美國合眾銀行 (USB) 2009 Q2 法說會逐字稿

Welcome to US Bancorp's second quarter 2009 earnings conference call.

Following a review of the results by Richard Davis, Chairman, President, and Chief Executive Officer, and Andy Cecere, US 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 noon eastern time through Wednesday, July 29 and 12 midnight eastern time.

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

Thank you, Michael.

And good morning to everyone listening to the call today.

Richard Davis, Andy Cecere, and Bill Parker are here with me to review US Bancorp's second quarter 2009 results and to 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 www.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, our details in our press release, and in our form 10K and subsequent reports on file with the SEC.

I will now turn the call over to Richard.

Thank you, Judy and good morning, everyone.

Thank you for joining us.

Andy and I will begin the call today with a short review of US Bancorp's second quarter.

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

Since our last earnings call a number of significant events have occurred that have impacted our investors and our customers, as well as our Company as a whole.

I would like to take a moment to summarize those events before Andy and I review the details of our second quarter financial results.

On May 8 the results of the Supervisory Capital Assessment Program or stress test were released.

As we announced US Bancorp passed the stress test.

I'm also very proud to say that we ranked the best among our peers in the category of Resources to Absorb Losses to Risk Weighted-Assets and Total Loan Loss Rates.

On May 11th, we announced a $2.5 billion common stock offering and a $1 billion nonguarantee debt issuance.

The capital raise was not prompted by the results of the stress test but rather by our Company's desire to redeem the $6.6 billion of preferred stock issued to the US Treasury under the Capital Purchase Program and a move forward from a position of strategic flexibility and independence.

The issuance of the nonguaranteed debt was also required to qualify to repay the TARP fund.

We were very pleased with the outcome of this issuance as it was completed at the best pricing of any other peer bank debt issuance up to that date and was a testament to the credit quality of our institution.

Both the common stock offering, which raised $2.7 billion of capital, and the debt issuance were successfully completed in one day.

On June 17, we announced we had redeemed the $6.6 billion of TARP funds and finally, on July 15th, announced we completed our participation in the program by repurchasing the warrant issued in the conjunction with the TARP fund for $139 million.

A successful exit from the TARP program validates the strength of US Bancorp.

We are grateful for the support of the taxpayers and the regulators during our participation in the program, and we are now looking forward to capitalizing on the position as one of the largest independent banks in the country.

While we were managing through these corporate events, the rest of the Company continued to run business as usual and produce strong core operating earnings in what can only be described as a very stressed economic environment.

US Bancorp recorded net income of $471 million for the second quarter of 2009.

Diluted earnings per common share were $0.12.

Once again we achieved record total net revenue this quarter, and it was driven by growth in both net interest income and fee revenue, the latter of which was led by mortgage banking activity.

Although core operating earnings were strong, significantly higher credit costs, including the costs of (inaudible) at allowance for credit costs reflecting economic conditions and higher FDIC insurance costs resulted in earnings that were lower than the second quarter of 2008 and the previous quarter.

Significant items impacting the Company's second quarter earnings per share included an FDIC special assessment of $123 million, accelerated amortization of the discount or deemed dividend of $154 million associated with the TARP preferred stock redemption, net securities losses of $19 million, and $466 million of provision expense in excess of net charge offs.

In total, significant (inaudible) reduced diluted earnings per common share in the second quarter by approximately $0.34.

Our performance metrics were impacted by these significant items with a return on average outset in the current quarter of .71% and a return on average common equity of 4.2%.

Excluding the significant items I just noted, return on average assets and return on average common equity would have been 1.41% and 15.9% respectively.

As I stated, our Company continued to perform well this quarter on an operating basis, and I would like to review a few of those financial highlights that impacted these results.

First, we recorded strong overall growth in total average loans year-over-year.

Total average loans outstanding increased by $20.8 billion or 12.8% with growth in all major categories.

Excluding the impact of recent acquisitions, total average loans on a core basis grew by over 5% year-over-year.

On a linked quarter basis total average loans decreased by 1%.

This linked quarter decrease from average loans outstanding was principally due to the reduction in commitment utilization.

Specifically, the average rate of commitment utilization by our corporate and commercial borrowers declined from an average of slightly over 37% in the first quarter of 2009 to slightly under 35% in the second quarter.

The decline also reflected an overall softening of demand for new loans by our customers, both commercial and consumer as they maintain a cautious outlook on the economy and their own growth opportunities.

We are, however, continuing to originate and renew new lines and loans for our current and for our new customers.

In fact, during the second quarter of 2009, US Bank originated over $16 billion of residential mortgages, another record quarter for US Bank Home Mortgage.

We originated over $4 billion of consumer loans, including installment loans, student loans, lines of credit, and home equity lines and loans.

We originated new prime based credit card accounts with lines totaling $2.5 billion.

And we issued almost $9 billion of new commitments and renewed over $16 billion of commitments to small businesses, commercial, and commercial real estate customers.

Overall, new origination plus new and renewed commitments were over 12% higher than in the previous quarter.

As I stated at the time we announced the redemption of our TARP preferred stock, we continue to look forward supporting the government's efforts to maintain the flow of credit in these stressful economic times.

We will continue to be responsive to the borrowing needs of our current and new credit-worthy customers, and more importantly, we have the capacity to do so.

Another highlight of the second quarter results was our outstanding growth in total average deposits.

