Good morning. My name is Lynn, and I will be your conference operator today. At this time, I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. 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 will now turn the call over to the 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 October 12, 2018, and P and T undertakes no obligation to update them. Now I'd like to turn the call over to Bill Demchak.
Thanks, Brian, and good morning, everybody. This morning, you would have seen P and C reported 3rd quarter net income of 1 point $4,000,000,000 or $2.82 per diluted common share. Overall, I thought we delivered another really solid quarter highlighted by continued progress on our strategic priorities and our key financial metrics all moving in the right direction. We grew average loans and deposits and we continue to add new clients. Net interest income increased, NIM expanded and fee income grew.
In fact, we hit a record high for fee income through 9 months with increases in basically every category other than residential mortgage. We continue to manage expenses well with the small increase this quarter reflecting higher business activity. Credit quality also remains strong with non performers and net charge offs down and our tangible book value per share grew again and we raised the quarterly dividend to $0.95 in August. Now I do want to touch on loan growth for a second because I know it's something you are all watching closely. While we did see modest growth in the quarter consistent with industry data, our corporate loan growth came in below our own expectations.
We attribute the shortfall to a combination of several factors including elevated competition, meaningfully higher payoffs this quarter and paydowns and overall lower The higher payoffs and pay downs appear to be driven by competition from non bank lenders, excess corporate cash and attractive opportunities for our clients in the bond markets. Interestingly, our secured lending businesses excluding real estate, which collectively comprise roughly a third of our book and face less competition, they grew at almost 3% this quarter. Now while we recognize these challenges, we can't impact all indirectly. What we can and are doing is executing upon our Main Street model of providing value added solutions and world class service. We continue to add new customers and deepen relationships that meet our risk adjusted returns.
On the consumer side, I was pleased to see loan growth again this quarter. And while our outlook for 4th quarter loan growth is up modestly as Rob is going to review with you a bit later, The economy is really strong. Consumers are in great financial shape and companies are optimistic and growing. In addition, recent market disruption may help to alleviate some of the challenges that I outlined a moment ago. So we expect to see continued opportunities for loan growth moving forward.
To that end, we're experiencing success in our national initiative to expand our middle market corporate banking franchise in faster growing markets. And we also recently launched our national retail digital strategy, leading with a high yield savings account and offering our virtual wallet checking account, which will be supported by an ultra thin retail network. In fact, we just opened our first out of footprint retail location in Kansas City earlier this week. As we work to expand the reach of our brand, we're excited about how we're positioned to drive growth and efficiency through time. And before I hand it over to Rob, I just want to thank our employees for their continued hard work as well as our clients for their trust in us.
With that, over to you, Rob.
Great. Thanks, Bill, and good morning, everyone. As you've seen by now, we've reported net income of $1,400,000,000 or 2.8 $2 per diluted common share. Our balance sheet is on Slide 4 and is presented on an average basis. Total loans grew approximately $700,000,000 linked quarter and $4,100,000,000 compared to the same quarter a year ago.
Investment securities of $80,800,000,000 increased $3,300,000,000 or 4% linked quarter. Purchases were primarily agency residential mortgage backed securities and U. S. Treasuries. Our cash balances at the Fed averaged $18,800,000,000 for the 3rd quarter, down $1,900,000,000 linked quarter and $4,600,000,000 year over year.
Deposits were up 1% on both the linked quarter and year over year basis. As of September 30, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.3%, down from 9.5% as of June 30, 2018, reflecting continued capital return to shareholders and a decline in accumulated other comprehensive income. Importantly, we maintained strong capital ratios even as we returned $914,000,000 of capital to shareholders. We repurchased 3,300,000 common shares for $469,000,000 and paid dividends of $445,000,000 Our return on average assets for the 3rd quarter was 1 point 4 7%. Our return on average common equity was 12.32 percent and our return on tangible common equity was 15.75%.
Our tangible book value was $73.11 per common share as of September 30, an increase of 5% compared to a year ago. Turning to Slide 5, average loans were up approximately $700,000,000 linked quarter and $4,100,000,000 or 2% compared to the same quarter last Commercial lending balances increased approximately $200,000,000 compared to the 2nd quarter. As Bill mentioned, our pipelines were strong throughout much of the quarter, but payoffs and paydowns were substantial. Compared to the same quarter a year ago, total commercial lending increased $3,000,000,000 and growth was broad based with the exception of real estate, which declined by $1,000,000,000 Importantly, we're seeing momentum in consumer lending. Balances increased by approximately $500,000,000 linked quarter and $1,100,000,000 year over year.
