U.S. Bancorp. (USB) — Q3 2019 Earnings Call Transcript

Thank you, Polly 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 2 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.

Thanks Jen. Good morning everyone and thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on Slide 3. In the third quarter, we earned $1.15 per share. Despite a more challenging interest rate environment, we reported record levels of revenue and net income, driven by healthy loan and deposit growth and continued momentum across our key businesses. Credit quality remained stable. Turning to capital management, our book value per share increased 10.6% from a year ago and during the quarter, we returned 80% of our earnings to shareholders through dividends and share buybacks. Slide 4 provides key performance metrics. In the third quarter, we delivered a return on average common equity of 15.3% and a return on average assets of 1.57%. Our return on tangible common equity was 19.4%. Positive operating leverage drove improvement in our efficiency ratio on both a linked-quarter and a year-over-year basis. Now, I'll turn the call over to Terry, who will provide more detail on the quarter as well as forward-looking guidance.

Thanks Andy. If you turn to Slide 5, I'll start with the balance sheet review followed by a discussion of third quarter earnings trends. As expected, average loans grew 1.1% on a linked-quarter basis and increased 4.7% year-over-year excluding the fourth quarter 2018 sale of FDIC-covered loans that had reached the end of the loss coverage period. Strong residential mortgage and credit card loan growth supported both linked-quarter and year-over-year performance. Commercial and industrial loans grew 0.4% sequentially and 4.7% on a year-over-year basis. Paydown activity picked up in the third quarter, primarily reflecting the rate environment and robust capital market conditions. New business activity remains healthy, although paydown activity is likely to continue at elevated levels near term. Commercial Real Estate loans decreased on a sequential and a year-over-year basis. This quarter, Commercial Real Estate contributed a 33-basis-point drag to linked-quarter average loan growth and an 89-basis-point drag to year-over-year average loan growth. Turning to slide 6, deposits increased 1.4% on a linked-quarter basis and grew 6.0% year-over-year. Compared with the prior period, we continued to see migration from non-interest-bearing to interest-bearing accounts. That migration, along with deposit growth momentum in both our Wealth Management and Corporate and Commercial Banking divisions, helped drive average savings deposits up 8.4% year-over-year. As you can see on slide 7, credit quality remained stable. On a dollar basis, non-performing assets increased 2.7% versus the second quarter, but decreased by 2.5% compared with a year ago. The ratio of non-performing assets to loans plus other real estate owned was stable at 33 basis points compared with the second quarter and modestly improved versus 36 basis points a year ago. Slide 8 highlights third quarter earnings results. We reported earnings per share of $1.15 compared with $1.06 a year ago. Turning to slide 9, net interest income on a fully taxable equivalent basis declined by 0.5% compared with the second quarter and increased by 0.8% year-over-year, which is in line with our expectations. Both linked quarter and year-over-year comparisons benefited from healthy loan growth, offset by the impact of declining rates and a flatter yield curve. Our net interest margin declined by 11 basis points versus the second quarter, in line with our expectations. About 4 basis points of the decline was due to higher cash balances, primarily reflecting changes in policies related to deposits by the European Central Bank. Slide 10 highlights trends in non-interest income. Middle-single-digit year-over-year growth in each of the three payment fee lines, credit and debit card, corporate payments products, and merchant processing was driven by higher sales volumes. As a reminder, processing day accounts will affect year-over-year credit and debit card revenue growth comparisons in several quarters in 2019. In the third quarter, three additional processing days versus a year ago benefited revenue growth. In the fourth quarter, two fewer days will be a drag on year-over-year growth. We continue to expect low-single-digit growth of credit and debit card fee revenue for the full year. Commercial product revenue increased 11.1% from a year ago, primarily due to higher corporate bond fees and trading revenue related to strong capital markets activity. Mortgage banking revenue increased 56.3% year-over-year on strong origination and sales revenue growth. Compared with the third quarter of 2018, mortgage production volume increased by 40.3%, and mortgage application volume increased by 53.1%. Refinancing activity represented about 40% of production in the third quarter of 2019 compared to about 30% in the linked-quarter. Refinancing represented 51% of applications in the third quarter. The year-over-year decline in deposit service charges reflected the impact of the sale of our third-party ATM servicing business in the fourth quarter of 2018. The increase in other revenue was partly driven by the inclusion of the related transition services revenue, which will decrease over time, as well as higher equity investment income and a gain on the sale of assets. Turning to slide 11, the year-over-year increase in non-interest expense reflected higher personnel costs, partly due to higher variable compensation related to business production within mortgage banking and the capital markets business lines as well as increased medical costs. Professional services expense increased primarily due to business investments and enhancement in risk management programs, while higher technology expense growth was primarily tied to business growth initiatives. A decrease in other expense primarily reflected lower costs related to tax-advantaged projects and lower FDIC assessment costs. Slide 12 highlights our capital position. At September 30, our common equity Tier 1 capital ratio estimated using the Basel III standardized approach was 9.6%, and this compares to our target of 8.5%. As previously discussed, our goal has been to manage the capital level closer to our target once we had clarity related to adopting CECL and the final capital rules were promulgated by the Federal Reserve. With the recent release of the final rules, we plan to make a request to the Federal Reserve to increase our share repurchase program to enable us to begin reducing our common equity Tier 1 ratio from 9.6% to approximately 9.0%. I'll now provide some forward-looking guidance. For the fourth quarter, we expect fully taxable equivalent net interest income to decline in the low-single digits on a year-over-year basis. We expect mid-single-digit fee income growth on a core basis year-over-year. We expect to deliver positive operating leverage for the full year 2019 on a core basis in line with our previous guidance. We continue to expect our taxable equivalent tax rate to be approximately 20% on a full-year basis. Credit quality in the fourth quarter is expected to remain stable compared to the third quarter; loan loss provision expense growth will continue to be reflective of loan growth.

