PNC Financial Services Group Inc (PNC) 2018 Q1 法說會逐字稿

Good morning.

My name is Kelly, and I will be your conference operator today.

At this time, I would like to welcome everyone to The PNC Financial Services Group Earnings Conference Call.

(Operator Instructions) As a reminder, this call is being recorded.

I will now turn the call over to the Director of Investor Relations, Mr. Bryan Gill.

Sir, please go ahead.

Well, thank you, and good morning, everyone.

Welcomes to today's conference call for The PNC Financial Services Group.

Participating on this call are PNC's Chairman, President and CEO, Bill Demchak; and Rob Reilly, Executive Vice President and Chief Financial Officer.

Today's presentation contains forward-looking information.

All forward-looking statements referring to PNC performance assume a continuation of the current economic trends and do not take into account the impact of potential legal and regulatory contingencies.

Actual results and future events could differ, possibly materially, from those anticipated in our statements and from historical performance due to a variety of risks and other factors.

Information about such factors as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss is included in today's conference call, earnings release and related presentation materials and in our 10-K and various other SEC filings and investor materials.

These are all available on our corporate website, pnc.com, under Investor Relations.

These statements speak only as of April 13, 2018, and PNC undertakes no obligation to update them.

Now I'd like to turn the call over to Bill Demchak.

Thanks, Bryan, and good morning, everybody.

As you've seen by now, for the first quarter, we reported net income of $1.2 billion or $2.43 per diluted common share.

Compared to the same period a year ago, we delivered higher net interest income and fee income, and we also benefited from a lower federal tax rate.

On the whole, it was a pretty good quarter, and I would like to thank our employees for their continued hard work.

On a sequential basis, we were impacted by seasonality, as we expected.

But in addition, there were couple of headwinds that are worth mentioning.

First, our average loan growth was modestly weaker than we expected, although spot loans grew by $1.2 billion.

Within C&IB's real estate business, multifamily agency warehouse lending declined in the first quarter as these balances tend to fluctuate pretty broadly.

Aside from that, pricing and structure in the commercial real estate space have become more aggressive, resulting in lower new volumes.

And at the same time, payoffs and maturities continue at a steady rate, which, of course, makes balanced growth more challenging.

Outside of CRE, the underlying trends in our loan portfolios are largely positive, and Rob is going to take you through those in more detail in a moment.

Secondly, the movement in rates impacted us this quarter.

Clearly, we benefited from higher loan yields as a result of the increase in Fed funds and 1-month LIBOR.

But on the other hand, our funding cost rose this quarter due to higher deposit pricing as betas continued to move higher.

And additionally, the sharp rise in 3-month LIBOR relative to 1-month LIBOR caused our cost of borrowed funds to increase more than we expected.

That said, we continued to execute well against our strategic priorities, and we're excited about our plans to tap new opportunities as the year unfolds.

You're all aware of the steps we've taken over the last 2 years to expand our middle-market franchise to Dallas, Kansas City and Minneapolis in 2017 and Denver, Houston and Nashville this year.

Now that work is going very well as our new regional presidents and our teams there have hit those -- in those markets have hit the ground running.

In addition, we've built an industry-leading technology platform, and we're beginning to leverage these capabilities to innovate and enhance with ease with which our customers do business with us.

And we're looking forward to beginning the rollout of our new national retail digital strategy later in the year, which will help us take advantage of our brand awareness and to begin serving more customers -- more consumer customers beyond our traditional Retail Banking footprint.

In fact, we're in the middle of our strategic planning season, and I can't actually recall a time when we've had as many attractive organic investment opportunities as we do right now.

With that, I'm going to turn it over to Rob for a closer look at our first quarter results, and then we'll take your questions.

Rob?

Yes.

Thanks, Bill, and good morning, everyone.

As Bill just mentioned, our first quarter net income was $1.2 billion or $2.43 per diluted common share.

Net interest margin expanded, capital return remained strong, expenses were well managed and of course, our results benefited from a lower tax rate.

Our balance sheet is on Slide 4 and is presented on an average basis.

Total loans were essentially flat linked quarter.

However, our spot loans grew by $1.2 billion since year-end.

Compared to the same quarter a year ago, both spot and average loans grew by $8.8 billion or 4%, and I'll discuss the drivers of this growth in a few moments.

Investment securities of $74.6 billion increased approximately $400 million or 1% linked quarter as purchases exceeded portfolio runoff.

Purchases were primarily made up of U.S. treasuries and agency RMBS.

In addition, $600 million of money market mutual fund securities were reclassified to equity investments due to an accounting standard adoption.

Excluding this reclassification, investment securities increased about $1 billion compared to the fourth quarter.

Our balances at the Federal Reserve were $25.4 billion for the first quarter, essentially flat linked-quarter and up $1.7 billion year-over-year.

