U.S. Bancorp

Welcome to the U.S. Bancorp second quarter 2023 earnings conference call. Following a review of the results, there will be a formal question and answer session. If you'd like to ask a question, please press 1 then 0 on your phone. If you'd like to withdraw, please press 1 then 0 again. This call will be recorded and available for replay beginning today at approximately 11 o'clock a.m. Central Time. I will now turn the conference call over to George Anderson, Senior Vice President and Director of Investor Relations for U.S. Bancorp.

Thank you, Brad, and good morning, everyone. With me today are Andy Cesari, our Chairman, President, and Chief Executive Officer, Terry Dolan, our Vice Chair and Chief Financial Officer, and John Stern, Senior Executive Vice President and Head of Finance. During initial prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules are available on our website at usbank.com. Please note 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, our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry, and John will take any questions that you have. I will now turn the call over to Andy.

Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on slide three. The second quarter was highlighted by our successful conversion of Union Bank and a meaningful increase in our common equity Tier 1 ratio to 9.1 percent, 60 basis points higher than the first quarter, driven by earnings accretion and balance sheet optimization actions. Earnings per share totaled 84 cents in the second quarter, including 28 cents per share of notable items. Excluding the impact of notable items, earnings per share was $1.12. Slide 4 provides reported and adjusted income statement results and other key metrics. Our second quarter results were supported by new customer account growth and deepening of relationships across our business lines, as well as continued disciplined expense management. Net interest income was lower compared with the first quarter, primarily due to pressures on deposit pricing. However, momentum in fee income businesses continued strong. One of the strengths of our business model is our diverse and stable funding that includes a mix of both consumer and operational wholesale deposits. This quarter, while our average deposit balances decreased by 2.6% late quarter, period end deposits were higher by 3.2% or approximately $522 billion, largely reflective of seasonal operational deposit flows in areas such as our corporate banking and trust businesses. Credit quality metrics remain strong versus pre-pandemic levels. but are normalizing as expected. This quarter, we strengthened our balance sheet by increasing the loan loss reserve reflective of our prudent approach to credit risk management. Slide five provides key performance metrics. Excluding notable items, our return on average assets was about 1.07% and our return on tangible common equity was 22.3%. Slide six provides a summary of our recently completed conversion of Union Bank. Following our main systems conversion on Memorial Day weekend, all credit card trust and investment accounts were transitioned to our platform in June. Early indications are encouraging, and I'm even more confident today of the strategic and financial merits of this deal. We continue to expect meaningful revenue opportunities, and our cost synergy targets remain intact. One highlight is the Union Bank customers are adopting our digital capabilities more quickly than expected. As of June 30th, just one month following conversion, we've had over a half a million enrollments in our digital product offerings, and this number continues to grow. Our teams are working diligently to leverage the value of overlaying all of our products and services to Union Bank customers, and we will continue to provide updates on our progress. I'll now turn the call over to Jerry, who will provide more detail on the quarter.

