美國合眾銀行 (USB) 2021 Q1 法說會逐字稿

Welcome to U.S. Bancorp's First Quarter 2021 Earnings Conference Call. Following a review of the results by Andy Cecere, Chairman, President and Chief Executive Officer; and Terry Dolan, Vice Chair and Chief Financial Officer, there will be a formal question-and-answer session. (Operator Instructions) This call will be recorded and available for replay beginning today at approximately 1:00 p.m. Central Time through Thursday, April 22, 2021, at 10:59 p.m. Central Time.

I will now turn the conference call over to Jen Thompson, Director of Investor Relations and Economic Analysis for U.S. Bancorp.

Thank you, Kara, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and CEO; and Terry Dolan, our Chief Financial Officer. Also joining us on the call are our Chief Risk Officer, Jodi Richard; and our Chief Credit Officer, Mark Runkel.

During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the slide presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com.

I would like to remind you that any forward-looking statement made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation, in our press release and in our Form 10-K and subsequent reports on file with the SEC.

I'll now turn the call over to Andy.

Thanks, Jen. Good morning, everyone, and thanks for joining our call today. Following our prepared remarks, Terry, Jodi, Mark and I will take any questions you have.

I'll begin on Slide 3. In the first quarter, we reported earnings per share of $1.45. Credit quality trends were better than expected, and the economic outlook has improved meaningfully over the past several months, given the pace of the vaccine rollout and the ongoing impact of significant government stimulus. Based on these factors, we released a little over $1 billion in loan loss reserves this quarter.

Revenue totaled $5.5 billion in the first quarter. As expected, net interest income decreased compared with the fourth quarter. However, we expect loans to grow as the year progresses. And given that securities reinvestment rates are now accretive to asset yields and our belief that premium amortization expenses likely peaked, we expect that the first quarter will be a low point for net interest income.

Improved economic activity is driving better consumer and business spending trends, which in turn is translating into improving payments volume. In each of our payments businesses, volumes, excluding COVID-impacted travel, hospitality and entertainment sectors, exceeded first quarter 2019 pre-pandemic levels. Our expenses were relatively stable compared with the fourth quarter.

In the lower-right quadrant, you can see that our capital and liquidity positions remained strong. And during the quarter, we returned $1.3 billion to shareholders in the forms of dividends and share buybacks.

Slide 4 provides key performance metrics. This quarter, our returns benefited from improved credit performance and reserve release. Longer term, we believe we will continue to deliver industry-leading returns on tangible common equity, driven by strong PPNR performance, consistent through-the-cycle credit performance and prudent capital management.

Slide 5 shows the pace of migration to the digital channel. Digital uptake is correlated with higher customer satisfaction, ease of use and lower cost of service, which we measure very closely. Digital transactions now account for nearly 80% of all transactions. In the lower right-hand chart, you can now see that more than 60% of loan sales now occurred digitally, which compares to less than 40% a year ago.

Now let me turn the call over to Terry who will provide more detail on the quarter.

Thanks, Andy. If you turn to Slide 6, I'll start with a balance sheet review followed by a discussion of first quarter earnings trends. Average loans declined 2.8% compared with the fourth quarter as the low interest rate environment continues to impact borrower behavior. Elevated corporate paydown activity late in the fourth quarter negatively impacted average commercial loan growth in the first quarter. Recently, we have seen improving pipelines, and we expect inventory building and M&A activity to pick up as we move further into 2021. Similarly, lower interest rates impacted consumer loans as increased refinancing activity impacted real estate loan balances. Credit card revolve rates continued to decline this quarter, causing balances to contract as consumers used excess liquidity from government stimulus programs to pay down debt.

Turning to Slide 7. Average deposits increased 0.9% compared with the fourth quarter, reflecting the level of liquidity in the financial system. As a reminder, our deposits are typically seasonally lower in the first quarter of the year. Our overall deposit mix continues to be favorable. In the first quarter, our noninterest-bearing deposits grew 2.8% while time deposits declined 17.7%.

Slide 8 shows our credit quality trends, which continue to be better than our expectations, reflecting improving economic conditions, supported by additional stimulus and increased vaccine availability. Our net charge-off ratio totaled 0.31% in the first quarter compared with 0.58% in the fourth quarter. The improvement reflects lower total commercial, credit card and other retail net charge-offs. The ratio of nonperforming assets to loans and other real estate was 0.41% at the end of the first quarter compared with 0.44% at the end of the fourth quarter. We released reserves this quarter, reflective of better-than-expected credit trends and an improving economic outlook versus our previous expectations.

In the first quarter, our loan loss provision was negative $827 million or $1.1 billion less the net charge-offs of $223 million. Our allowance for credit losses as of March 31 totaled $7.0 billion or 2.36% of loans. The allowance level reflected our best estimate of the impact of improving economic growth, lower unemployment and changing credit quality within the portfolios, driven in part by the benefits of continued government stimulus programs.

Slide 9 highlights our key underwriting metrics and loan loss allowance breakdown by loan category.

