美國合眾銀行 (USB) 2013 Q1 法說會逐字稿

Welcome to U.S. Bancorp's first-quarter 2013 earnings conference call.

Following a review of the results by Richard Davis, Chairman, President and Chief Executive Officer, and Andy Cecere, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session.

(Operator Instructions).

This call will be recorded and available for replay beginning today at approximately noon Eastern Daylight Time through Tuesday, April 23 at 12 midnight Eastern Daylight Time.

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

Thank you, Brooke, and good morning to everyone who has joined our call.

Richard Davis, Andy Cecere and Bill Parker are here with me today to review U.S. Bancorp's first-quarter 2013 results and to answer your questions.

Richard and Andy will be referencing a slide presentation during their prepared remarks.

A copy of the slide presentation as well as our earnings release and supplemental analyst schedule are available on our website at U.SBank.com.

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

Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, 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.

Thanks for joining us today to review US Banks' first-quarter results.

I would like to begin with a view quarterly highlights on page three of the presentation.

U.S. Bank reported net income of $1.4 billion for the first quarter of 2013 or $0.73 per diluted common share.

Although total net revenue of $4.9 billion was slightly lower than the same quarter of last year and the previous quarter due to a reduction in total expense, we achieved positive operating leverage year-over-year and linked quarter.

Total average loans grew year-over-year by 5.8% and as expected, 1% or 4% annualized linked quarter.

We experienced strong growth in total average deposits of 7.3% over the prior year and 0.5% over the fourth quarter of 2012.

Credit quality remains strong.

Total net charge-offs decreased by $35 million or 7.5% from the prior quarter while nonperforming assets declined at 9.9% linked quarter or 2.8% excluding covered assets.

We generated significant capital this quarter.

Our estimated Tier 1 common ratio under the most recent Basel III rules was 8.2% at March 31 with a Basel I, Tier 1 common equity ratio of 9.1% and a Tier 1 capital ratio of 11%.

We repurchased 17 million shares of common stock during the first quarter which along with our dividend resulted in a 69% return of earnings to our shareholders in the first quarter.

Slide four provides you with the trends in our industry leading performance metrics.

Return on average assets in the first quarter was 1.65% and return on average common equity was 16%.

Our net interest margin and efficiency ratio are shown on the graph on the right-hand side of slide four.

This quarter's net interest margin of 3.48% was as expected, 7 basis points lower than the prior quarter's rate of 3.55%.

Andy will discuss the margin in more detail in a few minutes.

Our efficiency ratio for the first quarter was 50.7% better than the prior year and the prior quarter.

We continue to manage our operating expenses effectively and in line with revenue trends.

We expect this ratio will remain in the low 50s going forward as we continue to manage expenses in relation to revenue trends while continuing to invest in and grow our businesses.

Turning to slide five.

The Company reported total net revenue in the first quarter of $4.9 billion, a 1.1% decrease from the prior year and a 4.7% decrease from the previous quarter.

The decline in revenue year-over-year was largely driven by mortgage banking while the linked quarter variance reflected both a reduction in mortgage banking as well as normal first-quarter seasonality within our business line.

Average loan and deposit growth is summarized on slide six.

Average total loans outstanding increased by over $12 billion or 5.8% year-over-year and 1% linked quarter.

Overall excluding covered loans of run-off portfolio, average total loans grew by 8% year-over-year and 1.4% linked quarter.

Once again the increase in average loans outstanding was led by strong growth in average commercial loans which grew by 16.8% year-over-year and 2.3% over the prior quarter.

Total average Commercial Real Estate also increased over the prior quarters.

Residential real estate loans continue to show strong growth, 19.2% over the same quarter of last year and 4.5% over the prior quarter.

Within the retail loan category, average credit card loan outstandings fell slightly as consumers paid down their balances and average home equity lines and loans continued to decline as pay downs more than offset new loan originations.

Auto loans and leases however posted good growth year-over-year.

We continue to originate and renewed loans and lines for our customers.

New originations excluding mortgage production plus new and renewed commitments totaled over $35 billion in the first quarter.

Total average revolving corporate and commercial commitments increased year-over-year by 11.9% and 1.7% on a linked quarter basis while utilization remained stable at approximately 25% basically where it has been for the past five quarters.

Total average deposits increased by $16.7 billion or 17.3% over the same quarter of last year and by $1.2 billion on a linked quarter basis with growth in low cost savings deposits particularly strong on a linked quarter basis.

Turning to slide seven and credit quality, total net charge-offs in the first quarter decreased by $35 million or 7.5% from the fourth quarter of 2012 while nonperforming assets excluding covered assets decreased by $59 million or 2.8%.

The ratio of net charge-offs to average loans outstanding in the first quarter declined to 0.79% from 0.85% in the fourth quarter.

During the first quarter, we released $30 million of reserves compared with $25 million in the fourth quarter and $90 million in the first quarter of 2012.

Given the mix and quality of our portfolio we expect net charge-offs to remain relatively stable in the second quarter while nonperforming assets will continue to trend lower.

Andy will now give you a few more details about our first-quarter results.

Thank you, Richard.

Slide eight gives you a view of our first-quarter 2013 results versus comparable time periods.

Our diluted EPS of $0.73 was 9% higher than the first quarter of 2012 and 1.4% higher than the prior quarter.

For comparison purposes recall that the fourth quarter 2012 results included an $80 million foreclosure related settlement expense accrual that reduced EPS by $0.03.

The key drivers of the Company's first-quarter earnings are summarized on slide nine.

The $90 million or 6.7% increase in net income year-over-year was the result of a decrease in expense and a lower provision for credit losses slightly offset by a reduction in net revenue.

Net interest income increased year-over-year by $19 million or 0.7%.

The favorable variance was largely driven by a $13.9 billion increase in average earning assets mostly offset by a decrease in net interest margin.

The 4.6% growth in average earning assets included increases in average total loans and loans held for sale as well as planned increases in the securities portfolio.

The net interest margin of 3.48% was 12 basis points lower than the same quarter of last year primarily due to lower yielding investment securities and lower loan rates partially offset by lower rates on deposits and (inaudible) funding and a reduction in cash balances held at the Fed.

