美國合眾銀行 (USB) 2008 Q1 法說會逐字稿

Welcome to U.S.

Bancorp's first quarter 2008 earnings conference call.

Following a review of the results by Richard Davis, Chairman, 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 11:00 a.m.

Eastern time through Tuesday, April 22, at 12:00 midnight, Eastern time.

I will now turn the conference over to Judy Murphy, Director of Investor Relations for U.S.

Bancorp.

Thank you, Christy, and good morning to everyone on the call today.

Richard Davis, Andy Cecere, and Bill Parker are here with me to review U.S.

Bancorp's first quarter 2008 results and answer your questions.

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

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

Factors that could materially change our current forward looking assumptions are 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.

Good morning and thank you for joining us this morning.

I'd like to begin today's call with an overview of our first quarter results and then turn the call to Andy who will provide you with additional comments about our earnings.

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

The Company's first quarter results reflected the disciplined approach we have taken over the past number of years toward managing credit and operating risk while prudently investing for growth.

Our Company recorded net income of $1.090 billion for the first quarter of 2008.

Reported earnings per diluted common share of $0.62 were $0.01 lower than the earnings per share in the same period of 2007 but $0.09 higher than the prior quarter.

The first quarter results included several significant items that combined reduced earnings per common diluted share by $0.02.

Briefly they included a $492 million gain related to the Visa IPO, a $253 million impairment of certain structured investment securities, a $62 million reduction in trading account income related to the adoption of the new accounting standard, a $192 million incremental provision for credit losses, a $25 million contribution to the U.S.

Bancorp Foundation and a $22 million accrual for litigation matters.

Andy will provide more detail on these items in a few minutes.

We achieved a return on average assets of 1.85% and a return on average common equity of 21.3% for the first quarter.

Excluding the net unfavorable impact of the significant items I've briefly mentioned, our return on average assets and our return on average common equity would have been 1.92% and 22.1% respectively.

Our first quarter net interest margin of 3.55% was higher than the 3.51% net interest margin we recorded in both the first and fourth quarters of 2007.

This 4 basis point improvement in our margin in addition to the strong growth in average earning assets resulted in an increase in net interest income of 9.8% year-over-year and 3.8% unannualized on a linked quarter basis.

As we have said in the past, a stable margin is one of the key components to our long term revenue growth assumptions.

At 3.55%, the margin is slightly higher than we'd anticipated at the start of the year primarily due to the decline in the Fed funds rate, growing at higher spread earnings assets and our ability to capitalize on lower short-term funding costs.

Our fee based businesses continued to show excellent growth year-over-year with payments related category, treasury management fees, commercial products revenue, and mortgage banking all increasing by more than 11%.

Trust and investment management fees grew but at a lower rate of 4% as positive growth in transactions and new customers were partially offset by unfavorable changes in the equity market valuations.

Linked quarter revenue growth for the first quarter of the year is historically the slowest for our Company.

This year was no exception as the majority of our fee categories were lower this quarter than last.

The treasury management and mortgage banking revenue lines were exceptions as both posted strong linked quarter increases.

Mortgage banking revenue in the first quarter benefited from strong growth in origination and servicing income in addition to favorable changes in accounting, the MSR valuation and economic hedging activity.

Bottom line, our mortgage banking division continues to benefit from the current market conditions, enjoying a flight to quality in both the production and servicing aspects of that business.

The growth in total revenue, net interest income plus fees, was 14.3% year-over-year.

More importantly, revenue growth, excluding the net impact of the Visa gain, asset valuation loss and accounting changes, was more than 8% year-over-year.

This is significantly higher than our Company has experienced in the past few years, demonstrating the powerful impact that a stable margin coupled with our strong fee based businesses can have on overall revenue growth.

Non-interest expense in the current quarter was $224 million higher than the first quarter of last year, but $172 million lower than the previous quarter.

A large portion of the increase in expense year-over-year can be attributed to core growth and our continued investment in both fee based businesses and our banking franchise.

In addition, this quarter's contribution to the Foundation, litigation expense, investments and tax advantage projects and credit related costs for other real estate owned and collection activity accounted for most of the remaining variance.

On a linked quarter basis, total non-interest expense was lower.

Although certain expense categories tend to be seasonally lower in the first quarter of each year, the majority of the positive dollar variance from the previous quarter was due to the $215 million Visa litigation charge taken in the fourth quarter partially offset by the current quarter's two special items, the Foundation contribution and the litigation expense.

In addition, compensation and benefits were higher this quarter reflecting annual merit increases and incentive accruals.

Our efficiency ratio, as reported for the first quarter of 2008, was 43.5%.

Excluding the significant items I detailed earlier, the ratio was more comparable to past quarters at 47.1%.

Importantly, excluding the significant items, we achieved positive operating leverage on a linked quarter basis.

