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US Bancorp
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Welcome to U.S. Bancorp’s Third 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. [Operator Instructions] This call will be recorded and available for replay beginning today at approximately noon, Eastern Daylight Time, through Wednesday, October 24th at 12:00 midnight, Eastern Daylight Time.
I will now turn the conference call over to Jenn Thompson, Director of Investor Relations for U.S. Bancorp. Please go ahead.
Thank you, Casey and good morning to everyone who has 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'll 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 up the call to Q&A.
Let me begin on slide three. In the third quarter, we reported record net income and earnings per share driven by record revenue and positive operating leverage. In line with our expectations, loan growth accelerated in the third quarter, supported by continued strength in consumer lending and a pickup in commercial loan growth.
On the right side of slide three, you can see that credit quality improved in the third quarter and our book value per share increased by 5.3% from year ago. During the third quarter, we returned 78% of our earnings to shareholders through dividends and share buybacks.
Slide four highlights our best-in-class performance metrics including a 19.9% return on tangible common equity. Our efficiency ratio, return on average assets, and return on average common equity all improved sequentially and on a year-on-year basis.
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 five, I'll start with the balance sheet review and follow-up with the discussion of earnings trends. Average loan grew 0.9% on a linked-quarter basis and increased 1.8% on a year-over-year basis excluding the impact of a student loan portfolio sale in the second quarter.
We saw continued growth in retail portfolios such as mortgage and retail leasing. Credit card loan growth was supported by expansion in both the number of active accounts and sales per active account.
We are seeing good momentum in digital acquisitions across platforms. As expected, commercial loan growth accelerated in the third quarter following modest growth in the first half of the year. Pipelines remain strong and we are seeing CapEx investment and M&A activity among our corporate clients.
Alternative funding sources such as the capital markets and companies own cash balances are limiting the clients' need to access the loan markets, but to a lesser extent, than during the last several quarters.
As investment spending gains traction and companies worked through their cash balances and tax repatriation, we expect commercial loan growth to continue to improve. Consistent with the past several quarters, commercial real estate loans declined reflecting our decisions not to extend credit as unfavorable terms and continued pay downs as customers seek alternative financing.
This quarter, excluding the impact of a student loan sale, commercial real estate contributed a 27 basis point drag to linked-quarter growth and a 122 basis point reduction to year-over-year loan growth. While pay down activity remains a headwind, it is gradually diminishing in intensity and we expect the trend to continue.
Turning to slide six, deposits declined 1.4% on a linked-quarter basis. This included the impact of an anticipated balance migration related to the business merger of a large financial client, which represents about half of the balance decline. This impact is expected to moderate in the fourth quarter.
About half of our deposits are retail customer balances within our consumer and business banking business line where we saw a 0.7% linked-quarter increase in average deposits, driven by a 2.7% increase in non-interest-bearing deposits.
Within corporate and commercial banking, our business customers are deploying the deposit balances to support growth and are migrating balances to alternative investment vehicles. This drove some of the decline this quarter.
Additionally our corporate trust business saw seasonal declines in deposit balances associated with the timing of the receipt and distribution of funds. These deposit flows are consistent with our asset liability modeling expectations.
Slide seven indicates that credit quality improved in the third quarter due to improving economic conditions with customer pay downs resulting in pressure on loan balances, but an improved credit profile. Notably our non-performing assets declined 8.0% compared with the second quarter and decreased 19.7% compared with the third quarter of 2017.
Slide eight provides highlights of third quarter earnings results including a 3.9% increase in diluted earnings per share on a linked-quarter basis. On slide nine, linked-quarter and year-over-year net interest income growth was supported by higher interest rates and earning asset growth which was partly offset by a shift in deposit and funding mix.
Year-over-year growth was negatively impacted by tax reform which reduced the taxable equivalent adjustment benefit related to tax exempt assets. In the third quarter, the net interest margin was 3.15%, up two basis points linked-quarter and one basis point compared with the year ago. The impact of tax reform and taxable equivalent earning assets year-over-year and net interest margin expansion by two basis points.
Our interest-bearing deposit betas continue to perform in line with our expectations during the last few rate hikes. As future rate hikes continue, we expect -- we continue to expect the deposit beta will trend toward 50%, which compares with the current level of about 45%.
The betas on our commercial and deposit -- and trust deposit basis, which represents about half of our total deposits, are in line with our estimated terminal betas. We expect that movement in the overall beta going forward will primarily be driven by our consumer deposit base.
Slide 10 highlights trends in non-interest income. On a year-over-year basis, we had strong growth in payments revenue and trust and investment management revenue partially offset by a decrease in commercial product revenue, mortgage banking revenue, and treasury management fees.
Commercial product revenue pressure reflected market dynamics in corporate bond underwriting and loan syndications. Mortgage revenue was affected by lower refinancing activity and lower gain on sale margins. Despite lingering market headwinds, we expect the year-over-year decline in mortgage banking revenue to moderate in the fourth quarter.
We are well-positioned as a waning refi market transitions to a more robust purchase mortgage market. We are optimistic that gain on sale margins in this business have stabilized and will expand as excess capacity leaves the origination market. The decline in treasury management fees reflects the impact of changes in earnings credits which is typical in a rising rate environment.
Turning to our payments business, we had strong growth in credit and debit card revenue and double-digit growth in corporate payment revenue each reflecting higher sales volumes.
