The PNC Financial Services Group, Inc. (PNC) Q1 2019 Earnings Report, Transcript and Summary

Good morning. My name is Silvana, and I will be your conference operator today. At this time, I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to turn the call over to Director of Investor Relations, Mr. Bryan Gill. Sir, please go ahead.

Well, thank you, and good morning, everyone. Welcome to today’s conference call for the PNC Financial Services Group. Participating on this call are PNC’s Chairman, President and CEO, Bill Demchak; and Rob Reilly, Executive Vice President and CFO. Today’s presentation contains forward-looking information. Cautionary statements about this information, as well as reconciliations of non-GAAP measures are included in today’s earnings release materials, as well as our SEC filings and other investor materials. These materials are all available on our corporate website pnc.com under Investor Relations. These statements speak only as of April 12, 2019, and PNC undertakes no obligation to update them. Now, I’d like to turn the call over to Bill Demchak.

Thanks, Bryan, and good morning, everybody. As you’ve seen this morning, PNC reported net income of $1.3 billion, or $2.61 per diluted common share for the first quarter. Rob is going to run you through all the numbers in a second but I thought I would highlight a few brief items here. As you know, the first quarter of the year is typically negatively impacted by some seasonality as well as two fewer days compared to the fourth quarter and with this as context I really think PNC delivered good results. Linked quarter we saw very strong growth in average commercial balances and a small growth in consumer loans as well. Within C&IB the growth was actually greater than the headline numbers as we had a decrease in our commercial real estate balances of approximately $1.8 billion driven principally by our multifamily warehouse lines. If you exclude that, the real estate book C&IB growth came in at just over 4% quarter-over-quarter. We saw continued growth in our secured lending areas but we also saw growth in our more traditional cash flow lending businesses for the first time in several quarters. Reflecting normal first quarter seasonality, total fee income came in about where we expected. Importantly, expenses were flat and our overall credit quality remained strong. Our loan loss provision came in higher than we anticipated. But as Rob is going to discuss, it was largely driven by our strong loan growth and some reserves for certain commercial credits, nothing that we saw on a broad base basis. As we look forward from here, we still feel very good about the economy. Notwithstanding some mix signals from economic indicators, we have seen very little from our clients that would indicate that there is inherent weakness in the US economy. Having said that, there is clear weakness in the global economy, pressure from trade and fears of hard Brexit that will continue to weigh on the US economy. Regardless of the path ahead, we believe having a strong balance sheet, a solid mix of fee-based businesses, significant focus on expense management and differentiated strategies for organic expansion, will provide the foundation for success. Lastly, I did want to mention a couple of things that I am particularly proud of this quarter. The first of these is that that we learned just a few weeks ago that PNC has received an Outstanding Community Reinvestment Act rating from the OCC, the highest possible rating and one that we are proud to have earned for every exam period since the inception of CRA in 1977. And second, we're very excited -- we were very excited just last week to celebrate the 15th anniversary of PNC Grow Up Great, our signature philanthropic program focused on early childhood education. As part of this celebration, we extended our commitment to Grow Up Great which is now a $500 million initiative. Reflecting our main street model, our success depends a lot on the success of the communities in which we operate. Investing in early childhood education has proven to generate very high economic returns for communities and we’re proud to support that. So overall, I’m very pleased with the quarter and I want to thank our employees for their continued hard work to both drive our business forward and help our communities thrive. And with that, I will turn it over to Rob for a closer look at our first quarter results and then we will take your questions. Rob?

