U.S. Bancorp

Welcome to U.S. Bancorís second quarter 2019 earnings conference call. Following review of the results by Andy Ciceri, Chairman, President and Chief Executive Officer, and Terry Dolan, U.S. Bancorís Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. If youíd like to ask a question, please press star 1 on your touchtone phone and press the pound key to withdraw. This call will be recorded and available for replay beginning today at approximately noon Eastern Daylight Time through Wednesday, July 24th at 12 midnight Eastern Daylight Time. I will now turn the conference over to Jen Thompson, Director of Invest Relations for U.S. Bancor.

Thank you, Jack, and good morning to everyone whoís joined our call. Andy Ciceri and Terry Dolan are here with me today to review U.S. Bancorís second quarter results and to answer your questions. Andy and Terry will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. Iíd like to remind you that any forward-looking statements made during todayís call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page 2 of todayís presentation in our press release and in our Form 10K and subsequent reports on file with the SEC. Iíll now turn the call over to Andy.

Thanks, Jen, and good morning, everyone. Thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. Iíll begin on slide 3. In the second quarter, we reported earnings per share of $1.09. Despite our more challenging interest rate environment for the banking industry that has seen it some time, we delivered strong financial results supported by top-line revenue growth and positive operating leverage of 1%. Loan and deposit trends improved compared with the first quarter, and we saw broad-based momentum across our fee businesses driven by account and volume growth. Credit quality remained stable, and we continue to prudently manage operating expense while appropriately investing for the future. Turning to capital management, our book value for share increased by .7% from the year ago. During the quarter, we returned 79% of our earnings to shareholders through dividends and share buybacks. In June, we received the results of our CCAR submission, and the Federal Reserve did not object to our capital plan, which included a dividend increase of 13.5%. Slide 4 provides key performance metrics. In the second quarter, we delivered a return on average common equity of 15% and a return on average assets of 1.55%. Our return on tangible common equity was 19.2%. Our efficiency ratio improved both on a linked quarter and -over-year basis. Now I want to turn the call over to Terry who will provide more detail on the quarter as well as forward-looking guidance.

Thanks, Andy. If you turn to slide 5, I'll start with a balance sheet review and follow up with a discussion of second quarter earnings trends. Average loans grew .1% on a linked quarter basis and increased .5% -over-year, excluding the fourth quarter 2018 sale of FDIC covered loans that had reached the end of the lost coverage period. Solid -over-year growth in mortgages, credit cards, and installment loans supported solid consumer loan trends, while commercial loan growth reflected strength in both large corporate and middle market lending, partly outspent by paydowns related to active capital markets. New business pipelines remain healthy, although paydown activity is likely to remain elevated and chubby near term. Commercial real estate loans decreased on a sequential and a -over-year basis. This quarter, commercial real estate contributed a 20 basis point drag to linked quarter average loan growth and an 80 basis point drag to -over-year average loan growth. Given what we consider to be unfavorable risk-reward dynamics in certain areas of commercial real estate lending, we expect paydown pressure to continue to restrict growth in this portfolio. Turning to slide 6, deposits increased .9% on a linked quarter basis and .1% -over-year. Compared with the prior year period, growth in consumer wealth management and corporate trust balances was offset by lower corporate and commercial customer balances. Balances continued to migrate to higher yielding, savings, and time deposits from non-interest bearing deposits. The decline in corporate and commercial banking balances were also affected in part by migration related to the business merger of a large financial client. This migration has stabilized and will be less impactful in future quarters. Slide 7 indicates that credit quality was relatively stable in the second quarter. Non-performing assets decreased .2% versus the first quarter and were down .6% from the same period a year ago. Commercial loan 90-day delinquencies were elevated this quarter as a result of an administrative matter related to a single customer and is expected to be resolved in the third quarter without a credit loss. Slide 8 highlights second quarter earnings results. We reported earnings of $1.09 per share in the second quarter of 2019 compared with earnings per share of $1.02 a year ago. Turning to slide 9, net interest income on a fully taxable equivalent basis grew by .4% compared with the first quarter and increased by .3% -over-year which was in line with our expectations. Both linked quarter and -over-year comparisons benefit from loan growth offset by the impact of a flatter yield curve. Linked quarter growth also reflected an additional day in the quarter and higher interest recoveries. Slide 10 highlights trends in non-interest income. On a -over-year basis we saw -single-digit growth in credit and debit card revenue, corporate payments revenue, and merchant processing revenues driven by a higher sales volume in each category. Trust and investment management fees grew .5% due to business growth and favorable market conditions and .4% growth in commercial product revenue was driven by higher corporate bond fees and trading revenue, partly offset by lower syndication fees. Mortgage origination revenue decreased on a -over-year basis. Strong origination and sales volumes were offset by an unfavorable change in the valuation of mortgage servicing rights, not of the hedging activity. The -over-year decline in deposit service charges reflected the impact of the sale of our third-party ATM servicing business in the fourth quarter of 2018. The increase in other income was partly driven by the inclusion of the related transition services revenue from the sale which will decline over time as well as higher tax credit syndications and equity investment revenue. Turning to slide 11, the -over-year increase in non-interest expense reflected higher personnel costs and professional services and technology expense tied to business growth initiatives. This was partially offset by a decrease in other expense, primarily reflecting lower costs related to tax-advantaged projects and lower FDIC assessment costs. Slide 12 highlights our capital position. At June 30, our common equity Tier 1 capital ratio, estimated using the Basel III standardized approach, was 9.5%. This compares to our target of 8.5%. I will now provide some forward-looking guidance. For the third quarter, we expect fully taxable equivalent net interest income to increase in the low single digits on a -over-year basis. We expect fee revenue to increase in the mid-single digits on a -over-year basis. We expect to deliver positive operating leverage of 100 to 150 basis points for the full year 2019 in line with our previous guidance. We continue to expect our taxable equivalent tax rates to be approximately 20% on a full year basis. Credit quality in the third quarter is expected to remain relatively stable compared with the second quarter. Loan loss provision expense growth will continue to be reflective of loan growth. Now I'll hand it back to Andy for closing remarks.

