U.S. Bancorp. (USB) — Q1 2018 Earnings Call Transcript

Thank you, James, and good morning to everyone who's joined our call. Andy Cecere, Terry Dolan, and Bill Parker are here with me today to review U.S. Bancorp's first 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 would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation, in our press release, and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Andy.

Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will open the call for questions. I'll start on Slide 3. In the first quarter, we reported earnings per share of $0.96, which compares with $0.82 reported in the first quarter of 2017. During the quarter, a lower-than-expected tax rate, offset by a transitional change in vesting provisions within our stock-based compensation program, increased earnings per share by $0.01. On a year-over-year basis, first quarter net revenue increased by 3.4% to $5.5 billion. Excluding the impact of tax reform on our net interest income, revenue growth would have been 3.9%. Loan growth is seasonally lowest in the first quarter of every year. Pay-downs have been a headwind in recent quarters due to capital markets activities by customers and our disciplined underwriting in commercial real estate at this stage of the business cycle. In addition, in the first quarter, loan demand has been lower across the industry. These factors offset solid growth in our retail loan portfolios and underlying strength in new business and market share gains in our commercial portfolios. We believe the early part of this year will prove to be a transition period. Tax reform impacted not only loan growth this quarter, but also commercial products revenue, as it influenced the timing and level of corporate bond issuance and deal funding. Combined with strong growth in pipelines, conversations with our customers give us confidence that commercial loan trends will improve as we move further into the year, although the timing of more robust growth tied to a resurgence in CapEx investment remains uncertain. In the meantime, we are focused on gaining market share across our lending and fee products. This quarter, we saw improved sales volume growth in merchant processing, higher sales growth in credit card and commercial payment services, and strong growth in new customer accounts and client balances in our Wealth Management and Investment Services businesses. We expect this momentum to continue into the year. On the right side of Slide 3, you will see that credit quality was stable in the first quarter, and our book value per share increased by 5.9% from a year ago. During the quarter, we returned 68% of our earnings to shareholders through dividends and share buybacks.

Thanks, Andy. If you turn to Slide 5, I'll start with a balance sheet review and follow up with a discussion of earnings trends. In the first quarter, average loans grew 2.3% compared with the first quarter of 2017, a decline of 0.1% on a linked-quarter basis. During the quarter, we reclassified $1.5 billion of student loans originated under the federal loan program to held for sale. As you know, we exited the student loan origination business in 2012, and the runoff portfolio is not as strategically important to our future businesses. The reclassification did not materially affect our average balance sheet for the quarter. However, it did affect ending loan balance growth. Turning to core trends. Average loan growth is slowest in the first quarter for each year, reflecting seasonality affecting credit card, auto lending, and mortgage banking, in particular. This quarter, mortgage loans increased 0.9% sequentially but were up 3.9% year-over-year. Similarly, retail loans declined 0.2% sequentially but increased 6.1% year-over-year. Retail and mortgage loan growth is seasonally stronger in the second quarter of each year, and we feel good about core trends in auto lending and leasing, where we continue to gain market share and credit card balances. Adding to the impact of seasonality on retail loan growth this quarter were a few factors. Commercial and commercial real estate portfolios continue to be impacted by elevated levels of pay-downs. While average commercial loans increased 4.0% from a year ago, average balances declined 0.1% sequentially. Pipelines improved as the quarter developed, and we continue to grow commitments. However, line utilization remains at historical lows, and pay-down activity was exacerbated this quarter by corporate clients flushed with cash on the heels of tax reform and continuing to deleverage their balance sheet. Turning to commercial real estate. Average loans declined 6.5% year-over-year and 1.6% on a linked-quarter basis. The risk-reward dynamics in commercial real estate remain unfavorable in our view, particularly in multifamily and certain areas of commercial mortgage lending. That discipline is influencing decisions to not extend credit on unfavorable terms and adding to the elevated pay-down pressures, driven by customers accessing the secondary market. This quarter, commercial real estate contributed a 25 basis point drag to the linked-quarter average loan growth and a 160 basis point drag to year-over-year average loan growth. In the near term, we intend to remain disciplined in our commercial real estate lending.

