Welcome to U. S. Bancorp's First Quarter 2018 Earnings Conference Call. Following a review of the results by Andy Cecere, Chairman, President and Chief Executive Officer and Terry Dolan, U. S.
Bancorp's Vice Chairman and Chief Financial Officer. There will be a formal question and answer session. This call will be recorded and available for replay beginning today at approximately noon Eastern Daylight Time through Wednesday, April 25 at 12 midnight Eastern Daylight Time. I will now turn the conference call over to Jen Thompson, Director of Investor Relations for U. S.
Bancorp.
Thank you, James, and good morning to everyone who has joined our call. Andy Cecere, Terry Dolan and Bill Parker are here with me today to review U. S. Bancorp's Q1 results and to answer your questions. Andy and Terry will be referencing a slide presentation during their prepared remarks.
A copy of the slide presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I would like to remind you that any forward looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward looking assumptions are described on page 2 of today's presentation, in our press release and in our Form 10 ks and subsequent reports on file with the SEC. I will now turn
the call over to Andy.
Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will be opening the call open up the call for questions. I'll start on slide 3. In the Q1, we reported earnings per share of $0.96 which compares with $0.82 reported in the Q1 of 2017. During the quarter, a lower than expected tax rate offset by a transitional change in investing provisions within our stock based compensation program increased earnings per share by $0.01 On a year over year basis, 1st quarter net revenue increased by 3.4 percent to $5,500,000,000 Excluding the impact of tax reform on our net interest income, revenue growth would have been 3.9%.
Loan growth is seasonally lowest in the Q1 of every year. Paydowns have been a headwind in recent quarters due to capital markets activities by customers and our disciplined underwriting in commercial real estate at this stage of the business cycle. In addition, in the Q1 loan demand has been lower across the industry. These factors offset solid growth in our retail loan portfolios and underlying strength in new business and market share gains in our commercial portfolios. We believe the early part of this year will prove to be a transition period.
Tax reform impacted not only loan growth this quarter, but also commercial products revenue as it influenced the timing and level of corporate bond issuance and deal funding. Combined with strong growth in pipelines, conversations with our customers gives us confidence that commercial loan trends will improve as we move further into the year. Although the timing of more robust growth tied to a resurgence in CapEx investment remains uncertain. In the meantime, we are focused on gaining market share across our lending and fee products. This quarter, we saw improved sales volume growth in merchant processing, higher sales growth in credit card and commercial payment services and strong growth in new customer accounts and client balances in our Wealth Management and Investment Services businesses.
We expect this momentum to continue into the year. On the right slide of slide 3, you will see that the credit quality was stable in the Q1 and our book value per share increased by 5.9% from a year ago. During the quarter, we returned 68% of our earnings to shareholders through dividends and share buybacks. Slide 4 highlights our best in class performance metrics including a 14.9% return on average common equity, a 1.5% return on average assets and our tangible return on common equity was 19.3%. Our efficiency ratio rose modestly from a year ago to 55.9%, reflecting increased investment in spending on technology and innovation and certain transitional matters related to stock based compensation that Terry will address in a moment.
As we discussed previously, we are stepping up our business investment in digital first capabilities, revenue enhancing initiatives and business automation. We expect a 55.9 percent efficiency ratio to be the high for the year. Now let me turn the call over to Terry who will provide more detail on the quarter as well as forward looking guidance.
Thanks, Andy. If you turn to slide 5, I'll start with the balance sheet review and follow-up with a discussion of earnings trends. In the Q1, average loans grew 2.3% compared with the Q1 of 2017, but declined by 0.1% on a linked quarter basis. During the quarter, we reclassified $1,500,000,000 of student loans originated under the federal loan program to held for sale. As you know, we exited the student loan origination business in 2012 and the runoff portfolio is now strategically important to our future businesses.
The reclassification did not materially our average balance sheet for the quarter. However, it did affect ending loan balance growth. Turning to core trends. Average loan growth is slowest in the Q1 for each year, reflecting seasonality affecting credit card, auto lending and mortgage banking in particular. This quarter mortgage loans increased 0.9% sequentially, but were up 3.9% year over year.
Similarly, retail loans declined 0.2% sequentially, but increased 6.1% year over year. Retail and mortgage loan growth is seasonally stronger in the Q2 of each year and we feel good about core trends in auto lending and leasing where we continue to gain market share and credit card balances. Adding to the impact of seasonality on retail loan growth this quarter were a few factors. Commercial and commercial real estate portfolios continued to be impacted by elevated levels of paydowns. While average commercial loans increased 4.0% from a year ago, average balances declined to 0.1% sequentially.
Pipelines improved as the quarter developed and we continue to grow commitments. However, line utilization remains at historical lows and paydown activity was exacerbated this quarter by corporate clients flush with cash on the heels of tax reform and continuing to deleverage their balance sheet. Turning to commercial real estate. Average loans declined 6.5% year over year and 1.6% on a linked quarter basis. The risk reward dynamics in commercial real estate remain unfavorable in our view, particularly in multifamily and certain commercial mortgage lending.
That discipline is influencing decisions do not extend credit on unfavorable terms and adding to the elevated pay down pressures driven by customers accessing the secondary market. This quarter, commercial real estate contributed a 25 basis point drag to linked quarter average loan growth and a 160 basis point drag to year over year average loan growth. In the near term, we intend to remain disciplined in our commercial real estate lending. Turning to slide 6, average deposit net average total deposits increased 1.9% year over year, but declined 1.4% on a linked quarter basis. The linked quarter decline partly reflects typical Q1 seasonality that we see in Corporate and Commercial Banking and Wealth Management and Investment Services.
