Good morning. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer 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 Chief Financial Officer. Today's presentation contains forward looking information. Our forward looking statements regarding P&C performance assume a continuation of the current economic trends and do not take into account the impact of potential legal and regulatory contingencies.
Actual results and future events could differ, possibly materially, from those anticipated in our statements and from historical performance due to a variety of risks and other factors. Information about such factors as well as GAAP reconciliations and other information on non GAAP financial measures we discuss is included in today's conference call, earnings release and related presentation materials and in our 10 ks and various other SEC filings and investor materials. These are all available on our corporate website, pnc.com, under Investor Relations. These statements speak only as of April 13, 2018, and PNC undertakes no obligation to update them. Now, I'd like to turn the call over to Bill Demchak.
Thanks, Brian, and good morning, everybody. As you've seen by now, for the Q1, we reported net income of $1,200,000,000 or $2.43 per diluted common share. Compared to the same period a year ago, we delivered higher net interest income and fee income, and we also benefited from a lower federal tax rate. On the whole, it was a pretty good quarter, and I would like to thank our employees for their continued hard work. On a sequential basis, we were impacted by seasonality as we expected, but in addition, there were a couple of headwinds that are worth mentioning.
First, our average loan growth was modestly weaker than we expected, although spot loans grew by $1,200,000,000 Within CNIB's real estate business, multifamily agency warehouse lending declined in the 1st quarter as these balances tend to fluctuate pretty broadly. Aside from that, pricing and structure in the commercial real estate space have become more aggressive, resulting in lower Outside of CRE, the underlying trends in our loan portfolios are largely positive, and Rob's going to take you through those in more detail in a moment. Secondly, the movement in rates impacted us this quarter. Clearly, we benefited from higher loan yields as a result of the increase in Fed funds and 1 month LIBOR. But on the other hand, our funding costs rose this quarter due to higher deposit pricing as betas continue to move higher.
And additionally, the sharp rise in 3 month LIBOR relative to 1 month LIBOR caused our cost of borrowed funds to increase more than we expected. That said, we continue to execute well against our strategic priorities, and we're excited about our plans to tap new opportunities as the year unfolds. You're all aware of the steps we've taken over the last 2 years to expand our middle market franchise to Dallas, Kansas City and Minneapolis in 2017 and Denver, Houston and Nashville this year. Now that work is going very well as our new regional presidents and our teams there have hit those in those markets have hit the ground running. In addition, we've built an industry leading technology platform and we're beginning to leverage its capabilities to innovate and enhance the ease with which our customers do business with us.
And we're looking forward to beginning the rollout of our new national retail digital strategy later in the year, which will help us take advantage of our brand awareness and begin serving more customers, more consumer customers beyond our traditional retail banking footprint. In fact, we're in the middle of our strategic planning season, and I can't actually recall a time when we've had as many attractive organic investment opportunities as we do right now. With that, I'm going to turn it over to Rob for a closer look at our Q1 results and then we'll take your questions.
Rob? Yes. Thanks, Bill, and good morning, everyone. As Bill just mentioned, our Q1 net income was $1,200,000,000 or $2.43 per diluted common share. Net interest margin expanded, capital return remained strong, expenses were well managed and of course our results benefited from a lower tax rate.
Our balance sheet is on Slide 4 and is presented on an average basis. Total loans were essentially flat linked quarter. However, our spot loans grew by $1,200,000,000 since year end. Compared to the same quarter a year ago, both spot and average loans grew by $8,800,000,000 or 4%, and I'll discuss the drivers of this growth in a few moments. Investment securities $74,600,000,000 increased approximately $400,000,000 or 1% linked quarter as purchases exceeded portfolio runoff.
Purchases were primarily made up of U. S. Treasuries and agency RMBS. In addition, dollars 600,000,000 of money market mutual fund securities were reclassified to equity investments due to an accounting standard adoption. Excluding this reclassification, investment securities increased about $1,000,000,000 compared to the 4th quarter.
Our balances at the Federal Reserve were $25,400,000,000 for the 1st quarter, essentially flat linked quarter and up $1,700,000,000 year over year. On the liability side, total deposits declined by approximately $800,000,000 compared to the 4th quarter, reflecting seasonal activity primarily on the commercial side. Year over year deposits increased by $5,700,000,000 or 2%. Average common shareholders' equity increased by approximately $300,000,000 linked quarter. During the quarter, we returned $1,100,000,000 of capital to shareholders or 96 percent of 1st quarter net income through repurchases of 4,800,000 common shares for $747,000,000 and dividends of $362,000,000 As of March 31, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.6%, down 20 basis points compared to December 31, 2017.
