PNC Financial Services (PNC) Q1 2018 Earnings Conference Call Transcript

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PNC Financial Services (NYSE: PNC) Q1 2018 Earnings Conference CallApril 13, 2018 9:30 a.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Kelly, and I will be your conference operator today. At this time I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. [Operator instructions]. As a reminder, this call is being recorded. I will now turn the call over to the director of investor relations, Mr.

Bryan Gill. Sir, please go ahead.

Bryan K. Gill -- Director, Investor Relations

Well, thank you and good morning, everyone. Welcome to today's conference call for the PNC Financial Services Group. Participating on this call are PNC's chairman, president, and CEO, Bill Demchak and Rob Reilly, executive vice president and chief financial officer.Today's presentation contains forward-looking information. Our forward-looking statements regarding PNC performance assume a continuation of the current economic trends and do not take into account the impact of potential legal and regulatory contingencies.

Actual results and future events could differ, possibly materially, from those anticipated in our statements and from historical performance due to a variety of risks and other factors. Information about such factors, as well as GAAP reconciliations and other information on non-GAAP financial measures we discuss, is included in today's conference call, earnings release, and related presentation materials, and in our 10-K and various other SEC filings and investor materials. These are all available on our corporate website pnc.com, under Investor Relations. These statements speak only as of April 13, 2018, and PNC undertakes no obligation to update them.Now I'd like to turn the call over to Bill Demchak.

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William S. Demchak -- Chairman, President, and Chief Executive Officer

Thanks, Bryan, and good morning everybody. As you've seen by now, for the first quarter we reported net income of $1.2 billion, or $2.43 per diluted common share. Compared to the same period a year ago, we delivered higher net interest income and fee income, and we also benefited from a lower federal tax rate.On the whole, it was a pretty good quarter. And I would like to thank our employees for their continued hard work.

On a sequential basis, we were impacted by seasonality, as we expected, but in addition, there were a couple of headwinds that are worth mentioning. First, our average loan growth was modestly weaker than we expected, although spot loans grew by $1.2 billion. Within C&IB's real estate business, multifamily agency warehouse lending declined in the first quarter as these balances tend to fluctuate pretty broadly. Aside from that, pricing and structure in the commercial real estate space have become more aggressive, resulting in lower new volumes.

And at the same time, payouts and maturities continue at a steady rate, which, of course, makes balanced growth more challenging.Outside of CRE, the underlying trends in our loan portfolios are largely positive, and Rob's going to take you through those in more detail in a moment. Secondly, the movement in rates impacted us this quarter. Clearly, we benefited from higher loan yields as a result of the increase in Fed funds and one-month LIBOR but on the other hand, our funding cost rose this quarter due to higher deposit pricing and as betas continued to move higher. And additionally, the sharp rise in three-month LIBOR relative to one-month LIBOR caused our cost of borrowed funds to increase more than we expected.

That said, we continue to execute well against our strategic priorities and we're excited about our plans to tap new opportunities as the year unfolds.You're all aware of the steps we've taken over the last two years to expand our middle-market franchise to Dallas, Kansas City, and Minneapolis in 2017, and Denver, Houston, and Nashville this year. Now that work is going very well as our new regional presidents and our teams there in those markets have hit the ground running. In addition, we've built an industry-leading technology platform and we're beginning to leverage these capabilities to innovate and enhance the ease in which our customers do business with us. And we are looking forward to beginning the roll-out of our new national retail digital strategy later in the year, which will help us take advantage of our brand awareness and to begin serving more customers and more consumer customers beyond our traditional retail banking footprint.

In fact, we're in the middle of our strategic planning season, and I can actually recall a time when we've had as many attractive organic investment opportunities as we do right now.With that, I'm going to turn it over to Rob for a closer look at our first-quarter results, and then we'll take your questions. Rob?

Robert Q. Reilly -- Chief Financial Officer

Yes. Thanks, Bill, and good morning, everyone. As Bill just mentioned, our first-quarter net income was $1.2 billion or $2.43 per diluted common share. Net interest margin expanded.

Capital return remained strong. Expenses were well-managed. And of course, our results benefited from a lower tax rate.Our balance sheet is on Slide 4 and is presented on an average basis. Total loans were essentially flat linked-quarter.

However, our spot loans grew by $1.2 billion since year-end. Compared to the same quarter a year ago, both spot and average loans grew by $8.8 billion, or 4%, and I'll discuss the drivers of this growth in a few moments. Investment securities of $74.6 billion increased approximately $400 million, or 1%, linked-quarter, as purchases exceeded portfolio runoff. Purchases were primarily made up of U.S.

Treasuries and agency RMBS. In addition, $600 million of money market mutual fund securities were reclassified to equity investments due to an accounting standard adoption. Excluding this reclassification, investment securities increased about $1 billion compared to the fourth quarter.Our balances at the Federal Reserve were $25.4 billion for the first quarter, essentially flat linked-quarter and up $1.7 billion year over year. On the liability side, total deposits declined by approximately $800 million compared to the fourth quarter, reflecting seasonal activity, primarily on the commercial side.

Year-over-year deposits increased by $5.7 billion, or 2%. Average common shareholders' equity increased by approximately $300 million linked-quarter. During the quarter, we returned $1.1 billion of capital to shareholders, or 96%, of first-quarter net income through repurchases of 4.8 million common shares for $747 million and dividends of $362 million. As of March 31, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.6%, down 20 basis points compared to December 31, 2017.

