Earnings Call Transcript
US BANCORP DE (USB)
Earnings Call Transcript - USB Q1 2023
Operator, Operator
Welcome to the U.S. Bancorp First Quarter 2023 Earnings Conference Call. Following a review of the results, there will be a formal question-and-answer session. This call will be recorded and available for replay beginning today at approximately 11 o'clock A.M. Central Time. I will now turn the conference call over to George Anderson, Senior Vice President and Director of Investor Relations for U.S. Bancorp.
George Anderson, Senior Vice President and Director of Investor Relations
Thank you, Brad. Good morning everyone. With me today are Andy Cecere, our Chairman, President, and Chief Executive Officer; and Terry Dolan, our Vice Chair and Chief Financial Officer. During the prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation, as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, our Form 10-K, and its subsequent reports on file with the SEC. Following their prepared remarks, Andy and Terry will take any questions that you have. I will now turn the call over to Andy.
Andy Cecere, Chairman, President, and Chief Executive Officer
Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on slide three. In the first quarter, we reported earnings per share of $1.04, which includes $0.12 per share of charges related to the MUFG Union Bank acquisition. Excluding those notable items, earnings per share was $1.16. We achieved record net revenue of $7.2 billion for the quarter. Following our successful close of the Union Bank acquisition in December of 2022, first quarter results reflected a full year's benefit of the acquired franchise, continued growth in earning assets, net interest margin expansion, and higher non-interest income led by stronger commercial product and mortgage banking fee revenues. Slide four details our reported and adjusted income statement results, as well as the end of period and average balances and other performance metrics. On the right, you'll see the credit quality remains strong, but is starting to normalize as expected. Our charge-off ratio of 30 basis points as adjusted is well below pre-COVID levels and reflective of our disciplined risk management culture. The CET1 ratio, our binding regulatory constraint was 8.5% at the end of the quarter and is consistent with our target capital ratio. We expect to exceed 9.0% later this year as we accrete capital back quickly over the next few quarters and continue to focus on risk-weighted asset optimization initiatives. Slide five provides key performance metrics. Excluding notable items, our return on average assets was 1.15% and our return on average common equity was 15.7%. Our return on tangible common equity was 24.3% on an adjusted basis. Slide six provides both a high-level timeline and general update on our planned conversion of Union Bank. Integration efforts have been progressing well and we remain on track for our successful main systems conversion over the upcoming Memorial Day weekend. We anticipate a full transition of all accounts by the second half of the year. Turning to slide seven. The industry disruption early in March has reinforced the importance of maintaining a well-diversified business with an appropriate risk profile. We maintain a resilient and diversified deposit base. Over half of our deposits are insured and 80% of the uninsured deposits are retail or operational in nature. Our diversified funding sources, ample liquidity levels, and strong credit quality supported by disciplined underwriting standards are all hallmarks of our approach to risk management. I'll now turn the call over to Terry, who can provide more detail on the balance sheet strength and the first quarter earnings results.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks, Andy. Turning to slide eight, a key strength of the bank is our well-diversified deposit base, which remains a stable source of low-cost funding. As a reminder, following the completion of our acquisition of Union Bank last quarter, our end-of-period deposits totaled $525 billion, including approximately $80 billion of deposits from Union Bank. As we discussed last quarter, $9 billion of Union Bank acquired deposits were transitory in nature, with $4 billion returned to MUFG in the fourth quarter and an additional $4.7 billion that moved back to MUFG in the first quarter of this year. In addition, $1.1 billion of acquired deposits were included in the branch sale or related to PurePoint, a broker deposit gathering mechanism that we discontinued. Importantly, prior to the events of March 8, we saw expected deposit outflow largely consistent with seasonal patterns, reflective of our business mix, including our large trust business. From March 8 through the end of the quarter, deposit balances were relatively stable, down only 0.6% as inflows from new customers were slightly offset by the impact of clients diversifying their deposits and seeking yield in money market funds consistent with broader industry trends. During this period, we saw an increase in money market funds of approximately $10 billion within our wealth management and investment services businesses. We expect the competition for deposits to remain high for the industry in 2023. Our cumulative deposit beta through the first quarter was approximately 34% and we expect that to increase to about 40% by the end of this rate cycle, generally in line with our previous expectations. Slide nine provides additional detail on the composition of our highly diversified deposit base. As the slide shows, our deposit balances are composed of a broad mix of consumer, corporate, and commercial customers that we support with an expansive branch distribution network and mobile capabilities across our national footprint. Our deposit base reflects the wide range of customers and industries that our companies serve. At March 31, our percent of insured deposits to total deposits was 51%. Approximately 80% of our uninsured deposits are composed of operational, wholesale trust, and retail deposits that are stickier, either because they are contractually bound or tied to treasury management services and trust activities provided to corporate and institutional clients. Combined with our consumer-based deposits, the stability of our funding source is sound. Moving to slide 10. U.S. Bank's total available liquidity as of March 31 was $315 billion, representing 126% of our uninsured deposits. As of December 31, our liquidity coverage ratio was 122%. As mentioned, our strong debt ratings reflect