Turning to Slide 10. Exposures to certain at-risk segments given the current environment are stable compared with the fourth quarter. The left table shows that customer balances included in payment relief programs continued to decline meaningfully in the first quarter to less than 1% of total loans.

Slide 11 provides an earnings summary. In the first quarter of 2021, we earned $1.45 per diluted share. These results include a reserve release of $1.1 billion.

Turning to Slide 12. Net interest income on a fully taxable-equivalent basis of $3.1 billion declined 3.5% compared with the fourth quarter due to fewer days in the quarter, lower average loan balances and a 7 basis point decline in net interest margin. The decrease in the net interest margin was primarily driven by higher premium amortization expense, lower portfolio reinvestment rates and mortgage loan prepayments. As mentioned earlier, we expect loans to grow as the year progresses. Also, given that securities reinvestment rates are now accretive to asset yields and our belief that premium amortization has likely peaked, we expect the first quarter will be the low point for net interest income.

Slide 13 highlights trends in noninterest income, which, as a reminder, is typically seasonally lower in the first quarter of each year. Noninterest income declined 5.7% from a year ago, primarily driven by lower mortgage revenue. On a year-over-year basis, strong refinancing activity drove higher production volumes and related production revenue. However, in the first quarter, we recorded a reduction of $120 million to the fair value of our mortgage servicing rights, net of hedges, which compares with a favorable increase in the valuation, net of hedges, of $25 million a year ago. With prepayment speeds declining, we would expect future changes in the MSR fair value adjustment to be more moderate. Business activity and strong underlying market conditions drove growth in trust and investment management fees, treasury management revenue and commercial product revenue, although deposit service charges were negatively impacted by lower consumer spend and increased consumer liquidity from government stimulus.

Slide 14 provides information on our payment services business, including a breakdown of segment volume for the first quarter of 2021 compared with more normalized 2019 levels.

Slide 15 indicates that sales volumes across our payments businesses have continued to rebound since bottoming in April of 2020.

In the first quarter, total payments fee revenue was essentially flat compared with the first quarter of 2020. Credit and debit card revenue increased 10.5% on a year-over-year basis, driven by higher interchange revenue and higher prepaid card fees as a result of government stimulus programs. Merchant services revenue decreased 5.6% compared with a year ago, which was better than what we had expected coming into the quarter. Improving sales growth in North America was more than offset by expected declines in European sales due to COVID-related shutdowns. Corporate payments revenue declined 13.1% year-over-year as travel and entertainment revenue continued to weigh.

Turning to Slide 16. Noninterest expenses were relatively stable on a linked-quarter basis, as expected. Year-over-year growth of 1.9% was driven by increased mortgage and capital markets production incentive costs and expenses related to business investments in digital and technology, which was partly offset by a decline in costs related to COVID-19 and a future delivery liability incurred in the first quarter of 2020.

Slide 16 (sic) [Slide 17] highlights our capital position. Our common equity Tier 1 capital ratio at March 31 was 9.9% compared with our target CET1 ratio of 8.5%. Given improving economic conditions in the first quarter, we bought back $650 million of common stock as part of our previously announced $3.0 billion repurchase program.

I'll now provide some forward-looking guidance. For the second quarter of 2021, we expect fully taxable-equivalent net interest income to increase in the low single digits compared with the first quarter, and we look for modest loan growth. We expect payments fee revenue to continue to improve sequentially as economic activity continues to accelerate.

Starting in the second quarter, growth rates will be meaningfully impacted by favorable year-over-year comps given the 2020 COVID environment. We expect noninterest expenses to be relatively stable compared with the first quarter.

The outlook for credit quality has improved in the past 2 quarters, along with the improving economic environment. However, we think that the net charge-off ratio is [not] (added by company after the call) likely to remain low as the first quarter level of 0.31%. As we move further into the year, we expect the net charge-off ratio to normalize toward pre-pandemic levels. We will continue to assess the adequacy of the allowance for credit losses as conditions change. For the full year 2021, we currently expect our taxable-equivalent tax rate to be approximately 21%.

I'll hand it back to Andy for closing remarks.

Thanks, Terry. One year ago, we were at the beginning stages of a pandemic-driven economic downturn, which had no precedence. We are confident in the strength of our balance sheet and our ability to support our customers, employees and communities through a difficult time. But we, along with the entire industry, faced an uncertain outlook. A lot has changed in a year. Our first quarter results were reflective of the lingering impact of an economy that continues to heal but has not fully recovered to pre-pandemic activity levels. However, we are optimistic about the trajectory from here. We believe we are well positioned to benefit from what many expect to be the strongest economic growth this country has seen in decades as we capture the potential of increased consumer and business spending across all of our business lines, most directly related to our 3 payments businesses.

Importantly, we expect our multiyear investments in digital and payments to continue to pay off well beyond any cyclical benefit that we see in the upcoming quarters. These investments aimed at enhancing the customer experience and leveraging the power of our payments ecosystem will position us at the forefront in banking and drive market share gains for many years to come.

Ultimately, our goal is to deliver industry-leading returns through the cycle. And as such, we'll invest to drive top line revenue growth while prudently managing expenses, credit quality and capital with the best interest of our long-term shareholders in mind.

