Welcome to the U.S. Bancorp's third quarter 2019 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. If you would like to ask a question, please press star one on your touch-tone phone and press the pound key to withdraw. This call will be recorded and available for replay beginning today at approximately 12:30 P.M. Eastern through Wednesday, October 23rd at 12:00 midnight Eastern Standard Time. I will now turn the conference over to Jen Thompson, Director of Investor Relations for U.S. Bancorp. You may begin.
Thank you, Polly, and good morning to everyone who's joined our call. Andy Cecere and Terry Dolan are here with me today to review U.S. Bancorp's third quarter 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'd 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 two of today's presentation, in our press release, and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Andy.
Thanks, Jen. Good morning, everyone. Thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on slide three. In the third quarter, we earned $1.15 per share. Despite a more challenging interest rate environment, we reported record levels of revenue and net income driven by healthy loan and deposit growth and continued momentum across our fee businesses. Credit quality remained stable. Turning to capital management, our book value per share increased 10.6% from a year ago, and during the quarter, we returned 80% of our earnings to shareholders through dividends and share buybacks. Slide four provides key performance metrics. In the third quarter, we delivered a return on average common equity of 15.3% and a return on average assets of 1.57%. Our return on tangible common equity was 19.4%.
Positive operating leverage drove improvement in our efficiency ratio on both a linked quarter and year-over-year basis. I'll turn the call over to Terry who'll provide more detail on the quarter as well as forward-looking guidance.
Thanks, Andy. If you turn to slide five, I'll start with a balance sheet review, followed by a discussion of third quarter earnings trends. As noted, average loans grew 1.1% on a linked quarter basis and increased 4.7% year-over-year, excluding the fourth quarter 2018 sale of FDIC-covered loans that had reached the end of the loss coverage period. Strong residential mortgage and credit card loan growth supported both linked quarter and year-over-year performance. Commercial and industrial loans grew 0.4% sequentially and 4.7% on a year-over-year basis. Paydown activity picked up in the third quarter, primarily reflecting the rate environment and robust capital market conditions. New business activity remains healthy, although paydown activity is likely to continue at elevated levels near term. Commercial real estate loans decreased on a sequential and a year-over-year basis.
This quarter, commercial real estate contributed a 33 basis point drag to linked quarter average loan growth and an 89 basis point drag to year-over-year average loan growth. Turning to slide six, deposits increased 1.4% on a linked quarter basis and grew 6.0% year-over-year. Compared with the prior period, we continued to see migration from non-interest-bearing to interest-bearing accounts. That migration, along with deposit growth momentum in both our wealth management and corporate and commercial banking divisions, helped drive average savings deposits up 8.4% year-over-year. As you can see on slide seven, credit quality remains stable. On a dollar basis, non-performing assets increased 2.7% versus the second quarter, but decreased by 2.5% compared with a year ago. The ratio of non-performing assets to loans plus other real estate owned was stable at 33 basis points compared with the second quarter and modestly improved versus 36 basis points a year ago.
Slide eight highlights third quarter earnings results. We reported earnings per share of $1.15 compared with $1.06 a year ago. Turning to slide nine, net interest income on a fully taxable equivalent basis declined by 0.5% compared with the second quarter and increased by 0.8% year-over-year, which is in line with our expectations. Both linked-quarter and year-over-year comparisons benefited from healthy loan growth offset by the impact of declining rates and a flatter yield curve. Our net interest margin declined by 11 basis points versus the second quarter in line with our expectations. About four basis points of the decline was due to higher cash balances, primarily reflecting changes in policies related to deposits by the European Central Bank. Slide 10 highlights trends in non-interest income.
Middle single-digit year-over-year growth in each of the three payment fee lines, credit and debit card, corporate payments products, and merchant processing was driven by higher sales volumes. As a reminder, processing day count will end up affecting year-over-year credit and debit card revenue growth comparisons in several quarters in 2019. In the third quarter, three additional processing days versus a year ago benefited revenue growth. In the fourth quarter, two fewer days will be a drag on year-over-year growth. We continue to expect low single-digit growth of credit and debit card fee revenue for the full year. Commercial product revenue increased 11.1% from a year ago, primarily due to higher corporate bond fees and trading revenue related to strong capital markets activity. Mortgage banking revenue increased 56.3% year-over-year on strong origination and sales revenue growth.
