Good morning. My name is Silvana, and I will be your conference All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. As a reminder, this call is being recorded. I would now like to turn the call over to Director of Investor Relations, Mr.
Brian Gill. Sir, please go ahead.
Well, thank you, and good morning, everyone. Welcome to today's conference call for the P&C Financial Services Group. Participating on this call are P&C'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 P&C undertakes no obligation to update them. Now, I'd like to turn the call over to Bill Demchak.
Thanks, Brian, and good morning, everybody. As you've seen this morning, P and C reported net income of $1,300,000,000 or $2.61 per diluted common share for the Q1. 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 Q1 of the year is typically negatively impacted by some seasonality, as well as 2 fewer days compared to the Q4. And with this as context, I really think P and C delivered good results.
Linked quarter, we saw very strong growth in average commercial balances and small growth in consumer loans as well. Within CNIB, the growth was actually greater than the headline numbers as we had a decrease in our commercial real estate balances of approximately $1,800,000,000 driven principally by our multifamily warehouse lines. If you exclude the real estate book, C and IB growth came in at just over 4% quarter over quarter. 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 Q1 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 is 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 is 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 P&C Grow Up Great, our signature philanthropic program focused on early childhood education. As part of the celebration, we extended our commitment to grow up great, which is now a $500,000,000 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 is 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 Q1 results and then we'll take
your questions. Rob? Yes. Thanks, Bill, and good morning, everyone. As Bill just mentioned, we reported 1st quarter net income of $1,300,000,000 or $2.61 per diluted common share.
Our balance sheet is on Slide 4 and is presented on an average basis. Total loans grew $2,600,000,000 or 1 percent to $229,000,000,000 in the Q1 compared to the Q4. Loan growth compared to the Q1 of 2018 was $7,400,000,000 or 3%. Investment securities of $82,300,000,000 remained relatively flat linked quarter as our purchases replaced portfolio runoff. Securities increased $7,700,000,000 or 10 percent year over year.
Our cash balances at the Fed averaged $14,700,000,000 for the 1st quarter, down $1,700,000,000 linked quarter and $10,700,000,000 year over year, commensurate with growth in loans and securities. Deposits were up slightly linked quarter and grew $6,600,000,000 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 $1,200,000,000 of capital to shareholders or 98% of 1st quarter net income. Total share repurchases were 5,900,000 common shares for $725,000,000 and common dividends were $438,000,000 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 $2,600,000,000 or 1% over the 4th quarter, driven by commercial lending balances, which increased $2,500,000,000 or 2%. We generated this growth despite the seasonal decline in our multifamily agency warehouse lending of approximately $1,500,000,000 compared with the 4th quarter. And while not on the slide, it is worth noting that our spot loan balances increased more than $6,000,000,000 linked quarter. As we pointed out previously, our corporate and 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 twenty eighteen, which was related to heavy competition, including non bank lenders and higher pay down activity. During the Q1, 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 $100,000,000 linked quarter $900,000,000 year over year.
We had growth in residential mortgage, auto, credit card and unsecured installment loans, while home equity and education loans continue to decline. Average deposits increased approximately $700,000,000 in the Q1 compared with the Q4, 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 $6,600,000,000 or 3%. In both comparisons and as expected, growth was in interest bearing accounts and we continue to see a shift from non interest bearing to interest bearing deposits. Our overall cumulative deposit beta increased in the Q1 to 32% from 30% in the 4th 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, Q1 total revenue was $4,300,000,000 down $54,000,000 linked quarter or 1%. Net interest income was relatively stable despite 2 fewer days in the quarter compared with the 4th quarter. Non interest income declined $48,000,000 or 3% linked quarter, reflecting seasonally lower fee income. Non interest expense was flat compared with the 4th quarter as expenses continued to be well managed.
Provision for credit losses in the Q1 increased $41,000,000 to $189,000,000 Our effective tax rate in the Q1 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 $2,500,000,000 was essentially flat compared to the 4th quarter, despite the impact of 2 fewer days in the Q1.
Net interest income grew $114,000,000 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 1st quarter, up 2 basis points linked quarter and 7 basis points year over year. Fee income declined $31,000,000 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 $9,000,000 or 2% and reflected higher average equity markets and residential mortgage non interest income, which increased $6,000,000 or 10%, primarily due to a lower negative RMSR valuation adjustment compared to the Q4.