As we have been signaling for several quarters, merchant promising revenue return to mid-single-digit base in the third quarter as we lapped the impact from the exit of joint ventures in the second quarter of 2017.
Merchant acquiring sales volume growth continues to be strong. We expect merchant processing revenue to continue to strengthen in the fourth quarter of 2018. Trust and investment management revenue growth was driven by business growth as well as favorable market conditions.
Turning to slide 11, non-interest expense decreased 1.3% on a linked-quarter basis, partly reflecting typical seasonality and increased 1.5% on a year-over-year basis. Compensation expense increased principally due to the impact of hiring to support business growth and compliance programs, merit increases, and higher variable compensation related to business production.
Notably within non-personnel expenses, professional services expense declined from year ago primarily due to fewer consulting services as compliance programs near maturity where we expect compliance related cost to continue to moderate through the year.
Other expense declined from a year ago due to lower deposit insurance and litigation costs as well as a reduction in cost related tax advantaged projects as we syndicate tax credits in the secondary market.
Slide 12 highlights our capital position. At September 30th, our common equity Tier 1 capital ratio estimated using the Basel III standardized approach was 9.0%. This compares to our capital target of 8.5%.
I'll now provide some forward looking guidance. For the fourth quarter, we expect fully taxable equivalent net interest income increased in the low single-digits on a year-over-year basis strengthening from the third quarter growth rate.
We expect fee revenue to increase in the low to mid-single-digits year-over-year. On a year-over-year basis, we expect to deliver positive operating leverage on a core basis in the fourth quarter and for the full year of 2018. We expect credit quality to remain relatively stable compared with the third quarter.
Now, I'll hand it back to Andy for closing remarks.
Thanks Terry. The second half of 2018 is shaping up as we had anticipated and momentum is building on our core businesses as we head into the end of the year. We expect the loan growth to continue to accelerate in the fourth quarter and our fee businesses remain on a good trajectory. Merchant acquiring revenue growth is gaining momentum and our other two payments businesses, retail card issuing and corporate payment services, are firing on all cylinders.
In wealth management and investment services, we are benefiting from favorable market conditions even as we continue to grow new accounts and reap the benefits of our strong market position in corporate trust.
We remain diligent in our focus on managing expenses for whatever revenue environment we are operating in and we are committed to delivering positive operating leverage in the upcoming quarter for the full year 2018 and 2019.
We manage our company for the long-term while balancing shorter term financial objectives. This approach means that we will be prudent with expense management, but continue to make traditional investments in our businesses and accelerate investments to enhance our digital and payments capabilities.
In terms of more traditional investments, we recently announced the expansion of our middle-market commercial banking team in the New York metro area where we have a strong presence in the large corporate space for over 10 years and will be able to leverage that existing platform.
On a technology and innovation front, we announced the creation of a new fully digital capability for small businesses to apply for and receive a loan or line of credit. The application of funding time is often less than an hour, improving on a process that can take weeks within the industry.
During the third quarter, we acquired Electronic Transaction Systems, which enhances our integrated software capabilities within our merchant processing business. It expands us into the new municipality industry vertical where we can leverage our government banking relationships within corporate and commercial banking. These investments and future investments will enable us to stay at the forefront in banking and will drive improved operating leverage over the next several years.
We understand the value we create for our shareholders starts with the value we create for our customers. As the banking industry evolves in this new era of digital capabilities, we continue to look for ways to use technology and innovation to make our customers' financial lives simpler and more productive while at the same time protecting their data, their personal information, and their privacy. If we do it right and we will do it right, our customers win, our employees win, and our shareholders.
In closing, I'd like to thank our U.S. Bank team members across the country for bringing their A game to work every day, to deliver on the promise of One U.S. Bank, and driving outstanding results for each of our stakeholders.
That concludes our formal remarks. Terry and I will now be happy to answer your questions.
Thank you. [Operator Instructions]
And your first question comes from John McDonald with Bernstein. Please go ahead, your line is open.
Hi good morning guys. Wanted to ask a little bit about the positive operating leverage, you had a nice print on positive operating leverage this quarter, looks like about 80 basis points. Just wondering how much help you got on the expense line this quarter from some of the accrual reversals and any other one-timers that you mentioned?
And then more importantly as you look out into next year and I think you've talked about shooting for operating leverage gap of 1% to 1.5% next year, what do you see as the drivers for that to accelerate next year to that range you talked about?
I'd ask Terry to start, then I'll jump in.
Yes, John, let me talk a little bit about the expense question that we had. Again our focus is around being able to deliver that positive operating leverage. But at the end of looking at expenses, we're kind of focused on a lot of different areas. You mentioned the litigation accruals, that actually is not a very big driver of the overall change. If you think about on a year-over-year basis, the biggest drivers is that is -- one is related to tax credit amortization costs which are lower this year versus last year. And when you think about it with tax reform and us having lower tax expenses, the capacity that we generate in tax credit production allows us to generate both fee revenue through tax credit syndication, but also reduce our tax credit amortization and that's something that we believe is both sustainable over the long haul.
The second thing that we've kind of talked about, our FDIC insurance is a little bit lower than what we expected and then if we think about our mortgage servicing costs, we continue to be just as the refi market has changed, et cetera, the mortgage servicing type of costs would come down and foreclosure related costs, et cetera. So, those are probably the biggest drivers.
On a quarter -- on a linked-quarter basis, the tax credit amortization represents the majority of the change. So, those are things I would focus on.
