Earnings Call
US Bancorp De (USB)
Earnings Call Transcript - USB Q1 2021
Operator, Operator
Welcome to U.S. Bancorp's First Quarter 2021 Earnings Conference Call. Following a review of the results by Andy Cecere, Chairman, President, and Chief Executive Officer; and Terry Dolan, Vice Chair and Chief Financial Officer, there will be a formal question-and-answer session. (Operator provided instructions.) This call will be recorded and available for replay beginning today at approximately 1:00 PM Central Time, through Thursday, April 22, 2021 at 10:59 PM Central Time. I would now like to turn the conference call over to Jen Thompson, Director of Investor Relations and Economic Analysis for U.S. Bancorp.
Jen Thompson, Director of Investor Relations and Economic Analysis
Thank you, Kara. And good morning, everyone. With me today are Andy Cecere, our Chairman, President and CEO; and Terry Dolan, our Chief Financial Officer. Also joining us on the call are our Chief Risk Officer, Jodi Richard; and our Chief Credit Officer, Mark Runkel. During their prepared remarks, Andy and Terry will be referencing a slide presentation. 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 risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release and in our Form 10-K and subsequent reports on file with the SEC. I'll now turn the call over to Andy.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Jen. And good morning, everyone, and thanks for joining our call today. Following our prepared remarks, Terry, Jodi, Mark and I will take any questions you have. I'll begin on slide 3. In the first quarter, we reported earnings per share of $1.45. Credit quality trends were better than expected and the economic outlook has improved meaningfully over the past several months, given the pace of the vaccine rollout and the ongoing impact of significant government stimulus. Based on these factors, we released a little over $1 billion in loan loss reserves this quarter. Revenue totaled $5.5 billion in the first quarter. As expected, net interest income decreased compared with the fourth quarter. However, we expect loans to grow as the year progresses and given that securities reinvestment rates are now accretive to asset yields and our belief that premium amortization expenses likely peaked, we expect that the first quarter will be a low point for net interest income. Improved economic activity is driving better consumer and business spending trends, which in turn is translating into improving payments volume. In each of our payments businesses, volumes, excluding COVID-impacted travel, hospitality, and entertainment sectors, exceeded first quarter 2019 pre-pandemic levels. Our expenses were relatively stable compared with the fourth quarter. In the lower right-hand quadrant, you can see that our capital and liquidity positions remained strong. And during the quarter, we returned $1.3 billion to shareholders in the form of dividends and share buybacks. Slide 4 provides key performance metrics. This quarter, our returns benefited from improved credit performance and reserve release. Longer term, we believe we will continue to deliver industry-leading returns on tangible common equity driven by strong PPNR performance, consistent through-the-cycle credit performance and prudent capital management. Slide 5 shows the pace of migration to the digital channel. Digital uptake is correlated with higher customer satisfaction, ease-of-use, and lower cost of service, which we measure very closely. Digital transactions now account for nearly 80% of all transactions. In the lower right-hand chart, you can now see that more than 60% of loan sales now occurred digitally, which compares to less than 40% a year ago. Now let me turn the call over to Terry who will provide more detail on the quarter.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks, Andy. If you turn to slide 6, I'll start with the balance sheet review followed by a discussion of first quarter earnings trends. Average loans declined 2.8% compared with the fourth quarter as the low interest rate environment continues to impact borrower behavior. Elevated corporate paydown activity late in the fourth quarter negatively impacted average commercial loan growth in the first quarter. Recently, we have seen improving pipelines, and we expect inventory building and M&A activity to pick up as we move further into 2021. Similarly, lower interest rates impacted consumer loans as increased refinancing activity impacted real estate loan balances. Credit card revolve rates continued to decline this quarter causing balances to contract as consumers used excess liquidity from government stimulus programs to pay down debt. Turning to slide 7, average deposits increased 0.9% compared with the fourth quarter, reflecting the level of liquidity in the financial system. As a reminder, our deposits are typically seasonally lower in the first quarter of the year. Our overall