On the liability side, total deposits declined by approximately $800 million compared to the fourth quarter, reflecting seasonal activity primarily on the commercial side.

Year-over-year, deposits increased by $5.7 billion or 2%.

Average common shareholders equity increased by approximately $300 million linked quarter.

During the quarter, we returned $1.1 billion of capital to shareholders or 96% of first quarter net income through repurchases of 4.8 million common shares for $747 million and dividends of $362 million.

As of March 31, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.6%, down 20 basis points compared to December 31, 2017.

This was primarily due to a decline in accumulated other comprehensive income as a result of the impact of higher interest rates on available-for-sale securities.

Our return on average assets for the first quarter was 1.34%.

Our return on average common equity was 11.04%.

And our tangible book value was $71.58 per common share as of March 31, which declined slightly on a linked quarter basis, reflecting the impact of AOCI, but was up 6% compared to the same date a year ago.

Turning to Slide 5. As I just mentioned, total average loans of $221 billion were essentially flat linked quarter.

However, the flattening effect, if you will, was largely due to a $1.5 billion decline in average agency warehouse lending balances, which, Bill mentioned, tend to fluctuate.

Importantly, spot loans increased by $1.2 billion or 1% linked quarter, and both spot and average loans increased $8.8 billion or 4% year-over-year.

As I mentioned, the commercial loan decline in the quarter was a result of the fourth quarter warehouse lending activity as well as slightly lower commercial real estate balances.

Offsetting this decline was broad-based growth in virtually all our other commercial lending segments, including corporate banking, which was up 1% linked quarter and 7% year-over-year; business credit, which was up 1% linked quarter and 13% year-over-year; and equipments finance, which was up 2% linked quarter and 14% year-over-year.

Commercial loans grew by $8.4 billion or 6% compared to the same period a year ago.

Consumer lending increased by $242 million linked quarter and $402 million year-over-year, driven by increases in residential mortgage, auto and credit card loans, which were partially offset by declines in home equity and education lending.

Turning to Slide 6. As expected, total deposits were down compared to the fourth quarter, primarily due to seasonal commercial outflows, somewhat offset by higher consumer deposits.

Compared to the same period a year ago, deposits increased by $5.7 billion or 2%, reflecting growth in both consumer and commercial deposits.

Total interest-bearing deposits increased $6.6 billion or 4% year-over-year, while noninterest-bearing deposits declined approximately $850 million during the same period, which reflected a shift in our deposit mix as a result of the rising rate environment.

In addition, deposit betas continued to move upward in the first quarter.

Our cumulative beta, which is the beta on our total interest-bearing deposits since December 2015, was 21%, and our current beta since December 2017 was 32% compared to our stated long-term expectation of 46%.

In simple terms, our accumulative commercial beta is already approaching stated levels.

And while our consumer betas have lagged, we do expect them to accelerate in the second quarter and throughout the balance of the year.

As I've already mentioned, and you can see on Slide 7, net income in the first quarter was $1.2 billion.

Net interest income increased $16 million or 1% linked quarter.

These higher loan yields were partially offset by higher funding costs and the impact of 2 fewer days in the quarter.

Compared to the fourth quarter, noninterest income declined $165 million or 9%, reflecting seasonally lower fee income and the impact of significant items on our fourth quarter results.

Noninterest expense decreased by $534 million or 17% compared to the fourth quarter, also reflecting the impact of significant items last quarter.

Expenses continued to be well managed due in part to our continuous improvement program.

Provision for credit losses in the first quarter was $92 million, a decrease of $33 million linked quarter as overall credit quality remained stable.

Our effective tax rate in the first quarter was 17%, reflecting the impact of federal tax legislation.

For the full year 2018, we continue to expect the effective tax rate to be approximately 17%.

Now let's discuss the key drivers of this performance in more detail.

Turning to Slide 8. Net interest income increased by $16 million or 1% linked quarter as higher loan yields were partially offset by higher deposit and borrowing costs as well as 2 fewer days in the quarter.

The day count impact was approximately $42 million.

As you'll recall, fourth quarter net interest income was negatively affected by $26 million due to the impact of tax legislation related to leverage leases.

Compared to the same quarter a year ago, net interest income increased by $201 million or 9%, driven by higher loan and securities yields and higher loan balances.

Net interest margin was 2.91%, an increase of 3 basis points compared to the fourth quarter as higher loan yields were partially offset by higher funding costs as a result of the sharp increase in 3-month LIBOR as well as the widening spread between 1-month LIBOR and 3-month LIBOR during the first quarter.

While a large portion of our loans are tied to 1-month LIBOR, essentially all of our borrowed funds are tied to 3-month LIBOR.

First quarter noninterest income was down $165 million or 9% linked quarter, reflecting seasonally lower trends as well as the impact of significant items in the fourth quarter.

Compared to the same quarter a year ago, noninterest income increased $26 million or 2%.

This reflected 6% growth in fee income, which was partially offset by a lower other noninterest income.

