美國合眾銀行 (USB) 2007 Q2 法說會逐字稿

Welcome to the U.S.

Bancorp's second quarter 2007 earnings conference call.

Following the review of the results by Richard Davis, President and Chief Executive Officer, and Andy Cecere, U.S.

Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session.

(OPERATOR INSTRUCTIONS) This call will be recorded and available for replay beginning today at approximately 4:00 p.m.

Eastern through Tuesday, July 24th at 12:00 midnight Eastern time.

I will now turn the conference call over to Judy Murphy, Senior Vice President.

Go ahead, please.

Thank you, (inaudible).

Thank you for joining us today.

This is Judy Murphy, Director of Investor Relations at U.S.

Bancorp.

Richard Davis and Andy Cecere are here with me today to review U.S.

Bancorp's second quarter 2007 results.

If you have not received a copy of our earnings release and supplemental analyst schedules they are available at our Web site at usbank.com.

I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty.

Factors that could materially change our current forward-looking assumptions are detailed in our press release and in our Form 10-K report on file with the SEC.

I will now turn the call over to Richard.

Thank you, Judy, and thank you for joining us this afternoon.

I'd like to begin the call today by taking a few minutes to review the highlights of our second quarter results.

I will then turn the call over to Andy Cecere who will provide you with additional detail about our earnings.

After we've completed our formal remarks we'll open the line to questions from the audience.

This morning our company recorded net income of $1.156 billion for the second quarter of 2007.

Earnings per diluted common share for the second quarter of $0.65 were $0.01, or 1.5% lower than the earnings per share in the same period of 2006, and $0.02, or 3.2% higher than the first quarter of 2007.

As many of you know, growth in the second quarter for our company is seasonally higher.

This year was no exception as strong loan growth and fee income led to a 2.3% increase in net income on a linked quarter basis.

As Andy and I discuss the current quarter's results with you today, we'd like you to keep in mind that consistent with last quarter there were no unusual items, positive or negative, affecting our reported earnings.

That being said, let me review some of the highlights for our second quarter.

First we achieved a return on average assets of 2.09% and a return on average common equity of 23% in the second quarter.

These profitability measurements continue to be among the best in our industry.

Our second quarter net interest margin of 3.44% was 24 basis points lower than the net interest margin we reported in the second quarter of last year and 7 basis points lower than the previous quarter.

You may recall that we had assumed the net interest margin would continue to decline another 5 to 10 basis points from the first quarter margin of 3.51%.

We continue to believe for a number of reasons that given the current rate environment, yield curve, and our balance sheet mix, our (inaudible) estimate of 5 to 10 basis points drop in the margin from the first quarter level still holds.

Andy will give you a little more insight into the reasons why we are comfortable with this position in just a few moments.

On a year-over-year basis the net interest margin declined by 24 basis points.

I mention this variance as well because tighter credit spreads have still had an impact on our margin.

During the past month credit spreads once again appeared to have stabilized for both commercial and retail loans.

And as you know, our company strategy has been to focus on high quality credits, which by their very nature carry the lower margins and continue to be the most aggressive competition for these types of loans.

Once again, our fee-based businesses exhibited excellent momentum.

Payments and trust-related revenue were particularly strong this quarter.

Year-over-year our payments-related fees grew by over 11% while trust and investment management fees increased by 8.9% over the same period of last year.

Our tangible efficiency ratio for the second quarter of 2007 was 44.1% making us one of the most efficient financial institutions in the industry.

That being said, our non-interest expense in the current quarter was 7.2% higher than the second quarter of last year and 6.1% higher than the previous quarter.

A portion of these increases and expenses is related to planned investments in our fee-based businesses and banking franchise such as personnel and marketing, business development and associated costs with our PowerBank initiative, the financial institutions services initiative, and the expansion of our FAF advisors third party distribution just to name a few of those initiatives.

In addition, the other portion of the increase in spending is related to distinct business events such as expense associated with signing of a new merchant contact and accelerated OREO disposition activity.

Andy will give you more detail on the expense (inaudible) in a moment.

However, know that our disciplined approach to expense control has not changed and will continue to be a focus and a hallmark for this company.

It is, in fact, our efficiency that allows to us invest while still maintaining our industry-leading profitability metrics.

At this point we are comfortable in saying that we expect positive operating leverage as we move forward through the remaining quarters of 2007.

One of the balance sheet highlights for the quarter was solid year-over-year growth in average total retail loans of 7.8% while growth in total commercial loans was 4.7%.

Going forward we expect that our company's growth in commercial and commercial real estate loans will be slightly lower than the industry average as we continue to concentrate on originating principally high quality credit.

In fact, commercial real estate loans, which we haven't grown as fast as the industry, are down versus prior quarters as refinancing has exceeded the growth in new business.

Further, the growth itself has been affected by the slowdown in residential homebuilding and the Company's decision to reduce condominium construction financing in selected markets.

Going forward, we will, however, continue to selectively originate high quality commercial real estate credits with our long-term highly valued customers.

Moving onto credit, once again our credit quality metrics were strong.

Net charge-offs were 53 basis points of average loans for second quarter 2007, slightly higher than the 50 basis points in the first quarter of this year and higher than the 36 basis points in the second quarter of last year.

These ratios equated to an increase of $66 million in net charge-offs year-over-year and $14 million on a linked quarter basis.

The increase over the prior quarter and the second quarter of 2006 was expected and primarily the result of an increase in retail net charge-offs.

The most significant increase was in the credit card loan net charge-offs as growth in outstandings, which grew by almost 24% year-over-year and over 5% from the first to second quarter, and a return to more normalized credit card charge-offs both led to this increase.

Specifically, the credit card net charge-off ratio was 3.56% this quarter, still below the historical ratios for this loan category.

Going forward we would expect that both commercial and retail net charge-offs will increase modestly as we move through this credit cycle.