This was primarily due to a decline in accumulated other comprehensive income as a result of the impact of higher interest rates on available for sale securities. Our return on average assets for the Q1 was 1.34%. Our return on average common equity was 11.04%. And our tangible book value was $71.58 per common share as of March 31, which declined slightly on a linked quarter basis, reflecting the impact of AOCI, but was up 6% compared to the same date a year ago. Turning to Slide 5.
As I just mentioned, total average loans of $221,000,000,000 were essentially flat linked quarter. However, the flattening effect, if you will, was largely due to a $1,500,000,000 decline in average agency warehouse lending balances, which Bill mentioned tend to fluctuate. Importantly, spot loans increased by $1,200,000,000 or 1% linked quarter and both spot and average loans increased $8,800,000,000 or 4 percent year over year. As I mentioned, the commercial loan decline in the quarter was a result of the 4th quarter warehouse lending activity as well as slightly lower commercial real estate balances. Offsetting this decline was broad based growth in virtually all our other commercial lending segments, including Corporate Banking, which was up 1% linked quarter and 7% year over year Business Credit, which was up 1% linked quarter and 13% year over year and equipment finance, which was up 2% linked quarter and 14% year over year.
Commercial loans grew by $8,400,000,000 or 6% compared to the same period a year ago. Consumer lending increased by $242,000,000 linked quarter $402,000,000 year over year, driven by increases in residential mortgage, auto and credit card loans, which were partially offset by declines in home equity and education lending. Turning to Slide 6. As expected, total deposits were down compared to the 4th quarter, primarily due to seasonal commercial outflows, somewhat offset by higher consumer deposits. Compared to the same period a year ago, deposits increased by $5,700,000,000 or 2%, reflecting growth in both consumer and commercial deposits.
Total interest bearing deposits increased $6,600,000,000 or 4% year over year, non interest bearing deposits declined approximately $850,000,000 during the same period, which reflected a shift in our deposit mix as a result of the rising rate environment. In addition, deposit betas continue to move upward in the Q1. Our cumulative beta, which is the beta on our total interest bearing deposits since December 20 15, was 21%, and our current beta since December 2017 was 32%, compared to our stated long term expectation of 46%. In simple terms, our cumulative commercial beta is already approaching stated levels. And while our consumer betas have lagged, we do expect them to accelerate in the Q2 and throughout the balance of the year.
As I've already mentioned and you can see on Slide 7, net income in the Q1 was $1,200,000,000 Net interest income increased $16,000,000 or 1% linked quarter as higher loan yields were partially offset by higher funding costs and the impact of 2 fewer days in the quarter. Compared to the Q4, non interest income declined $165,000,000 or 9%, reflecting seasonally lower fee income and the impact of significant items on our 4th quarter results. Non interest expense decreased by $534,000,000 or 17% compared to the Q4, also reflecting the impact of significant items last quarter. Expenses continue to be well managed due in part to our continuous improvement program. Provision for credit losses in the Q1 was $92,000,000 a decrease of $33,000,000 linked quarter as overall credit quality remained stable.
Our effective tax rate in the Q1 was 17%, reflecting the impact of federal tax legislation. For the full year 2018, we continue to expect the effective tax rate to be approximately 17%. Now let's discuss the key drivers of this performance in more detail. Turning to Slide 8. Net interest income increased by $16,000,000 or 1% linked quarter as higher loan yields were partially offset by higher deposit and borrowing costs as well as 2 fewer days in the quarter.
The day count impact was approximately $42,000,000 As you'll recall, 4th quarter net interest income was negatively affected by $26,000,000 due to the impact of tax legislation related to leverage leases. Compared to the same quarter a year ago, net interest income increased by $201,000,000 or 9%, driven by higher loan and securities yields and higher loan balances. Net interest margin was 2.91 percent, an increase of 3 basis points compared to the 4th quarter as higher loan yields were partially offset by higher funding costs as a result of the sharp increase in 3 months LIBOR as well as the widening spread between 1 month LIBOR and 3 month LIBOR during the Q1. While a large portion of our loans are tied to 1 month LIBOR, essentially all of our borrowed funds are tied to 3 month LIBOR. 1st quarter non interest income was down $165,000,000 or 9% linked quarter, reflecting seasonally lower trends as well as the impact of significant items in the Q4.
Compared to the same quarter a year ago, non interest income increased $26,000,000 or 2%. This reflected 6% growth in fee income, which was partially offset by lower other noninterest income. Slide 9 provides more detail on our non interest income. Looking at the various categories, asset management fees, which includes earnings from our equity investments in BlackRock were down $265,000,000 on a linked quarter basis, largely due to the flow through impact of tax legislation benefits on BlackRock's earnings in the Q4 of 2017. Compared to the same quarter last year, asset management fees increased by $52,000,000 or 13%, reflecting higher equity markets and a 5% increase in P and C's assets under management.
