U.S. Bancorp

Welcome to U.S. Bancorp's first quarter 2022 earnings conference call. Following a review of the result by Andy Cesare, Chairman, President and Chief Executive Officer, and Terry Dolan, Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. If you would like to ask the 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 11 a.m. Central Time through Thursday, April 21, 2022 at 10.59 p.m. Central Time. I will now turn the conference call over to Jen Thompson, Head of Corporate Finance and Investor Relations for U.S. Bancorp.

Thank you, Francie, and good morning, everyone. With me today are Andy Cesari, our Chairman, President, and CEO, and Terry Dolan, our Chief Financial Officer. During their 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'd like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, and in our Form 10-K and subsequent reports on file with the SEC. I'll now turn the call over to Andy.

Thanks, Jen. Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will take any questions you have. I'll begin on slide three. In the first quarter, we reported earnings per share of 99 cents and total revenue of $5.6 billion. The quarter was highlighted by strong loan growth, continued momentum in our payments businesses, well-controlled expenses, and strong credit quality. As expected, mortgage banking revenue declined in the first quarter due to slower refinancing activity in the market. However, we saw good momentum in business activity and related revenue growth within other fee businesses, including payments, trust and investment management, and treasury management. This quarter, we released $50 million in loan loss reserves, reflecting continued strong credit quality. And at March 31st, our CET1 capital ratio was 9.8%. Slide 4 provides key performance metrics. In the first quarter, we delivered a return on assets of 1.09% and a return on tangible common equity of 16.6%. Slide 5 highlights trends in digital engagement. Digital transactions account for over 80% of total transactions, and total digital loan sales account for about two-thirds of total loan sales. We are pleased with the progress we have seen so far, but believe there is further opportunity to increase customer engagement through digital adoption by helping consumers and business customers understand the full scope of capabilities available to a system in managing their financial lives. We are continually adding and enhancing digital features and functionality and applying a digital plus human approach. A great example of this is our do it together co-browse technology. Through this tool, interactions with our customers, a key driver of engagements, have increased in number and have become more efficient as well as effective. Turning to slide six, we believe our complete payments ecosystem is a competitive advantage for our company. The opportunity to connect our banking customers with our payments products and services and our payments customers with our banking products and services will continue to drive meaningful profit and return differentiation for our company over the next several years. Our small business initiative is just one example of many that we see driving both account growth and deeper relationships. We believe the suite of products we offer to our small business customers will allow us to grow those relationships by 15 to 20 percent and related revenue by 25 to 30 percent over the next few years. We are particularly encouraged by the trends we are seeing in the uptake of our TALIC point-of-sale functionality. which allows small business customers to manage their banking and payments needs in a simple, easy-to-use format that we provide in the form of a dashboard. On the right side of the slide, you can see that the number of new TALA customers increased five-fold in 2021 compared to 2020, and that strong growth trajectory has continued in 2022. Year-to-date, new TALA customers are 1.5 times the full-year 2020 level. Now let me turn the call over to Terry, who will provide more details on the quarter.