Thanks Terry. The record results and industry-leading returns that we delivered in the third quarter, despite a more challenging interest rate environment, is a testament to our well-balanced business model, our numerous competitive advantages, and our risk management discipline. As we head into the final quarter of 2019, we feel good about our loan and deposit trends and our ability to continue to gain market share across our franchise. As indicated on slide 13, we are seeing good digital adoption trends. As loans are increasingly sourced through our digital channels, we expect better customer experience, higher account and volume growth, and improved operational efficiency. Our core fee businesses are performing well. Investments made over the past few years in our payments and mortgage business lines are delivering anticipated results in the form of improving sales and volume growth. Our scale and differentiated service model is helping us win new business and expand existing relationships in our Trust and Investment Services business, which is driving strong asset under management and fee growth. Importantly, we are deepening relationships across our entire franchise, as we bring the power of one U.S. Bank to each of our business customers and consumers. Credit quality remains stable and we are not seeing any early indicators in our portfolio that cause concern. However, we are mindful that at some point the industry will experience a credit downturn, and we remain disciplined in terms of our origination quality and our long-term strategy of remaining within our defined credit box, regardless of the competitive environment. In closing, I'd like to reiterate the message I delivered at a recent Investor Day. We are in a position of strength and will continue to leverage the core competencies and competitive advantage that have taken us to where we are today. However, the world is changing rapidly and we are adjusting and investing for the future so that we can continue to deliver the industry-leading growth and return to our shareholders that they have come to expect from us. I'd like to thank our employees for their hard work and commitment they bring to the job every day. We will now open up the call for Q&A.

Good morning, Matt.

Polly, we're not hearing. We're not hearing, Matt.

We can go to the next caller and maybe Matt can dial in again.

Hi. Good morning.

Good morning, John.

Hi, Terry. Could you provide more details on the request for the capital increase? Specifically, what timeframe are you considering to reduce the percentage from 9.6% to 9%? Is this adjustment planned for a year or a couple of months? Additionally, could you clarify what factors contributed to your decision, such as CECL and tailoring?

Yes. Well, with respect to the second part, I think, that we've now been through a parallel run for a couple of different quarters, and the outlook from an economic standpoint is still relatively solid, and so I think we feel comfortable that we have a good range, and it's consistent with what we talked about at Investor Day. And then, obviously, the final rule coming out is helpful. From a timing standpoint, it won't be accelerated. I think it will be bringing that 9.6% down to 9.0% really during the 2019 CCAR cycle, so by the end of the second quarter.