We are one of the most efficient financial institutions in the industry.

And as a Company, we will continue with our disciplined approach to expense control while making prudent investments in our products, services, employees and franchise.

Turning to the balance sheet.

Total average loans grew by 7.3% year-over-year led by solid growth in average total commercial loans of 10%, retail loans of 7.4%, and residential mortgages of 6.5%.

On a linked quarter basis, total average loans increased by $3.8 billion or 10% on an annualized basis.

This increase was led by a $2.1 billion increase in total average commercial loans representing the extension of credit to both current and to new customers.

We are finding that our Company is benefiting from the uncertainty and volatility in the financial markets as customers seek stability in their financial services provider.

We have the capital to lend and we're in the position to provide the high quality banking products and services our customers seek.

That said, be assured that we will continue to concentrate on originating principally high quality credits.

We can and will compete on price for the best customers.

We saw very favorable deposit trends this quarter.

Average total deposits increased by 8.4% in the first quarter over the same quarter of last year and more than 4% unannualized over the prior quarter.

This deposit growth is in part seasonal, driven by higher broker dealer, government and institutional trust balances and the Company's ability to attract low cost wholesale funding in a somewhat volatile market.

In addition, the growth in deposits reflected our continued focus on our revenue initiatives particularly in the corporate banking business line.

Finally, moving on to credit.

Our first quarter credit results remained manageable.

As predicted, net charge-offs and non-performing assets were higher this quarter and somewhat higher than we expected 90 days ago.

Net charge-offs were 76 basis points of average loans for the first quarter of 2008, above the 59 basis points and 50 basis points of average loans in the fourth and first quarters of 2007 respectively.

The increase over both the prior quarter and the first quarter of 2007 was the result of continued stress in the residential home and mortgage related industries as well as the growth of our consumer loan portfolio.

Within the consumer loan portfolio, credit card loan net charge-offs accounted for the majority of the linked quarter and year-over-year increase.

The credit card net charge off ratio of 3.93% this quarter, however, still remains below our expected rate for this loan category.

We now anticipate this ratio will climb above its pre-bankruptcy reform rate of 4% plus.

Given the high quality of this prime portfolio, we still expect that our net charge off ratio will be lower than industry standards but higher than we anticipated at the beginning of the year.

Residential real estate related charge-offs including consumer first and second liens also increased at a faster rate last quarter following the recent trends in the industry.

We expected the growth in total net charge-offs to continue through the balance of the year due to the general economic conditions, continued stress in the home building and related industries and the upward trends in delinquencies in the consumer and residential real estate related categories.

The increase in net charge-offs is expected to be manageable and within our through the cycle range of 60 to 80 basis points on average and may approach 100 basis points at the high end during this economic slowdown.

This represents a slight revision upward from our prior forecast of 90 days ago.

Also, as expected, non-performing assets increased during the quarter to $845 million at March 31 from $690 million at December 31, a 22.5% increase.

We anticipate that our non-performing assets will continue to increase.

As a result of the current economic conditions and portfolio trends the first quarter results included an incremental provision for credit losses of $192 million.

With this addition to the reserve for loan losses, the Company's coverage ratios remain adequate.

The allowance to period end loans at March 31 was 1.54% while the allowance to non-performing loans was 358%.

Before I turn the call over to Andy, I'd like to say a few words about our recently announced agreement to purchase Mellon 1st Business Bank in Los Angeles, California.

This acquisition will more than double U.S.

Bank's deposit market share as well as significantly expand our middle market customer base in the Los Angeles area.

Mellon 1st Business Bank is an excellent example of the type of acquisitions we are searching for -- acquisitions that fill in and expand our presence in faster growing markets within our 24 state footprint, particularly when the price is right and the risks are manageable.

I will now turn the call over to Andy who will make a few more comments about this quarter.

Thanks, Richard.

I'd like to begin by summarizing the significant items that have impacted the comparison of our first quarter results to prior periods.

Other fee income in the first quarter included a $492 million gain related to the Visa initial public offering.

The other fee income line was also impacted by the adoption of FAS 157 fair value measurements, which decreased trading revenue by $62 million.

Recall that we discussed the impact of the adoption of this standard in our January earnings call.

For comparison purposes the other fee income line in the fourth quarter of 2007 included $107 million mark-to-market on approximately $3 billion of assets purchased from certain FAF advisor money-market funds.

During the current quarter an additional impairment charge of $253 million was recognized on these structured investment securities as they are now part of the Company's investment portfolio.

The impairment charge was booked as a securities loss.

As most of you are aware, spreads widen during the first quarter.

As a result, about two-thirds of the writedown on these structured investments was related to changes in market related credit spreads, while the remaining third was due to potential credit loss and pre-payment changes.