Compared with the Q1 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 non interest income of $308,000,000 declined $17,000,000 linked quarter and increased $63,000,000 year over year. Other non interest 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. 1st quarter expenses in total were essentially unchanged from the 4th quarter.
Seasonality drove increases in personnel 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 $51,000,000 or 2%. Personnel and marketing expense grew, reflecting both business investments and growth. Our efficiency ratio was 60% in the Q1 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 $300,000,000 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 $41,000,000 to $189,000,000 and net charge offs increased $29,000,000 to $136,000,000 On the commercial side, loan provision increased $31,000,000 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 $5,000,000 linked quarter to $12,000,000 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 $10,000,000 Consumer loan net charge offs increased $24,000,000 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. Non performing loans declined $41,000,000 or 2% compared to December 31, 2018, driven by a decrease in consumer non performers. And total delinquencies were down $49,000,000 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 growth 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, P and C 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 Q4 earnings call in January. Importantly, in the Q1 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 Q2 2019 compared to Q1 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 non interest income to be between $275,000,000 $325,000,000 excluding net securities and Visa activity. We expect expenses to be up low single digits and we expect provision to be between $125,000,000 $200,000,000 And with that, Bill and I are ready to take your questions.
Sylvain, would you poll for questions?
Thank you. And your first question comes from the line of John Pancari with Evercore ISI. Please proceed with your question.
Good morning.
Hey, John. Hey, John.
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 this 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?
Hey 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 twenty eighteen. And that was just increased activity across our commercial markets, very strong in legacy markets and the expansion and growth markets.
So we feel good about that. As far as the full year guidance, we guided to 3% to 4% growth. We had average growth of 1% here in the 4th or the Q1. 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. Thanks, Rob.
Sure.
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 of speculation out there regarding the Wells Fargo Post. And just we'd 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 in P&C and why it's certainly more attractive possibly to stay where you're seated? Thanks.
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.
No, it's fine. Just wanted to get your thoughts on your interest. Thanks, Bill.
Thanks, John.
Our next question comes from the line of Betsy Graseck with Morgan Stanley. Please proceed.
Hi, good morning.
Hey, good morning, Betsy.
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, etcetera?
It's almost an unanswerable question. I mean, I think the crack in the credit markets in the Q4 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 pickup in utilization, which would be totally independent of that. And we've And we continue a pace 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.
Change. Okay. No, that's helpful. And then separately, the Fed's got their NPR out there regarding moving the goalposts on advanced approaches banks. So maybe if you could give us a sense as to how you're thinking through the opportunities for you, assuming that NPR 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, you want me to
start there? Well, but yes, so as you know, the proposals we're encouraged by the proposals, 5 key items there, 2 of which are a lot of work for us that 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 three areas. One is the ability to opt out of AOCI. We'll examine that.
Secondly, the refinement to the SynBin 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 the full approach to a modified approach somewhere between 70% 85%. So early for us, we're encouraged by all of that. We see potential in that for us. But until they're all approved, Amit, 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, etcetera, I mean, is there a reason for not adopting that change if indeed the NPR goes through?
Not a terribly obvious one.
Yes. Not that I can say, but we've got time on the clock to be able to decide. So Okay. And then 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. Yes.
Okay. All right. Thank you.
Sure.
Our next question comes from the line of John McDonald with Autonomous Research. Please proceed with your question.
Hey, guys. Good morning.
Hi, John.
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 Q1, we're tracking to that.
So that's very fair.
Okay. And then expenses were up 2% year over year. Is that kind of consistent with your outlook for the full year? And what are you 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're seeing? 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 that. Well, yes, I think it that way. That's right.
Okay. And then the last thing for me is, how much of 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 has 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. 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 through the Q1 holds, we'll see less pressure on betters than what we might have expected when we started the year. And the final point, of course, is as it relates to total net interest income, all of those factors are dwarfed by our ability to continue to grow loans that makes sense in our risk bucket.
Yes, that's right. And that's why our full year guidance holds.
Got it. Okay. Thanks guys.
Sure.