Noninterest income declined by 3.3% year-over-year primarily due to mortgage banking revenue reflecting lower origination and sales revenue partially offset by higher servicing revenue and favorable change in the addition of mortgage reps and warranty repurchased reserve.

Also contributing to the decline in noninterest income year-over-year were lower equity investment gains, retail products revenue primarily due to fewer cars coming off lease and a commercial products revenue.

Offsetting these declines were increases in trust and investment management fees, retail payments and merchant processing revenue.

Noninterest expense was lower year-over-year by $90 million or 3.5%.

The majority of this favorable variance is attributable to favorable variances regulatory, insurance and litigation items partially offset by higher compensation and benefits expense and an increase in tax credit investment costs, net occupancy and technology expense.

Net income was higher on a linked quarter basis by $8 million or 0.6% as a result of an 8% decline in expense and a lower provision for credit losses partially offset by a 4.7% decrease in net revenue.

On a linked quarter basis, net interest income was lower as growth in average earning assets of $1.8 billion was offset by a 7 basis point decline in net interest margin and the impact of two fewer days.

The 7 basis point decline in net interest margin was primarily due to lower loan and securities rates and seasonally lower loan fees.

On a linked quarter basis, noninterest income was lower by $164 million or 7%.

This unfavorable variance was primarily the result of a decrease in mortgage banking revenue and seasonally lower payments and deposit service charges as well as commercial products revenue.

The variance in mortgage banking revenue largely reflected lower origination and sales revenue offset by favorable variances in the addition to reps and warranty repurchase reserve and mortgage servicing rights valuation.

On a linked quarter basis, noninterest expense was lower by $216 million mainly due to the fourth-quarter $80 million settlement expense accrual, lower professional services expense due to the reaching of that settlement, favorable variances in insurance and litigation items, and seasonally lower operating expense offset by higher benefits including pension and the expense related to low income housing and other tax advantaged projects.

Turning to slide 10, our capital position remains strong and continues to grow.

Based on our assessment of the full impact of the current proposed rules for Basel III standardized approach, we have an estimated that our Basel III Tier 1 common equity ratio was 8.2% at March 31 versus 8.1% at December 31.

At 8.2% we are well above the 7% Basel III minimum requirement and above our targeted ratio of 8%.

In March we received the results of the 2013 Comprehensive Capital Assessment and Review, the CCAR, including the Federal Reserve's non-objection to our capital plan.

Subsequently we announced a new one year buyback authorization totaling $2.25 billion effective April 1 and we expect to recommend to the Board of Directors that they approve an 18% increase in our common stock dividend in the second quarter.

These capital actions will allow us to maintain our goal of returning 60% to 80% of our earnings to shareholders in the form of dividends and buybacks in 2013.

In the first quarter we returned 69% of our earnings to shareholders including dividends and repurchase of 17 million shares of common stock.

Finally slide 12 provides updated detail on the Company's mortgage repurchase related expense and the reserve for expected losses on repurchases and make-whole payments.

The addition to the reps and warranties repurchased reserve this quarter was $36 million lower in the fourth quarter of 2012.

Recall that we booked additional reserves in the fourth quarter to address the put back risk of Freddie Mac loans originated in 2004 and 2005.

Our outstanding repurchased and make-whole request balance at March 31 was $66 million compared with $[151 million] at December 31.

I will now turn the call back to Richard.

Thanks, Andy.

Turning to slide 13 you will see the cover of our 2012 annual report, a rich heritage and a strong future.

Today we are in Boise Idaho, the site of our 2013 annual shareholders meeting.

I'm looking forward to presenting our shareholders with a brief look at our past and a view into our future.

Idaho in fact is part of our Company's rich heritage which began 150 years ago with the signing of our National Bank Charter in 1863.

The presentation will include the story of how we achieved these size and scale we are today and in particular what we accomplished in 2012 including record revenue, record earnings and industry-leading performance metrics against the backdrop of a slowly recovering and uncertain environment.

Even more important however to all of our shareholders is that we have positioned U.S. Bank for a strong future, a future that includes continued investment in our well diversified mix of businesses, prudent risk management, a focus on operating integrity and compliance, strong capital and liquidity and superior returns for our shareholders.

We are looking forward to the future as we move into 2013 with our first quarter now complete and we remain focused as always on producing consistent, predictable, repeatable results for the benefit of our customers, our employees, our communities and our shareholders.

That concludes our formal remarks.

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

(Operator Instructions).

Erika Penala, Bank of America.

Good morning.

Richard, your comments on cautious -- your cautious loan growth commentary during the Citi conference really resonated with the investor community so I was wondering if you could give us an update on your outlook for the balance of the year?

Thanks, Erika.

Yes, as much as I wish it were more positive I think we just need to be realistic in this environment and while you will recall that in quarter four we grew our linked quarter loans 1.4% we then suggested a month ago that while we wanted to be in the range of 1% to 1.5% for this most recent quarter we would be on the low end and here we are at 1%.

My guidance for next quarter which is as far as I can see, is somewhere between the 1% and 1.5% again.

If we get the seasonal lift that we expect and we normally see in the springtime then we will be in the middle of that to high end of that range.

If we see a continued cautious nature by our customers which we have now seen for the last few months, then it might be on the low end of that range but it will be somewhere in between.

So what I am saying is it is not going to be robustly coming back on all cylinders and that makes sense to us because there continues to be a withholding by both consumers and businesses in this uncertain environment particularly now on the heels of both the higher FICA costs and what we all know to be some of these slow but eventual sequester impact, the higher gasoline costs and the lack of any other catalyst for the business community to jump on the need to take action any earlier now with the commitment of forward interest rates being low for so long.

So longer view second half of the year I would hope we start moving into the higher end of the 1% to 2% linked quarter range but for now I'm going to say we are going be pretty set in that same kind of range bound 1% to 1.5% linked quarter until we see some catalyst.

Got it.

And my follow-up question would be on the expense side -- thank you so much for the color on looking for a low 50s efficiency ratio.

But you also mentioned the word flexible in your prepared remarks.