Total average deposits increased by $27.4 billion or 20.2% over the same quarter of last year and $2.7 billion or 1.7% un-annualized on a linked quarter basis.

With that acquisition, the year-over-year growth was a very stong 11.2%.

We continue to be one of the highest rated financial institutions in the country with our lead bank USBank National Association, rated AA1 by Moody's, AA minus by S&P, AA minus by Fitch, and AA High by DBRS.

These ratings have given us a significant advantage, as our customers make the decision as to where they should bank and where they should place their trust.

The excellent growth in the average deposits further illustrates our Company is benefiting from the uncertainty in the financial market and the flight to quality that consumers and businesses that are looking for a safe, stable, and sound financial institution.

As I previously mentioned, the Company reported record total revenue in the second quarter.

A major contributor to this success was Mortgage Banking, which also produced record setting revenue with increases year-over-year and linked quarter of $227 million and $75 million respectively.

The growth in Mortgage Banking revenue reflected higher origination fees, servicing revenue, and a favorable change in the fair value of mortgage servicing rights and other economic hedging activity.

The latter which had a positive impact on revenue this quarter.

Record mortgage production of $16.3 billion was significantly higher than both the same quarter of 2008 and of the prior quarter.

Finally, I would like to draw your attention to non-interest expense, which was impacted by the special FDIC assessment and overall increase in the rate of insurance coverage, partially offset by benefits from the implementation of the Company's cost-containment plan in late January.

Year-over-year, including the impact of acquisition and the incremental cost of FDIC insurance, total non-interest expense increased by less than 1%.

The $258 million increase in expense on a linked quarter basis was the result of the increase in FDIC expense, as well as seasonally adjusted higher operating expense, and a national marketing campaign, partially offset by the Company's cost saving efforts.

Our efficiency ratio as reported for the second quarter of 2009 was 51.0%.

Excluding the FDIC special assessment, the efficiency ratio was 48.0%.

We continue to be one of the most efficient financial institutions in the industry.

I'm pleased to report we achieved positive core operating leverage this quarter on a year over year basis.

Now moving on to credit.

As I pointed out earlier, an increase in credit costs, including the cost of building allowances for credit losses drove the year-over-year reduction in the Company's net income.

Net charge offs of $929 million were 17.9% higher than the first quarter of 2009, a lower percentage increase than we experienced in the previous quarters.

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

Also, and as expected, nonperforming assets increased this quarter.

The rate of increase at 17.8% was, however, lower than in the past number of quarters.

At June 30th, the total nonperforming assets were $4.016 billion compared with $3.410 billion on March 31.

Included in total nonperforming assets were $682 million of loans and other real estate covered by a loss share agreement with the FDIC in conjunction with our two California acquisitions.

There is a minimal amount of potential loss in these loans, given the terms of the agreement with the FDIC.

Excluding these covered assets, the majority of increase the nonperforming loans within the core bank portfolio was related to residential mortgage and residential construction related industries as well as other commercial real estate lending.

Restructured loans that continue to accrue interest rose by 10.8% as the Company continues to work with customers to renegotiate loan terms, enabling them to keep their homes.

Since 2008, including loans service for others, we have modified over 15,800 residential mortgage loans, totaling approximately $3.5 billion.

These efforts are consistent with the government's objective to restore the housing markets and are aimed to retain the value of these relationships for our shareholders.

As expected, given the upward trends of net charge off and nonperforming assets, in addition to the continued weakness in the economy, we increased the allowance for the loan loss this quarter by recording an incremental provision for loan losses in excess of net charge offs of $466 million.

This represents approximately 50% of the current quarter's total net charge offs of $929 million.

With this addition, the company's allowance for credit losses to period end-loans, excluding covered assets, was 2.66%, compared with 2.37% at March 31 and the ratio of allowance to nonperforming loans, excluding covered assets, was 152%.

As we look ahead ninety days, we anticipate continued growth in both net charge offs and nonperforming assets.

However, we expect the rate of growth to trend lower.

Going forward, we expect to continue to increase the allowance for loan losses until credit quality has stabilized and we have consistent evidence that net charge off levels are leveling off or declining.

We will continue to assess the adequacy of our allowance for loan losses and provide for credit losses in the level that reflects changes in the credit risk of the portfolio and the current economic conditions.

Finally, and importantly, our capital positions remain strong.

Our tier one in total capital ratios were 9.4% and 13.0% respectively at June 30th.

Both very comfortably above the well-capitalized bubble as defined by the regulators.

Additionally our tier one common equity ratio increased to 6.7% from 5.4% at March 31.

Our tangible common equity to tangible assets rose from 3.8% March 31 to 5.1% on June 30.

All these ratios benefited from the recent $2.7 billion capital issuance and positive earnings.

Let me now turn the call over to Andy.

Thanks, Richard.

Overall, the Company's second quarter results reflected the quality of our core franchise and its earnings power.

I would like to provide you with a few more details.

I'll begin with a quick summary of the significant items that impact the comparison of the second quarter results to prior periods.

First, non-interest income included $19 million in securities losses.

Included in this total were $88 million of impairment charges on securities, including perpetual preferred securities, our SIV exposure, and a few agency and nonagency mortgage backed securities.

These impairment charges were partially offset by gains on securities sold during the quarter of $69 million.

