美國合眾銀行 (USB) 2014 Q3 法說會逐字稿

Welcome to U.S. Bancorp's third-quarter 2014 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 EDT through Wednesday, October 29 at 12 o'clock midnight EDT. I will now turn the conference call over to Sean O'Connor, Director of Investor Relations for U.S. Bancorp.

Thank you, Tiffany, 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 third-quarter 2014 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 schedules are available on our website at USBank.com.

I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page 2 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.

Thanks, Sean, and good morning, everyone, thanks for joining our call. I will begin with a review of U.S. Bank's results with a summary of the quarter's highlights on page 3 of the presentation.

U.S. Bank reported net income of $1.5 billion for the third quarter of 2014 or $0.78 per diluted common share. Total average loans grew 6.3% year over year and 1.4% linked quarter. Excluding the impact from the Charter One acquisition we completed in late June, total average loans grew 5.9% year over year and 1.1% on a linked quarter basis.

In addition, we experienced strong growth in average deposits and credit quality remains strong. Total net charge-offs decreased by 3.7% on a linked quarter basis. Nonperforming assets, excluding covered assets, declined on both a linked quarter and a year-over-year basis.

[We] generated significant capital this quarter. Our common equity Tier 1 capital ratio, estimated for the Basel III standardized approach as is fully implemented, was 9% at September 30. We repurchased 16 million shares of common stock during the third quarter, which, along with our dividend, resulted in a 78% return of earnings to our shareholders in the third quarter.

Slide 4 provides you with a five quarter history of our performance metrics and they continue to be among the best in the industry. Return on average assets in the third quarter was 1.51% and return on average common equity was 14.5%.

Moving over to the graph on the right you can see that this quarter's net interest margin was 3.16%, in-line with our guidance. Our efficiency ratio for the third quarter was 52.4%. 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 5. The Company reported total net revenue in the third quarter of $5 billion, a 2% increase from the prior year. The increase was due to higher net interest income as well as higher revenue in most fee businesses partially offset by a reduction in Mortgage Banking revenue.

Average loan and deposit growth is summarized on slide 6. Average total loans outstanding increased by almost $15 billion or 6.3% year over year and 1.4% linked quarter. Adjusting for the Charter One acquisition total average loans grew 5.9% year over year and 1.1% linked quarter. Overall excluding covered loans, which is a run-off portfolio, average total loans grew by 7.7% year over year and 1.7% linked quarter.

Again this quarter the increase in average loans outstanding was led by strong growth in average total commercial loans which grew by 13.6% year over year and 3.1% over the prior quarter. Total average commercial real estate also increased over the prior quarters with average loans growing by 6.1% year over year and 0.8% linked quarter.

Residential real estate loans grew 5.8% year over year and 0.3% over the prior quarter. Average credit card loans increased 4.9% year over year and were up 2.1% on a linked quarter basis. Total other retail loans grew 3.6% year over year and 1.6% over the prior quarter mainly driven by steady growth in auto loans.

Total average revolving commercial and commercial real estate commitments continue to grow at a fast pace, increasing year over year by 12.9% and 3.2% on a linked quarter basis. Line utilization was relatively flat again in the third quarter.

Total average deposits increased almost $19 billion, or 7.4% over the same quarter of last year, and 3.3% over the previous quarter. Excluding the Charter One acquisition the growth rate remained strong at 5.5% on a year-over-year basis and 1.7% on a linked quarter basis. Growth in low cost savings deposits was particularly strong on both a year-over-year and linked quarter basis.

Turning to slide 7 and credit quality. Total net charge-offs declined 3.7% on a linked quarter basis and rose modestly on a year-over-year basis due to an unusually high recovery in third quarter 2013. The ratio of net charge-offs to average loans outstanding was 0.55% in the third quarter.

Nonperforming assets excluding covered assets decreased by 6.2% from the third quarter of 2013 and were essentially flat on a linked quarter basis.

During the third quarter we released $25 million of reserves, equal to the reserve release in the prior quarter and $5 million less than in the third quarter of 2013. Given the mix and quality of our portfolio we currently expect net charge-offs to remain relatively stable in the fourth quarter of 2014.

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

Thanks, Richard. Slide 8 gives you a view of our third-quarter 2014 results versus comparable time periods. Our diluted EPS of $0.78 was 2.6% higher than the third quarter of 2013 and equal to the prior quarter.

The key drivers of the Company's third-quarter earnings are summarized on slide 9. The $3 million or 0.2% increase in net income year over year was principally due to an increase in total net revenue driven by increases in both net interest income and fee based revenue. The Company also achieved positive operating leverage on a year-over-year basis.

Net interest income was up 1.3% year over year as an increase in average earning assets was partially offset by a lower net interest margin including lower loan fees. The $31.4 billion increase in average earning assets year over year included growth in average total loans as well as planned increases in the securities portfolio.

Offsetting a portion of the growth in these categories was a $1.4 billion reduction in average loans held for sale, reflecting lower mortgage origination activity versus the same quarter of last year.