And John, Andy. As we look at next year, I would highlight a couple of things. As we've talked about, we've lapped the payments to the merchant revenue issue and you saw that that's growing 4%. We continue to expect that to accelerate as we go into next quarter and next year.
Mortgage revenue which has been a little bit of a headwind in the industry, I think, will start to come back. We are seeing accelerated loan growth, continued economic growth, and then across all our business, we're seeing increase in market share and customer acquisition. So, those are all things that I was positive opportunities for 2019 revenue.
Okay. And Andy just a quick follow-up. Is the 1% to 1.5% still kind of a good target as you sit here now and look out to 2019 for the operating leverage that you're going to shoot for?
Yes, it is.
Okay. And then one quick follow-up Terry. The FDI insurance fees lower that you mentioned, what was the driver of that? And you still have a stepdown coming from the end of the surcharge later in the fourth quarter next year?
Yes. The biggest driver is really the FDIC rate as much as anything. And as we make capital decisions and other things and then if you think about kind of our risk profile, we are getting an FDIC kind of benefit from a rate standpoint, that's probably the biggest driver.
And then I think your second question was really related to the surcharge. If you think about the surcharge, so -- if you think about the fourth quarter, we expect the surcharge to continue and until it ends, we're going to continue to expect it to be there. So, we'll wait for that decision. The impact to us on a quarterly basis is about $20 million related to that surcharge. So that kind of gives you some sense in terms of the size of it as well as you're thinking about that for the future.
And John, importantly, we're not assuming that surcharge goes away as we think about positive operating leverage in 2019.
Great. Thanks guys.
Sure.
Your next question comes from John Pancari with Evercore. Please go ahead, your line is open.
Good morning.
Good morning.
Good morning John.
On the loan growth front, I heard you're on the expectation that we're going to see some good acceleration in growth in coming quarters, your release for next quarter. What is really driving that view? What is changing that you're calling out? Is more about the pay down abatement that you think is going to continue? Or the bond market flow finding its way back to the bank loan market? Or is it more about just outright demand? Thanks.
Yes, I mean, I think it's actually a combination of all of those things you think about it. I mean we've been talking about the fact that our pipelines have been getting stronger and M&A activity has been picking up. We've seen in our corporate payments business the spend by businesses in both discretionary and CapEx getting stronger. So, I think part of it is demand, at least, in terms of what we are seeing. I do -- we're also seeing the pay downs that we saw in late 2017 and in the second -- in the first half this year, those starting to moderate. They are still continuing, but I think they are moderating.
And so, it is kind of a combination of all those different activities. I also think that as the long end of the curve has moved up, the opportunity within the capital market spaces -- that dynamic has changed a little bit. So, I think it's a combination of all of those different things.
And we think -- as we think about the third quarter linked-quarter was up 0.9%, the fourth quarter will get a little stronger and we expect that to get stronger as we move into 2019 as well.
And related to that, the line utilization on slide 16, despite some of these trends, you're still seeing it trend down. I mean is that -- are you signaling an inflection that you expect that we should start to see next quarter?
Yes, well, I guess what we end up looking to utilization rates. We think as kind of stable it ends up balancing kind of up and down. I do believe that when you end up thinking about the optimism and capital expenditures that are -- that we are seeing, I do think that there's the opportunity for utilization to expand and so as we kind of think about that, that's a part of the equation let's say.
Okay. Terry thanks. And then just one last thing on the deposit side, how should we think about overall deposit growth trends going forward? I know you've flagged the volatility from the customer merger and all that you've flagged, but how should we think about growth from this level going forward on total deposit trends?
Yes. So, I think it's really kind of point to three things and I talked about some of those, but just let me just kind of reiterate. One is that our consumer deposits are growing. They grow -- they grew nicely both on a linked-quarter and year-over-year basis. So, I think that that's good and that that tells us that from prices standpoint, we feel pretty good about that and what we're seeing in that market is good.
The large customer -- or the financial customer that was part of a business combination, we've known and we've anticipated that those balances are going to be migrating and we've been working with that customer to kind of know and understand timing. But to, kind of, give you some perspective, on a year-over-year basis, the decline is nearly 100% related to the fact that that customer migration is occurring. On a linked-quarter basis that represents about half of that. So, when we kind of take that into consideration, we know that that's going to moderate in the fourth quarter. When we look at the fourth quarter, we think about 2019 in particular, we actually think it's going to moderate and allow us to be able to grow deposits again.
Got it. Thank you, Terry.
Your next question comes from Matt O'Connor with Deutsche Bank. Please go ahead, your line is open.
Hey Matt.
Good morning. Another one on loan growth because you're one of the few banks that had accelerating loan growth this quarter and seem a bit more optimistic than others. Any idea why maybe you're seeing a slowdown and pay downs and a couple of other of your peers have pointed to an acceleration. Is there something different in the mix or is it just the way the lumpiness in that business can be?
Yes, I mean I think -- again it's probably a combination of things that could be lumpiness. We're in different markets. We end up having a much bigger community banking market than maybe some of the other competitors have been describing. So, it probably is a combination of things. It's not necessarily one thing that we can kind of pinpoint, let's put it that way.
Okay. And then when you talk about accelerating loan growth in 4Q, is that versus the kind of 4% annualized growth that you had in 3Q versus 2Q? Or are you talking about on a year-over-year basis were loans were only up 1% in the third quarter?
Matt, this is Andy. We were talking about that, the 0.9% accelerating to a higher number on a linked-quarter basis.