However, given our risk reward profile we expect our credit quality to remain favorable when compared to our peers.

Non-performing assets decreased to $565 million at June 30 from $582 million at March 31, 2007 and we are now just slightly above the $550 million balance at June 30th of last year.

Looking forward into remaining quarters of 2007, we would expect any increases in non-performing assets to be modest.

As many of you know, we have been very prudent in our approach to subprime lending.

Our exposure to subprime residential loans, in addition to the related wholesale businesses, is minimal and very manageable, and little has changed from the end of the first quarter of 2007.

At the end of the quarter we had $3.2 billion of residential real estate loans outstanding to customers that could be considered subprime compared to $3.0 billion at March 31.

In addition, we had $900 million of home equity and second mortgages to subprime borrowers at June 30th, and that balance was unchanged from last quarter.

These two portfolios represent 2.8% of our total loans outstanding as of mid-year.

In terms of buybacks, we repurchased approximately 18 million shares of stock in the second quarter of 2007.

This, combined with our quarterly dividend, resulted in a 113% return of earnings to our shareholders in the second quarter.

At this point I'd like to share a few highlights from our business lines.

Our payment services group reported an impressive 16.8% increase in average loan outstandings year-over-year, the result of growth in both our corporate and retail card portfolios.

U.S.

Bank was one of the four issuers selected to participate in the federal government GSA SmartPay 2 card program.

We have been a payment provider to the federal government since inception of the purchasing card program in 1986.

This win allows us to continue to offer the full array of corporate payment products to current government agency customers and provides a tremendous opportunity to expand our share of government's business beginning in 2008.

The group completed the conversion of the CIBC Canadian purchasing and corporate card portfolio and the first phase of the First Horizon merchant processing conversion.

Other major milestones for this group included the issuance of the 18th millionth consumer gift card since the program begin in 2003, and the launch of the first hospital on payment finance solution whereby we issue cards on behalf of the hospital to help manage the billing and receivable processing.

Our wealth management group successfully completed the La Salle Corporate Trust conversion during the quarter, and the group gathered an additional $282 million in client assets through our recently launched SMA product.

This represents an increase of more than 60% over the balance of the end of the first quarter, and our pipeline remains strong.

The U.S.

Bancorp investments and insurance initiated a new retirement planning concept in the first quarter.

This first retirement planning center just opened in one of our Minneapolis branches.

The center, together with USBII's financial planning process, is designed to attract baby boomers that need financial help in managing and planning for their retirement.

And finally, in wealth management our FAF advisors continue to grow their third party retail and institutional distribution of our First American fund.

At the end of the second quarter the third party platform balances were over $5 billion, approximately 20% more than at the end of June last year.

Our consumer banking business line successfully completed the integration of the Heritage Bank in Montana, and excluding our new branch acquisition, the group opened five new in-store branches and added 59,000 net new checking accounts.

These new accounts, along with those opened in quarter one of this year, represent an annualized growth rate of 4.6% from the January 1st start point of 6 million checking accounts.

During the quarter we launched the PowerBank business model in our Portland market on April 30th with expanded hours in most branches.

The program now makes us the most convenient bank in that market.

We have seen positive improvement net new small business, DDA growth, client satisfaction scores, deposit and consumer loan growth versus last year along with much lower staff turnover.

As many of you know, the St.

Louis PowerBank initiative was launched on April 1st of last year, and since that time we've seen an improvement in employee morale, turnover and client satisfaction, all leading indicators of success.

We expect to roll out Denver market later this year with PowerBank as well as Minneapolis, Milwaukee, Cincinnati, and Seattle in 2008.

And finally, U.S.

Bank mortgage benefited from the flight to quality in the mortgage lending business this quarter with increases of over 17% in both production volume and the servicing portfolio.

Finally, within the wholesale banking group, we are transitioning our corporate bank from a large regional corporate banking model to a national corporate banking model.

The steps we have taken are many and include to date the hiring of a number of talented individuals with major money center experience.

We have new leaders for our national corporate banking group, derivative, business credits and leveraged finance.

We've established a 24-hour trading desk in Chicago and have expanded our calling program outside of our traditional banking footprint.

Our emphasis within the segment is on non-credit products.

Those fee-based products will effectively leverage our balance sheet and support our recent investment in payments and processing.

At this time I'll turn the call over to Andy to give you more details about our quarter.

Thanks, Richard.

The Company's second quarter net income of $1.156 billion was 3.7% lower than second quarter of 2006, but 2.3% higher than the first quarter of 2007.

As Richard mentioned, historically the second quarter of the year has always been the strongest in terms of linked quarter growth for our company, and this year was no exception as we experienced strong seasonal growth in payments, trust and investment management, deposit service charges and treasury management fee income.

I'd like to start the review with a year-over-year results.

The $45 million, or 3.7 percent reduction in net income from the second quarter of 2006 was primarily due to lower net interest income, an increase in provision for credit losses and higher non-interest expense.

These unfavorable variances were partially offset by solid growth in non-interest income and a reduction in the tax rate.

Net interest income was $47 million, or 2.8% lower year-over-year.

Although average earning assets increased by $7 billion, or 4.0%, net interest income declined [as] the 24 basis point drop in the margin more than offset the positive change in earning assets.

The margin contraction can be attributed to tighter credit spreads, primarily due to competitive load pricing, and in addition to the tighter spreads on credit, the cost of funding the Company has risen over the past year as rates on interest-bearing deposits have gone up and the mix of liabilities continues to shift towards higher cost deposits and other funding sources.

An increase in loan fees partially offset these negative factors.

Total non-interest income was higher in the current quarter than the same quarter of 2006 by $100 million, or 5.7%.

Year-over-year organic business growth was 7.8%, but this growth rate was muted by a $35 million gain from the initial public offering of a card association in the second quarter of 2006.

