美國合眾銀行 (USB) 2008 Q4 法說會逐字稿

Welcome to US Bancorp's fourth 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 Wednesday January 28th at 12.00 midnight Eastern time.

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

Bancorp.

Thank you, Rachel, and good morning to everyone who has joined us on the call today.

Richard Davis, Andy Cecere, and Bill Parker are here with me to review US Bancorp's fourth quarter 2008 results and to answer your questions.

If you have not received a copy of our earnings release and supplemental analysts' 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 risks and uncertainties.

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

I will now turn the call over to Richard.

Thank you, Judy, and good morning and thank you for joining us.

Andy and I would like to start the call today with a short review of our fourth quarter results.

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

Our Company recorded net income of $330 million for the fourth quarter of 2008.

Reported earnings per diluted common share of $0.15 were $0.38 lower than the earnings per diluted common share in the same period of 2007 and $0.17 lower than the prior quarter.

Although the company's operating business continues to do well, the decline in reported earnings from a year ago and the prior quarter was primarily the result of higher credit costs including the cost of building the reserve for credit losses and additional impairment charges on securities, a consequence of current market conditions.

Significant items impacting the company's fourth quarter earnings included $253 million of securities impairments and a $635 million incremental provision expense.

In total, significant items reduced earnings per diluted common share by approximately $0.34.

Our performance metrics were negatively impacted by these significant items as return on average assets in the current quarter fell to 0.51% from 1.63% in the fourth quarter of 2007.

A return on average common equity dropped to 5.3% from 18.3% in the fourth quarter of last year.

Without the securities impairments and reserve billed, return on average assets and return on average common equity would have been approximately 1.46% and 17.5%, respectively.

As I stated at the beginning, our operating businesses continued to do very well this quarter and the results were highlighted by the following.

Growth in total average loans, excluding the acquisitions of Mellon 1st Business Bank, PFF Bank & Trust, and Downey Financial of $19.2 billion or 12.7% year-over-year, with solid growth in all major categories.

On a linked-quarter basis, total average loans, excluding acquisitions, increased by $5.2 billion, or 12.4% on an annualized basis.

As many of you have heard me say in the past, you U.S Bank is open for business.

Our growth in average loans this quarter demonstrated that fact, and our fourth quarter new business statistics further illustrate just how successful our business lines were in attracting new loan customers and servicing the lending needs of our current customers.

During the fourth quarter, U.S.

Bank originated over $16 billion in new loans to businesses and consumers, including over $3 billion of consumer loans, over $8 billion of residential mortgages, over $1 billion of loans to small businesses, and well over $3 billion of commercial and commercial real estate loans.

And be assured that we have not strayed from our high quality credit standards to attract and establish all of these new and expanded customer relationships.

We also experienced exceptional growth in average total deposits this quarter.

Average total deposits, excluding acquisitions, increased by $12 billion, 9.6% over the same quarter of last year, and $5.8 billion or 17.2% annualized on a linked-quarter basis.

Our company continues to benefit from the uncertainty in the financial markets and a flight to quality by customers seeking our stability.

Net interest income in the fourth quarter increased by 22.6% year-over-year, and 9.9% on an annualized linked quarter.

This increase was the result of an improvement in the net interest margin which was 3.81% in the fourth quarter, a 16 basis points higher than the previous quarter, and 30 basis points higher than the same quarter of last year, in addition to the quarter's strong growth in average earning assets.

Moving on to fee income.

Seasonality, a slowing economy, and unfavorable equity markets led to the decline in a number of fee-based categories this quarter including payments, trust investment management fees, and deposit service charges.

Payments related fees, which include credit and debit card revenue, corporate payment products and merchant processing services were lower on both a year-over-year and linked-quarter basis, as a result of a decline in transaction volumes.

Trust and investment management fees were also lower year-over-year and linked quarter as adverse equity market conditions reduced the value of assets under management, and consequently, related management fees.

Deposit service charges decreased from both of the comparable time periods due to a change in consumer spending patterns in this challenging economic environment.

Mortgage banking revenue also declined year-over-year and linked quarter, primarily reflecting a change in the fair value of mortgage servicing right, net of the economic hedging activity.

Mortgage production of $8.1 billion was higher than both the same quarter of 2007 and the prior quarter, the majority of which was packaged and sold in to the secondary markets.

As many of you are aware, mortgage originations are up substantially in 2009 with the drop in interest rates, and we expect our mortgage originations to continue to accommodate the increased demand from both new and existing customers.

Treasury management fees and commercial product revenue were higher than the fourth quarter of 2007 by 9.4% and 8.3% respectively, reflecting the wholesale group's ongoing revenue initiatives.

On a linked-quarter basis, treasury management fees were seasonally flat while lower syndication fees offset increases in other lines within the commercial product revenue category.

Finally, within non-interest income, other income was lower year-over-year primarily due to the higher end of term residual losses and impairment on consumer auto leases, offset somewhat by the impact of a Visa gain of $59 million as the litigation escrow account maintained by Visa Inc.

was funded in the quarter in connection with their recent settlement with Discover.