Okay, got it. All right. Thank you.
Thanks Matt.
Your next question comes from Ken Usdin with Jefferies. Please go ahead, your line is open.
Hey Ken.
Good morning Ken.
Good morning guys. How are you? First question just on the on the balance sheet and repricing characteristics, so it's getting harder to talk about sequential betas per se, so deposit costs up 10 basis points, how would you characterize that in terms of your expectations of the rate of change in terms of what you saw this quarter? And how that might go forward in the context of that you had previously talked about NIMs continuing to expand. So, can you help us understand that dynamic within?
Yes. So, maybe a couple of things. We end up looking at net interest margin, of course, how it expands, how much better, is always a function of how your balance sheet ends up changing what sort of loan mix you have, et cetera.
Certainly as we kind of think about deposits or funding costs, well, let me kind of step back, I think there's other reasons, our investment portfolio continues to be a creative as we as we see roll-off and that will continue at least through the vast majority of next year.
So, I think there's a couple of things on the asset side that's positive. On the deposit side, I really think that -- and we've talked about this, deposit betas, they are at about 45%. We think they will migrate up to 50% whether it's this next rate hike or the following, but it's slowly moving in that direction.
And our corporate trust and our wholesale deposit pricing is pretty much at terminal level. So, the movement of the deposit betas is really going to be more a function of how fast consumer deposits and the move in.
And we are maybe seeing a little bit more competition in that particular space, but it hasn't been significantly greater. So, I think it's just kind of a function of all those different things.
And Terry our deposit beta assumptions have been consistent with what's happening.
Yes exactly.
Yes, fair. And Terry to that point you mentioned on the asset side, can you help us dig in a little bit? Can you talk to us about front book, back book, on the securities yields? And also the types of loan growth you were expecting to see increase, is that also the types of stuff that's also accretive to the existing loan yield? Thanks.
Yes. So, on the investment side of the equation, if you think about our portfolio -- our investment portfolio, it has a duration of around four years which is what we've talked about. We are seeing a fairly significant amount of low yielding treasuries and those types of securities that are now rolling off. The -- its pretty consistent with what we talked about last quarter that that roll-off is accretive at a 100 to 125 basis points, so that that continually gives you the opportunity to be able to see some accretion with respect to that particular portfolio.
Now, on the loan side, again, I would point to the fact that we've seen nice growth in residential and we've seen nice growth in our credit card and our consumer type of products. And that type of mix will be beneficial to us as we kind of look in the future and we would expect and anticipate that to continue.
Okay, got it. Thanks guys.
Thanks Ken.
Your next question comes from Erika Najarian with Bank of America. Please go ahead, your line is open.
Yes. Thank you. Good morning.
Good morning Erika.
Good morning Erika.
So, my first question is a follow-up to the competitive aspects on -- for commercial. The bond market was brought up, but I'm wondering if you could give us a sense of how much competition non-banks like private equity firms, how much competition that's posing to U.S. Bancorp?
And as an add-on to that. What is your on balance sheet exposure to broadly syndicated leverage lending and private equity-backed transaction?
You start there second question.
Yes. So, with respect to leverage lending, that is something in terms of our balance sheet, we have never really had any significant amount of lending in that particular space. So, it's an area that we managed pretty tightly and again, it kind of is reflective of our credit risk profile. So, as we think about the next downturn, we feel like we'll be in a pretty good spot from a leverage lending point of view.
And then Erika on your question on private equity you're now in bank or non-bank competition, I would say that is evident in some of the wholesale categories. I think it's probably most prominent in our commercial real estate category where some of the pay downs that are occurring are because of non-bank competition coming into the marketplace. But as we said and as Terry said in his remarks that is starting to abate here as we come into the third and fourth quarter.
Got it. And another follow-up question on the expense side. I wanted to make sure I understood the Ryan run in particular for other expenses. So, as I think about the three year sort of average for other expenses, the average is about $450 million and it was $414 million last quarter and $377 million this quarter. Terry, am I right to think that that's all the tax credit amortization expense that you were discussing earlier? And I'm wondering if that $377 million is a good run rate for us to think about. And whether or not there is an offset in the tax rate line that we need to consider?
Yes. Well, it's already incorporated into the tax rate that we have because when you think about when you establish your tax rate for the year, you think about the entire year in terms of what your tax credit production is going to be. So, it's already a low tax rate.
Here's the way that I would think about it Erika. I do think that the tax credit amortization is going to be an opportunity, it's going to be something that's going to continue, but it also has a quarterly cycle to it. The third and fourth quarter happened to be your strongest production quarters and so tax credit amortization and the impact associated with it, tends to be more dramatic in the third and fourth quarter. So, there's a little bit of a seasonality.
I guess if I were looking at it, I think the $377 million might be a little bit on the lower end of that range, but reasonable.
And the fourth quarter, Terry, is actually higher than the third quarter. So, we'll see a little bit of an increase in that -- in the fourth quarter because of that.
Yes. Last year it went up about $60 million, this year it's probably close to $40 million that it will increase just because of tax credit amortization.
Third quarter to fourth quarter?
Yes.
Got it. And just the follow-up question for you Andy. I think that the performance in bank stocks lately have seemed to reflect some revenue concerns rather than credit concerns for 2019. Although, of course, you bucked the trend in loan growth this quarter and I'm wondering what your message is on that positive operating leverage on 1% to 1.5%. So, I guess this is a two-part question. Where is the company in terms of it's -- not less traditional investment spend? So, let's talk about technology for example. And if the revenue environment is less robust for the whole industry than we'd hope, will you still be able to deliver that positive operating leverage for 2019?