The net interest margin of 3.16% was 27 basis points lower than the third quarter of 2013 primarily due to growth in the investment portfolio at lower average rates, lower loan fees and lower rates in new loans partially offset lower funding costs. Lower loan fees were due to the previously communicated wind down of Checking Account Advanced, our short-term small dollar deposit advance product.

Noninterest income increased $65 million or 3% year over year due to higher revenue in most fee businesses partially offset by lower Mortgage Banking revenue. We saw growth in retail and corporate payments, merchant processing, trust and investment management fees, deposit service charges and treasury management fees, commercial products revenue and investment product fees.

Noninterest income increased year-over-year by $49 million or 1.9% primarily due to an increase in compensation expense, reflecting the impact of merit increases, acquisitions and higher staffing for risk and compliance activities.

Net income was lower on a linked quarter basis by $24 million or 1.6% mainly due to the increased noninterest expense, partially offset by a decrease in the provision for credit losses. The second quarter of 2014 included two previously disclosed notable items impacting non -- other noninterest income and other noninterest expense that together had no impact to diluted earnings per common share.

On a linked quarter basis net interest income increased 0.1% due to an increase in average earning assets, mostly offset by our lower net interest margin including lower loan fees. Net interest margin of 3.16% was, as expected, 11 basis points lower than the second quarter, principally due to growth in lower rate investment securities and lower loan fees due to the checking account advanced product wind down.

On a linked quarter basis noninterest income was lower by $202 million or 8.3%, primarily due to the second quarter Visa stock sale, lower Mortgage Banking revenue and lower commercial products revenue partially offset by higher deposit service charges, corporate payments products revenue and trust and investment management revenue.

On a linked quarter basis noninterest expense decreased by $139 million or 5% due to the second quarter FHA DOJ settlement in other expense, partially offset by Charter One merger integration cost and higher mortgage servicing related costs.

Turning to slide 10, our capital position is strong. Beginning January 1, 2014 the regulatory capital requirements effective for the Company follow Basel III, subject to certain transition provisions from Basel I over the next four years to full implementation by January 1 of 2018.

In addition, beginning with the second quarter of 2014 the advanced approaches portion of Basel III became effective for the Company. A common equity Tier 1 capital ratio estimated using the Basel III standardized approach as if fully implemented at September 30 was 9%. At 9% we are well above the 7% Basel III minimum requirement.

Our tangible book value per share rose to $15.66 at September 30, representing a 13.3% increase over the same quarter of last year and a 2.6% increase over the prior quarter. I will now turn the call back to Richard.

Thanks, Andy. To conclude our formal remarks I will turn your attention to slide 11. We remain focused on extending our advantage which is our theme for 2014.

Our consistently solid financial performance is a result of our adhering closely to the core fundamentals of controlling expenses, of managing capital prudently, of selectively investing in initiatives that generate steady long-term growth and expanding existing customer relationships. That was really the case in the third quarter as our disciplined approach produced positive operating leverage.

As we head into the final quarter of the year we remain diligently focused on executing our plan, even with the ongoing economic headwinds with an emphasis on providing our customers with the trusted products and services to help them build more secure financial futures backed by the financial strength of U.S. Bank.

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

(Operator Instructions). Paul Miller, FBR Capital Markets.

Hi, guys, this is Jessica Ribner and for Paul Miller. How are you?

Hi, Jessica, good morning.

Good morning. We just had one question. Just taking into account the recent changes announced by the FHFA in terms of the 3% down payment and some reps and warrants clarity, does that change the way that you think about originating down the credit spectrum in the mortgage space? Or how do you guys view that?

It really doesn't. This is Richard. It is a good sound bite, but I think the test comes in whether or not there is a private market for investors to pick up these loans with lower or no down payment. And I am not sure there will be.

So we are going to continue to stick with the FHFA Freddie and Fannie deals that we originate that we sell off. We will continue to originate loans that we hold on the balance sheet for our more well-heeled customers. And we will continue to watch the progress in this space because we like very much to feel more comfortable making loans with I would say either a lower FICO with less down payment.

But unless we are convinced that the rules are going to be permanent and there is not going to be a look back or a reach back in future times or that there won't be a market for this, we are simply going to stay on the sidelines in the concerns of both compliance risks and other uncertainties. And we will just continue to do what we are doing now, which is I think is sufficient for the near term.

What do you -- just as a follow-up to that, what do you think would -- what do think that they would have to say or come out with to make you more comfortable in that space? Because you were talking about a reach back or something like that.

Right, right. That is a great question, Jessica, and I am not sure I have the answer because I would have to see it or believe it and then test it. And so it is going to take a while for me to have a belief that this litigation risk isn't as great as compliance risk, which used to be both less important than credit risk.

So when you think about all the risks we have, credit risk we can manage, we have done that through the whole cycle and we did it well before. In terms of litigation risk, that is kind of the new uncertainty. And with the statute I think of time coming upon us, there may be a softening of some of those look back/reach backs.

And where I started -- there is a private market out there has got to say they want to buy these loans without the guarantees. And they got to be willing to take those loans on with those lesser quality customers under the risk that perhaps they won't repay. And that is going to be a market that is going to be tested over time with a number of players that will have a chance to come in. And once we see that appetite that will probably be the first evidence we will be looking for.