Thanks, Terry. The early part of 2018 is shaping up to be what we thought it would. The economy is on solid footing, and consumer and business confidence is strong. While the business confidence has not translated into increased lending activity yet, we believe it will. Strong consumer spending, supported by a strong job market, higher wages, and lower taxes, should drive more business activity and business investment in technology and infrastructure, and we are well positioned to win the lending business that comes with it. Business optimism is evident in the conversations our bankers are having with our clients, and we are seeing that in terms of increased commitments and more robust pipelines. I feel very good about the outlook for our fee businesses. We are reaching an inflection point in merchant processing revenue, and our focus on retail-driven purchase mortgages is enabling us to capture market share in mortgage banking. And while reduced headwinds are a positive development, I'm most excited about the sales and volume trends we are seeing in some of our high-return fee businesses like payments and trust and investment services, which provides fuel to an already good momentum in the second quarter and beyond.

With respect to income taxes, our tax rate on a taxable-equivalent basis declined from approximately 29% in 2017, excluding notable items, to a tax rate on a taxable-equivalent basis of 18.9% in the first quarter of 2018. This tax rate was slightly lower than expected due to the accounting impact of stock-based compensation and the resolution of certain tax matters during the quarter.

This is actually Ricky Dodds from Matt's team. Just a quick question on expenses. Appreciate the color you gave. Just wonder if you could talk about expense growth as we exit 2018. Had an uptick in cost this year and in recent years. I was wondering if you could see expense growth sort of at the lower end of your long-term range in 2019 or maybe even below that.

Yes. So this is Terry, and thanks for the question, Ricky. With respect to expenses, we certainly expect them to be, in 2018, kind of on the higher end of that range, as we said. As we get into 2019, one of the things that we expect and we think is important is that we would start to see revenue accelerate because of some of the investments that we're making as well as some of the efficiencies that we would expect from business automation and other activities that we are investing in. So I don't know whether it will come down to the lower end of that range in 2019, but I think we'll start to see an inflection point where it will start to come down in the range during 2019.

Got it. And then maybe to follow up, sort of switching gears. Just thoughts on mortgage banking for the year. Maybe it was a bit weaker than we had expected in the first quarter. I'm just wondering if there's any read-throughs there. And then just sort of raw thoughts as we move throughout 2018.

Yes, let me address that question. In mortgage banking, we are observing a few different trends. Our focus has been on enhancing the retail channel and concentrating on purchase mortgages over the last couple of years. In our specific business, we've actually seen applications increase by about 11% year-over-year, but revenue has declined on a year-over-year basis. This is mainly due to the competitive nature of the industry, which is affecting the gain on sale margins we are experiencing and that others in the industry are seeing, especially in correspondent banking. As the year progresses, this margin compression is creating significant pressure on our competitors. We are continuing to gain market share, and as industry capacity decreases, we expect to see an improvement in margins, although the timing for this is uncertain.

And Terry, I'd add that our capabilities in the digital front, specifically our Loan Portal, position us well for that gain on share on the retail side.

Regarding the deposit topic, noninterest-bearing deposits have decreased by about 6%. I understand you referenced seasonality, but the year-over-year balance has still fallen by approximately 3.5%. Is there anything else affecting this? Could this be largely due to the influence of higher rates and increasing deposit betas? I would like to get more insight on this.

Yes. John, this is Terry again. When we look at deposit trends, for us, it's really kind of important to kind of look at the business mix of our deposits. We typically, in the first quarter, see deposits being down on a seasonal basis, and that's because deal flow within corporate trust tends to be higher in the fourth quarter and then lower in the first quarter. And so we always see kind of a runoff. If we look at kind of the deposit outflows that we saw in the first quarter, we didn't see anything significant in the consumer or the retail side at all. In fact, they were pretty stable from fourth quarter to first quarter. The Wholesale or our Corporate and Commercial Banking deposits were down, but at the end of looking year-over-year, seasonally, it's about the same. So the most significant decrease that we saw was within our Corporate Trust business, and we really think that's tied to 3 factors. The first is the fact that a lot of CLO deals got pulled forward because of tax reform into the fourth quarter, so fourth quarter balances were higher. And in the first quarter, the CLO investment managers started to deploy those deposit balances out of the trust. And so that's pretty natural. But I think because of the pull-forward, it was more pronounced in the first quarter. Second is just timing of M&A activity. We have escrow balances and we saw an outflow of escrow balances, which is really tied to M&A deals. With the pipeline of M&As strengthening, we would expect that to get stronger and then just normal seasonality. So it's kind of 3 different factors that are happening in the Corporate Trust business, not as much really tied to deposit pricing.