deposit mix continues to be favorable. In the first quarter, our non-interest bearing deposits grew 2.8%, while time deposits declined 17.7%. Slide 8 shows our credit quality trends, which continue to be better than our expectations, reflecting improving economic conditions, supported by additional stimulus and increased vaccine availability. Our net charge-off ratio totaled 0.31% in the first quarter compared with 0.58% in the fourth quarter. The improvement reflects lower total commercial, credit card and other retail net charge-offs. The ratio of non-performing assets to loans and other real estate was 0.41% at the end of the first quarter compared with 0.44% at the end of the fourth quarter. We released reserves this quarter reflective of better-than-expected credit trends and an improving economic outlook versus our previous expectations. In the first quarter, our loan loss provision was negative $827 million or $1.1 billion less the net charge-offs of $223 million. Our allowance for credit losses as of March 31st totaled $7.0 billion or 2.36% of loans. The allowance level reflected our best estimate of the impact of improving economic growth, lower unemployment, and changing credit quality within the portfolios driven in part by the benefits of continued government stimulus programs. Slide 9 highlights our key underwriting metrics and loan loss allowance breakdown by loan category. Turning to slide 10, exposures to certain at-risk segments given the current environment are stable compared with the fourth quarter. The left table shows that customer balances included in payment relief programs continued to decline meaningfully in the first quarter to less than 1% of total loans. Slide 11 provides an earnings summary. In the first quarter of 2021, we earned $1.45 per diluted share. These results include a reserve release of $1.1 billion. Turning to slide 12, net interest income on a fully taxable equivalent basis of $3.1 billion declined 3.5% compared with the fourth quarter due to fewer days in the quarter, lower average loan balances, and a 7 basis point decline in net interest margin. The decrease in the net interest margin was primarily driven by higher premium amortization expense, lower portfolio reinvestment rates, and mortgage loan prepayments. As mentioned earlier, we expect loans to grow as the year progresses. Also, given that securities reinvestment rates are now accretive to asset yields and we believe that premium amortization has likely peaked, we expect the first quarter will be the low point for net interest income. Slide 13 highlights trends in non-interest income, which as a reminder is typically seasonally lower in the first quarter of each year. Non-interest income declined 5.7% from a year ago, primarily driven by lower mortgage revenue. On a year-over-year basis, strong refinancing activity drove higher production volumes and related production revenue. However, in the first quarter, we recorded a reduction of $120 million to the fair value of our mortgage servicing rights, net of hedges, which compares with a favorable increase in the valuation net of hedges of $25 million a year ago. With prepayment speeds declining, we would expect future changes in the MSR fair value adjustment to be more moderate. Business activity and strong underlying market conditions drove growth in trust and investment management fees, treasury management revenue, and commercial product revenue, although deposit service charges were negatively impacted by lower consumer spend and increased consumer liquidity from government stimulus. Slide 14 provides information on our payment services business, including a breakdown of segment volume for the first quarter of 2021 compared with more normalized 2019 levels. Slide 15 indicates that sales volumes across our payments businesses have continued to rebound since bottoming in April of 2020. In the first quarter, total payments fee revenue was essentially flat compared with the first quarter of 2020. Credit and debit card revenue increased 10.5% on a year-over-year basis, driven by higher interchange revenue and higher prepaid card fees as a result of government stimulus programs. Merchant Services revenue decreased 5.6% compared with a year ago, which was better than what we had expected coming into the quarter. Improving sales growth in North America was more than offset by expected declines in European sales due to COVID-related shutdowns. Corporate payments revenue declined 13.1% year-over-year as travel and entertainment revenue continued to lag. Turning to slide 16, non-interest expenses were relatively stable on a linked quarter basis as expected. Year-over-year growth of 1.9% was driven by increased mortgage and capital markets production incentive costs and expenses related to business investments in digital and technology, which was partly offset by a decline in costs related to COVID-19 and a future delivery liability incurred