Additionally, our earnings from BlackRock benefited from a lower tax rate. Consumer services fees were down $9,000,000 or 2% compared to 4th quarter results, reflecting seasonally lower client activity. Compared to the same quarter a year ago, consumer services fees increased $25,000,000 or 8% and included growth in credit card, brokerage and debit card fees. Corporate service fees decreased by $29,000,000 or 6% compared to strong 4th quarter results, driven by seasonally lower M and A advisory fees and loan syndication fees. Compared to the same quarter a year ago, corporate services fees increased $15,000,000 or 4%, reflecting higher treasury management fees and operating lease income.
As we previously disclosed in our 10 ks, operating lease income is now reported in corporate services fees rather than other income and prior periods have been reclassified. Residential mortgage non interest income increased $68,000,000 linked quarter, reflecting a negative $71,000,000 related to updated MSR fair value assumptions in the 4th quarter. Residential mortgage income declined on a year over year basis, primarily driven by lower loan sales revenue, which reflected lower refinancing volumes. Service charges on deposits decreased by $16,000,000 or 9 percent compared to the Q4, driven by seasonally lower customer activity. On a year over year basis, however, service charges on deposits increased $6,000,000 or 4%, reflecting client growth.
Finally, other non interest income increased $86,000,000 compared to the 4th quarter, which included a negative $129,000,000 net impact of significant items. Excluding these items, other non interest income declined $43,000,000 linked quarter, primarily due to lower net gains on commercial mortgage loans held for sale. Compared to the same period a year ago, other non interest income declined $56,000,000 reflecting lower revenue from equity investments, including the impact of a Q1 2017 benefit from valuation adjustments related to the Volcker rule. Going forward and considering the reclassification of operating lease income into corporate services fees, we now expect the quarterly run rate for other non interest income to be in the range of $225,000,000 to $275,000,000 excluding net securities and Visa activity. Turning to Slide 10.
1st quarter expenses decreased by 534 17%, reflecting the impact of approximately $500,000,000 of significant items in the 4th quarter. These consisted of a contribution to the P and C Foundation, real estate disposition and exit charges and employee cash payments and pension account credits. Excluding the impact of these items, 1st quarter expenses declined $32,000,000 or 1%, reflecting seasonally lower expenses and our continued focus on cost management. We previously announced the goal to reduce costs by $250,000,000 in 2018 as part of our continuous improvement program and based on Q1 results, we are on track and confident we will achieve our full year target. Turning to Slide 11.
Overall credit quality remained stable in the Q1. Compared to the prior quarter, total non performing loans were down $23,000,000 continue to represent less than 1% of our total loans. Total delinquencies were down $131,000,000 or 9% linked quarter from elevated levels at year end that reflected seasonality and the residual impact of the 2017 hurricanes. Provision for credit losses of $92,000,000 decreased by $33,000,000 linked quarter, reflecting a lower provision for consumer loans, partially offset by a higher provision for commercial loans. The decline in consumer provision was driven by favorable historical performance on home equity loans, while the higher commercial provision reflects the impact of 4th quarter reserve releases.
These results take into account the outcome of the recently completed shared credit examination. Net charge offs decreased $10,000,000 to $113,000,000 in the Q1, primarily due to lower commercial net charge offs. In the Q1, the annualized net charge off ratio was 21 basis points, down 1 basis point linked quarter. In summary, P and C posted strong first quarter results. For the remainder of the year, we expect continued steady growth in GDP and a corresponding increase in short term interest rates 2 more times this year in June December, with each increase being 25 basis points.
Based on these assumptions, our full year 2018 guidance compared to 2017 adjusted full year results remains unchanged and positions us to deliver positive operating leverage in 2018. Looking ahead to the Q2 of 2018 compared to the Q1 of 2018 reported results, we expect modest loan growth, we expect total net interest income to be up low single digits, We expect fee income to be up mid single digits. We expect other 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.
Thank you, sir. Our first question comes from the line of John Pancari from Evercore ISI Research. You may proceed with your question.
Good morning.
Hey, John. Just wanted to see
if you could talk a little bit more about the increase in the cost on the borrowed funds. I know you indicated that the increase was more than you had expected. Can you just talk about how that exceeded your expectations? And also, I mean, just since its majority is tied to 3 month LIBOR, I assume you would have had pretty good visibility into that. So if you could talk about how that exceeded?
And then what are your plans there? Is there a plan to remix it? Or are you focusing more on the deposit side to help offset that? How do you address that going forward? Thanks.