Great, thank you so much.

John McDonald, Sanford Bernstein.

Just wondering about the outlook for the net interest margin next quarter. Andy, could you give us some of the puts and takes for the margin and what kind of outlook you have for net interest margin and net interest income growth?

Sure, John. So if you think about third quarter versus second, we were done 11 basis points and that was three things. The first is 5 basis points for CAA and that is done, so that won't repeat in the fourth quarter.

The second was about 3 basis points for the securities build and that will continue in the fourth quarter. We ended this quarter at about $96.5 billion. We'll end the fourth quarter just over $100 billion. So we will have additional migration down because of that 3 to 4 basis points.

The third factor was the loan mix. Most of our growth was in wholesale as opposed to retail and that was 2 to 3 basis points of pressure. That will continue likely in the fourth quarter also.

So all in, down 5 to 7 for the fourth quarter, but I still expect net interest income to grow. And then finally, that pressure on securities build will diminish, will go away beginning in 2015.

Okay, you will be done you think by the first quarter?

(Multiple speakers). We'll -- our expectation is that we will end this year at or above 100% in the LCR ratio. So our net securities growth will be more consistent with the overall balance sheet growth as opposed to building additional to meet the LCR ratio.

So, John, (multiple speakers) compression -- all that remains for 2015 is loan mix and interest rates in general. But we have really gotten rid of the other variables that have been moving all through this year taking the number down.

Okay. And, Richard, could you give us some color on your feelings about loan growth from here, both just kind of the absolute level of growth you are looking for and then the mix factors?

I am feeling pretty good actually. So let me -- I should say this to all of you. First, I'm glad to see that you are even on the call. I thought being last we might not have anybody come to our party. We always announce our earnings (multiple speakers).

Reporting with 10 other banks this time.

Well, I will tell you what, I mean who cares about what we have to say now, right?

(Laughter).

We have always announced earnings on the Wednesday after our Board meeting. And the Board meeting has always been the third Tuesday. For the first time in my years as CEO -- my eight years as CEO, the -- that (inaudible) the fourth Wednesday. And so that is why we are so late in the cycle, I'm talking to all of you a week later.

We have amended that with the Board and we are going to go back to announcing on the third Wednesday. So this will be the last time we have this trailer keeping you from writing your final reports. And so I just want to make that clear.

By the same token though I have this great visibility and clarity I have never had before on what the other banks have been saying. And so, I'm going to say we are generally positive about loan growth and I am saying that for the following reasons.

As Andy indicated, we had the 1.4% linked quarter growth, if you take out the Capital One acquisition it is 1.1%. And that is right in the range of what we telegraphed. And we are going to telegraph that again for quarter four, we think we are in that same place as we are still moving into the early stages of the fourth quarter.

We are seeing you at across the board, too, John. So I mean we are seeing -- in Wholesale Banking we are seeing people continue to support capital expenditures, particularly in large ticket leasing and in Corporate Banking. We are seeing the pipeline across all industries stronger as the year ages, which is pretty positive.

We're also seeing the leverage portion of the market remains pretty fast growing, but we don't participate much in that. And as you know, there is a regulatory oversight that is more heavy at this point in time and so it doesn't affect us near as much. And then strong market -- bond market is still strong so that does take some of the loan volume away. But overall we don't see anything less than we have seen in the last couple of quarters.

Commercial real estate is still pretty strong. If you look at the West, East Coast and you take kind of this [mile] down to Texas and you move around we see it is pretty active across most property buying areas. We are seeing some investors getting into the central part of the country, Minneapolis, Denver, Phoenix, places like that.

Property types are looking good, apartments, retail offices, lodging properties and we are seeing people get lines of credit and using their lines for property acquisitions.

And then we have seen also nice strength in home equity. For the first time we are actually putting more on the books than are running off now that we are at that part of the cycle. Auto loans continue to be a strong point for us and credit cards are growing nicely and are expected to, as you might expect, in the fourth quarter seasonally get even stronger.

So I mean 1% to 1.5% and probably right around this [window], 1.2% that we have been at isn't robust, but it is pretty solid. And what we are seeing is nice consistency in our pipelines would reflect not only what we are hearing anecdotally but the real facts that we have got some loan growth still well into our future.

Having low interest rates isn't increased for income, but it is pretty good for lending and people continue to see that benefit and we have that cost of funding advantage we have told you about allow us to lend to the highest quality customers at a preferred price and we're going to keep doing it.

Okay. And a little bit more -- thanks for the color. It's a little bit more led by the commercial which is the loan mix impact on the NIM?

Yes, I think it is very much the same, what you have seen in the last few quarters will be very much the same dominated by C&I. But starting to see consumers starting to vie for its position now. Quarter four will be strong consumer with credit card but will still be heavily mixed towards C&I which will still put some pressure on NIM. But as we talked, it starts to wane later into the process.

Okay. And one quickie on the noninterest income. The credit and debit card revenues were a little lighter than expected. You mentioned rewards cost in the write up. Is that kind of the new cost of business in a reward centric world here or is it any kind of one-time catch up in there?

