美國合眾銀行 (USB) 2009 Q3 法說會逐字稿

Welcome to US Bancorp's third 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 through Wednesday, October 28, at midnight.

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

Thank you, Kristi and good morning to everyone who has joined our call today, Richard Davis, Andy Cecere and Bill Parker are here with me today to review US Bancorp's third 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 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, everyone and thank you for joining us.

Andy and I begin the call today with a short review of US Bancorp's third quarter earnings results.

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

US Bancorp recorded net income of $603 million for the third quarter of 2009.

Diluted earnings per common share were $0.30 compared with $0.32 for diluted common share in the same quarter of last year.

A $0.02 or 6.3% decrease year-over-year and compared with $0.12 per diluted common share in the second quarter 2009.

Follow third quarter operating earnings defined as income before provision and taxes were higher than both the third quarter of 2008 and in the prior quarter and importantly kept pace with the increased costs of credit including the cost of building the allowance for future credit losses to reflect the current economic condition.

In total, a number of significant items reduced diluted earnings per common share in the third quarter by approximately $0.19.

Andy will provide more details on those items in a moment.

Our performance metrics were impacted by these significant items with the return on average assets in the current quarter of 0.9%, and a return on average common equity of 10%.

Excluding significant items, return on average assets and return on average common equity would have been approximately 1.46% and 16.3% respectively.

As I stated, our Company continued to perform very well this quarter on an operating basis.

Once again, we achieved record total net revenue this quarter driven by growth in both net interest income and fee revenue.

A few of the quarter's finance highlights included an increase in total average loans outstanding of $15.4 billion or 9.3% year-over-year with growth in all major categories except commercial.

Growth in total average loans was impacted by recent acquisitions.

Without acquisitions, total average loans grew by 2.6% year-over-year.

On a linked quarter basis, total average loans decreased by 1% driven mainly by a 5.2% decrease in average total commercial loans outstanding.

Similar to last quarter, the decrease in average loans outstanding was largely due to lower usage of outstanding commitments by our commercial customers.

Specifically, the average rate of commitment utilization by our corporate and commercial borrowers declined from an average of about 35% in the second quarter of 2009 to approximately 32% in the third quarter.

The decline in average balance is also reflected in overall softening of demand for our new loans by our customers both commercial and consumer as they remain cautious and are waiting to see concrete signs of an improving economy before investing and extending their businesses and debt obligations.

That being said, we are continuing to originate and renew lines and loans for our customers who want and need credit.

In fact, during the third quarter of 2009, US Bank originated almost $15 billion of new residential mortgages and over $32 billion of other loans, plus new and renewed commitments for our consumer, small business, commercial and commercial real estate customers.

Essentially equal to the previous quarter's total.

We remain responsive to the credit needs of our current and new credit worthy borrowers and continue to strongly support the government efforts to maintain the flow of credit necessary to stimulate and strengthen the economy.

Growth in average deposits was another highlight of our third quarter results.

Total average deposits increased by $32.8 billion or 24.6% over the same quarter of last year and $3.1 billion or 1.9% on annualized on a linked quarter basis.

Without acquisitions the year-over-year growth rate was an exceptionally strong 16.1%.

This growth clearly indicates that our company is continuing to benefit from a flight to quality.

As one of the highest rated financial institutions in the country, our lead bank, US Bank National Association has a significant advantage over the competition.

Consumers and businesses are looking for a safe, stable and sound financial institution and US Bank ranks at the top of that list when measured against those fundamental criteria.

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

Major contributor to the success was mortgage banking related revenue which grew year-over-year by $215 million.

Total mortgage banking revenue, however, was lower on a linked quarter basis as it fell back about 10% from the record setting revenue posted in the second quarter of this year.

Mortgage production of $14.8 billion was significantly higher than the $7.6 billion recorded in the same quarter of 2008 and modestly below the record setting $16.3 billion in production completed in the prior quarter.

The growth in mortgage banking revenue and production is another example of the flight to quality and our company's ability to capitalize on its unique position in this market.

We have moved from being one of the top 25 mortgage banking providers in the country to being one of the top seven.

As many of our competitors are either no longer in the business or they are pulling back while we continue to support our customers' mortgage needs with high quality mortgage products and underwriting processes.

In addition to mortgage banking, commercial products revenue and treasury management fees also showed solid double-digit growth year-over-year.

I call out these two categories in particular as they most clearly illustrate how the investments we have made over the past two years specifically in our corporate banking expansion and in building deeper relationships initiatives have now translated into positive and tangible results.

With an efficiency ratio of 47.5% in the third quarter, our company has a distinction of being one of the most efficient financial institutions in the country and I'm pleased to say that we achieved positive core operating leverage this quarter on both a year-over-year and linked quarter basis.

We are managing our operating expenses at a level appropriate for the current environment while prudently investing in our businesses and our employees to ensure future growth.

And now moving onto credit.

Credit costs in the third quarter including the cost of building the allowance for credit losses were higher than the same quarter of 2008 and the prior quarter but as expected, the rate of increased moderated on a linked quarter basis.

Third quarter net charge-offs of $1.041 billion were 12.1% higher than the second quarter of 2009.

This percentage increase was lower than the 17.9% increase recorded between the first and second quarters of this year.

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

The $376 million or 9.4% increase was lower than last quarter's linked quarter growth rate of 17.8%, another indication that the credit quality although not yet improving, is deteriorating at a slower pace.