Yes. Thanks, Bill, and good morning, everyone. As Bill just mentioned, we reported first quarter net income of $1.3 billion or $2.61 per diluted common share. Our balance sheet is on Slide 4 and is presented on an average basis. Total loans grew $2.6 billion, or 1% to $229 billion in the first quarter compared to the fourth quarter. Loan growth compared to the first quarter of 2018 was $7.4 billion or 3%. Investment securities of $82.3 billion remained relatively flat linked quarter, although purchases replaced portfolio runoff. Securities increased $7.7 billion or 10% year-over-year. Our cash balances at the fed averaged $14.7 billion for the first quarter, down $1.7 billion linked quarter and $10.7 billion year-over-year, commensurate with growth in loans and securities. Deposits were up slightly linked quarter and grew $6.6 billion or 3% year-over-year. As of March 31, 2019 our Basel III common equity Tier 1 ratio was estimated to be 9.8%, up from 9.6% as of December 31, 2018. Importantly, we maintained strong capital ratios even as we returned approximately $1.2 billion of capital to shareholders or 98% of first quarter net income. Total share repurchases were 5.9 million common shares for $725 million and common dividends were $438 million. And our tangible book value was $78.07 per common share as of March 31st, an increase of 9% compared to a year ago. Slide 5 shows our loans and deposits in more detail. Average loans grew $2.6 billion, or 1% over the fourth quarter, driven by commercial lending balances which increased $2.5 billion or 2%. We generated this growth despite the seasonal decline in our multifamily agency warehouse lending of approximately $1.5 billion, compared with the fourth quarter. And while not on the slide, it is worth noting that our spot loan balances increased more than $6 billion linked quarter. As we pointed out previously, our corporate and institutional banking loan portfolio can be divided into three categories: traditional cash flow; non-CRE secured lending; and commercial real estate. Our traditional cash flow lending grew 5% linked quarter, reflecting growth from new and existing customers, including higher utilization. This growth is in contrast to the lack of growth we experienced in this category in the second half of 2018, which was related to heavy competition, including non-bank lenders, and higher pay down activity. During the first quarter, we continued to see strong growth in secured lending which has increased 3% linked quarter and 14% year-over-year. Lastly, loans in our commercial real estate business declined linked quarter, primarily due to the seasonality of the warehouse lending but also due to competitive pressures. On the consumer side, balances increased approximately $100 million linked quarter and $900 million year-over-year. We had growth in residential mortgage, auto, credit card and unsecured installment loans, while home equity and education loans continued to decline. Average deposits increased approximately $700 million in the first quarter compared to the fourth quarter, reflecting growth in consumer deposits, substantially offset by seasonal declines in commercial deposits. Compared to the same quarter a year ago, average deposits increased by $6.6 billion or 3%. In both comparisons and as expected, growth was in interest-bearing accounts. And we continued to see a shift from non-interest-bearing to interest-bearing deposits. Our overall cumulative deposit beta increased in the first quarter to 32% from 30% in the fourth quarter. For the remainder of the year, we expect our deposit beta to continue to increase but at a slower pace than last year given the current Federal Reserve interest rate held lock. As you can see on Slide 6, first quarter total revenue was $4.3 billion, down $54 million linked quarter or 1%. Net interest income was relatively stable despite two fewer days in the quarter compared to the fourth quarter. Non-interest income declined $48 million or 3% linked quarter reflecting seasonally lower fee income. Non-interest expense was flat compared to the fourth quarter as expenses continued to be well managed. Provision for credit losses in the first quarter increased $41 million to $189 million. Our effective tax rate in the first quarter was 16.3%. For the full year 2019, we continue to expect the effective tax rate to be approximately 17%. Now, let's discuss the key drivers of this performance in more detail. Turning to Slide 7, net interest income of $2.5 billion was essentially flat compared to the fourth quarter despite the impact of two fewer days in the first quarter. Net interest income grew $114 million or 5% year-over-year. In both comparisons, higher earning asset yields and balances were