Overall the growth in non-interest income was driven by very favorable trends in payments, trust and investment management and treasury management fee income.

In addition, other income benefited from incremental bank-owned life insurance.

Non-interest expense in the second quarter of 2007 was $110 million higher than the same quarter in 2006.

We would classify much of the growth in two categories.

First, about half of the increase in expense can be best categorized as investments in our business lines and franchise including increases associated with recent acquisitions and the related business integration activities, increase in compensation expense, and a portion of the $18 million increase in legal and professional fees which was related to recent revenue initiatives.

Second, the remaining increase in other expense can be best categorized as business event driven.

Specifically included in the change year-over-year in the other expense was an increase in operating expense related to tax credit investments, additional merchant airline expense due to a new relationship and transaction growth, and other expense included higher OREO related expense as the Company accelerated efforts to dispose of acquired properties.

Finally, income taxes in the current quarter were lower than the second quarter of 2006 partially due to the decline of the Company's tax rate, the result of an increase in tax credit investments, higher balances of tax exempt municipal securities and additional bank-owned life insurance.

Moving on to a discussion of linked quarter variances.

Net income in the second quarter of 2007 was $26 million, or 2.3% higher than the first quarter of 2007.

A seasonally strong 9.4% increase in fee income and a slightly lower tax rate were partially offset by a 1% decline in net interest income, as well as increases in non-interest expense and the provision for credit losses.

Net interest income declined by $16 million on a linked quarter basis.

Although average earning assets rose by $1.2 billion quarter-over-quarter, the favorable impact from this growth on net interest income was more than offset by a 7 basis point decrease in net interest margin.

The decline in the margin can be attributed to tighter credit spreads, a continued migration of lower cost deposits into a higher priced deposits and funding sources, accompanied with the reduction in net free funds including the impact from the mid first quarter incremental investment in bank-owned life insurance.

During our last earnings call we estimated that the net interest margin would fall between 5 to 10 basis points from the 351level we reported in the first quarter.

As Richard indicated, we are still comfortable with that assumption for several reasons.

First, in the later part of the second quarter, credit spreads stabilized.

Second, the impact of bank-owned life insurance is now fully incorporated in the run rate, and finally, the change in deposit mix from the lower cost accounts to higher priced CDs has moderated in the last few months.

As I previously mentioned, non-interest income was seasonally strong on a linked quarter basis due to 11% increase in payments revenue, a 6% increase in trust and investment management fees, a 12% increase in deposit service charges, and a 13.5% increase in treasury management fees.

These are all non-annualized increases.

While trust and investment management and treasury management fees benefited from second quarter tax season activity, while payments and deposit service charges were higher due to seasonally strong transaction volumes.

The other income category was higher than the previous quarter having benefited from the purchase of incremental bank-owned life insurance in that quarter.

In addition, commercial product revenue and investment product fees and commissions also posted good linked quarter growth.

Offsetting a portion of the solid growth in non-interest income on a linked quarter basis was a $95 million, or 6.1% increase in non-interest expense.

Again, a portion of the increase could be defined as investment spending while the other increases are best described as business-event driven.

Contributing to the unfavorable variance were personnel related expenses which increased by $14 million, principally due to an increase in compensation associated with the annual merit increase season, commissions and the impact of the first quarter stock option grants.

Slightly offsetting these increases was a seasonally favorable variance in benefits, unfavorable variances in legal and professional, marketing and business development and a number of other expense line items reflecting the timing of business initiatives and advertising programs.

Finally, the other expense category was higher by $43 million.

The unfavorable variance primarily reflected the merchant airline expense associated with the new relationship, other loan expense related to accelerated efforts to dispose of OREO property, and additional operating expense related to tax credit investments and integration expense associated with our recent acquisitions including Heritage Banks, the corporate trust business of La Salle, and several merchant processing acquisitions.

At this point I would note that operating leverage was negative on a linked quarter basis as well.

And as Richard previously mentioned, we would expect to see operating leverage turn positive over the next quarters as the expense grows modestly from the current levels, net interest income stabilizes, and fee income continues to grow.

Finally, the current quarter's results benefit from a slightly lower tax rate.

Going forward, we expect the tax rate on a TEB basis will be comparable to the current quarter at approximately 30.9%.

Turning to the balance sheet, average earning assets rose by $7.4 billion, or 4% over the second quarter of 2006 which was primarily the result of a 4.5% increase in total loans.

The increase in average loans was driven by a 7.8 increase in retail loans led by credit card, a 4.7% increase in commercial loans, and a 4.6% increase in residential mortgages.

Commercial real estate loans declined year-over-year reflecting customer refinancings, the current slowdown in residential homebuilding, including certain markets for condominium development, and the Company's overall risk appetite.

On a linked quarter basis average earning assets grew by $1.2 billion driven by an increase in total loans [on a] slightly less than 1% and an increase in loans held for sale of 12.8%.

Again, average earning credit card loans grew faster than the other loan categories on a linked quarter basis as our own branch originated, co-branded and financial institution partner portfolios continued to expand.

Total average deposits in the second quarter of 2007 were $2.3 billion, or 1.9% lower in the second quarter of 2006.

The decrease in total average deposits was principally due to the Company's wholesale funding decisions whereby time deposits greater than $100,000 were replaced with other short-term borrowings.

Increases in average interest checking and time certificates year-over-year were essentially offset by decreases in average non-interest bearing deposits, the direct result of reductions of business demand deposits as customers reduced excess liquidity, money market savings and savings accounts.

Deposit balances in lower rate money market and regular savings account continue to migrate to higher rate time certificates of deposits in the consumer business lines.

Total average deposits in the second quarter were $1.8 billion, or 1.5% lower than the prior quarter.

Similar to the year-over-year variance, the change was primarily driven by the $1.7 billion increase in time deposits greater than $100,000, as management chose to replace these deposits with other short-term funding.