Thanks, Terry. The U.S. economy remains healthy, the jobs market is robust, and the business and consumer confidence remain supportive of favorable consumer spending patterns as well as related business investment. While the flattening yield curve has created a more challenging interest rate environment, our core deposit franchise, fast deposit mix, and consistent risk management philosophy puts us in a strong relative position from which we will navigate. Fundamental trends in each of our major feed businesses are healthy and importantly are being fueled by growth in new accounts and expansion of existing relationships, which in turn is driving strong volume growth. Our loan growth came in a little better than we had anticipated in the second quarter, and we are confident in our ability to win market share across our consumer as well as commercial portfolios. We are investing in the future with digital initiatives a key focus. As you can see on slide 13, loan sales are being increasingly sourced through our digital channels. We expect this trend to continue with the expected outcome of better customer experience, higher account and volume growth, and improved operational efficiency. The success of our digital mortgage platform continues to meet or exceed our expectations. Currently over 80% of all mortgage loan applications are completed digitally. Small business lending is another area where meaningful digital migration is occurring. As a reminder, last fall we launched a portal that allows small business customers to apply for and fund a loan up to $250,000 entirely digitally and then. Consumer reaction has been extremely positive. In June about 25% of our applications for loans of this size use our digital portal and year to date, loan volume in this category is up 7% of the same period a year ago. To summarize, the second quarter came in as we expected and we are well positioned as we head into the second half of the year. I'd like to thank our employees for their hard work and dedication which drove these results. That concludes our formal remarks. We will now open up the call for Q&A.

At this time, if you'd like to ask a question, please press star 1 on your telephone keypad. The first question comes from the line of Matt O'Connor with Deutsche Bank. Your line is open. Good

morning.

Morning,

Matt.

I'm sorry if I missed this. We've just been jumping around here. But the margin was a little more resilient this quarter than I would have thought given some of the growth and things like securities and other earning assets. It's basically lower yielding asset buckets. So even though the NIM was in line with what you guys had said, it did seem a little more resilient. I was wondering what drove that and then if you gave any NIM outlook. Thank you.

Yeah, I think this is Terry. I think part of that resiliency is just loan growth and where we ended up seeing. So that kind of a mix of loan growth. I think that was one of the major drivers. We continue to have a little bit of accretion with respect to the investment portfolio. Of course, the change in the yield curve came very late in the quarter. So I think there's a number of drivers like that. Then if you think about net interest margin, our outlook if you think about for our third quarter, our current forecast assumes a two rate decline for the rest of 2019. One in the end of July and one in September. And the long end of the curve staying essentially kind of where it is. And as a result of that, we're going to see some pressure with respect to net interest during the second half of the year. Okay. When we think about the margin, our expectation is going to decline in the high single digits in the third quarter. There are two reasons for that. The first one has really no impact on net interest income. And let me talk a little bit about that. So about half of the impact is due to a change in the regulatory, in a European regulatory policy that has the effect of restricting our ability to include these balances in the LCR ratio. It is an industry wide policy change by the European regulatory agencies. But because LCR is a binding constraint for us, we will have to increase our liquidity position by purchasing HQLA securities and funding this growth through borrowings that will have similar sort of rates. So earning assets will grow and

that will

offset the impact of about half of the change in net interest margin. The other half of net interest margin will decline because directly related to our expectation of the decline in rates as well as where the long term yields are right now.