Slide 9 provides more detail on our noninterest income.

Looking at the various categories, asset management fees, which includes earnings from our equity investments in BlackRock, were down $265 million on a linked quarter basis, largely due to the flow-through impact of tax legislation benefits on BlackRock's earnings in the fourth quarter of 2017.

Compared to the same quarter last year, asset management fees increased by $52 million or 13%, reflecting higher equity markets and a 5% increase in PNC's assets under management.

Additionally, our earnings from BlackRock benefited from a lower tax rate.

Consumer services fees were down $9 million or 2% compared to fourth quarter results, reflecting seasonally lower client activity.

Compared to the same quarter a year ago, consumer services fees increased $25 million or 8% and included growth in credit card, brokerage and debit card fees.

Corporate service fees decreased by $29 million or 6% compared to strong fourth quarter results, driven by seasonally lower M&A advisory fees and loan syndication fees.

Compared to the same quarter a year ago, corporate services fees increased $15 million or 4%, reflecting higher treasury management fees and operating lease income.

As we previously disclosed in our 10-K, operating lease income is now reported in corporate services fees rather than other income and prior periods have been reclassified.

Residential mortgage noninterest income increased $68 million linked quarter, reflecting a negative $71 million adjustment related to updated MSR fair value assumptions in the fourth quarter.

Residential mortgage income declined on a year-over-year basis, primarily driven by lower loan sales revenue, which reflected lower refinancing volumes.

Service charges on deposits decreased by $16 million or 9% compared to the fourth quarter, driven by seasonally lower customer activity.

On a year-over-year basis, however, service charges on deposits increased $6 million or 4%, reflecting client growth.

Finally, other noninterest income increased $86 million compared to the fourth quarter, which included a negative $129 million net impact of significant items.

Excluding these items, other noninterest income declined $43 million linked quarter, primarily due to lower net gains on commercial mortgage loans held for sale.

Compared to the same period a year ago, other noninterest income declined $56 million, reflecting lower revenue from equity investments, including the impact of a first quarter 2017 benefit from valuation adjustments related to the Volcker Rule.

Going forward and considering the reclassification of operating lease income into corporate services fees, we now expect the quarterly run rate for other noninterest income to be in the range of $225 million to $275 million, excluding net securities and visa activity.

Turning to Slide 10.

First quarter expenses decreased by $534 million or 17%, reflecting the impact of approximately $500 million of significant items in the fourth quarter.

These consisted of a contribution to the PNC Foundation, real estate disposition and exit charges and employee cash payments and pension account credits.

Excluding the impact of these items, first quarter expenses declined $32 million or 1%, reflecting seasonally lower expenses and our continued focus on cost management.

We've previously announced the goal to reduce cost by $250 million in 2018 as part of our continuous improvement program.

And based on first quarter results, we are on track and confident we will achieve our full year target.

Turning to Slide 11.

Overall credit quality remained stable in the first quarter.

Compared to the prior quarter, total nonperforming loans were down $23 million and continue to represent less than 1% of our total loans.

Total delinquencies were down $131 million or 9% linked quarter from elevated levels at year-end that reflected seasonality and the residual impact of the 2017 hurricanes.

Provision for credit losses of $92 million decreased by $33 million linked quarter, reflecting lower provision for consumer loans, partially offset by a higher provision for commercial loans.

The declining consumer provision was driven by favorable historical performance on home equity loans, while the higher commercial provision reflects the impact of fourth quarter reserve releases.

These results take into account the outcome of the recently completed Shared National Credit examination.

Net charge-offs decreased $10 million to $113 million in the first quarter primarily due to lower commercial net charge-offs.

In the first quarter, the annualized net charge-off ratio was 21 basis points, down 1 basis point linked quarter.

In summary, PNC posted strong first quarter results.

For the remainder of the year, we expect continued steady growth in GDP and a corresponding increase in short-term interest rates 2 more times this year, in June and December, with each increase being 25 basis points.

Based on these assumptions, our full year 2018 guidance compared to 2017 adjusted full-year results remains unchanged and positions us to deliver positive operating leverage in 2018.

Looking ahead to the second quarter of 2018 compared to the first quarter of 2018 reported results, we expect modest loan growth, we expect total net interest income to be up low single digits.

We expect fee income to be up mid-single digits.

We expect other noninterest income to be in the $225 million to $275 million range.

We expect expenses to be up low single digits.

And we expect provision to be between $100 million and $150 million.

And with that, Bill and I are ready to take your questions.

(Operator Instructions) Our first question comes from the line of John Pancari from Evercore ISI Research.

Just wonder if you could talk a little bit more about the increase in the cost on the borrowed funds.

I know you indicated that the increase was more than you had expected.

Can you just talk about how that exceeded your expectations?

And also, I mean, just since its majority is tied to 3-month LIBOR, I assume you would've had pretty good visibility into that.