Within our Corporate Trust business, CLO issuances and deal closings tend to be seasonally lower in the first quarter impacting balances. In addition, investment managers deployed funds for loan and other asset purchases taking advantage of favorable debt market conditions in the early part of the Q1. Recently, our deal pipeline strengthened within the Corporate Trust business and ending deposits began to seasonally increase across the business lines. Slide 7 indicates that credit quality was relatively stable. Net charge offs as a percentage of average loans increased 3 basis points on a linked quarter basis and were down 1 basis point compared with the Q1 of 2017.
Nonperforming assets were essentially flat compared with the 4th quarter and down 19.5% from the Q1 of 2017. Slide 8 provides highlights of Q1 earnings results. Please note that during the Q1, the company adopted accounting standards related to revenue recognition and certain revenue and expense categories have been recast to reflect the change in accounting standard. The adoption had no material impact on operating income as you can see on slide 9. Slide 9 also shows how tax reform impacted Q1 net interest income and the related revenue growth rates.
In the first quarter, net revenue of $5,500,000,000 was down 2 0.3% compared with the 4th quarter and up 3.4% versus the Q1 of 2017. Adjusting for the impact of tax reform on our taxable equivalent net interest income, revenue increased 3.9% on a year over year basis. On slide 10, net interest income on a fully taxable equivalent basis was $3,200,000,000 in the first quarter, essentially flat compared with the 4th quarter and up 5.5% year over year, which was in line with our guidance. Linked quarter growth was impacted by 2 fewer days, while year over year growth was supported by growth in loans and higher loan yields. In the Q1, the net interest margin was 3.13%.
This is 2 basis points higher than 4th quarter net interest margin of 3.11%. Both periods include the impact of the reclassifications related to the revenue recognition standards. Excluding the impact of tax reform on tax exempt earning assets, the net interest margin increased by 4 basis points on a linked quarter basis. The increase was driven by higher yields on earning assets due to higher rates and a steeper yield curve, partly offset by higher funding costs. Our interest bearing deposit betas continue to perform in line with past experience and our expectation after the December rate hike.
We expect the total interest bearing deposit beta following the most recent rate hike will be about 40%. As future rate hikes occur, we continue to expect our deposit beta will gradually trend toward a 50% level. Slide 11 highlights trends in non interest income, which decreased by 4.1% on a linked quarter basis and increased 0.6% on a year over year basis. Linked quarter results are affected by seasonality within our credit and debit card, merchant processing and mortgage banking businesses. On a year over year basis, we saw growth in credit and debit card revenue and corporate payments revenue due to higher sales volume.
Merchant processing services revenue increased 2.5% supported by strong volume growth. Merchant processing revenue continues to be impacted by exiting 2 joint ventures in the Q2 of 2017. We continue to expect that merchant acquiring revenue will return to a more normalized mid single digit pace by the Q3 of 2018. Trust and investment management fees increased 8.2% year over year driven by business growth, net asset inflows and favorable market conditions. Strong growth in payments revenue, trust and investment management revenue and deposit service fees was partly offset by an 11.1% decrease in mortgage banking revenue, which was affected by lower refinancing activity and lower gain on sale margins and a 10.9% decrease in commercial product revenue.
Treasury management fees declined 2% reflecting the impact of changes in earnings credit, which is a trend typical in a rising rate environment. Client behavior related to tax reform was a headwind to our commercial products revenue this quarter. Meaningful deleveraging by clients flush with cash led to reduced corporate bond issuance and investment grade underwriting activity. There was also a significant reduction in municipal market activity due to a pull forward of issuance into the Q4 of 2017 related to tax reform. Corporate bond market conditions have improved in the early weeks of the Q2 and announced M and A activity continues to pick up.
Turning to slide 12. Non interest expense decreased 0.6% on a linked quarter basis excluding notable items included in the 4th quarter. On a year over year basis, expenses grew by 5.0 percent in line with our expectation for the quarter. Personnel expenses were the biggest driver of costs, while non personnel expenses declined 1.2% from a year ago. Compensation expense increased 9.5%, principally due to the impact of hiring to support business growth and compliance programs, merit increases, higher variable compensation related to business production and the impact of changes in vesting provisions related to stock based compensation programs.
This vesting change was related to changes in our compensation programs in response to shareholder feedback and to ensure competitive programs within the employment and Bicom market. The vesting change negatively impacted year over year expense growth by 100 and 30 basis points. Excluding this impact, total non interest expense would have increased by 3.7% and compensation expense would have increased 6.9% from a year ago. Notably, within non personnel expenses, professional service expense declined 13.5% from a year ago, primarily due to fewer consulting services as compliance programs near maturity. As we discussed previously, we had an inflection point in the growth rate of costs related to the build out of programs related to our consent order in the second half of twenty eighteen.
Compliance related costs will continue to moderate through the year. We have started to deploy increased investment dollars towards digital capabilities and innovation projects, multicultural initiatives and brand. The impact of these investments will occur over the next several quarters and the magnitude will depend upon the timing of our investment opportunities. Including the impact of these business investments, we still expect full year 2018 expense growth will be within the 3% to 5% range we think of as normalized. As a result of our investments, we expect stronger revenue growth, improved productivity and expense efficiencies in the future.