This is Andy, John. So two things. One is just a number of processing days this quarter of 2014 versus the third quarter of 2013 caused a couple of percentage points decline, it was 90 days versus 94. So that is just a nuance with the number of business days.

And the second thing was the rewards, which is a little bit elevated, but I would expect it to be at this level or slightly downward in the future quarters. But if you think about it cards on a core basis ex the processing days was up closer to 5% to 6%.

Okay. Thanks, guys.

David George, Baird.

Richard, wanted to dovetail to John's question. It's more big picture, but a very popular macro topic and that is rates. Wanted to get, not so much your views on rates, but more from the perspective of how you are thinking about running the Company, allocating capital, making incremental investment, etc.

Do you run the Company any differently if rates stay here longer than people think? And any kind of industry implications that you think could emanate from that to the extent that macro backdrop persists? Thanks.

Yes, David, it is a great question and we are still evaluating our final view on what the rates will be. Because just a couple of weeks ago might well have been a different scenario, right, based on what the prevailing view was that rates would start moving up in the middle of the year and now people are thinking later next year.

Here is how we have been running it this year. So it was February 15, I remember the exact date, exactly the center of quarter one. And remember, it was a very tough winter quarter for every business. And we decided to adjust our plan all of 45 days into the year and we placed a hold on FTE in the Company.

And I'm going to repeat this, I told you about this last time too because it's responsive to your question. But placing a hold on FTE we didn't put in a hiring freeze. So if you have 881 people in your division you can have 881 people.

And in fact I am going to encourage you now more than ever to make sure that they're the 881 best people you could possibly have because there is limit on the quality of the people in the organization. But you can't go to 895 and you can't get to 906 until we see a revenue environment that is a little bit stronger.

And so, but for compliance and compliance-related activities where we didn't put any kind of a hold based on what we think is appropriate regulator focus, we've been doing that with quite good success. You might imagine one of my challenges to have the employees of this Company feel proud that because they are working harder is why we are doing well as opposed to make them wonder why we are doing so well, why am I working so hard. And we were trying to get that conversation organize properly.

But I wouldn't hesitate to ask the employees to continue to do that (technical difficulty) into next year if that is what the environment is going to state. Because we really do want to give you guys positive operating leverage to our shareholders on an annual basis, I have always said not in any one given quarter.

And the way to do that is decide what your revenue guardrails will be and then to stay within those based on your expenses. And with the cost of healthcare and the cost of merit increases what is left is to make sure you have got enough to not over spend before you have the revenue.

So we will do more of what we did this year the longer rates stay low or flat next year. By the same token, the minute we believe they are on their way up we will start to release some of those levels of limits and start moving forward more quickly.

Let me also clarify before I hear it my own way, that we are not slowing down on our investments or our capital expenditures or some of the longer-term necessary things you need to do to be ready for our future. So we are putting all of that into the long-term view of what is most important and prioritizing so we are still spending money.

And as you know, our expenses are still growing, just at a level less than our revenue and that is how we will continue to do it. But I will agree that the minute rates start moving up and we see evidence it gets a lot easier to run a company this long into a recession and a downturn.

Okay, that is helpful. Thanks.

Erika Najarian, Bank of America.

My first question is, Richard, you have always taken advantage of increasing your market share when your peers are challenged. And based on Governor Tarullo's speech, it sounds like some of your larger peers may have to contend with higher offers on common equity Tier 1.

I guess I am wondering if that does transpire and you have some of your larger peers operating at 11.5[%], 12%, 12.5%, does that -- do think that presents a further opportunity for U.S. Bank being that you would be under that G-SIB requirement?

I will tell you, Erika, I think it is just a continuation of the benefits we have experienced. Because first of all, you know that even if that occurs it doesn't have to be overnight. And not unlike us, but most banks, as we continue to get healthier, are creating capital.

So I don't think that is a real burden for them in the getting there and I don't think it is any different than it has been for the last couple of years as we have been a SIFI and they have been G-SIFI. But I do think at the end of the day our ability to be more profitable and be more attractive to shareholders and have a simpler, easier Company to understand and invest in, I think that continues to become more and more obvious.

And that is why we think we are in a particularly good position where we are as the first non-G-SIB. And I think there are advantages, many of which are continuing and some which might get a little stronger. But I don't think that very event changed any near-term outcome and it just continues to remind us how fortunate we are.

Got it. And just a follow-up question to that. As we think about long-term capital return prospects for the Company, which ratio should we think of as your binding constraint, the standardized CET one or advanced?

Standardized, Erika. So our advanced ratio is 200 plus basis points above our advanced, so our standardized will be our binding constraint and our target is 8%.

Got it. Thank you very much.

Betsy Graseck, Morgan Stanley.

So a couple questions. One a follow on to that on the funding side. Is there an opportunity here with the rate environment to maybe reset, reduce some of the longer-term funding costs that you have got?

Yes, Betsy. So when I gave you my expectation for rates into the fourth quarter and stability into next year it reflects the fact that we have some long-term debt coming due and that we will be refunding or repricing it at a lower rate.

And you could even take advantage to do more than just what is coming due or no?

No, I think our focus will be on what is maturing, which is planned over the next 12 months.