Short answer to your question Erika is yes. The longer answer is we do expect credit to continue to be favorable, its 46 basis points in charge-off this quarter. The loan growth is the only reason we added to our reserve. Credit quality underlying that is very stable, but we have good loan growth, so we added to reserve and as we have done in the past. As we think about next year in terms of the revenue, we have some positives as I talked about earlier. It's both the combination of less -- fewer headwinds as well as continuing momentum in certain businesses. But as we've also said we'll manage expenses consistent with what we see from the revenue side equations, sort of like we did in this quarter. So, we expect to continue accelerated revenue opportunity next year and we're managing expenses with that in mind. If the revenue doesn't happen as we think, we'll manage expenses more prudently.
That's helpful. Thank you.
You bet.
And Erika maybe one thing that I would just kind of add to that. I think when you end up looking our business mix, so this is one of the things that we've talked about in the past, the business mix having the strong fee base sort of businesses and payments, et cetera and with consumer spend continuing to get stronger, I just see that as something that differentiates us as we think about the future.
And your next question comes from Scott Siefers with Sandler O'Neill + Partners. Please go ahead, your line is open.
Morning guys. Thanks for taking the questioning.
Morning Scott.
Hello Scott.
Just wanted to go back to the deposit dynamics for a quick second. First just make sure I understand the large customer migration you talked about that just went from deposits out of deposits, right, rather than a move within the category of total deposits?
Yes. Those are deposit outflows from the company and if you think about it was acquired by another financial institution and they wanted to bring those deposits under their balance sheet. And it's something that we have been anticipating, that's been a part of our NIM and our asset liability modeling process for well over a year.
Yes, okay. Thank you for that. And then just within the categories same directional trend that you guys versus others which is sort of money coming out of non-interest-bearing into other categories. But the order of magnitude seemed a little larger for you guys and I've seen in others. So, I guess one given you guys are a little unique in terms of business mix with like corporate trust in there, for example, so there's an element of apples-to-oranges. But if maybe you could just briefly walk through how you guys differ from just sort of a typical bank? And then more importantly, I guess, how will that dynamic flush out or play out here as we move forward just given the uniqueness of your business mix?
Yes. Well, I mean again the thing that we end up really focus on in terms of the uniqueness is our corporate business and I mean within those trust structures as yields have gone up, they continue to look for opportunities to be able to get as much yield as they can within that structure and so migrations from non-interest-bearing to interest-bearing is something that we kind of anticipate and expected.
There is a portion of those structures though that is very operational in nature and is sticky within the non-interest-bearing. So, while that migration has been occurring, I don't know whether that will continue to be as strong as it has been in the past.
Andy, if you could--?
Yes, so the corporate trust business is a great -- not only great fee business, but it's a great deposit gathering business. And as Terry mentioned, there's two components to it, one is operational nature and the flows that occur will continue to occur regardless of the rate environment because it is a flow between the bond issuer and the bond holder.
The second component or what I would call more short-term investments and that's where we're seeing more of the volatility, but it's as we expected and particularly in this rate environment is new investment opportunities present themselves, so bottom-line Scott, I don't think it's anything that we didn't anticipate. We're going to be a little bit lumpier because of that second component, but it's in line with what we expect.
Now the other thing is that because of the corporate trust business, the size of our total deposits as a percentage of our total funding cost that even though our deposit pricing may be a little bit higher, our total funding costs are very competitive excuse me.
Okay, that's perfect. Thank you guys for the color. And then if I can ask one last sort of tic-tac question. You had the Elan unit sale that you have announced a few weeks back, any revenue or expense impact as we look into like 2019 that you guys would call out from the loss of that business?
Yes. So, I mean that sale is so impressed. Maybe I can just step back a little bit. That is very specific to third-party ATM processing and it's also the sale of our MoneyPass debit card network and so it's not related to our payments business. As I knew there was a little bit of confusion on that early, so I just want to make sure that actually--
It actually rolls up to consumer bank.
Yes. And the -- it would end up kind of dimensional, so 2017 revenue for that business on an annualized basis was $170 million. On a quarterly basis, third quarter, I believe the revenue was around $45 million and then the efficiency ratio of that business pretty similar to the rest of our company maybe a slightly higher, but pretty similar to the rest of our company. So, if you kind of take that information, you can get some sense, both in terms of fourth quarter and 2019.
From a fourth quarter perspective, right now we anticipate that the sale will close at the end of October, but if not in October, then the end of November and we just have to kind of wait and see based upon regulatory approval.
Okay. All right. That's great. Thank you guys very much.
Thanks Scott.
Your next question comes from Betsy Graseck with Morgan Stanley. Please go ahead, your line is open.
Hey good morning.
Morning Betsy.
Morning.
Andy can you talk a little bit about the different levers that you've got on the expense side, when we're thinking about the operating leverage for next year? I know you talked through kind of revenue line items already, but what's in your back pocket there?
Well, one of the things we talked about is we are investing in both traditional as we talked about the expansion in our commercial banking business as well as more of the digital and payments businesses. We did an acquisition in the third quarter as we talked about we are continuing to expand our capabilities on our mobile application, our capabilities in terms of sales activity on that application. And everything you think about from an investment standpoint as a little bit of a digital focus on it. So that will continue.