Second, other non-interest expense in the second quarter included a pre-tax $123 million charge for an FDIC special assessment that will be paid in the third quarter.

Third, diluted earnings per share was reduced by the impact of $154 million deemed dividend associated with the repayment of the TARP funds; and finally, we recorded an incremental provision for credit losses in excess of net charge offs of $466 million in the second quarter.

These significant items in the second quarter reduced diluted earnings per common share for approximately $0.34.

For comparison purposes, during the second quarter in 2008, the Company recorded $63 million in securities losses.

Additionally, results in the second quarter of 2008 included an incremental provision for credit losses of $200 million.

The net impact of the second quarter 2008 significant items reduced diluted earnings per share by approximately $0.11.

Finally, non-interest income in the first quarter of 2009 included $198 million in security losses, a $92 million gain on a corporate real estate transaction.

The prior quarter also included an incremental provision expense of $530 million.

Together these significant items reduced first quarter 2009 diluted earnings per common share by approximately $0.28.

As Richard mentioned at the beginning of the call we repurchased the warrant issued as part of the TARP program for $139 million on July 15th.

This payment will not have an impact on earnings in the third quarter as the payment represents a direct reduction in equity.

The payment will result in a nominal reduction in our tier one and total capital ratios of approximately 6 basis points.

Now a few comments about operating earnings.

Net interest income in the second quarter was 10.3% higher than the second quarter of 2008, primarily due to a strong 10.5% increase in average earning assets.

As projected, an interest margin for the quarter was 3.60%, one basis point higher than the previous quarter, or in other words relatively stable.

Our outlook for the net interest margin hasn't changed.

Going forward assuming the current rate environment and yield curve, we continue to expect non-interest margin to remain relatively stable.

Total non-interest income in the current quarter was higher year over year primarily due to strong mortgage banking revenue as well as favorable variances in net securities losses, commercial product revenue, ATM processing revenue, and treasury management fees.

The growth in both commercial product revenue and treasury management fees reflect the Company's ongoing initiatives.

Payment related revenue, trust and investment management fees, as well as deposit services charges and investment product fees and commissions declined year-over-year, adversely impacted by the slowing economy and unfavorable equity market conditions.

These revenue categories, particularly payments and trust in investment management, however, are positioned to rebound as the economy strengthens and the equity market stabilized.

Within non-interest income, other income was lower year-over-year, primarily due to an unfavorable variance in equity investment income which was partially offset by lower end-of-term lease residual losses.

Strong mortgage banking revenue and seasonally higher payment revenue, trust in investment management fees, deposit services charges, treasury management fees, all contributed to the growth in non-interest income excluding significant items on a $180 million on linked quarter basis.

Additionally, the other income category benefited from the lower end-of-term losses on auto leases.

As we indicated in our last call in January, the end-of-term losses on retail auto leases peaked in the third quarter of 2008 at $84 million as the number of cars coming off lease began to decline.

End-of-term losses in the second quarter of 2009 were down to $14 million.

Finally, excluding the increase in FDIC insurance costs and acquisitions, non-interest expense was essentially flat year-over-year, again demonstrating the Company's ability to control expense at a level appropriate for the current operating environment.

I will now turn the call back to Richard.

Thanks, Andy.

The past few months have been anything but ordinary for our Company.

We have been operating in one of the most challenging economic environments in our country's history.

We completed and passed the regulatory stress test, we raised $2.7 billion of new common equity.

We redeemed $6.6 billion of preferred stock and subsequently completed the repurchase of the related warrant.

Working against this extraordinary event filled backdrop, our Company posted record net revenue, maintained a controlled expense environment, continued to lend and gather deposits and preserved the strength of our credit ratings and capital base.

As we move forward, we will continue to build our franchise, enhance our products and services, and engage and develop our employees.

In other words, we will capitalize on our now unique position of strength and independence to further differentiate US Bank from its competitors.

In fact, in early July, we launched a nationwide ad campaign to reinforce that message to our current and future customers as well as all of our financial partners.

We felt this was the opportune time to further build brand awareness for our Company in its distinctive position as one of the nation's largest, independent financial institutions.

Our focus on revenue generation continues with an emphasis on building deeper relationship with our customers.

For example, 39 weeks into our relationship review initiative we have held over 6,700 meetings with clients and have identified almost 9,000 opportunities to increase share of wallet, which translates into potential incremental annual revenue of almost $400 million.

On the revenue side, approximately 10% of our households have now signed up for a relationship deepening package of product that provide our customers with superior value and create more value for our shareholders.

While focusing on these and other new revenue-producing initiatives we remain poised to capture the many opportunities that will present themselves as the financial markets and the worldwide economy recovers.

We expect to continue to be among the best performers in the industry, as our diversified mix of businesses, longstanding prudent approach to risk, dedicated employees and the strength of our balance sheet enable us to manage, and even prosper, in this period of unsurpassed economic stress.

In conclusion our second quarter results reaffirm that our fundamental businesses remain strong.

Although credit costs remain, and will remain, elevated in the near term, we are open for business and managing this Company for the long-term as we continue to prudently lend to credit worthy borrowers, judiciously invest in and grow our franchise, support our communities, serve our customers, and importantly create value for our shareholders by sustaining our earnings power, high quality balance sheet, and capital strength.

That concludes our formal remarks.

Andy, Bill Parker, and I will now be happy to answer first questions from the audience.