Compared to the third quarter of 2018, mortgage production volume increased by 40.3%, and mortgage application volume increased by 53.1%. Refinancing activity represented about 40% of production in the third quarter of 2019 compared to about 30% in the linked quarter. Refinancings represented 51% of applications in the third quarter. The year-over-year decline in deposit service charges reflected the impact of the sale of our third-party ATM servicing business in the fourth quarter of 2018. The increase in other revenue was partly driven by the inclusion of the related transition services revenue, which will decrease over time, as well as higher equity investment income and a gain on sale of assets. Turning to slide 11, the year-over-year increase in non-interest expense reflected higher personnel costs, partly due to higher variable compensation related to business production within mortgage banking and the capital markets business lines, as well as increased medical costs.
Professional services expense increased primarily due to business investment and enhancement in risk management programs, while higher technology expense growth was primarily tied to business growth initiatives. The decrease in other expense primarily reflected lower costs related to tax advantage projects and lower FDIC assessment costs. Slide 12 highlights our capital position. At September 30th, our common equity Tier 1 capital ratio, estimated using the Basel III standardized approach, was 9.6%. This compares to our target of 8.5%. As previously discussed, our goal has been to manage the capital level closer to our target once we had clarity related to adopting CECL and the final capital rules were promulgated by the Federal Reserve.
With the recent release of the final rules, we plan to make a request to the Federal Reserve to increase our share repurchase program to enable us to begin reducing our common equity Tier 1 ratio from 9.6% to approximately 9.0%. I'll now provide some forward-looking guidance. For the fourth quarter, we expect fully taxable equivalent net interest income to decline in the low single digits on a year-over-year basis. We expect mid-single-digit fee income growth on a core basis year-over-year. We expect to deliver positive operating leverage for the full year 2019 on a core basis, in line with our previous guidance. We continue to expect our taxable equivalent tax rate to be approximately 20% on a full-year basis. Credit quality in the fourth quarter is expected to remain stable compared to the third quarter. Loan loss provision expense growth will continue to be reflective of loan growth.
I'll hand it back to Andy for closing remarks.
Thanks, Terry. The record results and industry-leading returns that we delivered in the third quarter, despite a more challenging interest rate environment, is a testament to our well-balanced business model, our numerous competitive advantages, and our risk management discipline. As we head into the final quarter of 2019, we feel good about our loan and deposit trends and our ability to continue to gain market share across our franchise. As indicated on slide 13, we are seeing good digital uptake trends. As loans are increasingly sourced through our digital channels, we expect better customer experience, higher account and volume growth, and improved operational efficiency. Our core fee businesses are performing well. Investments made over the past few years in our payments and mortgage business lines are delivering anticipated results in the form of improving sales and volume growth.
Our scale and differentiated service model is helping us win new business and expand existing relationships in our trust and investment services business, which is driving strong asset under management and fee growth. Importantly, we are deepening relationships across our entire franchise as we bring the power of one U.S. Bank to each of our business customers and consumers. Credit quality remains stable, and we are not seeing any early indicators in our portfolio that cause us concern. However, we are mindful that at some point, the industry will experience a credit downturn, and we remain disciplined in terms of origination quality and our long-term strategy of remaining within our defined credit box regardless of the competitive environment. In closing, I'd like to reiterate the message I delivered at our recent Investor Day.
We are in a position of strength and will continue to leverage the core competencies and competitive advantages that got us to where we are today. However, the world is changing rapidly, and we are adjusting and investing for the future so that we can continue to deliver the industry-leading growth and returns our shareholders have come to expect from us. I'd like to thank our employees for their hard work and commitment they bring to the job every day. We will now open up the call for Q&A.
If you would like to ask a question, please press star, then the number 1 on your touch-tone phone, and press the pound key to withdraw. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Matthew O'Connor with Deutsche Bank.
Morning, Matt.
Polly, we're not hearing Matt.
Matt, your line is open.
We can go to the next caller, and maybe Matt can dial in again.
Okay, your next question comes from the line of John McDonald with Autonomous Research.
Hi, good morning.
Morning, John.
Hi, Terry. Was wondering if you could just give a little more color on the request for the capital increase. Just over what time frame you might be looking to do the 9.6 down to nine. Is that over the course of a year or a couple of months? Again, what was the clarity you were looking for? Was it CECL and tailoring, I think you mentioned?