Our next question comes from Erika Najarian with Bank of America. Please proceed with your question.
Yes. Hi, good morning. 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 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 in 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 would likely stay there. In terms of success of the effort, I guess I'd say a couple of things.
The first 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 re pricing your existing deposits on those platforms. We're spending more time today. Our deposits today are somewhere over $1,000,000,000 but to be honest with you, we spend more time 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.
So less worried about what the balances are doing day to day, more interested in the activation of accounts and the usage of accounts.
You you returned 14% intangible equity this quarter. And 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, Erica, 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, and 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 numbers 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 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 visavis 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 well capitalized is 7%, you're going to need to run some buffer above that simply for optics if no other reason, but also for fear of ever breaking that in a adverse economy. But we're going to have to as these tailoring rules 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 our it's 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.
Thank you. 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 slow down 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's some downturn looming that you can put that capital to work at a much better prices. But for where we are today, our intention would be to drive that ratio down return capital to shareholders.
Yes, because we have excess capital.
Yes. And to your point, dividend we're
in for Then we see real value there.
Great. Clear. Thank you so much.
Our next question comes from the line of Ken Austin with Jefferies. Please proceed with your question.
Thanks. Just continuing along the lines of capital usage and Bill, I know where you stood for a long time on the question of M and A, but just given the large transaction that happened intra quarter, and your comments just about your belief that you feel that the shares are attractive as is to play over the longer term even as far as being an acquirer or not?
Nothing has changed. The SunTrust BB and T merger, I think makes great sense for them. And I think it 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 ads 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 what are you putting on new stuff at versus where the roll off is?
Yes. So Ken, in the Q1, actually, we were what we were buying was accretive to the yields as the curve has 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 Q4, I don't know, 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
Yes. So the outcome won't be a dramatic change. But to the point of your question is the curve is 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 under invested. I still am a disbeliever in term rates, but they are where they are and all else equal, we 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.
Yes. Okay. Thanks guys.
Sure, Ken.
And our next question comes from the line of Kevin Barker with Piper Jaffray. Please proceed with your question.
Thank you. Just a follow-up on that question. 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 from
Yes.
Look, you're going to it wouldn't shock us to see them 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 and 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 deposits.
Okay. And then to 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.
Yes.
And you did mention consumer lending. Was there anything in particular around C and I or any one off credits given you saw the pickup in manufacturing NPAs?
Yes. Hey, 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's a couple of names, but that's one of our largest book. That's over 20,000,000,000 dollars 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.
Yes. One of the things that has probably masked this a little bit in the past is simply recoveries, corporates are largely operating at the rating level they want to achieve. And so, 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 swell a little bit.
But again, 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 1.1 6.
By the way, we do not solve that.
No, we don't solve that.
Yes, we don't solve that. It is literally unchanged.
Okay. And 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.
Switzer's less upgrades and more on any default.
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 what we're seeing this quarter, but through time, There'll be a gradual increase.
You'll see
a gradual increase. This quarter was more so than anything else just driven by growth, which will 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 now there's nothing in there that's bothering us this point.
That's the important point.
All right. Thank you very much.
Our next question comes from the line of Gerard Cassidy with RBC. Please proceed with your question. Good morning, guys.
Hey, Gerard. Hey, Gerard.
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. We were 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 and IB expansion, what our strategy is around that, the cost 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 a stated goal as to what we think this thing can be.
Right now, I think we just did we open the 2nd branch in Kansas? This month, later in April. Then a couple of 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 agree
with that.
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-50s.
Can you give us some ratios down toward the mid-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.
Yes, I did. Didn't remember all of it obviously. At
least part
of it. Right. 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 consolidating 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 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 through, 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'll see technology costs go up. You will see the marginal cost of deposits increase as the price paid for digital offerings and in effect in footprint physical offerings that 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 of marketing, the cost and ability to move deposits are going to offset the gains you get by otherwise using technology and removing physical plant. Distribution, yes. 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. 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
obviously indifferent to the amount of money we 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 $1,000,000 what is the $10,500,000,000 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 consolidating market. And we've been doing that.
You'll see us continue that.
Great. Appreciate all the color. Thank you.
Yes.
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.
Thanks everybody. Thank you.
This concludes today's conference call. You may now disconnect.