Thanks, Andy. Turning to slide seven, our balanced mix of consumer, corporate, and commercial deposits continues to be a key source of strength for the bank. As Andy highlighted, while average total deposits declined 2.6% or $13.1 billion on a linked quarter basis, we ended the period with $522 billion of deposits, representing a 3.2% increase in ending balances on a linked quarter. This quarter, our end-of-period percent of non-interest-bearing deposits declined to approximately 20% from 25% in the first quarter due to both industry dynamics and a change we made to Union Bank retail accounts at conversion. Specifically, about half of the decline was related to an increase in deposit volumes and mix shift, while the other half was primarily driven by a customer-friendly product conversion decision by us. To create a more positive customer experience, we upgraded Union Bank customers to our interest-bearing, bank-smartly checking product. which offers a better checking solution as well as other benefits. This change will provide customer retention benefits without a material impact on our net interest margin. Given current interest rate volatility and the significant competition for deposits across the industry, we now expect our cumulative deposit beta to be in the mid-40 percent range by the end of this rate cycle, slightly higher than our previous expectation, but consistent with the deposit pricing dynamics in the industry. On slide eight, average total loans this quarter were $389 billion, which was flat on a linked quarter basis and up 19.9% year-over-year. Commercial real estate loans represent approximately 14% of our total average loan portfolio, with commercial real estate office exposure representing only 2% of total loans and 1% of total commitments. Our office exposure is well balanced amongst suburban specialty and central business districts and had a weighted average loan to value ratio of approximately 55 percent at initial underwriting. Given current macro factors as well as other portfolio considerations, we increased the reserve ratio for commercial real estate office loans to 8.5 percent. Turning to slide nine, we reported diluted earnings per share of 84 cents for the quarter or $1.12 per share after adjusting for notable items in the amount of $575 million or $0.28 per diluted common share. Notable items this quarter included $310 million of merger and integration related charges associated with the acquisition of Union Bank, as well as $265 million related to balance sheet optimization and capital management actions largely driven by a provision charge of $243 million related to the securitization of approximately $4.4 billion of indirect auto loans, as well as an additional $4.2 billion sale of union bank mortgage loans. These moves enable us to more effectively position the balance sheet for profitable growth and optimized returns. Slide 10 provides a more detailed earnings summary for the quarter. Turning to slide 11, Net interest income on a fully taxable equivalent basis totaled approximately $4.4 billion, which represented a 4.7% decrease on a linked quarter basis and a 28.4% increase from a year ago due to the impact of rising rates in the acquisition of Union Bank. Our net interest margin declined from 3.10% in the first quarter to 2.90% in the second quarter, which is somewhat lower than expected. The link quarter decline was primarily due to the impact of maintaining higher cash levels given the debt ceiling concerns and deposit pricing pressures partially offset by higher rates on earning assets. Slide 12 highlights trends in non-interest income. Non-interest income increased 8.7% or $219 million on a link quarter basis driven by higher payment services revenue, trust investment management fees, and commercial product revenues. Within payment services, revenue increased $112 million on a link corner basis, reflecting credit card revenue growth of $62 million, or 17.2%, driven by higher margins and sales volume, and an increase in merchant processing revenue of $49 million, or 12.7%, driven by pricing. Also noteworthy were increases in trust investment management fees of $31 million, or 5.3%, driven by core business growth, and commercial product revenue of $24 million, or 7.2%, driven by strong debt capital markets activity in the quarter. Compared with a year ago, non-interest income for the company increased $178 million, or 7.0%, largely driven by higher core fee income. Turning to slide 13, reported non-interest expense for the company totaled $4.6 billion in the second quarter, which included $310 million of merger and integration-related charges. Non-interest expense, as adjusted, decreased $52 million, or 1.2%, on a linked quarter basis. Slide 14 shows credit quality trends, which continue to be strong from a historical perspective, but are normalizing as expected. The ratio of non-performing assets to loans and other real estate was 0.29% at June 30th compared to 0.30% at March 31st and 0.23% a year ago. Our second quarter net charge-off ratio of 0.35% as adjusted compared increased five basis points from a first quarter level of 0.30% as adjusted and was higher when compared to the second quarter 2022 level of 0.20%. Our allowance for credit losses as of June 30th totaled $7.7 billion or 2.03% of period on loans. Turning to slide 15, we accelerated our capital actions and ended the quarter with a CET1 capital ratio of 9.1%. The 60 basis points linked quarter increase in the CET1 ratio reflected 20 basis points of earnings accretion, net of distributions, and an additional 40 basis points attributable to risk-weighted asset and other balance sheet optimization initiatives with low to neutral earnings impact. During the quarter, we received the results of the Federal Reserve's 2023 stress test, and we expect to be subject to the minimum stress capital buffer requirement of 2.5 percent, which is unchanged from last year, despite this year's more stressful economic scenario and an additional $1.4 billion of merger-related charges with limited recognition of cost synergies related to Union Bank. I will provide third quarter and updated full year 2023 forward-looking guidance on slide 16. Starting with third quarter 2023 guidance, we expect net interest income of between $4.2 and $4.4 billion in the third quarter. Total revenue as adjusted is estimated to be in the range of $6.9 to $7.1 billion, including approximately $75 million of purchase accounting accretion. Total non-interest expense, as adjusted, is expected to be approximately $4.3 billion, inclusive of approximately $120 million of core deposit and tangible amortization related to the union bank acquisition. Our income tax rate, as adjusted, is expected to be approximately 23 to 24 percent on a taxable equivalent basis. We expect merger and integration charges of between 150 to $200 million in the third quarter. I will now provide updated guidance for the full year. For 2023, net interest income is expected to be in the range of $17.5 to $18.0 billion. Total revenue as adjusted is now expected to be in the range of $28.0 to $29.0 billion, inclusive of approximately $330 million a full-year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be approximately $17 billion, inclusive of approximately $500 million of core deposit and tangible amortization related to Union Bank. Our estimated full-year income tax rate on a taxable equivalent basis as adjusted is expected to be approximately 23% to 24%. We continue to expect to have $900 million to $1 billion of merger and integration charges in 2023, a total merger and integration cost of approximately $1.4 billion, consistent with earlier guidance. I will now hand it back to Andy for closing remarks. Thanks, Terry.