partially offset by higher funding costs and balances. Net interest margin increased to 2.98% in the first quarter, up 2 basis points linked quarter and 7 basis points year-over-year. Fee income declined $31 million or 2% linked quarter, driven by seasonally lower first quarter transaction volume in consumer services, corporate services and service charges on deposits. These declines were partially offset by growth in asset management fees which increased $9 million or 2% and reflect a higher average equity markets and residential mortgage non-interest income which increased $6 million or 10%, primarily due to a lower negative RMSR valuation adjustment compared to the fourth quarter. Compared with first quarter of 2018, total fee income was stable as growth in both consumer and corporate services fees were offset by declines in asset management and residential mortgage revenue. Other non-interest income of $308 million declined $70 million linked quarter and increased $63 million year-over-year. Other non-interest income includes the impact of Visa derivative fair value adjustments which fluctuates in part due to changes in the share price of Visa common stock. Turning to Slide 8, first quarter expenses in total were essentially unchanged from the fourth quarter. Seasonality drove increases in personnel and occupancy, as well as the decrease in marketing expense. Equipment and other expenses were lower linked quarter. Compared to the same period a year ago, expenses increased $51 million or 2%. Personnel and marketing expense grew, reflecting both business investment and growth. Our efficiency ratio was 60% in the first quarter, compared with 61% a year ago. Expense management continues to be a focus for us and we remain disciplined in our overall approach. As you know we have a goal to reduce costs by $300 million in 2019 through our continuous improvement program and we're confident we will achieve our full-year target. Our credit quality metrics are presented on Slide 9. On a linked quarter basis provision for credit losses increased $41 million to a $189 million and net charge-offs increased $29 million to $136 million. On the commercial side loan provision increased $31 million linked quarter and this reflects our strong loan growth and higher utilization as well as reserve increases related to certain commercial credits. Commercial loan net charge-offs increased $5 million linked quarter to $12 million and remained at very low levels with a net charge-off ratio of 3 basis points as of March 31, 2019. The provision for consumer lending increased by $10 million. Consumer loan net charge-offs increased $24 million linked quarter, primarily from higher net charge-offs in credit card and lower recoveries in home equity. Overall, our allowance for loan and lease losses to total loans was unchanged at 1.16% as of March 31, 2019 and has remained at that level for the past four quarters. Notably, our forward indicators are both down linked quarter. Non-performing loans declined $41 million or 2%, compared to December 31, 2018 driven by a decrease in consumer non-performance and total delinquencies were down $49 million linked quarter or 3%. Our overall credit quality remains strong. However, at these historically low levels of provision, we will continue to see some volatility quarter-to-quarter due to the pace and mix of loan growth and the timing of specific loan reserves and releases. We believe that we continue to be appropriately reserved for the current environment as reflected in our consistently strong credit quality metrics. And importantly, we’re not seeing any signs of broad based credit issues. In summary, PNC posted very good first quarter results. For the balance of this year, we expect continued steady growth in GDP and we no longer expect an increase in short-term interest rates this year. Our full year guidance remains consistent with what we shared on our fourth quarter earnings call in January. Importantly, in the first quarter of 2019, we generated over 2% positive operating leverage year-over-year and we remain well positioned to continue to deliver positive operating leverage for the full year 2019. Turning to Slide 11 and looking ahead to second quarter 2019 compared to first quarter 2019 reported results, we expect average loans to be up approximately 1%. We expect total net interest income to be up low single-digits. We expect fee income to be up mid single-digits. We expect other non-interest income to be between $275 million and $325 million excluding net securities and Visa activity. We expect expenses to be up low single-digits and we expect provision to be between $125 million and $200 million. And with that, Bill and I are ready to take your questions.

