings increased primarily reflecting the inclusion of our acquisition of City National, which contributed $290 million to earnings, lower restructuring costs relating to the International Wealth Management business, and benefits from our efficiency management activities. These factors were partially offset by lower transaction volumes. Insurance earnings increased largely due to the gain on the sale of RBC General Insurance Company, as noted above. Lower earnings from new U.K. annuity contracts and the reduction in earnings from the sale of our home and auto insurance manufacturing business, as noted above, were partially offset by growth in International Insurance. Personal & Commercial Banking earnings increased largely reflecting solid volume and fee-based revenue growth across most businesses in Canada, and higher earnings in the Caribbean. These factors were partially offset by lower spreads, higher costs in support of business growth and higher PCL in Canada. Investor & Treasury Services earnings increased primarily due to higher funding and liquidity earnings reflecting tightening credit spreads and favourable interest rate movements, and higher client deposit spreads. These factors were partially offset by increased investment in technology initiatives, higher staff costs and lower earnings from foreign exchange market execution. In addition, the prior year included an additional month of earnings in Investor Services of $42 million ($28 million after-tax). Capital Markets earnings decreased largely driven by higher PCL, lower results in our Global Markets and Corporate and Investment Banking businesses reflecting lower client activity, and higher compliance costs. These factors were partially offset by lower variable compensation, the impact from foreign exchange translation, and lower litigation provisions. For further details on our business segment results and CET1 ratio, refer to the Business segment results and Capital management sections, respectively. 2015 vs. 2014 In 2015, net income of $10,026 million was up $1,022 million or 11% from 2014. Diluted EPS of $6.73 was up $0.73 and ROE of 18.6% was down 40 bps. Our CET1 ratio was 10.6%, up 70 bps. Our results were driven by higher earnings in Personal & Commercial Banking, Capital Markets and Investor & Treasury Services, partially offset by lower earnings in Insurance and Wealth Management. Our results were also favourably impacted by a lower effective tax rate reflecting favourable income tax adjustments, the positive impact of foreign exchange translation, and a gain of $108 million (before- and after-tax) from the wind-up of a U.S.-based funding subsidiary as noted above. In addition, results in 2014 included a loss of $100 million (before- and after-tax) related to the sale of RBC Royal Bank (Jamaica) Limited (RBC Jamaica) and a provision of $40 million ($32 million after-tax) related to post-employment benefits and restructuring charges in the Caribbean. Personal & Commercial Banking earnings mainly reflected solid volume growth across most businesses in Canada, strong fee-based revenue growth, and higher earnings in the Caribbean, partially offset by higher costs to support business growth and lower spreads. Capital Markets earnings were driven by growth in our Global Markets business mainly reflecting increased client activity, continued solid performance in our Corporate and Investment Banking business, and the impact from foreign exchange translation, partially offset by lower results in certain legacy portfolios. Investor & Treasury Services earnings mainly reflected higher earnings from foreign exchange market execution, an additional month of earnings in Investor Services of $42 million ($28 million after-tax), increased custodial fees, and higher earnings from growth in client deposits. These factors were partially offset by lower funding and liquidity results. Insurance results decreased mainly due to a change in Canadian tax legislation impacting certain foreign affiliates which became effective November 1, 2014, a lower level of favourable actuarial adjustments, and higher net claims costs. These factors were partially offset by higher earnings from new U.K. annuity contracts, and a favourable impact of investment-related activities on the Canadian life business. Wealth Management earnings decreased primarily reflecting higher costs in support of business growth in our Global Asset Management and Canadian Wealth Management businesses, restructuring costs of $122 million ($90 million after-tax) largely related to our International Wealth Management business, lower transaction volumes and higher PCL. These factors were partly offset by higher earnings from growth in average fee-based client assets. Impact of foreign currency translation Our foreign currency-denominated results are impacted by exchange rate fluctuations. Revenue, PCL, insurance policyholder benefits, claims and acquisition expense (PBCAE), non-interest expense and net income denominated in foreign currency are translated at the average rate of exchange for the period. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 13 The following table reflects the estimated impact of foreign currency translation on key income statement items: (Millions of Canadian dollars, except per share amounts) 2016 vs. 2015 2015 vs. 2014 Table 5 Increase (decrease): Total revenue PCL PBCAE Non-interest expense Income taxes Net income Impact on EPS Basic Diluted $ $ 338 20 (39) 165 64 128 0.09 0.09 $ $ 1,012 11 75 652 113 161 0.11 0.11 The relevant average exchange rates that impact our business are shown in the following table: (Average foreign currency equivalent of C$1.00) (1) U.S. dollar British pound Euro (1) Average amounts are calculated using month-end spot rates for the period. 2016 0.755 0.544 0.683 2015 0.797 0.519 0.707 Table 6 2014 0.914 0.551 0.680 Total revenue (Millions of Canadian dollars, except percentage amounts) Interest income Interest expense Net interest income Net interest margin (on average earning assets) Investments (1) Insurance (2) Trading (see additional trading information section) Banking (3) Underwriting and other advisory Other (4) Non-interest income Total revenue $ $ $ 2016 24,452 7,921 16,531 1.70% 8,556 4,868 701 4,848 1,876 1,025 Table 7 2015 2014 $ 22,729 7,958 $ 14,771 1.71% $ 22,019 7,903 $ 14,116 1.86% $ 8,095 4,436 552 4,388 1,885 1,194 $ 7,355 4,957 742 4,090 1,809 1,039 $ $ 21,874 38,405 $ 20,550 $ 19,992 $ 35,321 $ 34,108 (1) (2) (3) (4) Includes securities brokerage commissions, investment management and custodial fees, and mutual fund revenue. Includes premiums and investment and fee income. Investment income includes the change in fair value of investments backing policyholder liabilities and is largely offset in PBCAE. Includes service charges, foreign exchange revenue other than trading, card service revenue and credit fees. Includes other non-interest income, net gain (loss) on available-for-sale (AFS) securities and share of profit in joint ventures and associates. 2016 vs. 2015 Total revenue increased $3,084 million or 9% from last year. The impact of foreign exchange translation this year increased our total revenue by $338 million. Net interest income increased $1,760 million or 12%, mainly due to the inclusion of our acquisition of City National, and volume growth of 6% across most of our businesses in Canadian Banking. Net interest margin was down 1 bp compared to last year, largely due to the continued low interest rate environment and competitive pressures. Investments revenue increased $461 million or 6%, mainly due to the inclusion of our acquisition of City National and higher average fee-based client assets reflecting net sales and capital appreciation. These factors were partially offset by lower transaction volumes. Insurance revenue increased $432 million or 10%, mainly reflecting the change in fair value of investments backing our policyholder liabilities resulting from changes in long-term interest rates, largely offset in PBCAE. This was partially offset by lower premiums reflecting the impact of the sale of our home and auto insurance manufacturing business. Banking revenue increased $460 million or 10% mainly due to the change in fair value of certain Canadian dollar-denominated available- for-sale (AFS) securities that were funded with U.S. dollar-denominated deposits which is offset in Other revenue, and increased client activity. Underwriting and other advisory revenue decreased $9 million, largely reflecting lower debt and equity origination activity and decreased loan syndication revenue largely in the U.S. These factors were mostly offset by increased M&A activity and the impact from foreign exchange translation. Other revenue decreased $169 million or 14% from last year mainly due to the change in fair value of certain derivatives used to economically hedge the AFS securities as noted above, partially offset by the gain related to the sale of RBC General Insurance Company. 14 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis 2015 vs. 2014 Total revenue in 2015 increased $1,213 million or 4% as compared to 2014, primarily due to the impact from foreign exchange translation which increased revenue by $1,012 million, growth in average fee-based client assets in Wealth Management resulting from capital appreciation and net sales, solid volume growth across most of our businesses in Canadian Banking, and higher fee-based revenue primarily attributable to strong mutual funds distribution fees in Canadian Banking reflecting higher average client fee-based assets. Higher debt origination reflecting increased client issuance activity, strong growth in M&A activity reflecting increased mandates in the U.S. and Europe, higher trading-related net interest income and solid lending growth in Capital Markets as well as a gain of $108 million from the wind-up of a U.S.-based funding subsidiary also contributed to the increase. These factors were partially offset by the negative change in fair value of investments backing our policyholder liabilities of $463 million resulting from an increase in long-term interest rates, and a reduction of revenue related to our retrocession contracts, both of which were largely offset in PBCAE. Additional trading information (Millions of Canadian dollars) Total trading revenue (1) Net interest income Non-interest income Total trading revenue Total trading revenue by product Interest rate and credit Equities Foreign exchange and commodities Total trading revenue Trading revenue (teb) by product Interest rate and credit Equities Foreign exchange and commodities Total trading revenue (teb) Trading revenue (teb) by product – Capital Markets Interest rate and credit Equities Foreign exchange and commodities Total Capital Markets trading revenue (teb) Table 8 2016 2015 2014 $ $ $ $ $ $ $ $ 2,376 701 3,077 1,804 684 589 3,077 1,804 1,166 590 3,560 1,473 1,205 402 3,080 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,398 552 2,950 1,400 1,045 505 2,950 1,400 1,614 504 3,518 1,238 1,590 376 $ 3,204 $ 2,029 742 2,771 1,560 814 397 2,771 1,560 1,305 397 3,262 1,293 1,244 333 2,870 (1) Includes a gain of $49 million (2015 – $40 million gain; 2014 – $105 million loss) related to a funding valuation adjustment on uncollateralized OTC derivatives. 2016 vs. 2015 Total trading revenue of $3,077 million, which comprises trading-related revenue recorded in Net interest income and Non-interest income, was up $127 million, or 4% including the impact from foreign exchange translation, mainly due to higher fixed income and foreign exchange trading revenue mainly in Europe and Canada. These factors were partially offset by lower equities trading revenue reflecting lower client activity. 2015 vs. 2014 Total trading revenue in 2015 of $2,950 million, which comprises trading-related revenue recorded in Net interest income and Non-interest income, was up $179 million, or 6% compared to 2014 including the impact from foreign exchange translation, mainly due to higher equities trading revenue reflecting increased client activity primarily in the first half of 2015. This factor was partially offset by lower revenue in certain legacy portfolios including the exit from certain proprietary trading strategies in 2014 to comply with the Volcker Rule, and lower fixed income trading revenue reflecting challenging market conditions in the second half of 2015. In addition, trading revenue in 2014 was unfavourably impacted by the implementation of funding valuation adjustments. Provision for credit losses (PCL) 2016 vs. 2015 Total PCL increased $449 million or 41% from a year ago, mainly due to higher PCL in Capital Markets, Personal & Commercial Banking, and a $50 million increase in PCL for loans not yet identified as impaired reflecting volume growth and ongoing economic uncertainty. The PCL ratio of 29 bps increased 5 bps. 2015 vs. 2014 Total PCL in 2015 decreased $67 million or 6% as compared to 2014, mainly due to lower PCL in Personal & Commercial Banking, partially offset by higher PCL in Capital Markets and Wealth Management. For further details on PCL, refer to Credit quality performance in the Credit Risk section. Insurance policyholder benefits, claims and acquisition expense 2016 vs. 2015 PBCAE increased $461 million or 16% from a year ago, mainly due to a change in the fair value of investments backing our policyholder liabilities, which was largely offset in revenue. This factor was partially offset by lower claims reflecting the impact from the sale of our home and auto insurance manufacturing business. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 15 2015 vs. 2014 PBCAE in 2015 decreased $610 million or 17% from 2014, mainly due to a reduction of PBCAE related to our retrocession contracts, and the change in fair value of investments backing our policyholder liabilities resulting from the change in long-term interest rates, both of which were largely offset in revenue. These factors were partially offset by business growth in Canadian and International Insurance, a lower level of favourable actuarial adjustments in 2015 reflecting management actions and assumption changes, and an increase due to the impact of foreign exchange translation. Non-interest expense (Millions of Canadian dollars, except percentage amounts) Salaries Variable compensation Benefits and retention compensation Share-based compensation Human resources Equipment Occupancy Communications Professional fees Amortization of other intangibles Other Non-interest expense Efficiency ratio (1) $ $ $ 2016 5,865 4,407 1,674 255 12,201 1,438 1,568 945 1,078 970 1,936 20,136 52.4% $ $ $ 2015 5,197 4,533 1,607 246 11,583 1,277 1,410 888 932 712 1,836 18,638 52.8% Table 9 2014 4,834 4,388 1,561 248 11,031 1,147 1,330 847 763 666 1,877 17,661 51.8% $ $ $ (1) Efficiency ratio is calculated as non-interest expense divided by total revenue. 2016 vs. 2015 Non-interest expense increased $1,498 million or 8%, due to the inclusion of City National, which increased non-interest expense $1,648 million, and included $196 million related to the amortization of intangibles, and $91 million related to integration costs. Lower variable compensation, largely due to changes in the deferral policy of the compensation plan in Capital Markets, continuing benefits from our efficiency management activities, lower restructuring costs relating to the International Wealth Management business, and lower litigation provisions in Capital Markets were partially offset by higher costs in support of business growth, the impact from foreign exchange translation of $165 million, increased investment in technology initiatives and higher compliance costs. Our efficiency ratio of 52.4% decreased 40 bps from 52.8% last year, mainly reflecting the increase in revenue due to the change in fair value of investments backing our policyholder liabilities, which was largely offset in PBCAE, continuing benefits from our efficiency management activities, and the gain on sale of RBC General Insurance Company. These factors were partially offset by the inclusion of our acquisition of City National. 2015 vs. 2014 Non-interest expense in 2015 increased $977 million or 6% compared to 2014, mainly reflecting the impact from foreign exchange translation of $652 million and higher costs in support of business growth. Restructuring costs of $122 million ($90 million after-tax) largely related to our International Wealth Management business also contributed to the increase. These factors were partially offset by lower litigation provisions and related legal costs in Capital Markets, and continuing benefits from our efficiency management activities. Non-interest expense in 2014 included the loss of $100 million related to the sale of RBC Jamaica and a provision of $40 million related to post-employment benefits and restructuring charges in the Caribbean. Our efficiency ratio of 52.8% increased 100 bps from 51.8% in 2014, mainly reflecting the decrease in revenue due to the change in fair value of investments backing our policyholder liabilities, and higher costs in support of business growth, partially offset by continuing benefits from our efficiency management activities. 16 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Income and other taxes (Millions of Canadian dollars, except percentage amounts) Income taxes Other taxes Goods and services sales taxes Payroll taxes Capital taxes Property taxes Insurance premium taxes Business taxes Total income and other taxes Income before income taxes Canadian statutory income tax rate (1) Lower average tax rate applicable to subsidiaries Tax-exempt income from securities Tax rate change Effect of previously unrecognized tax loss, tax credit or temporary differences Other Effective income tax rate Effective total tax rate (2) $ $ $ $ $ 2016 2,841 $ 2015 2,597 442 $ 627 106 134 45 69 1,423 $ 4,264 $ 13,299 $ 26.5% (2.6)% (3.1)% –% (0.4)% 1.0% 21.4% 29.0% 426 577 100 121 50 59 1,333 3,930 12,623 26.3% (0.9)% (3.6)% 0.3% (0.1)% (1.4)% 20.6% 28.2% $ $ $ $ $ Table 10 2014 2,706 395 529 86 106 51 8 1,175 3,881 11,710 26.3% (2.3)% (3.3)% –% (0.1)% 2.5% 23.1% 30.1% (1) (2) Blended Federal and Provincial statutory income tax rate. Total income and other taxes as a percentage of net income before income taxes and other taxes. 2016 vs. 2015 Income tax expense increased $244 million or 9% from last year, mainly due to higher earnings before income tax. The effective tax rate of 21.4% increased 80 basis points as last year included net favourable tax adjustments. Other taxes increased $90 million or 7% from 2015 mainly due to higher payroll resulting from the inclusion of our acquisition of City National. In addition to the income and other taxes reported in our Consolidated Statements of Income, we recorded income tax recoveries of $438 million (2015 – $878 million) in shareholders’ equity, primarily reflecting remeasurements of employee benefit plans. 2015 vs. 2014 Income tax expense decreased $109 million or 4% and the effective income tax rate of 20.6% decreased 250 bps from 2014, mainly due to net favourable tax adjustments in 2015, partially offset by higher earnings before income taxes. Other taxes increased $158 million or 13% from 2014, mainly due to higher business and payroll taxes, as well as higher goods and services sales taxes. Client assets Assets under administration Assets under administration (AUA) are assets administered by us which are beneficially owned by our clients. We provide services that are administrative in nature, including safekeeping, collecting investment income, settling purchase and sale transactions, and record keeping. Underlying investment strategies within AUA are determined by our clients and generally do not impact the administrative fees that we receive. Administrative fees can be impacted by factors such as asset valuation level changes from market movements, types of services administered, transaction volumes, geography and client relationship pricing based on volumes or multiple services. Our Investor & Treasury Services business is the primary business segment that has AUA with approximately 78% of total AUA, as at October 31, 2016, followed by our Wealth Management business with approximately 17% of total AUA. 2016 vs. 2015 AUA increased $376 billion or 8% compared to last year, mainly reflecting capital appreciation, net sales, the impact from foreign exchange translation and the inclusion of our acquisition of City National. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 17 The following table summarizes AUA by geography and asset class: AUA by geographic mix and asset class (Millions of Canadian dollars) Canada (1) Money market Fixed income Equity Multi-asset and other Total Canada U.S. (1), (2) Money market Fixed income Equity Multi-asset and other Total U.S. Other International (1) Money market Fixed income Equity Multi-asset and other Total International Total AUA (2) Table 11 2016 2015 $ 33,000 731,200 705,900 733,800 31,500 685,600 669,900 642,400 2,203,900 $ 2,029,400 36,400 126,800 200,800 44,800 408,800 50,300 426,200 856,400 1,113,300 $ $ $ 32,900 114,600 189,300 35,600 372,400 47,500 375,400 804,000 1,054,400 2,446,200 $ 2,281,300 5,058,900 $ 4,683,100 $ $ $ $ $ $ $ (1) (2) Geographic information is based on the location from where our clients are serviced. Amounts have been revised from those previously presented. Assets under management Assets under management (AUM) are assets managed by us which are beneficially owned by our clients. Management fees are paid by the investment funds for the investment capabilities of an investment manager and can also include administrative services. Management fees may be calculated daily, monthly or quarterly as a percentage of the AUM, depending on the distribution channel, underlying products and investment strategies. In general, equity strategies carry a higher fee rate than fixed income or money market strategies. Fees are also impacted by asset mix and relationship pricing for clients using multiple services. Higher risk assets generally produce higher fees, while clients using multiple services can take advantage of synergies which reduce the fees they are charged. Certain funds may also include performance fee arrangements, which are recorded when certain benchmarks or performance targets are achieved. These factors could lead to differences on fees earned by products and therefore net return by asset class may vary despite similar average AUM. Our Wealth Management segment is the primary business segment that has AUM. 2016 vs. 2015 AUM increased $88 billion or 18% compared to last year, primarily due to the inclusion of our acquisition of City National and capital appreciation. The following table presents the change in AUM for the year ended October 31, 2016: Client assets – AUM (Millions of Canadian dollars) AUM, beginning balance Institutional inflows Institutional outflows Personal flows, net Total net flows Market impact Acquisition Foreign exchange 2016 Table 12 2015 Money market Fixed income Equity Multi-asset and other Total $ 39,800 $ 11,200 (14,400) 700 (2,500) 200 9,800 600 196,300 $ 83,600 $ 35,800 (52,000) 4,300 (11,900) 8,100 4,200 2,000 4,800 (3,900) 500 1,400 5,100 10,200 500 178,700 $ 498,400 55,200 (72,100) 21,600 3,400 (1,800) 16,100 $ 457,000 n.a. n.a. n.a. 17,700 8,100 33,900 500 4,700 21,500 58,100 3,600 18,200 n.a. n.a. n.a. Total market, acquisition and foreign exchange impact 10,600 14,300 15,800 42,500 83,200 23,200 AUM, balance at end of year $ 47,900 $ 198,700 $ 100,800 $ 238,900 $ 586,300 $ 498,400 n.a. not available 18 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Business segment results Results by business segment (Millions of Canadian dollars, except percentage amounts) Net interest income Non-interest income Total revenue PCL PBCAE Non-interest expense Net income before income taxes Income tax Net income ROE (2) Personal & Commercial Banking Wealth Management 2016 Investor & Treasury Services Capital Markets (1) Corporate Support (1) $ $ $ $ $ $ $ $ 10,337 4,499 14,836 1,122 – 6,757 6,957 1,773 5,184 27.5% Insurance $ – 5,151 $ 5,151 1 3,424 622 1,955 6,834 8,789 48 – 6,801 1,940 467 $ 1,104 204 1,473 $ 900 $ $ $ $ 825 1,446 2,271 (3) – 1,460 814 201 613 $ $ $ $ 3,804 4,146 7,950 327 – 4,466 3,157 887 2,270 $ $ $ $ (390) $ (202) (592) $ 51 – 30 Total 16,531 21,874 38,405 1,546 3,424 20,136 (673) $ (691) 13,299 2,841 18 $ 10,458 10.9% 52.8% 17.9% 12.2% n.m. 16.3% Table 13 2015 2014 $ $ $ $ Total 14,771 20,550 35,321 1,097 2,963 18,638 12,623 2,597 10,026 18.6% $ $ $ $ Total 14,116 19,992 34,108 1,164 3,573 17,661 11,710 2,706 9,004 19.0% Average assets $ 403,800 $ 83,200 $ 14,400 $ 142,500 $ 508,200 $ 24,300 $ 1,176,400 $ 1,052,800 $ 906,500 (1) (2) Net interest income, total revenue and net income before income taxes are presented in Capital Markets on a taxable equivalent basis (teb). The teb adjustment is eliminated in the Corporate Support segment. For a further discussion, refer to the How we measure and report our business segments section. These measures may not have a standardized meaning under GAAP and may not be comparable to similar measures disclosed by other financial institutions. For further details, refer to the Key performance and non-GAAP measures section. How we measure and report our business segments Our management reporting framework is intended to measure the performance of each business segment as if it were a stand-alone business and reflects the way that the business segment is managed. This approach is intended to ensure that our business segments’ results include all applicable revenue and expenses associated with the conduct of their business and depicts how management views those results. The following highlights the key aspects of how our business segments are managed and reported: • Wealth Management reported results also include disclosure in U.S. dollars, primarily for U.S. Wealth Management (including City National) • • as we review and manage the results of this business largely in this currency. Capital Markets results are reported on a taxable equivalent basis (teb), which grosses up total revenue from certain tax-advantaged sources (Canadian taxable corporate dividends and the U.S. tax credit investment business) to their effective taxable equivalent value with a corresponding offset recorded in the provision for income taxes. We record the elimination of the teb adjustments in Corporate Support. We believe these adjustments are useful and reflect how Capital Markets manages its business, since it enhances the comparability of revenue and related ratios across taxable revenue and our principal tax-advantaged source of revenue. The use of teb adjustments and measures may not be comparable to similar generally accepted accounting principles (GAAP) measures or similarly adjusted amounts disclosed by other financial institutions. Corporate Support results include all enterprise-level activities that are undertaken for the benefit of the organization that are not allocated to our five business segments, including residual asset/liability management results, impact from income tax adjustments, net charges associated with unattributed capital and PCL on loans not yet identified as impaired. Key methodologies The following outlines the key methodologies and assumptions used in our management reporting framework. These are periodically reviewed by management to ensure they remain valid. Expense allocation To ensure that our business segments’ results include expenses associated with the conduct of their business, we allocate costs incurred or services provided by Technology & Operations and Functions, which are directly undertaken or provided on the business segments’ behalf. For other costs not directly attributable to our business segments, including overhead costs and other indirect expenses, we use our management reporting framework for allocating these costs to each business segment in a manner that is intended to reflect the underlying benefits. Capital attribution Our framework also determines the attribution of capital to our business segments in a manner that is intended to consistently measure and align economic costs with the underlying benefits and risks associated with the activities of each business segment. The amount of capital assigned to each business segment is referred to as attributed capital. Unattributed capital and associated net charges are reported in Corporate Support. For further information, refer to the Capital management section. Funds transfer pricing Funds transfer pricing refers to the pricing of intra-company borrowing or lending for management reporting purposes. We employ a funds transfer pricing process to enable risk-adjusted management reporting of segments. This process determines the costs and revenue for intra- company borrowing and lending of funds after taking into consideration our interest rate risk and liquidity risk management objectives, as well as applicable regulatory requirements. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 19 Provisions for credit losses PCL are recorded to recognize estimated losses on impaired loans, as well as losses that have been incurred but are not yet identified in our loans portfolio. This portfolio includes on-balance sheet exposures, such as loans and acceptances, and off-balance sheet items such as letters of credit, guarantees and unfunded commitments. PCL on impaired loans are included in the results of each business segment to fully reflect the appropriate expenses related to the conduct of each business segment. PCL on loans not yet identified as impaired are included in Corporate Support, as Group Risk Management (GRM) effectively controls this through its monitoring and oversight of various lending portfolios throughout the enterprise. For details on our accounting policy on Allowance for credit losses, refer to Note 2 of our 2016 Annual Consolidated Financial Statements. Key performance and non-GAAP measures Performance measures Return on common equity (ROE) We measure and evaluate the performance of our consolidated operations and each business segment using a number of financial metrics, such as net income and ROE. We use ROE, at both the consolidated and business segment levels, as a measure of return on total capital invested in our business. Management views the business segment ROE measure as a useful measure for supporting investment and resource allocation decisions because it adjusts for certain items that may affect comparability between business segments and certain competitors. Our consolidated ROE calculation is based on net income available to common shareholders divided by total average common equity for the period. Business segment ROE calculations are based on net income available to common shareholders divided by average attributed capital for the period. For each segment, average attributed capital includes the capital required to underpin various risks as described in the Capital Management section and amounts invested in goodwill and intangibles. The attribution of capital and risk capital involves the use of assumptions, judgments and methodologies that are regularly reviewed and revised by management as deemed necessary. Changes to such assumptions, judgments and methodologies can have a material effect on the segment ROE information that we report. Other companies that disclose information on similar attributions and related return measures may use different assumptions, judgments and methodologies. The following table provides a summary of our ROE calculations: Calculation of ROE Personal & Commercial Banking Wealth Management Insurance 2016 Investor & Treasury Services Table 14 2015 2014 Capital Markets Corporate Support Total Total Total $ $ 5,089 18,550 27.5% 1,412 12,950 10.9% $ 891 1,700 52.8% $ 596 3,350 17.9% $ 2,186 17,900 $ (63) 7,750 $ 10,111 62,200 $ 9,734 52,300 $ 8,697 45,700 12.2% n.m. 16.3% 18.6% 19.0% (Millions of Canadian dollars, except percentage amounts) Net income available to common shareholders Total average common equity (1), (2) ROE (3) (1) (2) Average common equity represents rounded figures. The amounts for the segments are referred to as attributed capital. Effective the first quarter of 2016, we increased our capital attribution rate to better align with higher regulatory capital requirements. ROE is based on actual balances of average common equity before rounding. (3) n.m. not meaningful Embedded value for Insurance operations Embedded value is a measure of shareholder value embedded in the balance sheet of our Insurance segment, excluding any value from future new sales. We use the change in embedded value between reporting periods as a measure of the value created by the insurance operations during the period. We define embedded value as the value of equity held in our Insurance segment and the value of in-force business (existing policies). The value of in-force business is calculated as the present value of future expected earnings on in-force business less the cost of capital required to support in-force business. We use discount rates equal to long-term risk free rates plus a spread. Required capital uses the capital frameworks in the jurisdictions in which we operate. Key drivers affecting the change in embedded value from period to period are new sales, investment performance, claims and policyholder experience, change in actuarial assumptions, changes in foreign exchange rates and changes in shareholder equity arising from transfers in capital. Embedded value does not have a standardized meaning under GAAP and may not be directly comparable to similar measures disclosed by other companies. Given that this measure is specifically used for our Insurance segment and involves the use of discount rates to present value the future expected earnings and capital required for the in-force business, reconciliation to financial statements information is not applicable. Non-GAAP measures We believe that certain non-GAAP measures described below are more reflective of our ongoing operating results, and provide readers with a better understanding of management’s perspective on our performance. These measures enhance the comparability of our financial performance for the year ended October 31, 2016 with results from last year as well as, in the case of economic profit, measure relative contribution to shareholder value. Non-GAAP measures do not have a standardized meaning under GAAP and may not be comparable to similar measures disclosed by other financial institutions. The following discussion describes the non-GAAP measures we use in evaluating our operating results. Economic profit Economic profit is net income excluding the after-tax effect of amortization of other intangibles less a capital charge for use of attributed capital. It measures the return generated by our businesses in excess of our cost of shareholder’s equity, thus enabling users to identify relative contributions to shareholder value. 20 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis The capital charge includes a charge for common equity and preferred shares. For 2016, our cost of common equity remained unchanged at 9.0%. The following table provides a summary of our Economic profit: Economic profit (Millions of Canadian dollars) Net income add: Non-controlling interests After-tax effect of amortization of other intangibles Goodwill and intangibles write-down Adjusted net income (loss) less: Capital charge Economic profit (loss) Personal & Commercial Banking $ $ $ 5,184 (8) 12 – 5,188 1,756 3,432 Wealth Management Insurance $ $ $ 1,473 – 183 – 1,656 1,229 427 $ $ $ 900 – – – 900 160 740 Table 15 2016 Investor & Treasury Services $ $ $ 613 (1) 16 – 628 316 312 Capital Markets 2,270 – – – 2,270 1,694 576 $ $ $ Corporate Support Total $ $ $ 18 (44) $ 10,458 (53) 1 – 212 – (25) 738 $ 10,617 5,893 (763) $ 4,724 (Millions of Canadian dollars) Net income add: Non-controlling interests After-tax effect of amortization of other intangibles Goodwill and intangibles write-down Adjusted net income (loss) less: Capital charge Economic profit (loss) 2015 2014 Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Total Total $ $ $ 5,006 (8) $ 22 – 5,020 1,544 3,476 $ $ 1,041 2 69 4 1,116 551 565 $ $ $ 706 – – – 706 148 558 $ $ $ 556 (1) $ 2,319 – 21 – 576 251 325 – – $ 2,319 1,550 $ 769 $ $ $ 398 (94) $ 10,026 (101) $ 9,004 (94) 1 – 113 4 123 8 305 852 $ 10,042 4,896 $ 9,041 4,341 (547) $ 5,146 $ 4,700 Results excluding specified items Our results were impacted by the following specified items: • For the year ended October 31, 2016, a gain of $287 million ($235 million after-tax) recorded in our Insurance segment, related to the sale of RBC General Insurance Company to Aviva Canada Inc., which involved the sale of our home and auto insurance manufacturing business. For the year ended October 31, 2014, in our Personal & Commercial Banking segment: – A total loss of $100 million (before- and after-tax) related to the sale of RBC Jamaica, comprised of a loss of $60 million (before- and • after-tax) in the first quarter of 2014, and a further loss of $40 million (before- and after-tax) in the third quarter of 2014 which includes foreign currency translation related to the closing of the sale of RBC Jamaica; and – A provision of $40 million ($32 million after-tax) related to post-employment benefits and restructuring charges in the Caribbean. The following tables provide calculations of our business segment results and measures excluding these specified items for the years ended October 31, 2016 and October 31, 2014. Insurance (Millions of Canadian dollars, except percentage amounts) Total revenue PBCAE Non-interest expense (1) Net income before income taxes Net income Selected balance and other information ROE (1) Includes Provision for credit losses of $1 million. 2016 Item excluded Gain related to the sale of RBC General Insurance $ (287) – – (287) $ (235) Table 16 Adjusted $ 4,864 3,424 623 817 665 $ 41.0% As reported $ 5,151 3,424 623 1,104 900 $ 52.8% Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 21 Personal & Commercial Banking (Millions of Canadian dollars, except percentage amounts) As reported 2014 Items excluded Loss related to the sale of RBC Jamaica (1) Provision for post-employment benefits and restructuring charges Total revenue PCL Non-interest expense Net income before taxes Net income Selected balances and other information Non-interest expense Total revenue Efficiency ratio Revenue growth rate Non-interest expense growth rate Operating leverage $ $ $ – – (100) 100 100 (100) $ $ $ $ $ $ 13,730 1,103 6,563 6,064 4,475 6,563 13,730 47.8% 5.5% 6.4% (0.9%) Table 17 Adjusted $ 13,730 1,103 6,423 6,204 4,607 $ – – (40) 40 32 (40) $ 6,423 13,730 46.8% 5.5% 4.2% 1.3% (1) Total loss is comprised of a loss of $60 million (before- and after-tax) recorded in Q1 2014 and a further loss of $40 million (before- and after-tax) in Q3 2014, including foreign currency translation. Personal & Commercial Banking Operating through two businesses – Canadian Banking and Caribbean & U.S. Banking, Personal & Commercial Banking is comprised of our personal and business banking operations, and our auto financing and retail investment businesses, including our online discount brokerage channel. We provide services to more than 13.5 million individual, business and institutional clients across Canada, the Caribbean and the U.S. In Canada, we provide a broad suite of financial products and services through our extensive branch, automated teller machine (ATM), online, mobile and telephone banking networks, as well as through a large number of proprietary sales professionals. In the Caribbean, we offer a broad range of financial products and services to individuals and business clients, and public institutions in targeted markets. In the U.S., we serve the cross-border banking needs of Canadian clients within the U.S. through online channels. In Canada, we compete with other Schedule I banks, independent trust companies, foreign banks, credit unions, caisses populaires and auto financing companies. We maintain top (#1 or #2) rankings in market share in this competitive environment for all key retail and business financial product categories, and have the largest branch network, the most ATMs and the largest mobile sales network across Canada. In the Caribbean, our competition includes banks, trust companies and investment management companies serving retail and corporate customers and public institutions. We continue to be the second-largest bank as measured by assets in the English Caribbean, with 77 branches in 17 countries and territories. In the U.S., we compete primarily with other Canadian banking institutions with operations in the U.S. Economic and market review We continued to see solid volume growth across most of our Canadian Banking businesses despite challenging economic conditions in Canada, particularly in the oil exposed regions. Overall, credit conditions have weakened from historically strong levels last year primarily due to higher unemployment in oil exposed provinces, while credit conditions remained relatively stable in other provinces. Our businesses continued to be impacted by competitive pressures and the low interest rate environment. In the Caribbean, unfavourable economic conditions continued to negatively impact our results through lower loan volume growth, and spread compression. Highlights In Canada: • We achieved solid volume growth across most products with particular strengths in: – Home equity supported by our focus on the key newcomer and first time home buyer segments, coupled with our Employee Pricing campaigns; Credit cards through strong account and balance growth in our industry leading Avion® card; Personal and business deposits through acquisition of new clients and strengthening our existing client relationships; Business lending through higher focus on select business segments and markets to strengthen our market share; and – – – – Mutual fund branch investments through strong net inflows and capital appreciation strengthening our leading market share position. Became the first Canadian bank to offer free Interac e-Transfer payments for all personal chequing accounts. • • We currently service 5.2 million active clients through our online and mobile platforms, and continued to invest in digitizing our client – – – experience with a focus on speed of service and simplifying end-to-end processes: – First North American financial institution to provide an in-branch, real-time, multi-language video capability available in more than 200 languages; Implemented “Disbursement Hub”, a new automated system that reduces the time it takes to provide funds to our mortgage clients upon closing, and connects all transaction stakeholders, including lawyers and notaries; Launched “Add It”, whereby pre-approved clients can set up their Royal Credit Line® with just four clicks, and without the need for paperwork or a branch visit; Rolled out Touch ID Login (iPhone) and our iWatch app release providing more options for our clients to bank securely with us anywhere, anytime; and Launched contactless point-of-sale at participating merchants by making Apple Pay‡ available to RBC debit and credit cardholders. – As a result of our successes, we received external recognition as an industry leader and were named or ranked: – – World’s Best Global Bank for Consumer Banking; Best Trade Finance Bank in Canada 4 years in a row (Global Finance) – Highest in Customer Satisfaction among the Big Five Retail Banks in Canada 2016 (J.D. Power) Best Payment Innovation and Best Use of Data Analytics for 2016 (Retail Banker International) • 22 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis In the Caribbean: • Improving our client experience through transformation of our branches, upgrade of our ATM network, rollout of the new mobile banking app and investment in specialized sales force capabilities. Continued to focus on quality asset growth in key client segments while reducing structural costs. As a result of our successes, we were named #1 Bank in the Caribbean for the second year in a row (The Banker). • • Outlook and priorities The Canadian economy is expected to grow by 1.8% in calendar 2017, driven by firm consumer spending, recovery in business investments and stable to improving unemployment rates. However, with risks remaining to the economic outlook, interest rates are expected to stay at their current low levels throughout 2017, underpinning solid volume growth for certain lending products. In addition, though the recent regulatory measures taken by Federal and Provincial governments to curb the pace of housing market growth in certain regions is expected to affect the demand for mortgage products, the continued low interest rate environment is expected to remain supportive of solid mortgage volume growth. As the low interest rate environment has resulted in compressed interest margins for industry participants, we continue to expect competitive pressures in the coming year. In 2017, we will continue to focus on building a digitally-enabled relationship bank and improving the client experience to successfully attract and retain new and existing clients. In the Caribbean, challenging market conditions and slow economic growth continue to temper our outlook for 2017. We expect net interest margins to remain challenged primarily due to competitive pressures. However, we expect to strengthen our business performance through efficiency management, increases in fee revenue and quality asset growth. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Key strategic priorities for 2017 In Canada, our priorities are to: • Transform how we serve clients by increasing points of access to our digital platforms and services and providing our clients with personalized advice and solutions, offers and client loyalty rewards. Accelerate growth in key segments and increase our presence in underpenetrated areas to achieve industry-leading volume growth. Rapidly deliver digital solutions to our clients. Innovate to become a more agile and efficient bank and accelerate our investments to simplify, digitize and automate for clients and employees. • • • In the Caribbean, we are focused on transforming our distribution channels to better serve our clients in target markets where we can compete and drive sustainable profitability, with a strategic focus on corporate, business, professional and business owner clientele. In the U.S., we are focused on meeting the banking and borrowing needs of our cross-border clients through an innovative direct banking approach by providing seamless access to their entire suite of RBC products. Personal & Commercial Banking (Millions of Canadian dollars, except number of and percentage amounts and as otherwise noted) Net interest income Non-interest income Total revenue PCL Non-interest expense Net income before income taxes Net income Revenue by business Canadian Banking Caribbean & U.S. Banking Key ratios ROE NIM (1) Efficiency ratio (2) Efficiency ratio adjusted (2), (3) Operating leverage Operating leverage adjusted (3) Selected average balance sheet information Total assets Total earning assets Loans and acceptances Deposits Other information AUA (4) AUM Number of employees (FTE) (5) Effective income tax rate Credit information Gross impaired loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances $ $ $ $ $ 2016 10,337 4,499 14,836 1,122 6,757 6,957 5,184 13,833 1,003 27.5% 2.68% 45.5% n.a. 1.5% n.a. 403,800 385,400 383,900 320,100 239,600 4,600 33,896 25.5% 0.43% 0.29% $ $ $ $ $ 2015 10,004 4,309 14,313 984 6,611 6,718 5,006 13,379 934 30.0% 2.71% 46.2% n.a. 3.5% 1.3% 386,100 369,000 367,500 298,600 223,500 4,800 35,211 25.5% 0.49% 0.27% $ $ $ $ $ Table 18 2014 9,743 3,987 13,730 1,103 6,563 6,064 4,475 12,869 861 29.0% 2.77% 47.8% 46.8% (0.9)% 1.3% 367,900 351,300 350,700 278,800 214,200 4,000 36,315 26.2% 0.55% 0.31% (1) (2) (3) (4) (5) n.a. NIM is calculated as Net interest income divided by Average total earning assets. Efficiency ratio is calculated as Non-interest expense divided by Total revenue. Measures have been adjusted by excluding the Q3 2014 loss of $40 million related to the closing of RBC Jamaica, and the Q1 2014 loss of $60 million related to the sale of RBC Jamaica and the provision of $40 million related to post-employment benefits and restructuring charges in the Caribbean. These are non-GAAP measures. For further details, refer to the Key performance and non-GAAP measures section. AUA represents period-end spot balances and includes securitized residential mortgages and credit card loans as at October 31, 2016 of $18.6 billion and $9.6 billion, respectively (October 31, 2015 – $21.0 billion and $8.0 billion; October 31, 2014 – $23.2 billion and $8.0 billion). Amounts have been revised from those previously presented. not applicable Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 23 Financial performance 2016 vs. 2015 Net income increased $178 million or 4%, largely reflecting solid volume growth across most businesses partially offset by lower spreads and fee-based revenue growth in Canadian Banking. Higher earnings in the Caribbean also contributed to the increase. These factors were partially offset by higher costs in support of business growth and higher PCL in Canada. Total revenue increased $523 million or 4% largely reflecting volume growth of 6% partly offset by lower spreads in Canada and higher fee- based revenue. Net interest margin decreased 3 bps mainly due to the low interest rate environment. PCL increased $138 million, with the PCL ratio increasing 2 bps, largely due to higher provisions in our Canadian personal and commercial lending portfolios and higher write-offs in our Canadian credit cards portfolio. These factors were partially offset by lower PCL in our Caribbean portfolios. Non-interest expense increased $146 million or 2%, primarily attributable to higher technology spend and increased costs in support of business growth. These factors were partially offset by continuing benefits from our efficiency management activities. Average loans and acceptances increased $16 billion or 4%, largely due to growth in Canadian residential mortgages and business loans. Average deposits increased $22 billion or 7%, as a result of growth in business and personal deposits. 2015 vs. 2014 Net income was up $531 million or 12% from 2014. Excluding the loss of $100 million (before- and after-tax) related to the sale of RBC Jamaica, and a provision of $40 million ($32 million after-tax) related to post-employment benefits and restructuring charges in the Caribbean in 2014, net income increased $399 million or 9%, largely reflecting solid volume growth across most businesses in Canada, higher fee-based revenue primarily attributable to higher mutual fund distribution fees reflecting higher average client fee-based assets, higher card service revenue, higher earnings in the Caribbean and lower PCL. These factors were partially offset by higher technology and staff costs to support business growth and lower spreads. Results excluding the specified items noted above are non-GAAP measures. For further details, including a reconciliation, refer to the Key performance and non-GAAP measures section. In Canada, we operate through three business lines: Personal Financial Services, Business Financial Services, and Cards and Payment Solutions. The following provides a discussion of our consolidated Canadian Banking results. Canadian Banking financial highlights Table 19 (Millions of Canadian dollars, except number of and percentage amounts and as otherwise noted) Net interest income Non-interest income Total revenue PCL Non-interest expense Net income before income taxes Net income Revenue by business Personal Financial Services Business Financial Services Cards and Payment Solutions Key Ratios ROE NIM (1) Efficiency ratio (2) Operating leverage Selected average balance sheet information Total assets Total earning assets Loans and acceptances Deposits Other information AUA (3) Number of employees (FTE) (4) Effective income tax rate Credit information $ $ $ $ 2016 9,683 $ 4,150 13,833 1,080 6,010 6,743 5,002 $ 7,810 $ 3,190 2,833 32.6% 2.63% 43.4% 1.4% 2015 9,377 4,002 13,379 912 5,891 6,576 4,877 7,634 3,091 2,654 36.4% 2.66% 44.0% 0.4% $ $ $ 2014 9,168 3,701 12,869 928 5,687 6,254 4,642 7,285 3,135 2,449 37.0% 2.71% 44.2% 1.2% 381,000 $ 364,900 352,800 368,100 358,500 374,600 281,200 301,400 $ 349,500 337,900 343,100 263,600 231,400 29,982 25.8% 213,700 31,057 25.8% 205,200 31,583 25.8% Gross impaired loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances 0.27% 0.30% 0.29% 0.25% 0.33% 0.27% (1) (2) (3) (4) NIM is calculated as Net interest income divided by Average total earning assets. Efficiency ratio is calculated as Non-interest expense divided by Total revenue. AUA represents period-end spot balances and includes securitized residential mortgages and credit card loans as at October 31, 2016 of $18.6 billion and $9.6 billion, respectively, (October 31, 2015 – $21.0 billion and $8.0 billion; October 31, 2014 – $23.2 billion and $8.0 billion). Amounts have been revised from those previously presented. 24 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Financial performance 2016 vs. 2015 Net income increased $125 million or 3% largely reflecting solid volume growth across most businesses partially offset by lower spreads, and fee-based revenue growth. These factors were partially offset by higher PCL and higher costs in support of business growth. Total revenue increased $454 million or 3%, largely reflecting volume growth of 6% partly offset by lower spreads. Fee-based revenue growth mainly from higher credit card balances and transaction volumes driving higher card service revenue, and increased client activity also contributed to the increase. Net interest margin decreased 3 bps compared to last year mainly due to the low interest rate environment. PCL increased $168 million, with the PCL ratio increasing 4 bps, mostly due to higher provisions in our personal and commercial lending portfolios and higher write-offs in our credit cards portfolio. Non-interest expense increased $119 million or 2% mainly due to higher technology spend and increased costs in support of business growth. These factors were partially offset by continuing benefits from our efficiency management activities. Average loans and acceptances increased $16 billion or 4%, mainly due to 7% average growth in residential mortgages and business loans. Average deposits increased $20 billion or 7%, primarily reflecting growth in both business and personal deposits. 2015 vs. 2014 Net income increased $235 million or 5% from 2014, reflecting solid volume growth across most businesses, strong fee-based revenue growth primarily attributable to higher mutual fund distribution fees due to higher average client fee-based assets, as well as higher credit card balances and transaction volumes driving higher card service revenue. These factors were partially offset by higher technology and staff costs to support business growth, and lower spreads. Business line review Personal Financial Services Personal Financial Services offers a full range of products focused on meeting the needs of our individual Canadian clients at every stage of their lives through a wide range of financing and investment products and services, including home equity financing, personal lending, deposit accounts, Canadian private banking, indirect lending (including auto financing), mutual funds and self-directed brokerage accounts, and Guaranteed Investment Certificates (GICs). We rank #1 or #2 in market share for all key personal banking products in Canada and our retail banking network is the largest in Canada with 1,268 branches and over 4,550 ATMs. Financial performance Total revenue increased $176 million or 2% compared to last year, primarily reflecting volume growth of 7% in deposits and residential mortgages partially offset by lower spreads, and increased client activity. Average residential mortgages increased 7% compared to last year, resulting from solid housing market activity supported by the continuing low interest rate environment and our targeted marketing strategy. Average other loans and acceptances decreased 3% from last year largely due to lower indirect lending volumes. Average deposits increased 7% from last year largely reflecting the acquisition of new clients as well as continued growth of existing client balances. Strong client acquisition contributed to increased client activity and continued growth of average client fee-based assets. Selected highlights Table 20 Average residential mortgages, personal loans and deposits (Millions of Canadian dollars) (Millions of Canadian dollars, except number of) 2016 2015 2014 Total revenue Other information (average) Residential mortgages Other loans and acceptances Deposits (1) Branch mutual fund balances (2) AUA – Self-directed brokerage (2) Number of: New deposit accounts opened (thousands) Branches ATM (1) (2) Includes GIC balances. Represents year-end spot balances. $ 7,810 $ 7,634 $ 7,285 210,400 81,800 185,600 132,100 69,700 197,300 84,100 173,000 122,000 61,400 186,000 85,400 165,100 111,600 60,500 1,346 1,268 4,555 1,420 1,275 4,542 1,514 1,272 4,620 216,000 180,000 144,000 108,000 72,000 36,000 0 120,000 100,000 80,000 60,000 40,000 20,000 0 2016 2015 2014 2016 2015 2014 2016 2015 2014 Residential mortgages Other loans and acceptances Deposits Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 25 Business Financial Services Business Financial Services offers a wide range of lending, leasing, deposit, investment, foreign exchange, cash management, auto dealer financing (floor plan), trade products and services to small and medium-sized commercial businesses, as well as agriculture and agribusiness clients across Canada. Our business banking network has the largest team of relationship managers and specialists in the industry. Our strong commitment to our clients has resulted in our leading market share in business loans and deposits. Financial performance Total revenue increased $99 million or 3% compared to last year primarily due to volume growth in both loans and deposits, which was partially offset by lower spreads reflecting the continuing low interest rate environment and competitive pressures. Average loans and acceptances increased 7% and average deposits were up 7%, despite a competitive environment, due to increased activity from existing and new clients. Selected highlights (Millions of Canadian dollars) Total revenue Other information (average) Loans and acceptances Deposits (1) (1) Includes GIC balances. Table 21 Average business loans and acceptances and business deposits (Millions of Canadian dollars) 2016 3,190 $ 2015 3,091 $ 2014 3,135 $ 66,400 115,800 62,000 108,200 57,600 98,500 68,000 59,500 51,000 42,500 34,000 25,500 17,000 8,500 0 120,000 105,000 90,000 75,000 60,000 45,000 30,000 15,000 0 2016 2015 2014 2016 2015 2014 Business loans and acceptances Business deposits Cards and Payment Solutions Cards and Payment Solutions provides a wide array of credit cards with loyalty and reward benefits, and payment products and solutions within Canada. We have over 7 million credit card accounts and have approximately 24% market share of Canada’s credit card purchase volume. In addition, this business line includes our 50% interest in Moneris Solutions, Inc., our merchant card processing joint venture with the Bank of Montreal. Moneris processes approximately $235 billion in annual credit and debit card transaction volumes. Financial performance Total revenue increased $179 million or 7% compared to last year, driven by higher credit card balances, increased transaction volumes, and improved spreads. Average credit card balances increased 6% and net purchase volumes increased 7% due to higher client activity, including strong new account acquisition. Selected highlights (Millions of Canadian dollars) Total revenue Other information 2016 2015 2014 $ 2,833 $ 2,654 $ 2,449 Average credit card balances Net purchase volumes 16,000 97,400 15,100 90,800 14,100 84,200 Table 22 Average credit card balances and net purchase volumes (Millions of Canadian dollars) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 98,000 85,750 73,500 61,250 49,000 36,750 24,500 12,250 0 2016 2015 2014 2016 2015 2014 Average credit card balances Net purchase volumes Caribbean & U.S. Banking Our Caribbean banking business offers a comprehensive suite of banking products and services, as well as international financing and trade promotion services through extensive branch, ATM, online and mobile banking networks. Our U.S. cross-border banking business serves the needs of our Canadian clients within the U.S. through online and mobile channels, and offers a broad range of financial products and services to individual and business clients across all 50 states. 26 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Financial performance Total revenue was up $69 million or 7% from last year, primarily due to the positive impact of foreign exchange translation, higher fee-based revenue reflecting full service pricing in the Caribbean, and higher interest earned in our securities investment portfolio. Average loans and acceptances increased 3%, and average deposits increased 7%, mostly due to the impact from foreign exchange translation. Selected highlights Table 23 Average loans and deposits (Millions of Canadian dollars) (Millions of Canadian dollars, number of and percentage amounts) Total revenue Other information Net interest margin Average loans and acceptances Average deposits AUA AUM Number of: Branches ATM Wealth Management 2016 2015 2014 $ 1,003 $ 934 $ 861 3.78% 3.87% $ 9,300 $ 9,000 17,400 9,800 4,800 18,700 8,200 4,600 4.29% $ 7,600 15,200 9,000 4,000 77 276 79 274 93 309 10,000 8,000 6,000 4,000 2,000 0 2016 2015 2014 2016 2015 2014 Loans and acceptances Deposits 20,000 16,000 12,000 8,000 4,000 0 Wealth Management comprises Canadian Wealth Management, U.S. Wealth Management (including City National), International Wealth Management and Global Asset Management (GAM). Wealth Management serves individual and institutional clients in target markets around the world. From our offices in key financial centres mainly in Canada, the U.S., the U.K., the Channel Islands and Asia, Wealth Management offers a comprehensive suite of investment, trust, banking, credit and other wealth management solutions to affluent, high net worth (HNW) and ultra- high net worth (UHNW) clients. Our asset management group, Global Asset Management, which includes BlueBay Asset Management (BlueBay), is an established global leader in investment management services, providing investment strategies and fund solutions directly to institutional investors and also to individual clients through our distribution channels and third-party distributors. On November 2, 2015, we completed the acquisition of City National, which has enhanced and complemented our existing U.S. businesses and product offerings. Economic and market review Canada and the U.S. saw a softening in growth and economic performance in 2016, which resulted in a challenging market environment during the first half of 2016. In the latter part of the year, we saw improved investor confidence and market conditions driving growth in our average fee- based client assets through capital appreciation and higher net sales. The Eurozone continued to stimulate economic activity through the ECB’s quantitative easing program. Globally, volatile capital markets have led to lower transactional volumes. Furthermore, increased regulatory requirements have had an adverse impact on compliance and technology costs. Highlights • The integration of City National has enhanced and complemented our presence in the U.S., further expanding our product offerings to select HNW clients, leveraging the combined platform for commercial clients, and continuing to extend industry verticals with RBC Capital Markets® expertise. • We continue to grow and invest in our high-performing global asset management business and maintain leading market share of 14.8% in • • • • the Canadian mutual fund industry with strong positive net inflows. We continued to increase BlueBay’s distribution footprint with institutional clients and expand our international distribution capabilities to the U.S. and international institutional clients and professional buyers. In Canada, our full service private wealth business is the industry leader. We continue to extend our leadership amongst HNW clients by focusing on delivering comprehensive value to our clients, leveraging our expertise around business owners, succession and wealth planning. In the U.S., we are among the top 10 full service brokerage firms in terms of assets under administration and number of advisors, and we continue to focus on improving advisor productivity. Furthermore, our recent acquisition of City National has enhanced our U.S. product offering. Outside Canada and the U.S., we continued to realign our International Wealth Management business to focus on key client segments, including HNW and UHNW clients in select target markets, while enhancing our product offering and operating environment to a more conservative risk profile. The strength of our global capabilities and continued commitment to deliver integrated global wealth management advice and solutions to HNW and UHNW clients has helped us earn significant industry awards. We were ranked or named: – Fifth largest global wealth manager by client assets (Scorpio Partnership’s 2016 Global Private Banking KPI Benchmark) for the third year in a row. Best Private Bank in Canada (PWM/The Banker Global Private Banking Awards, 2016) for the fifth consecutive year. Best Canadian Private Bank (Family Wealth Report Awards, 2016). – – Outlook and priorities With continued uncertainty in the major global economies, including Canada, low interest rates are expected to continue into 2017. Despite the overall economic uncertainty and volatile equity markets, we expect global private wealth to continue to drive growth in the HNW and UHNW client segments. We will continue to leverage our brand, reputation and financial strength to increase our market share of HNW and UHNW globally. In addition, changing demographics and rapid advancements in digitization are expected to drive change in client preferences, needs and service models, requiring a greater focus on delivering a digitally-integrated, multi-channel experience for our clients and client-facing professionals. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 27 Key strategic priorities for 2017 • • • Focus on extending our leadership position in Canadian retail asset management (e.g., GAM penetration of Personal & Commercial Banking, Wealth Management and third-party channels) while expanding distribution to primarily U.S., U.K. and certain European institutional clients Drive profitable growth through continued acquisition and retention of HNW and UHNW clients in priority segments and markets, driven by a differentiated client experience that is increasingly digitally-enabled and supported by data-driven insights Continue to deepen client relationships in Canada jointly with our partners (e.g., Private Banking and Commercial Banking in Personal & Commercial Banking), and leverage the combined strengths of City National, RBC U.S. Wealth Management and Capital Markets to accelerate growth in the U.S. Wealth Management (Millions of Canadian dollars, except number of and percentage amounts and as otherwise noted) Net interest income Non-interest income Fee-based revenue Transactional and other revenue Total revenue PCL Non-interest expense Income before income taxes Net income Revenue by business Canadian Wealth Management U.S. Wealth Management (including City National) U.S. Wealth Management (including City National) (US$ millions) International Wealth Management Global Asset Management (1) Key Ratios ROE NIM (2) Pre-tax margin (3) Selected average balance sheet information Total assets Loans and acceptances Deposits Attributed capital Other information Revenue per advisor (000s) (4) AUA (5), (6) AUM (5) Average AUA (6) Average AUM Number of employees (FTE) (6) Number of advisors (7) $ $ $ $ $ 2016 1,955 $ 5,109 1,725 8,789 48 6,801 1,940 1,473 $ 2,450 $ 4,123 3,118 430 1,786 10.9% 2.84% 22.1% 83,200 $ 49,200 85,400 12,950 1,157 $ 875,300 580,700 845,800 560,800 16,385 4,780 $ $ $ $ $ Table 24 2014 469 4,185 1,659 6,313 19 4,800 1,494 1,083 2,146 1,748 1,599 722 1,697 19.2% 2.68% 23.7% 25,800 15,700 36,200 5,500 983 781,400 452,300 711,700 427,800 12,636 4,245 2015 493 4,699 1,583 6,775 46 5,292 1,437 1,041 2,308 2,008 1,603 639 1,820 17.4% 2.50% 21.2% 29,100 17,700 39,500 5,900 1,089 823,700 492,800 826,700 484,700 12,325 3,954 Estimated impact of U.S. dollar, British pound and Euro translation on key income statement items (Millions of Canadian dollars, except percentage amounts and as otherwise noted) 2016 vs. 2015 Increase (decrease): Total revenue Non-interest expense Net income Percentage change in average US$ equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 Percentage change in average Euro equivalent of C$1.00 (1) (2) (3) (4) (5) (6) (7) Effective the first quarter of 2014, we have aligned the reporting period of BlueBay, which resulted in an additional month of earnings being included in 2014. NIM is calculated as Net interest income divided by Average total earning assets. Pre-tax margin is defined as net income before income taxes divided by Total revenue. Represents investment advisors and financial consultants of our Canadian and U.S. full-service wealth businesses. Represents year-end spot balances. Amounts have been revised from those previously presented. Represents client-facing advisors across all our wealth management businesses. $ 94 74 14 (5)% 5% (3)% Client assets – AUA (Millions of Canadian dollars) AUA, beginning balance Asset inflows Asset outflows Total net flows Market impact Acquisitions Foreign exchange Total market, acquisition and foreign exchange impact AUA, balance at end of year (1) n.a. Amount has been revised from those previously presented. not available 28 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis 2016 823,700 $ 251,000 (257,500) (6,500) 31,100 17,800 9,200 58,100 875,300 $ $ $ Table 25 2015 (1) 781,400 n.a. n.a. (28,900) n.a. n.a. n.a. 71,200 823,700 Client assets – AUM (Millions of Canadian dollars) AUM, beginning balance Institutional inflows Institutional outflows Personal flows, net Total net flows Market impact Acquisition Foreign exchange Total market, acquisition and foreign exchange impact AUM, balance at end of year n.a. not available AUA by geographic mix and asset class (Millions of Canadian dollars) Canada (1) Money market Fixed income Equity Multi-asset and other Total Canada U.S. (1), (2) Money market Fixed income Equity Multi-asset and other Total U.S. Other International (1) Money market Fixed income Equity Multi-asset and other Total International 2016 $ $ Money market 39,800 11,300 (14,400) 700 (2,400) 200 9,800 600 Fixed income 194,300 $ 35,300 (51,500) 4,300 (11,900) 8,200 4,200 2,000 Equity 83,600 4,800 (3,900) 500 1,400 5,100 10,200 500 Multi-asset and other $ 175,100 3,300 (1,800) 16,000 17,500 8,100 33,900 500 Total $ 492,800 $ 54,700 (71,600) 21,500 4,600 21,600 58,100 3,600 Table 26 2015 452,300 n.a. n.a. n.a. 18,200 n.a. n.a. n.a. 10,600 48,000 14,400 196,800 15,800 $ 100,800 42,500 $ 235,100 83,300 $ 580,700 $ 22,300 492,800 $ $ Table 27 2016 2015 $ 21,600 $ 36,300 89,100 180,700 $ 327,700 $ $ 36,100 $ 126,800 200,800 30,500 $ 394,200 $ $ 23,300 $ 21,400 89,600 19,100 $ 153,400 $ 21,500 34,900 79,800 157,400 293,600 32,700 114,600 189,300 20,200 356,800 24,500 26,500 93,300 29,000 173,300 $ 875,300 $ 823,700 Total AUA (2) (1) (2) Geographic information is based on the location from where our clients are serviced. Amounts have been revised from those previously presented. On November 2, 2015, we completed the acquisition of City National, which was combined with our U.S. Wealth Management business. Our U.S. & International Wealth Management business line was divided into two businesses: U.S. Wealth Management (including City National), and International Wealth Management. Financial performance 2016 vs. 2015 Net income increased $432 million or 41% compared to last year, largely reflecting the inclusion of our acquisition of City National, which contributed $290 million to net income, lower restructuring costs relating to the International Wealth Management business, and benefits from our efficiency management activities. These factors were partially offset by lower transaction volumes. Total revenue increased $2,014 million or 30%, mainly attributable to our inclusion of City National, which contributed $1,988 million (US$1,502 million), the impact from foreign exchange translation, and higher fee-based revenue primarily in our Canadian Wealth Management and U.S. Wealth Management businesses. These factors were partially offset by lower transaction volumes. PCL increased $2 million. PCL in the current year largely reflects provisions of $43 million recorded in City National. PCL in the prior year largely reflected provisions related to the International Wealth Management business. Non-interest expense increased $1,509 million or 29%, primarily reflecting our inclusion of City National, which increased expenses by $1,648 million, and included $196 million related to amortization of intangibles and $91 million related to integration costs. The impact from foreign exchange translation and costs relating to the exit of certain international businesses also contributed to the increase. These factors were partially offset by lower restructuring costs and benefits from our efficiency management activities. Assets under administration increased by $52 billion or 6% compared to the prior year, mainly reflecting capital appreciation, the impact of foreign exchange translation and the inclusion of our acquisition of City National. Assets under management increased by $88 billion or 18% compared to the prior year, primarily due to the inclusion of our acquisition of City National and capital appreciation. 2015 vs. 2014 Net income decreased $42 million or 4% from 2014, primarily reflecting higher costs in support of business growth in our Global Asset Management and Canadian Wealth Management businesses, restructuring costs of $122 million ($90 million after-tax) largely related to our International Wealth Management business, lower transaction volumes and higher PCL. These factors were partly offset by higher earnings from growth in average fee-based client assets resulting from capital appreciation and net sales. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 29 Business line review Canadian Wealth Management Canadian Wealth Management includes our full service Canadian wealth advisory business, which is the largest in Canada as measured by AUA, with over 1,650 investment advisors providing comprehensive advice-based financial solutions to affluent, HNW and UHNW clients. Additionally, we provide discretionary investment management and estate and trust services to our clients through approximately 70 investment counsellors and 91 trust professionals across Canada. We compete with domestic banks and trust companies, investment counselling firms, bank-owned full service brokerages and boutique brokerages, mutual fund companies and global private banks. In Canada, bank-owned wealth managers continue to be the major players. Financial performance Revenue increased $142 million or 6% from a year ago, mainly due to higher average fee-based client assets reflecting strong net sales and capital appreciation and higher net interest income reflecting growth in average deposits. Selected highlights (1) Table 28 Average AUA and AUM (1) (Millions of Canadian dollars) (Millions of Canadian dollars) Total revenue Other information Total loans and acceptances (2) Total deposits (2) AUA AUM Average AUA Average AUM Total assets under fee-based 2016 2015 2014 $ 2,450 $ 2,308 $ 2,146 3,200 16,300 326,600 76,000 309,100 69,400 3,100 15,200 297,400 62,800 289,500 58,100 2,700 13,600 280,400 55,100 265,000 49,100 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2016 2015 2014 2016 2015 2014 programs 206,900 184,500 168,300 AUA AUM (1) (2) Amounts have been revised from those previously presented. Represents an average amount, which is calculated using methods intended to approximate the average of the daily balances for the period. (1) Represents average balances, which we believe are more representative of the impact client balances have upon our revenue. U.S. Wealth Management (including City National) U.S. Wealth Management (including City National) includes our private client group, which is the 7th largest full service wealth advisory firm in the U.S., as measured by number of advisors, with over 1,800 financial advisors. Additionally, our correspondent and advisor services businesses deliver clearing and execution services for small to mid-sized independent broker-dealers and registered investment advisor firms. In the U.S., we operate in a fragmented and extremely competitive industry. There are approximately 4,000 registered broker-dealers in the U.S., comprising independent, regional and global players. As previously announced, we combined U.S. Wealth Management and City National into one line of business effective the first quarter of 2016. City National is headquartered in Los Angeles, California and operates through 73 offices, including 16 full service regional centres in Southern California, the San Francisco Bay area, New York City, Nashville and Atlanta. City National provides comprehensive financial solutions to affluent individuals, entrepreneurs, professionals, their businesses and their families and provides a premier banking and financial experience through a high-touch service model, proactive advice and financial solutions. City National offers a broad range of lending, deposit, cash management, international banking, equipment financing, and other products and services. City National competes with a variety of commercial banks and other financial institutions which serve high net worth individuals, entrepreneurs and their businesses. Financial performance Revenue increased $2,115 million or 105% from a year ago, mainly reflecting the inclusion of City National, which contributed $1,988 million (US$1,502 million). Selected highlights Table 29 Average AUA and AUM (1) (Millions of U.S. dollars) (Millions of Canadian dollars, except as otherwise noted) Total revenue Other information (Millions of U.S. dollars) Total revenue Total loans, guarantees and letters of credit (1) Total deposits (1) AUA AUM Average AUA Average AUM Total assets under fee-based programs 2016 2015 2014 $ 4,123 $ 2,008 $ 1,748 3,118 1,603 1,599 29,900 41,200 293,900 76,700 289,200 74,200 4,400 3,700 272,900 28,600 275,100 27,300 4,000 1,800 275,500 25,600 232,300 23,200 98,400 94,500 94,500 (1) Represents an average amount, which is calculated using methods intended to approximate the average of the daily balances for the period. 30 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis 300,000 250,000 200,000 150,000 100,000 50,000 0 2016 2015 2014 2016 2015 2014 AUA AUM 75,000 62,500 50,000 37,500 25,000 12,500 0 (1) Represents average balances, which we believe are more representative of the impact client balances have upon our revenue. International Wealth Management International Wealth Management includes operations in the British Isles and Asia. We provide customized and integrated trust, banking, credit and investment solutions to HNW and UHNW clients and corporate clients with over 1,400 employees located in key financial centres in Europe and Asia. Competitors to our International Wealth Management business comprise global wealth managers, traditional offshore private banks, domestic wealth managers and U.S. investment-led private client operations. Financial performance Revenue decreased $209 million or 33% from a year ago, mainly reflecting the exit of certain international businesses. Table 30 Average AUA and AUM (1) (Millions of Canadian dollars) Selected highlights (Millions of Canadian dollars) Total revenue Other information Total loans, guarantees and letters of credit (1) Total deposits (1) AUA AUM Average AUA Average AUM 2016 2015 2014 $ 430 $ 639 $ 722 7,200 14,600 154,500 9,100 153,700 9,700 11,700 19,700 169,500 10,900 192,300 17,700 12,000 20,600 190,500 17,700 192,300 18,000 200,000 160,000 120,000 80,000 40,000 0 (1) Represents an average amount, which is calculated using methods intended to approximate the average of the daily balances for the period. Global Asset Management 20,000 16,000 12,000 8,000 4,000 0 2016 2015 2014 2016 2015 2014 AUA AUM (1) Represents average balances, which we believe are more representative of the impact client balances have upon our revenue. Global Asset Management provides global investment management services and solutions for individual and institutional investors in Canada, the U.S., the U.K., Europe and Asia. We provide a broad range of investment management services through mutual, pooled and private funds, fee-based accounts and separately managed portfolios. We distribute our investment solutions through a broad network of bank branches, our self-directed and full service wealth advisory businesses, independent third-party advisors and private banks, and directly to individual clients. We also provide investment solutions directly to institutional clients, including pension plans, insurance companies, corporations, and endowments and foundations. We are the largest retail fund company in Canada as well as a leading institutional asset manager. We face competition in Canada from banks, insurance companies, asset management organizations and boutique firms. The Canadian fund management industry is large and mature, but still a relatively fragmented industry. In the U.S., our asset management business offers investment management solutions and services primarily to institutional investors and competes with independent asset management firms, as well as those that are part of national and international banks, and insurance companies. Internationally, through our leading global capabilities of BlueBay and RBC Global Asset Management®, we offer investment management solutions for institutions and, through private banks including RBC Wealth Management®, to HNW and UHNW investors. We face competition from asset managers that are part of international banks as well as national, regional and boutique asset managers in the geographies where we serve clients. Financial performance Revenue decreased $34 million or 2% from a year ago, reflecting unfavourable market conditions resulting in net redemptions in the first half of the year. This was partially offset by strong performance in the Canadian business in the second half of the year due to improved market conditions. Table 31 Average AUM (1) (Millions of Canadian dollars) Selected highlights (Millions of Canadian dollars) Total revenue (1) Other information 2016 2015 2014 $ 1,786 $ 1,820 $ 1,697 Canadian net long-term mutual fund sales (2) Canadian net money market mutual fund (redemptions) sales (2) AUM Average AUM 7,868 9,857 10,982 (439) 392,600 383,400 (605) 381,700 374,700 (1,229) 350,600 335,300 (1) (2) Effective the first quarter of 2014, we have aligned the reporting period of BlueBay, which resulted in an additional month of earnings being included in 2014. As reported to the Investment Funds Institute of Canada. Includes all prospectus-based mutual funds across our Canadian Global Asset Management businesses. 400,000 300,000 200,000 100,000 0 2016 2015 2014 (1) AUM Represents average balances, which we believe are more representative of the impact client balances have upon our revenue. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 31 Insurance Insurance comprises our operations in Canada and globally and operates under two business lines: Canadian Insurance and International Insurance, providing a wide range of life, health, home, auto, travel, wealth, group and reinsurance products and solutions. In Canada, we offer our products and services through our proprietary distribution channels, comprised of the field sales force which includes retail insurance stores, our field sales representatives, advice centres and online, as well as through independent insurance advisors and affinity relationships. Outside Canada, we operate in reinsurance markets globally offering life, accident and annuity reinsurance products. The competitive environment for each business is discussed below. Economic and market review The global macroeconomic environment continues to show improvement, with both the middle class and high net worth populations in quantity and financial resources on the rise in many countries. Key challenges for the insurance industry remain due to the increasing regulatory pressures, low interest rates, record high levels of debt, shifting demographics, changes in client expectations, and growth in non-traditional competitors. To overcome these challenges, many insurers are heavily investing in technological and digital solutions to improve the client experience and provide differentiation, refining products and distribution capability, and enhancing operational efficiency and managing expenses. Highlights • On July 1, 2016, we completed the sale of RBC General Insurance Company to Aviva Canada Inc. (Aviva). The transaction involved the sale of our home and auto insurance manufacturing business and included a 15-year strategic distribution agreement between RBC Insurance and Aviva. In our Canadian Insurance business, we experienced strong sales growth, maintaining our #1 ranking in individual disability sales, #11 in individual life products and have been increasing market share in Group Insurance and Wealth, which are targeted areas of focus. • We launched YourTermTM, a new life insurance product, as part of an innovative renewal and client retention strategy, allowing clients to • select a specific term for their life insurance. • We have partnered with digital insurer League to underwrite its expanded offerings, providing comprehensive coverage for unexpected emergencies, as well as a range of group life and health insurance products, including life, accidental death and dismemberment, and disability coverage. • We continued to focus on enhancing our client experience and our cost effectiveness through ongoing transformation of our legacy • business and enhancing our digital capabilities. In the fall of 2016, we introduced new and innovative tools to help clients who are on disability recover and return to work more quickly. These include an exclusive arrangement with Best Doctors Onward as well as a partnership with Medical Confidence. • We continued to expand our U.K. annuity business, though we experienced some volatility reflecting changing market conditions, including foreign exchange impacts after the Brexit vote. Outlook and priorities While we see signs of improvement in the macroeconomic environment, growing risk and economic insecurity continue to prevail; therefore, growth in the industry is projected to be moderate in the short to medium term. We are focusing on organic growth through our proprietary sales channels, improved claims performance and increased operational efficiency. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Key strategic priorities for 2017 • • Deepen client relationships by continuing to be an innovative, client-focused provider of a full suite of insurance products. Continue to improve our distribution efficiency by expanding our proprietary distribution channels and focusing on the delivery of technology and operational solutions. Simplify and innovate by accelerating our digital initiatives time to market, improving quality and cost effectiveness. Pursue select international opportunities, within our risk appetite, with the aim of continuing to grow our core reinsurance business. • • 32 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Insurance (Millions of Canadian dollars, except percentage amounts and as otherwise noted) 2016 2015 Non-interest income Net earned premiums Investment income (1) Fee income Total revenue Insurance policyholder benefits and claims (1) Insurance policyholder acquisition expense Non-interest expense (2) Income before income taxes Net income Revenue by business Canadian Insurance International Insurance Key ratios ROE Selected balances and other information Total assets Attributed capital Other information Premiums and deposits (3) Canadian Insurance International Insurance Insurance claims and policy benefit liabilities Fair value changes on investments backing policyholder liabilities (1) Embedded value (4) Number of employees (FTE) $ $ $ $ $ Table 32 2014 3,742 938 284 4,964 3,194 379 579 812 781 2,911 2,053 3,175 $ 1,422 554 5,151 3,208 216 623 1,104 900 $ 3,373 $ 1,778 3,507 $ 445 484 4,436 2,741 222 613 860 706 $ 2,725 $ 1,711 52.8% 44.3% 49.7% 14,400 $ 1,700 13,700 $ 1,600 12,000 1,550 4,594 $ 2,424 2,170 9,164 633 6,886 2,657 5,016 $ 2,725 2,291 9,110 (24) 6,952 3,163 5,164 2,419 2,745 8,564 439 6,239 3,126 Estimated impact of U.S. dollar and British pound translation on key income statement items (Millions of Canadian dollars, except percentage amounts) 2016 vs. 2015 Increase (decrease): Total revenue PBCAE Non-interest expense Net income Percentage change in average US$ equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 $ (54) (39) – (15) (5)% 5% (1) (2) (3) (4) Investment income can experience volatility arising from fluctuation of fair value through profit or loss (FVTPL) assets. The investments which support actuarial liabilities are predominantly fixed income assets designated as at FVTPL. Consequently, changes in the fair values of these assets are recorded in investment income in the consolidated statement of income and are largely offset by changes in the fair value of the actuarial liabilities, the impact of which is reflected in insurance policyholder benefits and claims. For 2016, includes PCL of $1 million (2015 - $nil; 2014 - $nil). Premiums and deposits include premiums on risk-based insurance and annuity products, and individual and group segregated fund deposits, consistent with insurance industry practices. Embedded value is defined as the sum of value of equity held in our Insurance segment and the value of in-force business (existing policies). For further details, refer to the Key performance and non-GAAP measures section. On July 1, 2016, we completed the sale of RBC General Insurance Company to Aviva Canada Inc. (Aviva) as previously announced on January 21, 2016. The transaction involved the sale of our home and auto insurance manufacturing business and included a 15-year strategic distribution agreement between RBC Insurance and Aviva. As a result of the transaction, we recorded a gain of $287 million ($235 million after-tax) in our results. For further details, refer to Note 11 of our 2016 Annual Consolidated Financial Statements. Financial performance 2016 vs. 2015 Net income increased $194 million or 27% from a year ago. Excluding the after-tax gain of $235 million on the sale of RBC General Insurance Company to Aviva, net income decreased $41 million or 6%, mainly due to lower earnings from new U.K. annuity contracts as well as lower earnings reflecting the impact from the sale of our home and auto insurance manufacturing business as noted above. These items were partially offset by growth in International Insurance. Total revenue increased $715 million or 16%, mainly due to a change of $657 million related to the fair value of investments backing our policyholder liabilities resulting from changes in long-term interest rates, largely offset in PBCAE, and the gain on the sale of RBC General Insurance Company as noted above. These factors were partially offset by lower premiums reflecting the impact of the sale of our home and auto insurance manufacturing business and the impact due to foreign exchange translation. PBCAE increased $461 million or 16%, mainly due to a change in the fair value of investments backing our policyholder liabilities, largely offset in revenue. This factor was partially offset by lower costs reflecting the impact from the sale of our home and auto insurance manufacturing business as noted above. Non-interest expense increased $10 million or 2%, largely in support of business growth and strategic initiatives, partially offset by reduced expenses reflecting the impact of the sale of our home and auto insurance manufacturing business, as noted above, and efficiency management activities. Premiums and deposits were down $422 million or 8%, reflecting the impact of the sale of our home and auto insurance manufacturing business, as noted above, and a reduction related to our retrocession contracts. This was partially offset by growth in International Insurance. Embedded value decreased $66 million, reflecting the impact of the sale of our home and auto insurance manufacturing business, as noted above, and the transfer of capital though dividends paid, largely offset by business growth. For further details, refer to the Key performance and non-GAAP measures section. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 33 2015 vs. 2014 Net income decreased $75 million or 10% from 2014, mainly due to a change in Canadian tax legislation impacting certain foreign affiliates that became effective November 1, 2014, a lower level of favourable actuarial adjustments in 2015, and higher net claims costs. These factors were partially offset by higher earnings from new U.K. annuity contracts and the favourable impact of investment-related activities on the Canadian life business. Results excluding the specified item noted above are non-GAAP measures. For further details, including a reconciliation, refer to the Key performance and non-GAAP measures section. Business line review Canadian Insurance We offer life, health, property and casualty insurance products, as well as wealth accumulation solutions, to individual and group clients across Canada. Our life and health portfolio includes universal life, term life, critical illness, disability, long-term care insurance and group benefits. We offer a wide range of property and casualty products including home, auto and travel insurance. Our travel products include out of province/ country medical coverage, and trip cancellation and interruption insurance. In Canada, the majority of our competitors specialize in life and health or property and casualty products. We hold a leading market position in disability insurance products, have a significant presence in life and travel products, and have a growing presence in wealth as well as in home and auto through our distribution agreement with Aviva. Financial performance Total revenue increased $648 million or 24% from last year, mainly due to the fair value of investments backing our policyholder liabilities resulting from changes in long-term interest rates, largely offset in PBCAE, and the gain on sale of our home and auto insurance manufacturing business as noted above, partially offset by lower premiums reflecting the impact of the sale. Premiums and deposits decreased $301 million or 11%, reflecting the impact of the sale of our home and auto insurance manufacturing business, as noted above. Selected highlights (Millions of Canadian dollars) Total revenue Other information Premiums and deposits Life and health Property and casualty Annuity and segregated fund deposits Fair value changes on investments backing policyholder liabilities International Insurance Table 33 Premiums and deposits (Millions of Canadian dollars) 2016 3,373 $ 2015 2014 2,725 $ 2,911 $ 1,438 674 1,484 958 1,266 951 312 283 202 3,000 2,500 2,000 1,500 1,000 500 0 575 54 490 Annuity and segregated fund deposits Property and casualty Life and health 2016 2015 2014 International Insurance is primarily comprised of our reinsurance businesses which insure risks of other insurance and reinsurance companies. We offer life and health, accident and annuity reinsurance products. The global reinsurance market is dominated by a few large players, with significant presence in the U.S., the U.K. and the Euro area. The reinsurance industry is competitive but barriers to entry remain high. Financial performance Total revenue increased $67 million or 4%, mainly due to a change in the fair value of investments backing our policyholder liabilities resulting from changes in long-term interest rates, largely offset in PBCAE. This factor was partially offset by a reduction in revenue related to our retrocession contracts, largely offset in PBCAE, and the impact due to foreign exchange translation. Premiums and deposits decreased $121 million or 5%, driven by the reduction in premium related to our retrocession contracts, partly offset by growth in the U.K. annuity contracts. Selected highlights (Millions of Canadian dollars) Total revenue Other information Premiums and deposits Life and health Property and casualty Annuity Fair value changes on investments backing policyholder liabilities Table 34 2016 1,778 $ 2015 2014 1,711 $ 2,053 $ 1,335 – 835 1,483 (4) 812 2,128 6 611 58 (78) (51) 34 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Investor & Treasury Services Investor & Treasury Services is a specialist provider of asset services, custody, payments and treasury services for financial and other institutional investors worldwide. We deliver custodial, advisory, financing and other services to safeguard client assets, maximize liquidity, and manage risk across multiple jurisdictions. We also provide short-term funding and liquidity management for RBC. We are a global custodian with a network of offices across North America, Europe and Asia-Pacific. While we compete against the world’s largest global custodians, we remain a specialist provider with a focus on asset managers offering offshore fund structures in Luxembourg and Ireland, and alternative asset managers of real estate and private equity funds. Our transaction banking business is a leading provider of Canadian dollar cash management, correspondent banking, and trade finance for financial institutions globally. Economic and market review The highly competitive environment in the global asset services industry continued to pressure margins. Sustained low to negative interest rates globally have reduced deposit rates, leading to margin compression from our deposit-gathering activities. Moreover, continued increases in financial services regulations have driven up compliance and technology costs. Market uncertainty (including Brexit and central bank policy rates) has impacted our core fees and foreign exchange transaction volumes; however, tightening credit spreads and favourable interest rate movements benefited our funding and liquidity business. Highlights • • • • • • Rated by our clients the #1 global custodian for six consecutive years (Global Investor/ISF Global Custody Survey, 2016). Rated #1 custodian overall in Canada and Europe (excl. Switzerland and the U.K.) (R&M Investor Services Survey, 2016). Named #1 Canadian sub-custodian (Global Custodian Agent Banks in Major Markets Survey, 2016). Maintained global position as the #1 fund administrator overall for four consecutive years (R&M Fund Accounting and Administration Survey, 2016). Named Best Trade Finance Bank in Canada for four consecutive years (Global Finance, 2016). High level of investment in client-focused technology solutions. Outlook and priorities In 2017, our aim is to continue to be the leading provider of domestic asset services and cash management in Canada and a leading provider of fund services to asset managers in select offshore markets. Our focus is on driving top-line growth by leveraging our leadership position in Canada and recognized capabilities in the offshore fund services markets in Luxembourg and Ireland to win new business and deepen existing client relationships. We continue to execute on our strategic and transformational technology initiatives to enhance client experiences. While we expect the global asset services industry to remain challenging in the near-term, we are well-positioned to compete in the continuously changing operating environment. For further details on our general economic review and outlook, refer to the Economic, market and regulatory review and outlook section. Key strategic priorities for 2017 • • • • Maintain our position as the #1 provider of domestic custody, asset services and cash management in Canada. Compete as a leading provider of asset services in the major offshore fund domicile markets of Luxembourg and Ireland. Continue to deliver a high-level of investment in client-focused technology solutions. Enhance our client centric service offering and improve efficiency. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 35 Investor & Treasury Services (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Net interest income Non-interest income Total revenue (1) Non-interest expense Net income before income taxes Net income Key Ratios ROE Selected average balance sheet information Total assets Deposits Client deposits Wholesale funding deposits Attributed capital Other Information AUA (2) Average AUA Number of employees (FTE) $ $ $ 2016 825 $ 1,446 2,271 1,457 814 613 $ Table 35 2014 732 1,152 1,884 1,286 598 441 2015 818 $ 1,220 2,038 1,300 738 556 $ 17.9% 20.3% 19.8% 142,500 $ 134,300 52,800 81,500 3,350 125,300 $ 139,600 50,400 89,200 2,700 94,200 112,100 42,700 69,400 2,150 3,929,400 3,770,200 4,776 3,620,300 3,793,000 4,774 3,702,800 3,463,000 4,963 Estimated impact of U.S. dollar, British pound and Euro translation on key income statement items (Millions of Canadian dollars, except percentage amounts) Increase (decrease): Total revenue Non-interest expense Net income Percentage change in average US$ equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 Percentage change in average Euro equivalent of C$1.00 2016 vs. 2015 $ 40 10 20 (5)% 5% (3)% (1) (2) Effective the third quarter of 2015, we have aligned the reporting period of Investor Services, which resulted in an additional month of earnings being included in 2015. The net impact of the additional month was recorded in revenue. Represents period-end spot balances. Financial performance 2016 vs. 2015 Net income increased $57 million or 10%, primarily due to higher funding and liquidity earnings reflecting tightening credit spreads and favourable interest rate movements, and higher client deposit spreads. These factors were partially offset by increased investment in technology initiatives, higher staff costs and lower earnings from foreign exchange market execution. In addition, the prior year included an additional month of earnings in Investor Services of $42 million ($28 million after-tax). Total revenue increased $233 million or 11%, mainly related to higher funding and liquidity revenue reflecting tightening credit spreads and favourable interest rate movements, increased revenue on higher client deposit spreads, and the impact from foreign exchange translation. These factors were partially offset by lower revenue from foreign exchange market execution. In addition, the prior year included the impact of an additional month in Investor Services as noted above. Non-interest expense increased $157 million or 12%, largely reflecting increased investment in technology initiatives, higher staff costs, and the impact from foreign exchange translation. 2015 vs. 2014 Net income was up $115 million or 26% from 2014, primarily due to higher earnings from foreign exchange market execution, an additional month of earnings in Investor Services as noted above, increased custodial fees and higher earnings from growth in client deposits. These factors were partially offset by lower funding and liquidity results. Capital Markets Capital Markets provides public and private companies, institutional investors, governments and central banks globally with a wide range of capital markets products and services across our two main business lines, Corporate and Investment Banking and Global Markets. Our legacy portfolio is grouped under Other. In North America, we offer a full suite of products and services which include corporate and investment banking, equity and debt origination and distribution, and structuring and trading. In Canada, we compete mainly with Canadian banks where we are a premier global investment bank and market leader with a strategic presence in all lines of capital markets businesses. In the U.S., we have full industry sector coverage and investment banking product range and compete with large U.S. and global investment banks as well as smaller regional firms. Outside North America, we have a select presence in the U.K. and Europe, and Other international, where we offer a diversified set of capabilities in our key sectors of expertise such as energy, mining and infrastructure and we have a growing presence in industrial, consumer and healthcare in Europe. In the U.K. and Europe, we compete in our key sectors of expertise with global and regional investment banks. In Other international, we compete with global and regional investment banks in select products, consisting of fixed income distribution and currencies trading and corporate and investment banking in Australia, Asia and the Caribbean. 36 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Economic and market review Following the deterioration of market conditions throughout the latter half of fiscal 2015, the first half of 2016 was characterized by volatile debt and equity markets as well as difficult market conditions. This was driven by the effect of stronger but still lower than historical levels for global oil and commodity prices, as well as diverging monetary policies amongst global central banks. This led to decreased levels of client activity and volumes. Our corporate and investment banking businesses saw debt underwriting rebound in the latter part of the year with good activity in investment grade and a recovery in high yield. Although the market backdrop improved in the latter half of the year, equity market volatility remained through the end of the year. Highlights • We continued to focus on the efficient deployment of our capital and growth throughout our businesses by re-allocating capital from trading • • • • • to corporate and investment banking businesses and managed risk by focusing on optimizing our trading products. In Canada, we maintained our market leadership by deepening our existing client relationships despite soft markets in both the energy and commodity sectors, gaining new clients by leveraging our strong global capabilities and improving collaboration with enterprise partners to drive operational efficiencies. We continued to win significant mandates including acting as lead left bookrunner on the TransCanada Pipelines $4.4 billion bought deal offering of subscription receipts in addition to being the joint bookrunner on the supporting US$3.2 billion equity bridge and the US$7.1 billion asset sale bridge. In the U.S., we continued to leverage our key strategic investments to expand our corporate and investment banking businesses as we optimized our lending relationships, focusing on leveraging these relationships to generate additional revenue. Despite softer investment banking fees from lighter industry-wide underwriting activity, we continued to win significant mandates including acting as joint bookrunner on the acquisition financing and financial advisor to Dell Inc. on the acquisition of EMC Corporation for US$49 billion in cash and stock transaction, joint lead arranger and joint bookrunner on the financing supporting Western Digital Corporation’s US$17 billion acquisition of SanDisk, as well as acting as financial advisor, joint lead arranger and joint bookrunner on the US$12.4 billion acquisition of ADT by Protection 1 and Apollo Global Management. In the U.K. and Europe, we continued to focus on maintaining momentum throughout the year and improving profitability through repositioning our fixed income business, as well as growing our corporate and investment banking presence in key markets, by developing strong client relationships. We acted as sole financial adviser to Kohlberg Kravis Roberts & Co. on the sale of Coriance Group SAS, a leading French district heating concession business, to First State Investments for an undisclosed amount. The transaction represents a successful example of cross-border cooperation involving an integrated advisory team across Utilities & Renewables, France and M&A. In Other international, we continued to focus on our corporate and investment banking, fixed income trading distribution and foreign exchange trading capabilities. As a result of our successes in each of our regions, we received external recognition as an industry leader and were named or ranked: Best Investment Bank in Canada (Euromoney Magazine) for the ninth consecutive year. – – Best Bank for Markets in North America (Euromoney Magazine) – World’s Best Developed Markets Banks (Canada) (Global Finance) – – The largest investment bank in Canada by fees for the first nine months of 2016 (Dealogic). The 10th largest investment bank globally and in the Americas by fees for the first nine months of 2016 (Thomson Reuters). Outlook and priorities Global market volatility dominated headlines for Investment Banking with the global fee pool down 10% in the first nine months of 2016 from the same period in 2015. With an improved market environment expected in 2017, our investment banking revenue is forecast to improve and healthier origination volumes should help lift secondary trading activity. We will focus on maximizing returns through business structure and continual optimization of the balance sheet, as well as improving operating leverage through cost containment initiatives. Regulatory impacts continue to make earnings growth a challenge as regulatory and tax changes constrain revenue growth and regulatory reform implementation continues to exert upward pressure on expenses and capital. For further details, refer to our Risk management – Top and emerging risks section. For further details on our general economic outlook, refer to the Economic, market and regulatory review and outlook section. Key strategic priorities for 2017 • • Capital Markets will maintain its focus on full service activities in Canada, the U.S. and Europe. Maintain our leadership position in Canada by focusing on long-term client relationships, leveraging our global capabilities and continuing to improve collaboration with Wealth Management. Continue to expand and strengthen client relationships in the U.S. by building on our momentum through expanded origination, advisory and distribution activity, and driving cross-selling through our diversified loan book. We expect the U.S. to continue to be the world’s most attractive market and it will remain Capital Markets’ priority growth market. Build on our core strengths in Europe in both Corporate and Investment Banking and Global Markets by continuing to grow and deepen client relationships and in Asia by optimizing the performance of our existing footprint. Optimize capital use to earn high risk-adjusted returns by maintaining both a balanced approach between investment banking and trading revenue and a disciplined approach to managing the risks and costs of our business. Manage through the significant changes in the regulatory environment. • • • • Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 37 Capital Markets financial highlights (Millions of Canadian dollars, except percentage amounts and as otherwise noted) Net interest income (1) Non-interest income (1) Total revenue (1) PCL Non-interest expense Net income before income taxes Net income Revenue by business Corporate and Investment Banking Global Markets (2) Other (2) Key ratios ROE Selected average balance sheet information Total assets Trading securities Loans and acceptances Deposits Attributed capital Other information Number of employees (FTE) Credit information Gross impaired loans as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances $ $ $ $ $ $ $ $ 2016 3,804 $ 4,146 7,950 327 4,466 3,157 2,270 $ 3,694 $ 4,361 (105) 2015 3,970 4,093 8,063 71 4,696 3,296 2,319 3,697 4,477 (111) 12.2% 13.6% 508,200 $ 104,900 88,100 61,500 17,900 3,883 1.73% 0.37% 477,300 116,200 79,700 60,300 16,550 3,996 0.37% 0.09% Table 36 2014 3,485 3,881 7,366 44 4,344 2,978 2,055 3,437 3,896 33 14.1% 392,300 103,800 64,800 47,600 14,100 3,917 0.08% 0.07% Estimated impact of U.S. dollar, British pound and Euro translation on key income statement items (Millions of Canadian dollars, except percentage amounts and as otherwise noted) 2016 vs. 2015 Increase (decrease): Total revenue Non-interest expense Net income Percentage change in average US$ equivalent of C$1.00 Percentage change in average British pound equivalent of C$1.00 Percentage change in average Euro equivalent of C$1.00 $ 259 72 115 (5)% 5% (3)% (1) (2) The taxable equivalent basis (teb) adjustment for 2016 was $736 million (2015 – $570 million, 2014 – $492 million). For further discussion, refer to the How we measure and report our business segments section of our 2016 Annual Report. Effective the first quarter of 2015, we reclassified amounts from Global Markets to Other related to certain proprietary trading strategies which we exited in the fourth quarter of 2014 to comply with the Volcker Rule. Prior period amounts have been revised from those previously presented. Revenue by region (Millions of Canadian dollars) 10,000 7,500 5,000 2,500 0 2016 2015 2014 Asia and other Europe U.S. Canada Financial performance 2016 vs. 2015 Net income decreased $49 million or 2%, driven by higher PCL, lower results in our Global Markets and Corporate and Investment Banking businesses reflecting lower client activity, and higher compliance costs. These factors were partially offset by lower variable compensation, the impact from foreign exchange translation and lower litigation provisions. Total revenue decreased $113 million or 1%, largely reflecting lower equity trading revenue and lower lending revenue primarily in the U.S. and Europe, and lower private equity investment gains. These factors were partially offset by the impact from foreign exchange translation and higher fixed income trading revenue mainly in Europe and Canada. PCL increased $256 million, primarily due to higher provisions in the oil & gas sector. For further details, refer to the Credit quality performance section. Non-interest expense decreased $230 million or 5%, reflecting lower variable compensation largely due to changes in the deferral policy of the compensation plan and lower litigation provisions, partially offset by the impact from foreign exchange translation and higher compliance costs. 38 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis 2015 vs. 2014 Net income increased $264 million or 13% from 2014, driven by growth in our Global Markets business mainly reflecting increased client activity, continued solid performance in our Corporate and Investment Banking business, and the impact from foreign exchange translation. These factors were partially offset by lower results in certain legacy portfolios. Business line review Corporate and Investment Banking Corporate and Investment Banking comprises our corporate lending, loan syndications, debt and equity origination, M&A advisory services, private equity, research, client securitization and the global credit businesses. For debt and equity origination, revenue is allocated between Corporate and Investment Banking and Global Markets based on the contribution of each group in accordance with an established agreement. Financial performance Corporate and Investment Banking revenue of $3,694 million decreased $3 million as compared to last year. Investment banking revenue increased $59 million or 3%, primarily due to growth in Municipal Banking in the U.S. and higher M&A activity across most regions, partially offset by lower private equity investment gains and lower equity origination activity largely in the U.S. Lending and other revenue decreased $62 million or 3%, due to lower spreads across most regions. Selected highlights (Millions of Canadian dollars) Total revenue (1) Breakdown of revenue (1) Investment banking Lending and other (2) Other information Average assets Average loans and acceptances Table 37 Breakdown of total revenue (Millions of Canadian dollars) 2016 2015 2014 $ 3,694 $ 3,697 $ 3,437 1,892 1,802 1,833 1,864 1,736 1,701 73,200 65,300 63,900 56,200 49,500 42,500 4,000 3,200 2,400 1,600 800 0 (1) (2) The teb adjustment for 2016 was $279 million (2015 – $25 million, 2014 – $13 million). For further discussion, refer to the How we measure and report our business segments section. Comprises our corporate lending, client securitization, and global credit businesses. 2016 2015 2014 Investment banking Lending and other Global Markets Global Markets comprises our fixed income, foreign exchange, equity sales and trading, repos and secured financing and commodities businesses. Financial performance Total revenue of $4,361 million decreased $116 million or 3% as compared to last year. Revenue in our Fixed income, currencies and commodities business increased $226 million or 12%, mainly due to higher fixed income and foreign exchange trading revenue, partially offset by lower debt origination activity across all regions. Revenue in our Equities business decreased $288 million or 20%, primarily due to lower equity trading revenue across most regions and lower volume in our cash equities businesses. Revenue in our Repo and secured financing business decreased $54 million or 5%, mainly due to lower trading revenue reflecting Table 38 Breakdown of total revenue (Millions of Canadian dollars) decreased client activity. Selected highlights (Millions of Canadian dollars) Total revenue (2) Breakdown of revenue (2) Fixed income, currencies and commodities Equities Repo and secured financing (3) Other information Average assets 2016 2015 (1) 2014 (1) $ 4,361 $ 4,477 $ 3,896 2,113 1,147 1,101 1,887 1,435 1,155 1,760 1,204 932 472,100 494,400 366,000 5,000 4,000 3,000 2,000 1,000 0 (1) (2) (3) Amounts have been revised from those previously presented. The teb adjustment for 2016 was $457 million (2015 – $545 million, 2014 – $470 million). For further discussion, refer to the How we measure and report our business segments section. Comprises our secured funding businesses for internal businesses and external clients. 