Thanks, Andy. If you turn to slide seven, I'll start with a balance sheet review, followed by a discussion of first quarter earnings trends. Average loans increased 3.4% compared with the fourth quarter, driven by 8.0% growth in commercial loans, 2.1% growth in mortgage loans, and 1.0% growth in total other retail loans. Commercial loan growth reflected slowing pay downs, increased business activity, and higher utilization rates across many sectors and most geographies. Client sentiment is stable, and commercial lending needs are being driven by inventory building, M&A activity, and CapEx expenditures. In the retail portfolio, we saw good growth in residential mortgage and other retail loans, including auto lending. Credit card balances declined a length of quarter, reflecting typical seasonality and the impact of certain loans being moved to health for sale in the fourth quarter, which impacted average balance growth. Turning to slide eight, total average deposits increased 1.0% compared with the fourth quarter, despite the typical seasonal reduction in non-interest-bearing deposits. Total average deposits increased 6.5% compared with a year ago. Slide 9 shows credit quality trends. Credit quality continues to be strong across our loan portfolio. The ratio of non-performing assets to loans and other real estate was 0.25% at March 31st compared with 0.28% at December 31st and 0.41% a year ago. Our first quarter net charge-off ratio of 0.21% was slightly higher than the fourth quarter level of 0.17%, but lower compared with the first quarter of 2021 level of 0.31%. Our allowance for credit losses as of March 31st totaled $6.1 billion, or 1.91% of period end loans. Slide 10 provides an earnings summary. In the first quarter of 2022, we earned 99 cents per diluted share. These results included a relatively small reserve release of $50 million. Turning to slide 11, net interest income on a fully taxable equivalent basis totaled $3.2 billion. The 1.6% linked quarter increase reflected strengthening margins and strong loan growth in the quarter, particularly commercial loan growth. Our net interest margin improved four basis points to 2.44% due to the changing yield curve, investment portfolio actions, and lower cash balances, partially offset by the impact of loan mix. Slide 12 highlights trends in non-interest income. Compared with a year ago, non-interest income increased 0.6%, reflecting strong payment services revenue, growth in trust and investment management fees, and higher treasury management fees offset by lower commercial product revenue and lower mortgage banking revenue. The decline in mortgage banking revenue reflected lower refinancing activity in the market and tighter gain on sale margins giving excess capacity in the industry. In the first quarter, total payments revenues increased 10.1% compared to a year earlier, reflecting both continued cyclical post-pandemic recovery as well as strong underlying business trends supported by investments we are making. Credit and debit card revenue increased 0.6% on a year-over-year basis as the impact of higher credit and debit card volume was offset by lower prepaid card activity. Excluding prepaid card revenue, credit and debit card fee revenue would have increased 9.6% compared with the first quarter of 2021. Both corporate payment, products revenue, and merchant processing fees increased at a double digit pace compared with a year ago, with growth driven by both the cyclical recovery of pandemic impacted industries, as well as underlying business momentum. Slides 13 and 14 provide additional information on our payment services business. In the middle of slide 13, we provide a table which illustrates the cyclicality that naturally occurs in each of our three payments businesses over the course of a typical year. On the right side of the slide, you can see that COVID-19 impacted industries continued to recover throughout the first quarter. As of the first quarter of 2022, credit and debit card travel volumes exceeded pre-pandemic levels. In March of 2022, airline volume was flat compared to March of 2019, the first time we have seen recovery to pre-pandemic levels. Although T&E-related volumes in our corporate payments business are still below pre-pandemic levels, they continue their upward trajectory. In March, corporate T&E volumes in CPS were back to 75% of the pre-pandemic level. Slide 14 provides linked corridor and year-over-year revenue growth trends for our three payments businesses. Because of the cyclical nature of our payments businesses, we believe year-over-year trends are the best indicator of underlying business performance in a normal environment. Year-over-year credit and debit card revenue growth rates continue to be negatively impacted by the decline in prepaid card revenue as the benefit of the government stimulus has dissipated. we provide details on prepaid card fee revenue over the past five quarters in the upper right quadrant. While prepaid card revenue is approaching a run rate on a link quarter basis, it will impact year-over-year credit and debit card fee revenue comparisons through the end of 2022. The bottom half of the slide illustrates the strong year-over-year growth rates in both merchant processing and corporate payments fee revenue over the past several quarters. which have partly reflected the pandemic-related recovery. While we expect the year-over-year growth rates to moderate from current levels, we continue to believe that both merchant processing and corporate payments fee revenue can grow at a high single-digit pace on a year-over-year basis in a post-pandemic environment. Turning to slide 15, non-interest expense decreased 0.9% on a link quarter basis. The decline was driven by lower professional services expense, marketing and business development expense, and technology and communication expenses, partially offset by increases in employee benefit expense, primarily due to seasonally higher payroll taxes, and other non-interest expenses. Linked quarter expense growth includes the impact of the acquisitions completed in the fourth quarter of 2021. Slide 16 highlights our capital position. Our common equity Tier 1 capital ratio at March 31st was 9.8%. As a reminder, at the beginning of the third quarter of 2021, we suspended our share buyback program due to the pending acquisition of Union Bank. After closing the acquisition, we expect to operate at a CET1 ratio between our target ratio and 9.0%. We continue to expect that our share repurchase program will be deferred until our CET1 ratio reaches 9.0% following the pending deal close. I will now provide some forward-looking guidance. The following guidance is for a U.S. bank on a standalone basis and does not include any potential impact from Union Bank. Let me start with full-year guidance. We have updated our interest rate expectations to be consistent with market expectations. Given our revised interest rate assumptions, we now expect total net revenue to increase 5% to 6% compared with 2021, reflecting 8% to 11% growth in taxable equivalent net interest income and stable fee income primarily due to lower mortgage banking revenue and deposit service charges offsetting growth in other fee businesses. We expect positive operating average of at least 200 basis points in 2022. As it relates to the second quarter specifically, we expect total revenue growth of 5% to 7% on a linked quarter basis benefiting from seasonal strength in many of our fee businesses, continued loan growth, and the second quarter impact of higher rates on net interest income and the recapture of fee waivers. In the second quarter, we expect expenses to increase 1% to 2% on a linked quarter basis, primarily due to seasonally higher compensation-related costs and business investment spend. Credit quality remains strong. Over the next few quarters, we expect the net charge-off ratio to remain lower than historical levels, but will continue to normalize over time. For the full year 2022, we expect our taxable equivalent tax rate to be approximately 21 to 22 percent. If you turn to slide 17, I'll provide an update on our previously announced pending acquisition of Union Bank. In September of 2021, we announced that we had entered into a definitive agreement to acquire the core regional banking franchise of MUFG Union Bank. We continued to make significant progress in planning for closing the deal in the first half of 2022. while we await regulatory approval. As you know, regulatory approvals are not within the company's control and may impact the timing of the closing of the deal. We expect to close the deal approximately 45 days after being granted U.S. regulatory approval. Conversion is anticipated late in the second half of 2022. We continue to believe this deal is a compelling use of our excess capital from both a strategic and financial perspective. We feel comfortable with our initial financial deal assumptions, including an expectation that it will generate an internal rate of return of about 20%, which is well above our cost of capital. Assuming a June 30th close date, we expect Union Bank to contribute approximately $310 million to our pre-tax, pre-provision net revenue in 2022 before considering cost synergies. We continue to expect to achieve approximately $900 million of total cost synergies related to the deal with approximately $85 to $100 million of cost savings achieved in the second half of 2022. We continue to target total merger and integration costs of $1.2 billion of which approximately $950 million will be incurred in 2022 with some charges anticipated in the second quarter as we prepare for system integration. In addition, there will be a day one loan loss provision required at closing in accordance with the existing CECL accounting rules of approximately $800 to $900 million. I'll hand it back to Andy for closing remarks.