So that's a good summary theory. And just to reiterate, about half of that decline in net interest margin is not impactful at all to net interest income. It's just a little higher asset offset by a little lower rate due to that regulatory change that we talked about. And I think when we're all said and done that, we expect on a year over year basis, net interest income to be up in that very low single digit range given the great declines that we expect here and as Terry talked about in the second half of the year.

Okay. And then, I mean, there's obviously some moving pieces on rates between here and the October call. But just as we think about, say, the fourth quarter NIM, the impact of building liquidity, is that going to be fully in the run rate in 3Q or is there going to be kind of a stub impact of that in 4Q? And then, you know, should we think about a similar kind of core decline in the NIM in the 4Q if we get another rate cut in September?

Yeah. So let me ask you to answer the first question first. So in the fourth quarter related to the build in liquidity, that will be fully in the run rate because it really becomes effective for us July 1st. So we are already kind of executing against that. So that will be fully in the run rate. As we think about the fourth quarter, you know, the fourth quarter, in the third quarter, we expect to see a rate cut at the end of July and then in September. And so, you know, that obviously assets will start to price down immediately and deposit pricing will kind of come down over time. So I would expect that in the fourth quarter, you're going to continue to see more pressure with respect to net interest margin. And that's just kind of the dynamics of the balance sheet.

Just last one to squeeze in, some banks are also giving guidance that if rates stay kind of stable, if rates are stable, the NIM X liquidity, is that kind of flat to down just a little bit or I don't know if you want to comment on more of a stable rate environment as well. Thanks. And then I'm done.

Stable to here? Yeah, I think that, I mean, essentially again, we think about net interest income being relatively stable relative to where it is in the second quarter.

It's relatively flat. All right. Thank

you.

John Pencare with Evercore. Your line is open.

Good morning.

Good morning, John.

Given your outlook for two cuts before the end of the year, the, how does that affect Does that impact your expectation for expense growth at all? Does that, does that impact how you're thinking about expenses? I know you had expected four-year expenses to be flat to up a percent or so for the four-year 19. And then also I know you saw a little bit of pressure this quarter on expenses. So curious how that growth expectation has changed. And then separately about operating leverage as you look for 2020, how are you thinking about that?

Yeah. So John, again, this is, this is Terry. You know, so when we think about the second half of the year, it clearly is going to be pressure on net interest income. But, you know, one of the things I think we're seeing is good momentum on the fee income side of the equation, which I think will help to offset, you know, some of that, at least a fair amount of that. So if you think about it, you know, we are seeing acceleration or momentum growing in our payments businesses, the consumer spend issues that were occurring in the early half of the year, they're really kind of normalized. And we're seeing good momentum with respect to our mortgage banking revenue. And while it was down about a percentage point year over year this quarter, you know, we would expect that to have hit the out of fraction point and start to grow in the third quarter. I think that that will help. You know, we're seeing good momentum, continuing momentum with respect to trust and investment securities. And I think with the decline in the rate environment, I think they'll see more fund formation, I think, in the third quarter with respect to corporate trust. So my point is that when you look across all of our fee categories, we see some pretty nice strength in that. I think that's, you know, kind of one of the benefits of our business model and the diversification that we have on the revenue side of the equation is that fee income tends to help offset some of that pressure on the net interest margin side of the equation. And,

John, specifically to your question, we'll continue to manage expense reflective revenue environment and we still continue to expect a full year operating leverage in that 1 to 1.5%. If the revenue is tougher, it'll be at the lower end of that range.

Got it. Thanks, Andy. That's helpful. And just one other follow-up. How would you think about operating leverage for 2020? I'm assuming, obviously, that's still very much part of it. But again, we could get a tougher backdrop as we go from the top line. So how do you think about what's attainable in 2020?

Yeah, well, our goal, I think, in 2020 continues to be that 100 to 150 basis points. You know, we'll end up having to manage through the rate environment, of course, making decisions short-term versus long-term investments that we end up needing to make. But as we think about 2020, you know, we'll continue to have that as our goal that we expect to achieve. You know, where we might have saw more expansion in a, you know, based upon what conditions were at the beginning of this year, you know, that may continue to stay more at the lower end of the range. But we'll have to just see how revenues develop. Got it.