I'll finish up on slide 17. The strength and stability of our balance sheet remains a differentiator for our company, and as these metrics indicate, we are well capitalized and prepared for a potentially more challenging economic environment given our strong liquidity, diversified business mix, and consistent and disciplined approach to credit risk management. Building capital remains a top priority as we prepare for Category 2 designation, and we are confident in our ability to execute on our strategic growth opportunities and key initiatives. Following the successful conversion of Union Bank this quarter, we enter the second half of the year well-positioned as a national banking franchise with increased scale, broader reach, and meaningful revenue growth opportunities provided by the addition of 1.2 million new consumer and small business customers. Across the business, from consumer to wealth management and commercial to business banking, we see significant opportunities to provide legacy Union Bank customers with a broad set of our products and services and industry-leading digital capabilities. Additionally, the $900 million of identified cost synergies are still expected to be fully reflected in run rate savings as we head into 2024. Let me close by thanking our employees for all that they do to help provide exceptional service that makes us a destination of choice for our clients and a valued partner to all our stakeholders. We'll now open up the call for Q&A.

We will now begin the question and answer session. If you have a question, please press 1, then 0 on your phone. If you wish to be removed from the queue, please press one, then zero again. Once again, if you have a question, please press one, then zero on your phone. We'll first go to Scott Safers with Piper Sandler. Please go ahead.

Morning, Scott.

Hey. I was hoping maybe we could start out with a couple thoughts or expand the thoughts on capital, maybe just sort of a refresher on anticipated capital build from here, especially in light of just how quickly you just how quick the pace was in the second quarter, and then, you know, ideally sort of what you're targeting presumably under Category 2 rules and when you might get there in your view.

Yeah, thanks, Scott. You know, I think that we ended up at 9.1% CET1 at the end of the second quarter. Our expectation now, you know, through the rest of this year is that we'll be at least at 9.5% by the end of the year. And that's going to be a function of earnings accretion, net of distributions, as well as some continued actions from a risk-weighted asset perspective. We had originally articulated about 50 basis points of risk-weighted asset optimization over kind of the two-year time horizon. We felt like we could accelerate that a lot because the vast majority of them were what I would call low to neutral impact on earnings accretion. We still have a number of different levers that we can pull, some of which we'll be able to execute on this year, some of which is in preparation for 2024. But we feel very confident that we have a game plan in order to be able to get to at least 9.5 by the end of this year and to be in a position to be able to fully adopt Category 2 by the end of 2024, if necessary. Okay.

All right, perfect. Thank you. And then maybe a question on the deposits. Appreciate all the commentary on the non-interest-bearing runoff being, I guess, about half driven by the product change as you integrated the union bank customers. But just given sort of the optics of it, just curious about any thoughts. Is that pretty much done, or would you expect for the broader or entirety of the firm, could NIB balances still continue to flow out just in light of where interest rates are and where would you see those flushing out maybe as a present of total deposits?

Hey, Scott. This is John. So, you know, in terms of the DDA mix, you illustrated that correctly. We moved about $15 billion of deposits over into the BankSmartly interest checking product. and so that gets us to about a 20% ratio. We think that that's about where we land here. It'll be plus or minus, of course, as we kind of go through the quarters, but we think that we're at a low point here. Perfect.

Okay, good. Thank you very much. Thanks, Scott.

And next, we move to John from Kyrie with Evercore. Please go ahead.

Hi, John.