Increases in average non-interest bearing deposits and interest checking account balances were offset by reductions in money market savings deposits.

Finally, as Richard mentioned earlier, we returned 113% of earnings to shareholders in the form of dividends and buybacks in the second quarter of 2007.

We remain well capitalized and on target with Tier 1 and total capital ratios of 8.5 and 13% respectively at June 30th.

I'd now like to turn the call back to Richard for his closing remarks.

Thanks, Andy.

I'm sure many of you in the audience today have had the chance to read our other press release this morning announcing that Mike Doyle has resigned from his position as Chief Credit Officer for our company.

I'd like to take this opportunity to thank Mike for his many years of service to U.S.

Bank.

As Chief Credit Officer, a position he has held since 2002, Mike was the driving force behind the establishment and implementation of our current credit policies, procedures, and our credit culture.

He's leaving the Company in excellent condition from a credit perspective, and we wish him well.

I'd be happy to answer questions about this change in personnel, but I want to be very clear.

Mike's departure in no way indicates concerns about our credit quality nor does it indicate a change in our credit philosophy.

We will continue to manage credit prudently with the goal of balancing risk and reward.

In conclusion, as a company we're focused on the future and continue to look for growth opportunities both organically and through acquisitions similar to those in our recent past which includes small banks and payment and processing businesses.

Our long-term goals have not changed.

Our constituents are counting on us to meet the challenges presented by this environment but not to take risks that might place to put us in harm's way in the future.

We've not been immune to the challenges but our year-to-date results, which can rightly be defines as pure core earnings, support my belief that this company is well positioned to produce a consistent, predictable and repeatable earnings stream going forward for the benefit of our customers, communities, employees and shareholders.

At this time Andy and I would now be happy to answer any questions from our audience leaving plenty of time for Q&A.

So operator, if you would join us again, please?

(OPERATOR INSTRUCTIONS) We'll go ahead and take our first question from the line of Mike Mayo of Deutsche Bank.

Go ahead please.

Good afternoon.

Hi, Mike.

Richard, can you elaborate more on the change in the wholesale banking?

You mentioned going from a regional to a national model and that you've made hires and expanding in all of these business lines.

What was the catalyst for this change?

Thanks, Mike, I'm glad to do that.

As you know, being the sixth largest commercial bank by asset size should, at least in many cases, put us in the camp of more deals where we either leading national company syndications or being part of these syndicated credits.

If you look at gold sheets which come out once a week, you'll notice that most of the time we're absent in those transactions, but it's partly because we have, through Heritage, become a major regional bank on the wholesale side but really not enjoyed the national corporate view that we've expanded now in our payment businesses and in our trust businesses.

So this is kind of the wholesale lending side catching up with the rest of the Company and taking advantage of our size and our scale and many of the customers we currently enjoy.

As you probably know, there is quite a strong quid pro quo coming forward in these days that in order to gain the non-lending business from core corporations across the country, you need to have a meaningful attachment to their credit line or their credit needs, and we need to step that up.

So in accordance with that, we have opened our first out of footprint office in New York City.

We have hired no less than almost 10 key people to lead our national corporate activities, our derivatives business, our business credit activities, healthcare, leveraged finance, food and ag, assets expansion and anything else I can't remember off the top of my head.

In other words, we are moving to a national footprint, and we have many of the customers already.

A high percent of the Fortune 500 customers we have some relationship with, but in order to really leverage this payment and processing capability, we need to step up and take more position with the very high Triple A rated customers across the country, and this is intended to do that.

So better share of wallet of your corporate customer.

So I guess that means would you ever consider spinning off the processing business or is it the opposite?

It's just the opposite, although it was a good transition, Mike.

Not at all like a Metavante or based on the activities since we last talked on this call with FDC, we all feel all the more emboldened to keep these businesses aligned.

It's the growth part of our company, it's the non-balance sheet aspect that makes it much more attractive in returning capital.

It's all the things that you know it to be.

And in accordance with that, I said this last time, we are a core bank that's going to expand in the payment and processing businesses which have, I think, a nice attribute to add to the bank.

We're not a payments processing company that's going to have a bank hinged onto it.

So it's quite, as you said, emboldened to us to keep the Company together and move forward with this nicely diversified and attractive revenue mix.

And one last follow-up.

How about more capital markets?

In a way maybe you wish you had Piper back?

Good question.

Not really.

By the way, we work very well with them, and we're in the same building.

When we didn't have capital markets capability, those of us from First Star, we often had a certainly level of envy wishing that we did, and once we enjoyed finally having that, we realized it might have been overrated in terms of our customers.

They either wanted to have access to what would be the perfect partner and/or they would ask to us find that partner for them.

But in no cases did we feel that we benefited while we had or lost necessarily when we didn't the direct relationship with an investment bank.

So having been there and done that, we really feel quite good about our position, and while it might be attractive in quarters like the most recent ones and probably this one where those money market revenues will look very attractive, we like the simpler more direct company that you all have come to track and that we are enjoying leading.

Thank you.

Thanks, Mike.

Thank you.

Our next question comes from the line of Matthew O'Connor of UBS.

Go ahead please.

Hi, guys.

Could you clarify the expense guidance a bit?

I think you had said a modest increase in 3Q and 4Q off the 2Q base?

We did.

Let me take a moment on that whole topic.

I don't like negative operating leverage, but I'm not apologizing for it to the extent that for us to make some investments in our core organic businesses we simply needed to do that, and in accordance with that, this is the quarter where that caused it reflects itself.

We're trying to dissuade anyone from thinking that I or Andy have lost control or that we're going to go crazy on expenses or give up what has become one of the hallmarks of this company.

So what we want you to know, that the next two quarters we see positive operating leverage and a very flattish expense base from the base that we've created here in second quarter, so that is what we're telegraphing.

