US Bancorp (NYSE: USB) Q1 2023 earnings call dated Apr. 19, 2023
Corporate Participants:
George Andersen — Senior Vice President and Director Investor Relations
Andrew Cecere — Chairman, President, Chief Executive Officer
Terrance Dolan — Vice Chairman, Chief Financial Officer
Analysts:
Scott Siefers — Piper Sandler — Analyst
Erika Najarian — UBS — Analyst
Mike Mayo — Wells Fargo — Analyst
John McDonald — Autonomous Research — Analyst
John Pancari — Evercore — Analyst
Gerard Cassidy — RBC Capital — Analyst
Ebrahim Poonawala — Bank of America — Analyst
Matt O’Connor — Deutsche Bank — Analyst
Chris Kotowski — Oppenheimer — Analyst
Ken Usdin — Jefferies — Analyst
Vivek Juneja — J.P. Morgan — Analyst
Presentation:
Operator
Welcome to the US Bancorp First Quarter 2023 Earnings Conference call. Following our review of the results, there will be a formal question-and-answer session. [Operator Instructions]
I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for US Bancorp.
George Andersen — Senior Vice President and Director Investor Relations
Thank you, Brad and 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 in 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.
Andrew Cecere — Chairman, President, 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 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 remained strong, but it’s 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 a 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.
Terrance Dolan — Vice Chairman, 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 pure point, a broker deposit-gathering mechanism that we discontinued. Importantly, prior to the events of March 8th, we saw expected deposit outflow largely consistent with seasonal patterns, reflective of our business mix, including our large trust business.
From March 8th 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, broad 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 31st, 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 base deposits, the stability of our funding sources sound.
Moving to Slide 10, US Banc’s total available liquidity as of March 31st was $315 billion, representing 126% of our uninsured deposits. As of March — as of December 31st, 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 31st, approximately 90% of the securities in our investment portfolio are back and are sponsored by the US 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, in 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 impacts of balance sheet optimization and purchase accounting adjustments now 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%, the 10 basis point increase from year end reflected 20 basis points of capital accretion, offset by the transitional impact of CCEL 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 started to — are starting to normalize across the portfolio. The ratio of non-performing 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 0.3% as adjusted increased 7 basis-points versus the fourth quarter level of 0.23% as adjusted and was 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 acquisition — 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 2013 (sic) 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, a 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 and anticipate charges of between $250 billion 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 billion 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.
Andrew Cecere — Chairman, President, 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. Business of banking involves taking balance risks and these risks must be carefully managed, appropriately regulated and prudently mitigated. At US Banc, we are focused on the strength of 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 stress-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.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Scott Siefers, Piper Sandler. Please go ahead.
Scott Siefers — Piper Sandler — Analyst
Good morning, everybody. [Speech Overlap]. 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, our expectation is that, if you end up just looking at the industry, there’s going to be pressure on deposits and high competition. We think we’ll fair quite well with respect to that. To the extent that we see changes in deposits, it will be kind of based upon that competition. So, but I would say relatively stable. And then coming to your second question, the mix of NIB as an example, in roughly fourth quarter was about 25%, 26% in that ballpark, it’s 25% and we think it’s kind of hitting that kind of stable level that keeping in mind that we have a lot of operational deposits tied to our, both our corporate and our corporate trust businesses and that kind of helps to sustain it. So, it’s a combination of things, Scott.
Scott Siefers — Piper Sandler — Analyst
Okay, perfect. Thank you. And then was hoping we could talk for a second about just the categorization and when you guys would expect to be a category two bank, I there’s a lot of of chatter going around, especially in light of that report from a couple of days ago. So maybe just in sort of in terms of when would you expect to be a category two 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, our trajectory with respect to category two is no earlier than the end of 2024 and that will be, I think that will be more driven by whether the Fed makes that decision or not rather than asset size. Again, as we kind of manage the company, we’re going to be continue to be very focused on profitable loan growth and things like that. So we give there when we get there, but that — our expectation right now is no sooner than end of 2024.