So if you could talk about how that exceeded.

And then what are your plans there?

Is there a plan to remix it?

Or are you focusing more on the deposit side to help offset that?

How do you address that going forward?

That's a good question.

Basically, what happened is that the spread between 1-month and 3-month LIBOR gapped out, particularly in March, wider than it's historically run.

I guess it's a 35, 34 basis points today.

And historically, it might have been half of that.

So all else equal in our forecast of NII, we wouldn't assume that you'd see that gap.

The issue is, today, it is as wide as any time it's been in history other than the financial crisis.

And a lot of people are writing that, that basis will collapse back in.

I -- we'll have to wait and see.

I think there's some pressures causing that as a function of the revamp of the money market industry coupled with some implications from this BEAT tax provision that is in the new federal tax code.

So we're going to have to wait and see.

If it doesn't change, we can -- and we'll probably do this anyway, we can start swapping our wholesale funding, our banknotes into 1 month just to get the basis mismatch between our loans and funding closer.

But that price will be embedded in that swap.

So we'll have to see, wait and see what happens.

John, I can jump in there.

So some of the increase in 3-month LIBOR is fundamental to rates rising.

The issue is just the gap.

And that gap, as Bill mentioned, was about 35 basis points, and we equate that to about $15 million or $20 million in the cost in the quarter.

Yes.

Got it.

Okay, all right.

And then, my follow-up is around loan growth.

I know you did not change your full year outlook around loan growth.

The average balances were somewhat flattish this quarter.

You did see good growth in the end of period.

So first of all, I'm assuming the end-of-period trends are likely more indicative of your expectations given you're not changing your full year outlook.

And then separately, can you talk about the broader macro backdrop?

I mean, we've seen weak industry loan growth, that's for sure, for the sector.

But the macro signs still point to improvement, particularly given tax reform.

So if you could just talk about that a little bit.

I think our own performance kind of mirrors what you see in the H.8 data where you saw a decent pickup in March and we're seeing that in our pipeline.

So I don't know what the anomaly was in Jan, Feb other than all the busy work everybody did prior to the tax getting enacted.

So all else equal, I would kind of say that March is the norm and Jan, Feb were the anomalies, and that should set us up well for the rest of the year.

The one exception to that, and I mentioned this, was in real estate, where we've just seen pricing and structure get to a place where it's kind of beyond our risk tolerance and versus our historical growth in that sector, we're most certain, to be slower.

Our next question comes from John McDonald with Bernstein.

In terms of the retail deposit betas changing, we're trying to get a sense of the pacing.

The disclosures you guys gave on Page 6 are really helpful.

So if we look at the 17% current deposit beta this quarter, it's up from the cumulative 8% since rates started rising.

Rob, any kind of broad sense of where that might have stood last quarter?

And is this something where we could get to the stated beta in a couple of quarters?

Or this could take a while to get there?

Any thoughts there?

Yes.

So good question in terms of the betas, particularly on the consumer side, where they've lagged.

We're keeping an eye on that.

Relative to last quarter, they have accelerated, so that's true.

And then going into the second quarter, we do expect it to accelerate on top of that.

How much remains to be seen because a lot of that's competitive pressures, but our best estimates are built into our NII guidance.

And what -- can you just remind us what factors you're looking at when you make these decisions?

You're looking at competition locally and I guess, nationally?

And then what your loan growth plans are, and everything gets put in the mix there?

All of the above.

Absolutely.

How about -- just last thing.

Any color on -- more color on the deposit mix shift you're seeing.

Just more consumer versus commercial within the deposit mix.

You're seeing folks move from checking to time and savings, but within PNC.

Yes.

Now the shift this quarter on commercial is more of a seasonal effect of commercial deposits.

It's sort of running down.

We would actually expect them to come back.

As you know, they don't help us particularly with LCR.

So it's not quite as important as to what -- versus what we do in the consumer side.

And in terms of the behavior that you're seeing on the consumer side?

Any more color there?

Pretty consistent, John, with what we've been seeing in terms of -- more to the savings and the relationship-driven deposits, which we've been pursuing for the better part of the last year, so that trend continues.

I guess, I was just asking, is that accelerated kind of like the deposit pricing?

Has that also gotten faster this quarter?

Yes, a little bit.

Yes, a little bit.

Our next question comes from Erika Najarian from Bank of America Merrill Lynch.

Yes.

My first question is on the Fed proposal for CET 1, specifically for the stress capital buffer.

I think the market was reading it as largely positive for banks like PNC in that the -- you now have a pretty set floor in terms of where your capital minimums would be.

And I'm wondering if the stress capital buffer did get finalized as it stands, how that would change how you're thinking about buybacks and dividends from here?

And also, how you're accounting for the volatility now in your business-as-usual CET 1 levels given, of course, your CCAR results now feed into it?

Okay.

Why not -- this is Rob.