Accruing loans 90 days or more past due excluding covered assets increased by 8% over the prior period.

The increase was largely related to the higher residential mortgages and a seasonal increase in credit card delinquencies plus the impact of recent card portfolio purchases.

With regard to early stage delinquencies, total 30 to 89 days past due loans at September 30 were just slightly higher than at June 30.

Our C&I commercial real estate and small business portfolios all experienced declines in early stage delinquencies relative to the second quarter.

Offsetting the positive variance in commercial related categories were increases in the early stage delinquencies in retail lending led by higher credit cards, first mortgages and home equity loans.

The increase in early stage delinquencies and credit cards reflected a normal seasonal pattern and recent portfolio purchases.

Early stage delinquencies and residential mortgages and home equity loans have been steadily increasing over the past number of quarters but at a growth rate is slowing.

Our auto loan and lease portfolios were the exception in the retail category this quarter with early stage delinquencies improving linked quarter as the value of used cars continues to recover.

Overall, these trends in our early stage delinquencies further support our view that the pace of deterioration in credit quality is decelerating.

Restructured loans that continue to accrue interest rose by 7% this quarter.

Our company began actively working with customers to renegotiate loan terms late in 2007 enabling many of them to keep their homes.

Since 2008, including loan service for others, we have modified over 21,000 residential mortgage loans totaling approximately $3.6 billion, additionally, we began participating in the HAMP, the government's mortgage modification program in August of this year and have since begun trial modifications on over 3500 loans or 12% of eligible loans.

Going forward, we will continue to actively assist our customers and support the government's objectives to restore the housing markets.

As expected, given the upward trends in both net charge-offs and nonperforming assets in the addition to the uncertain and soft economy we increased the allowance of credit losses this quarter by recording an $415 million incremental provision for loan losses.

This represented approximately 40% of the current quarters total net charge-offs of slightly over $1 billion.

This compares to an incremental provision equal to 50% of net charge-offs in both the second quarter of 2009 and the third quarter of 2008.

This incremental provision raised the Company's allowance for credit losses to period end loans excluding covered assets to 2.88% from 2.66% at June 30.

The ratio of allowance to nonperforming loans excluding covered assets ended the quarter at 150% while the allowance to nonperforming loans plus 90 days past due loans excluding covered assets remained unchanged from the prior quarter at 107%.

As we look ahead 90 days, we anticipate continued growth in both net charge-offs and nonperforming assets.

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

Consequently, we expect further increases to the allowance for credit losses as we wait to see credit quality stabilize and have consistent evidence that the net charge-offs are leveling off or declining.

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

Finally and importantly, our capital position remains strong.

Our tier 1 and total capital ratios were 9.5% and 13% respectively at September 20.

Both very comfortable above the well capitalized levels as defined by the regulators and following our repayment of the preferred stock issued under the US Treasury's Capital Purchase program.

Additionally, our tier 1 common equity ratio increased to 6.8% and our tangible common equity tangible assets ratio rose to 5.4% at the end of the third quarter.

All of our capital ratios benefited from the $2.7 billion capital issuance last May and continued positive earnings.

I'll now call -- turn the call over to Andy.

Thanks, Richard.

Once again our third quarter results demonstrated our company's ability to produce quality core earnings while managing through a difficult economic cycle and I would like to provide you a few details about the results.

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

First, third quarter results -- third quarter noninterest income included $76 million of securities losses, representing impairment charges on perpetual preferred securities, our SIV exposure and nonagency mortgage backed securities.

Second, other noninterest income included a $39 million gain related to our investment in Visa and, third, we recorded a $415 million provision for credit losses in excess of net charge-offs.

These three significant items reduced diluted earnings per common share in the third quarter by approximately $0.19.

For comparison purposes, during the third quarter of 2008, the Company recorded $411 million of securities losses as well as $39 million of market disruption-related losses.

Additionally, results in the third quarter of 2008 included an incremental provision for credit losses of $250 million.

These three significant items reduced diluted earnings per common share in the third quarter of 2008 by approximately $0.28.

Significant items in the second quarter of 2009 included $19 million of security losses, $123 million related to a special FDIC assessment and a $466 million provision for credit losses in excess of net charge-offs.

In addition, diluted earnings per share in the second quarter were reduced by the impact of the $154 million deemed dividend associated with the repayment of the TARP funds.

Together these significant items reduce second quarter 2009 diluted earnings per common share by approximately $0.34.

Finally, as a reminder we repurchased the warrant issued as part of the TARP program for $139 million on July 15.

This payment did not have an impact on earnings in the third quarter as the payment represented a direct reduction to equity.

Now a few comments about operating earnings.

Net interest income in the third quarter was 9.7% higher than in the third quarter of 2008 primarily due to the $19 billion or 8.9% increase in average earning assets.

Net interest income was 2.5% higher than the previous quarter largely due to favorable funding rates as average earnings assets were essentially flat on a linked quarter basis.

The favorable change in the Company's funding cost driven by both an increase in low cost deposit balances and lower rates paid on those balances led to an increase in net interest margin which was 3.67% in the third quarter versus 3.60% in the second quarter of 2009.

Assuming the current rate environment in yield curve we expect the net interest margin to remain relatively stable with a slight bias towards improvement in the fourth quarter.

Total noninterest income in the third quarter was higher year-over-year by $681 million partially due to the favorable impact of the significant items most notably lower securities losses.