Thanks, Terry. Our strong first quarter results have positioned us well for the rest of the year, and we are encouraged by the long growth trends and business activity that we are seeing in the early part of the second quarter. Credit quality remains strong. Nonetheless, we continue to approach credit decisions with a through-the-cycle lens. We feel good about the secular trends we are seeing across our fee businesses. Our payments revenue continues to recover, and we look to continued cyclical recovery in travel and entertainment as the year progresses. More importantly, over the near and intermediate term, our multi-year investments in this business and the strategic initiatives aimed at leveraging the power of our payments ecosystem will continue to pay off. We are closely managing operating expenses even as we invest in our digital initiatives, our payments capabilities, and our technology modernization. On that front, I'd like to highlight a few of our recent announcements. We enhanced a service that we call Extend Pay, an offering which allows our existing consumer and business cardholders to buy now, pay later option, where they can choose a flexible payment plan that suits their needs. We also rolled out a request for payment capability, which allows merchants to send bills directly to customers' bank accounts. Those customers have the option to send payment immediately to the biller via real-time payment rails. In February, we announced a meaningful investment in our cloud strategy, which is aimed at modernizing our technology foundation so as to further improve the security of our data, financial assets, and customer privacy, while allowing for the transformation of applications and infrastructure to create leading-edge customer experiences. We will continue to leverage our suite of products, services, and capabilities to enhance the customer experience, which we believe will support meaningful account growth and deeper relationships across our entire franchise over the next several years. In closing, 2022 is off to a good start, and I'd like to thank our employees for all they do to support our strategic goals and continue to serve our customers and communities. We will now open up the call for Q&A.

Thank you. And participants, if you would like to ask a question, you may press star, then the number one on your telephone keypad. Again, that's star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Your first question comes from the line of Matt O'Connor from Deutsche Bank. Your line is now open.

Good morning. I was hoping you guys could provide an update on asset sensitivity of USB standalone and then the impact of UB. I know at one point you had said it was going to make you a little more asset sensitive, but obviously the rate environment's changed. I'm not really sure what's happened to their balance sheet. So some updates there on asset sensitivity, please.

Yeah. Matt, let me kind of take that question. You know, with respect to asset sensitivity, you know, and I'm going to kind of refer back to maybe the disclosures we had in the 10K And probably the best one to look at would be kind of an upward gradual 200 basis point movement. I think that that is at least the environment that the market implied would expect at this particular point in time. So if you end up applying that rate sensitivity of about 5.4% to the fourth quarter, I think it gives you a pretty good estimate of what sort of benefit that we see in terms of net interest income kind of going forward. Maybe kind of qualitatively, you know, I think that, you know, when we see early in the cycle, you know, deposit betas will be relatively low. You know, our portfolio, when you look at loans, it's probably about 50, 55% is floating rate and about 45 to 50% is fixed rate. So, That probably gives you some perspective with respect to kind of what we're expecting to see. From a union bank point of view, as we've said in the past, it is a bit more asset sensitive than us. It should help us kind of, I would say, 35, 40 basis points. When you end up looking at their portfolio and the assets that we'll be acquiring, it's deposit heavy, so we'll have a substantial amount of cash and the opportunity to be able to reinvest that as rates move up.

Okay. And then separately, you gave the impact of the UB deal on tangible book value. I think it was just a 1% reduction. What's the estimated impact on CET1 capital? both from the actual acquisition and then the upfront marks that you mentioned earlier?

Yeah. So, you know, as we've said, you know, currently we're at 9.8% in terms of our CET1 ratio. We would expect it will be in the range of that 8.5% to 9%, you know, at the end of the closing. Of course, it will be dependent upon how much rates move between now and, you know, the actual closing time. I talked a little bit about the day one provision in terms of the credit mark. From an asset mark, I think it will be a little bit higher than what we had originally anticipated or disclosed at the time of the acquisition, simply because of the rising rates, but not significantly different.

