PNC Financial Services Group Inc (PNC) 2019 Q1 法說會逐字稿

Good morning.

My name is Silvana, 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 would now like to turn the call over to Director of Investor Relations, Mr. Bryan Gill.

Sir, please go ahead.

Well, thank you, and good morning, everyone.

Welcome 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 CFO.

Today's presentation contains forward-looking information.

Cautionary statements about this information as well as reconciliations of non-GAAP measures are included in today's earnings release materials as well as our SEC filings and other investor materials.

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

These statements speak only as of April 12, 2019, 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 this morning, PNC reported net income of $1.3 billion or $2.61 per diluted common share for the first quarter.

Rob is going to run you through all the numbers in a second, but I thought I would highlight a few brief items here.

As you know, the first quarter of the year is typically negatively impacted by some seasonality as well as 2 fewer days compared to the fourth quarter.

And with this as context, I really think PNC delivered good results.

Linked quarter, we saw very strong growth in average commercial balances and small growth in consumer loans as well.

Within C&IB the growth was actually greater than the headline numbers as we had a decrease in our commercial real-estate balances of approximately $1.8 billion driven principally by our multi-family warehouse lines.

If you exclude the real estate books, C&IB growth came in at just over 4% quarter-over-quarter.

We could -- we saw continued growth in our secured lending areas, but we also saw growth in our more traditional cash flow lending businesses for the first time in several quarters.

Reflecting normal first quarter seasonality, total fee income came in about where we expected.

Importantly, expenses were flat and our overall credit quality remained strong.

Our loan loss provision came in higher than we anticipated.

But as Rob's going to discuss, it was largely driven by our strong loan growth and some reserves for certain commercial credits.

Nothing that we saw on a broad-based basis.

As we look forward from here, we still feel very good about the economy.

Notwithstanding some mixed signals from economic indicators, we have seen very little from our clients that would indicate that there is inherent weakness in the U.S. economy.

Having said that, there's clear weakness in the global economy.

Pressure from trade and fears of a hard Brexit that will continue to weigh on the U.S. economy.

Regardless of the path ahead, we believe having a strong balance sheet, a solid mix of fee-based businesses, significant focus on expense management and differentiated strategies for organic expansion will provide the foundation for success.

Lastly, I did want to mention a couple of things that I'm particularly proud of this quarter.

The first of these is that we learned just a few weeks ago that PNC has received an outstanding Community Reinvestment Act rating from the OCC, the highest possible rating and one that we are proud to have earned for every exam period since the inception of CRA in 1977.

And second, we're very excited or we were very excited just last week to celebrate the 15th anniversary of PNC Grow Up Great, our signature philanthropic program, focused on early childhood education.

As part of this celebration, we extended our commitment to Grow Up Great, which is now a $500-million initiative, reflecting our Main Street model, our success depends a lot on the success of the communities in which we operate.

Investing in early childhood education has proven to generate very high economic returns for communities, and we are proud to support that.

So overall, I'm very pleased with the quarter, and I want to thank our employees for their continued hard work to both drive our business forward and help our communities thrive.

And with that, I'll 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, we reported first quarter net income of $1.3 billion or $2.61 per diluted common share.

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

Total loans grew $2.6 billion or 1% to $229 billion in the first quarter compared to the fourth quarter.

Loan growth compared to the first quarter of 2018 was $7.4 billion or 3%.

Investment securities of $82.3 billion remained relatively flat linked quarter as our purchases replaced portfolio runoff.

Securities increased $7.7 billion or 10% year-over-year.

Our cash balances at the Fed averaged $14.7 billion for the first quarter, down $1.7 billion linked quarter and $10.7 billion year-over-year, commensurate with growth in loans and securities.

Deposits were up slightly linked quarter and grew $6.6 billion or 3% year-over-year.

As of March 31, 2019, our Basel III common equity Tier 1 ratio was estimated to be 9.8%, up from 9.6% as of December 31, 2018.

Importantly, we maintained strong capital ratios even as we returned approximately $1.2 billion of capital to shareholders or 98% of first quarter net income.

Total share repurchases were 5.9 million common shares for $725 million and common dividends were $438 million.

And our tangible book value was $78.07 per common share as of March 31, an increase of 9% compared to a year ago.