Good morning. Regarding your interest income guidance of the 17.518, you know, beyond the... non-interest bearing mix commentary that you just provided. Can you also help unpack that guidance in terms of overall deposit growth expectations as well as maybe the margin assumption behind that and low growth as well, if possible? Thanks.

Sure. This is John again. So, you know, a couple things I would say maybe just to provide additional context. As you saw in our results, we saw A big increase in our deposits, up 3%, you know, on a period-ending basis to $522 billion. And then we had, as Terry mentioned about our capital actions, we had loans drop a start point of about 2% given the auto and the mortgage sale that we talked about within our comments yesterday. And so as I think about those things, you know, we will have the ability to be a little bit more disciplined and moderate in our deposit pricing as we go forward, given that line of thinking. And in addition, I think that, you know, as we bring on new loans, those loans are coming in at wider spreads, although loan growth is a little bit stalled. There's a little bit less demand for that in the near term here. And the mix here of loans should be more favorable as we're bringing on cards and less in mortgage and auto. So those are kind of the puts and takes to how we came up with the net interest income guidance. And then I think you made a comment about deposits there as well, and I can just touch on that. You know, I think on deposit side, we would, even though we had a large seasonal uplift as typical in the second quarter from our corporate trust and commercial businesses that bring in deposit balances, As that begins to normalize, we think we're probably in line with the industry, which we anticipate being more of a decline given the quantitative tightening and all the other sorts of things that are headwinds for deposits in the industry.

Yeah, and the other thing I would just mention, John, you asked a question regarding our expectation now, just kind of looking at the market-implied rate environment is that NIM is probably down a few basis points in the third quarter and then relatively stable through the rest of the year.

Got it. Thank you. That's very helpful. And just lastly, the confidence in your through cycle deposit beta of about 40% looks like we have a number of banks that are trending to the high 40s and into the 50s. Just what gives you the confidence in that through cycle beta expectation of around 40%?

Yeah, so we're looking at, you know, we're coming, our calculations shows at about 39% in the current beta, and we're indicating, you know, mid-40s is where we'll land. And, you know, I think it just goes back to some of the things that we talked about earlier where we did have a big flight in of deposits. We think, well, we have loans that have come down given the capital actions, and so that gives us a little bit more flexibility with pricing. But, of course, there'll be pressure as it relates to deposit betas just as we go through it. But all that is kind of baked into our mid-40s guide.

Okay, great. Thank you. Thanks, John.

Next, we'll go to Ibrahim Poonawalla with Bank of America. Please go ahead.

Good morning, Ibrahim. How are you?

Good. How are you? Good morning. I just wanted to follow up on this capital build issue. It's obviously a big topic. As we think about future RWA optimization, I think you mentioned some of the low-hanging fruit, I guess, things that were EPS neutral. It seems like you executed on those this quarter. As we look forward to, I think you mentioned some action in the back half, some into 2024. How punitive are those going to be from an EPS standpoint that we should think about? I'm assuming that's in your guidance for 2023. But give us a sense of just the EPS hit from these actions, and how much more of RW optimization should we think about between now and let's say a year and 24?

Yeah, great question Ibrahim. So let me maybe unpack it a little bit in terms of the different types of actions that we are likely to take. One as an example is we are going to be kind of winding down a cash provisioning of business That'll have very minimal impact from an earnings perspective because it's not that big of a business, but it is a pretty significant user of capital in terms of risk-weighted assets. That's one area and one example of how we still think that there's low to neutral opportunity in terms of enhancing or improving the risk-weighted asset position. You know, we'll continue to be focused on reducing our MSR, our mortgage servicing right portfolio, over the course of the next several quarters. You know, that's an area that, again, you know, it has some impact, but it's not significant. And probably more importantly, it allows us to rebalance our the size of the mortgage exposure, mortgage portfolio relative to the overall size of the business. We'll continue to look at kind of similarly mortgage loan sales out of the union bank portfolio. Again, that reduces our concentration in California and should have minimal sort of impact on kind of on a go-forward basis. And then there's just a number of other things, similar sort of structures that we've done. But the other thing that we're working on between now and the end of the year, which will kind of position us well to be able to continue to improve on a risk-weighted asset basis, is setting up some securitization programs related to some of our other balance sheet asset positions.