We had growth in our auto, residential mortgage, credit card and unsecured installment loan portfolios, while home equity and education lending continued to decline. Deposits increased by $3,000,000,000 or 1% compared to the same period a year ago. On a linked quarter basis, deposits increased $1,500,000,000 driven by seasonal growth in commercial deposits. During the quarter, consumer demand deposits decreased somewhat, reflecting seasonal consumer spending. However, our time deposits increased reflecting higher rates.
As the slide shows, our overall cumulative deposit beta increased in the 3rd quarter to 20 9%, driven by both commercial and consumer. Within that number, the cumulative commercial beta is near our stated level. However, our cumulative consumer beta is only 15% compared to a stated level of 37%. Increases in our overall betas, which we expect to continue, will primarily be driven by the consumer side going forward. As you can see on Slide 6, net income in the 3rd quarter was $1,400,000,000 Revenue was up 1% linked quarter driven by growth in both net interest income and fee income.
Non interest expense increased 1% compared to the 2nd quarter, reflecting higher business activity. Provision for credit losses in the 3rd quarter increased slightly to $88,000,000 as overall credit quality remained strong. Our effective tax rate in the 3rd quarter was 15.7% and this was the result of the timing of certain tax benefits that this year mostly occurred in the Q3. You'll recall our tax rate in the 2nd quarter was somewhat elevated at 18.3%. So when combined and due on a year to date basis, our effective tax rate year to date was 17%, consistent with our guidance and expectation for full year 2018.
Now let's discuss the key drivers of this performance in more detail. Turning to Slide 7, total revenue grew 1% linked quarter and 6% year over year. Net interest income increased $53,000,000 or 2% linked quarter and $121,000,000 or 5% compared to the same period last year as higher earning asset yields and balances were partially offset by higher funding costs. The linked quarter comparison also benefited from day in the Q3. Net interest margin was 2.99%, an increase of 3 basis points compared to the 2nd quarter.
Non interest income decreased 1% linked quarter and increased 6% year over year. Importantly, fee income grew 1% quarter and 8% compared to the same quarter last year. It's also worth noting that our fee income on a year to date basis was a record setting 4 point $7,000,000,000 with increases in every category except for residential mortgage. The main drivers of the linked quarter fee increase is were asset management fees, which include our earnings from our equity investment in BlackRock, increased $30,000,000 or 7%, reflecting higher average equity markets. Discretionary assets under management increased $10,000,000,000 in the quarter.
Service charges on deposits increased $17,000,000 or 10%, reflecting a seasonal increase in consumer spending. Corporate services fees declined $22,000,000 primarily due to a lower benefit from commercial mortgage servicing rights and lower loan syndication fees, partially offset by higher M and A advisory fees. Notably, Harris Williams had another record quarter. Finally, other non interest income of $301,000,000 decreased $33,000,000 linked quarter. These derivative fair value adjustments were negative in the 3rd quarter and positive in the second quarter, resulting in a change of $59,000,000 was partially offset by higher private equity investments.
Going forward, we continue to expect the quarterly run rate for other non interest income to be in the range of $225,000,000 $275,000,000 excluding net securities and Visa activity. Turning to Slide 8, 3rd quarter expenses increased by $24,000,000 or 1% linked quarter. Personnel expense increased $57,000,000 linked quarter, largely as a result of incentive compensation expenses related to business activities and an additional day in the quarter. Importantly, every other expense category declined quarter over quarter. Compared to the same period a year ago, expenses increased $152,000,000 Personnel expense grew 127,000,000 dollars year over year, reflecting revenue growth, higher staffing levels to support business investments and the increase in the minimum hourly wage commitments we made to our employees at the beginning of the year.
Additionally, marketing expense increased to support business growth, including our digital expansion efforts. Our efficiency ratio was 60% in the 3rd quarter, unchanged on both a linked quarter and a year over year basis. As you know, we have a goal to reduce costs by $250,000,000 in 2018 through our continuous improvement program and we are confident we will fully achieve our full year target. Our credit quality metrics are presented on Slide 9 and remained strong. Compared to the Q2, total non performing loans were down $25,000,000 or 1%.