This is primarily due to a decline in accumulated other comprehensive income as a result of the impact of higher interest rates on available for sale securities. Our return on average assets for the first quarter was 1.34%. Our return on average common equity was 11.04%. And our tangible book value was $71.58 per common share as of March 31, which declined slightly on a linked-quarter basis, reflecting the impact of AOCI, but was up 6% compared to the same days a year ago.Turning to Slide 5, as I just mentioned, total average loans of $221 billion were essentially flat linked-quarter.

However, the flattening effect, if you will, was largely due to a $1.5 billion decline in average agency warehouse lending balances which, Bill mentioned, tend to fluctuate. Importantly, spot loans increased by $1.2 billion, or 1%, linked-quarter and both spot and average loans increased $8.8 billion, or 4%, year over year.As I've mentioned, the commercial loan decline in the quarter was a result of the fourth-quarter warehouse lending activity as well as slightly lower commercial real estate balances. Offsetting this decline was broad-based growth and virtually all our other commercial lending segments, including corporate banking, which was up 1% linked-quarter and 7% year over year, business credit, which was up 1% linked-quarter and 13% year over year and equipments finance, which was up 2% linked-quarter and 14% year over year. Commercial loans grew by $8.4 billion, or 6%, compared to the same period a year ago.

Consumer lending increased by $242 million linked-quarter and $402 million year over year, driven by increases in residential mortgage, auto, and credit card loans, which were partially offset by declines in home equity and education lending.Turning to Slide 6, as expected, total deposits were down compared to the fourth quarter, primarily due to seasonal commercial outflows. Somewhat offset by higher consumer deposits, compared to the same period a year ago, deposits increased by $5.7 billion, or 2%, reflecting growth in both consumer and commercial deposits. Total interest-bearing deposits increased $6.6 billion, or 4%, year over year, while non-interest bearing deposits declined approximately $850 million during the same period, which reflected a shift in our deposit mix as a result of the rising rate environment.In addition, deposit betas continue to move upward in the first quarter. Our cumulative beta, which is the beta on our total interest-bearing deposits since December 2015, was 21% and our current beta since December 2017 was 32%, compared to our stated long-term expectation of 46%.

In simple terms, our accumulative commercial beta is already approaching stated levels and while our consumer betas have lagged, we do expect them to accelerate in the second quarter and throughout the balance of the year.As I've already mentioned, and you can see on Slide 7, net income in the first quarter was $1.2 billion. Net interest income increased $16 million, or 1%, linked-quarter. These higher-loan yields were partially offset by higher funding costs and the impact of two fewer days in the quarter. Compared to the fourth quarter, non-interest income declined $165 million, or 9%, reflecting seasonally lower fee income and the impact of significant items on our fourth-quarter results.

Non-interest expense decreased by $534 million, or 17%, compared to the fourth quarter, also reflecting the impact of significant items last quarter. Expenses continue to be well-managed due in part to our continuous improvement program.Provision for credit losses in the first quarter was $92 million, a decrease of $33 million linked-quarter, as overall credit quality remained stable. Our effective tax rate in the first quarter was 17%, reflecting the impact of federal tax legislation. For the full year 2018, we continue to expect the effective tax rate to be approximately 17%.Now let's discuss the key drivers of this performance in more detail.

Turning to Slide 8, net interest income increased by $16 million, or 1%, linked-quarter as higher loan deals were partially offset by higher deposit and borrowing costs as well as two fewer days in the quarter. The day count impact was approximately $42 million. As you'll recall, fourth-quarter net interest income was negatively affected by $26 million due to the impact of tax legislation related to leverage leases. Compared to the same quarter a year ago, net interest income increased by $201 million or 9%, driven by higher loan and securities yields and higher loan balances.Net interest margin was 2.91%, an increase of 3 basis points compared to the fourth quarter, as higher loan yields were partially offset by higher funding costs as a result of the sharp increase in three-month LIBOR as well as the widening spread between one-month LIBOR and three-month LIBOR during the first quarter.

While a large portion of our loans is tied to one-month LIBOR, essentially all of our borrowed funds are tied to three-month LIBOR. First-quarter non-interest income was down $165 million, or 9%, linked-quarter reflecting seasonally lower trends as well as the impact of significant items in the fourth quarter. Compared to the same quarter a year ago, non-interest income increased $26 million, or 2%. This reflected 6% growth in fee income, which is partially offset by a lower other non-interest income.Slide 9 provides more detail on our non-interest income, looking at the various categories, asset-management fees, which includes earnings from our equity investments and BlackRock, was down $265 million on a linked-quarter basis, largely due to the flow-through impact of tax legislation benefits on BlackRock's earnings in the fourth quarter of 2017.

Compared to the same quarter last year, asset-management fees increased by $52 million, or 13%, reflecting higher equity markets and a 5% increase in PNC's assets under management. Additionally, our earnings from BlackRock benefited from a lower tax rate.Consumer-services fees were down $9 million, or 2%, compared to fourth-quarter results, reflecting seasonally lower client activity. Compared to the same quarter a year ago, consumer-services fees increased $25 million, or 8%, and included growth in credit card, brokerage, and debit card fees. Corporate-service fees decreased by $29 million, or 6%, compared to strong fourth-quarter results, driven by seasonally lower M&A advisory fees and loan syndication fees.

Compared to the same quarter a year ago, corporate-services fees increased $15 million, or 4%, reflecting higher treasury-management fees and operating lease income.As we previously disclosed in our 10-K, operating lease income is now reported in corporate-services fees rather than other income and prior periods have been reclassified. Residential mortgage non-interest income increased $68 million linked-quarter, reflecting a negative $71 million adjustment related to updated MSR fair-value assumptions in the fourth quarter. Residential mortgage income declined on a year-over-year basis, primarily driven by lower loan sales revenue, which reflected lower refinancing volumes. Service charges on deposits decreased by $16 million, or 9%, compared to the fourth quarter, driven by seasonally lower customer activity.