Yeah. Well, with respect to the second part, I think that we've now been through parallel run for a couple of different quarters, the outlook from an economic standpoint is still relatively solid. I think we feel comfortable that we have a good range, and it's consistent with what we talked about at Investor Day. Obviously, the final rules coming out is helpful. From a timing standpoint, it won't be accelerated. I think it'll be bringing that 9.6 down to 9.0 really during the 2019 CCAR cycle. By the end of the second quarter.
Okay. Got it. It is for this cycle to do it by the second quarter of next year.
Yes.
Okay. Got it. I wanted to ask you guys just more broadly about your outlook, just in terms of kind of generating positive operating leverage in what's proving to be a more difficult rate environment. As you turn the corner into 2020, is that a goal? Is that 100 basis points kind of a bogey still? Terry, you had mentioned at the Investor Day that 2020 was a tougher year when you were talking about your three-year targets.
Yep.
Maybe also, Terry, you could just kind of clarify. I think at Investor Day, you said part of that outlook is you thought your net interest income might grow faster than your fees, and maybe you could just give a little follow-up color on that.
Yeah. A lot of different questions there. Certainly in terms of positive operating leverage, it's a balancing act between short and long term, and we always kind of take that into consideration. 2020, as I said at Investor Day, I think is going to be a challenging year because of where interest rates are today versus where they were a year ago. The long end of the curve, 10-year is, I think, down almost 150 basis points from where it was last year. The landscape certainly has changed relative to when that guidance came out. Right now, I think our outlook with respect to positive operating leverage is to achieve that in 2019 on a core basis. As we kind of think about different initiatives, the second thing is what we will take into consideration is the fact that we continue to transform from a digital perspective.
Derek talked about kind of a do it yourself sort of a focus. I think we're going to end up looking at a lot of different things that we can do in order to try to manage expenses as prudently as we can. I think part of it is just what happens with interest rates. It is volatile right now. It's hard to really know. Having an outlook that's much beyond a quarter is pretty tough. Coming back to net interest income versus fees, that guidance or those comments are really focused around what we think between now and three years out where that growth is going to come from. I think part of that is an assumption that once we get beyond 2020, the interest rate environment starts to normalize and either stabilizes or starts to come up.
I think that's the part of the thought process between where that mix is going to come from.
I just reiterate, John, that the theme that we talked about at Investor Day continues to hold, which is delivering in the short term while investing for the long term. We're going to manage short-term performance, understanding the rate environment and the economic environment, but deliver on what we talked about in terms of positive operating leverage, but at the same time, investing for the long-term growth that we're seeking.
Got it. Thank you.
Sure, John.
Your next question comes from the line of Betsy Graseck with Morgan Stanley.
Morning, Betsy.
Hey, good morning. Hi. One follow-up there on the tailoring rule. There's also a benefit, I think, to the LCR and how you're required to calculate that and carry cash around that. I'm wondering, does that have any impact on how you think about either the portfolio that you're holding or your ability to be more competitive for loans because you can value non-operating deposits or any other benefit from that maybe we could get a little under the hood on?
With the rules related to LCR coming out, it was essentially kind of reducing it to the 85% level. As we talked, that really helps free up liquidity probably in the range of $11 billion-$15 billion, kind of in that ballpark. We're still kind of formulating what our game plan is. I think that we'll look at kind of remixing the investment portfolio in order to be able to
Both extend duration and possibly enhance the yield a little bit. We may look at reducing our debt level in the wholesale markets. I think that a number of those different actions would be beneficial to the company. It's going to be basis points. It's not going to be a major change, I think, in terms of net interest income, just based upon kind of where the yield curve is, et cetera. We're looking at all sorts of things.
Right. No, I get that. Every little bit helps, though.
Yep.
So just-
It sure does.
good to understand.
Yep. Sure does.
Does it impact at all the competitiveness with regard to commercial lending or not really?
I don't think so.
Okay.
We end up driving from a competitive standpoint based upon what the pricing is in the marketplace, and I just don't see it impacting that a lot. Given our debt rating and our low cost of funds, we're already in a pretty good position regarding loan pricing.