Total delinquencies were up $67,000,000 or 5% and included higher auto loan delinquencies in the 30 to 59 day bucket related to the impact of Hurricane Florence. Provision for credit losses of $88,000,000 increased by $8,000,000 linked quarter, reflecting a higher consumer provision primarily due to credit card and auto loan growth. Net charge offs decreased $18,000,000 compared to the 2nd quarter. In the Q3, the annualized net charge off ratio was 16 basis points, down 4 basis points linked quarter. In summary, P and C posted strong 3rd quarter results.
During the Q4, we expect continued steady growth in GDP and we expect one more 25 basis point increase in short term interest rates in December. Looking ahead to Q4 2018 compared to Q3 2018 reported results. We expect loans to be up modestly. We expect both total net interest income and fee income to be up low single digits. We expect other non interest income to be in the $225,000,000 to $275,000,000 range.
We expect expenses to be up low single digits. And we expect provision to be between $100,000,000 $150,000,000 And with that, Bill and I are ready to take your questions.
Thank you. Our first question on the phone lines comes from the line of Scott Siefers with Sandler O'Neill. Please go ahead.
Good morning, guys. Hi, Scott. Let's see. First question just on loan growth. The guide for the Q4 is consistent with the guide for the Q3.
Just curious if you could give a sense for overall trajectory. Should we be expecting it to be same level, maybe a little better and why? And then I guess, Bill, just as you look at the numerous factors that seem to be impacting growth for you guys in the industry, given where we are in the cycle, what would it take for loan growth at banks like PNC to be able to reaccelerate towards something that you would expect would be more normal given the strength of the economy?
All good questions. So our guidance for the Q4, we're staying up modestly. I would tell you that our forecast as it sits today is up a little bit over the growth rate that we had in the Q3, so a little bit better. But I would also say that we were surprised by the Q3. Our actual production and new clients were pretty good.
We saw against that, we saw this broad based utilization drop and we saw a lot of pay downs that we hadn't expected. So I don't know how to forecast for that. I look at some of this disruption and some of the value loss in corporate bond funds. And I think, well, maybe that will slow some of that down, but I don't know, which is why we put the forecast out that we did. As I think Ford and you say, what should trigger growth here?
As we talk to companies, they are really bullish and they are investing. And we see CapEx expenditures going up and so you would think it would follow through in loan growth. Against that, we've seen a preponderance. I've seen all these charts of just the volume of non investment grade borrowing and even the volume of BBB inside of investment grade and then the size of the corporate bond markets all of which are playing against banks is sort of the shadow banking system has taken a lot of volume. So I'd like to think that it would change for the better, but we have some structural changes in the market I think that we saw play out in the Q3 that at least in the near term are impacting us.
Okay. All right. I appreciate that color. And then Rob, if I could expect in a rising rate environment. I think in your prepared comments, you had made some note about demand deposits being down seasonally.
What would be your best guess for how the mix of the overall deposit book trajects
here as we go forward?
I would expect, do you mean between interest bearing and non interest bearing?
Yes. I think sorry, I thought your comment was on demand deposits, but I could be wrong though.
Yes. Well, I just just the way I do and then you tell me if this answers your question in terms of just the consumer and the commercial side. On the consumer side, we're seeing a shift to savings, which we've seen for some time and now the beginnings of time deposits, which is natural and what you would expect. And then on the commercial side, we are seeing somewhat of a shift from non interest bearing to interest bearing. Again, all reflective of a higher rate environment.
Yes. Okay. All right. That sounds good. I appreciate the color.
Sure.
Thank you. Our next question comes from the line of John Pancari with Evercore ISI. Please go ahead.
Good morning. Hey, John.
On the expense side, just given the some of the pressures on balance sheet trends, particularly on the loan side that you just discussed, any thought as you're looking at the expense side of the equation to get more constructive on the CIP goals as you particularly as
you look through the rest
of this year and more importantly into 2019?