Okay. Got it. So, it is for this cycle to do it by the second quarter of next year.

Yes. Yes.

I wanted to ask you about your outlook for generating positive operating leverage in the current challenging rate environment. As we move into 2020, is that still a goal? Is the target of 100 basis points still in place? Terry, you mentioned at Investor Day that 2020 would be a tougher year when discussing your three-year targets.

Yes.

Could you clarify what you mentioned at Investor Day regarding your outlook, specifically that you expect net interest income to grow at a faster rate than your fees? A little more detail on that would be helpful.

Yes. So a lot of different questions there. Certainly, in terms of positive operating leverage, it's a balancing act between certain long-term investments. We always kind of take that into consideration. 2020, as I said at Investor Day, I think it is going to be a challenging year, because of where interest rates are today versus where they were a year ago. I mean, the long end of the curve, 10 years, is down almost 150 basis points from where it was last year. So, the landscape certainly has changed relative to when that guidance came out. Right now, I think our outlook, with respect to positive operating leverage, is to achieve that in 2019, on a quarter basis, and as we kind of think about different initiatives, we will consider that our continued transformation from a digital perspective. Derek talked about kind of a do-it-yourself sort of focus, so we're going to look to add different initiatives that we can do in order to try to manage expenses as prudently as we can. But, you know, I think part of it is just what happens with interest rates; I mean, as it’s volatile right now, it's hard to really know, and having an outlook that's much beyond a quarter is pretty tough. Coming back to net interest income versus fees that guidance, right, those comments are really focused on what we think between now and three years out where that growth is going to come from, and I think part of that is an assumption that once we get beyond 2020, the interest rate environment starts to normalize and either stabilizes or starts to come up, and so I think that's part of the thought process between where that mix is going to come from.

And I’d just reiterate John that the theme that we talked about at Investor Day continues to hold which is delivering in the short-term while investing for the long-term. So we're going to manage short-term performance, understanding the rate environment and the economic environment, but deliver on what we talked about in terms of positive operating leverage while at the same time investing for the long-term growth that we're seeking.

Got it. Thank you.

Sure, John.

Good morning, Betsy.

Hey, good morning. Hi. One follow-up there on the tailoring rule. There's also a benefit I think to the LCR and how your reports calculate that and carry cash around that? And I'm wondering, does that have any impact on how you think about either the portfolio that you're holding or your ability to be more competitive for, you know, loans because you can value non-operating deposits or any other benefit from that that maybe we could get a loan under the hood on?

Yes, so with the rules related to the LCR coming out, you know, all it was essentially kind of reducing it to an 80% to 85% level. And, as we’ve discussed, it really helps free up our liquidity probably in the range of $11 billion to $15 billion. And you know, we're still formulating kind of what our game plan is, but I think that we'll look at kind of remixing the investment portfolio in order to be able to both extend duration and possibly enhance the yield a little bit. We may look at reducing our debt level in the wholesale markets, and I think that a number of those different actions would be beneficial to the company, and it's going to be basis points, it's not going to be a major change in terms of net interest income just based upon kind of where the yield curve is, et cetera, but we're looking at all sorts of things.

Right. And I get that. Every little bit helps so.

Yes. It does.

And does it impact all the competitiveness with regard to commercial lending or not really?

I don't think so.

Okay.

I mean we drive from a competitive standpoint based upon what the pricing is in the marketplace. And I just don't see it impacting that a lot.

Okay. And then any just separately at Investor Day, really interesting kind of sidebar tech showcase that you had and I want to just understand how you're thinking about the offering that you've got for merchant acquiring Merchant Services? And understand where you think there's more that you can do there to expand your offering either to other verticals take what you've got and your restaurant hospitality, et cetera to other verticals? Or if there is more that you can do with adjacencies on some of the things that you've been adding to over the past year or so?