That's helpful. And just one follow-up. Strategically, I think the one question is this environment should be ideal for USB to take market share. Competitors are under pressure. Clearly, your balance sheet is holding up quite well. Give us a sense of just how much of a constrained capital levels are today as you think about getting new customer growth, picking up market share, adding sort of – maximizing the union franchise, just how much of a restrictive factor capital is to accomplish all of those?

Yeah, go ahead, Eddie. Go ahead. So, everyone, I wouldn't say it's a constraint. We're focused on profitable growth. We have a diverse set of business products and services that allow us to grow in a capital-efficient way. I mean, I'll give you a couple of examples. The union bank customer base, about 80% of the consumer small businesses are single-service customers. their penetration on credit cards is about half what ours is across the legacy U.S. banks. So we have a lot of opportunities to deepen relationships in a very capital-efficient way given the broad product set that we have. So that is an opportunity that we're very much focused on, looking forward to, and not feeling constrained.

And many of those single-service or balance sheet today deepening the relationship will be as much focused on fee-based sort of businesses, which are capital-efficient, as Andy said.

Thanks for taking my questions.

And next, we'll move to Ken Usdin with Jefferies. Please go ahead.

Hey, Ken.

Hey, good morning, guys. Hey, really good fee results this quarter. I just wanted to ask you, as I'm looking at the payment slide on page 19, it does look like the year-over-year growth rates did all slow versus the first quarter. Can you just talk about what's going on across the payments with regards to just where the consumer is and how you expect corporate spending to trend as you look ahead, given the potential for a slowing economy.

Yeah, and of course, that's the $100,000 question, is whether or not we actually move into a recession or not. But I think broadly, from a macro perspective, some of the things that we're seeing is that some of the excess savings that consumers have held in the past are has come down to really pre-pandemic levels at this particular point in time. So I think that manifests itself in kind of a normalization of consumer spend. So we are seeing what was very strong consumer spend starting to normalize and soften, if you will. I mean, yesterday was retail sales information that came out a little bit softer than maybe expected. We're seeing some of those same dynamics in the payments business where sales, for example, in the merchant side of the equation, slower, softer sort of retail sales. But there's still a fair amount of travel expenditure that's taking place. So customers are certainly choosing and maybe being a little more choosy as to where they're spending their dollars. Some of the dynamics that we're seeing is while sales have softened maybe a bit, the margins in some of the businesses have actually improved. So on the credit card side of the equation, where sales have come down a little bit, the margins have are actually a little stronger. You know, on the corporate payment side of the equation, margins continue to get stronger because T&E spend in the commercial corporate sectors has continued to be reasonably strong. So, you know, we continue to kind of look out the rest of the year, you know, on the merchant acquiring side of the equation of, you know, revenue kind of in that high single digits sort of range. on the credit card fee revenue still in that mid-single digits. And on the corporate payment side of the equation, it'll normalize, but it'll kind of normalize in that high single digits range. That's kind of what we're seeing, what we're kind of forecasting at this particular point in time based upon consumer behavior.

Got it. And one follow-up on capital. Can you just give us, just so we all have the right number from your perspective, where CET1 was this quarter inclusive of AFS unrealized losses and also just, you know, your view of if rates stay the same here, what that pull to par looks like as you look forward to that year-end 24 point. Thanks.

Yeah, so if you were to embed the ALCI into the CET1 calculation under Category 2, it would have been at 6.9%. And, you know, we expect that based upon all of our capital actions, you know, to, you know, get to kind of our target levels by the end of 2024. We have the game plan in order to be able to get there. We feel confident about that.

Okay. Do you just have the AFS piece of what does pull to par by the end of the year? Because it's hard for us to understand how much the risk-weighted asset part might be, but at least we can kind of track to your view of the portfolio maturity.

Yeah, do you have that, John?

Yeah, so in terms of the burndown between here and the end of 24, it's about 25% or so.

Okay, got it. Thank you.

Next, we can go to Erica Najarian with UBS. Please go ahead.

Hi, good morning. I need to ask a capital question again just because it's been such a big deal for your stock. And I'm wondering if you could indulge me in some sort of cavewoman math here. So 6.9% CT1, you have six quarters to generate capital. You know, based on what you're earning, you know, today, you could add another 120 basis points, right, for six quarters times 20, and that'll get you to 8%. So given that you've mentioned both Terry and John throughout the call, some additional RWA actions, you know, how much can RWA actions enhance that, you know, potential for, you know, 8% fully loaded CET1 by 4Q24, you know, just on earnings? How much can you add from RWA mitigation?