Silvana, would you pull for questions?

[Operator instructions]. Your first question comes from the line of John Pancari with Evercore ISI. Please proceed with your question.

On the balance sheet side, on the loan growth front, if you could just give us a little more color on what you're seeing there that’s driving the better line utilization and even the pay downs, is this something that you think is sustainable and is it enough to potentially bump up or see upside to your full year loan growth of 3% to 4%? I know you’ve kept that unchanged.

Yes. Hey, John. Good morning. It’s Rob. So just a couple of things. In terms of the composition of the growth, we were pleased with the loan growth that was predominantly on commercial side. I think the -- when I talked about those three categories, I think the traditional cash flow category was very strong in contrast to what you were talking about the second half of 2018. And that was just increased activity across our commercial markets, very strong in legacy markets and the expansion in growth markets. So we feel good about that. As far as the full year guidance, we’ve guided to 3% to 4% growth. We had average growth of 1% here in the first quarter itself. We're tracking to that range and I think we feel good about where we are but it’s a little early and premature to change the full year outlook.

Okay, alright. Thanks, Rob. And then separately I will just go straight to the elephant in the room. Bill, I just want to get your thoughts, I know there is a lot of speculation out there regarding the Wells Fargo post, and just would love to get your thoughts not only about if that would be of any interest but more importantly what would -- how you view your competitive position at PNC and why it’s certainly more attractive possibly to stay where you're seated? Thanks.

Almost don’t even know how to answer that. I like my job here, I like our company, I like our prospects, I like the people I work with, I like our clients, I like our communities and I will end by career here. Beyond that, I’m not going to speculate on successes or failures at our competitors.

Our next question comes from the line of Betsy Graseck with Morgan Stanley. Please proceed.

Just a couple of questions, one is on the commercial business. I know you talked about the loan growth coming in better. And I just wanted to understand how you're thinking about the competition in the non-bank space and do you feel that the interest rate and -- do you feel the pay downs that you had seen last year are slowing permanently or is this just a temporary slowdown due to 4Q’s disruption in the capital markets and higher interest rates et cetera?

It’s almost an unanswerable question. I mean I think the crack in the credit markets in the fourth quarter, Betsy, had to have helped on some of the volume that we saw at standalone market. But at the same time we saw pick up in utilization which would be totally independent of that. And we continue our pace just gathering new clients. So I think we will see what the future brings here. But we have seen for whatever reason the slowdown and pay downs and the uptake in the utilization and greater client growth, stronger retention, yes.

Now that’s helpful. And then separately, the Fed has got their NPR out there regarding moving the goal posts on advanced approaches banks. So could you give us a sense of how you're thinking through the opportunities for you assuming that NPR does get approved as written? And how you think through what to do with the incremental capital that you’ve been -- that you would generate as a function of that?

Let me start. Well Betsy, so as you know, the proposals were encouraged by the proposals, five key items there, two of which are a lot of work for us that you are not as interested in the elimination of the advanced approaches and then the possible elimination of the midyear [DFAS] [ph] for us. More meaningful in your interest would be the other three areas. One is the ability to opt out of AOCI, we will examine that. Secondly, the refinement to send in threshold deductions which for us is particularly meaningful because of our BlackRock stake. And then the third is the potential to reduce the LCR requirements from a full approach to a modified approach somewhere between 70% and 85%. So early for us. We are encouraged by all of that. We see potential in that for us. But until they're all approved, we don’t have a firm answer for you.

And just to make sure I understand when you say you would look at the AOCI impact et cetera, I mean is there a reason for not adopting that change if indeed NPR goes through?

Not terribly obvious one.

Yes. Not that I can say but we’ve got time on the clock to be able to decide so.

Okay. And can you size…

Your inclination is correct.

And then lastly, could you size like as you stand today and I know it’s a moving target because prices change obviously. But could you give us a sense of the size of the capital free-up that would occur if it were to come through like last quarter, March 31st?

Yes. What we said -- and again this is just an estimate, we said in combination that it could add as much as 1% to our capital ratio, and that’s an estimate but that gives you a rough sense of the lift.

Okay. That’s CET1, right?

CET1 yes.

Our next question comes from the line of John McDonald with Autonomous Research. Please proceed with your question.

I wanted to ask about operating leverage and the goals for the year. Rob, if I try to parse the linguistics in the outlook for the year, it looks like you're shooting for positive operating leverage in the range of 150 to 200 basis points. Is that fair, is it kind of a new target and in what would it take you to get to the upper end of that?

Yes. I think that’s fair and we affirmed our full year guidance. So you can do the math to get to 1.5% to 2% and first quarter, we're tracking to that. So that’s very fair.

And then expenses were up 2% year-over-year, is that kind of consistent with your outlook for the full year and what you’re shooting for a little closer to flattish? And I guess to what I am getting at here is, do you have expense saves that kind of gather steam which you get through the year or is this a good representation of ..?

Yes, so I just think it starts with your first question here in terms of the positive operating leverage which is what -- that’s our primary goal. Our guidance was for expense growth on the low end of the single-digit range which is where we are and I expect that to be the case going forward. It could direct higher if revenues go higher which would be a good thing, but then that just gets back to the operating leverage point.

And vice versa which we don’t have that.

Well, yes, right, think that way, that’s right.