Okay, thanks. Just a suggestion, by the way, lots of good guidance on the call. It would be great if you could put some of it in a slide. It's just such a busy day and scrambling to jot it all down. Some of your peers do that, and it's really helpful for us on this side. Thank you.

Yeah, we would anticipate we'll start to incorporate more of that as the deal moves forward.

Your next question comes from the line of Jan Pancari of Evercar ISI. Your line is now open.

Hi, Jan. Morning. Morning. On the card and payment side, I'm curious if you can just give us a little bit more detail on what you're seeing in terms of consumer spend behavior. Are you seeing any signs of any pullbacks and shifts in the type of spend that could some softening there. We're starting to see some shifts towards non-discretionary from discretionary spend. Curious if you're seeing that in your business, if that is impacting your outlook at all.

Yeah, so let me start and then Andy can kind of add to it. You know, certainly what we are continuing to see, John, you know, through the first quarter is, you know, good, strong, both year-over-year growth and comparisons back to 2019. Really across the board, I think a couple of the trends that we talked about is that travel, you know, specifically airline was back to pre-pandemic. And so that's continuing to develop and grow. And that's occurred specifically in March. And I think you'll see that continuing as we think about, you know, the second quarter and beyond. You know, we do continue to expect in the CPS business that travel and entertainment is going to continue to strengthen. And I think that that is a tailwind or an opportunity for us as we move forward. I would expect that there's probably going to be a shift to some extent from what I would call durable goods that people were spending their dollars on in the past to more service-oriented sort of activities. But in terms of the overall level of spend, I feel like that will continue at least for some period of time. Annie, what would you add?

I think that's a good summary, Terry. You know, John, it's interesting because consumer spend on the merchant side, if we look at that data versus pre-pandemic levels in the first quarter, still up 9% to 15%. Consumer credit card spend still up versus pre-pandemic 35%. And corporate payments still up 10%. The one area, Terry mentioned, that is not back to recovery yet is corporate T&E, which is about 75% of what is normal or pre-pandemic levels. And we would expect that to continue to get better as we all start to get out on the road more. So we're not seeing any negative trends thus far and it continues to be very strong.

Okay, great. Thank you. That's helpful. And then on the commercial side, I know you cited in your prepared remarks that you are beginning to see CapEx plans as a driver behind the loan growth dynamics on the commercial side. Do you expect that to continue as we look out here or Do you foresee a potential impact on borrower appetite amid still the inflationary dynamics and supply chain issues in Ukraine?

Yeah, I think that the capital expenditure is probably driven by a couple of different things. I think that, you know, most businesses over the course of the last couple of years have been kind of holding back with respect to capital expenditure. And so I think that there's a bit of, you know, an increase in that spend just related to that. And then I do think that as companies see more and more inflationary pressure, they're going to look to business and business automation as ways of kind of offsetting some of the pressure that they see with respect to being actually to acquire talent. And so I think that our expectation, at least in the near term, is that capital expenditure will continue to be reasonably strong.

And I think our utilization rates support that, Terry. You know, we have been running in that 19% plus or minus for a number of quarters, and we saw it increase, certainly not to normal levels yet, but in that 22% to 23% in the last few months.

Got it. Okay, thanks. It's very helpful.

Sure.

Your next question comes from the line of Betsy Grasick of Morgan Stanley. Your line is now open.

Hi, Betsy.

Hi, Betsy.

Hi, this is Ryan Kenney on behalf of Betsy. Good morning.

Hey, Ryan.

Wondering if we could dig in a little bit more on deposit betas. So I know that you mentioned that early in the cycle, you're expecting deposit betas to be relatively low. So on one hand, you have an industry with a lot of excess liquidity. But then on the other hand, you have consumers that might be a little bit more cognizant of rate hikes coming faster with inflation on the headlines every day. You have rising fintech competition. So putting that all together, I'm wondering how you're thinking about deposit betas really over the first 100 bps and then the following rates after that.

Yeah, so maybe I think it's helpful to maybe have a little context. You know, when you end up looking at our deposit business or balances, about 50% of it is consumer-based and 50% of it is institutional, if you will, which tends to have a little bit of a higher beta. But Our expectation, especially early in the cycle, is that betas will move relatively slow. And then as we get further into the development of the cycle, it'll start to accelerate a bit. But to kind of give you some perspective, we would expect probably through the full cycle of 2022 that betas on the consumer will be less than 10%. and then maybe slightly higher that on a terminal basis. On the institutional side, you know, we would expect, you know, through the 2022 cycle, somewhere between 50 and 60%, you know, with a terminal level that's maybe a little bit higher than that. A couple of things, you know, that, you know, as we are looking at it, you know, we believe that relative to, for example, the last cycle, that our deposit basis will be a little bit less sensitive for a couple of different reasons. One is, you know, the consumer balances are larger by about, you know, 5% relative to the last cycle. Our corporate trust deposit balances are lower, you know, in terms of the mix of the deposit basis changed. And then we have, you know, moved away from concentrations related to brokerage-related type of deposits, which we had more of in the past. We still have some, but a lower concentration. So all of those things are going to drive lower beta growth than what we saw in the past.