Slide 5 shows our loans and deposits in more detail.

Average loans grew $2.6 billion or 1% over the fourth quarter, driven by commercial lending balances, which increased $2.5 billion or 2%.

We generated this growth despite the seasonal decline in our multi-family agency warehouse lending of approximately $1.5 billion compared with the fourth quarter.

And while not on the slide, it is worth noting that our spot loan balances increased more than $6 billion linked quarter.

As we pointed out previously, our Corporate & Institutional Banking loan portfolio can be divided into 3 categories: traditional cash flow; non-CRE secured lending; and commercial real estate.

Our traditional cash flow lending grew 5% linked quarter, reflecting growth from new and existing customers, including higher utilization.

This growth is in contrast to the lack of growth we experienced in this category in the second half of 2018, which was related to heavy competition, including non-bank lenders and higher pay down activity.

During the first quarter, we continued to see strong growth in secured lending, which has increased 3% linked quarter and 14% year-over-year.

Lastly, loans in our Commercial Real Estate business declined linked quarter, primarily due to the seasonality of the warehouse lending, but also due to competitive pressures.

On the consumer side, balances increased approximately $100 million linked quarter and $900 million year-over-year.

We had growth in residential mortgage, auto, credit card and unsecured installment loans while home equity and education loans continued to decline.

Average deposits increased approximately $700 million in the first quarter compared with the fourth quarter, reflecting growth in consumer deposits, substantially offset by seasonal declines in commercial deposits.

Compared to the same quarter a year ago, average deposits increased by $6.6 billion or 3%.

In both comparisons and as expected, growth was in interest-bearing accounts, and we continued to see a shift from non-interest-bearing to interest-bearing deposits.

Our overall cumulative deposit beta increased in the first quarter to 32% from 30% in the fourth quarter.

For the remainder of the year, we expect our deposit beta to continue to increase, but at a slower pace than last year, given the current Federal Reserve interest rate outlook.

As you can see on Slide 6, first quarter total revenue was $4.3 billion, down $54 million linked quarter or 1%.

Net interest income was relatively stable despite 2 fewer days in the quarter compared with the fourth quarter.

Noninterest income declined $48 million or 3% linked quarter, reflecting seasonally lower fee income.

Noninterest expense was flat compared with the fourth quarter as expenses continued to be well managed.

Provision for credit losses in the first quarter increased $41 million to $189 million.

Our effective tax rate in the first quarter was 16.3%.

For the full year 2019, 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 7, net interest income of $2.5 billion was essentially flat compared to the fourth quarter, despite the impact of 2 fewer days in the first quarter.

Net interest income grew $114 million or 5% year-over-year.

In both comparisons, higher earning asset yields and balances were partially offset by higher funding costs and balances.

Net interest margin increased to 2.98% in the first quarter, up 2 basis points linked quarter and 7 basis points year-over-year.

Fee income declined $31 million or 2% linked quarter driven by seasonally lower first quarter transaction volume in consumer services, corporate services and service charges on deposits.

These declines were partially offset by growth in asset-management fees, which increased $9 million or 2% and reflected higher average equity markets and residential mortgage noninterest income, which increased $6 million or 10%, primarily due to a lower negative RMSR valuation adjustment compared to the fourth quarter.

Compared with first quarter of 2018, total fee income was stable as growth in both consumer and corporate services fees were offset by declines in asset management and residential-mortgage revenue.

Other noninterest income of $308 million, declined $17 million linked quarter and increased $63 million year-over-year.

Other noninterest income includes the impact of Visa derivative fair value adjustments, which fluctuates in part due to changes in the share price of Visa common stock.

Turning to Slide 8. First quarter expenses in total were essentially unchanged from the fourth quarter.

Seasonality drove increases in personnel and occupancy as well as a decrease in marketing expense.

Equipment and other expenses were lower linked quarter.

Compared to the same period a year ago, expenses increased $51 million or 2%.

Personnel and marketing expense grew reflecting both business investments and growth.

Our efficiency ratio was 60% in the first quarter compared with 61% a year ago.

Expense management continues to be a focus for us.

And we remain disciplined in our overall approach.

As you know, we have a goal to reduce costs by $300 million in 2019 through our continuous improvement program, and we're confident we'll achieve our full year target.