Yes, I think it's a three-pronged strategy. One is, continued focus on e-commerce and ISVs which we made good progress in over the last year, we'll continue to focus on it going forward. Secondly is the focus on certain verticals. You may have a couple of airlines, hotels, industry, and healthcare. And thirdly and importantly and probably the biggest opportunity is just the combination of banking products and services together with merchant products and services. The fact is all of our merchants need a bank, many of our small business customers need a merchant provider, and our ability to weave and put those products together in a comprehensive set that helps the customers run their business and gives them information I think is the key to our focus and one of the areas where we see the most potential.

And is it primarily U.S. or is it also Europe? I know you have a more global footprint in this business.

Yes, so the first two would be global across the board, that combination of banking and merchant processing would be principally in the U.S.

Okay. Thanks.

You bet.

Good morning, Ken.

Hey Ken.

Hey good morning guys. How are you doing? Just a couple of fee follow-ups, obviously, mortgage banking was very strong and I'm sure built into your outlook for the fourth quarter growth, but can you just talk about how much more pipeline you expect to pull through on the mortgage side and what you're just seeing in terms of the gain on sale outlook and the loan officer side of the equation there?

Yes, if you consider mortgage banking, it was indeed a strong quarter for refinancing. Looking ahead to the fourth quarter, the situation largely depends on the long-term interest rates. Since rates have recently increased a bit, it may not be as robust, but there should still be a positive year-over-year narrative from the mortgage banking perspective. The application volume remains strong, and production was solid in the third quarter, showing continued momentum. Additionally, we have been making good investments in mortgage loan officers on the retail side and enhancing that aspect. The digital platform we discussed has a high percentage of application capture, which supports our fees to market and enhances our ability to service customers and finalize loans. We experienced a relatively short processing time during the latest refinancing cycle compared to competitors and our past experiences, which can be attributed to those investments.

Got it. I have a second question. I know this comes up from time to time, but you always mention that the PE gains are there. We know the ATM agreement is included as well. Can you help us understand the magnitude of the PE gains, even on a comparison basis if not the exact number? Also, regarding the ATM services, how much is that in revenues and expenses today, and how does that work going forward? Thanks, Terry.

Yes. So, in terms of other revenue, it is a lumpy category. It ends up going up and down depending upon what's happening within the various categories. It includes a lot of different things and equity investment is just one piece of it. But if we end up looking at the overall increase on a year-over-year basis, I would break it down kind of like this about half of it is related to the transitional services revenue and about 25% of it's related to equity investment and then it's kind of a combination of a lot of other things that are kind of driving that. So, when we think about it, because I know this question is out there when we think about other revenue, we talked a little bit about this. Over the course of the last eight quarters, it has ranged anywhere on a quarterly basis from $160 million to as high as $300 million and when we end up looking at what is a core reasonable level that $200 million range is in that ballpark, give or take. It'll be up a little bit in some quarters and down a little bit in other quarters. And that's how we think about it.

Could you clarify if the expense related to the ATM contributes significantly to our growth in expenses alongside the services agreement?

Yeah, it is. That service agreement was really negotiated in order to be able to cover the costs, and the cost level associated with making that transition service agreement is fairly similar to the revenue that we’re generating. And from a timing standpoint that will start to go away as conversions are taking place between now and the end of 2020.

Got it. Thank you.

Yeah.

Thanks, Ken.

Hey, Mike.

Hi. I know we just had your Investor Day, you were talking about positive operating leverage, driven by the digital transformation, so I guess I have a front office and a back-office question. The front office question, I guess you closed what, like 150 branches in the last year, but it's still a decent deposit growth, so how much growth are you getting through digital channels, or some sort of metric that you can give us? And then the harder question, the back-office, I mean, you're retooling the inside of the company. Can you give us any metrics when, like data centers, the peak where you are now, where you expect them to go, or what percent of your applications you expect to migrate to the public cloud or anything else about the internal retooling too?

Mike I'll start and then Terry can add on. So from a sales perspective, as we think about the digital initiatives, the revamping of our app and the focus on the digital capabilities has been focused on a couple of areas, one is insights and improving the ability to connect with the customers. But secondly, it's also the ability to improve sales activity. You see some of our loan stats in the deck that we provide as part of the earnings call. Well, I tell you that both loan activity from a sales perspective as well as deposit activity is growing quite rapidly, and we will see a continued movement of more sales activity and transactions, is already high as you know digitally, but more sales activity to digital channels I think over time, which will allow for our continued opportunities on the expense side of the equation, and if you think about the backroom.