With respect to income taxes, our tax rate on a taxable equivalent basis declined from approximately 29% in 2017, excluding notable items to a tax rate on a taxable equivalent basis of 18.9% in the Q1 of 2018. This tax rate was slightly lower than expected due to the accounting impact of stock based compensation and the resolution of certain tax matters during the quarter. Slide 13 highlights our capital position. At March 31, our common equity Tier 1 capital ratio estimated using the Basel III standardized approach was 9.0%. This compares to our capital target of 8.5%.
I will now provide some forward looking guidance. For the Q2, we expect net interest income to increase in the mid single digit range on a year over year basis. We expect fee revenue to increase in the low single digit range year over year. As a reminder, fees are seasonally higher in the second quarter. We expect expense growth to be in the mid single digit range year over year within our long term growth target of 3% to 5%.
We expect to deliver positive operating leverage for the full year 2018. We expect credit quality to remain relatively stable compared with the Q1 and our full year tax rate on a taxable equivalent basis is estimated to be about 21%. I'll hand it back to Andy for closing remarks. Thanks, Gary.
The early part of 2018 is shaping up as we thought it would. The economy is on solid footing and consumer and business confidence is strong. While the business confidence has not translated into increased lending activity yet, we believe it will. Strong consumer spending supported by a strong job market, higher wages and lower taxes should drive more business activity and business investment in technology and infrastructure and we are well positioned to win the lending business that comes with it. Business optimism is evident in the conversations our bankers are having with our clients and we are seeing that in terms of increased commitments and more robust pipelines.
I feel very good about the outlook for our fee businesses. We are reaching an inflection point in merchant processing revenue and our focus on retail driven purchase mortgages is enabling us to capture market share in mortgage banking. And while reduced headwinds are a positive development, I'm most excited about the sales and volume trends we are seeing in some of our higher return fee businesses like payments and trusted investment services, which provides fuel to an already good momentum heading into the Q2 and beyond. As we have discussed previously, we are accelerating technology and innovation investment spend on initiatives aimed at enhancing the customer experience and leveraging our competitive positioning with a particular focus on payments, digital and mobile banking and B2B capabilities. These investments will position us at the forefront in banking and drive improved operating leverage over the next several years.
In closing, I'm confident that our business model combined with the hard work dedication and integrity of our entire U. S. Bank team will enable us to deliver improving returns on equity for shareholders in the near term and over the longer term without compromising our risk profile. That concludes our formal remarks. Terry, Bill and I will now be happy to answer your questions.
Your first question comes from the line of Matt O'Connor with Deutsche Bank. Go ahead please. Your line is open.
Hey guys. This is actually Ricky Doss from Matt's team. Just a quick question on expenses. I appreciate the color you gave. Just wondering if you could talk about expense growth as we exit 2018, added up taking cost this year and in recent years.
I was wondering if you could see expense growth sort of at the lower end of your long term range in 2019 or maybe even below that? Thanks.
Yes. So this is Terry and thanks for the question Ricky. With respect to expenses, we certainly expect them to be in 2018 kind of on the higher end of that range as we said. As we get into 2019, one of the things that we expect and we think is important is that we would start to see revenue accelerate because of some of the investments that we're making as well some of the efficiencies that we would expect from business automation and other activities that we are investing in. So I don't know whether it'll come down to the lower end of that range in 2019, but I think we'll start to see an inflection point where it will start to come down in the range during 2019.
Got it. Thank you. And then maybe a follow-up sort of switching gears. Just thoughts on mortgage banking for the year. It was a bit weaker than we had expected in the Q1.
I'm just wondering if there's any read throughs there and then just an overall thought as we move throughout 2018?
Yes. So again, let me kind of take that question. On mortgage banking, I think we're kind of seeing a couple of different things. One is that we've had a very strong focus on enhancing the retail channel and focusing on purchased mortgages over the last couple of years. What we are seeing in our particular business is we've actually seen applications increase on a year over year basis by about 11%, but the revenue coming down on a year over year basis.
And that's principally because in the industry, it's very competitive in terms of the gain on sale margins that we are seeing and the industry has seen particularly in the correspondent banking. I think that there as the year progresses that margin compression is placing a lot of pressure on our competitors. We're continuing to capture market share. And as capacity in the industry starts to go down, we should start to see improving margins. But the timing of that is hard to know.
And Terry, I'd add that our capabilities in the digital front specifically our loan portal position us well for that gain and share in the retail side.
Thanks guys.
You're welcome.
Your next question comes from the line of John Pancari from Evercore. Go ahead please. Your line is open.
Good morning. Good morning, John.
On the to the deposit topic, on the non interest bearing deposits down about 6%. I know you mentioned that seasonality, but the year over year balance is still down about 3.5% or so. So is there something else going on there? Is this more of the impact of higher rates and deposit betas picking up? And just want to
get some color on that. Thanks. Yeah. John, this is Terry again. When we look at deposit trends for us, it's really kind of important to kind of look at the business mix of our deposits.
We typically in the Q1 see deposits being down on a seasonal basis and that's because deal flow within Corporate Trust tends to be higher in Q4 and then lower in the Q1. And so we always see kind of a runoff. If we look at kind of the deposit outflows that we saw in the Q1, we didn't see anything significant in the consumer or the retail side at all. In fact, they were pretty stable from Q4 to Q1. The wholesale or our corporate and commercial banking deposits were down, but if you end up looking year over year, seasonally it's about the same.