Yeah. So maybe just kind of unpacked in a little bit. We still expect, Erica, that the benefit from capital accretion or earnings accretion is going to be somewhere in that 20 to 25 basis points on average. And a couple of different things to kind of keep in mind. While there's a little more pressure on the revenue side of the equation, the things that will start to come into the equation is a lot lower merger and integration charges next year. You know, we'll be substantially done with that, as well as, you know, the fact that, you know, by the end of the year, we will really be at kind of full run rate from a cost synergy standpoint. So I think that there's A number of things just in terms of why we feel confident that that accretion level starts to accelerate or creep up from where we're at today. You know, and then I think when you end up going through, you know, John talked a little bit about the burndown being at about 25% between now and the end of the year, and that's based upon market implied. But, you know, also keep in mind, as we have said, is, you know, we have, you know, put into place some hedging strategies to protect us from the upside risk that might exist, you know, if rates were to move up. So we feel pretty good about that. you know, where that is going to come in. And then the rest of it is really tied to, you know, risk-weighted asset actions, many of which I ended up talking about. And again, we have a pretty competent game plan with respect to our ability to reduce risk-weighted assets in order to be able to achieve, you know, the targets that we need to hit.

Let me just ask it another way, again, just because, you know, it feels like, some of the good stuff that's going on in the company is being ignored because of this capital question regarding Category 2. Based on your outlook and under a reasonable range of scenarios for the economy, do you think you could get to 8.5% to 9% fully loaded CET1 by 4Q24? Yeah, absolutely. Thank you.

And next we'll go to John McDonald with Atomic Research. Please go ahead.

Hi, John. Thanks, Terry. Yeah, just one last follow-up on that walk, you know, starting from the 6.9, getting to 8.5 to 9. So is that the idea that the ARCI is kind of like a 200, 210 basis point drag today, and that'll shrink to, in your numbers, something like 150 or that kind of drag by the end of next year? Yes.

Okay.

And does your walk include like FDIC assessment and CECL phase-in, things like that?

Yes.

Okay. The next question was just on credit. How do you see charge-off trajectory from here? I know you've said normalized 50. You won't get there for a while. But the jumping-off point is 35 basis points, I guess, this quarter. How do you see it kind of playing out from here?

Yeah, you know, it's going to continue to normalize for all the different things we have been talking about and I think the industry has been talking about. You know, our expectation is that that 35 creeps up into the kind of mid-40s by maybe the end of the year or early next year, and then it kind of normalizes around 50 basis points once we get into 2024.

Okay, got it. And does the full year guidance on expenses for this year incorporate some achievement of merger saves in the fourth quarter of this year?

In terms of cost synergies? Yeah, absolutely. It gets us to the run rate, John, of the full $900 million by the end of the quarter. So when we get into 2024, we will have achieved a full run rate of $900 million of cost synergies.

And you will have achieved most of those by the fourth quarter of this year? By the end of the fourth quarter, yep. Okay, and that's built into the guidance for the full year this year?

Yep, yes.

Okay, thank you. Thanks, John.

And we can go to Chris Katowski with Oppenheimer. Please go ahead.

Yeah, I think last quarter you shared that the average duration of your securities portfolio went down from like 4.3 to 3.8 years or something like that. And I wonder if you could give us the similar trend in the second quarter and the outlook for the balance of the year and just your philosophy in general about balance reinvesting maturities, is that kind of going into cash or are you kind of maintaining the duration that you have?

Yeah, the duration that we had talked about with respect to the AFS portfolio was 3.8 years, and it has continued to come down a little bit, not measurably, but down a little bit from there. Our game plan, I guess, is that we're going to continue to work on shortening the duration of the AFS portfolio, and it kind of helps us de-risk that. We will keep more in... in short-term sort of securities, whether it's that or cash, but it'll be kind of a combination.

And on the HTM portfolio, is there a similar kind of move to shorten duration, or are you comfortable where it is?

Yeah, well, with respect to the HTM portfolio, that's just kind of going to run down over time or burn down over time. We're not adding to the HTM portfolio at this particular point.