Okay. And then separately in the payment space, obviously you have got a great position with effectively a closed loop or pretty close to a closed loop. Could you give us an update on how you are thinking about your own digital wallet as well as broadening out use of tokenization for security-related purposes beyond just payments?

Well, those are different questions. Digital wallet, I think you know we continue to invest in virtually every scheme we can find and each partner that we have, many of which we don't announce. It is not our plan to announce things ['til contract].

But I will just remind you that we are both a leader in mobile banking but even more so mobile payments. Because, as you said it, we have a closed loop capability, we have got all sides of the equation and we are leveraging that.

I might also say that it wouldn't you surprise you, but we do a lot with customers. We have certain customer groups that we put together that help us think through the next best ideas and we gauge the tenor and interest of some customers, both small and large, into what kind of things they might want.

A closed loop, as you know, has to be a large enough critical mass that there is enough interest in all parties to see the benefits of staying outside of the -- we'll call it the normal freeway. And we still haven't found that combination yet and I don't know that we will. But we are going to keep looking for it and do our very best to use the digital environment that is advantage to us with a firing business to check it out.

As it relates to tokenization, we are at the very front of that because not only are we involved in it, but particularly through the clearinghouse we are working on a tokenization project for all of the 24 largest volume banks in the country.

Clearinghouse, as you know, is the half owner of the ACH system, the other half being the Federal Reserve. And so we are working with them on tokenization. And answering a question you didn't ask -- tokenization really will solve a number of these issues which in the interim look like they are being solved by the [chip] card or the EMV solution.

Those are really just a different alternative to a magnetic stripe. And at the end of the day it's tokenization that's going to give us all the protections we are seeking. You think of the Apple Pay, that is tokenization plus biometrics which allows for a different kind of protection. There will the all kinds of combinations.

So look, banks are going to seek whatever we can to have lower fraud losses because, as you know, most of these hacking circumstances, whether we issue the cards now or later, if there is any losses the banks take those losses and they are substantial amounts of money that have been in our run rates for years.

And to the extent that we can find a way to make the customer safer, not make them feel burdened by having to become safer, it reduces our fraud on the other side and it creates a safer environment. Tokenization is going to provide a great solve to that and then cyber security also gets an advantage as to higher levels of authentication.

So I will just say in answer to your question we are at the leading edge of all those topics either because of our position in the Association or because of our capability of being a full on payments provider. And we are testing all kinds of different scenarios and yet I have nothing grand enough to announce to you here because we haven't found the Holy Grail get on closed loop and we are continuing to watch for it.

Okay, but also on tokenization just to be clear, you could see the opportunity to use that technology not only in payments but also in your own internal peer-to-peer or customer access to funds and funds transfer?

Yes. And it is probably not tokenization as much as there could be a number of versions of closed loop more protected interchanges between let's say large banks that could do things much more quickly. That is a different answer as we're talking about a faster payments network, moving away from the 24-hour cycle. And we are announcing I think very soon that we are all going to be working on faster payment cycles.

The precursor to that though could be bank to bank or large entities to large entities doing intraday transfers on a trusted basis, like you would with a friend, and accelerating what would otherwise be the natural and final evolution of the entire payment system from a 24-hour cycle to a real-time.

That is probably a couple years away, but following the path of some other places around the globe and following the favor of customers we are all working on that. And I think that is something that you will be reading -- hearing a lot more about in the next couple quarters.

Yes, that makes a lot of sense especially given the Fed white paper that asks for 10 years which seems way too long.

You got it.

So then last question, just slightly separate topic, but the progress on the near prime push in auto. Could you just give us an update on how you are thinking about that and how that is impacting pretax margin?

I'm going to have Bill answer that question.

It has been successful. It has enabled us to provide a broader spectrum of yes answers in the dealership office. And we've expanded our presence in the used car market as well. And it is positive on the overall net interest margin on our indirect dealer book. So it is doing well and it is performing as we expected.

And broader context, if we recall, instead of just being a prime lender to an auto dealer, now that we are doing used auto and some near prime and the prime we get a higher shot at getting their fore planning and getting the rest of their business because now we are in all the categories they want, not just selectively picking prime. So there is another advantage.

And I also should say we have been a leasing bank for 61 years, which is back when leasing started. So we have got a long tenor there that I think -- and a less competitive environment for auto leasing and we are going to continue to expand that. And as rates go up, trust me, that is one of the first things you will see is people flipping from loans to leases for payment.

Yes, exactly. All right, thanks a lot.

Ken Usdin, Jefferies.

Just a question on the expenses. Andy, I heard your comments about kind of in the other there should be kind of a plus or minus, some offsetting. So is this the kind of the right base for expenses going forward? And to Richard's comment about staying in the low 50%s efficiency ratio, what does that imply for the ability to deliver operating leverage? Is it really just about getting rates up at some point from here?

Right, Ken. So in the third quarter we had a couple of items that are not going to repeat. We had about just under $20 million of conversion-related expenses principally related to our RBS acquisition -- or Charter One acquisition in Chicago. Those will not repeat into the fourth quarter.