If we fall into the lower end of the range on loan growth and clearly mortgage banking is a big question mark for the rest of the year, is the main message here is that there is still flexibility remaining in terms of managing the dollar number to keep the efficiency ratio in the low 50s no matter what happens to the revenue side for the rest of the year?

Yes, for a couple of reasons the answer is yes.

I am fairly comfortable that as you know we manage more to operating leverage than we do efficiency ratio and we have promised that as this year will be a harder year for revenue growth at least at the conservative manner in which we run the Company, likewise we are going to be conservative on our expense growth and as long as revenue growth [stops at] expenses you know that you have positive operating leverage and your efficiency ratio gets better so efficiency for us is a result not a goal.

But because of that, I can assure you it will stay in the low 50s.

I don't see any reason for that to be any different than it has for the last many years.

I will also add you will recall that while we are moving through this consent order and have substantially less cost and compliance for that purpose we do see the cost of compliance and operating integrity going up but well within the range of the amount that we are now going to be able to redeploy.

So even on a linked quarter basis for a company like ours while I hated all the money we were spending on the consent order, it now serves as a backdrop for us to use for summary deployment for what I know to be higher expenses in compliance and audit going forward.

So we have really no reason and if loan growth were to stay slow as you know because of our kind of 50-50 mix of spread income and fee income as long as the seasonality continues to happen along with our trust and our payments businesses and some of the non-balance sheet items, I also have confidence we can stay in the low 50s as an outcome.

Thank you for taking my question.

Matt O'Connor, Deutsche Bank.

I realize there is a lot of seasonality and fees quarter-to-quarter and year-over-year you highlight some of the declines obviously in mortgage and private equity.

But I guess just generally speaking it felt like fees broadly were a little bit weaker year-over-year as we looked at the service charges, the cash management, corporate areas just some areas that I thought would be grinding higher.

I didn't know if there was anything kind of unusual that just happened to all hit at once or is it just kind of sluggish client activity overall?

Matt, this is Andy.

So first, you are right, the first quarter in seasonally lower across a number of categories.

In addition to the seasonality I would highlight two things.

One is in our corporate products corporate payments revenue, we have about a 30% exposure to the US government with a high percentage of that related to the Defense Department and government spending is down approximately 15% to 30% depending upon the category so that is a principal driver of the lower year-over-year and a little lower linked quarter growth that you see in corporate payments.

So that is going to depend upon what the future is in terms of government spend but that is an unusual item that you see there.

The second category I would bring up is our commercial product revenue.

We have particular strength in our high-grade bond underwriting, that is doing very well and you are reading about the marketplace and how a lot of bond issues are occurring.

However, the marketplace is also indicating that FX, loan syndication, and some of the more one-time fees are slowing down a bit because -- somewhat because of that high bond underwriting activity.

So those are two things in addition to seasonality that I would call out.

Okay.

And then just separately following up on the net interest income -- or sorry the loan growth outlook as we think about the NIM component from here and the outlook comments on the net interest margin percent?

So we had indicated that we would be down 5 to 7. We were down 7. I will tell you my expectation was that is the most it will go down this year.

My expectation for the second quarter is closer to 4 to 6. Part of the reason for that is first quarter has seasonally lower loan fees.

And secondly, the compression of what is coming on versus what is coming off is dissipating so you will see continued improvement throughout the year and again second quarter 4 to 6.

And then when you combine that with the low single digit or low 1% loan growth, do you hold net interest income stable or can you get a little growth out of that?

Relatively stable to perhaps a little bit growth.

Okay, thank you very much.

John McDonald, Sanford Bernstein.

Good morning, guys.

Andy, a quick follow up on the net interest margin.

Your margin was very resilient for a lot of the low interest rate environment and the last couple of quarters you have had a little leakage down.

What is the dynamic there?

Did you have some funding cost ability to push that down and that is starting to dissipate or can you give us a little color there?

Yes, John, so that is the reason.

In 2012 we had about $12 billion of debt that either matured and was not replaced or was replaced at a much lower cost that helped us particularly the last half of 2012.

In 2013, we have a much lower number of debt coming due so we have less of that repricing that will help us.

However as I said, sort of offsetting that is the difference between what is coming on and off particularly in the securities portfolio, we will continue to improve each quarter so that will be an offset but that is the principal dynamic last year versus this year.

Okay.

Then can you just remind us of your positioning to higher interest rates and which interest rates matter most for you?

We are asset sensitive.

We continue to be asset sensitive.

What you saw in the fourth quarter annual report is very similar to what you will see in the first quarter Q so we are bias towards positive rates and the very most important part on the curve for us is 3 to 5 years.

Okay.

And then on the credit side, Richard, I guess do you envision being able to run at a below average charge-off rate for a considerable amount of time here, both you and the industry as there hasn't been much lending and housing is improving.

Do you see credit kind of running below average for a while?

I do and I think we predicted it year ago that we would all fall below our over the term rates and it would take years to come back.

I mean it is just the way the math works.

The temptation is for certain companies to decide that now is the time to take maybe a higher level of risk because A, it won't show up for a while.

And B, distress for [bad] asset growth is pretty high and that temptation is present in our Company but it ain't going to happen.

The fact is that we are going to continue to be prudent and we will take our hits.

If you guys don't like the loan growth but we are not going to put on structurally deficit asset fund to our books for the fear of them being a problem in many years forward.

We are just not going to do that.

So you will see us be prudent and we are not in the leveraged lending business to speak of so we are not enjoying that particular run up right now.

We are not going to get into things like enhanced lease residuals or get into some of the noninterest related activities.

But as I always say, we will continue to fight for our own customers and continue to build some growth in market share by using our pricing advantage which you all know we have a pretty substantial one which we can give a part of it back to our best customers and new customers.

I will also remind that our commitments grew almost 12% year-over-year and annualized linked quarter 7% and so we are continuing to enjoy bringing a lot of new customers in.

They are still sitting at that 25% usage level but once and when they start using it we would hope that whoever has the most customers on their balance sheet with open lines of credit will be the ones that does the best and we are counting on being one of those.

While it does sound like you will run below average or over the cycle you don't see much more impairment from this kind of 79 basis point level?

You think you will just hold somewhere in there?

Yes, I think we follow through with the 70s and we stay in there.