Thanks. That's a really helpful caller. And then just as a follow-up, wondering if you could dig into the book value per share decline of 9% link order. How much of that came from AOCI drawdowns on the AFS portfolio? And is there anything you can do to mitigate the AOCI hit going forward if the rate outlook keeps moving higher?

Yeah, the vast majority, if not all of it, was really tied to the change in the unrealized gains and losses on the investment portfolio. And then the driver, when we think about the future, we started to change a couple of different things. So in the fourth quarter, we moved about $43 billion of our investment securities to held to maturity. As we are reinvesting runoff associated with the investment portfolio, we'll continue to move more and more of that into the held to maturity sort of category. And then certainly as we close on Union Bank, we have the opportunity after the mark to move a lot of that into held to maturity as well. So today, About 30% of the overall portfolio is in the held to maturity category. And our expectation is over some period of time, we would move that percentage up significantly.

Thank you.

Your next question comes from the line of Erica Najarian of UBS. Your line is now open.

Good morning, Erica.

Hi. Good morning. Just putting together the most recent question and also Matt's question, you know, underneath the 8% to 11% NII growth, could you give us a little bit more of a breakdown in terms of what you're expecting for, you know, asset growth given the strength in your loan book today? And, Terry, I hear that you also short-term borrowing period end by $10 billion today. And, again, you know, going back to the question I think everybody's trying to ask, remind us how much of your deposit base is corporate trust today, and of those deposits, how much are indexed? Do they reprice immediately to the changes in underlying benchmark rates, or do you have some ability and pricing power, you know, to be able to perhaps delay some of that repricing?

Yeah, so let me start with the last question and kind of talk a little bit about the deposits. And then, you know, to the extent that I don't cover everything, just remind me. But deposits in the corporate trust business or in the trust institutional, the investment services group, which includes corporate trust, represent about 15% of their total interest-bearing deposits. Now, In the last rate cycle, that was about 22%. So it's down relative to the overall mix. And then the vast majority of it is not indexed to any particular rate. And so we do have the ability to manage that. A fair amount of the deposits within corporate trust are non-interest bearing as well. which I think is helpful. That percentage is probably a little bit higher than what it was in the past. But the competitive pressure will really come as money market funds start to move up. We do have the ability to lag relative to that, but that's where some of that competitive pressure comes from. Thank you.

follow up on the underlying earning asset assumption that you have? Yeah. Yeah.

Yeah. So, you know, when we end up looking at earning assets, you know, our expectation is that the investment portfolio will be relatively flat or stable really through the end of the year and the vast majority of the growth will come on the loan portfolio side of the equation. As we look into the second quarter, you know, our expectation is that, you know, loan growth will continue to be strong. You know, this and as a reminder, it was up on a link quarter basis about 3.4%. And while it may not be at that level, I think it'll still be up on a link quarter basis very nicely. And, you know, we would continue to expect good solid growth in the C&I portfolio as well as, you know, credit cards will start to seasonally get stronger, etc.,

Got it. And a follow-up question to Matt's question on CET1. When you closed Union Bank, I think I'm estimating your total asset size to be just shy of $690 billion. And how should we think about capital management as you potentially approach $600 billion asset mark in two years, Andy and Terry? And I'm just wondering in context of You know, the TCE hit was obviously more than the CET1 hit because AOCI doesn't run through your CET1. So I guess I'm wondering in terms of, like, you know, buybacks even after you replenish to nine, if you think about crossing the 700, you know, how that might influence your capital management and capital return potentially differently over the next two years.

Yeah, you know, Erica... I think your estimates with respect to the, you know, total size are reasonable. You know, our expectation is that, you know, to kind of give you some perspective, you know, when you end up looking at the rules, the rules say that you need to be able to, you need to be at an average of over a four-quarter period above $700 million. So there's a bit of runway that exists between now and, you know, when we might become a Category 2 sort of entity. Some of the actions that I talked about with respect to the held to maturity composition of the investment portfolio I think will help kind of mitigate that. Certainly will generate a fair amount of earnings between now and, let's say, six or seven quarters out. And I think all those things will kind of help us manage through that timeframe. The other thing is that when we do close on Union Bank, it's deposit heavy in terms of the mix. So there'll be a significant amount of cash and we would expect to utilize that to help us manage borrowings down and things like that in order to be able to stay below that $700 million or billion dollar threshold for our for an extended period of time.

Got it. Just to clarify, as you close UB, the intention for the cash is not to deploy it, but to shrink the pro forma balance sheet to be able to accommodate more client growth rather than just raw balance sheet growth from... Exactly.

Exactly. Got it.

Thanks so much.

Thanks, Erica.

Your next question comes from the line of Ken Uzzin, Of Jeffries, your line is now open.

