U.S. Bancorp

Welcome

to the U.S. Bank Corp's Third Quarter 2019 Earnings Conference Call. Following a review of the results by Andy Sosari, Chairman, President, and Chief Executive Officer, and Terry Dolan, U.S. Bank Corp's Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. If you would like to ask a question, please press star 1 on your touchtone phone and press the pound key to withdraw. This call will be recorded and available for replay beginning today at approximately 1230 p.m. Eastern through Wednesday, October 23rd at 12 midnight Eastern Standard Time. I will now turn the conference over to Jean Thompson, Director of Investor Relations for U.S. Bank Corp. You may begin.

Thank you, Polly, and good morning to everyone who has joined our call. Andy Sosari and Terry Dolan are here with me today to review U.S. Bank Corp's Third Quarter results and to answer your question. Andy and Terry will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I'd like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page 2 of today's presentation in our press release and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Andy.

Thanks, Jen. Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on slide 3. In the Third Quarter, we earned $1.15 per share. Despite a more challenging interest rate environment, we reported record levels of revenue and net income driven by healthy loan and deposit growth and continued momentum across our fee businesses. Credit quality remains stable. Turning to capital management, our book value per share increased .6% from a year ago, and during the quarter, we returned 80% of our earnings to shareholders through dividends and share buybacks. Slide 4 provides key performance metrics. In the Third Quarter, we delivered a return of average common equity of .3% and a return on average assets of 1.57%. Our return on tangible common equity was 19.4%. Positive operating leverage drove improvement in our efficiency ratio on both a link quarter and -over-year basis. Now I'll turn the call over to Terry to provide more detail on the quarter as well as forward looking guidance.

Thanks, Andy. If you turn to slide 5, I'll start with a balance sheet review followed by a discussion of Third Quarter earnings trends. As expected, average loans grew .1% on a link quarter basis and increased .7% -over-year, excluding the Fourth Quarter 2018 sale of FDIC covered loans that had reached the end of the lost coverage period. Strong residential mortgage and credit card loan growth supported both linked quarter and -over-year performance. Commercial and industrial loans grew .4% sequentially and .7% on a -over-year basis. Paydown activity picked up in the Third Quarter primarily reflecting the rate environment and robust capital market conditions. New business activity remains healthy, although paydown activity is likely to continue at elevated levels near term. Commercial real estate loans decreased on a sequential and a -over-year basis. This quarter, commercial real estate contributed a 33 basis point drag to link quarter average loan growth and an 89 basis point drag to -over-year average loan growth. Turning to slide 6, deposits increased .4% on a link quarter basis and grew .0% -over-year. Compared with the prior period, we continued to see migration from -interest-bearing to interest-bearing accounts. That migration, along with deposit growth momentum in both our wealth management and corporate and commercial banking divisions, helped drive average savings deposits up .4% -over-year. As you can see on slide 7, credit quality remains stable. On a dollar basis, non-performing assets increased .7% versus the Second Quarter, but decreased by .5% compared with a year ago. The ratio of non-performing assets to loans plus other real estate owned was stable at 33 basis points compared with the Second Quarter and modestly improved versus 36 basis points a year ago. Slide 8 highlights third quarter earnings results. We reported earnings per share of $1.15 compared with $1.06 a year ago. Turning to slide 9, net interest income on a fully taxable equivalent basis declined by .5% compared with the Second Quarter and increased by .8% -over-year, which is in line with our expectations. Both linked quarter and -over-year comparisons benefited from healthy loan growth offset by the impact of declining rates and a flatter yield curve. Our net interest margin declined by 11 basis points versus the Second Quarter in line with our expectations. About four basis points of the decline was due to higher cash balances primarily reflecting changes in policies related to deposits by the European Central Bank. Slide 10 highlights trends in non-interest income. Middle single-digit -over-year growth in each of the three payment fee lines, credit and debit card, corporate payments products, and merchant processing was driven by higher sales volumes. As a reminder, processing day count will end up affecting -over-year credit and debit card revenue growth comparisons in several quarters in 2019. In the Third Quarter, three additional processing days versus a year ago benefited revenue growth. In the Fourth Quarter, two fewer days will be a drag on -over-year growth. We continue to expect low single-digit growth of credit and debit card fee revenue for the full year. Commercial product revenue increased .1% from a year ago primarily due to higher corporate bond fees and trading revenue related to strong capital markets activity. Mortgage banking revenue increased .3% -over-year on strong origination and sales revenue growth. Compared to the Third Quarter of 2018, mortgage production volume increased by .3% and mortgage application volume increased by 53.1%. Refinancing activity represented about 40% of production in the Third Quarter of 2019 compared to about 30% in the linked quarter. Refinancing represented 51% of applications in the Third Quarter. The -over-year decline in deposit service charges reflected the impact of the sale of our third-party ATM servicing business in the Fourth Quarter of 2018. The increase in other revenue was partly driven by the inclusion of the related transitions services revenue which will decrease over time as well as higher equity investment income and a gain on sale of assets. Turning to slide 11, the -over-year increase in non-interest expense reflected higher personnel costs partly due to higher variable compensation related to business production within mortgage banking and the capital markets business lines as well as increased medical costs. Professional services expense increased primarily due to business investment and enhancement in risk management programs while higher technology expense growth was primarily tied to business growth initiatives. The decrease in other expense primarily reflected lower costs related to tax advantage projects and lower FDIC assessment costs. Slide 12 highlights our capital position. At September 30th, our common equity tier 1 capital ratio estimated using the Basel 3 standardized approach was 9.6%. This compares to our target of 8.5%. As previously discussed, our goal has been to manage the capital level closer to our target once we had clarity related to adopting FESOL and the final capital rules were promulgated by the Federal Reserve. With the recent release of the final rules, we plan to make a request to the Federal Reserve to increase our share repurchase program to enable us to begin reducing our common equity tier 1 ratio from .6% to approximately 9.0%. I'll now provide some forward-looking guidance. For the fourth quarter, we expect fully taxable equivalent net interest income to decline in the low single digits on a -over-year basis. We expect middle, -single-digit fee income growth on a core basis -over-year. We expect to deliver positive operating leverage for the full year 2019 on a core basis in line with our previous guidance. We continue to expect our taxable equivalent tax rate to be approximately 20% on a full year basis. Credit quality in the fourth quarter is expected to remain stable compared to the third quarter. Low loss provision expense growth will continue to be reflective of loan growth. I'll hand it back to Andy for closing remarks.