our diversified business profile, well-collateralized credit exposure, healthy capital and liquidity profiles, and disciplined asset liability management framework. These attributes work in concert with our strong balance sheet optimization and management practices to ensure strength and stability of our balance sheet. Slide 11 provides details on the composition of our investment securities portfolio. Over the last five quarters and well ahead of the most recent banking disruption, we reduced the size of our investment securities portfolio from 30% to 25% of total assets while increasing cash levels. In preparation for and as part of the completion of our acquisition of Union Bank, we repositioned our balance sheet by selling fixed-rate loans and investment securities, paid off borrowings, and increased cash balances in response to economic uncertainty, industry dynamics, rising interest rates, and increased market volatility. At March 31, approximately 90% of the securities in our investment portfolio are backed and are sponsored by the U.S. federal government with 55% of securities designated as held to maturity and 45% designated as available for sale. Further, available for sale unrealized losses as a percentage of our investment securities portfolio improved in the first quarter and total AOCI improved by 11% on a linked-quarter basis. Turning to slide 12. As a reminder, following the completion of our acquisition of Union Bank, our CET1 capital ratio declined from 9.7% at the end of the third quarter of 2022 to 8.4% as of December 31st, which reflected the impact of balance sheet optimization and purchase accounting adjustments that will accrete back into capital over the next few years. Strategically, we continue to be encouraged about the financial merits of this deal and the synergistic benefits we expect to realize as a combined institution. As Andy mentioned earlier, our CET1 capital ratio at March 31st was 8.5%, a 10 basis point increase from year-end reflected 20 basis points of capital accretion, offset by the transitional impact of CECL of 10 basis points. As of March 31st, we expect to accrete approximately 20 to 25 basis points of capital per quarter as we complete the Union Bank integration and realize cost synergies. Importantly, this does not include the impacts of planned RWA optimization initiatives mentioned earlier. Turning to slide 13. Total end-of-period loans were $388 billion, which was flat on a linked-quarter basis and up 21.6% year-over-year. Commercial real estate loans represent approximately 14% of our total loan portfolio with CRE office exposure representing approximately 2% of total loans and only 1% of total commitments. Leverage lending balances are not a significant component of the loan portfolio. Slide 14 shows credit quality trends, which continue to be strong, but as expected, are starting to normalize across the portfolio. The ratio of nonperforming assets to loans and other real estate was 0.3% at March 31st compared with 0.26% at December 31st and 0.25% a year ago. Our first quarter net charge-offs of 0.30% as adjusted increased seven basis points versus the fourth quarter level of 0.23% as adjusted and were higher when compared to the first quarter of 2022, which was a level of 0.21%. Our allowance for credit losses as of March 31st totaled $7.5 billion or 1.94% of period-end loans. As the chart on the upper right side of this slide demonstrates, our credit performance through the cycle serves as a key differentiator for the bank. Slide 15 provides a detailed earnings summary for the quarter. In the first quarter, we earned $1.16 per diluted share, excluding $0.12 of notable items related to the recent acquisition of Union Bank. Slide 16 highlights revenue trends for the quarter. Net revenue totaled $7.2 billion in the first quarter, which included a full quarter of revenue contribution from Union Bank of $832 million, primarily representing net interest income. Net interest income grew 7.9% on a linked-quarter basis and 45.9% year-over-year, driven by earning asset growth and continued net interest margin expansion, which benefited from rising interest rates. Non-interest income as adjusted increased 2.7% compared to the fourth quarter, driven by higher commercial product revenue, mortgage banking revenue, and trust and investment management fees, partially offset by losses of $32 million from securities sales. Turning to Slide 17. Adjusted non-interest expense for the company totaled $4.3 billion in the first quarter, including $546 million from Union Bank. Non-interest expense as adjusted increased 9.1% on a linked-quarter basis largely driven by the impact of two additional months of Union Bank's operating expenses, core deposit intangible amortization, and higher compensation and other non-interest expenses. I will now provide second quarter and updated full year 2023 forward-looking guidance on Slide 18. Starting with the second quarter of 2023 guidance, we expect average earning assets of between $600 billion and $605 billion in the second quarter and a net interest margin of approximately 3%. Total revenue, as adjusted, is estimated to be in the range of $7.1 billion to $7.3 billion, including approximately $85 million of purchase accounting accretion. Total non-interest expense as adjusted is expected to be in the range of $4.3 billion to $4.4 billion, inclusive of approximately $120 million of core deposit intangible amortization related to Union Bank. Our tax rate is expected to be approximately 23% on a taxable equivalent basis. To date, we have incurred $573 million in merger and integration costs and anticipated charges of between $250 million and $300 million for the second quarter. We continue to estimate total merger and integration costs of approximately $1.4 billion, consistent with earlier guidance. I will now provide updated guidance for the full year. For 2023, average earning assets are now expected to be in the range of $600 billion to $610 billion. We expect the net interest margin to be between 3.0% to 3.05% for the full year. Total revenue as adjusted is now expected to be in the range of $28.5 million to $30.5 billion, inclusive of approximately $350 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be in the range of $17.0 billion to $17.5 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis is now expected to be approximately 23.0%. We continue to expect to have $900 million to $1 billion of merger and integration charges in 2023. I will now hand it back to Andy for closing remarks.
