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PNC Financial Services Group, Inc. (NYSE:PNC)
Q1 2018 Earnings Conference Call
April 13th, 2018, 6:30 a.m. ET

Contents:

  • 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. If you would like to ask a question during this time, simply press the number 1 followed by the number 4 on your telephone keypad. If you would like to withdraw your question, please press 1 and then the number 3 on your telephone keypad. 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 Gill -- Senior Vice President, 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 the 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 feature 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 at our corporate website, pnc.com under Investor Relations. These statements speak only as of April 13th, 2018, and PNC undertakes no obligation to update them.

Now, I'd like to turn the call over to Bill Demchak.

William Stanton 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 but 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 CNIB's real estate business, multi-family agency warehouse lending declined in the first quarter. These balances tend to fluctuate pretty broadly. Aside from that, pricing and structure and the commercial real estate space have become more aggressive, resulting in lower new volumes, and at the same time, payoffs and maturities continue at a steady rate, which of course, makes balance growth more challenging.

Outside of CRE, the underlying trends in our loan portfolios are largely positive. 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 in one-month LIBOR.

But on the other hand, our funding costs rose this quarter due to higher deposit pricing as betas continue to move higher. Additionally, the sharp rise in three-month LIBOR caused or cost of borrowed funds to increase more than we expected. That said, we continued to execute well against our strategic priorities and we're excited 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 its capabilities to innovate and enhance the ease with which our customers do business with us. And we're looking forward to beginning the rollout of our new national retail digital strategy later in the year, which will help us take advantage of our brand awareness and will begin serving more customers, more consumer customers beyond our traditional retail banking footprint.

In fact, we're in the middle of our strategic planning season. I can't 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 -- Executive Vice President and Chief Financial Officer

Yeah. Thanks, Bill. 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 four and it's 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%. 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 US 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 31st, 2018, our Basel III common equity Tier 1 ratio was estimated to be 9.6%, down 20 basis points compared to December 31st, 2017. This was 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 1.3%. Our return on average common equity was 11.04%. And our tangible book value was $71.58 per common share as of March 31st, which declined slightly on a linked quarter basis, reflecting the impact of AOCI, but was up 6% compared to the same date a year ago.

Turning to slide five, 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 mentioned, the commercial loan decline in the quarter was the 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 equipment 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 six, 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 in our total interest-bearing deposits since December 2015 was 21% and our current beta since 2017 was 32% compared to our stated long-term expectation of 46%. In simple terms, our cumulative 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 seven, net income in the first quarter was $1.2 billion. Net interest income increased $16 million or 1% linked quarter. Its 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 over credit quality remains stable. Our effect 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 eight, net interest income increased by $16 million or 1% linked quarter. Its higher loan yields were partially offset by higher deposits 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 leveraged leases. Compared to the same quarter a year ago, net interest income increased by $201 million or 9% driven by higher loan and security 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 are 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 seasonably 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 was partially offset by a lower other non-interest income.

Slide nine provides more detail on our non-interest income, looking at the various categories, asset management fees, which includes earnings from our equity investments in Blackrock. We're down $265 million on 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, reflected 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 from 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 of other non-interest income to be in the range of $225 million to $275 million, excluding net securities and visa activity.

Turning to slide ten, 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 credits. Excluding the impact of these items, first quarter expenses declined $32 million or 1%, reflecting seasonally lower expenses and our contented focus on cost management.

We previously announced a goal to reduce costs by $250 million in 2018 as part of our continuous improvement program. 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 remains stable in the first quarter. Compared to the prior quarter, total non-performing 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. The results take into account the outcome of the recently completed Shared National Credit Examination.

Net charge off 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 point, down one 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 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

Thank you, sir. At this time, if you would like to ask a question, please press the number 1 followed by the number 4 on your telephone keypad. Please hold while we compile the Q&A roster.

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

John Pancari -- Evercore ISI Research -- Analyst

Good morning.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Hey, John.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Hey, John.

John Pancari -- Evercore ISI Research -- Analyst

I just wanted to see if you could talk a little bit more about the increase on the costs of the borrowed funds. I know you indicated the increase was more you had expected. Can you just talk about how that exceeded your expectations? Also, since the majority is tied to three-month LIBOR, I assume you would have had pretty good visibility into that. So, if you could talk about how that exceeded. Then what are your plans there? Is there a plan to remix it or are you focusing on the deposit side to offset that? How do you address that going forward? Thanks.