(Operator instructions).

Your first question comes from Matthew O'Connor with Deutsche Bank.

Good morning.

The past few quarters, I think you have been a little bit more explicit in your charge off guidance, and this time you are just saying will remain elevated.

Any comments you want to give in terms of what elevated might mean?

Up another 15, 20%?

Flattish?

Sure.

I would be happy to.

As I told you in the quarters before this, we were always projecting that we would see pretty much flat results from the prior quarters.

And then last time we met, ninety days ago, we said we would start on to see that coming down.

In other words the trajectory of the increase would come down.

I would expect the trajectory you saw coming down in this quarter from prior quarters will continue in that same direction in the future quarters.

In other words, we are starting to see this continued reduction in increase becoming now a more consistent outcome.

So, if you like what you saw between quarters one and two, I think you'll start to see the same trajectory follow in quarters two to three.

Okay, so charge off growth to slow, that would apply to MPAs as well?

It would do both.

They are not moving in direct lock step, but they're both moving in the direction the same way.

It is a fairly positive outcome.

Okay.

Just in general, if we think they picture here, you have managed the risk well on the market disruption the first part of the cycle consumer credit.

The second part, there are some folks out there, including myself, that are pretty much concerned on the C&I in the commercial real estate.

Two questions -- one what is your outlook for those loan buckets in general?

And two, has there been a meaningful difference in underwriting at USB, versus others the last several years?

Yes.

I want Bill to answer the specifics.

But I'll tell you I think we are continuing enjoy the benefits of the many years of not stretching to make loans to C&I commercial real estate customers.

I think you would agree, we were the last large bank into the recession in terms of credit distress, and I predict we'll be the first out because of the longevity of longstanding prudence is going to pay us dividends.

You'll see we are stressing like everyone else, but I think you'll continue to see that our peaks and valleys will be muted compared to others.

Bill?

Sure on the C&I portfolios, the mid markets, corporate portfolios, the only areas that have been problematic there are the newspapers, media, gaming type industries where you see higher leverage points.

But, we have do not have a large leverage portfolio.

So our core middle market and corporate is actually holding up pretty well.

They have taken the correct actions to weather the storm.

Small business, of course, sees some stress in this environment.

But, overall, C&I is holding up pretty well.

On commercial real estate, we talked about residential construction for a long time now.

We are almost two years into this.

What began in California -- our outstandings there are now $2.7 billion; that's down from over $4 billion before.

That is an area that is going to continue to be stressed and we are continuing to work through it.

I think I mentioned last time it has moved into the Pacific Northwest, where we also have over-exposure, but the loss there is not as bad as we have seen in California.

Okay, just lastly, Richard, if we look at commercial loan demand, it seems like it has fallen off a cliff, both for you guys and just the industry in general.

I guess from a broader point of view, is this a positive because customers are paying down debt, or is it a negative because it implies further cuts in output and staff.

I think could it be both?

It feels like both.

I think it is a positive in terms of banks balance sheets not taking on customers that will fall into further stress with this kind of duration of this down turn.

In our case, the reason I highlight the majority of our decrease in linked quarter outstandings was the derivative of our open-to-buy commitment was to show that the demand is there for the right customers.

And as you know, we're up 12.8% in linked quarter originations.

But, those who have the money, have the availability to use their money, have really restructured the way they run their business, and they are simply not drawing open-to-buy loans.

I believe the demand overall for the strongest customers is reflective of what you would expect a year year and a half into recession where they permanently reset their capital expenditures and some of their growth objectives and they're not using as much of the bank's balance sheet or their own, frankly, to grow.

I think that is a normal outcome in this point of the cycle.

I think it is good for banks if we continue to be prudent as an industry and not reach to get loan growth by reducing our underwriting.

Certainly won't do that at this Company.

As I have told you before because of our strong operating earnings we will compete on price for the AAA customers in order to keep our own or to go get someone else's.

Our margin stability, in part, reflects we could have a little margin increase but we want to give it back in the form of high quality customer attraction.

I think it is probably both, Matt, in terms of the economy.

It's not very good news for the banks.

I think, those who stay pure to their underwriting, you'll see the demand is the biggest reflection of why a loan growth isn't prominent across the industry.

And I think that is probably a good sign we are not reaching, trying to do something we shouldn't do.

Okay.

Thank you.

Next question comes from Ed Najarian with ISI group.

A couple of questions.

First, can you quantify the net gain in the valuation of mortgage servicing rights, net of any hedges.

Let me give you the hedge number.

The hedge gain, year-over-year.

So in the second quarter of 2009, it was a positive $45 million.

In the first quarter of 2009, a positive $2 million.

In the second quarter of 2008, it was a negative $25 million.

So on a year-over-year basis the improvement in the hedge was $70 million.

Okay, but this quarter, the number that impacted revenue positively was $45 million?

That is correct.

Then with regard to the remainder of the mortgage improvements, I would say two-thirds of it was rate related and one-third of it was volume related.

Okay.

Thanks.

Then secondarily, any comments on early stage delinquencies?

Looks like we are seeing a little bit less stability on early stage consumer delinquencies from you guys than maybe we have seen at other banks.

Yes, we did see some improvement.

Our card portfolio was down 30 plus.

It was down 43 basis points in the last 90 days.

That is good for our outlook on the third quarter.