Non-interest expense also included two significant items.

First, marketing and business development expense included a $25 million contribution to the Company's charitable foundation, while other expense was higher due to the $22 million litigation accrual.

For comparison purposes, recall that the fourth quarter of 2007 also included a significant expense item, a $215 million Visa litigation charge.

Finally, the adoption of FAS 157 resulted in an increase of $19 million in the compensation expense line.

This was offset, however, by a similar increase in the mortgage banking revenue line as the standard eliminates the deferral compensation expense related to the closing of mortgage loans held for sale.

As Richard discussed, the provision for credit losses recorded this quarter was $192 million in excess of net charge-offs.

The incremental provision was made in recognition of the current economic conditions, stress from the residential real estate industry and the growth of our consumer loan portfolio.

Earnings per diluted common share for the current quarter without these significant items would have been approximately $0.64.

For comparison purposes, fourth quarter 2007 earnings per diluted share without the impairment charge and the structured investment securities and the Visa litigation charge would have been approximately $0.66.

As Richard discussed net interest income in the first quarter was higher on both the year-over-year and linked quarter basis due to strong earning asset growth in an expanding margin.

The margin expansion year-over-year and on a link quarter basis can be attributed to growth in higher spread assets and the benefit for being liability sensitive in a declining rate environment.

Our Company has also benefited from the ability to strengthen -- secure favorable short-term funding rates given the volatility in market conditions.

Going forward, given the current rate environment and yield curve, we expect a stable net interest margin based on steady to slightly improving credit spreads, continued growth in higher spread products including credit card and other retail loans and the normalization of funding and liquidity in the overnight markets.

Our capital position remains strong.

As you may recall, we indicated in January that we would not buy back stock in the first quarter of 2008 in order to ensure that our Tier 1 capital ratio will return to our target level of 8.5% from the 8.3% we posted at December 31.

Our Tier 1 and total capital ratios were 8.6% and 12.6% respectively at March 31, both slightly exceeding our own target levels.

As Richard mentioned, we announced an agreement to purchase Mellon 1st Business Bank in March with an anticipated close by the end of the second quarter.

Because of this acquisition we expect to delay the buyback program during the second quarter in order to maintain our Tier 1 capital ratio near target at June 30.

Richard covered the highlights of our credit quality statistics for the quarter but I want to update you on our exposure to subprime lending.

Our exposure to subprime residential loans remains minimal and very little has changed from the end of the fourth quarter of 2007.

As of the end of the quarter we had $4 billion of residential real estate loans and home equity and second mortgage loans outstandings to customers that could be considered subprime.

These two portfolios represent a 2.6% of total loans outstanding as of March 31.

Given the current credit environment, we have published additional schedules this quarter as part of our earnings release package with more details on the credit performance of this portfolio.

In summary, we are pleased with our first quarter results.

The Company posted a solid loan growth on both a year-over-year and linked quarter basis, a 9.8% increase in net interest income year-over-year and a higher net interest margin.

Excluding significant items, total revenue growth of over 8% year-over-year and positive operating leverage on a linked quarter basis.

We had manageable increases in net charge-offs and finally -- and non-performing assets and, finally, we ended the quarter as we began with a strong capital base and liquidity position.

I will now turn the call back to Richard.

Thanks, Andy.

Our Board of Directors and management team are here today with me in Portland, Oregon, to host our 2008 annual meeting, where I'll be very proud to share our full year 2007 and first quarter 2008 results.

As our shareholders leave the meeting today, I want them to recognize that this management team and our 54,000 employees are focused on the future, not on repairing problems from the past.

We're focused on business growth initiatives and on our customers, not on downsizing businesses or eliminating positions.

In other words, U.S.

Bank is open for business.

As we successfully close the books on the first quarter of 2008 I'm confident that our Company will continue to perform and prosper, despite the challenges we face in the current economic environment.

This Company will continue to invest in new and existing products and services, in our communities and in our employees while focusing on our responsibility to produce consistent, predictable and repeatable results for our shareholders.

That concludes our formal remarks.

Andy, Bill and I would now be happy to answer questions from the audience.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Jon Arfstrom of RBC Capital Markets.

Good morning.

Hi, John.

Richard used the term "Incremental provision" in terms of the large increase sequentially and you guided to some modestly higher losses in the future and I guess the question is, how much of that is truly incremental and do you think that the provision will fall back to that 200 million type quarterly run rate?

This is Bill Parker.

The incremental provision Richard referred to was to increase the allowance, so that was the $192 million.

The core run rate charge-offs for the quarter were 293 but we do anticipate those levels of losses to continue to increase during the balance of the year.

Okay.

So John, this Company is going to be adequately protected over the long course, so you can count on the fact that, I said this last time and I'll say it again.

We can is see pretty clearly 30 days out.