And I thought six months ago we would fall to the low 80s so it got better faster and probably more sustainably than we thought which is why you saw some of our actions.

But just because of our large credit card portfolio and the mix of business, it shouldn't get much lower than that or then we really left too much on the table.

This is Bill.

I mean the area that still has room for improvement is anything related to the residential mortgage so residential mortgage, home equity still high and over the next year or two depending on housing prices that should continue to come down.

Bill, it looked like the home equity NPLs and charge-offs ticked up a little bit in the first quarter.

Is that a seasonality issue?

Yes, they will come down again in the second quarter and should be down through the balance of the year.

Okay, great.

Thanks, guys.

Paul Miller, FBR.

Yes, thank you very much.

So on the mortgage banking side a lot of people felt that we have been writing it off for the rest of the year.

What is your views for the gain on sale and volumes throughout the year?

Paul, I am going to give you -- I don't know the whole year.

I will give you what I can see in the second quarter.

And so the first quarter, our fees were down about 15.5% and that is principally because apps were down.

We book about 80% of our revenue at app and the remainder at close.

Apps were down about 20% and gain on sale margins were down 10, 15 basis points and the offset was positive servicing, our revenue, and the gain on sale -- or excuse me -- the servicing hedge.

So those are the gives and takes.

As we look into the second quarter, we believe mortgage revenue will grow and we believe the application volumes what we have seen thus far will increase.

So we think that this first quarter was a little bit seasonal, a little bit impacted by the blip in rates that occurred in late February.

We are starting to see some strength there so we expect an increase in mortgage revenue Q2.

And, Paul, we are sticking with mortgage.

We like it and we do it well.

We think as I said before that there will be a purchase money future out there and we want to have that same market share position if not greater with purchase money.

So we continue to prioritize our new customers and make sure that they are servicing and our performance on their on-boarding is exceptional so that they will be pleased.

A refinance is also important but it doesn't have the same time parameters attached to it because you don't have to have another party involved and we are going to continue to grow this business and do what we can to improve the mix of where the originations come from, more retail if we can.

At the same time we have a very good variability on our expense control so if things were to continue to fall and be less than we expect, we can adjust to that very quickly probably within 30 to 60 days based on the way we staff and the way we have set up our occupancy costs.

So we are able to flex with it but we like it and we are going to plan on it continuing to be strong.

And correct me if I am wrong but I don't think you have a lot of HARP eligible loans.

What type of HARP production are you doing right now?

About 11% is the HARP for us.

Okay, guys.

Thank you very much.

Ken Usdin, Jefferies.

Good morning.

Just wondering if you can just expand on the mortgage side, can you talk about how your mix of originations has changed and market share dynamic changes -- as Richard, as you talk about that being prepared for a purchased market?

So first of all from an originations standpoint if you think about production, about 72% of the production was refinancing.

Only about 62% of the applications however are refinancing.

So again that increase in rates that occurred did impact apps and refinancings did come down in the first quarter.

We are starting to see it shift back to more of that 70-30 refinancing and again we expect strength in the application volume into quarter two.

Given we don't have the full market data yet but we continue to expect that we will be either stable or slightly increasing in market share.

Okay, great.

My second question I wanted to ask you about noninterest-bearing deposits did decline on average a decent amount.

And I just wanted to ask you to flush that out a little bit how much of that was seasonal, how much of it is customers behaving differently and any changes with regards to even customers starting to potentially use some of their deposits instead of borrowing?

I think a factor there, Ken, was the elimination of tax so what we saw at the end of the year was a shift perhaps of about $6 billion of noninterest-bearing which had until year-end had unlimited insurance into a more interest-bearing category.

So I think customers thought about it and said I'm going to go after a few basis points since I don't have unlimited insurance so I think that is the phenomenon that we saw.

Ken, you make a great point because I have often said that the canary in the mine is the first good news for all of this industry is that deposits in total move down because people will be using them.

Then they will use the lines of credit that they have open to buy and they are paying for and then eventually they get more loans.

This is not that.

This is not that first mover where we are seeing total deposits moving down as a result of customers using it for other things particularly for growth.

They are really withholding.

They continue to be cautious and they're just building up the balance sheet no matter where they place it, they are just moving it about to seek a little higher yield.

And Richard, on that point, this'll be my last question -- can you just talk us through when you are talking to customers, we continue to hear about this delay in cautiousness.

What are customers looking for to make that change in their minds?

Everyone is very flush with cash, companies are strong from a financial perspective, we're seeing that in credit.

But so, we continue to hear about delay, delay, delay.

What are customers waiting for?

That is a great question and it has a lot of answers.

But mine would be that it is particularly the lack of a catalyst perhaps more than it is the uncertainty.

Even I am tired of talking about uncertainty without a very good definition.

We could tie last year to the fiscal cliff, we could tie the last quarter to the pending sequester, we can try to say it is going to be the national debt -- it is probably not any of those anymore.

There is no reason to take a bite right now of the apple and invest in something that will cost you more with the uncertainty of not knowing whether or not there is going to be a customer base for you.

So what I would say to you, Ken, is you've got the interest rates being decidedly low for a long time, so there is no catalyst for a company to rush to make a decision because rates are eventually going to move up.

They probably should be thinking that way, but based on the calculus and what the (inaudible) has done, by tying it to unemployment everyone can see that it is not imminent.

So absent that and absent a good deal where you see the M&A market still has some life to it, most companies are going to continue to just do what they do well, stick to their knitting, be very cautious and be proud of the fact that they're still being profitable.

And they are going to wait for a catalyst which I think will be interest rates eventually starting to move up and people taking advantage of that and/or the consumer getting much stronger, starting to seek more purchase consumer products and services and the companies starting to meet that demand.

None of that is present today.

It is not a horrible; it is slow recovery; it is torturously slow but there is no catalyst to jump on something earlier than you need to.

Thanks very much.

Brian Foran, Autonomous.

Good morning.

I wonder if I could follow up on this point you made about it is tempting at this point in the cycle to stretch for growth and maybe people getting to mid and even late cycle underwriting standards in certain products.

You referenced leveraged lending as one.

Are there other parts of the market that particularly concern you and maybe if I could specifically hone in on auto a little bit since you have some slides on it in the back of the deck?