2016 2015 2014 Repo and secured financing Global equities Fixed income, currencies and commodities Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 39 Other Other includes our legacy portfolio, which consists of our bank-owned life insurance (BOLI) stable value products, U.S. commercial mortgage- backed securities, U.S. auction rate securities (ARS), and structured rates in Asia. In recent years, in order to optimize our capital employed to improve our risk-adjusted returns and reduce our liquidity risk on various products, we have significantly reduced several of our legacy portfolios. Our legacy portfolio assets decreased by 3% as compared to last year. Financial performance Revenue increased $6 million as compared to last year. Corporate Support Corporate Support comprises Technology & Operations, which provide the technological and operational foundation required to effectively deliver products and services to our clients, and Functions, which includes our finance, human resources, risk management, internal audit and other functional groups. Reported results for Corporate Support mainly reflect certain activities related to monitoring and oversight of enterprise activities which are not allocated to business segments. Corporate Support also includes our Corporate Treasury function. For further details, refer to the How we measure and report our business segments section. Corporate Support (Millions of Canadian dollars, except as otherwise noted) Net interest income (loss) (1) Non-interest income (loss) (1) Total revenue (1) PCL Non-interest expense Net income (loss) before income taxes (1) Income taxes (recoveries) (1) Net income (loss) (2) Other information Number of employees (FTE) (3) Table 39 2016 2015 2014 (390) (202) (592) 51 30 (673) (691) 18 $ (514) 210 (304) (3) 125 (426) (824) 398 $ $ (313) 164 (149) (2) 89 (236) (405) 169 $ $ $ 13,913 13,371 12,540 (1) (2) (3) Teb adjusted. Net income reflects income attributable to both shareholders and Non-Controlling Interests (NCI). Net income attributable to NCI for the year ended October 31, 2016 was $44 million (October 31, 2015 – $94 million; October 31, 2014 – $93 million). Amounts have been revised from previously presented. Due to the nature of activities and consolidation adjustments reported in this segment, we believe that a comparative period analysis is not relevant. The following identifies material items affecting the reported results in each period. Total revenue and income taxes (recoveries) in each period in Corporate Support include the deduction of the teb adjustments related to the gross-up of income from Canadian taxable corporate dividends and the U.S. tax credit investment business recorded in Capital Markets. The amount deducted from revenue was offset by an equivalent increase in income taxes (recoveries). The teb amount for the year ended October 31, 2016 was $736 million as compared to $570 million last year and $492 million for the year ended October 31, 2014. In addition to the teb impacts noted above, the following identifies the other material items affecting the reported results in each period. 2016 Net income was $18 million largely reflecting asset/liability management activities, partially offset by net unfavourable tax adjustments and a $50 million ($37 million after-tax) increase in the provision for loans not yet identified as impaired. 2015 Net income was $398 million largely reflecting net favourable tax adjustments, asset/liability management activities, a gain of $108 million (before- and after-tax) from the wind-up of a U.S.-based funding subsidiary that resulted in the release of CTA, and a gain on sale of a real estate asset. These factors were partially offset by transaction costs related to our acquisition of City National. 2014 Net income was $169 million largely reflecting asset/liability management activities and gains on private equity investments mainly related to the sale of a legacy portfolio, partially offset by net unfavourable tax adjustments. 40 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Results by geographic segment (1) For geographic reporting, our segments are grouped into the following: Canada, U.S., and Other International. Transactions are primarily recorded in the location that best reflects the risk due to negative changes in economic conditions and prospects for growth due to positive economic changes. The following table summarizes our financial results by geographic region: Table 40 2016 2015 2014 (Millions of Canadian dollars) Canada U.S. Other International Total Canada U.S. Other International Total Canada U.S. Other International Total Net interest income Non-interest income $ 11,685 $ 3,241 $ 12,054 4,992 1,605 $ 16,531 21,874 4,828 $ 11,538 $ 1,977 $ 10,889 4,619 1,256 $ 14,771 20,550 5,042 $ 11,128 $ 1,697 $ 10,488 4,257 1,291 $ 14,116 19,992 5,247 Total revenue $ 23,739 $ 8,233 $ 6,433 $ 38,405 $ 22,427 $ 6,596 $ 6,298 $ 35,321 $ 21,616 $ 5,954 $ 6,538 $ 34,108 PCL PBCAE Non-interest expense Income taxes 1,231 2,304 10,229 2,158 254 – 6,151 397 61 1,120 3,756 286 1,546 3,424 20,136 2,841 933 1,976 10,139 1,727 98 – 4,762 649 66 987 3,737 221 1,097 2,963 18,638 2,597 922 2,188 9,650 1,983 52 1 4,199 660 190 1,384 3,812 63 1,164 3,573 17,661 2,706 Net income $ 7,817 $ 1,431 $ 1,210 $ 10,458 $ 7,652 $ 1,087 $ 1,287 $ 10,026 $ 6,873 $ 1,042 $ 1,089 $ 9,004 (1) For further details, refer to Note 30 of our audited 2016 Annual Consolidated Financial Statements. 2016 vs. 2015 Net income in Canada was up $165 million or 2% from the prior year, mainly due to higher earnings from growth in average fee-based client assets in Wealth Management, the gain on sale of our home and auto insurance manufacturing business, and volume and fee-based revenue growth across most businesses in Canadian Banking. These factors were partially offset by higher PCL, increased investment in technology, and higher costs to support business growth. In addition, the prior year benefited from a lower effective tax rate reflecting net favourable income tax adjustments, as well as a gain from the wind-up of a U.S. subsidiary. U.S. net income increased $344 million or 32% compared to last year, largely reflecting lower taxes, the inclusion of earnings from our acquisition of City National, and lower variable compensation in Capital Markets. This was partly offset by lower equity trading and lending earnings and higher PCL. Other International net income was down $77 million or 6% from the prior year, mainly due to higher costs to support business growth in Investor & Treasury Services and in the Caribbean, lower earnings from new U.K. annuity contracts in Insurance, and the exit of certain international businesses in Wealth Management. This was partially offset by higher fixed income trading results and increased M&A activity in Capital Markets, higher funding and liquidity earnings in Investor & Treasury Services reflecting tightening credit spreads and favourable interest rate movements, the impact from foreign exchange translation and higher fee-based revenue in the Caribbean. 2015 vs. 2014 Net income in Canada was up $779 million or 11% as compared to 2014, mainly due to solid volume growth and strong fee-based revenue growth across most businesses in Canadian Banking, a lower effective tax rate reflecting net favourable income tax adjustments, and higher earnings in Investor & Treasury Services. A gain of $108 million (before- and after-tax) from the wind-up of a U.S.-based funding subsidiary that resulted in the release of CTA also contributed to the increase. These factors were partially offset by higher costs in support of business growth, and lower spreads. U.S. net income was up $45 million or 4% as compared to 2014, primarily due to the impact from foreign exchange translation, growth in our global markets businesses reflecting increased client activity and more favourable market conditions in the first half of 2015, and higher results in most corporate and investment banking businesses. Lower litigation provisions and related legal costs in Capital Markets also contributed to the increase. These factors were partially offset by higher costs in support of business growth. Other International net income was up $198 million or 18% as compared to 2014, mainly due to lower PCL in our Caribbean portfolios, and higher lending activity in Europe. These factors were partially offset by restructuring costs related to our International Wealth Management business. In addition, our results in 2014 were unfavourably impacted by a loss of $100 million (before- and after-tax) related to the sale of RBC Jamaica and a provision of $40 million ($32 million after-tax) related to post-employment benefits and restructuring charges in the Caribbean. Quarterly financial information Fourth quarter 2016 performance Q4 2016 vs. Q4 2015 Fourth quarter net income of $2,543 million was down $50 million or 2% from last year. Diluted EPS of $1.65 was down $0.09 and ROE of 15.5% was down 240 bps. Our fourth quarter earnings decreased as lower results in Capital Markets were mostly offset by strong earnings in Wealth Management and Investor & Treasury Services, and higher earnings in Personal & Commercial Banking and Insurance. In addition, the prior year benefited from net favourable tax adjustments. Total revenue increased $1,246 million or 16%, mainly due to the inclusion of City National, which contributed $543 million (US$411 million), the change in the fair value of investments backing our policyholder liabilities, largely offset in PBCAE, and higher fixed income trading revenue and strong debt and equity origination activity. Higher funding and liquidity revenue reflecting tightening credit spreads and favourable interest rate movements, increased loan syndication revenue, and solid volume growth across most businesses in Canadian Banking also contributed to the increase. These factors were partially offset by lower equity trading revenue across most regions and lower premiums reflecting the impact of the sale of our home and auto insurance manufacturing business. Total PCL increased $83 million and the PCL ratio of 27 bps increased 4 bps from last year, mainly reflecting higher provisions in our Canadian personal and commercial lending portfolios and higher write-offs in our Canadian credit cards portfolio. Higher provisions, net of recoveries, in the energy sector in Capital Markets also contributed to the increase. PBCAE increased $105 million or 36%, largely reflecting the change in fair value of investments backing our policyholder liabilities, largely offset in revenue, and growth mainly in International Insurance. These factors were partially offset by the impact from the sale of our home and auto insurance manufacturing business as noted above. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 41 Non-interest expense increased $551 million or 12%, primarily reflecting the inclusion of our acquisition of City National, which increased expenses by $440 million, including $49 million related to the amortization of intangibles and $16 million related to integration costs. Higher variable compensation on improved results in Capital Markets and Wealth Management, and higher costs in support of business growth also contributed to the increase. These factors were partially offset by continuing benefits from our efficiency management activities and lower costs as a result of the sale of the home and auto insurance manufacturing business as noted above. The prior year also included restructuring costs largely related to our International Wealth Management business, including the sale of RBC Suisse. Income tax expense increased $557 million from last year, and the effective income tax rate increased from 7.6% last year to 23.2%, as the prior year included net favourable tax adjustments mainly in Corporate Support and Capital Markets. Q4 2016 vs. Q3 2016 Net income of $2,543 million decreased $352 million, or 12% compared to the prior quarter. The prior quarter included a gain of $287 million ($235 million after-tax) on the sale of our home and auto insurance manufacturing business. Lower earnings in Capital Markets mainly due to lower fixed income and equity trading results, and lower earnings in Personal & Commercial Banking largely driven by higher technology spend and seasonally higher marketing costs in support of business growth also contributed to the decrease. These factors were partially offset by strong earnings in Insurance mainly due to favourable actuarial adjustments reflecting management actions and assumption changes, and strong earnings in Investor & Treasury Services largely driven by higher funding and liquidity revenue reflecting tightening credit spreads and favourable interest rate movements. Quarterly results and trend analysis Our quarterly results are impacted by a number of trends and recurring factors, which include seasonality of certain businesses, general economic and market conditions, and fluctuations in the Canadian dollar relative to other currencies. The following table summarizes our results for the last eight quarters (the period): Quarterly results (1) Table 41 (Millions of Canadian dollars, except per share and percentage amounts) Net interest income Non-interest income Total revenue PCL PBCAE Non-interest expense Net income before income taxes Income taxes Net income EPS – basic – diluted Segments – net income (loss) Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Corporate Support Net income 2016 2015 Q4 $ 4,187 5,078 $ 9,265 358 397 5,198 $ 3,312 769 Q3 Q2 Q1 $ 4,123 6,132 $10,255 318 1,210 5,091 $ 3,636 741 $ 4,025 5,501 $ 9,526 460 988 4,887 $ 3,191 618 $ 4,196 5,163 $ 9,359 410 829 4,960 $ 3,160 713 Q4 $3,800 4,219 $8,019 275 292 4,647 $2,805 212 Q3 Q2 Q1 $ 3,783 5,045 $ 8,828 270 656 4,635 $ 3,267 792 $ 3,557 5,273 $ 8,830 282 493 4,736 $ 3,319 817 $ 3,631 6,013 $ 9,644 270 1,522 4,620 $ 3,232 776 $ 2,543 $ 2,895 $ 2,573 $ 2,447 $2,593 $ 2,475 $ 2,502 $ 2,456 $ 1.66 1.65 $ 1.88 1.88 $ 1.67 1.66 $ 1.59 1.58 $ 1.74 1.74 $ 1.66 1.66 $ 1.68 1.68 $ 1.66 1.65 $ 1,275 396 228 174 482 (12) $ 1,322 388 364 157 635 29 $ 1,297 386 177 139 583 (9) $ 1,290 303 131 143 570 10 $1,270 255 225 88 555 200 $ 1,281 285 173 167 545 24 $ 1,200 271 123 159 625 124 $ 1,255 230 185 142 594 50 $ 2,543 $ 2,895 $ 2,573 $ 2,447 $2,593 $ 2,475 $ 2,502 $ 2,456 Effective income tax rate Period average US$ equivalent of C$1.00 23.2% $ 0.757 20.4% $ 0.768 19.4% $ 0.768 22.6% $ 0.728 7.6% $0.758 24.2% $ 0.789 24.6% $ 0.806 24.0% $ 0.839 (1) Fluctuations in the Canadian dollar relative to other foreign currencies have affected our consolidated results over the period. Seasonality Seasonal factors may impact our results in certain quarters. The first quarter has historically been seasonally stronger for our capital markets businesses. The second quarter has fewer days than the other quarters, which generally results in a decrease in net interest income and certain expense items. The third and fourth quarters include the summer months which results in lower client activity and may negatively impact the results of our capital markets, brokerage and investment management businesses. Specified items affecting our consolidated results • • In the third quarter of 2016, our results included a gain of $287 million ($235 million after-tax) related to the sale of RBC General Insurance Company to Aviva Canada Inc. In the second quarter of 2015, our results included a gain of $108 million (before- and after-tax) from the wind-up of a U.S.-based subsidiary that resulted in the release of a foreign currency translation adjustment that was previously booked in other components of equity. Trend analysis The Canadian economy has generally improved over the period expanding in the first half of calendar 2016 due to solid consumer spending and housing activity, reflecting low interest rates and a resilient labour market. However, business investment remained weak and was compounded by the Alberta wildfires which temporarily halted oil production in the region. The U.S. economy has generally seen growth over the period, 42 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis experiencing modest growth in the second calendar quarter of 2016 boosted by robust consumer spending reflecting solid job growth and rising wages, offset by declines in business and residential investment. Global markets recorded minimal gains this year amid several periods of heightened volatility related to global growth concerns. For further details, refer to the Economic and market review and outlook section. Earnings have generally trended upwards over the period, driven by volume growth partially offset by lower spreads and higher fee-based revenue in our Canadian Banking businesses, as well as higher earnings from growth in average fee-based client assets reflecting strong net sales and capital appreciation in Wealth Management driven by improved market conditions. Results of our acquisition of City National have been reflected in our Wealth Management segment since the first quarter of 2016. Capital Markets results have remained relatively stable over the period, declining in the fourth quarter of 2016 primarily due to lower trading revenue largely in the U.S. and Europe, and lower equity origination activity in Canada. Results in our Insurance segment were impacted by the gain on the sale of RBC General Insurance Company in the third quarter of 2016. Investor & Treasury Services results have fluctuated over the period, and in the third quarter of 2015 benefited from an additional month of earnings in Investor Services. Higher funding and liquidity earnings reflecting tightening credit spreads and favourable interest rate movements contributed to the increase in the fourth quarter of 2016. Revenue has generally increased over the period reflecting solid volume and fee-based revenue growth in our Canadian Banking businesses, as well as growth in average fee-based client assets in Wealth Management. Wealth Management revenue has reflected the inclusion of our acquisition of City National since the first quarter of 2016. Trading revenue has generally trended upwards over the period, and has fluctuated since the second half of 2015 reflecting widening credit spreads, which stabilized in the first quarter of 2016, and lower client activity. Net interest income has trended upwards over the period, largely due to solid volume growth across our Canadian Banking businesses, higher trading-related net interest income, and the inclusion of City National since the first quarter of 2016. Over the period, the impact from foreign exchange translation due to a generally weaker Canadian dollar has also contributed to the increase in revenue. Insurance revenue was primarily impacted by changes in the fair value of investments backing our policyholder liabilities, which is largely offset in PBCAE. The credit quality of our portfolios has generally remained stable over the period, with an increase in 2016 to PCL recorded in our Capital Markets and Canadian Banking businesses mainly reflecting the impact of the sustained low oil price environment. PBCAE has fluctuated quarterly as it includes the changes to the fair value of investments backing our policyholder liabilities, which is largely offset in revenue. PBCAE has also increased due to business growth, and has been impacted by actuarial liability adjustments and claims costs over the period. While we continue to focus on efficiency management activities, non-interest expense has generally trended upwards over the period, mostly to support business growth and due to the inclusion of City National since the first quarter of 2016. Over the period, non-interest expense also increased due to higher compliance costs as well as the impact from foreign exchange translation. Our effective income tax rate has fluctuated over the period, mostly due to varying levels of income reported in jurisdictions with different tax rates, as well as fluctuating levels of income from tax-advantaged sources, principally Canadian taxable corporate dividends. Our effective income tax rate has generally been impacted over the period by higher earnings before income taxes, increased earnings in higher tax jurisdictions, and by net favourable tax adjustments. Financial condition Condensed balance sheets The following table shows our condensed balance sheet: (Millions of Canadian dollars) Assets (1) Cash and due from banks Interest-bearing deposits with banks Securities Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Segregated fund net assets Other – Derivatives – Other Total assets Liabilities (1) Deposits Segregated fund liabilities Other – Derivatives – Other Subordinated debentures Total liabilities Equity attributable to shareholders Non-controlling interests Total equity Total liabilities and equity Table 42 2016 2015 2014 $ 14,929 27,851 236,093 186,302 369,470 154,369 (2,235) 981 118,944 73,554 $ 12,452 22,690 215,508 174,723 348,183 126,069 (2,029) 830 105,626 70,156 $ 17,421 8,399 199,148 135,580 334,269 102,954 (1,994) 675 87,402 56,696 $ 1,180,258 $ 1,074,208 $ 940,550 $ 757,589 981 116,550 223,764 9,762 $ 697,227 830 107,860 196,985 7,362 $ 614,100 675 88,982 174,431 7,859 1,108,646 1,010,264 886,047 71,017 595 71,612 62,146 1,798 63,944 52,690 1,813 54,503 $ 1,180,258 $ 1,074,208 $ 940,550 (1) Foreign currency-denominated assets and liabilities are translated to Canadian dollars. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 43 2016 vs. 2015 Total assets were up $106 billion or 10% from last year. Foreign exchange translation decreased total assets by $4 billion. Interest-bearing deposits with banks increased $5 billion, largely reflecting higher deposits with the Federal Reserve. Securities were up $21 billion or 10% compared to last year, largely driven by our acquisition of City National, and higher corporate and government debt securities reflecting our management of liquidity and funding risk and increased client activities, partially offset by lower equity trading positions in support of business activities. Assets purchased under reverse repurchase agreements (reverse repos) and securities borrowed increased $12 billion or 7%, mainly attributable to higher client activity. Loans were up $50 billion or 10%, largely due to our acquisition of City National, and continued solid volume growth in residential mortgages and wholesale loans reflecting increased client activity. Derivative assets were up $13 billion or 13%, mainly attributable to higher fair values on foreign exchange contracts and interest rate swaps, partially offset by higher financial netting and the impact from foreign exchange translation. Other assets were up $3 billion or 5%, largely reflecting higher goodwill and intangible assets related to our acquisition of City National. Total liabilities were up $98 billion or 10% from last year. Foreign exchange translation decreased total liabilities by $4 billion. Deposits increased $60 billion or 9%, mainly driven by our acquisition of City National and growth in retail deposits largely reflecting increased client demand. Derivative liabilities were up $9 billion or 8%, mainly attributable to higher fair values on foreign exchange contracts and interest rate swaps, partially offset by higher financial netting and the impact from foreign exchange translation. Other liabilities increased $27 billion or 14%, mainly reflecting higher obligations related to repurchase agreements driven by increased business and client activities. Total equity increased $8 billion or 12%, largely reflecting earnings, net of dividends, and the issuance of common shares related to our acquisition of City National. Off-balance sheet arrangements In the normal course of business, we engage in a variety of financial transactions that, for accounting purposes, are not recorded on our Consolidated Balance Sheets. Off-balance sheet transactions are generally undertaken for risk, capital and funding management purposes which benefit us and our clients. These include transactions with structured entities and may also include the issuance of guarantees. These transactions give rise to, among other risks, varying degrees of market, credit, liquidity and funding risk, which are discussed in the Risk management section. We use structured entities to securitize our financial assets as well as assist our clients in securitizing their financial assets. These entities are not operating entities, typically have no employees, and may or may not be recorded on our Consolidated Balance Sheets. In the normal course of business, we engage in a variety of financial transactions that may qualify for derecognition. We apply the derecognition rules to determine whether we have effectively transferred substantially all the risks and rewards or control associated with the financial assets to a third party. If the transaction meets specific criteria, it may qualify for full or partial derecognition from our Consolidated Balance Sheets. Securitizations of our financial assets We periodically securitize our credit card receivables, residential and commercial mortgage loans and bond participation certificates primarily to diversify our funding sources, enhance our liquidity position and for capital purposes. We also securitize residential and commercial mortgage loans for sales and trading activities. We securitize our credit card receivables, on a revolving basis, through a consolidated structured entity. We securitize our single and multiple-family residential mortgages through the National Housing Act Mortgage-Backed Securities (NHA MBS) program. The mortgages associated with these securitization activities are recorded on our Consolidated Balance Sheets as they do not meet the derecognition criteria. We also securitize mortgages which we purchased from third party lenders. We derecognize these purchased mortgages from our Consolidated Balance Sheets when all the risks and rewards related to these mortgages have been substantially transferred. During 2016, no purchased mortgages were derecognized. During 2015, $967 million of purchased mortgages were derecognized where both the NHA MBS and the residual interests in the mortgages were sold to third parties resulting in the transfer of substantially all of the risks and rewards. For additional details of our securitization activities, refer to Note 6 and Note 7 of our audited 2016 Annual Consolidated Financial Statements. We periodically securitize residential mortgage loans for the Canadian social housing program through the NHA MBS program, which are derecognized from our Consolidated Balance Sheets when sold to third party investors. During 2016, there were no securitization activities associated with residential mortgage loans for the Canadian social housing program (2015 – $112 million). We also periodically securitize commercial mortgage loans by selling them in collateral pools, which meet certain diversification, leverage and debt coverage criteria, to structured entities, one of which is sponsored by us. Securitized commercial mortgage loans are derecognized from our Consolidated Balance Sheets as we have transferred substantially all of the risk and rewards of ownership of the securitized assets. During 2016, we securitized $700 million of commercial mortgages (2015 - $195 million). Our continuing involvement with the transferred assets is limited to servicing certain of the underlying commercial mortgages sold. As at October 31, 2016, there were $1.3 billion of commercial mortgages outstanding that we continue to service related to these securitization activities (October 31, 2015 – $1.1 billion). In prior years, we participated in bond securitization activities where we purchased government, government related and corporate bonds and repackaged those bonds in trusts that issue participation certificates, which were sold to third party investors. Securitized bonds are derecognized from our Consolidated Balance Sheets as we have transferred substantially all of the risk and rewards of ownership of the securitized assets. We did not securitize bond participation certificates during 2016 or 2015. Our continuing involvement with the transferred assets is limited to servicing the underlying bonds. As at October 31, 2016, there were $81 million of bond participation certificates outstanding related to these prior period securitization activities (October 31, 2015 – $138 million). Involvement with unconsolidated structured entities In the normal course of business, we engage in a variety of financial transactions with structured entities to support our customers’ financing and investing needs, including securitization of our client’s financial assets, creation of investment products, and other types of structured financing. We have the ability to use credit mitigation tools such as third party guarantees, credit default swaps, and collateral to mitigate risks assumed through securitization and re-securitization exposures. The process in place to monitor the credit quality of our securitization and re- securitization exposures involves, among other things, reviewing the performance data of the underlying assets. We affirm our ratings each quarter and formally confirm or assign a new rating at least annually. For further details on our activities to manage risks, refer to the Risk management section. 44 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Below is a description of our activities with respect to certain significant unconsolidated structured entities. For a complete discussion of our interests in consolidated and unconsolidated structured entities, refer to Note 7 of our audited 2016 Annual Consolidated Financial Statements. RBC-administered multi-seller conduits We administer multi-seller conduits which are used primarily for the securitization of our clients’ financial assets. We are involved in these conduit markets because our clients value these transactions. Our clients primarily use multi-seller conduits to diversify their financing sources and to reduce funding costs by leveraging the value of high-quality collateral. The conduits offer us a favourable revenue stream and risk- adjusted return. We provide services such as transaction structuring, administration, backstop liquidity facilities and partial credit enhancements to the multi-seller conduits. Fee revenue for all such services amounted to $252 million during the year (2015 – $213 million). We do not maintain any ownership in these multi-seller conduits and have no rights to, or control of, their assets. Our total commitment to the conduits in the form of backstop liquidity and credit enhancement facilities is shown below. The total committed amount of these facilities exceeds the total amount of the maximum assets that may have to be purchased by the conduits under the purchase agreements. As a result, the maximum exposure to loss attributable to our backstop liquidity and credit enhancement facilities is less than the total committed amounts of these facilities. Liquidity and credit enhancement facilities Table 43 As at October 31 (Millions of Canadian dollars) Backstop liquidity facilities Credit enhancement facilities Total (1) (2) (3) 2016 2015 Notional of committed amounts (1) Allocable notional amounts Outstanding loans (2) Maximum exposure to loss (3) Notional of committed amounts (1) Allocable notional amounts Outstanding loans (2) Maximum exposure to loss (3) $ $ 39,462 $ 36,494 $ 733 $ 37,227 $ 37,770 $ 34,163 $ 2,235 2,235 – 2,235 2,974 2,843 764 $ 34,927 2,843 – 41,697 $ 38,729 $ 733 $ 39,462 $ 40,744 $ 37,006 $ 764 $ 37,770 Based on total committed financing limit. Net of allowance for loan losses and write-offs. Not presented in the table above are derivative assets with a fair value of $11 million (2015 – $19 million) which are a component of our total maximum exposure to loss from our interests in the multi-seller conduits. Refer to Note 7 of our audited 2016 Annual Consolidated Financial Statements for more details. As at October 31, 2016, the notional amount of backstop liquidity facilities we provide increased by $1,692 million or 4% from last year. The increase in the amount of backstop liquidity facilities provided to the multi-seller conduits as compared to last year reflects increases in the foreign exchange translation and the outstanding securitized assets of the multi-seller conduits. The notional amount of partial credit enhancement facilities we provide decreased by $739 million from last year. The decrease in the credit enhancement facilities reflects fewer transactions requiring program-level credit enhancement due to support provided directly to those transactions and decreased client usage. Total loans extended to the multi-seller conduits under the backstop liquidity facilities decreased by $31 million from last year primarily due to principal repayments which were partially offset by the impact of foreign exchange translation. Maximum exposure to loss by client type Table 44 As at October 31 (Millions) Outstanding securitized assets Credit cards Auto loans and leases Student loans Trade receivables Asset-backed securities Equipment receivables Consumer loans Dealer floor plan receivables Fleet finance receivables Insurance premiums Residential mortgages Transportation finance Total Canadian equivalent 2016 2015 (US$) (C$) Total (C$) (US$) (C$) Total (C$) $ $ 5,057 9,489 2,352 2,002 547 1,428 1,470 760 914 – – 1,041 $ 25,060 $ 33,608 $ $ 510 2,646 – 51 – – – 903 306 163 1,122 153 5,854 $ 7,292 15,372 3,154 2,736 734 1,915 1,971 1,922 1,532 163 1,122 1,549 $ 4,679 8,606 3,473 2,175 584 1,362 706 1,261 441 128 – 1,204 $ 39,462 $ 24,619 5,854 $ 39,462 $ 32,190 $ $ $ 510 2,352 – 112 – – – 903 377 153 1,020 153 5,580 $ 6,628 13,604 4,541 2,956 764 1,781 923 2,552 954 320 1,020 1,727 $ 37,770 5,580 $ 37,770 Our overall exposure increased by 4% compared to last year, reflecting an increase in the outstanding securitized assets of the multi-seller conduits and foreign exchange translation. Correspondingly, total assets of the multi-seller conduits increased by $1,659 million or 4% over last year, primarily due to increases in the Auto loans and leases, Consumer loans and Credit cards asset classes, which were partially offset by decreases in the Student loans and Dealer floor plan asset classes. 100% of multi-seller conduits assets were internally rated A or above, consistent with last year. All transactions funded by the unconsolidated multi-seller conduits are internally rated using a rating system which is largely consistent with that of the external rating agencies. Multiple independent debt rating agencies review all of the transactions in the multi-seller conduits. Transactions financed in two U.S. multi-seller conduits are reviewed by Moody’s Investors Service (Moody’s), Standard & Poor’s (S&P) and Fitch Ratings (Fitch). One U.S. multi- seller conduit is reviewed by S&P. Transactions in the Canadian multi-seller conduits are reviewed by DBRS and Moody’s. Each applicable rating agency also reviews ongoing transaction performance on a monthly basis and may publish reports detailing portfolio and program information related to the conduits. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 45 As at October 31, 2016, the total asset-backed commercial paper (ABCP) issued by the conduits amounted to $24.7 billion, a decrease of $790 million or 3% from last year. The decrease in the amount of ABCP issued by the multi-seller conduits compared to last year is primarily due to a decrease in client usage partially offset by foreign exchange translation. The rating agencies that rate the ABCP rated 67% (October 31, 2015 – 71%) of the total amount issued within the top ratings category and the remaining amount in the second highest ratings category. In October 2014, the U.S. federal regulators adopted regulations related to the credit risk retention requirements of Section 15G of the Securities Exchange Act of 1934 (as added by Section 941 of the Dodd-Frank Act) for asset-backed securities (the Risk Retention Rules). To comply with the Risk Retention Rules, we plan to hold, on each day on and after December 24, 2016, ABCP from RBC administered U.S. multi- seller conduits in an amount equal to at least 5% of the aggregate principal amount of the then outstanding ABCP and any advances under the liquidity loan agreement. As at October 31, 2016, the fair value of the ABCP purchased in anticipation of the Risk Retention Rules was $670 million (October 31, 2015 – $nil). Based on the current outstanding amount of ABCP issued, we expect to hold approximately $1.2 billion of ABCP by December 24, 2016. This inventory is classified as Securities – Available-for-sale on our Consolidated Balance Sheet. We also purchase ABCP issued by the multi-seller conduits in our capacity as a placement agent in order to facilitate overall program liquidity. As at October 31, 2016, the fair value of our inventory was $5 million, a decrease of $12 million from last year. The fluctuations in inventory held reflect normal trading activity. This inventory is classified as Securities – Trading on our Consolidated Balance Sheets. Structured finance We invest in ARS of certain trusts which fund their long-term investments in student loans by issuing short-term senior and subordinated notes. Our maximum exposure to loss in these ARS trusts as at October 31, 2016 was $549 million (October 31, 2015 – $546 million). The increase in our maximum exposure to loss is primarily related to the impact of foreign exchange translation. Interest income from the ARS investments, which is reported in Net-interest income, was $6.3 million during the year (2015 – $6.9 million). We also provide liquidity facilities to certain municipal bond Tender Option Bond (TOB) trusts in which we have an interest but do not consolidate because the residual certificates issued by the TOB trusts are held by third parties. As at October 31, 2016, our maximum exposure to loss from these unconsolidated municipal bond TOB trusts was $1,640 million (October 31, 2015 – $856 million). The increase in our maximum exposure to loss relative to last year is primarily due to the addition of new trusts and the impact of foreign exchange translation. Fee revenue from provision of liquidity facilities to these entities reported in Non-interest income was $4.7 million during the year (2015 – $3.7 million). We provide senior warehouse financing to discrete unaffiliated structured entities that are established by third parties to acquire loans and issue term collateralized loan obligations. A portion of the proceeds from the sale of the term collateralized loan obligations is used to fully repay the senior warehouse financing that we provide. As at October 31, 2016, our maximum exposure to loss associated with the outstanding senior warehouse financing facilities was $141 million (October 31, 2015 – $444 million). The decrease in our maximum exposure to loss relative to last year is related to the issuance of term collateralized loan obligations where a portion of the proceeds were used to repay some of the senior warehouse financing that we provided and a decrease in the outstanding drawings on certain financing facilities. Investment funds We invest in hedge funds primarily to provide clients with desired exposures to reference funds. As we make investments in the reference funds, exposures to the funds are simultaneously transferred to clients through derivative transactions. Our maximum exposure to loss in the reference funds is limited to our investments in the funds. As at October 31, 2016, our maximum exposure to loss was $2.6 billion (October 31, 2015 – $2.6 billion). We also provide liquidity facilities to certain third party investment funds. The funds issue unsecured variable-rate preferred shares and invest in portfolios of tax exempt bonds. As at October 31, 2016, our maximum exposure to these funds was $764 million (October 31, 2015 – $744 million). The increase in our maximum exposure compared to last year is primarily due to the impact of foreign exchange translation. Third-party securitization vehicles We hold interests in certain unconsolidated third-party securitization vehicles, which are structured entities. We, as well as other financial institutions, are obligated to provide funding to these entities up to our maximum commitment level and are exposed to credit losses on the underlying assets after various credit enhancements. As at October 31, 2016, our maximum exposure to loss in these entities was $9 billion (October 31, 2015 – $9.7 billion). The decrease in our maximum exposure to loss compared to last year reflects a reduction in the securitized assets in these entities partially offset by foreign currency translation. Interest and non-interest income earned in respect of these investments was $95 million (2015 – $56 million). Guarantees, retail and commercial commitments We provide guarantees and commitments to our clients that expose us to liquidity and funding risks. Our maximum potential amount of future payments in relation to our commitments and guarantee products as at October 31, 2016 amounted to $340 billion compared to $315 billion last year. The increase compared to last year relates primarily to business growth, the acquisition of City National, and the impact of foreign exchange translation in other credit-related commitments and securities lending indemnifications. Refer to Liquidity and funding risk and Note 26 to our audited 2016 Annual Consolidated Financial Statements for details regarding our guarantees and commitments. Risk management Overview The ability to manage risk well is a core competency at RBC, and is supported by our strong risk conduct and culture, and an effective risk management approach. We define risk as the potential for loss or an undesirable outcome with respect to volatility of actual earnings in relation to expected earnings, capital adequacy or liquidity. Organizational design and governance processes ensure that our Group Risk Management (GRM) function is independent from the businesses it supports. We manage our risks by ensuring that business activities and transactions provide an appropriate balance of return for the risks assumed and remain within our risk appetite, which is collectively managed throughout RBC, through adherence to our Enterprise Risk Appetite Framework. Our major risk categories include credit, market, liquidity, insurance, operational, regulatory compliance, strategic, reputation, legal and regulatory environment, competitive, and systemic risks. In order to avoid excessive concentration of risks, we strive to diversify our business lines, products and sector exposures. 46 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Build shareholder value through leadership in strategic management risk Mission statement Objectives Identify, assess and measure our exposure to material individual, aggregate and emerging risks Ensure all risk taking activities and risk exposures are within the board-approved risk appetite, and risk limits Maintain and ensure continued enhancement of the Enterprise Risk Management Framework Provide independent and objective oversight of the management of risks arising from our businesses and operations Maintain an effective enterprise-wide risk management process Ensure continuous improvement in risk management processes, tools and practices Risk priorities Enable growth while ensuring top and emerging risks remain within risk appetite Continue to strengthen our risk conduct and culture practices Increase GRM’s efficiency and effectiveness Maintain focus on talent management, diversity and employee engagement Manage regulatory changes Enhance the risk organization for the U.S. region Risk management principles Effectively balancing risk and reward is essential for our success Responsibility for risk management is shared Business decisions must be based on an understanding of risk Avoid activities that are inconsistent with our vision, values, code of conduct or policies Proper focus on the client reduces our risks Use judgment and common sense Be operationally prepared for a potential crisis 2016 Accomplishments Throughout 2016, we have: • • • • • • • Kept our risk profile within our risk appetite; Maintained strong credit quality, notwithstanding sustained low energy prices impacting the oil & gas sector and oil-exposed regions; Maintained strong capital and liquidity ratios; Avoided major operational risk events; Enhanced stress testing capabilities and risk analysis frameworks; Increased focus on further strengthening risk conduct and culture; and Enhanced the risk organization for the U.S. CET1 ratio Total Capital ratio Total PCL ratio GIL ratio 10.8% 10.6% 14.4% 9.9% 9.6% 14.0% 14.0% 13.4% 0.29% 0.27% 0.24% 0.31% 0.73% 0.47% 0.44% 0.52% 2016 2015 2014 2013 2016 2015 2014 2013 2016 2015 2014 2013 2016 2015 2014 2013 Our capital position was strong with a Basel III CET1 ratio well in excess of regulatory requirements Our total capital ratio increased relative to last year mainly due to strong internal capital generation Our total PCL ratio remained within historical norms, up modestly compared to last year primarily as a result of the low oil price environment The quality of our credit portfolio remained high, notwithstanding the low oil prices, which led to higher impaired loans in the oil and gas sector Top and emerging risks Our view of risks is not static. An important component of our enterprise risk management approach is to ensure that continuously evolving top risks and emerging risks are appropriately identified, managed, and incorporated into existing enterprise risk management assessment, measurement, monitoring and escalation processes. These practices ensure management is forward-looking in its assessment of risks to the organization. Identification of top and emerging risks occurs in the course of business development and as part of the execution of risk oversight responsibilities by GRM, Finance, Corporate Treasury, Global Compliance and other control functions. Top and emerging risks occur as a result of exogenous factors, such as changes in the macroeconomic or regulatory environment, or endogenous factors, such as changes to our strategic imperatives, or failure to adapt to an evolving competitive or operational environment. A top risk is an existing, significant risk that can potentially affect our earnings or capital within a one-year time horizon. An emerging risk has a lower probability of occurring within a one-year horizon, but, in the event it materializes, can have a significant adverse impact on our ability to achieve our goals. Emerging risks are defined as “new” risks, “familiar risks in new or unfamiliar conditions”, or “existing risks that are expected to increase in significance” that have the potential of creating new or changing top risks within the next annual reporting cycle that may or could prevent us from achieving our business objectives. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 47 Top Risks Trend Commentary (cid:2) Risk did not increase in 2016 (cid:3) Risk heightened during 2016 (cid:3) Top Risk in 2016 Global uncertainty Brexit Oil & gas Cyber risk Anti-money laundering Exposure to more volatile sectors (cid:3) (cid:3) (cid:2) (cid:3) (cid:3) (cid:2) Uncertainty around the potential for a global recession remained heightened during 2016. Concerns remain around the social, political and economic impacts of mass immigration in continental Europe led by the Middle East’s changing political landscape, Russia-Ukraine tension and territorial disputes between Japan and China. Increasing income inequality, unemployment and decline in living standards against the backdrop of growing foreign ownership of strategic assets is driving an increase in nationalism and extremist political movements around the globe. Slow global growth and the attempts of central banks around the world to use monetary policy to stimulate their economies, even using negative interest rates, remains a key risk. Following the recent U.S. election, drastic policy changes including trade and fiscal policy, could be a key risk that may result in economic uncertainty for the U.S. and its trading partners, including Canada. The Brexit vote has resulted in increased concerns about the economic, legal, political, regulatory and trade consequences for the U.K. and Europe. We will be monitoring negotiations between the U.K., the EU and individual member states closely to assess the potential impacts to our business strategy in the U.K. and in Europe. The oil & gas sector experienced a partial recovery during 2016, easing pressure on Provision for Credit Losses (PCL) in the latter half of the year. However, the risks associated with sustained low oil prices remain. The low oil prices might lead to additional PCL in the longer term. We have performed a number of low oil price stress tests, which focus specifically on the impact to our retail and wholesale portfolios. In our view, our exposure to weak oil and gas prices remains within our risk appetite. Information and cybersecurity continue to be an increasingly problematic issue, not only for the financial services sector, but for other industries in Canada and around the globe. The volume and sophistication of cyber-attacks in the industry continue to increase and adversaries are becoming more organized. We continue to see challenges in the management of IT Risk with respect to third party hosted applications, eMessaging and social media related risks. We continue to leverage and mature advancements in cyber defense capabilities to support our business model, protect our systems and enhance the experience of our clients on a global basis by employing industry best practices and collaborating with peers and experts, to provide our customers with confidence in their financial transactions. We are subject to a dynamic set of anti-money laundering/anti-terrorist financing, economic sanctions and anti-bribery/anti-corruption (AML) laws and regulations across the multiple jurisdictions in which we operate. As the scope of criminal activities such as tax evasion, human trafficking, bribery and corruption continues to expand, regulators worldwide are intensifying regulatory requirements and increasing enforcement actions and penalties for those who fail to comply. We are committed to the management of AML risk and have implemented advanced and evolving AML policies, processes and controls to mitigate the risk of money laundering activities and meet our regulatory obligations to deter, detect and report such activities. We manage risks associated with our wholesale loan portfolio by focusing on diversification, driven by limits on single name, country and industry exposures across all businesses, portfolios and transactions. We continue to adhere to strict lending standards and stress test our portfolio to assist in evaluating the potential impact of severe economic conditions. 48 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Emerging Risks Trend Commentary (cid:2) Risk did not increase in 2016 (cid:3) Risk heightened during 2016 (cid:3) New Emerging Risk in 2016 Technological innovation and new entrants Increasing complexity of regulation Data management Litigation and administrative penalties (cid:2) (cid:2) (cid:3) (cid:2) The financial system continues to be subject to rapid technological change resulting in changing consumer habits and additional regulatory expectations and oversight responsibilities. New Fintech entrants have the potential to disrupt existing financial services value chains. These companies offer new payment methods and alternative lending solutions. In response, we have made digital and IT innovation a key strategic priority. We operate in multiple jurisdictions, and the continued expansion of the breadth and depth of regulations may lead to declining profitability and slower response to market needs. Financial reforms coming on stream in multiple jurisdictions may have significant impact on our businesses and could affect their strategies. Financial institutions are subject to increased informational demands from regulators and other stakeholders. We are continually investing in building better data management capabilities, including data ownership and stewardship, data architecture, metadata management, and data delivery, in order to enable consistent data aggregation, reporting and management. Some financial institutions have been affected by inadequate internal controls on risky or unlawful behaviour, including not conducting adequate due diligence on new clients, new products, misrepresentation, and not addressing customer privacy amid rapid increases in the scope and volume of personal data, leading to increased scrutiny from regulators. Enterprise risk management Under the oversight of the Board of Directors and senior management, the Enterprise Risk Management Framework provides an overview of our enterprise-wide programs for managing risk, including identifying, assessing, measuring, controlling, monitoring and reporting on the significant risks that face the organization. While our risk appetite encompasses “what” risks we are able and willing to take, our risk conduct and culture articulates “how” we expect to take those risks. Risk governance The risk governance model is well-established. The Board of Directors oversees the implementation of our risk management framework, while employees at all levels of the organization are responsible for managing the day-to-day risks that arise in the context of their mandate. As shown below, we use three lines of defence governance model to manage risks across the enterprise. BOARD OF DIRECTORS • • The Board of Directors establishes the tone from the top, approves our risk appetite, provides oversight and carries out its risk management mandate primarily through its committees which include the Risk Committee, the Audit Committee, the Governance Committee and the Human Resources Committee. The purpose of the Risk Committee is to oversee our risk management program. The Risk Committee’s oversight role is designed to ensure that the risk management function is adequately independent from the businesses whose activities it reviews, and that the policies, procedures and controls used by management are sufficient to keep risks within our risk appetite. Group Executive and Group Risk Committee • Actively shape enterprise risk appetite and recommend it for Board of Directors approval • Establish the tone from the top and visibly support and communicate enterprise risk appetite, ensuring that sufficient resources and expertise are in place to help provide effective oversight of adherence to the enterprise risk appetite Ensure alignment of strategic planning, financial planning, capital planning and risk appetite • • Via the Compensation Risk Management Oversight Committee, oversees the design of major compensation programs to ensure alignment with sound risk management principles and that risks that may not be fully captured in our current financial performance are appropriately considered in variable compensation payouts, including enterprise risk profile relative to risk appetite First line of defence Second line of defence Third line of defence Risk Owners Risk Oversight Independent Assurance • • Business and Support Functions embedded in the business Accountable for: – Identification – Assessment – Mitigation – Monitoring and – Reporting of risk against approved policies and appetite • • Establishes risk management practices and provides risk guidance Provides oversight of the effectiveness of First Line risk management practices • Monitors and independently reports on the level of risk against established appetite • • Internal and External Audit Independent assurance to management and the Board of Directors on the effectiveness of risk management practices Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 49 Risk Appetite Our risk appetite is the amount and type of risk that we are able and willing to accept in the pursuit of its business objectives. The goal in managing risk is to protect us from an unacceptable loss or an undesirable outcome with respect to earnings volatility, capital adequacy or liquidity, while supporting and enabling our overall business strategy. Our approach to articulating our risk appetite is focused around three key concepts: 1) The amount of “earnings at risk” that is determined to be acceptable over an economic cycle and including periods of moderate stress, using an expected future loss lens and considering potential revenue and expense contributions to earnings volatility; The amount of “capital at risk” that is determined to be acceptable under severe and very severe stress, using an unexpected future loss lens; and Ensuring adequate liquidity in times of stress. 2) 3) • • Our Enterprise Risk Appetite Framework has several major components as follows: Define our risk capacity by identifying regulatory constraints that restrict our ability to accept risk. Establish and regularly confirm our risk appetite, comprised of strategic drivers and self-imposed constraints that define both the minimum and maximum amount of risk we are willing to accept given our financial strength, corporate objectives and business strategies. Set risk limits and tolerances to ensure that risk-taking activities are within our risk appetite. Assess our risk posture to confirm whether our strategic priorities entail taking on more risk over a one-year time frame, using a scale of contracting, stable or expanding. Regularly measure and evaluate our risk profile, representing the risks we are exposed to, relative to our risk appetite, and ensure appropriate action is taken to prevent risk profile from surpassing risk appetite. • • • Risk Capacity Risk Appetite Risk Limits and Tolerances Risk Profile We are in the business of taking risk; however, we balance the risk-reward trade-off to ensure the long-term viability of the organization by remaining within our risk appetite. Our risk appetite is articulated in several complementary qualitative and quantitative risk appetite statements. Qualitative statements • Undertake only those risks that we understand. Our risk decisions are thoughtful and future- focused • Make decisions that balance risk with sustainable and stable business growth • Maintain a healthy control environment built to protect our stakeholders and meet regulatory and legal requirements • Avoid activities that compromise our values or code of conduct. Our compensation practices and code of conduct are built to reflect our culture of integrity • Never compromising our reputation and the trust of our clients for profits • Maintain our financial resilience and operational readiness for extreme events, both to protect stakeholder interests and to ensure we do not threaten financial stability or the broader economy Risk Appetite Quantitative statements • Manage exposure to future losses • Manage volatility of earnings • Avoid excessive concentrations of risk • • • • Low exposure to stress events Ensure sound management of liquidity and funding risk Ensure sound management of regulatory compliance risk and operational risk Ensure capital adequacy by maintaining capital ratios in excess of rating agency and regulatory expectations • Maintain strong credit ratings • Maintain a risk profile that is in the top half of our peer group The Enterprise Risk Appetite Framework is structured in such a way that it can be applied at the enterprise, business segment, business unit and legal entity levels. The risk appetite is integrated into our business strategies and capital plan. We also ensure that the business strategy aligns with the enterprise and business segment level risk appetite. Risk Conduct and Culture We define our risk conduct and culture as a shared set of behavioural norms that sustains our core values and enables us to proactively identify, understand and act upon our risks, thereby protecting our clients, safeguarding our shareholders’ value, and supporting the integrity, soundness and resilience of financial markets. Risk behaviour expectations are in place and articulated through: • • • • • • • Our Values; Code of Conduct; Risk management principles; Risk appetite statements; Regulatory conduct rules, practices and policies; Performance management processes; and The Risk Conduct and Culture Framework. 50 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis We have adopted the Financial Stability Board’s four fundamental practices as foundational to an effective risk conduct and culture in order to enable and reward the desired risk behaviours and outcomes, namely: • • • • Tone from the top; Accountability; Effective communication and challenge; and Incentives that reinforce desired risk management behaviours. These practices are largely grounded in our existing risk management and human resource disciplines and protocols, and, when combined with the elements of effective leadership and values, provide a base from which the resulting risk conduct and culture can be assessed, monitored, sustained and subject to ongoing enhancement. We hold ourselves to the highest standards of conduct to build the trust of our clients, investors, colleagues and community. The desired outcomes from effective risk conduct and culture practices align with our values and support our risk appetite statements: Practices Tone from the top Accountability Effective communication and challenge Incentives that reinforce desired risk management behaviours Support desired outcomes Undertaking only those risks that we understand. Our risk decisions are thoughtful and future-focused Making decisions that balance risk with sustainable and stable business growth Maintaining a healthy control environment built to protect our stakeholders and meet regulatory and legal requirements Avoiding activities that compromise our Values or Code of Conduct. Our compensation practices and Code of Conduct are built to reflect that culture of integrity Never compromising our reputation and the trust of our clients for profits Maintaining our financial resilience and operational readiness for extreme events, both to protect stakeholder interests and to ensure RBC does not threaten financial stability or the broader economy Sustaining and strengthening our risk conduct and culture relies upon effective linkages between our risk appetite, our enterprise-wide risk management program, our Code of Conduct, values, and human resources policies and practices. Regular assessment and monitoring is in place to identify strengths and weaknesses and areas for remediation. Our objective is to continually assess the effectiveness of our risk conduct and culture and to identify issues that could be signs of cultural problems and which, if not addressed, could undermine our long-term success, and, potentially jeopardize our safety and soundness. Risk measurement Our ability to measure risks is a key component of our enterprise-wide risk and capital management processes. Certain measurement methodologies are common to a number of risk types, while others only apply to a single risk type. While quantitative risk measurement is important, we also place reliance on qualitative factors. Our measurement models and techniques are continually subject to independent assessment for appropriateness and reliability. For those risk types that are difficult to quantify, we place greater emphasis on qualitative risk factors and assessment of activities to gauge the overall level of risk to ensure that they are within our risk appetite. In addition, judgmental risk measures are developed, and techniques such as stress testing, and scenario and sensitivity analyses can also be used to assess and measure risks. Quantifying expected loss Expected loss is used to assess earnings at risk and is a representation of losses that are statistically expected to occur in the normal course of business in a given period of time. For credit risk, the key parameters used to measure our exposure to expected loss are probability of default, loss given default, and exposure at default. For market risk, a statistical technique known as Value-at-Risk (VaR) is used to measure losses under normal market conditions. Quantifying unexpected loss Unexpected loss is used to assess capital at risk and is a statistical estimate of the amount by which actual earnings depart from the expected, over a specified time horizon, measured at a specified level of confidence. We hold capital to withstand these unexpected losses, should they occur. For further details, refer to the Capital management section. Stress testing Stress testing examines potential impacts arising from exceptional but plausible adverse events, and is an important component of our risk management framework. Stress testing results are used in: • • • • • Monitoring our risk profile relative to our risk appetite in terms of earnings and capital at risk; Setting limits; Identifying key risks to and potential shifts in our capital and liquidity levels, and our financial position; Enhancing our understanding of available mitigating actions in response to adverse events; and Assessing the adequacy of our target capital levels. Our enterprise-wide stress tests evaluate key balance sheet, income statement, leverage, capital, and liquidity impacts arising from risk exposures and changes in earnings. The results are used by the Group Risk Committee (GRC), the Board of Directors and senior management risk committees to understand our performance drivers under stress, and review stressed capital, leverage, and liquidity ratios against regulatory thresholds and internal targets. The results are also incorporated into our Internal Capital Adequacy Assessment Process (ICAAP) and capital plan analyses. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 51 We annually evaluate a number of enterprise-wide stress scenarios over a multi-year horizon, featuring a range of severities. Our Board of Directors reviews the recommended scenarios, and GRM leads the scenario assessment process. Results from across the organization are integrated to develop an enterprise-wide view of the impacts, with input from subject matter experts in GRM, Corporate Treasury, Finance, and Economics. Recent scenarios evaluated include global recessions, Canadian recessions, and energy price shocks. Ongoing stress testing and scenario analyses within specific risk types such as market risk, liquidity risk, structural interest rate risk, retail and wholesale credit risk, operational risk, and insurance risk supplement and support our enterprise-wide analyses. Results from these risk-specific programs are used in a variety of decision-making processes including risk limit setting, portfolio composition evaluation, our risk appetite articulation, and business strategy implementation. In addition to ongoing enterprise-wide and risk specific stress testing programs, we also use ad hoc and reverse stress testing to deepen our knowledge of the risks we face. Ad hoc stress tests are one-off analyses used to investigate developing conditions or stress a particular portfolio in more depth. Reverse stress tests, starting with a severe outcome and aiming to reverse-engineer scenarios that might lead to it, are used in risk identification and understanding of risk/return boundaries. In addition to internal stress tests, we participate in a number of regulator-required stress test exercises at both the consolidated and subsidiary levels. Back-testing We back-test many market and credit risk parameters, including probability of default, loss given default, and usage given default. Back-testing is performed on a quarterly basis by comparing the realized values to the parameter estimates that are currently used to ensure the parameters remain appropriate for regulatory and economic capital calculations. Validation of measurement models Models are widely used for many purposes at RBC, including the valuation of financial products and the measurement and management of different types of risk. Prior to their use, models are subject to an independent validation and approval by our model risk management function, a team of modelling professionals with reporting lines independent of those of the model developers and model users. The validation ensures that models are conceptually sound and capable of fulfilling their intended use. In addition to independently validating models prior to use, our model risk function provides controls that span the life-cycle of a model, including model change management procedures, requirements for ongoing monitoring, and annual assessments to ensure each model continues to be applicable. Risk control Our enterprise-wide risk management approach is supported by a comprehensive set of risk controls. Our risk management frameworks and policies are organized into the following five levels: • • • • • Level 1: Enterprise Risk Management Framework provides an overview of our enterprise-wide program for identifying, assessing, measuring, controlling, monitoring and reporting on the significant risks we face. This framework is underpinned by our Risk Appetite Framework and Risk Conduct and Culture Framework. Level 2: Risk-Specific Frameworks elaborate on each specific risk type and the mechanisms for identifying, measuring, monitoring and reporting of our principal risks; key policies; and roles and responsibilities. Level 3: Enterprise Risk Policies articulate minimum requirements, within which businesses and employees must operate. Level 4: “Multi-risk” Enterprise Risk Policies govern activities such as product risk review and approval, stress testing, risk limits, risk approval authorities and model risk management. Level 5: Business Segments and Corporate Support – Specific Policies and Procedures are established to manage the risks that are unique to their operations. Risk controls are anchored by our Enterprise Risk Management and Risk-Specific Frameworks. These frameworks lay the foundation for the development and communication of policies, establishment of formal risk review and approval processes, and the establishment of delegated authorities and limits. The implementation of robust risk controls enables the optimization of risk and return on both a portfolio and a transactional basis. 52 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Enterprise Risk Policy Architecture Enterprise Risk Management Framework RBC Code of Conduct Enterprise Risk Conduct and Culture Framework Enterprise Risk Appetite Framework Credit Risk Framework Market Risk Framework Operational Risk Management Framework IT Risk Management Framework Reputation Risk Framework Regulatory Compliance Management Framework Insurance Risk Framework Capital Management Framework Liquidity Risk Management Framework Risk Data Aggregation and Risk Reporting Framework Supporting Risk-Specific Enterprise-Wide Frameworks and Policy Documents (examples) Credit Risk Mitigation Policy Management of Market Risk Standing Order Fraud Risk Framework Information Security Policy Fiduciary Risk Policy Global AML Framework, Privacy Policy Insurance Risk Mitigation Policy Dividend Policy Liquidity Risk Policy Risk Data Standards, Risk Reporting Standards Enterprise-Wide Policies for Multiple Risk Types (e.g., Product Risk Review and Approval Policy; Risk Limits Policy; Stress-Testing Policy) Segment or Region Specific Risk Policy and Procedures Capital Markets Insurance Investor & Treasury Services Personal & Commercial Banking Wealth Management Corporate Support The approval hierarchy for risk frameworks and policy documents is as follows: Board of Directors or Board Committees Senior Management Committees (e.g., Policy Review Committee, Ethics and Compliance Committee, Asset Liability Committee) for most other frameworks and policies. Board or Board Committee approval is required in some instances (e.g., RBC Code of Conduct, Dividend Policy and AML Framework) Generally within businesses or Corporate support Committees. Group Risk Management approval required if there are significant risk implications Risk review and approval processes Risk review and approval processes are established by GRM based on the nature, size and complexity of the risk involved. In general, the risk review and approval process involves a formal review and approval by an individual, group or committee that is independent from the originator. The approval responsibilities are governed by delegated authorities based on the following categories: transactions, structured credit, projects and initiatives, and new products and services. Authorities and limits The Risk Committee of the Board of Directors delegates credit, market and insurance risk authorities to the President & CEO and the Group Credit Risk Officer (GCRO). The delegated authorities allow these officers to approve single name, geographic (country and region) and industry sector exposures within defined parameters to manage concentration risk, establish underwriting and inventory limits for trading and investment banking activities and set market risk tolerances. The Board of Directors also delegates liquidity risk authorities to the President & CEO, CAO & CFO, and GCRO. These limits act as a key risk control designed to ensure that reliable and cost-effective sources of cash or its equivalent are available to satisfy our current and prospective commitments. Reporting Enterprise and business segment level risk monitoring and reporting are critical components of our enterprise risk management program and support the ability of senior management and the Board of Directors to effectively perform their risk management and oversight responsibilities. In addition, we publish a number of external reports on risk matters to comply with regulatory requirements. On a quarterly basis, we provide to senior management and the Board of Directors the Enterprise Risk Report which includes a comprehensive review of our risk profile relative to our risk appetite and focuses on the range of risks we face along with an analysis of the related issues and trends. On an annual basis, we provide a benchmarking review which compares our performance to peers across a variety of risk metrics and includes a composite risk scorecard providing a more objective measure of our ranking relative to the peer group. In addition to our regular risk monitoring, other risk specific presentations are provided to and discussed with senior management and the Board of Directors on top and emerging risks or changes in our risk profile. Risk Pyramid Our risk pyramid identifies and categorizes our principal risks and provides a common language and discipline for the identification and assessment of risk in existing businesses, new businesses, products or initiatives, and acquisitions and alliances. It is maintained by GRM and reviewed regularly to ensure all key risks are reflected and ranked appropriately. The placement of the principal risks within the risk pyramid is a function of two primary criteria: • • Risk Drivers – Key factors that would have a strong influence on whether or not one or more of our risks will materialize, and Control and Influence – The risk types are organized vertically from the top of the pyramid to its base according to the relative degree of control and influence we are considered to have over each risk driver. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 53 Risk Drivers • Macroeconomic: Adverse changes in the macroeconomic environment can lead to a partial or total collapse of the real economy or the financial system in any of the regions in which we operate. Examples include a rapid deterioration in the Canadian housing market, severe North American recession and a downturn in China. Resultant impacts can materialize as loss of revenue, as well as realization of credit, market or operational risk losses. Strategic: Business strategy is a major driver of our risk appetite and consequently the strategic choices and capital allocations we make determine how our risk profile changes. Examples include acquisitions, responding to the threats posed by non-traditional competitors and responding to proposed changes in the regulatory framework. These choices also impact our revenue mix, affecting our exposure to earnings volatility and loss absorption capacity. Execution: The complexity and scope of our operations across the globe exposes us to operational and regulatory compliance risks, including fraud, anti-money laundering, cybersecurity and conduct/fiduciary risk. Transactional/Positional: This driver of risk presents a more traditional risk perspective. This involves the risk of credit or market losses arising from the lending transactions and balance sheet positions we undertake every day. • • • The base of the pyramid – The risk categories along the base level of our risk pyramid are those over which we have the greatest level of control and influence. We understand these risks and earn revenue by taking them. These are credit, market, liquidity and insurance risks. Operational risk and regulatory compliance risk, while still viewed as risks over which we have greater level of control and influence, are ranked higher on the pyramid than the other highly controllable risks. This ranking acknowledges the level of controllability associated with people, systems and external events. The top of the pyramid – Systemic risk is placed at the top of our risk pyramid, and is generally considered the least controllable type of risk arising from the business environment impacting us. However, we have in place measures for mitigating the impacts of systemic risk such as our diversified business model and funding sources, financial crisis management strategies and protocols, stress testing programs, and product and geographic diversification. Legal and regulatory environment and competitive risks, which can be viewed as somewhat controllable, can be influenced through our role as a corporate entity, and as an active participant in the Canadian and global financial services industry. MACROECONOMIC STRATEGIC EXECUTION L E S S SYSTEMIC LEGAL & REGULATORY ENVIRONMENT COMPETITIVE C o n t r o l & I n f l u e n c e STRATEGIC REPUTATION OPERATIONAL REGULATORY COMPLIANCE M O R E TRANSACTIONAL / POSITIONAL CREDIT MARKET LIQUIDITY INSURANCE The shaded text along with the tables specifically marked with an asterisk (*) in the following sections of the MD&A represent our disclosures on credit, market and liquidity and funding risks in accordance with IFRS 7, Financial Instruments: Disclosures, and include discussion on how we measure our risks and the objectives, policies and methodologies for managing these risks. Therefore, these shaded text and marked tables represent an integral part of our 2016 Annual Consolidated Financial Statements. Credit risk Credit risk is the risk of loss associated with an obligor’s potential inability or unwillingness to fulfill its contractual obligations. Credit risk may arise directly from the risk of default of a primary obligor (e.g., issuer, debtor, counterparty, borrower or policyholder), or indirectly from a secondary obligor (e.g., guarantor or reinsurer). Credit risk includes counterparty credit risk from both trading and non-trading activities. The failure to effectively manage credit risk across all our products, services and activities can have a direct, immediate and material impact on our earnings and reputation. The responsibility for managing credit risk is shared broadly following the three lines of defence governance model. The Board of Directors, through its Risk Committee, delegates credit risk approval authorities to the CEO and GCRO. Credit transactions in excess of these authorities must be approved by the Risk Committee. To facilitate day-to-day business operations, the Group Chief Risk Officer has been empowered to further delegate credit risk approval authorities to individuals within Group Risk Management, the business segments, and Corporate Support as necessary. We maintain a Credit Risk Framework and supporting policies that are designed to clearly define roles and responsibilities, acceptable practices, limits and key controls. The Credit Risk Framework describes the principles, methodologies, systems, roles and responsibilities, reports and controls that exist for managing credit risk within RBC. 54 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis We balance our risk and return by: • • • • • • • • Ensuring credit quality is not compromised for growth; Mitigating credit risks in transactions, relationships and portfolios; Using our credit risk rating and scoring systems or other approved credit risk assessment or rating methodologies, policies and tools; Pricing appropriately for the credit risk taken; Detecting and preventing inappropriate credit risk through effective systems and controls; Applying consistent credit risk exposure measurements; Ongoing credit risk monitoring and administration; Transferring credit risk to third parties where appropriate through approved credit risk mitigation techniques (e.g., sale, hedging, insurance, securitization); and Avoiding activities that are inconsistent with our values, Code of Conduct or policies. • Risk measurement – Credit risk We quantify credit risk, at both the individual obligor and portfolio levels, to manage expected credit losses in order to limit earnings volatility and minimize unexpected losses. We employ different risk measurement processes for our wholesale and retail credit portfolios. The wholesale portfolio comprises businesses, sovereigns, public sector entities, banks and other financial institutions, and certain individuals and small businesses that are managed on an individual client basis. The retail portfolio is comprised of residential mortgages, personal, credit card, and small business loans, which are managed on a pooled basis. Credit risk rating systems are designed to assess and quantify the risk inherent in credit activities in an accurate and consistent manner. In measuring credit risk and setting regulatory capital, two principal approaches are available: Internal Ratings Based Approach (IRB) and Standardized Approach. Most of our credit risk exposure is measured under the IRB. Economic capital, which is our internal quantification of risks, is used extensively for performance measurement, limit setting and internal capital adequacy. The key parameters that form the basis of our credit risk measures for both regulatory and economic capital are: • Probability of default (PD): An estimated percentage that represents the likelihood of default within a given time period of an obligor for a specific rating grade or for a particular pool of exposure. Exposure at default (EAD): An amount expected to be owed by an obligor at the time of default. Loss given default (LGD): An estimated percentage of EAD that is not expected to be recovered during the collections and recovery process. • • These parameters are determined based primarily on historical experience from internal credit risk rating systems in accordance with supervisory standards, and are independently validated and updated on a regular basis. Under the Standardized Approach, used primarily for our Caribbean banking operations and City National, risk-weights prescribed by the Office of the Superintendent of Financial Institutions (OSFI) are used to calculate risk-weighted assets (RWA) for credit risk exposure. Wholesale credit risk The wholesale credit risk rating system is designed to measure the credit risk inherent in our wholesale credit activities. Each obligor is assigned a borrower risk rating (BRR), reflecting an assessment of the credit quality of the obligor. Each BRR has a PD calibrated against it. The BRR differentiates the riskiness of obligors and represents our evaluation of the obligor’s ability and willingness to meet its contractual obligations on time over a three year time horizon. The assignment of BRRs is based on the evaluation of the obligor’s business risk and financial risk and is based on fundamental credit analysis. The determination of the PD associated with each BRR relies primarily on internal default history since the early 2000s. PD estimates are designed to be a conservative reflection of our experience across the economic cycle including periods of economic downturn. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 55 Our rating system is designed to stratify obligors into 22 grades, consistent with the external rating agencies. The following table aligns the relative rankings of our 22-grade internal risk ratings with the ratings used by S&P and Moody’s. Internal ratings map* Table 45 Ratings 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 BRR 1+ 1H 1M 1L 2+H 2+M 2+L 2H 2M 2L 2-H 2-M 2-L 3+H 3+M 3+L 3H 3M 3L 4 5 6 S&P AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC Moody’s Description Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca Investment Grade Non-investment Grade C Bankruptcy C Bankruptcy Impaired * This table represents an integral part of our 2016 Annual Consolidated Financial Statements. Each credit facility is assigned an LGD rate that is largely driven by factors that impact the extent of losses in the event the obligor defaults; including seniority of debt, collateral security, and the industry sector in which the obligor operates. Estimated LGD rates draw primarily on internal loss experience since the late 1990s. Where we have limited internal loss data we also refer to appropriate external data to supplement the estimation process. LGD rates are estimated to reflect conditions that might be expected to prevail in a period of an economic downturn, with additional conservatism added to reflect data limitations and statistical uncertainties identified in the estimation process. EAD is estimated based on the current exposure to the obligor and the possible future changes in that exposure driven by factors such as the nature of the credit commitment and the type of obligor. As with LGD, rates are estimated to reflect an economic downturn, with added conservatism to reflect data and statistical uncertainties identified in the modelling process. Estimates of PD, LGD and EAD are updated, and then validated and back-tested by an independent validation team within the bank, on an annual basis. In addition, quarterly monitoring and back-testing is performed by the estimation team. These ratings and risk measurements are used to determine our expected losses as well as economic and regulatory capital, setting of risk limits, portfolio management and product pricing. Counterparty credit risk Counterparty credit risk is the risk that a party with whom the bank has entered into a financial or non-financial contract will fail to fulfill its contractual agreement and default on the obligation. It is measured not only by its current value, but also by how this value can move as market conditions change. Counterparty credit risk usually occurs in trading-related derivative and repo-style transactions. Derivative transactions include financial (e.g., forwards, futures, swaps and options) and non-financial derivatives (e.g., precious metal and commodities). For further details on our derivative instruments and credit risk mitigation, refer to Note 8 of our 2016 Annual Consolidated Financial Statements. Wrong-way risk Wrong-way risk is the risk that exposure to a counterparty or obligor is adversely correlated with the credit quality of that counterparty. There are two types of wrong-way risk: • Specific wrong-way risk, which exists when our exposure to a particular counterparty is positively and highly correlated with the probability of default of the counterparty due to the nature of our transactions with them (e.g., loan collateralized by shares or debt issued by the counterparty or a related party); and General wrong-way risk, which exists when there is a positive correlation between the probability of default of counterparties and general macroeconomic or market factors This typically occurs with derivatives (e.g., the size of the exposure increases) or with collateralized transactions (the value of the collateral declines). • 56 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Retail credit risk Credit scoring is the primary risk rating system for assessing obligor and transaction risk for retail exposures. Credit scores are one of the factors employed in the acquisition of new clients and management of existing clients. Retail exposures are managed on a pooled basis, with each pool consisting of a group or segment of exposures that possess similar homogeneous characteristics. Criteria used to pool exposures for risk quantification include behavioural score, product type (mortgages, credit cards, lines of credit and instalment loans), collateral type (chattel, liquid assets and real estate), utilization rate, loan-to-value, and the delinquency status (performing, delinquent and default) of the exposure. Regular monitoring and periodic adjustments & alignments are conducted to ensure that this process provides for a meaningful differentiation of risk. Credit risk parameters (PD and EAD) are estimated based on pools which consider borrower and transaction characteristics, including behavioural credit score, product type, utilization rate and delinquency status. LGD parameter estimates are based on transaction specific factors, including products, loan-to-value and collateral types. All parameters are determined based on over 10 years of historical economic losses with a high degree of granularity and additional margins of conservatism. Parameters are back-tested regularly by the retail Basel team and validated by an independent team within Group Risk Management. The following table maps PD bands to various risk levels: Internal ratings map* Table 46 PD bands 0.000% – 1.718% 1.719% – 6.430% 6.431% – 99.99% 100% Description Low risk Medium risk High risk Impaired/Default * This table represents an integral part of our 2016 Annual Consolidated Financial Statements. Risk control – Credit risk The Board of Directors and its committees, the Group Executive (GE), the GRC and other senior management risk committees work together to ensure a Credit Risk Framework and supporting policies, processes and procedures exist to manage credit risk and approve related credit risk limits. Reports are distributed to the Board of Directors, the GRC, and senior executives to keep them informed of our risk profile, including trending information and significant credit risk issues and shifts in exposures to ensure appropriate actions can be taken where necessary. Our enterprise-wide credit risk policies set out the minimum requirements for the management of credit risk in a variety of borrower, transactional and portfolio management contexts. Credit policies are an integral component of our Credit Risk Framework and set out the minimum requirements for the management of credit risk as follows: Credit risk assessment • • • Mandatory use of credit risk rating and scoring systems. Consistent credit risk assessment criteria. Standard content requirements in credit application documents. Credit risk mitigation Structuring of transactions • Specific credit policies and procedures set out the requirements for structuring transactions. Risk mitigants include the use of guarantees, collateral, seniority, loan-to-value requirements and covenants. Product-specific guidelines set out appropriate product structuring as well as client and guarantor criteria. Collateral • We often require obligors to pledge collateral as security when we advance credit. The extent of risk mitigation provided by collateral depends on the amount, type and quality of the collateral taken. Specific requirements relating to collateral valuation and management are set out in our credit risk management policies. The types of collateral used to secure credit or trading facilities within the bank are varied. For example, the majority of our securities finance and over-the-counter (OTC) derivatives activities are secured by cash and liquid government securities such as Organisation for Economic Co-operation and Development (OECD) securities. Wholesale lending is often secured by pledges of the assets of a business, such as accounts receivable, inventory, operating assets and commercial real estate. In our Canadian Banking business and Wealth Management segment, collateral typically consists of a pledge over a real estate property, or a portfolio of debt securities and equities trading on a recognized exchange. • We are compliant with regulatory requirements that govern residential mortgage underwriting practices, including loan-to-value parameters and property valuation requirements. For further information regarding residential mortgages, refer to table 55. Credit derivatives • We use credit derivatives as a tool to mitigate industry sector concentration and single-name exposure. For a more detailed description of the types of credit derivatives we enter into and how we manage related credit risk, refer to Note 8 of our 2016 Annual Consolidated Financial Statements. Loan forbearance In our overall management of borrower relationships, economic or legal reasons may necessitate forbearance to certain clients with respect to the original terms and conditions of their loans. We have specialized groups and formalized policies that direct the management of delinquent or defaulted borrowers. We strive to identify borrowers in financial difficulty early and modify their loan terms in order to maximize collection and to avoid foreclosure, repossession, or other legal remedies. In these circumstances, a borrower may be granted concessions that would not otherwise be considered. Examples of such concessions to retail borrowers may include rate reduction, principal forgiveness, and term Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 57 extensions. Concessions to wholesale borrowers may include restructuring the agreements, modifying the original terms of the agreement and/ or relaxation of covenants. For both retail and wholesale loans, the appropriate remediation techniques are based on the individual borrower’s situation, the bank’s policy and the customer’s willingness and capacity to meet the new arrangement. During 2016, some concessions were made to clients affected by low oil prices, the associated slowdown in Alberta’s economy and the wildfires in Fort McMurray; however, the overall impact of these concessions on our financial results was minimal. Product approval • Proposals for credit products and services are comprehensively reviewed and approved under a risk assessment framework. New, amended and existing products must be reviewed relative to all risks in our risk pyramid, including credit risk. All products must be reviewed on a periodic basis, with high risk products being reviewed more frequently. Credit portfolio management • Concentration risk is defined as the risk arising from large exposures to borrowers aggregated under one or more single names, industry sectors, countries or credit products within a portfolio that are highly correlated such that their ability to meet contractual obligations could be similarly affected by changes in economic, political or other risk drivers. • We manage credit exposures and limits to ensure alignment with our risk appetite, to maintain our target business mix and to ensure • that there is no undue risk concentration. Credit concentration limits are reviewed on a regular basis after taking into account business, economic, financial and regulatory environments. Credit limits are established at the following levels: single name limits (notional and economic capital), underwriting risk limits, leveraged lending limits, geographic (country and region) limits (notional and economic capital), industry sector limits (notional and economic capital), and product and portfolio limits, where deemed necessary. Gross credit risk exposure Gross credit risk exposure is calculated based on the definitions provided under the Basel III framework. Under this method, EAD is calculated before taking into account any collateral and is inclusive of an estimate of potential future changes to that credit exposure. Gross credit risk is categorized into lending-related and other, and trading-related. Lending-related and other includes: • Loans and acceptances outstanding, undrawn commitments, and other exposures, including contingent liabilities such as letters of credit and guarantees, available-for-sale (AFS) debt securities and deposits with financial institutions. Undrawn commitments represent an estimate of the contractual amount that may be drawn upon at the time of default of an obligor. Trading-related credit includes: • Repo-style transactions, which include repurchase and reverse repurchase agreements and securities lending and borrowing transactions. For repo-style transactions, gross exposure represents the amount at which securities were initially financed, before taking into account collateral. Derivative amount which represents the credit equivalent amount, which is defined by OSFI as the replacement cost plus an add-on amount for potential future credit exposure. • 58 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Gross credit risk exposure by portfolio and sector* Table 47 October 31 2016 October 31 2015 As at Lending-related and other Trading-related Lending-related and other Trading-related Loans and acceptances Loans and acceptances (Millions of Canadian Undrawn Repo-style Total Undrawn Repo-style dollars) Outstanding commitments (1) Other (2) transactions Derivatives (3) exposure (4) Outstanding commitments (1) Other (2) transactions Derivatives (3) Total exposure (4) Residential mortgages $ 254,998 Personal 93,466 Credit cards 17,128 Small business (5) 3,878 $ 1,063 $ 82,527 24,571 6,188 214 $ 145 – 5 Retail $ 369,470 $ 114,349 $ 364 $ Business (5) Agriculture Automotive Consumer goods Energy Oil & Gas Utilities Forest products Industrial products Mining & metals Non-bank financial services Real estate & related Technology & media Transportation & environment Other sectors Sovereign (5) Bank (5) $ 6,515 7,279 10,052 $ 1,310 $ 5,785 9,562 74 $ 567 756 6,259 7,680 1,099 5,508 1,455 8,408 40,419 11,019 6,060 42,948 10,581 1,930 10,747 13,694 561 7,757 3,640 13,149 11,215 14,758 4,393 19,607 6,972 1,815 1,656 3,496 85 546 1,135 15,830 1,847 873 3,603 18,647 84,017 119,324 – – – – – – – – – – – – – 249,732 4 470 – 2,786 38,707 104,314 $ $ $ $ $ $ – – – – – 109 497 551 1,198 1,748 27 632 144 41,381 499 1,832 1,637 3,391 17,319 25,600 256,275 $ 233,975 94,346 176,138 15,859 41,699 4,003 10,071 $ – $ 78,885 24,827 5,370 206 $ 154 – 9 484,183 $ 348,183 $ 109,082 $ 369 $ 8,008 $ 14,128 20,921 19,860 26,618 1,772 14,443 6,374 328,500 53,984 28,952 15,693 87,379 157,596 252,983 6,057 6,614 7,146 7,691 5,162 1,169 4,725 1,402 6,428 33,802 6,599 5,907 35,133 9,887 1,800 $ 1,279 $ 5,104 7,093 80 $ 407 594 13,274 13,389 535 5,418 3,883 13,060 9,210 14,182 4,300 17,166 5,614 1,015 1,330 3,149 108 513 906 18,002 1,910 574 2,960 15,620 57,413 86,106 – – – – – – – – – 60 – – – 201,845 63 6 – 4,915 30,871 102,371 $ $ $ – $ – – – 234,181 173,385 40,686 9,382 – $ 457,634 86 $ 984 470 839 1,482 40 538 255 29,769 373 1,703 1,474 15,386 10,162 27,221 7,502 13,109 15,303 23,134 23,242 1,852 11,194 6,446 269,104 45,358 23,064 14,641 88,220 113,947 218,513 Wholesale $ 167,212 $ 124,965 $252,456 $ 396,013 $ 96,565 $ 1,037,211 $ 139,522 $ 114,522 $189,672 $ 340,131 $ 90,782 $ 874,629 Total exposure $ 536,682 $ 239,314 $252,820 $ 396,013 $ 96,565 $ 1,521,394 $ 487,705 $ 223,604 $190,041 $ 340,131 $ 90,782 $ 1,332,263 * (1) (2) (3) (4) (5) This table represents an integral part of our 2016 audited Annual Consolidated Financial Statements. Undrawn commitments represent an estimate of the contractual amount that may be drawn upon at the time of default of an obligor. Includes credit equivalent amounts for contingent liabilities such as letters of credit and guarantees, outstanding amounts for AFS debt securities, deposits with financial institutions and other assets. Credit equivalent amount after factoring in master netting agreements. Gross credit risk exposure is before allowance for loan losses. Exposures under Basel III asset classes of qualifying revolving retail and other retail are largely included within Personal and Credit cards, while HELOC are included in Personal. Refer to Note 5 of our audited 2016 Annual Consolidated Financial Statements for the definitions of these terms. 2016 vs. 2015 Total gross credit risk exposure increased $189 billion or 14% from last year, primarily due to the inclusion of City National, an increase in repo-style transactions and Other exposure related to AFS debt securities, higher deposits balances and volume growth in residential mortgages. The increase in wholesale loans mainly reflected increased client activity, as well as the impact from foreign exchange translation. Retail exposure increased $27 billion or 6%, mainly due to the inclusion of City National and continued volume growth in residential mortgages and credit cards. Wholesale exposure increased $163 billion or 19%, primarily attributable to the inclusion of City National, an increase in repo-style transactions, higher Other exposure related to corporate and government AFS debt securities and higher deposits with the Federal Reserve reflecting our management of liquidity and funding risk. Volume growth in wholesale loans across various industry sectors, higher fair values on foreign exchange contracts and interest rate swaps, and the impact from foreign exchange translation also contributed to the increase. Wholesale loan utilization was 40%, up from 37% last year. As at October 31, 2016, our loans and acceptances exposure to oil and gas was $17 billion (October 31, 2015 – $21 billion); which is comprised of outstanding loans of $6 billion (October 31, 2015 – $8 billion), and undrawn commitments of $11 billion (October 31, 2015 – $13 billion). The oil and gas portfolio represents 2.19% (October 31, 2015 – 2.95%) of our total loan and acceptances portfolio. Of the $17 billion exposure, 42% was to investment grade while 58% was to non-investment grade counterparties (October 31, 2015 – 46% and 54%, respectively). Our AFS Securities (banking book) exposures are rated 95% investment grade and 5% non-investment grade. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 59 Gross credit risk exposure by geography* (1) Table 48 October 31 2016 October 31 2015 As at Lending-related and other Trading-related Lending-related and other Trading-related Loans and acceptances Loans and acceptances (Millions of Canadian dollars) Outstanding Undrawn commitments Repo-style Total Other transactions Derivatives exposure Outstanding Undrawn commitments Repo-style Other transactions Derivatives Total exposure Canada U.S. Europe Other International $ 430,616 $ 76,481 14,886 14,699 151,481 $ 81,800 $ 76,094 $ 27,647 $ 69,006 15,367 3,460 81,168 74,547 15,305 208,759 71,722 39,438 14,315 48,318 6,285 767,638 $ 414,427 $ 449,729 224,840 79,187 40,186 17,706 15,386 144,352 $ 70,774 $ 60,031 15,574 3,647 50,915 52,294 16,058 64,855 $ 27,272 $ 721,680 344,176 188,954 77,453 14,023 44,480 5,007 179,021 58,900 37,355 Total Exposure $ 536,682 $ 239,314 $ 252,820 $ 396,013 $ 96,565 $ 1,521,394 $ 487,705 $ 223,604 $ 190,041 $ 340,131 $ 90,782 $ 1,332,263 * (1) This table represents an integral part of our 2016 audited Annual Consolidated Financial Statements. Geographic profile is based on country of residence of the borrower. 2016 vs. 2015 Canada exposure increased $46 billion or 6% compared to the prior year, primarily due to higher loans and acceptances and growth in repo-style transactions. U.S. exposure increased $106 billion or 31% compared to the prior year, mainly due to the inclusion of City National, growth in repo-style transactions, higher Other exposure related to AFS debt securities, higher deposits with the Federal Reserve, and the impact from foreign exchange translation. Europe exposure increased $36 billion or 19% compared to the prior year, mainly due to an increase in repo-style transactions, higher Other exposure related to AFS debt securities, and increased deposits with central banks. Other International exposure increased $2 billion or 2% compared to the prior year. Loans and acceptances outstanding and undrawn commitments* (1), (2) Table 49 (Millions of Canadian dollars) Retail (3) Residential mortgages Personal Credit cards Small business October 31 2016 Medium As at October 31 2015 Medium Low risk risk High risk Impaired Total Low risk risk High risk Impaired Total $ 231,399 $ 12,750 $ 2,090 $ 10,624 5,342 1,201 159,841 34,758 7,148 2,768 1,437 1,671 667 $ 246,906 $ 218,151 $ 13,080 $ 2,098 $ 300 – 46 173,533 41,537 10,066 157,996 34,547 6,878 12,020 4,772 1,047 2,916 1,367 1,403 $ 433,146 $ 29,917 $ 7,966 $ 1,013 $ 472,042 $ 417,572 $ 30,919 $ 7,784 $ As at October 31 2016 October 31 2015 646 $ 233,975 173,231 299 40,686 – 9,373 45 990 $ 457,265 (Millions of Canadian dollars) Wholesale (4) Business Sovereign Bank Total Investment grade Non-investment grade Impaired Total Investment grade Non-investment grade Impaired Total $ 107,510 15,939 1,881 $ 125,330 $ $ 132,967 786 943 134,696 $ 2,339 – 2 $ 2,341 $ 242,816 16,725 2,826 $ 262,367 $ 105,871 14,704 2,475 $ 123,050 $ $ 128,564 797 338 129,699 $ 1,293 – 2 $ 1,295 $235,728 15,501 2,815 $254,044 * (1) (2) (3) (4) This table represents an integral part of our audited 2016 Annual Consolidated Financial Statements. This table represents our retail and wholesale loans and acceptances outstanding and undrawn commitments by portfolio and risk category, excluding City National exposures of $41.6 billion. The amounts in the table are before allowance for impaired loans. Includes undrawn commitments of $1.0 billion, $82.4 billion, $24.6 billion, and $6.2 billion for Residential mortgages, Personal, Credit cards and Small business, respectively (October 31, 2015 – $nil, $78.9 billion, $24.8 billion and $5.4 billion, respectively). Includes undrawn commitments of $111.3 billion, $7.0 billion, and $1.2 billion for Business, Sovereign and Bank, respectively (October 31, 2015 – $107.9 billion, $5.6 billion, and $1.0 billion, respectively). 2016 vs. 2015 Growth in retail exposures was largely attributable to continued volume growth in residential mortgages and credit cards. Growth in wholesale exposures mainly reflects increased volumes across various industry sectors in investment grade and non-investment grade categories, as well as the impact from foreign exchange translation. 60 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Net European exposure by country (1), (2) (Millions of Canadian dollars) U.K. Germany France Total U.K., Germany, France Greece Ireland Italy Portugal Spain Total Peripheral (4) Luxembourg Netherlands Norway Sweden Switzerland Other Total Other Europe Net exposure to Europe (5), (6) As at October 31 2016 Repo-style Table 50 October 31 2015 Securities (3) transactions Derivatives Total Total Loans outstanding $ $ $ $ $ $ $ 8,027 783 1,066 9,876 – 684 54 6 339 1,083 898 1,067 227 258 1,178 1,447 5,075 16,034 $ $ $ $ $ $ $ $ $ $ $ $ 5,409 10,014 6,878 22,301 – 32 58 – 51 141 428 6,757 3,709 3,888 766 1,399 $ $ $ $ $ 1,102 1 1 1,104 – 80 – – – 80 5 7 – 1 97 32 3,418 475 453 $ 17,956 11,273 8,398 $ 20,964 9,496 4,533 4,346 $ 37,627 $ 34,993 $ $ $ – 84 8 10 56 158 53 743 9 21 230 104 $ – 880 120 16 446 $ 1,462 $ 1,384 8,574 3,945 4,168 2,271 2,982 – 1,319 100 9 439 1,867 4,890 4,983 4,886 3,376 1,753 3,345 16,947 39,389 $ $ 142 1,326 $ $ 1,160 $ 23,324 $ 23,233 5,664 $ 62,413 $ 60,093 (1) (2) (3) (4) (5) (6) Geographic profile is based on country of risk, which reflects our assessment of the geographic risk associated with a given exposure. Typically, this is the residence of the borrower. Exposures are calculated on a fair value basis and net of collateral, which includes $64.0 billion against repo-style transactions (October 31, 2015 – $58 billion) and $15.7 billion against derivatives (October 31, 2015 – $10.7 billion). Securities include $11.1 billion of trading securities (October 31, 2015 – $12.8 billion), $12.3 billion of deposits (October 31, 2015 – $11.5 billion), and $15.9 billion of AFS securities (October 31, 2015 – $13.0 billion). Gross credit risk exposure to peripheral Europe is comprised of Greece $nil (October 31, 2015 – $nil), Ireland $18.9 billion (October 31, 2015 – $11.7 billion), Italy $0.3 billion (October 31, 2015 – $0.3 billion), Portugal $0.1 billion (October 31, 2015 – $nil), and Spain $1.1 billion (October 31, 2015 – $1.2 billion). Excludes $1.9 billion (October 31, 2015 – $2.6 billion) of exposures to supranational agencies. Reflects $1.5 billion of mitigation through credit default swaps, which are largely used to hedge single name exposures and market risk (October 31, 2015 – $1.8 billion). 2016 vs. 2015 Net credit risk exposure to Europe increased $2.3 billion from last year, largely driven by increased exposure to France, the Netherlands and Germany, partially offset by a decrease in exposure to Luxembourg, the U.K. and Norway. Our net exposure to peripheral Europe, which includes Greece, Ireland, Italy, Portugal and Spain, remained minimal, with total outstanding exposure decreasing $0.4 billion during the year to $1.5 billion. Our European corporate loan book is managed on a global basis and the underwriting standards for this loan book reflect the same approach to the use of our balance sheet as we have applied in both Canada and the U.S. PCL taken during the year on this portfolio was not material. The gross impaired loans ratio of this loan book was 1.1%, up from 0.6% last year. Net European exposure by client type As at October 31 2016 Table 51 October 31 2015 (Millions of Canadian dollars) Financials Sovereign Corporate Total U.K. Germany France France Greece Ireland Italy Portugal Spain Total U.K., Germany, Total Peripheral Other Europe Total Europe Total Europe $ 8,372 $ 8,507 $ 1,176 $ 18,055 $ 1,746 7,838 1,671 1,095 6,762 460 10,179 9,393 – $ 158 $ – – 12 710 64 $ 12 44 10 $ – 6 27 $ – 419 259 $ 11,347 $ 29,661 $ 27,835 14,815 17,443 17,342 15,410 7,139 4,838 24 1,179 $ 17,956 $ 11,273 $ 8,398 $ 37,627 $ – $ 880 $ 120 $ 16 $ 446 $ 1,462 $ 23,324 $ 62,413 $ 60,093 2016 vs. 2015 Our net exposure to Sovereign increased $2.5 billion, mainly due to increases in France, Germany and Other Europe, partly offset by decreases in the U.K. The net exposure to Financials increased $1.8 billion, mostly in Germany and the U.K., partly offset by decreases in Other Europe. The net exposure to Corporate decreased $2.0 billion, mainly in the U.K. and Germany. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 61 Residential mortgages and home equity lines of credit (insured vs. uninsured) Residential mortgages and home equity lines of credit are secured by residential properties. The following table presents a breakdown by geographic region: Residential mortgages and home equity lines of credit Table 52 As at October 31, 2016 Residential mortgages (1) Home equity lines of credit (2) Insured (3) Uninsured Total Total $ 7,633 14,432 43,314 21,746 8,897 17,657 $ 113,679 2 13 $ 15 59% 50 43 58 54 40 47% – – – $ 5,409 14,429 58,016 15,429 7,730 27,024 $ 128,037 10,012 3,171 41% 50 57 42 46 60 53% 100 100 $ 13,042 28,861 101,330 37,175 16,627 44,681 $ 241,716 10,014 3,184 $ 13,183 100% $ 13,198 $ 113,694 45% $ 141,220 55% $ 254,914 $ $ $ $ 2,034 4,060 16,512 7,066 2,682 8,739 41,093 1,464 2,442 3,906 44,999 As at October 31, 2015 Residential mortgages (1) Home equity lines of credit (2) Insured (3) Uninsured Total Total $ 6,856 12,414 36,555 19,872 7,690 15,755 $ 99,142 – 14 $ 14 55% 46 39 55 48 36 43% – – – $ 5,586 14,621 58,036 16,423 8,174 27,555 $ 130,395 772 3,202 45% 54 61 45 52 64 57% 100 100 $ 12,442 27,035 94,591 36,295 15,864 43,310 $ 229,537 772 3,216 $ 3,974 100% $ 3,988 $ 99,156 42% $ 134,369 58% $ 233,525 $ $ $ $ 2,060 4,157 16,785 7,189 2,751 9,085 42,027 334 3,107 3,441 45,468 (Millions of Canadian dollars, except percentage amounts) Region (4) Canada Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories Total Canada (5) U.S. Other International Total International Total (Millions of Canadian dollars, except percentage amounts) Region (4) Canada Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories Total Canada (5) U.S. Other International Total International Total (1) (2) (3) (4) (5) The residential mortgages amounts exclude our third-party mortgage-backed securities (MBS) of $84 million (2015 – $450 million). HELOC includes revolving and non-revolving loans. Insured residential mortgages are mortgages whereby our exposure to default is mitigated by insurance through the Canada Mortgage and Housing Corporation (CMHC) or other private mortgage default insurers. Region is based upon address of the property mortgaged. The Atlantic provinces are comprised of Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick, and B.C. and territories are comprised of British Columbia, Nunavut, Northwest Territories and Yukon. Total consolidated residential mortgages in Canada of $242 billion (2015 – $230 billion) is largely comprised of $217 billion (2015 – $205 billion) of residential mortgages and $6 billion (2015 – $5 billion) of mortgages with commercial clients, of which $3 billion (2015 – $3 billion) are insured mortgages, both in Canadian Banking, and $19 billion (2015 – $19 billion) of residential mortgages in Capital Markets held for securitization purposes. Home equity lines of credit are uninsured and reported within the personal loan category. As at October 31, 2016, home equity lines of credit in Canadian Banking were $41 billion (2015 – $42 billion). Approximately 98% of these home equity lines of credit (2015 – 98%) are secured by a first lien on real estate, and 7% of the total homeline clients (2015 – 8%) pay the scheduled interest payment only. 62 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Residential mortgages portfolio by amortization period The following table provides a summary of the percentage of residential mortgages that fall within the remaining amortization periods based upon current customer payment amounts, which incorporate payments larger than the minimum contractual amount and/or higher frequency of payments: Residential mortgages portfolio by amortization period Table 53 As at October 31 2016 Canada U.S. and Other International Total Canada October 31 2015 U.S. and Other International 74% 25 1 – 40% 58 2 – 72% 27 1 – 75% 23 2 – 77% 23 – – 100% 100% 100% 100% 100% Total 75% 23 2 – 100% Amortization period ≤ 25 years > 25 years ≤ 30 years > 30 years ≤ 35 years > 35 years Total Average loan-to-value (LTV) ratio for newly originated and acquired uninsured residential mortgages and homeline products The following table provides a summary of our average LTV ratio for newly originated and acquired uninsured residential mortgages and homeline products by geographic region: Average LTV ratio Region (3) Atlantic provinces Quebec Ontario Alberta Saskatchewan and Manitoba B.C. and territories U.S. Other International Average of newly originated and acquired for the year (4), (5) Total Canadian Banking residential mortgages portfolio (6) October 31 2016 Uninsured Table 54 October 31 2015 Uninsured Residential mortgages (1) Homeline products (2) Residential mortgages (1) Homeline products (2) 73% 71 70 73 74 68 72 63 71% 54% 74% 74 69 72 74 65 n.m. n.m. 69% 51% 74% 71 70 73 74 69 72 61 71% 55% 75% 73 70 73 75 66 n.m. n.m. 70% 54% (1) (2) (3) (4) (5) Residential mortgages exclude residential mortgages within the homeline products. Homeline products are comprised of both residential mortgages and home equity lines of credit. Region is based upon address of the property mortgaged. The Atlantic provinces are comprised of Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick, and B.C. and territories are comprised of British Columbia, Nunavut, Northwest Territories and Yukon. The average LTV ratio for newly originated and acquired uninsured residential mortgages and homeline products is calculated on a weighted basis by mortgage amounts at origination. For newly originated mortgages and homeline products, LTV is calculated based on the total facility amount for the residential mortgage and homeline product divided by the value of the related residential property. Weighted by mortgage balances and adjusted for property values based on the Teranet – National Bank National Composite House Price Index. (6) n.m. not meaningful We employ a risk-based approach to property valuation. Property valuation methods include automated valuation models (AVM) and appraisals. An AVM is a tool that estimates the value of a property by reference to market data including sales of comparable properties and price trends specific to the Metropolitan Statistical Area in which the property being valued is located. Using a risk-based approach, we also employ appraisals which can include drive-by or full on-site appraisals. We continue to actively manage our entire mortgage portfolio and perform stress testing, based on a combination of increasing unemployment, rising interest rates and a downturn in real estate markets. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 63 Credit quality performance Provision for (recovery of) credit loss (Millions of Canadian dollars, except percentage amounts) Personal & Commercial Banking Wealth Management Capital Markets Corporate Support and Other (1) Total PCL Canada (2) Residential mortgages Personal Credit cards Small business Retail Wholesale PCL on impaired loans U.S. (2), (3) Retail Wholesale PCL on impaired loans Other International (2), (3) Retail Wholesale PCL on impaired loans PCL on loans not yet identified as impaired Total PCL PCL ratio Total PCL ratio PCL on impaired loans ratio Personal & Commercial Banking Canadian Banking Caribbean Banking Wealth Management PCL ratio – loans PCL ratio – acquired credit-impaired loans Capital Markets $ $ $ $ $ 2016 1,122 48 327 49 1,546 42 459 435 34 970 213 1,183 1 227 228 41 44 85 50 Table 55 $ 2015 984 46 71 (4) $ 1,097 $ $ $ 27 393 371 32 823 116 939 1 40 41 21 96 117 – $ 1,546 $ 1,097 0.29% 0.28% 0.29% 0.29% 0.53% 0.10% 0.08% 0.02% 0.37% 0.24% 0.24% 0.27% 0.25% 0.85% 0.26% 0.26% n.a. 0.09% (1) (2) (3) n.a. PCL in Corporate Support and Other primarily comprised of PCL for loans not yet identified as impaired. For further information, refer to the How we measure and report our business segments section. Geographic information is based on residence of borrower. Includes acquired credit-impaired loans. not applicable 2016 vs. 2015 Total PCL increased $449 million, or 41% from the prior year. The PCL ratio of 29 bps increased 5 bps. PCL in Personal & Commercial Banking increased $138 million or 14%, and the PCL ratio of 29 bps increased 2 bps, largely due to higher provisions in our Canadian personal and commercial lending portfolios and higher write-offs in our Canadian credit cards portfolio. These factors were partially offset by lower PCL in our Caribbean portfolios. PCL in Wealth Management increased $2 million mainly reflecting provisions recorded in City National. PCL in the prior year largely reflected provisions related to the International Wealth Management business. PCL in Capital Markets increased $256 million, primarily due to higher provisions in the oil & gas sector. PCL in Corporate Support and Other increased $52 million, reflecting a $50 million increase in PCL for loans not yet identified as impaired. 64 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Gross impaired loans (GIL) (Millions of Canadian dollars, except percentage amounts) Personal & Commercial Banking Wealth Management (1) Capital Markets Investor & Treasury Services Corporate Support and Other Total GIL Canada (2) Retail Wholesale GIL U.S. (1), (2) Retail Wholesale GIL Other International (2) Retail Wholesale GIL Total GIL Impaired loans, beginning balance Classified as impaired during the period (new impaired) (3) Net repayments (3) Amounts written off Other (3), (4) Impaired loans, balance at end of period GIL ratio (5) Total GIL ratio Personal & Commercial Banking Canadian Banking Caribbean Banking Wealth Management GIL ratio – loans GIL ratio – acquired credit-impaired loans Capital Markets $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2016 1,651 710 1,524 2 16 3,903 642 522 1,164 56 1,736 1,792 380 567 947 3,903 2,285 3,673 (946) (1,523) 414 3,903 $ 0.73% 0.43% 0.27% 7.56% 1.44% 0.59% 0.85% 1.73% Table 56 2015 1,809 178 296 2 – 2,285 624 512 1,136 10 204 214 356 579 935 2,285 1,977 1,709 (158) (1,338) 95 2,285 0.47% 0.49% 0.30% 9.13% 1.01% 1.01% n.a. 0.37% (1) (2) (3) (4) (5) n.a. Includes $418 million (2015 – $nil) related to acquired credit impaired loans, with over 80% covered by loss-sharing agreements with the Federal Deposit Insurance Corporation (FDIC). For further details refer to Notes 2 and 5 of our 2016 Annual Consolidated Financial Statements. Geographic information is based on residence of borrower. Certain GIL movements for Canadian Banking retail and wholesale portfolios are generally allocated to New Impaired, as Return to performing status, Net repayments, Sold, and Exchange and other movements amounts are not reasonably determinable. Certain GIL movements for Caribbean Banking retail and wholesale portfolios are generally allocated to Net repayments and New Impaired, as Return to performing status, Sold, and Exchange and other movements amounts are not reasonably determinable. Includes Return to performing status during the year, Recoveries of loans and advances previously written off, Sold, and Exchange and other movements. GIL as a % of loans and acceptances. not applicable 2016 vs. 2015 Total GIL increased $1,618 million or 71%, and the GIL ratio of 73 bps increased 26 bps, from a year ago. GIL in Personal & Commercial Banking decreased $158 million or 9%, and the GIL ratio of 43 bps decreased 6 bps, mainly due to lower impaired loans in our commercial lending portfolios. GIL in Wealth Management increased $532 million, mainly due to the inclusion of our acquisition of City National, largely reflecting acquired credit impaired loans (ACI) of $418 million. Over 80% of these loans are covered by loss-sharing agreements with the Federal Deposit Insurance Corporation (FDIC). For further details on ACI loans, refer to Notes 2 and 5 of our 2016 Annual Consolidated Financial Statements. GIL in Capital Markets increased $1,228 million, primarily due to higher impaired loans in the oil & gas sector reflecting the lower oil price environment. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 65 Allowance for credit losses (ACL) (Millions of Canadian dollars) Allowance for impaired loans Personal & Commercial Banking Wealth Management (1) Capital Markets Investor & Treasury Services Total allowance for impaired loans Canada (2) Retail Wholesale Allowance for impaired loans U.S. (1), (2) Retail Wholesale Allowance for impaired loans Other International (2) Retail Wholesale Allowance for impaired loans Total allowance for impaired loans Allowance for loans not yet identified as impaired Total ACL Table 57 2016 2015 520 73 216 – 809 160 119 279 2 177 179 180 171 351 809 1,517 2,326 $ $ $ $ $ $ $ 548 43 61 2 654 142 111 253 1 47 48 169 184 353 654 1,466 2,120 $ $ $ $ $ $ $ (1) (2) Effective Q1 2016, includes ACL related to acquired credit-impaired loans from our acquisition of City National. Geographic information is based on residence of borrower. 2016 vs. 2015 Total ACL increased $206 million or 10% from a year ago, mainly related to higher ACL in Capital Markets, reflecting the low oil price environment, and higher ACL in Wealth Management, largely due to the inclusion of our acquisition of City National. This was partially offset by lower ACL in Personal & Commercial Banking. In addition, we recorded a $50 million increase in the allowance for loans not yet identified as impaired recorded in the second quarter of 2016. Market risk Market risk is defined to be the impact of market prices upon our financial condition. This includes potential gains or losses due to changes in market determined variables such as interest rates, credit spreads, equity prices, commodity prices, foreign exchange rates and implied volatilities. The measures of financial condition impacted by market risk are as follows: 1. 2. 3. 4. Positions whose revaluation gains and losses are reported in Revenue, which includes: a) Changes in the fair value of instruments classified or designated as at fair value through profit and loss (FVTPL), including impaired securities, and b) Hedge ineffectiveness. CET1 capital, which includes: All of the above, plus a) Changes in the fair value of AFS securities where revaluation gains and losses are reported as other comprehensive income, b) Changes in the Canadian dollar value of investments in foreign subsidiaries, net of hedges, due to foreign exchange translation, c) and Remeasurements of employee benefit plans, including pension fund assets underperforming in the market resulting in a deficit and volatility between the pension liabilities and the fund assets, and/or estimated actuarial parameters not being realized such that pension liabilities exceed pension fund assets. d) CET1 ratio, which includes: All of the above, plus a) Changes in risk-weighted assets (RWA) resulting from changes in traded market risk factors, and b) Changes in the Canadian dollar value of RWA due to foreign exchange translation. c) The economic value of the Bank, which includes: a) b) Points 1 and 2 above, plus Changes in the value of other non-trading positions whose value is a function of market risk factors. 66 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Market risk controls – FVTPL positions As an element of the Enterprise Risk Appetite Framework, the Board of Directors approves our overall market risk constraints. GRM creates and manages the control structure for FVTPL positions that ensures that business is conducted consistent with Board requirements. The Market and Trading Credit Risk function within GRM is responsible for creating and managing the controls and governance procedures that ensure that risk taken is consistent with risk appetite constraints set by the Board. These controls include limits on probabilistic measures of potential loss such as Value-at-Risk and Stressed Value-at-Risk as defined below: Value-at-Risk (VaR) – is a statistical measure of potential loss for a financial portfolio computed at a given level of confidence and over a defined holding period. We measure VaR at the 99th percentile confidence level for price movements over a one day holding period using historic simulation of the last two years of equally weighted historic market data. These calculations are updated daily with current risk positions, with the exception of certain less material positions that are not actively traded and are updated on at least a monthly basis. Stressed Value-at-Risk (SVaR) – is calculated in an identical manner as VaR with the exception that it is computed using a fixed historical one-year period of extreme volatility and its inverse rather than the most recent two-year history. The stress period used is the interval from September 2008 through August 2009. Stressed VaR is calculated daily for all portfolios, with the exception of certain less material positions that are not actively traded and are updated on at least a monthly basis. VaR and SVaR are statistical estimates based on historical market data and should be interpreted with knowledge of their limitations – which include the following: • VaR and SVaR will not be predictive of future losses if the realized market movements differ significantly from the historical periods used to compute them. VaR and SVaR project potential losses over a one-day holding period and do not project potential losses for risk positions held over longer time periods. VaR and SVaR are measured using positions at close of business and do not include the impact of trading activity over the course of a day. • • We validate our VaR and SVaR measures through a variety of means – including subjecting the models to vetting and validation by a group independent of the model developers and by back-testing the VaR against daily marked-to-market revenue to identify and examine events in which actual outcomes in trading revenue exceed the VaR projections. Stress Tests – Our market risk stress testing program is used to identify and control risk due to large changes in market prices and rates. We conduct stress testing daily on positions that are marked-to-market. The stress tests simulate both historical and hypothetical events which are severe and long term in duration. Historical scenarios are taken from actual market events over the last 30 years and range in duration up to 90 days. Examples include the equity market crash of 1987 and the global financial crisis of 2008. Hypothetical scenarios are designed to be forward looking at potential future market stresses, and are designed to be severe but plausible. We are constantly evaluating and refining these scenarios as market conditions change. Stress results are calculated assuming an instantaneous revaluation of our positions with no management action. These measures are computed on all positions that are FVTPL for financial reporting purposes, with the exception of those in a designated hedging relationship and those in our insurance businesses. Market risk measures – FVTPL positions VaR and SVaR The following table presents our Market risk VaR and Market risk SVaR figures for 2016 and 2015. Market Risk VaR* (Millions of Canadian dollars) Equity Foreign exchange Commodities Interest rate Credit specific (1) Diversification (2) Market risk VaR Market risk SVaR Table 58 2015 For the year ended October 31 2016 For the year ended October 31 As at Oct. 31 Average High $ $ $ 13 5 5 18 4 (21) 24 46 $ $ $ 16 5 3 21 5 (17) 33 82 $ $ $ 32 8 5 32 7 (23) 53 150 $ $ $ As at Oct. 31 Low 7 3 2 14 4 (11) 20 41 $ $ $ Average High 20 4 3 26 6 (18) 41 109 $ $ $ 12 4 3 28 8 (22) 33 104 $ $ $ 31 8 6 34 9 (34) 45 157 $ $ $ Low 6 3 2 23 6 (15) 26 73 * (1) (2) This table represents an integral part of our 2016 Annual Consolidated Financial Statements. General credit spread risk is measured under interest rate VaR while credit specific risk captures issuer-specific credit spread volatility. Market risk VaR is less than the sum of the individual risk factor VaR results due to portfolio diversification. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 67 2016 vs. 2015 Average market risk VaR of $33 million remained unchanged from the prior year. Reduced inventories in fixed income and securitized product portfolios, as reflected in lower average interest rate and credit specific VaR in the year, and the impact from foreign exchange translation were offset by an increase in equity risk mainly attributable to client-driven activity and increased volatility in the historical window used to calculate VaR. Average SVaR of $82 million was down $22 million compared to last year largely due to the reduced inventories in fixed income and securitized product portfolios as noted above and reduced risk in certain legacy businesses. During Q4 2016, SVaR reached the lowest level observed during the two-year period encompassing fiscal 2015 and 2016. The following chart graphically displays a bar chart of our daily trading profit and loss and a line chart of our daily market risk VaR. We incurred net trading losses on 7 days in the year totalling $63 million, as compared to 9 days of losses totalling $25 million in 2015, with none of the losses exceeding VaR. Trading revenue and VaR (Millions of Canadian dollars) 60 40 20 0 -20 -40 -60 5 1 0 v . 1 , 2 o N 6 1 0 1 , 2 n . 3 J a 6 1 0 0 , 2 p r. 3 A 6 1 0 1 , 2 J u l. 3 6 1 0 1 , 2 c t. 3 O Daily Trading Revenue Market Risk VaR The following chart displays the distribution of daily trading profit and loss in 2016. The largest daily reported loss of $22 million on February 11, 2016 was primarily driven by volatility in equities and credit spreads resulting from global growth concerns. Of the 7 loss days in fiscal 2016, 1 occurred in the fourth quarter. This loss day was largely driven by market conditions that negatively impacted trading activity across major business lines. The largest reported profit was $39 million with an average daily profit of $14 million. Trading revenue for the year ended October 31, 2016 (teb) s y a D f o r e b m u N n i y c n e u q e r F 80 70 60 50 40 30 20 10 0 0 7 - 0 6 - 0 5 - 0 4 - 0 3 - 0 2 - 0 1 - 0 0 1 0 2 0 3 0 4 0 5 0 6 0 7 Daily net trading revenue (C$ millions), excluding VIEs 2016 2015 Market risk measures for other FVTPL positions – Assets and liabilities of RBC Insurance We offer a range of insurance products to clients and hold investments to meet the future obligations to policyholders. The investments which support actuarial liabilities are predominantly fixed income assets designated as fair value through profit or loss (FVTPL). Consequently, changes in the fair values of these assets are recorded in investment income in the consolidated statements of income and are largely offset by changes in the fair value of the actuarial liabilities, the impact of which is reflected in insurance policyholder benefits and claims. As at October 31, 2016, we had liabilities with respect to insurance obligations of $9.2 billion, up from $9.1 billion in the prior year, and trading securities of $7.2 billion in support of the liabilities, unchanged from last year. 68 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Market risk controls – Structural Interest Rate Risk (SIRR) positions (1) The interest rate risk arising from traditional banking products, such as deposits and loans, is referred to as SIRR and is subject to limits and controls. SIRR measures also include related hedges as well as the interest rate risk from securities held for liquidity management. Factors contributing to SIRR include the mismatch between asset and liability repricing dates, relative changes in asset and liability rates, and other product features that could affect the expected timing of cash flows, such as options to pre-pay loans or redeem term deposits prior to contractual maturity. The Board of Directors approves the risk appetite for SIRR, and the Asset-Liability Committee (ALCO), along with GRM, provides ongoing oversight of SIRR through risk policies, limits, operating standards and other controls. SIRR reports are reviewed regularly by GRM, ALCO, the Group Risk Committee, the Risk Committee of the Board and the Board of Directors. Details on the non-trading risks included in SIRR are outlined in Table 60. Structural Interest Rate Risk measurement To monitor and control SIRR, the Bank assesses two primary financial metrics, 12-month Net Interest Income (NII) risk and Economic Value of Equity (EVE) risk, under a range of market shocks and scenarios. Market scenarios include currency-specific parallel and non-parallel yield curve changes and interest rate volatility shocks. In measuring NII risk, detailed structural balance sheets and income statements are dynamically simulated to determine the impact of market stress scenarios on projected NII. Assets, liabilities and off-balance sheet positions are simulated using monthly time steps over a one-year horizon. The simulations incorporate product maturities, renewals and growth along with prepayment and redemption behaviour. Product pricing and volumes are calibrated from past experience and projected consistent with expectations for a given market stress scenario. EVE risk captures the market value sensitivity of structural positions to changes in longer-term rates. In measuring EVE risk, deterministic (single-scenario) and stochastic (multiple-scenario) valuation techniques are applied to detailed spot position data. NII and EVE risks are measured for a range of market risk stress scenarios which include extreme but plausible market rate changes, across interest rate curves and interest rate volatilities. The management of NII and EVE risks is complementary and supports efforts by the Bank to generate a sustainable high-quality NII stream. NII and EVE risks are measured daily, weekly or monthly depending on the size, complexity and hedge strategy applicable to a balance sheet or business activity. A number of assumptions affecting cash flows, product re-pricing and the administration of rates underlie the models used to measure NII and EVE risks. The key assumptions pertain to the expected funding profiles for retail mortgage rate commitments, prepayment behaviour for fixed-rate loans, term deposit redemption behaviour, and the treatment of non-maturity deposits. All assumptions are derived empirically from historical client and product experience and consider future product pricing and customer needs. All models and assumptions used to measure SIRR are subject to independent oversight by GRM. Market risk measures – Structural Interest Rate Sensitivities The following table shows the potential before-tax impact of an immediate and sustained 100 bps and 200 bps increase or decrease in interest rates on projected 12-month NII and EVE for the Bank’s non-trading balance sheet, assuming no subsequent hedging. Rate floors are applied within the declining rates scenarios, with floor levels set based on global rate movement experience. Interest rate risk measures are based upon interest rate exposures at a specific time and continuously change as a result of business activities and risk management actions. Market risk – SIRR measures* Table 59 Economic value of equity risk Net interest income risk (1) 2016 2015 2014 Canadian dollar impact U.S. dollar impact (2) Total Canadian dollar impact U.S. dollar impact (2) Total Economic value of equity risk Net interest income risk (2) Economic value of equity risk Net interest income risk (2) (Millions of Canadian dollars) Before-tax impact of: 100bps increase in rates 100bps decrease in rates $ (1,321) $ 1,083 (56) $(1,377) $ (439) 644 235 $ (300) Before-tax impact of: 185 $ 420 $ (1,072) $ (165) (465) 829 289 (370) $ (916) $ 754 200bps increase in rates 200bps decrease in rates (2,682) 1,105 (201) (441) (2,883) 664 344 (290) 367 (177) 711 (467) (2,221) 925 472 (379) (1,910) 1,259 * (1) (2) This table represents an integral part of our audited 2016 Annual Consolidated Financial Statements. Represents the 12-month Net interest income exposure to an instantaneous and sustained shift in interest rates. Represents the impact on the SIRR portfolios held in our U.S. banking operations. 414 (348) 763 (434) At the end of fiscal 2016, an immediate and sustained -100 bps shock would have had a negative impact to the Bank’s NII of $465 million, up from $370 million at the end of 2015. An immediate and sustained +100 bps shock at the end of fiscal 2016 would have had a negative impact to the Bank’s EVE of $1,377 million, up from $1,072 million in 2015. The year-over-year increases in NII and EVE risks are primarily attributed to our acquisition of City National and growth in our balance sheet, in particular the fixed-rate asset position. During fiscal 2016, NII and EVE risks were maintained well within approved limits. Market risk measures for other material non-trading portfolios AFS securities We held $70 billion of securities classified as AFS as at October 31, 2016, compared to $48 billion as at October 31, 2015. Growth in AFS securities was primarily driven by the consolidation of the City National AFS portfolio. We hold debt securities designated as AFS primarily as investments and to manage liquidity and interest rate risk in our non-trading banking activity. Certain legacy debt portfolios are also classified as AFS. As at October 31, 2016, our portfolio of AFS securities exposes us to interest rate risk of a pre-tax loss of $8.9 million as measured by the change in the value of the securities for a one basis point parallel increase in yields. The portfolio also exposes us to credit spread risk of a pre- tax loss of $22.8 million, as measured by the change in value for a one basis point widening of credit spreads. Changes in the value of these securities are reported in other comprehensive income. The value of the AFS securities included in our SIRR measure as at October 31, 2016 was $48.6 billion. Our AFS securities also include equity exposures of $1.6 billion as at October 31, 2016, down from $1.8 billion as at October 31, 2015. (1) SIRR positions include impact of derivatives in hedge accounting relationships and AFS securities used for interest rate risk management. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 69 Derivatives related to non-trading activity Derivatives are also used to hedge market risk exposures unrelated to our trading activity. In aggregate, derivative assets not related to trading activity of $5.1 billion as at October 31, 2016 were down from $6.4 billion as at October 31, 2015, and derivative liabilities of $4.1 billion as at October 31, 2016 were down from $4.5 billion last year. Non-trading derivatives in hedge accounting relationships The derivative assets and liabilities described above include derivative assets in a designated hedge accounting relationship of $2.4 billion as at October 31, 2016, down from $2.8 billion as at October 31, 2015, and derivative liabilities of $1.8 billion as at October 31, 2016, down from $2.0 billion last year. These derivative assets and liabilities are included in our Structural Interest Rate Risk measure and other internal non- trading market risk measures. We use interest rate swaps to manage our AFS securities and structural interest rate risk, as described above. To the extent these swaps are considered effective hedges, changes in their fair value are recognized in other comprehensive income. The interest rate risk for the designated cash flow hedges, measured as the change in the fair value of the derivatives for a one basis point parallel increase in yields, was $5.2 million as of October 31, 2016 compared to $5.5 million as of October 31, 2015. Interest rate swaps are also used to hedge changes in the fair value of certain fixed-rate instruments. Changes in fair value of the interest rate swaps and the hedged instruments that are related to interest rate movements are reflected in income. We also use foreign exchange derivatives to manage our exposure to equity investments in subsidiaries that are denominated in foreign currencies, particularly the U.S. dollar, British pound, and Euro. Changes in the fair value of these hedges and the cumulative translation adjustment related to our structural foreign exchange risk are reported in other comprehensive income. Other non-trading derivatives Derivatives, including interest rate swaps and foreign exchange derivatives, that are not in designated hedge accounting relationships are used to manage other non-trading exposures. These derivatives have been designated as FVTPL, with changes in the fair value of these derivatives reflected in income. Derivative assets of $2.7 billion as at October 31, 2016 on these trades were down from $3.6 billion as at October 31, 2015, and derivative liabilities of $2.3 billion as at October 31, 2016 were down from $2.5 billion last year. Non-trading foreign exchange rate risk Foreign exchange rate risk is the potential adverse impact on earnings and economic value due to changes in foreign currency rates. Our revenue, expenses and income denominated in currencies other than the Canadian dollar are subject to fluctuations as a result of changes in the value of the average Canadian dollar relative to the average value of those currencies. Our most significant exposure is to the U.S. dollar, due to our level of operations in the U.S. and other activities conducted in U.S. dollars. Other significant exposures are to the British pound and the Euro, due to our activities conducted internationally in these currencies. A strengthening or weakening of the Canadian dollar compared to the U.S. dollar, British pound and the Euro could reduce or increase, as applicable, the translated value of our foreign currency denominated revenue, expenses and earnings and could have a significant effect on the results of our operations. We are also exposed to foreign exchange rate risk arising from our investments in foreign operations. For unhedged equity investments, when the Canadian dollar appreciates against other currencies, the unrealized translation losses on net foreign investments decreases our shareholders’ equity through the other components of equity and decreases the translated value of the RWA of the foreign currency-denominated asset. The reverse is true when the Canadian dollar depreciates against other currencies. Consequently, we consider these impacts in selecting an appropriate level of our investments in foreign operations to be hedged. Our overall trading and non-trading market risk objectives, policies and methodologies have not changed significantly from 2015. 70 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Linkage of market risk to selected balance sheet items The following table provides the linkages between selected balance sheet items with positions included in our trading market risk and non- trading market risk disclosures, which illustrates how we manage market risk for our assets and liabilities through different risk measures: Linkage of market risk to selected balance sheet items Table 60 (Millions of Canadian dollars) Assets subject to market risk Cash and due from banks (3) Interest-bearing deposits with banks (4) Securities Trading (5) Available-for-sale (6) Assets purchased under reverse repurchase agreements and securities borrowed (7) Loans Retail (8) Wholesale (9) Allowance for loan losses Segregated fund net assets (10) Derivatives Other assets (11) Assets not subject to market risk (12) Total assets Liabilities subject to market risk Deposits (13) Segregated fund liabilities (14) Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities (15) Subordinated debentures Liabilities not subject to market risk (16) Total liabilities Total equity Total liabilities and equity As at October 31, 2016 Market risk measure Balance sheet amount Traded risk (1) Non-traded risk (2) Non-traded risk primary risk sensitivity $ 14,929 27,851 $ 5,906 16,058 $ 9,023 11,793 Interest rate Interest rate 151,292 84,801 144,001 – 7,291 84,801 Interest rate, credit spread Interest rate, credit spread, equity 186,302 186,033 269 Interest rate 369,470 154,369 (2,235) 981 118,944 68,353 5,201 9,081 2,341 – – 113,862 24,727 360,389 152,028 (2,235) 981 5,082 43,626 Interest rate Interest rate Interest rate Interest rate Interest rate, foreign exchange Interest rate $ 1,180,258 $ 757,589 981 $ $ 502,009 $ 673,048 118,815 – $ 638,774 981 50,369 50,369 – Interest rate Interest rate 103,441 116,550 61,987 9,762 7,967 103,441 112,500 19,984 – – 4,050 42,003 9,762 Interest rate Interest rate, foreign exchange Interest rate Interest rate $ 1,108,646 $ 405,109 $ 695,570 $ 71,612 $ 1,180,258 (1) (2) Traded risk includes FVTPL positions whose revaluation gains and losses are reported in revenue. Market risk measures of VaR, SVaR and Stress testing are used as risk controls for traded risk. Non-traded risk includes positions used in the management of the SIRR and other non-trading portfolios. Other material non-trading portfolios include positions from our Insurance business and AFS securities not included in SIRR. The following footnotes provide additional information on the Non-traded risk amounts: (3) (4) (5) (6) Cash and due from banks includes $8,954 million included in SIRR. An additional $69 million is included in other risk controls. Interest-bearing deposits with banks of $11,793 million are included in SIRR. Trading securities include $7,291 million in securities used in the management of the SIRR of RBC Insurance, which is not included in our disclosed SIRR measure. Includes available-for-sale securities of $69,922 million and held-to-maturity securities of $14,879 million. $63,475 million of the total securities are included in SIRR. An additional $1,901 million are held by our insurance businesses that do not contribute to our disclosed SIRR measures. The remaining $19,425 million are captured in other internal non-trading market risk reporting. Assets purchased under reverse repurchase agreements include $269 million reflected in SIRR. Retail loans include $360,138 million reflected in SIRR. An additional $251 million is used in the management of the SIRR of RBC Insurance. Wholesale loans include $150,619 million reflected in SIRR. An additional $1,409 million is used in the management of the SIRR of RBC Insurance. Investments for the account of segregated fund holders are included in the management of the SIRR of RBC Insurance. (7) (8) (9) (10) (11) Other assets include $41,168 million reflected in SIRR. An additional $2,458 million is used in the management of the SIRR of RBC Insurance. (12) Assets not subject to market risk include $5,201 million of physical and other assets. (13) Deposits include $638,774 million reflected in SIRR. (14) Insurance and investment contracts for the account of segregated fund holders are included in the management of the SIRR of RBC Insurance. (15) Other liabilities include $9,900 million used in the management of the SIRR of RBC Insurance and $32,103 million contribute to our SIRR measure. (16) Liabilities not subject to market risk include $7,967 million of payroll related and other liabilities. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 71 (Millions of Canadian dollars) Assets subject to market risk Cash and due from banks (3) Interest-bearing deposits with banks (4) Securities Trading (5) Available-for-sale (6) Assets purchased under reverse repurchase agreements and securities borrowed (7) Loans Retail (8) Wholesale (9) Allowance for loan losses Segregated fund net assets (10) Derivatives Other assets (11) Assets not subject to market risk (12) Total assets Liabilities subject to market risk Deposits (13) Segregated fund liabilities (14) Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned (15) Derivatives Other liabilities (16) Subordinated debentures Liabilities not subject to market risk (17) Total liabilities Total equity Total liabilities and equity As at October 31, 2015 Market risk measure Balance sheet amount Traded risk (1) Non-traded risk (2) Non-traded risk primary risk sensitivity $ 12,452 22,690 $ 5,720 15,764 $ 6,732 6,926 Interest rate Interest rate 158,703 56,805 151,420 – 7,283 56,805 Interest rate, credit spread Interest rate, credit spread, equity 174,723 174,594 129 Interest rate 348,183 126,069 (2,029) 830 105,626 64,082 6,074 16,337 140 – – 99,233 24,578 331,846 125,929 (2,029) 830 6,393 39,504 Interest rate Interest rate Interest rate Interest rate Interest rate, foreign exchange Interest rate $ 1,074,208 $ 697,227 830 $ $ 487,786 $ 580,348 151,776 – $ 545,451 830 47,658 47,658 – Interest rate Interest rate 83,288 107,860 58,184 7,362 7,855 83,165 103,348 19,757 – 123 4,512 38,427 7,362 Interest rate Interest rate, foreign exchange Interest rate Interest rate $ 1,010,264 $ 405,704 $ 596,705 $ 63,944 $ 1,074,208 (1) (2) Traded risk includes FVTPL positions whose revaluation gains and losses are reported in revenue. Market risk measures of VaR, SVaR and Stress testing are used as risk controls for traded risk. Non-traded risk includes positions used in the management of the SIRR and other non-trading portfolios. Other material non-trading portfolios include positions from our Insurance business and AFS securities not included in SIRR. The following footnotes provide additional information on the Non-traded risk amounts: (3) (4) (5) (6) Cash and due from banks includes $5,829 million included in SIRR. An additional $903 million is included in other risk controls. Interest-bearing deposits with banks of $6,926 million are included in SIRR. Trading securities include $7,283 million in securities used in the management of the SIRR of RBC Insurance, which is not included in our disclosed SIRR measure. Includes available-for-sale securities of $48,164 million and held-to-maturity securities of $8,641 million. $43,528 million of the total securities are included in SIRR. An additional $1,917 million are held by our insurance businesses that do not contribute to our disclosed SIRR measures. The remaining $11,360 million are captured in other internal non-trading market risk reporting. Assets purchased under reverse repurchase agreements include $129 million reflected in SIRR. Retail loans include $331,846 million reflected in SIRR. Wholesale loans include $124,701 million reflected in SIRR. An additional $1,228 million is used in the management of the SIRR of RBC Insurance. Investments for the account of segregated fund holders are included in the management of the SIRR of RBC Insurance. (7) (8) (9) (10) (11) Other assets include $36,728 million reflected in SIRR. An additional $2,776 million is used in the management of the SIRR of RBC Insurance. (12) Assets not subject to market risk include $6,074 million of physical and other assets. (13) Deposits include $545,451 million reflected in SIRR. (14) (15) Obligations related to assets sold under repurchase agreements include $123 million reflected in SIRR. (16) Other liabilities include $10,019 million used in the management of the SIRR of RBC Insurance, and $28,408 million contribute to our SIRR measure. (17) Insurance and investment contracts for the account of segregated fund holders are included in the management of the SIRR of RBC Insurance. Liabilities not subject to market risk include $7,855 million of payroll related and other liabilities. Liquidity and funding risk Liquidity and funding risk (liquidity risk) is the risk that we may be unable to generate sufficient cash or its equivalents in a timely and cost- effective manner to meet our commitments as they come due. Liquidity risk arises from mismatches in the timing and value of on-balance sheet and off-balance sheet cash flows. Our liquidity profile is structured to ensure that we have sufficient liquidity to satisfy current and prospective commitments in both normal and stressed business and liquidity environments. To achieve these goals, we operate under a comprehensive Liquidity Risk Management Framework (LRMF) and employ several liquidity risk mitigation strategies that include: • • An appropriate balance between the level of exposure allowed under our risk appetite and the cost of risk mitigation; Broad funding access, including preserving and promoting a reliable base of core client deposits and ongoing access to diversified sources of wholesale funding; A comprehensive liquidity stress testing program, contingency, recovery and resolution planning and status monitoring to ensure sufficiency of unencumbered marketable securities and demonstrated capacities to monetize specific asset classes; Timely and granular risk measurement information; Transparent liquidity transfer pricing and cost allocation; and A rigorous first and second line of defense governance model. • • • • 72 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Risk control Our liquidity risk objectives, policies and methodologies are reviewed regularly, and updated to reflect changing market conditions and business mix, to align with local regulatory developments and to position ourselves for the phase-in of Basel III regulatory liquidity standards. We continue to maintain liquidity and funding that is appropriate for the execution of our strategy. Liquidity risk remains well within our risk appetite. The Board of Directors annually approves the delegation of liquidity risk authorities to senior management. The Risk Committee of the Board annually approves the LRMF and the Pledging Policy and is responsible for their oversight. The Board of Directors, the Risk Committee of the Board, the Group Risk Committee (GRC) and the Asset/Liability Committee (ALCO) regularly review reporting on our enterprise-wide liquidity position and status. The GRC, the Policy Review Committee (PRC) and/or the ALCO also review liquidity documents prepared for the Board of Directors or its committees. • PRC annually approves the Liquidity Risk Policy (LRP), which establishes minimum risk control elements in accordance with the Board- approved risk appetite and LRMF. The ALCO annually approves the Liquidity Contingency Plan (LCP) and provides strategic direction and oversight to Corporate Treasury, other functions, and business segments on the management of liquidity. • These policies are supported by operational, desk and product-level policies that implement risk control elements, such as parameters, methodologies, management limits and authorities that govern the measurement and management of liquidity. Stress testing is also employed to assess the robustness of the control framework and inform liquidity contingency plans. Risk measurement Liquidity risk is measured by applying scenario-based assumptions against our assets and liabilities and off-balance sheet commitments to derive expected cash flow profiles over varying time horizons. For instance, government bonds can be quickly and reliably monetized without significant loss of value to generate cash inflow prior to their contractual maturity, and similarly, relationship demand deposits can be deemed as having little risk of short-term cash outflow, although depositors have the contractual right to redeem on demand. Risk methodologies and underlying assumptions are periodically reviewed and validated to ensure alignment with our operating environment, expected economic and market conditions, rating agency preferences, regulatory requirements and accepted practices. To manage liquidity risk within our liquidity risk appetite, we set limits on various metrics reflecting a range of time horizons and severity of stress conditions and develop contingency, recovery and resolution plans. Our liquidity risk measurement and control activities are divided into three categories as follows: Structural (longer-term) liquidity risk To guide our secured and unsecured wholesale term funding activities, we employ an internal metric to focus on the structural alignment between long-term illiquid assets and longer-term funding sourced from wholesale investors and core relationship deposits. Tactical (shorter-term) liquidity risk To address more immediate cash flow risks we may experience in times of stress, we use short-term net cash flow limits in conjunction with stress testing, to contain risk within the risk appetite at branch, subsidiary and currency levels. Net cash flow positions are derived from the application of internally generated risk assumptions and parameters to known and anticipated cash flows for all material unencumbered assets, liabilities and off-balance sheet activities. Encumbered assets are not considered a source of available liquidity. We also control tactical liquidity by adhering to group-wide and unit-specific prescribed regulatory standards, such as LCR. Contingency liquidity risk Contingency liquidity risk planning assesses the impact of and our intended responses to sudden stressful events. Our Liquidity Contingency Plan, maintained and administered by Corporate Treasury, guides our actions and responses to liquidity crises. This plan establishes a Liquidity Crisis Team, led by Corporate Treasury, and consisting of senior representatives with relevant subject matter expertise from key business segments, Group Risk Management, Finance, and Operations. This team contributes to the development of stress tests and funding plans and meets regularly to assess our liquidity status, conduct stress tests and review liquidity contingency preparedness. Our stress tests, which include elements of scenario and sensitivity analyses, measure our prospective exposure to global, country-specific and RBC-specific events over a period of several weeks. Different levels of severity are considered for each type of crisis with some scenarios reflecting multiple notch downgrades to our credit ratings. The contingency liquidity risk planning process identifies contingent funding needs (e.g., draws on committed credit and liquidity lines, demands for more collateral and deposit run-off) and sources (e.g., contingent liquid asset sales and incremental wholesale funding capacity) under various stress scenarios, and as a result, informs requirements for our earmarked contingent unencumbered liquid asset pools. Our contingent liquid asset pools consist of diversified, highly rated and liquid marketable securities, overnight government reverse repos, and deposits with central banks. These portfolios are subject to minimum asset quality levels and, as appropriate, other strict eligibility guidelines (e.g., maturity, diversification and eligibility for central bank advances) to maximize ready access to cash in emergencies. These securities, when added to other unencumbered liquid assets that we hold as a result of capital markets or other activities, combine to populate our liquidity reserve and asset encumbrance disclosures provided below. Liquidity reserve and asset encumbrance As recommended by the Enhanced Disclosure Task Force (EDTF), the following tables provide summaries of our liquidity reserve and asset encumbrance. In both tables, unencumbered assets represent, for the most part, a ready source of funding that can be accessed quickly. For the purpose of constructing the following tables, encumbered assets include: (i) bank-owned liquid assets that are either pledged as collateral (e.g., repo financing and derivative pledging) or not freely available due to regulatory or internal policy requirements (e.g., earmarked to satisfy mandatory reserve or local capital adequacy requirements and to maintain continuous access to payment and settlement systems); (ii) securities received as collateral from securities financing and derivative transactions which have either been re-hypothecated where permissible (e.g., to obtain financing through repos or to cover securities sold short) or have no liquidity value since re-hypothecation is prohibited; and (iii) illiquid Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 73 assets that have been securitized and sold into the market or that have been pledged as collateral in support of structured term funding vehicles. As per our liquidity management framework and practice, we do not include encumbered assets as a source of available liquidity in measuring liquidity risk. Unencumbered assets are the difference between total and encumbered assets from both on- and off-balance sheet sources. Liquidity reserve In the liquidity reserve table, available liquid assets consist of on-balance sheet cash and securities holdings, as well as securities received as collateral from securities financing (reverse repos and off-balance sheet collateral swaps) and derivative transactions, and constitute the preferred source for quickly accessing liquidity. The other component of our liquidity reserve consists primarily of uncommitted and undrawn central bank credit facilities that could be accessed under exceptional circumstances, provided certain pre-conditions could be met and where advances could be supported by eligible assets (e.g., certain unencumbered loans) not included in the liquid assets category. Liquidity reserve Table 61 (Millions of Canadian dollars) Cash and holding at central banks Deposits in other banks available overnight Securities issued or guaranteed by sovereigns, central banks or multicultural development banks (2) Other Liquidity assets eligible at central banks (not included above) (3) Undrawn credit lines granted by central banks (4) Other assets eligible as collateral for discount (5) Other liquid assets (6) Bank-owned liquid assets (1) $ 31,771 1,679 295,603 146,269 600 13,558 141,888 23,307 As at October 31, 2016 Securities received as collateral from securities financing and derivative transactions Total liquid assets Encumbered liquid assets Unencumbered liquid assets $ – – $ 31,771 1,679 $ 1,781 262 $ 29,990 1,417 28,564 34,386 – – – – 324,167 180,655 600 13,558 141,888 23,307 168,395 72,765 – – – 23,307 155,772 107,890 600 13,558 141,888 – Total liquid assets $ 654,675 $ 62,950 $ 717,625 $ 266,510 $ 451,115 (Millions of Canadian dollars) Cash and holding at central banks Deposits in other banks available overnight Securities issued or guaranteed by sovereigns, central banks or multilateral development banks (2) Other Liquidity assets eligible at central banks (not included above) (3) Undrawn credit lines granted by central banks (4) Other assets eligible as collateral for discount (5) Other liquid assets (6) As at October 31, 2015 Securities received as collateral from securities financing and derivative transactions Total liquid assets Encumbered liquid assets Unencumbered liquid assets $ – – $ 25,075 2,298 $ 1,719 1 $ 23,356 2,297 21,216 31,751 – – – – 278,554 174,464 63 11,844 128,401 21,675 127,702 80,349 – – – 21,675 150,852 94,115 63 11,844 128,401 – Bank-owned liquid assets (1) $ 25,075 2,298 257,338 142,713 63 11,844 128,401 21,675 Total liquid assets $ 589,407 $ 52,967 $ 642,374 $ 231,446 $ 410,928 (Millions of Canadian dollars) Royal Bank of Canada Foreign branches Subsidiaries Total unencumbered liquid assets As at October 31 2016 $ 264,522 53,006 133,587 October 31 2015 $ 252,052 64,684 94,192 $ 451,115 $ 410,928 (1) (2) (3) (4) (5) (6) 74 The bank-owned liquid assets amount includes securities owned outright by the bank as well as collateral received through reverse repurchase transactions. Includes liquid securities issued by provincial governments and U.S. government-sponsored entities working under U.S. Federal government’s conservatorship (e.g., Federal National Mortgage Association and Federal Home Loan Mortgage Corporation). Includes Auction Rate Securities. Includes loans that qualify as eligible collateral for the discount window facility available to us at the Federal Reserve Bank of New York (Federal Reserve Bank). Amounts are face value and would be subject to collateral margin requirements applied by the Federal Reserve Bank to determine collateral value/borrowing capacity. Access to the discount window borrowing program is conditional on meeting requirements set by the Federal Reserve Bank and borrowings are typically expected to be infrequent and due to uncommon occurrences requiring temporary accommodation. Represents our unencumbered Canadian dollar non-mortgage loan book (at face value) that could, subject to satisfying conditions precedent to borrowing and application of prescribed collateral margin requirements, be pledged to the Bank of Canada for advances under its Emergency Lending Assistance (ELA) program. ELA and other central bank facilities are not considered sources of available liquidity in our normal liquidity risk profile but could in extraordinary circumstances, where normal market liquidity is seriously impaired, allow us and other banks to monetize assets eligible as central bank collateral to meet requirements and mitigate further market liquidity disruption. Represents pledges related to OTC and exchange-traded derivative transactions. Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis 2016 vs. 2015 Total liquid assets increased $75.3 billion or 12%, primarily due to our acquisition of City National as well as an increase in collateral received under reverse repurchase and securities financing transactions. Asset encumbrance The table below provides a summary of cash, securities and other assets, distinguishing between those that are encumbered assets and those available for sale or use as collateral in secured funding transactions. Other assets, such as mortgages and credit card receivables can also be monetized, although over a longer timeframe than that required for marketable securities. As at October 31, 2016, our Unencumbered assets available as collateral comprised 38% of our total assets (October 31, 2015 – 38%). Asset encumbrance Table 62 October 31 2016 October 31 2015 As at Encumbered Unencumbered Encumbered Unencumbered (Millions of Canadian dollars) Pledged as collateral Other (1) Available as collateral (2) Other (3) Total (4) Pledged as collateral Other (1) Available as collateral (2) Other (3) Total (4) Cash and due from banks $ – $ 1,781 $ 13,148 $ – $ 14,929 $ – $ 1,719 $ 10,733 $ – $ 12,452 Interest-bearing deposits with banks Securities Trading Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Mortgage securities Mortgage loans Non-mortgage loans Wholesale Allowance for loan losses Segregated fund net assets Other – Derivatives – Others (5) – 262 27,589 – 27,851 1 – 22,689 – 22,690 66,734 2,858 179,534 34,624 40,293 10,422 3,477 – – – 23,307 – – – – – – – – – – – 83,219 78,966 1,339 2,977 151,292 84,801 66,752 7,800 – 669 90,551 45,548 1,400 2,788 158,703 56,805 89,200 15,204 283,938 148,117 35,591 12,796 – 131,694 100,612 41,445 3,438 109,447 70,215 184,783 114,472 154,369 35,889 36,422 8,314 3,376 – – – – (2,235) (2,235) – 981 118,944 50,247 981 118,944 73,554 – – 22,286 – – – – – – – – – 89,929 18,398 256,444 33,921 – – 127,743 100,040 40,867 5,854 81,826 69,810 164,165 114,208 126,069 – – – – (2,029) (2,029) 830 105,626 47,870 830 105,626 70,156 Total assets $361,249 $ 2,043 $ 482,566 $ 432,036 $ 1,277,894 $ 328,957 $ 2,388 $ 434,278 $ 390,306 $ 1,155,929 (1) (2) (3) (4) (5) Includes assets restricted from use to generate secured funding due to legal or other constraints. Includes loans that could be used to collateralize central bank advances. Our unencumbered Canadian dollar non-mortgage loan book (at face value) could, subject to satisfying conditions for borrowing and application of prescribed collateral margin requirements, be pledged to the Bank of Canada for advances under its ELA program. We also lodge loans that qualify as eligible collateral for the discount window facility available to us at the Federal Reserve Bank of New York. ELA and other central bank facilities are not considered sources of available liquidity in our normal liquidity risk profile. However, banks could monetize assets meeting central bank collateral criteria during periods of extraordinary and severe disruption to market-wide liquidity. Other unencumbered assets are not subject to any restrictions on their use to secure funding or as collateral but would not be considered readily available since they may not be acceptable at central banks or for other lending programs. Includes bank-owned liquid assets and securities received as collateral from off-balance sheet securities financing and derivative transactions. The Pledged as collateral amounts relate to OTC and exchange-traded derivative transactions. Funding Funding strategy Core funding, comprising capital, longer-term wholesale liabilities and a diversified pool of personal and, to a lesser extent, commercial and institutional deposits, is the foundation of our structural liquidity position. Deposit and funding profile As at October 31, 2016, relationship-based deposits, which are the primary source of funding for retail loans and mortgages, were $506 billion or 55% of our total funding (October 31, 2015 – $422 billion or 51%). The remaining portion is comprised of short- and long-term wholesale funding. Funding for highly liquid assets consists primarily of short-term wholesale funding that reflects the monetization period of those assets. Long-term wholesale funding is used mostly to fund less liquid wholesale assets and to support liquidity asset buffers. For further details on our wholesale funding, refer to the Composition of wholesale funding tables below. Long-term debt issuance During 2016, we continued to experience more favourable unsecured wholesale funding access and pricing compared to many of our global peers. We also continued to expand our unsecured long-term funding base by selectively issuing, either directly or through our subsidiaries, $25.4 billion of term funding in various currencies and markets. Total unsecured long-term funding outstanding decreased by $3.3 billion from the prior year due to maturities. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 75 We primarily use residential mortgage and credit card securitization programs as alternative sources of funding and for liquidity and asset/ liability management purposes. Our total secured long-term funding includes outstanding mortgage-backed securities (MBS) sold, covered bonds that are collateralized with residential mortgages, and securities backed by credit card receivables. Compared to 2015, our outstanding MBS sold decreased $2.2 billion. Our covered bonds and securitized credit card receivables increased $3.2 billion and $744 million. For further details, refer to the Off-balance sheet arrangements section. Long-term funding sources* (Millions of Canadian dollars) Unsecured long-term funding Secured long-term funding Commercial mortgage-backed securities sold Subordinated debentures Table 63 As at October 31 2016 October 31 2015 $ 98,827 69,971 1,297 9,597 $ 102,081 68,228 1,080 7,227 $ 179,692 $ 178,616 * This table represents an integral part of our 2016 Annual Consolidated Financial Statements. Our wholesale funding activities are well-diversified by geography, investor segment, instrument, currency, structure and maturity. We maintain an ongoing presence in different funding markets, which allows us to continuously monitor market developments and trends, identify opportunities and risks, and take appropriate and timely actions. We operate longer-term debt issuance registered programs. The following table summarizes these programs with their authorized limits by geography. Programs by geography Table 64 Canada U.S. Europe/Asia • Canadian Shelf – $25 billion • SEC Registered Medium Term Note • European Debt Issuance Program – Program – US$40 billion US$40 billion • SEC Registered Covered Bond Program – • Global Covered Bond Program – US$15 billion (1) €32 billion • Japanese Issuance Programs – ¥1 trillion (1) Subject to the €32 billion Global Covered Bond Program limit. We also raise long-term funding using Canadian Deposit Notes, Canadian NHA MBS, Canada Mortgage Bonds, credit card receivable-backed securities, Kangaroo Bonds (issued in the Australian domestic market by foreign firms) and Yankee Certificates of Deposit (issued in the U.S. domestic market by foreign firms). We continuously evaluate opportunities to expand into new markets and untapped investor segments since diversification expands our wholesale funding flexibility, minimizes funding concentration and dependency, and generally reduces financing costs. As presented in the following charts, our current long-term debt profile is well-diversified by both currency and product. Maintaining competitive credit ratings is also critical to cost-effective funding. 76 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Long-term debt (1) – funding mix by currency of issuance ($151 billion as at October 31, 2016) Long-term debt (1) – funding mix by product ($151 billion as at October 31, 2016) Other 8% Euro 14% Canadian dollar 37% October 31, 2016 $151 B U.S. dollar 41% Cards securitization 6% Unsecured funding 54% October 31, 2016 $151 B Covered bonds 26% MBS/CMB (2) 14% (1) Based on original term to maturity greater than 1 year (1) (2) Based on original term to maturity greater than 1 year Mortgage-backed securities and Canada Mortgage Bonds The following table provides our composition of wholesale funding based on remaining term to maturity and represents our enhanced disclosure in response to EDTF recommendations: Composition of wholesale funding (1) Table 65 (Millions of Canadian dollars) Deposits from banks (2) Certificates of deposit and commercial paper Asset-backed commercial paper (3) Senior unsecured medium-term notes (4) Senior unsecured structured notes (5) Mortgage securitization Covered bonds/asset-backed securities (6) Subordinated liabilities Other (7) Total Of which: – Secured – Unsecured (Millions of Canadian dollars) Deposits from banks (2) Certificates of deposit and commercial paper Asset-backed commercial paper (3) Senior unsecured medium-term notes (4) Senior unsecured structured notes (5) Mortgage securitization Covered bonds/asset-backed securities (6) Subordinated liabilities Other (7) Total Of which: – Secured – Unsecured $ $ $ $ $ $ As at October 31, 2016 Less than 1 month 1 to 3 months 3 to 6 months 6 to 12 months Less than 1 year sub-total 1 year to 2 years 2 years and greater 1,375 $ 3,072 1,503 1,135 141 – – – 1,173 80 $ 30 $ 8,950 1,600 9,140 305 686 1,674 – 2,053 10,692 3,551 7,582 213 514 626 – 43 38 5,199 2,923 7,282 554 1,435 5,834 128 738 $ 1,523 $ 27,913 9,577 25,139 1,213 2,635 8,134 128 4,007 – $ – $ 1,220 – 18,156 1,871 3,432 10,700 – 13 54 – 43,073 6,493 14,378 30,692 9,469 5,073 Total 1,523 29,187 9,577 86,368 9,577 20,445 49,526 9,597 9,093 8,399 $ 24,488 $ 23,251 $ 24,131 $ 80,269 $ 35,392 $ 109,232 $ 224,893 2,502 $ 5,528 $ 4,691 $ 10,192 13,939 5,897 18,560 18,960 $ 22,913 $ 14,132 $ 45,071 $ 82,116 142,777 21,260 64,161 57,356 As at October 31, 2015 Less than 1 month 1 to 3 months 3 to 6 months 5,107 $ 9,355 883 944 151 41 – 1,500 4,126 62 $ 13 $ 9,648 2,317 6,403 535 1,088 1,961 – 3,283 18,591 6,989 4,165 376 673 654 – 252 6 to 12 months 30 10,071 1,572 11,348 577 2,139 5,438 – 1,318 Less than 1 year sub-total 1 year to 2 years 2 years and greater $ 5,212 $ 47,665 11,761 22,860 1,639 3,941 8,053 1,500 8,979 – $ – $ 451 – 17,670 679 2,656 7,518 108 12 207 – 42,520 6,070 16,049 30,041 5,619 4,408 Total 5,212 48,323 11,761 83,050 8,388 22,646 45,612 7,227 13,399 22,107 $ 25,297 $ 31,713 $ 32,493 $111,610 $ 29,094 $ 104,914 $ 245,618 4,952 $ 7,506 $ 8,315 $ 9,149 23,344 23,398 17,791 17,155 $ 29,922 $ 10,174 $ 46,090 $ 86,186 159,432 18,920 58,824 81,688 (1) (2) (3) (4) (5) (6) (7) Excludes bankers’ acceptances and repos. Only includes deposits raised by treasury. Excludes deposits associated with services we provide to these banks (e.g., custody, cash management). Only includes consolidated liabilities, including our collateralized commercial paper program. Includes deposit notes. Includes notes where the payout is tied to movements in foreign exchange, commodities and equities. Includes credit card, auto and mortgage loans. Includes tender option bonds (secured) of $2,567 million (October 31, 2015 – $6,088 million), bearer deposit notes (unsecured) of $1,652 million (October 31, 2015 – $3,186 million) and other long-term structured deposits (unsecured) of $4,874 million (October 31, 2015 – $4,125 million). Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 77 Credit ratings Our ability to access unsecured funding markets and to engage in certain collateralized business activities on a cost-effective basis are primarily dependent upon maintaining competitive credit ratings. Credit ratings and outlooks provided by rating agencies reflect their views and methodologies. Ratings are subject to change, based on a number of factors including, but not limited to, our financial strength, competitive position and liquidity and other factors not completely within our control. On June 6, 2016, S&P revised our outlook to negative from stable and affirmed our ratings. On July 19, 2016, Moody’s affirmed our ratings with a negative outlook. On July 28, 2016, DBRS affirmed our ratings with a negative outlook. On October 28, 2016, Fitch Ratings affirmed our ratings with a negative outlook. The following table presents our major credit ratings (1) and outlooks: Credit ratings Table 66 As at November 29, 2016 Short-term debt Senior long-term debt Outlook Moody’s Standard & Poor’s Fitch Ratings Dominion Bond Rating Services P-1 A-1+ F1+ R-1(high) Aa3 AA- AA AA negative negative negative negative (1) Credit ratings are not recommendations to purchase, sell or hold a financial obligation inasmuch as they do not comment on market price or suitability for a particular investor. Ratings are determined by the rating agencies based on criteria established from time to time by them, and are subject to revision or withdrawal at any time by the rating organization. Additional contractual obligations for rating downgrades We are required to deliver collateral to certain counterparties in the event of a downgrade to our current credit rating. The following table presents the additional collateral obligations required at the reporting date in the event of a one-, two- or three-notch downgrade to our credit ratings. These additional collateral obligations are incremental requirements for each successive downgrade and do not represent the cumulative impact of multiple downgrades. The amounts reported change periodically as a result of several factors, including the transfer of trading activity to centrally cleared financial market infrastructures and exchanges, the expiration of transactions with downgrade triggers, the imposition of internal limitations on new agreements to exclude downgrade triggers, as well as normal course mark-to-market of positions with collateralized counterparties moving from a negative to a positive position. There is no outstanding senior debt issued in the market that contains rating triggers that would lead to early prepayment of principal. Additional contractual obligations for rating downgrades Table 67 As at October 31 2016 October 31 2015 (Millions of Canadian dollars) Contractual derivatives funding or margin requirements Other contractual funding or margin requirements (1) One-notch downgrade Two-notch downgrade Three-notch downgrade One-notch downgrade Two-notch downgrade Three-notch downgrade $ $ 487 293 $ 117 473 $ 501 – $ 760 421 $ 132 88 972 – (1) Includes GICs issued by our municipal markets business out of New York. Liquidity Coverage Ratio (LCR) The LCR is a Basel III metric that measures the sufficiency of HQLA available to meet liquidity needs over a 30-day period in an acute stress scenario. The BCBS and OSFI regulatory minimum coverage level for LCR is currently 100%. OSFI requires Canadian banks to disclose the LCR using the standard Basel disclosure template and calculated using the average of month- end positions during the quarter. 78 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Liquidity coverage ratio (1) Table 68 (Millions of Canadian dollars, except percentage amounts) High-quality liquid assets Total high-quality liquid assets (HQLA) Cash outflows Retail deposits and deposits from small business customers, of which: Stable deposits (3) Less stable deposits Unsecured wholesale funding, of which: Operational deposits (all counterparties) and deposits (4) in networks of cooperative banks Non-operational deposits Unsecured debt Secured wholesale funding Additional requirements, of which: Outflows related to derivative exposures and other collateral requirements Outflows related to loss of funding on debt products Credit and liquidity facilities Other contractual funding obligations (5) Other contingent funding obligations (6) Total cash outflows Cash inflows Secured lending (e.g., reverse repos) Inflows from fully performing exposures Other cash inflows Total cash inflows Total HQLA Total net cash outflows Liquidity coverage ratio For the three-months ended October 31 2016 October 31 2015 Total unweighted value (average) (2) Total weighted value (average) Total unweighted value (average) (2) Total weighted value (average) 224,518 72,570 151,948 234,455 106,040 113,719 14,696 226,706 59,910 5,364 161,432 30,951 448,854 126,615 10,559 45,207 207,541 17,372 2,177 15,195 99,877 25,491 59,690 14,696 26,069 67,106 34,299 5,364 27,443 30,951 6,814 248,189 31,978 7,042 45,207 84,227 180,831 60,399 120,432 217,592 97,255 101,632 18,705 195,694 43,709 4,893 147,092 28,056 433,181 119,274 11,709 29,309 194,785 13,856 1,813 12,043 97,305 23,342 55,258 18,705 26,709 51,288 17,747 4,893 28,648 28,056 6,224 223,438 32,982 8,013 29,309 70,304 Total adjusted value 207,541 163,962 127% Total adjusted value 194,785 153,134 127% (1) (2) (3) (4) (5) (6) LCR is calculated in accordance with OSFI’s LAR guideline, which, in turn, reflects liquidity-related requirements issued by the BCBS. With the exception of other contingent funding obligations, unweighted inflow and outflow amounts are items maturing or callable in 30 days or less. Other contingent funding obligations also include debt securities with remaining maturity greater than 30 days. As defined by BCBS, stable deposits from retail and small business customers are deposits that are insured and are either held in transactional accounts or the bank has an established relationship with the client making the withdrawal unlikely. Operational deposits from non-retail and non-small and medium-sized enterprise customers are deposits which clients need to keep with the bank in order to facilitate their access and ability to use payment and settlement systems primarily for clearing, custody and cash management activities. Other contractual funding obligations primarily include outflows from unsettled securities trades and outflows from obligations related to securities sold short. Other contingent funding obligations include outflows related to other off-balance sheet facilities that carry low LCR runoff factors (0% – 5%). We manage our LCR position within a target range that reflects management’s liquidity risk tolerance and takes into account business mix, asset composition and funding capabilities. The range is subject to periodic review in light of changes to internal requirements and external developments. We maintain HQLAs in major currencies with dependable market depth and breadth. Our treasury management practices ensure that the levels of HQLA are actively managed to meet target LCR objectives. Our Level 1 assets, as calculated according to OSFI LAR and the BCBS LCR requirements, represent 80% of total HQLA. These assets consist of cash, placements with central banks and highly rated securities issued or guaranteed by governments, central banks and supranational entities. LCR captures cash flows from on- and off-balance sheet activities that are either expected or could potentially occur within 30 days in an acute stress scenario. Cash outflows result from application of withdrawal and non-renewal factors to demand and term deposits, differentiated by client type (wholesale, retail and small- and medium-sized enterprises). Cash outflows also arise from business activities that create contingent funding and collateral requirements, such as repo funding, derivatives, short sales of securities and the extension of credit and liquidity commitments to clients. Cash inflows arise primarily from maturing secured loans, interbank loans and non-HQLA securities. LCR does not reflect any market funding capacity that management believes would be available to the Bank in a stress situation. All maturing wholesale debt is assigned 100% outflow in the LCR calculation. Q4 2016 vs. Q4 2015 The average LCR for the quarter ended October 31, 2016 of 127% was consistent with the prior year, reflecting active liquidity management in response to balance sheet growth and funding maturities. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 79 Contractual maturities of financial assets, financial liabilities and off-balance sheet items The following tables provide remaining contractual maturity profiles of all our assets, liabilities, and off-balance sheet items at their carrying value (e.g., amortized cost or fair value) at the balance sheet date. Off-balance sheet items are allocated based on the expiry date of the contract. Details of contractual maturities and commitments to extend funds are a source of information for the management of liquidity risk. Among other purposes, these details form a basis for modelling a behavioural balance sheet with effective maturities to calculate liquidity risk measures. For further details, refer to the Risk measurement section. Contractual maturities of financial assets, financial liabilities and off-balance sheet items Table 69 Less than 1 month 1 to 3 months 3 to 6 months 6 to 9 months 9 to 12 months 1 year to 2 years 2 years to 5 years 5 years and greater With no specific maturity Total As at October 31, 2016 $ 38,931 $ 342 $ 2 $ – $ 192 $ – $ – $ – $ 3,313 $ 42,780 98,843 1,648 5 4,854 18 2,011 – 1,810 24 1,687 40 8,869 117 25,709 6,183 36,587 46,062 1,626 151,292 84,801 81,801 42,092 24,771 14,988 11,090 3,380 303 – 7,877 186,302 15,526 13,154 16,863 21,512 23,120 109,075 198,054 38,887 85,413 521,604 8,362 8,443 28,659 4,403 10,367 741 73 4,800 484 3 3,355 222 – 3,511 62 – 12,794 43 2 26,563 38 – 49,099 414 – 12 1,372 12,843 118,944 32,035 $ 282,213 $ 75,958 $ 49,022 $ 41,890 $ 39,686 $ 134,201 $ 250,786 $ 131,170 $ 145,675 $ 1,150,601 29,657 19,455 2,991 1,824 1,259 2,579 887 130 295 237 (Millions of Canadian dollars) Assets Cash and deposits with banks Securities Trading (1) Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans (net of allowance for loan losses) Other Customers’ liability under acceptances Derivatives Other financial assets Total financial assets Other non-financial assets Total assets $ 283,472 $ 76,845 $ 49,152 $ 42,185 $ 39,923 $ 136,780 $ 252,610 $ 134,161 $ 165,130 $ 1,180,258 Liabilities and equity Deposits (2) Unsecured borrowing Secured borrowing Covered bonds Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other financial liabilities Subordinated debentures Total financial liabilities Other non-financial liabilities Equity $ 30,680 $ 35,333 $ 35,540 $ 16,684 $ 23,586 $ 34,044 $ 1,545 – 4,788 – 4,947 – 5,700 – 2,290 3,348 7,256 9,376 55,239 $ 20,660 24,936 8,362 4,403 50,369 – 73 – 3 – – – – – 2 – 15,123 $ 415,130 $ 8,569 2,815 – – – – – – 661,359 55,755 40,475 12,843 50,369 88,702 7,334 22,700 – 6,113 10,904 2,212 – 1,568 5,809 375 – – 3,939 125 – 756 2,976 218 – 8 13,562 154 – 21 25,945 290 115 – 46,081 4,762 9,647 6,273 – 482 – 103,441 116,550 31,318 9,762 $ 209,692 $ 63,753 $ 48,312 $ 26,451 $ 33,174 $ 64,400 $ 127,208 $ 86,997 $ 421,885 $ 1,081,872 863 – 3,692 – 276 – 155 – 154 – 1,199 – 2,466 – 9,408 – 8,561 71,612 26,774 71,612 Total liabilities and equity $ 210,555 $ 67,445 $ 48,588 $ 26,606 $ 33,328 $ 65,599 $ 129,674 $ 96,405 $ 502,058 $ 1,180,258 Off-balance sheet items Financial guarantees Lease commitments Commitments to extend credit Other credit-related commitments Other commitments Total off-balance sheet items $ 736 $ 62 2,255 $ 123 1,897 $ 184 3,199 $ 181 1,251 $ 177 3,010 $ 661 6,403 $ 1,528 79 $ 2,131 56 $ – 18,886 5,047 3,723 5,481 9,783 7,190 12,074 31,384 132,092 18,284 3,220 223,231 433 477 791 63 1,420 – 1,339 – 1,158 – 678 – 758 – 306 – 90,241 – 97,124 540 $ 5,431 $ 8,713 $ 13,284 $ 11,909 $ 14,660 $ 35,733 $ 140,781 $ 20,800 $ 93,517 $ 344,828 (1) (2) Trading debt securities classified as fair value through profit or loss have been included in the less than 1 month category as there is no expectation to hold these assets to their contractual maturity. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base, as explained in the preceding Deposit profile section, for our operations and liquidity needs. 80 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis (Millions of Canadian dollars) Assets Cash and deposits with banks Securities Trading (1) Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans (net of allowance for loan losses) Other Customers’ liability under acceptances Derivatives Other financial assets Total financial assets Other non-financial assets Total assets Liabilities and equity Deposits (2) Unsecured borrowing Secured borrowing Covered bonds Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other financial liabilities Subordinated debentures Total financial liabilities Other non-financial liabilities Equity Total liabilities and equity Off-balance sheet items Financial guarantees Lease commitments Commitments to extend credit Other credit-related commitments Other commitments Less than 1 month 1 to 3 months 3 to 6 months 6 to 9 months 9 to 12 months 1 year to 2 years 2 years to 5 years 5 years and greater With no specific maturity Total As at October 31, 2015 $ 31,355 $ 56 $ 17 $ 530 $ – $ – $ – $ – $ 3,184 $ 35,142 103,718 2,947 21 3,682 26 1,345 77 3,259 51 988 188 4,778 552 20,154 82,017 15,020 30,851 11,828 27,871 23,196 16,570 22,295 7,320 18,234 2,601 89,179 – 184,249 10,343 7,492 29,187 3,032 8,129 624 71 3,747 711 – 3,074 169 – 2,479 33 6 10,639 83 1 25,244 26 $ 282,079 $58,223 $56,984 $45,974 $29,105 $ 107,474 $ 230,226 $ 374 1,573 1,506 1,792 526 866 60 5,580 17,802 – 22,833 – 44,811 525 48,490 1,850 7,493 85,389 – 11 966 158,703 56,805 174,723 472,223 13,453 105,626 32,324 91,551 $147,383 $1,048,999 25,209 16,087 2,425 $ 283,871 $59,729 $57,510 $46,348 $29,165 $ 108,340 $ 231,799 $ 93,976 $163,470 $1,074,208 970 – 10,343 47,658 66,099 5,376 23,210 – 4,818 1,961 3,032 – 7,580 8,481 1,236 – $ 40,992 $29,994 $41,298 $20,175 $27,220 $ 30,697 $ 53,403 $ 8,602 – 7,567 2,293 2,676 1,165 9,708 3,269 19,318 24,064 14,479 $338,378 $ 596,636 63,395 37,196 9,736 4,444 – – 71 – – – – – 6 – 1 – – – – – 13,453 47,658 1,419 4,146 391 – 422 4,205 120 – 800 3,884 198 – 780 12,240 72 – 10 28,140 239 – $ 194,648 $57,102 $55,927 $34,782 $35,943 $ 56,772 $ 125,175 $ 142 – 2,564 – 3,291 – 894 – 170 – 169 – 990 – – 41,383 4,188 7,362 6,178 5 349 – 83,288 107,860 30,003 7,362 81,592 $344,910 $ 986,851 23,413 6,671 63,944 63,944 8,522 – $ 195,638 $60,393 $56,097 $34,924 $36,112 $ 57,666 $ 127,739 $ 90,114 $415,525 $1,074,208 $ 828 $ 2,798 $ 1,348 $ 2,115 $ 1,552 $ 62 3,801 623 353 123 6,005 828 – 180 9,854 1,172 – 175 10,976 1,169 – 177 8,281 1,014 – 2,861 $ 602 32,971 343 – 5,813 $ 1,293 127,747 834 – 147 $ 32 $ 1,808 14,127 272 – – 3,113 74,247 – 17,494 4,420 216,875 80,502 353 Total off-balance sheet items $ 5,667 $ 9,754 $12,554 $14,435 $11,024 $ 36,777 $ 135,687 $ 16,354 $ 77,392 $ 319,644 (1) (2) Trading debt securities classified as fair value through profit or loss have been included in the less than 1 month category as there is no expectation to hold these assets to their contractual maturity. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base, as explained in the preceding Deposit profile section, for our operations and liquidity needs. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 81 Contractual maturities of financial liabilities and off-balance sheet items – undiscounted basis The following tables provide remaining contractual maturity analysis of our financial liabilities and off-balance sheet items. The amounts disclosed in the following table are the contractual undiscounted cash flows of all financial liabilities (e.g., par value or amount payable upon maturity). The amounts do not reconcile directly with those in our consolidated balance sheets as the table incorporates only cash flows relating to payments on maturity and do not recognize premiums, discounts or mark-to-market adjustments recognized in the instruments’ carrying values as at the balance sheet date. Financial liabilities are based upon the earliest period in which they are required to be paid. For off-balance sheet items, the undiscounted cash flows potentially payable under financial guarantees and commitments to extend credit are classified on the basis of the earliest date they can be called. Contractual maturities of financial liabilities and off-balance sheet items – undiscounted basis * Table 70 (Millions of Canadian dollars) Financial liabilities Deposits (1) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures Off-balance sheet items Financial guarantees (2) Operating leases Commitments to extend credit (2) As at October 31, 2016 On demand Within 1 year 1 year to 2 years 2 years to 5 years 5 years and greater Total $ 358,254 $ 221,852 $ 50,293 $ 100,295 $ 25,422 $ 756,116 6,618 – 6,274 445 – 6,224 49,911 97,139 24,198 – – – 8 112 – 1 – 21 289 115 – – – 4,761 9,646 371,591 399,324 50,413 100,721 39,829 7,616 – 181,496 189,112 11,258 727 41,671 53,656 11 661 5 677 – 1,528 59 1,587 1 2,131 – 2,132 12,843 49,911 103,442 29,805 9,761 961,878 18,886 5,047 223,231 247,164 Total financial liabilities and off-balance sheet items $ 560,703 $ 452,980 $ 51,090 $ 102,308 $ 41,961 $ 1,209,042 (Millions of Canadian dollars) Financial liabilities Deposits (1) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures Off-balance sheet items Financial guarantees (2) Operating leases Commitments to extend credit (2) As at October 31, 2015 On demand Within 1 year 1 year to 2 years 2 years to 5 years 5 years and greater Total $ 311,743 $ 216,876 $ 43,631 $ 96,104 $ 28,539 $ 696,893 – – 6,179 334 – 13,446 47,658 76,320 25,174 – 6 – 780 72 – 1 – 10 237 – – – – 4,139 7,227 13,453 47,658 83,289 29,956 7,227 318,256 379,474 44,489 96,352 39,905 878,476 7,079 – 172,927 180,006 10,399 717 43,929 55,045 11 602 4 617 4 1,293 2 1,299 1 1,808 13 1,822 17,494 4,420 216,875 238,789 Total financial liabilities and off-balance sheet items $ 498,262 $ 434,519 $ 45,106 $ 97,651 $ 41,727 $ 1,117,265 * (1) (2) This table represents an integral part of our 2016 Annual Consolidated Financial Statements. A major portion of relationship-based deposits are repayable on demand or at short notice on a contractual basis while, in practice, these customer balances form a core base, as explained in the preceding Deposit profile section, for our operations and liquidity needs. We believe that it is highly unlikely that all or substantially all of these guarantees and commitments will be drawn or settled within one year, and contracts may expire without being drawn or settled. The management of the liquidity risk associated with potential extensions of funds is outlined in the preceding Risk measurement section. Insurance risk Insurance risk refers to the potential financial loss that may arise where the amount, timing and/or frequency of benefit payments under insurance and reinsurance contracts are different than expected. Insurance risk is distinct from those risks covered by other parts of our risk management framework (e.g., credit, market and operational risk) where those risks are ancillary to, or accompany the risk transfer. We have implemented an Insurance Risk Framework that provides an overview of our processes and tools for identifying, assessing, managing and reporting on the insurance risks that face the organization. Key insurance-specific processes and tools include: risk appetite, delegated authorities and risk limits, capital management, own risk and solvency assessment, comprehensive identification and assessment of risk process, stress testing, insurance product and project risk review and approval, insurance product pricing, reinsurance, insurance underwriting, insurance claims management, experience study analysis, actuarial liabilities, and embedded value. 82 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Operational risk Operational risk is the risk of loss or harm resulting from people, inadequate or failed internal processes and systems or from external events. Operational risk is inherent in all our activities, including the practices and controls used to manage other risks. Failure to manage operational risk can result in direct or indirect financial loss, reputational impact, regulatory censure, or failure in the management of other risks such as credit or market risk. Three lines of defence Our management of operational risk follows our established three lines of defence governance model. This model encompasses the organizational roles and responsibilities for a co-ordinated enterprise-wide approach for the management of operational risk. For further details, refer to the Risk management – Enterprise risk management section. Operational Risk Framework We have put in place an Enterprise Operational Risk Framework, which is founded on the principles of our Enterprise Risk Management Framework and sets out the processes to identify, assess, manage, monitor and report operational risk. The processes are established through the following core programs: • Internal events – Internal events are specific instances where operational risk leads to or could have led to an unintended, identifiable impact. The internal events program provides a structured and consistent approach for collecting and analyzing internal event data to facilitate the analysis of the operational risk events affecting us. External events – External events are operational risk events that affect institutions other than RBC. External event monitoring and analysis is critical to gain awareness of operational risk experience within the industry and to identify emerging industry trends. Business Environment and Internal Control Factors (BEICF) Assessments – BEICF Assessments are conducted to improve business decision- making by gaining awareness of the key risks and the strengths and vulnerabilities of internal controls. Key BEICF Assessment processes include: risk and control self-assessments conducted at both enterprise and business levels; change initiatives & new/amended product assessments conducted to ensure understanding of the risk and reward trade-off for initiatives (e.g., new products, acquisitions, changes in business processes, implementation of new technology, etc.) and that we do not assume risks not aligned with our risk appetite. Scenario analysis – Scenario analysis is a structured and disciplined process for making reasonable assessments of infrequent, yet plausible, severe operational risk events. Understanding how vulnerable we are to such “tail risks” identifies mitigating actions and informs the determination of related operational risk thresholds as part of the articulation of operational risk appetite. BEICF monitoring – BEICF monitoring is conducted on an ongoing basis through key risk indicators (KRIs) and other assurance/monitoring programs (e.g., business unit monitoring, second line of defence monitoring, audit results, etc.). • • • • Conclusions from the operational risk programs enable learning based on “what has happened to us, could it happen again elsewhere in RBC and what controls do we need to amend or implement,” support the articulation of operational risk appetite and are used to inform the overall level of exposure to operational risk, which defines our operational risk profile. The profile includes significant operational risk exposures, potential new and emerging exposures and trends, and overall conclusions on the control environment and risk outlook. We proactively identify and investigate corporate insurance opportunities to mitigate and reduce potential future impacts of operational risk. We consider risk/reward decisions in striking the balance between accepting potential losses versus incurring costs of mitigation, the expression of which is in the form of our operational risk appetite. Our operational risk appetite is established at the board level and cascaded throughout each of our business segments. Management reports have been implemented at various levels in order to support proactive management of operational risk and transparency of risk exposures. Reports are provided on a regular basis and provide detail on the main drivers of the risk status and trend for each of our business segments and RBC overall. In addition, changes to the operational risk profile that are not aligned to our business strategy or operational risk appetite are identified and discussed. Our operations expose us to many different operational risks, which may adversely affect our businesses and financial results. The following list is not exhaustive, as other factors could also adversely affect our results. Model risk The use of models plays an important role in many of our business activities. We use a variety of models for many purposes, including the valuation of financial products, risk measurement and management of different types of risk. Model risk is the risk of error in the design, development, implementation or subsequent use of models. We have established an enterprise-wide Model Risk Management Policy, including principles, policies and procedures, roles and responsibilities to manage model risk. One of the key factors in the policy to mitigate model risk is independent validation. Information technology and cybersecurity risk We use information technology for business operations and the enablement of strategic business goals and objectives. Information technology risk is the risk to our business associated with the use, ownership, operation, involvement, influence and adoption of information technology within the enterprise. It consists of information technology related events (e.g., cybersecurity incidents) that could potentially have an adverse impact on our business. Such events could result in business interruption, service disruptions, theft of intellectual property and confidential information, additional regulatory scrutiny, litigation and reputational damage. To manage our information technology risk, we have established an enterprise-wide Information Technology Risk Management Framework. Information management risk Information management risk is the risk of loss or harm resulting from the failure to manage information appropriately throughout its life-cycle. Exposure to this risk exists when information is acquired or created, processed, used, shared, accessed, retained or disposed. With respect to personal information, the failure to manage information appropriately can result in the misuse of personal information or privacy breaches. With respect to client information, the inability to process information accurately and on a timely basis can result in service disruptions. With respect to corporate and proprietary information, the mismanagement of information can result in the disclosure of confidential information, the unavailability of information when it is required and the reliance on inaccurate information for decision-making purposes. Such events could lead to legal and regulatory consequences, reputational damage and financial loss. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 83 Third-party and outsourcing risk Failing to effectively manage our service providers may expose us to service disruptions, regulatory action, financial loss, litigation or reputational damage. Third-party and outsourcing risk has received increased oversight from regulators and attention from the media. We formalized and standardized our expectations of our suppliers with a principles-based supplier code of conduct to ensure their behaviour aligns with our standards in the following key areas: business integrity, responsible business practices, responsible treatment of individuals, and the environment. Social media The scale and profile of social media has grown to present a number of risks. These risks include brand and reputational damage, information leaks, non-compliance with regulatory requirements and governance risk. To manage the risks associated with social media, we have implemented an enterprise-wide policy as well as business unit policies on the usage of external social media, which sets out the requirements for the business and corporate use of social media and is part of our larger Social Media Governance Framework. Processing and execution risk Processing and execution risk is the risk of failure to effectively design, implement and execute a process. Exposure to this risk is global, existing in all of our locations and operations, and in our employee’s actions. Examples of processing and execution events range from selecting the wrong interest rates, duplicating wire payment instructions, transposing figures, processing a foreign exchange transaction incorrectly, underinsuring a property and incorrectly investing funds. The potential impacts of such events include financial loss, legal and regulatory consequences and reputational damage. When identified, these situations are assessed, analyzed and mitigating actions are undertaken. Fraud Fraud risk is defined as the risk of intentional unauthorized activities designed to obtain benefits either from us or assets under our care, or using our products. Fraud can be initiated by one or more parties who can include employees, potential or existing clients, agents, suppliers or outsourcers, or other external parties. We have extensive professional resources allocated for the recovery of lost assets as a result of fraudulent activity or operational errors, as well as the improvement of loss avoidance experience through both enhanced intelligence and aggressive pursuit of those who attack enterprise assets. Operational risk capital On May 10, 2016, OSFI approved our application to use the Advanced Measurement Approach (AMA) for operational risk, subject to a capital floor. In Q3 2016, we formally began utilizing AMA to report regulatory capital. Operational risk loss events During 2016, we did not experience any material operational risk loss event. For further details on our contingencies, including litigation, refer to Notes 26 and 27 of our 2016 Annual Consolidated Financial Statements. Regulatory compliance risk Regulatory compliance risk is the risk of potential non-conformance with laws, rules, regulations and prescribed practices in any jurisdiction in which we operate. Issues regarding compliance with laws and regulations can arise in a number of areas in a large complex financial institution such as RBC, and are often the result of inadequate or failed internal processes, people or systems. Laws and regulations are in place to protect the financial and other interests of our clients, investors and the public. As a large-scale global financial institution, we are subject to numerous laws and to extensive and evolving regulation by governmental agencies, supervisory authorities and self-regulatory organizations in Canada, the U.S., Europe and other jurisdictions in which we operate. In recent years, such regulation has become increasingly extensive and complex. In addition, the enforcement of regulatory matters has intensified. Recent resolution of such matters involving other global financial institutions have involved the payment of substantial penalties, agreements with respect to future operation of their business, actions with respect to relevant personnel and guilty pleas with respect to criminal charges. Operating in this increasingly complex regulatory environment and intense regulatory enforcement environment, we are and have been subject to a variety of legal proceedings, including civil claims and lawsuits, criminal charges, regulatory examinations, investigations, audits and requests for information by various governmental regulatory agencies and law enforcement authorities in various jurisdictions, and we anticipate that our ongoing business activities will give rise to such matters in the future. Changes to laws, including tax laws, regulations or regulatory policies, as well as the changes in how they are interpreted, implemented or enforced, could adversely affect us, for example, by lowering barriers to entry in the businesses in which we operate, increasing our costs of compliance or limiting our activities and ability to execute our strategic plans. Further, there is no assurance that we always will be or will be deemed to be in compliance with laws, regulations or regulatory policies. Accordingly, it is possible that we could receive a judicial or regulatory judgment or decision that results in fines, damages, penalties, and other costs or injunctions, criminal convictions or loss of licences or registrations that would damage our reputation and negatively impact our earnings. In addition, we are subject to litigation arising in the ordinary course of our business and the adverse resolution of any litigation could have a significant adverse effect on our results or could give rise to significant reputational damage, which in turn could impact our future business prospects. Global compliance has developed a Regulatory Compliance Management Framework consistent with regulatory expectations from OSFI and other regulators. The framework is designed to manage and mitigate the regulatory compliance risks associated with failing to comply with, or adapt to, current and changing laws and regulations in the jurisdictions in which we operate. Regulatory compliance risk has been further defined as risks associated with financial crime (which includes, but is not limited to, money laundering, bribery and sanctions), privacy, market conduct, consumer protection, business conduct and prudential requirements. Specific compliance policies, procedures and supporting frameworks have been developed to support the minimum requirements for the prudent management of regulatory compliance risk. Within the framework there are six elements that form a cycle by which all regulatory compliance risk management programs are developed, implemented and maintained. The cycle revolves around and is informed by the people, processes, and technology that exist within the organization. • • Global compliance practices and methodologies: compliance policies, processes and methodologies that drive the regulatory compliance management approach. Regulatory compliance requirements: laws, rules and regulations with which we must comply. 84 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis • • • • Risk assessment: identification and assessment of regulatory compliance risk to ensure appropriate risk-based monitoring and testing programs are in place. Monitoring and testing: risk-based activities conducted to assess compliance with regulatory requirements. Issues identification and management: identification, timely escalation and management of compliance related issues. Communication and reporting: timely, accurate and complete reporting to key stakeholders, senior management and the Board of Directors. Strategic risk Strategic risk is the risk that the enterprise or particular business areas will make inappropriate strategic choices, or will be unable to successfully implement selected strategies or related plans and decisions. Business strategy is the major driver of our risk profile and consequently the strategic choices we make in terms of business mix determine how our risk profile changes. Responsibility for selecting and successfully implementing business strategies is mandated to the individual heads of the businesses. Oversight of strategic risk is the responsibility of the heads of the business segments and their operating committees, the Enterprise Strategy Office, Group Executive, and the Board of Directors. The Enterprise Strategy group supports the management of strategic risk through the strategic planning process (articulated within our Enterprise Strategic Planning Policy) ensuring alignment across our business, financial, capital and risk planning. For details on the key strategic priorities for our business segments, refer to the Business segment results section. Reputation risk Reputation risk is the risk that an activity undertaken by an organization or its representatives will impair its image in the community or lower public confidence in it, resulting in the loss of business, legal action or increased regulatory oversight. Reputation risk can arise from a number of events and primarily occurs in connection with credit risk, regulatory, legal and operational risks and failure to maintain strong risk conduct. Operational failures and non-compliance with laws and regulations can have a significant reputational impact on us. We have put in place a Reputation Risk Framework which provides an overview of our approach to the management of this risk. It focuses on our organizational responsibilities, and controls in place to mitigate reputation risks. The following principles guide our management of reputation risk: • We must operate with integrity at all times in order to sustain a strong and positive reputation. • Protecting our reputation is the responsibility of all our employees, including senior management, and extends to the Board of Directors. Legal and regulatory environment risk Certain regulatory reforms will impact the way in which we operate, both in Canada and abroad, and the full impact of some of these reforms on our business will not be known until final rules are implemented and market practices have developed in response. We continue to respond to these and other developments and are working to minimize any potential adverse business or economic impact. The following regulatory reforms have potential to increase our operational, compliance, and technology costs and adversely affect our profitability. Canadian Housing Market and Consumer Debt The Government of Canada (GoC) continues to express concerns with the level and sustainability of Canadian household debt, driven in part by higher levels of mortgage debt as a result of persistent and unprecedented low interest rates and continued elevation of house prices in the Vancouver and Toronto markets. The Office of the Superintendent of Financial Institutions (OSFI) has introduced a number of measures to address these concerns. These include updates to the regulatory capital requirements for loans secured by residential real estate, effective November 1, 2016, and proposals issued on September 23, 2016 to change the regulatory framework for mortgage insurers to better align capital requirements to market conditions and more accurately reflect underlying risks. In addition, on July 7, 2016, OSFI released a letter to all federally regulated financial institutions (FRFIs) outlining the regulator’s expectation for the internal controls and risk management practices of mortgage lenders and insurers to be sound and take into account changing market developments. The GoC has also been studying the Canadian housing market, particularly in areas such as affordability, supply and demand, and long-term sustainability, and, on October 3, 2016, announced additional measures. These include: (i) standardizing the eligibility criteria for high- and low-ratio insured mortgages (effective November 30, 2016); (ii) introducing a mortgage rate stress test for all insured mortgages (effective October 17, 2016); (iii) modifying eligibility for the capital gains tax exemption on the sale of a principal residence by non-residents and certain trusts; and (iv) expanding the authority of the Canada Revenue Agency to improve compliance and administration of the tax system with respect to the disposition of real estate. In addition, the GoC announced it will be holding further public consultations on whether lender- risk sharing for government-backed insured mortgages could enhance the current system. Credit Cards and Interchange Fees On September 14, 2016, the GoC announced its intention to further assess the fees charged by credit card networks in order to ensure adequate competition and transparency for Canadian businesses and consumers when it comes to the fees they incur when using credit cards. At the same time, the GoC indicated it will review the effects of the November 2014 voluntary fee reductions undertaken by Visa and MasterCard‡. Supervision of Foreign Banking Organizations (FBO) On February 18, 2014, the U.S. Federal Reserve (Fed) finalized a new oversight regime for non-U.S. banks with subsidiaries, affiliates and branches operating in the U.S. The Enhanced Prudential Standards applies to all Bank Holding Companies and FBOs and is intended to address the perceived systemic risk that large foreign banks could pose to U.S. financial markets. As an FBO with more than US$50 billion in U.S. non-branch assets, we were required to establish a separately capitalized U.S. Intermediate Holding Company (IHC), into which all of our U.S. legal entities must be placed and for which certain U.S.-based requirements apply. The IHC is subject to Fed oversight comparable to U.S. bank holding companies. On November 2, 2015, our existing U.S. holding company, RBC USA Holdco Corporation, became a U.S. bank holding company, subjecting it to certain U.S.-based requirements as a result of our acquisition of City National Bank Corporation, a U.S. insured depository institution. As of July 1, 2016, our required non-branch and non-agency U.S. assets were transferred into our U.S. holding company in order to establish the requisite IHC as it applies to RBC as an FBO. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 85 On March 4, 2016, the Fed re-proposed a rule to limit the credit exposures of large banking organizations, including FBOs and IHCs, to any single counterparty or group of related counterparties. We expect we will need to modify our existing systems and put in place appropriate monitoring and reporting mechanisms in order to comply with the prescribed limits by the implementation deadline that will be established once the final rule is issued. If the rule is adopted as proposed, compliance will be required to be met daily, with monthly reporting to the Fed evidencing compliance. We continue to enhance our existing risk management oversight and governance framework and practices in order to provide the governance and infrastructure needed to implement and support the remaining FBO-related requirements over the next several years, including those that relate to U.S. stress test and capital planning requirements. Canadian Bail-in Regime Bail-in regimes are being implemented in a number of jurisdictions in an effort to limit taxpayer exposure to potential losses of a failing institution and ensure the institution’s shareholders and creditors remain responsible for bearing such losses. On April 20, 2016, the GoC introduced legislation to create a bank recapitalization or “bail-in” regime for the six domestic systemically important banks (D-SIBs). On June 22, 2016, legislation came into force, amending the Bank Act, the Canada Deposit Insurance Corporation Act and certain other federal statutes pertaining to banks to create such a regime for D-SIBs. Under the regime, if OSFI is of the opinion that a D-SIB has ceased or is about to cease to be viable and its viability cannot be restored through the exercise of the Superintendent’s powers, the GoC can direct the Canada Deposit Insurance Corporation to convert certain shares and liabilities of the bank into common shares of the bank or its affiliates. The shares and liabilities that will be subject to conversion, as well as the terms and conditions of conversion, will be prescribed by regulations to be made at a future date. The legislation also provides that OSFI will require such designated D-SIBs to maintain a minimum capacity to absorb losses, also known as total loss-absorbing capital (TLAC). While the specific parameters around conversion and loss-absorbency are not yet known, these changes are not expected to have a material impact on our cost of long-term unsecured funding. Total Loss-Absorbing Capacity (TLAC) On November 9, 2015, the Financial Stability Board (FSB) finalized minimum common international standards related to TLAC of global systemically important banks (G-SIBs). The standards are intended to address the sufficiency of G-SIBs’ capital to absorb losses in a resolution situation in a manner that minimizes impact on financial stability and ensures continuity of critical and long-term debt functions. Under the final standards, G-SIBs would be expected to meet a 16% Risk-Weighted Asset (RWA) requirement by 2019, increasing to 18% by 2022. In addition, G-SIBs would be expected by 2019 to maintain a TLAC leverage ratio exposure of 6% of the Basel III leverage ratio denominator, increasing to 6.75% by 2022. We would become subject to these enhanced requirements if we are designated as a G-SIB by the FSB in the future. To date, neither RBC nor any other Canadian bank has been designated as a G-SIB. It is also uncertain how these standards will be integrated into the Canadian bail-in regime described above. On October 30, 2015, the Fed proposed rules establishing TLAC, long-term debt, and “clean holding company” requirements for U.S. G-SIBs and the IHCs of non-U.S. G-SIBs. We are not covered at this time by the proposal, but our U.S. IHC would become subject to these U.S. requirements should we be designated as a G-SIB in the future. Global Over-the-Counter (OTC) Derivatives Reform OTC derivatives reform continues on a global basis, with G20 governments transforming the capital regimes, regulatory frameworks and infrastructures in which market participants operate. On September 1, 2016, we began to exchange margin on bilateral OTC derivatives in accordance with U.S. regulatory guidelines and expect to become subject to Canadian rules on March 1, 2017. We will also be subject to EU and other jurisdictions’ margin rules once deadlines are finalized. Global margin rules represent a fundamental change in how non-centrally cleared OTC derivatives are traded and require specific documents to be in place with all in-scope counterparties. To avoid duplicative regulatory requirements and to mitigate banks’ regulatory costs, the Commodity Futures Trading Commission (CFTC) has issued substituted compliance relief to us and other Canadian banks who are registered as non-U.S. swap dealers. Such relief allows us to comply with Canadian rules in areas deemed comparable by the CFTC. We, along with other Canadian banks, continues to engage with the CFTC to ensure ongoing availability of no-action relief and substituted compliance determinations in connection with these U.S. rules. OTC derivatives reform in the EU is implemented through the European Market Infrastructure Regulation (EMIR) and the review of Markets in Financial Instruments Directive and accompanying Regulation (together, MiFID II/MiFIR). EU regulations will introduce requirements that certain products be traded on a new trading venue category, subject to a determination of sufficient liquidity by the European Securities and Markets Authority (ESMA), for certain OTC derivatives that ESMA has deemed to be subject to the clearing obligation under EMIR. The EU also announced it would delay implementation of MiFID II/MiFIR until January 2018. Uniform Fiduciary Standards On April 6, 2016, the U.S. Department of Labor issued a final rule establishing a uniform fiduciary standard for providers of investment advice and related services in connection with U.S. retirement plans and holders of individual retirement accounts, effective April 10, 2017. As reported previously, the rule will impose new requirements and costs on our U.S. Wealth Management brokers and investment advisors who currently provide individualized investment advice according to a “suitability” standard rather than a fiduciary interest standard. On April 28, 2016, the Canadian Securities Administrators proposed their own version of a regulatory “best interest standard” intended to replace the current requirement for registered advisors, dealers and representatives to deal “fairly, honestly, and in good faith” with their clients. Similar standards have been proposed or finalized in other jurisdictions, including the U.K. and Australia. While these impacts are not expected to materially affect our overall results, the U.S. rules could significantly impact our U.S. Wealth Management business. We are considering ways to minimize these impacts, including through changes to our current business structure and product offerings. Regulatory Capital and Related Requirements We continue to monitor and prepare for developments related to regulatory capital. The BCBS has issued a number of proposed revisions and new measures on a consultative basis that would reform the manner in which banks calculate, measure, and report regulatory capital and related risks, including with respect to the use of banks’ own internal risk models. The impact of these proposals on us will depend on the final standards adopted by the BCBS and how these standards are implemented by our regulators. The BCBS expects these proposals to have a relatively modest impact on capital and leverage for most banks upon finalization. For further details on regulatory capital and related requirements, refer to the Capital Management section. 86 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis U.K. and European regulatory reform In March 2016, certain RBC entities became subject to the U.K. Senior Managers Regime, which places a statutory duty on certain employees to take reasonable steps to prevent regulatory breaches in their areas of responsibility. A certification regime also applied to employees performing ‘significant harm’ roles. New conduct rules will also apply to in-scope employees from March 2017. The Market Abuse Regulation became effective July 2016 and brought changes to the civil regime for market abuse in the EU, establishing rules relating to investment recommendations, market soundings, insider lists, and monitoring of suspicious transactions and orders. Various articles within the Securities Financing Transactions Regulation took effect in 2016, including conditions around the re-use of collateral provided in the form of securities by EU counterparties. The Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, effective December 2016, requires prescribed disclosure documents to be provided to retail investors before they purchase PRIIPs. We will be responsible for creating and updating these documents for products which are manufactured by us, and for providing the relevant documents to clients who purchase PRIIPs from us, whether manufactured by us or by third parties. MiFID II/MiFIR becomes effective January 2018 and will have a significant technological and procedural impact for certain businesses operating in the EU. The reforms will introduce changes to pre- and post-trade transparency, market structure, trade and transaction reporting, algorithmic trading, and conduct of business. Following the result of the June 2016 referendum, the U.K. is planning to exit the EU. A formal notice of the U.K. Government’s intention to withdraw from the EU must be provided to European Council, triggering a two-year negotiation period during which the terms of the U.K.’s exit will be determined. Until those negotiations are concluded or the negotiation period expires, the U.K. will remain an EU Member State, subject to all EU legislation. Competitive risk The competition for clients among financial services companies in the markets in which we operate is intense. Client loyalty and retention can be influenced by a number of factors, including new technology used or services offered by our competitors, relative service levels, relative prices, product and service attributes, our reputation, actions taken by our competitors, and adherence with competition and anti-trust laws. Other companies, such as insurance companies and non-financial companies, are increasingly offering services traditionally provided by banks. For example, our payments business is facing intense competition from emerging non-traditional competitors. This competition could also reduce net interest income, fee revenue and adversely affect our results. Systemic risk Systemic risk is the risk that the financial system as a whole, or a major part of it – either in an individual country, a region, or globally – is put in real and immediate danger of collapse or serious damage with the likelihood of material damage to the economy, and that this will result in financial, reputation or other risks for us. Systemic risk is considered to be the least controllable risk facing us. Our ability to mitigate this risk when undertaking business activities is limited, other than through collaborative mechanisms between key industry participants, and, as appropriate, the public sector, to reduce the frequency and impact of these risks. The two most significant measures in mitigating the impact of systemic risk are diversification and stress testing. Our diversified business portfolios, products, activities and funding sources help mitigate the potential impacts from systemic risk. We also mitigate systemic risk by establishing risk limits to ensure our portfolio is well-diversified, and concentration risk is reduced and remains within our risk appetite. Stress testing involves consideration of the simultaneous movements in a number of risk factors. It is used to ensure our business strategies and capital planning are robust by measuring the potential impacts of credit, market, liquidity and funding and operational risks on us, under adverse economic conditions. Our enterprise-wide stress testing program uses stress scenarios featuring a range of severities based on plausible adverse economic and financial market events. These stress scenarios are evaluated across the organization, and results are integrated to develop an enterprise-wide view of the impacts on our financial results and capital requirements. For further details on our stress testing, refer to the Risk management – Enterprise risk management section. Overview of other risks In addition to the risks described in the Risk management section, there are other risk factors, described below, which may adversely affect our businesses and financial results. The following discussion is not exhaustive as other factors could also adversely affect our results. Business and economic conditions Our earnings are significantly affected by the general business and economic conditions in the geographic regions in which we operate. These conditions include consumer saving and spending habits as well as consumer borrowing and repayment patterns, business investment, government spending, exchange rates, sovereign debt risks, the level of activity and volatility of the capital markets, strength of the economy and inflation. For example, an extended economic downturn may result in high unemployment and lower family income, corporate earnings, business investment and consumer spending, and could adversely affect the demand for our loan and other products and result in higher provisions for credit losses. Given the importance of our Canadian operations, an economic downturn in Canada or in the U.S. impacting Canada would largely affect our personal and business lending activities in our Canadian banking businesses, including mortgages and credit cards, and could significantly impact our results of operations. Our earnings are also sensitive to changes in interest rates. A continuing low interest rate environment in Canada, the U.S. and globally would result in net interest income being unfavourably impacted by spread compression largely in Personal & Commercial Banking and Wealth Management. While an increase in interest rates would benefit our businesses that are currently impacted by spread compression, a significant increase in interest rates could also adversely impact household balance sheets. This could result in credit deterioration which might negatively impact our financial results, particularly in some of our personal and commercial banking and Wealth Management businesses. Deterioration in global capital markets could result in volatility that would impact results in Capital Markets while in Wealth Management, weaker market conditions would lead to lower average fee-based client assets and transaction volumes. In addition, worsening financial and credit market conditions may adversely affect our ability to access capital markets on favourable terms and could negatively affect our liquidity, resulting in increased funding costs and lower transaction volumes in Capital Markets and Investor & Treasury Services. For further details on Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 87 economic and market factors which may impact our financial performance, refer to the Wealth Management, Investor & Treasury Services and Capital Markets sections. Government fiscal, monetary and other policies Our businesses and earnings are affected by the fiscal, monetary or other policies that are adopted by the Bank of Canada and various other Canadian regulatory authorities, the Fed in the U.S. and other U.S. government authorities, as well as those adopted by international regulatory authorities and agencies in jurisdictions in which we operate. Such policies can also adversely affect our clients and counterparties in Canada, the U.S. and internationally, which may increase the risk of default by such clients and counterparties. Tax risk and transparency Tax risk refers to the risk of loss related to unexpected tax liabilities. The tax laws and systems that are applicable to RBC are complex and wide ranging. As a result, we ensure that any decisions or actions related to tax always reflect our assessment of the long-term costs and risks involved, including their impact on our relationship with clients, shareholders, and regulators, and our reputation. Our approach to tax is governed by our Taxation Policy and Risk Management Framework, and reflects the fundamentals of our Risk Pyramid. Oversight of our tax policy and the management of tax risk is the responsibility of Group Executive, the CAO & CFO and the Senior Vice President, Taxation. We discuss our tax position with the Audit Committee on a regular basis and discuss our tax strategy with the Audit and Risk Committees. Our tax strategy is designed to ensure transparency and support our business strategy, and is aligned with our corporate vision and values. We seek to maximize shareholder value by ensuring that our businesses are structured in a tax-efficient manner while considering reputational risk by being in compliance with all laws and regulations. Our framework seeks to ensure that we: • • • • Act with integrity and in a straightforward, open and honest manner in all tax matters; Ensure tax strategy is aligned with our business strategy supporting only bona fide transactions with a business purpose and economic substance; Ensure our full compliance and full disclosure to tax authorities of our statutory obligations; and Endeavour to work with the tax authorities to build positive long-term relationships and where disputes occur, address them constructively. With respect to assessing the needs of our clients, we consider a number of factors including the purposes of the transaction. We seek to ensure that we only support bona fide client transactions with a business purpose and economic substance. Should we become aware of client transactions that are aimed at evading their tax obligations, we will not proceed with the transaction. We operate in 38 countries worldwide. Our activities in these countries are subject to both Canadian and international tax legislation and other regulation, and are fully disclosed to the relevant tax authorities. The Taxation group and GRM both regularly review the activities of all entities to ensure compliance with tax requirements and other regulations. Given that we operate globally, complex tax legislation and accounting principles has resulted in differing legal interpretations between the respective tax authorities we deal with and ourselves, and we are at risk of tax authorities disagreeing with prior positions we have taken for tax purposes. When this occurs, we are committed to an open and transparent dialogue with the tax authorities to ensure a quick assessment and prompt resolution of the issues where possible. Failure to adequately manage tax risk and resolve issues with tax authorities in a satisfactory manner could adversely impact our results, potentially to a material extent in a particular period, and/or significantly impact our reputation. Tax contribution In 2016, total income and other tax expense to various levels of governments globally totalled $3.8 billion (2015 – $3.1 billion; 2014 – $3.2 billion). In Canada, total income and other tax expense for the year ended October 31, 2016 to various levels of government totalled $2.8 billion (2015 – $1.9 billion; 2014 – $2.2 billion). Income and other tax expense – by category (Millions of Canadian dollars) Income and other tax expense – by geography (Millions of Canadian dollars) 4,000 3,000 2,000 1,000 0 4,000 3,000 2,000 1,000 0 2016 2015 2014 2016 2015 2014 Business taxes Insurance premium taxes Property taxes Other International U.S. Canada Capital taxes Payroll taxes Income taxes Goods and services sales taxes For further details on income and other tax expense, refer to the Financial performance section. Environmental risk Environmental risk is the risk of loss to financial, operational or reputational value resulting from the impact of environmental issues. It arises from the business activities and operations of both us and our clients. Environmental issues that lead to environmental risk are broad and may include: air emissions, wastewater discharge, waste management, site contamination, environmental regulation, climate change and community and social impacts. Group Risk Management (GRM) is responsible for establishing policy requirements for the identification, assessment, control, monitoring and reporting of environmental risk, and for ensuring the policies are reviewed and updated periodically. The environmental risk associated with our clients and their operations is evaluated in order to establish the due diligence requirements for transactions. Business segments and corporate functions are responsible for incorporating environmental risk management requirements and controls within their operations. 