In closing, I'd like to thank our employees for all their hard work and their commitment to serving our customers with the expertise and integrity they have come to expect from us. We'll now open up the call to Q&A.

(Operator Instructions) Your first question comes from the line of David Rochester with Compass Point.

On -- just on fee income, you guys mentioned payment activities should continue to recover in 2Q. Was just hoping you could frame that potentially in a range. And then as you look out to a more normalized back half of the year versus where we are today, what kind of year-over-year growth in transaction volumes do you think we can see at that point? I just heard some other persons in the space talk about some pretty robust year-over-year growth as we move into the back half of the year. I was just curious what you guys are expecting.

Yes. I mean it's a great question. So when we end up -- obviously, the comparables on a year-over-year basis kind of going forward is going to be pretty strong simply because of what was happening in 2019. As we kind of look at different components of our revenue, let's take merchant acquiring as an example, in the first quarter we saw -- overall, it was down about 15%. But as Andy said, the non-airline, non-impacted sort of industries was actually up about 10%. And the airlines continue to be depressed at kind of in that 70% to 75% level. But we do expect all those different things, all those different categories to continue to improve.

Now our expectation when we end up looking at payments revenues kind of overall across the categories that by the time we get to -- by the end of the fourth quarter or certainly very early in the 2022 sort of time frame, that we will be back to pre-pandemic levels on a total basis in terms of total merchant acquiring, total credit/debit card as well as the CPS businesses.

Great. That's great color. I appreciate that. Maybe just switching to NIM real quick. You mentioned new securities yields are accretive to the book yield and prepays are declining. So that should bring down securities premium average expense. I know you mentioned NII was moving higher from here. Are you also saying you think you'll get some margin expansion here as well?

Yes. Well, here's the way I would kind of frame it. First of all, NIM is kind of an output with respect to how your balance sheet is changing. And of course, there's a lot of different dynamics that are occurring within the loan portfolio today. Our expectation from a NIM perspective is that in the second quarter, it's probably reasonably flat but expanding from there. And the dynamics are going to be really around loan growth balances, which will probably continue to be a little bit of a pressure, but offset by expanding and improving investment portfolio. And that's a driver of premium amortization. That's a driver of the fact that the differential from a reinvestment rate is getting much stronger because of the steepening yield curve and other factors.

Great. So flattish in 2Q, expanding in the back half of the year, potentially?

Yes. Yes.

Your next question comes from the line of John Pancari with Evercore ISI.

Yes. So on the loan demand side, I know you acknowledge that you do expect loans to be pressured near term. I guess can you just talk about when do you see a more notable inflection in loan growth? And what do you see as the drivers? And I guess also within the commercial side, can you just talk about the demand that you're seeing in terms of pipeline and utilization?

Yes. John, great question. So what we are seeing in terms of loan -- so let's just talk about loan growth. We've said that in the second quarter, we do expect this to start to expand, but it's going to be modest. I mean there's still, for example, pressure that will exist in certain categories.

On the commercial side, what we are seeing is that pipelines are getting stronger really across most areas and most geographies. In addition, when we think about the stimulus that's been put into the system, there's going to be a lot of consumer spend, especially as the second half of the year develops. And I think that businesses -- what we are starting to see is the businesses are becoming much more optimistic. They're thinking about inventory build, and they're thinking about capital expenditure. And I think that those are all really good signs.

And the second thing I would just say, probably more so for the second half of the year, is that we do see and believe that M&A activity is going to start to strengthen. And that will have positive implications with respect to C&I loans, which is all good.

We have -- if you end up looking at some of the other categories, the significant amount of stimulus on the consumer side has allowed consumers to be paying down debt, which is I think one of the things that the industry has been seeing. Revolve rates have come down, and that necessarily ends up impacting balances. But just as a reminder, we do typically see an increase in credit cards in the second quarter. And so those factors will offset each other a bit. Our auto lending has been very strong, and I would expect that, that will continue to be strong.

So it's a bit of a puts and takes in the near term, but we do -- I think the encouraging thing is we are seeing a lot of nice green shoots. And as consumer spend starts to expand and grow, I think that consumer lending will come back as well.

Got it. All right. And then, Andy, wondering if you could talk a little bit about M&A interest, both on the whole bank side and nonbank. I know a lot of attention out there regarding potential deals and certainly a big discussion around the scale, the need for scale by -- within the bank space given the competitive backdrop. So I just want to see if you can give us your updated thoughts on that front, both on the whole bank side, obviously, but also nonbank.

Yes. Thanks, John. And I think our view is consistent with what we've talked about in past calls, which we're open to looking at opportunities that would meaningfully move the needle from a traditional bank standpoint in terms of either acquiring customers or new geographies. And then in the nonbank space, and we are active in this as you saw in our payments business, looking to expand our capabilities and/or distribution. And those are areas that we continue to focus on, particularly as we think about this payments ecosystem and adding either partnerships or capabilities through M&A.