And Terry, I'd add our deposit beta assumptions were consistent with our expectations. We're still expecting them to trend towards 50 by the end of 2018. And the other point I'd make is that we saw acceleration in deposits actually here early in the second quarter.

Got it. Regarding loan growth, do you still anticipate a GDP-plus level of growth for 2018? Or could it potentially be weaker based on the trends observed this quarter?

Well, it does appear to be a little stronger in the second quarter than the first quarter. But we still think it's probably going to pick up mostly in the second half of the year. But we did see in the C&I side, for example, our ending balances were higher at the end of the quarter. So there are signals that things are starting to pick up.

Okay. So you're still good with the GDP-plus range for the full year?

Yes. I mean, that's something we talked about last year. We'll see loan growth, for example, in many of our retail categories. And that's going to be more tied to what GDP is doing, et cetera. So I think we see a number of signs that would still make us feel comfortable at this point.

I wanted to follow up a little bit on the expenses, just maybe bigger picture. Andy, the 3% to 5% kind of normalized expense growth, you mentioned that a few times and something you targeted at the Investor Day in 2016. Just remind us, like, what are the foundation assumptions of why 3% to 5% is what you target over time? And the reason I'm asking is we get the question, other regional banks seem able this year and maybe next year to self-fund their tech investments and keep expenses pretty flattish this year and next. So what's different about U.S. Bank in terms of maybe where you are in the cycle, that you're kind of at 3% to 5%, and in elevated, you're at 5% when others are kind of doing flattish?

Well, John, I'll start with the fact that we're starting from an efficiency ratio a bit lower than those other banks that you're describing. I do think we're going to and we are going to focus on positive operating leverage and making sure that our expense growth is below our revenue growth. But at the same time, we want to make sure we're balanced in terms of the making investments for the longer term. So we're factoring in all those things into our number of 3% to 5%. I do think it'll range in there for sure. I do think that there are periods it'll be at the low end of the range. But we want to make sure we're thinking about things not only in the short term, but in the long term.

John, the other thing I would add to that is it's important to remember our business mix relative to a lot of our regional banks that we end up competing against. With the payments business and the Investment Management business in particular, the payments business, a lot of those expenses are more variable in nature. And so as revenue grows, expenses will grow with that, but not to the same level, but also the business mix ends up impacting that a little bit.

Okay, that's helpful. And just as a reminder, what do you guys think is an appropriate medium-term efficiency target for you guys, say, over the next 1, 2, 3 years?

Well, as I said in the prepared remarks, John, I do expect that this first quarter is the high point for the year. And we continue to expect it will be in the mid- to low 50s in terms of our efficiency ratio. So I expect it to migrate down principally because we're going to have positive operating leverage.

Okay, great. And then just a reminder, Terry, where you stand on interest rate sensitivity. Has anything changed there? And can you kind of remind us of the split between the long- and short-end sensitivity?

Yes. So again, looking at our balance sheet, probably about 50% of our assets benefit from the short end of the curve in terms of movements in interest rates and about 50% of it benefits more on the long end of the curve. And that's really what's our business mix has been overall. From an asset liability sensitivity perspective, one of the things I would kind of maybe point out, and Andy talked a little bit about our deposit betas, but if you think about our Corporate Trust business, we're getting closer to, what I would call, that terminal beta level, and that's kind of starting to be baked into our rate movements as well as kind of the wholesale side. So the movement up of deposit betas for us, I think, will be impacted by that, to some extent, favorably, I think, relative to maybe some of our competitors. So that's the way we kind of think about it.