We have continued opportunity in terms of optimization of different business processes which we are working across the company in terms of our branch optimization across structures and where we are in this space and so forth. So, we have a number of things, a number of initiatives we're working on. And at a high level, actually I would describe it as continue to invest in the future while recognizing that some of the things that we've done in the past we can do better or do lesser.
And your tech investments spend, am I right in thinking it's around $1.5 billion, is that is that accurate?
Yes, so the CapEx related to technology is about $1.2 billion. And as Terry and I have talked about in the past, our operating expense related that probably another $1.5 billion. So, if you combine the two, it's just over $2.5 billion, but the CapEx that we talked about is $1.2 billion.
Got it. Okay. And so that line kind of holds in, but then the headcount or occupancy associated with these other things you're talking about pullback that's the push-pull in the line items?
Yes, that's a fair way to think about it. And just to be clear we've been at that spend level for a year and a half, two years, so that's in the numbers as we think about what we reported today.
Got it. And then can I shift gears a little bit and just ask the thoughts around CECL. I know that's not coming into play until 1Q 2020, but I'm sure you're prepping for it and going parallel next year, so maybe you can give us some thoughts as to how you're thinking about it from an early look perspective?
Yes, I mean as you said we're still kind of in the process of dimensioning it. 2019 is kind of our parallel year. If you end up looking across the entire industry, the entire industry is really in the process of kind of refining their models that they'll use as part of that process.
I would anticipate that we'll have better dimension around what the size of that is later this year. And of course one of the factors that comes into play is what is your outlook with respect to the economy, et cetera, as you get closer to the adoption of it. So, lot of moving parts, but we're on track. We feel good about at lease the position that we're in in terms of us being able to adopt it.
And are there areas you think there's a little give back because some of these ratios look pretty high. Part of it is because we've got very low losses right now, but I'm also wondering if you know there's some parts of the portfolio which could be a net giver of reserves as opposed to a taker?
Yes, that's the interesting thing about CECL, it is very product dependent in terms of within the company, in terms of what the impact of it's going to be. To the extent that you have longer live or longer duration assets like mortgages and that type of product, you're going to actually have a bigger negative impact or increasing the reserve that's going to come into play.
The area kind of -- to me it's a little counterintuitive, but commercial real estate is one of those -- especially on a construction site where you tend to get a little bit of benefit. But we really have to kind of look at the total mix. It's a little bit of a moving dynamic.
Got it, okay. Thank you.
Thanks Betsy.
Your next question comes from Mike Mayo with Wells Fargo Securities. Please go ahead, your line is open.
Hey Mike.
Hi. You mentioned digital banking quite a bit -- the digital platform; you've disclosed that you have 18 million customers, if that's correct in prior annual reports. Can you tell us the percentage of customers for online and the percentage of customers that use mobile banking? I think your other five large bank peers all disclosed this and it be great if you could give that to us, not now, then sometime in the future?
I can give it to you now. So, we have 18 million total customers. If I exclude single service customers, so some of our mortgage customers, card customers, and indirect customers who outside our market -- what they would call full banking customers were about 11 million and of 11 million about 50% use our digital platform.
And how many -- what percent mobile?
The majority of that is mobile.
Okay, great. I got my wish. -- And you've got one price for doing well and one price for not doing so well just follow-up on those two other issues. So when it comes to deposit growth, when we look year-over-year, it still doesn't look great. So, I guess that would kind of neutralize the seasonal aspects. And so I get the one-off merger -- the client lost in deposits and then some other ins and outs, is there anything else going on there? Maybe just what's your forecast for deposit growth over the next year or so?
Yes, I mean I think we've kind of covered all the dynamics that are taking place. On a year-over-year basis, again, the decline is 100% related to this part of our customer. Consumer deposits are growing. When we think about 2019, we do expect growth in deposits and I think that'll be kind of consistent with low single-digits. It will be kind of tied to economic growth, et cetera. But I don't think that we -- there's any unusual sort of dynamics that we haven't talked about.
Okay. Then on the positive side, the loan growth -- commercial loan growth, and I noticed been a lot of questions on that. And I'm just trying to get the main takeaway, are you executing better or are you taking more risk? Or is it simply mix if you were to characterize that, kind of what's the main -- a lot more cautious.
Yes, I want to be real clear on one thing it's not taking any more risk. Our credit box has not changed at all and we've been very prudent and strict around and disciplined for a long time and that is not changing at all.
I think it's a function of all the things we talked about. It's expanding our customer base, gaining market share, it's our diversified portfolio. It's not in any one area or geography, it's a function of all those things. And that's why we're feeling pretty good about it going forward.
And you open up a new office in the New York area. Are there some other newer offices that are getting traction that's helping with that commercial?
Yes, we've opened up a few offices in the south, the Dallas area and the south -- and the southeast New York. We'll look at other opportunities like this and it's typically leveraging presence that we already have in the market. And we talked about that also thinking about our consumer expansion doing the same, building a customer base that we already have.
Great. all right. Thank you.
Thanks Mike.
Your next question comes from Marty Mosby with Vining Sparks. Please go ahead, your line is open.
Thanks. Two questions. One if you look at merchant processing, it's kind of an anomaly in the growth rates. If you look at over last year, its 4% growth quarter-over-quarter. If you look at sequentially annualized, it's the 5% growth, so looks like an acceleration there. But if you look at year-to-date, it's only growing 3%. So, it's kind of strange how those three numbers all kind of working, but is there really -- is the momentum finally picking up here in essence what we are seeing same-store sales and we're seeing some retail purchases and we're getting that lift from the economy we've been waiting on for so long?