Got it. Okay. Then, Andy, just separately, at Investor Day, really interesting kind of sidebar tech showcase that you had. I want to just understand how you're thinking about the offering that you've got for merchant acquiring merchant services and understand where you think there's more that you can do there to expand your offering, either to other verticals, take what you've got in your restaurant, hospitality, et cetera, to other verticals, or if there's more that you can do with adjacencies on some of the things that you've been adding to over the past year or so.
Yeah, I think it's a three-pronged strategy. One is a continued focus on e-commerce and ISVs, which we've made great progress in over the last year and we'll continue to focus on it going forward. Secondly is the focus on certain verticals. You named a couple, airlines, hospitality industry, healthcare. Thirdly, and importantly, and probably the biggest opportunity is this combination of banking products and services together with merchant products and services. The fact is, all of our merchants need a bank. Many of our small business customers need a merchant provider. Our ability to weave and put those products together in a comprehensive set that helps the customers run their business and give them information, I think, is a key to our focus and one of the areas that I think we're going to see the most potential.
Is it primarily U.S. or is it also Europe? I know you have a more global footprint in this business.
Yeah. The first two would be global across the board. That combination of banking and merchant processing would be principally in the U.S.
Got it. Okay, thanks.
You bet.
Your next question comes from the line of Ken Usdin with Jefferies.
Morning, Ken.
Hey, Ken.
Hey, good morning, guys. How you doing? It's just a couple of fee follow-ups. Obviously mortgage banking was very strong and I'm sure built into your outlook for the fourth quarter of growth, but can you just talk about how much more pipeline you expect to pull through on the mortgage side and what you're just seeing in terms of the gain on sale outlook and the loan officer side of the equation there?
Yeah. If you think about mortgage banking, obviously that was a very strong quarter from refinancing. When we end up thinking about the fourth quarter, it's very dependent upon where long-term rates are. With the rates kind of coming up a little bit most recently, it probably will not be as strong. I think it'll still be a good year-over-year story from a mortgage banking perspective. The application volume was strong in production. It was strong in the third quarter. We continue to see that momentum. The other thing, Ken, is, and we talked about this, is we've been over time making good investment in mortgage loan officers on the retail side of the equation, enhancing that.
The digital platform that we talked about has a very high percentage of application capture, and that just helps because of the speed to market and our ability to be able to service those customers and get the loans booked. We went through the last, what I would say, cycle of refinancing, and our processing times were relatively short compared to competitors and certainly what we have experienced in the past, and it's all because of those investments.
Got it. A second question, I know this comes up from time to time, but inside the other, you always mention that the PE gains are there. We know that the ATM agreement is in there as well. Can you help us just understand magnitude of the PE gains even on a comparison basis, if not the number? Also just how the ATM services is, how much is that in revenues and expenses today and how does that work going forward? Thanks, Terry.
In terms of other revenue, it is a lumpy category. It ends up going up and down depending upon what's happening within the various categories. It includes a lot of different things, and equity investment is just one piece of it. If you end up looking at the overall increase on a year-over-year basis, I would break it down kind of like this. About half of it is related to the transitional services revenue, and about 25% of it's related to equity investment, and then it's kind of a combination of a lot of other things that are kind of driving that.
When we think about it, because I know this question is out there, when we think about other revenue, and we talked a little bit about this, over the course of the last 8 quarters, it has ranged anywhere from, on a quarterly basis, from $160 million to as high as $300 million. When we end up looking at kind of what is a core reasonable level, that $200 million range is kind of in that ballpark, give or take. It'll be up a little bit some quarters and down a little bit in other quarters, and that's how we kind of think about it.
Could you just, on the expense side of the ATM, is that a decent part of the growth on the expense side as well, the services agreement?
Yeah. That service agreement was really negotiated in order to be able to cover the cost. The cost levels associated with making that transition service agreement is fairly similar to the revenue that we're generating. From a timing standpoint, that will start to go away as conversions are taking place between now and the end of 2020.
Got it. Thank you.
Yep. Thanks again.
Your next question comes from the line of Mike Mayo with Wells Fargo Securities.
Hey, Mike.