Our credit quality metrics are presented on Slide 9. On a linked-quarter basis, provision for credit losses increased $41 million to $189 million and net charge-offs increased $29 million to $136 million.

On the commercial side, loan provision increased $31 million linked quarter.

And this reflects our strong loan growth and higher utilization as well as reserves increases related to certain commercial credits.

Commercial loan net charge-offs increased $5 million linked quarter to $12 million and remain at very low levels, with a net charge-off ratio of 3 basis points as of March 31, 2019.

The provision for consumer lending increased by $10 million.

Consumer loan net charge-offs increased $24 million linked quarter, primarily from higher net charge-offs in credit card and lower recoveries in home equity.

Overall, our allowance for loan and lease losses to total loans was unchanged at 1.16% as of March 31, 2019, and has remained at that level for the past 4 quarters.

Notably, our forward indicators are both down linked quarter.

Nonperforming loans declined $41 million or 2% compared to December 31, 2018, driven by a decrease in consumer non-performers.

And total delinquencies were down $49 million linked quarter or 3%.

Our overall credit quality remains strong.

However, at these historically low levels of provision, we will continue to see some volatility quarter-to-quarter due to the pace and mix of loan growths and the timing of specific loan reserves and releases.

We believe that we continue to be appropriately reserved for the current environment as reflected in our consistently strong credit quality metrics.

And importantly, we're not seeing any signs of broad-based credit issues.

In summary, PNC posted very good first quarter results.

For the balance of this year, we expect continued steady growth in GDP.

And we no longer expect an increase in short-term interest rates this year.

Our full year guidance remains consistent with what we shared on our fourth quarter earnings call in January.

Importantly, in the first quarter of 2019, we generated over 2% positive operating leverage year-over-year, and we remain well positioned to continue to deliver positive operating leverage for the full year 2019.

Turning to Slide 11, and looking ahead to second quarter 2019 compared to first quarter 2019 reported results: we expect average loans to be up approximately 1%; 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 between $275 million and $325 million, excluding net securities and Visa activity; we expect expenses to be up low single digits; and we expect provision to be between $125 million and $200 million.

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

Silvana, would you poll for questions?

(Operator Instructions) And your first question comes from the line of John Pancari with Evercore ISI.

On the balance sheet side, on the loan-growth front, if you could just give us a little more color on what you're seeing there that's driving the better line utilization and even the pay downs?

Is it something that you think is sustainable?

And is it enough to potentially bump up or see upside to your full year loan growth of 3% to 4%?

Because I know you kept that unchanged.

Yes.

John, good morning.

It's Rob.

So just a couple of things.

In terms of the composition of the growth, we were pleased with the loan growth that was predominantly on the commercial side.

I think the -- when I talked about those 3 categories, I think the traditional cash flow category was very strong in contrast to what you were talking about in the second half of 2018.

And that was just increased activity across our commercial markets, very strong in the legacy markets and the expansion in growth markets.

So we feel good about that.

As far as the full year guidance, you know we guided to 3% to 4% growth.

We had average growth of 1% here in the first quarter.

So we're tracking to that range, and I think it's -- we feel good about where we are, but it's a little early and premature to change the full year outlook.

Okay.

All right.

And then, separately, I'll just go straight to the elephant in the room.

Bill, just want to get your thoughts.

I know there's a lot speculation out there regarding the Wells Fargo post.

And just would love to get your thoughts not only about, if that would be of any interest, but more importantly, what would -- how you view your competitive position at PNC?

And why it's certainly more attractive, possibly, to stay where you're seated?

I almost don't even know how to answer that.

I like my job here, I like our company, I like our prospects, I like the people I work with, I like our clients, I like our communities, and I will end my career here.

Beyond that, I'm not going to speculate on successes or failures at our competitors.

Our next question comes from the line of Betsy Graseck with Morgan Stanley.

Just a couple of questions.

One is on the commercial business.

I know you talked about the loan growth coming in better.

And I just wanted to understand how you're thinking about the competition in the non-bank space?

And do you feel that the interest rate -- do you feel that the pay downs that you had seen last year are slowing permanently?

Or is this just a temporary slowdown due to 4Q's disruption in the capital markets and higher interest rates, et cetera?