However, core noninterest income including significant items and acquisitions grew by over 13% year-over-year, driven by mortgage banking revenue, commercial product revenue, treasury management fees, ATM servicing fees and lower end of term lease residual losses.

Partially offsetting these positive variances were trust and investment management fees, deposit service charges and investment product fees and commissions which declined year-over-year adversely impacted by the slow economy and equity market conditions.

Payment-related fees which were flat year-over-year despite a meaningful drop in same-store sales as well as trust in investment management fees continued to be well positioned to rebound once the economy strengthens and the equity markets stabilize.

This positioning is, in part, the result of a number of recent attractive strategic acquisitions including the bond trustee business of first Citizens Bank, the Mutual Fund Administration and Accounting Service Division of Fiduciary Management, the Diner's Club Merchant Portfolio from Citibank, the credit card issuing programs for KeyBanc and Associated Bank and a new merchant processing alliance relationship with Santander in the UK.

In late July we also announced a creation of Syncada a B-to-B joint venture with Visa.

As Richard mentioned mortgage banking revenue in the third quarter was higher than the same quarter of last year but lower on a linked quarter basis largely due to production volume.

Included in mortgage banking revenue this quarter was the benefit from the net impact of the change in fair value of mortgage servicing rights and the associated hedge.

The net amount of the gain was $67 million in the third quarter compared with a net loss of $32 million in the third quarter of 2008 and a gain of $45 million in the second quarter of 2009.

Within noninterest income the other income category was higher year-over-year primarily due to lower end of term lease residual losses as well as the Visa gain.

As we have noted during previously quarterly calls end of term lease residual losses peaked in the later half of 2008.

The end of term losses in the current quarter were $3 million compared with losses of $84 million in the third quarter of 2008 and $14 million in the second quarter of this year.

On a link quarter basis, seasonally higher payments-related revenue as well as higher commercial products revenue, deposit service charges, equity investment income and the Visa gain more than offset the declines and trust in investment management fees, mortgage banking and securities losses.

Total noninterest expense in the current quarter was $240 million or 13.2% higher than the same quarter of last year.

The variance was largely due to acquisitions, higher FDIC insurance premiums, marketing and business development expense related to our new FlexPerks Credit Card programs, increased costs related to investments and tax advantage projects which create an offsetting benefit in income tax expense and cost associated with mortgage servicing and other real estate owned.

Noninterest expense was lower on a linked quarter basis by $76million as the favorable variance resulting from the second quarter of special FDIC assessment was partially offset by an increase in marketing expense for the FlexPerks and higher costs related to our investments and tax advantage projects.

Finally, the tax rate in the third quarter of 2009 on a taxable equivalent basis was 18.4%.

This rate was lower than the previous comparable periods and reflected the marginal impact of tax exempt income, investments in affordable housing and other tax advantage projects combined with a lower pretax earning year-over-year.

The tax rate on a taxable equivalent basis in the fourth quarter is expected to stay relatively flat to the current quarter.

I will now turn the call back to Richard.

Thanks, Andy.

During our second quarter earnings call I said that the first half of 2009 had been anything but ordinary for our company as we had completed and passed the regulatory stress test, raised $2.7 billion of new common equity, paid back TARP and finally completed the repurchase of the related warrant.

Although we continue to operate in a challenging and uncertain economy, our vision into the future is clearer today than it was three months ago.

These past three months have brought us beginning signs of stabilization and even some improvement in the markets we serve.

While unemployment remains high and indications that that it has not peaked the rate of growth has moderated.

The housing sector remains weak but the pressure on housing prices has lessened and we have seen sales activity pick up in some of our most effective markets.

Our commercial customers are still decreasing the usage of their outstanding lines of credit and overall demand for new credit is not robust but our customers are efficiently managing their businesses and prudently saving for the future.

In the third quarter our company posted record net revenue achieved positive core operating leverage, continued to lend and gather deposits, and preserve the strength of our credit ratings and capital base.

I would consider this quarter to be much closer to business as usual than we have seen in quite some time.

Our senior management team just finished participating in an extended Board of Directors meeting.

During our time together we reviewed the Company's business line initiatives and overall strategic direction with the board.

After this review, the Board and the management team reaffirmed the strategic direction of our company and we now continue to move forward building our high quality franchise, enhancing our products and service delivery, engaging and developing our employees, and capitalizing on our unique position of strength and independence differentiate us to our competition.

Our third quarter results, once again, validated the strength of our diverse business lines and effectively demonstrated that the momentum we have created has and will continue to effectively carry us through the current cycle while positioning us to capitalize on the coming recovery.

US Bank remains open for business and we are managing this Company for the long-term.

As we continue to prudently lend to credit worthy borrows.

We judicially invest in and grow our franchise, we support our communities, we provide best-in-class customer service and importantly we create for our shareholders by sustaining our earnings power, high-quality balance sheet and capital strength.

Than concludes our formal remarks, Andy, Bill and I would now be happy to answer questions from the audience.

(Operator Instructions).

We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Matt O'Connor of Deutsche Bank.

Good morning.

Good morning.

You point to a lot of small acquisitions that you've done this quarter and just in general since the crisis began you've done a number of deals.

I was wondering if you had the total revenue hiccup that you've gotten from those deals and what the earnings opportunity might be over time because I feel like it's hard to keep track of each one but they are starting to add up.

Yes, this is Andy.

And what we try to do because each individual acquisition is relatively small but when you add them up, they do become a little bit bigger number.