And the point is that we will continue to make investments, but we have made probably a one-step launch forward in this quarter to create this negative environment for one quarter in order to create a new baseline to operate the Company at.

We still see our efficiency to be well better than anyone anywhere near our peer group, and it will continue to be one of the areas you will cite us for being the most efficient and the profitable, so really trying to temper what would otherwise be perhaps a runaway reaction from one quarter's activities all of which was intended and deliberate.

Okay.

And then somewhat related question.

As you go through the markets and implement PowerBanking, can you give us a sense of how much up front expenses there are either in dollars or percentages?

And then, you know, obviously, there's a lag before you get the revenue boost, and that's still to come, and give us a sense of how meaningful that might be over the next couple years?

Sure, Andy, why don't you do that.

You know, Matt, thank you.

We modeled out each of the locations, geographies that we're going to implement PowerBanking, and the incremental investment up front does vary by market depending upon the number of branches, the sort of level of staffing in those branches today, but they range anywhere from 5 to $15 million per market overall, so it's not hugely material.

The payback does occur within the first couple years.

The payback is a function of both increased loan volume, small business activity, and deposit growth.

And as Richard mentioned, our St.

Louis leading indicators give it a customer retention, employee retention, customer satisfaction scores are all positive leading indicators that's what we're seeing, and that's why we're very comfortable continuing to roll this out.

Okay.

And then just lastly if I may.

In April you had talked about targeting higher earnings in '07 versus '06.

If I think about what's coming in better or worse, the margin's right in line with expectations, credit's sort of in there well, the expense is really the outlier.

Is it fair to say that you've front ended some more of the expense initiatives than you initially thought earlier this year?

This is Richard.

I would say that we are delivering as we thought we would this year, but because the margin compression continued, and we admitted we didn't see that at the beginning of the year, we continued to pursue our expense initiatives even despite the fact that margin came down at this level because we do see that flattening out now, and we still think the investments made now will be handsomely rewarded in the future year or two.

So, Matt, we kind of stuck to the plan and did make an adjustment where we might well have been able to but we really felt it was more prudent to continue to make these investments at the timing and the well order that we expected them to be made in the first place.

Okay.

All right.

Thank you.

Thanks, Matt.

Thank you.

Our next question comes from the site of Gary Townsend of Friedman, Billings, Ramsey.

Go ahead please.

Hi, Gary.

Good afternoon.

How are you both?

Good.

You've developed some great non-interest businesses.

How do you unlock that value and find it reflected more in the multiple given the whole company?

Great question.

I have long given up on expecting the analyst community to discreetly give us PE value for the payment businesses or processing vis-a-vis the bank because I think what you're going to do is give us the value, and when you see is burdened in the kind of results we'll provide which should be better than some of our peers who don't have those options.

I'll respond with two specific responses.

One is on the initiative that you don't see that we don't talk about too often.

We are working for 2008 to a new plan.

It's actually a code word deepening customer relationships, but it's a very, very complete and complex movement toward having all employees receive direct, absolute credit for selling all products in the bank regardless of which line of business they're in or whose line of business they're selling the product for.

That sounds fairly simple, but those of you who know banking real well appreciate that that is using one of the reasons that banks suboptimize their ability to cross-sell and offer more to their customers because of some of the silos created.

So this year we are changing culturally, and it's not just a program, it's a cultural change to move forward on that basis.

I might marry that up with the fact that we are changing our incentive plans for 2008 whereby thousands of our top employees for this year and years before have been paid primarily on a discretionary pool, and the pool is funded at year's end based on the corporate performance, and then it is cascaded throughout the Company in the early part of the new year for incentive allocation.

In concert with this deepening customer relationship and tracking capability of all products, we're changing to a much more discreet specific incentive program for each person in the Company outside of the management committee who will remain fully vested in the overall corporate performance.

And these folks will now be much more as a percentage reliant on their own business line performance plus the corporate performance and have a much more discreet way during the year to track their behaviors, their performance and the rewards.

So number one, I believe we will unlock the value of these other non-lending capabilities by incentivizing our employees and get them excited about getting our customers more of these businesses.

The second piece to that answer would be that we have a capability of that which many companies don't have which is a payments expertise, and particularly, we are going to begin to develop more of an R&D capability as U.S.

Bank whereas a payment leader we're going to develop the next new products that our customers need.

Namely, we are building a small core of, I'll call it lab technicians, partnered with a number of bank employees who will go to our key customers routinely and say what's the next new thing you need in payments, not in bank language but in your language.

We can take it back to a core of people, figure out how to build it if we don't have it, buy it, and be able to deliver that.

As you have heard before, 4600 financial institutions in America use U.S.

Bank for some form of payments/partnership.

So when we build out for our customers, we'll build it for ourselves and we'll build it as a pass-along to other bank partners which may have, most of whom will not build it themselves, will not have the capability or the space or the interest in doing so and we can leverage some of those areas we've been talking about heretofore which have been more germane to just U.S.

Bank and talk more about how they become leveraged across the bank industry.

So those two things, I said a lot, but to me, they are huge levers and none of which are necessarily going to be discreetly priced because it's payments per se but because of what we do with it.

Do you have to grow the bank faster in order to get a better multiple for the Company?

The bank meaning the core bank?

Yes.

I think we do.

And I do because I believe that if we're really going to be a core bank with these special capabilities to leverage, then the core bank's got to be the core, and so I really want to see -- one of the things I'm looking forward to is a more particularly good use of our balance sheet to take on these corporate and wholesale customer activities, continue to deal in the top quality space but do more of it and become more important to the key customers who are both attractive, are profitable to us and how the interest and ability of taking on these other products that we're going to build because the more sophisticated customers are the ones who will jump on it first.

So I do think the core bank needs to grow faster than it has in the past but that leverage will accrue to the payment businesses as well.