Yes, we have been looking at the dynamics. We certainly are seeing a lift from consumer spending getting stronger. Our sales volumes have been quite strong in that 8% sort of range if you will.
The biggest issue on kind of in terms of both year-over-year growth and then kind of how it started to accelerate is really the fact that a year ago, we're starting to overlap the joint ventures that we had -- we've kind of talked a little bit about. But the overall business we've been making some investments in terms of both capabilities, industry verticals, variety of different things which I think as we kind of think about the future is going to continue to enable us to be able to expand revenue.
We saw one of your peers yesterday actually announced restructuring in the securities portfolio to accelerate that 100 to 125 basis points of net difference between the market and the portfolio rates. Any consideration since that's already kind of being taken out of tangible book value anyway in the mark-to-market that you just go ahead and realize that loss you know take it -- there was an extraordinary towards into this year and then accelerate the benefit in essence of what you get from what the market's going to give you over the next couple of years.
Yes, I mean short answer is we really don't have any plans to restructure our investment portfolio at this time.
And we've been managing to optimize it all along, right?
Yes.
Have you -- you have excess capital, so given the excess capital that you have it is a way to temporarily deploy it and actually accelerate the benefit while locking in rates. We wake up six months from now and all of sudden rates have somehow fallen back down, you kind of lose that opportunity or that window. So, I just was curious since it's already marked and you got to extra capital anyway, if that wouldn't be something that you couldn't lock in those higher rates why you got them?
Yes. Well, like I said, we don't necessarily have any particular plans to do it so.
Okay, thanks.
Yes.
Thanks Marty.
[Operator Instructions]
Your next question comes from Kevin Barker with Piper Jaffray. Please go ahead, your line is open.
Good morning.
Good morning Kevin,
Hey Kevin.
Just a follow-up on some of the deposit flows and some of the deposit questions you mentioned, the movement out of non-interest-bearing deposits specifically around the commercial deposits, do you have any offsets on fee income specifically around treasury management that could increase fee income as some of the balances come off of non-interest-bearing deposits?
Yes. I don't necessarily -- I can't necessarily kind of point to something like that. I mean I do think that when you end up looking -- and a lot of people end up talking about compensating balances as kind of being that offset or whatever, but I mean our core treasury management growth is about a little under 1% and the drag is really related to the rising rate environment, but there's nothing that I would specifically point to Kevin.
Okay. And then just to follow-up on the expense side. Your expense growth was below your long-term target this quarter on a year-over-year basis, I think you pointed to about 3% to 5% long-term target on year over year and obviously there's some puts and takes associated with the tax accrual and the amortization. But when you look out into the first half of 2019 and maybe in full year 2019, you think it's possible you could see expense growth run below your long-term target and maybe for the foreseeable future?
Kevin it depends a bit on the revenue side of the equations. So, we're managing the company for positive operating leverage and we'll manage expenses as we think about it consistent with the revenue opportunities. So, the numbers aren’t going to be specific, it's going to be relative to what we think on the revenue side.
Okay, all right. That's all I had. Thank you.
Thanks Kevin.
Your next question comes from Vivek Juneja with JPMorgan. Please go ahead, your line is open.
Hey Vivek.
Vivek Juneja with JPMorgan, please go ahead, your line is open.
Yes. Can you hear me? Sorry.
Yes, yes we can hear you. Thank you. Good morning.
Sorry. Thanks. Sorry to go back to the expense question. Just trying to understand Andy -- Terry, the $377 million, here you it will go up $40 million or so for the seasonal increase, but -- so should we think of that $377 million as a good run rate going forward, is there anything like you talked about a legal accrual changes, is there anything like that that's unusual that we need to factor in as we think about -- I know beyond 2018, I mean is this really the new base?
Yes, I mean I think Erika kind of talked a little bit about the averages associated with other expenses. I mean other expenses tends to be a little bit lumpy. It depends upon what businesses are growing, foreclosure, reserves, -- foreclosure or costs and those types of things in terms of how those are changing.
So, I would say that the $377 million is probably on the lower end of that band. And -- so when you kind of think about the future, I really think looking at kind of the averages associated with other expenses is probably a reasonable way to look at it.
Okay, great. Similar one on the other income side. You called out private equity gains, that's also -- that number is also running above if you look at last six quarter average, which is more like $191 million or $226 million. Again how much of it was private equity and what's a good set of run rate to think about?
Yes, so more of that was really related to the tax credit syndications that we were able to do in the third quarter. And again in the third quarter and the fourth quarter, those tend to be a little bit stronger; it will tend to be a little bit stronger. Now, we have the opportunity to be able to do that if we think about a kind of a full year basis because of the fact that we have a very good and strong production base of tax credit and because we can't -- we don't have the capacity to use all of them, we have the option to be able to syndicate them.
So, I think when you think about on a full year basis, there is kind of a little bit of a step-up associated with it, but it tends to be a little lumpy in the third and fourth quarter because of the -- just the timing of when that production occurs.
Okay. Okay, great. One last thing. At the Barclays Conference, you raised your long-term return on average common equity target by 100 basis points. When we do the math on the tax reform benefit, the benefit to you is 150 basis points. So, is there a plan to catch-up on that additional 50 basis points at some point?