Andy Cecere, Chairman, President, and Chief Executive Officer
Thanks, Terry. Events of the past few weeks have certainly raised questions about the overall health of the banking industry and the economic outlook. The business of banking involves taking balanced risks, and these risks must be carefully managed, appropriately regulated, and prudently mitigated. At U.S. Bank, we are focused on the strength and stability of our balance sheet. Our investment in risk management practice is guided by our core principle that includes always doing the right thing for the many stakeholders, communities, and constituents we serve. A key strength of our institution is our high-quality and diversified business mix and deposit base. The combination of a mix of consumer, corporate, and commercial customers with significant operational deposits, broad geographic reach, and a full breadth and depth of product and service offerings serves as a key differentiator for the bank. Our high debt ratings, resilient liquidity profile, available funding sources, and strong earnings capacity enable us to deliver industry-leading regulatory test results and contribute to our resiliency during times of uncertainty. As we continue to work to ensure a successful conversion of Union Bank next month, we are already seeing the benefits of increased scale and market share as we bring our enhanced digital capabilities and broad and diverse product set to the Union Bank customer base. Our reputation as a prudent risk manager has been earned through our performance over many cycles, and we have never been more focused on the strength and stability of our balance sheet. Let me close by thanking our employees for all that they do on a daily basis for our customers, communities, and shareholders. We have shown incredible strength and stability during these challenging times, and I am more confident than ever in our ability to continue to deliver exceptional client service, superior product offerings in a rapidly changing environment. We'll now open the call for Q&A.
Operator, Operator
Thank you. We will now begin the question-and-answer session. We'll go to Scott Siefers from Piper Sandler. Please go ahead.
Scott Siefers, Analyst
Good morning everybody.
Andy Cecere, Chairman, President, and Chief Executive Officer
Hi Scott.
Scott Siefers, Analyst
Hey. Lots of noise in the deposit flows in the first quarter. I guess, moving forward, what would your expectations be for total deposit flows or balances and then the mix of non-interest-bearing to total as we sort of get through this cycle?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. We expect that overall, the industry will experience pressure on deposits and heightened competition. We believe we will perform reasonably well in this environment. Any changes in deposits will likely be influenced by that competition, but I would describe the situation as relatively stable. Regarding your second question, the percentage of non-interest-bearing deposits in roughly the fourth quarter was around 25%, 26%. We believe it is reaching a stable level, considering we have a significant amount of operational deposits linked to both our Corporate and Corporate Trust businesses, which helps maintain that stability. So, it's a mix of factors, Scott.
Scott Siefers, Analyst
Okay, perfect. Thank you. And then I was hoping we could talk for a second about just the categorization and when you guys would expect to be a Category 2 bank, I think there's a lot of chatter going around, especially in light of that report from a couple of days ago. So, maybe just in sort of clear terms, when would you expect to be a Category 2 bank? Will that be due to your asset size or thanks to the Fed's flexibility to designate you as one? And then how would you guys get there by that time?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. Our plan for achieving Category 2 is at the earliest by the end of 2024. This timing will largely depend on the Federal Reserve's decision rather than our asset size. As we manage the company, our focus will remain on profitable loan growth and similar priorities. We will reach this milestone when the conditions are right, but our current expectation is that it will not happen before the end of 2024.
Scott Siefers, Analyst
Okay. Perfect. And you guys feel like you're prepared to get there by that time basically?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. It will involve a combination of several factors we discussed, including the capital generation from earnings, which is aided by the Union Bank transaction. Additionally, we are very focused on capital management due to our Category II status. We will concentrate on optimizing risk-weighted assets and ensuring that we are pursuing profitable growth.
Scott Siefers, Analyst
Perfect. Okay. Thank you very much.
Operator, Operator
Next, we'll go to Erika Najarian with UBS. Please go ahead.
Erika Najarian, Analyst
Hi. Good morning.
Terry Dolan, Vice Chair and Chief Financial Officer
Good morning, Erika.
Erika Najarian, Analyst
The question for USB is that investors seem confident in the through-the-cycle credit outperformance and PPNR strength. It’s noted that the change in your revenue outlook was minimal compared to peers. The main concern for investors is your starting point of 8.5% CET1. You mention the earnings power and organic capital generation of 20 to 25 basis points. However, as we expect Category II and considering the Fed's influence over timing rather than your asset size, what do you see as the new CET1 endpoint? As we move into this new category, many investors might not view 8.5% to 9% as an appropriate target. Additionally, is your priority to reach a higher capital level more quickly? If so, how are you planning to approach dividend growth this year?