On a year-over-year basis, however, service charges on deposits increased $6 million, or 4%, reflecting client growth.Finally, other non-interest income increased $86 million compared to the fourth quarter, which included a negative $129 million net impact of significant items. Excluding these items, other non-interest income declined $43 million linked-quarter, primarily due to lower net gains on commercial mortgage loans held for sale. Compared to the same period a year ago, other non-interest income declined $56 million, reflecting lower revenue from equity investments, including the impact of a first-quarter 2017 benefit from valuation adjustments related to the Volcker Rule. Going forward and considering the reclassification of operating lease income into corporate-services fees, we now expect the quarterly run rate for other non-interest income to be in the range of $225 million to $275 million, excluding net securities and visa activity.Turning to Slide 10, first-quarter expenses decreased by $534 million, or 17%, reflecting the impact of approximately $500 million of significant items in the fourth quarter.

These consisted of a contribution to the PNC Foundation, real estate disposition and exit charges, and employee cash payments and pension account credit. Excluding the impact of these items, first-quarter expenses declined $32 million, or 1%, reflecting seasonally lower expenses and our continued focus on cost management. We've previously announced the goal to reduce cost by $250 million in 2018 as part of our continuous improvement program, and based on first-quarter results we are on track and confident we will achieve our full-year target.Turning to Slide 11, overall credit quality remained stable in the first quarter compared to the prior quarter. Total nonperforming loans were down $23 million and continue to represent less than 1% of our total loans.

Total delinquencies were down $131 million, or 9%, linked-quarter from elevated levels at year-end that reflected seasonality and the residual impact of the 2017 hurricanes. Provision for credit losses of $92 million decreased by $33 million linked-quarter reflecting a lower provision for consumer loans, partially offset by a higher provision for commercial loans. The decline in consumer provision was driven by favorable historical performance on home equity loans, while the higher commercial provision reflects the impact of fourth-quarter reserve releases. These results take into account the outcome of the recently completed shared national credit examination.

Net charge-offs decreased $10 million to $113 million in the first quarter, primarily due to lower commercial net charge-offs. In the first quarter, the annualized net charge-off ratio was 21 basis points, down 1 basis point linked-quarter.In summary, PNC posted strong first-quarter results. For the remainder of the year, we expect continued steady growth in GDP and a corresponding increase in short-term interest rates two more times this year, in June and December, with each increase being 25 basis points. Based on these assumptions, our full-year 2018 guidance compared to 2017 adjusted full-year results remains unchanged and positions us to deliver positive operating leverage in 2018.

Looking ahead to the second quarter of 2018 compared to the first quarter of 2018 reported results, we expect modest loan growth. We expect total net interest income to be up low single digits. We expect fee income to be up mid-single digits. We expect other non-interest income to be in the $225 million to $275 million range.

We expect expenses to be up low single digits. And we expect the provision to be between $100 million and $150 million.And with that, Bill and I are ready to take your questions.

Questions and Answers:

Operator

[Operator instructions] Our first question comes from the line of John Pancari from Evercore ISI Research. You may proceed with your question.

John Pancari -- Evercore ISI -- Analyst

Good morning. Just wanted to see if you could talk a little bit more about the increase in the cost on the borrowed funds, I know you indicated that the increase was more than you had expected. Can you just talk about how that exceeded your expectations, and also, I mean, just since its majority is tied to three-month LIBOR, I assume you would've had pretty good visibility into that. So, if you could talk about how that exceeded? And then what are your plans there? Is there a plan to remix it? Or are you focusing more on the deposit side to help offset that? How do you address that going forward? Thanks.

William S. Demchak -- Chairman, President, and Chief Executive Officer

It's a good question. Basically what happened is that the spread between one-month and three-month LIBOR gapped out particularly in March wider than it's historically run. I guess it's a 35, 34 basis points today, and historically, it might have been half of that. So all else equal in our forecast of NII, we wouldn't assume that you'd see that gap.

The issue is -- today, it is as wide as any time it's been in history other than the financial crisis. And a lot of people are writing that that basis will collapse back in. We'll have to wait and see. I think there some pressures causing that as a function of the revamp of the money market industry coupled with some implications from this BEAT tax provision that is in the new federal tax code.

So we are going to have to wait and see. If it doesn't change, we can -- and we'll probably do this anyway, we can start swapping our wholesale funding to our banknotes into one-month just to get the basis mismatch between our loans and funding closer but that price will be embedded in that swap. So we'll have to see -- wait and see, what happens.

John Pancari -- Evercore ISI -- Analyst

OK, all right. Thanks.

Robert Q. Reilly -- Chief Financial Officer

Hey, John, I can jump in there. So. Some of the increase in three-month LIBOR is fundamental to rates rising. The issue is just the gap.

And that gap, as Bill mentioned, was about 35 basis points and we equate that to about $15 million or $20 million cost in the quarter.

John Pancari -- Evercore ISI -- Analyst

Got it. OK. All right. And then, my follow-up is around loan growth.

I know you did not change your full-year outlook around loan growth. The average balances were somewhat flattish this quarter. You did see good growth at the end of the period. So first of all, I'm assuming the end-of-period trends are likely more indicative of your expectations given you're not changing your full-year outlook.

And then separately, can you talk about the broader macro backdrop? I mean, we've seen weak industry loan growth, that's for sure for the sector, but the macro signs still point to improvement, particularly given tax reform. So if you could just talk about that a little bit?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. I think our own performance kind of mirrors what you see in the NHA data where you saw a decent pickup in March and we're seeing that in our pipeline. So I don't know what the anomaly was in Jan, Feb other than all the busywork everybody did prior to that tax getting enacted. So all else equal, I would kind of say that March is the norm and Jan and Feb were the anomalies and that should set us up well for the rest of the year.