William Stanton 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 at 35, 34 basis points today. Historically, it might have been half of that. All else equal, in our forecast of NII, we wouldn't assume you'd see that gap. An issue is today it is as wide as any time it's been in history other than the financial crisis. A lot of people are writing that basis will collapse back in. We'll have to wait and see.

I think there are 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. We're going to have to wait and see. If it doesn't change -- we'll probably do this anyway -- we can start swapping our wholesale funding, our bank notes 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 wait and see what happens.

John Pancari -- Evercore ISI Research -- Analyst

Okay. Thanks.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Hey, John, I can jump in there. Some of the increase in three-month LIBOR is fundamental to rates rising. The issue is just the gap. That gap is still mentioned as about 35 basis points. We equate that to about $15 million or $20 million in costs in the quarter.

John Pancari -- Evercore ISI Research -- Analyst

Got it. Okay. 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 flat this quarter. You did see good growth in the end of period. First off, I'm assuming the end of period trends are likely more indicative of your expectations given you're not changing your full-year outlook. Secondly, can you talk about the broader macro backdrop? We've seen weak industry loan growth, that's for sure, for the sector, but macro signs still point to improve, particularly given tax reform. So, if you can just talk about that a little bit.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

I think our own performance kind of mirrors what you've seen in the H8 data, where you saw a decent pickup in March. We're seeing it in our pipeline. I don't know what the anomaly was in Jan/Feb other than all the busy work everybody did prior to that tax getting enacted. So, all else equal, I would kind of say that March is the norm and Jan/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 and structure get to a place where it's beyond our risk tolerance versus our historical growth in that sector, where it most certainly could be slower.

John Pancari -- Evercore ISI Research -- Analyst

Okay. Great. Thanks, Bill.

Operator

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

John McDonald -- Bernstein -- Senior Research 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 give on page six are really helpful. So, if we 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 or is this something where we could get to the stated beta in a couple of quarters or this could take a while to get there? Any thoughts there?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Yeah. Good question in terms of the betas, particularly on the consumer side, where they've lagged and we're keeping an eye on that. Relative to last quarter, they have accelerated, So, that's true. 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 is competitive pressures, but our best estimates are built into our NII guidance.

John McDonald -- Bernstein -- Senior Research Analyst

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

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

All of the above.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Absolutely.

John McDonald -- Bernstein -- Senior Research Analyst

How about just a last thing -- any more color on the deposit mix shift you're seeing? Is this more consumer versus commercial within the deposit mix? You're seeing folks move from checking to time in savings but within PNC?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yes. Now, the shift this quarter on commercial is more of a seasonal affect of commercial deposits. It's sort of running down. We would actually expect us to come back. They don't help us particularly with LCRs. It's not quite as important as what we do on the consumer side.

John McDonald -- Bernstein -- Senior Research Analyst

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

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

John McDonald -- Bernstein -- Senior Research Analyst

I guess I was just asking -- is that accelerated kind of like the deposit pricing? Has that also gotten faster this quarter?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Yeah, a little bit.

John McDonald -- Bernstein -- Senior Research Analyst

Okay. Thanks.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure.

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.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Good morning.

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

Yes. 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 in that you now have a pretty set floor in terms of where your capital minimums would be. 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 -- Executive Vice President and Chief Financial Officer

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

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

I'll just sort of broaden that out a little bit in terms of the Fed's proposals 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 cap on dividends at the 30%. The reduction of base case capital actions in the severe scenario with the exception of a year's worth of dividends, the RWA growth in the severe scenario and then also the elimination of the quantitative fail. 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 '17 CCAR submissions, we were below that. It remains to be seen how the fed stresses us in this go round. We'll see. 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, it 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 does it -- how should you or how should your investors think about potential buffers that you would incorporate to account for that volatility of results?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

That's kind of the million-dollar question. So, internally, you've heard us talk about this before. We always work toward the end point on the severe stress as oppose to the starting point of what our capital is. We talk about a target capital state in CET1 of 8.25% and 8.50%. That number being driven historically by our own estimate of what a severe stress would look like.