On a linked quarter basis, the Visa gain made up the majority of positive variance, with end of term losses on retail auto leases slightly favorable, as well.

Total non-interest expense in the current quarter was essentially flat to the fourth quarter of last year, but $137 million higher than the previous quarter.

The variance, or a lack of a significant variance year-over-year, was largely the result of a $215 million Visa litigation charge which was taken in the fourth quarter of last year.

Offsetting this favorable year-over-year variance was approximately $70 million of operating and integration expenses related to recent acquisitions, as well as higher expenses associated with the ongoing investment in our business lines, our national marketing campaign, loan workout expense, and tax credit investments.

Our efficiency ratio as reported for the fourth quarter of 2008 was 50.6%, lower than the 55.1% we posted in the fourth quarter of 2007, and slightly higher than the previous quarter.

We continue to be one of the most efficient financial institutions in the industry with a full year efficiency ratio of 47.4%.

We have always operated with a disciplined approach to expense control and our ability to manage our costs is particularly important in this environment.

As many of you know, in addition to our standard profit plan, each of our managers submits a contingency budget that includes a 5% reduction in expenses relative to their approved plan.

This year's planning process was no exception and we have recently begun to ask managers in certain business lines to implement their expense reduction scenario.

Be assured that this company will implement cost saving strategies in a very thoughtful and deliberate manner so as not to hamper the momentum of the business lines and their future success.

Moving on to credit.

As expected, credit costs trended higher again this quarter.

Net charge-offs of $632 million were 26.9% higher than the third quarter of 2008.

An increase similar to what we experienced last quarter and in the middle of the range that we projected in December.

The increase in net charge-offs reflected continued stress in the residential home and mortgage-related industries, declining home prices, and the impact of the worsening economy on both our commercial and retail customers.

Total net charge-offs to average loans outstanding were 1.42% in the fourth quarter compared to 1.19% in the third quarter.

Also, as expected, non-performing assets increased this quarter.

The change reflects an increase in the bank's core loan portfolio and the affect on non-performing assets of the recent acquisitions of Downey Savings and PFF Bank and Trust.

At December 31st, total non-performing assets were $2.624 billion.

Included in non-performing assets was $643 million of loans and other real estate covered by a loss-share agreement with the FDIC in connection with our acquisition of PFF Bank & Trust and Downey Financial.

In other words, there is a minimal amount of potential loss given the terms of the agreement with the FDIC.

Excluding these covered assets, non-performing assets increased by $489 million or 32.8%.

This is also in line with our expectations, as previously communicated to investors.

The majority of the increase in the core bank portfolio was related to residential construction, residential mortgages and related industries.

However, the economic slowdown also had an impact on some of our commercial and retail customers.

The ratio of non-performing assets to loans, plus other real estate owned, excluding covered loans, was 114 basis points at December 31st, still well below the ratios posted by our peer banks to date.

Restructured loans that continued to accrue interest rose by 27.9% this quarter as the company continues to work with customers who are current or will become current on their payments, to renegotiate loan terms enabling them to keep their homes, and retain the value of that relationship for our shareholders.

As I've said in the past, we intend to protect the quality and strength of the balance sheet, and given the upward trends in both net chargeoffs and non-performing assets in addition to the current economic slowdown.

We increased the allowance for loan loss this quarter by reporting an incremental provision for loan losses of $635 million, or an amount equal to 100% of net charge-offs.

With this addition to the allowance for credit losses, the company's allowance for credit losses to period-end loans, excluding covered assets, was 2.09% compared with 1.71% at September 30th.

And the ratio of allowance to non-performing loans, excluding covered assets, was 206%.

Going forward, we will also continue to assess the adequacy of our reserve for loan losses and provide for credit losses to reflect changes in the credit risk of the loan portfolio and economic conditions.

Again, we enter this credit cycle with a strong balance sheet and we will continue to protect that position going forward.

And finally, and importantly, our capital position remains strong.

On November 3rd, we announced our participation in the Treasury's Capital Purchase Plan and subsequently issued $6.6 billion of preferred stock and related warrants to the U.S.

Treasury.

Our Tier 1 and total capital ratios were 10.6% and 14.3%, respectively, at December 31st, both well above our target levels.

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

Thanks, Richard.

I would like to begin with a quick summary of the significant items that have impacted the comparison of our fourth quarter results to prior periods.

At an investor conference in December, we disclosed a few significant items that were expected to impact our company's fourth quarter results, and the actual impact was as predicted.

Included in our December presentation were the following.

First, we expect an impairment charge on our SIV exposure of $200 million to $300 million.

The actual impairment was $253 million.

Second, we predicted net charge-offs to be in the range of $610 million to $650 million and that we were expected to build the company's loan loss reserve by an amount equal to 90% to 110% of net chargeoffs for the quarter at a rate higher than the previous quarters.

Net charge-offs in the fourth quarter equaled $632 million and the actual reserve build was $635 million.