So the most significant decrease that we saw was within our Corporate Trust business. And we really think that's tied to 3 factors. The first is the fact that a lot of CLO deals got pulled forward because of tax reform into the Q4. So 4th quarter balances were higher. And in the Q1, the CLO investment managers started to deploy those deposit balances out of the trust.
So that's pretty natural. But I think because of the pull forward it was more pronounced in the Q1. 2nd is just timing of M and A activity. We have escrow balances and we saw an outflow of escrow balances, which is really tied to M and A deals. With the pipeline of M and A strengthening, we would expect that to get stronger and then just normal seasonality.
So it's kind of 3 different factors that are happening in the Corporate Trust business, not as much really tied to deposit pricing.
And Terry, I'd add our deposit beta assumptions are consistent with our expectations approaching 40. We're still expecting the good 50 towards the middle and last part of 2018. And the other point I'd make is that we saw acceleration deposits actually here early in Q2. Yes.
Got it. Got it. Thank you. And then separately on the loan front, in terms of your expectation around the trajectory of loan growth, are you still comfortable with GDP plus level of loan growth as you look at 2018? And then then or could this or could it be weaker just given the trends we saw this quarter?
Thanks.
Well, it does appear to be a little stronger in the Q2 than the Q1, but we still think it's probably going to pick up mostly in the second half of the year. But we did see in the C and I side for example or any balances were higher at the end of the quarter. So there are signals that it's starting to pick up.
Okay. So you're still going with
the GDP plus range for the full year?
Yes. I mean, that's something we talked about last year. We'll see loan growth, for example, in many of our retail categories.
And that's going
to be more tied to what GDP is doing etcetera. So I think we see a number of signs that would still make us feel comfortable at this point. Okay. Thank you.
Thanks.
Your next question comes from the line of John McDonald from Bernstein. Go ahead please. Your line is
open. Hi, guys. I wanted to follow-up a little bit on the expenses. Just maybe bigger picture, Andy, the 3% to 5% kind of normalized expense growth, you mentioned that a few times and something you targeted at the Investor Day in 2016. Just remind us like what are the foundational assumptions of why 3% to 5% is what you target over time?
And the reason I'm asking is we get the question, are the regional banks seeing able this year and maybe next year to self fund their tech investments and keep expenses pretty flattish this year and next? So what's different about U. S. Bank terms of maybe where you are in the cycle that you're kind of at 3% to 5% and in elevated year you're at 5% when others are kind of doing flattish?
Well, John, I'll start from the fact that we're starting from an efficiency ratio a bit lower than those other banks that you're describing. I do think we're going to and we are going to focus on positive operating leverage and making sure that our expense growth is below our revenue growth. But at the same time, we want to make sure we're balanced in terms of making investments for the longer term. So we're factoring in all those things into our number of 3% to 5%. I do think it will range in there for sure.
I do think that there
are periods that will be at the
low end of the range. But we want to make sure we're thinking about things not only in the short term but in the long term.
John, the other thing that I would just add to that is, it's important to remember our business mix relative to a lot of our regional banks that we end up competing against. With the payments business and the investment management business in particular, And in Payments business, a lot of those expenses are more variable in nature. And so as revenue grows, expenses will grow with that, not to the same level, but so the business makes sense of impacting that a little bit.
Okay. That's helpful. And just as a reminder, what do you guys think is an appropriate medium term efficiency target for you guys, say, over the next 1, 2, 3 years?
Well, as I said in the prepared remarks, John, I do expect that this Q1 is the high point for the year and we continue to expect that we'll be in the mid to low 50s in terms of our business year ratio. So I expect it to migrate down principally because we're going to have positive operating leverage.
Okay. Great. And then just a reminder, Terry, where you stand on interest rate sensitivity. Has anything changed there? And can you kind of remind us of the split between the long and short end sensitivity?
Yes. So if you end up looking at our balance sheet, probably about 50% of our assets benefit from the short end of the curve in terms of movements in interest rates and about 50% of it benefits more on the long end of the curve. And that's really what our business mix has been overall. From an asset liability sensitivity perspective, one of the things I would kind of maybe point out and Andy talked a little bit about our deposit betas. But if you think about our Corporate Trust business, we're getting closer to what I would call that terminal beta level and that's kind of started to be baked into our rate movements as well as kind of the wholesale side.
So the movement up of deposit betas for us I think will be impacted by that to some extent favorably I think relative to maybe some of our competitors. So that's the way we kind of think about it. Because a lot of for about half
of our balances, it's already at the highest level.
Yes. Great. And then just one follow-up. You mentioned the overall retail beta or the beta assumptions getting to, I think you said 40 later in the year. Can you just talk about the retail beta?
And is that kind of the terminal assumption there? Or would
you expect to go kind
of higher than the terminal on retail over time since it's been so low for the 1st part of the cycle?
Yes. So, I mean the movement from 40 to 50 is probably going to be more so an assumption that retail deposits are going to start to move upward in terms of deposit betas. Through the most recent rate cycle or rate hike, we have seen very, very little movement in terms of deposit pricing. I do think that with the March rate hike and as we get into the rest of the year, we are going to see more competition with respect to retail deposits and we're just going to be pricing to meet that competition.
Okay. Thanks guys.
Thanks John.
Your next question comes from the line of Bessie Graceff from Morgan Stanley. Go ahead please. Your line is open.
Thanks. Good morning. Couple of questions. 1, just to continue the last conversation. Your loan to deposit ratio appears to
be pretty low. I think it's
in the low 80s. So I'd wonder if that's something you can use strategically to hold back on deposit beta at all?