We tried to as we did in this call demonstrate the earnings growth or the revenue growth or the balance growth related to acquisitions so as Richard mentioned, the 9% loan growth plus was about 2.8% without acquisitions and the net earnings from net interest income flow is around the same level.

The fee income growth was less so because that was driven by core mortgage growth and the expense growth as we said about 88 million of our increase year-over-year is related to acquisition.

We will continue to describe the growth both with and without acquisition in future periods because, again, no one individual acquisition is big but when you add them all up, they become a number that's worth mentioning.

Matt it is Richard, we haven't changed our philosophy that we won't do diluted transactions.

You'll find every one of them does add up but they my take us a little longer to be highly accretive but start out nondilutive.

And anything we did last month is starting to hit some point of benefit and I think over the course of time they will start to add up and given your question, we will do a better job of maybe isolating those for future calls and giving you a sense of what recent 12 month acquisition history has done for our earnings.

Great.

Separately, Wells Fargo came out today and provided a number of outlook comments regarding credit.

They talked about consumer losses potentially peaking first half of next year and commercial losses in the back half of next year and just wondering if you have any time frame on when you think your loss rates might peak in your portfolio or overall.

I read those too.

I'll tell you, I'm going to stick to what I've always said we can see 90 days very clearly.

At the beginning of each quarter we have been close to right at the end of that quarter so I'm going to stick to saying we can see to the end of the year pretty clearly and we do see the increase of both charge-offs and nonperforms to continue to go upward but decelerating rate.

Close to the point we are going to hit the inversion because we don't have that much less to keep reducing on an increasing rate.

I will say we do see the consumers are more predictable because it's more of an annuity business, we can track their behavior and assuming seasonality kicks back into historical patterns we have a pretty good idea that the consumer will track with unemployment and I think we see that sometime in next year but I don't know what part of next year.

On the commercial side based on the quality of our book, I think we will emerge faster from any problems than most of our peers but it's a little less even because it's more customer related than it is group or category related so I would also say that next year we expect those to peak but I wouldn't be so precise as to tell you when or which part of 2010 because we just can't see that far yet.

Okay.

Fair enough.

Thank you very much.

Yes.

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

Hi Betsy.

Good morning.

Thanks.

Couple of questions.

One is on the footprint and how you're thinking about capital usage for extending your footprint.

You indicated that the board reconfirmed the strategic plan for US Bank Corp.

Could you just help me understand what that means for capital usage and extending or enhancing the current footprint?

I can.

Thank you.

First of all, the headline was organic growth at an aggressively level, and M&A's will be opportunistic if and when they come along.

What we wanted to make sure the board is aware of is we are going to continue to pursue what we have done the last two in investing heavily in our franchise from technology to employee engagement to some of the products and services you'll start seeing more of as we build deeper relationships.

That's quite important because we want to set forward an M&A strategy for our future that would be a different approach to things We talked about deepening our investment in our 24 state franchise where you would see the consumer and small business bank as opposed to trying to expand it and perhaps dilute ourselves over more locations.

At the same time, we are going to spend those same energies organically on taking the commercial real estate commercial and corporate banks more at the national level along with the trust business to expand on what we have already been playing effectively.

So I think what -- it's a little unsexy but we basically are confirming doing more what we have done the last couple of years allowing M&A to be infill and depth building as opposed to expansionary and allowing M&A to be to our success but spending a fair amount of our capital in the organic measures of old-fashioned banking to get long-term gains.

At some point you will be hitting the density of presence in your current footprint at levels that perhaps you're targeting already.

I guess my point s at what point do you start seeing the ROIC in expansion at a better return than potentially increasing density of presence in your current footprint?

That's great point.

It's like you were in the room.

We have further to go probably than you think and I'm not disappointed to say that.

We have come to conclude, like a good retailer would, that when we have a market position either in deposits or branch rank and they can be combined, the one, two, or three position and 168 MSAs that we consider ourselves involved in, when, we are one, two, or three it's incremental and accretive, your investments are more than one for one, where your four, five, six or something below that, you'll find your investments are not as well returned and your goal would be to get up into the top three if you can in order to leverage your investments.

Of those 168 markets, slightly more than half of those we are in that one, two, three position but in slightly less than half, which is a whole lot of markets we are not so there's plenty of time and energy to be placed into some really good growth markets where our positions aren't very strong.

If infill, M&A helps, we will have that be a jump start, absent that, strategically we decide to go after directly and discretely to build our infrastructure in places where we are not going to get it otherwise.

Lastly on capital usage, the dividend, what are the key things you're looking for to yield a conclusion that you want to increase the dividend?

I'm (inaudible) without the (inaudible) question.

We are going to do exactly what we have done in all the years' past, very predictable.

By that, I mean it's been historically this Company's routine to look at the dividend December of every year and we will do that again in December of this year.

We will make a recommendation for the board to evaluate in December based wholly on our ability to have confidence in the next one and two-year earnings results for this Company.

Once we get a line of sight and we have a pretty good idea where that would be, we will stress test it for regulatory, policy and economic circumstances.

If we like where that number comes, even in the worst part of the stress test and we feel there's ample room to begin moving the dividend, then that will be the moment we will do it.

If it's December, you'll see it in December.

If not, that indicates we are going to wait a longer to get a line of sight to get a level of confidence.

Regulators aren't going to be coming with the capital requirements until the beginning of the year.

Is there an opportunity for you to rethink the dividend not just in December but in other quarterly --

Absolutely.

We will always rethink it and if we don't take action in December we will continue to evaluate it when we do.