Okay. All righty, great. Thank you.

Mm-hmm.

And we'll move to Vivek Junejo with J.P. Morgan. Please go ahead.

Vivek. Sorry if it's repetitive, given the multiple calls. So I guess a couple of things. On merchant processing, any color on why it's up only 2% year-on-year in terms of fees? I hear you on the travel flowing, but that's also a lower fee. What's caused such a sharp slowdown, and what turns that around to the mid-single digits, Terry?

Yeah, some of it's year-over-year comp and how it'll kind of play out. But the biggest driver, Vivek, in the merchant processing at this particular point is the fact that the travel airlines specifically is continuing to become a higher portion of the overall mix. That, we think, is starting to stabilize. In other words, much of that growth has been in the airline space, but we think that that kind of stabilizes. Airline happens to have a lower margin, and so that's the dynamic that you're seeing.

Got it. Okay. And OCI, your loss seems to have gone up. Did Did you not get any benefit from the hedges you put on, or is there something else going on underneath?

Yeah, I think the investment portfolio, AOCI, went declined or the mark declined by about $250 million in the link quarter. But rates went up, you know, 50 to 60 basis points upon the points of the curve that matter to the portfolio. So, As we talked about, there's a duration to that book, and so you would expect a wider mark given the higher level of rates. So I think with the hedges that we have put in place that helped mute that, it could have been higher. And we continue to add hedges across that portfolio and pick our spots when we see rates fall. Thank you.

And we'll go to Gerard Cassidy with RBC. Please go ahead.

Hi, Gerard. Good morning, gentlemen. Terry, you talked a bit about a normalization in net charge-offs moving into 2024. Can you share with us what kind of assumptions you're using to get to that normalization rate in charge-offs, both economic and just the way the customer base may behave?

From an economic standpoint, Gerard, I'll start. This is Andy. We think there's probably a fairly equal weight probability that we'll either see a soft landing or a mild recession. And if we do get a recession, our models would indicate it would be short and shallow, either late this year or early in 2024. You know there's still pricing pressure and the inflation's not solved, so we have one more rate hike by the end of the year modeled in. But on the other hand, as Terry mentioned, excess savings has come down significantly and consumer spending is slowing. So the Fed is getting its desired outcome. So big picture, we think the Fed's close to being done. And as I said, sort of this probability of either shallow and soft or mild recession and or a soft landing is what we've modeled in to get to those assumptions Terry's articulated.

A couple of things I would just add maybe from a portfolio dynamic perspective. You know, we're seeing nice growth in terms of credit card balances, you know, and as As credit card balances both increase and it normalizes, you'll start to see that ratio going up because that's a little higher mix for us. And then I think it may be somewhat lumpy, but it's kind of incorporated into it as just continuing to work through commercial real estate office space over the course of the next few years.

Very good. And then I apologize if you address this question, but with the expectation of the Basel III end-gain capital requirements coming shortly, and this week the disclosures that it seems like residential mortgages may be exposed to higher risk-weighted assets. How are you guys thinking about that in terms of RWA strategies if mortgages do get a bigger weight and other areas are greater than expected?

Yeah, well, certainly a lot of our actions, for example, with respect to mortgages and that particular business is just continuing to de-risk, so to speak. So we're kind of trying to take that into consideration. Our expectation right now, Gerard, is that it's probably going to be fairly neutral to maybe just a little bit of a benefit based upon everything that we're seeing in terms of the endgame. But we really have to wait and see what the final rules say and then apply it to our specific portfolio.

Thank you, Terry. Thank you, Andy.

Thanks, Jerry.

And next we go to Betsy Grasick with Morgan Stanley.

Morning, Betsy.

Hi, good morning. Just a couple of quick follow-ups. One, the asset sales that you did this quarter, was that at the beginning of the quarter or the end? I'm just trying to understand how much revenue from that portfolio you have in 2Q.

Yeah, most of them were completed closer to the end of the second quarter, so in the June timeframe.

Okay. And then the revenue outlook for the full year was, Is that based on June 30 balance sheet, or is that also including the RWA actions you're planning on taking between now and year end?

Both. It incorporates our capital actions in terms of what we expect to execute on between now and the end of the year.

Okay, got it. All right. Okay, thank you. That's it.

Betsy.