in the first quarter of 2020. Slide 16 highlights our capital position. Our common equity Tier 1 capital ratio at March 31st was 9.9% compared with our target CET1 ratio of 8.5%. Given improving economic conditions in the first quarter, we bought back $650 million of common stock as part of our previously announced $3.0 billion repurchase program. I'll now provide some forward-looking guidance. For the second quarter of 2021, we expect fully taxable equivalent net interest income to increase in the low single digits compared with the first quarter, and we look for modest loan growth. We expect payments fee revenue to continue to improve sequentially as economic activity continues to accelerate. Starting in the second quarter, growth rates will be meaningfully impacted by favorable year-over-year comps given the 2020 COVID environment. We expect non-interest expenses to be relatively stable compared with the first quarter. The outlook for credit quality has improved in the past two quarters, along with the improving economic environment. However, we think that the net charge-off ratio is likely to remain low as the first quarter level of 0.31%. As we move further into the year, we expect the net charge-off ratio to normalize toward pre-pandemic levels. We will continue to assess the adequacy of the allowance for credit losses as conditions change. For the full year 2021, we currently expect our taxable equivalent tax rate to be approximately 21%. I'll hand it back to Andy for closing remarks.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Terry. One year ago, we were at the beginning stages of a pandemic-driven economic downturn, which had no precedent. We are confident in the strength of our balance sheet and our ability to support our customers, employees and communities through a difficult time. But we, along with the entire industry, faced an uncertain outlook. A lot has changed in the year. Our first quarter results were reflective of the lingering impact of an economy that continues to heal, but has not fully recovered to pre-pandemic activity levels. However, we are optimistic about the trajectory from here. We believe we are well positioned to benefit from what many expect to be the strongest economic growth this country has seen in decades, as we capture the potential of increased consumer and business spending across all of our business lines, most directly related to our three payments businesses. Importantly, we expect our multi-year investments in digital and payments to continue to pay off well beyond any cyclical benefit that we see in the upcoming quarters. These investments aimed at enhancing the customer experience and leveraging the power of our payments ecosystem will position us at the forefront in banking and drive market share gains for many years to come. Ultimately, our goal is to deliver industry-leading returns through this cycle. And as such, we invest to drive top-line revenue growth, while prudently managing expenses, credit quality and capital with the best interest of our long-term shareholders in mind. In closing, I'd like to thank our employees for all their hard work and their commitment to serving our customers with the expertise and integrity they have come to expect from us. We'll now open up the call to Q&A.
Operator, Operator
(Operator provided instructions.) Your first question comes from the line of David Rochester with Compass Point.
David Rochester, Analyst (Compass Point)
Hey. Good morning, guys.
Andy Cecere, Chairman, President and Chief Executive Officer
Good morning, David.
David Rochester, Analyst (Compass Point)
On—just on fee income, you mentioned payment activities should continue to recover in 2Q. I was hoping you could frame that potentially in a range. And then, as you look out to a more normalized back half of the year versus where we are today, what kind of year-over-year growth in transaction volume do you think we could see at that point? I heard some other players in the space talk about pretty robust year-over-year growth as we move into the back half of the year. I was curious what you guys are expecting.
Terry Dolan, Vice Chair and Chief Financial Officer
It's a great question. The comparables on a year-over-year basis are going to be pretty strong simply because of what was happening in 2019. As we look at different components of our revenue, let's take merchant acquiring as an example. In the first quarter, overall it was down about 15%. But excluding airlines and other impacted industries, that segment was actually up about 10%. Airlines continued to be depressed in the 70% to 75% range, but we do expect all those categories to continue to improve. Our expectation is that by the end of the fourth quarter or certainly very early in 2022 we will be back to pre-pandemic levels on a total basis in terms of total merchant acquiring, total credit/debit card as well as the corporate payments services businesses.