Andy Cecere, Chairman, President, and Chief Executive Officer
So, Erika, good question. And so, I'm just going to go from the beginning. I think that would be helpful. So, as you know, we were well above 9% and came down to 8.4% as a result of the Union Bank transaction. The Union Bank transaction is a terrific transaction. We're exceeding our revenue expectations. We are coming in under our expense expectations. The accretion is greater than we expected. So the value of the franchise is positive for sure. As we think about the Category II, I have three or four factors, I think about. Number one is the earnings accretion that we talked about, which is strong and growing, and will become even more accretive as we get through the cost takeout component of the Union Bank integration. Number two is, we have a number of initiatives across the board for risk-weighted asset optimization. Those are things like credit transfers, risk transfers, and a number of things to optimize the balance sheet that I think we ought to be focused on and are very focused on to your question. And I think, with those two things, as I mentioned, we expect to exceed 9% by the end of this year. That, coupled with our AOCI burn down and additional accretion as we go into 2024, makes me comfortable that we are prepared with whatever event occurs as it relates to Category II in the timing, as Terry mentioned, no later than the end of 2024.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I would like to add a few points that align with what has been said. Regarding AOCI, its burn will depend on various factors. We have proactively worked on repositioning the AFS portfolio and exploring asset sales and securitization. To give you perspective, the duration of the investment portfolio, particularly the AFS portfolio, has decreased from just over 4.5% in the fourth quarter to about 3.8% at the end of the first quarter. We will continue to reduce the duration, which will aid in managing AOCI. Additionally, we have been working to minimize the volatility of AOCI in rising interest rate environments through hedging activities. This approach involves a combination of several strategies that we will implement.
Erika Najarian, Analyst
And is 9.5%, 10% an appropriate new bogey as we think about the shift change for next year on Cat II?
Andy Cecere, Chairman, President, and Chief Executive Officer
So Erika, as you know, the…
Erika Najarian, Analyst
Go ahead.
Andy Cecere, Chairman, President, and Chief Executive Officer
The regulators are currently analyzing how capital levels should be structured across the industry under Basel IV and any related changes in categorization. We are waiting, just like you, to understand what the new environment will entail. However, our plan is based on what Terry just discussed.
Erika Najarian, Analyst
And just if I could sneak in one last one in. One of your peers closest to you in size at the TLAC was pretty much done investing. I noticed that you mentioned your superior debt rating several times. Clearly, the debt markets are still a little bit dislocated. But how should we think about the wholesale funding stack from here? I noticed on a period-end basis, short-term borrowings went up by $25 billion. Terry, as you potentially anticipate TLAC, how should we think about your senior debt issuance plans or really hold that level of borrowings until there's a little bit more less dislocation in the senior debt market?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, TLAC is something we will better understand over the next 12 months. The key question is not whether TLAC will be implemented, as we expect it will, but rather how it will be adjusted for regional banks to reflect our risk profile compared to the larger banks. There are many estimates out there. One reasonable estimate could be based on foreign bank operators and their TLAC levels. If that applies to us, I believe it would be quite manageable and within a range we can handle, providing us with flexibility in how we use it within the bank.
Erika Najarian, Analyst
Thank you.
Andy Cecere, Chairman, President, and Chief Executive Officer
Thanks, Erika.
Operator, Operator
Next, we can go to Mike Mayo with Wells Fargo Securities. Please go ahead.
Andy Cecere, Chairman, President, and Chief Executive Officer
Good morning, Mike.
Mike Mayo, Analyst
Hi. Well, your PE, I believe consensus is close to seven and the market is around 20. So your relative PE is one of the lowest in history. So I would posit that the market is concerned about something other than earnings. So going back, I guess the simple question for you, Andy, is will U.S. Bancorp need to issue capital? And how confident are you about that? And on the other side, are buybacks potentially an option once you get to 9% CET1? And the reason I bring that up is you've seen the front-page articles and papers if you're forced to recognize the unrealized securities losses and you do a burn down and then people come up with all sorts of numbers. And would you be forced to realize that? You heard Congress talk about these issues. Could you be forced to incorporate that as part of the current stress test? Could the Fed force your hand sooner? Any color you can give. What's your confidence that you might need to issue capital over the next year or so?
Andy Cecere, Chairman, President, and Chief Executive Officer
Thanks, Mike. As I mentioned, that is not part of our current thinking. I'm confident that our earnings growth, RWA optimization, and AOC reduction will help us reach the right capital levels. This is a significant focus for me and the entire management team, including Terry. We are very dedicated to this. Regarding buybacks, we know that various capital changes are expected from a regulatory perspective, so we won't take any action until we gain more clarity, which we anticipate in the second half of the year. However, our main priority is to achieve the appropriate capital levels as quickly as possible, increase capital, and strengthen our capital base.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. And Mike, the thing that I would add to that, we're going to learn with respect to exactly how moving to category two and the inclusion in unrealized losses gets incorporated into the CCAR process. But just as a reminder, we have a pretty significant amount of buffer that already exists just based upon our credit performance and our PPNR performance because of the earnings capacity. We continue to reduce the volatility of AOCI to rising interest rates. We're doing that through pay-fixed hedges and just shortening the duration and things that I talked about earlier. I think there’s very likely that they will incorporate a higher rate environment into the CCAR process. I will tell you that we've done lots of scenarios that look at a stagflation sort of environment, and we actually perform better in that environment because the revenue streams tend to hold up given our mix of business, et cetera. So we're taking a lot of that into consideration. And like Andy said, we feel pretty confident that we don't have to go through a capital raise.
Mike Mayo, Analyst
As part of this year's stress test, would they include the unrealized securities losses since that would incorporate the nine-quarter time horizon or no?
Terry Dolan, Vice Chair and Chief Financial Officer
No. That is not required in the CCAR analysis as a condition of the way the deal was structured.