And then last one from me is, how much did the flattening of the curve affect the degree of difficulty on your net interest income goals for the year?

I think for the net interest income goals, not much, because the rate increase that we had built in was September and the curve has been flat for a little while, maybe a little bit more. So not so much on the NII, more so on the NIM, even though we don't have official NIM guidance it puts -- flat yield curve puts more pressure on the NIM.

Yes. I think you have a bunch of moving parts you need to think about. The flattening o the rally in the long end obviously impacts the yield at which we put our fixed rate assets and as those assets rolled on a curve and mature were now either making loans or investing in securities at a lower yield in the existing book. Having said all of that, the average life of our fixed rate assets is five years plus or minus. So it takes a long time for that to show up in the income statement and in NIM. The other thing is, we had a -- in our original forecast a rise in fed funds later in the year. But at the same time, we would've had commensurate expectations of deposit repricing which obviously fall away and remains to be seen what happens to betas here but if we're really on this sort of whole pattern, if what we’ve seen through the first quarter holds, we will see less pressure on betas than what we might have expected when we started the year. And the final point of course is as it relates to total net interest income, all of those factors are dwarfed by our ability to continue to grow loans that makes sense for -- in our risk bucket.

Yes, that’s right. And that’s why our full year guidance holds.

Our next question comes from Erika Najarian with Bank of America. Please proceed with your question.

Just wanted to follow-up on the commentary that you had on deposits. So can you give us a context of how robust or national digital strategy will continue to be if the fed continues to keep short rates where they are? And Bill was your comment on betas potentially easing if there wasn’t a September rate hike more on your established markets or your newer markets?

Both, I think towards the end of a rate cycle historically you might have seen betas actually accelerate to the extent that, that funds were much higher than where they are today. In this environment at least for the last bit of time in our expectations, we don't necessarily -- we're going to say they are going to go up a little bit, total cumulative beta but not necessarily the spike you would have seen at the traditional end of rate cycle. Our newer markets basically are -- have been sort of stable on our price offerings since the last hike and would likely stay there. In terms of success of the effort, I guess I would say a couple of things. The first is, you dial up or down deposit balances of almost any size you want by being top of the price paid chart, particularly as a new entrant because you're not repricing your existing deposits on those platforms. We're spending more time today -- our deposits today are somewhere over $1 billion but to be honest with you we spend more time ...

Than national digital.

National digital, yes. We're spending more time, I’m going to use the word experimenting, but maybe that’s right, trying different strategies as it relates to the effectiveness of marketing dollars, pricing, activation, many other things we want to learn as we sort of accelerate the rollout of this into additional markets. I’m so less worried about what the balances are doing day-to-day, more interested in the activation of accounts and the usage of accounts.

And the mix of the distribution.

Yes.

And my second question if I could just zoom out. You returned 14% intangible equity in this quarter, and the forward-look all seems to be positive in terms of positive operating leverage, continuing your superior credit quality and optimizing your capital. I’m wondering as we think over the next two years, if the US continues to be in good stead, what returns on tangible common equity can your shareholders expect to enjoy? And within that range what do you think is an optimal CET1 ratio for a bank with your risk profile?

You want to start with that?

Well, we don’t have ROE targets, Erika, as you know. We're encouraged in terms of the direction that you just summarized and would see our returns going up. We have a lot of E, as you know, and some of these proposed tailoring that might affect some of that. So we've always said in terms of what CET1 ratio do we need to run, we have always said around 8.5%, that indicates for the last handful of years that could come down a little bit following the proposed rules, but 8.5% is the best number that we have today.

Well to be clear on that, what we do every year in terms of sort of our targeted numbers as we solve for it as a function of the outcome of the fed’s severe or own severe stress outcome, we're doing that -- we've been doing that basically since the beginning. What's interesting is we go forward with the tailoring proposals as that outcome would likely drive or potentially drive our needed capital ratio to a level that would actually be below in my view where we would operate vis-à-vis the buffer to 7%. So what do I mean by that? Let's say that the math says, on my old math that I could actually run all the way down to 7.5% or even 7% in a quarter as a practical matter we wouldn’t run there because a well capitalized is 7%, you're going to need to run some buffer above that simply for optics if no other reason but also for fear of ever breaking in a adverse economy. So we're going to have -- as these tailoring rules come out, we're going to have to have a hard look at that. The issue on return on equity, we have a -- we can sit and parse our return against peers 50 different ways but Rob’s point is right, the biggest differentiation between us and others is we carry a lot of E. We also have a less goodwill. So on a tangible basis, we don’t have other assets that are effectively earning without a capital.