We can see marginally 90 days out and after that we really can't see what's going to happen with credit any further because there's just too much volatility and here's a lot of seasonality as well.

So we felt very good about being able to add that $192 million to bulk up our provision to be as strong, in fact even stronger than before an we will watch each quarter to see that we're adequately reserved and should we need to add to reserves we will but at this point in time we don't see that.

Okay, just two other quick questions.

Yes?

In light of the Mellon First Business Bank acquisition who is obviously a hot topic but can you talk about what does and what does not make sense in terms of M&A for your Company?

Sure.

In M&A I'll start by saying we will always take a look at anything that comes in front of us to be opportunistic and to make sure we don't pass on opportunities that might not otherwise at first glass look attractive, but we will do due diligence at a very thorough level and in many cases find it doesn't pass our test which in our minds it needs to be accretive, it needs to be to be used on revenue growth, not on expense benefits, and it needs to be relevant to our long term future growth where we're trying to build a wonderfully balanced diversification of revenue based on a core footprint banking business, a national wholesale business, and an international payments business, so you'll find us looking at payment companies, trust companies, and traditional banks, but I'm not looking for that transformational deal unless it were so advantage that it would be crazy to pass and we haven't seen anything like that in this period of time, so it's got to be all fashioned, small, sensible, accretive, and revenue focused.

Okay, that's helpful.

Yes.

And then just early thoughts on the Northwest/Delta merger and what kind of impact that might have on your payments business?

Sure.

It's too early to know exactly except to say that the merchant acquirer for both of those companies, which is positive, I think that the merger makes sense and is good for the new Company, the largest airline I guess in the world.

We are the merchant issuer or I'm sorry the card issuer for Northwest who are world perks, and we have a very good relationship with them.

We also have a great relationship with the current Head of Delta Airlines who used to be the head of Northwest and we've been the bank for Northwest I think for as many years as people can remember.

So I'm expecting that our relationship and the great partnership we've had with that organization will carry us forward into the next stage and we're looking forward frankly to having more business from the largest airline in the world.

Okay, thank you.

Yes.

Your next question comes from the line of Chris Spahr of Deutsche Bank.

Hi, Chris.

Hi, good morning.

I just wonder if you could give me a sense of the economic outlook for the potential 100 basis points increase in charge-offs, like unemployment, GDP growth, and what geographies are you seeing the greatest stress?

Yes, this is Bill Parker again.

Clearly, the geographies with the greatest stress are the Southwest specifically California markets, Arizona, Nevada, and then also Florida.

And then for really different reasons, the upper Midwest of Michigan and Ohio with the auto industry.

So those areas, I mean, you've seen the softening in employment over the last few months and if that continues, I mean, that's the kind of thing that will drive our losses towards that peak loss rate that Richard mentioned.

Yes, Chris, this is Richard.

I'll add to that.

I want to make it clear, we're not at 100 basis point increase nor at that level but I think last time when we spoke to this group we said at the high end of the cycle we would be in the mid 90s and if nothing else I want you all to be very comfortable that the three of us will tell you what we think and what we know, and we're thinking that that's probably a little low now, at the high end of the cycle we could approach 100 basis points.

It will be as we got there, right now if you look at our current situation, it will be just as the 76 basis points a points a day is spread pretty much across all categories, commercial, commercial real estate, residential, credit cards and other retail.

We don't see any particular areas suffering any more of a consequence to go from 76 to something higher, we see simply more of the same, and I think you know that in every one of those categories we are primarily prime, and to the extent that that has been the outcome that's occurred with this current economic downturn, I think it would be prudent for us to expect that it will get worse across the entire categories but we don't see anything necessarily beyond 30 or 90 days that say that it's Armageddon.

It just says that it's continuing to get worse and the stress is impaired in all categories.

Sure and then beyond homebuilding and commercial what are the other areas or pockets of -- are you focusing on right now in terms of weakness?

As Richard said, it's really across-the-board.

I mean we're a significant auto lender, we've seen higher delinquencies in our auto portfolio, it's still manageable, but the loss per vehicle when we do have to repossess a car is higher than it was 90 days ago.

Yes, Chris, anything related to the homebuilding starts to show stress at this point in time, so I don't know, let's say it's a small business that manufacturers faucets, they're stressed now, or companies that manufacture door bells they're stressed.

So most of the domestic providers of mortgage related business are going to find stress in this cycle and some of them show up as commercial loans, some of them show up as small business loans.

It's actually quite predictable when you think about it.

It's just a matter of how long this downturn might take people and how long they can hold on through these difficult times.

We are seeing that stress and we're managing it.

Thank you very much.

Yes.

Your next question comes from the line of Nancy Bush of NAB Research, LLC.

Good morning, Nancy.

Good morning, guys.