The one exception to that, and I mentioned this, was in real estate, where we've just seen pricing structure get to a place where it's kind of beyond our risk tolerance and versus our historical growth in that sector were most certain to be slower.

John Pancari -- Evercore ISI -- Analyst

OK, great. Thanks, Bill.

Operator

Our next question comes from John McDonald with Bernstein. You may proceed with your question.

John McDonald -- Sanford Bernstein -- Analyst

Hi. Good morning. In terms of the retail deposit betas changing, we're trying to get a sense of the pacing. The disclosures you guys gave on Page 6 were really helpful.

So if you look at the 17% current deposit beta this quarter, it's up from the cumulative 8% since rates started rising. Rob, any kind of broad sense of where that might have stood last quarter and is this something where we could get to the state of beta in a couple of quarters? Or this could take a while to get there? Any thoughts there?

Robert Q. Reilly -- Chief Financial Officer

Yes. So, good question in terms of the betas particularly on the consumer side where they've lagged. We're keeping an eye on that. Relative to last quarter, they have accelerated.

So that's true. And then going into the second quarter, we do expect it to accelerate on top of that. How much remains to be seen, because a lot of that's competitive pressures, but our best estimates are built into our NII guidance.

John McDonald -- Sanford Bernstein -- Analyst

And can you just remind us what factors you're looking at when you make these decisions, you're looking at competition locally, and I guess, nationally? And then what your loan growth plans are? And everything gets put in the mix there?

William S. Demchak -- Chairman, President, and Chief Executive Officer

All of the above.

Robert Q. Reilly -- Chief Financial Officer

Absolutely.

John McDonald -- Sanford Bernstein -- Analyst

Just the last thing, any more color on the deposit mix shift you're seeing? Just more consumer versus commercial within the deposit mix, you're seeing folks move from checking to time and savings but within PNC?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. Now the shift this quarter on commercial is more of a seasonal effect of commercial deposits. It's sort of running down. We would actually expect them to come back.

As you know, they don't help us, particularly with LCR. So it's not quite as important versus what we do on the consumer side.

John McDonald -- Sanford Bernstein -- Analyst

And in terms of the behavior that you're seeing on the consumer side, any more color there?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Pretty consistent, John, with what we've been seeing in terms of more of the savings and the relationship-driven deposits, which we've been pursuing for the better part of the last year. So that trend continues.

John McDonald -- Sanford Bernstein -- Analyst

I guess I was just asking. Is that accelerated kind of like the deposit pricing? Is that also gotten faster this quarter?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes, a little bit. Yes, a little bit.

John McDonald -- Sanford Bernstein -- Analyst

OK. Thanks.

Operator

Our next question comes from Erika Najarian from Bank of America Merrill Lynch. You may proceed with your question.

Erika Najarian -- Bank of America Merrill Lynch -- Managing Director

Yes, thank you. Good morning. My first question is on the Fed proposal for CET1, specifically, for the stress capital buffer. I think the market was reading it as largely positive for banks like PNC and you now have a pretty set floor in terms of where your capital minimums would be.

And I'm wondering if the stress capital buffer did get finalized as it stands, how that would change how you're thinking about buybacks and dividends from here? And also, how you're accounting for the volatility now in your business as usual CET1 levels given, of course, your CCAR results now feed into it?

Robert Q. Reilly -- Chief Financial Officer

OK. This is Rob. Why don't I take a shot at some of that?

William S. Demchak -- Chairman, President, and Chief Executive Officer

I'm not sure I understood the last part of the question.

Robert Q. Reilly -- Chief Financial Officer

Well, I mean, it broadened that out a little bit in terms of the Fed's proposal in terms of the changes to CCAR, which in broad measure are encouraging. We just got it Tuesday, as you know. So we're still reviewing it but a couple of things right off the top that are helpful, obviously, are the elimination of the soft capital on dividends at the 30%.The reduction of base case capital action from the severe scenario with the exception of a year's worth of dividends, the RWA growth in the severe scenario, and then also that the elimination of the quantitative sale. So all those things, I think, worked well and are encouraging.

The stress capital buffer itself, we have to review. If you take a look at our 2016 and 2017 CCAR submissions, we were below that. It remains to be seen how the Fed stresses us in this go around, we'll see but there is an issue there around, what we call, guardrails around the scenarios, because the severe scenarios, in any given year, are going to define that stress capital buffer, which, in the past has been below 2.5%, but theoretically could be higher.

Erika Najarian -- Bank of America Merrill Lynch -- Managing Director

To clarify that last question. Sorry to be confusing but given that volatility in results, the question there had been how should you or how should your investors think about potential buffers that you would incorporate to account for that volatility of result?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. That's kind of the million-dollar question. So, internally, you've heard us talk about this before. We always work toward the endpoint on a severe stress as opposed to the starting point of what our capital is.

And we've talked historically about a target capital state in CET1 of 8.25% to 8.5%. That number being driven historically by our own estimate of what a severe stress would look like. An issue for us is as we approach that number, if the Fed goes from a relatively benign severe stress perhaps as they did last year versus a much more severe stress perhaps as they did this year, you have to change your buffer on the fly, which causes you to then have volatility, as you point out, in your repurchases year-on-year. And I don't know how that plays out through time as a function of what scenarios they come up with but it's one of the things that we need to solve for us as we work through the next year.