So, John, this is Rob. So, on expenses in the quarter, in the linked quarter, we did well. Virtually all of the increase in the linked quarter was in personnel and all of that was essentially incentive compensation related to the When you drop back and take a look at our expenses year to date, that tells sort of the broader story. And if you look at our expenses year to date, we're up $382,000,000 so far this year over 2017. And of that $382,000,000 80 percent of that or 300,000,000
dollars of that is in personnel.
So if you the other categories are good. Occupancy is down, equipment expense, all other are in line and marketing expense is up part of our investments, but that's a smaller number. But back to that personnel number, that $300,000,000 about half of that in a typical year is what you'd expect to see. Half of that is merit and promotion as well as incentive compensation, which as I pointed out earlier is a little higher this year, which is a good thing. The other half of that, that other 150 really reflects investments that we've made that we make investments every year, but in 2018, they're particularly strong.
And they represent higher headcount to support our technology build out, our geographic physical geographic expansion in Corporate Banking and our digital expansion in Consumer Banking, as well as the commitment we made to raise the minimum wage to $15 an hour minimum paid $15 an hour. So that part, that $150 of the $300 reflects investments like all investments, we front end that and we expect to see return on that through time. Obviously, the technology investments, we'll talk about a little bit more. On the raise to the $15 an hour, we're already seeing lower attrition rates that we would expect will continue. So that's all deliberate and all factored in.
And our expense discipline and our program is on track.
I mean the quick answer, John, we focus on expenses every day and try to find ways to knock them down. At the same time, as you look at the changes that are happening in the banking industry would be a real mistake in my view to slow down and stop our investments. I like the idea of self funding them, which we've largely been able to do. But I don't want to cap off our growth rate because we see 1 quarter of slower loan growth. That's not the right
answer. Got it. All right. Thanks, Bill. And then separately on the capital side, you're sitting here at about a combined payout ratio of about 75%.
You've alluded to the potential to increase that given you might have been a bit too conservative as we look to this past CCAR. Can you give us your updated thoughts there? And your peers are around 115% combined payout. How do you where do you think you could go here as you look forward? Thanks.
Well, without getting specifically into payout, as I said at a recent conference, we did realize we went in a little bit light. There are couple of reasons why it made sense for us to go back to the Fed and resubmit. We are in conversations with the Fed at this point. Beyond that, I don't have any more detail to give. On a longer term, I like the idea of 100% payout.
We on our base case CCAR always tend to kind of get there. And then we tend to out earn our CCAR case largely because of some of assumptions you have to put in on loan loss provision and some other things. So we always struggle with this notion that we try to get to 100, maybe we have to budget for over 100 to solve back to 100. But we're not holding back from capital return at this point and our goal wouldn't be to.
Got it.
Thanks, Bill.
Thank you. Our next question comes from the line of John McDonald with Bernstein. Please go ahead.
Hi, good morning. Rob, I was wondering based on the some of the recent regulatory dialogue, it seems that you could potentially see a benefit from easier liquidity rules. Just if that happened, could you remind us how mechanically an easier LCR rule would allow you to perhaps do some things on the balance sheet you can't do now? And is there any way for us to think about the magnitude of that benefit?
Yes. Hey, good morning, John. We've spoken about this all year, and we are optimistic that something favorable will occur. I think the easiest way there's a lot of options. The easiest way obviously would be take a look at the $19,000,000,000 that we have on deposit at the Fed.
We would in simple terms be able to pay down debt or liabilities. In other instances, we'd be able to redeploy in the higher yield securities. So I think that the conservative route would be to establish what level of liquidity you need and then just reduce the debt short term debt accordingly.
Okay. And I guess in this environment, you wish you had more things to do with your current liquidity. So it just kind of add, I guess, to more of that?
Yes, that's right.
Okay. And you guys have obviously talked about different ways you're taking P and C on the road into new markets. I wanted to kind of ask the opposite question. When a big player like Bank of America comes into your hometown, how do you think about incremental competitive threats and ensure that you're maintaining your position in branding as market leader? And with digital and mobile, are you able to compete a little more on non price factors these
days? Well, that's so that's the dynamic that's playing out. This is Rob Bill. May want to add some color. That's the dynamic that's playing out.
We're excited about the initiatives that we have going out of footprint on the digitally led offering, which we can talk a little bit more about. In regard to other providers coming into our sort of legacy markets, we fully expect that that will occur. We can't control that.