An issue for us 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 then causes you to then have volatility, as you then point out, in your repurchases year on year. I don't know how that plays out through time as a function or what scenarios they come up with, but it's one of the things we need to solve for 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 opportunities have never been so attractive. I'm thinking could you share with us what your earn back period is for buyback activity at current valuation levels?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Sorry, our earn back? I would tell you that we look at it 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 -- Executive Vice President and Chief Financial Officer

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

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 ask just a question on expenses. I know there's a couple of things. You bought that little IR firm and a couple other moving parts. I'm noticing that personnel costs are up 8% year over year. Could you just help us understand is that recent hires? Are you starting to spend some of the tax benefits? How will we understand the balance of the growth versus the CIP, especially as it relates to personnel costs? Thanks.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure, Ken. So, just in terms of expenses in the first quarter and linked quarter, our expenses were down low single digits, which is 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.

Those expenses, which are about $27 million, are spread out between personnel and equipment expense, personnel because of the higher headcount and equipment expense 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 a continuous improvement program, we have high confidence that we'll achieve it.

Ken Usdin -- Jefferies & Company -- Managing Director

Okay. Got it. And just one quick follow-up -- I understand you moved the operating lease up to corporate services. 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 -- Executive Vice President and Chief Financial Officer

Sure. I can even 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. 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

Okay. Got it. Thanks for that, Rob.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure.

Operator

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

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Betsy, you there?

Betsy Graseck -- Morgan Stanley -- Managing Director

Yeah. Hey, good morning, talking on mute. Sorry about that.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

No problem.

Betsy Graseck -- Morgan Stanley -- Managing Director

Question just to 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 is going to be ramping over 2018?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

It's both. 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

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Oh, in terms of the continuous improvement program?

Betsy Graseck -- Morgan Stanley -- Managing Director

Correct.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Yeah. 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're investing -- retail, for example -- there's substantial continuous improvement savings there as well. So, it's broad-based.

Betsy Graseck -- Morgan Stanley -- Managing Director

Okay. And then separately, I wanted to drill a little bit down on C&I. I know that you went through the various categories and where you're seeing the loan growth. It does feel like it's decelerating a little bit. Year on year is 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 not only solid good, but maybe a little above peers, due to the new markets you're going into or is there any sign of increased interest in current borrowers increasing their leverage and borrowing more? Do you see more of the share gain where clients are increasing their activity levels that you already have?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

You saw in March I think C&I hit record levels, actually. So, there is increasing stock and effect of C&I loans out there. But inside of that, we continue, both through differentiated product and then through, in effect, the new markets and harvesting some of the new markets that we've been in. We've been able to outpace peers and 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 had in the past.

Betsy Graseck -- Morgan Stanley -- Managing Director

Okay.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

But we're still guiding to mid-single digital 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 from what you've had this quarter in terms of run rate.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Yeah. Like I said about the segments and I mentioned in my comments corporate banking up 1%, business credit up 1%, equipment finance up 2% -- pretty strong.

Betsy Graseck -- Morgan Stanley -- Managing Director

Yeah, Q on Q, yeah. Okay. 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 that one growth, just to follow-up there, does the retail digital strategy and the rollout of that have a big impact on your expected loan growth in the back half of this year?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

No. The retail strategy will progress, but it will start as a deposit gathering exercise, what we think will be attractive returns for us because we won't have the brick and mortar costs and we'll have an ability to pay somewhat above or pay at existing markets. We will augment that offering with loan offerings on all of our products through time. You should expect that it will start out as deposit and migrate over time.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

So, no in 2018, really.

Kevin Barker -- Piper Jaffray -- Analyst

Okay. 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 given that they're seeing better ROEs due to lower taxes?

William Stanton 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. It's a function of the after-tax ROE. 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 the special products.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Much like on the special and also not long enough to be able to affect that. Like Bill said, it's really anecdotal and the deals that we saw the first 90 days of the quarter.

Kevin Barker -- Piper Jaffray -- Analyst

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

William Stanton 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 loan, which is kind of the craziest place, in my view, to start competing away price because you still have the risk associated with a loan and your actual -- we had this discussion a quarter ago, your loss distribution on an after tax basis caused you to actually have to lower capital against this thing.