I will also indicate when I say stress test I clue possible outcomes that could be placed upon us under those scenarios too.

Got it.

Thanks.

Yes.

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

Good morning, guys.

Good morning, Nancy.

I think you said, Richard, that the REO adjusted for special items was about 16% this quarter; is that correct?

Correct.

How do you see that going forward?

I mean that's a very healthy ROE given a sort of zero interest rate environment.

Is that a sustainable number?

Is that a number you can build upon in quote normal times, if you could just give your thoughts there?

I will and I'll have Andy give you color around it.

First of all I think that banking in general, because of the higher new bars that will be placed on all of us going forward, namely higher loan loss provisions are likely than they were before the downturn, higher capital requirements are likely and now we are all paying insurance and will for quite some time that in many cases we were actually getting credits for, I think all three of those are natural negative bias toward the ROA and ROE of the long-term banks and the after versus before scenario but I I also think that the increasing old fashion banking on spread benefits a yield curve and the flight to quality that banks will have in being able to be the place where our capital is well recognized and we get paid for risk, I think that's a positive bias, so I think net net you can expect banks to go close to maybe slightly under where they were before and this bank was typically in the 21 to 22% ROE, today we are talking about normalized 16 and I think you'll see us between those numbers as things start to settle.

Having said that, we also do enjoy a strong balance sheet management and this Company doesn't bet on interest rates but we have bias based on the way we are constructed and I'l have Andy talk to that just briefly.

Yes, we are slightly asset sensitive as you know, Nancy so to the extent rates go up and or the yield curve steepens that will help us.

As Richard mentioned the key variable to get back to normalized would be the charge-off level and reserve build and two years ago, three years ago when we were earning in the 20%, we had a charge-off level below 1%.

We are now well above 2, so the extent wet get back to those levels is when we will get back to our normal ROE levels.

And I would ask a similar question about sort of normalized mortgage banking as you look at the mortgage market going forward, I think there's fair amount of confusion about, you know, what a real mortgage market is going to look like in the future.

Could you just speak to your outlook there?

Yes.

We will.

I just -- I'm going to have Andy give you -- we studied that in our strategy session.

We have set a path to increase our mortgage business by over a third from where it was a year ago so we have now added hundreds of new mortgage originators, we have created new operating centers in more states and you will see us to be a more robust player in the market even with the market shrinking, we have gotten bigger and trying to grab more market share as well.

As you know by our size and our composition of other earnings, we are not going to be a one trick pony in any one category but I felt that mortgage to be substantially higher given what we do think is a long-term good and effectively one day will be a predictable earnings stream we wanted to be a bigger part of that so our investments will reflect that and Andy --

I think that's exactly right.

So if you think about this quarter, Nancy, we have production about 14.8 billion and that compares to a year ago about half that level, 76.

The 14.8 is higher than what would be normal run rate because of the refinancing activity and the level of interest rates.

I would expect when we are down in the fourth quarter of next year, we will still be 25 to 40% higher than we were a year ago but probably not 100% higher.

We like the business Nancy, we think it's going to be volatile but it's such an old fashion core what banking does and it's still what people eventually need, banks will be a good place for them to get their mortgages and we want to be a bigger player in that.

All right.

Thank you.

Yes.

Your next question comes from the line of John McDonald of Stanford Bernstein.

Good morning John.

Good morning.

I was wondering if Andy you could give us a little color on the puts and takes in your margin and NII outlook.

Yes.

What's happened this quarter is similar to what's happened in prior quarters, John.

The loan rates, the loan yields have improved a bit, principally on the wholesale commercial side.

Earning assets are relatively flat but the big help, the big positive is our growth in core deposits, both demand deposits and interest bearing deposits.

And the mix in that shift has helped our margin a bit as we talked about 367 for the quarter.

I would expect a continued slight modest positive because of that fact and we see some of the trends here early in the fourth quarter.

In terms of either positioning with the securities portfolio I got two questions there.

Do you see any remaining risks in the securities book and what's your philosophy about kind of growing the securities portfolio given your rate outlook.

Right we are at about $43 billion, John.

Our risks in the future quarters are similar to what we experienced this quarter but albeit at a diminishing level.

They are in the SIV exposure which is down to just about a $1 billion now.

They are in the nonagency mortgage backs and slightly in smaller perpetual preferred.

Those would be our key areas.

In terms of the future, the $43 billion I would expect to be relatively stable perhaps slightly higher in future quarters.

Okay.

And last question on credit.

Do you also expect, you mentioned slowing pace of NTA growth and charge-off growth.

Do you also expect the magnitude of reserve bill to continue to moderate?

Yes.

This is Bill, John.

Yes, if you look back at over our past several quarters, I mean, fourth quarter last year we were at 100% of charge-offs on a reserve bill then it went 167, 50 and this quarter 40%.

Yes again we evaluated at the end of each quarter and it's highly dependent on our economic outlook at that time but yes we do anticipate that that assuming the losses and MPAs continue to moderate which we believe they will in the fourth quarter, that that would come down too.

Bill, I know you just started the HAMP modification program but just a general comment about how modifications even beyond HAMP and restructurings might be impacting your MPAs and delinquencies?

Yes, I mean we -- yes, as you know, we just did start HAMP and I will point out that we actually, when they published the results, they published us at a 3% effective rate or 3% of those that were eligible at two payments past due.

The actual number was 12% and we anticipate that will improve over the next quarter or two as we stabilize the program.