Thank you.

Thanks, Gary.

Thank you.

Our next question comes from John McDonald from Banc of America Securities.

Go ahead please.

Hi, John.

Hi, Richard.

I was wondering if you could just kind of remind us of your M&A interest and where you'd like to grow out the franchise and under what parameters?

Great.

Thanks for the opportunity to be clear.

We are more of the same would be the answer.

We would like to continue to find small banks of size, I'll say, from $500 million to $2 billion.

We would like to particularly find those in the growth markets of the western part of our franchise.

Let's say that we continue to have conversations in those situations, and we're looking for deals that are not auction.

We like to do private deals like the last two where we have an exclusive relationship with somebody who wants to be part of our future and appreciates what we will do to protect their franchise.

And so in the small bank area that would continue.

In the payment businesses and in the processing businesses we're continuing to find some continued momentum.

A number of payment companies come into our view, we talk with them, we make some evaluations, every once in a while we find one that works.

Last time we talked as a group one of the question was with private equity is there a way that we can continue to compete for payment businesses when so much private equity is out there paying different price points.

The fact is, yes, particularly because we are interesting to some of the owners who don't want to just hand over their company and their keys to a private equity partner, but they really want to have a going concern and in many cases a job and they want to work in a company that can add capital and do something with it.

So we continue to find some, a decent stable of small payment companies that comes into our view.

And in the processing and trust servicing side we haven't seen much activity lately, but there hasn't been much to see, but we believe that in short order that medium-sized trust company aspect of these medium banks will come into the forefront, we'll be one of the candidates that they can look at to take over the business and provide them the same kind of service we have for the many that precede them.

So more of the same, John.

Nothing transformational, nothing significant to change the order of magnitude that we're trying to build here, which is a slightly enhanced revenue stream that attracts all of you.

Okay.

Thanks.

And a quick one for Andy.

Was there any meaningful sales of NPAs this quarter, Andy?

Not meaningful, John, pretty much the same loans that we've experienced the last few quarters and below a few million dollars range.

So nothing unusual for prior quarters.

Okay.

Thanks.

Thanks, John.

Thank you.

Our next question comes from the line of Manuel Ramirez of KBW.

Go ahead please.

Hi, Manny.

Hi.

Good afternoon, everyone.

Two quick questions.

On your deposit charge growth it just looks like it's been decelerating a little bit in the last two to three quarters on a year-over-year basis, but based on your comments on account growth it seems like there hasn't been any real change there.

So maybe a little bit of background on what's going on with deposit charges.

And then the merchant processing business, you've been accounting for seasonal factors that came in better than I expected this quarter.

Was there anything unusual in that number or should we expect a continued strong level through the third quarter?

Thanks.

Manny, first on the deposit service charges we did see accelerated growth here in the second quarter versus the first quarter nearly 12% up.

As you recall, in the first quarter we mentioned that it started out first two months of the first quarter were a bit lower than we had been experiencing, so we did see some acceleration in that growth.

Second on a year-over-year basis our deposit growth is up about 3% now.

One factor in that may be that we have a new product called CAA, Checking Account Advantage, which the fees from that accrue to loan fees and are reflected in margin as opposed to deposit service charge and that may reflect a little bit of a shift in the way we're recognizing those fees.

But as we talked about last call, we would expect on a go-forward basis that the deposit service charge level would grow very much in conjunction with our growth in accounts which, as we've talked about, is in that 5 to 6% range.

With regard to merchant activity the second quarter is seasonally stronger, there is activity that occurs that is a little bit higher than the first quarter, but the double-digit growth that we've seen is consistent with what we have seen historically and what we would expect in the future.

Let me just add, this is Richard, Manny, to the deposit growth I would like to see more deposit growth and while we are accurate in depicting the movement of customer's balances to higher interest rate products and their usage of those for earnings credit, I do think that relevant to my earlier comments about the quid pro quo that comes with large corporate customers giving you more non-lending business when you have more expression of interest in the lending needs, I believe that their positive improvements will follow that in that regard as well, and that's one of reasons we're introducing this wholesale corporate banking initiative which, again, we'll have links to it in short order to show you.

On the merchant servicing side I do think it would be fair for you to amend your expectations.

This is a very attractive business, it grows quite handsomely.

We have tens of thousands of customers join every year into the merchant category, and because of our service area, and I know we all talk about service, but it's very bona fide here.

We wouldn't add this many net new customers as often as we have in merchant servicing if Nova didn't have the kind of brand and the equity in the marketplace that it does.

So we're quite emboldened by that and with FDC and some of the recent changes and some of those peers we see that as a near-term opportunity because that disruption for them is absolutely opportunity for us to the extent that customers like dealing with a known entity and there's no change on this side of the fence.

And just to clarify, the last meaningful acquisition would have closed in the first quarter of 2006, right, on the merchant processing side?

That's a pretty good cut at organic growth that we saw this quarter.

That is correct.

That would have been First Horizon, and you are correct.

Perfect.

Thank you.

Thanks, Manny.

Thank you.

Our next question comes from the line of Todd Hagerman of Credit Suisse.

Go ahead please.

Good afternoon, everybody.

Just a couple of quick questions on the card portfolio.

Obviously growth continues very strong.

I was wondering if you could just remind us in terms of the breakdown in the portfolio there in terms of your expectations, in terms of a normalized loss rate for that portfolio and then just update us in terms of kind of mix in terms of the channels and where that's coming from?

Sure, Todd.

This is Andy.

First, from a normalized loss rate, you know, about a year ago our loss rate in the credit card area was about 2.7% charge-offs, and, as you know, this quarter was 3.56.

As you recall in the fourth quarter of '05 with the change in bankruptcy legislation, there was an acceleration of charge-off activity, and it slowed greatly in the first few quarters of 2006.