Because for about half of our balances, it's already at the highest level.

Great. And then just one follow-up. You mentioned the overall retail beta or the beta assumptions getting to, I think you said 40 later in the year. Can you just talk about the retail beta? And is that kind of the terminal assumption there? Or would you expect to go kind of higher than the terminal on the retail over time since it's been so low for the first part of the cycle?

Yes. So I mean, the movement from 40 to 50 is probably going to be more so on assumption that retail deposits are going to start to move upward in terms of deposit betas. Through the most recent rate cycle or rate hike, we have seen very, very little movement in terms of deposit pricing. I do think that with the March rate hike and as we get into the rest of the year, we're going to see more competition with respect to retail deposits. And we're just going to be pricing to meet that competition.

I have a couple of questions. First, regarding our previous discussion, your loan-to-deposit ratio seems quite low, in the low 80s. I'm curious if you can leverage that to manage your deposit beta strategically.

Yes, I believe there is an opportunity. We can be more targeted and focused in how we approach retail deposits. We analyze pricing across 120 different markets, closely monitoring where competition is adjusting rates. As a result, we only need to make moves in those specific areas. Your observation is accurate; we can refine our strategy concerning deposit betas as they fluctuate. Although we haven't seen significant changes yet, we anticipate that will happen.

Okay. And then separately, on capital return dividend payout ratios, that kind of conversation, obviously, the Fed put out the SCB proposal recently. Maybe you could talk a little bit about how you see that proposal impacting you and your minimum capital ratios that you have been targeting because, obviously, your SCB is well below. The ratios that the Fed has been putting out there, the SCB of 2.5%, you're well below, I believe, right? So can you talk a little bit about that as well as how you think about the dividend payout ratio over the next couple of years here, given that the soft cap is likely to be removed?

Betsy, this is Andy. We continue to adhere to the base case rather than a distressed scenario. Our base case target is an 8.5% common equity Tier 1, and we are currently at 9%, so we fall within that range. Our capital distribution has aligned with our long-term targets of 30 to 40. I believe this situation may present an opportunity to enhance the dividend component as opposed to share buybacks. Therefore, you can expect to see an increase in the dividend as this regulation becomes clearer.

Okay. And any kind of expectation for how much that could move over time? I know I'm not asking for the specific CCAR, I know you can't talk about that. But you put in the low 30s, but then if I look precrisis, 10 years ago, you did run with a much higher dividend payout ratio. So just wondering how you think about what kind of, over time, payout ratio your business can handle, given the low earnings volatility that you typically have.

Sure. So Betsy, as we think about the $0.30 to $0.40 in dividends and the $0.30 to $0.40 in buybacks, I could see our dividend component migrating towards that $0.40.

My first question is a follow-up to what John was asking. And appreciate, Andy, that you're reminding us sort of the medium-term efficiency target of mid- to low 50s. As we think about 2019, I'm wondering if you could give us sort of a sense of timing of the investment spend relative to the revenue that you would reap from that investment spend. And I guess, really, the question I'm asking is, as we think about the efficiency ratio migrating over time lower, what that rate of change is going to look like in the initial year beyond 2018?

So Erika, I think we're making these investments that we talked about with a particular focus on customer experience and digital, B2B, all those things I've talked about. Those expenses are now starting to be baked into the run rate that you're seeing in the first quarter continuously for the rest of the year. We're going to work on the expense growth to be in that 3% to 5% range under the assumption that our revenue growth is above that, and we talked about our revenue growth assumptions. So to the extent the revenue growth is robust, I would expect, and as expected, I expect our expense to be 3% to 5%. If the revenue growth is below that, we'll manage expenses down, consistent with what our revenue opportunities are, again, with the objective of continuing to deliver positive operating leverage and a lower efficiency ratio over time.

I wanted to ask about the dynamics in commercial real estate. You usually lead in identifying trends in credit inflection. Can you provide more details on the unfavorable terms you're observing as loans come due for refinancing? There's concern in the industry that many commercial real estate loans were secured at very low rates. I'm curious if part of your decision not to refinance relates to developers having other options for low rates outside the banking sector and U.S. Bank, leading you to refrain from underwriting at market rates.