David Rochester, Analyst (Compass Point)
Great. That's great color. Maybe just switching to NIM real quick. You mentioned new securities yields are accretive to the book yield and prepayments are declining, so that should bring down securities premium and expense. I know you mentioned NII was moving higher from here. Are you also saying you think you'll get some margin expansion here as well?
Terry Dolan, Vice Chair and Chief Financial Officer
Here's how I'd frame it. NIM is an output with respect to how your balance sheet is changing. Our expectation from a NIM perspective is that in the second quarter, it's probably reasonably flat, but expanding from there. The dynamics will be around loan growth balances, which will probably continue to be a bit of a pressure, but offset by expanding and improving investment portfolio. That affects premium amortization, and the differential from reinvestment rates is getting much stronger because of the steepening yield curve and other factors.
David Rochester, Analyst (Compass Point)
Great. So flattish in 2Q, expanding in the back half of the year, potentially?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes.
David Rochester, Analyst (Compass Point)
Great. All right. Thanks, guys.
Operator, Operator
Your next question comes from the line of John Pancari with Evercore ISI.
John Pancari, Analyst (Evercore ISI)
Good morning.
Andy Cecere, Chairman, President and Chief Executive Officer
John, good morning.
John Pancari, Analyst (Evercore ISI)
So on the loan demand side, I know you acknowledged that you do expect loans to be pressured near term. Can you talk about when you see a more notable inflection in loan growth? What are the drivers? And within the commercial side, can you talk about the demand you are seeing in terms of pipeline and utilization? Thanks.
Terry Dolan, Vice Chair and Chief Financial Officer
Great questions. For loan growth, we expect modest expansion in the second quarter, but it will be modest. There is still pressure in certain categories. On the commercial side, pipelines are getting stronger across most areas and geographies. The stimulus in the system will drive consumer spend, especially in the second half of the year, and businesses are becoming more optimistic. They are thinking about inventory build and capital expenditures. We expect M&A activity to strengthen in the second half of the year, which will have positive implications for C&I loans. On the consumer side, significant stimulus allowed consumers to pay down debt, which has impacted card balances. We typically see an increase in credit cards in the second quarter, which will offset some contraction. Auto lending has been very strong and should continue to be strong. It's a mix of puts and takes in the near term, but we are seeing encouraging signs and expect consumer lending to come back as consumer spend expands.
John Pancari, Analyst (Evercore ISI)
Got it. Thanks, Terry. Andy, could you talk about M&A interest, both whole-bank and non-bank? Are you open to opportunities that would meaningfully move the needle for customers or geographies, and how active are you in the non-bank space?
Andy Cecere, Chairman, President and Chief Executive Officer
Our view is consistent with prior commentary. We're open to opportunities that would meaningfully move the needle from a traditional bank standpoint, such as acquiring customers or new geographies. In the non-bank space, we are active in expanding capabilities and distribution in payments. Those are areas of continued focus as we build our payments ecosystem through partnerships or M&A.
John Pancari, Analyst (Evercore ISI)
Got it. Thanks, Andy.
Operator, Operator
Your next question comes from the line of Betsy Graseck with Morgan Stanley.
Betsy Graseck, Analyst (Morgan Stanley)
Hi, good morning.
Andy Cecere, Chairman, President and Chief Executive Officer
Good morning, Betsy.
Betsy Graseck, Analyst (Morgan Stanley)
I wanted to dig into payments and what you can do on the corporate side, especially as you were one of the first to offer RTP. I hear clients are not that excited about RTP on the corporate side, but you might have a different view. Is there a potential needle mover coming over the next few years?
Andy Cecere, Chairman, President and Chief Executive Officer
I think there's a significant opportunity. There are many use cases across industries for request for pay, daily payroll, managing receivables and payables, and enhanced information for auto reconciliation. There is a lot of opportunity, but it requires initial investment and changes to client processes. We're working with customers to understand the opportunity and help with the investment and process changes. I believe payments mechanisms, particularly in business-to-business, will migrate fairly rapidly over the next few years away from checks, ACH and wires toward real-time solutions.