Erika Najarian -- Bank of America Merrill Lynch -- Managing Director

And just one more follow-up question. You mentioned that your organic investment opportunity has never been so attractive. And I'm thinking, could you share with us what in your earned-back period is for buyback activity at current valuation levels?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Sorry, our earn-back. I mean, I would tell you that we look at it sort of multiple ways but on an IRR basis, we're today, probably fairly tight. We look at that. We look at where we are price-to-book.

We look at what we think our forward earnings potential is which potentially offset those other two issues. I don't know that I've actually talked about an earn-back period internally.

Robert Q. Reilly -- Chief Financial Officer

But to your point, the investment opportunities that we take a look at clearly beat that.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Erika Najarian -- Bank of America Merrill Lynch -- Managing Director

Thank you.

Operator

Our next question comes from Ken Usdin with Jefferies. You may proceed with your question.

Ken Usdin -- Jefferies & Company -- Managing Director

Hey, guys. How are you doing? Thanks very much. I want to just ask a question on expenses, and I know there's a couple of things, you bought that little IRR firm and a couple of other moving parts. And noticing that the personnel costs are up 8% year over year, and can you just help us understand just is that recent hires? Are you starting to spend some of the tax benefits?

Robert Q. Reilly -- Chief Financial Officer

Yes.

Ken Usdin -- Jefferies & Company -- Managing Director

Just how will we understand kind of the balance of growth versus the CIP, especially as it relates to personnel cost? Thanks.

Robert Q. Reilly -- Chief Financial Officer

Yes. Sure, Ken. So just in terms of expenses in the first quarter, linked-quarter expenses were down low single-digits, which were part of our guidance. The year over year, there's a couple of things going on there.

First, and most prominently, first-quarter 2018 expenses reflect the expenses associated with the acquisitions that you pointed out that happened subsequent to the first quarter. Most notably, the leasing company which we acquired in the second quarter of 2017, and those expenses which are about $27 million are spread out between personnel and equipment expense, personnel because of the higher headcount, and equipment expenses because of the depreciation nature of the leasing business. So that's one.In addition, on the personnel side, we do have some increases around investments that we've made, the hourly wage increase for our retail employees that we announced at the end of the year is there, as well as some of the investments we've made in the new markets as you would expect. So personnel is a little bit higher, but year over year, occupancy is down, marketing is flat, and all other expenses, which are a lot of categories and where a lot of our CIP program is directed, is in line.

So we feel good about what we set out to do and that's why like I said, on the continuous improvement program, we have high confidence that we will achieve it.

Ken Usdin -- Jefferies & Company -- Managing Director

OK. Got it. And then just one quick follow-up. I understand that you move the operating lease up into the commercial, corporate services.

So can you now with that in there, can you just help us understand from a corporate-services perspective within your fee outlook for the second quarter, remind us of the seasonality and what drivers you would expect to flow from that?

Robert Q. Reilly -- Chief Financial Officer

Yes, sure. I can broaden that out for you in terms of our guidance for all the fee categories, not just corporate services, but it's fairly easy in terms of guidance, up mid-single digits in the whole. And for the first time in a while, for each of the five categories, asset management, consumer, corporate services, mortgages and service charges on deposits, all up mid-single digits. So, mid-single digits overall, mid-single digits in each of the categories, including corporate services.

Ken Usdin -- Jefferies & Company -- Managing Director

OK. Got it. Thanks for that, Rob.

Operator

Our next question comes from Betsy Graseck with Morgan Stanley. You may proceed with your question.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Betsy, are you there?

Betsy Graseck -- Morgan Stanley -- Managing Director

Yes. Hey, good morning. Talking on mute. Sorry about that.

Question. Just a follow-up on the expense discussion we just had. I wanted to understand if in 1Q any of the continuous improvement is in the quarter or is this something that you expect just going to be ramping over 2018.

Robert Q. Reilly -- Chief Financial Officer

It's both. This is some, as I mentioned, there's some in the first quarter largely directed at the all other expense line but there's more to go.

Betsy Graseck -- Morgan Stanley -- Managing Director

OK. And so you've got a run rate that you expect would be building throughout 2018. And would it be primarily focused on the real estate as opposed to people? I'm just trying to make sure I understand where improvements are coming from?

Robert Q. Reilly -- Chief Financial Officer

Yes, in terms of the continuous improvement program?

Betsy Graseck -- Morgan Stanley -- Managing Director

Correct.

Robert Q. Reilly -- Chief Financial Officer

I would say, now as I would say, again, just to back up, our objective is positive operating leverage. Our guidance is for expenses to be up low single digits for the year. Part of that is the implementation of the continuous improvement program savings that really are all over the bank. Each area has a targeted level that we review regularly to be able to achieve those.

So even in areas where we are investing, retail, for example, there are substantial continuous improvement savings there as well. So it's broad-based.

Betsy Graseck -- Morgan Stanley -- Managing Director

OK. And then separately I wanted to drill a little bit about on C&I. I know you went through the various categories in where you're seeing the loan growth. It does feel like it's decelerating a little bit.

I mean, year-on-year, it's clearly stronger than what the LQA would be but the question is, are you able to deliver the level of growth you've been generating which looks like it's not only solid good, but maybe little above peers due to the new markets you're going into or is there any sign of increased interest in current borrowers actually increasing their leverage and borrowing more? Do you see more of the share gain or clients are increasing their activity levels that you already have?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Well, what we've seen, you saw in March, I think C&I hit record levels actually. So there is increasing stock in effect of C&I loans out there but inside of that, we continue, both through differentiated product and then through an effect to new markets and kind of harvesting some of the new markets that we've been in, we've been able to sort of outpace peers. And we would expect that to continue with the one exception, I mentioned, of real estate. I don't know what peers are going to do but that market is increasingly tight.

We wouldn't expect to see the growth rates we have in the past.