88 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis We are a signatory to the Equator Principles and applies its credit risk management framework to determine, assess and manage environmental and social risks in project finance transactions. RBC Global Asset Management is a signatory to the UN Principles for Responsible Investment. Our approach to responsible investment integrates environmental, social and governance (ESG) issues into the investment process when doing so may have a material impact on our investment risk or return. Through the Carbon Disclosure Project we regularly publish corporate disclosure on risks associated with climate change and the management of greenhouse gas emissions from our own operations. We will continue to investigate and assess climate change risks related to the physical effects of changing climate, transitioning to a low-carbon economy, and regulatory requirements, and appropriate future climate-related financial disclosures. RBC Corporate Citizenship sets corporate environmental strategy and reports annually on environmental management in the Corporate Responsibility Report and Public Accountability Statements. Property insurance businesses can be affected due to changing climate patterns and an increase in the number and cost of claims associated with severe storms and other natural disasters. On July 1, 2016, we completed the sale of RBC General Insurance Company to Aviva Canada Inc., which involved the sale of our home and auto insurance manufacturing business. RBC Insurance had already exited the Property Reinsurance market in 2006. As a result of these transactions, RBC Insurance does not have any exposure to losses related to property and auto insurance. Other factors Other factors that may affect actual results include changes in government trade policy, changes in accounting standards, including their effect on our accounting policies, estimates and judgments, currency and interest rate movements in Canada, the U.S., and other jurisdictions in which we operate, changes to our credit ratings, the timely and successful development of new products and services, technological changes, effective design, implementation and execution of processes and their associated controls, fraud by internal and external parties, the possible impact on our business from disease or illness that affects local, national or global economies, disruptions to public infrastructure, including transportation, communication, power and water, international conflicts and other political developments including those relating to the war on terrorism, and our success in anticipating and managing the associated risks. We caution that the foregoing discussion of risk factors, many of which are beyond our control, is not exhaustive and other factors could also affect our results. Capital management We actively manage our capital to maintain strong capital ratios and high ratings while providing strong returns to our shareholders. In addition to the regulatory requirements, we consider the expectations of credit rating agencies, depositors and shareholders, as well as our business plans, stress tests, peer comparisons and our internal capital ratio targets. Our goal is to optimize our capital usage and structure, and provide support for our business segments and clients and better returns for our shareholders, while protecting depositors and senior creditors. Capital management framework Our capital management framework provides the policies and processes for defining, measuring, raising and investing all types of capital in a co-ordinated and consistent manner. It includes our overall approach to capital management, including guiding principles as well as roles and responsibilities relating to capital adequacy and transactions, dividends, solo capital and management of risk-weighted assets (RWA) and leverage ratio exposures. We manage and monitor capital from several perspectives, including regulatory capital, economic capital and subsidiary capital. Our capital planning is a dynamic process which involves various teams including Finance, Corporate Treasury, GRM, Economics and our businesses, and covers internal capital ratio targets, potential capital transactions as well as projected dividend payouts and share repurchases. The integral parts of our capital planning are comprised of our business operating plans, enterprise-wide stress testing and Internal Capital Adequacy Assessment Process (ICAAP), along with the considerations of regulatory capital requirements and accounting changes, internal capital requirements, rating agency metrics and solo capital. Our capital plan is established on an annual basis and is aligned with the management actions included in the annual business operating plan, which includes forecast growth in assets and earnings taking into account our business strategies, projected market and economic environment and peer positioning. This includes incorporating potential capital transactions based on our projected internal capital generation, business forecasts, market conditions and other developments, such as accounting and regulatory changes that may impact capital requirements. All of the components in the capital plan are monitored throughout the year and are revised as deemed appropriate. Capital impacts of severe but plausible scenarios Enterprise-wide Stress Testing Capital impacts of severe but plausible scenarios ICAAP Total capital requirements Capital available and target capital ratios Capital Plan and Business Operating Plan Our Enterprise-wide stress testing and ICAAP provide key inputs for capital planning, including setting the appropriate internal capital ratio targets. The stress scenarios are evaluated across the organization, and results are integrated to develop an enterprise-wide view of financial impacts and capital requirements, which in turn facilitate the planning of mitigating actions to absorb exceptional adverse events. ICAAP is an OSFI mandated annual process to assess capital adequacy and requirements to cover all material risks, with a cushion to cover severe but plausible contingencies. In accordance with the OSFI guideline, the major components of our ICAAP process include comprehensive risk assessment, stress testing, capital assessment and planning (both economic and regulatory capital), board and senior management oversight, monitoring and reporting and internal control review. Our internal capital targets are established to maintain robust capital positions in excess of OSFI’s Basel III “all-in” regulatory targets. The stress test results of our Enterprise-wide stress testing and ICAAP are incorporated into the OSFI capital conservation buffer and D-SIBs surcharge, with a view to ensuring the bank has adequate capital to underpin risks and absorb losses under all plausible stress scenarios given our risk profile and appetite. In addition, we include a discretionary cushion on top of the OSFI regulatory targets to maintain capital strength for forthcoming regulatory and accounting changes, peer comparatives, rating agencies sensitivities and solo capital level. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 89 The Board of Directors is responsible for ultimate oversight of capital management, including the annual review and approval of the Capital Plan. ALCO and GE share responsibility for capital management and receive regular reports detailing our compliance with established limits and guidelines. The Risk Committee annually approves the Capital Management Framework. The Audit and Risk Committees jointly approve the ICAAP process. The Audit Committee is also responsible for the ongoing review of internal controls over capital management. Basel III Our regulatory capital requirements are determined by guidelines issued by OSFI, which are based on the minimum Basel III capital ratios proposed by the Basel Committee on Banking Supervision (BCBS). Our capital requirements are determined at a consolidated level. The BCBS sets out the Basel III transitional requirements for Common Equity Tier 1 capital (CET1), Tier 1 capital and Total capital ratios at 5.125%, 6.625% and 8.625%, respectively for 2016, which would be required to be fully phased-in (“all-in”) to 7.0%, 8.5% and 10.5%, respectively, by January 1, 2019 (including minimums plus capital conservation buffer of 2.5%). However, other than providing phase-out rules for non-qualifying capital instruments, OSFI required Canadian banks to meet the BCBS Basel III “all-in” targets for CET1, Tier 1 capital and Total capital ratios in 2013. Effective January 1, 2016, we were required to include an additional 1% risk-weighted capital surcharge to each tier of capital for the above all-in requirements given our designation as a domestic systemic important bank (D-SIB) by OSFI in 2013 (similar to five other Canadian banks designated as D-SIBs). In 2014, OSFI also advised Canadian banks that it would begin phasing in the Credit Valuation Adjustment (CVA) risk capital charge required under the Basel III framework. In accordance with OSFI’s guidance, there are two possible options to phase in the CVA capital charge that a bank may consider. Under the option selected by RBC, the CVA capital charge for CET1, Tier 1 capital and Total capital was 64%, 71%, and 77%, respectively, for 2016. In 2017, the CVA capital charge will be 72%, 77% and 81%, respectively, and will reach 100% for each tier of capital by 2019. Under Basel III, banks select from two main approaches, the Standardized Approach or the Internal Ratings Based (IRB) Approach, to calculate their minimum regulatory capital required to support credit, market and operational risks. We adopted the Basel III IRB approach to calculate credit risk capital for consolidated regulatory reporting purposes. While the majority of our credit risk exposures are reported under the Basel III IRB Approach for regulatory capital purposes, certain portfolios continue to use the Basel III Standardized Approach for credit risk (for example, our Caribbean banking operations and City National). For consolidated regulatory reporting of market risk capital, we use both Internal Models-based and Standardized Approaches. For consolidated regulatory reporting of operational risk capital, we received approval from OSFI on May 10, 2016 for the use of the Advance Measurement Approach (AMA) for operational risk capital measurement subject to the application of a Standardized Approach floor. We commenced reflecting operational risk capital under the AMA in the third quarter of 2016. In October 2014, OSFI issued its “Leverage Requirements (LR) Guideline”, which replaced the OSFI Assets-to-Capital Multiple (ACM) with the Basel III Leverage ratio, beginning in the first quarter of 2015. The leverage ratio is defined as Tier 1 capital divided by leverage ratio exposure. The leverage ratio exposure is the sum of (a) on-balance sheet exposures; (b) derivative exposures; (c) securities financing transaction exposures and (d) off-balance sheet items. Canadian banks are expected to maintain a leverage ratio that meets or exceeds 3% at all times. All federally regulated banks with a Basel III leverage ratio total exposure exceeding €200 billion at their financial year-end are required, at a minimum, to publicly disclose in the first quarter following their year-end, the twelve indicators used in the G-SIB assessment methodology, with the goal of enhancing the transparency of the relative scale of banks’ potential global systemic importance and data quality. The FSB publishes an updated list of G-SIBs annually. We were not designated as a G-SIB as of November 2016. However, as we met the BCBS size threshold, we disclosed the 12 indicators using the OSFI prescribed template for the financial years ended 2014 and 2015 in our Q2 2016 Report to Shareholders. In January 2016, BCBS issued the revised minimum capital requirements for market risk, with an effective date no later than December 2019. The purpose of the revised market risk framework is to ensure that the standardized and internal model approaches to market risk deliver credible capital outcomes and promote consistent implementation of the standards across jurisdictions. In March 2016, the BCBS released a consultation paper entitled, “Pillar 3 disclosure requirements – consolidated and enhanced framework”. The proposed disclosure enhancements include the addition of a dashboard of key metrics and the disclosure of a risk-weighted asset benchmark determined only by the application of Basel standardized approaches, referred to as the hypothetical risk-weighted asset disclosure. In addition, the proposal also includes enhanced granularity for disclosure of prudent valuation adjustments and incorporates additions to the Pillar 3 framework to reflect ongoing reforms to the regulatory framework, such as the total loss-absorbing capacity regime for G- SIBs, the proposed operational risk framework, and the final standard for market risk. The BCBS’s proposal would also consolidate all existing Pillar 3 disclosure requirements of the Basel framework, including the leverage and liquidity ratios disclosure templates. Together with the BCBS Revised Pillar 3 disclosure requirements issued in January 2015, the proposed disclosure requirements included in this consultation paper would comprise the single Pillar 3 framework. OSFI originally required D-SIBs to implement the Basel Pillar 3 disclosure requirement by October 31, 2017, however, in August 2016, the implementation date was extended to October 31, 2018. OSFI’s final Pillar 3 guideline is expected to be issued in 2017. In July 2016, BCBS issued an updated version of the Basel III Document – Revisions to the securization framework, incorporating simple, transparent, and comparable securitization requirements. The revisions set out revised methodologies for the calculation of regulatory capital requirements for securitization exposures held by banks in the banking book in order to address certain shortcomings identified by the Basel Committee under the current Basel II securitization framework. It is expected to become effective in January 2018. We continue to monitor and prepare for developments related to regulatory capital and leverage. The BCBS has issued a number of proposed revisions and new measures on a consultative basis that would reform the manner in which banks calculate, measure, and report regulatory capital and related risks, including with respect to the use of banks’ own internal risk models. The BCBS is currently reviewing feedback and commentary on these revisions and will likely finalize these proposals in early 2017. The BCBS has indicated it does not expect these proposals to significantly increase capital and leverage for most banks upon finalization. 90 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis The following table provides a summary of OSFI regulatory target ratios under Basel III: Basel III – OSFI regulatory target Basel III Capital ratios and leverage OSFI regulatory target requirements for large banks under Basel III Minimum including Capital Conservation Buffer and D-SIB surcharge (1) Minimum including Capital Conservation Buffer Capital Conservation Buffer D-SIB Surcharge (1) Minimum Table 71 RBC capital and leverage ratios as at October 31, 2016 Meet or exceed OSFI regulatory target ratios Common Equity Tier 1 Tier 1 capital Total capital Leverage ratio > 4.5% > 6.0% > 8.0% > 3.0% 2.5% 2.5% 2.5% n.a. > 7.0% > 8.5% > 10.5% > 3.0% 1.0% 1.0% 1.0% n.a. > 8.0% > 9.5% > 11.5% > 3.0% 10.8% 12.3% 14.4% 4.4% ✓ ✓ ✓ ✓ (1) n.a. Effective January 1, 2016, the D-SIBs surcharge is applicable to risk-weighted capital. not applicable Regulatory capital, RWA and capital ratios Under Basel III, regulatory capital consists of CET1, Additional Tier 1 and Tier 2 capital. CET1 capital comprises the highest quality of capital. Regulatory adjustments under Basel III include full deductions of certain items and additional capital components that are subject to threshold deductions. Tier 1 capital comprises predominantly CET1 and Additional Tier 1 items including non-cumulative preferred shares that meet certain criteria. Tier 2 capital includes subordinated debentures that meet certain criteria, certain loan loss allowances and non-controlling interests in subsidiaries Tier 2 instruments. Total capital is defined as the sum of Tier 1 and Tier 2 capital. Preferred shares and subordinated debentures issued after January 1, 2013 require NVCC features to be included into regulatory capital. For further details on NVCC, refer to the discussion above. Regulatory capital ratios are calculated by dividing CET1, Tier 1 and Total capital by their respective RWA. The following chart provides a summary of the major components of CET1, Additional Tier 1 and Tier 2 capital. Total Capital Tier 1 Capital Common Equity Tier 1 (CET1) + Additional Tier 1 Capital + Tier 2 Capital Common shares Retained earnings Other components of equity Non-controlling interests in subsidiaries CET1 instruments Goodwill and other intangibles Deferred tax assets on loss carryforwards Defined benefit pension funds assets Non-significant investments in CET1 instruments of Financial Institutions(2) Shortfall of provisions to expected losses Significant investments in insurance subsidiaries and CET1 instruments in other Financial Institutions Mortgage servicing rights Deferred tax assets relating to temporary differences Higher quality capital s n o i t c u d e D d l o h s e r h T ) 1 ( s n o i t c u d e D Preferred shares Non-controlling interests in subsidiaries Tier 1 instruments Subordinated debentures Certain loan loss allowances Non-controlling interests in subsidiaries Tier 2 instruments Non-significant investments in Tier 1 instruments of Financial Institutions(2) Significant investments in other Financial Institutions and insurance subsidiaries Tier 1 instruments Non-significant investments in Tier 2 instruments of Financial Institutions(2) Significant investments in other Financial Institutions and insurance subsidiaries Tier 2 instruments Lower quality capital (1) (2) First level: The amount by which each of the items exceeds a 10% threshold of CET1 capital (after all deductions but before threshold deductions) will be deducted from CET1 capital. Second level: The aggregate amount of the three items not deducted from the first level above and in excess of 15% of CET1 capital after regulatory adjustments will be deducted from capital, and the remaining balance not deducted will be risk-weighted at 250%. Non-significant investments are subject to certain CAR criteria that drive the amount eligible for deduction. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 91 The following tables provide details on our regulatory capital, RWA and capital ratios. Our capital position remained strong and our capital ratios remain well above OSFI regulatory targets: Regulatory capital, risk-weighted assets (RWA) and capital ratios Table 72 (Millions of Canadian dollars, except percentage and multiple amounts and as otherwise noted) Capital (1) CET1 capital Tier 1 capital Total capital Risk-weighted Assets (RWA) used in calculation of capital ratios (1), (2) CET1 capital RWA Tier 1 capital RWA Total capital RWA Total capital RWA consisting of: (1) Credit risk Market risk Operational risk Total capital RWA Capital ratios and Leverage ratio (1), (3) CET1 ratio Tier 1 capital ratio Total capital ratio Leverage ratio Leverage ratio exposure (billions) As at October 31 2016 October 31 2015 $ $ 48,181 55,270 64,950 43,715 50,541 58,004 447,436 448,662 449,712 411,756 412,941 413,957 $ 369,751 23,964 55,997 $ 323,870 39,786 50,301 $ 449,712 $ 413,957 10.8% 12.3% 14.4% 4.4% 1,265.1 $ 10.6% 12.2% 14.0% 4.3% 1,170.2 $ (1) (2) (3) Capital, RWA, and capital ratios are calculated using OSFI Capital Adequacy Requirements based on the Basel III framework. Leverage ratios are calculated using OSFI Leverage Requirements Guideline based on the Basel III framework. In 2015 and 2016, the CVA scalars of 64%, 71% and 77% were applied to CET1, Tier 1 and Total Capital, respectively. In fiscal 2017, the scalars will be 72%, 77% and 81%, respectively. To enhance comparability among other global financial institutions, our transitional CET1, Tier 1, Total capital and leverage ratios as at October 31, 2016 were 11.8%, 12.3%, 14.4%, and 4.5%, respectively. Transitional is defined as capital calculated according to the current year’s phase-in of regulatory adjustments and phase-out of non-qualifying capital instruments. 92 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Regulatory Capital (Millions of Canadian dollars) CET1 capital: instruments and reserves and regulatory adjustments Directly issued qualifying common share capital (and equivalent for non-joint stock companies) plus related stock surplus Retained earnings Accumulated other comprehensive income (and other reserves) Directly issued capital subject to phase out from CET1 (only applicable to non-joint stock companies) Common share capital issued by subsidiaries and held by third parties (amount allowed in group CET1) Regulatory adjustments applied to CET1 under Basel III Common Equity Tier 1 capital (CET1) Additional Tier 1 capital: instruments and regulatory adjustments Directly issued qualifying Additional Tier 1 instruments plus related stock surplus Directly issued capital instruments to phase out from Additional Tier 1 Additional Tier 1 instruments issued by subsidiaries and held by third parties (amount allowed in group AT1) Regulatory adjustments applied to Additional Tier 1 under Basel III Additional Tier 1 capital (AT1) Tier 1 capital (T1 = CET1 + AT1) Tier 2 capital: instruments and provisions and regulatory adjustments Directly issued qualifying Tier 2 instruments plus related stock surplus Directly issued capital instruments subject to phase out from Tier 2 Tier 2 instruments issued by subsidiaries and held by third parties (amount allowed in group Tier 2) Collective allowance Regulatory adjustments applied to Tier 2 under Basel III Tier 2 capital (T2) Table 73 All-in basis 2016 2015 $ 18,161 41,217 4,926 $ 14,739 37,645 4,626 – – 13 (16,136) 13 (13,308) $ 48,181 $ 43,715 3,825 3,261 3 – 2,350 4,473 3 – 7,089 6,826 $ 55,270 $ 50,541 6,630 2,738 18 294 – 3,073 4,227 29 134 – $ 9,680 $ 7,463 Total capital (TC = T1 + T2) $ 64,950 $ 58,004 2016 vs. 2015 Continuity of CET1 ratio (Basel III) 123 bps 18 bps (94) bps 10.6% (24) bps (9) bps 10.8% October 31, 2015 (1) Internal capital generation (2) Net FX Impact CNB acquisition Pension and post-employment benefit obligations Share repurchases October 31, 2016 (1) (1) (2) Represents rounded figures. Internal capital generation includes $5.1 billion which represents Net income available to shareholders, less common and preferred shares dividends and excludes $235 million relating to the gain on the sale of RBC General Insurance Company to Aviva Canada Inc. Our CET1 ratio was 10.8%, up 20 bps from last year, mainly reflecting internal capital generation and the impact of foreign exchange translation. These factors were partially offset by the acquisition of City National, the impact of lower discount rates in determining our pension and other post-employment benefit obligations, and share repurchases. Our Tier 1 capital ratio of 12.3% was up 10 bps, mainly due to the factors noted above under the CET1 ratio and the net issuance of additional Tier 1 capital instruments. Our Total capital ratio of 14.4% was up 40 bps, mainly due to the factors noted above under the Tier 1 capital ratio and the net issuance of subordinated debentures. Our Leverage ratio was up 10 bps, mainly due to internal capital generation, partially offset by the acquisition of City National and higher leverage ratio exposures reflecting business growth, primarily in loans. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 93 Basel III RWA OSFI requires banks to meet minimum risk-based capital requirements for exposures to credit risk, operational risk, and, where they have significant trading activity, market risk. RWA is calculated for each of these risk types and added together to determine total RWA. In addition, OSFI requires the minimum risk-based capital to be no less than 90% of the capital requirements as calculated under the Basel I standards. If the capital requirement is less than 90%, a transitional adjustment to RWA must be applied as prescribed by OSFI CAR guidelines. Total capital risk-weighted assets As at October 31 (Millions of Canadian dollars, except percentage amounts) Credit risk Lending-related and other Residential mortgages Other retail Business Sovereign Bank 2016 Risk-weighted assets Table 74 2015 Standardized approach Advanced approach Other Total Total Average of risk weights (2) Exposure (1) $ 232,398 230,376 319,208 103,218 123,799 7% $ 23% 58% 9% 10% 6,546 $ 10,818 $ 5,632 42,933 2,929 2,161 46,532 143,352 6,847 9,640 – $ 17,364 52,164 – 186,285 – 9,776 – 11,801 – $ 12,797 51,157 151,565 9,175 7,695 Total lending-related and other $ 1,008,999 27% $ 60,201 $ 217,189 $ – $ 277,390 $ 232,389 Trading-related Repo-style transactions Derivatives – including CVA – CET1 phase-in adjustment $ 396,013 2% $ 69 $ 7,780 $ 75 $ 7,924 $ 6,680 96,565 31% 815 17,197 11,784 29,796 29,332 Total trading-related $ 492,578 8% $ 884 $ 24,977 $ 11,859 $ 37,720 $ 36,012 Total lending-related and other and $ 1,501,577 2,442 59,933 n.a. 45,259 $ 1,609,211 trading-related Bank book equities Securitization exposures Regulatory scaling factor Other assets Total credit risk Market risk Interest rate Equity Foreign exchange Commodities Specific risk Incremental risk charge Total market risk Operational risk CET1 capital risk-weighted assets (3) $ 1,609,211 Additional CVA adjustment, prescribed by OSFI, for Tier 1 capital Tier 1 capital risk-weighted assets (3) $ 1,609,211 Additional CVA adjustment, prescribed by OSFI, for Total capital Total capital risk-weighted assets (3) $ 1,609,211 21% $ 97% 16% n.a. 56% 61,085 $ 242,166 $ 11,859 $ 315,110 2,362 9,591 15,028 25,384 2,362 6,700 15,028 n.a. – – – 25,384 – 2,891 n.a. n.a. $ 268,401 2,045 7,363 14,400 29,460 23% $ 63,976 $ 266,256 $ 37,243 $ 367,475 $ 321,669 $ $ $ $ $ $ 1,835 $ 1,518 875 313 3,824 – 2,649 $ 1,487 56 13 1,906 9,488 – $ – – – – – 4,484 3,005 931 326 5,730 9,488 $ 8,174 3,731 988 956 11,800 14,137 8,365 $ 15,599 $ – $ 23,964 $ 39,786 3,891 52,106 n.a. $ 55,997 $ 50,301 76,232 333,961 37,243 $ 447,436 $ 411,756 76,232 333,961 38,469 $ 448,662 $ 412,941 1,226 1,226 1,185 76,232 $ 333,961 $ 39,519 $ 449,712 $ 413,957 1,050 1,050 1,016 (1) (2) (3) n.a. Total exposure represents exposure at default which is the expected gross exposure upon the default of an obligor. This amount is before any allowance against impaired loans or partial write-offs and does not reflect the impact of credit risk mitigation and collateral held. Represents the average of counterparty risk weights within a particular category. In fiscal 2015 and 2016, the CVA scalars of 64%, 71% and 77%, were applied to CET1, Tier 1 and Total Capital, respectively. In 2017, the scalars will be 72%, 77% and 81%, respectively. not applicable 2016 vs. 2015 During the year, CET1 RWA was up $36 billion, primarily as a result of the acquisition of City National and higher RWA (excluding the impact of foreign exchange translation), mainly in loans, partially offset by the impact of foreign exchange translation. 94 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Selected capital management activity The following table provides our selected capital management activity for the year ended October 31, 2016. Selected capital management activity (Millions of Canadian dollars, except number of shares) Tier 1 capital Common shares issued Issued in connection with share-based compensation plans (1) Table 75 2016 Issuance or redemption date Number of shares (000s) Amount Issued in connection with the acquisition of City National Purchased for cancellation (2) Issuance of preferred shares Series BK (3), (4) Issuance of preferred shares Series BM (3), (4) Redemption of RBC Trust Capital Securities – Series 2015 (3) Tier 2 capital Issuance of January 20, 2026 subordinated debentures (3), (4) Issuance of January 27, 2026 subordinated debentures (3), (4) Redemption of November 2, 2020 subordinated debentures (3) Other Issuance of preferred shares Series C-1 (3), (5) Issuance of preferred shares Series C-2 (3), (5) Purchase for cancellation of preferred shares Series C-1 (3), (5) Purchase for cancellation of preferred shares Series C-2 (3), (5) November 2, 2015 December 16, 2015 March 7, 2016 December 31, 2015 January 20, 2016 January 27, 2016 November 2, 2015 November 2, 2015 November 2, 2015 February 24, 2016 February 24, 2016 4,981 $ 41,619 (4,629) 29,000 30,000 175 100 (93) (80) 307 3,115 (56) 725 750 (1,200) 1,500 2,106 (1,500) 227 153 (120) (122) (1) (2) (3) (4) (5) Amounts include cash received for stock options exercised during the period and the fair value adjustments to stock options. Based on book value. For further details, refer to Notes 19 and 21 of our audited 2016 Annual Consolidated Financial Statements. Non-Viable Contingent Capital (NVCC) capital instruments. Based on fair value. On May 30, 2016, we announced our normal course issuer bid (NCIB), which commenced on June 1, 2016 and continues until May 31, 2017. In 2016, we repurchased approximately 4.6 million of our common shares. The total cost of the shares repurchased was $362 million, comprised of a book value of $56 million, with an additional $306 million premium paid on repurchase. Dividends Our common share dividend policy reflects our earnings outlook, payout ratio objective and the need to maintain adequate levels of capital to fund business opportunities. In 2016, our dividend payout ratio was 48%, which met our dividend payout ratio target of 40% to 50%. Common share dividends paid during the year were $4.8 billion. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 95 Selected share data (1) (Millions of Canadian dollars, except number of shares and as otherwise noted) Common shares outstanding First preferred shares outstanding Non-cumulative Series W (2) Non-cumulative Series AA Non-cumulative Series AB Non-cumulative Series AC Non-cumulative Series AD Non-cumulative Series AE Non-cumulative Series AF Non-cumulative Series AG Non-cumulative Series AJ (3) Non-cumulative Series AK (3) Non-cumulative Series AL (3) Non-cumulative Series AN (3) Non-cumulative Series AP (3) Non-cumulative Series AR (3) Non-cumulative Series AT (3) Non-cumulative Series AV (3) Non-cumulative Series AX (3) Non-cumulative Series AZ (3), (4) Non-cumulative Series BB (3), (4) Non-cumulative Series BD (3), (4) Non-cumulative Series BF (3), (4) Non-cumulative Series BH (4) Non-cumulative Series BI (4) Non-cumulative Series BJ (4) Non-cumulative Series BK (3), (4) Non-cumulative Series BM (3), (4) Non-cumulative Series C-1 (5) Non-cumulative Series C-2 (5) Treasury shares held – preferred Treasury shares held – common Stock options Outstanding (6) Exercisable Dividends Common Preferred 2016 2015 Number of shares (000s) Dividends declared per share Number of shares (000s) Amount Dividends declared per share Number of shares (000s) Amount Table 76 Dividends declared per share 2014 Amount 1,485,394 $ 17,939 $ 3.24 1,443,423 $ 14,573 $ 3.08 1,442,233 $ 14,511 $ 2.84 12,000 12,000 12,000 8,000 10,000 10,000 8,000 10,000 13,579 2,421 12,000 – – – – – – 20,000 20,000 24,000 12,000 6,000 6,000 6,000 29,000 30,000 82 20 31 (1,159) 11,388 6,909 1.23 300 1.11 300 1.18 300 1.15 200 1.13 250 1.13 250 1.11 200 1.13 250 0.88 339 0.60 61 1.07 300 – – – – – – – – – – – – 1.00 500 0.98 500 0.90 600 0.90 300 1.23 150 1.23 150 1.51 150 1.29 725 750 0.98 107 US$55.00 31 US$67.50 – (80) 12,000 12,000 12,000 8,000 10,000 10,000 8,000 10,000 13,579 2,421 12,000 – – – – – – 20,000 20,000 24,000 12,000 6,000 6,000 6,000 – – – – (63) 532 8,182 5,231 1.23 1.11 1.18 1.15 1.13 1.13 1.11 1.13 0.88 0.67 1.07 – – – – – – 1.00 0.98 0.73 0.63 0.58 0.42 – – – – – 300 300 300 200 250 250 200 250 339 61 300 – – – – – – 500 500 600 300 150 150 150 – – – – (2) 38 12,000 12,000 12,000 8,000 10,000 10,000 8,000 10,000 13,579 2,421 12,000 – – – – – 13,000 20,000 20,000 – – – – – – – – – 1 892 8,579 4,987 1.23 1.11 1.18 1.15 1.13 1.13 1.11 1.13 0.97 0.53 1.15 0.39 0.39 0.39 1.17 1.17 1.53 0.50 0.46 – – – – – – – – – 300 300 300 200 250 250 200 250 339 61 300 – – – – – 325 500 500 – – – – – – – – – – 71 4,817 294 4,443 191 4,097 213 (1) (2) (3) (4) (5) (6) For further details about our capital management activity, refer to Note 21 of our audited 2016 Annual Consolidated Financial Statements. Effective February 24, 2010, we have the right to convert into common shares at our option, subject to certain restrictions. Dividend rate will reset every five years. NVCC capital instruments. Represents 3,282,000 and 815,400 depositary shares relating to preferred shares Series C-1 and Series C-2, respectively. Each depositary share represents one-fortieth interest in a share of Series C-1 and Series C-2, respectively. Effective Q1 2016, includes share-based compensation awards from our acquisition of City National. As at November 25, 2016, the number of outstanding common shares and stock options and awards was 1,485,641,741 and 11,136,292, respectively, and the number of Treasury shares – preferred and Treasury shares – common was (30,253) and (369,236), respectively. NVCC provisions require the conversion of the capital instrument into a variable number of common shares in the event that OSFI deems the Bank to be non-viable or a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection. If a NVCC trigger event were to occur, our NVCC capital instruments preferred shares Series AZ, preferred shares Series BB, preferred shares Series BD, preferred shares Series BF, preferred shares Series BH, preferred shares Series BI, preferred shares Series BJ, preferred shares Series BK, preferred shares Series BM, subordinated debentures due on July 17, 2024, subordinated debentures due on September 29, 2026, subordinated debentures due on June 4, 2025, subordinated debentures due on January 20, 2026 and subordinated debentures due on January 27, 2026 would be converted into RBC common shares pursuant to an automatic conversion formula with a conversion price based on the greater of: (i) a contractual floor price of $5.00, and (ii) the current market price of our common shares at the time of the trigger event (10-day weighted average). Based on a floor price of $5.00 and including an estimate for accrued dividends and interest, these NVCC capital instruments would convert into a maximum of 2,762 million RBC common shares, on aggregate, which would represent a dilution impact of 65% based on the number of RBC common shares outstanding as at October 31, 2016. Attributed capital Our methodology for allocating capital to our business segments is based on the higher of fully diversified economic capital and the Basel III regulatory capital requirements. Risk-based capital attribution provides a uniform base for performance measurement among business segments, which compares to our overall corporate return objective and facilitates management decisions in resource allocation in conjunction with other factors. Attributed capital is calculated and attributed on a wider array of risks compared to Basel III regulatory capital requirements, which are calibrated predominantly to target credit, market (trading) and operational risk measures. Economic capital is our internal quantification of risks associated with business activities which is the capital required to remain solvent under extreme market conditions, reflecting our objective to 96 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis maintain strong credit ratings. Economic capital is calculated based on credit, market (trading and non-trading), operational, business and fixed asset, and insurance risks, along with capital attribution for goodwill and other intangibles. The common risks between the two frameworks are aligned to reflect increased regulatory requirements. • Business risk is the risk of loss or harm due to variances in volumes, prices and costs caused by competitive forces, regulatory changes, reputation and strategic risks. Fixed asset risk is defined as the risk that the value of fixed assets will be less than their book value at a future date. • For further discussion on Credit, Market, Operational and Insurance risks, refer to the Risk management section. Attributed capital is also used to assess the adequacy of our capital base. Our policy is to maintain a level of available capital, defined as common equity and other capital instruments with equity-like loss absorption features such as preferred shares that exceed Economic capital with a comfortable cushion. The calculation and attribution of capital involves a number of assumptions and judgments by management which are monitored to ensure that the economic capital framework remains comprehensive and consistent. The models are benchmarked to leading industry practices via participation in surveys, reviews of methodologies and ongoing interaction with external risk management industry professionals. The following outlines our attributed capital: Attributed capital (Millions of Canadian dollars) Credit risk Market risk (trading and non-trading) Operational risk Business and fixed asset risk Insurance risk Goodwill and other intangibles Regulatory capital allocation Attributed capital Unattributed capital Average common equity Table 77 2016 2015 $ 20,550 3,200 4,900 3,100 650 16,100 8,900 $ 57,400 4,800 $ 16,400 3,900 4,600 2,900 550 11,900 5,400 $ 45,650 6,650 $ 62,200 $ 52,300 2016 vs. 2015 Attributed capital increased $12 billion largely due to higher Credit and Goodwill and other intangibles risks, reflecting the acquisition of City National, business growth, and the impact of foreign exchange translation. Higher regulatory capital allocation, reflecting a higher capital attribution rate, also contributed to the increase. The increase in Operational and Business and fixed asset risks reflects higher revenue. Market risk decreased largely due to changes in risk treatment of certain portfolios and reduced inventories in fixed income and securitized product portfolios. We remain well capitalized with current levels of available capital exceeding the attributed capital required to underpin all of our material risks. Attributed capital in the context of our business activities In carrying out our business activities, we are exposed to a range of risks. The following chart provides a high level view of risks within our business segments, which includes credit, market and operational risks. We have used attributed capital to illustrate the relative size of the risks in each of our businesses. The attributed capital distribution reflects the diversified nature of our business activities. RWA represents our exposure to credit, market and operational risk for regulatory capital requirements. Within Personal & Commercial Banking, credit risk is the most significant risk, largely related to our personal financial services, business financial services and cards businesses. The primary risks within Wealth Management, which provides services to institutional and individual clients, are operational risk and credit risk. Risks within our Insurance operations are primarily related to insurance risk in our life and health businesses followed by market risk and operational risk. The largest risk within Investor & Treasury Services is market risk, followed by credit risk and operational risk. The most significant risk within Capital Markets is credit risk, followed by market risk. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 97 For additional information on the risks highlighted below, refer to the Risk management section. Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (3) 26 28 33% 5 8 RWA (C$ millions) (4) Credit Market Operational $367,475 23,964 55,997 Royal Bank of Canada Personal & Commercial Banking Wealth Management Insurance Investor & Treasury Services Capital Markets Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (5) 26 17 45% 2 10 Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (5) 63 9 19% 1 8 Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (5) 9 50 12% 14 15 Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (5) 15 40 11% 24 10 Attributed capital (1) Credit Market (2) Operational Goodwill and other intangibles Other (5) 6 31 47% 9 7 RWA (C$ millions) (4) Credit Market Operational $128,691 156 22,746 RWA (C$ millions) (4) Credit Market Operational $51,498 573 12,895 RWA (C$ millions) (6) Credit Market Operational $8,011 1 – RWA (C$ millions) (4) Credit Market Operational $18,007 8,453 3,880 RWA (C$ millions) (4) Credit Market Operational $156,938 14,432 15,880 (1) (2) (3) (4) (5) (6) Attributed capital: An estimate of the amount of equity capital required to underpin risks. It is calculated by estimating the level of capital that is necessary to support our various business, given their risks, consistent with our desired solvency standard and credit ratings. Market risk attributed capital: An estimate of the amount of equity capital required to underpin trading market risk and interest rate risk. Other – RBC: Includes (a) an estimate of the amount of equity capital required to underpin risks associated with business, fixed assets and insurance risks; (b) a regulatory capital adjustment since attributed capital is determined at the higher of regulatory or economic capital; and (c) unattributed capital reported representing common equity in excess of common equity attributed to our business segments which is reported in the Corporate Support segment only. RWA amount above represents RWA for CET1. Other – Business segments: Includes (a) an estimate of the amount of equity capital required to underpin risks associated with business, fixed assets and insurance risks; and (b) a regulatory capital adjustment since attributed capital is determined at the business segment level as the greater of regulatory or economic capital. Insurance RWA amount above represents our investments in the insurance subsidiaries capitalized at the regulatory prescribed rate as required under Basel CAR filing. Subsidiary capital Our capital management framework includes the management of our subsidiaries’ capital. We invest capital across the enterprise to meet any local regulators’ capital adequacy requirements and maximize returns to our shareholders. We invest in our subsidiaries as appropriate during the year. We set guidelines for defining capital investments in our subsidiaries and manage the relationship between capital invested in subsidiaries and our consolidated capital base to ensure that we can access capital recognized in our consolidated regulatory capital measurements. Each of our subsidiaries has responsibility for maintaining its compliance with any local regulatory capital adequacy requirements, which may include restrictions on the transfer of assets in the form of cash, dividends, loans or advances. Concurrently, Corporate Treasury provides centralized oversight of capital adequacy across all subsidiary entities. Other considerations affecting capital Capital treatment for equity investments in other entities is determined by a combination of accounting and regulatory guidelines based on the size or nature of the investment. Three broad approaches apply as follows: • • Consolidation: entities which we control are consolidated on our Consolidated Balance Sheets. Deduction: certain holdings are deducted from our regulatory capital. These include all unconsolidated “substantial investments,” as defined by the Bank Act (Canada) in the capital of financial institutions, as well as all investments in insurance subsidiaries. Risk weighting: equity investments that are not deducted from capital are risk weighted at a prescribed rate for determination of capital charges. • Regulatory capital approach for securitization exposures For our securitization exposures, we use an internal assessment approach (IAA) for exposures related to our ABCP business, and for other securitization exposures we use a combination of approaches including a ratings-based approach and the standardized approach. While our IAA rating methodologies are based in large part on criteria that are published by External Credit Assessment Institutions (ECAIs) such as S&P and therefore are similar to the methodologies used by these institutions, they are not identical. Our ratings process includes a comparison of the available credit enhancement in a securitization structure to a stressed level of projected losses. The stress level used is determined by the desired risk profile of the transaction. As a result, we stress the cash flows of a given transaction at a higher level in order to achieve a higher rating. Conversely, transactions that only pass lower stress levels achieve lower ratings. 98 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Most of the other securitization exposures (non-ABCP) carry external ratings and we use the lower of our own rating or the lowest external rating for determining the proper capital allocation for these positions. We periodically compare our own ratings to ECAIs ratings to ensure that the ratings provided by ECAIs are reasonable. GRM has responsibility for providing risk assessments for capital purposes in respect of all our banking book exposures. GRM is independent of the business originating the securitization exposures and performs its own analysis, sometimes in conjunction with but always independent of the applicable business. GRM has developed asset class specific criteria guidelines which provide the rating methodologies for each asset class. The guidelines are reviewed periodically and are subject to the ratings replication process mandated by Pillar I of the Basel rules. Additional financial information Exposure to U.S. subprime and Alt-A through RMBS, CDOs and mortgages Certain activities and transactions we enter into expose us to the risk of default of U.S. subprime and Alt-A residential mortgages. Our exposures to U.S. subprime and Alt-A residential mortgages of $71 million represented less than 0.1% of our total assets as at October 31, 2016, compared to $423 million or less than 0.1% last year. The decrease of $352 million was primarily due to the sale of certain securities. Commercial mortgage-backed securities The fair value of our total direct holdings of Canadian and U.S. commercial mortgage-backed securities was $355 million as at October 31, 2016. Assets and liabilities measured at fair value Our financial instruments carried at fair value are classified as Level 1, 2 or 3, in accordance with the fair value hierarchy set out in International Financial Reporting Standards (IFRS) 13, Fair Value Measurement. For further details on the fair value of our financial instruments and transfers between levels of the fair value hierarchy, refer to Note 3 of our audited 2016 Annual Consolidated Financial Statements. The following table presents the total fair value of each major class of financial assets and financial liabilities measured at fair value and the percentage of the fair value of each class categorized as Level 1, 2 or 3: Assets and liabilities measured at fair value Table 78 As at October 31, 2016 (Millions of Canadian dollars, except percentage amounts) Fair value Level 1 Level 2 Level 3 Total Financial assets Securities at FVTPL Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans Derivatives (1) Financial liabilities Deposits Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives (1) $ 151,292 69,833 40% 6 60% 90 –% 100% 4 100 121,692 2,412 216,086 – – 1 100 86 99 – 14 – 100 100 100 $ 98,856 50,369 –% 65 100% 35 –% 100% – 100 88,863 212,781 – 1 100 98 – 1 100 100 (1) The derivative assets and liabilities presented in the table above do not reflect the impact of netting. Accounting and control matters Critical accounting policies and estimates Application of critical accounting policies, judgments, estimates and assumptions Our significant accounting policies are described in Note 2 to our audited 2016 Annual Consolidated Financial Statements. Certain of these policies, as well as estimates made by management in applying such policies, are recognized as critical because they require us to make particularly subjective or complex judgments about matters that are inherently uncertain and because of the likelihood that significantly different amounts could be reported under different conditions or using different assumptions. Our critical accounting judgments, estimates and assumptions relate to the fair value of financial instruments, allowance for credit losses, goodwill and other intangible assets, employee benefits, consolidation, derecognition of financial assets, securities impairment, application of the effective interest method, provisions, insurance claims and policy benefit liabilities, and income taxes. Our critical accounting policies and estimates have been reviewed and approved by our Audit Committee, in consultation with management, as part of their review and approval of our significant accounting policies, judgments, estimates and assumptions. Fair value of financial instruments and securities impairment The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We determine fair value by incorporating all factors that market participants would consider in setting a price, including commonly accepted valuation approaches. The Board of Directors provides oversight on valuation of financial instruments, primarily through the Audit Committee and Risk Committee. The Audit Committee reviews the presentation and disclosure of financial instruments that are measured at fair value, while the Risk Committee assesses adequacy of governance structures and control processes for valuation of these instruments. We have established policies, procedures and controls for valuation methodologies and techniques to ensure fair value is reasonably estimated. Major valuation processes and controls include, but are not limited to, profit and loss decomposition, independent price verification (IPV) and model validation standards. These control processes are managed by either Finance or GRM and are independent of the relevant Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 99 businesses and their trading functions. Profit and loss decomposition is a process to explain the fair value changes of certain positions and is performed daily for trading portfolios. All fair value instruments are subject to IPV, a process whereby trading function valuations are verified against external market prices and other relevant market data. Market data sources include traded prices, brokers and price vendors. We give priority to those third-party pricing services and prices having the highest and most consistent accuracy. The level of accuracy is determined over time by comparing third-party price values to traders’ or system values, to other pricing service values and, when available, to actual trade data. Other valuation techniques are used when a price or quote is not available. Some valuation processes use models to determine fair value. We have a systematic and consistent approach to control model use. Valuation models are approved for use within our model risk management framework. The framework addresses, among other things, model development standards, validation processes and procedures, and approval authorities. Model validation ensures that a model is suitable for its intended use and sets parameters for its use. All models are revalidated regularly by qualified personnel who are independent of the model design and development. Annually our model risk profile is reported to the Board of Directors. In determining fair value, a hierarchy is used which prioritizes the inputs to valuation techniques. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Determination of fair value based on this hierarchy requires the use of observable market data whenever available. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model inputs that are either observable, or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 inputs are one or more inputs that are unobservable and significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available at the measurement date. The availability of inputs for valuation may affect the selection of valuation techniques. The classification of a financial instrument in the hierarchy for disclosure purposes is based upon the lowest level of input that is significant to the measurement of fair value. Where observable prices or inputs are not available, management judgment is required to determine fair values by assessing other relevant sources of information such as historical data, proxy information from similar transactions, and through extrapolation and interpolation techniques. For more complex or illiquid instruments, significant judgment is required in the determination of the model used, the selection of model inputs, and in some cases the application of valuation adjustments to the model value or quoted price for inactively traded financial instruments, as the selection of model inputs may be subjective and the inputs may be unobservable. Unobservable inputs are inherently uncertain as there is little or no market data available from which to determine the level at which the transaction would occur under normal business circumstances. Appropriate parameter uncertainty and market risk valuation adjustments for such inputs and other model risk valuation adjustments are assessed in all such instances. We record valuation adjustments to appropriately reflect counterparty credit quality of our derivative portfolio, differences between the overnight index swap (OIS) curve and London Interbank Offered Rates (LIBOR) for collateralized derivatives, funding valuation adjustments (FVA) for uncollateralized and under-collateralized OTC derivatives, unrealized gains or losses at inception of the transaction, bid-offer spreads, unobservable parameters and model limitations. These adjustments may be subjective as they require significant judgment in the input selection, such as probability of default and recovery rate, and are intended to arrive at fair value that is determined based on assumptions that market participants would use in pricing the financial instrument. The realized price for a transaction may be different from its recorded value that is previously estimated using management judgment, and may therefore impact unrealized gains and losses recognized in Non-interest income – Trading revenue or Other. Valuation adjustments are recorded for the credit risk of our derivative portfolios in order to arrive at their fair values. CVA takes into account our counterparties’ creditworthiness, the current and potential future mark-to-market of the transactions, and the effects of credit mitigants such as master netting and collateral agreements. CVA amounts are derived from estimates of exposure at default, probability of default, recovery rates on a counterparty basis, and market and credit factor correlations. Exposure at default is the amount of expected derivative related assets and liabilities at the time of default, estimated through modelling using underlying risk factors. Probability of default and recovery rate are generally implied from the market prices for credit protection and credit ratings of the counterparty. Correlation is the statistical measure of how credit and market factors may move in relation to one another. Correlation is estimated using historical data and market data where available. CVA is calculated daily and changes are recorded in Non-interest income – Trading revenue. In the determination of fair value of collateralized OTC derivatives using the OIS curve, our valuation approach accounts for the difference between certain OIS rates and LIBOR for derivatives valuation as valuation adjustments. FVA are also calculated to incorporate cost and benefit of funding in the valuation of uncollateralized and under-collateralized OTC derivatives. Future expected cash flows of these derivatives are discounted to reflect the cost and benefit of funding the derivatives by using a funding curve, implied volatilities and correlations as inputs. Where required, a valuation adjustment is made to reflect the unrealized gain or loss at inception of a financial instrument contract where the fair value of that financial instrument is not obtained from a quoted market price or cannot be evidenced by other observable market transactions based on a valuation technique incorporating observable market data. A bid-offer valuation adjustment is required when a financial instrument is valued at the mid-market price, instead of the bid or offer price for asset or liability positions, respectively. The valuation adjustment takes into account the spread from the mid to either the bid or offer price. Some valuation models require parameter calibration from such factors as market observed option prices. The calibration of parameters may be sensitive to factors such as the choice of instruments or optimization methodology. A valuation adjustment is also estimated to mitigate the uncertainties of parameter calibration and model limitations. We classify our financial instruments measured at fair value on a recurring basis into three levels based on the transparency of the inputs used to measure the fair values of the instruments. As at October 31, 2016, Level 2 instruments, whose fair values are based on observable inputs, include $505 billion of financial assets (October 31, 2015 – $456 billion) and $413 billion of financial liabilities (October 31, 2015 – $394 billion). These amounts represent 87% of our total financial assets at fair value (October 31, 2015 – 85%) and 92% of our total financial liabilities at fair value (October 31, 2015 – 91%), respectively. Level 3 instruments, whose valuations include significant unobservable inputs, include $4 billion of financial assets (October 31, 2015 – $6 billion) and $2 billion of financial liabilities (October 31, 2015 – $2 billion), representing 1% of our total financial assets at fair value (October 31, 2015 – 1%) and 0.4% of our total financial liabilities at fair value (October 31, 2015 – 1%), respectively. At each reporting date or more frequently when conditions warrant, we evaluate our AFS securities to determine whether there is any objective evidence of impairment, such as a significant or prolonged decline in the fair value of the security below its cost or when an adverse effect on future cash flows from the security can be reliably estimated. When assessing impairment for debt instruments we primarily consider counterparty ratings and security-specific factors, including collateral, external ratings, subordination and other market factors. For complex debt instruments including U.S. non-agency MBS, ABS and other structured products, we also use cash flow projection models which incorporate actual and projected cash flows for each security using a number of assumptions and inputs that are based on security specific factors. The inputs and assumptions used, such as default, prepayment and recovery rates, are based on updated market data. For U.S. non-agency MBS, 100 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis recovery rates are largely dependent upon forecasted property prices which were assessed at the municipal level, provided by a third-party vendor. In addition, we also consider the transaction structure and credit enhancement for the structured securities. If the result indicates that we will not be able to recover the entire principal and interest amount, we do a further review of the security in order to assess whether a loss would ultimately be realized. As equity securities do not have contractual cash flows, they are assessed differently than debt securities. In assessing whether there is any objective evidence that suggests that the security is impaired we consider factors which include the length of time and extent the fair value has been below the cost and the financial condition and near term prospects of the issuer. We also consider the estimated recoverable value and the period of recovery. We conduct further analysis for securities where the fair value had been below cost for greater than twelve months. If an AFS security is impaired, the cumulative unrealized losses previously recognized in Other components of equity are recognized directly in income under Non-interest income. As at October 31, 2016, our gross unrealized losses on AFS securities were $254 million (October 31, 2015 – $304 million). Refer to Note 4 to our audited 2016 Annual Consolidated Financial Statements for more information. Allowance for credit losses We maintain allowance for credit losses relating to on-balance sheet exposures, such as loans and acceptances, and off-balance sheet items such as letters of credit, guarantees and unfunded commitments, at levels that management considers appropriate to cover credit related losses incurred as at the balance sheet date. Allowances are determined individually for loans that are individually significant, and collectively for loans that are not individually significant and loans which are significant but for which there is no objective evidence of impairment, using current and historical credit information in both quantitative and qualitative assessments. For further information on allowance for credit losses, refer to Note 5 to our audited 2016 Annual Consolidated Financial Statements. Individually assessed loans Loans which are individually significant are assessed individually for objective indicators of impairment. A loan is considered impaired when management determines that it will not be able to collect all amounts due according to the original contractual terms or the equivalent value. Credit exposures of individually significant loans are evaluated based on factors including the borrower’s overall financial condition, resources and payment record, and where applicable, the realizable value of any collateral. If there is evidence of impairment leading to an impairment loss, then the amount of the loss is determined as the difference between the carrying amount of the loan, including accrued interest, and the estimated recoverable amount. The estimated recoverable amount is measured as the present value of expected future cash flows discounted at the loan’s original effective interest rate, including cash flows that may result from the realization of collateral less costs to sell. Collectively assessed loans Loans which are not individually significant, or which are individually assessed and not determined to be impaired, are collectively assessed for impairment. For the purposes of a collective evaluation of impairment, loans are grouped on the basis of similar risk characteristics, taking into account loan type, industry, geographic location, collateral type, past due status and other relevant factors. The collective impairment allowance is determined by reviewing factors including: (i) historical loss experience, which takes into consideration historical probabilities of default, loss given default and exposure at default, in portfolios of similar credit risk characteristics, and (ii) management’s judgment on the level of impairment losses based on historical experience relative to the actual level as reported at the balance sheet date, taking into consideration the current portfolio credit quality trends, business and economic and credit conditions, the impact of policy and process changes, and other supporting factors. Future cash flows for a group of loans are collectively evaluated for impairment on the basis of the contractual cash flows of the loans in the group and historical loss experience for loans with credit risk characteristics similar to those in the group. Historical loss experience is adjusted based on current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not currently exist. The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. Write-off of loans Loans and the related impairment allowance for credit losses are written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, they are generally written off after receipt of any proceeds from the realization of the collateral. In circumstances where the net realizable value of any collateral has been determined and there is no reasonable expectation of further recovery, write off may be earlier. For credit cards, the balances and related allowance for credit losses are written off when payment is 180 days in arrears. Personal loans are generally written off at 150 days past due. Total allowance for credit losses Based on the procedures discussed above, management believes that the total allowance for credit losses of $2,326 million is adequate to absorb estimated credit losses incurred in the lending portfolio as at October 31, 2016 (October 31, 2015 – $2,120 million). This amount includes $91 million (October 31, 2015 – $91 million) classified in Provisions under Other liabilities on our Consolidated Balance Sheets, which relates to off-balance sheet and other items. Goodwill and other intangible assets We allocate goodwill to groups of cash-generating units (CGU). Goodwill is not amortized and is tested for impairment on an annual basis, or more frequently if there are objective indications of impairment. We test for impairment by comparing the recoverable amount of a CGU with its carrying amount. A CGU’s recoverable amount is the higher of its fair value less cost of disposal and its value in use. The carrying amount of a CGU comprises the carrying amount of assets, liabilities, and goodwill allocated to the CGU. When the carrying value of a CGU exceeds its recoverable amount, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the CGU and then to the other assets of the CGU proportionally based on the carrying amount of each asset. Any impairment charge is recognized in income in the period it is identified. Subsequent reversals of goodwill impairment are prohibited. We estimate the value in use and fair value less costs of disposal of our CGUs primarily using a discounted cash flow method which incorporates each CGU’s internal forecasts of revenues and expenses. Significant management judgment is applied in the determination of expected future cash flows (uncertainty in timing and amount), discount rates (based on CGU-specific risks) and terminal growth rates. CGU-specific risks include country risk, business/operational risk, geographic risk (including political risk, devaluation risk and government regulation), currency risk and price risk (including product pricing risk and inflation). If the forecast earnings and other assumptions in future periods deviate significantly from the current amounts used in our impairment testing, the value of our goodwill could become impaired. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 101 Other intangible assets with a finite life are amortized on a straight-line basis over their estimated useful lives as follows: computer software – 3 to 10 years and customer relationships – 10 to 20 years. They are assessed for indicators of impairment at each reporting period if there is an indication that an asset may be impaired. An impairment test is performed by comparing the carrying amount of the intangible asset to its recoverable amount. Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the CGU to which the asset belongs. If the recoverable amount of the asset (or CGU) is less than its carrying amount, the carrying amount of the intangible asset is written down to its recoverable amount as an impairment loss. An impairment loss recognized previously is reversed if there is a change in the estimates used to determine the recoverable amount of the asset (or CGU) since the last impairment loss was recognized. If an impairment loss is subsequently reversed, the carrying amount of the asset (or CGU) is revised to the lower of its recoverable amount and the carrying amount that would have been determined (net of amortization) had there been no prior impairment. Significant judgment is applied in estimating the useful lives and recoverable amounts of our intangible assets and assessing whether certain events or circumstances constitute objective evidence of impairment. We do not have any other intangible assets with indefinite lives. As at October 31, 2016, we had $11.2 billion of goodwill (October 31, 2015 – $9.3 billion) and $4.6 billion of other intangible assets (October 31, 2015 – $2.8 billion). For further details, refer to Notes 2 and 10 to our 2016 Annual Consolidated Financial Statements. Employee benefits We sponsor a number of benefit programs for eligible employees, including registered pension plans, supplemental pension plans, health, dental, disability and life insurance plans. The calculation of defined benefit expenses and obligations depends on various assumptions such as discount rates, healthcare cost trend rates, projected salary increases, retirement age, and mortality and termination rates. The discount rate assumption is determined using spot rates from a derived AA corporate bond yield curve for our Canadian pension and other post-employment benefit plans, and spot rates from an AA corporate bond yield curve for our International pension and other post-employment benefit plans. All other assumptions are determined by management and are reviewed by the actuaries. Actual experience that differs from the actuarial assumptions will affect the amounts of benefit obligations and remeasurements that we recognize. The weighted average assumptions used and the sensitivity of key assumptions are presented in Note 17 to our audited 2016 Annual Consolidated Financial Statements. Consolidation Subsidiaries are those entities, including structured entities, over which we have control. We control an entity when we are exposed, or have rights, to variable returns from our involvement with the entity and have the ability to affect those returns through our power over the investee. We have power over an entity when we have existing rights that give us the current ability to direct the activities that most significantly affect the entity’s returns (relevant activities). Power may be determined on the basis of voting rights or, in the case of structured entities, other contractual arrangements. We are not deemed to control an entity when we exercise power over an entity in an agency capacity. In determining whether we are acting as an agent, we consider the overall relationship between us, the investee and other parties to the arrangement with respect to the following factors: (i) the scope of our decision making power; (ii) the rights held by other parties; (iii) the remuneration to which we are entitled; and (iv) our exposure to variability of returns. The determination of control is based on the current facts and circumstances and is continuously assessed. In some circumstances, different factors and conditions may indicate that various parties control an entity depending on whether those factors and conditions are assessed in isolation or in totality. Significant judgment is applied in assessing the relevant factors and conditions in totality when determining whether we control an entity. Specifically, judgment is applied in assessing whether we have substantive decision making rights over the relevant activities and whether we are exercising our power as a principal or an agent. We consolidate all subsidiaries from the date control is transferred to us, and cease consolidation when an entity is no longer controlled by us. Our consolidation conclusions affect the classification and amount of assets, liabilities, revenues and expenses reported in our Consolidated Financial Statements. Non-controlling interests in subsidiaries that we consolidate are shown on our Consolidated Balance Sheets as a separate component of equity which is distinct from our shareholders’ equity. The net income attributable to non-controlling interests is separately disclosed in our Consolidated Statements of Income. For further details, refer to the Off-balance sheet arrangements section and Note 7 to our audited 2016 Annual Consolidated Financial Statements. Derecognition of financial assets We periodically enter into transactions in which we transfer financial assets such as loans or packaged MBS to structured entities or trusts that issue securities to investors. We derecognized the assets when our contractual rights to the cash flows from the assets have expired, when we retain the rights to receive the cash flows but assume an obligation to pay those cash flows to a third party subject to certain pass-through requirements, or when we transfer our contractual rights to receive the cash flows and substantially all of the risks and rewards of the assets have been transferred. When we retain substantially all of the risks and rewards of the transferred assets, the transferred assets are not derecognized from our Consolidated Balance Sheets and are accounted for as secured financing transactions. When we neither retain nor transfer substantially all risks and rewards of ownership of the assets, we derecognize the assets if control over the assets is relinquished. If we retain control over the transferred assets, we continue to recognize the transferred assets to the extent of our continuing involvement. Management’s judgment is applied in determining whether we have transferred or retained substantially all risk and rewards of ownership of the transferred financial asset. The majority of assets transferred under repurchase agreements, securities lending agreements, and in our Canadian residential mortgage securitization transactions do not qualify for derecognition; as a result, we continue to record the associated transferred assets on our Consolidated Balance Sheets and no gains or losses are recognized for these securitization activities. Otherwise, a gain or loss is recognized on securitization by comparing the carrying amount of the transferred asset with its fair value at the date of the transfer. As at October 31, 2016, the carrying and fair values of the transferred assets that do not qualify for derecognition were $137 billion and $137 billion, respectively (October 31, 2015 – $119 billion and $119 billion, respectively), and the carrying and fair values of the associated liabilities totalled $137 billion and $138 billion, respectively (October 31, 2015 – $119 billion and $120 billion, respectively). For further information on derecognition of financial assets, refer to Note 6 to our audited 2016 Annual Consolidated Financial Statements. Application of the effective interest method Interest is recognized in Interest income and Interest expense in the Consolidated Statements of Income for all interest bearing financial instruments using the effective interest method. The effective interest rate is the rate that discounts estimated future cash flows over the 102 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis expected life of the financial asset or liability to the net carrying amount upon initial recognition. Significant judgment is applied in determining the effective interest rate due to uncertainty in the timing and amounts of future cash flows. Provisions Provisions are liabilities of uncertain timing or amount and are recognized when we have a present legal or constructive obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are measured as the best estimate of the consideration required to settle the present obligation at the reporting date. Significant judgment is required in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. We record provisions related to litigation, asset retirement obligations, and the allowance for off-balance sheet and other items. Provisions are recorded under Other liabilities on our Consolidated Balance Sheets. We are required to estimate the results of ongoing legal proceedings, expenses to be incurred to dispose of capital assets, and credit losses on undrawn commitments and guarantees. The forward-looking nature of these estimates requires us to use a significant amount of judgment in projecting the timing and amount of future cash flows. We record our provisions on the basis of all available information at the end of the reporting period and make adjustments on a quarterly basis to reflect current expectations. Should actual results differ from our expectations, we may incur expenses in excess of the provisions recognized. When some or all of the economic benefits required to settle a provision are expected to be recovered from a third party, such as an insurer, a separate asset is recognized if it is virtually certain that reimbursement will be received. Insurance claims and policy benefit liabilities Insurance claims and policy benefit liabilities represent current claims and estimates for future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method, which incorporates assumptions for mortality, morbidity, policy lapses and surrenders, investment yields, policy dividends, operating and policy maintenance expenses, and provisions for adverse deviation. These assumptions are reviewed at least annually and updated in response to actual experience and market conditions. Liabilities for property and casualty insurance represent estimated provisions for reported and unreported claims. Liabilities for life and property and casualty insurance are included in Insurance claims and policy benefit liabilities. Changes in Insurance claims and policy benefit liabilities are included in the Insurance policyholder benefits, claims and acquisition expense in our Consolidated Statements of Income in the period in which the estimates change. Refer to Note 15 to our audited 2016 Annual Consolidated Financial Statements for further information. Income taxes We are subject to income tax laws in various jurisdictions where we operate, and the complex tax laws are potentially subject to different interpretations by us and the relevant taxation authority. Management’s judgment is applied in the interpretation of the relevant tax laws and in the estimation of the provision for current and deferred income taxes, including the expected timing and amount of the realization. A deferred tax asset or liability is determined for each temporary difference based on the tax rates that are expected to be in effect in the period that the asset is realized or the liability is settled. Where the temporary differences will not reverse in the foreseeable future, no deferred tax amount is recognized. On a quarterly basis, we review whether it is probable that the benefits associated with our deferred tax assets will be realized, using both positive and negative evidence. Refer to Note 24 to our audited 2016 Annual Consolidated Financial Statements for further information. Changes in accounting policies and disclosure As a result of the acquisition of City National, we updated our accounting policies in the first quarter to reflect policies on Acquired Loans, Acquired Credit-Impaired Loans and Federal Deposit Insurance Corporation Covered Loans. Refer to Note 2 of our audited 2016 Annual Consolidated Financial Statements for details of these changes. Future changes in accounting policy and disclosure IFRS 15 Revenue from Contracts with Customers (IFRS 15) In May 2014, the International Accounting Standards Board (IASB) issued IFRS 15 which establishes principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard provides a single, principles based five-step model for revenue recognition to be applied to contracts with customers except for revenue arising from items such as financial instruments, insurance contracts and leases. In April 2016, the IASB issued amendments to IFRS 15, which clarify the underlying principles of IFRS 15 and provide additional transitional relief on initial application. IFRS 15 and its amendments will be effective for us on November 1, 2018. IFRS 9 Financial Instruments (IFRS 9) In July 2014, the IASB issued the complete version of IFRS 9, which brings together the classification and measurement, impairment and hedge accounting phases of the IASB’s project to replace IAS 39 Financial Instruments: Recognition and Measurement (IAS 39). In January 2015, OSFI issued an advisory with respect to the early adoption of IFRS 9 for D-SIBs, requiring D-SIBs to adopt IFRS 9 for the annual period beginning on November 1, 2017. As a result, we will be required to adopt IFRS 9 on November 1, 2017, with the exception of the own credit provisions of IFRS 9, which we adopted in the second quarter of 2014. On June 21, 2016, OSFI issued its final guideline on IFRS 9 Financial Instruments and Disclosures. The guideline provides guidance to Federally Regulated Entities on the application of IFRS 9, including the implementation of the expected credit loss framework under IFRS 9. The guideline is consistent with the BCBS Guidance on credit risk and accounting for expected credit losses, issued on December 18, 2015, which sets out supervisory expectations on sound credit risk practices associated with the implementation of expected credit loss accounting models. The OSFI guideline will be effective for us on November 1, 2017, consistent with the adoption of IFRS 9. Classification and measurement IFRS 9 introduces a principles-based approach to the classification of financial assets. Debt instruments, including hybrid contracts, are measured at FVTPL, fair value through other comprehensive income (FVOCI) or amortized cost based on an entity’s business model and the nature of the cash flows of the assets. These categories replace the existing IAS 39 classifications of AFS, loans and receivables, and held-to- maturity. Equity instruments are measured at FVTPL, unless they are not held for trading purposes, in which case an election can be made on initial recognition to measure them at FVOCI with no subsequent reclassification to profit or loss. The combined application of the contractual cash flow characteristics and business model tests as at November 1, 2017 are expected to result in some differences in the classification of financial assets when compared to our classification under IAS 39. We do not expect significant changes to the classification of most financial assets on our balance sheet; however we have identified certain assets currently held at amortized cost and AFS that may be reclassified to FVTPL under IFRS 9. For financial liabilities, IFRS 9 includes the pre-existing requirements for classification and measurement previously included in IAS 39. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 103 Impairment IFRS 9 introduces an expected credit loss impairment model that differs significantly from the incurred loss model under IAS 39 and is expected to result in earlier recognition of credit losses. Scope Under IFRS 9, the same impairment model is applied to all financial assets, except for financial assets classified or designated as at FVTPL and equity securities designated as at FVOCI, which are not subject to impairment assessment. The scope of the IFRS 9 expected credit loss impairment model includes amortized cost financial assets, debt securities classified as at FVOCI, and off balance sheet loan commitments and financial guarantees which were previously provided for under IAS 37 Provisions, Contingent Liabilities and Contingent Assets (IAS 37). The above-mentioned reclassifications into or out of these categories under IFRS 9 and items that previously fell under the IAS 37 framework will be considered in determining the scope of our application of the new expected credit loss impairment model. Expected credit loss impairment model Under IFRS 9, credit loss allowances will be measured on each reporting date according to a three-stage expected credit loss impairment model: • • • Stage 1 – From initial recognition of a financial asset to the date on which the asset has experienced a significant increase in credit risk relative to its initial recognition, a loss allowance is recognized equal to the credit losses expected to result from defaults occurring over the next 12 months. Stage 2 – Following a significant increase in credit risk relative to the initial recognition of the financial asset, a loss allowance is recognized equal to the credit losses expected over the remaining lifetime of the asset. Stage 3 – When a financial asset is considered to be credit-impaired, a loss allowance equal to full lifetime expected credit losses will be recognized. Interest revenue is calculated based on the carrying amount of the asset, net of the loss allowance, rather than on its gross carrying amount. Stage 1 and Stage 2 credit loss allowances effectively replace the collectively-assessed allowance for incurred but not identified losses recorded under IAS 39, while Stage 3 credit loss allowances effectively replace the individually and collectively assessed allowances for impaired loans. Under IFRS 9, the population of financial assets and corresponding allowances disclosed as Stage 3 will not necessarily correspond to the amounts of financial assets currently disclosed as impaired in accordance with IAS 39. Consistent with IAS 39, loans are written off when there is no realistic probability of recovery. Accordingly, our policy on when financial assets are written off is not expected to significantly change on adoption of IFRS 9. Because all financial assets within the scope of the IFRS 9 impairment model will be assessed for at least 12-months of expected credit losses, and the population of financial assets to which full lifetime expected credit losses applies is larger than the population of impaired loans for which there is objective evidence of impairment in accordance with IAS 39, the total allowance for credit losses is expected to increase under IFRS 9 relative to the allowance for credit losses under IAS 39. Changes in the required credit loss allowance, including the impact of movements between Stage 1 (12 month expected credit losses) and Stage 2 (lifetime expected credit losses), will be recorded in profit or loss. Because of the impact of moving between 12 month and lifetime expected credit losses and the application of forward looking information, provisions are expected to be more volatile under IFRS 9 than IAS 39. Measurement The measurement of expected credit losses will primarily be based on the product of the instrument’s PD, LGD, and EAD, discounted to the reporting date. The main difference between Stage 1 and Stage 2 expected credit losses is the respective PD horizon. Stage 1 estimates will use a maximum of a 12-month PD parameter while Stage 2 estimates will use a lifetime PD parameter. Stage 3 estimates will continue to leverage existing processes for estimating losses on impaired loans, but will consider the lifetime expected loss estimate produced by the Stage 2 models. An expected credit loss estimate will be produced for each individual exposure, including amounts which are subject to a more simplified model for estimating expected credit losses; however the relevant parameters will be modeled on a collective basis using the same underlying data pool supporting our stress testing and regulatory capital expected loss processes. Models have been developed, primarily leveraging our existing models for enterprise-wide stress testing, which will be validated and tested during 2017. For the small percentage of our portfolios that lack detailed historical information and/or loss experience, we will apply simplified measurement approaches that may differ from what is described above. These approaches will be designed to maximize the available information that is reliable and supportable for each portfolio and may be collective in nature. Movement between stages Movements between Stage 1 and Stage 2 are based on whether an instrument’s credit risk as at the reporting date has increased significantly relative to the date it was initially recognized. For the purposes of this assessment, credit risk is based on an instrument’s lifetime probability of default, not the losses we expect to incur. The assessment of significant increases in credit risk is a new concept under IFRS 9 and will require significant judgment. Our assessment of significant increases in credit risk will be based on changes in lifetime PD. We have established preliminary thresholds for significant increases in credit risk which will be validated throughout 2017. Additional qualitative reviews of the staging criteria by business, finance and risk representatives will be performed to verify the positions identified as having significantly increased in risk and identify any additional positions whose credit risk has increased significantly. As a backstop, instruments that are 30 days past due will move to Stage 2 even if our other metrics do not indicate that a significant increase in credit risk has occurred. Movements between Stage 2 and Stage 3 are based on whether financial assets are credit-impaired as at the reporting date. The determination of credit-impairment under IFRS 9 is expected to be similar to the individual assessment of financial assets for objective evidence of impairment under IAS 39. The assessments for significant increases in credit risk since initial recognition and credit-impairment are performed independently as at each reporting period. Assets can move in both directions through the stages of the impairment model. After a financial asset has migrated to Stage 2, once it is no longer considered that credit risk has significantly increased relative to initial recognition as at a subsequent reporting period, it will move back to Stage 1. Similarly, an asset that is in Stage 3 will move back to Stage 2 when it is no longer considered to be credit- impaired. 104 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Forward-looking information The measurement of expected credit losses for each stage and the assessment of significant increases in credit risk must consider information about past events and current conditions as well as reasonable and supportable forecasts of future events and economic conditions. The estimation and application of forward-looking information will require significant judgment. Our estimation of expected credit losses is expected to be a discounted probability-weighted estimate that considers multiple future macroeconomic scenarios. Scenarios will cover our base macroeconomic expectations as well as possible upside and downside conditions, and will be designed to capture the point of non-linearity of losses. Scenarios will be probability-weighted according to our best estimate of their relative likelihood based on historical frequency and current trends and conditions and macroeconomic factors such as gross domestic product and unemployment rates. Our assessment of significant increases in credit risk will be based on changes in probability-weighted forward-looking lifetime PD, using the same macroeconomic scenarios as the calculation of expected credit losses. Definition of default The definition of default used in the measurement of expected credit losses and the assessment for movement between stages is expected to be consistent with the definition of default used for internal credit risk management purposes. IFRS 9 does not define default, but contains a rebuttable presumption that default has occurred when an exposure is greater than 90 days past due. We are still assessing whether it is appropriate to rebut this presumption for any of our products. Regulatory capital Under the current Basel III regulatory capital framework, any shortfall of accounting allowances to expected losses calculated according to the Basel rules for IRB portfolios is a deduction from CET1 capital. If accounting allowances exceed Basel expected losses, the excess is included as Tier 2 capital. After the adoption of IFRS 9, expected loss models will be used for both regulatory capital and accounting purposes. Under both models, expected losses are calculated as the product of PD, LGD and EAD. However, there are several key differences under current Basel rules which could lead to significantly different expected loss estimates: • • • Basel PDs are based on long-run averages over an entire economic cycle. IFRS 9 PDs are based on current conditions, adjusted for estimates of future conditions that will impact PD under several probability-weighted macroeconomic scenarios. Basel PDs consider the probability of default over the next 12 months. IFRS 9 PDs consider the probability of default over the next 12 months only for instruments in Stage 1. Expected credit losses for instruments in Stage 2 are calculated using lifetime PDs. Basel LGDs are based on severe but plausible downturn economic conditions. IFRS 9 LGDs are based on current conditions, adjusted for estimates of future conditions that will impact LGD under several probability-weighted macroeconomic scenarios. As at October 31, 2016, our shortfall of accounting allowances under IAS 39 to Basel expected losses was $1.4 billion. Based on the current regulatory rules, the regulatory capital impact of an increase in our accounting allowances under IFRS 9 relative to IAS 39 will be mitigated to the extent of our current deduction from CET1 capital. Hedge accounting The new hedge accounting model under IFRS 9 aims to simplify hedge accounting, align the accounting for hedge relationships more closely with an entity’s risk management activities and permit hedge accounting to be applied more broadly to a greater variety of hedging instruments and risks eligible for hedge accounting. The new standard does not explicitly address the accounting for macro hedging activities, which is being addressed by the IASB through a separate project. As a result, IFRS 9 includes an accounting policy choice to retain IAS 39 for hedge accounting requirements until the amended standard resulting from the IASB’s project on macro hedge accounting is effective. We expect to elect the accounting policy choice to continue applying hedge accounting under the IAS 39 framework. The new hedge accounting disclosures required by the related amendments to IFRS 7 Financial Instruments: Disclosures, however, are required for the annual period beginning November 1, 2017. Transition The impairment and classification and measurement requirements of IFRS 9 will be applied retrospectively by adjusting our Consolidated Balance Sheet at November 1, 2017, the date of initial application of IFRS 9. There is no requirement to restate comparative periods other than for hedge accounting. At this stage, it is not possible to reliably quantify the potential financial effect to the Bank from the adoption of IFRS 9. To manage our transition to IFRS 9, we have implemented a comprehensive enterprise-wide program led jointly by Finance and Risk Management that focuses on key areas of impact, including financial reporting, data, systems and processes, as well as communications and training. During fiscal 2015, we completed a detailed assessment of the scope and complexity of the adoption of IFRS 9 which identified areas with differences between IFRS 9 and IAS 39 and secured resources to complete the implementation. We continue to monitor and revisit our preliminary conclusions in order to identify any further financial, capital and business implications. During fiscal 2016, we have continued to manage the IFRS 9 program through the completion of activities and deliverables to support the key areas of impact noted above. These include the following steps completed to date: • • • • • • • • • • • Assessed the classification of financial assets based on our business model and the nature of the cash flows of the assets under review; Assessed the financial and economic impacts and identified process and systems requirements to ensure a successful transition; Continually evaluated our resourcing model, including cost analysis and timeline, to ensure that sufficient program resources are available to meet key deliverables; Agreed on many key accounting interpretations and formulated position papers on key issues; Completed design specifications for data sourcing, systems, models, controls and processes to ensure alignment between finance and risk processes and systems; Leveraged our stress testing and Basel expected loss processes to build new impairment models and parameters; Prepared dry-run expected credit loss estimates based on initial models and staging parameters; Designed key performance indicators to assist in assessing our dry-run and parallel run results; Initiated design of controls and governance over future processes, including key judgmental areas such as the forecasting and probability-weighting of future macroeconomic scenarios; Continued to roll out training and educational seminars to key stakeholders across the Bank in the various business platforms and functional groups; and Provided regular updates to the Audit Committee, Risk Committee and senior management to ensure escalation of key issues and risks. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 105 In the upcoming year, steps we expect to complete include the following: • • • • • • • • Complete a parallel run, the results of which will be used to test our models and methodologies against our key performance indicators; Validate new impairment models through back-testing and other methods; Prepare for future system changes, including a tool to determine the appropriate classification of new assets, where appropriate; Complete documentation of updated bank-wide accounting and risk policies; Finalize governance and control frameworks over new processes and test internal controls; Document the roll-out and implementation of the IFRS 9 project and governance structure including key controls; Continue to provide training and educational seminars to impacted internal stakeholders; and Draft future external disclosures and transition adjustments. As we prepare for our transition to IFRS 9, we continue to monitor industry interpretations of the new standard and expect to adjust our transition and implementation plans accordingly. Our IFRS 9 program remains aligned to our implementation schedule and we are on track to meet the timelines essential to our transition. IFRS 16 Leases (IFRS 16) In January 2016, the IASB issued IFRS 16, which sets out the principles for the recognition, measurement, presentation and disclosure of leases. The standard removes the current requirement for lessees to classify leases as finance leases or operating leases by introducing a single lessee accounting model that requires the recognition of lease assets and lease liabilities on the balance sheet for most leases. Lessees will also recognize depreciation expense on the lease asset and interest expense on the lease liability in the statement of income. There are no significant changes to lessor accounting aside from enhanced disclosure requirements. IFRS 16 will be effective for us on November 1, 2019. IAS 7 Statement of Cash Flows (IAS 7) In January 2016, the IASB issued amendments to IAS 7, which will require specific disclosures for movements in certain liabilities on the statement of cash flow. These amendments will be effective for us on November 1, 2017. Regulatory developments BCBS revised Pillar 3 disclosure requirements On March 11, 2016, the BCBS released a consultation paper entitled, “Pillar 3 disclosure requirements – consolidated and enhanced framework”. The proposed enhancements include the addition of a “dashboard” of key metrics, a draft disclosure requirement of hypothetical risk-weighted assets calculated based on the Basel framework’s standardized approaches. The proposal also includes enhanced granularity for disclosure of prudent valuation adjustments and incorporates additions to the Pillar 3 framework to reflect ongoing reforms to the regulatory framework such as the total loss-absorbing capacity regime for global systemically important banks, the proposed operational risk framework, and the final standard for market risk. The BCBS’s proposal would also consolidate all existing Pillar 3 disclosure requirements of the Basel framework, including the leverage and liquidity ratios disclosure templates. Together with the Revised Pillar 3 disclosure requirements issued in January 2015, the proposed disclosure requirements included in this consultation paper would comprise the single Pillar 3 framework. In January 2016, OSFI issued a draft guideline indicating that all domestic systemically important banks are expected to implement the Basel Pillar 3 disclosure requirements for the reporting period ending October 31, 2017. In August 2016, OSFI revised its expectation on the implementation date to the reporting period ending October 31, 2018. The final guideline is expected to be issued in 2017. BCBS standards on interest rate risk in the banking book On April 21, 2016, the BCBS issued new standards for Interest Rate Risk in the Banking Book (IRRBB), which enhances disclosure requirements to promote greater consistency, transparency, and compatibility in the measurement and management of IRRBB. This includes quantitative disclosure requirements based on common interest rate shock scenarios. These disclosure requirements will be effective for us in the reporting period ending October 31, 2018. BCBS guidance on regulatory capital treatment of accounting provisions On October 12, 2016, the BCBS released a consultative document and a discussion paper on the regulatory treatment of accounting provisions under the Basel III regulatory capital framework. The papers address the impact of new expected credit loss accounting standards, such as IFRS 9, that will replace the current incurred loss models used for accounting purposes. IFRS 9 will be effective for us on November 1, 2017. For further details on the adoption of IFRS 9, including application regulatory guidance, refer to the Critical accounting policies and estimates section. The consultative document sets out the BCBS’s proposal to retain, for an interim period, the current regulatory treatment of credit loss provisions under the standardized and the IRB approaches. The document also considers the adoption of transitional arrangements to phase-in the impact of the new expected credit loss accounting standards on regulatory capital. The discussion paper explores policy options for the long-term regulatory treatment of loss allowances under the new expected credit loss accounting standards. Both papers are open for public comment until January 13, 2017. 106 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Controls and procedures Disclosure controls and procedures Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports filed or submitted under Canadian and U.S. securities laws is recorded, processed, summarized and reported within the time periods specified under those laws and include controls and procedures that are designed to ensure that information is accumulated and communicated to management, including the President and Chief Executive Officer, and the Chief Administrative Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. As of October 31, 2016, management evaluated, under the supervision of and with the participation of the President and Chief Executive Officer and the Chief Administrative Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as defined under rules adopted by the United States Securities and Exchange Commission. Based on that evaluation, the President and Chief Executive Officer and the Chief Administrative Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of October 31, 2016. Internal control over financial reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. However, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. See Management’s Report on Internal Control over Financial Reporting and the Report of Independent Registered Public Accounting Firm. No changes were made in our internal control over financial reporting during the year ended October 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Related party transactions In the ordinary course of business, we provide normal banking services and operational services, and enter into other transactions with associated and other related corporations, including our joint venture entities, on terms similar to those offered to non-related parties. We grant loans to directors, officers and other employees at rates normally accorded to preferred clients. In addition, we offer deferred share and other plans to non-employee directors, executives and certain other key employees. For further information, refer to Notes 12 and 29 of our audited 2016 Annual Consolidated Financial Statements. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 107 Supplementary information Net interest income on average assets and liabilities Table 79 Average balances Interest Average rate 2016 2015 2014 2016 2015 2014 2016 2015 2014 $ 11,679 $ 16,842 15,415 43,936 8,463 $ 5,567 14,837 28,867 1,692 $ 540 5,227 7,459 114 $ 71 (18) 167 70 $ 12 (5) 77 61 1 14 76 0.98% 0.42 (0.12) 0.38% 0.83% 0.22 (0.03) 0.27% 3.61% 0.19 0.27 1.02% 153,114 72,440 225,554 164,509 52,833 217,342 149,920 43,047 192,967 3,366 1,227 4,593 3,543 976 4,519 3,322 671 3,993 2.20 1.69 2.04 2.15 1.85 2.08 2.22 1.56 2.07 191,243 165,602 136,857 1,816 1,251 971 0.95 0.76 0.71 338,270 69,028 407,298 75,734 29,409 512,441 973,174 326,153 58,946 385,099 36,581 31,261 452,941 864,752 314,159 54,681 368,840 28,402 25,067 422,309 759,592 11,141 3,249 14,390 2,038 1,448 17,876 24,452 11,842 2,959 14,801 780 1,301 16,882 22,729 11,996 2,970 14,966 888 1,125 16,979 22,019 17,586 19,283 13,495 – – – 13,247 172,393 – – $ 1,176,400 $1,052,800 $ 906,500 $ 24,452 $ 22,729 $ 22,019 10,725 122,688 12,423 156,342 – – – – 3.29 4.71 3.53 2.69 4.92 3.49 2.51 – 3.63 5.02 3.84 2.13 4.16 3.73 2.63 – 3.82 5.43 4.06 3.13 4.49 4.02 2.90 – – – 2.08% – – 2.16% – – 2.43% 487,194 83,001 67,365 637,560 459,679 68,909 62,029 590,617 418,780 50,459 54,267 523,506 4,714 413 340 5,467 5,162 214 347 5,723 5,416 158 299 5,873 0.97% 0.50 0.50 0.86 1.12% 0.31 0.56 0.97 1.29% 0.31 0.55 1.12 50,262 56,827 50,548 1,579 1,645 1,494 3.14 2.89 2.96 (Millions of Canadian dollars, except for percentage amounts) Assets Deposits with other banks (1) Canada U.S. Other International Securities Trading Available-for-sale Asset purchased under reverse repurchase agreements and securities borrowed Loans (2) Canada Retail (3) Wholesale (3) U.S. Other International Total interest-earning assets Non-interest-bearing deposits with other banks Customers’ liability under acceptances Other assets (1) Total assets Liabilities and shareholders’ equity Deposits (4) Canada U.S. Other International Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Subordinated debentures Other interest-bearing liabilities (1) Total interest-bearing liabilities Non-interest-bearing deposits Acceptances Other liabilities (1) Total liabilities 110,231 8,931 15,437 822,421 112,071 13,248 159,215 278 246 12 7,903 – – – $ 1,106,955 $ 994,160 $ 854,495 $ 7,921 $ 7,958 $ 7,903 68,594 6,632 251 649,531 69,596 10,725 124,643 84,380 7,654 13,585 753,063 76,830 12,422 151,845 629 227 19 7,921 – – – 337 240 13 7,958 – – – Equity 69,445 58,640 52,005 n.a. n.a. n.a. Total liabilities and shareholders’ equity $ 1,176,400 $1,052,800 $ 906,500 $ 7,921 $ 7,958 $ 7,903 Net interest income and margin $ 1,176,400 $1,052,800 $ 906,500 $ 16,531 $ 14,771 $ 14,116 Net interest income and margin (average earning assets) Canada U.S. Other International Total $ 572,671 $ 539,333 $ 497,436 $ 11,694 $ 11,538 $ 11,121 1,896 1,099 $ 973,174 $ 864,752 $ 759,592 $ 16,531 $ 14,771 $ 14,116 246,065 154,438 135,876 126,280 165,083 160,336 3,241 1,596 1,977 1,256 0.57 2.54 0.12 0.96 – – – 0.72% n.a. 0.67% 1.41% 2.04% 1.32 1.03 1.70% 0.40 3.14 0.10 1.06 – – – 0.80% n.a. 0.76% 1.40% 2.14% 1.20 0.78 1.71% 0.41 3.71 4.78 1.22 – – – 0.92% n.a. 0.87% 1.56% 2.24% 1.40 0.87 1.86% (1) (2) (3) (4) Starting in 2015, we have included cash collateral and margin deposits, and cash collateral received in Deposits with other banks and Other interest-bearing liabilities, respectively (previously, in Other assets and Other liabilities). Insurance segment assets and liabilities are included in Other assets and Other liabilities, respectively. Interest income includes loan fees of $573 million (2015 – $503 million; 2014 – $516 million). Amounts have been revised from those previously presented. Deposits include personal savings deposits with average balances of $166 billion (2015 – $142 billion; 2014 – $133 billion), interest expense of $.4 billion (2015 – $.6 billion; 2014 – $.7 billion) and average rates of .3% (2015 – .4%; 2014 – .5%). Deposits also include term deposits with average balances of $362 billion (2015 – $345 billion; 2014 – $302 billion), interest expense of $4.3 billion (2015 – $4.5 billion; 2014 – $4.4 billion) and average rates of 1.20% (2015 – 1.30%; 2014 – 1.47%). 108 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Change in net interest income Table 80 (Millions of Canadian dollars) Assets Deposits with other banks (3) Canada (4) U.S. (4) Other international (4) Securities Trading Available-for-sale Asset purchased under reverse repurchase agreements and securities borrowed Loans Canada Retail (5) Wholesale (5) U.S. Other international Total interest income Liabilities Deposits Canada U.S. Other international Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Subordinated debentures Other interest-bearing liabilities (3) Total interest expense Net interest income 2016 (1) vs. 2015 Increase (decrease) due to changes in 2015 vs. 2014 Increase (decrease) due to changes in Average volume (2) Average rate (2) Net change Average volume (2) Average rate (2) Net change $ $ $ $ $ 27 24 – $ 17 35 (13) (245) 362 194 440 506 835 (77) 2,066 309 44 30 (190) 103 40 2 338 1,728 $ $ $ 68 (111) 371 (1,141) (216) 423 224 (343) $ (757) 155 (37) 124 189 (53) 4 (375) $ $ 32 44 59 (13) (177) 251 565 (701) 290 1,258 147 1,723 (448) 199 (7) (66) 292 (13) 6 (37) 1,760 $ $ $ $ 244 9 26 323 153 204 458 232 256 278 2,183 529 58 43 186 64 38 637 1,555 628 $ $ $ $ (235) $ 2 (45) (102) 152 76 (612) (243) (364) (102) (1,473) $ (783) (2) 5 (35) (5) (44) (636) (1,500) $ $ 27 9 11 (19) 221 305 280 (154) (11) (108) 176 710 (254) 56 48 151 59 (6) 1 55 655 (1) (2) (3) (4) (5) Insurance segment assets and liabilities are included in Other assets and Other liabilities, respectively. Volume/rate variance is allocated on the percentage relationships of changes in balances and changes in rates to the total net change in net interest income. Starting in 2015, we have included cash collateral and margin deposits, and cash collateral received in Deposits with other banks and Other interest-bearing liabilities, respectively (previously, in Other assets and Other liabilities). Geographic classification for selected assets and liabilities is based on the domicile of the booking point of the subject assets and liabilities. Amounts have been revised from those previously presented. Loans and acceptances by geography Table 81 As at October 31 (Millions of Canadian dollars) Canada Residential mortgages Personal Credit cards Small business Retail Business Sovereign (2) Bank Wholesale U.S. Retail Wholesale Other International Retail Wholesale Total loans and acceptances Total allowance for loan losses Total loans and acceptances, net of allowance for loan losses (1) (2) On a continuing operations basis. In 2015, we reclassified $4 billion from AFS securities to Loans. 