Betsy Graseck, Analyst (Morgan Stanley)
Is monetization through increased deposits or hard dollar fees?
Andy Cecere, Chairman, President and Chief Executive Officer
It will be a combination of both. Part will come from the balance sheet, part from fees, and some fee structures may differ to enable use cases that RTP provides versus per-transaction fees.
Betsy Graseck, Analyst (Morgan Stanley)
On credit, you mentioned normalizing toward pre-pandemic levels. Does that mean around a 50 basis point NCO rate? Pre-pandemic had certain asset classes with recoveries, so what number do you mean?
Andy Cecere, Chairman, President and Chief Executive Officer
Yes. Pre-pandemic we were in the 45 to 50 basis point range. The 31 basis points this quarter is probably lower than a long-term normal, and I would expect it to migrate back toward that 45 to 50 basis point level.
Mark Runkel, Chief Credit Officer
That's spot on. Over time we expect to get back to a more normalized level and see some recoveries come down, with the portfolio normalizing closer to that 50 basis point range.
Betsy Graseck, Analyst (Morgan Stanley)
Given your experience, what time frame should we think about? Next 12 months or 36 months?
Andy Cecere, Chairman, President and Chief Executive Officer
Predicting time frames is challenging. Given the significant improvement we see today, I think things could start to get back to more normal levels in the latter half of this year.
Betsy Graseck, Analyst (Morgan Stanley)
Okay. Thanks.
Operator, Operator
Your next question comes from the line of Scott Siefers with Piper Sandler.
Scott Siefers, Analyst (Piper Sandler)
Good morning, guys. Terry, a little more nuance on the margin: can you quantify how beneficial the decline in premium amortization could be for margin and NII going forward? Where is it now, where might it normalize? And thoughts on contribution from PPP in 2Q given some lumpiness?
Terry Dolan, Vice Chair and Chief Financial Officer
On PPP, first quarter versus second quarter, we don't see that as a big driver for us based upon the size of our origination. On premium amortization, on the way up we've seen quarter-over-quarter moves in the two to five basis point range. The impact will depend on how quickly prepayment speeds decline. It's a bit hard to put an exact impact for 2Q, but our expectation is that prepayment speeds will linger a little higher in April, then start to come down meaningfully in May and June.
Scott Siefers, Analyst (Piper Sandler)
Perfect. Thank you. On payments, once we get back to normalization, where could growth of those businesses be in aggregate compared to the traditional bank parts? Any thoughts on longer-term trajectory?
Andy Cecere, Chairman, President and Chief Executive Officer
I think there's a significant opportunity. We have over 1 million business banking customers ($25 million revenue and above). We believe we can grow these relationships 15% to 20% over the next few years and grow overall revenue levels 25% to 30% by expanding share of wallet. Less than 40% of our merchant customers have a business banking product and even fewer business banking customers have a merchant product. There's substantial opportunity to capture market share. It's not just card solutions; it's payroll, cash flow, payables and receivables, leveraging data and helping them run their business. That will be a driver of growth.
Terry Dolan, Vice Chair and Chief Financial Officer
We've been investing in e-commerce and tech-led capabilities within our merchant acquiring business. That segment has been growing in the 25% to 30% range over the last 12 to 18 months, and as it becomes a larger part of our business, it will help merchant acquiring.
Scott Siefers, Analyst (Piper Sandler)
Perfect. Thank you very much.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Scott.
Operator, Operator
Your next question comes from the line of Ken Usdin with Jefferies.
Ken Usdin, Analyst (Jefferies)
Thanks. Good morning, guys. First on fees: can you talk through the outlook for the mortgage business, understanding you had a $120 million MSR adjustment this quarter? You have been taking share on production, but gain on sale is coming down. Where do you think the mortgage business can go from here and the related puts and takes?