Richard, we're hearing from others who have capital and are steady in this market that they're seeing tremendous potential for earning asset growth and taking share, et cetera, et cetera.

Could you just comment to this whole phenomenon?

Are you seeing clients coming to you or are you seeing new clients or are you moving market share?

What's going on?

We are, Nancy, and in fact this might be the time I think when there's permanent shifts in market share.

It's I think quite logical it's surprising to me how pervasive it is but we are seeing customers coming to the Company, we call it a flight to quality, customers that are coming with a bigger position, customers who we perhaps had before and who now want to come back.

It works both ways too.

People want to get their lending relationship with you because they're confident that you aren't going to change your level of interest in supporting them.

They want to give you a deposit because they want to be comfortable that the Company is going to be able to support those deposits especially above FDIC levels so it is across the board.

It is complete, and it is from every single category and so what I need to make sure is that this Company remains prudent and that we neither get greedy at a time just because we can have more business.

If it doesn't fit our model of prime related and high end customer, I assure you we're going to pass on it.

Just because we could do more it doesn't mean we should, and in fact the more good prime stuff that comes to us, frankly we can price for it now because risk has been added back into the equation and because it's a buyers market for us as regards to customers so it's quite positive for us and I believe it will give us a long lasting benefit over the course of the next couple quarters.

Is this phenomenon being seen throughout the franchise or are there regions where you'd say you're claiming greater share than others?

I say it's everywhere but in terms of line of business it's probably showing up in corporate and middle market banking the most.

Consumer not as much.

I don't think those customers are as keened in on what's happening but I'd say in the corporate and middle market side, those are customers, CFOs, Treasurers, Controllers that they understand the difference and they're coming to us at higher levels.

Thank you very much.

Thanks, Nancy.

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

Good morning.

Hi, Matt.

I thought it was an interesting comment about the small business that makes the door bells and the faucets and things like that, the spill over impact and I'm just wondering, of your 46 billion of C&I how much would be quasi tied to housing if you had to estimate?

Yes, we actually track it.

We have about $5 billion in commitments, so that 40 billion of C&I really growth is up up to 100 billion or so of commitments so about 5 billion of commitments is in one way, shape, or form suppliers to the homebuilding industry.

So 5 to 10%, Matt, would be really what we're looking at and I'd say that it's, it can keep going and going and if you work really hard everything has something to do with a house if you try too hard but Bill's right we've been tracking housing related now for over a year as we can see, loans and downturns are pretty much like annuities.

You can see them coming, they're like a slow flood but you can predict.

You just can't exactly see where it's going to end and so in our case we don't have a material concentration across any of our portfolios either on geography or product or customer type but we do have our fair share of related businesses in this area which we're watching closely.

Any sense on how that 5 to 10% compares for the overall industry?

That would be consistent with if you looked at industry distributions of the economy.

That would be consistent.

Okay.

And then just Richard a question here.

We're seeing a lot of banks, some could argue are the weaker players getting capital without needing to restructure in a meaningful way and I guess some could argue that it's health it they're getting capital or some could argue it's not healthy because they're not taking out capacity, just wondering big picture what your thoughts are on that?

And is it a little frustrating that you're sitting here with capital in a multiple and maybe not having the unbelievable distressed opportunities that we might have thought we would have at this point of the cycle?

Right.

Thanks, Matt, it's a good question.

I'm not frustrated by it because I actually understand it, and so the frustration would be if it didn't make sense to me.

I'm not surprised how this process is rolling out in that I think nobody wants the industry to be stressed.

Capital is a good solution to keep the entire greater good theory alive and I don't think any bail outs are positive for anyone, and so I think that based on Nancy's question and what we are seeing across-the-board, we're getting benefited in the long term by this flight to quality and the benefits that accrue to our Company's reputation for not having been through the stress.

Capital can often be diluted as you know as well, so I'm looking forward to a shareholder meeting today where I at least of other things don't have to face shareholders who have felt a precipitous drop in their value or wonder if we're going to harm them by diluting their investment or by cutting their dividend.

So I think we're getting our fair benefit.

It's our job to leverage that benefit and take advantage of it while not making mistakes and you have my word we will do that, but we can live with that discord and the fact is, is that not being distracted is probably the biggest value I can offer you and I won't be able to prove that to you for probably a year from now but a year from now when things are maybe settled down hopefully we'll be talking about a very well oiled revenue Company here that made its change in course during this period of time when we weren't focused on retrofitting or downsizing or reconstructing the Company.

So I'm actually quite positive about it.

Okay, thank you very much.

Yes.

Thanks, Matt.

Your next question comes from the line of Ed Najarian of Merrill Lynch.

Good morning, Ed.

Good morning, Richard how are you?

Good.

Good.

Could you just go into a little more detail about your capital management outlook on this?