The decision regarding branch closures and reinvestment is influenced by factors such as branch locations, employee interactions, digital transformations, and customer behaviors, which are evolving. Transactions occurring in branches have decreased significantly, with 70% to 80% now occurring through digital channels. This presents an opportunity to reorganize the branch network in terms of size and number. We may shift from a service-oriented approach to a focus on sales or advisory services. I expect these trends to persist, although I don't have specific metrics at the moment. Regarding deposits, there is still potential for growth in sales percentages from deposits. As mentioned by Derek at Investor Day, the opportunity for digital sales, including deposits, could eventually reach 40% to 50% over time, though achieving this will depend on customer adoption.

Okay. And then, as far as the back-office, do you give any metrics on number of data centres? Or how many apps you expect to migrate to the public cloud or anything else just on the inside of the company?

We haven't disclosed the number of data centers. However, as we continue to move activities to the cloud, most of our new development will occur there, which provides several advantages in both capacity and cost development.

All right. Thank you.

Thanks, Mike.

Good morning, Scott.

Good morning, everyone. I appreciate you taking my questions. Terry, could you provide some updated insights on the margin, considering that the disturbances from some temporary issues in the third quarter should be easing in the fourth quarter? Additionally, when do you expect to see any further rate cuts reflected in your outlook? As we look ahead, are we still estimating around $40 million to $45 million in total, factoring in the effect of these rate cuts?

Yeah. Well, let me kind of talk a little bit about kind of our guidance. And hopefully these will kind of get to some of your points. So our guidance with respect to low-single digits is really looking at the implied market where rates in terms of where they're at in the first couple of weeks of October. And kind of implied in that is an assumption that, you know, rates are going to decline and our assumption is that it will be a 25 basis point cut in both October and in December. I think there is still a question as to whether December occurs. The long end of the curve, we are assuming that it's roughly kind of where it is right now. So, that's kind of the assumptions that we're baking into kind of our perspective regarding margin or net interest income. From a margin perspective, it's down about 11 basis points on a linked-quarter. There's about 4 basis points that's really related to those cash balances supporting the balances. And so, when we think about the fourth quarter, we would expect our net interest margin to decline, but kind of in the range of that core level which is 7 to 8 basis points.

Okay. So 7 to 8 basis points of margin decline in the fourth quarter?

In the fourth quarter. Yeah, I think the other thing is that, it's just kind of interesting, if you think about the third quarter, third quarter from an average perspective, short-term rates are actually up about 29 basis points, 30 basis points, although the long end was down about a little over 100. In the fourth quarter, that would be the first quarter on a year-over-year basis, when the short end is down, kind of in the range of that 40 to 50 basis points and the long end is down 150 basis points. So in the industry, that's why people are looking at it. And we would expect the fourth quarter to become more challenging as we go into the quarter end and into 2020.

Okay. So to clarify, does the 7 to 8 basis points imply that it might decrease as we anticipate further rate cuts, or is this a new rate that I should be aware of?

Yeah. I mean, I would say, that given the fact that it’s so volatile right now and we don't really know where rates are going, it's tough to look beyond the fourth quarter.

Okay. Fair enough. All right, thank you very much. I appreciate it.

Thanks, Scott.

Hi. Good morning.

Good morning, Erika.

I wanted to follow up on John's question. Even outside of mortgages, the fee income trends are quite strong. Payments have increased by 5% year-over-year, and trust and investment management has grown by 2% year-over-year. I'm curious about your long-term revenue targets: do you consider a 5% fee income increase over the next three years to be too optimistic or in line with your expectations? I'm emphasizing fees because, as you mentioned, Terry, there is significant uncertainty regarding the forward curve. In fact, the probability for October has changed in the past couple of hours. I'm trying to assess the impact of fees, and I have another question regarding balance sheet growth.