Andy Cecere, Chairman, President and Chief Executive Officer
We continue to capture market share on origination. We have been investing in retail and purchase mortgage capabilities, focusing on purchase mortgages that originate from home sales. Even as refinancings slow, we can ramp up purchase mortgage originations. Our technology and digital capabilities help capture share. We expect refinancing revenue to decline as rates move up, which will reduce gain-on-sale, but our investments have been positive and will continue to be. Mortgage revenue is likely to come down during the year but will remain a meaningful part of our business.
Ken Usdin, Analyst (Jefferies)
So the $120 million MSR valuation adjustment was more of a temporary phenomenon and not a new run-rate?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. The $299 million included about $120 million of MSR valuation adjustment. Excluding that, we still saw significant production and origination revenue in the first quarter. While it will settle down from that pace, we still expect it to be relatively strong through the year.
Ken Usdin, Analyst (Jefferies)
Second, on costs you mentioned flattish year-over-year. The first quarter had a high comp number even with the seasonal benefit. How much of the COVID cost is still in the cost number, and what's the impact of performance-based incentives and stock-based comp seasonality?
Terry Dolan, Vice Chair and Chief Financial Officer
We had higher costs related to COVID last year; those costs have come down, but we continue to have cleaning and safety costs until people are comfortable returning to offices. Compensation costs are seasonal, and performance-based incentives reset annually. Last year payouts were significantly lower, so there's an impact from refilling those pools. Stock-based compensation for retirees is higher in the first quarter due to accounting, and that will come down in the second quarter.
Ken Usdin, Analyst (Jefferies)
All right. Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
Thank you, Ken.
Operator, Operator
Your next question comes from the line of Matt O'Connor with Deutsche Bank.
Matt O'Connor, Analyst (Deutsche Bank)
Hi. Following up on expenses, outlook for flat in 2Q is good. Can you comment on the back half of the year and beyond? It feels like costs are still bloated. What can you do on expenses and operating leverage?
Terry Dolan, Vice Chair and Chief Financial Officer
Our goal is to manage expenses and keep them flat, especially in a challenging revenue environment. As revenue normalizes, we expect to achieve positive operating leverage, but timing is difficult to predict. We are focused on expense management for the rest of the year and into 2022.
Matt O'Connor, Analyst (Deutsche Bank)
At Investor Day 2019 you laid out targets. Those feel stale. What are updated two- to three-year targets? Efficiency ratio and ROE metrics?
Andy Cecere, Chairman, President and Chief Executive Officer
We previously discussed a 17.5% to 20% tangible return on common equity target. While results this quarter were higher due to reserve release, that's not repeatable. In a more normal environment with continued economic strengthening and rate normalization, we still believe we can achieve that 17.5% to 20% target, likely later this year or into 2022. From an efficiency perspective, the ratio is higher than normal primarily due to lower revenue levels. As revenue normalizes, our long-term target is the low 50s for the efficiency ratio.
Matt O'Connor, Analyst (Deutsche Bank)
So from 62 this quarter to low 50s longer term. That implies outsized operating leverage and revenue growth drivers beyond comp-related areas.
Andy Cecere, Chairman, President and Chief Executive Officer
Yes. Many revenue opportunities are less directly compensation-related. Margin and payments have different cost structures than mortgage, for example. We're managing expenses closely and balancing investments for customer acquisition and digital growth against short-term expense management. Expense efficiency is a top focus for management.
Matt O'Connor, Analyst (Deutsche Bank)
That was helpful. Thank you.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Matt.
Operator, Operator
Your next question comes from the line of Erika Najarian with Bank of America.
Erika Najarian, Analyst (Bank of America)
Hi, good morning.
Andy Cecere, Chairman, President and Chief Executive Officer
Good morning, Erika.
Erika Najarian, Analyst (Bank of America)
This is the second straight quarter where results were fine but the stock responded less favorably. Regarding normalized ROTCE of 17% to 20%, you've made investments—could those initiatives reset your normalized ROTCE higher, or is 20% the top end?