Scott Siefers — Piper Sandler — Analyst
Okay, perfect. And you guys feel like you’re prepared to get there by that time basically?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, it’ll be a combination of a couple of things we talked about the — just the capital generation from earnings and of course that is helped by the Union Bank transaction. And then we’re very focused on capital management, we have to be just because of the category two and we’ll be very focused on risk-weighted asset optimization and making sure that we’re focused on profitable growth.
Scott Siefers — Piper Sandler — Analyst
Perfect. Okay, thank you very much.
Operator
Next we’ll go to Erika Najarian with UBS. Please go ahead.
Erika Najarian — UBS — Analyst
Hi, good morning.
Andrew Cecere — Chairman, President, Chief Executive Officer
Good morning.
Erika Najarian — UBS — Analyst
The question for USB is, I don’t think your investors doubt the through the cycle credit outperformance or even the PPNR strength that’s well noted that, the adjustments to your revenue outlook was very minimal relative to peers. I think the big question that investors have is, you’re starting from 8.5% CET1, you note earnings power and capital, organic capital generation of 20 to 25 basis points. But as we anticipate type two and you’re telling us that the Fed could decide and not your asset size necessarily could decide when that line is, what is the new endpoint at CET1 in your view, because as we think about going into that new category, I don’t think investors think that 8.5% to 9% is the right bogey. And then the sort of the sub-question to that Andy is, is your priority getting to higher capital level faster. And if so, how are you thinking about dividend growth this year?
Andrew Cecere — Chairman, President, 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%, it 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 under on our expense expectations, the accretion is greater than we expected. So the value of the franchise is positive for short.
As we think about the category two, 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, credit transfers, risk transfers, 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, an additional accretion as we go into 2024 makes me comfortable that we are prepared with whatever event occurs as with ever relates to category two in the timing as Terry mentioned, no later no earlier than the end of 2024.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, couple of things that I would maybe add because that’s right on. Coming back to AOCI, that barrier will be kind of a function of a lot of different things. We have been very proactive in terms of repositioning the AFS portfolio, looking at assets, sales of securitizations or asset sales, security sales, etc. To kind of give you some sense, the duration of that investment portfolio of the AFS portfolio has gone from little over 4.5% in the fourth quarter to about 3.8% in at the end of the first quarter. So, we’re going to continue to shorten the duration, that’s going to help us with respect to managing AOCI. And then in addition to that, we have been essentially reducing the volatility of AOCI to up interest rate environments through hedging activities. So it’s a combination of a variety of things that we’re going to go through.
Erika Najarian — UBS — Analyst
And is 9.5%, 10% an appropriate new bogey as we think about the shift change for next year on cat two?
Andrew Cecere — Chairman, President, Chief Executive Officer
So, Erika as you know the [Speech Overlap].
Erika Najarian — UBS — Analyst
Go ahead.
Andrew Cecere — Chairman, President, Chief Executive Officer
Yeah, the regulators are going through that analysis and process right now to think about how capital levels ought to be in the industry across the board with a Basel IV end game and whatever changes to categorization that occur. So, we are waiting for that as you are to understand what the new environment will look like, but the plan that we have in place is assuming what you — what Terry just discussed.
Erika Najarian — UBS — Analyst
And just if I could sneak in one last one in. One of your peers closest to you in size said the TLAC was pretty much done and dusted. 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 are overly sort of hold at that level of borrowings until there is a little bit more less dislocation in the senior debt market?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, again TLAC is one of those things that we’re going to learn more as we kind of go over the course of next 12 months. I think the real question is not whether or not TLAC will exist because I do believe and we’re expecting that it will be something that gets put into place, but how does that get calibrated for the regional banks reflecting the risk profile that we have relative to the G subs. And there’s a wide range of estimates that are out there. I would — we end-up looking at that may be one reasonable estimate would be based upon the foreign bank operators and kind of what levels of TLAC. If that is the case for us, I think it would be very manageable. It would be within a range that we would be able to manage to and then that just gives us flexibility with respect to how we utilize that within the bank.