Why don't I take a shot at some of that?

I'm not sure I understood the last part of the question.

Well, I'll just sort of -- I mean, it -- broaden that out a little bit in terms of the Fed's proposals in terms of the changes to CCAR, which, in broad measure, are encouraging.

We just got it Tuesday, as you know, so we're still reviewing it.

But a couple of things right off the top that are helpful, obviously, are the elimination of the soft cap on dividends at the 30%; the reduction of base case capital action from the severe scenario, with the exception of a year's worth of dividends; the RWA growth in the severe scenario; and then also, the elimination of the quantitative fail.

So all those things, I think, work well and are encouraging.

The stress capital buffer itself, we have to review.

I -- if you take a look at our 2016 and '17 CCAR submissions, we were below that.

It remains to be seen how the Fed stresses us in this go round, we'll see.

But there is an issue there around what we call guardrails around the scenarios because the severe scenarios, in any given year, are going to define that stress capital buffer, which, in the past, has been below 2.5%, but theoretically could be higher.

To clarify that last question, sorry to be confusing, but given that volatility in results, the question there had been does it -- how should you or how should your investors think about potential buffers that you would incorporate to account for that volatility of result?

Yes, the -- that's kind of the million-dollar question.

So internally, this -- you've heard us talk about this before.

We always work towards the endpoint on a severe stress as opposed to the starting point of what our capital is.

And we've talked historically about a target capital state in CET 1 of 8.25% to 8.5%, that number being driven historically by our own estimate of what a severe stress would look like.

An issue for us is as we approach that number, if the Fed goes from a relatively benign severe stress perhaps as they did last year versus a much more severe stress perhaps as they did this year, it -- you have to change your buffer on the fly, which causes you to then have volatility, as you point out, in your repurchases year-on-year.

And I don't know how that plays out through time as a function of what scenarios they come up with.

But it's one of the things that we need to solve for as we work through the next year.

And just one more follow-up question.

You mentioned that your organic investment opportunities have never been so attractive.

And I'm thinking, could you share with us what your earn-back period is for buyback activity at current valuation levels?

Sorry, our earn-back?

I mean, I would tell you that we look at it sort of on multiple ways.

But on an IRR basis, we're, today, probably fairly tight.

We look at that.

We look at where we are price-to-book.

We look at what we think our forward earnings potential is, which potentially offset those other 2 issues.

I don't know that I've actually talked about an earn-back period internally.

But to your point, the investment opportunities that we take a look at clearly beat that.

Yes, yes.

Our next question comes from Ken Usdin with Jefferies.

I want to just ask a question on expenses, and I know there's a couple of things.

You bought that little IRR firm and a couple of other moving parts.

I'm noticing just that personnel costs are up 8% year-over-year.

And can you just help us understand just -- is that recent hires?

Is it -- are you starting to spend some of the tax benefits?

Just how will we understand the kind of balance of growth versus the CIP, especially as it relates to personnel costs?

Yes.

Sure, Ken.

So just in terms of expenses in the first quarter, linked quarter expenses were down low single digits, which was part of our guidance.

The year-over-year, there's a couple of things going on there.

First and most prominently, first quarter 2018 expenses reflect the expenses associated with the acquisitions that you pointed out that happened subsequent to the first quarter, most notably, the leasing company, which we acquired in the second quarter of 2017.

And those expenses, which are about $27 million, are spread out between personnel and equipment expense.

Personnel because of the higher headcount and equipment expenses because of the depreciation nature of the leasing business.

So that's one.

In addition, on the personnel side, we do have some increases around investments that we've made, the hourly wage increase for our retail employees that we announced at the end of the year is there as well as some of the investments we've made in the new markets, as you would expect.

So personnel is a little bit higher.

But year-over-year, occupancy is down, marketing is flat and all other expenses, which are a lot of categories and where a lot of our CIP program is directed is in line.

So we feel good about what we set out to do, and that's why, like I said on the continuous improvement program, we have high confidence that we'll achieve it.

Okay, got it.

And then just one quick follow-up on the -- I understand that you move the operating lease-up into the commercial -- corporate services.

So can you -- now with that in there, can you just help us understand from a corporate services perspective within your fee outlook for the second quarter, remind us of the seasonality and what drivers you would expect to flow from that?

Yes, sure.

I can broaden that out for you in terms of our guidance for all the fee categories, not just corporate services.

But it's fairly easy in terms of guidance, up mid-single digits in the whole.

And for the first time in a while, for each of the 5 categories, asset management, consumer, corporate services, mortgages and service charges on deposits, all up mid-single digits.

So mid-single digits overall, mid-single digits in each of the categories, including corporate services.

Our next question comes from Betsy Graseck with Morgan Stanley.

Question, just a follow-up on the expense discussion we just had.

I wanted to understand if, in 1Q, any of the continuous improvement is in the quarter.