We are now getting back to a more normalized rate and given the growth characteristics that we see in this portfolio, we're approaching what we would see sort of a normalized level in the mid 3.5 to 4%.

So we were lower in the first quarter and second quarters of last year, and this quarter I think represents more like what we would expect to see in future quarters.

Our actual rates will be a little bit higher but because of the growth that we see in the portfolio, the reflected rates will be the mid 3.5s like you saw this quarter.

In regarding where it's coming from, you know, it is really across three areas.

It is through our partners, it is through our branch activity, and it is through the direct sales activity that we see that growth.

So we are seeing growth in all categories, and I would also highlight that the growth that we're seeing in credit cards, principally, if not all prime credit cards, we don't have subprime activity, it is really solid credit in terms of the growth that we're seeing.

In fact, this is Richard.

I'll add to that.

There were some analysts that expected our charge-offs to actually come down if not be flat, and I'm only disappointed because I thought that was from prima fascia that as we are only a credit card prime portfolio and we're growing in the 20% range, and honest to God, that has a lot to do with our agent bank relationships and our partnerships, that's high quality great growth in a very valuable line of business.

And so we are hardly a reflection of bankruptcy, post bankruptcy charge-offs coming to something normal, which by the way, is 3.5 to 4% of (inaudible) will reflect the prime quality.

And secondly, just the absolute growth of the portfolio is expected, at least I expect, some prime customers to have some delinquency and some charge-offs.

And so for us I would say that 53 basis points was actually a point of pride I was holding for this quarter's results, and while some folks expected differently or may see it differently, I hope this call helps you all to kind of go back and look at both our subprime minimal impacts, the fact that our commercial quality credit as represented by NTAs have not, just absolute charge-offs is low, and our credit cards will continue to grow at a very prime level.

I think you should feel, as I do, feel quite good about the quality metrics associated with charge-offs, and in the future we've indicated that they will be modestly growing and that really is code word for mostly because the balance sheet will grow in the areas that have most likely the charge-off levels.

That's helpful.

And just to clarify, so while they may modestly pick up, you wouldn't expect them to fall outside of this kind of normalized range as you say.

And then just similarly, just in terms of the channel, you're seeing more of the growth coming out of the, mostly the agent end relationships if I understand you correctly?

Yes, we're seeing it from both so I mean from all of them, agent is quite attractive.

I'll give you an example.

We have year-to-date I think enjoyed, is it 23 portfolios or 23 banks that have sold us our credit card portfolio this year.

Those never get right evaluated.

They never get put out as a press release, but it shows you the kind of run rate we have in doing business which is very traditional, by the way, with banks who give us their card portfolios which are quite, in many cases cured, and that's a benefit a lot of our peers don't have because they're just not in that space.

In terms of organic growth, we're not a direct mail shop, Todd, and so this is really the opportunities that accrue to a company like ours that has a very strong branch related growth of credit cards and debit cards through 2500 branches.

And the fact is, there has been a fair amount of disruption in the prime credit card space and we have been able to move through that taking advantage of opportunities including co-brand and some affinity opportunities that have come to us because some of the larger partners have either lost track of them or just busy doing their own conversions.

So we're opportunistic for sure but I don't know how long we can keep 20% growth in prime credit cards, but as long as we can, it's good today and it's good for the future.

Great.

That's helpful.

Thank you.

Thank you.

Our next question comes from David Hilder of Bear Stearns.

Go ahead please.

Good afternoon.

Just a couple of real estate related questions.

First, I thought I heard you say that you have either curtailed or discontinued condo lending in certain areas, and I wonder where that might be?

Dave, this is Richard.

We have.

Not across the board by any means.

We have a lot of good customers we do condos with, but primarily the market's that have been stressed that we have reduced our exposure unless we know the customers particularly well would be in the Florida, the Nevada, and the Southern California markets to name three.

Our exposure in condos, our top markets actually are Washington state, Florida, Colorado, New York, and Utah.

And except for Florida, those other four are actually quite strong, and so we continue to do condo lending in those markets and enjoy good returns, but Florida, Nevada, Southern California are markets that we've either tapered, or by good fortune, weren't very deeply in anyway and continue to stay away from.

Okay.

Thank you.

That's very helpful.

And you referenced a couple of times a program, as I heard it, to accelerate your sale of OREO, and I was just wondering, it looks like your OREO balances certainly have gone up over the past year.

Why are you doing that?

Are you in fact concerned there'll be more coming or --

Yes, David.

Are you there, Dave?

We lost you.

David, you're back on.

Thank you.

We just didn't want to answer if you weren't there.

Okay.

David, in fact our OREO levels have declined in the last quarter, and part of the theory is that we think that it's pertinent at this time in the cycle to continue to be aggressive on moving those OREO properties off our books.

So the intent is to not to have it build but to be very aggressive in terms of selling those properties at prices that we think we are appropriate at this time, so that's what we're doing.

We would expect to continue to do that in the third and fourth quarter, again, achieving the level of ORE that we're seeing right now, and as you saw in the second quarter here, that actually came down for the first quarter.

David, you're right.

It is up year-over-year for sure, and that's I think a reflection of the market.

It's generally the philosophy of this company that if you're going to have a stressed property better to sell it sooner than later in this environment, and we're actually getting quite decent returns while we do take a haircut, and God knows somebody out there's making a market on this, of all of us who want to take this off balance sheet, us included.

We feel it's prudent, and we think that we can withstand those additional expenses to lighten the load of future OREOs, but it's not because we're worried about a downstream situation.

We really want to keep the steady state so that we don't have anything to speak about in the future.

And the increase in expenses, is that simply the cost of the loss on the properties or is it actually adding more people into the effort?

It's a little of both, but most of it's the former of the cost of the differential and the property versus the sale price.

You might explain there's two parts to the (inaudible).