Hey, thanks. Good morning, guys. Just a question on fees to start. In your revenue guide, do you fully contemplate the full recovery of fee waivers, which I think you said have been running around $70 million? How much do you have that recovering in 2Q, and I assume that's also fully recovered in the full year guide?

Yeah, so to answer the last piece, yes, it would be fully recovered certainly by the end of the year. And, you know, just given kind of projections in the marketplace with respect to rates, you know, we'll see a significant amount of that recovered in the second quarter with a residual amount kind of in the third quarter. Maybe as a reminder, we recover about 65% of it in the first 25 basis point movement, 90% of it in the next 25 basis point movement, and all of it, you know, after the third 25 basis point movement. So, Most of it in the second quarter, but some amount in the third.

So about 70% of it comes back in the second quarter, Terry.

Got it. Thank you, Terry. And then also just on the mortgage business, obviously the reset that you had given us the expectation for, just your outlook from here given where rates have gone and the ins and outs of production and servicing. Thanks.

Yeah. You know, obviously the mortgage banking business is, you know, going to trend along with, at this particular point in time, refinancings. You know, the mix of business is probably 70% home sales and 30% refinancing. So on a link quarter basis, the impact of refinancings will be less than what it has been in the past. So it'll come down to kind of home sale activity. You know, we continue to think that that'll be reasonably strong. And, you know, our investment in kind of the retail channel will be good. I think the things that will be drivers can in the future on a link quarter basis will really be, you know, where do gain on sale margins go and that will be driven based upon how fast the capacity comes out of the system. But at least at this particular point in time, just looking at kind of industry metrics I think is a good way of kind of thinking about how we'll perform as well.

All right, thanks very much.

Your next question comes from the line of Mike Mayo of Wells Fargo Securities. Your line is now open.

Hi. Hi, Mike. Just to clarify, so you improved 2022 guidance. Revenues from 3% to 4% to 5% to 6%. NII from 5%. to 8% to 11% and operating leverage from 100 basis points to 200 basis points. I just want to make sure I have my facts straight there. Is that correct?

You got it, Mike.

Okay, so that improved guidance, how much of that is due simply to higher interest rates? How much of that is due to better loan growth? And how much of that is due to payments or some other activities?

Yeah, I think that, again, we would expect that fee income will be relatively stable on a year-over-year basis. So when you end up looking at what's going to be the driver, it'll be net interest income. And from here on out, I think it's going to be kind of a balance between loan growth and interest rates. Because if I had to kind of give you a mix, and I don't necessarily have that with me, but it's probably 60%, 65% rates and 30%, 35% on the loan portfolio growth side of the equation.

Okay. So your loan growth is pretty – your commercial loan growth is kind of – fast and I'm just I think you said there might have been a one-time element in there but what sort of commercial loan growth are you expecting is this the the big pivot with the recovery from the pandemic is it inventory bills as a capex is it by differences by region it just this might wind up being to the best commercial loan growth that we see on you know in a link quarter basis and percentage-wise than any big bank. So just a little more color around that would be great.

Sure, Mike. I'll start. This is Andy. Interior add-on. It's across all those categories I mentioned earlier, and there is no one-timer in there, so it is core growth. One of the factors is our utilization rates, as I mentioned, have been hovering in that 19 or so percent, and they're up nearly 23 percent, which is a key component, which is, again, takedowns to fund all those things you talked about, which is CapEx and inventory growth and other activities. It's fairly widespread. It's true within our large corporate as well as our middle market and spread geographically as well. So it is strength across many categories. Terry, what would you add?

The other thing I would just say is that we'll start to see some seasonal benefit associated with the credit card portfolio as we get into the second, third quarter.

Okay. And then the other part of that question related to payments, I think payments was a little bit of a disappointment for us a little bit of time, and now it's come back a little bit this quarter, 10% year-over-year growth. So I guess, is payments back or not back? Is it performing to your expectations? Are there still headwinds? Or is recovery from the pandemic helping that business? How do you think about payments relative to your own expectations and the market's expectations?

Yeah. I mean, we're very excited about the payments business. I think there's a number of dynamics that are taking place. I think there's still cyclical recovery that's going to continue on for some period of time. And you're going to see that, you know, in the airline and the travel and entertainment and those sorts of areas. I think that that is all, that's all good. You know, Mike, we've talked a lot about investments that we've been making in our payments businesses. And I Over the course of the last few years, as an example, within the merchant acquiring, three years ago or so, our tech-led sort of revenue represented about 15% of our overall merchant acquiring revenue. Today it represents 30%, and we would expect that to continue to accelerate because of investments that we're making. We talked about the fact that in a normal environment, you know, as the cyclical recovery kind of starts to wane, that we would expect our merchant acquiring and our CPS business to grow at high single digits. You know, that's, you know, two or three times what we were seeing, let's say, four years ago when we started our investment. So, you know, we feel really good about where we're at from a payments perspective at this particular point. Andy, what would you add?