The third quarter also continues to build our tax amortization for our CDC Company. And that will continue to increase in the fourth quarter. That is just seasonal, and in the fourth quarter typically it is about $75 million or $80 million higher than the third quarter.

So you will see that and that, again, comes down in the first quarter. All in though I do expect positive operating leverage in the fourth quarter and I do expect our efficiency ratio to continue to be in the low 50%s.

You know what else, Ken? We are not there yet, but I think the -- we are probably at the highest level of total compliance and audit-related costs we are going to have over the cycle. I don't see them coming down right away, so I'm not saying that, but they aren't sustainably this high for the long-term.

So there will be on another advantage and it will happen probably sometime next year where just the run rate and the expenses start to come down a bit based on some of the focus we have all had in certain categories that will settle.

And so, it is not immediate but I think it would be improper to believe that our current expense base related all that in this very quarter or the ones you have seen in the last couple are the normal high rate because they are not going to be that high.

Understood. Okay, great. Just a second question on just the mortgage business. This quarter you had a huge jump in origination volume and it looks like the apps are pretty flat. And it looks like the MSR hedge came down as you had forecasted for us a quarter ago. So can you just walk us through the drivers from here on the revenue side in the mortgage business?

So as you mentioned, in the second quarter we had a gain on servicing that did not repeat in the third quarter. If you strip that out we were relatively flat and actually application volume was also relatively flat. The fourth quarter is typically seasonally lower and I would expect that to occur this year. And that will result in revenue being a little lower, I would call somewhere between 5% and 15% principally due to seasonality.

Okay, got it. Thanks, guys.

Bill Carcache, Nomura.

I had a question on your funding advantage. It hasn't arguably been as much of an advantage as it could be given the strong deposit growth that we have been seeing across the industry. But I wondered if you thought that might change, particularly if QE is indeed over after this month and deposit growth starts to slow -- not necessarily turn negative, just slow?

So I guess a two-part question. First, do you think deposit growth will slow with the end of QE? And then secondly, would your funding advantage become more valuable in that kind of environment assuming that loan growth continues?

Right. So, Bill, we do assume that at-- and at QE or when rates start to rise we do assume an outflow of deposits, that is part of our rate sensitivity analysis. And I do think the funding advantage will become more explicit and clear when that occurs.

It is there now because we still have some debt on the books and I think that advantage shows itself but it will show itself more as more debt replaces deposits as rates move up.

And importantly, about 15% of our deposits are corporate trust related, which are less sensitive to rates moving up so it is more a function of the operating model of the corporate trust business. So that helps us retain a core level of particularly DDA deposits that will be helpful as rates move up.

Right. But I was hoping maybe to follow up on that, Andy, if maybe you could separate for us the rise in rates, which there are some concerns that that is being pushed farther out. And the end of QE, which many believe is still going to happen this month.

So if we have that scenario where maybe we just set the higher rates aside for a second and just look at the impact of QE coming to an end. Would that alone be enough to slow industry deposit growth and bring the funding advantage to be more -- play more of an important role?

I think what will slow the deposit growth will be growth in the economy. And as businesses start to invest more in growth and expansion and such I think the first place they will go is their own funds, which are currently on our balance sheet. And I think that will be the principal change.

And then secondly, as rates start to move up the opportunity cost of having money in DDA goes up and I think you will start to see a shift out of DDA. But when the economy starts to grow the first place before we see loan growth we will see deposit declines.

Got it. And I wanted to also follow up on some of your comments about auto. Regulatory intervention has been in focus in auto finance and I was hoping maybe you could just share any thoughts on the potential for the CFPB to bring non-bank auto finance companies under its oversight and what that could mean for you and the rest of the banking industry. And I guess particularly to the extent that there are some non-bank lenders who either good pushed out or see their cost of compliance rise?

Bill, this is Richard, I think until we see any evidence of the CFPB (inaudible) any activities of the nonbanks we are just going to presume it will stay the way it is. As you can see, it didn't stop us as a banking industry to stay in the business. We are dealing with a little higher level of risk as it relates to the fair lending rules and the things that have been set.

But I think we have all gotten better at it and know what the risks are. We still are the best, I think, providers of lending to the auto businesses because of our cost of funding and because we are more traditional banks.

I have heard the same thing you have heard and I appreciate the fact that they are going to get some of the not banks. And I do think that if they were that would be a net positive just because the operating paradigms would be the same for all of us.

But it won't change in the near term, it wouldn't change in the near term. It wouldn't change anything we are doing at all. And I don't think until we see evidence of it for some period of time like a year or more any of us are going to adjust any of our thinking based on that.

So it will take a while for them to decide which part of the space they want to get into, what it means to oversee them, what adjustments they may make. And it will take I think such a substantial amount of time that I wouldn't expect any adjustment for at least a year because it takes that long for something like that to cultivate.

Understood, thank you.

Jon Arfstrom, RBC Capital Markets.

Just a few follow-ups. Bill, can you just touch a little bit on auto charge-offs and what is normal for your portfolio? There is a little bit of an uptick, I'm sure it is explainable, but just maybe just give us an idea of what is going on there?

Well, part of that is related to the expansion that we talked about earlier going into the near prime space. So some of that is coming to season. And then seasonally there is usually higher losses in the wintertime than in the summer months. So that is all relatively normal.