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

Operator. And if you would like to ask a question, please press star, then the number one on your touchtone phone and press the pound key to withdraw. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Matt O'Connor with Deutsche Bank.

Morning,

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

And Matt, your line is open.

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

And your next question comes from the line of John McDonald with Autonomous Research.

Hi, good morning. Morning, John. I was wondering if… Hi, Terry. I was wondering if you could just give a little more color on the request for the capital increase, just over what timeframe you might be looking to do the 9-6 down to 9. Is that over the course of a year or a couple months? Again, what was the clarity you were looking for? Was it CISO and the tailoring I think you mentioned?

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

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

Yes.

Okay, got it. And then I wanted to ask you guys just more broadly about your outlook, just in terms of kind of generating positive operating leverage in what's proving to be a more difficult rate environment. As you turn the corner into 2020, is that a goal? And is that 100 basis points kind of a bogey still? And Terry, you had mentioned that the Investor Day of 2020 was a tougher year when you're talking about your three-year targets. And maybe also, Terry, you could just kind of clarify, I think in Investor Day you said part of that outlook is you thought your net interest income might grow faster than your fees, and maybe you could just give a little follow-up color on that.

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

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

John M. Neumann Got it. Thank you.

Sure, John.

And your next question comes from the line of Betsy Krescic with Morgan Stanley.

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

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

Lauren Ruffin Right. Now I get that. Little bit helps though. And

does

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

John M. Neumann I don't think so. We end up driving from a competitive standpoint based upon what the pricing is in the marketplace. And I just don't see it impacted that a lot. And given our debt rating

and our low cost of funds, we're already in a pretty good position regarding low end pricing.

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

Andy B. Johnson Yeah, I think it's a three-pronged strategy. One is continue to focus on e-commerce and ISVs, which we've made great progress in over the last year. We'll continue to focus on it going forward. Secondly is the focus on certain verticals. You named a couple, airlines, hotel, the industry, healthcare. And thirdly and importantly, and probably the biggest opportunity is this combination of banking products and services together with merchant products and services. The fact is all of our merchants need a bank. Many of our small business customers need a merchant provider. And our ability to weave and put those products together in a comprehensive set that helps the customers run their business and give them information I think is the key to our focus and one of the areas that I think are the most important is to see the most potential.