Autos or auto portfolios, both our leasing and loan portfolios, showed a little bit of decline 1 to 5 basis points decline on the 30 to 30 plus.

At least that was stable.

Last year it was still trending up.

Then finally, on our small ticket leasing portfolio, their delinquencies came down about 50 basis points, so that was positive as well.

We have seen a little bit of more normal, seasonal uptick, or improvement in delinquency patterns.

But in terms of mortgage and home equity, I guess?

That is a little more mixed; on the late stage on both mortgage and home equity, we did see improvement, but we also saw an uptick in some of early stage.

You are still looking at those numbers and feeling confident that both MPAs and charge offs can increase at a slower tick.

Ed, this is Richard.

If there is anything we've gotten good at, it is modeling and forecasting and stress testing again our own forecast.

If there is anything I am comfortable with, it is our ability to predict 30 days for sure and now 90 days with a certain high level of certainty.

There is always a lumpiness where you can have any deal, a large customer come out of nowhere with a surprise and we're going to leave that on the table as a possibility.

In terms of the mechanics of the consumer, the home equity, the mortgage, those are very much annuities, you can get a pretty good line of sight now at 90 days.

Commercial,commercial real estate, a little lumpier.

But when you know your portfolio like we know ours, we have a high level of confidence in our ability to predict that.

I said this to you guys two years ago.

We'll always tell you the bad news clearly and honestly and transparently and when the news starts to get good, I'll hope to see with the responses then too.

We are not seeing all green shoots, and we're not seeing the end of the road here but we are starting to see our portfolio a new, repetitive improvement in overall performance of our credit.

We are starting to see that as first a decrease in the increase of negativity, and over the course of time, I think we will be one of the first to be at the top of the hill and get up the other side.

Richard, you have paid back the TARP.

You've strengthened your capital ratios.

Can you give us a sense of your M&A appetite at this point in the cycle?

Sure.

It is no difference for us all because of those other activities.

Those are just nice variables to have behind us.

The M&A activity interest remains the same, Ed.

We are, first and foremost, interested in payment businesses and corporate trust businesses that would add quickly to the scale and value of those businesses that right now have been impaired for the recession but will come back with gang busters had when things get better.

In terms of acquisitions, we'll always be available to the FDIC --a list of opportunities that come along weekly.

But we are going to keep our powder dry for an opportunity that may be above a more significant nature like the Downey PFF or something like that.

I'm not going to do a lot of the Bank of Idahos, a lot of the small five and ten branch deals, unless they are amazingly opportune.

But otherwise, we'll stay on the sidelines.

We'll watch if a larger FDIC opportunity and in the old fashioned sense of acquisitions, that continues to be a very slow, quiet process, given the new results of the FCap and everything else.

We are probably in the near term going to remain on the sidelines and watch and see the good things that come along be able to be opportunistic when and if it happens.

Nothing transformational and nothing outside of the bounds we have been talking Nothing outside of the bounds we have been talking about the last couple of years.

Thank you very much.

Your next question comes from Betsy Graseck with Morgan Stanley.

Thanks, good morning.

Couple of other questions on the early stage delinquencies.

You indicate those have been improving in a couple of different asset classes.

I guess I'm wondering where you fall out with regard to the debate on why they are coming down.

Some folks are kind of suggesting it is still seasonality.

Others are staying slow down in the unemployment rate, growth rate or the jobless claims.

Then another angle is, it is management doing a better job managing, or having an impact on managing these early stage delinquencies.

When you look at your portfolio, what are the drivers there?

I would have to say after seeing fourth quarter and first quarter, going through very rapid deterioration and the number of portfolios, part of it is that we completely upped our protocol on the collection areas.

That does make a difference.

But also, I think it is more a return just to some normal, seasonal patterns, which were not here before while the economy was deteriorating rapidly.

We expect, as the unemployment continues to rise, card loss will over time go up again but third quarter is normally a decent quarter for card losses.

Besty, for your benefit, we have an unemployment expectation of slightly over 10% by year end with a continued increase in 2010.

We are not sitting here thinking outside of the bounds of what others are expecting.

As you all know, a few basis points increase in unemployment, it is like the richter scale.

It is not linear.

It is a big deal and we appreciate how to stress test our portfolios.

For the most part, our unsecured portfolios are prime only and our collateral portfolios are well-written to low loan to value.

Whether it is an impairment in the beginning or an absolute loss, I think we are going to fare quite well.

On the housing side we are expecting an additional 5% to 10% drop in housing values, which at the end of this process will be a peak drop of around 40% fall.

Our expectations are so far aligned with that.

The mix of business we have across our primarily 24 states would reflect that that's not going to be above the average for the national, but probably near or at about that same level.

So I think we are in the range of expectations that some of the economists would predict as well.

Okay.

And then on deposits and deposit growth, did a great job with core deposits this quarter.

I'm sure this is in part the reflection of the efforts you have had with your branch strategies.

But could you speak to where you think the jumbo CDs are, relative to last quarter?

I mean obviously they are down a lot.

But is that kind of an exiting of low risk strategy?

Or did you price to get those folks out?

Betsy, this is Andy.

Our pricing strategy on the retail side is to focus on core checking and savings accounts.

That is where we are certainly more a bit more aggressive.

Not at the top of the peer group, but in the middle of the peer group.

That's been our focus in growing core accounts and we have been successful with regard to that.