All right. Thanks, Terry.

John McDonald with Autonomous Research. Your line is open.

Hi. I wanted to follow up on John's question, Terry. For the operating leverage for this year, you came in in the first half of the year, you know, towards the lower end at the 1%. Just kind of wondering, I think you mentioned some things that get better in the second half. What are the puts and takes towards maybe getting to the middle of the range, you know, in the second half of the year, maybe closer to the 1.5?

Yeah. I think, you know, for us, I mean, in the second half of the year, again, I think just given the revenue environment on the net interest income side of the equation, that that will be harder to achieve. But again, I think it depends upon how strong the fee income growth is as we go into the second half of the year. Again, we're seeing, you know, a nice acceleration with respect to our payments, our mortgage banking businesses, et cetera. So that's going to

be kind of the wild card there. And then, John, this is Andy. On the expense side of the equation, importantly, we continue to invest in a number of our technology and digital initiatives while at the same time optimizing the current business structure. And I think the put and take of those two things will, you know, drive the expense growth to the low side so that we're managing consistent with the revenue environment.

Okay. And then just to follow up on some of the NII questions, Terry, is there a way to size how much one 25 basis point cut hurts in terms of, you know, NII or NIM, everything else equal?

Yeah. So if you think of, and again, you can kind of do the math based upon some of our asset liability disclosures. But, you know, 25 basis point cut on the short end only probably has a $40 to $45 million impact to us. So that's kind of how we dimension that. And then, you know, if you end up looking at kind of on a shock basis, I guess, if you will, that would be, you know, 80 to 90 million. Across the country.

Okay. 80 would be like a parallel.

Yep.

Okay. And then just for the, yeah, so I guess that's the other point of it. Like right now, are the current reinvestment yields where the long end is, are current reinvestment yields accretive, dilutive, or kind of break evenish?

Yeah. And so, you know, our expectation, you know, when we think about the third quarter is that, you know, it certainly has come down in terms of the amount of accretion that you have. We still think there's opportunity for 20 to 25 basis points of accretion on the investment portfolio. I think in the short term, though, we're going to see some pressure with respect to premium amortization that may offset that.

Okay. Got it. But those securities that you plan to put on in terms of the, some of the pressure that you mentioned for the next quarter, are those kind of, are you thinking of those as NII accretive?

We're thinking of those as, in terms of the liquidity position and the regulatory issue specifically. Yeah. Yeah. So we think that that is, that's neutral from a net interest income perspective.

Got it. Got it. And a little bit hurtful to the NIM percent.

Yeah. It'll hurt the NIM, but it'll be neutral with respect to net interest income.

Got it. Okay. Great. Thanks, guys.

Thanks, John. Betsy Grasek with Morgan Stanley. Your line is open.

Hey. Good morning.

Good afternoon.

So just to make sure I understand, it's neutral for the coming quarter, but does it flip positive when premium amortization goes away?

You mean in terms of the investment portfolio?

Yeah.

Yeah. You know, again, it kind of depends on what ends up happening with respect to yield curve. So you know, if premium amortization starts to neutralize, it would have a little bit of a positive impact.

Right. Okay. And then I wanted to just ask a little bit around the mortgage business, obviously strong quarter there. Can you give us a sense as to how you're thinking that plays out over the rest of the year? Is this quarter reflect, you know, the significant pickup in applications? And when you close, you know, there's only a tail, a little tail left? Or do you feel like this will continue to ramp throughout the rest of the year?

Yeah. I think it continues to be beneficial through the rest of the year and for a couple of different reasons. You know, some of the benefit is because of the refinance activity and because of the change in the long end of the curve. But you know, refinancing has continued to be only about 30% of our overall volume. So a lot of that volume pickup for us, I think, is driven more by things like the investments we've made in our digital channel, the investments we've made in terms of the retail side of the channel versus the correspondence side of the equation. And the fact that because of that investment on the retail side of the equation, we've expected margins to start to improve. So we're going to see the benefit of higher margins because of that mix of business, but also on the purchase side of the equation, volumes have been very strong. So we expect to see a pickup in the second half and for it to continue.

Okay. And then can you talk a little bit about consumer spending and how that impacted you in the quarter?

So, actually, this is Andy. That's starting to come back. As we talked about late in 2018 into the first quarter in 19, that started to weaken a little bit, but we've seen sequential improvement in each month and now it's closer to that five, five and a half, six percent range, which is still a little bit below early last year, but starting to get back to normal levels.