Karen B. Johnson And is it primarily US or is it also Europe? I know you have a more global footprint in this. Andy B. Johnson Yeah,

so the first two would be global across the board. That combination of banking and merchant processing would be principally in the US.

Karen B. Johnson Okay, thanks.

Andy B. Johnson And your

next question comes from the line of Ken Houston with Jefferies.

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

Andy B. Johnson Yeah, so you know, if you think about mortgage banking, obviously, it was a very strong quarter from refinancing. When we end up thinking about the fourth quarter, it's very dependent upon where long term rates are. With the rates kind of back coming up a little bit, most recently, it probably will not be as strong. But I think it'll still be a good year over year story. From a mortgage banking perspective, the application volume is strong in production. It was strong in the third quarter, we continue to see that momentum. The other thing, Ken, is we talked about this, we've been over time making good investment in mortgage loan officers on the retail side of the equation, enhancing that. The digital platform that we talked about has a very high percentage of application capture. And that just helps because of the speed to market and our ability to be able to service those customers and get the loans booked. We went through the last, what I would say, cycle of refinancing and our processing times were relatively short compared to competitors and certainly what we have experienced in the past. And it's all because of those investments.

Ken Burns Got it. And a second question, I know this comes up from time to time, but inside the other, you always mentioned that the PE gains are there. And we know that the ATM agreement is in there as well. Can you help us just understand the magnitude of the PE gains, even on a comparison basis, if not the number? And then also just how the ATM services is, how much is that in revenues and expenses today and how does that work going forward? Thanks, Terry. Yeah,

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

And then to just on the expense side of the ATM, is that a decent part of the growth on the expense side as well, the services agreement?

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

Got it. Thank you.

Yep. Thanks, Ken.

And your next question comes from the line of Mike Mayo with Wells Fargo Securities.

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

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

Yeah, so I mean, what is the back room or even within the branches and a big part of the decision around, you know, you know, closures related to branches and reinvestment in branches as well, is really kind of that intersection of our employees or people in digital and our customers, you know, obviously, the customer behaviors are changing. You know, the amount of transaction activity that's happening in the branches is significantly less than where it was. In fact, 80% of it roughly 70 80% of it goes through the digital channel today. So you know, that gives us the opportunity to really reconfigure the branch network, both in terms of size and numbers, etc. And but also to change the focus from a service oriented type of location to something that's much more either sales and or advice focused. And so I think those trends are going to continue. You know, I don't necessarily have specific metrics. You know, on the deposit side, I would say that there's still room and opportunity for the percentage of sales from the deposit perspective to continue to grow. And I think, you know, Derek, as investor day had said, you know, when you think about you think about the opportunity from a digital perspective, from sales, and I and we would include deposits in this is that, you know, that should get us closer to that 40 50% over time, but it'll take a while for us to get there, because it's a customer adoption that has to take place.

Okay, and then as far as the back office, do you have any metrics on number of data centers, or how many apps you expect to migrate to the public cloud or anything else just on the inside of the company?

We haven't disclosed the number of data centers, I'll tell you Mike that we continue to migrate activity to the cloud. And Jeff Jeff I go around spoke a little bit today, an investor day, but most of our new activity development with will occur on the cloud, which offers a number of advantages, both from a capacity as well as the cost.

All right, thank you.

Thanks, Mike.

And your next question comes from Scott ciphers with O'Neill.

Thanks for taking the question. Just Terry, maybe some updated thoughts on the margin, given that the noise from some of the transitory stuff in the third quarter should presumably be settling in the fourth quarter. I guess one, when an apologies if you said this, but when do you have any additional rate cuts baked into your own outlook there? And then just as we go forward, we still think in kind of 40 to $45 million, sort of all else equal from impact from each rate cut.

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

Okay, so seven to eight basis points of margin decline in in the fourth quarter, in the fourth quarter. Yeah, and I think that, you know, the other thing is,

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

quarter and into 2020. Okay. And then, so with that, just so I understand, with that seven to eight basis point, presumably that kind of moderates as we would look at additional rate cuts, or is that that sort of a new, new proxy? I just want to make sure I'm sort of understanding that.

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

Okay.

Fair enough.