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

A couple of questions. One, just wanted to dig in a little bit on payments and what you think you can do there on the corporate side, especially as you're one of the first to offer the RTP. And I hear from different institutions like clients are not that excited about RTP on the corporate side, but I'm thinking you might have a different point of view. So wanted to drill into that a little bit and see if there's a needle-mover that's coming over the next few years or not.

Yes. Betsy, this is Andy. I think there's a pretty significant opportunity here. First of all, there are a number of use cases that we're currently working with, with a number of customers across many different industries. But I do think that everything from the way -- request for pay, daily payroll, the way you're managing receivables and payables, the information that comes with it, the auto reconciliation, there is a lot of opportunity.

Now the challenge is there's a lot of time-zero investment required to get to that opportunity. And that's why we're working with our customers because we want them to understand the opportunity, and we want to work with them on that investment and the change in their processes to gain that opportunity. And -- but I do believe that there's a pretty significant change coming. And the payments mechanisms that we have used for years and years, particularly in business-to-business, so thinking about checks and ACH and wires, are all going to migrate fairly rapidly over the next few years.

And then your monetization of that is through increasing deposits? Or is there hard dollar fees associated?

I think it will be a combination of both, not unlike how our payments business works today. Part of it is from the balance sheet and part of it is from fees. And part of it might be just having a fee structure to allow you to do the things that RTP will allow as opposed to perhaps a per-transaction fee.

Okay. And then follow-up question just on credit. I know you spoke about normalizing towards pre-pandemic levels over time. Does that mean around a 50 bp NCO rate? Or is that something lower? Because during pre-pandemic, we also had certain asset classes that were net positive on the NCO, meaning net negative, right? Like you had recoveries in some of the asset classes. So just trying to understand when you say pre-pandemic, what kind of number you're talking about.

I'll give you the high-level answer, then Mark Runkel is here with us, and he will add in. But yes, is the short answer to your question. If you think about pre-pandemic, we were in that 45 to 50 basis point range. As Terry said, 31 is probably lower than what is normal over a longer period of time, and I would expect it to migrate back to that level. Mark, what would you add?

Yes, that's exactly spot on. There's not much more to add. We're just thinking over time we'll get back to a more normalized level, and we'll see some of those recoveries that you're seeing potentially come down. And we'll see the portfolio start to normalize back closer to that 50 basis point range.

And just given your experience and how many cycles you've been through, what should we be thinking about as a time frame for that? Is that next 12 months? Or that's more like next 36 months or some other time frame?

First of all, any time I've tried to predict time frames in this environment, it's been challenging. So I don't claim to know any more than anybody else. But as we see the great improvement we have today, I think things start to get back to that normal level in the latter half of this year.

Your next question comes from the line of Scott Siefers with Piper Sandler.

Terry, maybe just a little more nuance on the margin. Are you able to quantify how beneficial an impact -- the decline in premium amortization could be for the margin and NII going forward? In other words, so where is it now? Where would you expect that to normalize out to? And then just any thoughts on contribution to the margin from PPP in the second quarter? So I think given the window closure from the SBA in the first quarter may be a little lumpier than we might have figured previously.

Yes. Let me take the second question first. From a PPP standpoint, first quarter versus second quarter, we don't see that as being a big driver for us, just based upon the size of our book of business and that sort of thing that we ended up originating.

From a premium amortization perspective, what we have seen kind of on the way up is that on a quarter-over-quarter basis, kind of in that -- anywhere from 2 to 4 basis points sort of range, 2 to 5 basis points sort of range. And a big part of it, Scott, will depend upon how quickly prepayment speeds do start to come down. So it's a little bit hard to kind of put an exact impact in terms of what it will have in the second quarter. But our expectation is that the prepayment speeds continue to linger a little higher in April, but then start to come meaningfully down in May and June.

Okay. Perfect. That's great. And then maybe if I could return to the payments business for a second as well. Once we get sort of back to normalization, it seems pretty clear there's a large opportunity here, both in the U.S. and Europe, as things kind of normalize. Once we get back to that steady state, maybe just a thought or two on where the growth rate of those businesses in the aggregate kind of flushes out. How does it compare to sort of the rest of the -- just the traditional bank part of USB? Maybe any thoughts on sort of longer-term trajectory there.

Yes. Scott, I'll take that one. This is Andy again. I think, as you said, we have the short-term cyclical positive that's going to occur as spending activities both for businesses and consumers get back to normal as well as corporate.

I think our longer-term opportunity is in that ecosystem we talked about. So we have over 1 million business banking customers that we define as $25 million in revenue and above. And we believe we can grow these relationships, just overall relationships, in the neighborhood of 15% to 20% over the next few years. And in addition, we believe we can grow the overall revenue levels 25% to 30% because of expanding the share of wallet. Because the fact is less than 40% of our merchant customers have a business banking product and an even lower number of our business banking customers have a merchant product. So there's a lot of opportunity there. And I think the upside is pretty significant.

And it's sort of like what I talked about with the RTP. It's just not about card solutions, but it's about managing their payrolls, their cash flows, their payables and receivables, leveraging data, helping them run their business. And that's just in the business banking category. I think there's additional opportunity in commercial and corporate as well. So that will be our focus, and I think that will be one of the drivers of growth going forward.