Okay. And if you think about our payment space, you know, that five and five and a half, which Andy talked about, but on the merchant side, you know, that's closer to about nine percent. Merchant acquiring volumes. Merchant acquiring volumes. And again, I think that is tied to some of the investments that we've been making in the business on the integrated software solutions, et cetera. And then, you know, the sales volumes on the corporate payment side of the equation continue to hold up. You know, that's really more kind of in the six percent range, so it's lower than it was a year ago, but it's still quite strong. And you know, those types of things give us some confidence with respect to, you know, where the economy is as well.

It was interesting just linking that to commercial loan growth. You had a nice pick up, Q&Q. I know you mentioned that the forward look will have, you know, some impact from pay downs. And I guess the question I have here is, have you seen pay downs accelerate at all in Q&Q?

Yeah. I would say that with respect to loan growth in the second quarter, not a lot of acceleration in terms of pay downs. We continue to see it in the commercial real estate side of the equation. And so where we say that there's going to be pressure, I think it's really more in commercial real estate. And I guess based upon where we're at in the economic cycle, I think we're fine with that. And those pay downs will come because of increased capital markets sort of activity based upon where commercial real estate developers can't refinance their projects. But you know, when we think about kind of our outlook from a loan standpoint, again, I think consumer spending continues to be strong. GDP is holding up okay. Unemployment is just fine. You know, we're seeing good growth in terms of the middle market space and really kind of across most regions in the country. So you know, we just think that there's a lot of signs that would suggest that that loan growth is going to continue. M&A activity, pipelines, et cetera. So we feel fairly confident about where we're at right now.

And just one last question for me. On the middle market side, you know, most regions doing better. I'm wondering if you're seeing any particular industries accelerate because, you know, as we look at the macro data, we've had some pullback in, you know, some of the manufacturing area, trade, ag or transportation, I should say, agriculture. So one of the things I've been getting from folks is, hey, you know, where's this strength in CNI coming from? I don't know if you have any, you know, things you want to share with us on that.

Yeah. Again, in the middle market side of the equation, you know, if you think about this kind of core commercial CNI, you know, our growth was on a link quarter basis, 2 plus percent. I think it did, there was a little bit of an offset or drag because of the agricultural lending that we have. And again, that's just kind of where the farming economy is at this particular point in time. You know, we don't do a lot of land financing. Ours is really tied more to, you know, farm operations. And the exposure to ag for us is really not that significant. So, you know, the, I think manufacturing continues to hold up reasonably well. It may be a little bit lower than what it's been in the past. But, you know, for us, our middle market business is pretty diversified across many different industries and across our entire footprint. So, you know, based upon what we're seeing right now, we would expect that to continue to hold.

All right. Thank you.

Thanks, Beth.

Erika Najarian with Bank of America. Your line is open. Erika.

Hi. Good morning. Good morning. Thank you so much for the detail on net interest margin sensitivity to rate cuts. I'm wondering if you could give us some insight on how you're thinking about deposit repricing in terms of both lag and magnitude of repricing relative to each 25 basis points.

Yeah. So, again, just to kind of give a reminder, if you think about our deposit base, about half of it is retail and about half of it is corporate interest. And, you know, the retail deposit beta is in the movement up was fairly inelastic. So, you didn't see a lot of movement with respect to deposit pricing there. But, you know, our corporate trust and our wholesale deposits tended to be much more sensitive, as you can imagine. So, when we think about a declining rate environment, you know, we believe that, you know, deposit betas are going to come down in the corporate trust world reasonably fast as rate cuts are occurring, but you're just not going to see as much with respect to retail.

So, perfectly fair, but, you know, the betas in corporate and trust were, I think, higher than expected. So, as I think about full year 2020, it seems like there's an opportunity for actually net interest margin, either stability or accretion relative to 4Q19, even in the face of rate cuts, if we assume repricing on just 50% of that book and assuming the curve stays where it is. Is that too optimistic of a conclusion?

Yeah, I think if you end up looking out to 2020 and you're assuming the rate cuts are occurring, I think that because of our mix of corporate trust and wholesale that, you know, we on a comparative basis are going to perform pretty well. So, that's going to be more sensitive and deposit price is going to come down more quickly in those particular areas. Right. I think, Jerry, what you

said was the betas for corporate trust and wholesale will continue to be high. Yes. They come down.

Absolutely.

Got it. And I noticed that comp expenses rose only 2% year over year. It had been trending in the 8 to 9% range annually previously. And I'm wondering if this is really the opportunity that always existed, even, you know, despite the change in the rate environment. And I'm wondering as we think about those comp levels or the rate of growth of comp, you know, is it between 2 to 8? And how should we think about the slowdown of that pace of growth?