Erika Najarian — UBS — Analyst
Thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thanks, Erika.
Operator
And next we can go to Mike Mayo with Wells Fargo Securities, please go ahead.
Andrew Cecere — Chairman, President, Chief Executive Officer
Good morning, Mike.
Mike Mayo — Wells Fargo — Analyst
Hi. While your PE we believe consensus is close to 7 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 US Bancorp need to issue capital and how confident are you about that? And on the other side, our buybacks potentially an option once you get to 9% CET1 and the reason I bring that up as you’ve seen the front-page articles in papers, if you are forced to recognize the unrealized securities losses, then 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, you 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?
Andrew Cecere — Chairman, President, Chief Executive Officer
Thanks, Mike. So as I said, I’m — that is not part of our thinking as we sit today. I am confident that our earnings accretion, our RWA optimization, our ALC burn down will all get us to a point that we will be at the appropriate capital levels. And I can assure you that it’s a high focus area for myself and the entire management team, including Terry. So that is something we’re very focused on.
Now as it relates to buybacks, I will tell you, as we all know, there’s a lot of capital changes that are likely to occur from a regulatory standpoint. So we’re not going to do anything until we have more clarity around that, which we hope to have in the second half of the year, but the focus on getting to the appropriate capital levels as quickly as possible, accreting capital and building our capital base is priority one.
Terrance Dolan — Vice Chairman, Chief Financial Officer
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. Just as a reminder, we have a pretty significant amount of buffer that already exist 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 FX hedges and just shortening the duration and things that I talked about earlier. I think there is 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 etc. 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 — Wells Fargo — 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
No, that is not required in the CCAR analysis as a condition of the way the deal was structured.
Mike Mayo — Wells Fargo — Analyst
And then last short one, your 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 to 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 on that and that the mix of NIB will be relatively stable around that 25% up or down. Part of the decline 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 pure point etc, all those things kind of tie into the reason why we saw the decline this quarter.
Mike Mayo — Wells Fargo — Analyst
All right. Thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thanks, Mike.
Operator
Next we go to John McDonald with Autonomous Research. Please go ahead.
Andrew Cecere — Chairman, President, Chief Executive Officer
Hey, John.
John McDonald — Autonomous Research — Analyst
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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, we think that the capital generation, the accretion that we’ll see of the 2025 is core earnings capability. So it does not rely on those RWA, so the RWA optimization that we will go through will be above and beyond that, it’s a part of that overall capital strategy that Andy talked about earlier.
John McDonald — Autonomous Research — Analyst
The benefits of that should happen and help you towards the end of this year, maybe into next year as we work towards end of 2024 capital target?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 two for well over a year, we’ve put a lot of things in-place in the third and fourth quarter, we took some actions in the fourth quarter and will 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 — Autonomous Research — Analyst
Yeah 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 closer, correct?.
Terrance Dolan — Vice Chairman, Chief Financial Officer
That is correct.
John McDonald — Autonomous Research — 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 aren’t 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 remind us of the duration again?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, the well, again, the duration of the AFS portfolio right now is about 3.8 years. So just if you kind of take that into consideration, the burn down will still be fairly reasonable even without interest rates and again, we’ve put some hedges into place in order to dampen the effect of rising interest rates with respect to AOCI.
John McDonald — Autonomous Research — Analyst
Okay, thanks.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thanks, John.
Operator
Next we’ll go to John Pancari with Evercore, please go ahead.
John Pancari — Evercore — Analyst
Good morning.
Andrew Cecere — Chairman, President, Chief Executive Officer
Good morning, John.
John Pancari — Evercore — Analyst
On the back of the RWA optimization, can you maybe give us a little more color on what you’re looking at there. I know you mentioned credit transfers and risk transfers, but maybe if you can kind of flush that out a little bit maybe an idea of the magnitude [Speech Overlap] that you see potentially materializing as a result of the RWA actions. And then lastly, is other business or portfolio sales or divestitures considered within that? Thanks.