On the wholesale side we have had volatility up and down, that's more a function of liquidity on the wholesale customers.

I would say overall, both in terms of wholesale and retail, we have had strong deposit growth.

I think it is a function of the flight to quality and the reputation of our Company.

This is Richard.

I know you followed us for a long time.

It is one of the advantages this down turn created for USBank with our chance to get back into the competitive game for pricing on core deposits.

As you know, we were probably the bottom dust aisle two years ago.

We are now very competitive.

But just because we are competitive for core, I want you to know we don't attract hot money.

We don't like it; we don't know what to do with it; it is not consistent and repeatable and so you just won't see us using our margin to go out and attract on rates on any basis where customers don't bring the rest of the relationship.

We've stayed true to that, but we have been fortunate enough to keep this strong margin at the same time redefine ourselves as a competitive deposit pricer for core deposits and that's helped as well as the flight to quality.

Thanks.

Next question comes from David Rochester with FBR Capital Markets.

Good morning, David.

Good morning, guys.

It sounds like your economic expectations may be a little bit weaker than they were in the last call, at least in terms of what you are looking for from the unemployment rate perspective.

But you are still looking for a deceleration in the growth in MPAs and charge offs.

Would you say that is largely predicated on what you are seeing in the early stage delinquency side; because you are seeing the dip there you are thinking that the rate of growth should slow?

Probably that.

I'll let Bill answer technically.

We don't spend, it is not all modeling.

A lot of it has to do with, we know our customers.

We know them very well.

MPAs are usually a proxy for future charge offs, right?

There are a lot of regulatory reviews.

It has a lot to do with capital allocation.

And those are all what we know them to be.

We want to know at the end of the day which of those MPAs would be a proxy for charge off and which unsecured loans, primarily consumer watch, should go to charge off and that has a lot to do with delinquencies and first and late stage; it has a lot to do with just knowing the quality of your portfolio.

We have a very high sensitivity to who we have lent our money to and how we have done it.

I would say it is a blend between the statistics, David, and what we know about our Company.

It would be very easy for me to take a very safe road and tell you it is going to be another many many quarters of the same 25%, 30% increase in both MPAs and charge offs.

We just don't see that.

We're going to tell you what we see.

We could be surprised like anyone else but our back set which has served us very well -- I don't think we have been wrong on any of our 90 day projections in the full cycle -- are based on a lost data a lot more than just unemployment, housing and delinquencies.

Bill, that is kind of a distilled version.

Well, I think the other thing I would mention is that we are potentially prime based lenders.

And you know, the early part of this economic downturn was really more market disruption, capital market disruption, unique events.

Now, we are entering a phase that looks more like a normal recession.

Not that it is not severe.

But, that has less of a dramatic impact than some of the things that occurred earlier on in this downturn.

Okay.

Thanks for that.

I appreciate that.

One last one.

Have you noticed any change at all, potentially improvement, in the redefault rates you are seeing in your restructured portfolio?

Have you seen any meaningful contributions, or more notable, I should say, contributions growth in this bucket in the C&I or CRE products?

Well, I'll dot residential mortgages ones first.

I'm guessing that is what you are asking about.

You know, our redefault rates there we do modifications, of course, for all of our mortgage portfolios first mortgage portfolios.

And we have a measure of 60 day default rate and right now, that is at about 22%.

And we also measure it based on who enters foreclosures and that is at about 12%.

We take steps to improve that all the time.

With increased significantly the number of mods that we do where the payment actually decreases.

We have doubled the percentage there up to about two out of three of them there where the payment decreases.

That should make the future performance even better.

Additionally, we are entering into the HAMP program this quarter; that's the administration's new program.

That should help, too.

On the commercial or commercial real estate side, we don't have a lot of TDRs there.

Generally, you know, we'll try to work with the borrowers.

The credits will go NPA.

If it is a real estate deal, we'll just charge it down to great value.

Thanks, guys.

Thank you.

Next question comes from John McDonald with Sanford Bernstein.

Hi, John.

Good morning.

I was wondering if you have an outlook on net interest income growth.

It seems that with the margin flat and loan demand being real tepid, it is going to be hard to grow net interest income at least in the near term.

Do you have any views there?

John, we do expect relatively stable margin.

On the earning asset front, I would separate wholesale from retail.

On the retail side we would expect flattish to moderate growth which is what you saw in this quarter.

On the wholesale side, a lot depends upon the utilization we talked about.

We are booking new loans, we're gaining new customers.

The offset is what the utilization would do.

I would expect that to be sort of flat to down.

So those two things may be offset and the bottom line from all that is maybe flattish net income.

Okay.

How about on the securities portfolio?

Andy you assume that will be pretty flattish?

I would not expect major changes there.

What you see in the last few quarters is what you expect in the next few quarters.

Okay.

You guys are pretty specific about the credit outlook.

How about our reserve build?

For the last couple of quarters you were building at 50% to 100% of charge offs and just a little below that this quarter?

What kind of outlook would you have there?

50% is in our history.

50%67%, 75% and 100%.

I just like round numbers that are divisible by something.

50% is on the low end of that six quarter range.

We are trying to telegraph that we are the low end of the sixth quarter trailing circumstances.

I guess what I think, John, is if we start to see a continuation of the kind of trends we saw this quarter, and that continues to bear out as I said in my comments, they need to be sustained and convincing.