Yes. I think the way that I would kind of think about it, Betsy, I do think that there is that opportunity. I think we can be a little bit more targeted and more focused with respect to how we think about retail deposits. We price in 120 different markets. And so we surgically kind of look at where the competition is moving rates and then we only really have to move in those particular markets.
So I think your point is correct in the sense that we can be more targeted and we can be a little bit more focused with respect to deposit paid as they end up changing. I think that we again, we haven't seen a lot of movement yet, but that's something that we're expecting.
Okay. And then separately on capital return, dividend payout ratios that kind of conversation. Obviously, the Fed put out the SEB proposal recently. Maybe you could talk a little bit about how you see that proposal impacting you and your minimum capital ratios that you have been targeting, because obviously your SCB is well below below the ratios that the Fed has been putting out there, the SCB of 2.5%, you're well below that I believe, right?
So
maybe we can talk
a little bit about that as well as how you think about the dividend payout ratio over the next couple of years here given that the soft cap is likely to be removed?
Yes, Jean, this is Andy. We continue to be bound by the base case, not the stress case. Our base case target is 8.5 percent common equity Tier 1. We're at 9%, so we're in the range. Our capital distribution has been in the range of our long term targets of that $30,000,000 to $40,000,000 I do think the one change that this may offer opportunity to do is to increase the dividend component of that share versus the buyback.
So you might you will see us increasing the dividend piece as this rule becomes more clear.
Okay. And any kind of expectation for how much that could move over time? I'm not asking for the specific C cards, I know you can't talk about that. But you've been in the low 30s. But then if I look pre crisis 10 years ago, you did run with a much higher dividend payout ratio.
So just wondering how you think about what kind of over time payout ratio your business can handle given the low earnings volatility that you typically have?
Sure. So, Betsy, as we
think about the 30 to 40 in
dividends and 30 to 40 in buybacks, I could see our dividend component migrating towards that $40,000,000
Okay. All right. Thanks so much.
You bet.
Your next question comes from the line of Erika Najarian from Bank of America. Go ahead please. Your line is open.
Hi, good morning.
Good morning, Erica.
My first question is a follow-up to what John was asking. And appreciate Andy that you were reminding us sort of the medium term efficiency target of mid to low 50s. As we think about 2019, I'm wondering if you could give us sort of a sense of timing of the investment spend relative to the revenue that you would reap from that investment spend. And I guess really the question I'm asking is, as we think about the efficiency ratio migrating over time lower, what that rate of change is going to look like in the initial year beyond 2018?
So Erica,
I think we're making these investments as we talked about with particular focus on customer experience in digital, B2B, all those things I've talked about. Those expenses are now starting to be baked into the run rate that you're seeing in the Q1 and you'll continue to see for the rest of the year. We're going to work on the expense growth to be in that 3% to 5% range under the assumption that our revenue growth is above that and we've talked about our revenue growth assumptions. So to the extent that revenue growth is robust, I would expect and as expected, I would expect our expense to be 3% to 5%. If the revenue growth is below that, we'll manage expenses down consistent with what our revenue opportunities are again with the objective of continuing to deliver positive operating leverage and a lower efficiency ratio over time.
Okay. And I just wanted to ask a little bit about the commercial real estate dynamics. You're typically the bellwether in terms of credit inflection trends. And I'm wondering as you could give us a little bit more detail on some of the unfavorable terms that you're seeing as some of these loans come up for refinancing. I think the worry that the industry or the market has is that a lot of commercial real estate loans had been struck at ultra low rates.
And I'm sort of wondering whether or not part of your decision to not refinance is that the developers are have other options for continued low rates outside of the banking industry and outside of U. S. Bank and you're refusing to underwrite it under market rate?
This is Bill. That's certainly part of it. It's either you'd see the rate and it's often tenor and just the lack of recourse structure on these long tenor deals that whether it's insurance companies or the securities markets are offering. So that's where we've seen the runoff in what we call the standing loan side or mortgage loan side. On the construction side, we're still very, very active.
We actually did see our ending construction loans up a little bit in the Q1. So that was encouraging. So that's where we focus. That's where we can add most value.
Got it. Thank you.
Thanks, Erica.
Your next question comes from the line of Ken Usdin from Jefferies. Go ahead, please. Your line is open.
Thanks. Good morning, everyone. Can I follow-up on the payments and the restatement for the revenue and expense recognition? It would seem that you've taken out that rewards payment that was in short term borrowings and also putting that back in and that's what changed out of the NII side. Is that right to say?
That's correct. So then as a go forward then, Terry, can you help us understand that now that that's going to be netted inside the payments lines, how does that change either the seasonality and the variability of payments revenues as we look ahead from this restated basis?
In terms of the seasonality, I don't think it's going to end up impacting it a lot. I mean the rebates that you're talking about are principally related to our corporate payments businesses. And we end up looking at the seasonality of that and then just how those rebates will match up against it. I think the seasonality will be the same. You just have to kind of reset your Q1 expectations regarding the line item.
Okay. And then so just more broadly on payments, I know you've talked about the merchant processing getting back to mid single by mid year. And on a restated basis, it looks like it was back to comping positive. Your corporate and debit is already doing 8 percent and corporate credit and debit is up 8% and then corporate is up 12%. Can those also historical growth rates overall in an aggregate for each of them?
Yes. So, I think, historical growth rates overall in an aggregate for each of them?