Mike Mayo, Analyst
And then last short one, you're non-interest-bearing deposits. I know you brought that up before. It certainly went down more than average this quarter, but you're not guiding your margin down too much. You said 3% to 3.05% versus, I guess, 3.1% this quarter. Why wouldn't you be guiding that down even further given the decline in non-interest-bearing deposits quarter-over-quarter?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. It's a couple of different things. One is, again, if you end up just looking at the mix of total deposits, we again think that total deposits will be relatively stable and that the mix of NIB will be relatively stable around that 25% up or down. Part of the decline in this particular quarter ties back to some of the seasonal flows, which are part of our trust business, but also the deposits that we knew were going to go out the door to MUFG because of closing down the PurePoint, et cetera. All of those things kind of tie in to the reason why we saw the decline this quarter.
Mike Mayo, Analyst
All right. Thank you.
Operator, Operator
Next, we go to John McDonald with Autonomous Research. Please go ahead.
Andy Cecere, Chairman, President, and Chief Executive Officer
Hey, John.
John McDonald, Analyst
Yes, hi. Good morning, guys. Wanted to ask on the idea of getting above 9% by the end of the year on CET1. Does that rely on the RWA mitigation opportunities, or is that just kind of the 20 to 25 basis points that Terry mentioned before the RWA benefit? Is that something that will help you next year? Can you talk a little bit about that?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, we think that the capital generation, the accretion that we'll see is core earnings capability. So it does not rely on those RWAs. So the RWA optimization that we will go through will be above and beyond that. That's a part of that overall capital strategy that Andy talked about earlier.
John McDonald, Analyst
The benefits of that should happen and help you towards the end of this year, maybe into next year as you work towards end of 2024 capital target?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, it will help us both this year as well as into next year. Absolutely. As you know, John, we've been kind of preparing for Cat 2 for well over a year. We put a lot of things in place in the third and fourth quarter. We took some actions in the fourth quarter, and we'll utilize a lot of those tools, if you will, as part of the RWA optimization process that we're going to go through.
John McDonald, Analyst
Yes. And just to clarify, Terry, this hasn't happened prior to the end of 2024, even with the Fed, right? The Fed would tell you on January 2024 that it would take effect by the end of 2024, right? So, it's not like they're going to tell you any color there, correct?
Terry Dolan, Vice Chair and Chief Financial Officer
That is correct.
John McDonald, Analyst
Okay. And then any idea of the pace of AOCI burn down? Obviously, the AOCI came down 11% this quarter with the help of rates. But in a world where rates are not coming down, what's the natural kind of burn-off pace that you might expect for that over a year or two? Any help on that? And just kind of reminding us of the duration again.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. The duration of the AFS portfolio right now is about 3.8 years. So, if you take that into consideration, the burden will still be fairly reasonable, even without interest rates. Additionally, we have factored in some of the rising interest rates with respect to AOCI.
John McDonald, Analyst
Okay. Thanks.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks, John.
Operator, Operator
Next we go to John Pancari with Evercore. Please go ahead.
John Pancari, Analyst
Good morning.
Andy Cecere, Chairman, President, and Chief Executive Officer
Good morning, John.
Terry Dolan, Vice Chair and Chief Financial Officer
Good morning, John.
John Pancari, Analyst
Can you provide more details on the RWA optimization? I know you mentioned credit transfers and risk transfers, but can you expand on that a bit? Additionally, what kind of benefits do you anticipate arising from the RWA actions? Lastly, are you considering other business or portfolio sales or divestitures in this context? Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
The second part of the question was?
Andy Cecere, Chairman, President, and Chief Executive Officer
Their business sales.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, at this moment, we are considering various options regarding businesses that we might sell. Portfolio optimization is a continual process for us, and we have engaged in it multiple times over recent years. Therefore, we will certainly explore this area. We have a significant mortgage servicing rights portfolio, and we will evaluate selling portions of that where it is appropriate. Additionally, we will consider asset securitization similar to what we did in the fourth quarter. There are various risk transfer structures that we have implemented and others we have prepared to initiate when the time is right. Overall, we will assess a range of options as we move forward, while also aiming to shift our focus towards growth in businesses that require less capital compared to capital-intensive ones. It will be a combination of different strategies as we progress.
John Pancari, Analyst
And do you have a way to help us estimate the magnitude in terms of how you're thinking about that targeted contribution from the RWA optimization strategies?
Andy Cecere, Chairman, President, and Chief Executive Officer
So the strategies that we have in place are reflected in the guidance that we provided. So that would not change that, and we'll continue to update that guidance, given the economic conditions and rates and the scenarios that we see. But as Terry mentioned, this is a priority for us, and we have a number of initiatives underway, which is the appropriate thing to do, because I think capital for all banks is going to be more precious as we think about the forward regulatory environment.
John Pancari, Analyst
Got it. And then, just one more for me. And I know you mentioned in terms of other regulatory potentially coming down the pipe. You're already in the advanced phase of proposed rulemaking on the TLAC. And can you just talk about the other potential regulatory changes you see coming down the pipeline? I know you had mentioned the AOCI efforts, but can you talk about potentially around FDIC or stress capital buffer, liquidity rules, anything on that front worth commenting on?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I mean, it could be a number of different things. I mean, we talked about TLAC, I mean, just levels of capital. You hear them talking about domestically significantly important banks. So increase in the level of the stress capital buffer is another piece of it. I think another one will be around LCR. And then, in the CCAR process, I think that they'll incorporate, I would say, multiple to kind of go back to what they used to do. They'll have kind of multiple scenarios, but one will be kind of, what I would say, a traditional sort of stress test where unemployment goes up and rates come down. Another one will be more, I think, some form of stagflation, where rates stay relatively high and you experience the credit loss stress. And again, we've run a variety of different scenarios, and I think we feel like we would be able to withstand either one of those, just based upon our risk profile.