And we don’t want to …

And so be it. So I think it’s very long answer to your question but the basic notion is let's grow the company on a healthy basis year-over-year being conscious of risks, be the firm that outperforms, so in the risk stress would be able to take advantage of that with a fortress balance sheet when it happens. We have done that for years, we will continue to do it.

Thank you. And just as a follow up -- I’m sorry to take so much time. But in the event that the proper capital ratio let's say based on what you were saying is let's say around 8 and you are closer to 10 today, what is the pace of optimization that you think would be appropriate for a bank again of your size and risk profile?

So you’re basically saying what are you going to do on capital return and I don’t want to -- we just submitted CCAR, so we will leave specifics out of it, but a couple of guiding principles. The first one is that we see very strong value in our shares today and see value in buying back our shares today, see value in providing a healthy dividend through time to our investors. I would tell you that there are prices in multiples of tangible at which we would slow down our buyback, we’re not there yet today but there are prices where that would happen and you could potentially see our capital buffer build in those instances simply because more often than not when you get the lofty levels on multiples to tangible book, there is some downturn looming that you can put that capital to work at a much better prices. But for where we are today our intention would be to drive that ratio down and return capital to shareholders.

Because we have access capital.

Yes.

And to your point, the dividend …

And we see real value there.

Our next question comes from the line of Ken Usdin with Jefferies. Please proceed with your question.

Just continuing along the lines of capital usage, and Bill, I know where you’ve stood for a long time on the question of M&A. But just given the large transaction happened intra quarter and your comments just about your belief that you feel that the shares are attractive as is balance sheet growth, just any light that you can share just on the evolution of the landscape and where or where not PNC would want to play over the longer term even as far as being an acquirer or not?

Nothing has changed, the SunTrust BB&T merger I think makes great sense for them and I think there is a set of competitors kind of waking up to the challenge of what it means to have scale particularly on technology spend as we get into a consolidated market. I think we've already done that spend. We already have that capability. We have the ability to grow organically. I don't value in acquisitions, particularly at today price, anything on the small side simply because of not the least of which because of prices but also just because if we take eye off the ball just doesn’t make sense and doesn’t change our outcome strategically. You will continue to see us look and execute on product or technology ads that aren’t major in scale but make a difference to the offerings we have to our clients. If there is a market disruption, if there is a crack in credit which we don't see today but if there is, you would see us use capital to take advantage of that.

Like we’ve done in the past.

As we’ve done in the past. But as of now we think we have a really strong hand to play just pursuing our organic growth.

Understood. And Rob one question for you. In terms of the fixed-rate assets and where the curve has gone, are you still seeing positive benefits as cash flows flow off of the securities book and the fixed rate loan book? And if so, what you’re putting on new stuff ad versus where the roll off is?

Yes, so Ken, in the first quarter actually we were -- what were buying was accretive to the yields as the curve has flattened out here in the latter half of the linked quarter, we’re a little bit below.

And would you expect that to be the case as you roll forward, sorry go ahead Bill?

Yes, I do, slightly below, I do.

Yes, I mean -- if you look at -- if you just look all our sequel, we have seen since the fourth quarter, I don’t know, 35 basis point rally and I’ll write swap yields in five years a little bit more than that in 10 years. And eventually again all else equal on risk that will show up through our fixed asset yields, that delta through time. It’s a long period of time that, that will …

Yes, so the outcome won't be a dramatic change. But the point to your question is the curves flattened out, so we're a little bit below now on our purchases.

And are you guys hedged to the point where you want to be to that point, can I get your point on the swap delta, so do you have the construction set up as far as this rate environment carrying forward?