We'll start to move that 50% down to 40% or 30% or 25%.

Eventually, we'll get down to very close to where we'll only reserve build for the growth we expect in the portfolio, which will be very nominal.

I want us to have all the reserves built possible so that when the recovery is among us we don't have to take any of the earnings away from that recovery in order to continue to backfill on reserves; and we started this cycle as one of the strongest balance sheets I promised you every quarter we ended.

You'll see us be generous on provision that we will also telegraph our views of the future by the way we start to move that down when it finally starts to happen.

If the credit outlook plays out as you expect with the growth rate moderating in both MPAs and charge offs, we see that reserve bill magnitude start to stay at the 50 and maybe go down from 50?

Yes, it has a positive bias to getting smaller.

We didn't talk about -- it has a lot to do with if you like where you are at the moment in time.

If you like your coverage and we do like our coverage ratios.

I must say we are adequately reserved.

That is the appropriate way to define it.

I like the way we are satisfactorily adequate and I think we are at a place we like if that is the only variable and that starts to become loan loss forecasting and those become favorably bias and I think, so too, will the reserve build

Particularly if the loan books is not growing?

All that much?

Yes we want it to grow.

I'm hoping those commitments just the recovery, the best thing about open commitments, those were 35%.

As the world gets better and our high quality customers decide to start drawing on our lines rise away, that's the easiest, best loan growth you're going to get.

I know with the quality of our portfolio, we'll take that all day long.

I think you'll see a growing balance sheet as well at the prime level that we have had in the past.

Okay.

Then the last thing is with TARP repaid, there is still some uncertainty I guess about maybe new regulatory regimes.

What kind of capital ratios will you guys manage to and which matrix can we look for you to manage.

We have two principal targets that we've talked about.

One is the tier one capital one level.

As you know, historically, we have been targeting 8.5%.

We raised capital to get above 9%.

Given the current environment, I would expect us to continue to be above nine.

Two-thirds of that over two-thirds being tier one common.

The ratios you see now would be consistent to what we would manage to in the future.

You like that two-thirds of total tier one being common?

Is that a good?

At least two-thirds.

At least.

Thank you.

Your next question comes from Nancy Bush with NAB Research.

Good morning, guys.

A question for the future.

Assuming there is going to be one.

Could you clarify what the regulatory input is that you are getting on reserves when we come to the end of this credit cycle?

In other words, are you going to be able to draw down reserves as we did in past cycles?

Or are the regulators going to expect reserve levels to stay high?

We have had no guidance on that.

I have to report we have had no reason to have conversation in any of the last two years on any quarter with our selection of both reserve bills and our adequate coverage.

So we don't have the dialog even to reflect back on and what kind of guidance they are giving.

I will tell from my perspective and what I know and what I'm affected by, I think we all agree the capital ratios will be higher in a pro-cyclical world than they were going into it and I think we are going to be required to keep both cap and I'm sorry loan loss reserves at a higher level.

I also think in the future when I talk to you about loan growth being 10% forecast growth we are going to have to apply a 110% loan loss reserve build, all things being equal, so that we are starting to build for our future book.

I have no conversations, though, to record with anybody here on any guidance whatsoever.

I just think is that on the prevailing wind that is on a pro-cyclical basis, all of us at banks will have higher capital requirements, higher loan loss requirements, and we will be paying insurance premiums for many years forward, all of which were at lower levels or nonexistent going into this cycle.

So that is all I know.

So your view is that the emphasis on the regulatory basis will swing from there anti-cyclical to a pro-cyclical emphasis going forward?

Yes, pro-cyclical is a funny definition, but I think what you meant is there will be vis a vis the old Sun Trust argument they had too much.

There will be a tight balance where we can have the appropriate level, but I don't think anyone is going to argue more is worse than less.

But it is going to be important that we don't build reserves to use for future earnings because that is just bad business and doesn't give you, or our shareholders, a clear line of sight on real earnings.

I think there will be more guidance coming out as it becomes clear the recovery is ending and the banks will no longer look on linked quarter.

They'll just say are you at the right place and we'll probably get that definition in a couple of quarters, but we have been seen them yet.

Just on the capital front Richard, could you just give your philosophy about rebuilding the dividend?

Sure.

Wow, it took six people to get to the dividend.

The philosophy hasn't changed here, first of all.

So I'm going to give you everything but the math.

But we said for a long time we'll give a high percentage of our earnings back to the shareholders in the form of dividend and in stock buy back.

As much as we all forgot stock buy back, it is still a reasonable approach to use.

I think it will come back one day as one of the options.

So if US Bank give a majority of its earnings to the shareholders in those two methods, and I believe both methods will be used in the future by your Company, then the dividend will be something a percentage of a large amount of our earnings will go to the dividend.

But it will be a line of sight that I have to have and the board has to have as we look into the next year and as we begin to evaluate our first dividend increase.

Once we get into the latter part of this year we'll have a good idea for 2010.

It is my commitment to give a dividend increase at a level that is both sustainable, one we can grow from and predicted on the basis of future earnings and that is meaningful.

But I will hold back some for potential stock buy backs to benefit the shareholders in that way and keep a little for ourselves to continue to invest in the future.

Nancy, you have known us for a long time.

Our percentage of high value to shareholders through those two forms has not changed and it is just a matter of now getting my head around what those numbers will be and giving a high percentage of it back to the shareholders.