And just most of our book is still -- even though we did expand the low end, most of the book is still very prime, high prime portfolio. So the level of losses you see this quarter, they'll be pretty stable from there.

Okay, good. Andy or Richard, just on the risk and compliance spending. I think that is good news that we are maybe at the peak. But can you give us an idea of the magnitude maybe year over year in terms of spending and FTEs that you have devoted to risk and compliance?

I think about the third quarter versus a year ago I would say we have somewhere between $30 million and $40 million of additional expense in the run rate related to risk and compliance.

Okay, all right. But you are thinking that that is near the peak at this point?

Yes, but I also said it stays there for a while. In the midterm it goes down, there is a new permanent level. You didn't ask Andy for three to five years ago, but it would be probably three times what it was a couple years ago. And so we are getting to that place now and we will just reassign some of the parties.

Because compliance, as you know, isn't just a -- it isn't just a unit or a division, it is across every part of the business line. So even my sales team in the front lines all need to have more of a compliance view, we'll call it the first line defense. So every employee has to be thinking more appropriately about doing things perfectly the first time and, therefore, there is an extra cost in each incremental FTE.

So it is not just a group we bring it, but it is a way of doing business. And we have been adding that to everybody's job over the last couple years. Plus we have been having outside third parties and we have added bulked up staff in certain places to deal with regulatory issues to align with the new higher mark of [HIFN] standards. But once we get that settled, I can see some of that going back down a bit as we get more efficient. And as you know, we are pretty efficient once we know what the rules are.

Okay. And then just one more on capital return. Richard, you are --sometimes quotes get taken out of context, but you are on the record of saying that you think 2015 could take off. Wondering if you feel like the capital return in the current range is appropriate for next year. Do you feel like you can potentially return more? Do you feel like you need to retain some more for some maybe greater expected balance sheet growth in 2015? Just walk us through that.

Yes, Jon, that is a hard question, right. But I will tell you to the extent that we can operate, and have now for at least five years in this very low interest rate slow economy, I think we have proven our ability to withstand a more challenging environment. But we are looking forward to the moment when -- I think when rates move up, it is less a proxy for the fact that we are poised to do better when rates move up. It means that the economy is doing better, and we get way more benefit out of that.

So for me, it is a proxy of when the economy starts to turn up. We certainly think we can protect our capital positions, that is for sure, because we know how to manage it in an environment like this. But the sooner rates move up and, again, as a proxy for the economy doing better, the sooner we will be able to telegraph that we will be increasing our capital distributions.

Until we see that I'm going to stay (inaudible) and just indicate there is a positive bias as soon as we see the economy improve. We are certainly safe on what we have, but we are going to be careful on telegraphing when we can move up until we see a more sustained revenue environment which allows us therefore to predict a higher level of capital return.

Okay, all right, thank you.

Matt Burnell, Wells Fargo Securities.

Just maybe, Andy, a question for you related to expenses next year. Questions have come up on a couple of earlier calls about pension expense. I think you guided this year that pension expense will be down about -- it will be down a bit from the prior year.

And I am just curious, I realize we are not at year end when you set the pension rate -- or the discount rate and the pension expense. But how are you thinking about pension expenses affecting your overall expenses in 2015?

Sure, Matt. So if you think about 2013 and 2014, because of the increase in the discount rate we actually had a lower pension expense of about $130 million on an annual basis. If I were going to reset the rate today I would lose that $100 million or so because rates are back to where they were a year ago. But as you said, we won't know that until the end of the year.

Okay. And just a question, Richard, I think you mentioned home-equity loans were growing, that that is a relatively new trend. Could you give us a little more color on where that demand is coming from? Are there any geographies that are growing faster in that product specifically than you have seen in the past? And I'm just curious about any color you can provide on competition from either larger regional banks or maybe some of the smaller local banks who are looking to get into that space as well.

Yes, so, Matt, let's go back to the beginning. U.S. Bank for our balance sheet doesn't have an oversized home-equity portfolio, never have. And if you look back to just the Mortgage Banking, one of the things we didn't have going into the recession was an overly active subprime or near prime mortgage business either.

So we are not feeding off of a lot of runoff, we don't have a lot of deals that are coming due at their five- or seven-year mark that might've been originated in the earlier days. So we actually have a pretty core steady book. So for us it is really simply a matter of the pay downs now are being outpaced by the new originations. And again, you will look at the size of our portfolio, it's pretty average. And that is okay because the quality is very high.

The application levels are particularly high right now and we are very aggressive in a marketing campaign with an internal rate pricing feature and that is across the entire 25 states and that's serving us quite well.

I think when I was talking about or pricing advantages, everyone on the call rightfully jumps to Wholesale Banking and thinks about the advantages we have on cost of funds based on our highest debt ratings and that transcends into better rates and competitive issues on adjustable-rate. But we can do it too on things like Consumer Products as long as we match fund it properly.

And so, we have a very strong new account pipeline going now. And the activation rate is even more impressive. So I'll give you an example. Our six-month activation rate on a year ago was 61%, so we get a line of credit on and 61% within six months later was being used, that is now up to 77%.