It's almost an unanswerable question.

I mean I think the crack in the credit markets in the fourth quarter, Betsy, had to have helped on some of the volume that we saw stay in the loan market.

But at the same time, we saw a pickup in utilization which would be totally independent of that.

And we've -- and we continue apace just gathering new clients.

So I think we'll see what the future brings here, but we have seen for whatever reason that the slowdown in pay downs and the uptake in utilization and greater client growth.

Strong retention.

Okay.

No, that's helpful.

And then, separately, the Fed's got their MPR out there regarding moving the goal posts on advanced approaches banks.

So maybe you could give us a sense as to how you're thinking through the opportunities for you assuming that MPR does get approved as written and how you think through what to do with the incremental capital that you've been -- that you would generate as a function of that.

Bill, do you want me to start there?

Well, Betsy, so as you know, the proposal's -- we are encouraged by the proposal's 5 key items there, 2 of which are a lot of work for us.

But you're not as interested in the elimination of the advanced approaches and then the possible elimination of the midyear DFAST for us.

More meaningful in your interest would be the other 3 areas: one is, the ability to opt out of AOCI, we'll examine that; secondly, the refinement to the [CET1] threshold deductions, which for us is particularly meaningful because of our BlackRock stake; and then the third is, the potential to reduce the LCR requirements from a full approach to a modified approach, somewhere between 70% and 85%.

So early for us, we're encouraged by all of that, we see a potential in that for us, but until they're all approved, I don't have a firm answer for you.

Okay.

And just to make sure I understand when you say, "You would look at the AOCI impact, et cetera." I mean is there a reason for not adopting that change if indeed the MPR goes through?

Not a terribly obvious one.

Yes.

Not that I can see, but we've got time on the clock to be able to decide.

So...

Okay.

And can you size...

Your inclination is correct.

Okay.

And then, just lastly, could you size -- like as you stand today, and I know it's a moving target because prices change, obviously.

But could you give us a sense of the size of the capital free-up that would occur, if it were to come through, say, like last quarter?

March 31?

Yes.

What we've said -- and again, this is just an estimate, we've said in combination that it could add as much as 1% to our capital ratio.

And that's an estimate, but that gives you a rough sense of the lift.

Okay.

That's CET1, right?

CET1, yes.

Our next question comes from the line of John McDonald with Autonomous Research.

I wanted to ask about operating leverage and the goals for the year.

Rob.

If I try to parse the linguistics in the outlook for the year, it looks like you're shooting for positive operating leverage in the range of 150 to 200 basis points.

Is that fair as, kind of -- your target?

And what would it take to get to the upper end of that?

Yes.

I think that's fair.

That's fair.

And as you know, we affirmed our full year guidance.

So you can do the math to get to 1.5% to 2%.

And you know, first quarter, we're tracking to that.

So that's very fair.

Okay.

And then, expenses are up 2% year-over-year.

Is that kind of consistent with your outlook for the full year?

And are you're shooting for a little closer to flattish?

And, I guess, what I'm getting at here is, do you have expense saves that kind of gather steam as you get through the year?

Or is this a good representation of what you think about it...

Yes.

No, I got you.

Well, yes, so I just think it starts with your first question there in terms of the positive operating leverage, which is what -- that's our primary goal.

Our guidance was for expense growth on the low end of the single-digit range, which is where we are, and I expect that to be the case going forward.

It could drift higher if revenues go higher, which would be a good thing.

But then, that just gets back to the operating leverage point.

And vice versa, which we don't want to have happen.

Well, yes.

We're not thinking that way, that's right.

Okay.

And then the last thing for me is, how much does the flattening of the curve affect the degree of difficulty on your net interest income goals for the year?

Well, I think for the net interest income goals, not much because the rate increase that we had built-in was September and then the curve's been flat for a little while, maybe a little bit more.

So not so much on the NII, more so on the NIM, even though we don't have official NIM guidance.

It puts -- the flat yield curve puts more pressure on the NIM.

Yes.

I think you have a bunch of moving parts you need to think about.

The flattening of the rally in the long end, obviously, impacts the yield at which we put on fixed rate assets.

And as those assets roll down the curve and mature, we're now either making loans or investing in securities that are lower yield than the existing book.