It's a good question. Basically what happened is that the spread between 1 month and 3 month LIBOR gapped out, particularly in March, wider than it's historically run. I guess it's at 35, 34 basis points today. And historically, it might have been half of that. So all else equal, in our forecast of NII, we wouldn't assume that you'd see that gap.
An issue is today it is as wide as any time it's been in history other than the financial crisis. And a lot of people are writing that that basis will collapse back in. We'll have to wait and see. I think there's some pressures causing that as a function of the revamp of the money market industry coupled with some implications from this BEAT tax provision that is in the new federal tax code. So we're going to have to wait and see.
If it doesn't change, we can and we'll probably do this anyway. We can start swapping our wholesale funding, our bank notes into 1 month just to get the basis mismatch between our loans and funding closer. But that price will be embedded in that swap. So we'll have to see wait and see what happens.
Okay. All
right. Thanks,
Patrick. Hey, John. I can jump in there. So some of the increase in 3 months LIBOR is fundamental to rates rising. The issue is just the gap and that gap, as Bill mentioned, was about 35 basis points and we equate that to about $15,000,000 or $20,000,000 in costs in the quarter.
Got it. Okay. All right. And then my follow-up is around loan growth. I know you did not change your full year outlook around loan growth.
The average balances were somewhat flattish this quarter. You did see good growth in the end of period. So first of all, I'm assuming the end of period trends are likely more indicative of your expectations given you're not changing your full year outlook. And then separately, can you talk about the broader macro backdrop? I mean, we've seen weak industry loan growth, that's for sure, for the sector, but the macro signs still point to improvement, particularly given tax reforms.
So if you
could just talk about that a little bit? Yes. I think our own performance kind of mirrors what you've seen in the data where you saw a decent pickup in March and we're seeing that in our pipeline. So I don't know what the anomaly was in Jan Fab other than all the busy work everybody did prior to the tax getting enacted. So all else equal, I would kind of say that March is the norm and Jan, Feb were the anomalies and that should set us up well for the rest of the year.
The one exception to that, and I mentioned this was in real estate where we've just seen pricing and structure get to a place where it's kind of beyond our risk tolerance and versus our historical growth in that sector, we're most certain to be slower.
Our next question comes from John McDonald with Bernstein.
In terms of the retail deposit beta is changing, we're trying to get a sense of the pacing. The disclosures you guys give on Page 6 are really helpful. So if we look at the 17% current deposit beta this quarter, it's up from the cumulative 8% since rates started rising. Rob, any kind of broad sense of where that might have stood last quarter? And is this something where we could get to the stated beta in a couple of quarters or this could take a while to get there?
Any thoughts there?
Yes. So good question. In terms of the betas, particularly on the consumer side where they've lagged, we're keeping an eye on that. Relative to last quarter, they have accelerated. So that's true.
And then going into the second quarter, we do expect it to accelerate on top of that. How much remains to be seen because a lot of that's competitive pressures, but our best estimates are built into our NII guidance.
And when what factors can you just remind us what factors you're looking at when you make these decisions? You're looking at competition Anthony. How about just the last thing, any color on more color on the deposit mix shift you're seeing, just more consumer versus commercial within the deposit mix, you're seeing folks move from checking to time and savings, but within P and C?
Yes. Now the shift this quarter on commercial is more of a seasonal effect that commercial deposits is sort of running down. We would actually expect them to come back. As you know, they don't help us particularly with LCR. So it's not quite as important as to what versus what we do on the consumer side.
And in terms of the behavior that you're seeing on the consumer side, any more color there?
Pretty consistent, John, with what we've been seeing in terms of more to the savings and the relationship driven deposits, which we've been pursuing for the better part of the last year. So that trend continues.
I guess I was just asking, is that accelerated kind of like the deposit pricing? Is that also gotten faster this quarter?
Yes, a little bit. Yes, a little
bit. Okay. Yes.
Okay. Thanks.
Sure.
Our next question comes from Erika Najarian from Bank of America Merrill Lynch. You may proceed with your question.
Yes. Thank you. Good morning.
Good morning, everyone.
Yes. My first question is on the Fed proposal for CET1 specifically for the stress capital buffer. I think the market was reading it as largely positive for banks like P&C in that you now have a pretty set floor in terms of where your capital minimums would be. And I'm wondering if the stress capital buffer did get finalized as it stands, how that would change how you're thinking about buybacks and dividends from here? And also how you're accounting for the volatility now in your business as usual CET1 levels given of course your CCAR results now feed into it?
Okay. Well, I don't this is Rob. Why don't I take a shot at some of that?