All right. Thank you very much. I appreciate it. Yeah, I'm Scott.

And your next question comes from the line of Erica Nigerian with Bank of America.

Hi, good

morning.

Good morning, Erica.

I wanted to follow up on John's line of questioning. So, even outside of mortgage, the fee income trends are quite strong, you know, payments up 5% year over year, trust and investment management up 2% year over year. And I'm wondering, as we tie that back to your long term revenue targets, you know, is a 5% fee income, you know, clip over that three year period, you know, too optimistic or about in line with what you're thinking? I guess the reason I'm focusing on fees is because, like you said, Terry, nobody has any idea and what the curve, a forward curve is going to look like, right? I mean, the probability of change over the past two hours. So I'm trying to think about the contribution of fees and I have a follow up on balance sheet growth.

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

And on the balance sheet growth contribution to those long term revenue targets, you know, fully acknowledge that 2020 is going to be challenging. If the rate curve doesn't normalize as you think, but doesn't necessarily get worse and what's in the current expectation, is there enough opportunity in terms of, you know, delivering all of the bank into your current customers with regards to loan growth? In other words, you know, that implies to me that you would, you know, we would need mid single digits, digit loan growth over those over that three year period in order to potentially mitigate some of the growth rates that we're seeing. So, you know, I think that's a good point. And I think that's a good point, too, is that we need to be able to help from the yield curve rather.

Yeah, maybe a couple of things that, you know, the targets that we set are kind of based upon where we think, you know, the growth rates are going to be as we get into the second and third year. You know, I tried to be clear that that's not our expectation with respect to 2020 and it's not necessarily a compounded rate over the three years because of the challenges that will happen in 2020. But, you know, when you end up when we think about, you know, the balance sheet right now, you know, and again, this is all kind of dependent upon what happened in the economy and that's a little bit hard to predict. But, you know, consumer spend and consumer confidence continues to be strong. I think business activity continues to be strong. I think it's moderated somewhat because of tariff policy and that sort of thing or trade policy. But, you know, generally, I think the economy is solid. And, you know, when we end up thinking about 2020 from a loan growth perspective, we think that some of the trends that we're seeing this year will continue. And, you know, as we talk, you know, third quarter loan growth of about .7% on a core basis, we think that's achievable. And I think, you know, from U.S. banks perspective, you know, we have the lowest cost of funds in the industry and we have some competitive advantages from a pricing perspective that will enable us to be able to achieve those things. So, I feel reasonably confident.

Yeah. And,

Eric, you know, if you think, if you step back and look at the third quarter, our earning asset growth was just under 5% or deposit growth -over-year was just about 6%. So, thinking about the balance sheet growing in that single digit, I think is about right.

Yeah. Got

it. Great. Thank you.

Yeah, sure.

And your next question comes from Vivek Junjai with JP Morgan.

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

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

And then another one, which is positive operating leverage. Your previous guidance, you used to have the 100 to 150, which went to 100. Are you thinking fully on 19 given everything going on? You've obviously got positives on mortgage banking, other income running higher, but then NII softer, is it still closer to 100 basis points? Or do you think given where rates have gone, it's, that's going to be harder to get to?

We're consistent with we talked about investor David Beck, which is somewhat below 100 basis points, but still positive operating leverage.

Okay. Okay. Great. Thank you. Yep.

And your next question comes from the line of Matt O'Connor with Deutsche Bank.

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

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

Yeah, I think I would just kind of maybe add to that, because, you know, we see that in mortgage, we see that in capital markets, specifically, but from an optimization standpoint, we talked about investor day, you know, very focused on, you know, as the customer behaviors are changing, making sure that we're staying locked stuff with that. And I think there is both opportunity in the front office from a branch perspective, and we'll continue to look at that. And as I said, you know, we may accelerate or increase, you know, some of the activity associated with that, but it's going to be tied to what happens from a customer standpoint. And then, you know, as we continue to move to a digital platform, I think there's back office opportunities in terms of optimization. And then, you know, the other thing, and this kind of gets back to the digital activities that you're talking about, we're making important investments in all of our lines of businesses. And, you know, we want to, and we'll continue to do that, because it's important for us to look both short term as well as long term.

So. Okay, that's helpful. And I just, I think sometimes we're also focused on the absolute level of operating leverage. And 4% revenue growth is a lot better than, you know, 1% plus operating leverage with 1% revenue growth, just the way the math works. So, okay, thank you.