John Pancari, Analyst
Got it. Okay. Thanks, Terry.
Operator, Operator
Next we can go to Gerard Cassidy with RBC. Please, go ahead.
Terry Dolan, Vice Chair and Chief Financial Officer
Hey, Gerard. Good morning.
Andy Cecere, Chairman, President, and Chief Executive Officer
Good morning, Gerard.
Gerard Cassidy, Analyst
Good morning, Terry. Good morning, Andy. I have a narrower question. I think it was on slide eight. You guys talked about the impacts of deposits following March 8. The inflows that you referenced, did that come primarily in the Union Bank franchise? Because, obviously, it was located in California. I know you guys have been in California as well. And then second, was it more commercial versus consumer or more interest-bearing versus non-interest-bearing?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. In terms of the mix, shortly after March 8, we observed a significant number of account openings, predominantly on the commercial corporate side, accounting for about 70% compared to the consumer side. We did see some inflows, but these were somewhat offset by seasonal flows within corporate trust as the month progressed. Additionally, when I examine net new customer accounts for deposits, particularly in California on the consumer side, we actually noted a considerable increase in March compared to the previous months. I believe we are likely experiencing some benefits as a result of this. I think that answers your questions.
Gerard Cassidy, Analyst
Thank you. And then over the years, you guys have always done quite well and underwriting your loan portfolio, you show up well in the CCAR tests over the years on credit. And so you don't have a very big exposure to commercial real estate. And I always find it interesting to talk to banks that don't have big exposures to a potential credit area that could be a problem. What are you guys seeing in that commercial real estate area, particularly in the office portfolio? Any color would be helpful.
Andy Cecere, Chairman, President, and Chief Executive Officer
Sure, Gerard. So first of all, the rest of the portfolio is very stable. If you look at our charge-off rates and non-accruals and so forth in the numbers around credit metrics, the rest of the portfolio is stable and starting to normalize, but normalizing as we expected. I do think the area of focus for all of us is office within real estate. And I do think there's some activity occurring there with tenants, behavior changes, sponsor behavior changes. That is going to cause some pressure in the industry because of maybe an acceleration of what we thought was going to be a little longer process occurring more rapidly. So you can imagine that we're very focused on it as well. We have not put on a lot of CRE office over the last many years. We've been very, very conservative around that. So as you say, we don't have a large exposure, but I do think it's an area of a lot of emphasis and focus because I do think there are going to be pressures occurring.
Gerard Cassidy, Analyst
Thank you.
Operator, Operator
Next, we can go to Ebrahim Poonawala with Bank of America. Please go ahead.
Terry Dolan, Vice Chair and Chief Financial Officer
Good morning, Ebrahim.
Ebrahim Poonawala, Analyst
Good morning. I had a follow-up question. I think you briefly mentioned about I think AOCI hedges against if rates spiked. I was wondering, Terry, if you can elaborate on that. We've seen the five-year come back again in the last few weeks. Just what's the downside risk to capital or just an increase in AOCI if rates spiked another 50 basis points? And just talk to us in terms of the extent to which you expect to hedge against that?
Terry Dolan, Vice Chair and Chief Financial Officer
We have been implementing various strategies to mitigate the impact. This includes selling securities when necessary, successfully shortening the duration in the first quarter, and establishing pay-fixed swaps to address the long end of the yield curve. These measures help lessen the effect of rising rates, particularly in the five and ten-year range. If rates were to increase by 50 basis points, it would certainly affect AOCI to some degree, but we have significantly reduced that impact over the past couple of quarters.
Ebrahim Poonawala, Analyst
Understood. And just going back to deposit betas. I think you talked about 40% relative to 34% this quarter. I mean I'm sure you all do a ton of analysis on where terminal betas might end up. But what's the downside risk? I mean, we've obviously had a shock to the system, Fed funds being 5% plus. What's the risk? How do you handicap the risk of that 40% beta actually turning out to be something much higher, maybe closer to 50%.
Terry Dolan, Vice Chair and Chief Financial Officer
Yeah. We've done a lot of different analysis. And I mean, you are right. The competition for deposits is getting stronger. We've taken that into consideration. We're seeing over 5% in some markets. Generally, it is smaller banks where that is occurring, community markets, those sorts of things. And that's because for those entities, that's their primary source of funding. And so that's going to occur. But all of that has been kind of taken into consideration in terms of looking at that 40% deposit beta. If you end up looking at our business, again, in terms of who we end up competing against, et cetera. But what we end up looking at and tracking is, especially on the institutional corporate side of the equation is money market rates and those sorts of things. Right now, that's kind of in the high fours. And our deposit pricing is very competitive with that, which is why it gives us confidence with respect to both flows and the deposit betas that we've articulated.