Terrance Dolan — Vice Chairman, Chief Financial Officer
The second part of the question was…
Andrew Cecere — Chairman, President, Chief Executive Officer
Are there business sales…
Terrance Dolan — Vice Chairman, Chief Financial Officer
Oh, business sales, yeah, at least to this particular point in time, obviously we’ll look at a lot of different things in terms of businesses that we may look at to sell, I mean that’s portfolio optimization is something we’re always doing and we’ve done that a number of different times over the last several years. So that obviously will be something we’ll look at, but we have a sizable mortgage servicing rise portfolio, we’ll take a look at selling portions of that where that makes sense, we’ll look at asset securitization like we did in the fourth quarter.
There are a whole variety of risk transfer sort of structures that both we put — we have put into place where you have on the shelf and we’re ready to kind of start moving forward on when we can. So I think it’s a whole variety of different things that we will take a look at, as well as balancing the mix toward growth and what I would say capital-intensive businesses as opposed to capital-intensive businesses. So it’s a — it will be a whole combination of things as we move forward, John.
John Pancari — Evercore — Analyst
And do you have a way to help us estimate the magnitude in terms of how you’re thinking about that targeting contribution from the RWA optimization strategies?
Andrew Cecere — Chairman, President, Chief Executive Officer
So the strategies that we have in place are reflected in the guidance that we provided. So that would that change that and we’ll continue to update our 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 — Evercore — Analyst
Got it. And then just one more for me and I know you mentioned in terms of other regulatory [Indecipherable] potentially coming down the pike, you’re already in the advanced phase of proposed rule making on the TLAC. And could you just talk about the other potential regulatory changes you see coming down the pike. 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 will incorporate, I would say multiple 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, you know, unemployment goes up and rates come down, now there are going to be more I think some form of stagflation where rates stay relatively high and you experienced 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 — Evercore — Analyst
Got it. Okay, thanks, Terry.
Operator
Next we can go to Gerard Cassidy with RBC. Please go ahead.
Andrew Cecere — Chairman, President, Chief Executive Officer
Hey, Gerard. Good morning.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Good morning, Gerard.
Gerard Cassidy — RBC Capital — Analyst
Good morning, Terry and 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 8th. The inflows that you referenced, did that come primarily in the Union Bank franchise because 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, maybe just in terms of the mix, so right after March 8th, we actually saw a lot of account customer opening more so on the commercial corporate side, I would say probably 70% on that side as opposed to on the consumer side of the equation, we saw inflows. But again that ended-up getting offset by kind of seasonal flows within Corporate Trust as the rest of the month kind of progressed. The other thing that I would say is that you know when I look at deposit net-new customer accounts in specifically in California and the consumer side, we actually saw a nice increase or pop-in March relative to previous months. So I think that we’re actually probably seeing some benefits associated with that and I think that addresses the question that you had.
Gerard Cassidy — RBC Capital — Analyst
Thank you. And then over the years, you guys have always done quite well in 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.
Andrew Cecere — Chairman, President, 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 and 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 is 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 — RBC Capital — Analyst
Thank you.
Operator
Next we can go to around Poonawala with Bank of America. Please go ahead.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Good morning, Ebrahim.
Ebrahim Poonawala — Bank of America — Analyst
Good morning. I had a follow-up question, I think you briefly mentioned about I think AOCI hedges against if rate 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 rates spiked another 50 basis-points. And just talk to us in terms of the extent to which you expect to hedge against that?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, so again, we’ve been taking a number of different actions in order to kind of dampen the effect, as I said, selling securities where appropriate, shortening the duration which we did very nicely I guess in the first quarter. And then putting in place pay-fixed, swaps against the long-end of the curve, so dampening the effect of I’ll move I mean up of rates in both for example in the five and 10-year sort of space. We — if rates moved up 50 basis-points obviously AOCI would be impacted to some extent, but we’ve dampened that quite a bit over the course the last couple of quarters.