Next, we can move to Mike Mayo with Wells Fargo Security. Please go ahead. Hi, Mike.

Hi, Mike.

Hi. Well, on the capital issue, I asked last quarter, do you think there's any chance that you need to raise capital or cut the dividend? I'll just ask again. I mean, people were doing these mechanistic analyses where they would take the underlying securities losses, reduce that from tangible equity, give you no credit, and then say you would need to raise capital. So now that you've met your year-end capital target, I guess, would you reiterate or to what degree would you reiterate no capital increase, no dividend cut? And in addition, if you could put it in a broader context, the vice chair of the Fed, Barr, last week said that actually the economic value of equity at banks goes up because of higher value of deposits. So it seems like he signs on to a lot of the analysis that we analysts do. So just if you could comment on the bigger picture about your capital and the flexibility there.

Yeah, Mike, this is Andy. And as Terry mentioned, so we accelerated our WA actions, got to 9-1 at the end of the second quarter, well ahead of our 9-0 by the end of the year. We expect to be at least 9-5 by the end of the year, if not better. And we have a game plan we're comfortable with and confident enough to get to 9 under the Basel, under the Cat 2 definition by the end of 2024. So all those things make us confident in the capital walk that we talked about and the actions we're taking.

And then on the negative side, you and a lot of regional banks have continued to lower guidance on NII. And here we go again with that. And look, I mean, rates went up faster than you or anyone had expected. The yield curve is a lot more inverted. I guess competition has picked up more than expected. What inning do you think you're in in terms of this downward revision for NII? Do you think you're kind of there now? You know, you said third quarter could be down, you know, a little bit. And as you exit the year, do you think you maintained that third quarter level? Or I think you said NIM would be flat after that, but I'm not sure if you mentioned NII. So it's a downward revision for NII done or eighth inning, seventh inning. And what does that mean for kind of run rate going to next year?

Yeah, so again, obviously you heard the guidance with respect to NII and NIM. We expect it to be a few basis points down in the third quarter and then relatively stable from there. Obviously this is Fed policy kind of dependent, so we're trying to look at what the current environment looks like. But we feel like if I had to kind of but what inning are we in? I think we're in the late innings simply because of where the Fed is from a monetary policy standpoint. So while there may continue to be a little bit of downward pressure, we don't see it as being significant from here. Andy, what would you add?

Mike, the other thing I'd add is I think one of the benefits of our business model is the diversity of revenue. So even in a stressed environment on deposits, which you're absolutely right about, we have the payments revenue, the trust revenue, the commercial products revenue, And on top of all that, $900 million of cost synergies that we're going to act on. So we're pulling lots of levers, not just on margin.

Okay, thank you.

You bet.

And next we have a follow-up from John McDonald with Autonomous Research. Please go ahead.

Hi, Terry. Thanks. One more on the mitigation and optimization opportunity. Originally, you had talked about 50 basis points of opportunity to harness this year. Obviously, you got 40 this quarter. And now it sounds like the total is more. Is there a way to size how much more you might see out there between the remainder of this year and next year, you know, relative to the original 50 you were targeting?

Yeah, you know, again, the 50 that we were targeting, we knew we had a high level of confidence in terms of being able to achieve it because they were low to kind of neutral impact, and they were things that we could kind of execute on. We definitely believe that as we get into 2024, you know, the standing up, which, you know, obviously takes a little longer, standing up of securitization programs, And many of the actions that I talked about earlier, you know, gets us to, you know, where we need to be from a capital perspective when you take into consideration the burndown, et cetera. So, you know, that opportunity, I think, is, you know, certainly probably in line with another 50 basis points would be my guess.

Okay. And when you say no impact or low impact, we did see some this quarter, like in terms of the charge-offs and taxes. I guess they're not run rate. Is that what you mean? Like you could have episodic one-quarter type impacts?

Yeah, absolutely. We'll continue to see that as we reposition the balance sheet. But again, those impacts are all taken into consideration when we think about the net RWA impacts.

Okay. And again, your target that you want to get to for the fully loaded by the end of next year is what? Yeah.

Well, it would be fully adopted. It would be roughly 8.5%, 9%. Okay.

Thank you.

And we have no further questions at this time. I'll turn it back to George Anderson. Please continue.

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

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