Having said all of that, the average life of our fixed rate assets is 5 years, plus or minus.

So it takes a long time for that to show up in the income statement and in NIM.

The other thing is we had a, in our original forecast, a rise in Fed funds later in the year.

But at the same time, we would have had commensurate expectations of deposit repricing, which, obviously, fall away.

And it remains to be seen what happens to betas here.

But if we are really on this, sort of, hold pattern -- if what we've seen though the first quarter holds, we'll see less pressure on betas than what we might have expected when we started the year.

And the final point, of course, as it relates to total net interest income, all of those factors are dwarfed by our ability to continue to grow loans that make sense for -- in our risk bucket.

Yes.

That's right, and that's why our full year guidance holds.

Our next question comes from Erika Najarian with Bank of America.

Just wanted to follow-up on the commentary that you had on deposits.

So can you give us a context of how robust your national digital strategy will continue to be if the Fed continues to keep short rates where they are?

And, Bill, was your comment on betas potentially easing if there are -- there wasn't a September rate hike, more on your established markets or your newer markets?

Both.

I mean I think towards the end of a rate cycle, historically, you might have seen betas actually accelerate to the extent that funds were much higher than where they are today.

In this environment, at least for the last bit of time and our expectations, we don't necessarily -- we're going to say, they're going to go up a little bit, total cumulative beta, but not necessarily the spike you would have seen at a traditional end of rate cycle.

Our newer markets, basically are -- have been, sort of, stable on our price offering since the last hike and will -- would likely stay there.

In terms of success of the effort, I guess, I'd say a couple of things.

The first thing is, you can dial up or down deposit balances of almost any size you want by being top of the price-paid chart, particularly, as a new entrant because you're not repricing your existing deposits on those platforms.

We're spending more time today.

Our existing -- our deposits today are somewhere over $1 billion.

But to be honest with you, we spend more time...

Than national digital.

National digital, yes.

We're spending more time -- I'm going to use the word experimenting, but that's -- maybe that's right -- trying different strategies as it relates to the effectiveness of marketing dollars, pricing, activation and many other things we want to learn as we, sort of, accelerate the rollout of this into additional markets.

And so we're less worried about what the balances are doing day-to-day, more interested in the activation of accounts and the usage of accounts.

And the mix of the distribution.

Yes.

Got it.

And my -- for my second question, if I could just zoom out, you returned 14% on tangible equity this quarter.

In the forward look, all seems to be positive in terms of positive operating leverage, continuing your superior credit quality and optimizing your capital.

I'm wondering, as we think over the next 2 years, if the U.S. continues to be in good stead, what returns on tangible common equity can your shareholders expect to enjoy?

And within that range, what do you think is an optimal CET1 ratio for a bank with your risk profile?

Do you want to start with that?

Well, we don't have ROE targets, Erika, as you know.

We're encouraged in terms of the direction that you just summarized and would see our returns going up.

We have a lot of E, as you know, in some of these proposed tailoring that might affect some of that.

So we've always said in terms of what CET ratio do we need to run?

We've always said around 8.5.

That's been the case for the last handful of years.

That could come down a little bit following the proposed rules.

But 8.5 is the best number that we have today.

It's -- I mean, to be -- well, to be clear on that, what we do every year in terms of, sort of, our targeted number is we solve for it as a function of the outcome of the Fed severe, our own severe stress outcome.

We've been doing that, basically, since the beginning.

What's interesting as we go forward with the tailoring proposals is that outcome would likely drive or potentially drive our needed capital ratio to a level that would actually be below, in my view, where we would operate vis-à-vis the buffer to 7%.

So what do I mean by that?

Let's say, that the math says on my old math that I could actually run all the way down at 7.5 or even 7.25.

As a practical matter, we wouldn't run there because if well capitalized is 7, you're going to need to run some buffer above that simply for optics, if for no other reason, but also for fear of ever breaking that in an adverse economy.

But we're going to have to -- as these tailoring roles come out, we're going to have to have a hard look at that.

The issue on return on equity, we have a -- we can sit and parse our return against peers 50 different ways.

But Rob's point is right.

The biggest differentiation between us and others is we carry a lot of E. We also have less goodwill.