So I'm going to hit corporate payments and Terry will talk about retail payments. On the corporate payments side, they're having an exceptional they've had an exceptional year last year and continue to see that in the Q1. We had sales growth of 12%, revenue growth of 10% And you're seeing really strong growth in both the government as well as the corporate sector. A lot of that's driven by some of the technology corporate payments at the very corporate payments at the very high end of that single digit or low double digit range. Now when
you think about the retail credit card, we've been talking about mid single digit sort of revenue growth for the year. That business tends to be a little bit seasonal in the sense that the Q1 tend to be a little bit higher in terms of the revenue growth. So I think it's important to kind of keep that in mind. To the extent that we I mean we haven't seen strengthening with respect to consumer spend in that super space. And I think that based upon everything that we're seeing, we would we believe that that can continue.
But it will be really tied to what does that retail customer spend look like over the course of the year.
Okay. Thanks guys. Thanks Ken.
Your next question Thanks, Ken.
Your next question comes
from the line of Mike Mayo from Wells Fargo Securities. Go ahead please. Your line is open.
Can you hear me?
Yes. Mike, I can hear you.
Okay. So is this new information or are you reiterating the old information about accelerating investing in tech and innovation? I thought and correct me if I'm wrong, your tech budget is $1,000,000,000 each year and it's gone up to $1,200,000,000 to 1,300,000,000 dollars So when you're saying you're accelerating investing there, is this a little more of a step change than you were thinking before? And if so, why?
No, Mike. It's not new information. It's reiteration of what
we talked about in the Q4.
Okay. And if we could just get a little bit more kind of meat on the bones. In terms of the areas where you're investing, if you could just give us a little more granularity? And what are the outcomes that you expect? You clearly said you want revenues to grow fast and expenses over time that you're playing the long game.
Yes. In terms of mobile and online users or other metrics like that, some banks disclose that, others don't. What should we look for on the outside to monitor your progress?
Thanks Mike. So let me break it into 3 categories. I'll start with the payments categories. And in there, it's going to be a focus on increasing our capabilities around e commerce and integrated software providers. We are good there.
I want to be even better in those categories because that's where the growth is. On the retail side of the equation is increasing our digital capabilities. Today about 65% to 70% of transactions occur on our mobile device, but under 20% of sales. We want to continue to enhance our capabilities around the sales side of the equation, offering convenience and speed for customers as we think about a digital first world.
And then on the business side
of the equation, it's all focused on B2B and the new rails that are being built and our 3 areas of focus. The outcome of those would be increased sales activity and customer acquisition on all three fronts and particularly on the consumer front a more central relationship with those consumers and our ability to expand beyond our footprint with consumer customers. And Mike, I might add maybe just a couple
of things. Obviously, on the retail side, the areas of focus we started in mortgage because we have an important business there in terms of our loan portal, bringing online capabilities for people to be able to acquire autos online and be able to get the lending within essentially kind of minutes associated with that and then checking deposits and all sorts of things. A lot of the digital capabilities in the industry today are very service oriented though and so a big significant focus for us is really more on the sales side as we go forward, right?
All right. That's helpful. So just big picture, are you doing this because you have the money with the tax reduction to catch up or to get ahead of the industry? How do you think about it?
Mike, I'm doing this because I
think this is where the industry is headed and I want to be at the forefront.
Got it. All right. Thank you.
Your next question comes from the line of Brian Ferrand from Autonomous Research. Go ahead please. Your line is open.
Hi. Most of my questions have been asked, but maybe just two quick ones. First on the guidance, all the year over year comparisons you're referencing are based on the newly reported numbers not like what was in the 2Q release, right?
That's right based upon all the recasted numbers.
And then in the NPE schedules, there was a little bit of a jump in C and I. I appreciate it was fully offset by improvement elsewhere, but just any color on what drove that in broader C and I credit views? Well, the credit is
very stable, but yes, we did have one commercial account that's a consumer products account that did go nonperforming. So it was just an isolated incident. But overall, credit metrics are very, very stable.
Perfect. Thank you. Thanks, Brian.
Your next question comes from the line of Vivek Juneja from JPMorgan.
Go ahead please. Your line is open. Hi. Thanks. A couple of quick questions.
Number 1, merchant processing. In the past you've highlighted when the dollar was strengthening that you had an impact a negative impact from translation. Given that the dollar has been weakening, can you give us some color on how much of a benefit you got from FX translation now?
Yes. So if you end up looking at revenue in merchant acquiring is on a year over year basis up about 2.5%. And what we have been guiding for the first half of the year is really that merchant acquiring revenue on a core basis would be relatively flat on a year over year basis. And that's essentially what the difference is between the 2 is the FX. Saying that, again, when we end up looking at the second half of the year and we think about the core growth within that business, we think about that in terms of the mid single digits.
So we do expect it to continue to strengthen. And the things that we end up looking at in particular is new business activity and sales volumes and sales volumes continue to strengthen that business as well.
Okay. Great.
Second one, the deposit betas on the whole Wealth Management side, where are those running now? What would you how would you what level is it? 70% Any color on that because obviously that's a different business?
Yes. And so within our Wealth Management business, we started increasing deposit betas in the last rate cycle. And where there was literally no movement in earlier rate hikes, we started to see betas in the 10% to 15%. But they're well below what you see on the wholesale side or the other institutional side. But that's kind of what we've been experiencing.
When you say institutional, you're talking when I was referring to wealth management, I was referring to the whole sort of wealth and institute as a corporate trust. So
okay. Yes.