Ebrahim Poonawala, Analyst
Got it. I mean you don't see a major shift in consumer and retail deposit pricing today versus maybe at the start of the year?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. It's going to depend. I mean, obviously, it depends upon the rate environment. I mean, if the Fed, for example, goes up another 50 or 100 basis points from here, that would put more pressure on deposit betas. But if you end up looking at the market implied or even up a bit, I still feel pretty comfortable with where we're at.
Ebrahim Poonawala, Analyst
Got it. Thank you.
Operator, Operator
Next, we can go to Matt O'Connor with Deutsche Bank. Please go ahead.
Andy Cecere, Chairman, President, and Chief Executive Officer
Good morning, Matt.
Matt O'Connor, Analyst
It's Deutsche Bank. You have very strong reserves to loans on a stated basis. Can you remind us of the impact if you adjust for the Union Bank loans that were marked at fair value when you acquired them?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I missed the first part of the question. Andy, do you?
Andy Cecere, Chairman, President, and Chief Executive Officer
I think you're trying to understand if Union Bank has an impact on our reserve to loans ratio and what it is. I don't think it has a major impact.
Terry Dolan, Vice Chair and Chief Financial Officer
Not a significant one.
Matt O'Connor, Analyst
Okay. And then just broadly speaking like as you think about the rest of the year, I mean, you're obviously taking your best guess on reserves at the current period at your thoughts on.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. So our expectation is that, again, Andy has talked about the fact that we're preparing for any economic sort of outcome that might exist. I think if you end up looking at the consensus in the marketplace, some form of recession, probably a softer or moderate sort of recession late this year, early next year. And if you look at the market implies, I would kind of tie into that. When we go through our reserving process, we look at multiple scenarios. We wait to the conservative side. We look at five different scenarios. We make assumptions with respect to that. Only 35% of it's weighted towards what I would call the base case and the rest of it is downside. So we feel pretty good about where reserve levels are. Obviously, if we saw economic shock above and beyond kind of what is being expected that might be a little bit different. But we feel pretty good about how we're thinking about it.
Matt O'Connor, Analyst
Okay. Great. And then maybe if I could just squeeze in on spending trends throughout 1Q, you guys, through your payments business, obviously see a lot. Just any observations on kind of trends throughout the quarter? And maybe any comments so far in April? Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
In our Payments business, we continue to experience strong sales, particularly over 10% in our merchant processing segment and solid mid to high single-digit growth in our corporate payments sector. When comparing these figures to pre-pandemic levels, they are remarkably high. We are still observing good spending patterns within the business. However, after the recent market disruption, we've noticed a slight decline in retail sales that we will keep an eye on. It's too soon to determine if this is a lasting trend or if it's simply a reaction to the market disruption, but we will continue to monitor the situation. Andy, do you have anything to add?
Andy Cecere, Chairman, President, and Chief Executive Officer
Yes. And that is still growing to match, but it's just growing at a lower rate, particularly in retail. Airline spend continues to be very, very high, which is a little bit of the reason that we have a differential between sales growth and in revenue growth because the airline spread is a little thinner. So, travel continues to be strong. Retail came down a bit, but still growing.
Matt O'Connor, Analyst
Great. Thank you.
Andy Cecere, Chairman, President, and Chief Executive Officer
Sure.
Operator, Operator
Next, we can go to Chris Kotowski with Oppenheimer & Co. Please go ahead.
Andy Cecere, Chairman, President, and Chief Executive Officer
Yes, good morning, Chris.
Chris Kotowski, Analyst
Thanks. Good morning. Thanks for taking my question. You've given us a lot of good detail on the AFS side. I just wonder if you could discuss a little bit how you anticipate managing the held-to-maturity portfolio. Do you also plan to let that kind of burn down and shorten? And I'm curious just given that that's a lot of mortgage backs and that they are principal payments each month. How quickly does that portfolio burn down, or do you see the need to maintain a lot of duration there just in case we get another decline in rates?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, we consider both sides of the equation. The reduction on the held-to-maturity side is mainly influenced by the speed of payoffs and the duration that results from it. As we evaluate the size of the investment portfolio, we will take into account the desired level of duration in the held-to-maturity portfolio, but this will primarily depend on pay downs and payoffs over time.
Chris Kotowski, Analyst
Yes. I mean, I guess my question is that directionally in the next couple of quarters, you would probably allow the duration to decrease and the size of the portfolio to reduce if left to your own devices.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. Yes. Absolutely. Yes.
Chris Kotowski, Analyst
Okay. All righty. That’s it from me. Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks Chris.
Operator, Operator
Next we have Ken Usdin with Jefferies. Please go ahead.
Ken Usdin, Analyst
Hey guys. Good morning. First question, I just want to ask you on credit. On an adjusted basis, your charge-offs were 30 basis points this quarter. And per the comments you made earlier, about CRE and some of the data we see in the release about delinquencies and NPAs increasing. What's your outlook for charge-offs as we go forward versus the 30 basis points that we saw in the first?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, I mean our expectation is that 30 basis will continue to normalize throughout the year and into 2024, probably on a similar sort of pace. I think it's 23 basis points in the fourth quarter. So, I think that, that will continue to kind of move up as the year progresses, just part of normalization.