Or is this something that you expect just going to be ramping over 2018?

It's both.

There's some, as I mentioned, there's some in the first quarter largely directed at the all other expense line, but there's more to go.

Okay.

And so you've got a run rate that you expect would be building throughout 2018.

And would it be primarily focused on like the real estate as opposed to people?

I'm just trying to make sure I understand where...

In terms of the continuous improvement program?

Correct.

Yes.

I would say -- now so I would say, again, just to back up, our objective is positive operating leverage.

Our guidance is for expenses to be up low-single digits for the year.

Part of that is the implementation of the continuous improvement program savings that really are all over the bank.

Each area has a targeted level that we review regularly to be able to achieve those.

So even in areas where we're investing, retail, for example, there's substantial continuous improvement savings there as well, so it's broad based.

Okay.

And then separately, just -- I wanted to drill a little bit down on C&I.

I know that you went through the various categories and where you're seeing the loan growth.

It does feel like it's decelerating a little bit.

I mean, year-on-year, it's clearly stronger than what the LQA would be.

But the question is, are you able to deliver the level of growth you've been generating, which looks like it's not only solid good, but maybe a little above peers, due to the new markets you're going into?

Or is there any sign of increased interest in current borrowers actually increasing their leverage and borrowing more?

Do you see more of the share gain or clients are increasing their activity levels that you already have?

Well, we've seen -- you saw in March, I think C&I hit record levels actually.

So there is increasing stock in effect of C&I loans out there.

But inside of that, we continue -- both through differentiated product and then through an effect of new markets and kind of harvesting some of the new markets that we've been in, we've been able to sort of outpace peers and would expect that to continue with the one exception, I mentioned, of real estate.

I don't know what peers are going to do.

But that market is increasingly tight.

We wouldn't expect to see the growth rates we had in the past.

But we're still going to mid-single-digit loan growth for the year, so that's all part of it.

So a little bit of a pickup though from what you've had this quarter in terms of run rate there?

Yes, although -- it's interesting.

When you think through all the noise this quarter, they actually had a pretty decent quarter in C&I.

We had a big drawdown on mortgage warehousing as I said and still managed to grow spot.

Yes.

And even -- like I said on the segments, and I mentioned in my comments, corporate banking, up 1%; business credit, up 1%; equipment finance, up 2%.

Yes.

Pretty strong.

Yes, Q-on-Q.

Yes, yes.

Our next question comes from Kevin Barker with Piper Jaffray.

In regards to the loan growth, just a follow-up there, does the retail digital strategy and the rollout of that have a big impact on your expected loan growth at the back half of this year?

No, no.

It's -- the retail strategy will progress, but it will start as a deposit-gathering exercise.

If it -- what we think will be attractive returns for us because we don't have the brick-and-mortar costs and we'll have an ability to pay somewhat above what we pay in existing markets.

We will augment that offering with loan offerings in all of our products through time.

But you would -- you should expect that it will start out as deposit and then sort of migrate over time.

So no in 2018 really.

Yes, yes.

Okay.

And then given we've had tax reform, lower taxes for a few months now, have you seen any behavioral changes as far as competition amongst your peers in order -- given that they're seeing better ROEs due to lower taxes?

Yes, anecdotally.

So deal on deal and certain behaviors would suggest that people are willing to cut price as a function of the after-tax ROE.

And the competition for sort of plain vanilla C&I loans was tough in the first quarter in terms of price.

So I think that is starting to show its end, much less so in any of that specialty costs.

Much less on the specialty and also not long enough to be able to assess that.

Like Bill said, it's really anecdotal and the deals that we saw in the first 90 days of the quarter.

Yes.

So is it primarily on C&I lending or any particular industries that you're seeing that competition pick up?

Or is it broadly on several different loan categories?

It's interesting.

It's on the most generic 1 bank can hold the whole deal C&I loan, which is kind of the craziest place, in my view, to start competing away price because you still have the risk associated with the loan and your actual -- we had this discussion a quarter ago.

Your loss distribution on an after-tax basis causes you to actually have to hold more capital against this things.

So it would -- it kind of surprises me.

I would have expected to see more competition on deposit pricing and on fee-based services in terms of giving some of the excess margin back.

And I don't think we've seen that at all.

How much of it do you think is due to pretty low loan growth?

And just the amount of capital in the system versus taxes?

It's some amount of that, and I think it's also -- we have -- whatever the number is, 5,500 depository institutions in this country, many of which don't have much to offer beyond loans.

So that's a product they compete with.

And as you go downsize in loans, where somebody can hold the entire loan, you run into that group.

It's less -- it's not happening on the big syndicated loans.

It's not happening on asset base or anything that takes -- where there's only really a handful of credible players.

Our next question comes from Gerard Cassidy with RBC.

I apologize if I had to jump off for a minute, if you answered this question already.

But Bill, you started your presentation off with the comment about -- you've not seen as many good organic investment opportunities as you're seeing today.