We're -- I mean in effect we went into this -- and hindsight is 2020 but we went into this as a sense of ever short in effect, under invested. I still am a disbeliever in firm rates but they are where they are and all else equal we made a mistake on that. Having said that, we're not going to invest into this type of yield curve, we will kind of maintain where we are and watch it play out.

And our next question comes from the line of Kevin Barker with Piper Jaffray. Please proceed with your question.

Just a follow-up on that question. Rates flat here, I mean deposit pricing likely to continue to move higher and reinvesting at negative yields on the fixed-rate assets, I mean would you expect a little bit of pressure here maybe in the second and third quarter on NIM before flattening out? Obviously you guided to NII staying stable …

Yes, you’re going to -- it wouldn’t shock us to see NIM drop a couple of basis points as we move through the course of the year. There are so many things that move around inside of that as it relates to asset spreads as well and what we buy. But all else equal, yes, NIM should drop 1 or 2 basis points as securities and fixed rate loans roll down and we replace them at lower yields. There is a lot of stuff that would be on the other side of that, we’ll have to wait and see.

Yes. I think that’s right and then obviously a big variable is the deposit betas and the cost of those deposits.

And then following on some of your comments around credit. Obviously we know the simple trend and feel comfortable with that but it did come above your guidance -- the provision did come above your guidance. And you did mention consumer lending. Was there anything in particular around C&I or any one-off credits given you saw the pickup in manufacturing NPAs?

Yes. Hey, Kevin. This is Rob. No, nothing in terms of broad themes. Our provision was about guidance this quarter in large part because of the growth. But then a handful of specific credits that don't really had any common theme, the manufacturing that you see in the supplement there, there’s a couple of names but that’s one of our largest book, that’s over 20 billion in loans there. So no broad theme, it’s just you get a little quarterly volatility working off of these lower levels and in any given quarter a couple names could go on, a couple of names could go off and that’s the variance that we experience.

One of the things that is probably masked this a little bit in the past is simply recoveries certainly starting out in the crisis when they were very high and basically we’ve kind gotten to a place at this point where recoveries has trended off, corporates are largely operating at the rating level they want to achieve. And so we have less sort of upgrades as people get back to where they are and we have the traditional business of growing loans which is causing provision to slow a little bit.

But again, so -- it's such a function off of these lower levels. When you take a look at our reserves to loan ratio, it is not almost 1.16, every quarter it is 1.16.

But by the way we do not solve …

No, we don’t solve that, yes, we don’t solve that yes. It is literally unchanged.

And just quickly, so would you structurally expect higher severity going forward, frequency in line with what you’ve expected in the past years?

Higher severity meaning loss given the follow up or higher …?

Higher losses, yes, so if there’s less upgrades and more loss on any default?

None on a single default. I think all else equal, we’re running at a charge off ratio that is unsustainable. So yes through time you would expect through the cycle charges to be higher. By the way, ours and everybody else as everybody keeps saying the same thing. Bizarrely, I don’t know that that’s what we're seeing this quarter but through time you will see a gradual increase. This quarter was more so than anything else just driven by growth which will take every time and by the way if you find that hard to stomach, wait till CECL comes along. And you see the impact from loan growth in your quarterly provision. But now there is nothing in there that’s bothering us at this point.

That’s the important point.

Our next question comes from the line of Gerard Cassidy with RBC. Please proceed with your question.

Bill, you mentioned in your shareholder letter about expanding into markets through the technological innovations of digital banking. Can you share with us at what point we may actually see some metrics or maybe you have them already that we can monitor to see the success that you're having with the penetration from that strategy rather than the old-fashioned as you mentioned making acquisitions doesn't make sense today or you are going to do it through organic growth? How do we as outsiders measure that success?

That’s a completely fair question, Gerard, and we are working on exactly how to bring that to life. I would tell you for now what we're looking at -- and we started out with a notion, we will launch a digital platform on a national basis with offerings that are geo-fenced and try to convert what starts out as a higher yield savings product into full-time clients, so ultimately metrics on how many accounts, how many deposits, how many are active, how many moved to virtual wallet and so forth. But also inside of our learnings as we go through that is how many branches we build in this digitally thin markets, largely following our C&IB expansion and what our strategy is around that, the cost associated with that. All of that continues to be developed and tell why we’re spending time learning and testing in each of these new markets before we come out with the stated goal as to what we think this thing can be. Right now I think we just -- did we open the second branch in Kansas?