Andy Cecere, Chairman, President and Chief Executive Officer
2020 was a low point for many reasons, especially payments. Those headwinds are now tailwinds. Margin should improve for the reasons Terry described. We had a step-up in investments in prior years that has leveled off. Branch closures and investments in the tech stack and operations will produce efficiencies. These investments enable customer acquisition and more efficient operations. Taken together, we believe the 17.5% to 20% range is appropriate for a normalized environment.
Erika Najarian, Analyst (Bank of America)
In 2018 when you achieved 20% ROTCE, efficiency was almost 55%. If you get to low 50s efficiency, could normalized ROTCE be above 20%?
Andy Cecere, Chairman, President and Chief Executive Officer
We believe the 17.5% to 20% range is the right target for normalized conditions based on our modeling and projections.
Erika Najarian, Analyst (Bank of America)
Got it. Thank you.
Operator, Operator
Your next question comes from the line of Bill Carcache with Wolf Research.
Bill Carcache, Analyst (Wolf Research)
Thanks. Good morning, Andy and Terry. How do you think about pent-up demand dynamics and how they may differ across consumer and commercial businesses? Where is more geared to the reopening? Also, how does excess liquidity impact both sides in terms of loan growth outlook?
Terry Dolan, Vice Chair and Chief Financial Officer
On consumer versus commercial, stimulus will show up in consumer spend fairly quickly, helping fees and consumer loans as the year progresses. On the commercial side, businesses need to rebuild inventories and make capital investments after holding off. Timing is more subdued earlier because there's substantial liquidity and deposit balances that companies will burn through before turning to loans. We expect more robust loan growth in the second half of the year.
Andy Cecere, Chairman, President and Chief Executive Officer
The last category to come back is corporate travel and entertainment. That remains well below 2019 levels and will be the last to recover as people resume travel.
Bill Carcache, Analyst (Wolf Research)
On investment securities, your mix grew to just over 31% of average earning assets this quarter, which is high historically, and you expect to grow that. Can you discuss weighing NII opportunities from growing the securities book with OCI risk and overall ALM perspective?
Terry Dolan, Vice Chair and Chief Financial Officer
In the near term, until loan demand solidifies, deploying low-cost deposits into the investment portfolio makes sense. We'll weigh opportunities as the yield curve steepens and pick points to make investments. Given our expectation that longer-term rates will continue to move up while the shorter end lags, investing in the securities portfolio can be sensible.
Bill Carcache, Analyst (Wolf Research)
One last question, Andy: how active are you in discussions with regulators regarding the uneven playing field with fintechs benefiting from unregulated debit interchange and similar advantages? Is there expectation for leveling or is this the new reality?
Andy Cecere, Chairman, President and Chief Executive Officer
Our focus with regulators is on safety and soundness for customers—data protection, liquidity, ensuring deposits and customer protections. We want to ensure a consistent level of oversight for customers across all providers, which is an area of focus.
Bill Carcache, Analyst (Wolf Research)
Thank you for taking my questions.
Andy Cecere, Chairman, President and Chief Executive Officer
Sure.
Operator, Operator
Your next question comes from the line of Mike Mayo with Wells Fargo Securities.
Mike Mayo, Analyst (Wells Fargo Securities)
Hi. I have one negative and one positive question. First, six years of negative operating leverage at U.S. Bancorp—there are reasons, regulatory situation, pandemic, under-indexed capital markets, over-indexed payments. Costs are higher and revenues lower. Are you saying PPNR is at a low point in 1Q and should improve from here?
Andy Cecere, Chairman, President and Chief Executive Officer
Yes. The dynamics we've discussed—rate environment improvement and payments recovery—should create revenue tailwinds and support PPNR improvement from first quarter levels for the rest of the year.
Mike Mayo, Analyst (Wells Fargo Securities)
You also said flat expenses in 2Q. With branch closures, why haven't we seen greater improvement in operating leverage? Are you investing more in digital infrastructure? Can you share where you are spending and the end game—can you become a Square-like competitor?