Yes. Well, maybe, just kind of, again, this kind of ties a little bit to Investor Day and some of the guidance associated with that. The outlook for fee income, in part, will depend upon what happens with rates. I mean, the puts and takes with respect to mortgage banking and so all kind of a function in terms of what happens from a rate perspective. But, I think, we’re confident when we think about the investments that we've been making both in the payment space of business and our corporate trust and some of the digital capabilities, our capital markets business, all of those, we feel like we have a position of strength at this particular point in time and that momentum will continue to carry. I mean, there will be puts and takes. It kind of depends upon what happens in the environment. Consumer spend continues to be strong. We don't see anything in the short-term, but where that ends up turning, I wouldn’t get into 2020; is anybody's game.

And on the balance sheet growth contribution to those long-term revenue targets, fully acknowledging that 2020 is going to be challenging. If the rate curve doesn't normalize as you think, but doesn't necessarily get worse than what's in the current expectation. Is there enough opportunity in terms of delivering all of the bank to your current customers, with regards to loan growth. In other words, that implies to me that we would need mid-single-digit loan growth over that three-year period in order to potentially mitigate some of the net interest margin volatility, or lack of help from the yield curve rather.

We have set our targets based on our expectations for growth rates over the next two to three years. I want to clarify that these do not reflect our outlook for 2020 and aren't necessarily an average over the three years due to the anticipated challenges in 2020. Regarding our current balance sheet, it largely hinges on economic conditions, which can be difficult to forecast. However, consumer spending and confidence remain robust, and business activity is generally strong, even though it has been slightly tempered by trade policies. Overall, the economy appears stable. Looking ahead to 2020, we believe the loan growth trends we're seeing this year will persist. We achieved approximately 4.7% core loan growth in the third quarter, and we believe that is attainable moving forward. From the U.S. Bank's standpoint, we have the industry's lowest cost of funds, along with competitive pricing advantages that should help us reach our goals, so I feel fairly optimistic.

Yeah. And, Erika, if you take a moment to reflect on the third quarter, our earning asset growth was just under 5%. Our deposit growth compared to last year was around 6%. So considering the balance sheet growth in that mid-single-digit range, I believe that’s about right.

Got it. Great. Thank you.

Yeah.

Sure.

Good morning, Vivek.

Hey, Vivek.

Good morning. Hi. Sorry, we've been jumping on multiple calls. I'm apologizing if I'm making you repeat something. The other income, did you give any sort of way to think about what's the sort of run rate that seems reasonable?

Yeah. We did talk a little bit about that, and maybe just to reiterate, we end up looking at that level on a quarterly basis, it's gone anywhere from $160 million to $300 million. And as a function of the lumpiness that exists across a lot of different categories of income within that, including equity investments, et cetera. But if I were to – when we think about kind of that core level on a quarterly basis, $200 million, plus or minus is kind of where we believe that is a reasonable kind of range. If you remember in the past, I had said, somewhere between $175 million and $225 million, and that's kind of in that ballpark. So, when you end up looking at the year-over-year for the third quarter, about half of that growth is related to the transition servicing agreement that's tied to the ATM business, and so that goes away over time during 2020 tied to when those conversions occur.

Together with the expense.

Together with the expense. And the expense is pretty similar to the increase related to the transition service agreement from a revenue point of view.

And then, another one which is positive operating leverage. Your previous guidance you used to have the 100 to 150, which went to 100. Are you thinking full year 2019 given everything going on you've obviously got positives on mortgage banking, other income running higher, but then NII softer? Is it still closer to 100 basis points, or do you think given where rates have gone it's going to be harder to get to?

We're consistent with what we talked about Investor Day, Vivek, which is somewhat below 100 basis points but still positive operating leverage.

Okay, great. Thank you.

Thank you.

Hey, Matt.

Welcome back, Matt.

Hi. Thanks. Sorry about that before. Just stepping back kind of a bigger picture this whole operating leverage question. You've got the best revenue growth year-to-date I think of the big banks about 4%. It seems like the expense growth is also the highest. And I guess I am just conceptually wondering like is that the cost of doing business like to get that much revenue growth, that's the expense growth that you need or is there still some catching up in terms of infrastructure or something you are working on a few years ago? Or is there something trying to get ahead of kind of to help drive revenue growth in the future. And obviously, I'm not looking for specific numbers, but just conceptually, some people would look at you and say, okay the revenue growth is really good but the expense growth was a bit higher, and it might just cost that much to generate that much revenue growth. So maybe you could just comment on something like that.