If we look at our total restructured loan book, we have about a billion three in restructured mortgages.

We look at that to (inaudible) which is the way the regulators often report that two payment default, three default rate.

For overall book that's at about 25%, and we also look at it for those that go into the program but then eventually foreclose and that's at about 15%.

Those are the two key metrics that we launch.

John, this is Richard.

We don't get too many chances to offer clarity on things but the HAMP participation has a lot do with the quality of your book too.

We may never get to the high end of that number and I'm not going to apologize for it if we don't have a portfolio that warrants that but we will be at everybody else's best practice in terms of doing the right job at restructuring the mortgages and helping people stay in their homes but I would caution all of you that it's not the only modifications we do and it probably has a lot more to do with the quality of what you start with and necessarily your willingness to participate.

Okay.

Thank you.

Your next question comes from the line of Mike Mayo of CLSA.

Good morning, Mike.

Good morning.

My questions are really on kind of what's normal, so starting with the loan utilization down from 35% in the second quarter to 32% in the third quarter, is this an all time low, what's a long-term average?

What do you think about that?

Yes.

This is Richard.

It's a record low for as long as we have been tracking them on this management team but I know there have probably been times when it's been in the 30% range as well.

I think what I would tell you over the normal course is when you take the mix of our businesses, we are probably in the 35 to 40% range of utilization and we are pretty well diversified across commercial and consumer.

And that's probably the better place to market.

So it doesn't sound like a lot but when you take it on, 100 plus billion dollars and you lose a couple of percentage points, it's meaningful and I think moving from 32 back up into the mid-30s and maybe eventually high 30s will be as impressive as just making loans the old fashion way.

I also offer it to you all as evidence that when it will appear that banks are not participating in the recovery in the economy because our loan books are shrinking and in some cases that may be accurate but for this bank is certainly isn't accurate to say that.

I think the reflection of customers' usage, people who already have loans approved, lines approved probably at pretty preferred rate and they are choosing not only to get more of it, they are actually choosing to pay it down which is the best evidence we have as a proxy for new demand being equally low given the circumstances and people's tolerance right now to extend their balance sheet.

So pay-downs are influencing the bottom line number there?

Most of it in fact for our 1% linked quarter a decrease, majority of it is coming from a decrease in the utilization.

And are you also seeing switch back to the capital markets from bank financing?

Yes, that's also a factor, Mike.

That's a good point.

And, that has opened up and loosened quite a bit in the last couple of quarters and that has helped some of the higher graded companies alternative sources and capital.

So things recover on the negative side, though, the overdraft charges, a couple of the big banks indicated that this was going to impact them starting with the fourth quarter.

How much should a reduction in overdraft fees impact you and when do you think it might impact you?

Well, okay.

First of all, I'm not smart enough to guess on what the newest item is coming out of the senate or the congress.

I know Senator Dodd two days ago came out with a very aggressive position.

I'm not even going to justify it because I'm going to count on the fact that we will have plenty of time to get that into committee and come up with a solution that makes sense.

But in the meantime, we along with others made comments some 30, 40 days ago that ours would begin in the first quarter of 2010, nothing in 2000 -- the fourth quarter of this year and in accordance with that, you can size it to yourself but I think the best estimates have been that that could be a couple hundred million dollars in reduced fees and depending on how the customer behavior moves forward, how they decided to opt out, whether or not they -- their behaviors are, as we would predict them to be that's a pretty wide swing.

For us it's not going to move the needle, not going to change the way we run the company but it's something to watch for and I would say it has nothing but negative vibes towards long-term fee businesses that banks are in but I'm not ready to size it because I don't know what the final rules will be.

When you said a couple hundred million in less fees that's what some people have estimated and that might not be a crazy estimate?

That's right.

And then last question, just a fool follow-up to the mortgage banking question, is there any way to kind of give a rough estimate, how much of your mortgage banking fees this quarter, for example, were due to refinance versus people buying new homes?

About 80% is refinancing, Mike.

And because I heard recently someone said starting in a year or so for the next several years, the only mortgage banking business you'll see is due to the purchase of new homes.

Is that just a stupid statement or is there some truth to that?

I don't know if it's a stupid statement.

I do think there's some pent-up demand for new home activity in addition to the refinancing that we are seeing in this period, so I think the mix will likely change in the future and as we talked about, I don't expect the current levels to continue, our $14.6 billion production is higher than what would be normal but we will be well above where we were a year ago.

Probably -- there will be a gap period that we would guess and I don't know how long or when, but when rates start to go back up, there will be that last flash of people who think, my gosh, I still haven't refinanced, they will go for it and then as rates start to come up and I think that will be faster than new volume to get to the old days.

Net negative to overall mortgage banking income in that window, could be 90 days, six months, I don't know, but whenever that happens, there will probably be a small hole in the earnings continuity but on the other side of it, you'll get back to where houses are fairly priced, people are getting in new homes and they will start refinancing because they have to not because it's rate driven and I think it will be an old-fashioned business in a couple of years.

All right.

That's helpful.

Thank you.

Yes.

Thanks, Mike.

Thanks, Mike.

Your next question comes from the line of Ed Najarian of ISI Group.

Good morning, guys.

Hello?

Yes.

Hi, Ed.

Hi.

Most of my questions have been answered but just one more on the tax rate.

You've been running with these below normal tax rates for the last several quarters.

You indicated that's going to stay low in the fourth quarter.

Can you talk about the pace that that might normalize in 2010 and 2011.