At the high level we announced that the tax improvement in the fourth quarter of 2017, we also announced the step-up on some spend activity, particularly related to digital and payments and so forth. So, that is -- the numbers that we talked about incorporate both sides of the equation which is what we're seeing right now.
Okay. All right. Thanks.
You bet.
Your next question comes from Saul Martinez with UBS. Please go ahead, your line is open.
Hey good morning guys.
Good morning Saul.
Two quick -- couple of questions. Just changing gears a little bit. Want to ask you how you're seeing the regulatory environment quarreled has indicated that preference for prudential regulations to be based more on complexity that size, you highlighted that very recently. But do you feel like once we get the proposals out of the way for the $1 billion to 250 billion asset banks, you could see some relief for banks of your size and complexity as well?
I'm hopeful Saul, as I think about our balance sheet, our business mix, our risk profile, our trading book which is you know minimal, all those characteristics are more like a smaller regional bank or medium-sized regional bank there like the large money center banks. So, as you know 2155 [ph] talks about the tailoring shall occur and if you think about tailoring based on risk characteristics, I'm hopeful that we'll get some relief.
Okay. Okay. And just your changing gears and I hate to beat a dead horse on the other expense question; I just want to make sure I understand it right. But I think Terry you mentioned the $377 million should be you just sort of at the lower end of what a reasonable range would be. But am I right in saying that that reasonable range should also be lower than maybe what it's been in the recent past which is average about $450 million for some of the reasons that you talked about the changes in the tax credit amortization business, lower FDIC surcharges and whatnot. But I guess is that the right way to think about it that range should be a little bit lower than what we've seen historically?
Yes, I mean whatever your assumption is with respect to the surcharge in the future, I mean that's kind of where that ends up getting the impact. I mean your point is well taken I think that I wouldn’t just focus on other expenses though. I'd focus on how we're managing the overall expenses. We've got opportunity with respect to the plans and risk programs and mortgage servicing and a whole variety of different things. So, I know there's been -- and I think my horse might be dead. I wouldn’t just focus on other expenses, let's put it that way.
All right. No, point taken. Thanks a lot.
Okay.
Your next question comes from Gerard Cassidy with RBC. Please go ahead, your line is open.
Good morning Andy. Good morning Terry.
Good morning Gerard.
Can you guys to share with us -- when we go back and look at your non-interest-bearing deposits to total deposits during the 1994-1995 tightening cycle or even to the 2004 to 2006 tightening cycle, they held in pretty constant. Particularly in 2004 to 2006, you really didn't lose much in non-interest-bearing deposits. Can you give us some color? Do you think your mix is similar to those time periods? I know Andy, you've obviously -- both of you have been in the bank a long time, maybe you can share with us some comparisons to those time periods?
Yes Gerard, I don't think our mix is all that different. I do think in those time periods, we were in the midst of acquiring corporate trust businesses that they have impacted the activity in the deposits because we were growing -- we've done 22 acquisitions in corporate trust over the years, many of them in the years that you describe. So, that may be a factor in the comps.
Very good. And then following up on regulatory. I know you guys have done everything required from your BSA/AML issues; can you just give us an update on where that stands now?
We have. We completed our activity and our verification from an internal standpoint on June 30th consistent with our schedule. It now sits with the regulators and we're hopeful.
Okay. And just one quick question. What's the duration of the securities portfolio?
Yes, the duration is about four years.
Great. Thank you so much.
Your next question comes from Brian Klock with Keefe, Bruyette & Woods. Please go ahead, your line is open.
Good morning.
Good morning Brian.
So, I promise I won't ask anything about other expenses. I know that you guys talk about the average commercial real estate loan growth and it seems like maybe even some of the headwinds that others have seen in the industry, the pay downs and those sort of headwinds might be abating, but it seems like on end of period basis, I look at page 20 of your sup, if I'm right, commercial real estate loans, the first time you end of period loans have actually grown since the first -- or third quarter of 2016. I'm just wondering is there anything that you're saying is this sort of the inflection point when you think about overall end of period balance growth going forward.
Yes. It’s a good question. We certainly hope that it is. The end of looking at commercial real estate as we said, pay downs were particularly strong. Before tax reform, a lot of commercial real estate developers were derisking, taking a lot of things off -- a lot of their chips off the table and they were paying down and then they had the uptrend to be in the capital market space. So, those were definitely some headwinds.
We haven't necessarily changed -- we haven't changed with respect to our credit box. We're still not -- we're not doing anything crazy from a structural standpoint. So, we are optimistic that it is at an inflection point and no, big part of it is just the pay downs that we saw earlier in the year and have really started to slow.
Got it. Thanks for that. And just trying to triangulate -- I haven't tried to put it back through my model yet, but the big picture guidance you gave for the fourth quarter, it seems like it's implying at least a continued upward trend -- really flattish to upward in the NIM. I know you don't give NIM guidance, but is that a fair assumption even with your beta assumptions that the NIM could be better in the fourth quarter than the third?
Yes. Well, as we said, I mean when we think about the opportunity for NIM to expand, we still think there's opportunity for expansion.
Great. Thanks for your time guys.
Thanks Brian.
Thank you.
And there are no further questions at this time. I will turn the call back over to the presenters for any closing remarks.
That concludes our earnings call. Thanks for listening and please contact the Investor Relations department if you have any follow-up questions.
And ladies and gentlemen, this concludes today's conference call. You may now disconnect.