You mentioned no buyback s related to Mellon First Business Bank, I guess in the second quarter.

Could you just just remind us of a couple of things, number one, what amount of cash you're paying for that and number two, does that mean we should expect some resumption of buybacks in the second half of the year?

Ed, this is Andy.

Thanks for the question.

We did not disclose the financial details of that transaction, but suffice it to say that we will not be in the buyback market in the second quarter.

Due to that we expect that to close June or so of the second quarter, and that essentially takes the capacity for buybacks in Q2, given everything we see thus far, we would expect to be back in the buyback market in the second half of the year.

So I'm guessing then from those comments that you're expecting that that and maybe you haven't disclosed this, that that's 100% cash deal in terms of structure?

Yes, it is 100% cash.

Okay, thanks.

You bet.

Your next question comes from the line of Betsy Graseck of Morgan Stanley.

Hi, Betsy.

Hi.

A couple questions.

One, just finishing up on the capital question, how do you think about the capital levels in an economy that is deteriorating as you point out?

I guess I'm wondering if as credit deteriorates, does that lead you to a need to increase capital, to deal with that?

Betsy, this is Andy.

We've targeted our capital levels at the 8.5% Tier 1 and we'll continue to maintain that target level.

Capital is very important in this environment, you're right but we're 250 basis points above what would be defined as well capitalized so we're very comfortable with that position an that together with our strong liquidity and our earnings power and our relatively speaking, strong credit position all makes us conformability with our targets at 8.5.

So you'd say that today you're in an over capitalized position expecting a deterioration in the credit outlook?

I'd say we're at the target levels that we set for ourselves and we'll continue to maintain that target.

Okay.

And then on the margin side, just looking forward as -- looking at the forward yield curve and some improvement expected there at least at the long end of the curve, how can you take advantage of that?

How do you plan to take advantage of the steepness in sort of the 210 portion of the curve?

Right, thank you.

We did come up in margin a bit more than we expected.

If you'll recall back in our January earnings call we thought we would be flattish to what we experienced in the fourth quarter of '07 in the low 350s and we were at 355.

I think there are three things that are causing that increase.

Number one is some of the loan volume that we're getting as Richard and Bill both mentioned, the flight to quality offers this opportunity with spread coming back into the equation and we'll be able to compete very effectively and we have the capital and we have the funds to lend so that's helping us.

Secondly, there has been a flight to quality on the deposit side of the balance sheet which is offering us opportunities to grow deposits and our national market funding is also very favorable in this environment.

And then finally, as you know, we're a bit liability sensitive so the fact rates came down 125 basis points in the first quarter helped us out a bit.

We continue to be liability sensitive albeit at a lower level because we're hitting deposit floors so to the extent we see further drop in rates and a steepening of the yield curve that will benefit us a bit, but as we talked about in the call, given today's yield curve and today's rate scenario, we expect a relatively stable margin.

And Betsy--.

There's nothing you would plan to do with swaps and trying to capture some incremental NII from the 210 portion of the curve?

what we try to do is manage our interest rate risk within the constraints of our policies and that's -- we'll continue to do that.

Okay, thanks.

Betsy it's Richard.

One more thing.

Capital is king right now.

We get that and we're going to protect it as maybe our most precious asset.

I will also remind you that our ability to generate capital is far and away ahead of our peers based on both the business mix, the quality of our assets and our efficiency.

So our ability to generate return on tangible common of 42% a year is also probably the gift that keeps giving so in our case, we are focused on protecting those capital levels.

We also know we can generate them pretty quickly and at least at this point in time I still don't feel so bad and I said this 90 days a go that the buyback is the first thing to give up right now because I'm not sure with the volatility of the Stock Market the correlation of a buyback is as high as it would be in more normal cases and the dividend must be protected and is very important to us, having increased at 6.25% back in December and protecting it going forward that's my first and foremost concern for the shareholders, so that all kind of comes together in the focus we put on capital protection and generation.

Okay, thanks.

Thanks.

Your next question comes from the line of [Ted Grossbeck] of Grossbeck Investments.

Hi, Ted.

Yes, good morning, thank you.

A question for you.

In the mortgage business, what percentage of originations were refinanced?

Our non-purchase money you mean?

No.

In the regular mortgage originations, how much was refinancings of mortgages?

Oh.

That's probably about 50%.

50%.

Okay.

And in the charge-offs, were there any commercial loan charge-offs in the quarter?

Yes.

There were.

About how much?

I think it was 55.

And also a question, if there were no buybacks during the quarter, it looked like the weighted average share count was down?

It was about flat.

Okay, thank you.

Your next question comes from the line of [David Knudsen] of LGIMA.

Hi.

I had a couple of quick questions, one, in regards to the I guess the latter part of the first quarter.

Did you see a change in the payment profile of your clients?