We compete with them everywhere already other than maybe Pittsburgh. And I would tell you in our own experience where we go into a market dominated by somebody else and we are the underdog, the growth rate always tends to surprise me largely, I think, because there's some percentage of the population for whatever reason wants to try a different bank. And I suspect if somebody comes into Pittsburgh, they'll pick up some amount of that. We have 60% market share or something in Pittsburgh and there's 40% left to go around without really major bank presence sitting here. So I suspect they'll do fine.
Okay. Thanks.
But not necessarily with our customers.
Thank you. Our next question comes from the line of Betsy Graseck with Morgan Stanley. Please go ahead.
Hey, good morning.
Hi, good morning.
Two questions. One, just one more on expenses. So up a little bit this quarter, partly a function of the marketing and the investments that you're doing. I think it's related to the digital banking. I'm just wondering how much of that persists from here, because you've got the start up costs and then you've got the ongoing marketing.
So should we expect that some of that fades as start up is done? Or maybe you could talk through that a little bit.
You're going to have some offsetting things. We didn't kick off the digital program until late in Q3. Having said that, the Q3, I think, was probably the 1st full quarter we had the total impact of the $15 raise increase. So there's a whole bunch of moving pieces in there between personnel and what we'll do in marketing. And all of that's embedded in Rob's guidance.
Yes, I
think and for the Q4 guidance, Betsy, that's it. The most notable item is that our marketing expense will increase in the Q4. Typically that hasn't happened and that marketing is largely directed toward the digital initiatives.
And then could
you talk a little bit about the branch rationalization that you're doing in your core your legacy markets, is there run rate is that run rate going to persist at current kind of levels or is there more to do there? Or are you almost done? Just give us a sense on that side of the equation.
Yes. No, we're pretty steady there, Betsy. And on our plan for the year, we've been averaging about 100 consolidations a year. And this year, we're on track to do a comparable number. So that's the current path and I'd expect that to continue.
Yes. Part of the issue with accelerating that is the amount of time and effort we put into preparing customers for a branch to close. So what's very important is that we retain the balances and the customers as we consolidate a branch. So we spent a lot of time on that. And I'm not sure as a practical matter that we could actually do more or substantially more than the 100 a year we're currently doing.
And we'll continue to go kind of at that run rate until and if the market tells us based on client attrition that we need to slow down.
Got it. Okay. No, that's helpful. And then just lastly on the mortgage side, I know you did a lot in improving the efficiency of that platform over the last couple of years. Could you just tell us strategically how you're positioned?
And is there have you created some operating leverage for yourself as you build out into some of these new markets?
Well, we're finally seeing the costs come down in terms of sort of duplicative personnel as we are running 2 systems. We still have the last leg of bringing home equity origination onto that platform. With that, we will have in effect digital origination capability and closing capability with home equity in our auto footprint markets should we choose to offer that. I'm not exactly sure where we are on that yet. But that's a dramatic improvement from where we are today where, believe it or not, to close a home equity loan at P&C today, you've got to go into a branch.
So all of this system change sort of puts home equity mortgage on the same front end, same servicing platform. And independent of volumes, which we hope would increase, you'll see costs continue to bleed out of that system.
Okay. Thanks so much.
Thank you. Our next question comes from the line of Erika Najarian from Bank of America. Please go ahead.
Hi, good morning.
Good morning, Erica.
Can I ask a little bit, Bill, about the tenor of competition from non banks? And I'm really most curious about more on the competition with regards to structure and what you're observing in terms of competition from private direct middle market lenders? And then sort of as a follow-up to that, you mentioned structural changes in the market, which I agree with. But I wonder as the Fed continues to drain liquidity out of the system, how much of the opportunity can go back to banks over time?
Yes. Again, all good questions. And I guess what I would say is, we continue to think that the leverage loan market is overheated. I continue to think that as rates rise, it's going to put real pressure on those credits that LIBOR going up as much as it does. Eventually that turns.
Now as it relates to kind of our near term flow, we don't really play in the leverage loan market. But that market being as open as it is has caused a number of our private middle market companies that we historically have banked to go to private equity. And while we might keep them as a transaction client, TM and so forth, we don't participate in the financing of that. So that M and A wave is kind of pulling loan demand off and out of the banking system by levering it and putting it into CLOs and so forth. But I do think there'll be a crack in that at some point as rates continue to rise.