I'm going to have Bill answer the hard one.

I will take auto because that is very timely.

We are one of the larger -- we are the seventh largest auto lender so it is meaningful 2.3% market share.

We are also one of the larger auto lessors and we have been in that business for as many years as auto leasing has been around so we are good at it.

It has a lot of attributes to it like end of term used market sales, values, all of those kinds of things.

And one of the opportunities you would have is to enhance your residual value and so if you're going to get a loan from Bank X and they are going to say after a three-year return your value is going to be X you will get it from us and we say after a three-year term your value is going to be let's say lower, then you are going to have a higher payment with our Company because we are going to have you take a larger spread.

When the car comes back in three, four or five years that is when we have to meet our maker and decide whether or not we expected the value to be higher or lower and then take an adjustment well outside of the interest income that would have been derived.

So it is an example where we have done this business long enough we are not going to do something anymore than we would take a structural credit risk on a customer hoping that they are going to get better when we don't see the evidence.

So auto has a leasing issue that is probably more germane.

Let's pause for a minute though and also look at what happened with the CFPB last week as they are starting to ring fence the discretion at the pricing level in the auto sales rooms.

And you know that the banks are now going to be held accountable for disparate lending behaviors by auto dealers all through the country as it relates to the kind of up charges they might provide a customer or add-on products they might deliver.

So that is all going to be well worth watching in the next 90 days to see what the banks are going to do.

We immediately responded by ring fencing the amount of latitude we give our dealers.

We will probably lose a little market share in the beginning but we know that is the endpoint so we wanted to adjust quickly and I think you are going to find that this starts moving towards a much more probably predictable pricing scheme in auto dealers across the country and probably margin compression and that may well end up becoming an issue for affordability as the dealers want to take on some of that profit back in another manner.

So auto lending is really in flux given what just happened but germane to your question, we are simply not going to enhance residuals or take the risk outside of what would otherwise be credit structure.

So Bill, for the other topics?

I think the other category would be Commercial Real Estate.

Historically banks have liked commercial real estate because it is actually a pretty easy area to generate instant outstandings.

There is always a developer with a project and seeking money so that is an area that over the years has been subject to too much money going into too many projects.

The way we manage that is we start with our customers and the first thing we do is really underwrite -- understand our customer.

It is common that we do not necessarily do every project for our customer base.

We look at the ones that we like.

It has been a successful strategy for us for decades.

Commercial Real Estate is the other area.

I wonder as a follow-up if I could almost ask the opposite question.

You have been pretty good at being countercyclical and maybe extending into products when others are still afraid to do them.

And are there any opportunities that are still out there like that and the specific one I guess I am getting at is in residential mortgage, ALT-A has become maybe a dirty word but at the same time the whole market is doing 760 average FICOs.

You cite yours at 765 with a weighted average LTV of 64%.

Is there an opportunity to do some kind of prime minus business and is this a good point in the cycle to be thinking about that?

I would say a little different answer than the prime minus.

We have held a lot of our underwriting fairly steady there and we have the capability to do home equity up to 90% loan to value.

We haven't changed that in several years.

The issue being a lot of people are just not taking advantage of that getting back to Richard's comments about sentiment.

So it is available.

We use it in some of our piggyback loans but the volumes are just not that great and I think it is less us changing our standards and more of the market eventually coming back to them as people get more confidence.

Great, thanks for taking my questions.

Keith Murray, Nomura.

Good morning.

Just ask you a question -- you talked about loan growth.

Are you seeing the ability to take share and which particular loan categories are you seeing it?

This is Richard.

Small business for sure.

Five years ago we started a trip to become a really high quality small business originator and we did it through our branch managers and you are welcome to call any of them.

All 3100 of them, their job is to be a community leader and know that whole neighborhood like it was a small little town and part of that goes along with being the bank for the small business owners in and around that location.

So we have been taking market share.

That continues to be one of our strongest growth both in what you call traditional small business as well as SBA lending, we are the second largest SBA lender at the national level at this point as well.

So we see a lot of value in being good at that and it is a real execution game.

It is not so much just pricing and product, it is knowing your customer and giving them what they need.

The other thing that I would say that we are continuing to focus on in terms of market share grab would be first position second mortgages.

We have been very, very successful that it is for a lot of people it is a way to get into the equity without having to go through the typical steps you would have to go for a first position traditional mortgage.

They are a very high quality customer, they like the product, they like the access and in particular they don't want to do it another credit card.

They still feel comfortable using the equity in their home and those have been two really growth businesses for us.

Bill, did I miss something?

I think the other big area is really our corporate bank and especially their inroads into the investment-grade space whether that is through commitments and taking joint lead or lead positions with a number of our clients and with that comes the investment-grade underwriting that we established in Charlotte so I would say that is another area that has come a long way in the last (multiple speakers)

Four years ago Keith, we didn't really even have that and now we are leading transactions and what comes with that too, Bill, is the fee business which is part of the quid pro quo.

So that would be another good place.

So we feel we have got a lot of room and space for market share growth in places we are still getting better at but I think we also have the advantage of being ahead of some of the curves on that and we are going to play it out.

Thanks.

Then on the payment side, you mentioned the government spending piece of it having an impact but what is your growth outlook for that business?

A lot of clients ask the question, it looks like growth has slowed there.

Just what is your view on the space?

Let me put it by piece so the merchant growth is going to be a bit of a function of same-store sales growth which will range somewhere between 3% and 5% we expect for the rest of the year.

We will grow a little bit above that because we are adding new customers but same-store sales drives that.

On the card side, it is going to be consumer spend and what we are seeing is spending relatively stable but the paydown of the loans continues to increase, in other words revolve rate is such that people are paying down their outstanding debt so that is what is impacting outstandings.

And then on the corporate card side as we said, we have a fair exposure to the government and T&E spend both which are weak for the reasons that Richard already has gone through so purchasing the traditional purchasing is stronger but the T&E and government is a little weaker so that will depend again on the sentiment on a go-forward basis.

One of our hidden benefits and it is hidden because it is still growing is this international growth and our merchant acquiring.

You heard that we closed the deal with Santander last week.