So I realize different definition
of length. Yes. So if you end up looking at corporate trust, when we get to more of a a terminals are sort of deposit beta, it's in that 70% to 75% range and we're pretty much there already. That's why as we think about the future, we believe from our asset viability subsidy standpoint, that's pretty much baked in. So that's kind of on the Corporate Trust side of the equation.
And then on the what I would say on the core Wealth Management side is closer to that 15%. Okay. Thanks. Yes.
Your next question comes from the line of Saul Martinez from UBS. Go ahead please. Your line is open. Hi, good morning guys.
I think in the last quarter you highlighted that you expected to be sort of at the high end of the 3% to 5% expense guidance because of the reinvestment of portion of profit windfall. Sorry if I missed it, but is that still the expectation within that guide for 2018? And or is it more revenue dependent?
No. That is our expectation. Okay.
Thanks. And I guess a little bit more of a detailed question. The other non interest income line you mentioned this quarter was off because of lower equity investment income. Could you help size that up? And I know it's a difficult line item to gauge on a quarter to quarter basis, but this quarter was light relative to last year even on a restated basis.
Can you just give us a sense or help us understand what a more normalized level should be going forward?
Yes. Saul, that in terms of getting the specifics regarding equity investments, we've never really provided that specific type of guidance. I will say in other revenue there's many different categories of types of revenues that are part of that including for example end of term gains and losses on residuals etcetera, etcetera. It tends to be lumpy because of not only equity investments, but just the way that all those different categories end interacting from 1 quarter to the next. So I think what I would suggest is kind of look over a period of time and you can kind of see a range.
And I would just kind of look within that range as kind of a way of getting some sense on other income.
Got it. It's just the number is about $30,000,000 higher lower this quarter than the average of last year. So just wanted to make sure I understood that
a little bit better. Better. Yes. It tends to be lumpy.
Got it. And just a final one, quick one on the consent order. Any update there in terms of how that's progressing? And just anything you could share on that?
We're nothing different. We are in our sustainability phase. Things are going as expected. We expect to be done with our part of the equation in midyear June 30. And then the regulators will continue with what they're doing and that timing is uncertain, but we're right on track with what we expect.
Great. Thanks a lot. You bet.
Your next question comes from the line of Kevin Barker from Piper Jaffray. Go ahead please. Your line is open.
Thanks. Just a follow-up on the deposit betas. Can you give us an idea of where your deposit beta on wholesale side stood this quarter and where it was in the previous quarter? And where you expect that terminal rate to be?
Yes. On the wholesale side, the betas are kind of in that 55% to 65% sort of range. And that's getting pretty close to the terminal level that we have experienced in the past. It's that's kind of where it is today, Kevin.
So overall, your wealth management combined with the wholesale are getting pretty close to the terminal side? Yes.
And then
it's just basically catch up on the retail, right?
Yes. That's correct. That's exactly right.
Okay. And then a follow-up on some of the mortgage questions. You mentioned the correspondent has been seeing heavy competition. Could you give us an idea where your gain on sale margins dropped on a correspondent basis from 4Q to 1Q? And what your expectations are at least for the next couple of quarters?
Yes. If you end up looking at margins on the correspondent side, they're in the low high single to low double digit sort of range. And that's probably 20 to 30 basis points lower than what we would normally see. Our expectation is that as we get into the latter half of the year and probably more so into the Q4 that they will start to rebound because there's a lot of pressure on the smaller players and the players that just don't have the capacity to be able to deal with the margins that low. But that's kind of where they're at and our expectation is it will start to improve.
It's just a matter of timing.
Okay. All right. Thank you for taking my questions.
Thank you.
Your next question comes from the line of Gerard Cassidy with RBC Capital Markets. Go ahead please. Your line is open.
Thank you. Good morning, Andy. Good morning, Terry.
Good morning, Gerard.
On the terminal betas that you guys have been talking about on the call, it sounds like the terminal level and please correct me if I'm wrong is around the 65% range. Is that fair? Or is it a
little lower or a little higher? Well, that would be kind of on the wholesale side. It's probably just a little bit lower, but kind of in that ballpark. On the corporate trust side, it tends to be a little bit higher, because we end up having the substitute investment is government funds, for example, in the money market fund area or T bills. So you have to kind of track that.
But that tends to be closer to 70% to 75%.
Okay. Thank you. And could we ever see them get to 100%? I mean in your guys' experience because obviously we're in a rate environment we've not seen before being so low. Could these terminal betters ever get to 100%?
Yeah.
It certainly isn't our expectation based upon both our experience in the business and also from a client standpoint. There is certain operating sort of needs and cash flow. And so there's a benefit to having those deposits with the bank. And so I don't think from the perspective of having to be competitive in terms of what they're accomplishing that we have to go that high. I think we're very we're at or very close to what we where we need to be.
Very good. And I apologize Terry if you address this. In prior calls you talked about the impact that the hurricanes and natural disasters had on your merchant processing and acquiring businesses. And I think you pointed out in the spring of this year you thought that would get back to normal. Where are we if you haven't addressed it, where are we on that kind of timeline?
Yes. Good follow-up. And in terms of the impact of Irma and Harvey, that is pretty much dissipated. So certainly early in the Q1 any effect associated with that is pretty much kind of worked its way in. Puerto Rico is much smaller for us.
It really isn't that significant, but it will take more time for that to recover.