Significant items totaling $888 million were very close to the expectations, and reduced earnings per diluted common share by approximately $0.34.

For comparison purposes, during the third quarter of 2008, the company recorded $411 million of security losses, the result of impairment charges on the structured investment securities, other preferred securities, and non-agency mortgage-backed securities.

Other income in the third quarter included $39 million of losses related to the bankruptcy of an investment banking firm.

In addition, third quarter results included incremental provision expense of $250 million.

Together these significant items reduced third quarter earnings per diluted common share by approximately $0.28.

Finally, as you may recall, the fourth quarter of 2007 included two significant items, including a $107 million charge to other income related to the original purchase of the structured investment vehicles from an affiliate, and a $215 million charge related to Visa, Inc.'s litigation settlement.

Now, just a few comments about operating earnings.

Net interest income in the fourth quarter was higher on a year-over-year and linked quarter basis due to both earning asset growth and strong net interest margin.

The improvement in margin on both a year-over-year and linked quarter basis was the result of growth in higher spread assets, the benefit of being liability sensitive in a declining rate environment, and net free funds.

In addition, we were also able to maintain very favorable short term funding rates as market volatility continued throughout the quarter.

Going forward, assuming the current rate environment and yield curve, we expect net interest margin to moderate to a level comparable to the average for 2008, or in the low to mid-360s.

This expectation accounts for the impact of the recent acquisitions of PFF and Downey Financial, the downward repricing of certain consumer loan products, and the normalization of funding and liquidity in the wholesale funding markets.

As Richard mentioned the growth in non-interest income was affected in the fourth quarter by losses on auto lease residuals.

Specifically $71 million of the decrease in other income, year-over-year was attributed to residual losses.

On a linked quarter basis, we saw a $3 million improvement in the total amount of losses from retail auto leases.

We continue to carefully manage the residual risk on this portfolio.

Given the current market for used cars, we expect adverse market pressure on auto lease residual values to continue in into 2009 but overall losses will be manageable as the number of vehicles coming off lease declines.

On November 21st, U.S.

Bancorp acquired substantially all of the assets, assumed all deposits and most of the liabilities of Downey Savings & Loan and PFF Bank & Trust from the FDIC.

We did not acquire the legal entities of either of these institutions.

And I'd like to clarify a few points regarding the impact that these acquisitions had on the results in financial reporting.

First, the company purchased net assets of approximately $1.6 billion between these two acquisitions for a nominal amount of consideration.

Second, as part of these transactions, U.S.

Bancorp entered in to a loss-sharing agreement with the FDIC which provided for a specific credit loss and asset yield protection for a significant portion of the loans and foreclosed real estate.

These assets encompassed by the loss sharing agreement with the FDIC are referred to as covered assets in our financial reporting and are segregated from all other assets for transparency.

Table eight in our fourth quarter earnings release includes a summary of these covered assets.

As of December 31st, we have estimated that these covered assets with a contract value of $13.8 billion will incur cumulative credit losses of approximately $4.7 billion or 34%.

Of the $4.7 billion, $2.4 billion represents the company's estimate of the losses to be offset by the loss-sharing agreement with the FDIC.

The remaining $2.3 billion represents U.S.

Bancorp's first loss position of $1.6 billion, essentially equal to the net assets received at close, plus an additional $700 million of losses which represents the company's remaining share of expected losses.

Finally, because the majority of the assets acquired in the Downey and PFF transactions were experiencing credit deterioration, they were recorded in the financial statements at their estimated fair market value to reflect expected credit losses and the estimated impact of loss sharing agreements.

Accordingly, we will not record additional provision or chargeoffs related to covered assets unless further credit deterioration occurs going forward.

You will note that we have provided credit statistics with and without these covered loans for comparison purposes.

I will now turn the call back to Richard.

Thank you, Andy.

In conclusion, overall I was disappointed with the relative size of our earnings this quarter, and our inability to increase earnings on either a linked quarter or year-over-year basis.

However, I'm very proud of the fact that our company continues to profitably navigate through this difficult economic environment while continuing to build momentum for our future.

Our fundamental businesses remain strong.

We are, however, a bank, and therefore not immune to the challenges facing our industry.

But as the results of the fourth quarter and full-year 2008 demonstrate, we are actively lending to credit-worthy borrowers.

We are judiciously investing in and growing our banking franchise and businesses.

We are serving our communities through business partnerships and employee volunteerism.

And we are creating value for our shareholders by maintaining our prudent approach to risk, preserving the quality of our balance sheet and the strength of our capital, and positioning U.S.

Bank to meet both the challenges of today and the opportunities of tomorrow.

That concludes our formal remarks.

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

(Operator Instructions) Your first question comes from the line of Matt O'Connor with UBS.

Good morning.

Andy, I was hoping you could give us a little more color in terms of how you calculate the tangible common equity ratio.

I think you are showing 4.5, and I get 3.8 when I ex goodwill, and then when I exclude other intangibles I get closer to 3.3.