So, it kind of surprises me. I would have expected to see more competition on deposit pricing and on fee-based services in terms of giving some of the excess margin 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, the amount of capital in the system versus taxes?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

It's some of 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 anything to offer beyond loans. So, that's the product they compete with. As you go downsize in loans, where somebody can hold the entire loan, you run into that group. It's not happening on the big syndicated loans. It's not happening on asset-based or anything where there's only really a handful of credible players.

Kevin Barker -- Piper Jaffray -- Analyst

Thank you for taking my questions.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Thanks, Kevin.

Operator

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

Gerard Cassidy -- RBC Capital -- Managing Director

Good morning, guys.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Hey, Gerard.

Gerard Cassidy -- RBC Capital -- Managing Director

I apologize, I had to jump off for a minute, if you answered this question already, but Bill, you started your presentation off with the comment about you'd 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 organic investment opportunities that you guys are looking at that gives you that kind of positive tone to it?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

The success we've had in newer markets obviously brings up a desire to do more. The list we have on digital things we want to roll out in consumer, but also importantly in C&I and the TM space is quite large. There's a lot of asks on the table of things that make a lot of business sense and I think differentiate us longer term. Some of it's product-based, some of it's market expansion-based. Some of it is investment in consumer service, the speed at which we can do fulfillment and the ease at which we can serve consumers, which offer a differentiated product to our customers. There's a lot.

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Gerard, 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 Stanton Demchak -- Chairman, President, and Chief Executive Officer 

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 the core infrastructure.

Gerard Cassidy -- RBC Capital -- 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 had it on a scale of one to ten, ten being most critical, one 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 Stanton Demchak -- Chairman, President, and Chief Executive Officer 

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

12.

Gerard Cassidy -- RBC Capital -- Managing Director

Yeah. Good.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Things have to be simple. They have to be fast. They have to be coordinated. Customer information has 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 that allows you to do it.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

And the client's expectations continue to accelerate.

Gerard Cassidy -- RBC Capital -- Managing Director

Absolutely. Then just finally, as you guys 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 at a couple of years, do you see a dividend payout ratio coming in north of 40% or 40%?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yes.

Gerard Cassidy -- RBC Capital -- Managing Director

Okay. Good. Thank you.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yeah.

Operator

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

Rob -- Deutsche Bank -- Analyst

Yeah, hi. Good morning. This is Rob from Matt's team. Just on commercial loan yields, they're up nicely this quarter. I was just curious. How do current new money yields compare given the March rate hike, but also your commentary about higher competition in commercial lending right now.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yeah. Do you have the new spreads, Rob?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Yeah.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

The actual spread on loans didn't move a lot.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

On the yields, you mean? Yeah, spreads have held up.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yeah. So, new deal spreads, they're kind of spot on where they were. So, we haven't seen a lot of a change.

Rob -- Deutsche Bank -- Analyst

Okay. Similar question on securities yields. They were down a few basis points in 1Q. I'm just curious if you could speak to that and where reinvestment rates are currently.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

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 maybe more than you want to know, we changed the accounting standard to the contractual life of the security. Prior, we had used the estimated life.

That moved yields around a little bit and actually elevated them after adjusting for the fourth quarter and then went back to normal this quarter. So, our print is down 282 to 279, but when you adjust for it, it might be marginally up. The other thing I would say too, our purchases on the securities portfolio in the first quarter were largely treasuries, which carry a little bit of a lower yield, but I'd just add that in.

Rob -- Deutsche Bank -- Analyst

Got it. Thank you very much.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure.

Operator

Our next question comes from Brian Clark with [inaudible] [00:49:00]. You may proceed with your question.

Brian Clark -- Unknown -- Analyst

Good morning, guys.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Hey, Brian.

Brian Clark -- Unknown -- Analyst

So, Rob, I wanted 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 form the incentive compensation or maybe how much of that is in the first quarter versus the second quarter?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

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

Brian Clark -- Unknown -- Analyst

I guess for the second quarter, then the guidance, they have the low single digit growth from the first quarter, so is that that same expectation for personnel? I guess personnel is somewhat --

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

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 Clark -- Unknown -- Analyst

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

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

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

Brian Clark -- Unknown -- Analyst

Thanks for that. Just a follow-up question -- on the loan growth side, I know earlier you said the mortgage warehouse business on average was down quarter over quarter. When I look at table six on the spot basis, that financial services line was up a billion and a half. Can you tell us what the balances were in each quarter for that warehouse business?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

I don't have the balances. The balances quarter over quarter are down a lot for the warehouse. That includes a lot of 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 facility, it's categorized that way.