Great. And then just lastly, you guys have addressed the commercial real estate lending. You guys obviously have conservative underwriting standards. What are you seeing in the other areas, whether it's retail or commercial? Is there any evidence of those underwriting standings getting a little too aggressive from your competitors that makes you wonder what they're doing?
This is Phil. Economic expansion and credit cycle. We just try to keep our underwriting consistent throughout the period. There have been I mean, I've talked about the real estate and a lot of activity in that long term fixed rate pricing, which has affected our mortgage book. But on the other side, it's pretty much steady as you go.
There's a lot of pricing pressure. But basically, we compete to have a full relationship and bring the other commercial products to the table.
Great. Thank you so much. Thanks, Gerald.
Your next question comes from the line of Matt O'Connor from Deutsche Bank. Go ahead please. Your line is open.
Thanks for the follow-up. I jumped on a little bit late here, but it sounds like you're not committing to lower expense growth next year, which I guess is a little surprising given the increase in investment spend this year. But it also sounds like you expect a nice increase in revenues. So I was hoping you could kind of frame it in terms of operating leverage percent that you're targeting if things go according to plan. And I appreciate it's a year out.
But I think we're all focused on the expense growth continue to be quite high. And without having the context of the revenue expectations, it's a little not fully clear.
Sure, Matt. And then this
is Andy. Let me clarify a little bit. So we talked about 3% to 5% this year at the high end of the range because of some of that increased investment we talked about. That increased investment will be in the run rate. We expect positive operating leverage this year.
And going into next year, I would continue to expect that. We're not going to increase our tech spend again next year. So that will be baked into the run rate. And I would expect that growth rates next year will start to migrate down within that 3% to 5% range.
Okay. And in terms of the amount of positive leverage that you're targeting because it will likely be modest this year I think based on the guidance and how much are you hopeful to achieve next year?
It will be modest this year and it will continue to increase as we go into 2019 beyond because our expectation is these investments will produce the revenue that we're looking for and that's why we're doing it.
Okay. I know a couple of years ago, you put out some of these medium term revenue growth targets. And I think the hope was that you would achieve that in year 3, which I think is next year. Is that something that's still possible? And remind us how much that revenue growth was?
So our revenue growth rates and our expense growth rates, we do expect to be in the ranges. We were in the 6% to 8% range on revenue, 3% to 5% on expense. And our return numbers were already in that range. One thing I will mention Matt is that we intend to increase our ranges on our returns given the new tax situation that we're in. We'll communicate more about that.
But as you saw, we're up in that range already in the middle of the range.
Okay. So just to summarize, you are hopeful of the 6% to 8% revenue growth next year, 3% to 5% expense growth, but hopefully drifting below the high end of that 3% to 5% range?
That's our target.
Okay. All right. Thank you for clarifying.
You bet.
Your next question comes from the line of Brian Klock from Keefe, Ruiz, Woods. Go ahead please. Your line is open. Good morning, everyone.
Good morning. Hey, Brian.
So I just wanted to follow-up a little bit on the commercial loan growth from earlier in the call. And I thought what was interesting looking at your segment data is, I know you guys mentioned that there's still some corporate deleveraging and a lot of your peers have talked about the same issue of some large pay downs on
the corporate side.
When we look at your Corporate and Commercial Banking segment, I know it's just as averages versus end of period, so maybe there's a difference on end of period. But the Corporate Banking and Other actually balances were slightly up on average or up almost 3.6% year over year, but the middle market was actually down. And it seems like that's a trend that's a little bit different at some of your peers. I wasn't sure if this is just an average issue or if your end of period balances is in March were showing a different trend versus the average. So maybe you can just talk about that in that page 10 of your supplement?
Yes. Well, when I think about kind of ending balances on a spot basis, Brian, they are a little bit higher than the averages. So we do expect to see some momentum as we think about the Q2. And thinking about middle market, for us middle market, we're continuing to grow on the commitment side. But one of the things that we have seen a little bit is just the impact of paydowns or payoffs.
And the principal driver behind that is from market to market, we see some M and A activity and that M and A activity ends up negatively impacting some of the middle market. If you're looking across kind of all of our markets, we're seeing nice growth in at least half of them a little bit stronger than that. And we're seeing flat sort of growth in the others. And so it kind of depends market to market and it changes from quarter to quarter too. Got it.
Got it. Thank you
for that Terry. And so I guess my other follow-up is just on the funding side. Everyone been focused on the betas and you talked about on the wholesale deposit side, the larger trust deposits getting closer to your terminal expectations. On the borrowing side, on your wholesale funding side, the borrowing piece of this, can Terry, can you remind us how much of that is swapped out the 3 month LIBOR? And I mean, what are your expectations on the borrowing side with either refinancings or work at the borrowing cost?
Yes. I know there's been a lot of conversation around the LIBOR basis risk etcetera on some of the other calls. For us, we at the end of the Q1 as an example, we have very little that is floating rate on 3 month LIBOR. So we don't have the same sort of basis risk to increase the 3 month LIBOR at this point. Okay.
So is there
anything swapped out for that? Or are you saying just overall it's more fixed on that borrowing base?
Yes. Well, typically when we go into the marketplace in kind of a normal cycle. We have gone about 75% fixed, 25% LIBOR or floating and tied to the 3 months. But we have substantially swapped that out to fixed at this point.
Got it. Great. Thanks for your time.
All right.
And with that, I'd like to turn the call back over to Jen Thompson for closing remarks.
Thank you for listening to our call this quarter. Please call us if you have any follow-up comments or questions.