This month, later in April, Dallas, midsummer.

Still early on at this and we’re not spending huge dollars on it but I want to get sort of results that we can bucket that show our progress once we get a very clear go-to-market strategy around of each these new markets but we do that.

Very good. And then the follow up question, when you guys look -- I know you targeted an efficiency ratio that as you mentioned on the return on tangible common equity ratio earlier in the call and you look at where you guys are today about 60%, many of your competitors have really started to make inroads into bring in their ratios down toward the mid 50s. Can you give us some color how do you think you may get what your roadmap is to bring that down? Again I know it’s not a focus point for you folks. But how do you hope to bring that kind of number down which would of course drive profitability higher?

So if you read my annual letter.

Well, he did.

I did, didn’t remember all of that.

But I think part of it?

Right.

Gerard, the issue here, we don’t mange to an efficiency ratio but we could drive that number down quickly and materially by basically burying our heads in the sand and saying that we are not going to try to survive this digital onslaught of what is happening in retail banking. And bluntly many of our peers are shrinking themselves to greatness and not investing in what is an aggressively consolidating industry, whose share at this point going to the largest players largely on the back of great offerings. I want to be one of those people with great offerings and a larger player that consolidates across this country. And to do that we need to continue to invest which we’ve been doing aggressively for the last seven or eight years. So we could stop doing that and show you metrics for the next couple of years that looked great and I think in the course of doing so we would seal our fate. So our focus here is on intelligent organic growth, good risk-adjusted return for shareholders and we think we have a real opportunity to do that inside of an industry that is just going through transformational change right now. So long story short that will be an outcome, not a targeted number.

Do you think on the -- like you said it’s not targeted number, is it more a denominator driven number, meaning you mentioned responsible growth, obviously you're investing in the numerator, which is expenses, any improvement will come more from just the growth being better at the bottom rather than cutting back on expenses?

Yes. My best guess is I’d play this whole thing through, as you can imagine I do this most nights when I’m struggling to sleep. I think what happens is you will see and you heard me talk about, this change in the income statement whereby you will see occupancy costs drop, you will see which has already happened, you will see technology costs go up, you will see the marginal cost of deposits increase as the price paid for digital offerings in an effect in footprint physical offerings if there’s such a thing merge through time. You are going to see banks in their existing networks, expand in MSAs if they don’t operate it today. And my best guess is our efficiency ratio doesn’t change materially through time as much as our total E increases, as we grab share across this consolidating market. It depends on so many things but I think the cost to marketing, the cost and ability to move deposits are going to offset the gains you get by otherwise using technology and removing physical plans …

At distribution.

Yes. So the gross metrics don’t change but the line items in the income statement do and I think growth potentially accelerates materially in the out years as this industry consolidates.

Yes. And Gerard I’ll just add -- it’s Rob, clearly investment is a big component of our spend. But in sort of the short-term it is about the operating leverage. So provided that revenues are growing, we're okay with expenses growing especially if they are part of that revenue. So we have great fee businesses that have higher efficiency ratio and we’d like to grow those as much as we can.

And the final thing I will say because I am not -- we're not obviously indifferent to the amount of money we spend and we're very good at managing expenses. We go into our budgeting process every year and we don't talk about necessarily what are the new investments we want to make as much as we talk about $1, what is the $10.5 billion, whatever the number is that we're going to spend this year and build up from a base. So we take the management of expenses very seriously. But inside of that we're aggressive at wanting to be able to maintain the investment necessary to ensure our place and when I think is going to be consolidating market and we’ve been doing that, you will see us continue that.

As there are no further questions at this time, I'll turn the call back to you.

Okay. Well, thank you very much for joining us and we look forward to working with you this quarter.

Thanks, everybody.

Thank you.

This concludes today's conference call. You may not disconnect.