Brian Clark -- Unknown -- Analyst

Okay. So, on a spot basis, the warehouse business was down on average it was down on spot also?

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

That's right. I know in terms of the warehouse facility, the elevation was in the fourth quarter, but the average started to average that. I can get you the number where we are, but it's on the low side because typically in the first quarter --

Bryan Gill -- Senior Vice President, Investor Relations

I can get you that offline, Brian.

Brian Clark -- Unknown -- Analyst

Okay. We think securitization activity would probably normalize in the second quarter, so maybe that could offset a little bit of the core growth you guys are seeing?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

It ought to eventually normalize. They actually have a pretty good pipeline, though.

Brian Clark -- Unknown -- Analyst

Okay. Thanks. Appreciate your time, guys.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Sure.

Operator

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

Mike Mayo -- Wells Fargo Securities -- Managing Director

Hi. My question is 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 Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Well, without naming cities, maybe you could name them yourselves. We looked for cities we're not in that have a target corporate population that kind of matches off against our product suite and expertise. When we started this exercise, we were in less than half of the large markets that have C&I opportunities. Through time, we would hit most of them. I don't know what time means, but we've had success and we'll keep rolling out as opportunity presents itself.

Mike Mayo -- Wells Fargo Securities -- Managing Director

I'm sure you can see success. If you look at Dallas, Kanas City, 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 because the new investing in Denver, Houston, Nashville can be offsetting. So, I guess generically, what is the time -- 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 for investing to harvesting?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Let's look at the Southeast, I guess, as maybe the best example. So, when we bought the RBC branches, that's in effect what we did, although we had a branch network there. We grew balances. We met customers, but it was probably three years before we really saw the acceleration in volume pickup 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 break even pretty quickly. A couple big deals and you break even in a year. But before they really start to contribute on a return on capital basis, you're probably looking at that three-year threshold.

Mike Mayo -- Wells Fargo Securities -- Managing Director

Which is the corporate banking sales cycle, basically.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Yeah. 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. 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.

Mike Mayo -- Wells Fargo Securities -- Managing Director

I get it.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

In broader measure, though, we're very encouraged in terms of the receptivity to our products, our services, our client interaction.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

It's working.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

The energy is high.

Mike Mayo -- Wells Fargo Securities -- Managing Director

One more follow-up -- I get it. Your expenses are up a little more than $100 million year over year. If you buy a bank, you're spending $10 billion. If you spending 100 times, more, you spend $100 million, you get tons of questions. I get it. But what is your sales pitch as you go in the new market? As you said, a lot of these smaller banks that are causing the plan vanilla 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 the very large banks that have more scale and the broader product suite? Who are you competing against in these new markets?

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

We compete against JPMorgan and Wells Fargo and B of A in every market we're in. It's nothing new. We go with our A team into middle market and small or large corporate with a very credible, capable TM service in leading 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. It works for us. We win or tie on a lot of these things in a lot of the markets we're already in. We come to a new market and do the same thing.

Mike Mayo -- Wells Fargo Securities -- Managing Director

Alright. Thank you.

Operator

We have no further phone questions at this time.

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Okay. Thank you all for joining us on the call this quarter.

Bryan Gill -- Senior Vice President, Investor Relations

Thanks, everybody.

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

This concludes today's conference call. You may now disconnect your lines.

Duration: 55 minutes

Call participants:

William Stanton Demchak -- Chairman, President, and Chief Executive Officer 

Robert Q. Reilly -- Executive Vice President and Chief Financial Officer

Bryan Gill -- Senior Vice President, Investor Relations

John Pancari -- Evercore ISI Research -- Analyst

John McDonald -- Bernstein -- Senior Research 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 -- Managing Director

Rob -- Deutsche Bank -- Analyst

Brian Clark -- Unknown -- Analyst

Mike Mayo -- Wells Fargo Securities -- Managing Director

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