The other thing that I might add is that we've been making fairly significant investment in e-commerce and tech-led sort of capabilities within our merchant acquiring space. And that is a segment that over the course of the last 12, 18 months have been growing kind of in that 25% to 30% range. And as that becomes a bigger and bigger part of our business, I think that, that continues to help our merchant acquiring space.

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

Question first, just on the fee side. I was just wondering if you can talk us through some more detail on your outlook for the mortgage business, understanding it had $120 million MSR adjustment this quarter. But you guys have been share takers on the production side, but obviously you mentioned the gain on sale coming down. Where do you think the mortgage business can go from here and some of those puts and takes?

Yes. Great question. So when we think about the mortgage business, we continue to think that on the origination side that we have been capturing market share. We think that there's still opportunity to do that. And here's the reason why. Over the course of the last several years, we've been making significant investment. We've talked about the fact that we've been focused on the retail side of the equation, purchase mortgage and home mortgages that originate from the home sale side of the equation. So even as refinancings come down, we do have the capability and the capacity to be able to continue to ramp up on the home sale side of the equation or the purchase mortgage side of the equation. So I think that, that is an opportunity.

I think that our technology continues to outpace the competition, and our digital capabilities enable us to be able to capture that market share. So that's all good.

You're right that there will be impacts with respect to refinancing starting to slow as rates move up. And that's something that we would expect, and the gain on sale will start to decline as capacity in the system has gotten stronger. But I think that the implications of the investments that we have made have been positive and will continue to be positive. So while mortgage revenue is likely to come down during the year, it is still going to be a good part of our business. Does that help, Ken?

Yes. I was just wondering, do you mean come down on a full year basis, which is kind of obvious based on where we started? Or do you mean that it could still settle lower from where we just got to, the $299 million?

No, it's not the latter. I'm sorry, the $299 million, keep in mind, in the $299 million is about $120 million MSR valuation adjustment. So when you back that out or when you exclude that, we still saw some pretty significant production and origination revenue in the first quarter. And while it will settle down a little bit from there, we still think it's pretty strong through the year.

And Terry, that MSR valuation was more of a temporary phenomenon, and we wouldn't expect that to continue at that level going forward.

That's right. That's right.

Right. So it was more of a -- okay, just to check you again, it was more of a -- obviously, it's going to be a tough comp on a full year basis, but this might not have been the top tick for mortgage banking revenues going forward?

Absolutely. That's absolutely correct.

Okay. Got it. Second question, just on costs. You mentioned flattish year-over-year. The first quarter had a really high comp number even with the seasonal benefit in it. And so I just want to make sure that, that as usual comes off and how much of that seasonal adjustment is in there? And then I know you said the COVID cost came down, but how much of a burden is that still in the cost number as well?

Yes. Well, with respect to COVID, we had more costs last year. We continue to have those costs. And while it's come down some, that hasn't been an impactful change relative to, for example, a year ago. We still have all the cleaning costs and things like that, that we need to do. And I think that's going to continue until people get comfortable being back in the office, et cetera.

When you end up looking at compensation costs, again, part of it is seasonal. Part of it is also -- when you end up looking at our performance-based incentives, every year we have to reset that to be fully funded. And last year, just given the performance and the payouts being significantly lower, there is the impact of kind of refunding that on an annual basis. So...

And Terry, the third part is stock-based comp for retirees is higher in the first quarter just because of the -- that's the seasonal matter that you talked about. It's higher because of the way we account for it all at time-zero.

Yes. And that will come down in the second quarter.

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

I want to follow up first on Ken's question just on expenses. Yes, so the outlook for flat in 2Q is good. But can you give us some comments kind of looking to the back half this year and beyond? Because it does feel like the costs are still bloated. And as we think about revenue accelerating from some of the things that you talked about, maybe you can give us a sense of what you think you can do on the expense side and the operating leverage.

Yes. Well, Matt, as we've said, our goal is always to manage the expenses as best we can and keep them flat, especially in kind of a challenging revenue environment, which we're still in. Certainly, as we get into a more normal revenue environment, we do expect that we would be able to achieve positive operating leverage. But the timing of that is still difficult to kind of get your head around. And we have to see things like either rising or steepening yield curve, kind of a normalization of the payments space and just settling out of where mortgage ends up being. So a little bit hard to end up predicting kind of the timing associated with that. We do have a very strong focus with respect to expenses, though, as we think about the rest of the year and going into 2022.

And then maybe asking a little bit of a different way and segue into like some broader business metrics. You laid out financial targets at the Investor Day, it goes back in 2019. Obviously, the world has changed. Those feel kind of stale. What would be some updated targets if you look out 2 to 3 years? And I'm thinking the efficiency ratio, which has gotten quite high. And then any kind of ROE metrics that you'd like to update as well would be helpful.