Robert Q. Reilly -- Chief Financial Officer

But we are still got into mid-single-digit loan growth for the year. So that's all part of it.

Betsy Graseck -- Morgan Stanley -- Managing Director

So a little bit of a pickup though from what you've had this quarter, in terms of run rate there?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. It's interesting. When you think through all the noise this quarter, they actually had a pretty decent quarter in C&I. We had a big drawdown in mortgage warehousing as I said and still managed to grow spot.

Robert Q. Reilly -- Chief Financial Officer

Yes, and even, like I said on the segments, and I mentioned in my comments, corporate banking, up 1%; business credit, up 1%; equipment finance, up 2%.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Robert Q. Reilly -- Chief Financial Officer

Pretty strong.

Betsy Graseck -- Morgan Stanley -- Managing Director

Yes, Q on Q. OK. Thank you.

Operator

Our next question comes from Kevin Barker with Piper Jaffray. You may proceed with your question.

Kevin Barker -- Piper Jaffray -- Analyst

Thank you. In regards to the loan growth, just a follow-up there. Do the retail digital strategy and the roll-out of that have a big impact on your expected loan growth in the back half of this year?

William S. Demchak -- Chairman, President, and Chief Executive Officer

No. No. It's -- the retail strategy will progress but it will start with a deposit gathering exercise. What we think will be attractive returns for us because we don't have the brick-and-mortar costs and we'll have an ability to pay somewhat above what we pay in existing markets.

We will augment that offering with loan offerings in all of our products through time but you should expect that it will start out as deposit and sort of migrate over time.

Robert Q. Reilly -- Chief Financial Officer

So no in 2018, really.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Kevin Barker -- Piper Jaffray -- Analyst

OK. And then given we've had tax reform, lower taxes for a few months now, have you seen any behavioral changes as far as competition among your peers in order -- given that they're seeing better ROEs due to lower taxes?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes, anecdotally. So deal on deal and certain behaviors would suggest that people are willing to cut price as a function of the after-tax ROE. And the competition for sort of plain vanilla C&I loans was tough in the first quarter in terms of price. So I think that is starting to show its hand, much less so in any of that special products.

Robert Q. Reilly -- Chief Financial Officer

Much less so in the special, yeah, -- and also not long enough to be able to access that like Bill said it's really anecdotal and the deals that we saw in the first 90 days in the first quarter.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Kevin Barker -- Piper Jaffray -- Analyst

So is it primarily on C&I lending? Or any particular industries that you're seeing that competition pick up or is it broadly in several different loan categories?

William S. Demchak -- Chairman, President, and Chief Executive Officer

It's interesting. It's on the most generic -- one bank can hold the whole deal -- C&I loans, which is kind of the craziest place, in my view, to start competing away price because you still have the risk associated with the loan and your actual -- we had this discussion a quarter ago, your loss distribution on an after-tax basis causes you to actually have held more capital again such thing.

Kevin Barker -- Piper Jaffray -- Analyst

Right.

William S. Demchak -- Chairman, President, and Chief Executive Officer

So it kind of surprises me. I would expect to see more competition for deposit pricing and on fee-based services in terms of giving some of the excess margins back. And I don't think we've seen that at all.

Kevin Barker -- Piper Jaffray -- Analyst

How much of it do you think is due to pretty low loan growth? And just the amount of capital versus taxes?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Some amount of that and I think it's also we have whatever the number is 5,500 depository institutions in this country, many of which don't have much to offer beyond loans. So that's a product they compete with. And as you go downsize in loans or something that can hold entire loan, you run into that group. It's not happening on the big syndicated loans.

It's not happening on asset base or anything that takes where there's only really a handful of credible players.

Kevin Barker -- Piper Jaffray -- Analyst

Thank you for taking my question.

Operator

Our next question comes from Gerard Cassidy with RBC. You may proceed with your question.

Gerard Cassidy -- RBC Capital Markets -- Managing Director

Good morning, guys. I apologize I had to jump out for a minute if you answered this question already but Bill you started your presentation off with the comment about that you've not seen as many good organic investment opportunities as you're seeing today. You've already talked about the national consumer. What are some of the other organic investment opportunities that you guys are looking at that gives you that kind of positive tone to it?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. So the success we've had in newer markets, obviously, brings up the desire to do more. The list we have on digital things that we want to roll out in consumer, but also importantly in C&I and the TM space is quite large. So there's a lot of asks on the table, the things that make a lot of business sense that I think differentiate us longer term.

Some of it is product-based. Some of it is market expansion-based. Some of it is investment in, in effect, consumer service, the speed of which we can do fulfillment and the ease of which we can serve consumers, which would offer a differentiated product to our customers. So there's a lot.

And you've heard me talk about this before. We didn't feel like we starved our firm for investment through the lower rate environment. We invested pretty, pretty heavily, which was a good thing. And we're at a place now where that ask has sort of accelerated as I guess is what I'm seeing in the strategic planning session this season.

Robert Q. Reilly -- Chief Financial Officer

Yes, Gerald, I just would extend on that in the sense that much of it is possible because of the technology investments we've made over the last couple of years. So things that were interesting before we just didn't have the technology to be able to facilitate, we do now.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes. And part of that is we're now spending an ever-increasing percentage of our tech budget on consumer-facing applications as opposed to building and running --

Robert Q. Reilly -- Chief Financial Officer

Infrastructure.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Gerard Cassidy -- RBC Capital Markets -- Managing Director

In fact, following up on that, how critical is having that capability? Obviously, your big competitors have it, but maybe some of the smaller banks you run into in different markets don't have as good of a product that you guys have. So when you guys look at that, if you have had it on a scale of 1 to 10, 10 being most critical, 1 not being critical at all, how important is it for you guys to have that ability to generate this kind of business through this digital channel?