As you know, as the loan goes from, when the loan goes into foreclosure, the initial charge is to net charge-offs and is put on our books as an ORE asset and then to the extent there's a further decline in value and we sell it for lower than the book value, that goes to operating losses and that was part of the increase we saw in other expense this quarter.

Okay.

Thanks very much.

You bet.

Thank you.

Our next question comes from Betsy Graseck of Morgan Stanley.

Go ahead please.

Hi.

How are you?

I just wanted to understand the process of the investment spending.

I know you talked about that in the beginning of the call, but it would be helpful to understand how you are determining what you're going to incrementally spend on the kind of return time frame that you have for getting paid back on those investments and how far through the incremental investment spending, you know, you are?

Okay.

Got it.

This is Richard.

I think we shared last quarter that every Wednesday in order to -- one of my platforms is to create a little more innovation, at least in discussion around this company about investment opportunity.

And every Wednesday morning Andy and I have an M&A discussion with anybody who has either a deal to talk about, which traditionally comes from the outside, and/or an organic initiative, or as I think one of our peers called it, embedded opportunities, take a look at where we can do more with what we already have for an investment.

Each time they meet with us, Betsy, we have with us the Chief Technology Officer, the Chief Legal Officer, the Chief Risk Officer, and the Chief Credit Officer.

The reason I say that is because if someone has an idea and we decide it has legs, then in order to get it evaluated quickly we need to treat it like an outside deal and throw a lot of resources into a quick evaluation.

That evaluation comes back within a week or two, we evaluate it against a return and an expectation of both time and ROI, if you will, and if it meets those hurdle rates, each of them are a bit different.

I'll have Andy describe a little further our general benchmarks, and then if in fact it has legs, then we make that investment, we burden it into the plan, and we put it out there and treat it like an outside deal.

As you all may know from your experience in banking, an outside deal gets everyone's attention because it's got the headline and it's got everyone excited about it.

We've tried to create the same level of enthusiasm for opportunities in the Company like the PowerBank or the distribution of FAF or the opportunity for cross-bank initiatives.

So we find that to be a formalized process now which what gets tracked gets done and we're getting a lot more of this.

In fact, we're turning down a lot more, too, which helps me see where that kind of level of willingness I have and we have to make investments for near-term and long-term.

And Andy, you might add a little bit of (inaudible).

Betsy, we are tracking these things very specifically.

We look at the, both the next year or two in terms of the profitability, the net present value, the internal rate of returns and we're looking at all of these things and examples of investments we made, we talked about PowerBank, we look at it market by market, we look at the investment required and the returns we expect.

Richard talked about the people and the offices on the corporate banking side.

That's another example.

Then we have a number of embedded opportunities within our payments group that we continue to invest in, again, the returns are typically, the payback is typically within two years, 18 months, across most of these activities, and we try to measure those, and we try to track them.

We are tracking them they succinctly, very specifically.

And you mentioned that the pace of the ITF flow has been picking up.

It has, Betsy, and what I mean by that is we'll have somebody come in from, say, equipment finance and say, you know, if we want to get into this line of equipment, not only do I know how to do it, I have maybe a team of people that I know that can do it, it would cost us this much to get into the situation, it would take this long to build the balance sheet up to a recovery point of the investment, and let's talk about it.

And a year ago those ideas were never embedded, now there's a formal opportunity for us to say yes, no, we like it, maybe not now, maybe later, and we do evaluate things on cost of capital and the ROI's got to be as good or better than any deal we would bring from the outside, and it's got to be accretive to the Company in this 18-month range Andy talked about, or good ideas may well not happen just because we can't afford them.

Okay.

And the ROIC I would think has the cost of capital been impacted at all by the general rise in rates recently?

You know, as we think about it, Betsy, we're looking at our returns, the returns in the projects we're looking for are anywhere from 14 to 20%.

Okay.

Great.

Thanks.

Thanks, Betsy.

Thank you.

Thank you.

Our final question today comes from the line of Vivek Juneja of JPMorgan.

Go ahead please.

Hi, Richard, hi, Andy.

Just to follow-up on the REO disposition, was this prime or subprime properties and what kind much pricing did you get on the cents on the dollar?

And to your comment about your intent to do more in the third and fourth quarter, is that more the new stuff that flows into REO or more that's still sitting there and that you intend to?

It was a combination of both prime and subprime or non-prime, Vivek, and we would expect it to continue to flow from NPAs to REO and then out of REO through the disposition process that we see.

I would not expect a significant increase in expense from the current levels but more of the same that you saw in the second quarter.

Okay.

All right.

Great.

Thanks.

Thanks, Vivek.

Is that our last call, operator?

Yes, it is.

I will turn it back over to you.

This is Richard.

As we close, let me first of all, thank you for your continued interest and support in our company and let me tell you how excited I am about the future of this company and yet how much I appreciate the reaction that you need to have to the fact that we're making some investments, intentional investments to move the Company forward.

I think I would be safe in this audience to say that no company is proven over its legacy that it knows how to do more with the dollar of expense than this company by virtue of not only our disciplines, our D&A, but our investment capability.

What I'm saying to you is there are some well thought through, longer term opportunities that we need to bring back to the street, bring back to you, enable this company to be as capable on the revenue side as it has been for years on the expense side, and with a very careful, well-placed increase in investments that is not long-lived and not significant to harm any of the profitability measures we enjoy today.

I believe that's the right decision to make for this company and one that I believe you as investors and analysts will follow over the course of time to been the right decision.

I thank you for that continued follow-up.

So Judy, your closing one-liner?

Thank you for listening to our review of second quarter 2007 results.

If you have any follow-up questions or need hard copies of our press release and schedules, please feel free to contact me at 612-303-0783.

Thanks a lot.

Thanks, everybody.

Thank you.

Thanks, operator.

Thank you.

This does conclude our conference call for today.

We appreciate your participation, and you may now disconnect.