Thanks, Matt. This is Andy. I think we talked about a 17.5% to 20% tangible return on common, and I'm going to focus on that ratio. While it was higher in this quarter, that was all because of the credit reserve release. And we know that's not a repeatable item. And as I think about this year, it's going to be below that, to your point. But we still feel comfortable that in a more normal environment, where the economy continues to strengthen, the rates continue to normalize and we get back to the normal spend levels. So all the things we talked about on this call, we still believe we can get to that 17.5% to 20%. And that number is what we think we get to when we get to that normal environment, which likely will be later this year, more likely, as we get into 2022.

From an efficiency ratio standpoint, same point, and building on what Terry talked about, it's higher than normal right now. But the higher is principally because of the denominator, which is revenue. And again, as we get to more normal levels, our expectation and our focus is to continue to get to the low 50s.

Okay. So from the 62 this quarter to -- I'm sorry, you said the low 50s or the mid-50s, as that had been the target once before?

The long-term target is the low 50s.

Okay. All right. So that would obviously imply outsized operating leverage. Again, look, the revenue needs to be there. I think everybody gets that. But I think there's concern that if revenue grows 5% and it's being driven by rates and loans, you can't have 3% expense growth against that to meet the efficiency targets. Obviously, if it's driven by mortgage and things like that, that have a lot of comp, I think people understand the higher expense growth. But you would need mathematically a few years of outsized operating leverage.

Yes. And if you think about where the revenue opportunities are, they're less directly comp-related. So for example, margin and payments have a different compensation structure than, for example, mortgage, to your point.

And Matt, just to tell you, we're managing expenses very closely. We meet with all our business lines on a regular basis. And we're always balancing the investments we're making to get that digital acquisition, the customers, the growth that we've talked about against managing the short-term expenses and looking for efficiencies in operations and the way we're doing business on a day-to-day basis. So that's an area of focus, I can assure you, for both Terry and myself as well as the entire management committee.

Your next question comes from the line of Erika Najarian with Bank of America.

My follow-up question is actually a piggyback off of Matt's question. This is sort of the second straight quarter where results are fine, but the stock has responded less favorably. And Andy, I'm wondering, in the discussion of a normalized ROTCE between 17% to 20%, we hear you loud and clear through this call and other calls that you have made investments throughout the years. And you did hit 20% in 2018. I guess the investor base is really -- the feedback I'm getting is, well, what's the upside from here?

And I'm wondering, clearly, rates have to normalize. And to Matt's point, operating leverage will be wider when we actually get short rates going. But can the initiatives get you to at least the top end of the range, again, imagining a world where you have some normalization in the short end but also we're past the point of reserve releases. In other words, have the investments potentially reset your normalized ROTCE higher? Or 20% is sort of the top end of what you see?

So Erika, let me take your question in maybe 2 parts. From a revenue standpoint, I do think for sure 2020 was a low point for all the reasons you're well aware of, and particularly the payments business, which had significant headwinds. And those headwinds now have become tailwinds. And I think the same could be said for the margin component, which I think all the reasons Terry talked about, net interest income, I think, goes up from the points we are today. And at some point, particularly in the second half of the year, I think loan growth starts to come back. So I think the revenue has positive bias across all categories.

If you go back to 2018, a couple of things. Number one is we were investing in digital capabilities, and we had an increased step-up in that investment that I think is more leveled off right now. So you're not going to see that same increase that you saw the last few years. The second thing is we also have the opportunity from some of the branch closures that we've achieved, the 25% over the last couple years, some of which has been and will be reinvested, some of which will come to the bottom line.

And then as I talked about with Matt, we're looking for efficiencies from our tech stack, from the way we're doing business, our operational component. And those investments in digital not only allow us to gain customer acquisition, but it also allows us to more efficiently run the business. And from an operating cost standpoint, it's favorable. So all those things add up to why I answer the question as I do.

Got it. And just a follow-up there. Your efficiency ratio in 2018 when you achieved 20% ROTCE was almost 55%. And so I guess the question here is, are we being too optimistic by then concluding that if you do dial back down to the low 50s, that your natural ROTCE in a more normalized rate environment could be above 20%?

Yes. I think our return on tangible, that 17.5% to 20%, is the way we think about it, and the modeling that we have and the projections that we have would get us to that level.

Your next question comes from the line of Bill Carcache with Wolfe Research.

Andy and Terry, can you discuss how you think about pent-up demand dynamics and how they may differ across your consumer and commercial businesses? Where do you think there's more gearing to the reopening? Is it either -- is it consumer side, commercial side? Are they pretty similar? And if you could work into your response how you think the excess liquidity on hand impacts both sides in terms of loan growth outlook, that would be great.

Yes. Let me kind of take it first, and then Andy can add on. But when we end up looking at the consumer versus commercial, I think that the stimulus that's been put into the system, we'll see that on the consumer side pretty quickly. In other words, consumer spend we do expect to continue to ramp up from here and really probably through at least the end of the year. And you see that in the GDP growth predictions -- or projections that are out there really being driven by that. I do think that that's going to help us on the fee side of the equation. And it will also, as the year progresses, help us in terms of consumer loans, which I talked about earlier.