William S. Demchak -- Chairman, President, and Chief Executive Officer

I think in the future state of the world, I think it's a 10 I mean, 12.

Gerard Cassidy -- RBC Capital Markets -- Managing Director

Yes, no, good.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Things have to be simple. They have to be fast. They have to be coordinated. Customer information needs to be consolidated.

It needs to be in one place. All of that stuff, you can't really execute unless you have a core backbone kind of that allows you to do it.

Robert Q. Reilly -- Chief Financial Officer

And the clients' expectations continue to accelerate.

Gerard Cassidy -- RBC Capital Markets -- Managing Director

Absolutely. And then just finally, as you guys you know, there's been changes coming out of Washington on regulations regarding capital and the CCAR stress test, etc. There seems to be news coming out that the dividend-payout ratio is not going to be limited anymore. You won't get enhanced regulatory review if you go over 30%.

What does the board think? And you guys think in terms of if we look out a couple of years, do you see a dividend-payout ratio coming in north of 40% or 40%?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Gerard Cassidy -- RBC Capital Markets -- Managing Director

OK, good. Thank you.

Operator

Our next question comes from Matt O'Connor with Deutsche Bank. You may proceed with your question.

Rob -- Deutsche Bank -- Analyst

Yes. Hi, good morning. This is Rob from Matt's team. Just on commercial loan yields.

They're up nicely this quarter. Just curious, how do current kind of new money yields compare just given the March rate hike, but also your commentary about kind of higher competition on commercial lending right now?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Do you have the new spreads up for me? The actual spread on loans didn't move a lot, but I think --

Robert Q. Reilly -- Chief Financial Officer

It's four [Inaudible] on the yields, you mean? So spreads, yes, spreads have held up.

Rob -- Deutsche Bank -- Analyst

New deal spreads aren't -- they're kind of spot-on where they were so we haven't seen a lot of the change.

Robert Q. Reilly -- Chief Financial Officer

That's right.

Rob -- Deutsche Bank -- Analyst

OK. And then similar question on securities yields. They were down a few basis points in 1Q. Just curious if you could speak to that and where the expense rates are?

Robert Q. Reilly -- Chief Financial Officer

Yes. They're actually up a little bit when you take into consideration in the fourth quarter. There was a lot going on in the fourth quarter but in the securities book, we did have an accounting change that, in effect, decreased the yields in the RMBS, the non-agency RMBS and increased the yields in the CMBS because that may be more than you want to know, we changed the accounting standard to the contractual life of the security. Prior, we used the estimated life.

So that moves yields around a little bit and actually elevated them. So yields after adjusting for that for the fourth quarter and then went back to normal this quarter. So our print is down three -- 282 to 279, but when you adjust for it, it might be marginally up.

Rob -- Deutsche Bank -- Analyst

OK.

Robert Q. Reilly -- Chief Financial Officer

The other thing I would say too, our purchases on the securities portfolio on the first quarter was largely treasuries, which carry a little bit of a lower yield but I'll just add that in.

Rob -- Deutsche Bank -- Analyst

Got it. Thank you very much.

Operator

Our next question comes from Brian Klock with Keefe, Bruyette & Woods. Sir, you may proceed with your question.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

Good morning guys. So, Rob, I want to follow up on the expense side. On the personnel expenses, can you remind us how much of the first quarter has the seasonal bump that you get from spike and food, and the incentive compensation? And maybe how much that is in the first quarter versus second quarter?

Robert Q. Reilly -- Chief Financial Officer

That's in the first quarter, for sure, in terms of merit and promotion. So that's definitely there, which tends to be a little bit more first-quarter-loaded. The bigger issue just is on a year over year and I don't know if you were on the call earlier, is the acquisition expenses. So the leasing business as well as the investments that we've made.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

Right. So, I guess, for the second quarter then, the guidance, they have the low-single-digit growth from the first quarter. So is that the same expectation for personnel? And I guess personnel is somewhat connected by the recent acquisitions?

Robert Q. Reilly -- Chief Financial Officer

Well, yes, I would say most of the increase in expenses as part of our guidance reflects the higher business activity that we expect in the second quarter, particularly on the fee side.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

Got you. So there's really the mid-single-digit growth you're expecting in fees and the comp-to-revenue ratio should be constant but is just going to go up with that?

Robert Q. Reilly -- Chief Financial Officer

Yes. I haven't done that math, but that's generally right.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

OK. All right. Thanks for that. And just a follow-up question, I think, on the loan-growth side, I know, earlier you said the mortgage warehouse business, I know, on average was down quarter over quarter, when I look at Table 6 on the spot basis, that financial services line was up $1.5 billion.

Can you tell us what the balances were in each quarter for that warehouse business?

Robert Q. Reilly -- Chief Financial Officer

I don't have the balances. The balances quarter over quarter are down a lot for the warehouse because that includes a lot of our securitizations which had a strong quarter in the first quarter. So those aren't necessarily two financial services companies, but because of the structure of the facilities categorized that way.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

OK. And so on a spot basis, the warehouse business was down, not just on average, it was down on spot also?

Robert Q. Reilly -- Chief Financial Officer

Yes, that's right.

William S. Demchak -- Chairman, President, and Chief Executive Officer

You know that?

Robert Q. Reilly -- Chief Financial Officer

Well, I don't know that. In terms of the warehouse facility, the elevation was in the fourth quarter, which actually paid down in the fourth quarter but sort of the average there. I can get you the number, where we are, but it's on the low side because typically in the first quarter.