Yes, Mike.

The tax rate at 18-3 this quarter is down because of two reasons, principally the increase in tax related business which causes an increase in expense.

So you see our expense going up about $41 million both on the linked quarter and on a year-over-year basis.

That has a direct relation to a lower tax rate.

That combined with the fact that our income levels are just lower that what would be normal so as I talked about them on the last call, we think our full year number is about 20%.

We still think that.

The first half of the year is just above 20%.

The second half will be just below 20%.

We would expect the activities related to CDC continue to be strong as we continue to go into this year and next year.

Over time when we get back to a normalized level our tax rate will begin to increase from the 20s approaching the 30% but it will take a while until we get to normalized revenue levels.

Really that move from 20% to 30% is mostly a function of getting -- of the earnings normalizing?

That is correct.

Great.

Thanks.

Your next question comes from the line of Heather Wolfe of UBS.

Good morning, Heather.

Hi, good morning.

Just a quick follow-up on your outlook, the one to two-year view of earnings and the stress test for capital levels and reserve levels.

Would you be willing to share with us what some of those stress tests are?

Well, the categorically the stress test would be first and foremost the economy, starting with unemployment rates and how they affect our portfolios and which parts.

Expected usage of lines and commitments we talked about earlier from our commercial customers.

Then move to regulatory and political.

And they are different.

Both very different and the stress test would cause us to be pretty wide on our variances in terms of what we think could happen in both law, policy, the new consumer protection agency, some of those activities are certainly new variables that weren't there before.

And then finally, I add back all of the momentum that this company is having today on its organic, well invested organic initiatives of the last couple years, the flight to quality and then getting things to a point of normal.

I believe flight to quality is even bigger than it was a few months ago for this company and frankly the longer the downturn is present, the more benefit on a relative basis it tracks to US Bank but it's not good for all of us to be in this circumstance so we are building a circumstance where eventually the flight to quality is neutralized and we are not getting gains from.

We are getting it from being a provider of more services to more people with more relationship in more places and carrying that momentum with the kind of normalcy that you've comes to expect years before so the flight to quality is a great opportunity for us to use this to reinvest in the bank while we are getting those benefits but really to not rely on it for too long.

Put all that in the mix, Heather and I think the scenarios are provocative -- and the board was seeing how we would aline the risks and rewards but net net we feel very positive that the old fashion way of banking for a company like ours which is big but pretty simple is going to be pretty positive.

Very nice positive vibe to it over the next couple of years.

And more specifically on the regulatory stress test, what kinds of capital levels and reserve levels will you be stressing for?

Now, that's the art of it, right, not the science.

So that I'm not going to disclose to you because that's proprietary, but let's agree that what you see in the institution the last couple of quarters, namely raised $2.7 million in May to get to a point that we thought was more than sufficient to accept a balance sheet with a good capital position, able to withstand any of the variances of continuing decreasing economy and hopefully to be enough to be a place where the regulators under any circumstances would say you're well capitalized and we are satisfied with where you are.

But that's the art of it.

And so our decisions were made on our own best estimates and they continue to be that and the fact that this company [earns] capital every quarter based on the fact that we make decent amount of money every quarter we believe gives us an ability to feel all the more confident that if where we are isn't good enough we are going to be there shortly no matter what the rules are.

We put that out for not a high risk for this Company but one to protect.

And the 1.3 billion in mortgage TDRs, can you give us a dollar value that's in nonaccrual versus the dollar value on performing?

Well, the ones that are -- the 1.3 is all performing.

Okay.

Wonderful.

Thank you very much.

Thanks, Heather.

Thanks, Heather.

Your next question comes from the line of Carol Burger of Soleil Security.

Hello, Carol.

Hi, Carol.

Carol, are you there?

Yes.

Good morning, guys.

Good morning.

I had my mute on.

Most of my questions have been asked and answered.

I was just wondering, do you have a figure for tangible book value per share?

704.

704?

Right.

Correct.

Thank you.

You bet.

Thanks, Carol.

Nice to hear from you.

Your next question comes from the line of Chris Kotowski of Oppenheimer.

Hi.

If I compare you to most regional banks and I guess I would say your mix of business is very much a regional bank kind of mix of business, one of the things that's really different about you is that you've held your margin very well, whereas it's been under severe pressure for most of the rest of the industry.

And most of the other companies are now kind of guiding to incremental repricing of loans and deposits, adding a couple of basis points a quarter maybe, but then should rates ever go up, then we will get a benefit and see margins going back to where they were a while back and I'm just kind of curious, you're kind of guiding to flattish, slightly up margins.

I mean, if the industry -- if the -- if the regional banking industry generally recaptures 30, 40, 50 basis points that they lost over the last two years, how much of a benefit would you anticipate getting from that?

So Chris whether I talked about a relatively flat with a positive bias, I prefaced it with given the current rate in volume and yield curve and we continue to expect that and we have been pretty close to our expectations with regard to margin and perhaps have beaten it a bit each of the quarters.

So we expect it to migrate up a little bit but not a lot.

To the extent rates increase and more importantly the yield curve steepens, that will be a positive bias to us and I would imagine to many banks partly because we are asset sensitive and partly because the steep yield curve helps.

Chris, it's Richard.

If you look back a couple of years in the [420s, 430], I'm not -- I wouldn't guide you to that number again.

Part of the reason we were there is because we were fairly uncompetitive in deposit pricing.