I'm not sure I understood the last part of
the question. I'll just sort of I mean it broaden that out a little bit in terms of the Fed's proposals in terms of the changes to CCAR, which in broad measure are encouraging. We just got a Tuesday, as you know, so we're still reviewing it. But a couple of things right off the top that are helpful, obviously, are the elimination of the soft cap on dividends at the 30%, the reduction of base case capital actions in the severe scenario with the exception of a year's worth of dividends, the RWA growth in the severe scenario and then also that elimination of the quantitative sale. So all those things I think worked well and are encouraging.
The stress capital buffer itself, we have to review. If you take a look at our 2016 and 2017 CCAR submissions, we were below that. It remains to be seen how the Fed stresses us in this go round, we'll see. But there is an issue there around what we call guardrails around the scenarios because the severe scenarios in any given year are going to define that stress capital buffer, which in the past has been below 2.5%, but theoretically could be higher.
To clarify that last question, sorry to be confusing, but given that volatility in results, the question there had been, does it how should you or how should your investors think about potential buffers that you would incorporate to account for that volatility of result?
Yes, that's kind of the $1,000,000 question. So internally, this you've heard us talk about this before. We always work towards the endpoint on a severe stress as opposed to the starting point of what our capital is and we've talked historically about a target capital state in CET1 of 8.25% to 8.5%. That number being driven historically by our own estimate of what a severe stress would look like. An issue for us is, as we approach that number, if the Fed goes from a relatively benign severe stress, perhaps as they did last year versus a much more severe stress, perhaps as they did this year, you have to change your buffer on the fly, which causes you to then have volatility, as you point out, in your repurchases year on year.
And I don't know how that plays out through time as a function of what scenarios they come up with, but it's one of the things that we need to solve for as we work through the next year.
And just one more follow-up question. You mentioned that your organic investment opportunities have never been so attractive. And I'm thinking, could you share with us what your earn back period is for buyback activity at current valuation levels?
Sorry, our earn back. I mean, I would tell you that we look at it sort of multiple ways, but on an IRF basis, we're today probably fairly tight. We look at that. We look at where we are priced to book. We look at what we think our forward earnings potential is, which potentially offset those other two issues.
I don't know that I've actually talked about an earn back period internally.
But to your point, the investment opportunities that we take a look at clearly beat that. Yes.
Thank you.
Our next question comes from Ken Usdin with Jefferies. You may proceed with your question.
Hey, guys. How are you doing? Thanks very much. I want to ask just a question on expenses. And I know there's a couple of things you bought that little IR firm and couple other moving parts.
I'm noticing just that the personnel costs are up 8% year over year. And can you just help us understand just is that recent hires? Is it are you starting to spend some of the tax benefits? Just how we understand kind of the balance of the growth versus the CIP, especially as it relates to personnel costs? Thanks.
Yes, sure, Ken. So just in terms of expenses in the Q1 linked quarter, expenses were down low single digits, which was part of our First and most prominently, Q1 2018 expenses reflect the expenses associated with the acquisitions that you pointed out that subsequent to the Q1, most notably the leasing company, which we acquired in the Q2 of 2017. And those expenses, which are about $27,000,000 are spread out between personnel and equipment expense. Personnel because of the higher headcount and equipment expense because of the depreciation nature of the leasing business. So that's one.
In addition, on the personnel side, we do have some increases around investments that we've made. The hourly wage increase for our retail employees that we announced at the end of the year is there as well as some of the investments we've made in the new markets as you would expect. So personnel is a little bit higher, but year over year occupancy is down, marketing is flat and all other expenses, which are a lot of categories and where a lot of our CIP program is directed is in line. So we feel good about what we set out to do. And that's why, like I said, on the continuous improvement program, we have high confidence that we'll achieve it.
Okay, got it. And just one quick follow-up on the I understand that you moved the operating lease up into the corporate services. So can you now with that in there, can you just help us understand from a corporate services perspective within your fee outlook for the Q2, remind us of the seasonality and what drivers you would expect to flow from that?
Yes, sure. I can broaden that out for you in terms of our guidance for all the fee categories, not just corporate services, But it's fairly easy in terms of guidance, up mid single digits in the whole. And for the first time in a while, for each of the 5 categories, asset management, consumer, corporate services, mortgages and service charges on deposits, all up mid single digits. So mid single digits overall, mid single digits in each of the categories, including corporate services.
Okay, got it. Thanks for that, Rob.
Sure.
Our next question comes from Betsy Graseck with Morgan Stanley. You may proceed with your question.
Betsy, are you there?
Hey, yes. Hey, good morning. Talking on mute. Sorry about that. Question, just to follow-up on the expense discussion we just had.
I wanted to understand if in 1Q any of the continuous improvement is in the quarter? Or is this something that you expect is going to be ramping over 2018?