You've already talked about the national consumer.

What are some of the other organic investment opportunities that you guys are looking at that gives you that kind of positive tone to it?

Yes.

So that -- the success we've had in newer markets obviously brings up the desire to do more.

The list we have on digital things that we want to roll out in consumer but also importantly, in C&I and the TM space, is quite large.

So there's a lot of asks on the table of the things that make a lot of business sense that I think differentiate us longer term.

Some of it's product based, some of it's market expansion based, some of it is investment, in effect, consumer service, the speed of which we can do fulfillments and the ease at which we can serve consumers, which would offer a differentiated product to our customers.

So there's a lot.

And you've heard me talk about this before, we didn't feel like we starved our firm for investment through the low rate environment.

We invested pretty heavily, which was a good thing.

And we're at a place now where that ask has sort of accelerated is, I guess, what I'm seeing in this strategic planning session this season.

Yes.

And I would -- Gerald, I just would extend on that in the sense that much of it is possible because of the technology investments we've made over the last couple of years.

So things that were interesting before, we just didn't have the technology to be able to facilitate, we do now.

Yes.

And part of that is we're now spending an ever-increasing percentage of our tech budget on consumer-facing applications as opposed to building and running the core...

Infrastructure.

Yes.

In fact, following up on that, how critical is having that capability?

Obviously, your big competitors have it.

But maybe some of the smaller banks you run into in different markets don't have as good of a product that you guys have.

So when you guys look at that, if you have -- had it on a scale of 1 to 10, 10 being most critical, 1 not being critical at all, how important it is -- is it for you guys to have that ability to generate this kind of business through this digital channel?

I think in the future state of the world, I think it's a 10.

I mean, you can say 12...

Yes.

No, good.

Things have to be simple.

They have to be fast.

They have to be coordinated.

Customer information needs to be consolidated.

It needs to be in one place.

All of that stuff, you can't really execute unless you have a core backbone kind of that allows you to do it.

And the clients' expectations continue to accelerate.

Absolutely.

And then just finally, as you guys know, there's been changes coming out of Washington on regulations regarding capital and the CCAR stress test, et cetera.

There seems to be news coming out that the dividend payout ratio is not going to be limited anymore or you won't get enhanced regulatory review if you go over 30%.

What does the board think and you guys think in terms -- about -- if we look out a couple of years, do you see a dividend payout ratio coming in north of 40% or 40%?

Yes.

Our next question comes from Matt O'Connor with Deutsche Bank.

This is Rob from Matt's team.

Just on commercial loan yields, they're up nicely this quarter.

Just curious, how do current kind of new money yields compare just given the March rate hike, but also your commentary about kind of higher competition in commercial lending right now?

Do you have the new spreads up for me?

The total -- -- the actual spread on loans didn't move a lot, but I think we have...

It's 4-0-9.

On the yields, you mean?

Yes, so the spreads, yes, spreads have held up.

New deal spreads aren't -- they're kind of spot on where they were, so we haven't seen a lot of a change.

That's right.

Okay.

And then similar question on securities yields.

They were down a few basis points in 1Q.

Just curious if you could speak to that and where you expect the rates are currently.

Yes, they're actually up a little bit when you take into consideration -- in the fourth quarter, and there was a lot going on in the fourth quarter.

But in the securities book, we did have an accounting change that, in effect, decreased the yields in the RMBS, the nonagency RMBS and increased the yields in the CMBS because that may be more than you want to know.

We changed the accounting standard to the contractual life of the security.

Prior, we used the estimated life.

So that moves yields around a little bit and actually elevated them.

So yields, after adjusting for that...

For the fourth quarter.

Yes.

For the fourth quarter and then went back to normal this quarter.

So our print is down 3, 2.82 to 2.79, but when you adjust for it, it might be marginally up.

The other thing I would say too, our purchases on the securities portfolio in the first quarter were largely treasuries, which carry a little bit of a lower yield, but I'll just add that in.

Our next question comes from Brian Klock with Keefe, Bruyette & Woods.

So Rob, I want to follow up on the expense side.

On the personnel expenses, can you remind us how much of the first quarter has the seasonal bump that you get from FICO and (inaudible) the incentive compensation and -- or maybe how much of that is in the first quarter versus the second quarter?

Well, that's in the first quarter, for sure, in terms of merit and promotion.

So that's definitely there, which tends to be a little bit more first quarter loaded.

The bigger issue just is on a year-over-year, and I don't know if you were on the call earlier, is the acquisition expenses from the leasing business as well as the investments that we've made.

Right.

So I guess, in the -- for the second quarter then, the guidance, they have the low-single-digit growth from the first quarter.

So that's the same expectation for personnel?

And I guess, personnel is somewhat impacted by the recent acquisition?

Well, yes -- what I would say -- yes, I would say most of the increase in expenses that's part of our guidance reflects the higher business activity that we expect in the second quarter, particularly on the fee side.