Ebrahim Poonawala — Bank of America — 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 do, 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%?
Terrance Dolan — Vice Chairman, 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 kind of 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 etc, 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 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 — Bank of America — Analyst
Got it. And you don’t see a major shift in consumer and retail deposit pricing today versus maybe at the start of the year?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 — Bank of America — Analyst
Got it, thank you.
Operator
And next we go to Matt O’Connor with Peoria Bank. Please go ahead.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Good morning, Matt.
Matt O’Connor — Deutsche Bank — Analyst
Good morning. It’s Deutsche Bank. You got very strong reserves to loans on a stated basis. I guess first, can you remind us, what the impact is if you adjusted for the Union Bank loans that were marked at fair-value when you took them on, if you have that handy?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, I missed the very first part of the question, Andy, do you…
Andrew Cecere — Chairman, President, Chief Executive Officer
I think Mike, you’re trying to understand or Matt, you’re trying to understand the — 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.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Not a significant one.
Matt O’Connor — Deutsche Bank — 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 [Speech Overlap].
Operator
Sorry.
Matt O’Connor — Deutsche Bank — Analyst
Yeah.
Operator
Sorry, it’s hard to hear you.
Matt O’Connor — Deutsche Bank — Analyst
Sorry, can you hear me better now?
Terrance Dolan — Vice Chairman, Chief Financial Officer
That’s better.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thank you, Matt.
Matt O’Connor — Deutsche Bank — Analyst
Okay, sorry about that. I was just asking about the outlook for the loan-loss reserves from here brief case?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 we 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 implied that 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 its weighted toward what I would call the base-case and the rest of it is downside. So we feel pretty good about where reserved levels are. Obviously, if we saw economic shock above and beyond kind of what has been expected, that might be a little bit different, but we feel pretty good about how we’re thinking about it.
Matt O’Connor — Deutsche Bank — Analyst
Okay, great. And then maybe if I could just squeeze in on spending trends throughout 1Q regards through your payments business obviously see a lot. Just any observations on kind of trend throughout the quarter and maybe any comments so far in April? Thank you.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, in our payments business we continue to see pretty strong sales, 10 plus percent for example in our payments. Merchant processing business, a very strong mid to high single-digits with respect to our corporate payments business. If you end-up in comparing any of these things to pre pandemic as you know through the rough. So we continue to see good spend in the business. I would say that after the market disruption, there was a bit more softness in retail sales which we’re going to continue to watch, it’s really too early to tell whether or not that’s a trend or whether that was really some of the concerns around the market disruption, but we’ll continue to watch that.
Andy, what would you add?
Andrew Cecere — Chairman, President, Chief Executive Officer
Yeah, it’s still growing math, 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 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 — Deutsche Bank — Analyst
Great, thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
Sure.
Operator
Next we can go to Chris Kotowski with Oppenheimer and Company. Please go ahead.
Andrew Cecere — Chairman, President, Chief Executive Officer
Yeah, good morning, Chris.
Chris Kotowski — Oppenheimer — Analyst
Good morning. Thanks for taking my question. You’ve given us a lot of good detail on the AFS side, just wondering 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 it’s a lot of mortgage backs and their 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, I mean, obviously we look at both sides of the equation, the burn down on the HTM side simply because of the nature of it is really more tied to how quickly you see payoffs and what the duration of that ends up looking at. I think as we look at the size of the investment portfolio, etc, we’ll take into consideration what level of duration we want to have in that — in the HTM portfolio, but that’s going to be more a function of just paydowns and payoffs overtime.
Chris Kotowski — Oppenheimer — Analyst
Yeah, but I mean, just I guess question directionally the next couple of quarters there is, you’d probably let the duration shorten and the size of the portfolio burn down left to your own device?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, yeah, absolutely, yeah.