It's both. No, there's some as I mentioned, there's some in the Q1 largely directed at the all other expense line, but there's more to go.
Okay. And so you've got a run rate that you expect would be building throughout 2018. And would it be primarily focused on like the real estate as opposed to people? I'm just trying to sure I understand where the improvements are coming from. Correct.
Yes. I would say, not so I would say, again, just to back up, our objective is positive operating leverage. Our guidance is for expenses to be up low single digits for the year. Part of that is the implementation of the continuous improvement program savings that really are all over the bank. Each area has a targeted level that we review regularly to be able to achieve those.
So even in areas where we're investing, retail, for example, there's substantial continuous improvement savings there as well. So it's broad based.
Okay. And then separately, just I wanted to drill a little bit down on C and I and I know that you went through the various categories and where you're seeing the loan growth. It does feel like it's decelerating a little bit. I mean year on year is clearly stronger than what the LQA would be. But the question is, are you able to deliver the level of growth you've been generating, which looks like it's not only solid, good, but maybe a little above peers due to the new markets you're going into?
Or is there any sign of increased interest in current borrowers actually increasing their leverage and borrowing more? Do you see more of the share gain or clients are increasing their activity levels that you already have?
Well, we've seen you saw in March, I think C and I hit record levels actually. So there is increasing stock in effect of C and I loans out there. But inside of that, we continue both through differentiated product and then through in effect the new markets and kind of harvesting some of the new markets that we've been in. We've been able to sort of outpace peers and would expect that to continue with the one exception I mentioned of real estate. I don't know what peers are going to do, but that market is increasingly tight.
We wouldn't expect to see the growth rates we had in the past.
Okay.
And But we're still guiding to mid single digit loan growth for the year. So that's all part of it.
So a little bit of a pickup though from what you've had this quarter in terms of
run rate? Yes. Although, it's interesting, when you dig through all the noise this quarter, they actually had a pretty decent quarter in C and I. We had a big drawdown on mortgage warehousing, as I said, and still managed to grow
spot. Yes. And Ethan, like I said on the segments and I mentioned in my comments, corporate banking, up 1%, Business Credit up 1%, Equipment Finance up 2%, pretty strong.
Our next question comes from Kevin Barker with Piper Jaffray. You may proceed with your question.
Thank you. In regards to the loan growth, just a follow-up there. Does the retail digital strategy and the rollout of that have a big impact on your expected loan growth in the back half of this year?
No, no. It's the retail strategy will progress, but it will start as a deposit gathering exercise. But what we think will be attractive returns for us because we go into brick and mortar cost and we'll have an ability to pay somewhat above where we pay in existing markets. We will augment that offering with loan offerings in all of our products through time, but you should expect that it will start out as deposit and then sort of migrate over time.
So no in 2018 really. Yes. Okay.
And then given we've had tax reform, lower taxes for a few months now, have you seen any behavioral changes as far as competition amongst your peers, in order given that they're seeing better ROEs due to lower taxes?
Yes, anecdotally. So deal on deal and certain behaviors would suggest that people are willing to cut price as a function of the after tax ROE and the competition for sort of plain vanilla C and I loans was tough in the Q1 in terms of price. So I think that is starting to show its end, Much less so in any of that specialty.
Much less in the specialty and also not long enough to be able to assess that. Like Bill said, it's really anecdotal and the deals that we saw in the 1st 90 days of the quarter.
Yes. So is it primarily on C and I lending or any particular industries that you're seeing that competition pick up or is it broadly on several different loan categories?
It's interesting. It's on the most generic, one bank can hold the whole deal C and I loan, which is kind of the craziest place, in my view, to start competing away price because you still have the risk associated with the loan in your actual we had this discussion a quarter ago, your loss distribution on an after tax basis causes you to actually have to hold more capital against this thing. Right. So it kind of surprises me. I would have expected to see more competition on deposit pricing and on fee based services, in terms of giving some of the excess margin back and I don't think we've seen that at all.
How much of it do you think is due to pretty low loan growth and just the amount of capital versus taxes?
It's some amount of that. And I think it's also we have whatever the number is 5,500 depository institutions in this country, many of which don't have much to offer beyond loans. So that's the product they compete with. And as you go downsize in loans or somebody can hold the entire loan, you run into that group. It's less it's not happening on the big syndicated loans, It's not happening on asset based or anything that takes where there's only really a handful of credible players.
Our next question comes from Gerald Cassidy with RBC. You may proceed with your question.
Good morning, guys.
Hey, Gerard. Troy.
I apologize if I had to jump off for a minute if you answered this question already. But Bill, you started your presentation off with the comment about you've not seen as many good organic investment opportunities as you're seeing today. You've already talked about the national consumer. What are some of the other organic investment opportunities that you guys are looking at that gives you that kind of positive tone to it?