And I think when that happens, see probably more traditional flows back into the banks. But I just don't know the time line in that.
Great. Thank you. Thank you. Our next question comes from the line of Mike Mayo with Wells Fargo. Please go ahead.
Hi.
Well, thanks for your honesty, Bill, in terms of what's happening with your loan growth and that is tough to forecast. So when you go back to your team at P&C, what kind of message do you want to send? I mean, you could send all sorts of messages. You could be angry, you could be happy, you could accept what's taking place or you could pause. So let me just you could be angry because you say, hey, we're not executing as well as we need to, do better or you could be happy and say, you know what, you've seen these cycles before, you see the crazies out there, we're going to stick to what we do and that's fine.
You could accept what's taking place and say it's not going to get better and have a new expense program or something. Or you could be or you could pause and say, you know what, this is just weird and we're just going to see what happens over the next couple of quarters. So what message will you be sending to your team?
Mike, I don't really have to do any of the above in the following sense. We have, since I've been at P&C followed the same model, the same credit box, the same clients we want to bank are the ones that we bank. And if a risk is outside of our box, we just don't do it and we can't control the market. Now what was weird about the Q3 was we actually originated a lot of business. So I'm actually pleased with the activity of our bankers and the number of new clients that we brought on board.
I'm disappointed by the environment in the sense that utilization went down and we had pay downs, but there's nothing I can do about that. And as a practical matter, we will never be the bank. And by the way, we could be very easily that simply says go get loan growth. I can make loan growth whatever you want for the next 6 months or a year or until the cycle cracks. And we just don't do that.
We don't need to do it given our ability to grow fee income. And our plan to just bank is 3 yards and a cloud of dust and you do it consistently forever and you produce a good franchise and that's what we're after. Your question on expenses, I get back to this, Nelson, we're fighting every day to drop expenses. But having said that, again, we could choose to simply curtail investment in digital. We could choose to curtail investment in cyber.
We could choose to not have active active data centers in terms of resiliency of our client facing applications. And in the near term that would make our expenses look great. And in the long term, it would kill us. And I think a lot of our competitors are choosing to do that on expenses and choosing to do that on loans. And that's just that's not who we are.
So let me see if
I have this straight. So I mean, I think I hear you saying you're going to barrel through with your strategy that's worked for the last several years and the environment will eventually come your way since you're looking through an entire cycle. Is that paraphrasing it correctly?
On credit, yes, right? So you can't figure out who's lying or not with respect to loan growth until you have a credit crunch. And you've heard me say forever that banks are the only industry in the world where you can lie about your cost of goods sold until there's a downturn. And I always want to be the bank that outperforms in that environment. And if that means that we have to at the margin slow top line growth by not chasing deals that just don't hit our return metrics then so be it.
All right. And then lastly, the line utilization, is that from some of the borrowers going elsewhere? Or what else is
No. You know what I think that is, is simply corporates are flush. The lower tax rate is basically increased cash flow in companies. And all else equal, they're not spending the incremental difference in totality on CapEx, and so they're dropping their line
utilization. I think that's Yes. Mike, this is Rob.
I can jump in on that. That's exactly right. And Bill referenced this in his opening And the two headwinds are cash flush borrowers, which is dropping utilization and that's a function of lower tax rates, repatriation, all the things you read about and these pay downs and payoffs. Those two items are the headwinds to the extent that they abate, which we expect that they might at some point. That's the issue.
Yes. And by the way, Mike, our pipeline as it sits today in the forward months looks great. It looks stronger than it's looked in the last 6 months, I think. I'm kind of rod the nod. But yes, it does.
And so our only hesitation on this stuff is the out of our we can get lots of deals that meet our risk criteria in this environment and we're winning them. What ends up happening is our existing book of business is borrowing less and or disappearing through paydowns, either public market or paydowns because they were taken private.
Yes, that's helpful.
Okay. Thanks.
Thank you.
Thank you. Our next question comes from the line of Gerard Cassidy with RBC. Please go ahead.
Good morning, guys.
Good morning, Gerard.