Did you see any credit deterioration, was it weakness back end loaded I guess?

Yes, this is Richard.

In fact I think we've said that March will be the month we'll earn a lot.

We did.

We saw some additional stress in the ability to repay both in the credit card side and some of the auto categories primarily.

We hold off on our concerns until we see the stimulus refund and what happens in April and May when the refund checks come in a normal situation so before we get too concerned we'll let March be a slight decrease to prior periods but we'll wait and maybe call the decision in May in next month when we get a sense for how the stimulus and the money back into the markets come to bear.

We're also being very careful to watch our forward looking delinquencies and they are fairly predictable.

They aren't stressing a great deal.

Bankruptcy is a little higher bit higher, but everything is just incremental.

It's a very slow incremental continuation of a downturn in the prime businesses, where I think it's reflective of this economic downturn and the duration now of whether we're in a recession or not, call it what you will, we've been in a slowdown for awhile so I think David that's really the cost that we're seeing on the consumer side.

One follow-up question too that.

The last time that we had a stimulus package, similar to the one we're expecting, what area -- did it benefit the consumer credit card business the best, the auto business or the small owners or what was the meaningful or can you try and quantify it for us?

It went two places, actually we saw it three places.

It went into deposits, more like the money-markets and checking accounts, it went into credit card paydowns, because it's the most fluid item for people, and it affected -- the two together affected a lower NSF OD fee business because people were bringing themselves current on their checking account side.

So, we kind of see the effects on both sides.

Deposits balloon up, fees go down a bit and credit card payments are higher and charge-offs are lower so it's kind of where you'd expect it to go to more of the day-to-day kind of stuff.

There hasn't been any increased speed in the roll rate of delinquencies over the quarter?

People moving from 30 days to just simply going no more payments or has there been?

This is Bill Parker.

No, the thing that has occurred in the last 90, 120 days is really those that do go delinquent, go seriously delinquent 90 plus have a much more difficult time getting out of that situation.

That's the pattern that's changed during this slowdown.

Thank you very much.

Thanks, David.

Thank you.

Your next question comes from the line of Brock Vandervliet of Galleon.

Hi, Brock.

Thanks very much for taking the call.

I just wanted to get some color on the book of Mellon Business Bank.

I remember that bank from years ago but just kind of wanted to freshen up on size and what's under the covers there a little bit.

Sure, okay.

Brock this is Andy Cecere speaking.

It is principally a deposit gathering bank and from a size perspective it is much more deposit versus the loan.

We have a book of about $1 billion on the loan front and about $2.8 billion on the deposit front.

Very little in securities and so that will be incremental to our balance sheet.

We also see a lot of opportunity here to continue to extend the deposit side of the balance sheet and the loan side with the products and services that we're able to offer, particularly on the payments and treasury management side.

What kind of reserves were they running?

Their reserve level is about 10%.

Okay.

And what had been their historical credit experience?

Pardon me?

What had been their historical credit experience?

It was very strong.

We did a thorough due diligence of their loan portfolio and they're primarily a middle market lender.

They aren't in the investor real estate business.

So it's pretty solid ground.

Got it.

Okay, thank you.

Thanks, Brock.

Thank you.

Your next question comes from the line of [Greg Gunther] of Garden State.

Good morning, Richard.

Hi, Greg.

I know you mentioned that due to declining home prices in many of your exposed markets that net charge-offs and non-performing assets increased in the first quarter and going forward you forecasted these charge-offs would continue to be increasing but at a manageable clip.

So my question is what's the watermark we really need to see that would concern management as far as net charge-offs going forward?

Well, we said 60 to 80 in the range, we're at 76 today so we're in the range.

If this range gets longer or more steep, then I would say once we get to that 100 basis points or the 1% that we offered up here that would be a point of worry for me.

I'll mention that I said that our charge-offs were higher than we thought they would be 90 days ago.

In order of magnitude this Company made over $0.60 earnings per share this quarter and the difference between what would have been an amazingly great quarter and one that disappointed me because it was worse was less than $0.01.

So this isn't going to take us from profit to loss but it's going to just be a lag on the ability to let the pre-provision earnings of this Company not be erased by some of the after provision and so it's not going to be Armageddon under any scenario that I can see, Greg, under any circumstances, but I do think that once we approach that 100 basis points then we're at a point of stress that is both probably going to continue for somewhat longer than we would have thought and it starts to erase some of the great things we're seeing above the line that I was hoping would shine through earlier so I think in the next 90 pays, we'll learn a great deal on the trajectory of the rest of year.

It will be a bit more clarity in the next quarter?

Right.

Thank you.

Okay.

Your next question comes from the line of Kevin St.

Pierre of Sanford Bernstein.

Hi, Kevin.

Good morning, gentlemen.