Yeah. So, if you think about compensation at that 8% range, and that really was a period of time when we were building our risk and compliance and, you know, different areas with respect to investments in the business. So, you know, that was unusually high. And as we said, that kind of started to moderate in late 2017, certainly 2018. 2019, I think, is kind of all of that has normalized. When I think about, you know, a 2 to 3% sort of compensation range, we certainly think that we can manage it within that level for an extended period of time. And I think that will help us. Some of that compensation obviously is tied to revenue. For example, in the capital market space or, you know, some of the wealth management areas. But, you know, so it will be somewhat dependent upon what sort of revenue streams we see on the P side of the equation, but that would be a good thing.

Got it. Thank you.

Ken Dustin with Jeffries. Your line is open.

Hey, good morning, guys. I'm just going to ask a couple quick cleanup ones. Can you help us understand the magnitude of the interest recoveries that came through the NIM this quarter relative to last?

Yeah, you know, I mean, Ken, we always have interest recoveries that are occurring. I think the reason why we want to highlight that a bit is simply because we're at the late end of the business cycle. And, you know, just given where credit has been for an extended period of time, you know, we just don't know whether or not that will continue. So it's more just trying to highlight that a little bit because of where we're at in the business cycle.

Okay. So was it above normal? I mean, you always do have them, but was it above normal even?

I would say it was kind of normalized, but maybe a little bit high given where we're at in the business cycle.

Got it. Okay. On the, you mentioned in other, you had some elevated, you've been successfully harvesting some gains. And do you see a lot of opportunities on that front, especially where we are in the equity cycle? Should that continue to also be relatively strong as far as the other income line, other fee income line is concerned?

Yeah, I mean, other income includes a lot of different things. It includes, you know, tax syndication revenues. It includes some of the transition revenue related to our ATM sales, the sale of our ATM business. And, you know, that will continue through 2020, but it will start to dissipate as we go through that conversion. On the equity investment side of the equation, you know, we still think there's opportunity there.

Okay. And then last one, just as we get hopefully closer to the Fed's, you know, making some of the rules finalized at some point on the tailoring front, can you just talk through where you're seeing or anticipating to be the potential biggest opportunity sets and can you get ahead of any of those at all? Or do you have to wait till they get formalized? Thanks, Harry.

Yeah. Certainly from a capital management standpoint, there's going to be a benefit because of the ALCI and then on the liquidity side that will help us as well. You know, we really will have to wait until or we're going to wait until we have clarity with respect to the adoption of that and then kind of make decisions both with respect to capital management and LCR. You know, we've talked about in the past that we think that there's the opportunity to bring down HQLA by, you know, the 10 to 15 billion dollar range and either redeploy it or think about, you know, the investment security portfolio. On the capital management side, you know, we're at 9.5 today and, you know, once we have clarity around CISO and tailoring rules, you know, we would expect to start managing that back down closer to the .5% target.

Got it. Thanks, Harry.

Marty Mosby with Vining Sparks. Your line is open.

Thanks. I had one big strategic question and a very specific accounting question. Let's start with the accounting side. When you talked about premium amortization, you talked about maybe a headwind. You kind of said, well, there's some headwind coming. What I was curious about is most of the other calls we've actually heard management talking about how, you know, they had accelerated. So I know you can from an accounting standpoint estimate amortization. And so when rates move, you get kind of whipsawed around or you can kind of pay as you go. I was just curious in the sense of how you're amortizing that premium. Are you really more kind of a pay as you go or are you estimating what you think the rates are going to do to you?

Well, we're certainly taking into consideration what we expect rates to do to premium amortization. I think the, you know, for us anyway, you know, there is just a little bit of a lag. Most of the most significant changes end up occurring very late in June. And so I know the way that we end up accounting for it, it'll end up coming really more so through the third quarter than it was in the second quarter, just the way we end up accounting for

it. So it's just a quarter lag more than anything else in that sense. Yeah,

and again, that's assuming that the rate curve kind of stays where it is, you know, in terms of what the impact is going to be going forward.

And that happens in the third quarter. And then if rates stay where they're at, that's kind of behind you. And you go into the fourth quarter then with no impact, you know, in the sense that rates don't change anymore.

That's what we're hoping.

All right. All right. And then the other thing I was trying to get at was merchant processing. You were talking about growth in the 8 or 9 percent when revenues are kind of growing into 4 to 6 percent. How is a competitive environment for merchant processing? It seems like you've been picking some momentum back up there. But do you feel like you're going to be growing with, you know, kind of the same store sales and maybe a little bit of market share gain? How do you envision that merchant processing as you're looking at the competitive environment right now?