In fact, if any of you followed us for the long time we were in the bottom [depth] file.

We are competitive, in the middle of the pack in places we want to win, we will go out even higher.

My earlier discussion on being a market leader is affords you more leverage when you do change rates.

So on the deposit side, I think loans will get stronger over time for the industry because we will continue to have more opportunity, we will get more than we did with the shadow bank diminished and we will be able to have unrisk premium we didn't have going into the downturn.

On the deposit side for US Bank it's probably closer to where it is now than it will be either a risk or reward going forward so we are pleased with where we are and we have given some of that margin back in the form of deposits.

Okay.

Thank you.

Thanks, Chris.

Your next question comes from the line of David Conrad of KBW.

Hi, David.

Good morning.

I was wondering if you would talk more about the processing company.

Overall processing revenues were flat year-over-year but linked quarter up quit a bit and really the run rate from this year is up quite a bit.

So I don't know, it seems a little bit more than seasonal based on looking at last year, but and perhaps it has something to do with the recent acquisitions, it looks like pretty good growth rate.

Just wondering if you could comment on that.

Thank you.

It would of been one of the things I would of hung up and been disappointed we didn't talk about.

The fact that it's flat and the portfolios that we do processing for are 8% same-store sales down over the same period.

We are as proud as that number as anything else on the docket and it doesn't get a lot of visibility and thank you for calling it out.

It has a little bit to do with acquisitions but a lot more to do with our European and our international processing coming into (inaudible) now.

A year ago right now we were talking about a big investment in an international payments platform that would be scalable and usable all over the world.

That was installed about a year ago.

Started out this year.

It's changed greatly the ability for us to be scalable on some of these acquired properties outside of the states and in the states we just continue to have a better benefit on renegotiating some of our terms with our merchants, having a much better retention than we have had in years past, the attrition is way down and frankly a lot of our competitors in the merchant (inaudible) states are very disruptive or and we have been completely steady safe, slow, sure and boring but overall making more money on it.

When that cylinder comes back, I always talk about this bank having four key cylinders and the corporate trust affected by the market and the payment business affected by the economy, when those two hit back their strides and this is a four cylinder company with kind of a V8 underneath it.

We are satisfied that is a good beginning to show improvement in the economy and we are going to call that out as one of the positive bias.

Great.

Thank you.

Yes.

Your next question comes from the line of Moshe Orenbuch of Credit Suisse.

Good morning.

Thanks.

Was hoping you could expand a little bit the -- within the expenses it seemed like the increase was heavily concentrated in marketing and business development, you alluded in the text of the press release to card products and things.

Could you please expand a little bit more on what your plans might be going forward in that area?

Yes.

So we talked a lot about FlexPerks and just to be specific there, FlexPerks as you recall was our solution to the decision when the WorldPerks card portfolio was taken by AmEx, when Delta and Northwest merged.

The portfolio was ours on.

We never gave up the portfolio.

It's ours to keep and we decided to invest heavily in the portfolio to recreate a different rewards program for those customers.

I will tell you that our early results have been significantly better than we had hoped in terms of retention of customers to keep their WorldPerks card now called FlexPerks.

The challenge we have is make sure that turns into spending behavior not just card retention and while it comes in that order by the way.

We have plenty more cards than we thought we would have in our original expectation so the advertising seems to have worked now we need to create a rewards program routine and a behavior that helps people say I really want to use this card.

So ask me again in 90 days and we will tell you how that's going but the investment of advertising which is also marketing and collateral and all the things that go along with creating the rewards themselves has been part of that cost.

The other thing in that category, expenses you will see will be overall brand development, advertising and some collateral that we have been doing with our clients and also underneath that as part of our corporate bank and wealth management restructurings that we have been talking about for a couple of quarters where we are getting more national in our view on the corporate side and doing a better job with a higher end wealth management clients than we have done in the past creating a new brand called private client reserve and spending a lot energy bringing in new employees with those talents to amend what we have not had in the years past which is a high wealth management capability.

Those expenses are both noninterest expense and personnel expense and they are all aligned with that organic investment I've been talking about during the call all of which will probably yield benefits in future quarters more than they have now.

That, though, is pretty much the real delta between the variances of prior period and current period.

It's been marketing and people.

Great.

Thanks very much.

Yes.

Thank you.

And we have reached the allotted time for the question-and-answer session.

Are there any closing remarks?

Thank you, Kristi.

First of all, I can't thank you enough for your interest in our company and I mean that.

I will tell you it was very good strategic meeting we came back from actually it was yesterday.

We have been gone over the weekend and I must say when you put it on paper to explain to your Board of Directors where your opportunities lie, where your weaknesses are and where your future is going, it gives us great celebration to pause and say simple and basic is good and you're going to see more of that from us.

You have my commitment we will continue to protect our prudent risk and credit underwriting philosophies, you'll see us to be a watchful on the expenses but we are also making a lot more revenue so we will reinvest that.

I'm well aware that the dividend is an important step in our shareholder focus and finally I can't put words around it but the momentum we are feeling in the Company by the employee engagement and their pride of being part of this Company is palpable, you can taste it.

And I'm excited to show it off to you over the coming quarters.

Thanks for your interest in our Company and if you have any questions, Judy, Andy, Bill or I are happy to answer the questions.

Absolutely.

Thank you for listening to our call and absolutely feel free to call me if you do have questions later today.

Thank you.

Thanks, Kristi.

Thank you.

This clouds today's conference call.

You may now disconnect.