Got you.

So there's really the mid-single-digit growth you're expecting in fees and this is just going to be a comp-to-revenue ratio, it should be constant, but it's just going to go up with that?

Yes, I haven't done that math, but that's generally right.

Okay, all right.

And just a follow-up question, I think, on the loan growth side.

I know earlier, you said the mortgage warehouse business, I know, on average was down quarter-over-quarter.

When I look at Table 6 on the spot basis, the financial services line was up $1.5 billion.

Can you tell us what the balances were in each quarter for that warehouse business?

Jeez, I don't have the balances.

The balances quarter-over-quarter are down a lot for the warehouse.

But that line is up because that includes a lot of our securitizations, which had a strong quarter in the first quarter.

So those aren't necessarily 2 financial services companies, but because of the structure of the facility is categorized that way.

Okay.

And so on a spot basis, the warehouse business was down, not just on average, it was down on spot also?

Yes, that's right.

So -- well, I don't know the -- I know the -- in terms of the warehouse facility, the elevation was in the fourth quarter, which actually paid down in the fourth quarter, but the average to average started to average that.

The -- I can get you the number where we are, but it's on the low side because typically in the first quarter...

I can get you that offline, Brian.

Okay.

And so where would you think that securitization activity will probably normalize in the second quarter?

So maybe that could offset a little bit of the core growth you guys are seeing in your other businesses?

It ought to eventually normalize.

They actually have a pretty good pipeline though.

That's right, that's right.

Our next question comes from Mike Mayo with Wells Fargo Securities.

My question's on the new market strategy in commercial.

So after Denver, Houston and Nashville this year, what cities might be next?

And how many total cities might you expand to?

Well, without naming cities, maybe I'd just let -- you could name them yourselves.

In effect, we look for cities that we are not in that have target corporate population that kind of matches off against our product suite and expertise.

And when we started this exercise, we were less than half, I think, of the large markets that have C&I opportunities.

Yes, that's right.

Through time, we would hit most of them.

I don't know what time means, but we've had success and we'll keep kind of rolling out as opportunity presents itself.

And I'm sure you can see success.

If you look at Dallas and Kansas City and Minneapolis, you've said you've seen success in the new markets.

But we, on the outside, we can't see that in the aggregated results, right, because the new investing in Denver, Houston, Nashville is going to be offsetting.

So I guess, just generically, what is the time that you invest -- you go from investing to harvesting in a new city?

And in aggregate, for the total new market strategy, what's the total time for going from investing to harvesting?

Well, it -- I mean, let's look at the Southeast, I guess, as maybe the best example.

So when we bought the RBC branch because that's, in effect, what we did, although we had a branch network there, it -- we grew balances.

We met customers.

But it's probably 3 years before we really saw the acceleration in volume pick up and importantly, cross-sell with fee-based products.

In the newer markets that we've just entered, it's -- they don't cost that much money.

We get to breakeven pretty quickly, a couple of big deals and you're breakeven in a year.

But before they really start to contribute, sort of on a return on capital basis, you're probably looking at that 3 year...

Which is the corporate banking sales cycle basically.

If we get this -- just to continue, if we get this right, of course, those investment dollars sort of are continuous.

So in effect, we'll be harvesting new markets as we start other ones.

So it won't be a net drain.

All else equal, we have a small net drain right now because we've done 6 in 2 years.

Yes, that's right.

No, I get it.

Look...

In broader measure, that we're very encouraged in terms of the receptivity to our products, our services, our...

Client calls to new clients to the business and it's working.

Yes, our client interactions.

The energy is high.

One more follow-up.

No, I get it.

Look, your expenses were up a little more than $100 million year-over-year.

As you buy a bank, you're spending $10 billion, you're spending 100x more, you've spent $100 million.

You get tons of questions.

I get it.

But what is your sales pitch as you go in the new market?

Because as you said, a lot of these smaller banks that are causing the plain vanilla C&I loan competition, that's all they have is -- are loans.

So I guess, you have a very good sales pitch against them.

But what's your sales pitch against some of the very large banks that have more scale and a broader product suite.

And so who are you competing against these new markets?

So it's -- we compete against JPMorgan and Wells Fargo and BofA in every market we're in.

That's nothing new.

Yes, that's nothing new.

And we go with our A team in the middle market and small or large corporate with a very, credible, capable TM service leading against -- in all the surveys.

We go with a capital markets business that is relevant to that type of client.

We're not on the equity business, but we are not trying to do equity deals for the Fortune 100.

And it works for us.

We win or tie on a lot of these things in all the markets we're already in.

We go into a new market and we do the same thing.

We have no further phone questions at this time.

Okay.

Well, thank you all for joining us on the call this quarter.

Thanks, everybody.

Thank you.

This concludes today's conference call.

You may now disconnect your lines.