Yeah. You know, so certainly the difference between the two is, you know, the turn that you have in the book of business. You know, our growth rates, I do think that will, you know, from 4.5 percent or so will continue to accelerate, you know, as that new business comes on board. You know, the other thing is that, you know, you have effects of foreign exchange and other things that are dampening the growth rate on the revenue side of the equation. You know, so there's just a number of kind of dynamics. But when we think about the underlying business, we think it's accelerating and we think it's strong. And

I'd add that I think the team has done a terrific job of accelerating our integrated software vendor capabilities as well as our -the-channel capabilities and importantly integrating with the other banking components so that we have a full set of products and capabilities that we can offer our middle market and small business customers. So those activities are, I think, also driving the growth in a very positive way. Great. Thanks.

Antonio Chapa with UBS.

Your line is open. Hey, guys. This is Saul Martinez at UBS. Hey, how's it going? So a couple of questions. First of all, wanted to follow up on Erica's question on the trajectory of deposit costs and fully get the difference between retail and corporate and trust deposits. But if I bring all of that together, how do we think about just the overall trajectory of your cost of interest bearing deposits? Because historically, there's typically a sort of a one to two quarter lag between when the cost of deposits start to decline and when the Fed starts to cut. So as we think about 3Q, 4Q, should you see an immediate benefit from, say, a July hike or I'm sorry, July cut? Or does it take a couple quarters for that to start to filter in, in the .12% interest bearing cost deposit starts to come down later in 2019 or 1Q? Or should we start to see that fall in 3Q?

Yeah. So let's take corporate trust or the wholesale side equation. That will be fairly quick in terms of the July rate cut. Some of it is the timing of the fact that the July rate cut would probably happen at the end of the month. There's just opportunities for us to be able to incorporate that into our process. So on the corporate trust side equation, it'll be pretty quick. But there is always a little bit of a lag in terms of it kind of getting incorporated into the process. So the benefit will be stronger in the fourth quarter certainly than in the third.

Right. In your guidance, I mean, are we assuming, are you assuming that the overall cost deposit come in from 2Q levels?

Yeah, yeah, we

are. Okay. All right. In 3Q. All right. Change gears a little bit on your branch strategy. You've highlighted 10% to 15% branch reductions now over, I guess, a couple of years. On the surface, you know, on the 3,000 branches, that doesn't seem like a huge number. But it's about 3 to 450 if I'm thinking about it right on 3,000 branches. And I think what you've said in the past is, you know, your community bank branches, which are like, you know, a little over 1,000, and in-store branches, you know, which would take you cumulatively on those two to about 2,000, aren't really, you know, subject to being rationalized. So effectively, your metro markets, you're cutting a huge amount of your existing branches in urban markets, if my logic is right. Something like 30 to 45% of your metro markets. So I guess my question is, first, am I thinking about that right? Are the cuts going to be exclusively or almost exclusively in the metro markets, which are like 1,000 branches? And, you know, what's driving this? Because it seems like a pretty substantial repositioning of your branch network.

Yes, Sal, you're right. We have three sort of segments of branches, 1,000 in a community, just under 1,000 in-store and outside, and just over 1,000 in metro. What we said is we're not going to exit communities. So we are not going to exit and have no branch standing in a community market we're currently in. But we do have some opportunity in community markets to rationalize or consolidate branches, particularly those that are close together. And that's also true of an in-store. So it is not only focused in metro. The other thing I mentioned to you is that 10 to 15% is a net number. That includes optimization, moving branches to a better location, entering new markets like we've announced in Charlotte, so forth. So that's a net number across all categories.

Okay. But should we assume that the vast majority of the branch rationalization occurs in metro markets? Because even if there is some rationalization in the community banking and in-store branches, it seems like, especially considering that's a net number of branches you'll open in Charlotte, Atlanta, Dallas, whatever, it seems like a pretty big proportion of your existing branch network gets rationalized in urban markets.

Yeah. No, we're looking at optimization of our branch network. It's really across all three categories. You know, we do believe that there's opportunity with respect to all categories. I mean, think about community as an example. It includes some sizable markets like at Des Moines or in Omaha or Boise, et cetera, where we do have fairly significant branch networks. So it will be across all of them. It will tilt toward the metro markets, but it will include all markets.

Okay. So it's not as black and white as those maybe thinking about it. Okay. All right. Thanks a lot.