Hi. I know we just had your investor day. You're talking about positive operating leverage driven by the digital transformation. I guess I have a front office and kind of a back office question. The front office question, I guess you closed, what, like 150 branches in the last year but still had decent deposit growth. How much growth are you getting through digital channels, or some sort of metric that you can give us? The harder question, the back office, you're retooling the inside of the company. Can you give us any metrics on data centers, the peak, where you are now, where you expect them to go, or what % of your applications you expect to migrate to the public cloud, or anything else about the internal retooling too?
Mike, I'll start, and then Terry can add on. From a sales perspective, as we think about the digital initiatives, the revamping of our app, and the focus on the digital capabilities, it's focused on a couple of areas. One is insights and improving the ability to connect with the customers. Secondly, it's also the ability to improve sales activity. You see some of our loan stats in the deck that we provide as part of the earnings call. We'll tell you that both loan activity from a sales perspective as well as deposit activity is growing quite rapidly, and we will see a continued movement of more sales activity. Transactions is already high, as you know, digitally, but more sales activity to digital channels, I think over time, which will allow for continued opportunities on the expense side of the equation.
If you think about the backroom?
Yeah. Whether it's the backroom or even within the branches, and a big part of the decision around closures related to branches and reinvestment in branches as well is really kind of that intersection of our employees, our people, the digital, and our customers. Obviously, the customer behaviors are changing. The amount of transaction activity that's happening in the branches is significantly less than where it was. In fact, 80% of it, roughly 70%-80% of it goes through the digital channel today. That gives us the opportunity to really reconfigure the branch network, both in terms of size and numbers, et cetera, but also to change the focus from a service-oriented type of location to something that's much more either sales and/or advice focused. I think those trends are going to continue. I don't necessarily have specific metrics.
On the deposit side, I would say that there is still room and opportunity for the percentage of sales from the deposit perspective to continue to grow. I think Derek at Investor Day had said when you think about the opportunity from a digital perspective from sales, and we would include deposits in this, is that should get us closer to that 40%-50% over time. It'll take a while for us to get there because it's a customer adoption that has to take place.
Okay. As far as the back office, do you have any metrics on number of data centers or how many apps you expect to migrate to the public cloud or anything else just on the inside of the company?
We haven't disclosed the number of data centers, but I will tell you, Mike, that we continue to migrate activity to the cloud. Jeff Van Gorden spoke a little bit to that at Investor Day. Most of our new activity and development will occur on the cloud, which offers a number of advantages, both from a capacity as well as a cost standpoint. Yep.
All right. Thank you.
Mm-hmm. Thanks, Mike.
Your next question comes from Scott Siefers with Sandler O'Neill.
Hi, Scott.
Hey, Scott.
Morning, guys. Thanks for taking the question. Just, Terry, maybe some updated thoughts on the margin, given that the noise from some of the transitory stuff in the third quarter should presumably be settling in the fourth quarter. I guess, one, apologies if you said this, when do you have any additional rate cuts baked into your own outlook there? Just as we go forward, we still thinking kind of $40 million-$45 million sort of all else equal from impact from each rate cut?
Yeah. Well, let me kind of talk a little bit about kind of our guidance, and hopefully this will kind of get to some of your points. Our guidance with respect to low single digits is really kind of looking at the implied market rates in terms of where they're at in the first couple of weeks here of October. Implied in that is an assumption that rates are going to decline. Our assumption is that it will be in a 25-basis point cut in both October and then in December. I think there's still question as to whether December occurs. The long end of the curve, I think we're assuming that it's roughly kind of where it is right now. That's kind of the assumptions that we're baking into kind of our perspective regarding margin or net interest income.
From a margin perspective, it's down about 11 basis points on a linked quarter. There's about four basis points that's really related to those cash balances or building the balances. When we think about the fourth quarter, we would expect our net interest margin to decline, but kind of in the range of that core level, which is seven to eight basis points.
Okay. Seven to eight basis points of margin decline in the fourth quarter.
In the fourth quarter. Yeah, I think that the other thing is it's kind of interesting. If you think about third quarter, third quarter from an average perspective, short-term rates were actually up about 29 basis points, 30 basis points, while the long end was down about 100, a little over 100. In the fourth quarter, that'll be the first quarter on a year-over-year basis when the short end is down kind of in the range of that 40-50 basis points and the long end is down 150 basis points. In the industry, that's why people are looking at it and just we would expect fourth quarter to become more challenging as we go into the quarter and into 2020.