I'm just trying to reconcile how you're calculating it to get to 4.5.

Sure, Matt.

It is a calculation that we have actually used for over a decade and it's been consistently applied.

I believe the fundamental difference between the way you are calculating and we are is some components of OCI and the inclusion of those.

And we start with core capital.

And probably the biggest difference is the exclusion of the unrealized gain loss in securities in our calculation.

We believe that starting with the core capital number is more appropriate.

Are you excluding -- obviously you are excluding goodwill, but what about the intangibles?

Yes, we are.

So all intangibles other than the MSR, I would assume.

That is correct.

All goodwill, all intangibles, and then adding back, or not excluding the MSR, correct.

Okay, that's helpful.

Separately, Richard, you guys have been one of the more responsible banks out there, you're one of the stronger banks out there.

But the outlook for the industry overall seems rather dire.

And I know this might be a little bit of an unfair question, but how do you think about what the government can do to fix the industry overall?

You guys have been dragged down by it and I think everybody is kind of looking around for some solutions, and I'm wondering if you have any thoughts on how you think this all plays out.

Thanks, Matt.

First of all I'm actually quite optimistic with the new administration and the new team that we will have some new solutions and I think perhaps a more collaborative view of asking a lot of us in the banking community how we think different solutions might be best suited.

So I'm looking forward to being more a part of it.

I would also tell you that as difficult as things look, I'm looking forward to the time when banks will start to trade again on their core earnings.

And I know that's quite a ways into the future when the fear and the unknown finally is extracted from the formula.

But our company is pretty simple, as you know, and we are doing exactly what we did a few years ago in exactly the same way, all the same businesses.

And despite the economy bringing us slower with some revenue based on the payments and trust businesses which is an interim solution that will eventually recover, and the fact that loan losses are a reality, and we're taking our fair share of those but still earning well above those, I'm kind of encouraged that, at least in the simple form of things, that as this is a cycle.

It is longer than we thought it would be, it might be deeper and more protracted than we thought it would be in more places.

I'm actually looking forward to getting to the other side because our core fundamentals haven't been affected and we're still operating the old fashioned way of a balance sheet bank growing the business with fees and spending money to ensure there is a future.

In terms of the actions that the government hopefully can take, I think we all agree that part of this is just confidence.

In fact, it might be the biggest part, and that's very intangible.

But to the extent we can get things moving again, I think it's going to be instructive for people to believe that there is a market out there that's willing to help them ether grow their companies or grow their personal assets.

You know, you look at the headline that banks aren't lending, and obviously we don't participate in that headline because, as I said, we lent over $16 billion in new loans last quarter, I should typically celebrate the fact that we're having a flight to quality and many of our peers are not.

But in this circumstance, we're no longer celebrating that distinction.

We're wishful that everybody will get back onto the game and that we'll have a more robust banking environment where people start coming back to banks for lending.

So I'm looking for a solution that will help all of us equally, and I think getting the housing situation fixed will be the first remedy.

Getting the foreclosures behind us, and getting the turn in the market where the valuations start to improve instead of degradate is going to be helpful.

And I think the confidence is the other piece that kicks in because after real estate and real estate-related issues, which are many, we're just going to have people needing to turn the corner and believing that an investment in themselves and their homes and their companies is going to be a well-placed investment that will eventually yield a return.

And what I'm happy to report in my long answer to your question is that banks are the place again where they are going to go.

Despite all of this turmoil and discord in the last couple of years, I don't know if anyone's noticed but banking is back again.

It's a really good business.

And it's the place where consumers and businesses are going to go to grow their companies and grow their lives.

The risk premium is back, the yield curve is back.

The confidence isn't, but it will be.

And eventually, when you look at the alternatives of the interlopers that came in with international funding, foreign investors, private equity, most of that has been there, visited, and left.

So on the long view, if we can get past this difficult time, the structure of core banking is sound and I'm looking forward to getting there first.

In the near term, specific to USB, would you be interested in additional capital from the government or some sort of loss-sharing arrangement?

Or do you feel like your capital structure is adequate as is?

I feel like our capital structure is very adequate as is.

And while you never know what plans may come along, we don't have any projected view of needing any additional capital or needing any government assistance in virtually any combination of outcomes.

Thank you very much.

Thanks, Matt.

Your next question comes from the line of David Rochester with FBR Capital Markets.

Good morning, guys.

A quick question regarding your dividend.

I just want to get your updated thoughts on that in the context of the deepening recession and with the tangible common equity reduction you guys took this quarter.

If you get to the point where you are internally looking at under earning the dividend for more than just a couple of quarters, whether it's due to securities impairments or continued reserve building, are you thinking that in that kind of a scenario you'd take a closer look at that payout ratio?

Yes, David, thanks for fashioning it that way because that's exactly the right way to ask it, and the answer is yes.

Let me just remind our investors, every 90 days our board evaluates the dividend.

And seriously every 90 days, there's never been anything rubberstamped about it.