We have got this continuing growth in this early stage kind of nascent partnership with Citi down in Brazil.

I was in Mexico City just a couple of weeks ago where we have 400 employees and we have been working on partnerships with some of the largest merchants in Mexico.

And so these are businesses that are fairly young, a few years old but they are the kind that have the great growth curves so they are moving from red to pink to gray to black in terms of bottom line and they have got great trajectories of growth.

And that is probably something you will hear about in the future quarters which isn't present in today's run rate.

Thank you.

Betsy Graseck, Morgan Stanley.

Good morning.

A couple of questions, follow-ups.

One, you mentioned earlier the mortgage origination revenues 80% at app, 20% at close.

What drives that difference?

Is it a function of the type of loan that you are originating?

No, you principally book the gain at lock and you book some of the miscellaneous fees at close.

Okay.

And then for your budget when you are looking at one and two years, what kind of interest-rate environment are you basing that on?

The budget that we plan under is very similar to the CCAR base case budget, Betsy, which is a basically low rate environment the next couple of years at the low end with some increase at the longer end towards the end of this year into next year.

Okay, so is it fair to say it is in line with what the FOMC is suggesting they are going to do with rights?

Yes, it is very close to the Blue Chip consensus.

Okay.

And then lastly on payment space, so obviously there is a lot going on in the payments industry right now and just wanted to get your thoughts on how you are thinking about positioning USB longer term specifically around some of the payment strategies in the US?

You know that JPM and Visa have signed into a unique partnership.

Is there anything that would make sense for USB?

Obviously you've got your own merchant acquirer so wanted to see what your thoughts are there?

And then separately in non-US, you have been increasing your footprint pretty significantly in the merchant acquiring.

Is there any more that you could do there?

Lastly, on the Internet space, what kind of options do you have to increase your share of wallet?

This is Richard.

I was going to say payments can now mask as either cards or mobile banking, right, so we will take those separately.

The traditional payment space, we too have relationships with partners that we just are working on.

We don't necessarily announce them so you can read between those lines but by the way it is not exclusive what you mentioned with the other bank.

So we are in R&D mode in a significant way with all types of ways to use our acquiring partnership with merchants and in some cases directly to consumer [all the square] and some of those things that you have read about.

So we are not left out of anything, nothing has come across our desk that we wish we had been a part of and we are just more likely to announce it once it has been tested and out as opposed to the fact that we are going to test it.

So just trust us, we have a different cycle than the one which we announced.

As it relates to international, once we get this beachhead down in Brazil there is a lot of good growth in South America and if our reputation builds like I believe it will as a partner with Citi where they have a great deal of relationships, we would expect to see us moving through South America rather like we did moving from west to east across Pan Europe and then eventually further along perhaps down into the Pacific Rim.

We are more careful in Asia-Pacific because we are not exactly sure of the politics in some of those environments but like anywhere else, our entire story has always been built on the partnership of another bank that is local to that market and we work with them to become their preferred merchant provider.

It is usually a rent to own kind of a relationship and we bring our international platform that we built years ago and bring it to any country and flip it on and we start doing business.

So there is really very few parts of the world I would tell you we are not interested in but we are going to be careful because of the politics that go along with doing business in countries that we may not have the experience and the partner is going to be more important probably than the country itself.

As it relates to just mobile payments, we are spending an inordinate amount of time and energy on that as well both keeping ourselves open for all channel options and for all partner options which in many cases are mobile providers and some of the less-known brands that are being built in garages across the country.

So we're spending an inordinate amount of time on that and you will see some of our M&A will very likely be the continuation of traditional merchant acquiring but I will bet you are going to see some purchases of some less-known capabilities and technologies as it relates to the channel of moving money in nontraditional ways particular to mobile.

So more of that will come but you will hear about it in our case after it is working, not the announcement of the idea.

And then on the mobile side that would be something that you could then provide to other financial institutions that you are running their payments business for?

Excellent point.

So we will as a correspondent bank is to smaller banks, we have done that in the merchant acquiring space forever where many of the regional banks, smaller banks use us to be their merchant acquirer under a private label.

We will do exactly the same thing with mobile technology.

We will build it, we will brand it, we will white label it, we will sell it to them and they can have the benefit we will also get the mark up.

Okay, thanks.

Chris Kotowski, Oppenheimer.

Good morning.

I hear what you say about consumer confidence and people not wanting to lever up but I guess I always kind of viewed that loan growth and especially consumer loan growth kind of should go with nominal GDP.

And you see auto sales up 40% off the bottom and while you were speaking, housing starts hit the tape, it was over one million units for the first time in a couple of years and 2X off what it was on the bottom.

And you think about all of the furniture and rugs and all of the stuff that goes with housing starts and just how can it not translate into loan growth?

I am wondering is it purely consumer behavior or is it some of the new strictures that are on you?

Is it like the inability to raise card limits and so on?

How does all of this other activity not translate into loans?

Chris, those are all good questions and we consider them all the time too.

First of all, let's talk about auto loans.

Auto loans are probably the squeeze play between the lack of equity in homes and the lack of people's willingness to extend their unsecured credit card any further.

So it used to be home equity would mask a great deal of the auto purchasing and even credit cards would end up allowing people to feel more comfortable that they had other alternatives to pull on.

People are paying down their credit card more than they are using it and people's equity while it probably is starting to warm up hasn't been that good that long for them to be comfortable.

So it makes sense to me that autos are probably the single and exclusive space of strength in the consumer side.

That is how I put it into my head at least.

But as it relates to the next steps you've got the consumer is like a small business like a large corporation, they have figured out that they can be better with their budgets than they thought they could.

They can find out they can live on less than they thought they could and they do not want to get once burned twice shy.

And so the behaviors are reasonable but they are more emotional than they are practical or financial and I think this will eventually recover as people feel more comfortable.

They now know what their cost is going to be and their paycheck every two weeks now that FICA has been changed.

They are probably getting a better sense of what is going to happen in terms of the cost of gasoline as we move into the summer months and they start looking whether or not they have got money for a vacation.

This is the perfect time of the year where we are in a flux to figure out where things are going to settle and in our company April and May pretty much tell us the rest of the year.