Okay. With that, just so I understand, with that seven to eight basis points, presumably that kind of moderates as we would look at additional rate cuts or is that sort of a new proxy? I just want to make sure I'm sort of understanding that.
Yeah. I would say that given the fact that it is so volatile right now and we don't really know where rates are going, I'd hate to look out beyond the fourth quarter.
Okay. Fair enough. All right. Thank you very much. I appreciate it.
Yeah. Scott.
Your next question comes from the line of Erika Najarian with Bank of America.
Great.
Hi, good morning.
Morning, Erika.
I wanted to follow up on John's line of questioning. Even outside of mortgage, the fee income trends are quite strong. Payments up 5% year-over-year, trust and investment management up 2% year-over-year. I'm wondering, as we tie that back to your long-term revenue targets, is a 5% fee income clip over that three-year period too optimistic or about in line with what you're thinking? I guess the reason I'm focusing on fees is because, like you said, Terry, nobody has any idea on what the forward curve is going to look like, right? I mean, the probability of October changed over the past two hours. I'm trying to think about the contribution of fees, and I have a follow-up on balance sheet growth.
Yeah. Well, maybe just kind of, again, this kind of ties a little bit to Investor Day and some of the guidance associated with that. The outlook for fee income in part will depend upon what happens with rates. I mean, the puts and takes with respect to mortgage banking and stuff, all kind of a function in terms of what happens from a rate perspective. I think we're confident when we think about the investments that we've been making, both in the payment space of the business and our corporate trust and some of the digital capabilities, our capital markets business. All of those we feel like we have a position of strength at this particular point in time, that momentum will continue to carry. There will be puts and takes. It kind of depends upon what happens in the environment.
Consumer spend continues to be strong. We don't see anything in the short term, but where that ends up turning when we get into 2020 is anybody's game.
On the balance sheet growth contribution to those long-term revenue targets, fully acknowledge that 2020 is going to be challenging. If the rate curve doesn't normalize as you think, but doesn't necessarily get worse than what's in the current expectation, is there enough opportunity in terms of delivering all of U.S. Bank into your current customers with regards to loan growth? In other words, that implies to me that we would need mid-single-digit loan growth over that three-year period in order to potentially mitigate some of the net interest margin volatility or lack of help from the yield curve, rather.
Yeah. Maybe a couple of things. The targets that we set are kind of based upon where we think the growth rates are going to be as we get into the second and third year. I tried to be clear that that's not our expectation with respect to 2020, and it's not necessarily a compounded rate over the three years because of the challenges that will happen in 2020. When we think about the balance sheet right now, and again, this is all kind of dependent upon what happens in the economy, and that's a little bit hard to predict, consumer spend and consumer confidence continues to be strong. I think business activity continues to be strong. I think it's moderated somewhat because of tariff policy and that sort of thing, or trade policy. Generally, I think the economy is solid.
When we end up thinking about 2020 from a loan growth perspective, we think that some of the trends that we're seeing this year will continue. As we talked, third quarter loan growth of about 4.7% on a core basis, we think that's achievable. I think from U.S. Bank's perspective, we have the lowest cost of funds in the industry, and we have some competitive advantages from a pricing perspective that will enable us to be able to achieve those types of things. I feel reasonably confident. Yeah. Erika, if you step back and look at the third quarter, our earning asset growth was just under 5%. Our deposit growth year-over-year is just about 6%. Thinking about the balance sheet growing in that mid-single digits, I think is about right. Yeah.
Got it. Great. Thank you.
Yeah, sure.
Your next question comes from Vivek Juneja with JPMorgan.
Morning, Vivek.
Hey, Vivek.
Morning. Hi. Sorry, we've been jumping around multiple calls, so I'm apologizing if I'm making you repeat something. The other income, did you give any sort of way to think about what's the sort of run rate that seems reasonable?
Yeah. We did talk a little bit about that, and maybe just to reiterate. When you end up looking at it, Vivek, and when we think about it, if you end up looking at that level on a quarterly basis, it's gone anywhere from $160 million-$300 million.