Ken Usdin, Analyst
Yeah. Understood on that. Okay. And then just coming back to the full year guide. Obviously, you made a modest adjustment which is well expected given the change in the rate outlook. We can back into that, I think it's mostly on the NII side, just given that that's where seemingly some of the changes were versus the prior outlook. But can you just kind of refresh us and just give us kind of just some underlying thoughts of NII growth versus fee growth and any changes you had on, if any, on the fee side versus your prior outlook? Thank you.
Andy Cecere, Chairman, President, and Chief Executive Officer
To your point, most of the changes were in NII, and it's a function of the rate curve, the rate environment, the expectation about rate increases as well as the deposit pricing that Terry made reference to in the beta of approaching 40%. So most of the change was in NII.
Ken Usdin, Analyst
Okay. And then so just last follow-up. So then embedded in your fee outlook for the year is pretty decent growth, it would seem then. And are you expecting that to still be mostly driven by the payments business, or are there other areas that you're expecting to see some good growth in?
Andy Cecere, Chairman, President, and Chief Executive Officer
We have a great diversity of revenue sources and they're all doing well. So payments is up approaching double digits, 9% on a year-over-year basis, as Terry talked about, spend levels are good. We have had a bang of a quarter in our Commercial Products group across the categories, and that is doing just terrifically in this environment and just driving revenue growth as well. Trust is doing well. So – and mortgage. So that's the value of a diverse revenue stream. There are many different sources of revenue and fee income.
Ken Usdin, Analyst
Got it. Understood. Thanks, guys.
Andy Cecere, Chairman, President, and Chief Executive Officer
Thank you.
Operator, Operator
Next, we can go to Vivek Juneja with JPMorgan.
Andy Cecere, Chairman, President, and Chief Executive Officer
Hi, Vivek.
Vivek Juneja, Analyst
Hi, Andy. Hi, Terry. A couple of just clarifications, I think you all mentioned that accretion from the deal, Andy, is going better than you had expected any. I know you've talked a lot, just trying to pull this all together, where are you seeing it better thus far?
Andy Cecere, Chairman, President, and Chief Executive Officer
We discussed in the fourth quarter that we expected the accretion to be between 8% and 11%, and it has actually turned out to be better. Looking at the larger picture, when we first evaluated the deal, Union Bank had a revenue base of around $2.9 billion and an expense base of about $2.6 billion, or $2.3 billion, resulting in a $600 million PPNR. In the first quarter, that figure is now double. The revenues are stronger, primarily due to the value of deposits in the current rate environment. The expenses are slightly lower, and our efficiency expectations are still on target. All these factors contribute to a higher accretion.
Terry Dolan, Vice Chair and Chief Financial Officer
Net higher accretion in the net purchase accounting is actually negative given the car deposit intangibles. So it's very strong.
Vivek Juneja, Analyst
Right. And that's before you even complete the integration, which won't be until the second quarter anyway.
Terry Dolan, Vice Chair and Chief Financial Officer
Yeah.
Andy Cecere, Chairman, President, and Chief Executive Officer
That's right.
Ebrahim Poonawala, Analyst
Understood. Thank you.
Operator, Operator
And next, we can go to Erika Najarian with UBS.
Erika Najarian, Analyst
Yeah. Sorry to prolong the call. I just had one follow-up question. Andy, I asked the question in a compound way, so I apologize. But if you think about accreting to over 9% CET1 by year-end, how would you stack rank dividend growth as a priority?
Andy Cecere, Chairman, President, and Chief Executive Officer
Dividend growth continues to be a priority, Erika. So our expectation is we would have continued growth in the dividend. The dividend growth numbers are not hugely material to the capital accretion math. If you go through the numbers on that, that is a relatively small component of a negative downturn in capital. So that expectation that I talked about includes the expectation of a strong dividend.
Erika Najarian, Analyst
Thank you.
Operator, Operator
And next over to Mike Mayo with Wells Fargo Securities.
Andy Cecere, Chairman, President, and Chief Executive Officer
Hey, Mike.
Mike Mayo, Analyst
Hi. Hey, last quarter, you mentioned your reserves were for an environment with 6% unemployment. I was wondering if you had an update for that. And given CECL accounting, does that mean you're reserving done before the recession has even started, or how do you think about that? And what about the release of reserves the extent you stay down this low charge-off range even with some of the normalization?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, we'll wait to see how things develop given the current economic uncertainty. We previously mentioned the weighted average, which peaked at just over 6%. Today, it stands at about 5.9%, which is consistent with our earlier estimates.
Mike Mayo, Analyst
Okay. And your outlook for the economy, soft recession, hard landing, kind of what you're thinking?
Andy Cecere, Chairman, President, and Chief Executive Officer
So Mike, we expect a soft recession, a moderate recession later half of this year. But as Terry mentioned, our CECL accounting is assuming a sort of a two-thirds downturn, one-third base case. So we are reserved to a little bit more downward scenario.
Mike Mayo, Analyst
Okay. Thank you.
Andy Cecere, Chairman, President, and Chief Executive Officer
You bet.
Operator, Operator
And we have no further questions at this time. I will now turn it back to George Anderson. Please continue.
George Anderson, Senior Vice President and Director of Investor Relations
Thank you for listening to our call. Please contact the Investor Relations department if you have any follow-up questions.
Operator, Operator
And this concludes today's conference. Thanks for participating. You may now disconnect.