Just to follow-up on that, I just want to get a little more into your -- how you're thinking about reserving here and Richard, you've remained at the high end of the industry in terms of reserve adequacy and that's still the case.

But how should we be thinking about reserves now and when you think about remaining adequately reserved, are you thinking about reserves to annualize charge-offs, reserves to NPAs or is it that if things worsen we bump up reserve to loans?

How are you thinking about that?

Kevin, thank you.

There's a lot of allowance coverage ratios but I look at two, and primarily the two are the most important.

One is total allowance for total loans, and that's a bit of a misnomer if you don't understand the business mix you have and the portfolio but in our case, that's very important to us and our allowance for total loans is 1.54% which at least last quarter would have put us in the very top of our peer group near the top and I think it will stay there.

The next thing I look at and equally important is allowance to total non-performing loans because as logic would prevail those are the loans that are having some form of stress.

This particular quarter we'll be at 288% which is almost three times coverage.

I feel very comfortable with that especially compared to our peer group and while I will keep our eye on non-performs perhaps one of the most instructive things I can offer you all is both based on regulator concerns and needs to be aggressive in down grading at this point in the cycle, I don't think that necessarily non-performing loans mean the risk of total loss as they may have meant in some of the more traditional days, they're simply a recognition of higher stress and potential loss.

So I like to look at both because NPAs might be an overkill, but allowance either way in my mind has got to be at the high end of our peer group and well within what we'll call adequate to satisfy the regulators and in most cases I think our actions this quarter to add that $192 million as part of the benefit was to bulk that up, strengthen it and give us plenty of time to watch the next couple quarters and see if we have a need to do that again.

Great.

Thank you that's helpful.

And you mentioned in there to satisfy the regulators, is it your sense that the regulators, the safety and soundness regulators are a bit more, are paying more attention or paying closer attention to the levels of reserves at your bank and at your competitors?

Well, I know they're satisfied with our bank.

I suppose they're watching closely because that's certainly an area of concern for them.

I'll say that particularly the regulators have been very aggressive in making sure that stress credits are recognized quickly, downgrades are recognized quickly, and benefit of the doubt goes to the downside, and that doesn't surprise me, that's probably prudent at a time like this and and regulators have a lot of concern that banks don't take too long to recognize problems or don't look for an outcome when in fact they would be better served to be prepared for the worst so we see it as a little bit of that but we see it every cycle.

It's not unusual.

Thanks very much.

Your next question comes from the line of [Jeff Buskoni] of Viking Investors.

Hi, Jeff.

Hi, this is is Tom Purcell.

Thanks for taking the call.

Just a follow-up on Kevin's question earlier.

When you guys look at the NPAs do you exclude the 90 plus accrued in restructured?

If you do, what's the thought process?

Thanks.

They are excluded from the NPA totals; however there's also a table that includes the 90 plus, so you can look at it both ways.

So it's however you choose to look at it.

I guess I was wondering from the reserve adequacy standpoint, Richard said you looked at reserve to loans and reserve to NPAs.

Yes.

For yourself when you're looking at it do you include those or do you exclude them?

Well, effectively you include them.

The ratio Richard was citing excluded.

It's just the NPAs without the 90 days but when you actually do the reserve methodology, since it's mostly the consumer assets that are more than 90 days, it does factor into the allowance methodology and analysis.

But the nomenclature people use for externally reported numbers is often just allowance the NPLs or NPAs without the 90 days.

Okay.

When Richard said just staying at the top of the peer group on the 150 to total loans and watching that, do you want to keep the reserve above the combination of NPLs plus restructured plus 90 day plus or is that not actually, should I not think about it that way?

I wouldn't think about it that way.

I mean there's two things.

One we obviously look at how we believe we should be well capitalized and adequately reserved relative to our peers and we are a highly rated bank and those are important measures but then we also have the internal methodology to calculate the allowance and that's where you get into the delinquencies and the underlying ratings of commercial credits, et cetera, which Richard was also talking about.

Okay.

Thanks a lot.

Yes.

Your next question comes from the line of [Tom Dohini] of Decade Capital.

Good morning, Tom.

Good morning.

Just a quick question.

I apologize if you hit on this but the decline in credit and debit card revenue from the fourth quarter I realize there's a lot of seasonality in that line but anything else you can hit on in terms of the decline from a linked quarter basis or is that just purely seasonality?

No, it's purely seasonality.

In fact it's even got the increase in fuel prices offsetting that, so it's absolutely and wholly seasonality.

There's nothing remarkable in there at all.

Great.

Thanks a lot.

(OPERATOR INSTRUCTIONS) There are no further questions at this time.

Thanks.

So Judy, wrap it up.

Thanks, everybody for joining us.

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

Thanks.

This does conclude today's conference call.

You may now disconnect.