That's right. And, you know, that 0.8 positive operating leverage on 54, efficiency ratio 54 is a lot different than, you know, 1% on 62. You know, so you have all sorts of things. Part of it's the starting point. Thanks, Matt.

And your next question comes from the line of Silo Martinez with UBS.

Hey, good morning, guys. So, you guys addressed a lot of my question. I was going to ask you to speak to some of the loan growth trends, which, you know, pretty pronounced, not only in terms of the absolute level of balance sheet growth, but just the mix with commercial, on an end of period basis, commercial growing 3% and consumer 7%, even with home equity declining. So the core is even faster than that. So I guess a couple parts, though, you know, maybe you can address how much of that growth is related to, you know, exogenous factors or is dependent on a strong macro environment. Continuing in how much of the growth is, you know, a function of, you know, things you're doing at company level to deepen relationships, use analytics and whatnot. And I guess the second part of my question, though, is, you know, around Cecil and whether, you know, do you guys even, do you guys consider the impact of Cecil on, you know, when, you know, addressing this growth? Because a lot of the growth is occurring in lending segments that are going to be disproportionately impacted by Cecil, that have longer term, longer weighted average lives and higher loss content, like cards. And you, I think yourself, Terry mentioned at the investor day that you'll have a higher HLLL to maintain that HLLL ratio, you have to provision more. But with this mix shift, that HLLL ratio will continue to migrate upwards. And is that something you guys think about? Or do you guys just say that, hey, that's accounting noise and the economics of this lending activity is the same, it doesn't really matter. And over the life of the loan, the loss is the loss. So just kind of, you know, whether, you know, the Cecil impact on your growth is something you guys think about and how we should think about in terms of modeling it.

Yeah, good question. And then we kind of talked a little bit about this in the past, you know, when we think about loan growth and where it comes from, and kind of our focus within the company, we really think about it more on an economic basis than we do on an accounting, because I do think there's a lot of accounting noise that occurs within Cecil for a lot of different reasons. One is that every company is going to have their own forecast with respect to what happens in the economy and, you know, all the things that we've talked about. So, you know, we really think about it more from an economic standpoint. In terms of in terms of loan growth, you know, again, this just comes back in terms of where we're seeing today. And what we see today is that, you know, consumer confidence is strong and consumer spend is strong. And, you know, those things should tend toward, you know, good growth from a consumer perspective. And, you know, even on the business side, you know, that while it may moderate, it's still a very solid business. You know, so, you know, some of it is driven by macroeconomic, other especially as we kind of think out on a longer term basis, you know, is driven by initiatives, you know, we started an ABS lending sort of platform a year ago. But, you know, this focus and Andy talked about it, you know, we have merchants and the merchant acquiring side of the equation and small businesses and, you know, there is a significant opportunity for us to be able to leverage both of those. So, when we think about, you know, loan growth, we also think it's tied to some of our initiatives.

Okay, no, that's helpful. Thank you very much.

Thanks. And your final question comes from the line of Gerard Cassidy with RBC.

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

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

And do you think, speaking of that, Andy, do you think Zelle will play a role in that on a go-forward basis as Zelle goes from a P2P to possibly a B2B?

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

Yeah, and I agree. The other thing, Gerard, I would just say is that I think the challenge or the competitive landscape is going to be one based upon who is able to make the investments in connecting the rail, the real-time rail, or Zelle or whatever might be the case, to the customer. And that's where our area of focus has really been around the use cases that create a value proposition to the customer. And that investment is very important and it's an area of focus for us. That's absolutely right. Thank you.

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

Gerard, we have a housing capital group that does focus on home builders and we are seeing good growth there. There are West Coast and South principally is where our focus area is and that business is doing well and growing. Some of the other aspects of the commercial real estate and some of the declines you're seeing are really a function of some of the credit components that we're seeing our competitors move to that we're not comfortable with. So, yes, positives, but we have some negatives and we're sticking with our core customers and within the credit box that we participate in.

Great. Thank you so much. Appreciate it. Thank

you. All right. Have a great day.

And there are no further audio questions. Are there any closing remarks?

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

And thank you, ladies and gentlemen. This concludes today's conference call. Thank you for your participation. You may now disconnect.