2016 2015 2014 2013 2012 (1) $ 241,800 82,205 16,601 3,878 344,484 76,266 8,586 1,278 $ 86,130 $ 430,614 $ 229,987 84,637 15,516 4,003 334,143 71,246 8,508 530 $ 80,284 $ 414,427 $ 215,624 86,984 14,650 4,067 321,325 64,643 3,840 413 $ 68,896 $ 390,221 $ 206,134 86,102 13,902 4,026 310,164 58,920 3,807 823 $ 63,550 $ 373,714 $ 195,552 80,000 13,422 2,503 291,477 51,212 3,751 390 $ 55,353 $ 346,830 17,134 59,349 76,483 5,484 34,702 40,186 4,686 23,639 28,325 3,734 19,443 23,177 3,138 17,081 20,219 7,852 21,733 29,585 $ 536,682 (2,235) $ 534,447 8,556 24,536 33,092 $ 487,705 (2,029) $ 485,676 8,258 21,881 30,139 $ 448,685 (1,994) $ 446,691 6,768 17,103 23,871 $ 420,762 (1,959) $ 418,803 5,673 16,900 22,573 $ 389,622 (1,996) $ 387,626 Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 109 Loans and acceptances by portfolio and sector As at October 31 (Millions of Canadian dollars) Residential mortgages Personal Credit cards Small business Retail Business Agriculture Automotive Consumer goods Energy Oil & gas Utilities Financial products Forest products Health services Holding and investments Industrial products Mining & metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale Total loans and acceptances Total allowance for loan losses Table 82 2016 2015 2014 2013 2012 (1) $ 254,998 93,466 17,128 3,878 $ 233,975 94,346 15,859 4,003 $ 219,257 96,021 14,924 4,067 $ 209,238 93,260 14,142 4,026 $ 198,324 85,800 13,661 2,503 $ 369,470 $ 348,183 $ 334,269 $ 320,666 $ 300,288 6,515 7,279 10,052 6,259 7,680 8,840 1,099 7,763 7,195 5,508 1,455 8,408 11,582 40,419 11,019 6,060 7,568 10,581 1,930 6,057 6,614 7,146 7,691 5,162 10,093 1,169 6,023 6,935 4,725 1,402 6,428 8,834 33,802 6,599 5,907 3,248 9,887 1,800 5,694 6,209 7,172 5,849 3,766 3,670 979 4,052 6,865 4,665 1,320 5,688 8,322 30,387 4,822 5,432 3,695 4,628 1,201 5,441 6,167 6,230 5,046 3,860 3,162 893 3,786 4,973 4,038 1,074 4,903 8,090 24,413 4,006 5,593 2,705 4,396 1,320 5,202 3,585 5,432 4,981 3,821 4,316 811 3,766 4,625 3,938 965 3,895 7,003 20,650 4,203 5,221 1,737 4,193 990 $ 167,212 $ 139,522 $ 114,416 $ 100,096 $ 89,334 $ 536,682 $ 487,705 $ 448,685 $ 420,762 $ 389,622 (2,235) (2,029) (1,994) (1,959) (1,996) Total loans and acceptances, net of allowance for loan losses $ 534,447 $ 485,676 $ 446,691 $ 418,803 $ 387,626 (1) On a continuing operations basis. 110 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis Impaired loans by portfolio and geography As at October 31 (Millions of Canadian dollars, except for percentage amounts) Residential mortgages Personal Small business Retail Business Agriculture Automotive Consumer goods Energy Oil and gas Utilities Financing products Forest products Health services Holding and investments Industrial products Mining & metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale Acquired credit-impaired loans Total impaired loans (2) Canada Residential mortgages Personal Small business Retail Business Agriculture Automotive Consumer goods Energy Oil & gas Utilities Financing products Forest products Health services Holding and investments Industrial products Mining & metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale Total U.S. Retail Wholesale Total Other International Retail Wholesale Total Total impaired loans Allowance for impaired loans Net impaired loans Gross impaired loans as a % of loans and acceptances Residential mortgages Personal Small business Retail Wholesale Total Allowance for impaired loans as a % of gross impaired loans $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2016 709 304 46 1,059 43 43 165 1,264 78 111 21 21 72 43 15 3 109 241 93 45 57 – 2 2,426 418 3,903 368 228 46 642 34 9 91 57 15 – 21 18 5 39 12 – 49 121 27 24 – – – 522 1,164 56 1,736 1,792 380 567 947 3,903 (809) 3,094 0.28% 0.33% 1.19% 0.29% 1.69% 0.73% 20.72% 2015 646 299 45 990 41 11 130 156 57 109 28 17 185 45 17 1 69 297 34 53 43 – 2 1,295 – 2,285 356 223 45 624 39 8 65 39 20 – 5 17 3 39 7 – 51 161 34 29 (5) – – 512 1,136 10 204 214 356 579 935 2,285 (654) 1,631 $ $ $ $ $ $ $ $ $ $ $ 0.28% 0.32% 1.13% 0.28% 0.93% 0.47% 28.64% $ $ $ $ $ $ $ $ $ $ $ 2014 678 300 47 1,025 40 12 108 6 – – 25 18 132 48 9 3 99 314 38 32 66 – 2 952 – 1,977 388 224 47 659 36 11 70 4 – – 6 19 3 41 9 1 67 171 37 11 1 – – 487 1,146 13 18 31 353 447 800 1,977 (632) 1,345 0.31% 0.31% 1.16% 0.31% 0.84% 0.44% 31.98% Table 83 2012 (1) 674 273 33 980 52 17 83 2 – 50 30 17 38 88 2 5 97 353 251 73 110 – 2 1,270 2,250 475 206 34 715 44 11 34 – – – 12 15 22 34 2 3 50 153 238 22 1 – – 641 1,356 7 162 169 258 467 725 2,250 (636) 1,614 0.34% 0.32% 1.32% 0.33% 1.42% 0.58% 28.33% $ $ $ $ $ $ $ $ $ $ $ 2013 691 363 37 1,091 43 12 101 14 – 39 26 25 40 54 2 1 101 367 117 98 67 – 3 1,110 2,201 464 229 36 729 38 9 58 14 – – 8 15 3 40 2 1 59 169 86 21 3 – – 526 1,255 14 98 112 348 486 834 2,201 (599) 1,602 0.33% 0.39% 0.83% 0.34% 1.11% 0.52% 27.22% (1) (2) On a continuing operations basis. Past due loans greater than 90 days not included in impaired loans were $337 million in 2016 (2015 – $314 million; 2014 – $316 million; 2013 – $346 million; 2012 – $393 million). Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 111 Provision for credit losses by portfolio and geography Table 84 (Millions of Canadian dollars, except for percentage amounts) Residential mortgages Personal Credit cards Small business Retail Business Agriculture Automotive Consumer goods Energy Oil and gas Utilities Financial products Forest products Health services Holding and investments Industrial products Mining & metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale Acquired credit-impaired loans Total provision for credit losses on impaired loans Canada Residential mortgages Personal Credit cards Small business Retail Business Agriculture Automotive Consumer goods Energy Oil & gas Utilities Financing products Forest products Health services Holding and investments Industrial products Mining & metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale Total U.S. Retail Wholesale Other International Retail Wholesale Total provision for credit losses on impaired loans Total provision for credit losses on non-impaired loans Total provision for credit losses Total PCL as a % of average net loans and acceptances PCL on impaired loans as a % of average net loans and acceptances (1) On a continuing operations basis. 112 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis $ 2016 77 458 442 34 $ 1,011 $ 10 13 20 320 16 1 4 4 – 12 7 – (5) 36 8 (4) 36 – (3) 475 10 $ 1,496 $ $ $ 42 459 435 34 970 10 3 19 99 – – 5 4 – 10 7 – 14 26 2 8 6 – – $ 213 $ 1,183 1 227 228 $ 41 44 85 $ $ 1,496 50 $ 1,546 0.29% 0.28% $ $ $ 2015 47 388 378 32 845 9 3 33 47 9 39 6 – 18 4 8 7 4 29 5 8 24 – (1) 252 – $ 1,097 $ $ $ $ $ $ 27 393 371 32 823 9 3 21 22 1 – 1 – – 7 3 – – 13 6 7 23 – – 116 939 1 40 41 $ $ $ 2014 94 441 353 44 932 3 2 27 (5) 32 3 7 – 29 14 2 – 18 58 14 2 26 – – 232 – $ 1,164 $ $ $ $ $ $ 27 393 345 44 809 4 3 25 (5) – – 1 – – 14 2 – 6 34 14 3 22 – – 123 932 2 40 42 $ $ $ 2013 41 458 354 32 885 4 3 17 (6) – 1 4 – (6) 21 1 10 14 62 157 35 35 – – 352 – $ 1,237 $ $ $ $ $ $ 27 391 346 32 796 4 3 16 (6) – – 3 – (8) 14 1 – 3 37 50 2 30 – – 149 945 3 32 35 21 96 117 $ $ 1,097 – $ 1,097 0.24% 0.24% 121 69 190 $ $ 1,164 – $ 1,164 0.27% 0.27% 86 171 257 $ $ 1,237 – $ 1,237 0.31% 0.31% $ $ $ $ $ $ $ $ $ $ $ $ $ 2012 (1) 67 445 394 43 949 8 (2) 27 (11) 2 5 – (1) 32 – 1 (3) 82 102 47 63 – – 352 – 1,301 34 413 391 43 881 8 (2) 13 (11) – – 5 – – 12 – 1 – 43 98 10 30 – – 207 1,088 4 29 33 64 116 180 1,301 (2) 1,299 0.35% 0.35% Allowance for credit losses by portfolio and geography (Millions of Canadian dollars, except percentage amounts) Allowance at beginning of year Provision for credit losses Write-offs by portfolio Residential mortgages Personal Credit cards Small business Retail Business Sovereign Bank Wholesale Total write-offs by portfolio Recoveries by portfolio Residential mortgages Personal Credit cards Small business Retail Business Sovereign Bank Wholesale Total recoveries by portfolio Net write-offs Adjustments (3) Total allowance for credit losses at end of year Allowance against impaired loans Canada Residential mortgages Personal Small business Retail Business Agriculture Automotive Consumer goods Energy Oil & gas Utilities Financing products Forest products Health services Holding and investments Industrial products Mining and metals Non-bank financial services Other services Real estate & related Technology & media Transportation & environment Other Sovereign Bank Wholesale U.S. Retail Wholesale Other International Retail Wholesale Total allowance against impaired loans Allowance against non-impaired loans Residential mortgages Personal Credit cards Small business Retail Wholesale Off-balance sheet and other items Total allowance against non-impaired loans Total allowance for credit losses Key ratios Allowance for credit losses as a % of loans and acceptances Net write-offs as a % of average net loans and acceptances $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ Table 85 2013 2,087 1,237 2012 (1), (2) 2,056 1,299 $ 2016 2,120 1,546 (42) (556) (564) (40) (1,202) (321) – – (321) (1,523) $ $ $ $ $ 2015 2,085 1,097 $ (64) (494) (497) (40) (1,095) $ (243) $ – – (243) $ (1,338) $ 2014 2,050 1,164 $ (30) (565) (466) (47) (1,108) $ (221) $ – – (221) $ (1,329) $ $ $ $ 5 111 122 10 248 38 – – $ 38 $ 286 (1,237) $ (103) 2,326 $ $ $ $ 7 105 119 10 241 33 – 1 $ 34 275 $ (1,063) $ 1 2,120 $ $ $ $ 2 106 114 9 231 32 – – $ 32 263 $ (1,066) $ (63) 2,085 $ (24) (498) (466) (35) (1,023) $ (448) $ – – (448) $ (1,471) $ $ $ $ 2 96 112 9 219 51 – – $ 51 270 $ (1,201) $ (73) 2,050 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 35 105 20 160 6 4 14 6 – – 5 6 1 11 4 – 18 23 10 11 – – – 119 279 2 177 179 180 171 351 809 96 385 386 45 912 514 91 1,517 2,326 0.43% 0.23% $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 27 96 19 142 5 4 12 – 1 – 3 6 1 13 1 – 19 28 12 7 (1) – – 111 253 1 47 48 169 184 353 654 83 396 386 45 910 465 91 1,466 2,120 0.43% 0.23% $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 31 93 19 143 6 4 22 – – – 3 6 1 18 1 – 28 48 17 5 1 – – 160 303 1 16 17 172 140 312 632 78 400 385 45 908 454 91 1,453 2,085 0.46% 0.25% $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 36 97 16 149 6 4 15 1 – – 4 6 2 15 1 – 23 42 46 6 (1) – – 170 319 2 19 21 146 113 259 599 48 405 385 45 883 477 91 1,451 2,050 0.49% 0.30% (32) (499) (496) (50) (1,077) (288) – (32) (320) (1,397) 1 83 102 8 194 39 – – 39 233 (1,164) (104) 2,087 41 89 12 142 9 7 14 1 – – 6 6 10 10 1 – 20 45 107 8 (5) – – 239 381 1 38 39 96 120 216 636 48 392 403 60 903 457 91 1,451 2,087 0.54% 0.31% (1) (2) (3) On a continuing operations basis. Opening allowance for credit losses as at November 1, 2011 has been restated due to the implementation of amendments to IFRS 11. Under IFRS, other adjustments include $100 million of unwind of discount and $3 million of changes in exchange rate (2015 – $80 million and $(81) million; 2014 – $87 million and $(24) million; 2013 – $86 million and $(13) million). For further details, refer to Note 5 of our audited 2016 Annual Consolidated Financial Statements. Management’s Discussion and Analysis Royal Bank of Canada: Annual Report 2016 113 Credit quality information by Canadian province Table 86 (Millions of Canadian dollars) Loans and acceptances Atlantic provinces (2) Quebec Ontario Alberta Other Prairie provinces (3) B.C. and territories (4) Total loans and acceptances in Canada Gross impaired loans Atlantic provinces (2) Quebec Ontario Alberta Other Prairie provinces (3) B.C. and territories (4) Total gross impaired loans in Canada Provision for credit losses on impaired loans Atlantic provinces (2) Quebec Ontario Alberta Other Prairie provinces (3) B.C. and territories (4) 2016 2015 2014 2013 2012 (1) $ 23,947 53,518 185,434 66,277 30,143 71,295 $ 23,040 51,197 175,315 28,607 65,785 70,483 $ 22,130 50,748 159,817 61,197 27,341 68,988 $ 21,263 48,060 152,258 58,318 25,697 68,118 $ 19,953 42,920 141,566 53,987 23,200 65,204 $ 430,614 $ 414,427 $ 390,221 $ 373,714 $ 346,830 $ $ $ $ $ $ 101 207 336 313 93 114 1,164 67 92 654 226 64 80 93 213 341 224 115 150 1,136 57 96 590 77 52 67 939 $ $ $ $ 81 205 391 185 73 211 1,146 51 92 588 71 40 90 932 $ $ $ $ 83 177 424 233 97 241 1,255 50 78 605 74 39 99 945 $ $ $ 67 180 502 250 88 269 1,356 62 96 704 79 41 106 $ 1,088 Total provision for credit losses on impaired loans in Canada $ 1,183 $ (1) (2) (3) (4) On a continuing operations basis. Comprises Newfoundland and Labrador, Prince Edward Island, Nova Scotia and New Brunswick. Comprises Manitoba and Saskatchewan. Comprises British Columbia, Nunavut, Northwest Territories and Yukon. 114 Royal Bank of Canada: Annual Report 2016 Management’s Discussion and Analysis EDTF recommendations index On October 29, 2012, the Enhanced Disclosure Task Force (EDTF), established by the Financial Stability Board, issued its report Enhancing the Risk Disclosures of Banks, which included 32 recommendations aimed at achieving transparent, high-quality risk disclosures. As a result, our enhanced disclosures have been provided in our 2016 Annual Report and Supplementary Financial Information package (SFI). The following index summarizes our disclosure by EDTF recommendation: Location of disclosure Recommendation 1 2 Disclosure Table of contents for EDTF risk disclosure Define risk terminology and measures Type of Risk General Risk governance, risk management and business model Capital adequacy and risk-weighted assets (RWA) Liquidity Funding Market risk Credit risk Other 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 Annual Report page 115 49-54, 208-210 47-49 90-93 49-54 49-51 98 51-52, 67 90-93 Top and emerging risks New regulatory ratios Risk management organization Risk culture Risk in the context of our business activities Stress testing Minimum Basel III capital ratios and Domestic systemically important bank surcharge Composition of capital and reconciliation of the accounting – balance sheet to the regulatory balance sheet Flow statement of the movements in regulatory capital Capital strategic planning RWA by business segments Analysis of capital requirement, and related measurement model information RWA credit risk and related risk measurements Movement of risk-weighted assets by risk type Basel back-testing Quantitative and qualitative analysis of our liquidity reserve Encumbered and unencumbered assets by balance sheet category, and contractual obligations for rating downgrades Maturity analysis of consolidated total assets, liabilities and off-balance sheet commitments analyzed by remaining contractual maturity at the balance sheet date Sources of funding and funding strategy Relationship between the market risk measures for trading and non-trading portfolios and the balance sheet Decomposition of market risk factors Market risk validation and back-testing Primary risk management techniques beyond reported risk measures and parameters Bank’s credit risk profile Quantitative summary of aggregate credit risk exposures that reconciles to the balance sheet Policies for identifying impaired loans Reconciliation of the opening and closing balances of impaired loans and impairment allowances during the year Quantification of gross notional exposure for OTC derivatives or exchange-traded derivatives Credit risk mitigation, including collateral held for all sources of credit risk Other risk types Publicly known risk events – 89-93 – 54-58 – – 52, 56 73-75, 78-79 75, 78 80-81 75-77 71-72 66-70 67 66-71 54-66, 156-158 110-114 57-58, 101 131-132 – 60 57 82-89 85-87, 195-196 SFI page 1 – – – – – – – – 21-24 25 – 28 26-27 42-44 28 42 – – – – – – – – 31-44 40 – 33,37 46 41 – – Index for Enhanced Disclosure Task Force recommendations Royal Bank of Canada: Annual Report 2016 115 REPORTS AND CONSOLIDATED FINANCIAL STATEMENTS 117 Reports 117 Management’s Responsibility for Financial Reporting 117 Management’s Report on Internal Control over Financial Reporting 126 Notes to Consolidated Financial Statements 126 Note 1 General information 126 Note 2 Summary of significant accounting policies, estimates and judgments 118 Reports of Independent Registered Public Accounting 138 Note 3 Fair value of financial instruments Firms 121 Consolidated Financial Statements 121 Consolidated Balance Sheets 122 Consolidated Statements of Income 123 Consolidated Statements of Comprehensive Income 124 Consolidated Statements of Changes in Equity 125 Consolidated Statements of Cash Flows 116 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements 151 Note 4 Securities 155 Note 5 Loans 157 Note 6 Derecognition of financial assets 158 Note 7 Structured entities 162 Note 8 Derivative financial instruments and hedging activities 167 Note 9 Premises and equipment 168 Note 10 Goodwill and other intangible assets 170 Note 11 Significant acquisition and dispositions 171 Note 12 Joint ventures and associated companies 172 Note 13 Other assets 172 Note 14 Deposits 173 Note 15 Insurance 175 Note 16 Segregated funds 176 Note 17 Employee benefits – Pension and other post-employment benefits 181 Note 18 Other liabilities 181 Note 19 Subordinated debentures 182 Note 20 Trust capital securities 183 Note 21 Equity 185 Note 22 Share-based compensation 187 Note 23 Income and expenses from selected financial instruments 188 Note 24 Income taxes 190 Note 25 Earnings per share 190 Note 26 Guarantees, commitments, pledged assets and contingencies 194 Note 27 Legal and regulatory matters 195 Note 28 Contractual repricing and maturity schedule 196 Note 29 Related party transactions 197 Note 30 Results by business segment 200 Note 31 Nature and extent of risks arising from financial instruments 201 Note 32 Capital management 201 Note 33 Offsetting financial assets and financial liabilities 203 Note 34 Recovery and settlement of on-balance sheet assets and liabilities 204 Note 35 Parent company information 205 Note 36 Subsequent events Management’s Responsibility for Financial Reporting The accompanying consolidated financial statements of Royal Bank of Canada were prepared by management, which is responsible for the integrity and fairness of the information presented, including the many amounts that must of necessity be based on estimates and judgments. These consolidated financial statements were prepared in accordance with the Bank Act (Canada) and International Financial Reporting Standards as issued by the International Accounting Standards Board. Financial information appearing throughout our Management’s Discussion and Analysis is consistent with these consolidated financial statements. Our internal controls are designed to provide reasonable assurance that transactions are authorized, assets are safeguarded and proper records are maintained. These controls include quality standards in hiring and training of employees, policies and procedures manuals, a corporate code of conduct and accountability for performance within appropriate and well-defined areas of responsibility. The system of internal controls is further supported by a compliance function, which is designed to ensure that we and our employees comply with securities legislation and conflict of interest rules, and by an internal audit staff, which conducts periodic audits of all aspects of our operations. The Board of Directors oversees management’s responsibilities for financial reporting through an Audit Committee, which is composed entirely of independent directors. This Committee reviews our consolidated financial statements and recommends them to the Board for approval. Other key responsibilities of the Audit Committee include reviewing our existing internal control procedures and planned revisions to those procedures, and advising the directors on auditing matters and financial reporting issues. Our Chief Compliance Officer and Chief Internal Auditor have full and unrestricted access to the Audit Committee. The Office of the Superintendent of Financial Institutions Canada (OSFI) examines and inquires into our business and affairs as deemed necessary to determine whether the provisions of the Bank Act are being complied with, and that we are in sound financial condition. In carrying out its mandate, OSFI strives to protect the rights and interests of our depositors and creditors. PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm appointed by our shareholders upon the recommendation of the Audit Committee and Board, has performed an independent audit of the consolidated balance sheet as at October 31, 2016 and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for the year ended October 31, 2016 and the effectiveness of our internal control over financial reporting as at October 31, 2016. Their report, which expressed an unqualified opinion, can be found on the following pages of the consolidated financial statements. PricewaterhouseCoopers LLP has full and unrestricted access to the Audit Committee to discuss their audit and related findings. The consolidated balance sheet as at October 31, 2015, and the consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the years in the two-year period ended October 31, 2015 were audited by our previous auditors, Deloitte LLP, who expressed an unqualified opinion on those statements in their report dated December 1, 2015. David I. McKay President and Chief Executive Officer Janice R. Fukakusa Chief Administrative Officer and Chief Financial Officer Toronto, November 29, 2016 Management’s Report on Internal Control over Financial Reporting Management of Royal Bank of Canada is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the President and Chief Executive Officer and the Chief Administrative Officer and Chief Financial Officer and effected by the Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. It includes those policies and procedures that: • Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions related to and dispositions of our assets; • Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and our receipts and expenditures are made only in accordance with authorizations of our management and directors; and • Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements on a timely basis. Also, projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management evaluated, under the supervision of and with the participation of the President and Chief Executive Officer and the Chief Administrative Officer and Chief Financial Officer, the effectiveness of our internal control over financial reporting as of October 31, 2016, based on the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that, as of October 31, 2016, internal control over financial reporting was effective based on the criteria established in the Internal Control—Integrated Framework (2013). Also, based on the results of our evaluation, management concluded that there were no material weaknesses that have been identified in internal control over financial reporting as of October 31, 2016. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 117 The effectiveness of our internal control over financial reporting as of October 31, 2016, has been audited by PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm, as stated in their report, which expressed an unqualified opinion on our internal control over financial reporting and appears herein. David I. McKay President and Chief Executive Officer Janice R. Fukakusa Chief Administrative Officer and Chief Financial Officer Toronto, November 29, 2016 Reports of Independent Registered Public Accounting Firms Independent Auditor’s Report – Current Auditor To the Shareholders of Royal Bank of Canada We have completed an integrated audit of Royal Bank of Canada’s (the Bank) 2016 consolidated financial statements and its internal control over financial reporting as at October 31, 2016. Our opinions, based on our audits, are presented below. Report on the consolidated financial statements We have audited the accompanying 2016 consolidated financial statements of Royal Bank of Canada, which comprise the consolidated balance sheet as at October 31, 2016, and the consolidated statements of income, comprehensive income, changes in equity, and cash flows for the year ended October 31, 2016 and the related notes, which comprise a summary of significant accounting policies and other explanatory information. Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit as at October 31, 2016 and for the year then ended in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. Canadian generally accepted auditing standards also require that we comply with ethical requirements. An audit involves performing procedures to obtain audit evidence, on a test basis, about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Bank’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting principles and policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audit is sufficient and appropriate to provide a basis for our audit opinion on the consolidated financial statements. Opinion In our opinion, the 2016 consolidated financial statements present fairly, in all material respects, the financial position of Royal Bank of Canada as at October 31, 2016 and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. Report on internal control over financial reporting We have also audited Royal Bank of Canada’s internal control over financial reporting as at October 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s responsibility for internal control over financial reporting Management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. 118 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Auditor’s responsibility Our responsibility is to express an opinion on the Bank’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our audit opinion on the company’s internal control over financial reporting. Definition of internal control over financial reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Inherent limitations Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Opinion In our opinion, Royal Bank of Canada maintained, in all material respects, effective internal control over financial reporting as at October 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by COSO. PricewaterhouseCoopers LLP Chartered Professional Accountants Licensed Public Accountants Toronto, Canada November 29, 2016 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 119 Independent Auditor’s Report – Predecessor Auditor To the Shareholders of Royal Bank of Canada We have audited the accompanying consolidated financial statements of Royal Bank of Canada and subsidiaries (the “Bank”), which comprise the consolidated balance sheet as at October 31, 2015, and the consolidated statements of income, statements of comprehensive income, statements of changes in equity, and statements of cash flows for each of the years in the two-year period ended October 31, 2015, and a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the balance sheet of Royal Bank of Canada and subsidiaries as at October 31, 2015, and their financial performance and cash flows for each of the years in the two-year period ended October 31, 2015 in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. Deloitte LLP Chartered Professional Accountants Licensed Public Accountants Toronto, Canada December 1, 2015 120 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Consolidated Balance Sheets (Millions of Canadian dollars) Assets Cash and due from banks Interest-bearing deposits with banks Securities (Note 4) Trading Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans (Note 5) Retail Wholesale Allowance for loan losses (Note 5) Segregated fund net assets (Note 16) Other Customers’ liability under acceptances Derivatives (Note 8) Premises and equipment, net (Note 9) Goodwill (Note 10) Other intangibles (Note 10) Other assets (Note 13) Total assets Liabilities and equity Deposits (Note 14) Personal Business and government Bank Segregated fund net liabilities (Note 16) Other Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives (Note 8) Insurance claims and policy benefit liabilities (Note 15) Other liabilities (Note 18) Subordinated debentures (Note 19) Total liabilities Equity attributable to shareholders (Note 21) Preferred shares Common shares (shares issued – 1,484,234,375 and 1,443,954,789) Retained earnings Other components of equity Non-controlling interests (Note 21) Total equity Total liabilities and equity As at October 31 2016 October 31 2015 $ 14,929 $ 12,452 27,851 22,690 151,292 84,801 236,093 158,703 56,805 215,508 186,302 174,723 369,470 154,369 523,839 (2,235) 521,604 348,183 126,069 474,252 (2,029) 472,223 981 830 12,843 118,944 2,836 11,156 4,648 42,071 192,498 13,453 105,626 2,728 9,289 2,814 41,872 175,782 $ 1,180,258 $ 1,074,208 $ 250,550 $ 488,007 19,032 757,589 220,566 455,578 21,083 697,227 981 830 12,843 50,369 103,441 116,550 9,164 47,947 340,314 13,453 47,658 83,288 107,860 9,110 43,476 304,845 9,762 7,362 1,108,646 1,010,264 6,713 17,859 41,519 4,926 71,017 595 71,612 5,098 14,611 37,811 4,626 62,146 1,798 63,944 $ 1,180,258 $ 1,074,208 The accompanying notes are an integral part of these Consolidated Financial Statements. David I. McKay President and Chief Executive Officer David F. Denison Director Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 121 Consolidated Statements of Income (Millions of Canadian dollars, except per share amounts) Interest income Loans Securities Assets purchased under reverse repurchase agreements and securities borrowed Deposits and other Interest expense Deposits and other Other liabilities Subordinated debentures Net interest income Non-interest income Insurance premiums, investment and fee income (Note 15) Trading revenue Investment management and custodial fees Mutual fund revenue Securities brokerage commissions Service charges Underwriting and other advisory fees Foreign exchange revenue, other than trading Card service revenue Credit fees Net gains on available-for-sale securities (Note 4) Share of profit in joint ventures and associates (Note 12) Other Total revenue Provision for credit losses (Note 5) Insurance policyholder benefits, claims and acquisition expense (Note 15) Non-interest expense Human resources (Note 17 and 22) Equipment Occupancy Communications Professional fees Amortization of other intangibles (Note 10) Other Income before income taxes Income taxes (Note 24) Net income Net income attributable to: Shareholders Non-controlling interests Basic earnings per share (in dollars) (Note 25) Diluted earnings per share (in dollars) (Note 25) Dividends per common share (in dollars) The accompanying notes are an integral part of these Consolidated Financial Statements. 122 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements For the year ended October 31 2016 October 31 2015 October 31 2014 $ 17,876 4,593 1,816 167 $ 16,882 4,519 1,251 77 $ 16,979 3,993 971 76 24,452 22,729 22,019 5,467 2,227 227 7,921 5,723 1,995 240 7,958 5,873 1,784 246 7,903 16,531 14,771 14,116 4,868 701 4,240 2,887 1,429 1,756 1,876 964 889 1,239 76 176 773 21,874 38,405 1,546 3,424 12,201 1,438 1,568 945 1,078 970 1,936 20,136 13,299 2,841 4,436 552 3,778 2,881 1,436 1,592 1,885 814 798 1,184 145 149 900 20,550 35,321 1,097 2,963 11,583 1,277 1,410 888 932 712 1,836 18,638 12,623 2,597 $ 10,458 $ 10,026 $ 10,405 53 $ 9,925 101 $ 10,458 $ 10,026 $ $ 6.80 6.78 3.24 6.75 6.73 3.08 $ $ $ $ 4,957 742 3,355 2,621 1,379 1,494 1,809 827 689 1,080 192 162 685 19,992 34,108 1,164 3,573 11,031 1,147 1,330 847 763 666 1,877 17,661 11,710 2,706 9,004 8,910 94 9,004 6.03 6.00 2.84 Consolidated Statements of Comprehensive Income (Millions of Canadian dollars) Net income Other comprehensive income (loss), net of taxes (Note 24) Items that will be reclassified subsequently to income: Net change in unrealized gains (losses) on available-for-sale securities Net unrealized gains (losses) on available-for-sale securities Reclassification of net losses (gains) on available-for-sale securities to income Foreign currency translation adjustments Unrealized foreign currency translation gains (losses) Net foreign currency translation gains (losses) from hedging activities Reclassification of losses (gains) on foreign currency translation to income Reclassification of losses (gains) on net investment hedging activities to income Net change in cash flow hedges Net gains (losses) on derivatives designated as cash flow hedges Reclassification of losses (gains) on derivatives designated as cash flow hedges to income Items that will not be reclassified subsequently to income: Remeasurements of employee benefit plans (Note 17) Net fair value change due to credit risk on financial liabilities designated as at fair value through profit or loss Total other comprehensive income (loss), net of taxes Total comprehensive income Total comprehensive income attributable to: Shareholders Non-controlling interests The accompanying notes are an integral part of these Consolidated Financial Statements. For the year ended October 31 2016 October 31 2015 October 31 2014 $ 10,458 $ 10,026 $ 9,004 73 (48) 25 147 113 – – 260 (35) 52 17 (1,077) (322) (1,399) (1,097) (76) (41) (117) 5,885 (3,223) (224) 111 2,549 (541) 330 (211) 582 350 932 3,153 143 (58) 85 2,743 (1,585) 44 3 1,205 (108) 28 (80) (236) (59) (295) 915 $ $ $ 9,361 $ 13,179 $ 9,919 9,306 $ 55 9,361 $ 13,065 $ 114 13,179 $ 9,825 94 9,919 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 123 y t i u q e f o s t n e n o p m o c r e h t O l a t o T y t i u q e g n i l l o r t n o c - n o N o t e l b a t u b i r t t a s t n e n o p m o c y t i u q E r e h t o l a t o T h s a C w o l f n g i e r o F y c n e r r u c e l a s - r o f - e l b a l i a v A s t s e r e t n i l s r e d o h e r a h s y t i u q e f o s e g d e h n o i t a l s n a r t s e i t i r u c e s d e n i a t e R i s g n n r a e y r u s a e r T – s e r a h s n o m m o c y r u s a e r T – s e r a h s d e r r e f e r p s e r a h s n o m m o C s e r a h s d e r r e f e r P 0 6 4 , 9 4 $ 5 9 7 , 1 $ 5 6 6 , 7 4 $ 8 0 2 , 1 $ 5 7 1 $ 6 8 6 $ 7 4 3 $ 8 3 4 , 7 2 $ 1 4 $ 1 $ 7 7 3 , 4 1 $ 0 0 6 , 4 $ ) 1 ( ) 5 2 3 ( 1 9 3 , 1 5 1 2 , 6 ) 0 5 2 , 6 ( ) 2 4 ( ) 3 8 2 ( ) 3 4 4 , 4 ( 3 5 1 , 3 6 2 0 , 0 1 – – – – – – ) 2 9 ( ) 7 3 ( 3 1 1 0 1 ) 5 2 3 ( 1 9 3 , 1 5 1 2 , 6 ) 0 5 2 , 6 ( ) 1 ( ) 5 ( ) 1 9 1 ( ) 3 4 4 , 4 ( 5 2 9 , 9 0 4 1 , 3 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 8 0 2 , 2 ) 1 1 2 ( 6 3 5 , 2 ) 7 1 1 ( – – – ) 1 ( ) 1 2 ( ) 5 ( ) 1 9 1 ( ) 3 4 4 , 4 ( 2 3 9 5 2 9 , 9 ) 3 1 1 ( 6 3 1 , 1 ) 5 2 5 , 1 ( 7 5 4 , 5 ) 8 2 4 , 5 ( ) 9 ( ) 7 0 3 ( ) 7 9 0 , 4 ( 0 1 5 1 9 4 0 0 , 9 – – – – – – – ) 4 9 ( 8 1 4 9 – ) 3 1 1 ( 6 3 1 , 1 ) 5 2 5 , 1 ( 7 5 4 , 5 ) 8 2 4 , 5 ( ) 9 ( ) 3 1 2 ( ) 7 9 0 , 4 ( ) 8 ( 5 1 9 0 1 9 , 8 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 0 1 2 , 1 ) 0 8 ( 5 0 2 , 1 5 8 ) 4 1 ( ) 7 9 ( – – – ) 9 ( ) 3 1 2 ( ) 7 9 0 , 4 ( ) 8 ( ) 5 9 2 ( 0 1 9 , 8 – – – – – – 3 3 3 , 5 ) 3 0 3 , 5 ( 4 2 1 ) 5 2 1 ( 3 0 5 , 4 5 $ 3 1 8 , 1 $ 0 9 6 , 2 5 $ 8 1 4 , 2 $ 5 9 $ 1 9 8 , 1 $ 2 3 4 $ 5 1 6 , 1 3 $ 1 7 $ ) 2 6 3 ( ) 4 6 2 ( 1 6 2 , 5 ) 0 0 2 , 1 ( 5 4 1 , 5 ) 1 6 2 , 5 ( ) 4 5 ( ) 7 1 8 , 4 ( ) 7 5 3 ( 6 1 2 ) 7 9 0 , 1 ( 8 5 4 , 0 1 – – – ) 0 0 2 , 1 ( – – – – ) 3 6 ( 5 2 3 5 – ) 2 6 3 ( ) 4 6 2 ( 1 6 2 , 5 5 4 1 , 5 ) 1 6 2 , 5 ( ) 4 5 ( ) 7 1 8 , 4 ( ) 4 9 2 ( 1 1 2 ) 9 9 0 , 1 ( 5 0 4 , 0 1 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 0 0 3 7 1 8 5 2 5 2 ) 6 1 ( ) 2 2 ( ) 6 0 3 ( – – – ) 4 5 ( ) 7 1 8 , 4 ( ) 4 9 2 ( 1 1 2 ) 9 9 3 , 1 ( 5 0 4 , 0 1 2 1 6 , 1 7 $ 5 9 5 $ 7 1 0 , 1 7 $ 6 2 9 , 4 $ ) 9 9 ( $ 5 8 6 , 4 $ 0 4 3 $ 9 1 5 , 1 4 $ ) 0 8 ( $ – – – – – – – – – – – – – – – – – – – – – – – – – – 8 9 0 , 6 ) 1 3 1 , 6 ( 7 1 1 ) 9 1 1 ( – – – – – – – – 3 7 9 , 4 ) 1 9 0 , 5 ( 2 7 1 ) 0 7 1 ( – – – – – – – – – – – – – – – – ) 6 1 ( 0 5 1 – – – – – – – – – – – – – – – – – – 0 0 0 , 1 ) 5 2 5 , 1 ( $ 1 1 5 , 4 1 $ 5 7 0 , 4 $ – – – – – – – – – 2 6 – – – – – – – – ) 5 2 3 ( 0 5 3 , 1 – – – – – – – – – – ) 6 5 ( 2 2 4 , 3 – – – – – – – – – – ) 2 4 2 ( 5 5 8 , 1 4 4 9 , 3 6 $ 8 9 7 , 1 $ 6 4 1 , 2 6 $ 6 2 6 , 4 $ ) 6 1 1 ( $ 7 2 4 , 4 $ 5 1 3 $ 1 1 8 , 7 3 $ 8 3 $ ) 2 ( $ 3 7 5 , 4 1 $ 0 0 1 , 5 $ y t i u q E n i s e g n a h C f o s t n e m e t a t S d e t a d i l o s n o C n o i t a l l e c n a c r o f d e s a h c r u p s e r a h s n o m m o C r e h t o d n a s e r a h s d e r r e f e r p n o s d n e d i v i D s d r a w a n o i t a s n e p m o c d e s a b - e r a h S s e r a h s n o m m o c n o s d n e d i v i D d e m e e d e r s e r a h s d e r r e f e r P s e r a h s y r u s a e r t f o s e l a S s e r a h s y r u s a e r t f o s e s a h c r u P e m o c n i t e N r e h t O 3 1 0 2 , 1 r e b m e v o N t a e c n a l a B l a t i p a c e r a h s f o s e u s s I y t i u q e n i s e g n a h C ) s r a l l o d n a i d a n a C f o s n o i l l i M ( s e x a t f o t e n , ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o l a t o T s e x a t f o t e n , ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o l a t o T r e h t o d n a s e r a h s d e r r e f e r p n o s d n e d i v i D s d r a w a n o i t a s n e p m o c d e s a b - e r a h S s e r a h s n o m m o c n o s d n e d i v i D e m o c n i t e N r e h t O n o i t a l l e c n a c r o f d e s a h c r u p s e r a h s n o m m o C n o i t a l l e c n a c r o f d e s a h c r u p s e r a h s d e r r e f e r P s e i t i r u c e s l a t i p a c t s u r t f o n o i t p m e d e R r e h t o d n a s e r a h s d e r r e f e r p n o s d n e d i v i D s d r a w a n o i t a s n e p m o c d e s a b - e r a h S s e r a h s n o m m o c n o s d n e d i v i D s e r a h s y r u s a e r t f o s e s a h c r u P s e r a h s y r u s a e r t f o s e l a S e m o c n i t e N r e h t O 5 1 0 2 , 1 3 r e b o t c O t a e c n a l a B l a t i p a c e r a h s f o s e u s s I y t i u q e n i s e g n a h C s e x a t f o t e n , ) s s o l ( e m o c n i e v i s n e h e r p m o c r e h t o l a t o T d e m e e d e r s e r a h s d e r r e f e r P s e r a h s y r u s a e r t f o s e l a S s e r a h s y r u s a e r t f o s e s a h c r u P l a t i p a c e r a h s f o s e u s s I 4 1 0 2 , 1 3 r e b o t c O t a e c n a l a B y t i u q e n i s e g n a h C 124 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements $ 9 3 9 , 7 1 $ 3 1 7 , 6 $ 6 1 0 2 , 1 3 r e b o t c O t a e c n a l a B . s t n e m e t a t S l a i c n a n i F d e t a d i l o s n o C e s e h t f o t r a p l a r g e t n i n a e r a s e t o n g n i y n a p m o c c a e h T Consolidated Statements of Cash Flows (Millions of Canadian dollars) Cash flows from operating activities Net income Adjustments for non-cash items and others Provision for credit losses Depreciation Deferred income taxes Amortization and impairment of other intangibles Net changes in investments in joint ventures and associates Losses (Gains) on sale of premises and equipment Losses (Gains) on available-for-sale securities Losses (Gains) on disposition of business Impairment of available-for-sale securities Adjustments for net changes in operating assets and liabilities Insurance claims and policy benefit liabilities Net change in accrued interest receivable and payable Current income taxes Derivative assets Derivative liabilities Trading securities Loans, net of securitizations Assets purchased under reverse repurchase agreements and securities borrowed Deposits, net of securitizations Obligations related to assets sold under repurchase agreements and securities loaned Obligations related to securities sold short Brokers and dealers receivable and payable Other Net cash from (used in) operating activities Cash flows from investing activities Change in interest-bearing deposits with banks Proceeds from sale of available-for-sale securities Proceeds from maturity of available-for-sale securities Purchases of available-for-sale securities Proceeds from maturity of held-to-maturity securities Purchases of held-to-maturity securities Net acquisitions of premises and equipment and other intangibles Proceeds from dispositions Cash used in acquisitions Net cash from (used in) investing activities Cash flows from financing activities Redemption of trust capital securities Issue of subordinated debentures Repayment of subordinated debentures Issue of common shares Common shares purchased for cancellation Issue of preferred shares Redemption of preferred shares Preferred shares purchased for cancellation Sales of treasury shares Purchases of treasury shares Dividends paid Issuance costs Dividends/distributions paid to non-controlling interests Change in short-term borrowings of subsidiaries Net cash from (used in) financing activities Effect of exchange rate changes on cash and due from banks Net change in cash and due from banks Cash and due from banks at beginning of period (1) Cash and due from banks at end of period (1) Cash flows from operating activities include: Amount of interest paid Amount of interest received Amount of dividend received Amount of income taxes paid For the year ended October 31 2016 October 31 2015 October 31 2014 $ 10,458 $ 10,026 $ 9,004 1,546 573 (479) 973 (184) 19 (176) (268) 90 1,040 (67) 1,189 (13,224) 8,593 6,827 (19,297) (11,369) 18,931 20,153 2,711 47 (1,230) 26,856 (3,109) 8,056 34,005 (55,327) 1,691 (3,155) (1,257) 634 (2,964) (21,426) 1,097 527 302 719 (146) (32) (220) (77) 59 546 (279) (905) (18,228) 18,893 (7,401) (34,964) (39,143) 86,979 18,957 (2,687) 664 (10,538) 24,149 (14,456) 10,331 33,294 (51,304) 16 (1,942) (1,337) 255 – (25,143) (1,200) 3,606 (1,500) 307 (362) 1,475 – (264) 5,145 (5,261) (4,997) (16) (63) (4) (3,134) 181 2,477 12,452 14,929 $ – 1,000 (1,700) 62 – 1,350 (325) – 6,215 (6,250) (4,564) (21) (92) (105) (4,430) 455 (4,969) 17,421 12,452 $ 7,097 $ 7,096 $ 23,237 1,680 1,581 21,132 1,843 2,046 $ $ 1,164 499 (207) 674 (224) 14 (228) 95 25 530 187 (206) (12,580) 12,237 (7,253) (27,096) (18,063) 52,339 3,915 3,233 (638) (2,247) 15,174 640 8,795 38,950 (54,208) 285 (1,625) (1,227) 173 – (8,217) (900) 2,000 (1,600) 150 (113) 1,000 (1,525) – 5,457 (5,428) (4,211) (14) (94) (6) (5,284) 198 1,871 15,550 17,421 7,186 20,552 1,702 2,315 (1) We are required to maintain balances with central banks and other regulatory authorities. The total balances were $3.3 billion as at October 31, 2016 (October 31, 2015 – $2.6 billion; October 31, 2014 – $2.0 billion; November 1, 2013 – $2.6 billion). The accompanying notes are an integral part of these Consolidated Financial Statements. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 125 Note 1 General information Royal Bank of Canada and its subsidiaries (the Bank) provide diversified financial services including personal and commercial banking, wealth management, insurance, investor services and capital markets products and services on a global basis. Refer to Note 30 for further details on our business segments. The parent bank, Royal Bank of Canada, is a Schedule I Bank under the Bank Act (Canada) incorporated and domiciled in Canada. Our corporate headquarters are located at Royal Bank Plaza, 200 Bay Street, Toronto, Ontario, Canada and our head office is located at 1 Place Ville- Marie, Montreal, Quebec, Canada. Our common shares are listed on the Toronto Stock Exchange and New York Stock Exchange with the ticker symbol RY. These Consolidated Financial Statements are prepared in compliance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). Unless otherwise stated, monetary amounts are stated in Canadian dollars. Tabular information is stated in millions of dollars, except per share amounts and percentages. These Consolidated Financial Statements also comply with Subsection 308 of the Bank Act (Canada), which states that, except as otherwise specified by the Office of the Superintendent of Financial Institutions (OSFI), our Consolidated Financial Statements are to be prepared in accordance with IFRS. The accounting policies outlined in Note 2 have been consistently applied to all periods presented. On November 29, 2016, the Board of Directors authorized the Consolidated Financial Statements for issue. Note 2 Summary of significant accounting policies, estimates and judgments The significant accounting policies used in the preparation of these Consolidated Financial Statements, including the accounting requirements prescribed by OSFI, are summarized below. These accounting policies conform, in all material respects, to IFRS. General Use of estimates and assumptions In preparing our Consolidated Financial Statements, management is required to make subjective estimates and assumptions that affect the reported amount of assets, liabilities, net income and related disclosures. Estimates made by management are based on historical experience and other assumptions that are believed to be reasonable. Key sources of estimation uncertainty include: securities impairment, determination of fair value of financial instruments, the allowance for credit losses, derecognition of financial assets, insurance claims and policy benefit liabilities, pensions and other post-employment benefits, income taxes, carrying value of goodwill and other intangible assets, litigation provisions, and deferred revenue under the credit card customer loyalty reward program. Accordingly, actual results may differ from these and other estimates thereby impacting our future Consolidated Financial Statements. Refer to the relevant accounting policies in this Note for details on our use of estimates and assumptions. Significant judgments In preparation of these Consolidated Financial Statements, management is required to make significant judgments that affect the carrying amounts of certain assets and liabilities and the reported amounts of revenues and expenses recorded during the period. Significant judgments have been made in the following areas and discussed as noted in the Consolidated Financial Statements: Consolidation of structured entities Fair value of financial instruments Allowance for credit losses Employee benefits Goodwill and other intangibles Note 2 – page 126 Note 7 – page 158 Note 2 – page 129 Note 3 – page 138 Note 2 – page 131 Note 5 – page 155 Note 2 – page 133 Note 17 – page 176 Note 2 – page 134 Note 10 – page 168 Note 11 – page 170 Securities impairment Application of the effective interest method Derecognition of financial assets Income taxes Provisions Note 2 – page 128 Note 4 – page 151 Note 2 – page 131 Note 2 – page 132 Note 6 – page 157 Note 2 – page 134 Note 24 – page 188 Note 2 – page 135 Note 26 – page 190 Note 27 – page 194 Basis of consolidation Our Consolidated Financial Statements include the assets and liabilities and results of operations of the parent company, Royal Bank of Canada, and its subsidiaries, including certain structured entities, after elimination of intercompany transactions, balances, revenues and expenses. Consolidation Subsidiaries are those entities, including structured entities, over which we have control. We control an entity when we are exposed, or have rights, to variable returns from our involvement with the entity and have the ability to affect those returns through our power over the investee. We have power over an entity when we have existing rights that give us the current ability to direct the activities that most significantly affect the entity’s returns (relevant activities). Power may be determined on the basis of voting rights or, in the case of structured entities, other contractual arrangements. We are not deemed to control an entity when we exercise power over an entity in an agency capacity. In determining whether we are acting as an agent, we consider the overall relationship between us, the investee and other parties to the arrangement with respect to the following factors: (i) the scope of our decision making power; (ii) the rights held by other parties; (iii) the remuneration to which we are entitled; and (iv) our exposure to variability of returns. The determination of control is based on the current facts and circumstances and is continuously assessed. In some circumstances, different factors and conditions may indicate that different parties control an entity depending on whether those factors and conditions are assessed in isolation or in totality. Significant judgment is applied in assessing the relevant factors and conditions in totality when determining whether we control an entity. Specifically, judgment is applied in assessing whether we have substantive decision making rights over the relevant activities and whether we are exercising our power as a principal or an agent. 126 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements We consolidate all subsidiaries from the date we obtain control and cease consolidation when an entity is no longer controlled by us. Our consolidation conclusions affect the classification and amount of assets, liabilities, revenues and expenses reported in our Consolidated Financial Statements. Non-controlling interests in subsidiaries that we consolidate are shown on our Consolidated Balance Sheets as a separate component of equity which is distinct from our shareholders’ equity. The net income attributable to non-controlling interests is separately disclosed in our Consolidated Statements of Income. Investments in joint ventures and associates Our investments in associated corporations and limited partnerships over which we have significant influence are accounted for using the equity method. The equity method is also applied to our interests in joint ventures over which we have joint control. Under the equity method of accounting, investments are initially recorded at cost, and the carrying amount is increased or decreased to recognize our share of the investee’s net profit or loss, including our proportionate share of the investee’s other comprehensive income (OCI), subsequent to the date of acquisition. Non-current assets held for sale and discontinued operations Non-current assets (and disposal groups) are classified as held for sale if their carrying amounts will be recovered principally through a sale transaction rather than through continuing use. This condition is satisfied when the asset is available for immediate sale in its present condition, management is committed to the sale, and it is highly probable to occur within one year. Non-current assets (and disposal groups) classified as held for sale are measured at the lower of their previous carrying amount and fair value less costs to sell and if significant, are presented separately from other assets on our Consolidated Balance Sheets. A disposal group is classified as a discontinued operation if it meets the following conditions: (i) it is a component that can be distinguished operationally and financially from the rest of our operations and (ii) it represents either a separate major line of business or is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations. Disposal groups classified as discontinued operations are presented separately from our continuing operations in our Consolidated Statements of Income. Changes in accounting policies During the first quarter, we adopted the following accounting policies as a result of the acquisition of City National Corporation (City National). Acquired Loans Acquired loans are initially measured at fair value, which reflects estimates of incurred and expected future credit losses at the acquisition date and interest rate premiums or discounts relative to prevailing market rates. No allowance for credit losses is recorded on acquisition. At the purchase date, acquired loans are classified as performing where we expect timely collection of all amounts due according to the original contractual terms and as acquired credit-impaired (ACI) where it is probable that we will be unable to collect all amounts due according to the original contractual terms. Acquired performing loans are subsequently accounted for at amortized cost using the effective interest method. The expected future cash flows used in this calculation are based on the contractual terms of the asset and any acquisition-related premiums and discounts. Credit-related discounts relating to incurred losses for acquired loans are not accreted. Acquired loans are assessed for impairment at each balance sheet date in a manner consistent with assessments performed for our originated loan portfolio. Acquired Credit-Impaired Loans ACI loans, which include Federal Deposit Insurance Corporation (FDIC) covered loans, are identified as impaired on acquisition based on the specific risk characteristics of the loans, including indications that the borrower is experiencing significant financial difficulty, probability of bankruptcy or other financial reorganization, payment status or economic conditions that correlate with defaults. ACI loans are measured at fair value on acquisition based on the present value of expected future cash flows and subsequently accounted for at amortized cost using the effective interest method. Estimates of expected future cash flows are reassessed at each balance sheet date for changes in expected default rates, loss severities, the amount and timing of prepayments, and other factors that are reflective of current market conditions. Probable decreases in expected future cash flows result in an impairment loss, which is measured as the difference between the carrying amount of the loan and the present value of the revised expected future cash flows, discounted at the loan’s effective interest rate. Impairment losses result in an increase to the Allowance for credit losses which is recorded through the Provision for credit losses in our Consolidated Statements of Income. Probable increases in expected future cash flows result in a reversal of previous impairment losses, with the present value of any remaining increase recognized as Interest income. Federal Deposit Insurance Corporation Covered Loans FDIC covered loans are loans subject to loss-share agreements with the FDIC. Under these agreements, the FDIC reimburses us for 80% of the net losses incurred on the underlying loan portfolio. Impairment losses are recognized on acquired FDIC covered loans consistent with other ACI loans, as described above. The amounts expected to be reimbursed by the FDIC are recognized separately as indemnification assets. Indemnification assets are initially recorded at fair value and are subsequently adjusted for any changes in estimates related to the overall collectability of the underlying loan portfolio. Additional impairment losses on the underlying loan portfolio generally result in an increase of the indemnification asset through the Provision for credit losses. Decreases in expected losses on the underlying loan portfolio generally result in a decrease of the indemnification asset through the Provision for credit losses to the extent that impairment losses were previously taken, with the remainder recorded in Net interest income. The indemnification asset is drawn down as payments are received from the FDIC pertaining to the loss-share agreements. Indemnification assets are recorded in Other assets on the Consolidated Balance Sheets. In accordance with each loss-share agreement, we may be required to make a payment to the FDIC if actual losses incurred are less than the intrinsic loss estimate as defined in the loss-share agreements (clawback liability). The clawback liability is determined as 20% of the excess between the intrinsic loss estimate and actual covered losses determined in accordance with each loss-share agreement, net of specified servicing costs. Subsequent changes to the estimated clawback liability are considered in determining the adjustment to the indemnification asset as described above. Clawback liabilities are recorded in Other liabilities on the Consolidated Balance Sheets. Financial instruments – Recognition and measurement Securities Securities are classified at inception, based on management’s intention, as at fair value through profit or loss (FVTPL), available-for-sale (AFS) or held-to-maturity. Certain debt securities with fixed or determinable payments and which are not quoted in an active market may be classified as loans and receivables. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 127 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Trading securities include securities purchased for sale in the near term which are classified as at FVTPL by nature and securities designated as at FVTPL under the fair value option. Obligations to deliver trading securities sold but not yet purchased are recorded as liabilities and carried at fair value. Realized and unrealized gains and losses on these securities are recorded as Trading revenue in Non-interest income. Dividends and interest income accruing on Trading securities are recorded in Interest income. Interest and dividends accrued on interest-bearing and equity securities sold short are recorded in Interest expense. AFS securities include: (i) securities which may be sold to meet liquidity needs, in response to or in anticipation of changes in interest rates and resulting prepayment risk, changes in foreign currency risk, changes in funding sources or terms, and (ii) loan substitute securities which are client financings that have been structured as after-tax investments rather than conventional loans in order to provide the clients with a borrowing rate advantage. AFS securities are measured at fair value. Unrealized gains and losses arising from changes in fair value are recorded in OCI. Changes in foreign exchange rates for AFS equity securities are recognized in Other components of equity, while changes in foreign exchange rates for AFS debt securities are recognized in Foreign exchange revenue, other than trading in Non-interest income. When the security is sold, the cumulative gain or loss recorded in Other components of equity is included as Net gains on AFS securities in Non-interest income. Purchase premiums or discounts on AFS debt securities are amortized over the life of the security using the effective interest method and are recognized in Net interest income. Dividends and interest income accruing on AFS securities are recorded in Interest income. At each reporting date, and more frequently when conditions warrant, we evaluate our AFS securities to determine whether there is any objective evidence of impairment. Such evidence includes: for debt instruments, when an adverse effect on future cash flows from the asset or group of assets can be reliably estimated; for equity securities, when there is a significant or prolonged decline in the fair value of the investment below its cost. When assessing debt securities for impairment, we primarily consider counterparty ratings and security-specific factors, including subordination, external ratings, and the value of any collateral held for which there may not be a readily-accessible market. Significant judgment is required in assessing impairment as management is required to consider all available evidence in determining whether objective evidence of impairment exists and whether the principal and interest on the AFS debt security can be fully recovered. For complex debt instruments, we use cash flow projection models which incorporate actual and projected cash flows for each security based on security-specific factors using a number of assumptions and inputs that involve management judgment, such as default, prepayment and recovery rates. Due to the subjective nature of choosing these inputs and assumptions, the actual amount of the future cash flows and their timing may differ from the estimates used by management and consequently may cause a different conclusion as to the recognition of impairment or measurement of impairment loss. When assessing equity securities for impairment, we consider factors which include the length of time and extent the fair value has been below cost, along with management’s assessment of the financial condition, business and other risks of the issuer. Management weighs all these factors to determine the impairment but to the extent that management judgment may differ from the actual experience of the timing and amount of the recovery of the fair value, the estimate for impairment could change from period to period based upon future events that may or may not occur, and the conclusion for the impairment of the equity securities may differ. If an AFS security is impaired, the cumulative unrealized loss previously recognized in Other components of equity is removed from equity and recognized in Net gains on AFS securities under Non-interest income. This amount is determined as the difference between the cost/ amortized cost and current fair value of the security less any impairment loss previously recognized. Subsequent to impairment, further declines in fair value are recorded in Non-interest income, while increases in fair value are recognized in Other components of equity until sold. For AFS debt securities, reversal of previously recognized impairment losses is recognized in our Consolidated Statements of Income if the recovery is objectively related to a specific event occurring after recognition of the impairment loss. Held-to-maturity securities are debt securities where we have the intention and the ability to hold the investment until its maturity date. These securities are initially recorded at fair value and are subsequently measured at amortized cost using the effective interest method, less any impairment losses which we assess using the same impairment model as for loans. Interest income and amortization of premiums and discounts on debt securities are recorded in Net interest income. For held-to-maturity securities, reversal of previously recognized impairment losses is recognized in our Consolidated Statements of Income if the recovery is objectively related to a specific event occurring after the recognition of the impairment loss. Reversals of impairment losses on held-to-maturity securities are recorded to a maximum of what the amortized cost of the investment would have been, had the impairment not been recognized at the date the impairment is reversed. Held-to-maturity securities have been included with AFS securities on our Consolidated Balance Sheets. We account for all of our securities using settlement date accounting and changes in fair value between the trade date and settlement date are reflected in income for securities classified or designated as at FVTPL, and changes in the fair value of AFS securities between the trade and settlement dates are recorded in OCI except for changes in foreign exchange rates on debt securities, which are recorded in Non-interest income. Fair value option A financial instrument can be designated as at FVTPL (the fair value option) on its initial recognition even if the financial instrument was not acquired or incurred principally for the purpose of selling or repurchasing it in the near term. An instrument that is designated as at FVTPL by way of this fair value option must have a reliably measurable fair value and satisfy one of the following criteria: (i) it eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets or liabilities, or recognizing gains and losses on them, on a different basis (an accounting mismatch); (ii) it belongs to a group of financial assets or financial liabilities or both that are managed, evaluated, and reported to key management personnel on a fair value basis in accordance with our risk management strategy, and we can demonstrate that significant financial risks are eliminated or significantly reduced; or (iii) there is an embedded derivative in the financial or non-financial host contract and the derivative is not closely related to the host contract. These instruments cannot be reclassified out of the FVTPL category while they are held or issued. Financial assets designated as at FVTPL are recorded at fair value and any unrealized gain or loss arising due to changes in fair value is included in Trading revenue or Non-interest income – Other. Financial liabilities designated as at FVTPL are recorded at fair value and fair value changes attributable to changes in our own credit risk are recorded in OCI. Amounts recognized in OCI will not be reclassified subsequently to net income. The remaining fair value changes are recorded in Trading revenue or Non-interest income – Other. Upon initial recognition, if we determine that presenting the effects of own credit risk changes in OCI would create or enlarge an accounting mismatch in net income, the full fair value change in our debt designated as at FVTPL is recognized in net income. To determine the fair value adjustments on our debt designated as at FVTPL, we calculate the present value of the instruments based on the contractual cash flows over the term of the arrangement by using our effective funding rate at the beginning and end of the period with the change in present value recorded in OCI, Trading revenue or Non-interest income – Other as appropriate. 128 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Determination of fair value The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We determine fair value by incorporating all factors that market participants would consider in setting a price, including commonly accepted valuation approaches. The Board of Directors provides oversight on valuation of financial instruments, primarily through the Audit Committee and Risk Committee. The Audit Committee reviews the presentation and disclosure of financial instruments that are measured at fair value, while the Risk Committee assesses adequacy of governance structures and control processes for valuation of these instruments. We have established policies, procedures and controls for valuation methodologies and techniques to ensure fair value is reasonably estimated. Major valuation processes and controls include, but are not limited to, profit and loss decomposition, independent price verification (IPV) and model validation standards. These control processes are managed by either Finance or Group Risk Management and are independent of the relevant businesses and their trading functions. Profit and loss decomposition is a process to explain the fair value changes of certain positions and is performed daily for trading portfolios. All fair value instruments are subject to IPV, a process whereby trading function valuations are verified against external market prices and other relevant market data. Market data sources include traded prices, brokers and price vendors. We give priority to those third-party pricing services and prices having the highest and most consistent accuracy. The level of accuracy is determined over time by comparing third-party price values to traders’ or system values, to other pricing service values and, when available, to actual trade data. Other valuation techniques are used when a price or quote is not available. Some valuation processes use models to determine fair value. We have a systematic and consistent approach to control model use. Valuation models are approved for use within our model risk management framework. The framework addresses, among other things, model development standards, validation processes and procedures, and approval authorities. Model validation ensures that a model is suitable for its intended use and sets parameters for its use. All models are revalidated regularly by qualified personnel who are independent of the model design and development. Annually our model risk profile is reported to the Board of Directors. IFRS 13 Fair Value Measurement permits an exception, through an accounting policy choice, to measure fair value of a portfolio of financial instruments on a net open risk position basis when certain criteria are met. We have elected to use this policy choice to determine fair value of certain portfolios of financial instruments, primarily derivatives, based on a net exposure to market or credit risk. We record valuation adjustments to appropriately reflect counterparty credit quality of our derivative portfolio, differences between the overnight index swap (OIS) curve and London Interbank Offered Rates (LIBOR) for collateralized derivatives, funding valuation adjustments (FVA) for uncollateralized and under-collateralized over-the-counter (OTC) derivatives, unrealized gains or losses at inception of the transaction, bid- offer spreads, unobservable parameters and model limitations. These adjustments may be subjective as they require significant judgment in the input selection, such as implied probability of default and recovery rate, and are intended to arrive at fair value that is determined based on assumptions that market participants would use in pricing the financial instrument. The realized price for a transaction may be different from its recorded value that is previously estimated using management judgment, and may therefore impact unrealized gains and losses recognized in Non-interest income – Trading revenue or Other. Valuation adjustments are recorded for the credit risk of our derivative portfolios in order to arrive at their fair values. Credit valuation adjustments (CVA) take into account our counterparties’ creditworthiness, the current and potential future mark-to-market of the transactions, and the effects of credit mitigants such as master netting and collateral agreements. CVA amounts are derived from estimates of exposure at default, probability of default, recovery rates on a counterparty basis, and market and credit factor correlations. Exposure at default is the amounts of expected derivative related assets and liabilities at the time of default, estimated through modeling using underlying risk factors. Probability of default and recovery rate are implied from the market prices for credit protection and credit ratings of the counterparty. When market data is unavailable, it is estimated by incorporating assumptions and adjustments that market participants would use in determining fair value using these inputs. Correlation is the statistical measure of how credit and market factors may move in relation to one another. Correlation is estimated using historical data. CVA is calculated daily and changes are recorded in Non-interest income – Trading revenue. In the determination of fair value of collateralized OTC derivatives using the OIS curve, our valuation approach accounts for the difference between certain OIS rates and LIBOR for derivatives valuation as valuation adjustments. FVA are also calculated to incorporate cost and benefit of funding in the valuation of uncollateralized and under-collateralized OTC derivatives. Future expected cash flows of these derivatives are discounted to reflect the cost and benefit of funding the derivatives by using a funding curve, implied volatilities and correlations as inputs. Where required, a valuation adjustment is made to reflect the unrealized gain or loss at inception of a financial instrument contract where the fair value of that financial instrument is not obtained from a quoted market price or cannot be evidenced by other observable market transactions based on a valuation technique incorporating observable market data. A bid-offer valuation adjustment is required when a financial instrument is valued at the mid-market price, instead of the bid or offer price for asset or liability positions, respectively. The valuation adjustment takes into account the spread from the mid to either the bid or offer price. Some valuation models require parameter calibration from such factors as market observed option prices. The calibration of parameters may be sensitive to factors such as the choice of instruments or optimization methodology. A valuation adjustment is also estimated to mitigate the uncertainties of parameter calibration and model limitations. In determining fair value, a hierarchy is used which prioritizes the inputs to valuation techniques. The fair value hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Determination of fair value based on this hierarchy requires the use of observable market data whenever available. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and model inputs that are either observable, or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 inputs are one or more inputs that are unobservable and significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available at the measurement date. The availability of inputs for valuation may affect the selection of valuation techniques. The classification of a financial instrument in the hierarchy for disclosure purposes is based upon the lowest level of input that is significant to the measurement of fair value. Where observable prices or inputs are not available, management judgment is required to determine fair values by assessing other relevant sources of information such as historical data, proxy information from similar transactions, and through extrapolation and interpolation techniques. For more complex or illiquid instruments, significant judgment is required in the determination of the model used, the selection of model inputs, and in some cases the application of valuation adjustments to the model value or quoted price for inactively traded financial instruments, as the selection of model inputs may be subjective and the inputs may be unobservable. Unobservable inputs are inherently uncertain as there is little or no market data available from which to determine the level at which the transaction would occur under normal business circumstances. Appropriate parameter uncertainty and market risk valuation adjustments for such inputs and other model risk valuation adjustments are assessed in all such instances. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 129 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Interest Interest is recognized in Interest income and Interest expense in the Consolidated Statements of Income for all interest-bearing financial instruments using the effective interest method. The effective interest rate is the rate that discounts estimated future cash flows over the expected life of the financial asset or liability to the net carrying amount upon initial recognition. Significant judgment is applied in determining the effective interest rate due to uncertainty in the timing and amounts of future cash flows. Transaction costs Transaction costs are expensed as incurred for financial instruments classified or designated as at FVTPL. For other financial instruments, transaction costs are capitalized on initial recognition. For financial assets and financial liabilities measured at amortized cost, capitalized transaction costs are amortized through net income over the estimated life of the instrument using the effective interest method. For AFS financial assets measured at fair value that do not have fixed or determinable payments and no fixed maturity, capitalized transaction costs are recognized in net income when the asset is derecognized or becomes impaired. Offsetting financial assets and financial liabilities Financial assets and financial liabilities are offset on the balance sheet when there exists both a legally enforceable right to offset the recognized amounts and an intention to settle on a net basis, or realize the asset and settle the liability simultaneously. Assets purchased under reverse repurchase agreements and sold under repurchase agreements We purchase securities under agreements to resell (reverse repurchase agreements) and take possession of these securities. We monitor the market value of the securities purchased and additional collateral is obtained when appropriate. We have the right to liquidate the collateral held in the event of counterparty default. Reverse repurchase agreements are treated as collateralized lending transactions. We also sell securities under agreements to repurchase (repurchase agreements), which are treated as collateralized borrowing transactions. The securities received under reverse repurchase agreements and securities delivered under repurchase agreements are not recognized on, or derecognized from, our Consolidated Balance Sheets, respectively, unless the risks and rewards of ownership are obtained or relinquished. Reverse repurchase agreements and repurchase agreements are carried on our Consolidated Balance Sheets at the amounts at which the securities were initially acquired or sold, except when they are designated as at FVTPL and are recorded at fair value. Interest earned on reverse repurchase agreements is included in Interest income, and interest incurred on repurchase agreements is included in Interest expense in our Consolidated Statements of Income. Changes in fair value for reverse repurchase agreements and repurchase agreements designated as at FVTPL are included in Trading revenue or Other in Non-interest income. Derivatives Derivatives are primarily used in sales and trading activities. Derivatives are also used to manage our exposure to interest, currency, credit and other market risks. The most frequently used derivative products are interest rate swaps, interest rate futures, forward rate agreements, interest rate options, foreign exchange forward contracts, cross currency swaps, foreign currency futures, foreign currency options, equity swaps and credit derivatives. All derivative instruments are recorded on our Consolidated Balance Sheets at fair value, including those derivatives that are embedded in financial or non-financial contracts and are not closely related to the host contracts. When derivatives are embedded in other financial instruments or host contracts, such combinations are known as hybrid instruments with the effect that some of the cash flows of a hybrid instrument vary in a way similar to a stand-alone derivative. If the host contract is not carried at fair value with changes in fair value reported in our Consolidated Statements of Income, the embedded derivative is generally required to be separated from the host contract and accounted for separately as at FVTPL if the economic characteristics and risks of the embedded derivative are not closely related to those of the host contract. All embedded derivatives are presented on a combined basis with the host contracts although they are separated for measurement purposes when conditions requiring separation are met. When derivatives are used in sales and trading activities, the realized and unrealized gains and losses on these derivatives are recognized in Trading revenue in Non-interest income. Derivatives with positive fair values are reported as Derivative assets and derivatives with negative fair values are reported as Derivative liabilities. In accordance with our policy for offsetting financial assets and financial liabilities, the net fair value of certain derivative assets and liabilities are reported as an asset or liability, as appropriate. Valuation adjustments are included in the fair value of Derivative assets and Derivative liabilities. Premiums paid and premiums received are shown in Derivative assets and Derivative liabilities, respectively. When derivatives are used to manage our own exposures, we determine for each derivative whether hedge accounting can be applied, as discussed in the Hedge accounting section below. Hedge accounting We use derivatives and non-derivatives in our hedging strategies to manage our exposure to interest rate, currency, credit and other market risks. Where hedge accounting can be applied, a hedge relationship is designated and documented at inception to detail the particular risk management objective and strategy for undertaking the hedge transaction. The documentation identifies the specific asset, liability or anticipated cash flows being hedged, the risk that is being hedged, the type of hedging instrument used and how effectiveness will be assessed. We assess, both at the inception of the hedge and on an ongoing basis, whether the hedging instruments are ‘highly effective’ in offsetting changes in the fair value or cash flows of the hedged items. A hedge is regarded as highly effective only if the following criteria are met: (i) at inception of the hedge and throughout its life, the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, and (ii) actual results of the hedge are within a pre-determined range. In the case of hedging a forecast transaction, the transaction must have a high probability of occurring and must present an exposure to variations in cash flows that could ultimately affect the reported net profit or loss. Hedge accounting is discontinued when it is determined that the hedging instrument is no longer effective as a hedge, the hedging instrument or hedged item is terminated or sold, or the forecast transaction is no longer deemed highly probable. Refer to Note 8 for the fair value of derivatives and non-derivative instruments categorized by their hedging relationships as well as derivatives that are not designated in hedging relationships. 130 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Fair value hedges In a fair value hedging relationship, the carrying value of the hedged item is adjusted for changes in fair value attributable to the hedged risk and recognized in Non-interest income. Changes in fair value of the hedged item, to the extent that the hedging relationship is effective, are offset by changes in the fair value of the hedging derivative, which are also recognized in Non-interest income. When hedge accounting is discontinued, the carrying value of the hedged item is no longer adjusted and the cumulative fair value adjustments to the carrying value of the hedged items are amortized to Net income over the remaining life of the hedged items. We predominantly use interest rate swaps to hedge our exposure to changes in a fixed interest rate instrument’s fair value caused by changes in interest rates. Cash flow hedges In a cash flow hedging relationship, the effective portion of the change in the fair value of the hedging derivative, net of taxes, is recognized in OCI while the ineffective portion is recognized in Non-interest income. When hedge accounting is discontinued, the cumulative amounts previously recognized in Other components of equity are reclassified to Net interest income during the periods when the variability in the cash flows of the hedged item affects Net interest income. Unrealized gains and losses on derivatives are reclassified immediately to Net income when the hedged item is sold or terminated early, or when the forecast transaction is no longer expected to occur. We predominantly use interest rate swaps to hedge the variability in cash flows related to a variable-rate asset or liability. Net investment hedges In hedging our foreign currency exposure to a net investment in a foreign operation, the effective portion of foreign exchange gains and losses on the hedging instruments, net of applicable taxes, is recognized in OCI and the ineffective portion is recognized in Non-interest income. The amounts, or a portion thereof, previously recognized in Other components of equity are recognized in Net income on the disposal, or partial disposal, of the foreign operation. We use foreign exchange contracts and foreign currency-denominated liabilities to manage our foreign currency exposures to net investments in foreign operations having a functional currency other than the Canadian dollar. Loans Loans are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and which are not classified as AFS. Loans are initially recognized at fair value. When loans are issued at a market rate, fair value is represented by the cash advanced to the borrowers. Loans are subsequently measured at amortized cost using the effective interest method less impairment, unless we intend to sell them in the near future upon origination or they have been designated as at FVTPL, in which case they are carried at fair value. We assess at each balance sheet date whether there is objective evidence that the loans (including debt securities reclassified as loans) are impaired. Evidence of impairment may include indications that the borrower is experiencing significant financial difficulty, probability of bankruptcy or other financial reorganization, as well as a measurable decrease in the estimated future cash flows evidenced by the adverse changes in the payments status of the borrower or economic conditions that correlate with defaults. Whenever a payment is 90 days past due, loans other than credit card balances and loans guaranteed or insured by a Canadian government (Federal or Provincial) or a Canadian government agency (collectively, Canadian government) are classified as impaired unless they are fully secured and collection efforts are reasonably expected to result in repayment of debt within 180 days of the loans becoming past due. Loans guaranteed by a Canadian government are classified as impaired when the loan is contractually 365 days in arrears. Credit card balances are written off when a payment is 180 days in arrears. Assets acquired to satisfy loan commitments are recorded at their fair value less costs to sell. Fair value is determined based on either current market value where available or discounted cash flows. Any excess of the carrying value of the loan over the fair value of the assets acquired is recognized by a charge to Provision for credit losses. Interest on loans is recognized in Interest income – Loans using the effective interest method. The estimated future cash flows used in this calculation include those determined by the contractual term of the asset, all fees that are considered to be integral to the effective interest rate, transaction costs and all other premiums or discounts. Fees that relate to activities such as originating, restructuring or renegotiating loans are deferred and recognized as Interest income over the expected term of such loans using the effective interest method. Where there is a reasonable expectation that a loan will be originated, commitment and standby fees are also recognized as interest income over the expected term of the resulting loans using the effective interest method. Otherwise, such fees are recorded as Other Liabilities and amortized into Non-interest income over the commitment or standby period. Prepayment fees on mortgage loans are not included as part of the effective interest rate at origination as the amounts are not reliably measurable. If prepayment fees are received on a renewal of a mortgage loan, the fee is included as part of the effective interest rate, and if not renewed, the prepayment fee is recognized in interest income at the prepayment date. Allowance for credit losses An allowance for credit losses is established if there is objective evidence that we will be unable to collect all amounts due on our loans portfolio according to the original contractual terms or the equivalent value. This portfolio includes on-balance sheet exposures, such as loans and acceptances, and off-balance sheet items such as letters of credit, guarantees and unfunded commitments. The allowance for credit losses is increased by the impairment losses recognized and decreased by the amount of write-offs, net of recoveries. The allowance for credit losses for on-balance sheet items is included as a reduction to assets, and the allowance for credit losses relating to off-balance sheet items is included in Provisions under Other Liabilities. We assess whether objective evidence of impairment exists individually for loans that are individually significant and collectively for loans that are not individually significant. If we determine that no objective evidence of impairment exists for an individually assessed loan, whether significant or not, the loan is included in a group of loans with similar credit risk characteristics and collectively assessed for impairment. Loans that are individually assessed for impairment and for which an impairment loss is recognized are not included in a collective assessment of impairment. Allowance for credit losses represent management’s best estimates of losses incurred in our loan portfolio at the balance sheet date. Management’s judgment is required in making assumptions and estimations when calculating allowances on both individually and collectively assessed loans. The underlying assumptions and estimates used for both individually and collectively assessed loans can change from period to period and may significantly affect our results of operations. Individually assessed loans Loans which are individually significant are assessed individually for objective indicators of impairment. A loan is considered impaired when management determines that it will not be able to collect all amounts due according to the original contractual terms or the equivalent value. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 131 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Credit exposures of individually significant loans are evaluated based on factors including the borrower’s overall financial condition, resources and payment record, and where applicable, the realizable value of any collateral. If there is evidence of impairment leading to an impairment loss, then the amount of the loss is determined as the difference between the carrying amount of the loan, including accrued interest, and the estimated recoverable amount. The estimated recoverable amount is measured as the present value of expected future cash flows discounted at the loan’s original effective interest rate, including cash flows that may result from the realization of collateral less costs to sell. Individually-assessed impairment losses reduce the carrying amount of the loan through the use of an allowance account and the amount of the loss is recognized in Provision for credit losses in our Consolidated Statements of Income. Following impairment, interest income is recognized on the unwinding of the discount from the initial recognition of impairment. Significant judgment is required in assessing evidence of impairment and estimation of the amount and timing of future cash flows when determining the impairment loss. When assessing objective evidence of impairment, we primarily consider specific factors such as the financial condition of the borrower, borrower’s default or delinquency in interest or principal payments, local economic conditions and other observable data. In determining the estimated recoverable amount, we consider discounted expected future cash flows at the effective interest rate using a number of assumptions and inputs. Management judgment is involved when choosing these inputs and assumptions used, such as the expected amount of the loan that will not be recovered and the cost of time delays in collecting principal and/or interest, and when estimating the value of any collateral held for which there may not be a readily accessible market. Changes in the amount expected to be recovered would have a direct impact on the Provision for credit losses and may result in a change in the Allowance for credit losses. Collectively assessed loans Loans which are not individually significant, or which are individually assessed and not determined to be impaired, are collectively assessed for impairment. For the purposes of a collective evaluation of impairment, loans are grouped on the basis of similar risk characteristics, taking into account loan type, industry, geographic location, collateral type, past due status and other relevant factors. The collective impairment allowance is determined by reviewing factors including: (i) historical loss experience, which takes into consideration historical probabilities of default, loss given default and exposure at default, in portfolios of similar credit risk characteristics, and (ii) management’s judgment on the level of impairment losses based on historical experience relative to the actual level as reported at the balance sheet date, taking into consideration the current portfolio credit quality trends, business and economic and credit conditions, the impact of policy and process changes, and other supporting factors. Future cash flows for a group of loans are collectively evaluated for impairment on the basis of the contractual cash flows of the loans in the group and historical loss experience for loans with credit risk characteristics similar to those in the group. Historical loss experience is adjusted based on current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not currently exist. The methodology and assumptions used for estimating future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. Collectively-assessed impairment losses reduce the carrying amount of the aggregated loan position through an allowance account and the amount of the loss is recognized in Provision for credit losses. Following impairment, interest income is recognized on the unwinding of the discount from the initial recognition of impairment. The methodology and assumptions used to calculate collective impairment allowances are subject to uncertainty, in part because it is not practicable to identify losses on an individual loan basis due to the large number of individually insignificant loans in the portfolio. Significant judgment is required in assessing historical loss experience, the loss identification period and its relationship to current portfolios including delinquency, and loan balances; and current business, economic and credit conditions including industry specific performance, unemployment and country risks. Changes in these assumptions would have a direct impact on the Provision for credit losses and may result in changes in the related Allowance for credit losses. Write-off of loans Loans and the related impairment allowance for credit losses are written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, they are generally written off after receipt of any proceeds from the realization of the collateral. In circumstances where the net realizable value of any collateral has been determined and there is no reasonable expectation of further recovery, write off may be earlier. For credit cards, the balances and related allowance for credit losses are written off when payment is 180 days in arrears. Personal loans are generally written off at 150 days past due. Derecognition of financial assets Financial assets are derecognized from our Consolidated Balance Sheets when our contractual rights to the cash flows from the assets have expired, when we retain the rights to receive the cash flows of the assets but assume an obligation to pay those cash flows to a third party subject to certain pass-through requirements or when we transfer our contractual rights to receive the cash flows and substantially all of the risk and rewards of the assets have been transferred. When we retain substantially all of the risks and rewards of the transferred assets, the transferred assets are not derecognized from our Consolidated Balance Sheets and are accounted for as secured financing transactions. When we neither retain nor transfer substantially all risks and rewards of ownership of the assets, we derecognize the assets if control over the assets is relinquished. If we retain control over the transferred assets, we continue to recognize the transferred assets to the extent of our continuing involvement. Management’s judgment is applied in determining whether the contractual rights to the cash flows from the transferred assets have expired or whether we retain the rights to receive cash flows on the assets but assume an obligation to pay for those cash flows. We derecognize transferred financial assets if we transfer substantially all the risk and rewards of the ownership in the assets. When assessing whether we have transferred substantially all of the risk and rewards of the transferred assets, management considers the Bank’s exposure before and after the transfer with the variability in the amount and timing of the net cash flows of the transferred assets. In transfers in which we retain the servicing rights, management has applied judgment in assessing the benefits of servicing against market expectations. When the benefits of servicing are greater than fair value, a servicing asset is recognized in Other assets in our Consolidated Balance Sheets. When the benefits of servicing are less than fair value, a servicing liability is recognized in Other liabilities in our Consolidated Balance Sheets. Derecognition of financial liabilities We derecognize a financial liability from our Consolidated Balance Sheets when our obligation specified in the contract expires, or is discharged or cancelled. We recognize the difference between the carrying amount of a financial liability transferred and the consideration paid in our Consolidated Statements of Income. 132 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Guarantees Financial guarantee contracts are contracts that contingently require us to make specified payments (in cash, other assets, our own shares or provision of services) to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. Liabilities are recognized on our Consolidated Balance Sheets at the inception of a guarantee for the fair value of the obligation undertaken in issuing the guarantee. Financial guarantees are subsequently remeasured at the higher of (i) the amount initially recognized less accumulated amortization and (ii) our best estimate of the present value of the expenditure required to settle the present obligation at the end of the reporting period. If the financial guarantee contract meets the definition of a derivative, it is measured at fair value at each balance sheet date and reported under Derivatives on our Consolidated Balance Sheets. Insurance and segregated funds Premiums from long-duration contracts, primarily life insurance, are recognized when due in Non-interest income – Insurance premiums, investment and fee income. Premiums from short-duration contracts, primarily property and casualty, and fees for administrative services are recognized in Insurance premiums, investment and fee income over the related contract period. Unearned premiums of the short-duration contracts, representing the unexpired portion of premiums, are reported in Other liabilities. Investments made by our insurance operations are classified as AFS or loans and receivables, except for investments supporting the policy benefit liabilities on life and health insurance contracts and a portion of property and casualty contracts. These are designated as at FVTPL with changes in fair value reported in Insurance premiums, investment and fee income. Insurance claims and policy benefit liabilities represent current claims and estimates for future insurance policy benefits. Liabilities for life insurance contracts are determined using the Canadian Asset Liability Method (CALM), which incorporates assumptions for mortality, morbidity, policy lapses and surrenders, investment yields, policy dividends, operating and policy maintenance expenses, and provisions for adverse deviation. These assumptions are reviewed at least annually and updated in response to actual experience and market conditions. Liabilities for property and casualty insurance represent estimated provisions for reported and unreported claims. Liabilities for life and property and casualty insurance are included in Insurance claims and policy benefit liabilities. Changes in Insurance claims and policy benefit liabilities are included in the Insurance policyholder benefits, claims and acquisition expense in our Consolidated Statements of Income in the period in which the estimates change. Premiums ceded for reinsurance and reinsurance recoveries on policyholder benefits and claims incurred are reported in income and expense as appropriate. Reinsurance recoverables, which relate to paid benefits and unpaid claims, are included in Other assets. Acquisition costs for new insurance business consist of commissions, premium taxes, certain underwriting costs and other costs that vary with the acquisition of new business. Deferred acquisition costs for life insurance products are implicitly recognized in Insurance claims and policy benefit liabilities by CALM. For property and casualty insurance, these costs are classified as Other assets and amortized over the policy term. Segregated funds are lines of business in which we issue an insurance contract where the benefit amount is directly linked to the market value of the investments held in the underlying fund. The contractual arrangement is such that the underlying segregated fund assets are registered in our name but the segregated fund policyholders bear the risks and rewards of the funds’ investment performance. Liabilities for these contracts are calculated based on contractual obligations using actuarial assumptions and are at least equivalent to the surrender or transfer value calculated by reference to the value of the relevant underlying funds or indices. Segregated funds’ assets and liabilities are separately presented on our Consolidated Balance Sheets. As the segregated fund policyholders bear the risks and rewards of the funds’ performance, investment income earned by the segregated funds and expenses incurred by the segregated funds are offset and are not separately presented in our Consolidated Statements of Income. Fee income we earn from segregated funds includes management fees, mortality, policy administration and surrender charges, and these fees are recorded in Non-interest income – Insurance premiums, investment and fee income. We provide minimum death benefit and maturity value guarantees on segregated funds. The liability associated with these minimum guarantees is recorded in Insurance claims and policy benefit liabilities. Liability adequacy tests are performed for all insurance contract portfolios at each balance sheet date to ensure the adequacy of insurance contract liabilities. Current best estimates of future contractual cash flows, claims handling and administration costs, and investment returns from the assets backing the liabilities are taken into account in the tests. When the test results indicate that there is a deficiency in liabilities, the deficiency is charged immediately to our Consolidated Statements of Income by writing down the deferred acquisition costs in Other assets and/ or increasing Insurance claims and policy benefit liabilities. Employee benefits – Pensions and other post-employment benefits Our defined benefit pension expense, which is included in Non-interest expense – Human resources, consists of the cost of employee pension benefits for the current year’s service, net interest on the net defined benefit liability (asset), past service cost and gains or losses on settlement. Remeasurements of the net defined benefit liability, which comprise actuarial gains and losses and return on plan assets (excluding amounts included in net interest on the net defined benefit liability), are recognized immediately in OCI in the period in which they occur. Actuarial gains and losses comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred), as well as the effects of changes in actuarial assumptions. Amounts recognized in OCI will not be reclassified subsequently to net income. Past service cost is the change in the present value of the defined benefit obligation resulting from a plan amendment or curtailment and is charged immediately to income. For each defined benefit plan, we recognize the present value of our defined benefit obligations less the fair value of the plan assets as a defined benefit liability reported in Employee benefit liabilities on our Consolidated Balance Sheets. For plans where there is a net defined benefit asset, the amount is reported as an asset in Employee benefit assets on our Consolidated Balance sheets. The calculation of defined benefit expenses and obligations requires significant judgment as the recognition is dependent on discount rates and various actuarial assumptions such as healthcare cost trend rates, projected salary increases, retirement age, and mortality and termination rates. Due to the long-term nature of these plans, such estimates and assumptions are subject to inherent risks and uncertainties. For our pension and other post-employment plans, the discount rate is determined by reference to market yields on high quality corporate bonds. Since the discount rate is based on currently available yields, and involves management’s assessment of market liquidity, it is only a proxy for future yields. Actuarial assumptions, set in accordance with current practices in the respective countries of our plans, may differ from actual experience as country specific statistics are only estimates of future employee behaviour. These assumptions are determined by management and are reviewed by actuaries at least annually. Changes to any of the above assumptions may affect the amounts of benefits obligations, expenses and remeasurements that we recognize. Our contributions to defined contribution plans are expensed when employees have rendered services in exchange for such contributions. Defined contribution plan expense is included in Non-interest expense – Human resources. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 133 Note 2 Summary of significant accounting policies, estimates and judgments (continued) Share-based compensation We offer share-based compensation plans to certain key employees and to our non-employee directors. To account for stock options granted to employees, compensation expense is recognized over the applicable vesting period with a corresponding increase in equity. Fair value is determined by using option valuation models, which take into account the exercise price of the option, the current share price, the risk free interest rate, the expected volatility of the share price over the life of the option and other relevant factors. When the options are exercised, the exercise price proceeds together with the amount initially recorded in equity are credited to common shares. Our other compensation plans include performance deferred share plans and deferred share unit plans for key employees (the Plans). The obligations for the Plans are accrued over their vesting periods. The Plans are settled in cash. For cash-settled awards, our accrued obligations are adjusted to their fair value at each balance sheet date. For share-settled awards, our accrued obligations are based on the fair value of our common shares at the date of grant. Changes in our obligations, net of related hedges, are recorded as Non-interest expense – Human resources in our Consolidated Statements of Income with a corresponding increase in Other liabilities for cash-settled awards and in Retained earnings for share-settled awards. The compensation cost attributable to options and awards granted to employees who are eligible to retire or will become eligible to retire during the vesting period, is recognized immediately if the employee is eligible to retire on the grant date or over the period between the grant date and the date the employee becomes eligible to retire. Our contributions to the employee savings and share ownership plans are expensed as incurred. Income taxes Income tax comprises current tax and deferred tax and is recognized in our Consolidated Statements of Income except to the extent that it relates to items recognized directly in equity, in which case it is recognized in equity. Current income tax payable on profits is recognized as an expense based on the applicable tax laws in each jurisdiction in the period in which profits arise, calculated using tax rates enacted or substantively enacted by the balance sheet date. Deferred tax is recognized on temporary differences between the carrying amounts of assets and liabilities for accounting and tax purposes. A deferred income tax asset or liability is determined for each temporary difference, except for earnings related to our subsidiaries, branches, associates and interests in joint ventures where the temporary differences will not reverse in the foreseeable future and we have the ability to control the timing of reversal. Deferred tax assets and liabilities are determined based on the tax rates that are expected to be in effect in the period that the asset is realized or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted at the balance sheet date. Current tax assets and liabilities are offset when they are levied by the same taxation authority on either the same taxable entity or different taxable entities within the same tax reporting group (which intends to settle on a net basis), and when there is a legal right to offset. Deferred tax assets and liabilities are offset when the same conditions are satisfied. Our Consolidated Statements of Income include items that are non-taxable or non- deductible for income tax purposes and, accordingly, this causes the income tax provision to be different from what it would be if based on statutory rates. Deferred income taxes accumulated as a result of temporary differences and tax loss carryforwards are included in Other assets and Other liabilities. On a quarterly basis, we review our deferred income tax assets to determine whether it is probable that the benefits associated with these assets will be realized; this review involves evaluating both positive and negative evidence. We are subject to income tax laws in various jurisdictions where we operate, and the complex tax laws are potentially subject to different interpretations by us and the relevant taxation authorities. Significant judgment is required in the interpretation of the relevant tax laws, and the determination of our tax provision which includes our best estimate of tax positions that are under audit or appeal by relevant taxation authorities. We perform a review on a quarterly basis to incorporate our best assessment based on information available, but additional liability and income tax expense could result based on decisions made by the relevant tax authorities. The determination of our deferred tax asset or liability also requires significant management judgment as the recognition is dependent on our projection of future taxable profits and tax rates that are expected to be in effect in the period the asset is realized or the liability is settled. Any changes in our projection will result in changes in deferred tax assets or liabilities on our Consolidated Balance Sheets, and also deferred tax expense in our Consolidated Statements of Income. Business combinations, goodwill and other intangibles All business combinations are accounted for using the acquisition method. Non-controlling interests, if any, are recognized at their proportionate share of the fair value of identifiable assets and liabilities, unless otherwise indicated. Identifiable intangible assets are recognized separately from goodwill and included in Other intangibles. Goodwill represents the excess of the price paid for the business acquired over the fair value of the net identifiable assets acquired on the date of acquisition. Goodwill Goodwill is allocated to cash-generating units or groups of cash-generating units (CGU) for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. Impairment testing is performed annually as at August 1, or more frequently if there are objective indicators of impairment, by comparing the recoverable amount of a CGU with its carrying amount. The recoverable amount of a CGU is the higher of its value in use and its fair value less costs of disposal. Value in use is the present value of the expected future cash flows from a CGU. Fair value less costs of disposal is the amount obtainable from the sale of a CGU in an orderly transaction between market participants, less disposal costs. The fair value of a CGU is estimated using valuation techniques such as a discounted cash flow method, adjusted to reflect the considerations of a prospective third-party buyer. External evidence such as binding sale agreements or recent transactions for similar businesses within the same industry is considered to the extent that it is available. Significant judgment is involved in estimating the model inputs used to determine the recoverable amount of our CGU, in particular future cash flows, discount rates and terminal growth rates, due to the uncertainty in the timing and amount of cash flows and the forward-looking nature of these inputs. Future cash flows are based on financial plans agreed by management which are estimated based on forecast results, business initiatives, planned capital investments and returns to shareholders. Discount rates are based on the bank-wide cost of capital, adjusted for CGU-specific risks and currency exposure as reflected by differences in expected inflation. Bank-wide cost of capital is based on the Capital Asset Pricing Model. CGU-specific risks include country risk, business/operational risk, geographic risk (including political risk, devaluation risk, and government regulation), currency risk, and price risk (including product pricing risk and inflation). Terminal growth rates reflect the expected long-term gross domestic product growth and inflation for the countries within which the CGU operates. Changes in these assumptions may impact the amount of impairment loss recognized in Non-interest expense. The carrying amount of a CGU includes the carrying amount of assets, liabilities and goodwill allocated to the CGU. If the recoverable amount is less than the carrying value, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the CGU 134 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements and then to the other non-financial assets of the CGU proportionately based on the carrying amount of each asset. Any impairment loss is charged to income in the period in which the impairment is identified. Goodwill is stated at cost less accumulated impairment losses. Subsequent reversals of goodwill impairment are prohibited. Upon disposal of a portion of a CGU, the carrying amount of goodwill relating to the portion of the CGU sold is included in the determination of gains or losses on disposal. The carrying amount is determined based on the relative fair value of the disposed portion to the total CGU. Other intangibles Intangible assets represent identifiable non-monetary assets and are acquired either separately or through a business combination, or generated internally. Intangible assets acquired through a business combination are recognized separately from goodwill when they are separable or arise from contractual or other legal rights, and their fair value can be measured reliably. The cost of a separately acquired intangible asset includes its purchase price and directly attributable costs of preparing the asset for its intended use. In respect of internally generated intangible assets, cost includes all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Research and development costs that are not eligible for capitalization are expensed. After initial recognition, an intangible asset is carried at its cost less any accumulated amortization and accumulated impairment losses, if any. Intangible assets with a finite-life are amortized on a straight-line basis over their estimated useful lives as follows: computer software – 3 to 10 years; and customer relationships – 10 to 20 years. We do not have any intangible assets with indefinite lives. Intangible assets are assessed for indicators of impairment at each reporting period. If there is an indication that an intangible asset may be impaired, an impairment test is performed by comparing the carrying amount of the intangible asset to its recoverable amount. Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the CGU to which the asset belongs. If the recoverable amount of the asset (or CGU) is less than its carrying amount, the carrying amount of the intangible asset is written down to its recoverable amount as an impairment loss. An impairment loss recognized previously is reversed if there is a change in the estimates used to determine the recoverable amount of the asset (or CGU) since the last impairment loss was recognized. If an impairment loss is subsequently reversed, the carrying amount of the asset (or CGU) is revised to the lower of its recoverable amount and the carrying amount that would have been determined (net of amortization) had there been no prior impairment. Due to the subjective nature of these estimates, significant judgment is required in determining the useful lives and recoverable amounts of our intangible assets, and assessing whether certain events or circumstances constitute objective evidence of impairment. Estimates of the recoverable amounts of our intangible assets rely on certain key inputs, including future cash flows and discount rates. Future cash flows are based on sales projections and allocated costs which are estimated based on forecast results and business initiatives. Discount rates are based on the bank-wide cost of capital, adjusted for asset-specific risks. Changes in these assumptions may impact the amount of impairment loss recognized in Non-interest expense. Other Translation of foreign currencies Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at rates prevailing at the balance sheet date. Foreign exchange gains and losses resulting from the translation and settlement of these items are recognized in Non-interest income in the Consolidated Statements of Income. Non-monetary assets and liabilities that are measured at historical cost are translated into Canadian dollars at historical rates. Non- monetary financial assets classified as AFS securities, such as equity instruments, that are measured at fair value are translated into Canadian dollars at rates prevailing at the balance sheet date, and the resulting foreign exchange gains and losses are recorded in Other components of equity until the asset is sold or becomes impaired. Assets and liabilities of our foreign operations with functional currencies other than Canadian dollars are translated into Canadian dollars at rates prevailing at the balance sheet date, and income and expenses of these foreign operations are translated at average rates of exchange for the reporting period. Unrealized gains or losses arising as a result of the translation of our foreign operations along with the effective portion of related hedges are reported in Other components of equity on an after-tax basis. Upon disposal or partial disposal of a foreign operation, an appropriate portion of the accumulated net translation gains or losses is included in Non-interest income. Premises and equipment Premises and equipment includes land, buildings, leasehold improvements, computer equipment, furniture, fixtures and other equipment, and are stated at cost less accumulated depreciation, except for land which is not depreciated, and accumulated impairment losses. Cost comprises the purchase price, any costs directly attributable to bringing the asset to the location and condition necessary for its intended use, and the initial estimate of any disposal costs. Depreciation is recorded principally on a straight–line basis over the estimated useful lives of the assets, which are 25 to 50 years for buildings, 3 to 10 years for computer equipment, and 7 to 10 years for furniture, fixtures and other equipment. The amortization period for leasehold improvements is the lesser of the useful life of the leasehold improvements or the lease term plus the first renewal period, if reasonably assured of renewal, up to a maximum of 10 years. Depreciation methods, useful lives, and residual values are reassessed at each reporting period and adjusted as appropriate. Gains and losses on disposal are recorded in Non–interest income. Premises and equipment are assessed for indicators of impairment at each reporting period. If there is an indication that an asset may be impaired, an impairment test is performed by comparing the asset’s carrying amount to its recoverable amount. Where it is not possible to estimate the recoverable amount of an individual asset, we estimate the recoverable amount of the CGU to which the asset belongs and test for impairment at the CGU level. An impairment charge is recorded to the extent the recoverable amount of an asset (or CGU), which is the higher of value in use and fair value less costs of disposal, is less than its carrying amount. Value in use is the present value of the future cash flows expected to be derived from the asset (or CGU). Fair value less costs of disposal is the amount obtainable from the sale of the asset (or CGU) in an orderly transaction between market participants, less costs of disposal. After the recognition of impairment, the depreciation charge is adjusted in future periods to reflect the asset’s revised carrying amount. If an impairment is later reversed, the carrying amount of the asset is revised to the lower of the asset’s recoverable amount and the carrying amount that would have been determined (net of depreciation) had there been no prior impairment loss. The depreciation charge in future periods is adjusted to reflect the revised carrying amount. Provisions Provisions are liabilities of uncertain timing or amount and are recognized when we have a present legal or constructive obligation as a result of a past event, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are measured as the best estimate of the consideration required to settle the present obligation at the reporting Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 135 Note 2 Summary of significant accounting policies, estimates and judgments (continued) date. Significant judgment is required in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. We record provisions related to litigation, asset retirement obligations, and the allowance for off-balance sheet and other items. Provisions are recorded under Other liabilities on our Consolidated Balance Sheets. We are required to estimate the results of ongoing legal proceedings, expenses to be incurred to dispose of capital assets, and credit losses on undrawn commitments and guarantees. The forward-looking nature of these estimates requires us to use a significant amount of judgment in projecting the timing and amount of future cash flows. We record our provisions on the basis of all available information at the end of the reporting period and make adjustments on a quarterly basis to reflect current expectations. Should actual results differ from our expectations, we may incur expenses in excess of the provisions recognized. When some or all of the economic benefits required to settle a provision are expected to be recovered from a third party, such as an insurer, a separate asset is recognized if it is virtually certain that reimbursement will be received. Commissions and fees Portfolio management and other management advisory and service fees are recognized based on the applicable service contracts. Fees related to provision of services including asset management, wealth management, financial planning and custody services that cover a specified service period, are recognized over the period in which the service is provided. Investment management and custodial fees are generally calculated as a percentage of daily or period-end net asset values, and are received monthly, quarterly, semi-annually or annually, depending on the terms of the contracts. Management fees are generally derived from assets under management (AUM) when our clients solicit the investment capabilities of an investment manager and administrative fees are derived from assets under administration (AUA) where the investment strategy is directed by the client or a designated third party manager. Performance-based fees, which are earned upon exceeding certain benchmarks or performance targets, are recognized only when the benchmark or performance targets are achieved. Fees such as underwriting fees and brokerage fees that are related to the provision of specific transaction type services are recognized when the service has been completed. Dividend income Dividend income is recognized when the right to receive payment is established. This is the ex-dividend date for listed equity securities, and usually the date when shareholders have approved the dividend for unlisted equity securities. Leasing A lease is an agreement whereby the lessor conveys to the lessee the right to use an asset for an agreed upon period of time in return for a payment or series of payments. A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of the leased asset to the lessee, where title may or may not eventually be transferred. An operating lease is a lease other than a finance lease. Operating leases When we are the lessee in an operating lease, we record rental payments on a straight-line basis over the lease term in Non-interest expense. Finance leases When we are the lessee in a finance lease, we initially record both the leased asset and the related lease obligation in Premises and equipment, Other intangibles and Other liabilities on our Consolidated Balance Sheets at an amount equal to the fair value of the leased asset or, if lower, the present value of the minimum lease payments, each determined at the date of inception of the lease. Initial direct costs directly attributed to the lease are recognized as an asset under the finance lease. Earnings per share Earnings per share is computed by dividing Net income available to common shareholders by the weighted average number of common shares outstanding for the period. Net income available to common shareholders is determined after deducting dividend entitlements of preferred shareholders, any gains (losses) on redemption of preferred shares net of related income taxes and the net income attributable to non- controlling interests. Diluted earnings per share reflects the potential dilution that could occur if additional common shares are assumed to be issued under securities or contracts that entitle their holders to obtain common shares in the future, to the extent such entitlement is not subject to unresolved contingencies. For contracts that may be settled in cash or in common shares at our option, diluted earnings per share is calculated based on the assumption that such contracts will be settled in shares. Income and expenses associated with these types of contracts are excluded from the Net income available to common shareholders, and the additional number of shares that would be issued is included in the diluted earnings per share calculation. These contracts include our convertible Preferred Shares and Trust Capital Securities with the conversion assumed to have taken place at the beginning of the period or on the date of issue, if later. For stock options whose exercise price is less than the average market price of our common shares, they are assumed to be exercised and the proceeds are used to repurchase common shares at the average market price for the period. The incremental number of common shares issued under stock options and repurchased from proceeds is included in the calculation of diluted earnings per share. Share capital We classify a financial instrument that we issue as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. Our common shares held by us are classified as treasury shares in equity and accounted for at weighted average cost. Upon the sale of treasury shares, the difference between the sale proceeds and the cost of the shares is recognized in Retained earnings. Financial instruments issued by us are classified as equity instruments when there is no contractual obligation to transfer cash or other financial assets. Incremental costs directly attributable to the issue of equity instruments are included in equity as a deduction from the proceeds, net of tax. Financial instruments that will be settled by a variable number of our common shares upon their conversion by the holders as well as the related accrued distributions are classified as liabilities on our Consolidated Balance Sheets. Dividends and yield distributions on these instruments are classified as Interest expense in our Consolidated Statements of Income. 136 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Future changes in accounting policy and disclosure The following standards have been issued, but are not yet effective for us. We are currently assessing the impact of adopting these standards on our Consolidated Financial Statements: IFRS 15 Revenue from Contracts with Customers (IFRS 15) In May 2014, the IASB issued IFRS 15 which establishes principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard provides a single, principles based five-step model for revenue recognition to be applied to contracts with customers except for revenue arising from items such as financial instruments, insurance contracts and leases. In April 2016, the IASB issued amendments to IFRS 15, which clarify the underlying principles of IFRS 15 and provide additional transitional relief on initial application. IFRS 15 and its amendments will be effective for us on November 1, 2018. IFRS 9 Financial Instruments (IFRS 9) In July 2014, the IASB issued the complete version of IFRS 9, first issued in November 2009, which brings together the classification and measurement, impairment and hedge accounting phases of the IASB’s project to replace IAS 39 Financial Instruments: Recognition and Measurement (IAS 39). IFRS 9 introduces a principles-based approach to the classification of financial assets based on an entity’s business model and the nature of the cash flows of the asset. All financial assets, including hybrid contracts, are measured as at FVTPL, fair value through OCI or amortized cost. For financial liabilities, IFRS 9 includes the requirements for classification and measurement previously included in IAS 39. IFRS 9 also introduces an expected credit loss impairment model for all financial assets not measured as at FVTPL. The model has three stages: (1) on initial recognition, a loss allowance is recognized equal to 12 months expected credit losses; (2) if credit risk increases significantly relative to initial recognition, a loss allowance equal to full lifetime expected credit losses is recognized; and (3) when a financial asset is considered credit-impaired, a loss allowance equal to lifetime expected credit losses is recognized and interest revenue is calculated based on the carrying amount of the asset, net of the loss allowance, rather than its gross carrying amount. Changes in the required loss allowance, including the impact of movement between 12 months and lifetime expected credit losses, will be recorded in profit or loss. Finally, IFRS 9 introduces a new hedge accounting model that aligns the accounting for hedge relationships more closely with an entity’s risk management activities, permits hedge accounting to be applied more broadly to a greater variety of hedging instruments and risks and requires additional disclosures. We adopted the own credit provisions of IFRS 9 in the second quarter of 2014. The remaining sections of IFRS 9 will be effective for us on November 1, 2017. IFRS 16 Leases (IFRS 16) In January 2016, the IASB issued IFRS 16, which sets out the principles for the recognition, measurement, presentation and disclosure of leases. The standard removes the current requirement for lessees to classify leases as finance leases or operating leases by introducing a single lessee accounting model that requires the recognition of lease assets and lease liabilities on the balance sheet for most leases. Lessees will also recognize depreciation expense on the lease asset and interest expense on the lease liability in the statement of income. There are no significant changes to lessor accounting aside from enhanced disclosure requirements. IFRS 16 will be effective for us on November 1, 2019. IAS 7 Statement of Cash Flows (IAS 7) In January 2016, the IASB issued amendments to IAS 7, which will require specific disclosures for movements in certain liabilities on the statement of cash flow. These amendments will be effective for us on November 1, 2017. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 137 Note 3 Fair value of financial instruments Carrying value and fair value of selected financial instruments The following tables provide a comparison of the carrying and fair values for each classification of financial instrument. Carrying value and fair value Financial instruments classified as at FVTPL Financial instruments designated as at FVTPL Available- for-sale instruments measured at fair value As at October 31, 2016 Carrying value Fair value Financial instruments measured at amortized cost Financial instruments measured at amortized cost Total carrying amount Total fair value (Millions of Canadian dollars) Financial assets Securities Trading Available-for-sale (1) $ 141,265 $ 10,027 $ – 141,265 – 10,027 $ – 69,922 69,922 Assets purchased under reverse repurchase agreements and securities borrowed – 121,692 Loans Retail Wholesale Other Derivatives Other assets (2) Financial liabilities Deposits Personal Business and government (3) Bank (4) Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities (5) Subordinated debentures 71 1,437 1,508 118,944 – $ 113 $ – – 113 50,369 – 116,550 282 – – 904 904 – 894 15,142 82,871 730 98,743 – 88,863 – 10 131 – – – – – – $ – 14,879 14,879 64,610 368,145 151,047 519,192 – 43,981 235,295 405,136 18,302 658,733 – 14,578 – 43,865 9,631 $ – $ 15,207 15,207 151,292 $ 84,801 236,093 151,292 85,129 236,421 64,498 186,302 186,190 369,012 150,720 519,732 – 43,979 368,216 153,388 521,604 118,944 44,875 369,083 153,061 522,144 118,944 44,873 $ 235,490 $ 406,881 18,312 660,683 250,550 $ 488,007 19,032 757,589 250,745 489,752 19,042 759,539 – 50,369 50,369 14,583 – 43,838 9,700 103,441 116,550 44,157 9,762 103,446 116,550 44,130 9,831 (Millions of Canadian dollars) Financial assets Securities Trading Available-for-sale (1) Carrying value and fair value Carrying value Fair value As at October 31, 2015 Financial instruments classified as at FVTPL Financial instruments designated as at FVTPL Available- for-sale instruments measured at fair value Financial instruments measured at amortized cost Financial instruments measured at amortized cost Total carrying amount Total fair value $ 148,939 $ – 148,939 9,764 $ – 9,764 – 48,164 48,164 $ $ – 8,641 8,641 – $ 8,759 8,759 158,703 $ 56,805 215,508 158,703 56,923 215,626 Assets purchased under reverse repurchase agreements and securities borrowed – 114,692 Loans Retail Wholesale Other Derivatives Other assets (2) Financial liabilities Deposits Personal Business and government (3) Bank (4) Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Other liabilities (5) Subordinated debentures 166 1,280 1,446 105,626 – $ 69 $ – – 69 47,658 – 107,860 192 – – 1,327 1,327 – 925 16,828 93,319 5,376 115,523 – 73,362 – 13 112 – – – – – – $ 60,031 346,795 122,655 469,450 – 44,852 203,669 362,259 15,707 581,635 – 9,926 – 43,251 7,250 60,071 174,723 174,763 348,513 121,316 469,829 – 44,852 346,961 125,262 472,223 105,626 45,777 348,679 123,923 472,602 105,626 45,777 $ 204,019 $ 363,305 15,713 583,037 220,566 $ 455,578 21,083 697,227 220,916 456,624 21,089 698,629 – 47,658 47,658 9,928 – 43,196 7,078 83,288 107,860 43,456 7,362 83,290 107,860 43,401 7,190 (1) (2) (3) (4) (5) AFS securities include held-to-maturity securities that are recorded at amortized cost. Includes Customers’ liability under acceptances and financial instruments recognized in Other assets. Business and government deposits include deposits from regulated deposit-taking institutions other than banks. Bank deposits refer to deposits from regulated deposit-taking institutions. Includes Acceptances and financial instruments recognized in Other liabilities. 138 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Loans and receivables designated as at fair value through profit or loss For our loans and receivables designated as at FVTPL, we measure the change in fair value attributable to changes in credit risk as the difference between the total change in the fair value of the instrument during the period and the change in fair value calculated using the appropriate risk- free yield curves. (Millions of Canadian dollars) Interest-bearing deposits with banks Assets purchased under reverse repurchase agreements and securities borrowed Loans – Wholesale Other assets As at October 31, 2016 October 31, 2015 Carrying amount of loans and receivables designated as at FVTPL 15,967 $ Maximum exposure to credit risk 15,967 $ Carrying amount of loans and receivables designated as at FVTPL 15,717 $ Maximum exposure to credit risk 15,717 $ 121,692 904 132 121,692 904 132 114,692 1,327 202 114,692 1,327 202 $ 138,695 $ 138,695 $ 131,938 $ 131,938 There were no significant changes in the fair value of the loans and receivables designated as at FVTPL attributable to changes in credit risk during the years ended October 31, 2016 and October 31, 2015, and cumulatively since initial recognition of the assets. The extent to which credit derivatives or similar instruments mitigate the maximum exposure to credit risk is nominal as at October 31, 2016 and October 31, 2015. Liabilities designated as at fair value through profit or loss For our financial liabilities designated as at FVTPL, we take into account changes in our own credit spread and the expected duration of the instrument to measure the change in fair value attributable to changes in credit risk. As at or for the year ended October 31, 2016 Difference between carrying value and contractual maturity amount Changes in fair value attributable to changes in credit risk included in net income for positions still held Changes in fair value attributable to changes in credit risk included in OCI for positions still held Cumulative change in fair value attributable to changes in credit risk for positions still held (1) Contractual maturity amount Carrying value $ 15,138 $ 15,142 $ 4 $ 81,860 730 97,728 82,871 730 98,743 1,011 – 1,015 88,863 10 128 88,863 10 131 $ 186,729 $ 187,747 $ – – 3 1,018 $ – $ – – – – – – – $ 99 $ 354 – 453 – – 1 454 $ 25 25 – 50 – – (2) 48 As at or for the year ended October 31, 2015 Difference between carrying value and contractual maturity amount Changes in fair value attributable to changes in credit risk included in net income for positions still held Changes in fair value attributable to changes in credit risk included in OCI for positions still held Cumulative change in fair value attributable to changes in credit risk for positions still held (1) Contractual maturity amount Carrying value $ 16,595 $ 16,828 $ 93,225 5,376 115,196 93,319 5,376 115,523 73,364 13 108 73,362 13 112 $ 188,681 $ 189,010 $ 233 $ 94 – 327 (2) – 4 329 $ – $ – – – – – – – $ (93) $ (387) – (480) – – – (480) $ (74) (329) – (403) – – (3) (406) (Millions of Canadian dollars) Term deposits Personal Business and government (2) Bank (3) Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures (Millions of Canadian dollars) Term deposits Personal Business and government (2) Bank (3) Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures (1) (2) (3) The cumulative change is measured from the initial recognition of the liabilities designated as at FVTPL. For the year ended October 31, 2016, $14 million of fair value gains previously included in OCI relate to financial liabilities derecognized during the year (October 31, 2015 – $3 million fair value losses). Business and government term deposits include deposits from regulated deposit-taking institutions other than regulated banks. Bank term deposits refer to deposits from regulated deposit-taking institutions. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 139 Note 3 Fair value of financial instruments (continued) Fair value of assets and liabilities measured at fair value on a recurring basis and classified using the fair value hierarchy (Millions of Canadian dollars) Financial assets Interest-bearing deposits with banks Securities Trading Canadian government debt (1) Federal Provincial and municipal U.S. state, municipal and agencies debt (1) Other OECD government debt (2) Mortgage-backed securities (1) Asset-backed securities CDO (3) Non-CDO securities Corporate debt and other debt Equities Available-for-sale (4) Canadian government debt (1) Federal Provincial and municipal U.S. state, municipal and agencies debt (1) Other OECD government debt Mortgage-backed securities (1) Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Loan substitute securities Assets purchased under reverse repurchase agreements and securities borrowed Loans Other Derivatives Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Total gross derivatives Netting adjustments Total derivatives Other assets Financial Liabilities Deposits Personal Business and government Bank Other Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Total gross derivatives Netting adjustments Total derivatives Other liabilities Subordinated debentures October 31, 2016 October 31, 2015 As at Fair value measurements using Level 1 Level 2 Level 3 Total gross fair value Netting adjustments Assets/ liabilities at fair value Fair value measurements using Level 1 Level 2 Level 3 Total gross fair value Netting adjustments Assets/ liabilities at fair value $ – $ 15,967 $ – $ 15,967 $ $ 15,967 $ – $ 15,717 $ – $ 15,717 $ $ 15,717 13,072 – 3,358 1,390 – – – 25 43,155 61,000 44 – 1 3,416 – – – – 376 49 3,886 10,214 11,928 37,002 5,530 1,457 – 557 20,630 2,531 89,849 378 2,364 24,668 10,484 395 1,630 1,886 21,110 331 25 63,271 – – 1 – – – 4 62 376 443 – – 747 – – – 217 956 756 – 2,676 23,286 11,928 40,361 6,920 1,457 – 561 20,717 46,062 151,292 422 2,364 25,416 13,900 395 1,630 2,103 22,066 1,463 74 69,833 23,286 11,928 40,361 6,920 1,457 – 561 20,717 46,062 151,292 422 2,364 25,416 13,900 395 1,630 2,103 22,066 1,463 74 69,833 10,793 – 1,641 3,131 – – – 16 45,811 61,392 346 – – 4,752 – – – – 431 94 5,623 9,364 13,888 32,798 9,215 2,907 67 1,636 24,502 2,556 96,933 2,198 1,600 12,051 7,535 318 1,510 881 12,372 323 – 38,788 – 5 16 – 15 5 23 191 123 378 – – 797 – – – 197 1,757 987 – 3,738 20,157 13,893 34,455 12,346 2,922 72 1,659 24,709 48,490 158,703 2,544 1,600 12,848 12,287 318 1,510 1,078 14,129 1,741 94 48,149 – – 121,692 2,083 – 329 121,692 2,412 121,692 2,412 – – 114,692 2,301 – 472 114,692 2,773 3 – – 2,855 – 2,858 153,216 56,752 191 3,613 (1,429) 212,343 555 26 – 307 (3) 885 153,774 56,778 191 6,775 (1,432) 216,086 762 132 – 894 153,774 56,778 191 6,775 (1,432) 216,086 (97,142) 118,944 894 7 – – 4,424 – 4,431 142,096 41,021 90 5,637 (1,265) 374 91 4 712 (38) 142,477 41,112 94 10,773 (1,303) 187,579 1,143 193,153 723 202 – 925 (97,142) (87,527) 20,157 13,893 34,455 12,346 2,922 72 1,659 24,709 48,490 158,703 2,544 1,600 12,848 12,287 318 1,510 1,078 14,129 1,741 94 48,149 114,692 2,773 142,477 41,112 94 10,773 (1,303) 193,153 (87,527) 105,626 925 $68,506 $505,337 $ 4,333 $578,176 $ (97,142) $ 481,034 $72,169 $456,212 $ 5,731 $534,112 $ (87,527) $ 446,585 $ $ – – – $ 14,830 82,869 730 425 2 – $ 15,255 82,871 730 $ $ $ 15,255 82,871 730 $ – $ 16,508 93,311 – 5,376 – 389 8 – $ 16,897 93,319 5,376 $ 50,369 50,369 31,945 15,713 32,672 17,696 – 88,863 – – – 3,135 – 3,135 145,055 57,438 263 5,543 (133) 208,166 1 – 1,003 41 – 429 7 1,480 88,863 146,058 57,479 263 9,107 (126) 212,781 124 – 80 131 88 – 292 131 88,863 – 73,362 3 – – 3,835 – 3,838 135,455 46,675 166 8,075 (281) 190,090 146,058 57,479 263 9,107 (126) 212,781 (96,231) 116,550 292 131 (96,231) – – 820 33 5 1,025 9 1,892 47,658 73,362 136,278 46,708 171 12,935 (272) 195,820 (87,960) 145 – 13 112 47 – 205 112 $ 16,897 93,319 5,376 47,658 73,362 136,278 46,708 171 12,935 (272) 195,820 (87,960) 107,860 205 112 $35,931 $413,365 $ 1,996 $451,292 $ (96,231) $ 355,061 $35,928 $394,485 $ 2,336 $432,749 $ (87,960) $ 344,789 (1) (2) (3) (4) As at October 31, 2016, residential and commercial mortgage-backed securities (MBS) included in all fair value levels of trading securities were $14,987 million and $10 million (October 31, 2015 – $10,315 million and $137 million), respectively, and in all fair value levels of AFS securities were $13,212 million and $346 million (October 31, 2015 – $3,394 million and $242 million), respectively. OECD stands for Organisation for Economic Co-operation and Development. CDO stands for collateralized debt obligations. Excludes $89 million of AFS securities (October 31, 2015 – $15 million) that are carried at cost. 140 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Fair values of our significant assets and liabilities measured on a recurring basis are determined and classified in the fair value hierarchy table using the following valuation techniques and inputs. Interest-bearing deposits with banks A majority of our deposits with banks are designated as at FVTPL. These FVTPL deposits are composed of short-dated deposits placed with banks, and are included in Interest-bearing deposits with banks in the fair value hierarchy table. The fair values of these instruments are determined using the discounted cash flow method. The inputs to the valuation models include interest rate swap curves and credit spreads, where applicable. They are classified as Level 2 instruments in the hierarchy as the inputs are observable. Government bonds (Canadian, U.S. and other OECD governments) Government bonds are included in Canadian government debt, U.S. state, municipal and agencies debt, Other OECD government debt and Obligations related to securities sold short in the fair value hierarchy table. The fair values of government issued or guaranteed debt securities in active markets are determined by reference to recent transaction prices, broker quotes, or third-party vendor prices and are classified as Level 1 in the hierarchy. The fair values of securities that are not traded in active markets are based on either security prices, or valuation techniques using implied yields and risk spreads derived from prices of actively traded and similar government securities. Securities with observable prices or rate inputs as compared to transaction prices, dealer quotes or vendor prices are classified as Level 2 in the hierarchy. Securities where inputs are unobservable are classified as Level 3 in the hierarchy. Corporate and U.S. municipal bonds The fair values of corporate and U.S. municipal bonds, which are included in Corporate debt and other debt, U.S. state, municipal and agencies debt and Obligations related to securities sold short in the fair value hierarchy table, are determined using either recently executed transaction prices, broker quotes, pricing services, or in certain instances, the discounted cash flow method using rate inputs such as benchmark yields (Canadian Dealer Offered Rate, LIBOR and other similar reference rates) and risk spreads of comparable securities. Securities with observable prices or rate inputs are classified as Level 2 in the hierarchy. Securities where inputs are unobservable are classified as Level 3 in the hierarchy. Asset-backed securities and Mortgage-backed securities Asset-backed securities (ABS) and MBS are included in Asset-backed securities, Mortgage-backed securities, Canadian government debt, U.S. state, municipal and agencies debt, and Obligations related to securities sold short in the fair value hierarchy table. ABS include collateralized debt obligations (CDO). Inputs for valuation of MBS and CDO are, when available, traded prices, dealer or lead manager quotes, broker quotes and vendor prices of the identical securities. When prices of the identical securities are not readily available, we use industry standard models with inputs such as discount margins, yields, default, prepayment and loss severity rates that are implied from transaction prices, dealer quotes or vendor prices of comparable instruments. Where security prices and inputs are observable, ABS and MBS are classified as Level 2 in the hierarchy. Otherwise, they are classified as Level 3 in the hierarchy. Auction rate securities Auction rate securities (ARS) are included in U.S. state, municipal and agencies debt, and Asset-backed securities in the fair value hierarchy table. The valuation of ARS involves discounting forecasted cash flows from the underlying student loan collateral and incorporating multiple inputs such as default, prepayment, deferment and redemption rates, and credit spreads. These inputs are unobservable, and therefore, ARS are classified as Level 3 in the hierarchy. All relevant data must be assessed and significant judgment is required to determine the appropriate valuation inputs. Equities Equities and Obligations related to securities sold short in the fair value hierarchy table consist of listed and unlisted common shares, private equities and hedge funds with certain redemption restrictions. The fair values of common shares are based on quoted prices in active markets, where available, and are classified as Level 1 in the hierarchy. Where quoted prices in active markets are not readily available, fair value is determined based on quoted market prices for similar securities or through valuation techniques, such as multiples of earnings and the discounted cash flow method with forecasted cash flows and discount rate as inputs. Private equities are classified as Level 3 in the hierarchy as their inputs are not observable. Hedge funds are valued using Net Asset Values (NAV). If we can redeem a hedge fund at NAV prior to the next quarter end, the fund is classified as Level 2 in the hierarchy. Otherwise, it is classified as Level 3 in the hierarchy. Derivatives The fair values of exchange-traded derivatives, such as interest rate and equity options and futures, are based on quoted market prices and are classified as Level 1 in the hierarchy. OTC derivatives primarily consist of interest rate and cross currency swaps, interest rate options, foreign exchange forward contracts and options, and commodity options and swaps. The exchange-traded or OTC interest rate, foreign exchange and equity derivatives are included in Interest rate contracts, Foreign exchange contracts and Other contracts, respectively, in the fair value hierarchy table. The fair values of OTC derivatives are determined using valuation models when quoted market prices or third-party consensus pricing information are not available. The valuation models, such as discounted cash flow method or Black-Scholes option model, incorporate observable or unobservable inputs for interest and foreign exchange rates, equity and commodity prices (including indices), credit spreads, corresponding market volatility levels, and other market-based pricing factors. Other adjustments to fair value include bid-offer, CVA, FVA, OIS, parameter and model uncertainties, and unrealized gain or loss at inception of a transaction. A derivative instrument is classified as Level 2 in the hierarchy if observable market inputs are available or the unobservable inputs are not significant to the fair value. Otherwise, it is classified as Level 3 in the hierarchy. Securities borrowed or purchased under resale agreements and securities loaned or sold under repurchase agreements In the fair value hierarchy table, these instruments are included in Assets purchased under reverse repurchase agreements and securities borrowed, and Obligations related to assets sold under repurchase agreements and securities loaned. The fair values of these contracts are determined using valuation techniques such as the discounted cash flow method using interest rate curves as inputs. They are classified as Level 2 instruments in the hierarchy as the inputs are observable. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 141 Note 3 Fair value of financial instruments (continued) Deposits A majority of our deposits are measured at amortized cost but certain deposits are designated as at FVTPL. These FVTPL deposits include deposits taken from clients, the issuance of certificates of deposits and promissory notes, and interest rate and equity linked notes, and are included in Deposits in the fair value hierarchy table. The fair values of these instruments are determined using the discounted cash flow method and derivative option valuation models. The inputs to the valuation models include benchmark yield curves, credit spreads, interest rates, equity and interest rate volatility, dividends and correlation, where applicable. They are classified as Level 2 or 3 instruments in the hierarchy, depending on the significance of the unobservable credit spreads, volatility, dividend and correlation rates. Quantitative information about fair value measurements using significant unobservable inputs (Level 3 Instruments) The following table presents fair values of our significant Level 3 financial instruments, valuation techniques used to determine their fair values, ranges and weighted averages of unobservable inputs. As at October 31, 2016 (Millions of Canadian dollars, except for prices, percentages and ratios) Fair value Range of input values (2), (3) Products Reporting line in the fair value hierarchy table Assets Liabilities Valuation techniques Non-derivative financial instruments Asset-backed securities Asset-backed securities $ 28 $ Price-based Discounted cash flows Auction rate securities Discounted cash flows Corporate debt Government debt and municipal bonds U.S. state, municipal and agencies debt Asset-backed securities Corporate debt and other debt Loans Obligations related to securities sold short Canadian government debt U.S. state, municipal and agencies debt Corporate debt and other debt Private equities, hedge fund investments and related equity derivatives Equities Derivative-related assets Derivative-related liabilities 717 193 98 329 – 31 920 1,132 77 1 168 Significant unobservable inputs (1) Low High Weighted average / Inputs distribution (4) Prices Discount margins Yields Default rates Prepayment rates Loss severity rates Discount margins Default rates Prepayment rates Recovery rates 100.06 n.a. 2.44% n.a. n.a. n.a. 1.57% 3.00% 4.00% 40.00% 100.19 n.a. 2.44% n.a. n.a. n.a. 3.75% 9.30% 10.00% 97.50% Prices Yields Capitalization rates Credit Spread Credit enhancement $ 20.00 5.25% 5.99% 1.51% 12.04% $ 127.54 8.85% 8.35% 12.54% 16.05% Price-based Discounted cash flows Price-based Discounted cash flows Prices Yields $ 60.00 1.48% $ 99.79 20.92% Market comparable Price-based Discounted cash flows EV/EBITDA multiples P/E multiples EV/Rev multiples Liquidity discounts (5) Discount rate Net asset values / prices (6) 6.94X 12.12X 0.30X 15.00% 12.00% n.a. 1.79% 1.49% 19.00% 29.00% 68.00% n.a. 15.50X 23.25X 5.90X 40.00% 17.00% n.a. 2.43% 1.97% 67.00% 56.00% 68.00% n.a. $ $ 100.12 n.a. 2.44% n.a. n.a. n.a. 2.43% 3.02% 4.44% 92.37% 111.93 7.39% 7.17% 7.02% 14.04% 63.30 4.16% 9.65X 14.45X 3.42X 29.21% 16.53% n.a. Even Even Even Even Even n.a. Lower Middle Middle Lower Derivative financial instruments Interest rate derivatives and interest-rate-linked structured notes (7) Equity derivatives and equity- linked structured notes (7) Other (8) Total Derivative-related assets Derivative-related liabilities 566 Discounted cash flows Option pricing model 1,014 Interest rates CPI swap rates IR-IR correlations FX-IR correlations FX-FX correlations IR volatilities Discounted cash flows Dividend yields Option pricing model Equity (EQ)-EQ correlations EQ-FX correlations EQ volatilities 0.04% 13.90% (71.40)% 20.64% 97.40% 32.40% 3.00% 118.00% Derivative-related assets Deposits Derivative-related liabilities Mortgage-backed securities Derivative-related assets Deposits Derivative-related liabilities Other liabilities 217 – 25 425 242 2 56 88 $ 4,333 $ 1,996 142 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements As at October 31, 2015 (Millions of Canadian dollars, except for prices, percentages and ratios) Fair value Range of input values (2), (3) Significant unobservable inputs (1) Low High Weighted average / Inputs distribution (4) Prices Discount margins Yields Default rates Prepayment rates Loss severity rates Discount margins Default rates Prepayment rates Recovery rates Prices Yields Capitalization rates Credit Spread Credit enhancement n.a. 3.43% 1.39% –% –% 20.00% 1.65% 9.00% 4.00% 40.00% n.a. 13.10% 2.78% 5.00% 30.00% 70.00% 4.50% 10.00% 8.00% 97.50% $ 47.61 $ 164.29 $ 2.98% 6.07% n.a. n.a. 8.00% 8.50% n.a. n.a. Products Reporting line in the fair value hierarchy table Assets Liabilities Valuation techniques Non-derivative financial instruments Asset-backed securities Asset-backed securities $ 48 $ Price-based Discounted cash flows Auction rate securities Discounted cash flows Corporate debt Government debt and municipal bonds U.S. state, municipal and agencies debt Asset-backed securities Corporate debt and other debt Loans Obligations related to securities sold short Canadian government debt U.S. state, municipal and agencies debt Corporate debt and other debt Private equities, hedge fund investments and related equity derivatives Equities Derivative-related assets Derivative-related liabilities 699 177 198 472 5 114 1,750 1,110 3 – 218 Price-based Discounted cash flows Price-based Discounted cash flows Prices Yields $ 64.98 $ 126.22 $ 0.27% 31.37% Market comparable Price-based Discounted cash flows EV/EBITDA multiples P/E multiples EV/Rev multiples Liquidity discounts (5) Discount rate Net asset values / prices (6) 4.67X 9.40X 0.28X 15.00% 12.00% n.a. 2.25% 1.67% 19.00% 29.00% 68.00% 0.11% 15.50X 22.40X 5.90X 40.00% 17.00% n.a. 2.27% 1.90% 67.00% 56.00% 68.00% 6.11% Derivative-related assets Derivative-related liabilities 428 Discounted cash flows Option pricing model 822 Interest rates CPI swap rates IR-IR correlations FX-IR correlations FX-FX correlations IR volatilities Discounted cash flows Dividend yields Option pricing model Equity (EQ)-EQ correlations EQ-FX correlations EQ volatilities 0.01% 13.90% (69.10)% 29.09% 96.90% 29.20% 1.70% 190.00% Derivative-related assets Deposits Derivative-related liabilities Mortgage-backed securities Derivative-related assets Deposits Derivative-related liabilities Other liabilities 559 15 153 389 569 8 283 47 $ 5,731 $ 2,336 Derivative financial instruments Interest rate derivatives and interest-rate-linked structured notes (7) Equity derivatives and equity- linked structured notes (7) Other (8) n.a. 8.27% 1.79% 2.50% 15.00% 45.00% 2.78% 9.96% 4.35% 91.66% 96.57 3.89% 7.28% n.a. n.a. 84.50 3.89% 7.38X 12.14X 2.64X 27.34% 16.46% n.a. Even Even Even Even Even Middle Lower Middle Middle Lower Total (1) (2) (3) (4) (5) (6) (7) (8) n.a. The acronyms stand for the following: (i) Enterprise Value (EV); (ii) Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA); (iii) Price / Earnings (P/E); (iv) Revenue (Rev); and (v) Consumer Price Index (CPI). The low and high input values represent the actual highest and lowest level inputs used to value a group of financial instruments in a particular product category. These input ranges do not reflect the level of input uncertainty, but are affected by the different underlying instruments within the product category. The input ranges will therefore vary from period to period based on the characteristics of the underlying instruments held at each balance sheet date. Where provided, the weighted average of the input values is calculated based on the relative fair values of the instruments within the product category. The weighted averages for derivatives are not presented in the table as they would not provide a comparable metric; instead, distribution of significant unobservable inputs within the range for each product category is indicated in the table. Price-based inputs are significant for certain debt securities and are based on external benchmarks, comparable proxy instruments or pre-quarter-end trade data. For these instruments, the price input is expressed in dollars for each $100 par value. For example, with an input price of $105, an instrument is valued at a premium over its par value. The level of aggregation and diversity within each derivative instrument category may result in certain ranges of inputs being wide and inputs being unevenly distributed across the range. In the table, we indicated whether the majority of the inputs are concentrated toward the upper, middle, or lower end of the range, or evenly distributed throughout the range. Fair value of securities with liquidity discount inputs totalled $127 million (October 31, 2015 – $131 million). NAV of a hedge fund is total fair value of assets less liabilities divided by the number of fund units. The NAV of the funds and the corresponding equity derivatives referenced to NAV are not considered observable as we cannot redeem certain of these hedge funds at NAV prior to the next quarter end. Private equities are valued based on NAV or valuation techniques. The range for NAV per unit or price per share has not been disclosed for the hedge funds or private equities due to the dispersion of prices given the diverse nature of the investments. The structured notes contain embedded equity or interest rate derivatives with unobservable inputs that are similar to those of the equity or interest rate derivatives. Other primarily includes certain insignificant instruments such as commodity derivatives, foreign exchange derivatives, credit derivatives, bank-owned life insurance and Bank funding and deposits. not applicable Sensitivity to unobservable inputs and interrelationships between unobservable inputs Yield, credit spreads/discount margins A financial instrument’s yield is the interest rate used to discount future cash flows in a valuation model. An increase in the yield, in isolation, would result in a decrease in a fair value measurement and vice versa. A credit spread/discount margin is the difference between a debt instrument’s yield and a benchmark instrument’s yield. Benchmark instruments have high credit quality ratings, similar maturities and are often government bonds. The credit spread/discount margin therefore represents the discount rate used to determine the present value of future cash flows of an asset to reflect the market return required for uncertainty in the estimated cash flows. The credit spread/discount margin for an instrument forms part of the yield used in a discounted cash flow method. Generally, an increase in the credit spread or discount margin will result in a decrease in fair value, and vice versa. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 143 Note 3 Fair value of financial instruments (continued) Funding spread Funding spreads are credit spreads specific to our funding or deposit rates. A decrease in funding spreads, on its own, will increase fair value of our liabilities, and vice versa. Default rates A default rate is the rate at which borrowers fail to make scheduled loan payments. A decrease in the default rate will typically increase the fair value of the loan, and vice versa. This effect will be significantly more pronounced for a non-government guaranteed loan than a government guaranteed loan. Prepayment rates A prepayment rate is the rate at which a loan will be repaid in advance of its expected amortization schedule. Prepayments change the future cash flows of a loan. An increase in the prepayment rate in isolation will result in an increase in fair value when the loan interest rate is lower than the then current reinvestment rate, and a decrease in the prepayment rate in isolation will result in a decrease in fair value when the loan interest rate is lower than the then current reinvestment rate. Prepayment rates are generally negatively correlated with interest rates. Recovery and loss severity rates A recovery rate is an estimation of the amount that can be collected in a loan default scenario. The recovery rate is the recovered amount divided by the loan balance due, expressed as a percentage. The inverse concept of recovery is loss severity. Loss severity rate is an estimation of the loan amount not collected when a loan defaults. The loss severity rate is the loss amount divided by the loan balance due, expressed as a percentage. Generally, an increase in the recovery rate or a decrease in the loss severity rate will increase the loan fair value, and vice versa. Capitalization rates A capitalization rate is a rate of return on a real estate property investment calculated by dividing a property’s income by the property’s value. A lower capitalization rate increases the property value, and vice versa. Volatility rates Volatility measures the potential variability of future prices and is often measured as the standard deviation of price movements. Volatility is an input to option pricing models used to value derivatives and issued structured notes. Volatility is used in valuing equity, interest rate, commodity and foreign exchange options. A higher volatility rate means that the underlying price or rate movements are more likely to occur. Higher volatility rates may increase or decrease an option’s fair value depending on the option’s terms. The determination of volatility rates is dependent on various factors, including but not limited to, the underlying’s market price, the strike price and maturity. Dividend yields A dividend yield is the underlying equity’s expected dividends expressed as an annual percentage of its price. Dividend yield is used as an input for forward equity price and option models. Higher dividend yields will decrease the forward price, and vice versa. A higher dividend yield will increase or decrease an option’s value, depending on the option’s terms. Correlation rates Correlation is the linear relationship between the movements in two different variables. Correlation is an input to the valuation of derivative contracts and issued structured notes when an instrument’s payout is determined by correlated variables. When variables are positively correlated, an increase in one variable will result in an increase in the other variable. When variables are negatively correlated, an increase in one variable will result in a decrease in the other variable. The referenced variables can be within a single asset class or market (equity, interest rate, commodities, credit and foreign exchange) or between variables in different asset classes (equity to foreign exchange, or interest rate to foreign exchange). Changes in correlation will either increase or decrease a financial instrument’s fair value depending on the terms of its contractual payout. Interest rates An interest rate is the percentage amount charged on a principal or notional amount. Increasing interest rates will decrease the discounted cash flow value of a financial instrument, and vice versa. Consumer Price Index swap rates A CPI swap rate is expressed as a percentage of an increase in the average price of a basket of consumer goods and services, such as transportation, food and medical care. An increase in the CPI swap rate will cause inflation swap payments to be larger, and vice versa. EV/EBITDA multiples, P/E multiples, EV/Rev multiples, and liquidity discounts Private equity valuation inputs include EV/EBITDA multiples, P/E multiples and EV/Rev multiples. These are used to calculate either enterprise value or share value of a company based on a multiple of earnings or revenue estimates. Higher multiples equate to higher fair values for all multiple types, and vice versa. A liquidity discount may be applied when few or no transactions exist to support the valuations. Credit Enhancement Credit enhancement is an input to the valuation of securitized transaction and is the amount of loan loss protection for a senior tranche. Credit enhancement is expressed as a percentage of the transaction size. An increase in credit enhancement will cause the credit spread to decrease and the tranche fair value to increase, and vice versa. Interrelationships between unobservable inputs Unobservable inputs of ARS, including the above discount margin, default rate, prepayment rate, and recovery and loss severity rates, may not be independent of each other. The discount margin of ARS can be affected by a change in default rate, prepayment rate, or recovery and loss severity rates. Discount margins will generally decrease when default rates decline or when recovery rates increase. Prepayments may cause fair value to either increase or decrease. 144 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Changes in fair value measurement for instruments measured on a recurring basis and categorized in Level 3 The following tables present the changes in fair value measurements on a recurring basis for instruments included in Level 3 of the fair value hierarchy. (Millions of Canadian dollars) Assets Securities Trading Canadian government debt Provincial and municipal U.S. state, municipal and agencies debt Other OECD government debt Mortgage-backed securities Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Available-for-sale U.S. state, municipal and agencies debt Other OECD government debt Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Loans Other Net derivative balances (3) Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Other assets Liabilities Deposits Personal Business and government Other For the year ended October 31, 2016 Total realized/ unrealized gains (losses) included in earnings Total unrealized gains (losses) included in OCI (1) Fair value November 1, 2015 Purchases of assets/ issuances of liabilities Sales of assets/ settlements of liabilities and other (2) Transfers into Level 3 Transfers out of Level 3 Fair value October 31, 2016 Changes in unrealized gains (losses) included in earnings for assets and liabilities for positions still held – $ – $ – $ – – – (5) $ – – – – $ 1 – – $ 5 $ 16 – 15 5 23 191 123 378 797 – – 197 1,757 987 3,738 472 (446) 58 (1) (313) (47) – – $ (2) – (1) – $ – – – – (4) – (160) (167) (12) – – (1) (5) 50 32 17 (18) (66) – (121) – (2) – – 5 7 12 26 – – 18 17 (49) 12 (13) 1 (6) – (1) – – 21 – 8 – 23 144 492 688 93 – – 26 2,437 76 2,632 102 30 (19) – (39) – 2 (34) – (22) (5) (39) (294) (89) (483) (157) – – (23) (2,825) (308) (3,313) 1 1 159 10 171 – – – – 21 – 21 (641) 396 (18) (2) 1 213 23 – 29 23 – 51 – – (1) – (143) (7) (156) – – – – (446) – (446) (4) (26) (3) – 88 14 – – 4 62 376 443 747 – – 217 956 756 2,676 329 (448) (15) – (122) (10) – $ 3,839 $ (325) $ 5 $ 3,396 $ (4,220) $ 691 $ (533) $ 2,853 $ (191) – – – – – – – (163) (163) n.a. n.a. n.a. n.a. n.a. n.a. n.a. – (17) (64) (2) 55 – – (16) (1) – (11) (28) Obligations related to securities sold short Other liabilities – (47) – (22) – (3) (1) (93) $ (389) $ (8) (24) $ (1) 2 $ – (207) $ – 82 $ (562) $ 9 – 23 (2) – – 673 $ – (425) $ (2) – 54 (1) (88) $ (444) $ (47) $ (1) $ (301) $ 114 $ (564) $ 727 $ (516) $ Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 145 Note 3 Fair value of financial instruments (continued) For the year ended October 31, 2015 Total realized/ unrealized gains (losses) included in earnings Total unrealized gains (losses) included in OCI (1) Fair value November 1, 2014 Purchases of assets/ issuances of liabilities Sales of assets/ settlements of liabilities and other (2) Transfers into Level 3 Transfers out of Level 3 Fair value October 31, 2015 Changes in unrealized gains (losses) included in earnings for assets and liabilities for positions still held (Millions of Canadian dollars) Assets Securities Trading – $ 6 – 4 – $ (1) – (4) – $ 1 – – Canadian government debt Provincial and municipal U.S. state, municipal and agencies debt Other OECD government debt Mortgage-backed securities Asset-backed securities $ CDO Non-CDO securities Corporate debt and other debt Equities Available-for-sale U.S. state, municipal and agencies debt Other OECD government debt Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Loans Other Net derivative balances (3) Interest rate contracts Foreign exchange contracts Credit derivatives Other contracts Valuation adjustments Other assets Liabilities Deposits Personal Business and government Other Obligations related to securities sold short Other liabilities 74 364 149 166 763 1,389 11 24 182 1,573 1,028 4,207 461 24 (7) (1) (29) (18) 7 – – (1) – 105 111 (8) (370) 9 (5) (502) (85) – 4,478 $ (497) $ (70) (4) (20) (591) $ (89) 46 (15) (113) (3) – (89) $ 73 $ (5) – (28) 40 $ $ $ $ – $ – $ 40 – 25 102 137 93 16 413 136 4 30 – 2,524 52 2,746 605 (30) – (27) (146) (345) (143) (75) (766) (846) (2) – (24) (2,586) (225) (3,683) (547) 37 34 – 28 1 – 3,864 $ (7) (7) 19 216 45 – (4,730) $ 5 $ – 20 30 – $ – (20) (13) 13 24 211 45 348 – – – – 37 17 54 1 (11) 7 (1) (98) (3) – (44) (197) (123) (24) (421) (46) (13) (57) – (37) (55) (208) (87) (4) (37) 2 233 – – 297 $ (522) $ 5 $ 16 – 15 5 23 191 123 378 797 – – 197 1,757 987 3,738 472 (446) 58 (1) (313) (47) – 3,839 $ (545) $ (78) (11) – (634) $ 88 $ (376) $ 51 – 909 $ 93 (389) $ (8) 15 6 (1) – 160 $ (377) $ 1,003 $ 1 – – (47) (444) $ – – – – – (2) – (28) (30) n.a. n.a. n.a. n.a. n.a. n.a. n.a. – (15) 36 (3) 124 – – 112 45 – – (22) 23 (18) 47 5 24 59 157 – 3 40 246 65 511 47 (2) 6 (1) (77) (2) – 541 $ (41) $ 1 – (5) (45) $ (1) (2) (3) n.a. These amounts include the foreign currency translation gains or losses arising on consolidation of foreign subsidiaries relating to the Level 3 instruments, where applicable. The unrealized losses on AFS securities recognized in OCI were $27 million for the year ended October 31, 2016 (October 31, 2015 – losses of $5 million), excluding the translation gains or losses arising on consolidation. Other includes amortization of premiums or discounts recognized in net income. Net derivatives as at October 31, 2016 included derivative assets of $885 million (October 31, 2015 – $1,143 million) and derivative liabilities of $1,480 million (October 31, 2015 – $1,892 million). not applicable Transfers between fair value hierarchy levels for instruments carried at fair value on a recurring basis Transfers between Level 1 and Level 2, and transfers into and out of Level 3 are assumed to occur at the end of the period. For an asset or a liability that transfers into Level 3 during the period, the entire change in fair value for the period is excluded from the Total realized/unrealized gains (losses) included in earnings column of the above reconciliation, whereas for transfers out of Level 3 during the period, the entire change in fair value for the period is included in the same column of the above reconciliation. Transfers between Level 1 and Level 2 are dependent on whether fair value is obtained on the basis of quoted market prices in active markets (Level 1). During the year ended October 31, 2016, transfers out of Level 1 to Level 2 included $266 million of Trading U.S. state, municipal and agencies debt and $490 million of Obligations related to securities sold short. During the year ended October 31, 2015, transfers out of Level 1 to Level 2 included $284 million of Trading Canadian government debt, $1,988 million of Trading and AFS U.S. state, municipal and agencies debt and $641 million of Obligations related to securities sold short. During the year ended October 31, 2016, transfers out of Level 2 to Level 1 included $424 million of Trading U.S. state, municipal and agencies debt, $65 million of AFS U.S. state, municipal and agencies debt and $11 million of Obligations related to securities sold short. During the year ended October 31, 2015, transfers out of Level 2 to Level 1 included $128 million of Trading Canadian government debt, $331 million of Trading U.S. state, municipal and agencies debt, $840 million of Trading and AFS Equities, $412 million of AFS Other OECD government debt and $61 million of Obligations related to securities sold short. Transfers between Level 2 and Level 3 are primarily due to either a change in the market observability for an input, or a change in an unobservable input’s significance to a financial instrument’s fair value. For the year ended October 31, 2016, transfers of Trading and AFS Corporate debt and other debt, Other contracts, Trading Non-CDO securities and Loans were due to changes in the market observability of inputs, and transfers relating to Personal deposits were due to changes in the significance of unobservable inputs to their fair value. 146 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements During the year ended October 31, 2016, significant transfers out of Level 3 to Level 2 included $143 million of Trading Corporate debt and other debt, $446 million of AFS Corporate debt and other debt and $673 million of Personal deposits. In addition, during the year ended October 31, 2016, significant transfers out of Level 3 to Level 2 included $28 million (net assets) of OTC equity options in Other contracts comprised of $682 million of derivative-related assets and $654 million of derivative related liabilities and $24 million (net assets) of commodity swaps in Other contracts comprised of $126 million of derivative-related assets and $102 million of derivative related liabilities. During the year ended October 31, 2015, significant transfers out of Level 3 to Level 2 included $201 million of net OTC equity options in Other contracts, $197 million of Trading Non-CDO securities, $123 million of Trading Corporate debt and other debt and $909 million of Personal deposits. During the year ended October 31, 2016, significant transfers out of Level 2 to Level 3 included $159 million of Trading Corporate debt and other debt, $396 million of Loans and $562 million of Personal deposits. In addition, during the year ended October 31, 2016, significant transfers out of Level 2 to Level 3 included $58 million (net assets) of OTC equity options in Other contracts comprised of $407 million of derivative-related assets and $349 million of derivative-related liabilities. During the year ended October 31, 2015, significant transfers out of Level 2 to Level 3 included $211 million of Trading Corporate debt and other debt and $314 million of Personal deposits. Positive and negative fair value movement of Level 3 financial instruments from using reasonably possible alternative assumptions A financial instrument is classified as Level 3 in the fair value hierarchy if one or more of its unobservable inputs may significantly affect the measurement of its fair value. In preparing the financial statements, appropriate levels for these unobservable input parameters are chosen so that they are consistent with prevailing market evidence or management judgment. Due to the unobservable nature of the prices or rates, there may be uncertainty about the valuation of these Level 3 financial instruments. The following table summarizes the impacts to fair values of Level 3 financial instruments using reasonably possible alternative assumptions. This sensitivity disclosure is intended to illustrate the potential impact of the relative uncertainty in the fair value of Level 3 financial instruments. In reporting the sensitivities below, we offset balances in instances where: (i) the move in valuation factor caused an offsetting positive and negative fair value movement, (ii) both offsetting instruments are in Level 3, and (iii) exposures are managed and reported on a net basis. With respect to overall sensitivity, it is unlikely in practice that all reasonably possible alternative assumptions would simultaneously be realized. (Millions of Canadian dollars) Securities Trading Canadian government debt Provincial and municipal U.S. state, municipal and agencies debt Mortgage-backed securities Asset-backed securities Corporate debt and other debt Equities Available-for-sale U.S. state, municipal and agencies debt Asset-backed securities Corporate debt and other debt Equities Loans Derivatives Deposits Derivatives Other Securities sold short, other liabilities October 31, 2016 October 31, 2015 Positive fair value movement from using reasonably possible alternatives Negative fair value movement from using reasonably possible alternatives Level 3 fair value Positive fair value movement from using reasonably possible alternatives Negative fair value movement from using reasonably possible alternatives Level 3 fair value $ – $ 1 – 4 62 376 747 217 956 756 329 885 $ 4,333 $ $ (427) $ (1,480) (89) $ (1,996) $ – $ – – – 1 – 14 13 8 74 9 17 136 $ 13 $ 33 – 46 $ – – – – (1) – (31) (19) (8) (13) (10) (16) (98) (13) (53) – (66) $ 5 $ 16 15 28 191 123 797 197 1,757 987 472 1,143 $ 5,731 $ $ (397) $ (1,892) (47) $ (2,336) $ – $ 1 1 2 2 – 12 11 11 76 8 16 140 $ 13 $ 33 – 46 $ – (1) (1) (3) (2) – (36) (16) (11) (33) (23) (10) (136) (13) (43) – (56) Sensitivity results As at October 31, 2016, the effects of applying other reasonably possible alternative assumptions to the Level 3 asset positions would be an increase of $136 million and a reduction of $98 million in fair value, of which $109 million and $67 million would be recorded in Other components of equity, respectively. The effects of applying these assumptions to the Level 3 liability positions would result in a decrease of $46 million and an increase of $66 million in fair value. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 147 Note 3 Fair value of financial instruments (continued) Level 3 valuation inputs and approaches to developing reasonably possible alternative assumptions The following is a summary of the unobservable inputs used in the valuation of the Level 3 instruments and our approaches to developing reasonably possible alternative assumptions used to determine sensitivity. Financial assets or liabilities Asset-backed securities, corporate debt, government debt and municipal bonds Sensitivity methodology Sensitivities are determined based on adjusting, plus or minus one standard deviation, the bid-offer spreads or input prices if a sufficient number of prices is received, or using high and low vendor prices as reasonably possible alternative assumptions. Auction rate securities Private equities, hedge fund investments and related equity derivatives Interest rate derivatives Equity derivatives Sensitivity of ARS is determined by decreasing the discount margin between 11% and 16% and increasing the discount margin between 22% and 32%, depending on the specific reasonable range of fair value uncertainty for each particular financial instrument’s market. Changes to the discount margin reflect historical monthly movements in the student loan asset-backed securities market. Sensitivity of direct private equity investments is determined by (i) adjusting the discount rate by 2% when the discounted cash flow method is used to determine fair value, (ii) adjusting the price multiples based on the range of multiples of comparable companies when price-based models are used, or (iii) using an alternative valuation approach. Net asset values of the private equity funds, hedge funds and related equity derivatives are provided by the fund managers, and as a result, there are no other reasonably possible alternative assumptions for these investments. Sensitivities of interest rate and cross currency swaps are derived using plus or minus one standard deviation of the inputs, and an amount based on model and parameter uncertainty, where applicable. Sensitivity of the Level 3 position is determined by shifting the unobservable model inputs by plus or minus one standard deviation of the pricing service market data including volatility, dividends or correlations, as applicable. Bank funding and deposits Sensitivities of deposits are calculated by shifting the funding curve by plus or minus certain basis points. Structured notes Sensitivities for interest-rate-linked and equity-linked structured notes are derived by adjusting inputs by plus or minus one standard deviation, and for other deposits, by estimating a reasonable move in the funding curve by plus or minus certain basis points. 148 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Fair value for selected financial instruments that are carried at amortized cost and classified using the fair value hierarchy (Millions of Canadian dollars) Held-to-maturity securities (2) Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Other assets Deposits Personal Business and government Bank Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures (Millions of Canadian dollars) Held-to-maturity securities (2) Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Other assets Deposits Personal Business and government Bank Obligations related to assets sold under repurchase agreements and securities loaned Other liabilities Subordinated debentures As at October 31, 2016 Fair value always approximates carrying value (1) Fair value may not approximate carrying value Fair value measurements using Level 1 Level 2 Level 3 Total Total fair value $ – $ 41,686 66,404 6,155 72,559 43,229 157,474 175,114 241,950 12,387 429,451 13,032 38,467 – $ 480,950 $ 2 – – – – – 2 – – – – – – – – $ 15,194 $ 11 $ 15,207 $ 15,207 22,812 – 22,812 64,498 297,602 137,216 434,818 457 5,006 7,349 12,355 293 302,608 144,565 447,173 750 473,281 12,659 485,942 59,475 163,782 5,883 229,140 1,551 265 9,643 901 1,149 42 2,092 – 5,106 57 60,376 164,931 5,925 231,232 1,551 5,371 9,700 369,012 150,720 519,732 43,979 643,416 235,490 406,881 18,312 660,683 14,583 43,838 9,700 $ 240,599 $ 7,255 $ 247,854 $ 728,804 As at October 31, 2015 Fair value always approximates carrying value (1) Fair value may not approximate carrying value Fair value measurements using Level 1 Level 2 Level 3 Total Total fair value $ – $ 39,587 67,330 5,525 72,855 43,889 156,331 148,570 197,435 10,538 356,543 9,095 38,344 – $ 403,982 $ 2 – – – – – 2 – – – – – – – – $ 8,750 $ 20,484 276,661 110,816 387,477 583 417,294 54,400 164,415 5,107 223,922 833 381 7,022 7 – 4,522 4,975 9,497 380 9,884 1,049 1,455 68 2,572 – 4,471 56 $ 8,759 $ 8,759 20,484 60,071 281,183 115,791 396,974 963 427,180 55,449 165,870 5,175 226,494 833 4,852 7,078 348,513 121,316 469,829 44,852 583,511 204,019 363,305 15,713 583,037 9,928 43,196 7,078 $ 232,158 $ 7,099 $ 239,257 $ 643,239 (1) (2) Certain financial instruments have not been assigned to a level as the carrying amount always approximates their fair values due to the short-term nature (instruments that are receivable or payable on demand, or with original maturity of three months or less) and insignificant credit risk. Included in Securities – Available-for-sale on the Consolidated Balance Sheets. Fair values of financial assets and liabilities carried at amortized cost and disclosed in the table above are determined using the following valuation techniques and inputs. Held-to-maturity securities Fair values of Canadian Federal and OECD government bonds, and corporate bonds are based on quoted prices. Fair values of certain Non-OECD government bonds are based on vendor prices or the discounted cash flow method with yield curves of other countries’ government bonds as inputs. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 149 Note 3 Fair value of financial instruments (continued) Assets purchased under reverse repurchase agreements and securities borrowed, and Obligations related to assets sold under repurchase agreements and securities loaned Valuation methods used for the long-term instruments are described in the Fair value of assets and liabilities measured on a recurring basis and classified using the fair value hierarchy section of this note. The carrying values of short-term instruments generally approximate their fair values. Loans – Retail Retail loans include residential mortgages, personal and small business loans and credit cards. For residential mortgages, and personal and small business loans, we segregate the portfolio based on certain attributes such as product type, contractual interest rate, term to maturity and credit scores, if applicable. Fair values of these loans are determined by the discounted cash flow method using applicable inputs such as prevailing interest rates, contractual and posted client rates, client discounts, credit spreads, prepayment rates and loan-to-value ratios. Fair values of credit card receivables are also calculated based on a discounted cash flow method with portfolio yields, charge offs and monthly payment rates as inputs. The carrying values of short-term and variable rate loans generally approximate their fair values. Loans – Wholesale Wholesale loans include Business, Bank and Sovereign loans. Where market prices are available, loans are valued based on market prices. Otherwise, fair value is determined by the discounted cash flow method using the following inputs: market interest rates and market based spreads of assets with similar credit ratings and terms to maturity, loss given default, expected default frequency implied from credit default swap prices, if available, and relevant pricing information such as contractual rate, origination and maturity dates, redemption price, coupon payment frequency and date convention. Deposits Deposits are comprised of demand, notice, and term deposits which include senior deposit notes we have issued to provide us with long-term funding. Fair values of term deposits are determined by one of several valuation techniques: (i) for term deposits and similar instruments, we segregate the portfolio based on term to maturity. Fair values of these instruments are determined by the discounted cash flow method using inputs such as client rates for new sales of the corresponding terms; and (ii) for senior deposit notes, we use actual traded prices, vendor prices or the discounted cash flow method using a market interest rate curve and our funding spreads as inputs. The carrying values of short-term term deposits, and demand and notice deposits generally approximate their fair values. Other assets and Other liabilities Other assets and Other liabilities include receivables and payables relating to certain commodities. Fair values of the commodity receivables and payables are calculated by the discounted cash flow method using applicable inputs such as market interest rates, counterparties’ credit spreads, our funding spreads, commodity forward prices and spot prices. Subordinated debentures Fair values of Subordinated debentures are based on recent transaction prices. 150 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 4 Securities Carrying value of securities The following table presents the contractual maturities of the carrying values of financial instruments held at the end of the period: (Millions of Canadian dollars) Trading (2) Canadian government debt U.S. state, municipal and agencies debt Other OECD government debt Mortgage-backed securities Asset-backed securities (3) Corporate debt and other debt Bankers’ acceptances Certificates of deposit Other (4) Equities Available-for-sale (2) Canadian government debt Federal Amortized cost Fair value Yield (5) Provincial and municipal Amortized cost Fair value Yield (5) U.S. state, municipal and agencies debt Amortized cost Fair value Yield (5) Other OECD government debt Amortized cost Fair value Yield (5) Mortgage-backed securities Amortized cost Fair value Yield (5) Asset-backed securities Amortized cost Fair value Yield (5) Corporate debt and other debt Amortized cost Fair value Yield (5) Equities Cost Fair value Loan substitute securities Cost Fair value Yield (5) Amortized cost Fair value Held-to-maturity (2) Amortized cost Fair value As at October 31, 2016 Term to maturity (1) Within 3 months 3 months to 1 year 1 year to 5 years 5 years to 10 years Over 10 years With no specific maturity Total $ 6,761 6,582 1,639 – 42 $ 10,350 6,150 1,646 34 80 $ 9,208 5,912 2,808 3 219 $ 2,742 5,988 389 1 139 $ 6,153 15,729 438 1,419 81 $ – – – – – $ 35,214 40,361 6,920 1,457 561 361 155 1,748 – – 132 4,450 – – 14 7,473 – – 2 2,472 – – 19 3,891 – 17,288 22,842 25,637 11,733 27,730 – – – 46,062 46,062 361 322 20,034 46,062 151,292 43 43 0.5% – – – 1,030 1,029 2.7% 3,109 3,108 (0.1%) – – – 671 671 – 1,520 1,521 1.7% – – – – – 6,373 6,372 130 130 1 1 0.3% 139 139 1.3% 895 896 0.9% 1,396 1,398 1.1% 16 16 2.2% 9 8 1.1% 2,933 2,934 1.8% – – – – – 291 293 1.5% 1,863 1,873 1.9% 1,735 1,734 1.9% 9,070 9,095 1.1% 27 27 2.2% 539 540 1.1% 16,457 16,495 1.6% – – – – – 27 27 1.8% 90 92 4.1% 1,161 1,159 2.7% 293 292 1.0% 19 20 2.8% 834 835 2.2% 553 558 2.8% – – – – – 56 58 4.2% 252 260 3.8% 20,668 20,598 2.4% 7 7 3.9% 330 332 2.3% 1,733 1,679 2.2% 552 558 4.7% – – – – – 5,389 5,392 29,982 30,057 116 116 4,521 4,583 2,977 2,983 5,718 5,953 23,598 23,492 4,394 4,425 – – – – – – – – – – – – – – – – – – – – – 1,291 1,552 70 74 4.5% 1,361 1,626 – – 418 422 1.7% 2,344 2,364 2.2% 25,489 25,416 2.4% 13,875 13,900 0.8% 392 395 2.3% 3,786 3,733 1.6% 22,015 22,066 1.8% 1,291 1,552 70 74 4.5% 69,680 69,922 14,879 15,207 Total carrying value of securities (2) $23,790 $ 28,350 $60,215 $ 20,434 $55,616 $47,688 $236,093 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 151 Note 4 Securities (continued) (Millions of Canadian dollars) Trading (2) Canadian government debt U.S. state, municipal and agencies debt Other OECD government debt Mortgage-backed securities Asset-backed securities (3) Corporate debt and other debt Bankers’ acceptances Certificates of deposit Other (4) Equities Available-for-sale (2) Canadian government debt Federal Amortized cost Fair value Yield (5) Provincial and municipal Amortized cost Fair value Yield (5) U.S. state, municipal and agencies debt Amortized cost Fair value Yield (5) Other OECD government debt Amortized cost Fair value Yield (5) Mortgage-backed securities Amortized cost Fair value Yield (5) Asset-backed securities Amortized cost Fair value Yield (5) Corporate debt and other debt Amortized cost Fair value Yield (5) Equities Cost Fair value Loan substitute securities Cost Fair value Yield (5) Amortized cost Fair value Held-to-maturity (2) Amortized cost Fair value As at October 31, 2015 Term to maturity (1) Within 3 months 3 months to 1 year 1 year to 5 years 5 years to 10 years Over 10 years With no specific maturity Total $ 2,310 1,450 2,237 – 90 $ 9,737 12,867 4,373 20 64 $ 9,755 7,906 4,402 42 263 – 38 14,318 – 36,724 $ $ 3,618 3,056 941 33 846 $ 8,630 9,176 393 2,827 468 – $ 34,050 34,455 – 12,346 – 2,922 – 1,731 – – 12 1,836 – – 18 3,714 – – – – 48,490 105 456 24,148 48,490 10,342 25,226 48,490 158,703 1 329 2,866 – 30,257 572 574 0.9% 11 11 3.3% 2,563 2,563 0.6% 503 503 1.2% – – – 6 6 2.2% 1,603 1,601 1.9% – – – – – 104 59 1,414 – 7,664 251 251 0.4% – – – 379 379 0.2% 3,946 3,947 – – – – – – – 1,164 1,163 1.2% – – – – – 5,740 5,740 889 889 1,603 1,605 1.3% 1,271 1,274 1.8% 161 154 5.7% 7,491 7,501 1.0% 57 57 1.8% 644 650 0.6% 10,545 10,516 1.7% – – – – – 68 68 2.9% 64 64 3.1% 304 302 1.6% 338 336 2.2% – – – 702 710 0.9% 369 369 3.9% – – – – – 47 46 4.3% 253 251 4.2% 9,533 9,450 2.3% – – – 258 261 1.9% 1,291 1,222 1.7% 490 480 4.4% – – – – – 5,258 5,258 21,772 21,757 334 334 3,175 3,189 1,845 1,849 4,133 4,239 11,872 11,710 110 108 – – – – – – – – – – – – – – – – – – – – – 1,457 1,756 95 94 5.1% 1,552 1,850 2,541 2,544 1.2% 1,599 1,600 2.2% 12,940 12,848 1.9% 12,278 12,287 0.7% 315 318 1.9% 2,643 2,588 1.2% 14,171 14,129 1.8% 1,457 1,756 95 94 5.1% 48,039 48,164 – – 8,641 8,759 Total carrying value of securities (2) $14,293 $ 35,849 $61,656 $ 16,324 $37,046 $50,340 $215,508 (1) (2) (3) (4) (5) Actual maturities may differ from contractual maturities shown above since borrowers may have the right to extend or prepay obligations with or without penalties. Trading securities and AFS securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost. Includes CDO which are presented as Asset-backed securities – CDO in the table entitled Fair value of assets and liabilities measured on a recurring basis and classified using the fair value hierarchy in Note 3. Primarily composed of corporate debt, supra-national debt, and commercial paper. The weighted average yield is derived using the contractual interest rate and the carrying value at the end of the year for the respective securities. 152 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Unrealized gains and losses on available-for-sale securities (1), (2) (Millions of Canadian dollars) Canadian government debt Federal Provincial and municipal U.S. state, municipal and agencies debt (3) Other OECD government debt Mortgage-backed securities Asset-backed securities CDO Non-CDO securities Corporate debt and other debt Equities Loan substitute securities October 31, 2016 October 31, 2015 As at Cost/ Amortized cost Gross unrealized gains Gross unrealized losses Cost/ Amortized cost Gross unrealized gains Gross unrealized losses Fair value Fair value $ 418 $ 4 $ 2,344 25,489 13,875 392 1,628 2,158 22,015 1,291 70 22 57 35 5 2 5 89 273 4 – $ (2) (130) (10) (2) 422 2,364 25,416 13,900 395 $ 2,541 $ 1,599 12,940 12,278 315 7 $ 8 14 24 4 (4) $ 2,544 1,600 (7) 12,848 (106) 12,287 (15) 318 (1) – (60) (38) (12) – 1,630 2,103 22,066 1,552 74 1,506 1,137 14,171 1,457 95 12 7 39 314 – (8) (66) (81) (15) (1) 1,510 1,078 14,129 1,756 94 $ 69,680 $ 496 $ (254) $ 69,922 $ 48,039 $ 429 $ (304) $ 48,164 (1) (2) (3) Excludes $14,879 million of held-to-maturity securities as at October 31, 2016 (October 31, 2015 – $8,641 million) that are carried at amortized cost. The majority of the MBS are residential. Cost/Amortized cost, gross unrealized gains, gross unrealized losses and fair value related to commercial MBS are $346 million, $1 million, $1 million and $346 million, respectively as at October 31, 2016 (October 31, 2015 – $243 million, $nil, $1 million and $242 million). Includes securities issued by U.S. non-agencies backed by government insured assets, MBS and asset-backed securities issued by U.S. government agencies. AFS securities are assessed for objective evidence of impairment at each reporting date and more frequently when conditions warrant. Depending on the nature of the securities under review, we apply specific methodologies to assess whether the cost/amortized cost of the security would be recovered. As at October 31, 2016, our gross unrealized losses on AFS securities were $254 million (October 31, 2015 – $304 million). We believe that there is no objective evidence of impairment on our AFS securities that are in an unrealized loss position as at October 31, 2016. Net gain and loss on available-for-sale securities (1) (Millions of Canadian dollars) Realized gains Realized losses Impairment losses For the year ended October 31 2016 October 31 2015 October 31 2014 $ $ 179 $ (17) (86) 76 $ 218 $ (20) (53) 145 $ 232 (15) (25) 192 (1) The following related to our insurance operations are excluded from Net gains on AFS securities and included in Insurance premiums, investment and fee income in the Consolidated Statements of Income for the year ended October 31, 2016: Realized gains of $14 million (October 31, 2015 – $22 million; October 31, 2014 – $12 million) and $4 million in impairment losses (October 31, 2015 – $6 million; October 31, 2014 – $nil). There were no realized losses for the year ended October 31, 2016 (October 31, 2015 – $nil; October 31, 2014 – $1 million). During the year ended October 31, 2016, $76 million of net gains were recognized in Non-interest income as compared to $145 million in the prior year. The current year reflects net realized gains of $162 million mainly comprised of distributions from, and gains on sales of certain Equities and U.S. state, municipal and agencies debt. Also included in the net gains are $86 million of impairment losses primarily on certain Equities, U.S. state, municipal and agencies debt, and Loan substitute securities. This compares to net realized gains for the year ended October 31, 2015 of $198 million which was partially offset by $53 million of impairment losses. Held-to-maturity securities Held-to-maturity securities measured at amortized cost are subject to periodic impairment review and are classified as impaired when, in management’s opinion, there is no longer reasonable assurance of the timely collection of the full amount of principal and interest. The impairment review of held-to-maturity securities is primarily based on the impairment model for loans. We believe that there is no objective evidence of impairment on our held-to-maturity securities as at October 31, 2016. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 153 Note 4 Securities (continued) Reclassification of financial instruments During 2016, we reclassified debt securities with carrying amounts of $897 million from AFS to loans and receivables as a result of a change in our intention to hold these securities for the foreseeable future. Upon reclassification, the previous carrying amount of these AFS securities became the new amortized cost under the loans and receivables classification. The net unrealized losses in Other components of equity at the respective reclassification dates will be amortized to Net interest income over the remaining life of the reclassified securities using the effective interest method. This amortization will be offset by the accretion of the fair value discount on these securities. On their respective reclassification dates, the AFS debt securities reclassified to loans and receivables had a weighted average effective interest rate of 1.31%, with aggregate estimated cash flows expected to be recovered on an undiscounted basis of $925 million. As at October 31, 2016, the fair value and carrying value of the securities reclassified to loans and receivables were $781 million and $782 million, respectively. During the year ended October 31, 2016, a nominal amount of unrealized gains was recorded in OCI related to changes in the fair value of these debt securities. A nominal amount of unrealized losses would also have been recognized in OCI for the year ended October 31, 2016 had these debt securities not been reclassified. Interest income of $15 million was recognized in net income for the year ended October 31, 2016. The following table provides information regarding certain securities that we reclassified in prior reporting periods. Financial instruments reclassified in prior periods (Millions of Canadian dollars) Financial assets – FVTPL reclassified to available-for-sale (1) CDO Mortgage-backed securities Financial assets – Available-for-sale reclassified to loans and receivables (2) Canadian government debt – Federal Financial assets – Available-for-sale reclassified to held-to-maturity (3) Canadian government debt – Federal As at October 31, 2016 October 31, 2015 Carrying value Fair value Carrying value Fair value $ $ – – 2,910 3,923 6,833 $ $ – – 2,916 3,970 6,886 $ $ 561 19 4,083 5,231 9,894 $ $ 561 19 4,078 5,231 9,889 (1) (2) (3) On October 1, 2011 and November 1, 2011, we reclassified $1,872 million and $255 million, respectively, of certain CDO and U.S. non-agency MBS from classified as at FVTPL to AFS. On October 1, 2015, we reclassified $4,132 million of certain debt securities from classified as AFS to loans and receivables. On October 1, 2015, we reclassified $5,240 million of certain debt securities from classified as AFS to held-to-maturity. The following table provides the amounts recorded in net income and OCI from the debt securities after the reclassification. (Millions of Canadian dollars) FVTPL reclassified to available-for-sale CDO Mortgage-backed securities Available-for-sale reclassified to loans and receivables (2) Canadian government debt – Federal Available-for-sale reclassified to held-to- maturity (2) Canadian government debt – Federal October 31, 2016 For the year ended October 31, 2015 October 31, 2014 Unrealized gains (losses) during the period (1) Interest income/ gains (losses) recognized in net income during the period Unrealized gains (losses) during the period (1) Interest income/ gains (losses) recognized in net income during the period Unrealized gains (losses) during the period (1) Interest income/ gains (losses) recognized in net income during the period $ $ (4) $ – (7) $ 11 – 76 (38) (49) $ 135 222 $ (17) $ – (8) (9) (34) $ 28 2 7 14 51 $ $ (29) $ (2) n.a. n.a. (31) $ 58 4 n.a. n.a. 62 (1) (2) n.a. This represents the unrealized gains or losses that would have been recognized in profit or loss (for reclassifications from FVTPL) or OCI (for reclassifications from AFS) had the assets not been reclassified. Interest income/gains (losses) recognized in net income during the period includes amortization of net unrealized gains associated with reclassified assets that were included in Other components of equity on the date of reclassification. not applicable 154 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 5 Loans (Millions of Canadian dollars) Canada October 31, 2016 United States Other International As at Total Canada Retail (1) Residential mortgages Personal Credit cards Small business (2) Wholesale (1) Business (3) Bank (4) Sovereign (5) Total loans Allowance for loan losses $ 241,800 82,205 16,601 3,878 $ 10,014 6,853 267 – $ 3,184 $ 254,998 93,466 17,128 3,878 4,408 260 – $ 229,987 84,637 15,516 4,003 $ 344,484 17,134 7,852 369,470 334,143 65,756 1,027 6,625 73,408 417,892 (1,491) 58,010 445 827 59,282 76,416 (262) 20,304 207 1,168 21,679 29,531 (482) 144,070 1,679 8,620 154,369 523,839 (2,235) 60,221 530 6,332 67,083 401,226 (1,416) October 31, 2015 United States Other International Total 772 4,623 89 – 5,484 34,385 115 – 34,500 39,984 (131) $ 3,216 $ 233,975 94,346 15,859 4,003 5,086 254 – 8,556 348,183 21,952 1,155 1,379 24,486 116,558 1,800 7,711 126,069 33,042 (482) 474,252 (2,029) Total loans net of allowance for loan losses $ 416,401 $ 76,154 $ 29,049 $ 521,604 $ 399,810 $ 39,853 $ 32,560 $ 472,223 (1) (2) (3) (4) (5) Geographic information is based on residence of borrower. Includes small business exposure managed on a pooled basis. Includes small business exposure managed on an individual client basis. Bank refers primarily to regulated deposit-taking institutions and securities firms. Sovereign refers to all central governments and agencies, central banks, as well as other qualifying public sector entities and multilateral development banks. Loans maturity and rate sensitivity Maturity term (1) Rate sensitivity As at October 31, 2016 (Millions of Canadian dollars) Retail Wholesale Total loans Allowance for loan losses Total loans net of allowance for loan losses Under 1 year (2) 1 to 5 years Over 5 years Total Floating Fixed Rate Non-rate- sensitive Total $ 190,834 $ 161,953 23,721 121,625 $ 16,683 $ 369,470 154,369 9,023 $ 116,355 $ 247,021 95,133 55,639 $ 6,094 $ 369,470 154,369 3,597 $ 312,459 $ 185,674 $ 25,706 $ 523,839 (2,235) $ 521,604 $ 171,994 $ 342,154 $ 9,691 $ 523,839 (2,235) $ 521,604 Maturity term (1) Rate sensitivity As at October 31, 2015 (Millions of Canadian dollars) Retail Wholesale Total loans Allowance for loan losses Total loans net of allowance for loan losses Under 1 year (2) 1 to 5 years Over 5 years Total Floating Fixed Rate Non-rate- sensitive Total $ 194,596 $ 143,352 19,505 101,922 $ 10,235 $ 348,183 126,069 4,642 $ 126,141 53,799 216,841 70,827 5,201 $ 348,183 126,069 1,443 $ 296,518 $ 162,857 $ 14,877 $ 474,252 (2,029) $ 472,223 $ 179,940 $ 287,668 $ 6,644 $ 474,252 (2,029) $ 472,223 (1) (2) Generally, based on the earlier of contractual repricing or maturity date. Includes variable rate loans that can be repriced at the clients’ discretion without penalty. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 155 Note 5 Loans (continued) Allowance for credit losses (Millions of Canadian dollars) Retail Residential mortgages Personal Credit cards Small business Wholesale Business Bank Acquired credit-impaired loans Total allowance for loan losses Allowance for off-balance sheet and other items (1) Total allowance for credit losses Individually assessed Collectively assessed Total allowance for credit losses (Millions of Canadian dollars) Retail Residential mortgages Personal Credit cards Small business Wholesale Business Bank Total allowance for loan losses Allowance for off-balance sheet and other items (1) Total allowance for credit losses Individually assessed Collectively assessed Total allowance for credit losses (Millions of Canadian dollars) Retail Residential mortgages Personal Credit cards Small business Wholesale Business Bank Total allowance for loan losses Allowance for off-balance sheet and other items (1) Total allowance for credit losses Individually assessed Collectively assessed Total allowance for credit losses For the year ended October 31, 2016 Balance at beginning of period Provision for credit losses Write-offs Recoveries Unwind of discount Exchange rate changes/ other Balance at end of period $ $ $ $ 77 $ (42) $ 5 $ 242 $ 530 386 64 1,222 458 442 34 1,011 (556) (564) (40) (1,202) 805 2 807 – 2,029 91 528 (3) 525 10 1,546 – 2,120 $ 1,546 $ (1,523) $ (321) – (321) – (1,523) – 252 $ 351 $ (224) $ 1,868 2,120 $ 1,546 $ (1,523) $ (1,299) 1,195 111 122 10 248 38 – 38 – 286 – 286 $ 25 $ 261 286 $ (24) $ (14) – (3) (41) (59) – (59) – (100) – (100) $ (50) $ (50) (100) $ 15 $ – – – 15 273 529 386 65 1,253 979 (12) – 1 979 (11) 3 (7) 2,235 (3) – 91 (3) $ 2,326 11 $ (14) 365 1,961 (3) $ 2,326 For the year ended October 31, 2015 Balance at beginning of period Provision for credit losses Write-offs Recoveries Unwind of discount Exchange rate changes/ other Balance at end of period 46 $ (64) $ 7 $ $ 240 $ 535 385 64 1,224 768 2 770 1,994 91 384 378 32 840 258 (1) 257 1,097 – (494) (497) (40) (1,095) (243) – (243) (1,338) – $ 2,085 $ 1,097 $ (1,338) $ $ 214 $ 149 $ 948 $ 2,085 $ 1,097 $ (1,338) $ (132) $ (1,206) 1,871 $ 151 $ 583 385 61 1,180 777 2 779 1,959 91 444 353 44 936 228 – 228 1,164 – (565) (466) (47) (1,108) (221) – (221) (1,329) – $ 2,050 $ 1,164 $ (1,329) $ $ 240 $ 160 $ (188) $ 1,810 1,004 $ 2,050 $ 1,164 $ (1,329) $ (1,141) 105 119 10 241 33 1 34 275 – 275 $ 18 $ 257 275 $ 106 114 9 231 32 – 32 263 – 263 $ 16 $ 247 263 $ (23) $ (16) – (2) (41) (39) – (39) (80) – (80) $ (26) $ (54) (80) $ 36 $ 16 1 – 53 242 530 386 64 1,222 28 – 28 81 – 805 2 807 2,029 91 81 $ 2,120 252 29 $ 52 1,868 81 $ 2,120 (26) $ (23) – (2) (51) (36) – (36) (87) – (87) $ (24) $ (63) (87) $ 48 $ (10) (1) (1) 36 240 535 385 64 1,224 (12) – (12) 24 – 768 2 770 1,994 91 24 $ 2,085 10 $ 214 1,871 14 24 $ 2,085 For the year ended October 31, 2014 Balance at beginning of period Provision for credit losses Write-offs Recoveries Unwind of discount Exchange rate changes/ other Balance at end of period 95 $ (30) $ 2 $ (1) The allowance for off-balance sheet and other items is reported separately in Other liabilities – Provisions. 156 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Net interest income after provision for credit losses (Millions of Canadian dollars) Net interest income Provision for credit losses For the year ended October 31 2016 October 31 2015 October 31 2014 $ 16,531 $ 14,771 $ 14,116 1,164 1,097 1,546 Net interest income after provision for credit losses $ 14,985 $ 13,674 $ 12,952 Loans past due but not impaired October 31, 2016 October 31, 2015 As at (Millions of Canadian dollars) 1 to 29 days 30 to 89 days 90 days and greater Retail Wholesale $ $ 3,450 848 4,298 $ $ 1,296 372 1,668 $ $ 337 – 337 $ $ Total 5,083 1,220 6,303 1 to 29 days 30 to 89 days 90 days and greater $ $ 3,054 417 3,471 $ $ 1,298 184 1,482 $ $ 314 – 314 Total $ 4,666 601 $ 5,267 Gross carrying value of loans individually determined to be impaired (1) (Millions of Canadian dollars) Retail (2) Wholesale (2) Business Bank Acquired credit-impaired loans As at October 31 2016 October 31 2015 $ $ 16 $ 2,130 2 418 2,566 $ – 991 2 – 993 (1) (2) Average balance of gross individually assessed impaired loans for the year ended October 31, 2016 was $2,037 million (October 31, 2015 – $830 million). Excludes ACI loans. Acquired Credit-Impaired Loans ACI loans resulting from the acquisition of City National include Retail, Wholesale and FDIC covered loans with outstanding unpaid principal balances of $27 million, $73 million and $642 million and fair values of $22 million, $62 million and $596 million, respectively, as at November 2, 2015 (the acquisition date). The following table provides further details of our ACI loans. (Millions of Canadian dollars) City National Unpaid principal balance (1) Credit related fair value adjustments Interest rate and other related premium/(discount) Carrying value Individually assessed allowance Carrying value net of related allowance (2) (1) (2) Represents contractual amount owed net of write-offs since the acquisition of the loan. Carrying value does not include the effect of FDIC loss-share agreements. As at October 31 2016 $ $ 409 (12) 21 418 (3) 415 FDIC Covered Loans As at October 31, 2016, the balance of FDIC covered loans was $374 million and was recorded in Loans on the Consolidated Balance Sheet. As at October 31, 2016, the balances for indemnification assets and clawback liabilities were $2 million and $26 million, respectively. Note 6 Derecognition of financial assets We enter into transactions in which we transfer financial assets such as loans or securities to structured entities or other third parties. The majority of assets transferred under repurchase agreements, securities lending agreements, and in our Canadian residential mortgage securitization transactions do not qualify for derecognition as we continue to be exposed to substantially all of the risks and rewards of the transferred assets, such as prepayment, credit, price, interest rate and foreign exchange risks. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 157 Note 6 Derecognition of financial assets (continued) Transferred financial assets not derecognized Securitization of Canadian residential mortgage loans We securitize insured Canadian residential mortgage loans through the creation of MBS pools under the National Housing Act MBS (NHA MBS) program. All loans securitized under the NHA MBS program are required to be insured by the Canadian Mortgage Housing Corporation or a third- party insurer. We require the borrower to pay the insurance for mortgages in which the loan amount is greater than 80% of the original appraised value of the property (loan-to-value (LTV) ratio). For residential mortgage loans securitized under this program with an LTV ratio less than 80%, we are required to insure the mortgages at our own expense. Under the NHA MBS program, we are responsible for making all payments due on our issued MBS, regardless of whether we collect the necessary funds from the mortgagor or the insurer. When a borrower defaults on a mortgage payment, we submit a claim to the insurer if the amount recovered from the collection or foreclosure process is lower than the sum of the principal balance, accrued interest and collection costs on the outstanding loan. The insurance claim process is managed by the insurance provider in accordance with the insurer’s policies and covers the entire unpaid loan balance plus generally up to 12 months of interest, selling costs and other eligible expenses. If an insurance claim is denied, a loss is recognized in Provision for credit losses in our Consolidated Statements of Income. The amount recorded as a loss is not significant to our Consolidated Financial Statements and no significant losses were incurred due to legal action arising from a mortgage default during 2016 and 2015. We sell the NHA MBS pools primarily to a government-sponsored structured entity under the Canada Mortgage Bond (CMB) program. The entity periodically issues CMBs, which are guaranteed by the government, and sells them to third-party investors. Proceeds of the CMB issuances are used by the entity to purchase the NHA MBS pools from eligible NHA MBS issuers who participate in the issuance of a particular CMB series. Our continuing involvement includes servicing the underlying residential mortgage loans we have securitized, either ourselves or through a third- party servicer. We also act as counterparty in interest rate swap agreements where we pay the entity the interest due to CMB investors and receive the interest on the underlying MBS and reinvested assets. As part of the swaps, we are also required to maintain a principal reinvestment account for principal payments received on the underlying mortgage loans to meet the repayment obligation upon maturity of the CMB. We reinvest the collected principal payments in permitted investments as outlined in the swap agreements. We have determined that certain of the NHA MBS program loans transferred to the entity do not qualify for derecognition as we have not transferred substantially all of the risks and rewards of ownership. As a result, these transferred MBS continue to be classified as residential mortgage loans and recognized on our Consolidated Balance Sheets. The cash received for these transferred MBS is treated as a secured borrowing and a corresponding liability recorded in Deposits – Business and government on our Consolidated Balance Sheets. Securities sold under repurchase agreements and securities loaned We also enter into transactions such as repurchase agreements and securities lending agreements where we transfer assets under agreements to repurchase them on a future day and retain substantially all of the risks and rewards associated with the assets. These transferred assets remain on our Consolidated Balance Sheets and are accounted for as collateralized borrowing transactions. The following table provides information on the carrying amount and fair value of the transferred assets that did not qualify for derecognition, and their associated liabilities. As at October 31, 2016 October 31, 2015 Canadian residential mortgage loans (1) (2) Securities sold under repurchase agreements (3) Securities loaned (3) Total Canadian residential mortgage loans (1) (2) Securities sold under repurchase agreements (3) Securities loaned (3) Total $ 33,648 $ 100,556 $ 2,885 $ 137,089 $ 35,707 $ 78,327 $ 4,961 $ 118,995 (Millions of Canadian dollars) Carrying amount of transferred assets that do not qualify for derecognition Carrying amount of associated liabilities 33,670 100,556 2,885 137,111 36,130 78,327 4,961 119,418 Fair value of transferred assets Fair value of associated $ 33,574 $ 100,556 $ 2,885 $ 137,015 $ 35,770 $ 78,327 $ 4,961 $ 119,058 liabilities 34,730 100,556 2,885 138,171 37,150 78,327 4,961 120,438 Fair value of net position $ (1,156) $ – $ – $ (1,156) $ (1,380) $ – $ – $ (1,380) (1) (2) (3) Includes Canadian residential mortgage loans transferred primarily to Canada Housing Trust at the initial securitization and other permitted investments used for funding requirements after the initial securitization. CMB investors have legal recourse only to the transferred assets, and do not have recourse to our general assets. Does not include over-collateralization of assets pledged. Note 7 Structured entities In the normal course of business, we engage in a variety of financial transactions with structured entities to support our financing and investing needs as well as those of our customers. A structured entity is an entity in which voting or similar rights are not the dominant factor in deciding control. Structured entities are generally created to achieve a narrow and well defined objective with restrictions around their ongoing activities. We consolidate a structured entity when we control the entity in accordance with our accounting policy as described in Note 2. In other cases, we may sponsor or have an interest in such an entity but not consolidate it. Consolidated structured entities We consolidate the following structured entities, whose assets and liabilities are recorded on our Consolidated Balance Sheets. Third-party investors in these structured entities generally have recourse only to the assets of the related entity and do not have recourse to our general assets unless we breach our contractual obligations to those entities. In the ordinary course of business, the assets of each consolidated structured entity can generally only be used to settle the obligations of that entity. 158 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Credit card securitization vehicle We securitize a portion of our credit card receivables through a structured entity on a revolving basis. The entity purchases co-ownership interests in a pool of credit card receivables and issues senior and subordinated term notes collateralized by the underlying pool of credit card receivables. Investors who purchase the term notes have recourse only to the underlying pool of credit card receivables. We continue to service the credit card receivables sold and perform an administrative role for the entity. We also provide first-loss protection through our retained interest in the transferred assets, the cash reserve balance we fund from time to time, and also through certain subordinated notes which we retain. Additionally, we may own some senior notes as investments or for market-making activities; we provide subordinated loans to the entity to pay upfront expenses; and we act as counterparty to interest rate and cross currency swap agreements which hedge the entity’s interest rate and currency risk exposure. We consolidate the structured entity because we have decision making power over the timing and size of future issuances and other relevant activities which were predetermined by us at inception. We also obtain significant funding benefits and are exposed to the majority of the residual ownership risks through the credit support provided. As at October 31, 2016, $9.8 billion of notes issued by our credit card securitization vehicle were included in Deposits on our Consolidated Balance Sheets (October 31, 2015 – $9.1 billion). Collateralized commercial paper vehicle We established a funding vehicle that provides loans to us and finances those loans by issuing commercial paper to third-party investors. The structured entity’s commercial paper carries an equivalent credit rating to RBC because we are obligated to advance funds to the entity in the event there are insufficient funds from other sources to settle maturing commercial paper. We pledge collateral to secure the loans and are exposed to the market and credits risks of the pledged securities. We administer the entity and earn an administration fee for providing these services. We consolidate the structured entity because we have decision making power over the relevant activities, are the sole borrower from the structure, and are exposed to a majority of the residual ownership risks through the credit support provided. As at October 31, 2016, $9.6 billion of commercial paper issued by the vehicle was included in Deposits on our Consolidated Balance Sheets (October 31, 2015 – $11.8 billion). Innovative capital vehicles RBC Capital Trust was created to issue innovative capital instruments, the proceeds from which were used to purchase mortgages from RBC. We consolidate the trust as, through our roles as trustee, administrative agent and equity investor, we have the decision making power over the relevant activities of the trust and are exposed to variability from the performance of the underlying mortgages. Refer to Note 20 for further details on our innovative capital instruments. Covered bonds RBC Covered Bond Guarantor Limited Partnership (Guarantor LP) was created to issue guarantees of covered bonds that we issue. We periodically transfer mortgages to Guarantor LP to support funding activities and asset coverage requirements under our covered bond program. The covered bonds guaranteed by Guarantor LP are direct, unsecured and unconditional obligations of RBC; therefore, investors have a claim against the Bank which will continue if the covered bonds are not paid by the Bank and the mortgage assets in Guarantor LP are insufficient to satisfy the obligations owing on the covered bonds. We act as general partner, limited partner, swap counterparty, lender and liquidity provider to Guarantor LP and registered issuer of the covered bonds. We consolidate Guarantor LP as we have the decision making power over the relevant activities through our role as general partner and are exposed to variability from the performance of the underlying mortgages. As at October 31, 2016, the total amount of mortgages transferred and outstanding was $53.8 billion (October 31, 2015 – $54.5 billion) and $40.5 billion of covered bonds were recorded as Deposits on our Consolidated Balance Sheets (October 31, 2015 – $37.2 billion). Municipal bond TOB structures We sell taxable and tax-exempt municipal bonds into Tender Option Bond (TOB) structures, which consist of a credit enhancement (CE) trust and a TOB trust. The CE trust purchases a bond from us, financed with a trust certificate issued to the TOB trust. The TOB trust then issues floating- rate certificates to short-term investors and a residual certificate that is held by us. We are the remarketing agent for the floating-rate certificates and provide a liquidity facility to the TOB trust which requires us to purchase any certificates tendered but not successfully remarketed. We also provide a letter of credit to the CE trust under which we are required to extend funding if there are any losses on the underlying bonds. We earn interest on the residual certificate and receive market-based fees for acting as remarketing agent and providing the liquidity facility and letter of credit. We consolidate both the CE trust and TOB trust when we are the holder of the residual certificate as we have decision making power over the relevant activities, including the selection of the underlying municipal bonds and the ability to terminate the structure, and are exposed to variability from the performance of the underlying municipal bonds. As at October 31, 2016, $2.5 billion of municipal bonds were included in AFS securities related to consolidated TOB structures (October 31, 2015 – $6.0 billion) and a corresponding $2.5 billion of floating-rate certificates were included in Deposits on our Consolidated Balance Sheets (October 31, 2015 – $6.1 billion). Non-RBC managed investment funds We enter into certain fee-based equity derivative transactions where our investments in the reference funds are held by an intermediate limited partnership entity (intermediate entity) in which we hold a substantial majority of the equity interests. We consolidate the intermediate entity because we have decision making power to direct all the activities of the entity and are exposed to a majority of the risks and rewards through our equity investments. As at October 31, 2016, $179 million of Trading securities representing our investments in the reference funds were recorded on our Consolidated Balance Sheets (October 31, 2015 – $227 million). RBC managed investment funds We are sponsors and investment managers of mutual and pooled funds, which give us the ability to direct the investment decisions of the funds. We consolidate those mutual and pooled funds in which our interests, which include direct investment in seed capital plus management or performance fees, indicate that we are acting as a principal. As at October 31, 2016, $498 million of Trading securities held in the consolidated funds (October 31, 2015 – $586 million) and $126 million of Other liabilities representing the fund units held by third parties (October 31, 2015 – $190 million) were recorded on our Consolidated Balance Sheets. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 159 Note 7 Structured entities (continued) Unconsolidated structured entities We have interests in certain structured entities that we do not consolidate but have recorded assets and liabilities on our Consolidated Balance Sheets related to our transactions and involvement with these entities. The following table presents the assets and liabilities recorded on our Consolidated Balance Sheets and our maximum exposure to loss related to our interests in unconsolidated structured entities. It also presents the size of each class of unconsolidated structured entity, as measured by the total assets of the entities in which we have an interest. (Millions of Canadian dollars) On-balance sheet assets Securities Loans Derivatives Other assets On-balance sheet liabilities Derivatives Other liabilities Multi-seller conduits (1) (2) Structured finance As at October 31, 2016 Non-RBC managed investment funds RBC managed investment funds Third-party securitization vehicles $ $ $ $ 675 $ 733 11 – – $ 1,179 – 549 1,419 $ 1,728 $ 2,543 $ – – 3 2,546 $ 213 $ – – 156 369 $ – $ 4,359 3 – 4,362 $ 68 $ – 68 $ – $ – – $ – $ 27 27 $ – $ – – $ – $ – – $ Other Total 777 – 21 75 873 3 1 4 $ $ $ $ 4,208 6,271 35 783 11,297 71 28 99 Maximum exposure to loss (3) $ Total assets of unconsolidated structured entities $ 8,998 $ 1,301 39,475 $ 4,725 $ 38,703 $ 20,650 $ 587,125 $ 308,683 $ 113,627 $ 63,792 3,378 $ 370 $ 58,247 $ $ 1,132,580 (Millions of Canadian dollars) On-balance sheet assets Securities Loans Derivatives Other assets On-balance sheet liabilities Derivatives Other liabilities Maximum exposure to loss (3) Multi-seller conduits (1) (2) Structured finance $ $ $ $ $ 17 $ – $ 764 19 – 1,323 2 547 800 $ 1,872 $ 24 $ – 24 $ – $ – – $ 37,789 $ 3,681 $ As at October 31, 2015 Non-RBC managed investment funds RBC managed investment funds Third-party securitization vehicles 2,661 $ – – 1 2,662 $ – $ 33 33 $ 3,440 $ 275 $ – – 225 500 $ – $ – – $ 490 $ – $ 5,447 3 – 5,450 $ – $ – – $ 9,694 $ Other Total 697 – 54 57 808 11 2 13 927 $ $ $ $ $ 3,650 7,534 78 830 12,092 35 35 70 56,021 Total assets of unconsolidated structured entities $ 37,044 $ 21,621 $ 658,236 $ 278,474 $ 125,294 $ 67,658 $ 1,188,327 (1) (2) (3) Total assets of unconsolidated structured entities represent the maximum assets that may have to be purchased by the conduits under purchase commitments outstanding. Of the purchase commitments outstanding, the conduits have purchased financial assets totalling $24.6 billion as at October 31, 2016 (October 31, 2015 – $25.2 billion). Securities include $670 million of asset-backed commercial paper (ABCP) purchased pursuant to the Risk Retention Rules (October 31, 2015 – $nil). The maximum exposure to loss resulting from our interests in these entities consists mostly of investments, loans, fair value of derivatives, liquidity and credit enhancement facilities. The maximum exposure to loss of the multi-seller conduits is higher than the on-balance sheet assets primarily by the notional amounts of the backstop liquidity and credit enhancement facilities. Refer to Note 26. Below is a description of our involvement with each significant class of unconsolidated structured entity. Multi-seller conduits We administer five multi-seller ABCP conduit programs (multi-seller conduits) – two in Canada and three in the U.S. These conduits primarily purchase financial assets from clients and finance those purchases by issuing ABCP. We do not maintain any ownership in the multi-seller conduits that we administer and have no rights to, or control of, their assets. As the administrative agent, we earn a residual fee for providing services such as coordinating funding activities, transaction structuring, documentation, execution and monitoring of transactions. The ABCP issued by each multi-seller conduit is in the conduit’s own name with recourse to the financial assets owned by each multi-seller conduit, and is non-recourse to us except through our participation in liquidity and/or credit enhancement facilities. In October 2014, the U.S. federal regulators adopted regulations related to the credit risk retention requirements for asset-backed securities (Risk Retention Rules) of the Dodd-Frank Act. We have begun purchasing ABCP from the U.S. multi-seller conduits as part of our implementation plan to comply with the Risk Retention Rules by December 24, 2016. We continue to serve as placement agent for the multi-seller conduits and may purchase ABCP issued by these conduits from time to time in order to facilitate the overall program liquidity. We provide transaction-specific and program-wide liquidity facilities to the multi-seller conduits. In addition, we provide program-wide credit enhancement to the multi-seller conduits which obligate us to purchase assets or advance funds in the event the multi-seller conduit does not otherwise have funds from other sources, such as from the liquidity facilities, to settle maturing ABCP. In some cases, we or another third party may provide transaction-specific credit enhancement which can take various forms. We receive market-based fees for providing these liquidity and credit facilities. For certain transactions, we act as counterparty to foreign exchange forward contracts and interest rate swaps to facilitate our clients’ securitization of fixed rate and/or foreign currency denominated assets through the conduits. These derivatives expose us to foreign exchange and interest rate risks that are centrally managed by our foreign exchange trading and swap desks, respectively, and credit risk on the underlying assets that is mitigated by the credit enhancement described below. 160 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Each transaction is structured with transaction-specific first loss protection provided by the third-party seller. This enhancement can take various forms, including but not limited to overcollateralization, excess spread, subordinated classes of financial assets, guarantees or letters of credit. The amount of this enhancement varies but is generally sized to cover a multiple of loss experience. An unrelated third party (expected loss investor) absorbs losses, up to a maximum contractual amount, that may occur in the future on the assets in the multi-seller conduits before the multi-seller conduits’ debt holders and us. In return for assuming this multi-seller conduit first-loss position, each multi-seller conduit pays the expected loss investor a return commensurate with its risk position. The expected loss investor has substantive power to direct the majority of the activities which significantly impact the conduit’s economic performance, including initial selection and approval of the asset purchase commitments and liquidity facilities, approval of renewal and amendment of these transactions and facilities, sale or transfer of assets, ongoing monitoring of asset performance, mitigation of losses, and management of the ABCP liabilities. We do not consolidate these multi-seller conduits as we do not have decision making power to direct the relevant activities noted above. Structured finance We purchased U.S. ARS from certain trusts (U.S. ARS Trusts) which fund their long-term investments in student loans by issuing short-term senior and subordinated notes. We are subject to losses on these U.S. ARS Trusts if defaults are experienced on the underlying student loans; however, in the majority of these structures, the principal and accrued interest on the student loans are guaranteed by U.S. government agencies. We act as auction agent for some of these entities but have no legal obligation to purchase the notes issued by these entities in the auction process. We do not consolidate these U.S. ARS Trusts as we do not have decision making power over the investing and financing activities of the Trusts, which are the activities that most significantly affect the performance of the Trusts. Additionally, we invest in certain municipal bond TOB structures that we do not consolidate. These structures are similar to those consolidated municipal bond TOB structures described above; however, the residual certificates are held by third-parties and we do not provide credit enhancement of the underlying assets. We provide liquidity facilities on the floating-rate certificates which may be drawn if certificates are tendered but not able to be remarketed. We do not have decision making power over the relevant activities of the structures; therefore, we do not consolidate these structures. The assets transferred into these programs are derecognized from our Consolidated Balance Sheets. We provide senior warehouse financing to structured entities that are established by third parties to acquire loans for the purposes of issuing a term collateralized loan obligation (CLO) transaction. Subordinated financing is provided during the warehouse phase by one or more third-party equity investors. We act as the arranger and placement agent for the term CLO transaction. Proceeds from the sale of the term CLO are used to repay our senior warehouse financing, at which point we have no further involvement with the transaction. We do not consolidate these CLO structures as we do not have decision making power over the relevant activities of the entity, which include the initial selection and subsequent management of the underlying debt portfolio. Non-RBC managed investment funds We enter into fee-based equity derivative transactions with third parties including mutual funds, unit investment trusts and other investment funds. These transactions provide their investors with the desired exposure to a reference fund, and we economically hedge our exposure to these derivatives by investing in those reference funds. We also act as custodian or administrator for several funds. We do not consolidate those reference funds that are managed by third parties as we do not have power to direct their investing activities. We provide liquidity facilities to certain third-party investment funds. The funds issued unsecured variable-rate preferred shares and invest in portfolios of tax-exempt municipal bonds. Undrawn liquidity commitments expose us to liquidity risk of the preferred shares and drawn commitments expose us to the credit risk of the underlying municipal bonds. We do not consolidate these third-party managed funds as we do not have power to direct their investing activities. RBC managed investment funds We are sponsors and investment managers of mutual and pooled funds, which gives us the ability to direct the investment decisions of the funds. We do not consolidate those mutual and pooled funds in which our interests indicate that we are exercising our decision making power as an agent of the other unit holders. Third-party securitization vehicles We hold interests in securitization vehicles that provide funding to certain third parties on whose behalf the entities were created. The activities of these entities are limited to the purchase and sale of specified assets from the sponsor and the issuance of asset-backed notes collateralized by those assets. The underlying assets are typically receivables, including auto loans and leases. We, as well as other financial institutions, are obligated to provide funding up to our maximum commitment level and are exposed to credit losses on the underlying assets after various credit enhancements. Enhancement can take various forms, including but not limited to overcollateralization, excess spread, subordinated classes of financial assets, guarantees or letters of credit. The amount of this enhancement varies but is generally sized to cover a multiple of loss experience. We do not consolidate these entities as we do not have decision making power over the relevant activities, including the investing and financing activities. Other Other structured entities include credit investment products and tax credit funds. We use structured entities to generally transform credit derivatives into cash instruments, to distribute credit risk and to create customized credit products to meet investors’ specific requirements. We enter into derivative contracts, including credit derivatives, to purchase protection from these entities (credit protection) and convert various risk factors such as yield, currency or credit risk of underlying assets to meet the needs of the investors. We act as sole arranger and swap provider for certain entities and, in some cases, fulfill other administrative functions for the entities. We do not consolidate these credit investment product entities as we do not have decision making power over the relevant activities, which include selection of the collateral and reference portfolio, and are not exposed to a majority of the benefits or risks of the entities. We created certain funds to pass through tax credits received from underlying low-income housing or historic rehabilitation real estate projects to third parties (tax credit funds). We are sponsors of the tax credit funds as a result of our responsibility to manage the funds, arrange the financing, and perform the administrative duties of these tax credit funds. We do not consolidate the tax credit funds as the third-party investors in these funds have the decision making power to select the underlying investments and are exposed to the majority of the residual ownership and tax risks of the funds. We also purchase passive interests in renewable energy tax credit entities created and controlled by third parties. We do not consolidate these third party funds as we do not have decision making power over the relevant activities and our investments are managed as part of larger portfolios which are held for trading purposes. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 161 Note 7 Structured entities (continued) Other interests in unconsolidated structured entities In the normal course of business, we buy and sell passive interests in certain third-party structured entities, including mutual funds, exchange traded funds, and government-sponsored asset backed securities vehicles. Our investments in these entities are managed as part of larger portfolios which are held for trading, liquidity or hedging purposes. We did not create or sponsor these entities and do not have any decision making power over their ongoing activities. Our maximum exposure to loss is limited to our on-balance sheet investments in these entities, which are not included in the table above. As at October 31, 2016, $51 billion of investments in these entities were included in Trading and AFS securities on our Consolidated Balance Sheet. Refer to Note 3 and Note 4 for further details on our investment securities. Sponsored entities We are a sponsor of certain structured entities in which we have interests but do not consolidate. In determining whether we are a sponsor of a structured entity, we consider both qualitative and quantitative factors, including the purpose and nature of the entity, our initial and continuing involvement and whether we hold subordinated interests in the entity. We are considered to be the sponsor of certain credit investment products, tax credit entities, RBC managed mutual funds and a commercial mortgage securitization vehicle. During the year ended October 31, 2016, we transferred commercial mortgages with a carrying amount of $660 million (October 31, 2015 – $195 million) to a sponsored securitization vehicle in which we did not have any interests as at the end of the reporting period. Financial support provided to structured entities During the years ended October 31, 2016, 2015 and 2014, we have not provided any financial or non-financial support to any consolidated or unconsolidated structured entities when we were not contractually obligated to do so. Furthermore, we have no intention to provide such support in the future. Note 8 Derivative financial instruments and hedging activities Derivative instruments are categorized as either financial or non-financial derivatives. Financial derivatives are financial contracts whose value is derived from an underlying interest rate, foreign exchange rate, credit risk, and equity or equity index. Non-financial derivatives are contracts whose value is derived from a precious metal, commodity instrument or index. The notional amount of derivatives represents the contract amount used as a reference point to calculate payments. Notional amounts are generally not exchanged by counterparties, and do not reflect our exposure at default. Financial derivatives Forwards and futures Forward contracts are effectively non-standardized agreements that are transacted between counterparties in the OTC market, whereas futures are standardized contracts with respect to amounts and settlement dates, and are traded on regular futures exchanges. Examples of forwards and futures are described below. Interest rate forwards (forward rate agreements) and futures are contractual obligations to buy or sell an interest-rate sensitive financial instrument on a predetermined future date at a specified price. Foreign exchange forwards and futures are contractual obligations to exchange one currency for another at a specified price for settlement at a predetermined future date. Equity forwards and futures are contractual obligations to buy or sell at a fixed value (the specified price) of an equity index, a basket of stocks or a single stock at a predetermined future date. Swaps Swaps are OTC contracts in which two counterparties exchange a series of cash flows based on agreed upon rates applied to a notional amount. Examples of swap agreements are described below. Interest rate swaps are agreements where two counterparties exchange a series of payments based on different interest rates applied to a notional amount in a single currency. Cross currency swaps involve the exchange of fixed payments in one currency for the receipt of fixed payments in another currency. Cross currency interest rate swaps involve the exchange of both interest and notional amounts in two different currencies. Equity swaps are contracts in which one counterparty agrees to pay or receive from the other cash flows based on changes in the value of an equity index, a basket of stocks or a single stock. Options Options are contractual agreements under which the seller (writer) grants the purchaser the right, but not the obligation, either to buy (call option) or sell (put option) a security, exchange rate, interest rate, or other financial instrument or commodity at a specified price, at or by a predetermined future date. The seller (writer) of an option can also settle the contract by paying the cash settlement value of the purchaser’s right. The seller (writer) receives a premium from the purchaser for this right. The various option agreements that we enter into include but are not limited to interest rate options, foreign currency options, equity options and index options. Credit derivatives Credit derivatives are OTC contracts that transfer credit risk related to an underlying financial instrument (referenced asset) from one counterparty to another. Credit derivatives include credit default swaps, credit default baskets and total return swaps. Credit default swaps provide protection against the decline in the value of the referenced asset as a result of specified credit events such as default or bankruptcy. They are similar in structure to an option, whereby the purchaser pays a premium to the seller of the credit default swap in return for payment contingent on a credit event affecting the referenced asset. Credit default baskets are similar to credit default swaps except that the underlying referenced financial instrument is a group of assets instead of a single asset. Total return swaps are contracts where one counterparty agrees to pay or receive from the other cash amounts based on changes in the value of a reference asset or group of assets, including any returns such as interest earned on these assets, in exchange for amounts that are based on prevailing market funding rates. Other derivative products Other contracts include precious metal, commodity, stable value and equity derivative contracts. 162 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Non-financial derivatives We also transact in non-financial derivative products including precious metal and commodity derivative contracts in both the OTC and exchange markets. Derivatives issued for trading purposes Most of our derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to clients to enable them to transfer, modify or reduce current or expected risks. Trading involves market-making, positioning and arbitrage activities. Market-making involves quoting bid and offer prices to other market participants with the intention of generating revenue based on spread and volume. Positioning involves managing market risk positions with the expectation of profiting from favourable movements in prices, rates or indices. Arbitrage activities involve identifying and profiting from price differentials between markets and products. Derivatives issued for other-than-trading purposes We also use derivatives for purposes other than trading, primarily for hedging, in conjunction with the management of interest rate, credit, equity and foreign exchange risk related to our funding, lending, investment activities and asset/liability management. Interest rate swaps are used to manage our exposure to interest rate risk by modifying the repricing or maturity characteristics of existing and/or forecasted assets and liabilities, including funding and investment activities. Purchased options are used to hedge redeemable deposits and other options embedded in consumer products. We manage our exposure to foreign currency risk with cross currency swaps and foreign exchange forward contracts. We predominantly use credit derivatives to manage our credit exposures. We mitigate industry sector concentrations and single-name exposures related to our credit portfolio by purchasing credit derivatives to transfer credit risk to third parties. Certain derivatives and cash instruments are specifically designated and qualify for hedge accounting. We apply hedge accounting to minimize volatility in earnings and capital caused by changes in interest rates or foreign exchange rates. Interest rate and currency fluctuations will either cause assets and liabilities to appreciate or depreciate in market value or cause variability in forecasted cash flows. When a hedging relationship is effective, gains, losses, revenue and expenses of the hedging instrument will offset the gains, losses, revenue and expenses of the hedged item. We assess and measure the effectiveness of a hedging relationship based on the change in the fair value or cash flows of the derivative hedging instrument relative to the change in the fair value or cash flows of the hedged item attributable to the hedged risk. When cash instruments are designated as hedges of foreign exchange risks, only changes in their value due to foreign exchange risk are included in the assessment and measurement of hedge effectiveness. From time to time, we also enter into derivative transactions to economically hedge certain exposures that do not otherwise qualify for hedge accounting, or where hedge accounting is not considered economically feasible to implement. In such circumstances, changes in fair value are reflected in Non-interest income. After-tax unrealized losses relating to de-designated hedges of $70 million (before-tax unrealized losses of $95 million) included in Other components of equity as at October 31, 2016, are expected to be reclassified to Net interest income within the next 12 months. The following table presents the fair values of the derivative and non-derivative instruments categorized by their hedging relationships, as well as derivatives that are not designated in hedging relationships. Derivatives and non-derivative instruments October 31, 2016 Designated as hedging instruments in hedging relationships As at October 31, 2015 Designated as hedging instruments in hedging relationships Cash flow hedges Fair value hedges Net investment hedges Not designated in a hedging relationship Cash flow hedges Fair value hedges Net investment hedges Not designated in a hedging relationship $ 546 $ 1,686 $ 183 $ 116,529 $ 842 $ 1,814 $ 167 $ 102,803 1,266 – 430 – 113 19,982 114,741 n.a. 1,629 – 311 – 49 18,804 105,871 n.a. (Millions of Canadian dollars) Assets Derivative instruments Liabilities Derivative instruments Non-derivative instruments n.a. not applicable Results of hedge activities recorded in Net income and Other comprehensive income (Millions of Canadian dollars) Fair value hedges For the year ended October 31 2016 October 31 2015 October 31 2014 Gains (losses) on hedging instruments (1) Gains (losses) on hedged items attributable to the hedged risk (1) Ineffective portion (1) (2) $ (235) $ 135 (100) 313 $ (424) (111) Cash flow hedges Ineffective portion (1) Effective portion (3) Reclassified to income during the period (4) (5) Net investment hedges Ineffective portion (1) Foreign currency gains (losses) (3) Gains (losses) from hedges (3) 1 (35) (71) – 147 113 3 (541) (447) (1) 5,885 (3,223) 216 (329) (113) (13) (108) (38) 1 2,743 (1,585) (1) (2) (3) (4) (5) Amounts are recorded in Non-interest income. Amounts include losses of $97 million (October 31, 2015 – $106 million; October 31, 2014 – $109 million) that are excluded from the assessment of hedge effectiveness and are offset by economic hedges. Amounts are included in OCI, net of taxes. Amounts are recorded in Net interest income. After-tax losses of $52 million were reclassified from Other components of equity to income during the year ended October 31, 2016 (October 31, 2015 – $330 million; October 31, 2014 – $28 million). Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 163 Note 8 Derivative financial instruments and hedging activities (continued) Notional amount of derivatives by term to maturity (absolute amounts) (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives (2) Other contracts Exchange-traded contracts Interest rate contracts Futures – long positions Futures – short positions Options purchased Options written Foreign exchange contracts Futures – long positions Futures – short positions Other contracts (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives (2) Other contracts Exchange-traded contracts Interest rate contracts Futures – long positions Futures – short positions Options purchased Options written Foreign exchange contracts Futures – long positions Futures – short positions Other contracts As at October 31, 2016 Within 1 year Term to maturity 1 to 5 years Over 5 years (1) $ 522,944 1,991,365 114,519 97,283 $ 9,121 3,485,607 161,584 182,233 $ – 2,285,420 70,160 71,503 $ 1,288,656 8,869 272,029 28,601 28,676 1,581 58,863 26,076 35,269 18,196 10,978 312 423 178,615 44,980 34,931 544,195 16,538 14,723 10,314 59,133 14,496 19,551 165 – – 3 55,820 939 30,866 251,371 4,619 4,924 4,306 22,355 3 – – – – – 617 Total Trading 532,065 7,762,392 346,263 351,019 1,334,575 74,666 1,067,595 49,758 48,323 16,201 140,351 40,575 54,820 18,361 10,978 312 426 235,052 $ 532,065 7,464,144 346,263 351,019 1,314,103 69,626 1,013,958 49,758 48,323 15,842 136,205 40,575 54,820 18,361 10,978 312 426 235,052 Other than Trading $ – 298,248 – – 20,472 5,040 53,637 – – 359 4,146 – – – – – – – $ 4,683,255 $ 4,653,394 $ 2,747,083 $ 12,083,732 $ 11,701,830 $ 381,902 As at October 31, 2015 Within 1 year Term to maturity 1 to 5 years Over 5 years (1) $ 602,072 1,717,989 106,908 107,213 $ 26,334 3,946,377 99,994 108,237 $ – 2,482,659 34,649 44,268 $ 1,273,434 7,404 246,668 25,921 24,933 1,250 75,723 18,934 36,589 17,282 1,281 308 714 170,464 45,591 24,711 609,751 13,773 12,168 9,759 57,344 10,469 25,939 9,119 956 – 13 43,345 1,275 31,010 323,403 4,274 4,677 3,947 24,819 10 2 – – – – 1,197 Total Trading 628,406 8,147,025 241,551 259,718 1,320,300 63,125 1,179,822 43,968 41,778 14,956 157,886 29,413 62,530 26,401 2,237 308 727 215,006 $ 628,406 7,922,567 241,551 259,718 1,271,428 59,423 1,129,357 43,968 41,778 14,286 154,504 29,413 62,530 26,401 2,237 308 727 215,006 Other than Trading $ – 224,458 – – 48,872 3,702 50,465 – – 670 3,382 – – – – – – – (1) (2) Includes contracts maturing in over 10 years with a notional value of $883 billion (October 31, 2015 – $876 billion). The related gross positive replacement cost is $79 billion (October 31, 2015 – $60 billion). Credit derivatives with a notional value of $0.4 billion (October 31, 2015 – $0.7 billion) are economic hedges. Trading credit derivatives comprise protection purchased of $10.1 billion (October 31, 2015 – $8.9 billion) and protection sold of $5.7 billion (October 31, 2015 – $5.3 billion). $ 4,435,087 $ 5,043,880 $ 2,956,190 $ 12,435,157 $ 12,103,608 $ 331,549 164 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements The following tables indicate the periods when the cash flows are expected to occur and when they are expected to affect profit or loss for cash flow hedges. (Millions of Canadian dollars) Cash inflows from assets Cash outflows from liabilities Net cash flows (Millions of Canadian dollars) Cash inflows from assets Cash outflows from liabilities Net cash flows Fair value of derivative instruments (Millions of Canadian dollars) Held or issued for trading purposes Interest rate contracts Forward rate agreements Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Options purchased Options written Credit derivatives Other contracts Held or issued for other-than-trading purposes Interest rate contracts Swaps Options purchased Options written Foreign exchange contracts Forward contracts Cross currency swaps Cross currency interest rate swaps Credit derivatives Other contracts Total gross fair values before netting Valuation adjustments determined on a pooled basis Impact of netting agreements that qualify for balance sheet offset Impact of netting agreements that do not qualify for balance sheet offset (2) As at October 31, 2016 Within 1 year 192 $ (387) 1 to 2 years 175 $ (789) 2 to 3 years 122 $ (559) 3 to 5 years 90 $ (3,136) Over 5 years 39 $ (77) $ Total 618 (4,948) $ (195) $ (614) $ (437) $ (3,046) $ (38) $ (4,330) As at October 31, 2015 Within 1 year 156 $ (1,004) 1 to 2 years 189 $ (282) 2 to 3 years 192 $ (730) 3 to 5 years 243 $ (3,556) Over 5 years 12 $ (151) $ Total 792 (5,723) $ (848) $ (93) $ (538) $ (3,313) $ (139) $ (4,931) As at October 31, 2016 October 31, 2015 Average fair value for year ended (1) Year end fair value Average fair value for year ended (1) Year end fair value Positive Negative Positive Negative Positive Negative Positive Negative $ 369 $ 387 $ 267 $ 156,800 4,008 – 149,440 – 5,420 146,464 4,455 – 244 138,742 – 5,601 $ 340 $ 303 $ 323 $ 136,398 4,155 – 130,623 – 5,380 135,901 3,330 – 291 129,829 – 4,573 161,177 155,247 151,186 144,587 140,893 136,306 139,554 134,693 18,604 4,556 25,010 2,123 – 50,293 137 7,640 18,717 4,191 28,834 – 1,830 53,572 178 10,175 18,565 5,423 27,499 2,084 – 53,571 191 6,662 18,853 4,438 29,165 – 1,857 54,313 242 8,994 16,505 3,039 21,445 3,026 – 44,015 130 9,431 16,294 3,254 27,584 – 2,486 49,618 200 12,868 11,599 3,844 19,931 2,337 – 37,711 94 10,704 11,477 4,109 26,385 – 1,898 43,869 153 12,866 219,247 219,172 211,610 208,136 194,469 198,992 188,063 191,581 2,588 – – 2,588 257 314 2,636 3,207 – 113 1,471 – – 1,471 338 542 2,286 3,166 21 113 5,908 4,771 217,518 212,907 (1,432) (126) (97,142) (96,231) 118,944 116,550 (79,296) (79,296) $ 39,648 $ 37,254 2,923 – – 2,923 274 20 3,107 3,401 – 69 1,585 – – 1,585 253 506 2,080 2,839 18 69 6,393 4,511 194,456 196,092 (1,303) (272) (87,527) (87,960) 105,626 107,860 (71,833) (71,833) $ 33,793 $ 36,027 (1) (2) Average fair value amounts are calculated based on monthly balances. Additional impact of offsetting credit exposures on contracts that do not qualify for balance sheet offset. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 165 Note 8 Derivative financial instruments and hedging activities (continued) Fair value of derivative instruments by term to maturity October 31, 2016 October 31, 2015 As at (Millions of Canadian dollars) Derivative assets Derivative liabilities Less than 1 year 1 to 5 years Over 5 years Total $ 30,475 $ 39,357 $ 49,112 $ 118,944 116,550 39,507 46,081 30,962 Less than 1 year 1 to 5 years Total $ 24,920 $ 35,883 $ 44,823 $ 105,626 107,860 41,388 40,380 26,092 Over 5 years Derivative-related credit risk Credit risk from derivative transactions is generated by the potential for the counterparty to default on its contractual obligations when one or more transactions have a positive market value to us. Therefore, derivative-related credit risk is represented by the positive fair value of the instrument and is normally a small fraction of the contract’s notional amount. We subject our derivative transactions to the same credit approval, limit and monitoring standards that we use for managing other transactions that create credit exposure. This includes evaluating the creditworthiness of counterparties, and managing the size, diversification and maturity structure of the portfolio. Credit utilization for all products is compared with established limits on a continual basis and is subject to a standard exception reporting process. We use a single internal rating system for all credit risk exposure. In most cases, these internal ratings approximate the external risk ratings of public rating agencies. Netting is a technique that can reduce credit exposure from derivatives and is generally facilitated through the use of master netting agreements. A master netting agreement provides for a single net settlement of all financial instruments covered by the agreement in the event of default. However, credit risk is reduced only to the extent that our financial obligations to the same counterparty can be set off against obligations of the counterparty to us. We maximize the use of master netting agreements to reduce derivative-related credit exposure. Our overall exposure to credit risk that is reduced through master netting agreements may change substantially following the reporting date as the exposure is affected by each transaction subject to the agreement as well as by changes in underlying market rates. Measurement of our credit exposure arising out of derivative transactions is reduced to reflect the effects of netting in cases where the enforceability of that netting is supported by appropriate legal analysis as documented in our trading credit risk policies. The use of collateral is another significant credit mitigation technique for managing derivative-related counterparty credit risk. Mark-to- market provisions in our agreements with some counterparties, typically in the form of a Credit Support Annex, provide us with the right to request that the counterparty pay down or collateralize the current market value of its derivatives positions when the value passes a specified threshold amount. Replacement cost represents the total fair value of all outstanding contracts in a gain position after factoring in the master netting agreements. The credit equivalent amount is defined as the sum of the replacement cost plus an add-on amount for potential future credit exposure as defined by OSFI. The risk-weighted amount is determined by applying the standard OSFI defined measures of counterparty risk to the credit equivalent amount. Derivative-related credit risk (Millions of Canadian dollars) Over-the-counter contracts Interest rate contracts Forward rate agreements Swaps Options purchased Foreign exchange contracts Forward contracts Swaps Options purchased Credit derivatives (4) Other contracts Exchange traded contracts October 31, 2016 (1) October 31, 2015 (1) Replacement cost Credit equivalent amount (2) Risk-weighted equivalent (3) Replacement cost Credit equivalent amount (2) Risk-weighted equivalent (3) As at $ $ 232 15,118 334 6,914 13,763 416 31 1,409 2,933 $ 250 27,214 1,092 12,952 12,492 1,045 920 6,188 11,756 53 5,429 662 3,896 3,790 456 188 3,463 235 $ $ 182 14,747 340 5,041 7,686 322 34 2,499 4,245 $ 233 27,688 700 11,254 9,809 547 913 7,539 12,048 50 5,197 446 3,202 3,878 276 204 4,320 241 $ 41,150 $ 73,909 $ 18,172 $ 35,096 $ 70,731 $ 17,814 (1) (2) (3) (4) The amounts presented are net of master netting agreements in accordance with Basel III. The total credit equivalent amount includes collateral applied of $21 billion (October 31, 2015 – $17.8 billion). The risk-weighted balances are calculated in accordance with Basel III. Excludes credit derivatives issued for other-than-trading purposes related to bought protection. Replacement cost of derivative instruments by risk rating and by counterparty type Risk rating (1) Counterparty type (2) As at October 31, 2016 (Millions of Canadian dollars) Gross positive replacement cost Impact of master netting agreements Replacement cost (after netting agreements) AAA, AA Total $ 37,119 $ 151,992 $ 20,634 $ 7,773 $ 217,518 $ 62,112 $ 21,824 $ 133,582 $ 217,518 176,438 176,438 114,409 139,912 52,535 20,704 14,255 1,567 9,494 Banks Other Total BBB A BB or lower OECD governments $ 16,415 $ 12,080 $ 6,379 $ 6,206 $ 41,080 $ 9,577 $ 12,330 $ 19,173 $ 41,080 166 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements (Millions of Canadian dollars) Gross positive replacement cost Impact of master netting agreements Replacement cost (after netting Risk rating (1) Counterparty type (2) As at October 31, 2015 AAA, AA Total $ 30,824 $ 136,843 $ 16,191 $ 10,598 $ 194,456 $ 56,631 $ 16,374 $ 121,451 $ 194,456 159,360 159,360 102,988 124,603 10,971 45,401 22,751 2,746 9,260 Banks Other Total BBB A BB or lower OECD governments agreements) $ 8,073 $ 12,240 $ 6,931 $ 7,852 $ 35,096 $ 11,230 $ 5,403 $ 18,463 $ 35,096 (1) (2) Our internal risk ratings for major counterparty types approximate those of public ratings agencies. Ratings of AAA, AA, A and BBB represent investment grade ratings and ratings of BB or lower represent non-investment grade ratings. Counterparty type is defined in accordance with the capital adequacy requirements of OSFI. Note 9 Premises and equipment (Millions of Canadian dollars) Cost Balance at October 31, 2015 Additions (1) Acquisitions through business combination Transfers from work in process Disposals Foreign exchange translation Other Balance at October 31, 2016 Accumulated depreciation Balance at October 31, 2015 Depreciation Disposals Foreign exchange translation Other Balance at October 31, 2016 Land Buildings Computer equipment Furniture, fixtures and other equipment Leasehold improvements Work in process Total $ 123 – 52 – (3) – (1) $ 171 $ $ – – – – – – $ $ $ $ $ 1,294 1 94 14 (15) 1 (10) 1,379 534 48 (4) (1) (7) 570 809 $ $ $ $ $ 1,508 156 55 83 (38) (17) (61) 1,686 1,070 219 (38) (13) (29) 1,209 477 $ $ $ $ $ 1,292 35 2 40 (47) (4) 34 1,352 875 126 (40) (8) 8 961 391 $ $ $ $ $ 2,464 46 63 137 (111) (8) (25) 2,566 1,642 180 (107) (7) 2 1,710 856 Net carrying amount at October 31, 2016 $ 171 (Millions of Canadian dollars) Cost Balance at October 31, 2014 Additions (1) Transfers from work in process Disposals Foreign exchange translation Other Balance at October 31, 2015 Accumulated depreciation Balance at October 31, 2014 Depreciation Disposals Foreign exchange translation Other Balance at October 31, 2015 Net carrying amount at October 31, 2015 Land Buildings Computer equipment Furniture, fixtures and other equipment Leasehold improvements $ $ $ $ $ 137 – – (25) 7 4 123 – – – – – – 123 $ $ $ $ $ 1,347 4 11 (95) 18 9 1,294 499 44 (8) 6 (7) 534 760 $ $ $ $ $ 1,278 195 52 (101) 54 30 1,508 925 197 (98) 42 4 1,070 438 $ $ $ $ $ 1,248 53 61 (108) 30 8 1,292 839 103 (96) 21 8 875 417 $ $ $ $ $ 2,192 82 212 (98) 69 7 2,464 1,463 183 (64) 42 18 1,642 822 $ $ $ $ $ $ $ $ $ $ 168 $ 6,849 487 249 317 51 (274) – (214) – (29) (1) (124) (61) 132 $ 7,286 – $ 4,121 573 – (189) – (29) – (26) – – $ 4,450 132 $ 2,836 Work in process Total 208 $ 6,410 678 344 (336) – (427) – 182 4 6 (52) 168 $ 6,849 – $ 3,726 527 – (266) – 111 – 23 – – $ 4,121 168 $ 2,728 (1) At October 31, 2016, we had total contractual commitments of $301 million to acquire premises and equipment (October 31, 2015 – $157 million; October 31, 2014 – $216 million). Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 167 Note 10 Goodwill and other intangible assets Goodwill The following table presents changes in the carrying amount of goodwill by CGU for the years ended October 31, 2016 and 2015. (Millions of Canadian dollars) At October 31, 2014 Dispositions Currency translations At October 31, 2015 Acquisition Dispositions Currency translations At October 31, 2016 Canadian Banking Caribbean Banking Canadian Wealth Management Global Asset Management U.S. Wealth Management (including City National) International Wealth Management Investor & Treasury Services Insurance $ 2,527 $ 1,593 $ – – (23) 250 $ 2,527 $ 1,820 $ – – – – – (49) 558 $ – 21 579 $ – – 3 2,042 $ – 177 2,219 $ – – (256) 582 $ – 91 673 $ 2,113 – 68 141 $ 118 $ (15) 16 – – 142 $ 118 $ – – (27) – (6) – Capital Markets Total 937 $ 8,647 (38) 680 – 125 149 $ – – 149 $ 1,062 $ 9,289 2,113 (7) (239) – (1) – – – 22 $ 2,527 $ 1,771 $ 582 $ 1,963 $ 2,854 $ 115 $ 112 $ 148 $ 1,084 $ 11,156 We perform our annual impairment test by comparing the carrying amount of each CGU to its recoverable amount. The recoverable amount of a CGU is represented by its value in use, except in circumstances where the carrying amount of a CGU exceeds its value in use. In such cases, we determine the CGU’s fair value less costs of disposal and its recoverable amount is the greater of its value in use and fair value less costs of disposal. Our annual impairment test is performed as at August 1. In our 2016 and 2015 annual impairment tests, the recoverable amounts of our Caribbean Banking and International Wealth Management CGUs were based on fair value less costs of disposal. The recoverable amounts of all other CGUs tested were based on value in use. Value in use We calculate value in use using a five-year discounted cash flow method, with the exception of our U.S. Wealth Management (including City National) CGU where cash flow projections covering a ten-year period were used, which more closely aligns with the strategic growth plan resulting from the acquisition of City National. Future cash flows are based on financial plans agreed by management, estimated based on forecast results, business initiatives, capital required to support future cash flows and returns to shareholders. Key drivers of future cash flows include net interest margins and average interest-earning assets. The values assigned to these drivers over the forecast period are based on past experience, external and internal economic forecasts, and management’s expectations of the impact of economic conditions on our financial results. Beyond the initial cash flow projection period, cash flows are assumed to increase at a constant rate using a nominal long-term growth rate (terminal growth rate). Terminal growth rates are based on the current market assessment of gross domestic product and inflation for the countries within which the CGU operates. The discount rates used to determine the present value of each CGU’s projected future cash flows are based on the bank-wide cost of capital, adjusted for the risks to which each CGU is exposed. CGU-specific risks include: country risk, business/ operational risk, geographic risk (including political risk, devaluation risk, and government regulation), currency risk, and price risk (including product pricing risk and inflation). The estimation of value in use involves significant judgment in the determination of inputs to the discounted cash flow model and is most sensitive to changes in future cash flows, discount rates and terminal growth rates applied to cash flows beyond the forecast period. These key inputs and assumptions used to determine the recoverable amount of each CGU using value in use were tested for sensitivity by applying a reasonably possible change to those assumptions. The post-tax discount rates were increased by 1%, terminal growth rates were decreased by 1%, and future cash flows were reduced by 10%. As at August 1, 2016, no change in an individual key input or assumption, as described, would result in a CGU’s carrying amount exceeding its recoverable amount based on value in use. The terminal growth rates and pre-tax discount rates used in our discounted cash flow models are summarized below. As at August 1, 2016 August 1, 2015 Discount rate (1) Terminal growth rate Discount rate (1) Terminal growth rate 10.0% 12.1 11.2 11.1 13.6 9.6 10.9 12.0 14.1 3.0% 4.3 3.0 3.0 3.0 3.0 3.0 3.0 3.0 10.6% 13.2 11.9 11.7 16.3 11.9 11.2 12.4 15.7 3.0% 4.3 3.0 3.0 3.0 3.0 3.0 3.0 3.0 Group of cash generating units Canadian Banking Caribbean Banking Canadian Wealth Management Global Asset Management U.S. Wealth Management (including City National) International Wealth Management Insurance Investor & Treasury Services Capital Markets (1) Pre-tax discount rates are determined implicitly based on post-tax discount rates. 168 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Fair value less costs of disposal – Caribbean Banking For our Caribbean Banking CGU, we calculated fair value less costs of disposal using a discounted cash flow method that projects future cash flows over a 5-year period. Cash flows are based on management forecasts, adjusted to approximate the considerations of a prospective third- party buyer. Cash flows beyond the initial 5-year period are assumed to increase at a constant rate using a nominal long-term growth rate. Future cash flows, terminal growth rates, and discount rates are based on the same factors noted above. This fair value measurement is categorized as level 3 in the fair value hierarchy as certain significant inputs are not observable. The estimation of fair value less costs of disposal involves significant judgment in the determination of inputs to the discounted cash flow model and is most sensitive to changes in future cash flows, discount rates and terminal growth rates applied to cash flows beyond the forecast period. These key inputs and assumptions were tested for sensitivity by applying a reasonably possible change to those assumptions. The post-tax discount rates were increased by 1%, terminal growth rates were decreased by 1%, and future cash flows were reduced by 10%. As at August 1, 2016, no reasonably possible change in an individual key input or assumption, as described, would result in the CGU’s carrying amount exceeding its recoverable amount based on fair value less costs of disposal. Fair value less costs of disposal – International Wealth Management For our International Wealth Management CGU, we calculated fair value less costs of disposal using a multiples-based approach. Each business within the CGU was valued using either a Price-to-assets-under-administration (P/AUA) or Price-to-revenue (P/Rev) multiple, as appropriate, to reflect the considerations of a prospective third-party buyer. In 2016 and 2015, we applied a P/AUA multiple of 2.5% to AUA as at August 1 and a P/Rev multiple of 2.5x to revenue for the 12 months preceding the testing date. These multiples represent our best estimate from a range of reasonably possible inputs based on precedent transactions for comparable businesses. This fair value measurement is categorized as level 3 in the fair value hierarchy as certain significant inputs are not observable. The estimation of fair value less costs of disposal involves significant judgment in the determination of the appropriate valuation approach and inputs and is most sensitive to changes in the P/AUA and P/Rev multiples. These key inputs were tested for sensitivity by reducing each multiple to the low end of the range of reasonably possible inputs considered. As at August 1, 2016, no reasonably possible change in an individual key input or assumption, as described, would result in the CGU’s carrying amount exceeding its recoverable amount based on fair value less costs of disposal. Other intangible assets The following table presents the carrying amount of our other intangible assets. (Millions of Canadian dollars) Gross carrying amount Balance at October 31, 2015 Additions Acquisitions through business combination Transfers Dispositions Impairment losses Currency translations Other changes Balance at October 31, 2016 Accumulated amortization Balance at October 31, 2015 Amortization charge for the year Dispositions Impairment losses Currency translations Other changes Balance at October 31, 2016 Net balance, at October 31, 2016 Internally generated software $ 3,929 11 23 569 (10) – (33) (54) Other software $ 1,193 58 47 34 (6) – 19 44 $ $ 4,435 $ 1,389 $ $ (2,750) $ (893) $ (560) 7 – 31 49 (97) 5 – (18) (51) $ (3,223) $ (1,054) $ As at October 31, 2016 Core deposit intangibles Customer list and relationships In process software $ $ 1,538 – 322 – – – (99) – $ 580 765 – (603) – – (2) 38 194 – 1,558 – – – 32 – 1,784 $ 1,761 $ 778 $ 10,147 Total 7,434 834 1,950 – (16) – (83) 28 (194) $ (158) – – 4 – (348) $ (783) $ (155) – – 64 – (874) $ – – – – – – – $ (4,620) (970) 12 – 81 (2) $ (5,499) $ 1,212 $ 335 $ 1,436 $ 887 $ 778 $ 4,648 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 169 Note 10 Goodwill and other intangible assets (continued) (Millions of Canadian dollars) Gross carrying amount Balance at October 31, 2014 Additions Transfers Dispositions Impairment losses Currency translations Other changes Balance at October 31, 2015 Accumulated amortization Balance at October 31, 2014 Amortization charge for the year Dispositions Impairment losses Currency translations Other changes Balance at October 31, 2015 Internally generated software $ $ 3,402 50 503 (98) – 84 (12) 3,929 Other software $ 1,186 75 19 (132) – 49 (4) $ 1,193 $ $ $ (2,293) $ (494) 97 (3) (60) 3 (888) $ (81) 125 – (30) (19) $ (2,750) $ (893) $ As at October 31, 2015 Core deposit intangibles Customer list and relationships In process software 168 – – – – 26 – 194 $ $ (151) $ (18) – – (25) – (194) $ 1,511 – – (30) (22) 79 – 1,538 $ $ (647) $ (119) 9 18 (41) (3) (783) $ Total 6,754 740 – (260) (22) 255 (33) 7,434 487 615 (522) – – 17 (17) 580 $ $ – – – – – – – $ (3,979) (712) 231 15 (156) (19) $ (4,620) Net balance, at October 31, 2015 $ 1,179 $ 300 $ – $ 755 $ 580 $ 2,814 Note 11 Significant acquisition and dispositions Acquisition Wealth Management On November 2, 2015, we completed the acquisition of City National. City National’s business gives us an expansion platform for long-term growth in the U.S. and the opportunity to enhance and complement our existing U.S. businesses in line with our strategic goals. Total consideration of $7.1 billion (US$5.5 billion) at the date of close included $3.4 billion (US$2.6 billion) in cash, 41.6 million RBC common shares issued at a price of US$57.16 per share for a total value of $3.1 billion (US$2.4 billion), US$275 million of first preferred shares (Series C-1 and Series C-2), with a fair value of $380 million (US$290 million), as well as share-based compensation amounts of $204 million (US$156 million), including the conversion of 3.8 million stock options with a fair value of $147 million (US$112 million), based on the Black-Scholes model. Our purchase price allocation assigns $47.8 billion to assets and $44.7 billion to liabilities on the acquisition date. Goodwill of $2.1 billion reflects the expected synergies from the combined U.S. Wealth Management operations, expected growth of the platform, and the ability to cross sell products between segments. Goodwill is not expected to be deductible for tax purposes. The following table presents the fair value of the assets acquired and liabilities assumed as at the acquisition date. (Millions of Canadian dollars, except percentage) Percentage of shares acquired Purchase consideration Fair value of identifiable assets acquired Cash and due from banks Interest-bearing deposits with banks Securities Trading Available-for-sale Held-to-maturity Loans (1) Retail Wholesale Other assets Total fair value of identifiable assets acquired Fair value of identifiable liabilities assumed Deposits Personal Business and government Bank Other liabilities Total fair value of identifiable liabilities assumed Fair value of identifiable net assets acquired Intangible assets (2) Goodwill Total purchase consideration $ $ 100% 7,138 499 2,779 321 7,409 4,723 9,597 20,555 1,885 $ 47,768 10,481 31,593 169 2,450 $ 44,693 $ 3,075 1,950 2,113 $ 7,138 (1) (2) The fair value of loans reflects estimates of incurred and expected future credit losses at the acquisition date and interest rate premiums or discounts relative to prevailing market rates. Gross contractual receivables amount to $30.1 billion. Intangible assets primarily include core deposits and customer relationships which are amortized on a straight-line basis over an estimated useful life of 10 years. 170 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements During the year, we revised our preliminary purchase price allocation, primarily due to additional information on certain tax benefits relating to City National’s prior business acquisitions. As a result, goodwill was reduced by $233 million. Since the acquisition date, City National increased our 2016 consolidated revenue and net income by $1,988 million and $290 million, respectively. All results of operations are included in our Wealth Management segment and goodwill is allocated to our U.S. Wealth Management (including City National) CGU (previously called U.S. Wealth Management). Dispositions Insurance On July 1, 2016, we completed the sale of RBC General Insurance Company, which includes certain home and auto insurance manufacturing businesses, including claims, underwriting and product development capabilities, to Aviva Canada Inc. We also entered into an exclusive 15-year distribution agreement with Aviva Canada Inc. to market and sell a full suite of property and casualty insurance products to our existing and new clients. As a result of the transaction, we recorded a pre-tax gain on disposal of $287 million in Non-interest income – Other ($235 million after-tax). Investor & Treasury Services On October 21, 2016, we completed the sale of RBC Investor Services España S.A.U. and its wholly-owned subsidiary to Banco Inversis S.A. The transaction did not have a significant impact on Non-interest income. Wealth Management On November 4, 2015, we entered into a definitive agreement to sell our trust, custody and fund administration business in the Caribbean to SMP Group Limited. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals. As a result of the disposition, the assets and liabilities included in the disposal group are classified as held for sale, measured at the lower of their carrying amount and fair value less costs to sell and presented in Other assets and Other liabilities. The major classes of assets, liabilities and equity that are included in the disposal group are not significant. On August 28, 2015, we completed the sale of Royal Bank of Canada (Suisse) SA, announced on July 14, 2015. The transaction did not have a significant impact on our Consolidated Statements of Income. Personal & Commercial Banking On July 31, 2015, we completed the sale of RBC Royal Bank (Suriname) N.V., announced on April 1, 2015. As a result of the transaction, we recorded a total loss on disposal of $19 million (before and after-tax), consisting of a loss of $23 million in the second quarter included in Non-interest expense – Other, and a gain of $4 million in the third quarter primarily relating to foreign currency translation gains reclassified from Other components of equity. On June 27, 2014, we completed the sale of RBC Royal Bank (Jamaica) Limited and RBTT Securities Jamaica Limited to Sagicor Group Jamaica Limited, as announced on January 29, 2014. As a result of the transaction, we recorded a total loss on disposal of $100 million (before and after-tax), including a loss of $60 million in the first quarter and $40 million primarily relating to foreign currency translation losses reclassified from Other components of equity in the third quarter of 2014. The loss on disposal has been included in Non-Interest expense – Other. Note 12 Joint ventures and associated companies The following table summarizes the carrying value of our interests in joint ventures and associated companies accounted for under the equity method as well as our share of the income of those entities. (Millions of Canadian dollars) Carrying amount Share of: Net income Other comprehensive income Joint ventures Associated companies As at and for the year ended October 31 2016 151 $ October 31 2015 223 $ October 31 2014 180 $ October 31 2016 465 $ October 31 2015 137 $ October 31 2014 115 $ 124 (5) 119 $ 119 8 127 $ 131 5 136 $ $ 52 – 52 $ 30 2 32 $ 31 – 31 We do not have any joint ventures or associated companies that are individually material to our financial results. During the year ended October 31, 2016, we reversed previously recognized impairment losses of $8 million with respect to our interests in associated companies (October 31, 2015 – impairment losses of $3 million; October 31, 2014 – $nil) and recognized no gains on sales of associated companies (October 31, 2015 – $nil; October 31, 2014 – $62 million). Certain of our subsidiaries, joint ventures and associates are subject to regulatory requirements of the jurisdictions in which they operate. When these subsidiaries, joint ventures and associates are subject to such requirements, they may be restricted from transferring to us our share of their assets in the form of cash dividends, loans or advances. As at October 31, 2016, restricted net assets of these subsidiaries, joint ventures and associates were $28.4 billion (October 31, 2015 - $30.8 billion). Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 171 Note 13 Other assets (Millions of Canadian dollars) Cash collateral Margin deposits Receivable from brokers, dealers and clients Accounts receivable and prepaids Investments in joint ventures and associates Employee benefit assets Insurance-related assets Collateral loans Policy loans Reinsurance assets Other Deferred income tax asset Taxes receivable Accrued interest receivable Precious metals Other Note 14 Deposits The following table details our deposit liabilities. As at October 31 2016 $ 18,979 4,308 2,458 3,487 616 29 October 31 2015 $ 18,619 4,399 2,608 2,843 360 245 1,198 98 713 43 2,827 2,264 1,870 306 2,875 1,176 106 683 576 2,072 2,343 1,757 106 3,979 $ 42,071 $ 41,872 October 31, 2016 October 31, 2015 As at (Millions of Canadian dollars) Personal Business and government Bank Demand (1) $ 128,206 221,506 8,533 Notice (2) $ 46,096 10,740 49 Term (3) $ 76,248 255,761 10,450 Total $ 250,550 488,007 19,032 Demand (1) $ 128,101 175,931 7,711 Notice (2) $ 19,758 6,854 23 Term (3) $ 72,707 272,793 13,349 Total $ 220,566 455,578 21,083 $ 358,245 $ 56,885 $ 342,459 $ 757,589 $ 311,743 $ 26,635 $ 358,849 $ 697,227 Non-interest-bearing (4) Canada United States Europe (5) Other International Interest-bearing (4) Canada United States Europe (5) Other International $ 78,692 34,172 1,009 5,753 $ 4,686 93 – 4 $ – – – – $ 83,378 34,265 1,009 5,757 $ 70,286 1,158 1,172 6,706 $ 3,754 31 – 6 $ – – – – $ 74,040 1,189 1,172 6,712 200,911 999 32,864 3,845 14,979 32,388 1,108 3,627 272,999 41,427 17,966 10,067 488,889 74,814 51,938 17,539 192,736 4,177 31,554 3,954 13,529 4,966 606 3,743 269,395 67,710 12,270 9,474 475,660 76,853 44,430 17,171 $ 358,245 $ 56,885 $ 342,459 $ 757,589 $ 311,743 $ 26,635 $ 358,849 $ 697,227 (1) (2) (3) (4) (5) Deposits payable on demand include all deposits for which we do not have the right to require notice of withdrawal. These deposits include both savings and chequing accounts. Deposits payable after notice include all deposits for which we can legally require notice of withdrawal. These deposits are primarily savings accounts. Term deposits include deposits payable on a fixed date. These deposits include term deposits, guaranteed investment certificates and similar instruments. The geographical splits of the deposits are based on the point of origin of the deposits and where the revenue is recognized. As at October 31, 2016, deposits denominated in U.S. dollars, British pounds, Euro and other foreign currencies were $264 billion, $16 billion, $37 billion and $29 billion, respectively (October 31, 2015 – $235 billion, $13 billion, $32 billion and $28 billion). Europe includes the United Kingdom, Luxembourg and the Channel Islands. The following table presents the contractual maturities of our term deposit liabilities. (Millions of Canadian dollars) Within 1 year: less than 3 months 3 to 6 months 6 to 12 months 1 to 2 years 2 to 3 years 3 to 4 years 4 to 5 years Over 5 years Aggregate amount of term deposits in denominations of one hundred thousand dollars or more 172 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements As at October 31 2016 October 31 2015 $ 72,346 40,487 51,608 50,676 39,499 31,482 29,854 26,507 $ 78,735 49,900 61,096 43,674 39,809 26,792 30,184 28,659 $ 342,459 $ 358,849 $ 309,000 $ 331,000 The following table presents the average deposit balances and average rates of interest. (Millions of Canadian dollars, except for percentage amounts) Canada United States Europe Other International Note 15 Insurance October 31, 2016 Average balances $ 561,711 113,125 50,341 24,454 Average rates 0.84% 0.37 0.15 1.07 For the year ended October 31, 2015 Average balances $ 526,544 70,100 48,173 22,630 Average rates 0.98% 0.31 0.28 0.95 October 31, 2014 Average balances $ 477,316 52,058 43,429 20,299 Average rates 1.13% 0.30 0.21 1.03 $ 749,631 0.73% $ 667,447 0.86% $ 593,102 0.99% Risk management Insurance risk is the risk of fluctuations in the timing, frequency or severity of insured events, relative to our expectations at the time of underwriting. We do not have a high degree of concentration risk due to our geographic diversity and business mix. Concentration risk is not a major concern for the life and health insurance business as it does not have a material level of regional specific characteristics like those exhibited in the property and casualty insurance business. Exposure to concentrations of insurance risks for the property and casualty business, up to the sale of certain home and auto insurance manufacturing businesses to Aviva Canada Inc. on July 1, 2016, was primarily mitigated through prudent underwriting practices and diversification by product offerings and geographical areas. Reinsurance is also used for all insurance businesses to lower our risk profile and limit the liability on a single claim. We manage underwriting and pricing risk through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted, pricing policies by product line and centralized control of policy wordings. The risk that claims are handled or paid inappropriately is mitigated by using a range of IT system controls and manual processes conducted by experienced staff. These, together with a range of detailed policies and procedures, ensure that all claims are handled in a timely, appropriate and accurate manner. Reinsurance In the ordinary course of business, our insurance operations reinsure risks to other insurance and reinsurance companies in order to lower our risk profile, limit loss exposure to large risks, and provide additional capacity for future growth. These ceding reinsurance arrangements do not relieve our insurance subsidiaries from their direct obligations to the insureds. We evaluate the financial condition of the reinsurers and monitor our concentrations of credit risks to minimize our exposure to losses from reinsurer insolvency. Reinsurance amounts (ceded premiums) included in Non-interest income are shown in the table below. Net premiums and claims (Millions of Canadian dollars) Gross premiums Premiums ceded to reinsurers Net premiums Gross claims and benefits Reinsurers’ share of claims and benefits Net claims October 31 2016 4,335 (1,160) $ For the year ended October 31 2015 4,721 (1,214) $ October 31 2014 4,962 (1,220) $ $ $ $ 3,175 3,754 (546) 3,208 $ $ $ 3,507 3,237 (496) 2,741 $ $ $ 3,742 3,692 (498) 3,194 Insurance claims and policy benefit liabilities All actuarial assumptions are set in conjunction with Canadian Institute of Actuaries Standards of Practice and OSFI requirements. The assumptions that have the greatest effect on the measurement of insurance liabilities, the processes used to determine them and the assumptions used as at October 31, 2016 are as follows: Life insurance Mortality and morbidity – Mortality estimates are based on standard industry insured mortality tables, adjusted where appropriate to reflect our own experience. Morbidity assumptions are made with respect to the rates of claim incidence and claim termination for health insurance policies and are based on a combination of industry and our own experience. Future investment yield – Assumptions are based on the current yield rate, a reinvestment assumption and an allowance for future credit losses for each line of business, and are developed using interest rate scenario testing, including prescribed scenarios for determination of minimum liabilities as set out in the actuarial standards. Policyholder behaviour – Under certain policies, the policyholder has a contractual right to change benefits and premiums, as well as convert policies to permanent forms of insurance. All policyholders have the right to terminate their policies through lapse. Lapses represent the termination of policies due to non-payment of premiums. Lapse assumptions are primarily based on our recent experience adjusted for emerging industry experience where applicable. Non-life insurance Assumptions related to unpaid claims concern the patterns of development of claims from inception to ultimate settlement. The reserving assumptions, based on historical paid/incurred development patterns adjusted for changes in products, claims processes and legislative trends, result in a collective loss ratio when compared with earned premium. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 173 Note 15 Insurance (continued) Significant insurance assumptions Life Insurance Canadian Insurance Mortality rates (1) Morbidity rates (2) Reinvestment yield (3) Lapse rates (4) International Insurance Mortality rates (1) Reinvestment yield (3) Non-life Insurance Expected loss ratio (5) (6) As at October 31 2016 October 31 2015 0.13% 1.68 4.00 0.50 0.43 2.75 n.a. 0.12% 1.69 3.45 0.50 0.46 2.75 60.47 (1) (2) (3) (4) (5) (6) n.a. Average annual death rate for the largest portfolio of insured policies. Average net settlement rate for the individual and group disability insurance portfolio. Ultimate reinvestment rate of the insurance operations. Ultimate policy termination rate (lapse rate) for the largest permanent life insurance portfolio that relies on higher termination rate to maintain its profitability (lapse-supported policies). Ratio of incurred claim losses and claim expenses to net premiums of the property and casualty business, measuring the profitability or loss experience on our total book of business. Due to the sale of RBC General Insurance Company to Aviva Canada Inc. in 2016, which includes certain home and auto insurance manufacturing businesses, the expected loss ratio included above is no longer applicable. Refer to Note 11. not applicable Insurance claims and policy benefit liabilities The following table summarizes our gross and reinsurers’ share of insurance liabilities at the end of the year. (Millions of Canadian dollars) Life insurance policyholder liabilities Life, health and annuity Investment contracts (1) Non-life insurance policyholder liabilities Unearned premium provision (1) Unpaid claims provision As at October 31, 2016 October 31, 2015 Gross Ceded Net Gross Ceded Net $ $ $ $ $ 9,137 $ 22 9,159 $ 545 $ – 545 $ 8,592 22 8,614 23 $ 27 50 $ – $ 4 4 $ 23 23 46 9,209 $ 549 $ 8,660 $ $ $ $ $ 8,084 $ 10 8,094 $ 450 $ 1,026 1,476 $ 9,570 $ 519 $ – 519 $ – $ 38 38 $ 557 $ 7,565 10 7,575 450 988 1,438 9,013 (1) Insurance liabilities for investment contracts and unearned premium provision are reported in Other liabilities on the Consolidated Balance Sheets. Reconciliation of life insurance policyholder liabilities (Millions of Canadian dollars) Balances, beginning of the year New and in-force policies Changes in assumption and methodology Net change in investment contracts Balances, end of the year Reconciliation of non-life insurance policyholder liabilities (Millions of Canadian dollars) Balances, beginning of the year Changes in unearned premiums provision Written premiums Less: Net premiums earned Less: Disposal (1) Changes in unpaid claims provision and adjustment expenses Incurred claims Less: Claims paid Less: Disposal (1) Balances, end of the year (1) October 31, 2016 $ Gross 8,094 $ 1,132 (78) 11 $ 9,159 $ Ceded 519 $ 26 – – 545 $ $ Net 7,575 1,106 (78) 11 October 31, 2015 Gross 7,560 $ 598 (69) 5 Ceded 390 $ 129 – – Net 7,170 469 (69) 5 8,614 $ 8,094 $ 519 $ 7,575 October 31, 2016 October 31, 2015 Gross 1,476 $ $ Ceded 38 $ Net 1,438 $ Gross 1,429 $ Ceded 29 $ Net 1,400 665 (665) (429) 482 (439) (1,040) 19 (21) – 18 (4) (46) 646 (644) (429) 464 (435) (994) 937 (906) – 614 (598) – 39 (39) – 27 (18) – 898 (867) – 587 (580) – $ 50 $ 4 $ 46 $ 1,476 $ 38 $ 1,438 RBC General Insurance Company was sold to Aviva Canada Inc. in 2016, which includes certain home and auto insurance manufacturing businesses. Refer to Note 11. 174 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements The net decrease in Insurance claims and policy benefit liabilities over the prior year was comprised of the decrease in liabilities resulting from the impact of the sale of certain home and auto insurance manufacturing businesses (refer to Note 11), partially offset by the net increase in life and health, reinsurance and property and casualty liabilities attributable to business growth and market movements on assets backing life and health liabilities. During the year, we reviewed all key actuarial methods and assumptions which are used in determining the policy benefit liabilities resulting in a $78 million net decrease to insurance liabilities comprised of: (i) a decrease of $72 million for assumption updates due to net favourable interest rate and equity market changes; (ii) a decrease of $13 million due to valuation system and data changes; and (iii) an increase of $7 million arising from insurance risk related assumption updates largely due to mortality, morbidity, maintenance, property and casualty margin for adverse deviation and expense assumptions. Changes in Insurance claims and policy benefit liabilities are included in Insurance policyholder benefits, claims and acquisition expenses in our Consolidated Statements of Income in the period in which the estimates changed. Sensitivity analysis The following table presents the sensitivity of the level of insurance policyholder liabilities disclosed in this note to reasonably possible changes in the actuarial assumptions used to calculate them. The percentage change in variable is applied to a range of existing actuarial modelling assumptions to derive the possible impact on net income. The disclosure is not intended to explain the impact of a percentage change in the insurance assets and liabilities disclosed above. The analyses are performed where a single assumption is changed while holding other assumptions constant, which is unlikely to occur in practice. (Millions of Canadian dollars, except for percentage amounts) Increase in market interest rates (1) Decrease in market interest rates (1) Increase in equity market values Decrease in equity market values Increase in maintenance expenses Life Insurance Adverse change in annuitant mortality rates Adverse change in assurance mortality rates Adverse change in morbidity rates Adverse change in lapse rates Non-life Insurance Increase in expected loss ratio (2) Change in variable 1% 1 10 10 5 2 2 5 10 5 Net income impact for year ended $ October 31 2016 (2) 7 4 (4) (30) $ October 31 2015 – 14 3 (2) (28) (129) (46) (183) (229) n.a. (117) (48) (156) (206) (9) (1) (2) n.a. Sensitivities for market interest rates have been calculated by increasing or decreasing 100 basis points at all points on the yield curve, with changes persisting for one year. Due to the sale of RBC General Insurance Company to Aviva Canada Inc. in 2016, which includes certain home and auto insurance manufacturing businesses, the expected loss ratio included above is no longer applicable. Refer to Note 11. not applicable Note 16 Segregated funds We offer certain individual variable insurance contracts that allow policyholders to invest in segregated funds. The investment returns on these funds are passed directly to the policyholders. Amounts invested are at the policyholders’ risk, except where the policyholders have selected options providing maturity and death benefit guarantees. A liability for the guarantees is recorded in Insurance claims and policy benefit liabilities. Segregated funds net assets are recorded at fair value. All of our segregated funds net assets are categorized as Level 1 in the fair value hierarchy. The fair value of the segregated funds liabilities is equal to the fair value of the segregated funds net assets. Segregated funds net assets and segregated funds liabilities are presented on separate lines on the Consolidated Balance Sheets. The following tables present the composition of net assets and the changes in net assets for the year. Segregated funds net assets (Millions of Canadian dollars) Cash Investment in mutual funds Other liabilities, net Changes in net assets (Millions of Canadian dollars) Net assets, beginning of year Additions (deductions): Deposits from policyholders Net realized and unrealized gains Interest and dividend Payment to policyholders Management and administrative fees Net assets, end of year As at October 31 2016 1 981 (1) $ October 31 2015 – 832 (2) $ $ 981 $ 830 For the year ended October 31 2016 830 $ October 31 2015 675 $ 330 41 25 (221) (24) 321 2 26 (173) (21) $ 981 $ 830 Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 175 Note 17 Employee benefits – Pension and other post-employment benefits Plan characteristics We sponsor a number of programs that provide pension and post-employment benefits to eligible employees. The majority of beneficiaries of the pension plans are located in Canada and other beneficiaries of the pension plans are primarily located in the U.S., the U.K. and the Caribbean. The pension arrangements including investment, plan benefits and funding decisions are governed by local pension committees or trustees, who are legally segregated from the Bank, or management. Significant plan changes require the approval of the Board of Directors. Our defined benefit pension plans provide pension benefits based on years of service, contributions and average earnings at retirement. Our principal defined benefit pension plans are closed to new members. New employees are generally eligible to join defined contribution pension plans. The specific features of these plans vary by location. We also provide supplemental non-registered (non-qualified) pension plans for certain executives and senior management that are typically unfunded or partially funded. Our defined contribution pension plans provide pension benefits based on accumulated employee and Bank contributions. The Bank contributions are based on a percentage of an employee’s annual earnings and a portion of the Bank contribution may be dependent on the amount being contributed by the employee and their years of service. Our primary other post-employment benefit plans provide health, dental, disability and life insurance coverage and cover a number of current and retired employees who are mainly located in Canada. These plans are unfunded unless required by legislation. We measure our benefit obligations and pension assets as at October 31 each year. All plans are valued using the projected unit-credit method. We fund our registered defined benefit pension plans in accordance with actuarially determined amounts required to satisfy employee benefit obligations under current pension regulations. For our primary pension plan, the most recent funding actuarial valuation was completed on January 1, 2016, and the next valuation will be completed on January 1, 2017. For the year ended October 31, 2016, total contributions to our pension plans (defined benefit and defined contribution plans) and other post-employment benefit plans were $409 million and $49 million (October 31, 2015 – $391 million and $56 million), respectively. For 2017, total contributions to our pension plans and other post-employment benefit plans are expected to be $643 million and $77 million, respectively. Risks By their design, the defined benefit pension and other post-employment plans expose the Bank to various risks such as investment performance, reductions in discount rates used to value the obligations, increased longevity of plan members, future inflation levels impacting future salary increases as well as future increases in healthcare costs. By closing membership in our principal defined benefit pension and other post-employment plans and migrating to defined contribution plans, the volatility associated with the aforementioned risks will reduce over time. The following table presents the financial position related to all of our material pension and other post-employment benefit plans worldwide, including executive retirement arrangements. As at October 31, 2016 October 31, 2015 Defined benefit pension plans Other post- employment benefit plans Defined benefit pension plans Other post- employment benefit plans $ 11,416 12,680 $ 1 1,760 $ 10,847 10,840 $ 11 1,569 (1,264) $ (1,759) 7 $ (1,558) $ $ $ 1,043 1,199 (156) $ $ $ – 134 (134) 1 1,894 $ $ $ 1,049 1,134 (85) $ 11,896 11,974 $ $ $ $ (78) – (78) 245 (323) (78) $ $ $ – 88 (88) 11 1,657 $ (1,646) – $ (1,646) $ – (1,646) $ (1,646) (Millions of Canadian dollars) Canada Fair value of plan assets Present value of defined benefit obligation Net (deficit) surplus International Fair value of plan assets Present value of defined benefit obligation Net (deficit) Total Fair value of plan assets Present value of defined benefit obligation $ 12,459 13,879 Total net (deficit) Effect of asset ceiling Total net (deficit), net of effect of asset ceiling Amounts recognized in our Consolidated Balance Sheets Employee benefit assets Employee benefit liabilities Total net (deficit), net of effect of asset ceiling $ $ $ $ (1,420) $ (1,893) (3) – (1,423) $ (1,893) 29 (1,452) (1,423) $ – (1,893) $ (1,893) 176 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements The following table presents an analysis of the movement in the financial position related to all of our material pension and other post- employment benefit plans worldwide, including executive retirement arrangements. (Millions of Canadian dollars) Change in fair value of plan assets Opening fair value of plan assets Interest income Remeasurements – Return on plan assets (excluding interest income) Change in foreign currency exchange rate Contributions – Employer Contributions – Plan participant Payments Payments – amount paid in respect of any settlements Other Closing fair value of plan assets Change in present value of benefit obligation Opening benefit obligation Current service costs Past service costs Interest expense Remeasurements Actuarial losses (gains) from demographic assumptions Actuarial losses (gains) from financial assumptions Actuarial losses (gains) from experience adjustments Change in foreign currency exchange rate Contributions – Plan participant Payments Payments – amount paid in respect of any settlements Business combinations/Disposals Other Closing benefit obligation Unfunded obligation Wholly or partly funded obligation Total benefit obligation As at or for the year ended October 31, 2016 October 31, 2015 Defined benefit pension plans (1) Other post- employment benefit plans Defined benefit pension plans (1) Other post- employment benefit plans $ 11,896 498 $ 447 (138) 257 52 (536) (4) (13) $ 12,459 $ 11 – 2 – 49 18 (79) – – 1 $ 11,351 460 $ 243 113 235 51 (513) (31) (13) $ 11,896 $ 4 – 11 – 56 16 (76) – – 11 $ 11,974 313 (5) 496 $ 1,657 36 (3) 71 $ 11,805 345 (16) 490 $ 1,832 34 – 75 (5) 1,644 79 (128) 52 (536) (4) – (1) (17) 194 17 – 18 (79) – – – 7 (296) (7) 139 51 (513) (31) – – (176) (33) (27) 15 16 (76) – (3) – $ 13,879 $ 33 13,846 $ 13,879 $ 1,894 $ 1,732 162 $ 1,894 $ 11,974 $ 33 11,941 $ 11,974 $ 1,657 $ 332 1,325 $ 1,657 (1) For pension plans with funding deficits, the benefit obligations and fair value of plan assets as at October 31, 2016 were $12,705 million and $11,267 million, respectively (October 31, 2015 – $1,020 million and $709 million, respectively). Pension and other post-employment benefit expense The following table presents the composition of our pension and other post-employment benefit expense related to our material benefit plans worldwide. (Millions of Canadian dollars) Current service costs Past service costs Net interest expense (income) Remeasurements of other long term benefits Administrative expense Defined benefit pension expense Defined contribution pension expense Pension plans Other post-employment benefit plans For the year ended October 31 2016 October 31 2015 $ $ $ 313 $ (5) (2) – 13 319 $ 152 471 $ 345 $ (16) 30 – 12 371 $ 156 527 $ October 31 2014 315 97 14 – 13 439 137 576 $ $ $ October 31 2016 October 31 2015 36 $ (3) 71 16 – 120 $ – 120 $ 34 $ – 75 2 – 111 $ – 111 $ October 31 2014 31 – 80 9 – 120 – 120 Service costs for the year ended October 31, 2016 totalled $300 million (October 31, 2015 – $335 million; October 31, 2014 – $307 million) for pension plans in Canada and $8 million (October 31, 2015 – $(6) million; October 31, 2014 – $105 million) for International plans. Net interest expense (income) for the year ended October 31, 2016 totalled $(6) million (October 31, 2015 – $25 million; October 31, 2014 – $10 million) for pension plans in Canada and $4 million (October 31, 2015 – $5 million; October 31, 2014 – $4 million) for International plans. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 177 Note 17 Employee benefits – Pension and other post-employment benefits (continued) Remeasurements of employee benefit plans The following table presents the composition of our remeasurements recorded in OCI related to our material benefit plans worldwide. (Millions of Canadian dollars) Actuarial (gains) losses: Changes in demographic assumptions Changes in financial assumptions Experience adjustments Return on plan assets (excluding interest based on discount rate) Change in asset ceiling (excluding interest income) $ $ For the year ended Defined benefit pension plans Other post-employment benefit plans October 31 2016 October 31 2015 October 31 2014 October 31 2016 October 31 2015 October 31 2014 (5) $ 7 $ 1,644 79 (447) 3 1,274 $ (296) (7) (243) – $ 76 830 6 (647) – (539) $ 265 $ (20) $ 186 12 (2) – 176 $ (174) $ (30) (34) (11) – (249) $ (54) 113 – – – 59 Remeasurements recorded in OCI for the year ended October 31, 2016 were losses of $1,180 million (October 31, 2015 – gains of $526 million; October 31, 2014 – losses of $238 million) for pension plans in Canada and losses of $94 million (October 31, 2015 – gains of $13 million; October 31, 2014 – losses of $27 million) for International plans. Investment policy and strategies Defined benefit pension plan assets are invested prudently in order to meet our longer-term pension obligations. The pension plan’s investment strategy is to hold a diversified mix of investments by asset class and geographic location in order to reduce investment-specific risk to the funded status while maximizing the expected returns to meet pension obligations. Investment of the plan’s assets is conducted with careful consideration of the pension obligation’s valuation sensitivity to interest rates and credit spreads which are key risk factors impacting the obligation. The asset mix policy is therefore consistent with an asset/liability framework. Factors taken into consideration in developing our asset mix include but are not limited to the following: (i) (ii) (iii) (iv) (v) the nature of the underlying benefit obligations, including the duration and term profile of the liabilities; the member demographics, including expectations for normal retirements, terminations, and deaths; the financial position of the pension plans; the diversification benefits obtained by the inclusion of multiple asset classes; and expected asset returns, including asset and liability volatility and correlations. To implement our asset mix policy, we may invest in equity securities, debt securities, alternative investments and derivative instruments. Our holdings in certain investments, including common shares, emerging market equity and debt, debt securities rated lower than BBB and residential and commercial mortgages, cannot exceed a defined percentage of the market value of our defined benefit pension plan assets. We may use derivative instruments as either a synthetic investment to more efficiently replicate the performance of an underlying security, or as a hedge against financial risks within the plan. To manage our credit risk exposure, counterparties of our derivative instruments are required to meet minimum credit ratings and enter into collateral agreements. Our defined benefit pension plan assets are primarily comprised of equity and debt securities. Our equity securities generally have unadjusted quoted market prices in an active market (Level 1) and our debt securities generally have quoted market prices for similar assets in an active market (Level 2). Alternative investments and other includes cash, hedge funds, and private fund investments including infrastructure, real estate leases, private equity and derivative financial instruments. In the case of private fund investments, no quoted market prices are usually available (Level 2 or Level 3). These fund assets are either valued by an independent valuator or priced using observable market inputs. During the year ended October 31, 2016, investment changes and risk factor diversification continued in support of our efforts to reduce variability in the funded status primarily through improved credit and duration matching between the plan’s assets and liabilities. An increasing allocation to debt securities is used to reduce asset liability duration mismatch and hence variability of the plan’s funded status due to interest rate changes. Longer maturity debt securities, given their price sensitivity to movements in interest rates, are considered to be a good economic hedge to risk associated with the plan’s liabilities, which are discounted using predominately long maturity bond interest rates as inputs. We expect to continue to move towards a higher weighting of debt securities as market conditions permit, to further reduce risk of variability in the funded status. 178 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Asset allocation of defined benefit pension plans (1) (Millions of Canadian dollars, except percentages) Fair value As at October 31, 2016 October 31, 2015 Percentage of total plan assets Quoted in active market (2) Percentage of total plan assets Quoted in active market (2) Fair value Equity securities Domestic Foreign Debt securities Domestic government bonds Foreign government bonds Corporate and other bonds Alternative investments and other $ 1,487 2,971 2,536 533 2,648 2,284 12% 24 20 4 21 19 100% 89 $ 1,277 2,645 – – – 24 2,232 561 2,548 2,633 11% 22 19 5 21 22 100% 98 – – – 8 $ 12,459 100% 38% $ 11,896 100% 34% (1) (2) The asset allocation is based on the underlying investments held directly and indirectly through the funds as this is how we manage our investment policy and strategies. If our assessment of whether or not an asset was quoted in an active market was based on direct investments, 42% of our total plan assets would be classified as quoted in an active market (October 31, 2015 – 36%). The allocation to equity securities of our pension plans in Canada is 37% (October 31, 2015 – 34%) and that of our International plans is 17% (October 31, 2015 – 17%). The allocation to debt securities of our pension plans in Canada is 45% (October 31, 2015 – 44%) and that of our International plans is 60% (October 31, 2015 – 57%). The allocation to alternative investments and other in our pension plans in Canada is 18% (October 31, 2015 – 22%) and that of our International plans is 23% (October 31, 2015 – 26%). As at October 31, 2016, the plan assets include 1 million (October 31, 2015 – 1 million) of our common shares with a fair value of $99 million (October 31, 2015 – $85 million) and $62 million (October 31, 2015 – $71 million) of our debt securities. For the year ended October 31, 2016, dividends received on our common shares held in the plan assets were $4 million (October 31, 2015 – $4 million). Maturity profile The following table presents the maturity profile of our defined benefit pension plan obligation. (Millions of Canadian dollars, except participants and years) Number of plan participants Actual benefit payments 2016 Benefits expected to be paid 2017 Benefits expected to be paid 2018 Benefits expected to be paid 2019 Benefits expected to be paid 2020 Benefits expected to be paid 2021 Benefits expected to be paid 2022-2026 Weighted average duration of defined benefit payments As at October 31, 2016 Canada International Total $ 72,748 481 $ 551 576 598 619 639 3,454 15.7 years 8,595 59 $ 51 51 52 58 59 331 19.1 years 81,343 540 602 627 650 677 698 3,785 16.0 years Significant assumptions Our methodologies to determine significant assumptions used in calculating the defined benefit pension and other post-employment benefit expense are as follows: Discount rate For the Canadian pension and other post-employment benefit plans, all future expected benefit payments at each measurement date are discounted at spot rates from a derived AA corporate bond yield curve. The derived curve is based on actual short and mid-maturity corporate AA rates and extrapolated longer term rates. The extrapolated corporate AA rates are derived from observed corporate A, corporate AA and provincial AA yields. For the International pension and other post-employment benefit plans, all future expected benefit payments at each measurement date are discounted at spot rates from an AA corporate bond yield curve. Spot rates beyond 30 years are set to equal the 30-year spot rate. The discount rate is the equivalent single rate that produces the same discounted value as that determined using the entire discount curve. This valuation methodology does not rely on assumptions regarding reinvestment returns. Rate of increase in future compensation The assumptions for increases in future compensation are developed separately for each plan, where relevant. Each assumption is set based on the price inflation assumption and compensation policies in each market, as well as relevant local statutory and plan-specific requirements. Healthcare cost trend rates Healthcare cost calculations are based on both short and long term trend assumptions established based on the plan’s recent experience as well as market expectations. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 179 Note 17 Employee benefits – Pension and other post-employment benefits (continued) Weighted average assumptions to determine benefit obligation Discount rate Rate of increase in future compensation Healthcare cost trend rates (1) – Medical – Dental As at Defined benefit pension plans Other post-employment benefit plans October 31 2016 October 31 2015 October 31 2014 October 31 2016 October 31 2015 October 31 2014 3.50% 3.30% n.a. n.a. 4.30% 3.30% n.a. n.a. 4.10% 3.30% n.a. n.a. 3.60% n.a. 4.10% 4.00% 4.40% n.a. 4.10% 4.00% 4.20% n.a. 3.50% 4.00% (1) n.a. For our other post-employment benefit plans, the 2016 assumed trend rates used to measure the expected benefit costs of the defined benefit obligations are also the ultimate trend rates. not applicable Mortality assumptions Mortality assumptions are significant in measuring our obligations under the defined benefit pension plans. These assumptions have been set based on country specific statistics. Future longevity improvements have been considered and included where appropriate. The following table summarizes the mortality assumptions used for major plans. As at October 31, 2016 October 31, 2015 Life expectancy at 65 for a member currently at Life expectancy at 65 for a member currently at Age 65 Age 45 Age 65 Age 45 Male Female Male Female Male Female Male Female 23.1 20.8 24.0 23.6 22.8 26.0 24.1 20.5 26.1 24.6 22.9 28.3 23.1 21.2 24.0 23.6 23.2 25.9 24.1 21.7 26.0 24.5 24.1 28.2 (In years) Country Canada United States United Kingdom Sensitivity analysis Assumptions adopted can have a significant effect on the obligations for defined benefit pension and other post-employment benefit plans. The increase (decrease) in obligation in the following table has been determined assuming all other assumptions are held constant. In practice, this is unlikely to occur, as changes in some of the assumptions may be correlated. The following table presents the sensitivity analysis of key assumptions for 2016. (Millions of Canadian dollars) Discount rate Impact of 50bps increase in discount rate Impact of 50bps decrease in discount rate Rate of increase in future compensation Impact of 50bps increase in rate of increase in future compensation Impact of 50bps decrease in rate of increase in future compensation Mortality rate Impact of an increase in longevity by one additional year Healthcare cost trend rate Impact of 100bps increase in healthcare cost trend rate Impact of 100bps decrease in healthcare cost trend rate n.a. not applicable Defined benefit pension plans – Increase (decrease) in obligation Other post-employment benefit plans – Increase (decrease) in obligation $ (1,048) $ 1,176 68 (69) 333 n.a. n.a. (137) 152 1 (1) 37 113 (92) 180 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 18 Other liabilities (Millions of Canadian dollars) Cash collateral Accounts payable and accrued expenses Payroll and related compensation Payable to brokers, dealers and clients Negotiable instruments Accrued interest payable Deferred income Taxes payable Precious metals certificates Dividends payable Insurance related liabilities Deferred income taxes Provisions Employee benefit liabilities Other Note 19 Subordinated debentures As at October 31 2016 14,545 $ 1,191 6,448 2,919 2,277 1,630 1,971 2,730 485 1,309 328 989 485 3,345 7,295 47,947 $ $ $ October 31 2015 15,249 999 6,358 2,981 2,309 1,679 2,028 1,533 420 1,194 735 201 512 1,969 5,309 43,476 The debentures are unsecured obligations and are subordinated in right of payment to the claims of depositors and certain other creditors. The amounts presented below are net of our own holdings in these debentures, and include the impact of fair value hedges used for managing interest rate risk. (Millions of Canadian dollars, except percentage and foreign currency) Maturity November 14, 2014 (1) August 12, 2019 June 15, 2020 November 2, 2020 July 15, 2022 June 8, 2023 July 17, 2024 (6) December 6, 2024 June 4, 2025 (6) January 20, 2026 (6) January 27, 2026 (6) September 29, 2026 (6) November 1, 2027 June 26, 2037 October 1, 2083 June 29, 2085 Deferred financing costs Earliest par value redemption date June 15, 2015 (2) November 2, 2015 (4) July 17, 2019 December 6, 2019 June 4, 2020 January 20, 2021 September 29, 2021 November 1, 2022 June 26, 2017 Any interest payment date Any interest payment date Interest rate 10.00% 9.00% 4.35% (3) 3.18% (5) 5.38% 9.30% 3.04% (7) 2.99% (8) 2.48% (9) 3.31% (10) 4.65% 3.45% (11) 4.75% 2.86% (12) (13) Denominated in foreign currency (millions) US$75 US$150 US$1,500 TT$300 JPY 10,000 US$174 As at $ October 31 2016 – 115 – – 218 110 1,014 2,055 1,003 1,496 2,057 1,061 60 131 224 233 $ October 31 2015 – – – 1,500 – 110 1,014 2,061 1,004 – – 1,055 62 112 224 227 $ $ 9,777 (15) 9,762 $ $ 7,369 (7) 7,362 The terms and conditions of the debentures are as follows: (1) (2) (3) (4) (5) (6) All $200 million outstanding 10.00% subordinated debentures matured on November 14, 2014. All $1.5 billion outstanding subordinated debentures were redeemed on June 15, 2015 for 100% of their principal amount plus accrued interest to the redemption date. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.41% above the 90-day Bankers’ Acceptance rate. All $1.5 billion outstanding subordinated debentures were redeemed on November 2, 2015 for 100% of their principal amount plus accrued interest to the redemption date. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.21% above the 90-day Bankers’ Acceptance rate. The notes include non-viability contingency capital (NVCC) provisions, necessary for the notes to qualify as Tier 2 regulatory capital under Basel III. NVCC provisions require the conversion of the instrument into a variable number of common shares in the event that OSFI deems the Bank non-viable or a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection. In such an event, each note is convertible into common shares pursuant to an automatic conversion formula with a multiplier of 1.5 and a conversion price based on the greater of: (i) a floor price of $5.00 and (ii) the current market price of our common shares based on the volume weighted average trading price of our common shares on the Toronto Stock Exchange. The number of shares issued is determined by dividing the par value of the note (including accrued and unpaid interest on such note) by the conversion price and then times the multiplier. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.08% above the 90-day Bankers’ Acceptance rate. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.10% above the 90-day Bankers’ Acceptance rate. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.10% above the 90-day Bankers’ Acceptance rate. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 2.35% above the 90-day Bankers’ Acceptance rate. Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.12% above the 90-day Bankers’ Acceptance rate. Interest at a rate of 40 basis points above the 30-day Bankers’ Acceptance rate. Interest at a rate of 25 basis points above the U.S. dollar 3-month London Interbank Mean Rate (LIMEAN). In the event of a reduction of the annual dividend we declare on our common shares, the interest payable on the debentures is reduced pro rata to the dividend reduction and the interest reduction is payable with the proceeds from the sale of newly issued common shares. (7) (8) (9) (10) (11) (12) (13) Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 181 Note 19 Subordinated debentures (continued) All redemptions, cancellations and exchanges of subordinated debentures are subject to the consent and approval of OSFI, except for the debentures maturing on August 12, 2019 and July 15, 2022. Maturity schedule The aggregate maturities of subordinated debentures, based on the maturity dates under the terms of issue, are as follows: (Millions of Canadian dollars) 1 to 5 years 5 to 10 years Thereafter Note 20 Trust capital securities October 31 2016 115 9,014 648 $ $ 9,777 We issued innovative capital instruments, RBC Trust Capital Securities (RBC TruCS), through the structured entity RBC Capital Trust (Trust). The Trust has issued non-voting RBC TruCS Series 2010, 2011, 2015 and 2008-1 (RBC TruCS 2010, 2011, 2015 and 2008-1). RBC TruCS 2010 and 2011 were redeemed in 2010 and 2011, respectively. On December 31, 2015, the Trust redeemed all issued and outstanding RBC TruCS 2015 for cash at a redemption price of $1,000 per unit. The holders of the remaining outstanding RBC TruCS do not have any conversion rights or any other redemption rights. As a result, upon consolidation of the Trust, RBC TruCS are classified as non-controlling interests. Holders of RBC TruCS 2008-1 are eligible to receive semi-annual non-cumulative fixed cash distributions until June 30, 2018, and floating-rate cash distributions thereafter. No cash distributions will be payable by the Trust on RBC TruCS if we fail to declare regular dividends (i) on our preferred shares, or (ii) on our common shares if no preferred shares are then outstanding. In this case, the net distributable funds of the Trust will be distributed to us as holders of residual interest in the Trust. Should the Trust fail to pay the semi-annual distributions in full, we will not declare dividends of any kind on any of our preferred or common shares for a specified period of time. The table below presents the significant terms and conditions of RBC TruCS. Significant terms and conditions of RBC Trust Capital Securities (Millions of Canadian dollars, except for percentage amounts) Issuance date Distribution dates RBC Capital Trust (1) (2) (3) (4) (5) (6) Included in Non-controlling interests As at Earliest redemption date At the option of the issuer October 31 2016 Principal amount October 31 2015 Principal amount Annual yield 1,200,000 Trust Capital Securities – Series 2015 500,000 Trust Capital Securities – Series 2008-1 October 28, 2005 April 28, 2008 June 30, December 31 June 30, December 31 4.87% (7) December 31, 2010 6.82% (7) June 30, 2013 $ $ – 500 1,200 500 The significant terms and conditions of the RBC TruCS are as follows: (1) (2) (3) (4) (5) (6) (7) Subject to the approval of OSFI, the Trust may, on the earliest redemption date specified above, and on any distribution date thereafter, redeem in whole (but not in part) RBC TruCS 2008-1, without the consent of the holders. RBC TruCS 2015 were redeemed on December 31, 3015. Subject to the approval of OSFI, upon occurrence of a special event as defined in the RBC TruCS 2008-1 prospectus, prior to the earliest redemption date specified above, the Trust may redeem in whole (but not in part) the RBC TruCS 2008-1 without the consent of the holders. Issuer Redemption Price: RBC TruCS 2008-1 may be redeemed for cash equivalent to (i) the Early Redemption Price, if the redemption occurs prior to June 30, 2018 or (ii) the Redemption Price, if the redemption occurs on or after June 30, 2018. RBC TruCS 2015 were redeemable for cash equivalent to (i) the Early Redemption Price, prior to December 31, 2015, and (ii) the Redemption Price, on or after December 31, 2015. Redemption Price refers to an amount equal to $1,000 plus the unpaid distributions to the redemption date. Early Redemption Price refers to an amount equal to the greater of (i) the Redemption Price and (ii) the price calculated to provide an annual yield, equal to the yield on a Government of Canada bond issued on the redemption date with a maturity date of June 30, 2018, plus 77 basis points, for RBC TruCS 2008-1, and a maturity date of December 31, 2015, plus 19.5 basis points, for RBC TruCS 2015. Automatic Exchange Event: Without the consent of the holders, each RBC TruCS 2008-1 will be exchanged automatically for 40 of our non-cumulative redeemable First Preferred Shares Series AI, upon occurrence of any of the following events: (i) proceedings are commenced for our winding-up; (ii) OSFI takes control of us; (iii) we have a Tier 1 capital ratio of less than 5% or Total capital ratio of less than 8%; or (iv) OSFI has directed us to increase our capital or provide additional liquidity and we elect such automatic exchange or we fail to comply with such direction. The First Preferred Shares Series AI pay semi-annual non-cumulative cash dividends. Without the consent of the holders, each RBC TruCS 2015 was automatically exchangeable for 40 of our non-cumulative redeemable First Preferred Shares Series Z, upon occurrence of any of the aforementioned exchange events. From time to time, we purchase some of the innovative capital instruments and hold them temporarily. As at October 31, 2016, we held $nil RBC TruCS 2008-1 (October 31, 2015 – $6 million) as treasury holdings. Treasury holdings are deducted from regulatory capital. Regulatory capital: In accordance with OSFI Capital Adequacy Requirements, effective January 2013, RBC TruCS no longer qualify as additional Tier 1 capital due to their lack of non-viability contingent capital terms and conditions. As such, outstanding RBC TruCS are being phased out of regulatory capital in accordance with OSFI guidelines. The non-cumulative cash distribution on the RBC TruCS 2015 was 4.87% paid semi-annually until December 31, 2015. The non-cumulative cash distribution on the RBC TruCS 2008-1 will be 6.82% paid semi-annually until June 30, 2018, and one half of the sum of 180-day Bankers’ Acceptance rate plus 3.5% thereafter. 182 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 21 Equity Share capital Authorized share capital Preferred – An unlimited number of First Preferred Shares and Second Preferred Shares without nominal or par value, issuable in series; the aggregate consideration for which all the First Preferred Shares and all the Second Preferred Shares that may be issued may not exceed $20 billion and $5 billion, respectively. Common – An unlimited number of shares without nominal or par value may be issued. Outstanding share capital The following table details our common and preferred shares outstanding. (Millions of Canadian dollars, except the number of shares and dividends per share) Preferred shares First preferred (1) Non-cumulative, fixed rate Series W Series AA Series AB Series AC Series AD Series AE Series AF Series AG Series BH Series BI Series BJ Series C-1 (2) Non-cumulative, 5-Year Rate Reset Series AJ (3) Series AL Series AX (4) Series AZ Series BB Series BD Series BF Series BK (5) Series BM (6) Non-cumulative, floating rate Series AK (3) Non-cumulative, fixed rate/floating rate Series C-2 (7) Common shares Balance at beginning of year Issued in connection with the acquisition of City National Issued in connection with share-based compensation plans (8) Purchased for cancellation (9) Balance at end of year Treasury shares – Preferred shares Balance at beginning of year Sales Purchases Balance at end of year Treasury shares – Common shares Balance at beginning of year Sales Purchases Balance at end of year As at October 31, 2016 October 31, 2015 Number of shares (thousands) Dividends declared per share Number of shares (thousands) Dividends declared per share Amount Amount $ 1.23 1.11 1.18 1.15 1.13 1.13 1.11 1.13 0.58 0.42 – – 0.88 1.07 – 1.00 0.98 0.73 0.63 – – 0.67 – $ 3.08 12,000 12,000 12,000 8,000 10,000 10,000 8,000 10,000 6,000 6,000 6,000 82 13,579 12,000 – 20,000 20,000 24,000 12,000 29,000 30,000 2,421 20 $ 300 300 300 200 250 250 200 250 150 150 150 107 339 300 – 500 500 600 300 725 750 61 $ 1.23 1.11 1.18 1.15 1.13 1.13 1.11 1.13 1.23 1.23 1.51 US$ 55.00 0.88 1.07 – 1.00 0.98 0.90 0.90 1.29 0.98 0.60 $ 12,000 12,000 12,000 8,000 10,000 10,000 8,000 10,000 6,000 6,000 6,000 – 13,579 12,000 – 20,000 20,000 24,000 12,000 – – 2,421 300 300 300 200 250 250 200 250 150 150 150 – 339 300 – 500 500 600 300 – – 61 31 $ 6,713 US$ 67.50 – – $ 5,100 $ 3.24 1,443,423 41,619 $ 14,573 3,115 4,981 (4,629) 1,485,394 307 (56) $ 17,939 (63) 7,267 (7,173) 31 532 64,678 (66,369) (1,159) $ $ $ $ (2) 172 (170) – 38 4,973 (5,091) (80) 1,442,233 – $ 14,511 – 1,190 – 1,443,423 62 – $ 14,573 1 4,736 (4,800) (63) 892 78,852 (79,212) 532 $ $ $ $ – 117 (119) (2) 71 6,098 (6,131) 38 (1) (2) (3) (4) (5) (6) (7) (8) (9) First Preferred Shares were issued at $25 per share with the exception of Non-Cumulative Perpetual First Preferred Shares, Series C-1 (Series C-1) and Non-Cumulative Fixed Rate/Floating Rate First Preferred Shares, Series C-2 (Series C-2) which were issued at US$25 per depositary share. On November 2, 2015, we issued 175 thousand Series C-1, totalling $227 million, in connection with the acquisition of City National. On February 24, 2016, we purchased for cash 3,717,969 depositary shares, each representing a one-fortieth interest in a share of Series C-1. The purchased depositary and underlying Series C-1 shares were subsequently cancelled. On February 24, 2014, we issued 2.4 million Non-Cumulative Floating Rate First Preferred Shares, Series AK, totalling $61 million through a holder option, one-for-one conversion of some of our Non-Cumulative 5-year Rate Reset First Preferred Shares, Series AJ. On November 24, 2014, we redeemed all 13 million of issued and outstanding Non-Cumulative 5-year Rate Reset First Preferred Shares Series AX for cash at a redemption price of $25 per share. On December 16, 2015, we issued 27 million Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series BK (Series BK) and on December 31, 2015, we issued an additional 2 million Series BK, totalling $725 million. On March 7, 2016, we issued 30 million Non-Cumulative 5-year Rate Reset First Preferred Shares, Series BM, totalling $750 million. On November 2, 2015, we issued 100 thousand Series C-2, totalling $153 million, in connection with the acquisition of City National. On February 24, 2016, we purchased for cash 3,184,562 depositary shares, each representing a one-fortieth interest in a share of Series C-2. The purchased depositary and underlying Series C-2 shares were subsequently cancelled. Includes fair value adjustments to stock options of $60 million (2015 – $7 million). During the year ended October 31, 2016, we purchased common shares for cancellation at an average cost of $78.10 per share with a book value of $12.03 per share. During the year ended October 31, 2015, we did not purchase any common shares for cancellation. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 183 Note 21 Equity (continued) Significant terms and conditions of preferred shares As at October 31, 2016 Preferred shares First preferred Non-cumulative, fixed rate Series W (4) Series AA Series AB Series AC Series AD Series AE Series AF Series AG Series BH (5) Series BI (5) Series BJ (5) Series C-1 (6) Initial Period Annual Yield Premium Current Dividend per share (1) Earliest redemption date (2) Issue Date Redemption price (2), (3) 4.90% 4.45% 4.70% 4.60% 4.50% 4.50% 4.45% 4.50% 4.90% 4.90% 5.25% 5.50% $ January 31, 2005 $ February 24, 2010 .306250 April 4, 2006 May 24, 2011 .278125 July 20, 2006 .293750 August 24, 2011 November 1, 2006 .287500 November 24, 2011 February 24, 2012 December 13, 2006 .281250 January 19, 2007 February 24, 2012 .281250 March 14, 2007 May 24, 2012 .278125 April 26, 2007 .281250 May 24, 2012 June 5, 2015 .306250 November 24, 2020 .306250 November 24, 2020 July 22, 2015 October 2, 2015 February 24, 2021 .328125 US$ 13.750000 November 13, 2017 25.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 26.00 26.00 26.00 November 2, 2015 US$ 1,000.00 Non-cumulative, 5-Year Rate Reset (7) Series AJ Series AL Series AZ (5) Series BB (5) Series BD (5) Series BF (5) Series BK (5) Series BM (5) Non-cumulative, floating rate Series AK (8) Non-cumulative, fixed rate/floating rate 5.00% 1.93% 5.60% 2.67% 4.00% 2.21% 3.90% 2.26% 3.60% 2.74% 3.60% 2.62% 5.50% 4.53% 5.50% 4.80% February 24, 2014 September 16, 2008 .220000 November 3, 2008 February 24, 2014 .266250 January 30, 2014 May 24, 2019 .250000 August 24, 2019 June 3, 2014 .243750 January 30, 2015 .225000 May 24, 2020 .225000 November 24, 2020 March 13, 2015 May 24, 2021 December 16, 2015 .343750 March 7, 2016 .343750 August 24, 2021 1.93% .151359 February 24, 2019 February 24, 2014 25.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 25.00 Series C-2 (9) 6.75% 4.052% US$ 16.875000 November 7, 2023 November 2, 2015 US$ 1,000.00 (1) (2) (3) (4) (5) (6) (7) (8) (9) Non-cumulative preferential dividends of each Series are payable quarterly, as and when declared by the Board of Directors, on or about the 24th day (13th and 7th day for Series C-1 and Series C-2, respectively) of February, May, August and November. Subject to the consent of OSFI and the requirements of the Bank Act (Canada), we may, on or after the dates specified above, redeem First Preferred Shares. In the case of Series AJ, AL, AZ, BB, BD, BF, BK, BM and AK, these may be redeemed for cash at a price per share of $25 if redeemed on the earliest redemption date and on the same date every fifth year thereafter. In the case of Series W, AA, AB, AC, AD, AE, AF, AG, BH, BI and BJ, these may be redeemed for cash at a price per share of $26 if redeemed during the 12 months commencing on the earliest redemption date and decreasing by $0.25 each 12-month period thereafter to a price per share of $25 if redeemed four years from the earliest redemption date or thereafter. Series C-1 and Series C-2 may be redeemed at a price of US$1,000 on the earliest redemption date and any dividend payment date thereafter. Subject to the consent of OSFI and the requirements of the Bank Act (Canada), we may purchase the First Preferred Shares of each Series for cancellation at the lowest price or prices at which, in the opinion of the Board of Directors, such shares are obtainable. Subject to the approval of the Toronto Stock Exchange, we may, on or after February 24, 2010, convert First Preferred Shares Series W into our common shares. First Preferred Shares Series W may be converted into that number of common shares determined by dividing the current redemption price by the greater of $2.50 and 95% of the weighted average trading price of common shares at such time. The preferred shares include non-viability contingency capital (NVCC) provisions, necessary for the shares to qualify as Tier 1 regulatory capital under Basel III. NVCC provisions require the conversion of the instrument into a variable number of common shares in the event that OSFI deems the Bank non-viable or a federal or provincial government in Canada publicly announces that the Bank has accepted or agreed to accept a capital injection. In such an event, each preferred share is convertible into common shares pursuant to an automatic conversion formula with a conversion price based on the greater of: (i) a floor price of $5.00 and (ii) the current market price of our common shares based on the volume weighted average trading price of our common shares on the Toronto Stock Exchange. The number of shares issued is determined by dividing the preferred share value ($25.00 plus declared and unpaid dividends) by the conversion price. Series C-1 do not qualify as Tier 1 regulatory capital. The dividend rate will reset on the earliest redemption date and every fifth year thereafter at a rate equal to the 5-year Government of Canada bond yield plus the premium indicated. The holders have the option to convert their shares into non-cumulative floating rate First Preferred Shares subject to certain conditions on the earliest redemption date and every fifth year thereafter at a rate equal to the three-month Government of Canada Treasury Bill rate plus the premium indicated. The dividend rate is equal to the three-month Government of Canada Treasury Bill rate plus the premium indicated. The holders have the option to convert their shares into non-cumulative First Preferred Shares, Series AJ subject to certain conditions on February 24, 2019 and every fifth year thereafter. The dividend rate will change on the earliest redemption date at a rate equal to the 3-month LIBOR plus the premium indicated. Series C-2 do not qualify as Tier 1 regulatory capital. Restrictions on the payment of dividends We are prohibited by the Bank Act (Canada) from declaring any dividends on our preferred or common shares when we are, or would be placed as a result of the declaration, in contravention of the capital adequacy and liquidity regulations or any regulatory directives issued under the Act. We may not pay dividends on our common shares at any time unless all dividends to which preferred shareholders are then entitled have been declared and paid or set apart for payment. We have agreed that if the Trust fails to pay any required distribution on the trust capital securities in full, we will not declare dividends of any kind on any of our preferred or common shares. Refer to Note 20. Currently, these limitations do not restrict the payment of dividends on our preferred or common shares. 184 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Dividend reinvestment plan Our dividend reinvestment plan (DRIP) provides common and preferred shareholders with a means to receive additional common shares rather than cash dividends. The plan is only open to shareholders residing in Canada or the United States. The requirements of our DRIP are satisfied through either open market share purchases or shares issued from treasury. During 2016 and 2015, the requirements of our DRIP were satisfied through open market share purchases. Shares available for future issuances As at October 31, 2016, 45.8 million common shares are available for future issue relating to our DRIP and potential exercise of stock options outstanding. In addition, we may issue up to 38.9 million common shares from treasury under the RBC Umbrella Savings and Securities Purchase Plan that was approved by shareholders on February 26, 2009. Non-controlling interests (Millions of Canadian dollars) RBC Trust Capital Securities (1) Series 2015 Series 2008-1 Other As at October 31 2016 October 31 2015 $ $ – 511 84 595 $ $ 1,219 505 74 1,798 (1) As at October 31, 2016, RBC TruCS Series 2015 includes $nil accrued interest (October 31, 2015 – $20 million). Series 2015 was redeemed on December 31, 2015. Series 2008-1 includes $11 million of accrued interest (October 31, 2015 – $11 million), net of $nil treasury holdings (October 31, 2015 – $6 million). Note 22 Share-based compensation Stock option plans We have stock option plans for certain key employees. Under the plans, options are periodically granted to purchase common shares. The exercise price for the majority of the grants is determined as the higher of the volume-weighted average of the trading prices per board lot (100 shares) of our common shares on the Toronto Stock Exchange (i) on the day preceding the day of grant; and (ii) the five consecutive trading days immediately preceding the day of grant. The exercise price for the remaining grants is the closing market share price of our common shares on the New York Stock Exchange on the date of grant. All options vest over a four-year period, and are exercisable for a period not exceeding 10 years from the grant date. The compensation expense recorded for the year ended October 31, 2016, in respect of the stock option plans was $8 million (October 31, 2015 – $6 million; October 31, 2014 – $7 million). The compensation expense related to non-vested options was $4 million at October 31, 2016 (October 31, 2015 – $3 million; October 31, 2014 – $4 million), to be recognized over the weighted average period of 1.9 years (October 31, 2015 – 1.8 years; October 31, 2014 – 1.4 years). Analysis of the movement in the number and weighted average exercise price of options is set out below: A summary of our stock option activity and related information (Canadian dollars per share except share amounts) Outstanding at beginning of year Granted (1) Exercised (2) (3) Forfeited in the year Outstanding at end of year Exercisable at end of year Available for grant October 31, 2016 October 31, 2015 October 31, 2014 Number of options (thousands) 8,182 7,403 (4,825) (110) Weighted average exercise price (4) 55.78 $ 55.74 50.97 69.79 10,650 6,909 9,267 $ $ 57.64 49.47 Number of options (thousands) 8,579 803 (1,190) (10) Weighted average exercise price 52.36 $ 78.59 46.44 70.25 8,182 5,231 10,649 $ $ 55.78 50.75 Number of options (thousands) 10,604 705 (2,723) (7) Weighted average exercise price 50.39 $ 69.17 49.03 52.92 8,579 4,987 11,443 $ $ 52.36 49.60 (1) (2) (3) (4) Total consideration in our acquisition of City National included share-based compensation amounts of US$156 million, including the conversion of 3.8 million stock options with a fair value of US$112 million, based on the Black-Scholes model. Refer to Note 11 for details on this acquisition. Cash received for options exercised during the year was $246 million (October 31, 2015 – $55 million; October 31, 2014 – $133 million) and the weighted average share price at the date of exercise was $76.90 (October 31, 2015 – $76.87; October 31, 2014 – $74.27). New shares were issued for all stock options exercised in 2016, 2015 and 2014. The weighted average exercise prices reflect the conversion of foreign currency-denominated options at the exchange rate as of October 31, 2016. For foreign currency-denominated options exercised during the year, the weighted average exercise prices are translated using exchange rates as at the settlement date. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 185 Note 22 Share-based compensation (continued) Options outstanding as at October 31, 2016 by range of exercise price (Canadian dollars per share except share amounts and years) $20.17 – $45.70 $46.72 – $51.83 $52.60 – $58.43 $58.65 – $73.14 $74.39 – $78.59 Options outstanding Options exercisable Number outstanding (thousands) 1,865 2,007 1,906 2,198 2,674 Weighted average exercise price (1) 37.35 $ 48.83 53.92 63.61 76.17 Weighted average remaining contractual life (years) 3.52 4.60 3.31 6.45 8.67 Number exercisable (thousands) 1,865 2,007 1,906 1,000 131 Weighted average exercise price (1) 37.35 $ 48.83 53.92 61.32 77.02 10,650 $ 57.64 5.58 6,909 $ 49.47 (1) The weighted average exercise prices reflect the conversion of foreign currency-denominated options at the exchange rate as of October 31, 2016. The weighted average fair value of options granted during the year ended October 31, 2016 was estimated at $4.83 (October 31, 2015 – $6.75; October 31, 2014 – $7.19). This was determined by applying the Black-Scholes model on the date of grant, taking into account the specific terms and conditions under which the options are granted, such as the vesting period and expected share price volatility estimated by considering both historic average share price volatility and implied volatility derived from traded options over our common shares of similar maturity to those of the employee options. The following assumptions were used to determine the fair value of options granted: Weighted average assumptions (Canadian dollars per share except percentages and years) Share price at grant date Risk-free interest rate Expected dividend yield Expected share price volatility Expected life of option For the year ended $ October 31 2016 72.49 0.94% 4.07% 16% 6 years $ October 31 2015 77.58 1.40% 3.76% 17% 6 years $ October 31 2014 68.75 1.95% 3.94% 18% 6 years Employee savings and share ownership plans We offer many employees an opportunity to own our common shares through savings and share ownership plans. Under these plans, the employees can generally contribute between 1% and 10% of their annual salary or benefit base for commission-based employees. For each contribution between 1% and 6%, we will match 50% of the employee contributions in our common shares. For the RBC Dominion Securities Savings Plan, our maximum annual contribution is $4,500 per employee. For the RBC U.K. Share Incentive Plan, our maximum annual contribution is £1,500 per employee. For the year ended October 31, 2016, we contributed $91 million (October 31, 2015 – $88 million; October 31, 2014 – $85 million), under the terms of these plans, towards the purchase of our common shares. As at October 31, 2016, an aggregate of 37 million common shares were held under these plans (October 31, 2015 – 37 million common shares; October 31, 2014 – 38 million common shares). Deferred share and other plans We offer deferred share unit plans to executives, non-employee directors and to certain key employees. Under these plans, the executives or directors may choose to receive all or a percentage of their annual variable short-term incentive bonus or directors’ fee in the form of deferred share units (DSUs). The executives or directors must elect to participate in the plan prior to the beginning of the year. DSUs earn dividend equivalents in the form of additional DSUs at the same rate as dividends on common shares. The participant is not allowed to convert the DSUs until retirement or termination of employment/directorship. The cash value of the DSUs is equivalent to the market value of common shares when conversion takes place. We have a deferred bonus plan for certain key employees within Capital Markets. The deferred bonus is invested as RBC share units and a specified percentage vests on each of the three anniversary dates following the grant date. Each vested amount is paid in cash and is based on the original number of RBC share units plus accumulated dividends valued using the average closing price of RBC common shares during the five trading days immediately preceding the vesting date. We offer performance deferred share award plans to certain key employees, all of which vest at the end of three years. Upon vesting, the award is paid in cash and is based on the original number of RBC share units granted plus accumulated dividends valued using the average closing price of RBC common shares during the five trading days immediately preceding the vesting date. A portion of the award under certain plans may be increased or decreased up to 25%, depending on our total shareholder return compared to a defined peer group of global financial institutions. We previously offered deferred compensation to certain employees in the form of common shares that were held in trust and accumulated dividends during the three year vesting period. We maintain non-qualified deferred compensation plans for non-employee directors and certain key employees in the United States. These plans allow eligible directors and employees to defer a portion of their annual income and allocate the deferrals among specified fund choices, including a share unit fund that tracks the value of our common shares. Certain deferrals may also be eligible for matching contributions, all of which are allocated to the RBC share unit fund. Our liabilities for the awards granted under the deferred share and other plans are measured at fair value, determined based on the quoted market price of our common shares. The following tables present our obligations under the deferred share and other plans, and the related compensation expenses (recoveries) recognized for the year. 186 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Obligation under deferred share and other plans October 31, 2016 October 31, 2015 October 31, 2014 Units granted during the year Units outstanding at the end of the year Units granted during the year Units outstanding at the end of the year Units granted during the year (Millions of Canadian dollars except units and per unit amounts) Deferred share unit plans Deferred bonus plan Performance deferred share award plans Deferred compensation plans Other share-based plans Number granted (thousands) Weighted average fair value 388 $ 74.89 83.30 4,545 2,656 74.49 72.52 124 1,394 76.04 9,107 $ 79.11 $ $ Carrying amount 376 1,444 Number granted (thousands) Weighted average fair value 343 $ 69.68 75.60 5,849 502 2,049 77.69 333 157 2,812 64 879 79.52 76.44 9,184 $ 75.95 $ $ Carrying amount 334 1,442 Number granted (thousands) Weighted average fair value 315 $ 71.57 78.97 5,339 429 2,181 68.09 313 114 2,632 69 845 74.68 70.32 8,749 $ 75.12 Units outstanding at the end of the year Carrying amount 333 1,585 503 343 118 2,882 $ $ Compensation expenses recognized under deferred share and other plans (Millions of Canadian dollars) Deferred share unit plans Deferred bonus plan Performance deferred share award plans Deferred compensation plans Other share-based plans For the year ended $ October 31 2016 62 195 246 134 91 $ October 31 2015 (1) (139) 135 36 39 $ October 31 2014 61 121 243 147 65 $ 728 $ 70 $ 637 Note 23 Income and expenses from selected financial instruments Gains and losses arising from financial instruments held at FVTPL are reported in Non-interest income. Related interest and dividend income are reported in Net interest income. Net gains (losses) from financial instruments held at fair value through profit or loss (1) (Millions of Canadian dollars) Net gains (losses) Classified as at fair value through profit or loss (2) Designated as at fair value through profit or loss (3) By product line Interest rate and credit Equities Foreign exchange and commodities For the year ended October 31 2016 October 31 2015 October 31 2014 $ $ $ $ $ $ $ 371 216 587 404 (345) 528 587 $ (218) 750 532 149 (89) 472 532 $ $ $ $ 922 (132) 790 603 (190) 377 790 (1) (2) (3) The following related to our insurance operations are included in Insurance premiums, investment and fee income in the Consolidated Statements of Income: Net gains from financial instruments designated as at FVTPL of $617 million (October 31, 2015 – $51 million; October 31, 2014 – $515 million). Excludes derivatives designated in a hedging relationship. Refer to Note 8 for net gains (losses) on these derivatives. For the year ended October 31, 2016, $428 million of net fair value gains on financial liabilities designated as at FVTPL, other than those attributable to changes in our own credit risk, were included in Non-interest income (October 31, 2015 – gains of $1,118 million; October 31, 2014 – losses of $414 million). Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 187 Note 23 Income and expenses from selected financial instruments (continued) Net interest income from financial instruments (1) (Millions of Canadian dollars) Interest income Financial instruments held as at fair value through profit or loss Other categories of financial instruments (2) Interest expense Financial instruments held as at fair value through profit or loss Other categories of financial instruments Net interest income October 31 2016 For the year ended October 31 2015 October 31 2014 $ 5,181 19,271 24,452 $ 4,810 17,919 22,729 $ 4,246 17,773 22,019 $ 2,952 4,969 7,921 $ 16,531 $ 2,621 5,337 7,958 $ 14,771 $ 2,198 5,705 7,903 $ 14,116 (1) (2) The following related to our insurance operations are included in Insurance premiums, investment and fee income in the Consolidated Statements of Income: Interest income of $474 million (October 31, 2015 – $449 million; October 31, 2014 – $435 million), and Interest expense of $4 million (October 31, 2015 – $3 million; October 31, 2014 – $nil). Refer to Note 5 for interest income accrued on impaired financial assets. Income from other categories of financial instruments (1), (2) (Millions of Canadian dollars) Net gains (losses) arising from financial instruments measured at amortized cost (3) Net fee income which does not form an integral part of the effective interest rate of financial assets and liabilities Net fee income arising from trust and other fiduciary activities October 31 2016 (22) $ For the year ended October 31 2015 (6) $ October 31 2014 (7) $ 4,817 9,988 4,604 9,587 4,190 9,138 (1) (2) (3) Refer to Note 4 for net gains (losses) on AFS securities. Refer to Note 4 for impairment losses on AFS and held-to-maturity securities, and Note 5 for impairment losses on loans. Financial instruments measured at amortized cost include held-to-maturity securities, loans and financial liabilities measured at amortized cost. Note 24 Income taxes The components of tax expense are as follows. (Millions of Canadian dollars) Income taxes (recoveries) in Consolidated Statements of Income Current tax October 31 2016 For the year ended October 31 2015 October 31 2014 Tax expense for current year Adjustments for prior years Recoveries arising from previously unrecognized tax loss, tax credit or temporary difference of a $ prior period Deferred tax Origination and reversal of temporary difference Effects of changes in tax rates Adjustments for prior years Recoveries arising from previously unrecognized tax loss, tax credit or temporary difference of a prior period Write-down Income taxes (recoveries) in Consolidated Statements of Comprehensive Income and Changes in Equity Other comprehensive income Net unrealized gains (losses) on available-for-sale securities Reclassification of net losses (gains) on available-for-sale securities to income Unrealized foreign currency translation gains (losses) Net foreign currency translation gains (losses) from hedging activities Reclassification of losses (gains) on net investment hedging activities to income Net gains (losses) on derivatives designated as cash flow hedges Reclassification of losses (gains) on derivatives designated as cash flow hedges to income Remeasurements of employee benefit plans Net fair value change due to credit risk on financial liabilities designated as at fair value through profit or loss Issuance costs Share-based compensation awards Total income taxes $ 188 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements 3,012 (26) (61) 2,925 (111) (3) 27 – 3 (84) 2,841 29 (20) 3 51 – (13) 19 (373) (118) (6) (10) (438) 2,403 $ $ 2,244 91 (5) 2,330 312 35 (74) (6) – 267 2,597 (22) (12) 8 (1,140) 38 (193) 117 206 127 (7) – (878) 1,719 $ $ 2,858 (64) (4) 2,790 (156) (3) 74 (3) 4 (84) 2,706 70 (12) 5 (561) 1 (39) 10 (88) (22) (7) – (643) 2,063 Our effective tax rate changed from 20.6% for 2015 to 21.4% for 2016, principally due to net favorable tax adjustments last year. The following is an analysis of the differences between the income tax expense reflected in the Consolidated Statements of Income and the amounts calculated at the Canadian statutory rate. Reconciliation to statutory tax rate (Millions of Canadian dollars, except for percentage amounts) Income taxes at Canadian statutory tax rate Increase (decrease) in income taxes resulting from Lower average tax rate applicable to subsidiaries Tax-exempt income from securities Tax rate change Effect of previously unrecognized tax loss, tax credit or temporary differences Other Income taxes in Consolidated Statements of Income / effective tax rate $ 2,841 For the year ended October 31, 2015 October 31, 2014 October 31, 2016 $ 3,524 26.5% $ 3,320 (340) (410) (3) (61) 131 (2.6) (3.1) – (116) (452) 35 (0.4) 1.0 (11) (179) 21.4% $ 2,597 26.3% $ 3,080 26.3% (0.9) (3.6) 0.3 (0.1) (1.4) (272) (386) (3) (7) 294 (2.3) (3.3) – (0.1) 2.5 20.6% $ 2,706 23.1% Deferred tax assets and liabilities result from tax loss carryforwards and temporary differences between the tax basis of assets and liabilities and their carrying amounts on our Consolidated Balance Sheets. Significant components of deferred tax assets and liabilities (Millions of Canadian dollars) Net deferred tax asset/(liability) Allowance for credit losses Deferred compensation Business realignment charges Tax loss carryforwards Deferred income Available-for-sale securities Premises and equipment and intangibles Deferred expense Pension and post-employment related Other Comprising Deferred tax assets Deferred tax liabilities (Millions of Canadian dollars) Net deferred tax asset/(liability) Allowance for credit losses Deferred compensation Business realignment charges Tax loss carryforwards Deferred income Available-for-sale securities Premises and equipment and intangibles Deferred expense Pension and post-employment related Other Comprising Deferred tax assets Deferred tax liabilities As at October 31, 2016 Net Asset November 1, 2015 Change through equity Change through profit or loss Exchange rate differences Acquisitions/ disposals Net Asset October 31, 2016 $ $ $ $ $ 372 1,296 6 54 147 12 (539) (86) 412 197 $ – 10 – (1) – (12) – 8 373 8 $ 90 40 2 (19) (32) 1 62 5 39 (104) 1,871 $ 386 $ 84 $ 2 23 – (2) 1 4 (10) – 1 (7) 12 $ $ 2,072 (201) 1,871 20 189 – – (21) 5 (594) 13 – (127) (515) $ $ $ $ 484 1,558 8 32 95 10 (1,081) (60) 825 (33) 1,838 2,827 (989) 1,838 As at October 31, 2015 Net Asset November 1, 2014 Change through equity Change through profit or loss Exchange rate differences Acquisitions/ disposals Net Asset October 31, 2015 (2) (375) (4) 4 27 (13) 81 3 46 (34) (267) $ $ (2) 158 1 4 – 3 (17) – 1 10 158 $ $ $ $ $ $ $ 376 1,513 9 44 120 30 (604) (98) 566 222 $ – – – 2 – (8) – 9 (201) – 2,178 $ (198) $ 2,382 (204) 2,178 – – – – – – 1 – – (1) – $ $ $ $ 372 1,296 6 54 147 12 (539) (86) 412 197 1,871 2,072 (201) 1,871 The tax loss carryforwards amount of deferred tax assets relates to losses in our Caribbean and Japanese operations. Deferred tax assets of $32 million were recognized at October 31, 2016 (October 31, 2015 – $54 million) in respect of tax losses incurred in current or preceding years Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 189 Note 24 Income taxes (continued) for which recognition is dependent on the projection of future taxable profits. Management’s forecasts support the assumption that it is probable that the results of future operations will generate sufficient taxable income to utilize the deferred tax assets. The forecasts rely on continued liquidity and capital support to our business operations, including tax planning strategies implemented in relation to such support. As at October 31, 2016, unused tax losses, tax credits and deductible temporary differences of $372 million, $541 million and $3 million (October 31, 2015 – $525 million, $356 million and $6 million) available to be offset against potential tax adjustments or future taxable income were not recognized as deferred tax assets. This amount includes unused tax losses of $26 million which expire within one year (October 31, 2015 – $158 million), $3 million which expire in two to four years (October 31, 2015 – $28 million), and $343 million which expire after four years (October 31, 2015 – $339 million). There are $73 million of tax credits that will expire in two to four years (October 31, 2015 – $11 million) and $468 million that will expire after four years (October 31, 2015 – $345 million). In addition, there are no deductible temporary differences that will expire within one year (October 31, 2015 – $1 million) and $3 million that will expire after four years (October 31, 2015 – $5 million). The amount of temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures for which deferred tax liabilities have not been recognized in the parent bank is $11.7 billion as at October 31, 2016 (October 31, 2015 – $11.2 billion). Tax examinations and assessments In September 2016, the Canada Revenue Agency reassessed Royal Bank of Canada approximately $225 million of additional income tax and interest by denying the tax deductibility of certain dividends received from Canadian Corporations in years 2009 and 2010 on the basis that they were part of a “dividend rental arrangement.” The circumstances of the dividends subject to the reassessment are similar to those prospectively addressed by the rules in the 2015 Canadian federal budget. We are confident that our tax filing position was appropriate and intend to defend ourselves vigorously. Note 25 Earnings per share (Millions of Canadian dollars, except share and per share amounts) Basic earnings per share Net Income Preferred share dividends Net income attributable to non-controlling interest Net income available to common shareholders Weighted average number of common shares (in thousands) Basic earnings per share (in dollars) Diluted earnings per share Net income available to common shareholders Dilutive impact of exchangeable shares Net income available to common shareholders including dilutive impact of exchangeable shares Weighted average number of common shares (in thousands) Stock options (1) Issuable under other share-based compensation plans Exchangeable shares (2) Average number of diluted common shares (in thousands) Diluted earnings per share (in dollars) For the year ended October 31 2016 October 31 2015 October 31 2014 $ $ $ 10,458 (294) (53) 10,111 1,485,876 6.80 10,111 15 10,126 1,485,876 3,329 731 4,201 $ $ $ 10,026 (191) (101) 9,734 1,442,935 6.75 9,734 15 9,749 1,442,935 2,446 – 4,128 $ $ $ 9,004 (213) (94) 8,697 1,442,553 6.03 8,697 21 8,718 1,442,553 2,938 – 6,512 1,494,137 6.78 $ 1,449,509 6.73 $ 1,452,003 6.00 $ (1) (2) The dilutive effect of stock options was calculated using the treasury stock method. When the exercise price of options outstanding is greater than the average market price of our common shares, the options are excluded from the calculation of diluted earnings per share. For the year ended October 31, 2016, an average of 802,371 outstanding options with an average exercise price of $78.58 were excluded from the calculation of diluted earnings per share. For the year ended October 31, 2015, an average of 703,808 outstanding options with an average exercise price of $78.59 were excluded from calculation of diluted earnings per share. For the year ended October 31, 2014, no outstanding options were excluded from the calculation of diluted earnings per share. Includes exchangeable preferred shares and trust capital securities. Note 26 Guarantees, commitments, pledged assets and contingencies Guarantees and commitments We use guarantees and other off-balance sheet credit instruments to meet the financing needs of our clients. The table below summarizes our maximum exposure to credit losses related to our guarantees and commitments provided to third parties. The maximum exposure to credit risk relating to a guarantee is the maximum risk of loss if there was a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions, insurance policies or from collateral held or pledged. The maximum exposure to credit risk relating to a commitment to extend credit is the full amount of the commitment. In both cases, the maximum risk exposure is significantly greater than the amount recognized as a liability in our Consolidated Balance Sheets. 190 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements (Millions of Canadian dollars) Financial guarantees Financial standby letters of credit Commitments to extend credit Backstop liquidity facilities Credit enhancements Documentary and commercial letters of credit Other commitments to extend credit Other credit-related commitments Securities lending indemnifications Performance guarantees Other Maximum exposure to credit losses As at October 31 2016 October 31 2015 $ 18,886 $ 17,494 38,910 2,598 232 181,491 90,230 6,844 50 40,387 3,348 216 172,924 74,239 6,042 221 Our credit review process, our policy for requiring collateral security, and the types of collateral security held are generally the same for guarantees and commitments as for loans. Our clients generally have the right to request settlement of, or draw on, our guarantees and commitments within one year. However, certain guarantees can only be drawn if specified conditions are met. These conditions, along with collateral requirements, are described below. We believe that it is highly unlikely that all or substantially all of the guarantees and commitments will be drawn or settled within one year, and contracts may expire without being drawn or settled. Financial guarantees Financial standby letters of credit Financial standby letters of credit represent irrevocable assurances that we will make payments in the event that a client cannot meet its payment obligations to the third party. For certain guarantees, the guaranteed party can request payment from us even though the client has not defaulted on its obligations. The term of these guarantees can range up to eight years. Our policy for requiring collateral security with respect to these instruments and the types of collateral security held is generally the same as for loans. When collateral security is taken, it is determined on an account-by-account basis according to the risk of the borrower and the specifics of the transaction. Collateral security may include cash, securities and other assets pledged. Commitments to extend credit Backstop liquidity facilities Backstop liquidity facilities are provided to asset-backed commercial paper conduit programs administered by us and third parties, as an alternative source of financing in the event that such programs are unable to access commercial paper markets, or in limited circumstances, when predetermined performance measures of the financial assets owned by these programs are not met. The average remaining term of these liquidity facilities is approximately four years. Backstop liquidity facilities are also provided to non-asset backed programs such as variable rate demand notes issued by third parties. These standby facilities provide liquidity support to the issuer to buy the notes if the issuer is unable to remarket the notes, as long as the instrument and/or the issuer maintain the investment grade rating. The terms of the backstop liquidity facilities do not require us to advance money to these programs in the event of bankruptcy or insolvency and generally do not require us to purchase non-performing or defaulted assets. Credit enhancements We provide partial credit enhancement to multi-seller programs administered by us to protect commercial paper investors in the event that the collections on the underlying assets together with the transaction-specific credit enhancements or the liquidity facilities prove to be insufficient to pay for maturing commercial paper. Each of the asset pools is structured to achieve a high investment-grade credit profile through credit enhancements from us and other third parties related to each transaction. The average remaining term of these credit facilities is approximately three years. Documentary and commercial letters of credit Documentary and commercial letters of credit, which are written undertakings by us on behalf of a client authorizing a third party to draw drafts on us up to a stipulated amount under specific terms and conditions, where some are collateralized based on the underlying agreement with the client and others are collateralized by cash deposits or other assets of the company which may include the underlying shipment of goods to which they relate. Other commitments to extend credit Commitments to extend credit represent unused portions of authorizations to extend credit in the form of loans, bankers’ acceptances or letters of credit. Other credit-related commitments Securities lending indemnifications In securities lending transactions, we act as an agent for the owner of a security, who agrees to lend the security to a borrower for a fee, under the terms of a pre-arranged contract. The borrower must fully collateralize the security loaned at all times. As part of this custodial business, an indemnification may be provided to securities lending customers to ensure that the fair value of securities loaned will be returned in the event that the borrower fails to return the borrowed securities and the collateral held is insufficient to cover the fair value of those securities. These indemnifications normally terminate without being drawn upon. The term of these indemnifications varies, as the securities loaned are recallable on demand. Collateral held for our securities lending transactions typically includes cash, securities that are issued or guaranteed by the Canadian government, U.S. government or other OECD countries or high quality equity instruments. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 191 Note 26 Guarantees, commitments, pledged assets and contingencies (continued) Performance guarantees Performance guarantees represent irrevocable assurances that we will make payments to third-party beneficiaries in the event that a client fails to perform under a specified non-financial contractual obligation. Such obligations typically include works and service contracts, performance bonds, and warranties related to international trade. The term of these guarantees can range up to eight years. Our policy for requiring collateral security with respect to these instruments and the types of collateral security held is generally the same as for loans. When collateral security is taken, it is determined on an account-by-account basis according to the risk of the borrower and the specifics of the transaction. Collateral security may include cash, securities and other assets pledged. Indemnifications In the normal course of our operations, we provide indemnifications which are often standard contractual terms to counterparties in transactions such as purchase and sale contracts, fiduciary, agency, licensing, custodial and service agreements, clearing system arrangements, director/ officer contracts and leasing transactions. These indemnification agreements may require us to compensate the counterparties for costs incurred as a result of changes in laws and regulations (including tax legislation) or as a result of litigation claims or statutory sanctions that may be suffered by the counterparty as a consequence of the transaction. The terms of these indemnification agreements vary based on the contract. The nature of the indemnification agreements prevents us from making a reasonable estimate of the maximum potential amount we could be required to pay to counterparties. Historically, we have not made any significant payments under such indemnifications. Uncommitted amounts Uncommitted amounts represent undrawn credit facilities for which we have the ability to unilaterally withdraw the credit extended to the borrower. These include both retail and commercial commitments. As at October 31, 2016, the total balance of uncommitted amounts was $229 billion (October 31, 2015 – $209 billion). Other commitments We act as underwriter for certain new issuances under which we alone or together with a syndicate of financial institutions purchase the new issue for resale to investors. In connection with these activities, our commitments were $540 million as at October 31, 2016 (October 31, 2015 – $353 million). Pledged assets and collateral In the ordinary course of business, we pledge assets and enter in collateral agreements with terms and conditions that are usual and customary to our regular lending, borrowing and trading activities recorded on our Consolidated Balance Sheets. The following are examples of our general terms and conditions on pledged assets and collateral: • • • • The risks and rewards of the pledged assets reside with the pledgor. The pledged asset is returned to the pledgor when the necessary conditions have been satisfied. The right of the pledgee to sell or re-pledge the asset is dependent on the specific agreement under which the collateral is pledged. If there is no default, the pledgee must return the comparable asset to the pledgor upon satisfaction of the obligation. We are also required to provide intraday pledges to the Bank of Canada when we use the Large Value Transfer System (LVTS), which is a real-time electronic wire transfer system that continuously processes all Canadian dollar large-value or time-critical payments throughout the day. The pledged assets earmarked for LVTS activities are normally released back to us at the end of the settlement cycle each day. Therefore, the pledged assets amount is not included in the table below. For the year ended October 31, 2016, we had on average $3.4 billion of assets pledged intraday to the Bank of Canada on a daily basis (October 31, 2015 – $3.5 billion). There are infrequent occasions where we are required to take an overnight advance from the Bank of Canada to cover a settlement requirement, in which case an equivalent value of the pledged assets would be used to secure the advance. There were no overnight advances taken on October 31, 2016 and October 31, 2015. 192 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Details of assets pledged against liabilities and collateral assets held or re-pledged are shown in the following tables: (Millions of Canadian dollars) Sources of pledged assets and collateral Bank assets Interest-bearing deposits with banks Loans Securities Other assets Client assets (1) Collateral received and available for sale or re-pledging Less: not sold or re-pledged Uses of pledged assets and collateral Securities lent Securities borrowed Obligations related to securities sold short Obligations related to securities lent or sold under repurchase agreements Securitization Covered bonds Derivative transactions Foreign governments and central banks Clearing systems, payment systems and depositories Other As at October 31 2016 October 31 2015 $ – 85,351 55,479 23,307 $ 1 81,397 63,761 22,305 $ 164,137 $ 167,464 266,974 (73,341) 193,633 357,770 $ 25,057 33,980 50,369 116,279 43,502 40,293 29,183 1,574 3,521 14,012 232,499 (74,471) 158,028 325,492 $ 21,767 33,306 47,658 88,834 44,203 36,422 27,411 2,770 4,017 19,104 $ 357,770 $ 325,492 (1) Primarily relates to Obligations related to securities lent or sold under repurchase agreements, Securities lent and Derivative transactions. Lease commitments Finance lease commitments We lease computer equipment from third parties under finance lease arrangements. The leases have various terms, escalation and renewal rights. The future minimum lease payments under the finance leases are as follows: (Millions of Canadian dollars) Future minimum lease payments No later than one year Later than one year and no later than five years As at October 31, 2016 October 31, 2015 Total future minimum lease payments Future interest charges Present value of finance lease commitments Total future minimum lease payments Future interest charges Present value of finance lease commitments $ $ 21 20 41 $ $ (2) (2) (4) $ $ 19 18 37 $ $ 38 22 60 $ $ (4) (3) (7) $ $ 34 19 53 The net carrying amount of computer equipment held under finance lease as at October 31, 2016 was $47 million (October 31, 2015 – $65 million). Operating lease commitments We are obligated under a number of non-cancellable operating leases for premises and equipment. These leases have various terms, escalation and renewal rights. The lease agreements do not include any clauses that impose any restriction on our ability to pay dividends, engage in debt financing transactions, or enter into further lease agreements. The minimum future lease payments under non-cancellable operating leases are as follows. October 31, 2016 October 31, 2015 As at (Millions of Canadian dollars) Future minimum lease payments No later than one year Later than one year and no later than five years Later than five years Less: Future minimum sublease payments to be received Land and buildings $ 662 1,993 2,140 4,795 (24) Equipment Equipment $ $ Land and buildings $ 590 1,822 1,811 4,223 (14) 70 206 – 276 – 276 131 80 – 211 – 211 Net future minimum lease payments $ 4,771 $ $ 4,209 $ Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 193 Note 27 Legal and regulatory matters We are a large global institution that is subject to many different complex legal and regulatory requirements that continue to evolve. We are and have been subject to a variety of legal proceedings, including civil claims and lawsuits, regulatory examinations, investigations, audits and requests for information by various governmental regulatory agencies and law enforcement authorities in various jurisdictions. Some of these matters may involve novel legal theories and interpretations and may be advanced under criminal as well as civil statutes, and some proceedings could result in the imposition of civil, regulatory enforcement or criminal penalties. We review the status of all proceedings on an ongoing basis and will exercise judgment in resolving them in such manner as we believe to be in our best interest. This is an area of significant judgment and uncertainty and the extent of our financial and other exposure to these proceedings after taking into account current accruals could be material to our results of operations in any particular period. The following is a description of our significant legal proceedings. LIBOR regulatory investigations and litigation Various regulators and competition and enforcement authorities around the world, including in Canada, the United Kingdom, and the U.S., are conducting investigations related to certain past submissions made by panel banks in connection with the setting of the U.S. dollar London interbank offered rate (LIBOR). These investigations focus on allegations of collusion between the banks that were on the panel to make submissions for certain LIBOR rates. Royal Bank of Canada is a member of certain LIBOR panels, including the U.S. dollar LIBOR panel, and has been the subject of regulatory requests for information. In addition, Royal Bank of Canada and other U.S. dollar panel banks have been named as defendants in private lawsuits filed in the U.S. with respect to the setting of LIBOR including a number of class action lawsuits which have been consolidated before the U.S. District Court for the Southern District of New York. The complaints in those private lawsuits assert claims against us and other panel banks under various U.S. laws, including U.S. antitrust laws, the U.S. Commodity Exchange Act, and state law. Based on the facts currently known, it is not possible at this time for us to predict the ultimate outcome of these investigations or proceedings or the timing of their resolution. Royal Bank of Canada Trust Company (Bahamas) Limited Proceedings On April 13, 2015, a French investigating judge notified Royal Bank of Canada Trust Limited (RBC Bahamas) of the issuance of an ordonnance de renvoi referring RBC Bahamas and other unrelated persons to the French tribunal correctionnel to face the charge of complicity in estate tax fraud relating to actions taken relating to a trust for which RBC Bahamas serves as trustee. RBC Bahamas believes that its actions did not violate French law and contested the charge in the French court. The trial of this matter has concluded and a verdict is expected on January 12, 2017. On October 28, 2016, Royal Bank of Canada was granted a temporary one year exemption by the U.S. Department of Labour that will allow Royal Bank of Canada and its current and future affiliates to continue to qualify for the Qualified Professional Asset Manager exemption under the Employee Retirement Income Security Act despite any potential conviction of RBC Bahamas in the French proceeding. An application to grant more lengthy exemptive relief is pending. Based on the facts currently known, it is not possible at this time to predict the ultimate outcome of the French proceeding; however, we believe that its ultimate resolution will not have a material effect on our consolidated financial position, although it may be material to our results of operations in the period it occurs. Interchange fees litigation Since 2011, seven proposed class actions have been commenced in Canada: Bancroft-Snell v. Visa Canada Corporation, et al., 9085-4886 Quebec Inc. v. Visa Canada Corporation, et al., Coburn and Watson’s Metropolitan Home v. Bank of America Corporation, et al. (Watson), Macaronies Hair Club and Laser Centre Inc. v. BofA Canada Bank, et al., 1023926 Alberta Ltd. v. Bank of America Corporation, et al., The Crown & Hand Pub Ltd. v. Bank of America Corporation, et al., and Hello Baby Equipment Inc. v. BofA Canada Bank, et al. The defendants in each action are VISA Canada Corporation (Visa), MasterCard International Incorporated (MasterCard), Royal Bank of Canada and other financial institutions. The plaintiff class members are Canadian merchants who accept Visa and/or MasterCard branded credit cards for payment. The actions allege, among other things, that from March 2001 to the present, Visa and MasterCard conspired with their issuing banks and acquirers to set default interchange rates and merchant discount fees and that certain rules (Honour All Cards and No Surcharge) have the effect of increasing the merchant discount fees. The actions include claims of civil conspiracy, breach of the Competition Act, interference with economic relations and unjust enrichment. The claims seek unspecified general and punitive damages. In Watson, a decision to partially certify the action as a class proceeding was released on March 27, 2014, and was appealed. On August 19, 2015, the British Columbia Court of Appeal struck the plaintiff class representative’s cause of action under section 45 of the Competition Act and reinstated the plaintiff class representative’s cause of action in civil conspiracy by unlawful means, among other rulings. In October 2016, the trial court in Watson denied a motion by the plaintiff to revive the stricken section 45 Competition Act claim, and also denied the plaintiff’s motion to add new causes of action. The plaintiff class representative has now appealed that decision. The Watson proceeding has been set down for trial commencing September 2018. Based on the facts currently known, it is not possible at this time for us to predict the ultimate outcome of this proceeding or the timing of its resolution. Foreign Exchange Matters Various regulators, including the Brazilian civil antitrust authority Administrative Council for Economic Defense (CADE) are conducting inquiries regarding potential violations of antitrust law by a number of banks, including Royal Bank of Canada, regarding foreign exchange trading. On July 31, 2015, RBC Capital Markets, LLC was added as a defendant in a pending putative class action initially filed in November 2013 in the United States District Court for the Southern District of New York. The action is brought against multiple foreign exchange dealers and alleges, among other things, collusive behaviour in foreign exchange trading. On September 11, 2015, a class action lawsuit was filed in the Ontario Superior Court of Justice and a motion for authorization of a class action was filed in the Quebec Superior Court, both on behalf of an alleged class of Canadian investors, against Royal Bank of Canada, RBC Capital Markets, LLC and a number of other foreign exchange dealers. The Canadian class actions also allege collusive behaviour in foreign exchange trading. Based on the facts currently known, it is not possible at this time to predict the ultimate outcome of the Foreign Exchange Matters or the timing of their ultimate resolution. Wisconsin school districts litigation RBC Capital Markets, LLC, RBC Europe, Ltd. and RBC USA Holdco Corporation are defendants in a lawsuit relating to their role in transactions involving investments made by a number of Wisconsin school districts in certain CDOs. These CDO transactions were also the subject of a regulatory investigation and in September 2011, we reached a settlement with the Securities and Exchange Commission which was paid to the school districts through a Fair Fund. Based on the facts currently known, it is not possible at this time to predict the ultimate outcome of this proceeding or the timing of its resolution; however, we believe the ultimate resolution of this proceeding will not have a material adverse effect on our consolidated financial position or results of operations. 194 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Panama Papers inquiries Following media reports on the contents of files misappropriated from a Panamanian-based law firm, Mossack Fonseca & Co about special purpose entities associated with that firm, regulatory, tax and enforcement authorities are conducting inquiries. The inquiries focus on, among other issues, the potential use of such entities by third parties to avoid tax and disclosure obligations. Royal Bank of Canada has received, and is responding to, information and document requests by a number of such authorities. Other matters We are a defendant in a number of other actions alleging that certain of our practices and actions were improper. The lawsuits involve a variety of complex issues and the timing of their resolution is varied and uncertain. Management believes that we will ultimately be successful in resolving these lawsuits, to the extent that we are able to assess them, without material financial impact to the Bank. This is, however, an area of significant judgment and the potential liability resulting from these lawsuits could be material to our results of operations in any particular period. Various other legal proceedings are pending that challenge certain of our other practices or actions. While this is an area of significant judgment and some matters are currently inestimable, we consider that the aggregate liability, to the extent that we are able to assess it, resulting from these other proceedings will not be material to our consolidated financial position or results of operations. Note 28 Contractual repricing and maturity schedule The following table details our exposure to interest rate risk. The carrying amounts of financial assets and financial liabilities are reported below based on the earlier of their contractual repricing date or maturity date. The following table does not incorporate management’s expectation of future events where expected repricing or maturity dates differ significantly from the contractual dates. We incorporate these assumptions in the management of interest rate risk exposure. These assumptions include expected repricing of trading instruments and certain loans and deposits. Taking into account these assumptions on the consolidated contractual repricing and maturity schedule at October 31, 2016, would result in a change in the under-one-year gap from $26.2 billion to $99.0 billion. (Millions of Canadian dollars) Assets Cash and deposits with banks Trading securities Available-for-sale securities Assets purchased under reverse repurchase agreements and securities borrowed Loans (net of allowance for loan losses) Derivatives Segregated fund net assets Other assets Liabilities Deposits Obligations related to assets sold under repurchase agreements and securities loaned Obligations related to securities sold short Derivatives Segregated fund net liabilities Other liabilities Subordinated debentures Non-controlling interests Shareholders’ equity Total gap Canadian dollar Foreign currency Total gap Immediately interest rate-sensitive Under 3 months 3 to 6 months 6 to 12 months 1 to 5 years Over 5 years Non-rate- sensitive As at October 31, 2016 $ 14,036 $ 24,531 $ 26 $ 62 $ 385 $ 24 $ 3,716 $ 27 – 32,091 23,493 6,689 1,904 12,455 2,723 18,194 28,157 36,096 26,898 45,740 1,626 1,533 171,994 118,944 – 2 160,416 90,913 – – 23,265 17,233 12,811 – – – 6,115 36,741 – – – – 185,674 – – – – 16,015 – – 97 1,005 7,456 – 981 50,190 Total 42,780 151,292 84,801 186,302 521,604 118,944 981 73,554 $ $ $ $ $ $ 306,536 $ 354,709 $ 38,663 $ 58,096 $ 232,410 $ 79,130 $ 110,714 $1,180,258 291,941 $ 134,929 $ 24,315 $ 40,176 $ 120,821 $ 20,982 $ 124,425 $ 757,589 2,603 99,332 806 – – – 700 103,441 2 116,550 – 43 – – – 2,144 – – 14,540 224 – 200 1,491 – – 26 233 – 800 216 – – 57 131 – 1,050 8,877 – – 1,852 6,738 511 4,524 14,189 – – 7,194 2,436 – – 23,450 – 981 46,242 – 84 64,443 50,369 116,550 981 69,954 9,762 595 71,017 411,139 $ 251,369 $ 27,671 $ 41,630 $ 143,323 $ 44,801 $ 260,325 $1,180,258 (104,603) $ 103,340 $ 10,992 $ 16,466 $ 89,087 $ 34,329 $ (149,611) $ (74,619) $ 20,796 $ 1,841 $ 18,661 $ 115,791 $ (1,725) $ (80,745) $ (2,195) (29,984) (68,866) (26,704) 82,544 36,054 9,151 (104,603) $ 103,340 $ 10,992 $ 16,466 $ 89,087 $ 34,329 $ (149,611) $ – – – – Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 195 Note 29 Related party transactions Related parties Related parties include associated companies, post-employment benefit plans for the benefit of our employees, key management personnel (KMP), the Board of Directors (Directors), close family members of KMP and Directors, and entities which are, directly or indirectly, controlled by, jointly controlled by or significantly influenced by KMP, Directors or their close family members. Key management personnel and Directors KMP are defined as those persons having authority and responsibility for planning, directing and controlling our activities, directly or indirectly. They include the senior members of our organization called the Group Executive. The Group Executive is comprised of the President and Chief Executive Officer and individuals that report directly to him, including the Chief Administrative Officer and Chief Financial Officer, Chief Human Resources Officer, Group Chief Risk Officer, and Group Heads for Wealth Management and Insurance, Capital Markets and Investor & Treasury Services, Technology & Operations, and Personal & Commercial Banking. The Directors do not plan, direct, or control the activities of the entity; they oversee the management of the business and provide stewardship. Compensation of key management personnel and Directors (Millions of Canadian dollars) Salaries and other short-term employee benefits (2) Post-employment benefits (3) Share-based payments For the year ended October 31 2016 26 2 41 $ October 31 2015 21 2 37 $ October 31 2014 (1) 22 7 26 $ $ 69 $ 60 $ 55 (1) (2) (3) During the year ended October 31, 2014, certain executives who were members of the Bank’s Group Executive as at October 31, 2013 left the Bank and therefore, were no longer part of KMP. Compensation for the year ended October 31, 2014, attributable to the former executives, including benefits and share-based payments relating to awards granted in prior years was $60 million. Includes the portion of the annual variable short-term incentive bonus that certain executives elected to receive in the form of DSUs. Refer to Note 22 for further details. Directors receive retainers but do not receive salaries and other short-term employee benefits. Directors do not receive post-employment benefits. Stock options, stock awards and shares held by key management personnel, Directors and their close family members (Millions of Canadian dollars, except number of units) Stock options (1) Other non-option stock based awards (1) RBC common and preferred shares (1) Directors do not receive stock options or any other non-option stock based awards. As at October 31, 2016 October 31, 2015 No. of units held 2,110,038 1,703,221 789,295 4,602,554 Value $ 42 143 66 $ 251 No. of units held 2,494,007 1,485,976 738,777 4,718,760 Value $ 44 111 55 $ 210 Transactions, arrangements and agreements involving key management personnel, Directors and their close family members In the normal course of business, we provide certain banking services to KMP, Directors, and their close family members. These transactions were made on substantially the same terms, including interest rates and security, as for comparable transactions with persons of a similar standing and did not involve more than the normal risk of repayment or present other unfavourable features. As at October 31, 2016, total loans to KMP, Directors and their close family members were $10 million (October 31, 2015 – $7 million). We have no allowance or provision for credit losses relating to these loans as at and for the year ended October 31, 2016. No guarantees, pledges or commitments have been given to KMP, Directors or their close family members. Joint ventures and associates In the normal course of business, we provide certain banking and financial services to our joint ventures and associates, including loans, interest and non-interest bearing deposits. These transactions meet the definition of related party transactions and were made on substantially the same terms as for comparable transactions with third-party counterparties. As at October 31, 2016, loans to joint ventures and associates were $71 million (October 31, 2015 – $65 million) and deposits from joint ventures and associates were $25 million (October 31, 2015 – $27 million). We have no allowance or provision for credit losses relating to loans to joint ventures and associates as at and for the year ended October 31, 2016. No guarantees have been given to joint ventures or associates. Other transactions, arrangements or agreements involving joint ventures and associates (Millions of Canadian dollars) Commitments and other contingencies Other fees received for services rendered Other fees paid for services received As at or for the year ended October 31 2016 554 40 189 $ October 31 2015 365 41 182 $ October 31 2014 315 45 185 $ 196 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 30 Results by business segment Composition of business segments For management purposes, based on the products and services offered, we are organized into five business segments: Personal & Commercial Banking, Wealth Management, Insurance, Investor & Treasury Services and Capital Markets. Personal & Commercial Banking is comprised of our personal and business banking operations, and our auto financing and retail investment businesses including our online discount brokerage channel and operates through four business lines: Personal Financial Services, Business Financial Services, Cards and Payment Solutions (Canadian Banking), and Caribbean & U.S. Banking. In Canada, we provide a broad suite of financial products and services through our extensive branch, automated teller machines, online, mobile and telephone banking networks, as well as through a large number of proprietary sales professionals. In the Caribbean, we offer a broad range of financial products and services to individuals, business clients and public institutions in targeted markets. In the U.S., we serve the cross-border banking needs of Canadian clients within the U.S. through online channels. Wealth Management is comprised of Canadian Wealth Management, U.S. Wealth Management (including City National), International Wealth Management and Global Asset Management. We serve affluent, high net worth and ultra-high net worth clients in Canada, the U.S., the U.K., Europe, and Asia with a comprehensive suite of investment, trust, banking, credit and other wealth management solutions. We also provide asset management products and services directly to institutional and individual clients as well as through RBC distribution channels and third- party distributors. Insurance is comprised of our insurance operations in Canada and globally and operates under two business lines: Canadian Insurance and International Insurance, providing a wide range of life, health, home, auto, travel, wealth, group and reinsurance products and solutions. In Canada, we offer our products and services through our proprietary distribution channels, comprised of the field sales force which includes retail insurance branches, our field sales representatives, advice centers and online, as well as through independent insurance advisors and affinity relationships. Outside Canada, we operate in reinsurance markets globally offering life, accident and annuity reinsurance products. Investor & Treasury Services is a specialist provider of asset services, custody, payments and treasury services for financial and other institutional investors worldwide. We also provide Canadian dollar cash management, correspondent banking and trade finance for financial institutions globally and short-term funding and liquidity management for RBC. Capital Markets provides public and private companies, institutional investors, governments and central banks globally with a wide range of capital markets products and services across our two main business lines: Corporate and Investment Banking and Global Markets. In North America, we offer a full suite of products and services which include corporate and investment banking, equity and debt origination and distribution, and structuring and trading. Outside North America, we have a select presence in the U.K., Europe, and Other International, where we offer a diversified set of capabilities in our key sectors of expertise such as energy, mining and infrastructure and we have a growing presence in industrial, consumer and health care in Europe. All other enterprise level activities that are not allocated to these five business segments, such as enterprise funding, securitizations, net charges associated with unattributed capital, and consolidation adjustments, including the elimination of the Taxable equivalent basis (Teb) gross-up amounts, are included in Corporate Support. Teb adjustments gross up income from certain tax-advantaged sources from Canadian taxable corporate dividends and U.S. tax credit investments recorded in Capital Markets to their effective tax equivalent value with the corresponding offset recorded in the provision for income taxes. Management believes that these Teb adjustments are necessary for Capital Markets to reflect how it is managed and enhances the comparability of revenue across our taxable and tax-advantaged sources. Our use of Teb adjustments may not be comparable to similarly adjusted amounts at other financial institutions. The Teb adjustment for the year ended October 31, 2016 was $736 million (October 31, 2015 – $570 million, October 31, 2014 – $492 million). Geographic segments For geographic reporting, our segments are grouped into Canada, United States and Other International. Transactions are primarily recorded in the location that best reflects the risk due to negative changes in economic conditions and prospects for growth due to positive economic changes. This location frequently corresponds with the location of the legal entity through which the business is conducted and the location of our clients. Transactions are recorded in the local currency and are subject to foreign exchange rate fluctuations with respect to the movement in the Canadian dollar. Management reporting framework Our management reporting framework is intended to measure the performance of each business segment as if it were a stand-alone business and reflects the way our business segments are managed. This approach is intended to ensure that our business segments’ results reflect all relevant revenue and expenses associated with the conduct of their businesses. Management regularly monitors these segments’ results for the purpose of making decisions about resource allocation and performance assessment. These items do not impact our consolidated results. The expenses in each business segment may include costs or services directly incurred or provided on their behalf at the enterprise level. For other costs not directly attributable to one of our business segments, we use a management reporting framework that uses assumptions, estimates and methodologies for allocating overhead costs and indirect expenses to our business segments and that assists in the attribution of capital and the transfer pricing of funds to our business segments in a manner that fairly and consistently measures and aligns the economic costs with the underlying benefits and risks of that specific business segment. Activities and business conducted between our business segments are generally at market rates. All other enterprise level activities that are not allocated to our five business segments are reported under Corporate Support. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 197 Note 30 Results by business segment (continued) Our assumptions and methodologies used in our management reporting framework are periodically reviewed by management to ensure that they remain valid. The capital attribution methodologies involve a number of assumptions and estimates that are revised periodically. Personal & Commercial Banking $ 10,337 $ 4,499 Wealth Management (1) (Millions of Canadian dollars) Net interest income (3) (4) Non-interest income Total revenue Provision for credit losses Insurance policyholder benefits, 14,836 1,122 claims and acquisition expense Non-interest expense Net income (loss) before income taxes Income taxes (recoveries) – 6,757 6,957 1,773 For the year ended October 31, 2016 Investor & Treasury Services Insurance Capital Markets (2) Corporate Support (2) Total Canada 1,955 $ 6,834 8,789 48 – 6,801 1,940 467 – $ 825 $ 5,151 5,151 1 3,424 622 1,104 204 1,446 2,271 (3) – 1,460 814 201 3,804 $ 4,146 (390) $ (202) 16,531 $ 11,685 $ 21,874 12,054 7,950 327 – 4,466 3,157 887 (592) 51 – 30 (673) (691) 38,405 1,546 23,739 1,231 3,424 20,136 13,299 2,841 2,304 10,229 9,975 2,158 8,233 254 – 6,151 1,828 397 United States 3,241 $ 4,992 Other International 1,605 4,828 Net income $ 5,184 $ 1,473 $ 900 $ 613 $ 2,270 $ 18 $ 10,458 $ 7,817 $ 1,431 $ Non-interest expense includes: Depreciation and amortization Impairment of other intangibles Restructuring provisions $ 338 $ 420 $ 17 $ 52 $ 22 $ 694 $ 1,543 $ 1,103 $ 302 $ 138 – – – 10 – – – – – – 3 – 3 10 3 1 – 4 – 5 Total assets $ 411,251 $ 91,901 $ 14,245 $ 139,701 $ 492,899 $ 30,261 $ 1,180,258 $ 614,834 $ 328,088 $ 237,336 Total assets include: Additions to premises and equipment and intangibles $ 302 $ 2,532 $ 27 $ 63 $ 278 $ 386 $ 3,588 $ 849 $ 2,585 $ 154 Total liabilities $ 411,320 $ 91,908 $ 14,281 $ 139,608 $ 493,044 $ (41,515) $ 1,108,646 $ 543,072 $ 328,205 $ 237,369 (Millions of Canadian dollars) Net interest income (3) (4) Non-interest income Personal & Commercial Banking $ 10,004 $ 4,309 Total revenue Provision for credit losses Insurance policyholder benefits, 14,313 984 claims and acquisition expense Non-interest expense Net income (loss) before income taxes Income taxes (recoveries) – 6,611 6,718 1,712 For the year ended October 31, 2015 Wealth Management Insurance Investor & Treasury Services Capital Markets (2) Corporate Support (2) 493 $ – $ 818 $ 6,282 6,775 46 – 5,292 1,437 396 4,436 4,436 – 2,963 613 860 154 1,220 2,038 (1) – 1,301 738 182 3,970 $ 4,093 8,063 71 – 4,696 3,296 977 (514) $ 210 (304) (3) – 125 (426) (824) Total Canada 14,771 $ 11,538 $ 20,550 10,889 35,321 1,097 22,427 933 2,963 18,638 12,623 2,597 1,976 10,139 9,379 1,727 6,596 98 – 4,762 1,736 649 United States 1,977 $ 4,619 Other International 1,256 5,042 Net income $ 5,006 $ 1,041 $ 706 $ 556 $ 2,319 $ 398 $ 10,026 $ 7,652 $ 1,087 $ Non-interest expense includes: Depreciation and amortization Impairment of other intangibles Restructuring provisions $ 345 $ 157 $ 16 $ 54 $ 28 $ 639 $ 1,239 $ 1,046 $ 40 $ 153 1 – 4 83 – – – – – – 2 – 7 83 3 25 1 45 3 13 Total assets $ 397,132 $ 26,891 $ 14,139 $ 132,294 $ 478,289 $ 25,463 $ 1,074,208 $ 584,419 $ 252,845 $ 236,944 Total assets include: Additions to premises and equipment and intangibles $ 327 $ 122 $ 23 $ 46 $ 256 $ 644 $ 1,418 $ 1,071 $ 206 $ 141 Total liabilities $ 397,157 $ 26,906 $ 14,160 $ 132,275 $ 478,291 $ (38,525) $ 1,010,264 $ 520,420 $ 252,970 $ 236,874 198 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements 6,433 61 1,120 3,756 1,496 286 1,210 6,298 66 987 3,737 1,508 221 1,287 (Millions of Canadian dollars) Net interest income (3) (4) Non-interest income Total revenue Provision for credit losses Insurance policyholder benefits, claims and acquisition expense Non-interest expense Net income (loss) before income taxes Income taxes (recoveries) Net income Personal & Commercial Banking $ 9,743 $ 3,987 13,730 1,103 – 6,563 For the year ended October 31, 2014 Wealth Management Insurance Investor & Treasury Services Capital Markets (2) Corporate Support (2) 469 $ – $ 732 $ 5,844 6,313 19 4,964 4,964 – – 4,800 3,573 579 1,152 1,884 – – 1,286 – 4,344 3,485 $ 3,881 7,366 44 (313) $ 164 (149) (2) United States 1,697 $ 4,257 Other International 1,291 5,247 Total Canada 14,116 $ 11,128 $ 19,992 10,488 34,108 1,164 21,616 922 3,573 17,661 2,188 9,650 5,954 52 1 4,199 6,064 1,589 4,475 $ $ 1,494 812 598 2,978 411 1,083 $ 31 781 $ 157 441 $ 923 2,055 $ 11,710 8,856 1,702 2,706 9,004 $ 1,983 6,873 $ 660 1,042 $ 6,538 190 1,384 3,812 1,152 63 1,089 – 89 (236) (405) 169 $ Non-interest expense includes: Depreciation and amortization $ Impairment of other intangibles Restructuring provisions 338 $ 147 $ 16 $ 58 $ 28 $ 578 $ 1,165 $ 971 $ 39 $ 155 – 20 6 16 – – – – 2 – – – 8 36 2 – 6 16 – 20 Total assets $ 376,188 $ 27,084 $ 12,930 $ 103,822 $ 400,314 $ 20,212 $ 940,550 $ 496,120 $ 194,879 $ 249,551 Total assets include: Additions to premises and equipment and intangibles $ 318 $ 105 $ 16 $ 30 $ 147 $ 563 $ 1,179 $ 924 $ 154 $ 101 Total liabilities $ 376,154 $ 27,022 $ 12,988 $ 103,798 $ 400,114 $ (34,029) $ 886,047 $ 441,607 $ 194,946 $ 249,494 (1) (2) (3) (4) In the first quarter of 2016, we changed the organizational structure of our Wealth Management operations resulting in a new operating segment U.S. Wealth Management (including City National) representing our legacy U.S. Wealth Management operations and City National. This new operating segment is combined with our other Wealth Management operations as a single reportable segment because they have comparable products, regulatory frameworks, processes, customers and distribution channels, and show similar economic characteristics (such as pre-tax margin). Taxable equivalent basis. Inter-segment revenue and share of profits in joint ventures and associates are not material. Interest revenue is reported net of interest expense as management relies primarily on net interest income as a performance measure. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 199 Note 31 Nature and extent of risks arising from financial instruments We are exposed to credit, market and liquidity and funding risks as a result of holding financial instruments. Our risk measurement and objectives, policies and methodologies for managing these risks are disclosed in the shaded text along with those tables specifically marked with an asterisk (*) on pages 54 to 82 of the Management’s Discussion and Analysis. These shaded text and tables are an integral part of these Consolidated Financial Statements. Concentrations of credit risk exist if a number of our counterparties are engaged in similar activities, are located in the same geographic region or have comparable economic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in economic, political or other conditions. Concentrations of credit risk indicate the relative sensitivity of our performance to developments affecting a particular industry or geographic location. The amounts of credit exposure associated with certain of our on- and off-balance sheet financial instruments are summarized in the following table. (Millions of Canadian dollars, except percentage amounts) On-balance sheet assets other than derivatives (1) Derivatives before master netting agreements (2) (3) Off-balance sheet credit instruments (4) Committed and uncommitted (5) Other (Millions of Canadian dollars, except percentage amounts) On-balance sheet assets other than derivatives (1) Derivatives before master netting agreements (2) (3) Off-balance sheet credit instruments (4) Committed and uncommitted (5) Other Canada % United States % Europe Other International % % Total As at October 31, 2016 $ 485,575 67% $ 141,703 20% $ 55,610 8% $ 40,096 5% $ 722,984 19,393 9 23,091 11 167,084 76 7,950 4 217,518 $ 504,968 54% $ 164,794 17% $ 222,694 24% $ 48,046 5% $ 940,502 $ 254,680 62,725 57% $ 151,028 18,236 54 33% $ 32,983 34,032 16 7% $ 29 $ 317,405 56% $ 169,264 30% $ 67,015 12% $ 13,425 1,017 14,442 3% $ 452,116 116,010 1 2% $ 568,126 Canada % United States % Europe Other International % % Total As at October 31, 2015 $ 453,650 68% $ 110,341 17% $ 56,984 9% $ 41,453 6% $ 662,428 20,911 11 22,877 12 143,414 74 7,254 3 194,456 $ 474,561 55% $ 133,218 16% $ 200,398 23% $ 48,707 6% $ 856,884 $ 239,351 49,740 57% $ 137,204 17,520 51 33% $ 32,638 29,213 18 8% $ 30 $ 289,091 56% $ 154,724 30% $ 61,851 12% $ 10,312 1,523 11,835 2% $ 419,505 97,996 1 2% $ 517,501 (1) (2) (3) (4) (5) Includes assets purchased under reverse repurchase agreements and securities borrowed, loans and customers’ liability under acceptances. The largest concentrations in Canada are Ontario at 49% (October 31, 2015 – 47%), the Prairies at 20% (October 31, 2015 – 21%), British Columbia and the territories at 15% (October 31, 2015 – 16%) and Quebec at 11% (October 31, 2015 – 11%). No industry accounts for more than 36% (October 31, 2015 – 35%) of total on-balance sheet credit instruments. A further breakdown of our derivative exposures by risk rating and counterparty type is provided in Note 8. Excludes credit derivatives classified as other than trading. Balances presented are contractual amounts representing our maximum exposure to credit risk. Represents our maximum exposure to credit risk. Retail and wholesale commitments respectively comprise 36% and 64% of our total commitments (October 31, 2015 – 36% and 64%). The largest concentrations in the wholesale portfolio relate to Financing products at 14% (October 31, 2015 – 15%), Non-bank financial services at 9% (October 31, 2015 – 10%), Real estate & related at 9% (October 31, 2015 – 8%), Technology & media at 8% (October 31, 2015 – 8%), and Utilities at 8% (October 31, 2015 – 9%). 200 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 32 Capital management Regulatory capital and capital ratios OSFI formally establishes risk-based capital and leverage targets for deposit-taking institutions in Canada. We are required to calculate our capital ratios using the Basel III framework. Under Basel III, regulatory capital includes Common Equity Tier 1 (CET1), Tier 1 and Tier 2 capital. CET1 capital mainly consists of common shares, retained earnings and other components of equity. Regulatory adjustments under Basel III include deductions of goodwill and other intangibles, certain deferred tax assets, defined benefit pension fund assets, investments in banking, financial and insurance entities, and the shortfall of provisions to expected losses. Tier 1 capital comprises predominantly CET1, with additional items that consist of capital instruments such as certain preferred shares, and certain non-controlling interests in subsidiaries. Tier 2 capital includes subordinated debentures that meet certain criteria and certain loan loss allowances. Total capital is the sum of CET1, additional Tier 1 capital and Tier 2 capital. Regulatory capital ratios are calculated by dividing CET1, Tier 1 and Total capital by risk-weighted assets. The leverage ratio is calculated by dividing Tier 1 capital by an exposure measure. The exposure measure consists of total assets (excluding items deducted from Tier 1 capital) and certain off-balance sheet items converted into credit exposure equivalents. Adjustments are also made to derivatives and secured financing transactions to reflect credit and other risks. During 2016, we complied with all capital and leverage requirements imposed by OSFI. (Millions of Canadian dollars, except Capital ratios and leverage ratios) Capital (1) Common Equity Tier 1 capital Tier 1 capital Total capital Risk-weighted assets used in calculation of capital ratios (1) (2) Common Equity Tier 1 capital ratio Tier 1 capital ratio Total capital ratio Total capital risk-weighted assets (1) Credit risk Market risk Operational risk Capital ratios and leverage ratios (1) Common Equity Tier 1 capital ratio Tier 1 capital ratio Total capital ratio Leverage ratio Leverage ratio exposure (billions) As at October 31 2016 October 31 2015 $ 48,181 55,270 64,950 $ 43,715 50,541 58,004 447,436 448,662 449,712 369,751 23,964 55,997 $ 449,712 10.8% 12.3% 14.4% 4.4% $ 1,265.1 411,756 412,941 413,957 323,870 39,786 50,301 $ 413,957 10.6% 12.2% 14.0% 4.3% $ 1,170.2 (1) (2) Capital, risk-weighted assets and capital ratios are calculated using OSFI Capital Adequacy Requirements. Leverage ratio is calculated using OSFI Leverage Requirements. Effective the third quarter of 2014, the credit valuation adjustment to our risk-weighted asset calculation implemented in the first quarter of 2014 must reflect different percentages for each tier of capital. This change reflects a phase-in of credit valuation adjustments ending in the fourth quarter of 2018. During this phase-in period, risk-weighted assets for Common Equity Tier 1, Tier 1 and Total capital ratios will be subject to different annual credit valuation adjustment percentages. Note 33 Offsetting financial assets and financial liabilities Offsetting within our Consolidated Balance Sheets may be achieved where financial assets and liabilities are subject to master netting arrangements that provide the currently enforceable right of offset and where there is an intention to settle on a net basis, or realize the assets and liabilities simultaneously. For derivative contracts and repurchase and reverse repurchase arrangements, this is generally achieved when there is a market mechanism for settlement (e.g., central counterparty exchange, or clearing house) which provides daily net settlement of cash flows arising from these contracts. Margin receivables and margin payables are generally offset as they settle simultaneously through a market settlement mechanism. These are generally presented in Other assets or Other liabilities. Amounts that do not qualify for offsetting include master netting arrangements that only permit outstanding transactions with the same counterparty to be offset in an event of default or occurrence of other predetermined events. Such master netting arrangements include the ISDA Master Agreement or derivative exchange or clearing counterparty agreements for derivative contracts, global master repurchase agreement and global master securities lending agreements for repurchase, reverse repurchase and other similar secured lending and borrowing arrangements. The amount of financial collateral received or pledged subject to master netting arrangements or similar agreements but not qualified for offsetting refers to the collateral received or pledged to cover the net exposure between counterparties by enabling the collateral to be realized in an event of default or the occurrence of other predetermined events. Certain amounts of collateral are restricted from being sold or re-pledged unless there is an event of default or the occurrence of other predetermined events. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 201 Note 33 Offsetting financial assets and financial liabilities (continued) The tables below provide the amount of financial instruments that have been offset on the Consolidated Balance Sheets and the amounts that do not qualify for offsetting but are subject to enforceable master netting arrangements or similar agreements. The amounts presented are not intended to represent our actual exposure to credit risk. Financial assets subject to offsetting, enforceable master netting arrangements and similar agreements Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2016 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) Assets purchased under reverse repurchase agreements and securities borrowed Derivative assets (3) Other financial assets Gross amounts of financial assets before balance sheet offsetting Amounts of financial liabilities offset on the balance sheet Net amount of financial assets presented on the balance sheet Impact of master netting agreements Financial collateral received (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 199,586 208,936 1,244 409,766 $ $ 14,290 97,142 803 112,235 $ $ 185,296 111,794 441 297,531 $ $ 422 79,296 – 79,718 $ 184,359 17,249 46 $ 201,654 $ $ 515 15,249 395 16,159 $ $ 1,006 7,150 91 8,247 $ $ 186,302 118,944 532 305,778 Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2015 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) Assets purchased under reverse repurchase agreements and securities borrowed Derivative assets (3) Other financial assets Gross amounts of financial assets before balance sheet offsetting Amounts of financial liabilities offset on the balance sheet Net amount of financial assets presented on the balance sheet Impact of master netting agreements Financial collateral received (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 183,493 185,654 1,560 370,707 $ $ 9,846 87,527 1,283 98,656 $ $ 173,647 98,127 277 272,051 $ $ 30 71,833 – 71,863 $ 172,910 14,956 52 $ 187,918 $ $ 707 11,338 225 12,270 $ $ 1,076 7,499 78 8,653 $ $ 174,723 105,626 355 280,704 (1) (2) (3) Financial collateral is reflected at fair value. The amount of financial instruments and financial collateral disclosed is limited to the net balance sheet exposure, and any over-collateralization is excluded from the table. Includes cash collateral of $11 billion (October 31, 2015 – $11 billion) and non-cash collateral of $191 billion (October 31, 2015 – $177 billion). Includes cash margin of $2.2 billion (October 31, 2015 – $1.5 billion) which offset against the derivative balance on the balance sheet. Financial liabilities subject to offsetting, enforceable master netting arrangements and similar agreements Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2016 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) Obligations related to assets sold under repurchase agreements and securities loaned Derivative liabilities (3) Other financial liabilities Gross amounts of financial liabilities before balance sheet offsetting Amounts of financial assets offset on the balance sheet Net amount of financial liabilities presented on the balance sheet Impact of master netting agreements Financial collateral pledged (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 117,031 203,874 3,271 324,176 $ $ 14,290 96,231 2,231 112,752 $ $ 102,741 107,643 1,040 211,424 $ $ 422 79,296 – 79,718 $ 102,029 15,993 514 $ 118,536 $ $ 290 12,354 526 13,170 $ $ 700 8,907 15 9,622 $ $ 103,441 116,550 1,055 221,046 Amounts subject to offsetting and enforceable netting arrangements As at October 31, 2015 Amounts subject to master netting arrangements or similar agreements but do not qualify for offsetting on the balance sheet (1) Obligations related to assets sold under repurchase agreements and securities loaned Derivative liabilities (3) Other financial liabilities Gross amounts of financial liabilities before balance sheet offsetting Amounts of financial assets offset on the balance sheet Net amount of financial liabilities presented on the balance sheet Impact of master netting agreements Financial collateral pledged (2) Net amount Amounts not subject to enforceable netting arrangements Total amount recognized on the balance sheet $ $ 92,564 186,400 2,348 281,312 $ $ 9,846 87,960 1,517 99,323 $ $ 82,718 98,440 831 181,989 $ $ 30 71,833 – 71,863 $ 82,476 15,060 551 $ 98,087 $ $ 212 11,547 280 12,039 $ $ 570 9,420 3 9,993 $ $ 83,288 107,860 834 191,982 (1) (2) (3) Financial collateral is reflected at fair value. The amount of financial instruments and financial collateral disclosed is limited to the net balance sheet exposure, and any over-collateralization is excluded from the table. Includes cash collateral of $14 billion (October 31, 2015 – $13 billion) and non-cash collateral of $105 billion (October 31, 2015 – $85 billion). Includes cash margin of $0.8 billion (October 31, 2015 – $1.3 billion) which offset against the derivative balance on the balance sheet. 202 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Note 34 Recovery and settlement of on-balance sheet assets and liabilities The table below presents an analysis of assets and liabilities recorded on our Consolidated Balance Sheets by amounts to be recovered or settled within one year and after one year, as at the balance sheet date, based on contractual maturities and certain other assumptions outlined in the footnotes below. As warranted, we manage the liquidity risk of various products based on historical behavioural patterns that are often not aligned with contractual maturities. Amounts to be recovered or settled within one year, as presented below, may not be reflective of management’s long-term view of the liquidity profile of certain balance sheet categories. (Millions of Canadian dollars) Assets Cash and due from banks (1) Interest-bearing deposits with banks Securities Trading (2) Available-for-sale Assets purchased under reverse repurchase agreements and securities borrowed Loans Retail Wholesale Allowance for loan losses Segregated fund net assets Other Customers’ liability under acceptances Derivatives (2) Premises and equipment, net Goodwill Other intangibles Other assets Liabilities Deposits (3) Segregated fund net liabilities Other Within one year October 31, 2016 After one year Total Within one year October 31, 2015 After one year Total As at $ 12,049 27,850 $ 2,880 1 $ 14,929 27,851 $ 10,466 22,690 $ 1,986 – $ 12,452 22,690 142,045 12,153 9,247 72,648 151,292 84,801 149,150 12,338 9,553 44,467 158,703 56,805 182,618 3,684 186,302 172,122 2,601 174,723 81,683 34,887 287,787 119,482 – 981 12,841 116,533 – – – 33,754 2 2,411 2,836 11,156 4,648 8,317 369,470 154,369 (2,235) 981 12,843 118,944 2,836 11,156 4,648 42,071 92,012 25,842 256,171 100,227 – 13,446 103,618 – – – 35,350 830 7 2,008 2,728 9,289 2,814 6,522 348,183 126,069 (2,029) 830 13,453 105,626 2,728 9,289 2,814 41,872 $ 656,413 $ 526,080 $ 1,180,258 $ 637,034 $ 439,203 $ 1,074,208 $ 579,571 – $ 178,018 981 $ 757,589 981 $ 528,109 – $ 169,118 830 $ 697,227 830 Acceptances Obligations related to securities sold short Obligations related to assets sold under repurchase agreements and securities loaned Derivatives (2) Insurance claims and policy benefit liabilities Other liabilities Subordinated debentures 12,841 41,927 103,412 114,321 118 33,314 – 2 8,442 29 2,229 9,046 14,633 9,762 12,843 50,369 103,441 116,550 9,164 47,947 9,762 13,446 41,156 82,498 105,271 97 28,563 1,500 7 6,502 790 2,589 9,013 14,913 5,862 13,453 47,658 83,288 107,860 9,110 43,476 7,362 $ 885,504 $ 223,142 $ 1,108,646 $ 800,640 $ 209,624 $ 1,010,264 (1) (2) (3) Cash and due from banks are assumed to be recovered within one year, except for cash balances not available for use by the Bank. Trading securities classified as at FVTPL and trading derivatives not designated in hedging relationships are presented as within one year as this best represents in most instances the short- term nature of our trading activities. Non-trading derivatives designated in hedging relationships are presented according to the recovery or settlement of the related hedged item. Demand deposits of $358 billion (October 31, 2015 – $312 billion) are presented as within one year due to their being repayable on demand or at short notice on a contractual basis. In practice, these deposits relate to a broad range of individuals and customer-types which form a stable base for our operations and liquidity needs. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 203 Note 35 Parent company information The following table presents information regarding the legal entity of Royal Bank of Canada with its subsidiaries presented on an equity accounted basis. Condensed Balance Sheets (Millions of Canadian dollars) Assets Cash and due from banks Interest-bearing deposits with banks Securities Investments in bank subsidiaries and associated corporations (1) Investments in other subsidiaries and associated corporations Assets purchased under reverse repurchase agreements and securities borrowed Loans, net of allowance for loan losses Net balances due from bank subsidiaries (1) Other assets Liabilities and shareholders’ equity Deposits Net balances due to other subsidiaries Other liabilities Subordinated debentures Shareholders’ equity (1) Bank refers primarily to regulated deposit-taking institutions and securities firms. Condensed Statements of Income and Comprehensive Income (Millions of Canadian dollars) Interest income (1) Interest expense Net interest income Non-interest income (2) Total revenue Provision for credit losses Non-interest expense Income before income taxes Income taxes Net income before equity in undistributed income of subsidiaries Equity in undistributed income of subsidiaries Net income Other comprehensive income, net of taxes Total comprehensive income As at October 31 2016 October 31 2015 $ 3,164 16,126 132,100 30,248 61,705 25,129 458,675 5,437 162,790 $ 3,123 15,838 130,326 22,907 60,378 23,418 444,169 19,118 147,330 $ 895,374 $ 866,607 $ 573,933 55,473 185,583 $ 566,903 66,879 163,379 814,989 797,161 9,368 71,017 7,300 62,146 $ 895,374 $ 866,607 For the year ended October 31 2016 $ 17,542 5,486 October 31 2015 $ 18,287 5,785 October 31 2014 $ 18,415 5,882 12,056 3,896 15,952 1,456 8,014 6,482 1,544 4,938 5,520 10,458 (1,097) 12,502 5,474 17,976 1,027 8,051 8,898 1,939 6,959 3,067 10,026 3,153 12,533 6,007 18,540 1,010 7,801 9,729 2,283 7,446 1,558 9,004 915 $ 9,361 $ 13,179 $ 9,919 (1) (2) Includes dividend income from investments in subsidiaries and associated corporations of $23 million (2015 – $120 million; 2014 – $10 million). Includes share of profit from associated corporations of $19 million (2015 – profit of $15 million; 2014 – profit of $7 million). 204 Royal Bank of Canada: Annual Report 2016 Consolidated Financial Statements Condensed Statements of Cash Flows (Millions of Canadian dollars) Cash flows from operating activities Net income Adjustments to determine net cash from operating activities: Change in undistributed earnings of subsidiaries Change in deposits, net of securitizations Change in loans, net of securitizations Change in trading securities Change in obligations related to assets sold under repurchase agreements and securities loaned Change in assets purchased under reverse repurchase agreements and securities borrowed Change in obligations related to securities sold short Other operating activities, net Net cash from (used in) operating activities Cash flows from investing activities Change in interest-bearing deposits with banks Proceeds from sale of available-for-sale securities Proceeds from maturity of available-for-sale securities Purchases of available-for-sale securities Net acquisitions of premises and equipment and other intangibles Change in cash invested in subsidiaries Change in net funding provided to subsidiaries Proceeds from sale of associated corporations Net cash (used in) from investing activities Cash flows from financing activities Issue of subordinated debentures Repayment of subordinated debentures Issue of preferred shares Issuance costs Redemption of preferred shares Issue of common shares Common shares purchased for cancellation Preferred shares purchased for cancellation Dividends paid Net cash used in financing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year Supplemental disclosure of cash flow information Amount of interest paid in year Amount of interest received in year Amount of dividends received in year Amount of income taxes paid in year Note 36 Subsequent events For the year ended October 31 2016 October 31 2015 October 31 2014 $ 10,458 $ 10,026 $ 9,004 (5,520) 7,030 (14,488) 9,004 8,511 (1,711) 3,145 (2,736) 13,693 (288) 2,868 20,802 (33,668) (750) (3,140) 2,275 – (11,901) 3,606 (1,500) 1,475 (16) – 307 (362) (264) (4,997) (1,751) 41 3,123 3,164 5,331 17,411 30 736 $ $ (3,067) 70,802 (33,904) (10,663) 2,687 (6,343) (1,244) (7,845) (1,558) 41,428 (22,865) (4,193) (2,712) (2,497) (1,305) 182 20,449 15,484 (10,050) 620 25,207 (36,408) (937) (978) 2,081 4 (20,461) 1,000 (1,700) 1,350 (21) (325) 62 – – (4,564) (4,198) (4,210) 7,333 3,123 5,786 18,001 106 1,323 $ $ (3,081) 1,225 28,875 (36,165) (803) (2,409) 4,889 70 (7,399) 2,000 (1,600) 1,000 (14) (1,525) 150 (113) – (4,211) (4,313) 3,772 3,561 7,333 5,814 18,582 10 1,286 $ $ On November 10, 2016, Moneris Solutions Corporation (Moneris) entered into a definitive agreement to sell its U.S. operations to Vantiv Inc. for US$425 million. The transaction is expected to close in the first quarter of fiscal 2017 and is subject to customary closing conditions, including the receipt of regulatory approvals. We have a 50% interest in Moneris and account for our interest as a joint venture. Our share of the gain to be recognized by Moneris is currently estimated to be approximately $200 million, based on the exchange rate as at October 31, 2016. This estimate is subject to change. Consolidated Financial Statements Royal Bank of Canada: Annual Report 2016 205 Ten-year statistical review Condensed Balance Sheet (Millions of Canadian dollars) 2016 2015 2014 2013 2012 2011 2011 2010 2009 2008 2007 IFRS CGAAP Assets Cash and due from banks Interest-bearing deposits with banks Securities Assets purchased under reverse repurchase agreements and securities borrowed Loans net of allowance Other Total Assets Liabilities Deposits Other Subordinated debentures Trust capital securities Preferred shares liabilities Non-controlling interest in subsidiaries $ 14,929 $ 27,851 236,093 12,452 $ 17,421 $ 15,550 $ 12,428 $ 12,428 6,460 9,039 22,690 167,022 182,710 215,508 8,399 199,148 10,246 161,602 $ 13,247 $ 12,181 179,558 186,302 521,604 193,479 174,723 472,223 176,612 135,580 435,229 144,773 117,517 408,850 126,079 112,257 378,241 149,180 84,947 347,530 175,446 84,947 296,284 165,485 8,440 $ 13,254 183,519 72,698 273,006 175,289 7,584 $ 11,086 $ 8,919 177,298 20,041 171,134 4,226 11,881 178,255 41,580 258,395 161,213 44,818 289,540 187,240 64,313 237,936 103,735 $ 1,180,258 $ 1,074,208 $ 940,550 $ 859,745 $ 823,954 $ 793,833 $ 751,702 $ 726,206 $ 654,989 $ 723,859 $ 600,346 $ 757,589 $ 697,227 $ 614,100 $ 563,079 $ 512,244 $ 479,102 263,625 8,749 894 – n.a. 305,675 7,362 – – n.a. 264,088 7,859 – – n.a. 239,763 7,443 – – n.a. 259,174 7,615 – – n.a. 341,295 9,762 – – n.a. $ 444,181 $ 414,561 $ 378,457 $ 438,575 $ 365,205 201,404 229,699 6,235 6,461 1,400 1,395 300 – 1,483 2,071 256,124 7,749 – – 1,941 263,030 6,681 727 – 2,256 242,744 8,131 1,400 – 2,371 Total Liabilities 1,108,646 1,010,264 886,047 810,285 779,033 752,370 709,995 687,255 618,083 693,221 576,027 Equity attributable to shareholders Non-controlling interest Total equity 71,017 595 71,612 62,146 52,690 47,665 43,160 39,702 41,707 38,951 36,906 30,638 24,319 1,798 1,813 1,795 1,761 1,761 n.a. n.a. n.a. n.a. n.a. 63,944 54,503 49,460 44,921 41,463 41,707 38,951 36,906 30,638 24,319 Total liabilities and equity $ 1,180,258 $ 1,074,208 $ 940,550 $ 859,745 $ 823,954 $ 793,833 $ 751,702 $ 726,206 $ 654,989 $ 723,859 $ 600,346 Condensed Income Statement (Millions of Canadian dollars) Net interest income Non-interest income Total revenue Provision for credit losses (PCL) Insurance policyholder benefits, claims and $ acquisition expense Non-interest expense (NIE) Non-controlling interest Net income from continuing operations Net loss from discontinued operations Net income 2016 16,531 $ 21,874 38,405 1,546 3,424 20,136 n.a. 10,458 – 10,458 IFRS CGAAP 2015 2014 2013 2012 2011 2011 2010 2009 2008 14,771 $ 14,116 $ 13,249 $ 12,439 $ 11,357 16,281 17,433 20,550 27,638 30,682 35,321 1,133 1,237 1,097 19,992 34,108 1,164 16,708 29,147 1,299 $ 10,600 $ 10,338 $ 10,705 $ 15,744 26,082 1,240 15,736 26,441 2,167 16,830 27,430 975 2,963 18,638 n.a. 10,026 – 10,026 3,573 17,661 n.a. 9,004 – 9,004 2,784 16,214 n.a. 8,342 – 8,342 3,621 14,641 n.a. 7,558 (51) 7,507 3,358 14,167 n.a. 6,970 (526) 6,444 3,360 14,453 104 6,650 (1,798) 4,852 3,546 13,469 99 5,732 (509) 5,223 3,042 13,436 100 5,681 (1,823) 3,858 9,054 $ 12,528 21,582 1,595 1,631 12,351 81 4,555 – 4,555 2007 7,700 14,762 22,462 791 2,173 12,473 141 5,492 – 5,492 Other Statistics – reported (Millions of Canadian dollars, except percentages and per share amounts) PROFITABILITY MEASURES (1) Earnings per shares (EPS) – basic – diluted Return on common equity (ROE) Return on risk-weighted assets (RWA) (2) Efficiency ratio (1) KEY RATIOS PCL on impaired loans as a % of Average net loans and acceptances Net interest margin (total average assets) Non-interest income as a % of total revenue SHARE INFORMATION (3) Common shares outstanding (000s) – end of period Dividends declared per common share Dividend yield Dividend payout ratio Book value per share Common share price (RY on TSX) – close, end of period Market capitalization (TSX) Market price to book value CAPITAL MEASURES – CONSOLIDATED (4) Common Equity Tier 1 capital ratio Tier 1 capital ratio Total capital ratio Assets-to-capital multiple Leverage Ratio 16.3% 2.34% 52.4% 0.28% 1.41% 57.0% 1,485,394 3.24 $ 4.3% 48% 43.32 $ $ $ $ 2016 2015 2014 2013 2012 2011 2011 2010 2009 2008 2007 IFRS CGAAP $ $ 6.80 $ 6.78 $ 6.75 $ 6.73 $ 6.03 $ 6.00 $ 5.53 $ 5.49 $ 4.96 $ 4.91 $ 18.6% 2.45% 52.8% 19.0% 2.52% 51.8% 19.7% 2.67% 52.8% 19.6% 2.70% 50.2% 4.25 4.19 18.7% 2.44% 51.3% $ $ 3.21 $ 3.19 $ 3.49 $ 3.46 $ 2.59 $ 2.57 $ 3.41 $ 3.38 $ 12.9% 1.87% 52.7% 14.9% 2.03% 51.6% 11.9% 1.50% 50.8% 18.1% 1.78% 57.2% 4.24 4.19 24.7% 2.23% 55.5% 0.24% 1.40% 0.27% 1.56% 0.31% 1.56% 0.35% 1.55% 0.33% 1.52% 0.34% 1.49% 0.45% 1.59% 0.72% 1.64% 0.53% 1.39% 0.33% 1.33% 58.2% 58.6% 56.8% 57.3% 58.9% 61.4% 60.4% 59.5% 58.0% 65.7% 1,443,423 1,442,233 1,441,056 1,445,303 1,438,376 2.08 3.9% 45% 24.25 2.53 $ 4.0% 46% 29.87 $ 2.84 $ 3.8% 47% 33.69 $ 3.08 $ 4.1% 46% 39.51 $ 2.28 $ 4.5% 46% 26.52 $ 1,438,376 1,424,922 1,417,610 1,341,260 1,276,260 1.82 $ 3.3% 43% 17.49 2.00 $ 4.8% 52% 22.67 $ 2.00 $ 3.6% 52% 23.99 $ 2.00 $ 4.2% 59% 20.90 $ 2.08 $ 3.9% 47% 25.65 $ $ 83.80 $ 74.77 $ 80.01 $ 70.02 $ 56.94 $ 124,476 1.93 107,925 1.89 115,393 2.38 100,903 2.34 82,296 2.15 48.62 69,934 2.00 $ 48.62 $ 54.39 $ 54.80 $ 46.84 $ 69,934 1.90 77,502 2.27 77,685 2.42 62,825 2.24 10.8% 12.3% 14.4% n.a. 4.4% 10.6% 12.2% 14.0% n.a. 4.3% 9.9% 11.4% 13.4% 17.0X n.a. 9.6% 11.7% 14.0% 16.6X n.a. n.a. 13.1% 15.1% 16.7X n.a. n.a. n.a. n.a. n.a. n.a. n.a. 13.3% 15.3% 16.1X n.a. n.a. 13.0% 14.4% 16.5X n.a. n.a. 13.0% 14.2% 16.3X n.a. n.a. 9.0% 11.0% 20.1X n.a. 56.04 71,522 3.20 n.a. 9.4% 11.5% 20.0X n.a. (1) (2) (3) (4) Ratios for 2009-2012 represent continuing operations. Return on risk-weighted assets (RWA) for fiscal 2011 is based on RWA reported under CGAAP and Income reported under IFRS. On April 6, 2006, we paid a stock dividend of one common share on each of our issued and outstanding common shares. The effect was the same as two-for-one split of our common shares. All common share and per share information have been adjusted retroactively for the stock dividend. Effective 2013 we calculate the capital ratios and multiples using the Basel III (all-in basis) framework unless otherwise stated. 2008-2012 capital ratios and multiples were calculated using the Basel II framework. 2004-2007 capital ratios and 2005-2007 asset-to-capital multiples were calculated using the Basel I framework. Capital ratios and multiples for 2011 were determined under Canadian GAAP. 206 Royal Bank of Canada: Annual Report 2016 Ten-year statistical review Glossary Acceptances A bill of exchange or negotiable instrument drawn by the borrower for payment at maturity and accepted by a bank. The acceptance constitutes a guarantee of payment by the bank and can be traded in the money market. The bank earns a “stamping fee” for providing this guarantee. Acquired Credit Impaired (ACI) loans Loans identified as impaired on the acquisition date based on specific risk characteristics such as indications that the borrower is experiencing significant financial difficulty, probability of bankruptcy or other financial reorganization, payment status and economic conditions that correlate with defaults. Allowance for credit losses The amount deemed adequate by management to absorb identified credit losses as well as losses that have been incurred but are not yet identifiable as at the balance sheet date. This allowance is established to cover the lending portfolio including loans, acceptances, guarantees, letters of credit, and unfunded commitments. The allowance is increased by the provision for credit losses, which is charged to income and decreased by the amount of write-offs, net of recoveries in the period. Alt-A assets A term used in the U.S. to describe assets (mainly mortgages) with a borrower risk profile between the prime and subprime categorizations. Categorization of assets as Alt- A (as opposed to prime) varies, such as limited verification or documentation of borrowers’ income or a limited credit history. Asset-backed securities (ABS) Securities created through the securitization of a pool of assets, for example auto loans or credit card loans. Assets-to-capital multiple (ACM) Total assets plus specified off-balance sheet items, as defined by OSFI, divided by total regulatory capital on a transitional basis. ACM has been replaced in 2015 by the Basel III Leverage Ratio. Assets under administration (AUA) Assets administered by us, which are beneficially owned by clients, as at October 31, unless otherwise noted. Services provided in respect of assets under administration are of an administrative nature, including safekeeping, collecting investment income, settling purchase and sale transactions, and record keeping. Assets under management (AUM) Assets managed by us, which are beneficially owned by clients, as at October 31, unless otherwise noted. Services provided in respect of assets under management include the selection of investments and the provision of investment advice. We have assets under management that are also administered by us and included in assets under administration. Auction rate securities (ARS) Securities issued through structured entities that hold long-term assets funded with long- term debt. In the U.S., these securities are issued by sponsors such as municipalities, student loan authorities or other sponsors through bank-managed auctions. Average earning assets Average earning assets include interest- bearing deposits with other banks including certain components of cash and due from banks, securities, assets purchased under reverse repurchase agreements and securities borrowed, loans, and excludes segregated fund net assets and other assets. The averages are based on the daily balances for the period. Bank-owned life insurance contracts (BOLI) Our legacy portfolio includes BOLI where we provided banks with BOLI stable value agreements (“wraps”), which insure the life insurance policy’s cash surrender value from market fluctuations on the underlying investments, thereby allowing us to guarantee a minimum tax-exempt return to the counterparty. These wraps allow us to account for the underlying assets on an accrual basis instead of a mark-to-market basis. Basis point (bp) One one-hundredth of a percentage point (.01%). Collateral Assets pledged as security for a loan or other obligation. Collateral can take many forms, such as cash, highly rated securities, property, inventory, equipment and receivables. Collateralized debt obligation (CDO) Securities with multiple tranches that are issued by structured entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand. Commercial mortgage-backed securities (CMBS) Securities created through the securitization of commercial mortgages. Commitments to extend credit Unutilized amount of credit facilities available to clients either in the form of loans, bankers’ acceptances and other on-balance sheet financing, or through off-balance sheet products such as guarantees and letters of credit. Common Equity Tier 1 (CET1) capital A regulatory Basel III capital measure comprised mainly of common shareholders’ equity less regulatory deductions and adjustments for goodwill and intangibles, defined benefit pension fund assets, shortfall in allowances and other specified items. Common Equity Tier 1 capital ratio A risk-based capital measure calculated as CET1 capital divided by risk-weighted assets. Covered bonds Full recourse on-balance sheet obligations issued by banks and credit institutions that are also fully collateralized by assets over which investors enjoy a priority claim in the event of an issuer’s insolvency. Credit default swaps (CDS) A derivative contract that provides the purchaser with a one-time payment should the referenced entity/entities default (or a similar triggering event occur). Derivative A contract between two parties, which requires little or no initial investment and where payments between the parties are dependent upon the movements in price of an underlying instrument, index or financial rate. Examples of derivatives include swaps, options, forward rate agreements and futures. The notional amount of the derivative is the contract amount used as a reference point to calculate the payments to be exchanged between the two parties, and the notional amount itself is generally not exchanged by the parties. Dividend payout ratio Common dividends as a percentage of net income available to common shareholders. Earnings per share (EPS), basic Calculated as net income available to common shareholders divided by the average number of shares outstanding. Earnings per share (EPS), diluted Calculated as net income available to common shareholders divided by the average number of shares outstanding adjusted for the dilutive effects of stock options and other convertible securities. Economic capital An estimate of the amount of equity capital required to underpin risks. It is calculated by estimating the level of capital that is necessary to support our various businesses, given their risks, consistent with our desired solvency standard and credit ratings. The identified risks for which we calculate Economic Capital are credit, market (trading and non-trading), operational, business, fixed asset, and insurance. Additionally, Economic Capital includes goodwill and intangibles, and allows for diversification benefits across risks and business segments. Expected credit losses The difference between the contractual cash flows due to us in accordance with the relevant contractual terms and the cash flows that we expect to receive, discounted to the balance sheet date. Glossary Royal Bank of Canada: Annual Report 2016 207 Fair value Fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Federal Deposit Insurance Corporation (FDIC) An independent U.S. government agency that aims to preserve and promote public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions; identifying, monitoring and addressing risks to these deposits; and limiting the effect on the economic and financial system when a bank or thrift institution fails. Funding Valuation Adjustment Funding valuation adjustments are calculated to incorporate cost and benefit of funding in the valuation of uncollateralized and under- collateralized OTC derivatives. Future expected cash flows of these derivatives are discounted to reflect the cost and benefit of funding the derivatives by using a funding curve, implied volatilities and correlations as inputs. Gross-adjusted assets (GAA) GAA are used in the calculation of the Assets- to-Capital multiple. They represent our total assets including specified off-balance sheet items and net of prescribed deductions. Off balance sheet items for this calculation are direct credit substitutes, including letters of credit and guarantees, transaction-related contingencies, trade-related contingencies and sale and repurchase agreements. Commencing Q1/15, the Asset-to-capital multiple and GAA have been replaced with the leverage ratio and leverage ratio exposure respectively. Guarantees and standby letters of credit These primarily represent irrevocable assurances that a bank will make payments in the event that its client cannot meet its financial obligations to third parties. Certain other guarantees, such as bid and performance bonds, represent non-financial undertakings. Hedge A risk management technique used to mitigate exposure from market, interest rate or foreign currency exchange risk arising from normal banking operations. The elimination or reduction of such exposure is accomplished by establishing offsetting positions. For example, assets denominated in foreign currencies can be offset with liabilities in the same currencies or through the use of foreign exchange hedging instruments such as futures, options or foreign exchange contracts. Hedge funds A type of investment fund, marketed to accredited high net worth investors, that is subject to limited regulation and restrictions on its investments compared to retail mutual funds, and that often utilize aggressive strategies such as selling short, leverage, program trading, swaps, arbitrage and derivatives. High-quality liquid assets (HQLA) Assets are considered to be HQLA if they can be easily and immediately converted into cash at little or no loss of value during a time of stress. Net interest margin (average assets) Net interest income as a percentage of total average assets. Home equity products This is comprised of residential mortgages and secured personal loans whereby the borrower pledges real estate as collateral. International Financial Reporting Standards (IFRS) IFRS are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board. Impaired loans Loans are classified as impaired when there has been a deterioration of credit quality to the extent that management no longer has reasonable assurance of timely collection of the full amount of principal and interest in accordance with the contractual terms of the loan agreement. Credit card balances are not classified as impaired as they are directly written off after payments are 180 days past due. Innovative capital instruments Innovative capital instruments are capital instruments issued by structured entities, whose primary purpose is to raise capital. We previously issued innovative capital instruments, RBC Trust Capital Securities (RBC TruCS) and RBC Trust Subordinated Notes (RBC TSNs), through three structured entities: RBC Capital Trust, RBC Capital Trust II and RBC Subordinated Notes Trust. As per OSFI Basel III guidelines, non-qualifying innovative capital instruments treated as additional Tier 1 capital are subject to phase out over a ten year period beginning on January 1, 2013. Leverage Ratio A Basel III regulatory measure, the ratio divides Tier 1 capital by the sum of total assets plus specified off-balance sheet items. Liquidity Coverage Ratio (LCR) The Liquidity Coverage Ratio is a Basel III metric that measures the sufficiency of HQLA available to meet net short-term financial obligations over a thirty day period in an acute stress scenario. Loan-to-value (LTV) ratio Calculated based on the total facility amount for the residential mortgage and homeline product divided by the value of the related residential property. Master netting agreement An agreement between us and a counterparty designed to reduce the credit risk of multiple derivative transactions through the creation of a legal right of offset of exposure in the event of a default. Net interest income The difference between what is earned on assets such as loans and securities and what is paid on liabilities such as deposits and subordinated debentures. Net interest margin (on average earning assets) Calculated as net interest income divided by average earning assets. Normal course issuer bid (NCIB) A program for the repurchase of our own shares for cancellation through a stock exchange that is subject to the various rules of the relevant stock exchange and securities commission. Notional amount The contract amount used as a reference point to calculate payments for derivatives. Off-balance sheet financial instruments A variety of arrangements offered to clients, which include credit derivatives, written put options, backstop liquidity facilities, stable value products, financial standby letters of credit, performance guarantees, credit enhancements, mortgage loans sold with recourse, commitments to extend credit, securities lending, documentary and commercial letters of credit, note issuances and revolving underwriting facilities, securities lending indemnifications and indemnifications. Office of the Superintendent of Financial Institutions Canada (OSFI) The primary regulator of federally chartered financial institutions and federally administered pension plans in Canada. OSFI’s mission is to safeguard policyholders, depositors and pension plan members from undue loss. Operating leverage The difference between our revenue growth rate and non-interest expense growth rate. Options A contract or a provision of a contract that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. Primary dealer A formal designation provided to a bank or securities broker-dealer permitted to trade directly with a country’s central bank. Primary dealers participate in open market operations, act as market-makers of government debt and provide market information and analysis to assist with monetary policy. Provision for credit losses (PCL) The amount charged to income necessary to bring the allowance for credit losses to a level determined appropriate by management. This includes both provisions on impaired loans and loans not yet identified as impaired. 208 Royal Bank of Canada: Annual Report 2016 Glossary Repurchase agreements These involve the sale of securities for cash and the simultaneous repurchase of the securities for value at a later date. These transactions normally do not constitute economic sales and therefore are treated as collateralized financing transactions. Securities sold short A transaction in which the seller sells securities and then borrows the securities in order to deliver them to the purchaser upon settlement. At a later date, the seller buys identical securities in the market to replace the borrowed securities. Residential mortgage-backed securities (RMBS) Securities created through the securitization of residential mortgage loans. Securitization The process by which various financial assets are packaged into newly issued securities backed by these assets. Return on common equity (ROE) Net income available to common shareholders, expressed as a percentage of average common equity. Reverse repurchase agreements These involve the purchase of securities for cash and the simultaneous sale of the securities for value at a later date. These transactions normally do not constitute economic sales and therefore are treated as collateralized financing transactions. Risk-weighted assets (RWA) Assets adjusted by a regulatory risk-weight factor to reflect the riskiness of on and off- balance sheet exposures. Certain assets are not risk-weighted, but deducted from capital. The calculation is defined by guidelines issued by OSFI. For more details, refer to the Capital management section. Securities lending Transactions in which the owner of a security agrees to lend it under the terms of a prearranged contract to a borrower for a fee. The borrower must collateralize the security loan at all times. An intermediary such as a bank often acts as agent for the owner of the security. There are two types of securities lending arrangements: lending with and without credit or market risk indemnification. In securities lending without indemnification, the bank bears no risk of loss. For transactions in which the bank provides an indemnification, it bears the risk of loss if the borrower defaults and the value of the collateral declines concurrently. Structured entities A structured entity is an entity in which voting or similar rights are not the dominant factor in deciding who controls the entity, such as when the activities that significantly affect the entity’s returns are directed by means of contractual arrangements. Structured entities often have restricted activities, narrow and well defined objectives, insufficient equity to finance their activities, and financing in the form of multiple contractually-linked instruments. Standardized Approach Risk weights prescribed by OSFI are used to calculate risk-weighted assets for the credit risk exposures. Credit assessments by OSFI- recognized external credit rating agencies of S&P, Moody’s, Fitch and DBRS are used to risk- weight our Sovereign and Bank exposures based on the standards and guidelines issued by OSFI. For our Business and Retail exposures, we use the standard risk weights prescribed by OSFI. Structured investment vehicle Managed investment vehicle that holds mainly highly rated asset-backed securities and funds itself using the short-term commercial paper market as well as the medium-term note (MTN) market. Subprime loans Subprime lending is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. Subprime lending carries more risk for lenders due to the combination of higher interest rates for the borrowers, poorer credit histories, and adverse financial situations usually associated with subprime applicants. Taxable equivalent basis (teb) Income from certain specified tax advantaged sources (eligible Canadian taxable corporate dividends) is increased to a level that would make it comparable to income from taxable sources. There is an offsetting adjustment in the tax provision, thereby generating the same after-tax net income. Tier 1 capital Tier 1 capital comprises predominantly of CET1 capital, with additional Tier 1 items such as preferred shares, innovative instruments and non-controlling interests in subsidiaries Tier 1 instruments. Tier 2 capital Tier 2 capital consists mainly of subordinated debentures that meet certain criteria, certain loan loss allowances and non-controlling interests in subsidiaries’ Tier 2 instruments. Total capital and total capital ratio Total capital is defined as the total of Tier 1 and Tier 2 capital. The total capital ratio is calculated by dividing total capital by risk- weighted assets. Tranche A security class created whereby the risks and returns associated with a pool of assets are packaged into several classes of securities offering different risk and return profiles from those of the underlying asset pool. Tranches are typically rated by ratings agencies, and reflect both the credit quality of underlying collateral as well as the level of protection based on the tranches’ relative subordination. Trust Capital Securities (RBC TruCS) Transferable trust units issued by structured entities RBC Capital Trust or RBC Capital Trust II for the purpose of raising innovative Tier 1 capital. Value-at-Risk (VaR) A generally accepted risk-measurement concept that uses statistical models based on historical information to estimate within a given level of confidence the maximum loss in market value we would experience in our trading portfolio from an adverse one-day movement in market rates and prices. Glossary Royal Bank of Canada: Annual Report 2016 209 Directors and executive officers Directors W. Geoffrey Beattie (2001) Toronto, Ontario Chief Executive Officer Generation Capital Andrew A. Chisholm (2016) Toronto, Ontario Corporate Director Jacynthe Côté (2014) Montreal, Quebec Corporate Director Toos N. Daruvala (2015) New York, New York Senior Advisor and Director Emeritus McKinsey & Company David F. Denison, O.C., FCPA, FCA (2012) Toronto, Ontario Corporate Director Richard L. George, O.C. (2012) Calgary, Alberta Partner, Novo Investment Group Alice D. Laberge (2005) Vancouver, British Columbia Corporate Director Michael H. McCain (2005) Toronto, Ontario President and Chief Executive Officer Maple Leaf Foods Inc. David I. McKay (2014) Toronto, Ontario President and Chief Executive Officer Royal Bank of Canada Heather Munroe-Blum, O.C., O.Q., Ph.D., FRSC (2011) Montreal, Quebec Professor Emerita and Principal Emerita McGill University Thomas A. Renyi (2013) New Harbor, Maine Corporate Director Edward Sonshine, O.Ont., Q.C. (2008) Toronto, Ontario Chief Executive Officer RioCan Real Estate Investment Trust Kathleen P. Taylor (2001) Toronto, Ontario Chair of the Board Royal Bank of Canada Bridget A. van Kralingen (2011) New York, New York Senior Vice President Industry Platforms IBM Corporation Thierry Vandal (2015) New York, New York President Axium Infrastructure US Inc. The date appearing after the name of each director indicates the year in which the individual became a director. Group Executive Mike Dobbins(1) Head, Strategy and Corporate Development Zabeen Hirji Chief Human Resources Officer Janice R. Fukakusa, FCPA, FCA(2) Chief Administrative Officer and Chief Financial Officer Doug Guzman Group Head, Wealth Management and Insurance Mark Hughes Group Chief Risk Officer A. Douglas McGregor Group Head, Capital Markets and Investor & Treasury Services David I. McKay President and Chief Executive Officer Bruce Ross Group Head, Technology & Operations Jennifer Tory Group Head, Personal & Commercial Banking (1) (2) Effective November 1, 2016, Mike Dobbins was appointed Head, Strategy and Corporate Development and joined Group Executive. Janice R. Fukakusa will retire as Chief Administrative Officer and Chief Financial Officer on January 31, 2017. Rod Bolger will take over as Chief Financial Officer effective December 1, 2016 and will join Group Executive on January 31, 2017. 210 Royal Bank of Canada: Annual Report 2016 Directors and executive officers Principal subsidiaries Principal subsidiaries (1) Royal Bank Holding Inc. Royal Mutual Funds Inc. RBC Insurance Holdings Inc. RBC Insurance Company of Canada RBC Life Insurance Company RBC Direct Investing Inc. RBC Phillips, Hager & North Investment Counsel Inc. R.B.C. Holdings (Bahamas) Limited RBC Caribbean Investments Limited Royal Bank of Canada Insurance Company Ltd. Investment Holdings (Cayman) Limited RBC (Barbados) Funding Ltd. Capital Funding Alberta Limited RBC Global Asset Management Inc. RBC Investor Services Trust RBC Investor Services Bank S.A. RBC (Barbados) Trading Bank Corporation BlueBay Asset Management (Services) Ltd RBC USA Holdco Corporation (2) RBC Capital Markets, LLC (2) RBC Bank (Georgia), National Association (2) City National Bank RBC Global Asset Management (U.S.) Inc. RBC Dominion Securities Limited RBC Dominion Securities Inc. RBC Holdings (Barbados) Ltd. RBC Financial (Caribbean) Limited RBC Finance S.à r.l./B.V. (2) RBC Holdings (Luxembourg) S.A R.L. RBC Holdings (Channel Islands) Limited Royal Bank of Canada (Channel Islands) Limited RBC Capital Trust RBC Europe Limited Royal Bank Mortgage Corporation The Royal Trust Company Royal Trust Corporation of Canada Principal office address (2) Toronto, Ontario, Canada Toronto, Ontario, Canada Mississauga, Ontario, Canada Mississauga, Ontario, Canada Mississauga, Ontario, Canada Toronto, Ontario, Canada Toronto, Ontario, Canada Nassau, New Providence, Bahamas George Town, Grand Cayman, Cayman Islands St. Michael, Barbados George Town, Grand Cayman, Cayman Islands St. Michael, Barbados Calgary, Alberta, Canada Toronto, Ontario, Canada Toronto, Ontario, Canada Esch-sur-Alzette, Luxembourg St. James, Barbados London, England New York, New York, U.S. New York, New York, U.S. Atlanta, Georgia, U.S. Los Angeles, California, U.S. Minneapolis, Minnesota, U.S. Toronto, Ontario, Canada Toronto, Ontario, Canada St. Michael, Barbados Port of Spain, Trinidad and Tobago Amsterdam, Netherlands Luxembourg, Luxembourg Jersey, Channel Islands Guernsey, Channel Islands Toronto, Ontario, Canada London, England Toronto, Ontario, Canada Montreal, Quebec, Canada Toronto, Ontario, Canada RBC Covered Bond Guarantor Limited Partnership Toronto, Ontario, Canada Carrying value of voting shares owned by the Bank (3) $ 52,178 18,771 7,926 3,556 3,205 1,633 1,593 1,118 619 255 166 (1) (2) (3) The Bank directly or indirectly controls each subsidiary. Each subsidiary is incorporated or organized under the law of the state or country in which the principal office is situated, except for RBC USA Holdco Corporation which is incorporated under the laws of the State of Delaware, U.S., RBC Capital Markets, LLC, which is organized under the laws of the State of Minnesota, U.S. RBC Finance S.à r.l. / B.V. is a company incorporated in the Netherlands with its official seat in Amsterdam, the Netherlands, and place of effective management, central administration, and principal establishment in Luxembourg, Grand Duchy of Luxembourg. RBC Bank (Georgia), National Association is a national banking association organized under the laws of the U.S. with its main office in Atlanta, Georgia and management offices in Raleigh, North Carolina. The carrying value (in millions of Canadian dollars) of voting shares is stated as the Bank’s equity in such investments. Principal subsidiaries Royal Bank of Canada: Annual Report 2016 211 Shareholder Information Corporate headquarters Street address: Royal Bank of Canada 200 Bay Street Toronto, Ontario M5J 2J5 Canada Tel: 1-888-212-5533 Mailing address: P.O. Box 1 Royal Bank Plaza Toronto, Ontario M5J 2J5 Canada website: rbc.com Transfer Agent and Registrar Main Agent: Computershare Trust Company of Canada 1500 Robert-Bourassa Blvd. Suite 700 Montreal, Quebec H3A 3S8 Canada Tel: 1-866-586-7635 (Canada and the U.S.) or 514-982-7555 (International) Fax: 514-982-7580 website: computershare.com/rbc Co-Transfer Agent (U.S.): Computershare Trust Company, N.A. 250 Royall Street Canton, Massachusetts 02021 U.S.A. Co-Transfer Agent (U.K.): Computershare Investor Services PLC Securities Services – Registrars P.O. Box 82, The Pavilions, Bridgwater Road, Bristol BS99 6ZZ U.K. Stock exchange listings (Symbol: RY) Common shares are listed on: Canada – Toronto Stock Exchange (TSX) U.S. – New York Stock Exchange (NYSE) Switzerland – Swiss Exchange (SIX) All preferred shares are listed on the TSX with the exception of the series C-1 and C-2. The related depository shares of the series C-1 and C-2 preferred shares are listed on the NYSE. Valuation day price For Canadian income tax purposes, Royal Bank of Canada’s common stock was quoted at $29.52 per share on the Valuation Day (December 22, 1971). This is equivalent to $7.38 per share after adjusting for the two-for-one stock split of March 1981 and the two-for-one stock split of February 1990. The one-for-one stock dividends in October 2000 and April 2006 did not affect the Valuation Day amount for our common shares. Shareholder contacts For dividend information, change in share registration or address, lost stock certificates, tax forms, estate transfers or dividend reinvestment, please contact: Computershare Trust Company of Canada 100 University Avenue, 8th Floor Toronto, Ontario M5J 2Y1 Canada Tel: 1-866-586-7635 (Canada and the U.S.) or 514-982-7555 (International) Fax: 1-888-453-0330 (Canada and the U.S.) or 416-263-9394 (International) email: service@computershare.com For other shareholder inquiries, please contact: Shareholder Relations Royal Bank of Canada 200 Bay Street South Tower Toronto, Ontario M5J 2J5 Canada Tel: 416-955-7806 Financial analysts, portfolio managers, institutional investors For financial information inquiries, please contact: Investor Relations Royal Bank of Canada 200 Bay Street North Tower Toronto, Ontario M5J 2W7 Canada Tel: 416-955-7802 or visit our website at rbc.com/investorrelations Direct deposit service Shareholders in Canada and the U.S. may have their RBC common share dividends deposited directly to their bank account by electronic funds transfer. To arrange for this service, please contact our Transfer Agent and Registrar, Computershare Trust Company of Canada. Eligible dividend designation For purposes of the Income Tax Act (Canada) and any corresponding provincial and territorial tax legislation, all dividends (and deemed dividends) paid by RBC to Canadian residents on both its common and preferred shares, are designated as “eligible dividends,” unless stated otherwise. Common share repurchases We are engaged in a Normal Course Issuer Bid (NCIB). During the one-year period commencing June 1, 2016, we may repurchase for cancellation, up to 20 million common shares in the open market at market prices. We determine the amount and timing of the purchases under the NCIB, subject to prior consultation with the Office of the Superintendent of Financial Institutions Canada (OSFI). A copy of our Notice of Intention to file a NCIB may be obtained, without charge, by contacting our Corporate Secretary at our Toronto mailing address. 2017 Quarterly earnings release dates First quarter Second quarter Third quarter Fourth quarter February 24 May 25 August 23 November 29 2017 Annual Meeting The Annual Meeting of Common Shareholders will be held on Thursday, April 6, 2017, at 9:30 a.m. (Eastern Time), at the Sony Centre for the Performing Arts, 1 Front Street East, Toronto, Ontario, Canada. Dividend dates for 2017 Subject to approval by the Board of Directors Common and preferred shares series W, AA, AB, AC, AD, AE, AF, AG, AJ, AK, AL, AZ, BB, BD, BF, BH, BI, BJ, BK and BM Preferred shares series C-1 (US$) Preferred shares series C-2 (US$) Ex-dividend dates January 24 April 21 July 24 October 24 Record dates January 26 April 25 July 26 October 26 Payment dates February 24 May 24 August 24 November 24 February 1 May 3 August 2 November 1 January 25 April 26 July 26 October 25 February 5 May 5 August 4 November 3 January 27 April 28 July 28 October 27 February 13 May 15 August 14 November 13 February 7 May 8 August 7 November 7 Governance Summaries of the significant ways in which corporate governance practices followed by RBC differ from corporate governance practices required to be followed by U.S. domestic companies under the NYSE and Nasdaq listing standards are available on our website at rbc.com/ governance. Information contained in or otherwise accessible through the websites mentioned in this report to shareholders does not form a part of this report. All references to websites are inactive textual references and are for your information only. Trademarks used in this report include the LION & GLOBE Symbol, ROYAL BANK OF CANADA, RBC, RBC CAPITAL MARKETS, RBC CAPITAL TRUST, RBC GLOBAL ASSET MANAGEMENT, RBC INSURANCE, RBC REWARDS, RBC SUBORDINATED NOTES TRUST, RBC TSNs, RBC TruCS, RBC WEALTH MANAGEMENT, DIGITALLY ENABLED RELATIONSHIP BANK, ROYAL CREDIT LINE, YOURTERM which are trademarks of Royal Bank of Canada used by Royal Bank of Canada and/or by its subsidiaries under license. VISA is a registered trademark of Visa International Service Association. All other trademarks mentioned in this report, including those that are identified with the ‡ symbol, which are not the property of Royal Bank of Canada, are owned by their respective holders. 212 Royal Bank of Canada: Annual Report 2016 Shareholder information ‡ All paper used in the production of this report is FSC® (Forest Stewardship Council®) certified. This paper has been certified to meet the environmental and social standards of the Forest Stewardship Council® (FSC®) and comes from responsibly managed forests and verified recycled sources. ® / ™ Trademarks of Royal Bank of Canada. ‡ All other trademarks are the property of their respective owner(s). This is a carbon neutral publication. Carbon dioxide equivalent emissions associated with the production and distribution of this report have been neutralized through the purchase and retirement of high quality carbon offsets. The carbon offsets were acquired through the RBC Capital Markets emissions trading group. rbc.com/ar2016 81104 (12/2016) 

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