So on a tangible basis, we don't have other assets that are effectively earning without a capital.

And we don't want to.

Yes.

And so be it.

So I think -- a very long answer to your question.

But the basic notion is, let's grow the company on a healthy basis year-over-year, being conscious of risks, be the firm that outperforms when there is stress, and be able to take advantage of that with a fortress balance sheet when it happens.

We've done that for years, we'll continue to do it.

And just as a follow-up, I'm sorry to take so much time, but in the event that the proper capital ratio, let's say, based on what you were saying is, let's say, around 8, and you're closer to 10 today, what is the pace of optimization that you think would be appropriate for a bank, again, of your size and risk profile?

So you're basically saying, what are we going to do on capital return.

And I don't want to -- we just submitted CCAR so we'll leave specifics out of it.

But a couple of guiding principles: the first one is that we see very strong value in our shares today, and see value in buying back our shares today; see value in providing a healthy dividend through time to our investors.

I would tell you that there are prices and multiples of tangible at which we would slowdown our buyback.

We're not there today, but there are prices where that would happen, and you could potentially see our capital buffer build in those instances simply because more often than not when you get to lofty levels on multiples to tangible book, there is some downturn looming that you could put that capital to work at much better prices.

But for where we are today, our intention would be to drive that ratio down and return capital to shareholders.

We -- because we have excess capital.

And to your point, the dividend...

And we see real value there.

Our next question comes from the line of Ken Usdin with Jefferies.

Just continuing along the lines of capital usage and, Bill, I know where you've stood for a long time on the question of M&A.

But just given the large transaction that happened intraquarter and your comments just about your belief that you feel that the shares are attractive as is balance sheet growth, just any light you can shed just on the evolution of the landscape and where or where not PNC would want to play over the longer term, even as far as being an acquirer or not.

Nothing has changed.

The SunTrust BB&T merger, I think, makes great sense for them.

And I think as a set of competitors, kind of, waking up to the challenge of what it means to have scale, particularly, on technology spend as we get into a consolidating market.

I think we have already done that spend.

We already have that capability.

We have the ability to grow organically.

I don't see value in acquisitions, particularly, at today's price.

Anything on the small side simply because of -- not the least of which because of prices, but also just because it would take our eye off the ball, just doesn't make sense and doesn't change our outcome strategically.

You'll continue to see us look and execute on product or technology adds that aren't major in scale but make a difference to the offerings we have to our clients.

If there's a market disruption, if there is a crack in credit, which we don't see today, but if there is, you would see us use capital to take advantage of that.

Like we've done in the past.

As we've done in the past.

But as of now, we think we have a really strong hand to play, just pursuing our organic growth.

Okay.

Understood.

And, Rob, one question for you on -- in terms of the fixed rate assets and where the curve has gone, are you still seeing positive benefits as cash flows flow off of the securities book and the fixed rate loan book?

And if so, what's the -- where do you put non new stuff at versus where the roll-off is?

Yes.

Yes.

Yes, so Ken, in the first quarter actually we were.

What we were buying was accretive to the yields.

As the curve had flattened out here in the latter half of the quarter, we're a little bit below.

And would you expect that to be the case as you roll forward?

Sorry.

Go ahead, Bill.

Yes, I do.

Slightly below, I do.

Yes.

I mean -- look, if you just look at all else equal we've seen since the fourth quarter, I don't know, a 35 basis point rally in outright swap yields in 5 years and a little bit more than that in 10 years.

And eventually, again, all else equal on risk that will show up through our fixed asset yields that delta through time.

But it's a long period of time that that will occur over that...

Yes.

So the outcome won't be a dramatic change.

But to the point of your question is the curve has flattened out so we're a little bit below now in our purchases.

And are you guys hedged to the point where you want to be to that point?

Like I get your point on the swap delta.

So do you have the construction set up as far as this rate environment carrying forward?

We are -- I mean in effect, we went into this and hindsight is 2020.

But we went into this asset sensitive or short in effect, underinvested.

I still am a disbeliever in term rates.

But they are where they are.

All else equal, we've made a mistake on that.

Having said that, we're not going to invest into this type of yield curve.

We'll kind of maintain where we are and watch it play out.

And our next question comes from the line of Kevin Barker with Piper Jaffray.