This is Bill. That's definitely a factor. It's related to the interest rate, often the duration, and the absence of recourse structures for these long-term deals, whether we’re dealing with insurance companies, securities markets, or offerings. This has contributed to the decline we’ve seen in what we refer to as the standing loan or mortgage loan sector. On the construction side, however, we remain very active. In fact, we noticed an increase in our construction loans at the end of the first quarter, which was encouraging. That’s where we concentrate our efforts and can provide the most value.

Can I follow up on the payments and the restatement for the revenue and expense recognition? It would seem that you're taking out that rewards payment that was in short-term borrowings and also putting that back in, and that's what changed out of the NII side. Is that right to say?

That's correct.

So then as a go-forward then, Terry, can you help us understand that now that that's going to be netted inside the payments lines, how does that change either the seasonality and the variability of payments revenues as we look ahead from this restated basis?

In terms of the seasonality, I don't think it's going to end up impacting it a lot. I mean, the rebates that you're talking about are principally related to our corporate payments businesses. And we end up looking at the seasonality of that and then just how those rebates will match up against it. I think the seasonality will be the same. You just have to kind of reset your first quarter expectations regarding the line item.

Okay. And then so just more broadly on payments. I know you've talked about the merchant processing getting back to mid-single by midyear, and on a restated basis, it looks like it was back to comping positive. Your corporate and debit is already doing 8%, and corporate's up 12%. Can those also continue to post improving rates of growth as we also move into the second half of the year? So just how coincidental is this overall rise in the payments business? Can you get back to those historical growth rates overall in an aggregate for each of them?

I'm going to discuss corporate payments, while Terry will focus on retail payments. On the corporate payment side, we've had an outstanding year last year and are continuing to see strong performance in the first quarter. We achieved sales growth of 12% and revenue growth of 10%. There is particularly strong growth in both the government and corporate sectors. This is largely driven by technology investments, including virtual pay, which has seen a year-over-year increase of about 20%. I anticipate continued strong growth in these areas of corporate payments, staying at the high end of the single-digit or low double-digit range.

When considering retail credit cards, we've been discussing mid-single-digit revenue growth for the year, and this business often experiences seasonality, with the first quarter typically showing higher revenue growth. It's crucial to keep this in mind. We have noticed an increase in consumer spending in this area, and based on our observations, we believe this trend can continue. However, it will be closely linked to consumer spending patterns throughout the year.

So is this new information or are you reiterating the old information about accelerating investing in tech and innovation? I thought, and correct me if I'm wrong, your tech budget is $1 billion each year and it's gone up to $1.2 billion to $1.3 billion. So when you're saying you're accelerating investing there, is this a little more of a step change than you're thinking before? And if so, why?

No, Mike, it's not new information. It's a reiteration of what we talked about in the fourth quarter.

Okay. And then if we could just get a little bit more kind of meat on the bones. In terms of the areas where you're investing, if you could just give us a little more granularity. And what are the outcomes that you expect? You've clearly said you want revenues to grow fast in expenses over time, that you're playing the long game. In terms of the mobile and online users or other metrics like that, some banks disclose that, others don't. What should we look for on the outside to monitor your progress?

Thanks, Mike. So let me break it into 3 categories. I'll start with the payments categories. And in there, it's going to be a focus on increasing our capabilities around e-commerce and integrated software providers. We're good there and want to be even better in those categories because that's where the growth is. On the retail side of the equation, it's increasing our digital capabilities. Today, about 65% to 70% of transactions occur in our mobile device, but under 20% of sales. We want to continue to enhance our capabilities around the sales side of the equation, offering convenience and speed for customers as we think about a digital-first world. And then on the business side of the equation, it's all focused on B2B and the new rails are being built and our capabilities around those rails. So those are the 3 areas of focus. The outcome of those will be increased sales activity and customer acquisition on all 3 fronts and particularly, on the consumer front, a more central relationship with those consumers and our ability to expand beyond our footprint with consumer customers.