William S. Demchak -- Chairman, President, and Chief Executive Officer

I can get you that offline, Brian.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

OK. And so where would you think that securitization activity will probably normalize in the second quarter. So maybe that fit could offset a little bit of the core growth you guys are seeing rather late?

William S. Demchak -- Chairman, President, and Chief Executive Officer

It ought to eventually normalize. So we actually have a pretty good pipeline though.

Robert Q. Reilly -- Chief Financial Officer

That's right. Yes, that's right.

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

OK. All right. Thanks. Appreciate your time guys.

Operator

Our next question comes from Mike Mayo with Wells Fargo Securities. You may proceed with your question.

Mike Mayo -- Wells Fargo Securities -- Analyst

Hi. My question's on the new market strategy in commercial. So after Denver, Houston, and Nashville this year, what cities might be next? And how many total cities might you expand to?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Well, without naming cities, maybe you could name them yourselves. And in fact, we look for cities that we are not in that have target corporate population that kind of matches off against our product suite and expertise. And when we started this exercise, we were less than half, I think, of the large markets that have C&I opportunities.

Robert Q. Reilly -- Chief Financial Officer

Yes. That's right.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Through time, we would hit most of them. I don't know what time means, but we've had success and we will keep rolling out as opportunity presents itself.

Mike Mayo -- Wells Fargo Securities -- Analyst

And I'm sure you can see success if you look at Dallas, Kansas City, and Minneapolis. You said you've seen success in the new markets but we, on the outside, we can't see that in the aggregated results, right, because the new investing in Denver, Houston, Nashville is going to be offsetting. So I guess just generically, what is the time that you go from investing to harvesting in a new city? And in aggregate, for the total new market strategy, what's the total time for going from investing to harvesting?

William S. Demchak -- Chairman, President, and Chief Executive Officer

Well, I mean, let's look at the Southeast, I guess, as maybe the best example. So when we bought the RBC branch, is that in effect what we did although we had a branch network there. We grew balances. We met customers but it's probably three years before we really saw the acceleration and volume pick up, and importantly, cross-sell with fee-based products.

In the newer markets that we've just entered, they don't cost that much money. We get to breakeven pretty quickly; a couple of big deals and you're breakeven in a year but before they really start to contribute. Sort of on a return-on-capital basis, you're probably looking at that three years.

Robert Q. Reilly -- Chief Financial Officer

Which is the corporate banking sales cycle basically.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Yes.

Mike Mayo -- Wells Fargo Securities -- Analyst

And with the sales.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Just to continue, if we get this right, of course, those investment dollars sort of are continuous. So in effect, we'll be harvesting new markets as we start other ones. So it won't be a net drain. All else equal, we have a small net drain right now because we've done six in two years.

Robert Q. Reilly -- Chief Financial Officer

Yes, that's right. No, I get it. Look in broader measure, that we're very encouraged in terms of receptivity to our products, our services, our --

William S. Demchak -- Chairman, President, and Chief Executive Officer

Client calls to new clients --

Robert Q. Reilly -- Chief Financial Officer

Yes, our client interactions.

William S. Demchak -- Chairman, President, and Chief Executive Officer

It's working, yes.

Robert Q. Reilly -- Chief Financial Officer

The energy is high.

Mike Mayo -- Wells Fargo Securities -- Analyst

One more follow-up. No, I get it. Look, your expenses are up a little more than $100 million year over year. As you buy a bank, you're spending $10 billion, you're spending 100 times more, you spent $100 million.

You get tons of questions. I get it but what is your sales pitch as you go into the new market? Because as you said a lot of these smaller banks that are causing the claim the C&I loan competition, that's all they have are loans. So I guess you have a very good sales pitch against them but what's your sales pitch against some of the very large banks that have more scale and a broader product suite, and so who are you competing against these new markets?

William S. Demchak -- Chairman, President, and Chief Executive Officer

We compete against JPMorgan and Wells Fargo and BofA in every market we're in.

Robert Q. Reilly -- Chief Financial Officer

That's nothing new.

William S. Demchak -- Chairman, President, and Chief Executive Officer

That's nothing new. And we go with our A team, in the middle market and small or large corporate with a very credible, capable TM service in a leading against in all the surveys. We go with a capital markets business that is relevant to that type of client. We're not in the equity business but we're not trying to do equity deals for the Fortune 100.

And it works for us. We win our time and a lot of these things and all the market we are already in. We go into a new market and we do the same thing.

Mike Mayo -- Wells Fargo Securities -- Analyst

All right. Thank you.

Operator

We have no further phone questions at this time.

Bryan K. Gill -- Director, Investor Relations

OK. Well, thank you all for joining us on the call this quarter.

William S. Demchak -- Chairman, President, and Chief Executive Officer

Thanks, everybody.

Robert Q. Reilly -- Chief Financial Officer

Thank you.

Operator

[Operator signoff]

Duration: 55 minutes

Call Participants:

Bryan K. Gill -- Director, Investor Relations

William S. Demchak -- Chairman, President, and Chief Executive Officer

Robert Q. Reilly -- Chief Financial Officer

John Pancari -- Evercore ISI -- Analyst

John McDonald -- Sanford Bernstein -- Analyst

Erika Najarian -- Bank of America Merrill Lynch -- Managing Director

Ken Usdin -- Jefferies & Company -- Managing Director

Betsy Graseck -- Morgan Stanley -- Managing Director

Kevin Barker -- Piper Jaffray -- Analyst

Gerard Cassidy -- RBC Capital Markets -- Managing Director

Rob -- Deutsche Bank -- Analyst

Brian Klock -- Keefe, Bruyette & Woods -- Managing Director

Mike Mayo -- Wells Fargo Securities -- Analyst

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