I think that's right. And Mike, when you asked about the guidance and Terry mentioned that fees are relatively stable, you know, that is mortgage coming down a fair bit as well as deposit service charges with some of the changes that we made in overdrafts, which is offset positively by some of our payments businesses and the expectations that we now have for the full year. as well as the trust businesses. So there's some value in the diversification of those revenue streams, and it's coming through in payments and trust.

That was a detailed answer. If I could just push the limits. Any numbers around the payments growth? Should it be high single digits? Can you keep that 10% growth up, or should it settle back down to a lower range?

Yeah. You know, again, I think if you end up looking at the components, merchant and CPS on an ongoing basis, high single digits, I think credit card will be, you know, probably at a lower level than that, but it will be consistent with the way the rest of the industry is growing.

And part of that credit card comp, Mike, is the prepaid impacts of prior years is still impacting the comps year over year in 2022. Okay, thank you. Sure. Thanks, Mike.

Your next question comes from the line of Vivek Janija of JP Morgan. Your line is now open.

Thank you, Vivek. Andy, morning. Terry, just a clarification there. So the high single digit on merchant processing and corporate payments, are you referring to that for 22 or beyond? And because the credit card should be hooked in 22, but after that, those comps should get easier. So what do you think post 22 for credit cards? So just want to clarify those.

Again, for merchant and CPS, you know, we think post 22, high single digits. And we believe that credit card will perform kind of consistent with the rest of the industry. You know, the comps, as you say, you know, this year will be impacted by the prepaid card revenue that has coming down. But then that starts to normalize as you get into 2023.

And within this, I think, are you expecting any more? big contract renewals that could impact this, or has that been factored into your guidance, or are you just not expecting much of that to come up?

Yeah, we don't expect a lot of that. The large contracts that got renegotiated were more on the CPS side of the equation about two years ago, and that's kind of fully in the run rate At this particular point in time, as you know, those contracts are usually 10, 12 years in length, so we don't see anything on the horizon there. Okay.

One request, and that is FICO mix of your loan portfolios. I know we've talked about this in the past. Could you look into actually disclosing it? Your peers do, and I think given your high consumer mix of loans, it would be very helpful to have that.

All right, thanks, Shivak. We'll take a look at that. Thanks for the feedback. Thanks.

Your next question comes from the line of Gerard Cassidy of RBC. Your line is now open.

Hi, Gerard.

Hi, Gerard. Hi, Terry. Hi, Annie. Terry, following up your comments on the mortgage banking business, with the rates where they are possibly going higher, probably depressing refinancing activity for the industry as well as yourselves because of the higher rates. Can you attempt or can you look to growing your home equity business, home equity lines, et cetera? This business, of course, for the industry and yourselves has been an industry or a line of business that has been shrinking over the years. But could that be an alternative to people refinancing and moving into home equity lines?

You know, I think that it certainly won't shrink at the same level it has been shrinking, Gerard, just for the reasons you mentioned. Because of refinancing, people would have money out and that would be, would cause, would replace home equity, so to speak. So I think you'll see a positive trend there. It certainly is not going to offset the mortgage impacts directly, but I think it will be positive.

Is there any plan on your guys' part to maybe be more aggressive in marketing those products or have you not really thought about that?

You know, we're always looking at opportunities to serve the customers in areas they need. The other, you know, another sort of related is the whole buy now, pay later component that we talked about. I mentioned some examples in my prepared remarks, but as you think about home equity improvements, a new way of financing that is through a buy now, pay later or financing a point of sale. So that's something we're also focused on.

Got it. And then second, obviously, U.S. Bancorp has distinguished itself over the years with having a very strong focus on credit and delivering very strong returns to shareholders. And the question I have, because credit obviously is not an issue today for most banks, yours included, when do you start to get nervous or do you get nervous In this interest rate environment, you know, the Fed comes through and we have 200 basis points of Fed funds at the end of the year and possibly, you know, a 10-year that's well above 3%. How do you guys kind of think about that when you assess the risks for the business here at US Banker?

Yeah, fair question. And I think there's a lot more conversation around that in terms of whether or not there will be recessionary sort of pressures, you know, 12 to 18 months out. You know, I would start by just saying, you know, when we end up looking at the economic outlook right now and kind of what we're seeing, we continue to see a pretty robust environment. That said, Gerard, I think it's a fair question because, you know, credit issues that we, decisions we made today and a year ago are what's going to affect us. And, you know, we never really changed our underwriting approach. We've always been very focused on, as an example, you know, in the consumer side, We focus on prime and super prime customers in our card business, in our auto business, et cetera. I think the mortgage, just the underwriting associated with mortgages is different today than it was 10, 15 years ago, which will help. But then on the C&I side of the equation or the corporate side of the equation, we do very little leveraged lending sort of activities And, you know, areas that have been kind of structurally impacted like retail, et cetera, retail malls, et cetera, you know, we've kind of made a lot of changes to our portfolio the last several years. So I actually think that, you know, we'll perform quite well in the event that we were to see recessionary pressures develop.