So I will start it Matt and Terry will add on. So first from a big picture standpoint, three big puts and takes. Number one is we're going to continue to optimize the number of initiatives from an operation standpoint, the way we’re delivering products and services. The way we are operating in the back room and all those things will allow for some saves because that's a positive. Secondly, we are going to continue to invest with the long-term. In the digital initiatives we talked about Investor Day, so that's going to cost a bit more; a lot of that’s already in the run rate. If you look at the third quarter specifically though, there were a couple of areas of revenue growth, specifically mortgage and capital markets that have expenses related to missions associated with them and that was one of the reasons for a little higher expense growth.

Yes, I would like to add that we observe changes in customer behavior in both the mortgage and capital markets sectors. We are focused on optimizing our operations in line with these changes, particularly from a front office perspective at our branches. We may increase our activities in that area, but we need to closely monitor customer responses. As we transition to a digital platform, there are also opportunities for optimization in the back office. Additionally, we are making significant investments across all our business lines, which we view as essential for both short-term and long-term success.

Okay, that’s helpful. I just, I think sometimes we're also focused on the absolute level of operating leverage and the fact of the matter is, 80 bps of operating leverage with 4% revenue growth is a lot better than 1% plus operating leverage with 1% revenue growth, just the way the math works so, okay. That’s right. Thank you.

Yes, that's correct. A positive operating leverage of 0.8 on an efficiency ratio of 54 is significantly different from 1% on a ratio of 62. It's all part of the initial considerations.

Thanks Matt.

Good morning, Gerard.

Hey, Gerard.

Good morning guys. You guys have been very good at sharing with us the competition in Commercial Real Estate lending and what's going on in different loan markets. We hear from many of the smaller commercial banks that they're building out their treasury management products. Are you guys seeing any increased competition in that part of the commercial customer base that you deal with regarding products?

Gerard, I would say it's not any different than we've seen historically. I would say probably the change that is occurring to treasury management. You continue to see it going forward is the migration and the use case is really the real-time payments that have been developed and the new products and services as a result of that. So, I think that is going to continue to be a change and as you think about our capabilities in treasury management combined with our corporate payments, I think you're going to continue to see those things coming together and changing with these new rails that have been developed.

And do you think, speaking of that, do you believe Zelle will have a role in this as it transitions from a peer-to-peer service to potentially a business-to-business service?

Well, Zelle, we’ll start to use those new rails as a component of their mechanism, for sure that’s one. Number two, I think Zelle has a lot of opportunities for growth in different aspects and there are also use cases, requests for payment and other things there in the Zelle side. So you’re going to see changes on the business-to-business side related to the real-time rails. You’re going to see continued migration and changes and enhancements on the consumer side related to Zelle, and at some point, some of those things, particularly small business may come together a little bit.

Great.

I agree, Gerard. The key challenge in the competitive landscape will revolve around who can invest in connecting real-time rail systems or Zelle, highlighting the case for the customer. Our focus has really been on the use cases that create value for the customer, and that investment is essential; it's a priority for us.

That's absolutely right. Thank you.

Thank you. And then to pivot, you guys have been very conservative in your construction lending; the portfolio is about $10.7 billion down, just under 5% on a year-over-year basis, but there seems to be recently a resurgence in housing, today the National Association of Home Builders' market index rose bidding and consensus. There seems to be recently some pickup in activity here. Are you guys seeing that in any of your markets and are there opportunities for you to capture some of that growth?

Gerard, we have a housing capital group that focuses on home builders, and we are experiencing good growth, particularly on the West Coast and in the South. That business is performing well. However, some aspects of Commercial Real Estate are experiencing declines due to credit components that our competitors are adopting, which we are not comfortable with. So, while there are positives, there are also negatives, and we are committed to our core customers and the credit parameters we are comfortable with.

Great. Thank you so much. Appreciate it.

Thank you. All right.

Yes. Thank you for listening to our earnings call, and please call the Investor Relations Department if you have any follow-up questions. That concludes our call.