As you know, we just declared our dividend at the late middle of last month, just paid it out a couple of weeks ago, and we are scheduled to look at it again in the middle of March, at which time we will.

To the extent that we have a dividend out there, it should reflect to you that we think we can more than cover our dividend with earnings and that's how we identify the level at which we should pay out.

To the extent that the world becomes more impaired or there becomes scenarios that aren't currently contemplated even by us at this point in time, then we'll use that information to evaluate in March and again in June and again in September, and we'll make the right call.

We're not going to preserve the dividend to be ridiculous about being dead right if it's not going to be appropriately covered by earnings.

But we're also not going to reduce the dividend until which time we feel that it's appropriate and necessary given, number one, the constraint on being able to raise it again, and, number two, on the fact that we recognize that's a value to our investors and our shareholders is part of the strength of this company.

Okay.

Thanks for that.

And just one last one, in terms of the restructure loans, and the increase linked quarter, can you talk about what drove that increase, where you saw most of this, and was any part due to the inclusion of Downey and PFF?

This is Bill Parker.

The restructured loan increase is just a continuation of something we began more than two years ago.

Primarily two areas.

One, residential mortgages where ether we know people have great recess coming up, and we'll be proactive and get a hold of them, and if they are current we'll say you will not have to increase your payment, just keep making the same payment.

That's about half of the residential mortgage restructuring loan increase.

And then the other piece is where people have fallen behind, we have a variety of programs to help them.

We verify their income and hopefully can create a program where they can continue making a reasonable payment.

If it's something where they can't make a payment, that at least has some kind of market rate to it, then it will be a non-performing loan, even if they do stay in the home.

On the credit card side, where the other increase comes from, we have a variety of either hardship or workout programs, and, again, we will offer what we consider fair rates of something less than what they have been paying to allow them to get back on their feet.

You might also add for David that with the Downey acquisition we agreed to participate in the FDIC's restructure program and we're actually having good success with that.

Right.

And the restructured loans that you see in our table do not include the Downey, PFF.

Most of the single-family homes came out of Downey, $10 billion to $11 billion.

We're offering a specific program that was put forth by the FDIC, all goes through verified income.

You can extend the loan term up to 40 years, you can reduce the interest rate down to 3%.

All of those are covered assets, and to the extent we reduce our rates below something which is market, that is part of what the FDIC has offered up as their loss sharing.

It's not just a credit loss sharing, it's also a value loss sharing.

Thanks, Okay.

Great, and one last one, I just thought of.

The increase in terms of the net charge-offs in C&I, can you talk about that, and what industries you saw increased stress that contributed to that?

Yes, we did have a couple of larger C&I charge-offs in the fourth quarter.

One of them was related to the oil and gas energy industry.

It was a pipeline and storage company.

And another credit we had a larger loss on was in the gaming industry.

Both are industries that we have active roles in financing, but there were issues in both of those credits.

Okay.

Great.

Thanks a lot, guys.

Your next question comes from the line of Mike Mayo with Deutsche Bank.

Hi, Mike.

Hi, how are you doing?

Good.

Can you comment more on your outlook for credit and non-performing assets and what you are seeing.

And to follow up that last question, what other industry groups are you monitoring more closely?

And also as related to the covered assets, is there any scenario where you can lose money on those covered assets.

I'm just trying to figure out, when I look at a reserve to NPA ratio, should I permanently exclude those covered assets?

Or is there a chance we could have losses down the road?

I'll have Andy answer the last question first, and I'll answer the first one last.

Mike, on the covered asset question, first of all I should highlight that our current expectation is very, very consistent with the expectation we had a month-and-a-half ago, two months ago, when we did the deal.

For the most part we're at the point of the loss sharing agreement on those covered assets that it's a 95% FDIC loss, 5% U.S.

Bank loss.

So, to the extent that we're wrong, for the most part we're at that level of sharing.

As regards to our view looking out on credit losses, both charge-offs and non-performs, I'm happy to report that as basic and as predictable as we have been in the last four quarters, you can just go forward so far on the same trajectory.

We're seeing the same kind of linked quarter, 20%, 30% increase in non-performs and chargeoffs.

I don't see that changing in the near term.

I have always been a pundit to say if you can see 90 days out, after that it gets a bit blurry.

But in the 90 days out, we're seeing nothing remarkable, but nothing improving.

We're just seeing a continuation of what we have seen heretofore, and that's why we thought we would at the end of the year basically double down on our reserves to continue to be at the high end of a fortress balance sheet.

And that may or may not need to continue because we may not see that as necessary if we just continue the same kind of trajectory.

We are looking forward, Mike, to that moment when all of a sudden loan losses appear to start flattening out and eventually settling and going down.

Somewhere around that time, reserve build starts to slow and goes down to equal to earning asset growth.

And when those days happen, those will be great days for at least those of us that are just operating standard above the line in core growth, and then it will be able to shine through.

But in the meantime, I think we're going to project the rest of this year as probably more of that traditional increase in losses first, reserve build along the way, and we haven't seen a place yet where that turn in the corner is evident.