And Mike, I might add maybe just a couple of things. Obviously, on the retail side, the areas of focus, we started in mortgage because we have an important business there in terms of our Loan Portal, bringing online capabilities for people to be able to acquire autos online and be able to get the lending within essentially kind of minutes associated with that, and then checking deposits and all sorts of things. A lot of the digital capabilities in the industry today are very service-oriented, though, and so a big significant focus for us is really more on the sale side as we go forward.

Right.

All right, that's helpful. So just big picture, are you doing this because you have the money with the tax reduction to catch up or to get ahead of the industry? How do you think about it?

Mike, I'm doing this because I think this is where the industry is headed, and I want to be at the forefront.

Most of my questions have been asked, but maybe just 2 quick ones. First on the guidance. All the year-over-year comparisons you're referencing are based on the newly reported numbers, not like what was in the 2Q release, right?

That's right. Based upon all of the recasted numbers.

And then in the NPL schedules, there was a little bit of a jump in C&I. I appreciate it was fully offset by improvement elsewhere. But just any color on what drove that and broader C&I credit views.

Well, the credit's very stable, but yes, we did have one commercial account that's a consumer products account that did go nonperforming. So it was just an isolated incident. But overall, credit metrics are very, very stable.

I have a couple of quick questions. First, regarding merchant processing. Previously, you mentioned that a strengthening dollar had a negative impact from foreign exchange translation. Now that the dollar has weakened, can you provide some insight into the benefit you've received from foreign exchange translation?

Yes. So if you end up looking at revenue in merchant acquiring is, on a year-over-year basis, up about 2.5%. And what we have been guiding for the first half of the year is really that merchant acquiring on a core basis would be relatively flat on a year-over-year basis, and that's essentially what the difference is between the 2, is the FX. Saying that, again, when we end up looking at the second half of the year and we think about the core growth within that business, we think about that in terms of the mid-single digit. So we do expect to continue to strengthen. And those things that we end up looking at, in particular as new business activity and sales volumes, the sales volumes continue to strengthen that business as well.

Okay, great. Regarding the deposit betas for the wealth management division, where are those currently? What level are they at, around 70%? Can you provide any details on that? It’s important to note that this is a different business.

Yes. And so within our Wealth Management business, we started increasing deposit betas in the last rate cycle. And where there was literally no movement in earlier rate hikes, we started to see betas in the 10% to 15%. But they're well below what you see on the wholesale side of the other institutional side. But that's kind of what we've been experiencing.

When I mentioned institutional, I was referring to Wealth Management as it relates to the entire Wealth and Institute of the Corporate Trust. I understand that there's a different definition.

Yes, yes. So if you end up looking at Corporate Trust, when we get to more of a terminal, there are certain deposit betas in that 70% to 75% range, and we're pretty much there already. That's why as we think about the future, we believe the asset viability sensitivity standpoint, that's pretty much baked in. So that's kind of on the Corporate Trust side of the equation. And then on the, what I would say, on the core Wealth Management side, it's closer to that 15%.

I think, in the last quarter, you highlighted that you expected to be sort of at the high end of the 3% to 5% expense guidance because of the reinvestment of a portion of the profit windfall. Sorry, if I missed it, but is that still the expectation within that guide for 2018 and/or is it more revenue-dependent?

No, that is still our expectation.

Okay. And I guess, a little bit more of a detailed question. The other noninterest income line, you mentioned this quarter was off because of lower equity investment. And can you help size that up? And I know it's a difficult line item to gauge on a quarter-to-quarter basis, but this quarter was light relative to last year, even on a restated basis. Can you just give us a sense or help us understand what a more normalized level should be going forward?

Yes, Saul. In terms of giving the specifics regarding equity investments, we've never really provided that specific type of guidance. I will say, in other revenue, there are many different categories of types of revenues that are part of that, including, for example, end-of-term gains and losses on residuals, et cetera, et cetera. It tends to be lumpy because of not only equity investments but just the way that all those different categories end up interacting it from one quarter to the next. So I think what I would suggest is kind of look over a period of time and you kind of see a range, and I would just kind of look within that range as kind of a way of getting some sense on other income.