That's a function of the lumpiness that exists across a lot of different categories of income within that, including equity investments, et cetera. When we think about that core level on a quarterly basis, $200 million ± is where we believe that is a reasonable range. If you remember in the past I had said somewhere between $175 million and $225 million, and that's in that ballpark. When you end up looking at the year-over-year for the third quarter, about half of that growth is related to the transition servicing agreement that's tied to the ATM business. That goes away over time during 2020, tied to when those conversions occur.
Together with the expense.
Together with the expense. The expense is pretty similar to the increase related to the transition service agreement from a revenue point of view.
Another one, which is positive operating leverage. Your previous guidance, you used to have the 100 to 150, which went to 100. Are you thinking full-year 2019, given everything going on? You've obviously got positives on mortgage banking, other income running higher, but then NII softer. Is it still closer to 100 basis points, or do you think given where rates have gone, that's going to be harder to get to?
We're consistent with we talked about at Investor Day, Vivek, which is somewhat below 100 basis points, but still positive operating leverage.
Okay. Great.
Thank you.
Thank you.
Yep.
Your next question comes from the line of Matthew O'Connor with Deutsche Bank.
Hey, Matt. Welcome back.
Hi. Thanks. Sorry about that before. Just stepping back kind of bigger picture on this whole operating leverage question. You've got the best revenue growth year to date, I think, of the big banks, about 4%. It seems like the expense growth is also the highest. I guess I'm just conceptually wondering, is that the cost of doing business? Like to get that much revenue growth, that's the expense growth that you need, or is there still some catching up in terms of infrastructure or some of the stuff that you were working on a few years ago? Is there some trying to get ahead to help drive revenue growth in the future?
Obviously I'm not looking for specific numbers, but just conceptually some people would look at you and say, "Okay, the revenue growth is really good, but the expense growth is a bit higher, and it might just cost that much to generate that much revenue growth." Maybe you could just comment on some of that.
I'll start, Matt, and Terry will add on. First, from a big picture standpoint, three big puts and takes. Number one is we're going to continue to optimize a number of initiatives from an operations standpoint, the way we're delivering products and services, the way we're operating in the back room, and all those things will allow for some saves. That's a positive. Secondly, we're going to continue to invest for the long term in the digital initiatives we talked about on Investor Day. That's going to cost a bit more. A lot of that's already in the run rate. If you look at the third quarter specifically, though, there were a couple of areas of revenue growth, specifically mortgage and capital markets, that have expenses related to commissions associated with them, and that was one of the reasons for the little higher expense growth. Matt?
Yeah. The thing I would just maybe add to that, because we see that in mortgage, we see that in capital markets specifically. From an optimization standpoint, we talked about this at Investor Day. Very focused on as the customer behaviors are changing, making sure that we're staying lockstep with that. I think there is both opportunity in the front office from a branch perspective, and we'll continue to look at that. As I said, we may accelerate or increase some of the activity associated with that, but it's going to be tied to what happens from a customer standpoint. As we continue to move to a digital platform, I think there's back-office opportunities in terms of optimization. The other thing, and this kind of gets back to the digital activities that Andy was talking about.
We're making important investments in all of our lines of businesses, and we want to and will continue to do that because it's important for us to look both short term as well as long term.
Okay. That's helpful. I think sometimes we're also focused on the absolute level of operating leverage, and the fact of the matter is, call it 80 basis points of operating leverage with 4% revenue growth is a lot better than 1% plus operating leverage with 1% revenue growth, just the way the math works. Okay.
Yeah.
Appreciate it. Thank you.
No, that's right. That 0.8% positive operating leverage on efficiency ratio 54% is a lot different than 1% on 62%. It's all those sorts of things. Part of it is the starting point. Thanks, Matt.
Your next question comes from the line of Saul Martinez with UBS.
Hey, good morning, guys. You guys addressed a lot of my question. I was going to ask you to speak to some of the loan growth trends, which pretty pronounced, not only in terms of the absolute level balance sheet growth, but just the mix with commercial. On an end-of-period basis, commercial growing 3% and consumer 7%, even with home equity declining. The core is even faster than that. I guess a couple parts, though. Maybe you can address how much of that growth is related to exogenous factors or is dependent on a strong macro environment continuing, and how much of the growth is a function of things you're doing at the company level to deepen relationships, use analytics and whatnot.