Yes. So the success we've had in newer markets, obviously brings up the desire to do more. The list we have on digital things that we want to roll out in consumer, but also importantly in C and I and the TM space is quite large. So there's a lot of asks on the table of things that make a lot of business sense and I think differentiate us longer term. Some of it's product based, some of it's market expansion based.
Some of it is investment in effect consumer service, the speed at which we can do fulfillment, and the ease at which we can serve consumers, which would offer a differentiated product to our customers. So there's a lot. And you've heard me talk about this before. We didn't feel like we starved our firm for investment through the low rate environment. We invested pretty heavily, which was a good thing.
And we're at a place now where that has sort of accelerated is I guess what I'm seeing in the strategic planning session this season. Yes.
And I would Gerard, I just would extend on that in the sense that much of it is possible because of the technology investments we've made over the last couple of years. So things that were interesting before, we just didn't have the technology to be able to facilitate, we do now.
Yes. And part of that is we're now spending an ever increasing percentage of our tech budget on consumer facing applications as opposed to building and running the core.
In fact, following up on that, how critical is having that capability? Obviously, your big competitors have it, but maybe some of the smaller banks you run into in different markets don't have as good of a product that you guys have. So when you guys look at that, if you have had it on a scale of 1 to 10, 10 being most critical, 1 not being critical at all, How important is it for you guys to have that ability to generate this kind of business through this digital channel?
I think in the future state of the world, I think it's a 10. I mean, good day. Okay. Okay. Yes.
No, good. Things have to be simple. They have to be fast. They have to be coordinated. Customer information needs to be consolidated.
It needs to be in place. All of that stuff you can't really execute unless you have a core backbone kind of that allows you
to do it. And the client's expectations continue to accelerate.
Absolutely. And then just finally, as you guys know, there's been changes coming out of Washington on regulations regarding capital and in the CCAR stress test, etcetera. There seems to be news coming out that the dividend payout ratio is not going to be limited anymore or you won't get enhanced regulatory review if you go over 30%. What is the Board thinking and you guys think in terms about if we look out a couple of years, do you see a dividend payout ratio coming in north of 40% or 40%?
Yes.
Okay. Good. Thank you.
Our next question comes from Matt O'Connor with Deutsche Bank. You may proceed with your question.
This is Rob from Matt's
team. Just on commercial loan yields, they're up nicely this quarter. I was just curious how the current kind of new money yields compare, just given the March rate hike, but also your commentary about kind of higher competition in commercial lending right now?
Do you have the new spreads up? I mean, the actual spread on loans didn't move a lot. The decline
on the yields, I mean, yes, so. No, I was just wondering. Spreads have held up.
Yes. New deal spreads aren't they're kind of spot on where they were. So we haven't seen
a lot of a change. That's right.
Okay. And then similar question on securities yields, they were down a few basis points in 1Q. Just curious if you could speak to that and where reinvestment rates are currently?
Yes. They're actually up a little bit when you take into consideration in the Q4 and there was a lot going on in the Q4. But in the securities book, we did have an accounting change that in effect decreased the yields in the RMBS, the non agency RMBS and increased the yields in the CMBS because maybe more than you want to know, we changed the accounting standard to the contractual life of the security prior we used the estimated life. So that moved yields around a little bit and actually elevated them. So yields after adjusting for that for the Q4.
Yes, for the Q4 and then went back to normal this quarter. So our print is down $2.82 to $2.79 but when you adjust for it, it might be marginally up
smaller dollars. Yes. The other thing I would
say too, our purchases in the securities portfolio in the Q1 were largely treasuries, which carry a little bit of a lower yield, but I'll just add that in.
Our next question comes from Brian Klock with Keefe, Bruyette and Woods. You may proceed with your question.
Good morning, guys.
Hey, Brian.
Hey, Brian.
So, Rob, I want to follow-up on the expense side. On the personnel expenses, can you remind us how much of the Q1 has the seasonal bump that you get from FICO and FUTA, the incentive compensation and maybe how much of that's in the Q1 versus the Q2?
That's in the Q1 for sure in terms of merit and promotion. So that's definitely there, which tends to be a little bit more Q1 loaded. The bigger issue just is on the year over year and I don't know if you were on the call earlier is the acquisition expenses from the leasing business as well as the investments that we've made.
Right. So I guess in the for the Q2 then the guidance to have the low single digit growth from the Q1. So is that the same expectation for personnel? And I guess personnel is somewhat impacted by the recent acquisition.
Yes, I would say most of the increase in expenses as part of our guidance reflects the higher business activity that we expect in the Q2, particularly on the fee side.