Just a follow-up on that question.

With rates flat here, I mean, deposit pricing likely to continue to move higher and reinvesting at negative yields on the fixed rate assets.

I mean, would you expect a little bit of pressure here maybe in the second and third quarter on NIM before flattening out?

Obviously, you guided to NII staying stable for...

Yes.

Look, you're going to -- it wouldn't shock us to see NIM drop a couple of basis points as we move through the course of the year.

There's so many things that move around inside of that as it relates to asset spreads as well and what we buy.

But all else equal, yes, NIM should drop 1 or 2 basis points as securities and fixed rate loans roll down, and we replace them at lower yields.

There's a lot of stuff that would be on the other side of that.

We'll have to wait and see.

Yes.

I think that's right.

And then, obviously, a big variable is the deposit betas and the cost of the spot.

Okay.

And then, a follow-up on some of your comments around credit.

Obviously, no discernible trend and feel comfortable about it.

But it did come above your guidance -- the provision did come above your guidance.

And you did mention consumer lending, was there anything in particular around C&I or any one-off credits given you saw the pickup in manufacturing NPAs?

Yes.

Kevin, this is Rob.

No, nothing in terms of broad themes.

Our provision was above guidance this quarter, in large part because of the growth.

But then a handful of specific credits that don't really have any common theme.

The manufacturing that you see in the supplement there, there is a couple of names.

But that's one of our largest books.

That's over $20 billion in loans there.

So no broad theme.

It's just you get a little quarterly volatility working off these low levels.

And in any given quarter, a couple of names could go on, a couple of names could go off.

And that's the variance that we experience.

One of the things that has probably masked this a little bit in the past is simply recoveries, certainly starting out in the crisis when they were very high.

And basically, we've kind of gotten to a place at this point where recoveries have trended off, corporates are largely operating at the rating level they want to achieve.

And so we have less, sort of, upgrades as people get back to where they are, and we have the traditional business of growing loans, which is causing provision to slow a little bit.

But, again, it's so -- it's such a function off of these low levels.

When you take a look at our reserves-to-loan ratio, it is not almost 1.16.

Every quarter, it is 1.16.

By the way, we do not solve...

No.

We don't solve for that.

Yes.

We don't solve for that.

It is literally unchanged.

Okay.

Just quickly, so would you structurally expect higher severity going forward with frequency in line with what you've expected in past years?

Higher severity meaning loss given default?

Or higher...

Or higher losses.

Yes.

So if there are less upgrades and more loss on any defaults?

Well, not on a single default.

I think all else equal, right?

We're running at a charge-off ratio that is unsustainable.

So, yes, through time you would expect our through the cycle charges to be higher.

By the way, ours and everybody else's, everybody keeps saying the same thing.

Bizarrely, I don't know that that's where we're seeing this quarter.

But through time...

There'll be a gradual...

You'll see a gradual increase.

You know this quarter was more so than anything else just driven by growth, which we'll take every time.

And by the way, if you find that hard to stomach, wait till CECL comes along and you see the impact from loan growth in your quarterly provision.

But, no, there's nothing in there that's bothering us at this point.

That's the important point.

Our next question comes from the line of Gerard Cassidy with RBC.

Bill, you mentioned in your shareholder letter about expanding into markets through the technological innovation of digital banking.

Can you share with us at what point we may actually see some metrics?

Or maybe you have them already, that we can monitor to see the success that you're having with the penetration from that strategy rather than the old fashioned, as you mentioned, making acquisitions doesn't make sense today, but you're going to do it through organic growth.

How do we, as outsiders, measure that success?

That's a completely fair question, Gerard.

And we're working on exactly how to bring that to life.

I would tell you, for now, what we are looking at, we started out with a notion, we will launch a digital platform on a national basis with offerings that are geo-fenced and try to convert what starts out as a higher-yield savings product into full-time clients.

So ultimately, metrics on how many accounts, how many deposits, how many are active, how many move to Virtual Wallet, and so forth.

But also, inside of our learnings as we go through that, is how many branches we build in these digitally thin markets, largely following our C&IB expansion, what our strategy is around that, the costs associated with that.

All of that continues to be developed.

And until it's why we're spending time learning and testing in each of these new markets, before we come out with the stated goal as to what we think this thing could be.