Can you talk a little bit about the non interest bearing deposits? When you look at your levels, which represent about 31% of total interest bearing liabilities, What do you think in a rising rate environment that's going to settle out at when you think back at P&C, maybe prior to the financial crisis where those levels were, do we have just as a risk for everybody in a rising rate environment, those deposits tend to fall?
Yes, Gerard, I can answer that. I mean, obviously, that's a period. We watch it all the time. I would expect that the continued shift that's occurring that will occur. I don't we haven't really handicapped where it's going to stop or where it's going to be because there's obviously a lot of variables involved there.
But we managed this way, we managed this way before. It will be fine either way.
I see. Okay. And then coming back to the competition on commercial lending that you've already addressed. Have you sensed that other competitors with the lower tax rate or maybe competing away some of the lower tax rate? Is there any way of seeing if that's happening?
For all the talk around that, we actually haven't seen it. There was some talk early on that we heard from some clients that competitors were maybe doing that at the margin. But practically that isn't really what we're seeing. We're seeing competition on structure. We're seeing deals that should be ABL going cash flow, those kinds of things.
But I don't see people outright sort of recating tax reform.
I see. And then just finally, in this whole commercial competitive area that you've referenced, is it primarily in the legacy P and C footprint? Or are you also seeing it in your newer markets that you've been expanding into?
It's everywhere. And by the way, that's it's intuitive, right? If what you're offering is a commodity, which is money, there's no special skill involved there's no special secured financing or technology, then you're offering a commodity. And
No doubt. No doubt. Part of your question though is in our expansion in growth markets, we do see better growth dynamics just because it's off a smaller base, even though those factors are in place there.
Got you. Okay. Thank you.
Yes. Thank you. Our next question comes from the line of Ken Usdin with Jefferies. Please go ahead.
Thanks. Good morning, guys. Recently, there's been some talk talking about banks of your size and the potential maybe helpers on the regulatory front from either capital liquidity. I know you've discussed this in the past, but I'm just wondering just where that conversation sits in your mind and what you're at this point hoping for directionally?
Well, I think in Governor Quarles' last testimony, he spoke to this and talked about Large non GSIBs. Yes, with the large non GSIBs and having something out in the market before the end of the year and that's consistent with my own dialogue with the Fed. I'm not exactly sure what they're going to do. I think they're thinking about the notion and we would like to see the notion that you get rid of the step function of 250. Not only as it relates to LCR, but frankly as it relates to some of the relief you see on capital to the groups below 250, the change in the sin bucket items.
AOCI. AOCI and some other things. So we'll have to see. But I think there is an inclination amongst the regulators to put more finesse on allowing regulation to fit the size and risk of the firm as opposed to doing its step function off of asset value that they came up with 15 years ago.
Which they call tailoring. Yes.
Yes. Okay. Got it. So a little wait and see on that. And then just a follow-up on the choices that you have on the mix of the excess cash.
Just in terms what are you doing right now in terms of just investment portfolio? Obviously, it was up at period end, but in terms of the types of new rates you're seeing versus what's rolling off the back book in the securities book?
Just a couple of things. The securities balances were up quarter to quarter, but our actual duration dollars were flat because we unwound or reduced receive fixed swap position. So it looks like we put a lot of money to work in the Q3 and we didn't really. We just moved from synthetic to cash. That said, particularly with the rate environment where it's been for the last couple of weeks, the yield that we're seeing on income and securities that at this point are largely mortgage backed and treasuries are in excess of the portfolio that's running off.
So there's clear benefit from this going forward.
Yes. And Bill, one just follow-up on that. Will you continue to continue to move that synthetic to cash just at this point of the rate cycle? How do you balance just where you stand on asset sensitivity versus starting to kind of mortgage it a little
bit? Well, we're still asset sensitive.
For sure.
So we're nowhere near done here. The move from synthetic to cash is simply a value trade. Swaps when we put them on offered a lot more value than they did. So we unwound those and went into securities. And we'll do that opportunistically.
We go back the other way if change. So I that was just a value trade. I think going forward, we will be investing into this market. You've heard us say forever, we're not going to bet on red in one big swoop, but we'll increment our way into it. And our patience thus far, looks like it's going to pay dividends.
Yes. Okay.
Understood. Thank you. Yes.
Ahead. Thank you. Our next question comes from the line of Kevin Barker with Piper Jaffray. Please go ahead.