On the commercial side, I think that, again, there are things that the customers will need to do in order to be able to meet that consumer demand, if you will, and that is in the form of continuing to build their inventories and make some capital investments, which they, just like many of us, have been kind of holding off. So the timing of that, though, is probably a little bit more subdued earlier simply because of the fact that there is, as you said, a fair amount of liquidity and deposit balances that exist. And so they need to burn through that. Similar to what we saw the last cycle that we kind of went through. So what we're first going to see is that -- utilizing those deposit balances and then starting to see more robust sort of loan growth. And that's why we think it's really probably more a second half of the year before that starts to happen.

I wouldn't add much, Terry. I think the last category to come back is going to be corporate T&E. That category is still 75% down versus 2019 levels. We all are experiencing what we're experiencing with not traveling right now, and I think that's going to be the last category to come back.

Got it. That's very helpful. On your excess liquidity commentary, I wanted to ask if your mix of investment securities relative to average earning assets grew to just over 31% this quarter, which I believe is the highest that we've seen relative to your history. And it sounds like you guys expect to grow that from here, if I heard you correctly. Can you discuss how you're weighing the incremental NII opportunity there from growing that securities book with the OCI risk and just from an overall asset-liability management perspective?

Yes. I guess when we think about it, at least in the near term, one of the things we're going to end up having to do is to kind of weigh the opportunity that the yield curve continues to steepen even further from here. And so we'll kind of pick our points with respect to where we make those investments. But I think in the near-term until loan growth and that demand really starts to solidify, I think the ability to deploy low-cost deposits that we see as part of inflows into the investment portfolio makes sense.

And you're right, it is kind of a balancing act that you end up having to kind of take a look at. And just based upon kind of our expectation that the longer end of the curve continues to move up, the shorter end of the curve probably lags out a bit, that, to us, makes some sense.

Got it. If I could squeeze in one last one for Andy. Andy, can you discuss how active you are in your discussions with regulators regarding the uneven playing field with many of the fintech players, particularly those who are benefiting from things like unregulated debit interchange, which was obviously originally introduced as a small bank exemption under Durbin, not for them? But is there any expectation for little bit more of a leveling of the playing field? Or is this the competitive landscape that is just sort of the new reality?

I think our focus on that from a banking perspective is on the safety and soundness from a customer's perspective. You think about data protection, liquidity, ensuring that the deposits are there, all those things which makes banks a very safe industry, we want to make sure that those same -- that same level of oversight is there for our customers and for customers using some of those other capabilities. And that's a real area of focus.

Your next question comes from the line of Mike Mayo with Wells Fargo Securities.

Okay. I have one, I guess, kind of negative question and one positive question. So we can start with the negative one first, I guess you've heard. But look, there's 6 years of negative operating leverage at U.S. Bancorp, and there's stories around it, right? You had the regulatory situation and you have the pandemic. You don't have -- you're undersized in capital markets, which have been a record versus some of your larger peers. And you're over-indexed in payments, which has been hurt. So I mean there's certainly reasons here. But if you look at the cost, link-quarter or year-over-year, they're higher. You look at the revenues, link-quarter, year-over-year, they're lower. So I know you've given some guidance. But just to be crystal clear, are you saying that PPNR is at a low point in the first quarter and should improve from here?

Well, yes, I mean, when you -- again, when you end up thinking about the dynamics we've been talking about, I do think that the rate environment and what we're going to see in terms of net interest income is going to be positive going forward. I think that, that is a tailwind. I think the tailwind that exists with respect to the payments will also help us as we start to look into -- especially the latter half of 2021 and into 2022. So I think there's a number of things that create tailwinds from a revenue standpoint that actually do help us quite a bit from a PPNR standpoint.

And you also said flat expenses at least in the second quarter. So I guess one question is, with all the branch closures that you had, why we haven't seen more -- or less negative operating leverage. I just suspect you're investing more in your digital infrastructure. Can you share any of those numbers, like how much you're investing? I know you haven't disclosed that yet.

But more generally, what are you trying to build? And when do you think you can get there? It's -- kind of like the payment ecosystem, connecting your payments customers with your commercial customers, what's the total addressable market? Can you become like a Square-like competitor? Just a little more elaboration on where you're spending and what the end game is.

Yes, Mike. And to answer your negative question with a short answer, the answer is yes on positive PPNR from the first quarter levels for the rest of the year. In terms of where we're investing, it's what I talked about, the -- just in the business banking side for our business, we have about 1 million customers. And we believe there's, as I talked about, 15% to 20% growth in customer opportunity, 25% to 30% growth in revenue opportunity. And that's just in the business banking segment, not including commercial and corporate. So I think that's where a lot of opportunity exists.

Where we've been investing is exactly in that ecosystem, in the ability to acquire customers in a digital fashion, ease of customer use from a customer experience standpoint, reflecting the fact that they're not utilizing the branches. So we're closing the branches, as you talked about, reflecting transactions aren't taking place there; they're taking place in the digital way, investing on the digital site. So that -- everything you said is correct, and that's the way we're thinking about it as well.

Your next question comes from the line of Terry McEvoy with Stephens.