And so FDIC covers 95% of the covered assets, so you are exposed 5% of what number?

Would it be of the $5 billion that's currently covered or of an original amount?

It's at the original amounts.

We expected a certain amount of loss.

We wrote down our assets to that loss level.

There was a 20/80 loss-sharing agreement, Mike, 20% to U.S.

Bank, 80% to the FDIC.

Up to some level.

We're just about to that level.

There's a little bit left to go, and then after that it would be 95% FDIC, 5%.

5% of the $14 billion?

5% of whatever losses occur on that loan portfolio.

Of the original $14 billion.

So it can't hurt you too much at this point.

That's right.

That's correct.

And you are right on the $14 billion.

And then just one separate question, the processing businesses, how much of the decline is seasonal, and how much is more, permanent through this cycle, especially with consumer spending going down the way it has?

Can you just elaborate on that?

The processing businesses we'll define -- my answer will include merchant processing and we'll say corporate card, corporate spend, some of the less traditional businesses that a lot of our peers don't have.

I would say that the decreases you have seen are, the majority of those are recession related.

They are not seasonal.

Seasonality would typically bring us to a fairly flat quarter four over quarter three because the government is higher quarter three and comes down in four but the retail goes up in quarter four from quarter three.

Instead they are both down.

And they are both down linked quarter and they're down year-over-year, and that is almost entirely recessionary or slowing.

We saw, as you all did, on the merchant side you can see either our big portfolio of airlines, hotels, and resorts, or retailing.

It's a third, a third, a third.

They all showed a certain level of significant drop year-over-year in the month of December, and the government spending went to almost nothing in the last half of the last month of the quarter based on what appears to be a lot of cost-cutting and budget controls.

January we expected to be slower.

It is slower.

It is not exceeding our expectations, so it's actually firmed up a bit over perhaps the delta year-over-year that December had.

But make no mistake about it, consumers and businesses are spending less, they're traveling less, and they're watching their nickels and dimes.

We'll be affected by that in the near term.

What I like best about this business, though, is the pipeline, if you will, is built and it's done, so it's just less is flowing through it.

When the market recovers, we just start putting more through it, and it's very scalable.

So we don't have any structural losses here, and we have no loss of customers.

We're still building our base of new businesses.

We simply have less per customer incidence for I think the next six months or so.

And last followup, since it is so scalable, and revenues aren't quite as strong, why not do another acquisition in the processing area?

Absolutely could.

That would be brilliant.

And to the extent that we're able to find our, you could expect that to be on the shortest list of things that we could do.

Thank you.

Yes.

Thanks, Mike.

Your next question comes from the line of Chris Metascio with Stifel Nicolaus.

Good morning, all.

I wanted to follow up on Matt's original question.

If I calculate the tangible common ratio like I do for most banks, instead of getting a range, I get 3.2%.

We've had other banks that are below 3 of course have gotten hit hard because of that.

Can you just give me thoughts on your comfort level with a TC ratio, again, calculated like we do for other banks, in the low 3s?

Yes, Chris, this is Andy again.

First of all, as you know that ratio is calculated a bit differently among different entities.

Different banks calculate it differently.

Some of the rating agencies calculate it differently.

So we have been using this consistent calculation and again, we start with the core capital number.

As we've talked about, we think the way we calculate it, we'd like to stay above the 4% ratio as sort of on internal target we have set for ourselves, perhaps the way you're calculating it, it's above 3%.

So it is something we are cognizant of, however, we have a very strong earnings power.

We have great businesses.

We're very comfortable with the ratio as it is.

And as Richard mentioned, we don't see any need to capital raise or anything around that to improve that ratio.

We're comfortable where it is.

And if I can follow up on a different question, you gave some margin guidance, so I think some of this was already answered, and I missed the first part of the call, so forgive me.

Of the 16 or so basis points of margin expansion in the quarter, was any of that tied to the acquisitions made in the quarter or not?

No, Chris, none of it was tied to the acquisitions.

First, we benefited from rates coming down in the fourth quarter.

We're liability sensitive so that helped us out.

That will level in the first quarter and the rest of 2009.

Second, as you know, and particularly in the month of November, there was a very volatile market, particularly in LIBOR, and we are [growing] LIBOR on the asset side of the equation so that helped us out a little bit.

The acquisitions actually are a bit negative to our net interest margin, and once we have the full impact of the quarter in there, that's why we said we'll be in the low 360s.

Chris, it is Richard.

I'm going to go back and just confirm what we just said.

Basically the way we define tangible common, and you can define it however you want, we're not going to debate that, but based on our measurements we have indicated and would indicate here, that while we didn't do another deal, a transaction, we set a minimum limit for ourselves of 4%, the way we define it.

There's no magic about that, but we thought it would be instructive for our investors to know that we do think there is a minimum level that is appropriate to have, no matter what your preferred or Tier 1 capital is, and we would make sure that we would go out and raise the difference to protect those levels.

I appreciate that, Richard, thank you.