We don't trust the first quarter for a lot of reasons.

I don't have to go much past May to know how the year is going to go but we are right on the heels of figuring out what the consumer behavior will be and I will tell you it is probably going to be cautious because -- for the same reasons I mentioned for corporate.

There is no catalyst but for to be careful and protect yourself given the uncertainty of what things could happen.

So your view is it is purely behavioral, it is not new regulations and structure?

Thank you.

For our Company, it is not the latter.

We are not bound by capital, by regulators, by any enforcement actions.

We are simply doing the business we think is based down and repeatable and so far that has been aligned with what the regulators would expect.

I will also point out -- I mean the housing start statistic is heavily weighted now with multifamily starts.

So the single family I see is actually down so when you talk about consumer sentiment yes, you build an apartment building you need carpet but what you are talking about is a consumer going out and buying a new home and refurnishing it, etc.

and that is a different behavior and that is still fairly tepid.

All right, that is it for me.

Thanks.

Dan Werner, Morningstar.

I apologize if I got on the call late.

With regard to the allowance of loan losses and given your improving asset quality and even provisioning slightly less than what you are charging off, where do you see the loan-loss reserve long-term?

Well, I am not going to comment long-term but --

Or at least for the rest of the year?

(multiple speakers) Usually we go a quarter at a time.

But in general terms, there is still a little more room for improvement in the credit profile.

There is still -- wholesale is almost back to what I would call pre-recession levels but there is still a few things to work out so that will give us a little more relief on the allowance but basically it is similar to what it has been doing.

All right, thank you.

Todd Hagerman, Sterne, Agee.

Good morning, everybody.

Andy, a couple of questions just some follow up.

First, in terms of you were mentioning on the spread outlook kind of the stable to maybe some growth.

What I am curious about is how we should think about the earning asset mix with the balance sheet, obviously has been growing.

And one of the things that stands out is really the growth in mortgage held on balance sheet and this quarter we saw a bit of a drop off in terms of held for sale.

So I am just wondering how to think about kind of the ongoing mortgage retain on balance sheet, how you think about perhaps the fee income versus the spread component in conjunction with your comments on the spread?

Right, so there are a few questions in there.

First, let me make it clear that a qualifying mortgage is Freddie Fannie, we are not holding our balance sheet other than held for sale so we are selling those.

What you are seeing in terms of mortgage traditional loans on the balance sheet is our smart refinance product which is that branch based mortgage originated, high-quality customer that is not a Freddie Fannie product.

That is what you are seeing grow and we would expect continued growth there for the reasons that we have talked about.

In terms of I want to be also clear net interest income we expect to be relatively stable to some growth.

We do still see some expectation for that 4 to 6 basis point decline (inaudible) offset by the earning asset growth.

And finally I would say that I expect loan and securities growth to be in sync so we have stopped in terms of the build on the securities portfolio and it will grow in conjunction with overall balance sheet growth.

Okay, that is really helpful.

Then just switching gears a little bit in terms of again like the mortgage outlook if you will, but in particular on the reps and warranties, you guys had a nice drop off this quarter in terms of the associated costs on the repurchase risk as well as on the legal side as well.

I was just wondering how we should think about the provisions if you will on a go forward basis.

Is that more in sync with the current production levels or are we going to see more of a drop off and decline in the reserve or how should we think about that?

Right, so as you recall in the fourth quarter we increased our reserve principally due to the look back period on Freddie Mac going back a couple of more years so that was unusually high.

The first quarter may be a little bit low because of timing and some of the workthrough of that additional look back period.

But I do expect that to sort of be stable but down in future quarters so I think we have reached the peak there in terms the additional reserve and we will start to see it come down.

And then similarly I don't know if the question was addressed before but just in terms of litigation again relative to some of your bigger peers, the legal while it is difficult to predict if you will, it seems like we might be at a better or kind of more stable run rate if you will in terms of how we think about the legal going forward in terms of -- and your existing accruals?

There is no unusual legal accruals in the first quarter.

As you will recall, the fourth quarter had the $80 million but first quarter was relatively straightforward.

So first quarter looks like more of like consistent in terms of the outlook?

Nothing unusual from a litigation reserve standpoint.

Okay, great.

Thanks very much.

Kevin Barker, Compass Point.

Good morning.

The 15% markup in the MSR this quarter and the MSR looks like it is valued at about 7.7% of total Tier 1 common equity per Basel III.

Can you just talk about how you would expect to manage that if the MSR continues to mark up if we have an increase in rates here?

Yes, so you are talking about the potential impact to reduction in capital?

Yes.

So we have plenty of room there so part of the reason for the increase in the value was that increase in rates that we talked about.

But from an overall standpoint we could almost double our securities -- or our MSR book and still not have the haircut from a Basel III perspective.

So we are not bound by that.

We continue to expect to grow the mortgage business as we talked about and again as we talked about, we expect that to grow more in the second quarter relative to the first quarter because of the seasonality but we are not bound by MSR and capital.

Is part of that due to the deferred tax liabilities associated with that?

There is a lot of different calculations but that is not a binding constraint right now.

Okay.

And then also you had 11% of your loans were HARP which is similar to what you had in the last couple of quarters.

Was the reason why HARP continues to stay elevated due to you are doing cross service or refis or is it just your own book where you are doing HARP loans?

Primarily our own book.

Okay, thank you very much.

Chris Mutascio, KBW.

Good morning.

Andy, I want to make sure I wrote down a couple of things right.

Did you say the gain on sale was down only 15 basis points because I am coming out with a much bigger hit to the gain on sale margin this quarter?

Yes and you know the reason for that and I know Chris where you're coming from.

So the reason for that is you are calculating it on production which is what we are putting in our reports and I am doing it on net apps after fallout expectations.

So our apps price -- production level looks sort of flattish, apps are down about 20% so if you go through the math on that you will see the gain on sale margin is down 10 or 20 basis points.

Okay, that explains the difference what I was doing.

Staying with mortgage for a quick second, you had mentioned that 2Q could be up to over 1Q in terms of mortgage banking income.

There are kind of four puts and takes in mortgage.

There is production volume and there are gain on sale margin, and I guess servicing and your rep and warranty expense.