Got it. The number is about $30 million lower this quarter than the average of last year. I just wanted to make sure I understood that a little bit better.

Yes. It tends to be lumpy.

Got it. And just a final one, quick one. On the consent order, any update there in terms of how that's progressing and just anything you could share on that?

Nothing different. We are in our sustainability phase. Things are going as expected. We expect to be done with our part of the equation in midyear, June 30. And then the regulators will continue with what they're doing, and that timing is uncertain. But we're right on track with what we expect.

Just to follow up on the deposit betas. Can you give us an idea where your deposit beta on the wholesale side stood this quarter and where it was in the previous quarter and where you expect that terminal rate to be?

On the wholesale side, the betas are in the range of 55% to 65%. That's getting pretty close to the terminal level we've experienced in the past. That's the situation today, Kevin.

So overall, your Wealth Management, combined with the wholesale, are getting pretty close to the terminal side, and that's just based on catch-up on the retail, right?

Yes, that's exactly right.

That's correct.

Okay. I have a follow-up regarding some mortgage questions. You mentioned that the correspondent side has been facing significant competition. Can you provide insight into how your gain-on-sale margins decreased on a correspondent basis from the fourth quarter to the first quarter and what your expectations are for at least the next couple of quarters?

Yes. When looking at margins on the correspondent side, they are in the low high single to low double-digit range. This is likely 20% to 30 basis points lower than what we typically observe. We expect that as we move into the latter half of the year, especially in the fourth quarter, these margins will begin to recover. There is considerable pressure on smaller players and those without the capacity to manage such low margins. However, this is the current situation, and we anticipate improvement; it is just a matter of timing.

On the terminal betas that you guys have been talking about on the call, it sounds like the terminal level, and please correct me if I'm wrong, is around the 65% range. Is that fair? Or is it a little lower, a little higher?

Well, that would be kind of on the wholesale side, it's probably just a little bit lower but in that ballpark. On the Corporate Trust side, it tends to be a little bit higher because we end up having the substitute investment as government funds, for example, in the money market fund area or T-bills. So you have to kind of track that, but that tends to be closer to 70% to 75%.

Okay. And could we ever see them get to 100%? I mean, in your guys' experience, because, obviously, we're in a rate environment we've not seen before being so low, could these terminal betas ever get to 100%?

Yes. This certainly isn't our expectation based upon both our experience in the business and also from a client standpoint. There is certain operating sort of need, the cash flow. And so there's a benefit to having those deposits with the bank. And so I don't think from the perspective of having to be competitive in terms of what they're accomplishing that we have to go that high. I think we're at or very close to what we need to be.

Very good. I apologize if you already covered this, Terry. In previous calls, you mentioned the effects that hurricanes and natural disasters had on your merchant processing and acquiring businesses. You indicated in the spring that things would return to normal. Can you update us on that timeline?

Yes, good follow-up. And in terms of the impact of Irma and Harvey, that has pretty much dissipated. So certainly, early in the first quarter, any effect associated with that has pretty much kind of worked its way in. Puerto Rico is much smaller for us. It really isn't that significant, but it will take more time for that to recover.

Great. And then just lastly, you guys have addressed the commercial real estate lending, how you guys obviously have conservative underwriting standards. What are you seeing in the other areas, whether it's retail or commercial? Is there any evidence of those underwriting spending getting a little too aggressive from your competitors that makes you wonder what they're doing?

This is Bill. I would say not necessarily. We're currently in the later stages of economic expansion and the credit cycle. We strive to maintain consistent underwriting throughout this period. I mentioned the activity in real estate and its impact on our mortgage portfolio due to long-term fixed rate pricing. On the other hand, things are pretty stable overall. There is significant pricing pressure, but we focus on building full relationships and offering additional commercial products.

I joined the call a bit late, but it seems you are not committing to reducing expense growth for next year, which is somewhat surprising considering the increase in investment spending this year. However, it also appears that you anticipate a significant rise in revenues. I was hoping you could provide clarity on the operating leverage percentage you are targeting if everything goes according to plan. I understand it's a year away, but we are all concerned about consistent high expense growth. Without the context of revenue expectations, it is somewhat unclear.