(Operator Instructions) Your next question comes from the line of Brian Foran with Goldman Sachs.

Good morning.

I'm sorry if I missed this but do you have any redefault metrics you can give us on restructured loan books so we can think about how much of that ultimately ends up in performing versus non performing?

Yes, everything in restructured loans gets reported as either current loan, delinquent loan or if it does redefault goes into non accrual.

Two comments on that.

One, we have been doing this for over a couple of years.

One of the ways we measure that is looking at, on residential mortgages, anybody that eventually does go into, for the first time, into foreclosure.

By that measurement, it's at about 13%.

And I will say, though, that that has a blend of much older loans, which are going to have a higher rate, and that can get up to 20% or 30%, along with the newer ones that we have just restructured, which are obviously, at least in the short-term, doing fine.

But on a blended rate basis, up through our data on the fourth quarter, it was a 13% rate going back -- not back into it, but into foreclosure.

This is Richard.

I would say, from the layman view, we do have some comps against some of our OCC brethren and we are slightly more successful than our peers have been.

I don't exactly know that it's the approaches we're all taking or the time in which we grab the customer and do what we can to restructure, but that's favorable.

And I would say we would do this again and again and again.

This is good business at times like this.

We have long given up the need to be dead right and hold onto the terms and conditions of a loan and put a customer out of their car, out of their home, out of their credit card.

We have found it for years to be smart, to restructure, but it's never to our benefit to let the numbers lie or confuse any of you.

So, for us it's not 100% guarantee it is going to stave off an eventual loss but it's well worth the effort, and in many cases it's proven to be successful.

And then if I could just follow up, and not to beat a dead horse, on the tangible common, but is there any piece of the securities portfolio you would highlight?

The 4.5% basically assumes that a lot of this stuff will revert to par.

Is there any piece of the sub piece of the securities portfolio that you would highlight as potentially actually being at risk of defaulting at some point in the future that we should think about into '09?

This is Andy again.

If you think about our portfolio of about $40 billion, about 60% of it is agency-backed, mortgage-backed securities, high quality.

About 20% is municipal or treasury related securities, also high quality.

And then we have about $3 billion of jumbo, about $1 billion of Alt-A, and then some other debt securities and trust preferred.

I would say we have appropriately priced all of those, and the stresses that occurred in this quarter relate to spread widening on some of those securities I talked about.

We reflected the losses, other than temporary impairment, and I'm very comfortable with the accounting there, so overall it is a high-quality portfolio.

There may be additional stress also in there, obviously the SIV portfolio which is down to $1.225 billion now.

It's a high-quality portfolio.

We've reflected the prices and the OTTI and the permanent impairment correctly.

I appreciate that.

Thank you.

On the SIVs, Andy, let's go back and reflect.

We're down to $1.2 billion.

It's now marked at about $0.54 on the dollar.

Right, so we're not here to tell you that it's over and that we won't have any further impairments, but based on the starting point of a year ago at $3.1 billion, and both the paydowns, and the writedowns and the current position, we don't feel any longer that that is a material surprise activity for any of us to forecast, and while there may be some additional losses in the tens of millions of dollars over the next few quarters, it's just that.

And so now we're down to just being a simple bank with earnings above the line and loan losses and reserves [billed] below it.

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

Good morning, everybody.

Richard, I was just wondering just in terms of your outlook on the credit side and expectations for that higher loss levels going forward, and MPAs and so forth, what kind of unemployment scenario are you factoring in?

And as you have talked in the past about your recession outlook and plan and so forth can you give us a little bit more color in terms of the general economic backdrop you're factoring in whether it's the [data] lease residuals or the car portfolio and so forth?

Sure.

First of all to answer your question, we're looking at 7% to 8% scenario moving through to 8%, maybe even a little higher by year's end.

We're not at the Armageddon, 9.55, 10.5% levels but we're also reflecting what we see in the current world.

One thing I'll say, Todd, is as you know, because our portfolios are wholly prime based in the credit card side and the majority of that on the consumer side and all of that in the mortgage side, we probably haven't felt all of the effects yet of the unemployment trickling in to the customer's inability to pay.

In other words, at 6.5% or 6.7% unemployment, you would probably agree with me that even most of us on this telephone call don't know a lot of people unemployed.

And those aren't the people that we've been making loans to or doing business with on the lending side.

But if all of a sudden you get to 7.5%, 8%, 8.5%, we are all going to start knowing people that have viable positions that now lost their job and they have assets that they owe banks to and all those things.

So we're expecting to see something less than linear, perhaps something more than linear in that losses will start to move up as unemployment goes higher.

So, my point is, we've accounted for it that way.

I don't think that you'll see our loan losses to be very predictable and pretty steady based on the quality of our portfolio, but where you are seeing losses in credit cards, retail lending or home-based products, we'll continue to see that move up over the course of 90 days in a very steady way.

On the chargeoffs, that could come from commercial real estate or from commercial lending, C&I lending, that's a little lumpier, and while 2008 will have been be our look back on taking care of some fairly big losses in our California housing and developer portfolio, those are done and paid for.