Good morning. I just wanted to follow-up on some of the deposit conversations and questions. We've seen the period end non interest bearing deposits drop significantly. And you mentioned part of that was due to business customers. Was there any shift also from the consumer side?
And do you expect the rate of change between non interest bearing deposit growth and interest bearing deposit growth to remain the same going into the 4th and 1st quarters?
Hi, Kevin, it's Rob. To answer your first part of your question, firstly, all the movement we saw was on the commercial side. So not much in terms of the consumer side. If anything on the consumer side, as I said earlier, is more a migration to savings and time deposits, but from already interest bearing accounts. Going forward, we'll just have to monitor it.
I don't see anything in terms of a radical step change.
One thing that will happen over time is we do accelerate our digital expansion is the bulk of those new monies will come in the form of interest bearing.
Yes. And that's growth.
Yes. But it's growth in interest bearing that would largely outpace because we're not bringing in a proportional amount of non interest bearing at the same time. So it could cause our mix to shift over time.
Over time, but not necessarily in the short term.
Okay. So when I think about the shift to digital, I mean, you already have plenty of liquidity. You're meeting your LCR ratio. Your loan to deposit ratio is running in the mid-80s, much better than most of your peers. When I look at the digital offering, are you going to continue to be are you going to
be a price leader here
in the beginning just to show that
you
can grow those deposits and then slow it down?
You have to compare it to the alternative and the alternative today is wholesale funding. So it's a lot cheaper than what we pay on wholesale funding. Even with LCR, if they make LCR changes, our ability to mix shift some of our more expensive wholesale funding into retail, which is beneficial to us. So we'll continue to be competitive on our digital offering. We have no real cost structure other than advertising behind it.
So the margin to it is actually pretty good. And as you know, there's
a big qualitative element to it. This is experiment in terms of the future of banking. So it's largely that versus a need for the deposits. The one thing I
would say and it's really early days and what we're doing in digital is we have been pleasantly surprised by the number of clients who choose to open the virtual wallet account, which is a full service account, versus just open the high yield savings account, which is obviously our dream scenario. We want full service clients and we have a large percentage of the people out of the gate choosing to be that. My own assumption going in was that, that would take longer, frankly, to convert these clients. And so that's a good thing.
Do you see that starting to generate higher loan growth on the consumer side, particularly in card and auto because of that shift?
It's too early. It's too early. It's anomalous. It's something we're going to track and we're going to have to figure out the right metrics to show you guys, which we will. All right.
Thank you for taking my
question.
Yes. Thank you. Our next question comes from the line of Brian Klock with Keefe, Bruyette and Woods. Please go ahead.
Hey, good morning, gentlemen.
Good morning.
Rob, I was wondering if you could follow-up a little bit and I apologize if you answered this already, but on the expense guidance for the Q4, I think you did talk a little bit about having some of the seasonal marketing expenses that would be in that guidance for the Q4. But are you assuming that the FDIC surcharge is still in that expense for the Q4?
Yes. So in our guidance, we assume no change in the surcharge amount. So there's the potential that we don't have that expense. And if that's the case, that would be a good thing, but it's not part of our guidance.
Guidance. If I understand correctly, even if it's still there for the Q4, one way or the other, it's not going to be in 2019, right? So there'll be some sort of settlement.
That's the FDIC expectation. Right. And if you're hitting all Yes,
go ahead.
It's a matter of hitting their threshold on the diff fund.
That's right. That's right. So if anything, the Q4 guidance you're giving is not an expectation of a normalized expense level? I know you're not giving 2019 guidance yet, but maybe just to add some seasonal items.
The only thing I'd say Brian is, it's a seasonal aspect of marketing, it's not that. Typically in years past, our marketing expense actually declined in the Q4. This quarter is going up because of the digital investments that were made, so the investment component of that. It's not seasonal, it's deliberate.
Okay. Okay. So will that digital investment be something that stays into the expense base going forward? I guess is that what will be different?
Well, we'll get into 2019 when we get on later in the year. Okay. Okay. All right. That's helpful.
Thank you.
Thank you. It appears that there are no further questions on the phone lines at this time.
Okay. Well, I'd like to thank all of you for joining us for this quarterly call.
Thanks, everybody. Thank you.
Thank you, ladies and gentlemen. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.