Sure, Matt. And this is Andy. Let me clarify a little bit. So we talked about 3% to 5% this year, at the high end of the range because of some of that increased investment we talked about. That increased investment will be in the run rate. We expect positive operating leverage this year. And going into next year, I would continue to expect that we're not going to increase our tax spend again next year. So that will be baked into the run rate, and I would expect the growth rates next year will start to migrate down within that 3% to 5% range.

Okay. In terms of the amount of positive operating leverage that you're targeting because it'll likely be modest this year, I think, based on the guidance and how much are you hopeful to achieve next year?

It will be modest this year and it will continue to increase as we go into 2019 and beyond because our expectation is these investments will produce the revenue that we're looking for, and that's why we're doing it.

Okay. I know a couple of years ago, you put out some of these medium-term revenue growth targets. And I think the hope was that you would achieve that in year 3, which I think is next year. Is that something that's still possible? And remind us how much that revenue growth was.

So our revenue growth rates and our expense growth rates, we do expect to be in the ranges, that we were in the 6% to 8% range on revenue, 3% to 5% on expense. And our return numbers, we're already in that range. One thing I will mention, Matt, is that we intend to increase our ranges on our returns, given the tax situation that we're in. We'll communicate more about that. But as you saw, we're up in that range already in the middle of the range.

Okay. So just to summarize, you are hopeful of the 6% to 8% revenue growth next year, 3% to 5% expense growth, but hopefully drifting below the high end of that 3% to 5% range?

That's our target.

So I just wanted to follow up a little bit on the commercial loan growth from earlier in the call. And I thought what was interesting, looking at your segment data, is I know you guys mentioned that there's still some corporate deleveraging and a lot of your peers have talked about the same issue of some large pay-downs on the corporate side. When we look at your Corporate and Commercial Banking segment, I know this is averages versus end of period, so maybe there was a difference on end of period. But the Corporate Banking and other, actually, balances were slightly up on average or up almost 3.6% year-over-year, but the middle market was actually down and it seemed like that's a trend. It's a little bit different at some of your peers. I wasn't sure if this is just an average issue or if your end-of-period balances in March were showing a different trend versus the average. So maybe we can just talk about that in that Page 10 of your supplement.

Yes. Well, when I think about kind of ending balances, on a spot basis, Brian, they are a little bit higher than the averages. So we do expect to see some momentum as we think about the second quarter. And of thinking about middle market, for us, middle market, we're continuing to grow on the commitment side. But one of the things that we have seen a little bit is just the impact of pay-downs or payoffs. And the principal driver behind that is from market to market, we see some M&A activity, and that M&A activity ends up negatively impacting some of the middle market. If you're looking across kind of all of our markets, we're seeing nice growth in at least half of them, a little bit stronger than that. And we're seeing flat sort of growth in the others. And so it kind of depends market to market and the change is from quarter to quarter, too.

I understand. My other follow-up is regarding funding. I've been focused on the betas, and you mentioned that on the wholesale deposit side, the larger trust deposits are nearing your expected levels. On the borrowing side of your wholesale funding, could you remind us how much of that is swapped out to 3-month LIBOR? Also, what are your expectations regarding borrowing, particularly in terms of refinancings or changes in borrowing costs?

Yes. I understand there has been considerable discussion about LIBOR basis risk in other conversations. However, at the end of the first quarter, we had very little exposure to floating rates based on 3-month LIBOR. Therefore, we are not facing the same basis risk related to increases in 3-month LIBOR at this time.

Okay. So is there anything swapped out for that? Or are you saying just overall it's more fixed on that borrowing base?

Yes. Well, typically, when we go into the marketplace, it's kind of a normal cycle. We have gone about 75% fixed, 25% LIBOR or floating and tied to the 3 months. But we have substantially swapped that out to fixed at this point.

Thank you for listening to our call this quarter. Please call us if you have any follow-up comments or questions.