Now I think in 2009 we'll have a fairly steady equal amount in losses in commercial real estate attributed to just more traditional commercial real estate across our national footprint.

And on the C&I side, I don't expect that to change a great deal.

I just think we'll continue to have new names to replace prior names with a slight increase over the course of time.

So for us, I think when the cycle is done, we'll have continued to enjoy a meaningful spread below the losses of most of our peers, but we're going to see a meaningful increase from where we ended last year by the end of 2009 just because the world is going to get worse before it gets better.

I appreciate that, and just more specifically with the card portfolio, again essentially a prime based portfolio but as you mentioned before, potentially with the unemployment level perhaps exceeding 8% in the near term, your loss rate is over 5% now.

I mean conceptually, and again, a big part of your loss coming through in the card portfolio, could that conceptually go over 6%?

I got you.

I know the sound bite you want now.

Yes, in quarter four you see we are at 5.18% in credit card.

We are going to forecast that to be slightly over 6% -- 6% to 6.5% at the end of this year or a year from today as we're talking about on quarter four.

We're not talking 7% and 8% but we're not talking it stays in the 5s.

We see it continue to atrophy to something more like 100, to 125 basis points above where it is.

Thanks very much.

Your next question comes from the line Eric Wasserstrom with Galleon.

Hi, how are you?

Two quick questions.

I just wanted to make sure I understood how the incremental $700 million of losses from the acquired portfolio is going to be treated.

That does or does not flow through the provision?

Most of those losses do not flow through the provision.

Most of the loans that we acquired are accounted for at a fair value level and those have been marked down, so to the extent there is further mark downs against it over and above our expectations, that would flow through.

But to the extent they're at their fair value, that's already being marked down and will not flow through charge-offs.

So the $1.6 billion taken at closing, the incremental loss above that, you are saying was actually captured in the basis adjustment?

Yes, so think of it this way, Eric, we purchased an entity that was $1.6 billion long in assets.

And our total loss expectation for the portfolio is just over $4.5 billion, of which about half is covered by the FDIC covered guarantee.

So the remainder, let's call it $2.3 billion, you really net against the long asset position of the $1.6 billion, and that represents the $700 million that we really think economically will be a loss to U.S.

Bancorp that's reflected in our numbers.

Okay.

And that's the basis adjustment portion?

Yes.

And we have marked those down.

Those assets we have marked down to 34% consistent with what we talked about in both the presentation and our call here.

So those have been marked down.

Our expectation loss is 34%, and that's how, going through the math I described, we get to the $700 million net number for ourselves.

I'm bringing it up, because we will undoubtedly have something flow through provision, I'm sure, but it won't be very much to the extent that we have already marked them down to 66% of the original value, and because we have accounted for so much of the stress that's happened in those portfolios at this point in time.

I will say, though, how grateful we are that we have that loss sharing agreement and the backstop that protects us, given what could be a more dire scenario for some of those California -- primarily California assets.

Thank you for that explanation.

And just one other quick item.

I didn't understand from the press release what happened with your tax rate in the period.

Can you just explain that to me?

Yes, simply stated, we have a number of items that are tax-benefited income items, and to the extent that our revenues and our net income was lower, those tax benefited revenue items were a bigger component of the overall income number, therefore our tax rate went down We would expect it to go back up or to more normal levels in 2009.

Thanks very much.

Despite the fact I told Andy I really like that tax level.

Yes, I'm sure.

He's not very helpful about that.

There are no further questions at this time.

I would now like to turn the call back over to Richard for closing remarks.

Thank you, Rachel.

I just want to say one last thing in terms of our closing comments.

I am very, as I said, disappointed about our top-line earnings, but I can tell you, I'm very proud of the momentum we're building in this company, and at the end of the day we'll be traded eventually on our core innings with reasonable loan losses and reserve build, and I think you'll see we'll be one of those banks to come through this even stronger than we started.

I also draw your attention to the rating agencies that have recently made a number of changes since the 1st of December.

And at least as we speak to you today, both with S&P and Moody's we now are alone as the most highly rated bank of our large-bank peer group with a AA rating and a stable outlook with S&P, and an AA2 and stable outlook with Moody's.

And we are quite proud of that, and to the extent you would agree that that's some reflection of the quality of both our balance sheet and our earnings ability.

We close with that as one of our points of pride, and certainly the employees here and I are using that to our benefit to continue to grab this opportunity that has been created in this environment where we are taking market share, we are growing deposits and loans, and we're able to continue to invest in some of the businesses that you expect us to be investing in, so that we're distinctly different and diversified in earnings and prepared for, I think, a better day, when things start to improve.

So that's all we have and we thank you for your attention and interest in our company.

Judy, I'll turn it to you for the final legal close.

Thanks, Richard, and thank all of you for listening to our review of the fourth quarter 2008 results.

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

And thank you, Rachel, for your help.

You welcome.

This does conclude today's conference call.

You may now disconnect.