Right now, I think we just -- did we open the second branch in Kansas?

This month, later in April.

Dallas, midsummer.

And then, a couple in Dallas.

So we're so early on at this, and we're not spending huge dollars on it.

But I want to get, sort of, results that we can bucket that show our progress once we get a very clear go-to-market strategy around each of these new markets.

But we do that.

Yes.

No, very good.

And then, as a follow-up question.

When you guys -- look, I know you don't target an efficiency ratio that as you mentioned on the return on tangible common equity ratio earlier in the call, and you look at where you guys are today, about 60%, many of your competitors have really started to make inroads into bringing their ratios down toward the mid of 50s.

Can you give us some color how do you think you may get -- what your roadmap is to bring that down?

Again, I know it's not a focus point for you folks, but how do you hope to bring that, kind of, number down, which would, of course, drive profitability higher?

So if you read my annual letter...

Well, you did, you did.

I did, didn't remember all of it obviously.

At least part of it, right.

So Gerard, the issue here, we don't manage to an efficiency ratio, but we could drive that number down quickly and materially by basically burying our heads in the sand and saying that we are not going to try to survive this digital onslaught of what is happening in Retail Banking.

And bluntly, many of our peers are shrinking themselves to greatness and not investing in what is an aggressively consolidated industry with share at this point going to the largest players, largely on the back of great offerings.

I want to be one of those people with great offerings and a larger player that consolidates across this country.

And to do that, we need to continue to invest, which we've been doing aggressively for the last 7 or 8 years.

So we could stop doing that and show you metrics for the next couple of years that look great.

And I think in the course of doing so, we'd seal our fate.

So our focus here is on intelligent, organic growth, good risk-adjusted return for shareholders.

And we think we have a real opportunity to do that inside of an industry that is just going through transformational change right now.

So long story short, that will be an outcome, not a targeted number.

Do you think -- on the -- like you said, it's not a targeted number, is it more a denominator-driven number?

Meaning, you mentioned responsible growth.

Obviously, you're investing in the numerator, which is expenses.

Any improvement, will it come more from the -- just the growth being better at the bottom rather than cutting back on expenses?

Yes.

My best guess is, as I play this whole thing though, as you can imagine, I do this most nights when I'm struggling to sleep.

I think what happens is you will see, and you've heard me talk about this, change in the income statement whereby you'll see occupancy costs drop, you will see, which has already happened, you will see technology costs go up, you will see the marginal cost of deposits increase as the price paid for digital offerings and in an effect in-footprint physical offerings, if there's such a thing, merge through time.

You're going to see banks thin their existing networks, expand in MSAs that they don't operate in today.

And my best guess is, our efficiency ratio doesn't change materially through time as much as our total E increases as we grab share across this consolidating market.

It depends on so many things.

But I think the cost to marketing, the cost and ability to move deposits are going to offset the gains you get by otherwise using technology and removing physical plant.

Distributions.

Yes.

So I don't -- the gross metrics don't change, but the line items in the income statement do.

And I think growth potentially accelerates materially in the out years as this industry consolidates.

Yes.

And, Gerard, I'll just add to this -- It's Rob, clearly investment is a big component of our spend.

But in, sort of, the short term, it is about the operating leverage.

So provided that revenues are growing, we're okay with expenses growing, especially, if they're part of that revenue.

So we have great fee businesses that have higher efficiency ratio, and we'd like to grow those as much as we can.

Yes.

And before -- and the final thing I'll say, because I'm not -- we're not, obviously, indifferent to the amount of money we've spend, and we're very good at managing expenses.

We go into our budgeting process every year, and we don't talk about necessarily what are the new investments we want to make as much as we talk about dollar one, what is the $10.5 billion whatever the number is that we're going to spend this year and build up from a base.

So we take the management of expenses very seriously.

But inside of that, we are aggressive at wanting to be able to maintain the investment necessary to ensure our place in what I think is going to be a consolidating market.

And we've been doing that.

You'll see us continue that.

And there are no further questions at this time.

I'll turn the call back to you.

Okay.

Well, thank you very much for joining us, and we look forward to working with you this quarter.

Thanks, everybody.

Thank you.

This concludes today's conference call, you may now disconnect.