Thank you.

Next question comes from Mike Mayo with CSI.

Good morning.

Good morning.

You are pursuing some national advertising.

And I just, my first thought is, "oh you must be doing a big deal out of market." Maybe I'm too skeptical there.

You are gaining some share within your market.

Why national advertising and how much might that cost?

Sure the national advertising is intended to be certainly all end market too.

But we are 24 stake franchise and the other 26 we don't usually get a lot of visibility for.

This follows perfectly on our newfound growth of the corporate bank, moving it from a regional corporate bank to a high quality national corporate bank.

As you know we have offices now in both New York and Charlotte and enhanced our team by more than 100 senior lenders and Capital Markets.

People in these markets.

And so number one, Mike, you know the story from a couple of years ago.

But our newest result on Fortune 500 companies is 467 of them do business with us.

But only a mere 132 do corporate banking with us.

The others do corporate trust and/or corporate payments.

All very good.

But we are a national bank and we should have the national corporate capability.

We are talking to the litany of high quality customers both private and public that are starting to know us by our quality, knowing our brand a bit.

If they don't know it, it is at least a neutral equity and now we want to build positive equity.

The campaign is slightly more than $10 million.

It will run the majority of quarter three and a little into quarter four.

It will be TV, and it will be print, and it will be equally end market and out of market identifying primarily the attraction of key suite leaders outside of market and small businesses and consumers end market.

So it's got a nice, kind of bifurcated view.

It is all about strength, stable and being an honest partner with people who need a good partner at times like this.

You touched on this before in terms of larger out of market acquisition?

Yes.

You are a little more open to that, and is that correct?

No.

I didn't mean to say that.

I'm glad you clarified.

Out of market acquisitions are going to be, first and foremost, costly to this Company on two basis.

One is, we have so much momentum going in our organic initiatives, many of which you all have not seen yet, that the cost of us doing a deal in or out of market is substantial.

Will put stress again that momentum.

I'm willing to take it if it is right, but I'm not looking for it.

Out of market, additionally, has a cultural risk.

At least, when we do an end market deal, you have the ability to introduce your culture and confirm it remains.

We have a culture now that I really like.

I don't want it to get diluted -- to do an out of market which caused us to put a lot of people out of the current market to get into those current markets and create a culture.

I wouldn't be unwilling to do it, but it would have to be a remarkably great deal to pursue and at this point in time we don't see anything like that.

I didn't mean to indicate that out of market is of higher interest than end market.

There aren't a lot of opportunities.

I want to let you all know, if a great deal comes along, we'll look at anything.

But we won't do anything our prudent approach we used in the past.

But, if in a couple of years nothing big has come along and we haven't done a big deal, I hope you are not disappointed, because I like who we are.

We are very relevant and we're very good at what we do, and acquisitions is not a course this Company has to take unless the opportunity presents itself, at which point we'll evaluate it.

Last question.

In terms of delinquencies as a good predictor for loan problems, maybe I'm haunted.

I think it was 2001 Labor Day or the day after that when you had your investor conference.

That is before your CEO, you had a different chief credit officers, but it was six weeks or so after that conference when you had the big credit quality surprise.

So just through your experience a couple of decades of doing this, how good of a predictor are delinquencies on future NPAs?

Are there times when it hasn't worked so well?

You mixed a couple of things there, but, first of all in dog years 2001, you are right.

That's five generations ago.

I'm going to tell you this Company and this team is much more able to forecast and we simply would not make that mistake.

I guarantee you that.

In terms of predictability I think delinquencies have always been the best predictor of most likely loss effects from consumers and from the small business portfolio because it is the annuity aspect of it, it just doesn't change that fast.

It is not at all a good predictor, of course, in nonPAs as a predictor of loss in commercial and commercial real estate.

I would say it hasn't changed seven years later.

It is still the best predictor.

But this company has changed.

We know how to do that better; we have a different team here; our focus and Bill mentioned it earlier has been to bring on as much competence on the defense of knowing what is going on in our credit of quality as it was in offense before.

I think it is a good time for you to have trust in our ability to predict.

That last by gone of 2001 is just that.

Bill, you want to add to that?

No, I second that.

I think the delinquencies plus bankruptcy trends are a very good indicator at least for the next 90, 120 days on mostly consumer and small business.

And again on the wholesale side.

It is not necessarily a good predictor at all.

You have to look at other factors.

If there is one factor that makes you better on the whole sale side or maybe it is just the offset to the two, aren't we getting going on the commercial real estate side?

Yes, there is still plenty of stress on our residential construction portfolio.

Like I said, our stress there has moved into our portfolio in the Pacific Northwest about a $700 million portfolio.

So yes we still see stress.

I think Mike, two things.

One would be the mix of our business, unsecured versus secured.

That which is secured was underwritten at a fairly conservative level we can tell the majority of the downturn and predicted downturn.

Risk to loss continues to be less than perhaps likelihood of NPA in both the mix of our portfolio and the quality of those that were underwritten.

We will definitely see the continued stress.

We are not immune to it at all which is why we are not saying losses or NPAs will go down; we'll just continue to think it will go up.

There are no further questions at this time.

Michael, thank you very much.

Judy, your official close?

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

If you have any questions, please feel free to give me a call at 612-303-0783.

Thank you, ladies and gentlemen.