Actually, just one left on my list here. The ACL ratio down for every loan class except CRE, up on a percentage basis, I'm just wondering is that something to do with the COVID-impacted industries or anything else within that $38 billion, $39 billion portfolio?

Yes. This is Mark. I'll just add to that. That's an area that we continue to be very focused in on. You hit it right, there's some of those COVID-impacted industries. But I think there's longer systemic shifts, if you will, potentially with office and some of the multifamily that we're continuing to be very focused in on and that could play out a little bit longer as we work our way through the cycle.

Your next question comes from the line of Vivek Juneja with JPMorgan.

Andy, Terry, more importantly, I applaud you for changing the time on your call. Thank you for listening. It's not always that we see that. Couple of questions. Firstly, you continue to see good growth in commercial products. Pardon me, if I -- even though you did move it, there's still been lots of calls today, so if I missed that, sorry if I'm making you repeat it. What drove that growth? And what do you see as the drivers there -- what do you see as the outlook for that? I'll start with that.

Yes. So on the commercial product side, maybe a couple of dynamics. Part of it is year-over-year. First quarter was fairly volatile a year ago and had some implications on a year-over-year basis. There's some growth that is occurring. When we think about the future quarters, for the rest of 2021, I think one of the dynamics that will help that is that what we are seeing right now is with rising rates, there are a lot of companies when they're thinking about their debt -- or capital structure, pulling forward out of probably 2022 into 2021 some of their refinancing activities.

And then if you remember from last year, there was a lot of activity in terms of capital markets. Companies are really trying to rebuild or build as much liquidity as they could. And a year later, just given the environment and the economic outlook, they had the opportunity to refinance that even after just a year. And so they're taking advantage of that.

So it's kind of those activities related to churn, pulling some things forward, et cetera, that are going to help commercial product revenue kind of hold up through the year.

Okay. And then a different question for you folks. I noticed that branches were down a little over 100 or so. Andy, you had mentioned last quarter that you want to -- you expect to shrink branches in the double-digit range. Is that still part of the plan? And if so, how much? And is that -- what's the timing on that as you look out?

Sure, Vivek. So if you look at a couple years ago, we were just over 3,000 branches and now we're closer to 2,300. So we're down about 25%. I wouldn't expect additional major changes in the number of branches. You'll have some puts and takes. In fact, you'll see some additions in certain markets and some subtractions or branch consolidation where appropriate. But I wouldn't expect a significant change from current levels.

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

Andy, can you touch on -- and I apologize if you addressed this. But I know you guys have talked about the low level of net charge-offs this quarter is not likely sustainable. And I think you said in one of the answers to a question earlier that it could start to creep up by the second half of this year to the more normalized pre-pandemic levels that you have identified. Can you share with us what would cause it not to go up? What will you guys have to see that this would continue at 30 to 35 basis points through the remainder of the year?

Yes, I'm going to start and Mark can add in. Gerard, so some of the things we're seeing right now, individuals have a lot of cash, either because of the stimulus checks that have occurred or not spending money in other things. So our payment rates in credit card, Terry talked about that, that's impacting balances. All those things drive to near-record levels of low charge-offs in our credit card portfolio and our delinquencies. And the consumer is just very liquid right now, and that's part of the reason that we're at such a low level. And we do expect that to continue to normalize over time as they start to utilize those savings and get back to spending money in a more traditional sense. So that's one of the things that we would expect. If there's a delay on that, then we're probably going to be at a low level for a longer time frame. And then the area that we would expect to start to migrate up a little bit as well is on the areas impacted by the pandemic that Mark talked about, and I'll let Mark answer.

Yes. The other area that I might focus in on is we've seen strong asset value. So if you look at autos has been strong. We've seen a 6% increase in auto value, for example, Gerard, in February alone as well as the residential real estate continues to be strong. So I think if those trends continue to strengthen, we could continue to be at these lower levels.

But I think our view would be those start to normalize and, to Andy's point, the liquidity starts to come down, we see spending activity picking back up, which would lead you to kind of more normalized levels as we move through the back half of the year.

Very good. And then just as a follow-up, Andy, over the past earnings calls, you've often commented about outlooks for mergers and acquisitions. And I don't think you were asked that question today. But what is your outlook for depository type of acquisitions? I know banks are sold, they're not bought. But just give an update on what you guys are thinking about expanding possibly through that strategy.

Sure, Gerard. And that did come up a little earlier. But our focus continues to be, from a traditional bank standpoint, something that would be meaningful from a customer acquisition or a geographic sense. I do think the value and the importance of scale is even more important than it was 12 months ago or 24 months ago. So that's something we're very focused on.

And then the other areas that we're focused on are, what I would call, partnerships or M&A related to capabilities on the payment side, building our ecosystem, building the distribution. And those are smaller deals, technology-related deals that we've done already in the payments business and we'll continue to focus on.

There are no further questions at this time. I would like to turn the call back over to Ms. Jen Thompson.

Thank you, everyone, for listening to our earnings call. Please reach out to the Investor Relations department if you have any follow-up questions.

This concludes today's conference call. You may now disconnect.