Andy Cecere, Chairman, President and Chief Executive Officer
Yes on the expected PPNR improvement. We've invested in business banking and digital that enable customer acquisition and more efficient operations. We have been closing branches given digital migration, and investments are focused on digital acquisition, customer experience, and payments ecosystem capabilities. That is the strategy to drive long-term growth and efficiency.
Mike Mayo, Analyst (Wells Fargo Securities)
All right. Thank you.
Operator, Operator
Your next question comes from the line of Terry McEvoy with Stephens.
Terry McEvoy, Analyst (Stephens)
Hi, good morning. The ACL ratio was down for every loan class except CRE, which was up on a percentage basis. Is that related to COVID-impacted industries or anything specific within that $38 billion portfolio?
Mark Runkel, Chief Credit Officer
We remain focused on CRE. There are some COVID-impacted industries, and there may be longer-term shifts with office and some multifamily segments that we'll continue to monitor. Those areas could play out over a longer period as we work through the cycle.
Terry McEvoy, Analyst (Stephens)
Thanks.
Operator, Operator
Your next question comes from the line of Vivek Juneja with JPMorgan.
Vivek Juneja, Analyst (JPMorgan)
Andy, Terry, thanks for taking my questions, and thank you for changing the time of the call. First, you continue to see good growth in commercial products; what drove that growth and what is the outlook?
Terry Dolan, Vice Chair and Chief Financial Officer
Commercial product growth benefited from year-over-year comparisons and activity related to companies managing liquidity and refinancing earlier than expected due to rising rates. Companies that built liquidity last year are now taking advantage of opportunities to refinance. Those dynamics and churn will help commercial product revenue through the year.
Vivek Juneja, Analyst (JPMorgan)
Branches were down about 100. Andy, last quarter you mentioned branch reductions in the double-digit range; is that still the plan and what's the timing?
Terry Dolan, Vice Chair and Chief Financial Officer
A couple of years ago we had just over 3,000 branches and now we're closer to 2,300—down about 25%. I wouldn't expect major additional changes to the number of branches. You'll see additions in some markets and consolidations in others, but no significant change from current levels.
Vivek Juneja, Analyst (JPMorgan)
All right. Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
Thank you.
Operator, Operator
Your next question comes from the line of Gerard Cassidy with RBC.
Gerard Cassidy, Analyst (RBC)
Andy, can you touch on why net charge-offs might not go up? What would you need to see to maintain the 30 to 35 basis point level through the remainder of the year?
Andy Cecere, Chairman, President and Chief Executive Officer
Individuals currently have a lot of cash from stimulus and reduced spending, which has driven strong payment rates and low delinquencies, especially in credit cards. If that liquidity persists and asset values remain strong, net charge-offs could remain low. If liquidity diminishes and spending rebounds, we would expect charge-offs to normalize. Mark can add more detail.
Mark Runkel, Chief Credit Officer
Asset values have been strong—autos and residential real estate in particular. If those trends continue, low net charge-off levels could persist. However, as liquidity comes down and spending picks up, we would expect normalization toward pre-pandemic levels in the back half of the year.
Gerard Cassidy, Analyst (RBC)
Very good. On depository acquisitions, any update on your appetite for whole-bank deals?
Andy Cecere, Chairman, President and Chief Executive Officer
We remain focused on traditional bank deals that would be meaningful from a customer acquisition or geographic standpoint. Scale is more important now than before, so that's an area of focus. We are also focused on partnerships and smaller technology or payments deals to expand capabilities and distribution.
Gerard Cassidy, Analyst (RBC)
Thank you.
Andy Cecere, Chairman, President and Chief Executive Officer
You're welcome.
Operator, Operator
There are no further questions at this time. I would like to turn the call back over to Ms. Jen Thompson.
Jen Thompson, Director of Investor Relations and Economic Analysis
Thank you, everyone, for listening to our earnings call. Please reach out to the Investor Relations department if you have any follow-up questions.
Operator, Operator
This concludes today's conference call. You may now disconnect.