So there's really the mid single digit growth you're expecting in fees and this is just going to be a comp to revenue ratio should be constant, but it's just going to go up with that?
Yes, I haven't done that, Matt, but that's generally right.
Okay. All right. Thanks for that. And just a follow-up question, I think on the loan growth side, I know earlier you said, the mortgage warehouse business, I know on average was down quarter over quarter. When I look at Table 6 on the spot basis, that financial services line was up $1,500,000,000 Can you tell us what the balances were in each quarter for that warehouse business?
Oh,
geez, I don't have the balances. The balances quarter over quarter are down a lot for the warehouse, but that line is up because that a lot of our securitizations, which had a strong quarter in the Q1. So those aren't necessarily 2 financial services companies, but because of the structure of the facility is categorized that way.
Okay. And so on a spot basis, the warehouse business was down, not just on average, it was down on spot also?
Yes, that's right. So well, I don't know that. I know in terms of the warehouse facility, the elevation was in the Q4, which actually paid down in the Q4, but the average start to average that. I can get you the number where we are, but it's on the low side because typically in the Q1.
I can
get you that offline, Brian.
Okay, Brian. Okay. And so we would think that securitization activity would probably normalize in the second quarter. So maybe that could offset a little bit of the core growth you guys are seeing in the growth rate?
It ought to eventually normalize. They actually have a pretty good pipeline though.
That's right.
Yes, that's right.
Okay. All right. Thanks. Appreciate your time, guys.
Yes, sure.
Our next question comes from Mike Mayo with Wells Fargo Securities. You may proceed with your question.
Hi. My question is on the new market strategy in commercial. So after Denver, Houston and Nashville, this year, what cities might be next and how many total cities might you expand to?
Well, without naming cities, maybe I'd just let you could name them yourselves. In fact, we look for cities that we are not in that have target corporate population that kind of matches off against our product suite and expertise. And when we started this exercise, we were in less than half, I think, of the large markets that have C and I opportunities. Yes, that's right. Through time, we would hit most of them.
I don't know what time means, but we've had success and we'll keep rolling out as opportunity presents itself.
And I'm sure you can see success. If you look at Dallas and Kansas City and Minneapolis, you said you've seen success in the new markets. But we on the outside, we can't see that in the aggregated results, right? Because the new investing in Denver, Houston, Asheville is going to be offsetting. So I guess just generically, what is the time that you invest you go from investing to harvesting in a new city?
And in aggregate for the total new market strategy, what's the total time for going from investing to harvesting?
Well, I mean, let's look at the Southeast, I guess, is maybe the best example. So when we bought the RBC branches, that's in effect what we did, although we had a branch network there. And we grew balances, we met customers, but it's probably 3 years before we really saw the acceleration in volume pickup and importantly cross sell with fee based products. In the newer markets that we've just entered, it's they don't cost that much money. We get to breakeven pretty quickly, a couple of big deals in your breakeven a year.
But before they really start to contribute sort of on a return on capital basis, you're probably looking at that 3 year.
Which is the corporate banking sales cycle, basically. And Mike, if
we get this just to continue, if we get this right, of course, that those investment dollars sort of are continuous. So in effect, we'll be harvesting new markets as we start other ones. So it won't be a net drain. All else equal, we have a small net drain right now because we've done 6 in 2 years.
No, I get it.
In broader measure though, we're very encouraged in terms of the receptivity to our products, our services, our client interaction, the energy is high.
One more follow-up. No, I get it. Look, your expenses are up a little more than $100,000,000 year over year. If you buy a bank, you're spending $10,000,000,000 or spending 100 times more, you spend $100,000,000 you get tons of questions. I get it.
But what is your sales pitch as you go in the new market? Because as you said, a lot of these smaller banks that are causing the Plameenella C and I loan competition, that's all they have is our loans. So I guess you have a very good sales pitch against them. But what's your sales pitch against some of the very large banks that have more scale and a broader product suite? And so who are you competing against these new markets?
So it's we compete against JPMorgan and Wells Fargo and BofA in every market we're in.
That's nothing new.
Yes, it's nothing new. And we go with our A team in the middle market and small or large corporate with a very credible, capable TM service leading against in all the surveys. We go with a capital markets business that is relevant to that type of client. We're not in the equity business, but we're not trying to do equity deals for the Fortune 100. And it works for us.
We win or tie on a lot of these things in all the markets we're already in. We go into a new market and we do the same thing.
All right. Thank you.
We have no further phone questions at this time.
Okay. Well, thank you all for joining us on the call this quarter.
Thanks, everybody. Thank you.
This concludes today's conference call. You may now disconnect your lines.