I guess the second part of my question, though, is around CECL and do you guys consider the impact of CECL when addressing this growth? Because a lot of the growth is occurring in lending segments that are going to be disproportionately impacted by CECL have longer-term, longer-weighted average lives and higher loss content like cards. You, I think yourself, Terry, mentioned at the investor day that you'll have a higher ALL. To maintain that ALL ratio, you have to provision more. With this mix shift, that ALL ratio will continue to migrate upwards.
Is that something you guys think about, or do you guys just say that, "Hey, that's accounting noise and the economics of this lending activity is the same, it doesn't really matter, and over the life of the loan, the loss is the loss," just kind of whether the CECL impact on your growth is something you guys think about and how we should think about in terms of modeling it?
Good question. We kind of talked a little bit about this in the past. When we think about loan growth and where it comes from and kind of our focus within the company, we really think about it more on an economic basis than we do on an accounting because I do think there's just a lot of accounting noise that occurs within CECL for a lot of different reasons. One is that every company is going to have their own forecast with respect to what happens in the economy and all the things that we've talked about. We really think about it more from an economic standpoint.
In terms of loan growth, again, this comes back in terms of what we're seeing today, and what we see today is that consumer confidence seems to be strong and consumer spend is strong, and those things should tend toward good growth from a consumer perspective. Even on the business side, while it may moderate, it's still a very solid business. Some of it is driven by macroeconomic. Other, especially as we kind of think out on a longer-term basis, is driven by initiatives. We started an ABS lending sort of platform a year ago. This focus, and Andy talked about it, we have merchants in the merchant acquiring side of the equation and small businesses, and there is a significant opportunity for us to be able to leverage both of those.
When we think about the loan growth, we also think it's tied to some of our initiatives.
Okay. No, that's helpful. Thank you very much.
Thanks.
Your final question comes from the line of Gerard Cassidy with RBC.
Morning, Gerard.
Good morning.
Hey, Gerard.
Good morning, guys. You guys have been very good at sharing with us the competition in commercial real estate lending and what's going on in the different loan markets. We hear from many of the smaller commercial banks that they're building out their treasury management products. Are you guys seeing any increased competition in that part of the commercial customer base that you deal with that use those products?
Gerard, I would say it's not any different than we've seen historically. I would say probably the change that's occurring in treasury management, you'll continue to see it going forward, is the migration and the use cases related to the real-time payment rails that have been developed and the new products and services as a result of that. I think that is going to continue to be a change.
As you think about our capabilities in treasury management combined with our corporate payments, I think you're going to continue to see those things coming together and changing with these new rails that have been developed.
Speaking of that, Andy, do you think Zelle will play a role in that on a go-forward basis as Zelle goes from a P2P to possibly a B2B?
Zelle will start to use those new rails as a component of their mechanism, for sure. That's one. Number 2 is I think Zelle has a lot of opportunity for growth in different aspects, and there are also use cases, request for payment and other things that are occurring on the Zelle side. You're going to see changes on the business-to-business side related to the real-time rails. You're going to see continued migration and changes and enhancement on the consumer side related to Zelle. At some point, some of those things, particularly the small business, may come together a little bit.
Yeah, I think the other thing-
Great
Gerard, I would just say is that I think the challenge or the competitive landscape is going to be one based upon who is able to make the investments in connecting the rail, the real-time rail or Zelle or whatever might be the case, to the customer. That's where our area of focus has really been around the use cases that create a value proposition to the customer.
Right.
That investment is very important, and it's an area of focus for us.
That's absolutely right. Thank you.
Thank you. Then to pivot, you guys have been very conservative in your construction lending. The portfolio is about, what, $10.7 billion, down just under 5% on a year-over-year basis. There seems to be recently a resurgence in housing. Today, the National Association of Home Builders, their market index rose, beating consensus, and there seems to be recently some pickup in activity here. Are you guys seeing that in any of your markets, and are there opportunities for you to capture some of that growth?
Gerard, we have a housing capital group that does focus on home builders, and we are seeing good growth there. They're West Coast and South principally is where our focus area is, and that business is doing well and growing. Some of the other aspects of the commercial real estate and some of the declines that you're seeing are really a function of some of the credit components that we're seeing our competitors move to that we're not comfortable with. You have some positives, but we have some negatives, and we're sticking with our core customers and within the credit box that we participate in.
Great. Thank you so much. Appreciate it.
Thank you.
All right. Have a great day.
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