Chris Kotowski — Oppenheimer — Analyst
Yeah, okay. All right, that’s it from me. Thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thanks, Chris.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Thanks, Chris.
Operator
Next we have Ken Usdin with Jefferies. Please go ahead.
Ken Usdin — Jefferies — 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 for 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-point that we saw in the first?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, 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 is 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 — Jefferies — 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’s where it 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.
Andrew Cecere — Chairman, President, Chief Executive Officer
To your point, most of the changes were in NII and it’s a function of the great curve the rate environment, the expectation about rate increases as well as the deposit pricing and Terry made reference to in the beta approaching 40%, so most of the change was in NII.
Ken Usdin — Jefferies — 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 there other areas that you’re expecting to see some good growth in?
Andrew Cecere — Chairman, President, 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% year-over-year basis as Terry talked about spend levels are good. We’ve had a bang-up 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 — Jefferies — Analyst
Got it, understood. Thanks, guys.
Andrew Cecere — Chairman, President, Chief Executive Officer
Thank you.
Operator
Next we can go to Vivek Juneja with J.P. Morgan.
Vivek Juneja — J.P. Morgan — Analyst
Hi, Andy. Hi, Terry. Couple of just clarifications. I think you had 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 altogether, where you’re seeing it better thus far?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, so and we talked about this back in the fourth quarter that the expectation of that 8% going through 11% and the return, the return is actually better. So if I look at it in the big picture, when we initially thought about the deal, Union Bank had a $2.9 billion so revenue base and a $2.6 billion or $2.3 billion expense base, so 600 PPNR and you look at the first quarter and it’s double at. So the revenues are stronger, principally because of the value deposits in this rate environment. The expenses are a little less and our expectations on our efficiencies are continuing to be on plan. So all that adds up to a higher accretion and that higher accretion is the net purchase accounting is actually negative given the core deposit intangible, so it’s very strong.
Vivek Juneja — J.P. Morgan — Analyst
Right. And that’s before you even finish the integration of that deal, I mean that’s not till second quarter anyway?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, that’s right, that’s correct.
Vivek Juneja — J.P. Morgan — Analyst
All right. Thank you.
Operator
Next we can go to Erika Najarian with UBS.
Erika Najarian — UBS — Analyst
Sorry to prolong the call, just had one follow-up question. Andy, I asked the question the compound [Indecipherable] 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?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Dividend growth continues to be a priority, Erika. So our expectation is we would have continued growth in the dividend, dividend growth number is 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 — UBS — Analyst
Thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
Sure.
Operator
And next we’ll go to Mike Mayo with Wells Fargo Securities.
Terrance Dolan — Vice Chairman, Chief Financial Officer
Hey, Mike.
Mike Mayo — Wells Fargo — Analyst
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 your reserving done before the recession has even started or how do you think about that? And what about the release of reserves, the extend that you stay down as low charge-off range even with some of the normalization?
Terrance Dolan — Vice Chairman, Chief Financial Officer
Yeah, well, I think we’ll wait and see what ends up happening given the uncertainty that’s in the economy regarding the last bit of it, but yeah, no, we had said that it was the weighted average at the peak was on peak quarter was about little over 6%. It’s about 5.9% today is kind of what our weighted average case kind of comes up to, so very similar to what we had before.
Mike Mayo — Wells Fargo — Analyst
Okay and your outlook for the economy, soft recession hard landing and what you’re thinking?
Andrew Cecere — Chairman, President, Chief Executive Officer
So Mike, we expect a soft recession, a moderate recession later half of this year, but as Terry mentioned, our CCEL 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 — Wells Fargo — Analyst
Okay, thank you.
Andrew Cecere — Chairman, President, Chief Executive Officer
You bet.
Operator
And we have no further questions at this time. I will now turn it back to George Andersen, please continue.
George Andersen — Senior Vice President and Director Investor Relations
Thank you for listening to our call, please contact the Investor Relations department if you have any follow-up questions.
Operator
[Operator Closing Remarks]