Thanks, Tom. Yep. Again, if you'd like to ask a question, please press star one on your telephone keypad. David Long with Raymond James. Your line is open.

Good morning, everyone.

Hey, David. Hey, David.

You guys have, you know, I guess this is a follow-up to that last question, but talking about some of the areas where you're looking to add branches. And just curious how the rate backdrop plays into how aggressive you are in pursuing that strategy.

I don't think the rate backdrop is directly impactful to it. I think what we're trying to do is enter new markets where we already have a large employee base, a customer base that have one or two or three other products that have U.S. bank in their wallet that don't have a full banking relationship and trying to extend that relationship using the data and things that would be valuable to that customer, regardless of the rate environment.

Yeah. So it's about building the overall relationship with the customer. And then you think about it, I mean, this is really a long-term strategy. So, you know, the current rate impairment is, you know, only one consideration on data point.

Got it. And then the second question I had was related to CISIL and the impact that may have. Are you guys at a position, at a point where we can talk about what the impact may be on your overall reserve level and also your appetite to make loans into certain categories?

Yeah. So, yeah, I think what we have talked about in the past is 20 to 40 percent. And in the third quarter, we'll be kind of going through a more substantive parallel run. I think we'll have better insights with respect to, you know, the implications associated with that for a point in time. But we've, you know, we've said it's a range of probably 20 to 40 percent increase in the reserve. And I think we've even said it's, you know, kind of closer to that 30 percent sort of range. So you can kind of do the math. But, you know, we're probably going to wait until we get through that third quarter assessment. You know, the other thing is I think we'll have better visibility with respect to what the economy will look like. And of course, that's certainly a driver in the process. You know, as we thought about, you know, the different products and what we'll emphasize or de-emphasize, you know, we're really making decisions more based upon the economics of the product profitability than we are, you know, allowing the accounting model to influence that sort of a decision. So at this particular point in time, we haven't really said we're going to change that approach.

Got it. Thanks for taking my question.

Yeah, thanks, David. Thanks, David. Gerard Cassidy with RBC Capital Markets. Your line is open.

Thank you. Good morning, guys.

Hey, Gerard. How are you doing?

Good. Can you guys give us some color? Obviously, payments is a very important part of your business model. And we've seen the announcement on Libra and what they're going to try to do. So have you guys, you know, read the white paper? And can you give us your thoughts on what you think?

We have read the white paper and we've had a number of discussions on it. You know, I think it's in the early stages, Gerard, so I don't think there's an immediate impact to it. But we have a number of initiatives going on with our payments. We're trying to understand the impact of not only that, but really optimizing the new real-time rails that have been built and are being used, a number of use cases across the company, the migration of treasury management, moving to corporate payments activities, and the impact on the consumer side to all the real-time activity that's occurring. So it is one component of a more substantive change that's occurring in the environment, which is around payments overall, which is very impactful and very much something we're focused on.

Very good. And then coming back, over the years, obviously, you guys have been very successful in making depository acquisitions as well as other non-depository acquisitions. Can you give us your view on what you're thinking over the next maybe 12, 24 months on depository transactions as well as non-depository transactions? Are you interested or is that something that could happen if the right opportunities came up?

Yeah. So as you know, most of our recent transactions have been non-depository. They've been either card portfolios, payments capabilities, trust, things of that sort, technology capabilities. And I think that will continue to be a focus for us. As we talked about, we are working on entering new markets without an acquisition, but in this concept of a digital first branch life strategy. So I think that is a new way to enter a market, in my view, more efficiently and effectively without paying a big premium and having a attrition that occurs after the fact. So if we were looking at anything larger, and we'll look at all opportunities, it would have to be substantial. It would have to be meaningful. And we'd also have to weigh that transaction against the great momentum that we have across the company right now, across many of the businesses, and think about it from a long-term perspective. So we'll consider all those things, but I wouldn't expect us to enter a new market with a small depository acquisition given our other opportunities to do that.

And speaking of the other opportunities, Andy, can any early read yet on that digital strategy that you guys have launched into these markets? Or is it too early to tell? Or what are you guys seeing from the early results?

It's just starting, George. So we are, in fact, in the next month we will have the first branch there, and the others will come after that. So it's too early in the game to

tell. Okay. I appreciate it. Thank you.

Thank you.

There are no further questions at this time. I would now like to turn the call back over to the presenters for final remarks.

Thank you for listening to our earnings call this morning. Please contact the Investor Relations Department if you have any follow-up questions.

This concludes the U.S. Bancor Second Quarter 2019 earnings conference call. We thank you for your participation. You may now disconnect.