And Terry, just to follow up there. How about from a balance sheet standpoint, you talked about moving more of your available for sale into health and maturity in your bond portfolio. In this rising rate environment, do we start to see greater risks in that part of the business, not just for U.S. Bancorp, but maybe for the industry as well?

Within, for example, the investment portfolio?

Correct, correct. Just the marks that people may have to take. I know health and maturity, you don't mark the market, but I'm just Because we haven't had to focus on this in, God, years. And I'm just wondering if there's something that we need to keep our eyes open for.

Yeah, I mean, I think it's worthwhile just kind of trying to understand the mix of the types of investment securities that people are putting into their particular portfolio. You know, when you get into stress in the economy, et cetera, you know, certain types of investments may not perform as well. In terms of our own portfolio, highly concentrated in treasury and government-backed, mortgage-backed securities. So we don't see a lot of credit risk in our particular portfolio. But it is something I think, you know, from an industry standpoint, it's worthwhile watching.

Great. Appreciate all the comment. Thank you.

Thanks, Jared.

Your next question comes from the line of Terry McEvoy from Stephens. Your line is now open.

Hi, good morning. Thanks for taking my questions. If I go back to September, I think you expected to realize 25% of the cost savings from union this year, which was about $225 million. Terry, I believe on the call, was it 85 to 100 million this year? And is that just simply a function of pushing out the conversion to late in 2022?

Yes, it's all really related to the timing.

And then your thoughts on 2023, the full 100% by the end of the year, any kind of update on 2023 when a bulk of that savings will occur?

Yeah, I mean, I think that the bulk of that savings, we certainly start to realize some of it later this year, but the bulk of it does get realized in 2023. And certainly when we get close to the end of the fourth quarter and first quarter of 24, the vast majority of it will be realized. So I think the timing is very consistent with what we talked about, just affected by the timing of the deal.

Understood. Thank you. And as a follow-up, the 6% decline in non-interest-bearing deposits, I think that was on an average basis. In the release, it was seasonal kind of factors coming into play. Anything beyond that in terms of the decline, or do you truly think that was just a seasonal component?

Yeah, with our corporate trust business, we always see a ramp up in that type of deposit near the end of the year as deals try to get closed. And almost like clockwork, you know, around the 10th of January and through February, we see a runoff. So it's all really seasonal from our standpoint. Great.

Thank you, Terry.

Yep.

Your next question comes from the line of Bill Carcaccio of Wolf Research. Your line is now open.

Hey, Bill.

Hey, good morning, Terry and Andy. I apologize if this was talked about before, I might have missed it. But I wanted to ask if you could comment on as we think about the runoff of the Fed balance sheet and, you know, happening faster than when we exited the last ZERP cycle period. and the risk of non-interest bearing deposits outflowing perhaps a bit faster and, you know, perhaps impacts on deposit betas. Could you comment on that? And if you already have, I'll just go back to the transcript.

Yeah, no, it's a good question. And, you know, as we kind of go through the modeling and we look at, you know, the information and kind of how we think it's going to end up affecting not only us but I think the industry, So you're going to see that deposit growth is going to slow. But I do, and our expectation is certainly that deposit levels overall will grow slowly. And that'll be more in line with just the overall growth of the economy. So our expectation is that deposits continue to grow, but at a lower rate.

Understood. And following up on your commentary, I believe, Andy, around new point of sale solutions that you're looking at, there seems to be a little bit of debate among some banks who appear willing to promote the use of Zelle for retail payments versus others that would prefer to wait. Can you remind us where USB stands in that debate and how you think about the risk of a product like Zelle potentially cannibalizing some of your payments volume?

What we're focused on with Zelle is just increasing utilization of Zelle across our customer base. I think it's a terrific product. It has a lot of use cases. We're looking at different use cases, but overall what we're trying to do is just increase the utilization.

Understood. And then finally, if I may, there's been this view, just following up on the strengths you're seeing in the merchant acquiring side, There's been this view among some FinTech investors that Elevon is a legacy player using legacy technology and losing share in merchant acquiring. But Nielsen published its market share stats for the top U.S. merchant acquirers, and it shows Elevon actually moved up from number eight in 2020 to number seven in 2021 based on dollar volume. So from where you stand, do you think the investments that you're making in Palik and other digital initiatives can actually help you continue to gain share in the acquiring space or or is it more effectively protecting your position?

No, we do think, Bill, that it can allow us to gain share. I think it's a combination of a number of things. Terry talked about the investments we've made over the last three or four years, our focus on tech-led initiatives and the selling points differently than it was four or five years ago, and then that combination of bringing banking together with merchant processing into a comprehensive product set. I talked about TALIC and the dashboard. I think all those things position as well for future growth, both growth within the customer base that we have, but also expanding and acquiring new customers.

Got it. Thank you for taking my questions.

You bet.

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