Of those four little subsets, which one is going to be better than in first quarter in order to drive an upward pressure in mortgage banking first to second?

Application volume.

The others might be better too but the application volume is going to be the key driver.

And is that just because of seasonality?

Principally seasonality and principally because of that slowdown that occurred with the increase in rates in the middle of the first quarter.

Okay.

And you are pretty confident in this?

I tell you what I know.

We only say what we know.

Are right.

Thank you very much.

I appreciate the color.

Nancy Bush, NAB Research.

Good morning, guys.

I have a capital question for you, Richard.

The big discussion if you want to put it that way today is the proper level of capital for the systemic banks and this whole brown (inaudible) and is it going to be 10%, is it going to be 15%, whatever?

I think we are all sort of coming to the conclusion that the largest banks are probably going to have to have more capital even than Basel dictates.

So do you see this as a competitive advantage for you or do you think that these demands for higher capital will then trickle down to the next tier of large banks in which you and a number of the other large regionals reside?

Nancy, a good question.

First of all, we are just a little tiny bank from Bloomington, and I want to make sure you all know that.

I am convinced that there will be a ratability here.

There will be a sliding scale even if it doesn't look like it at first.

If you recall, G-SIFI or G-SIB requirements, we were the first bank not to be given one but we weren't comfortable to have zero as a buffer in our minimum capital charge.

We just knew it couldn't be zero but we were not given a number so we picked 50 basis points.

I think that this whole too big to fail issue has been -- we have failed at an industry to provide confidence to the people who worry the most that we really have ring fenced this problem by six ways to Sunday and as a bank that might otherwise look like an advantaged bank because we're not typically in that first conversation, we are going to be affected by it in some manner as well and I believe for the good of this country we need to have banks larger than us and we need have banks smaller than us.

But we are preparing to be part of something and we think we will get our pro-rata share.

I do not think it will be excessive but I don't think it will be advantageous either.

I think we will get our fair measure of whatever the rule is here to try to make banks safer and if capital is the measure so be it.

If it is loan losses, it might be that, it might be a liquidity ratio.

It could be all kinds of things.

I am worried that too big to fail is just introducing the idea that we need so many different ways to protect the banks that we will become so risk-free that we will end up losing our benefits to those of you who invest in us.

So that is a bigger worry but I think we will get whatever is fair assigned to us based on our size and our complexity.

I don't see it as an advantage or a disadvantage.

I think the whole thing though is a disappointment because we should do a better job of convincing people who are worried that we really have this ring fenced.

Do you think that the concept of risk weighted assets is going to still be with us or are we going to go back to just assets?

Nancy, this is Andy.

I think we will still have risk weighted assets and maybe a tangible ratio will come into play in addition.

One of the things I want to highlight in our bank, our risk weighted asset Basel III, our total (inaudible) asset is about 87%.

So we don't have a huge discount on the risk weightings that you're reading about and some others so it may come into play but it won't be a big deal for us.

All right, thank you.

You bet.

Moshe Orenbuch, Credit Suisse.

Thanks.

Back on the payments I guess looking at least through the first two months of the year, Visa had kind of talked about their volume and US credit and your consumer business seems to be somewhat slower.

I know you mentioned T&E being somewhat slower but are there any other things going on and I've kind of got a follow-up on the partnership thing that you had mentioned?

On the merchant side, our portfolio is heavily weighted toward resorts, airlines, hoteliers, not retail.

And those are areas that are typically very slow in the first quarter, they always are and they are even slower right now based on the T&E spend of some of the corporations.

So that is why we might be slightly disparate because we are not as heavy on retail as the averages you would hear from MasterCard or Visa.

And you mentioned kind of talking to Visa about the potential partnerships but waiting until they are a little more clearly defined.

What is your view as to what that could accomplish?

I won't talk to any one specific deal but the goal that everyone is trying to figure out is who is going to carve out what space as it relates to the interlopers that are not financial institutions in moving money for people in nontraditional ways.

I should write that down because that was a long sentence.

But the fact of the matter is that is what we are trying to do.

When you are a merchant acquirer, you are the only group that has a shot at it and if you blow it then you are going to have an interloper come in and take a position that we have otherwise had as one of the people -- trusted parties in a transaction between consumers and merchants.

So that is really where this is at for us.

That is why I tell you we are dealing with many partners, we are dancing with a lot of different folks.

We can do all kinds of different dances if we need to but we are not leaving ourselves out of the conversation.

We are in virtually every one to decide what we think is a surviving technology or the surviving partner or the surviving customer behavior and it is changing pretty quickly.

So all you should know from us is that we are not waiting to be left standing by ourselves.

We are out trying all kinds of different things.

I just think it is a more prudent approach to deliver on things and show you even pilots be before we announce partnerships.

You can just trust me on this call, we are partnering with everybody you would want us to make sure we are not leaving out the advantaged (inaudible) to a 30 year merchant acquirer who is already in the space and does it very well and everybody wants to be a partner with.

Got you.

One last follow-up and that is you did mention M&A and it is interesting because after a couple of years with Visa, MasterCard, American Express making a lot of acquisitions and there have been a lot of acquisitions in the space, it kind of died out.

Can you talk a little bit about what you might be thinking about in terms of relative size of transactions because you sounded like there is stuff going on?

It wouldn't be very big.

I think I tried to mention it would be names you haven't heard of and people who put it together in a garage two years ago.

It is a technology, intellectual property we would like to buy.

We are big enough that we can bring it in house and we can manage things and do them ourselves but kind of a nascent technology that we think starts to work is better brought in house we can then own it and probably bring them in with us and have them help us derive some of that.

But we are better off to buy their idea enough to try to create a laboratory where we have everyone trying to come up with something new and there are people out there doing that today.

It will not be names that you are going to be looking at today in the paper and they are not going to be big transactions that would cause you to change the sense of balance of how we make our money.

Perfect.

Thank you.

Thanks, Brooke, for hosting and I want to thank everyone for listening to our call.

If you have any follow-up questions, please feel free to call us in investor relations.

Thanks, everybody.

Thank you.

This concludes U.S. Bancorp's first-quarter 2013 earnings conference call.

You may now disconnect.