And so, that means that we are finding better customers who really want it and need it and are using it. And increase that with a fixed rate lock option which is another feature we have included in our advertising and we are spending money to talk about it in both social media and in traditional marketing. Let that be one of our leading products.

If you lived in our market, like Jon does, you would see the commercials and you would hear the commercial and you would see some of the social media. So we are putting a lot of energy because we really want that to [term] permanently and we think that that is one of the best core quality types of loans that you can have.

And it is across the whole state -- the whole country for us particularly -- most notably in the western part where the balances on markets are growing faster, so home appreciation is related which totally makes a lot of sense. And I would say our outlook for quarter four is to continue to see some growth in both the originations and the balance sheet.

So that is a pretty positive story off of kind of a slow starting point, but with some permanence around it not which, up until recently, might have been just one or two months and then a fall backwards. And I think we are on a sustainable growth pattern to grow.

Okay, thank you very much.

Chris Mutascio, KBW.

Andy, I wonder if you could talk a little bit about the merchant acquiring business, the underlying trends. What I'm trying to get at -- when I look at acquiring revenue per transaction, that's down about 5% year over year and the acquiring spread is also down about 6% year over year. And (inaudible) a longer trend of deteriorating of those two metrics can you kind of give me some color of what is going on in that business from kind of a margin and spread perspective?

Yes. So the DIA rate this quarter was about 40 basis points and it is down a little bit from a year ago. Two reasons it is down. Number one is a little bit of margin pressure, as you talked about. I think that is beginning to stabilize. But we did see the last 12 months have some pressure in pricing.

The second factor is the mix of businesses that we acquired for. So to the extent that where are large retailers or airlines in particular there is a little thinner spread there. But I would say the decline related to margin pressure is beginning to stabilize, the rest of it will be depending on the mix of spend in the next 12 months.

Great. Thank you for the color.

Mike Mayo, CLSA.

I had a few follow-up questions. First, what do you estimate to be your deposit beta?

Mike, this is Andy. It ranges from 5% to 90% depending upon the deposit product. So it is not just one number, we have very detailed by product by line.

And on average?

On average it depends upon the deposit mix we have any point in time. But if we think about a few years ago where it was let's say 20% to 30%, it is above that now because of the higher level of DDA and other activities we have. So it is higher than it was in our modeling.

Okay. Richard, you talked about the capital advantage and that gives you a pricing advantage with higher-quality borrowers. And you said it is not really anything new, it is a continuation. But can you somehow quantify that?

I mean, you do have required regulatory capital that is significantly below your much larger peers. And I am just trying to figure out to what degree does that give you a pricing advantage, which in turn allows you to gain market share?

So, Mike, if you think about it, we are assuming our SIFI buffers is about 50 basis points. We don't know that, that is our assumption, that is when we get to our 8%. So if you are a G-SIB that has a [250] buffer, so let's call it 200 basis points more and you go through the math, you would have about a 30 to 35 basis points advantage to achieve the same return or less than that and get a higher return. So it is not insignificant, it is a pretty significant advantage.

And, Mike, additionally, which we've talked about. When we go into the market if we have to issue any kind of a debt, we have an advantage to every other bank. And whatever that time period is and however much that raise was, we have that much delta to offer up. And as I said earlier, it could be to wholesale, it could even be to consumer businesses and there is a net positive.

But here is the trick, you only use it on the highest end quality customers because otherwise you are starting to dip down into things with loan losses and compliance costs and things you may not really understand.

So for us I'd expect you to hear on other calls that the pricing competitiveness is still high and pretty peaked. You haven't heard that here because we either are part of the problem or we choose to use our funding advantage to be more competitive on price not on underwriting. And for the most part most of the pricing seems to be pretty stable in the competitive environment as we see it. So we are not feeling disadvantaged by it either.

So you go to the table and you are competing to get a large high-quality corporate client and you say we will price this loan 30 basis points less, give us your business or 25 basis points less? Is that the conversation?

I would say that is the conversation more for the middle market. On a large client it is more of a national funding market and in that example I think what the outcome is we have a higher return for the same price.

That's right.

Isn't that somewhat similar though to other regional banks that also have a capital advantage versus the largest peers?

Capital yes, debt rating no.

It is a twofer.

And then the last question. Richard, to follow up before, you said 2015 can take off, it is right around the corner. I think there is some quotes and that all looks great. And we are all thinking, okay, if Richard Davis is right this economy is set to take off. And then you look at the 10-year bond which is saying the opposite. So who is right, Richard Davis or the 10-year bond?

Wow. I have never met the 10-year bond. I am going to go with me. But I'll tell you what, I do think -- and I have said this before too -- I think the stock market is a head fake if people are using that as a measure of the quality or the wealth of the intention of consumers to start spending and acting.

In fact, in some respects the stronger the stock market is because there is nowhere else to put it. So I am not changing my view that in 2015 things can turn around quickly and start to take off because when they do take off I think it is pretty likely they will be fast.

And again, the pipelines I am talking about, customer intentions I'm talking about, (inaudible) waiting for the final decision when rates start to move which will create this I think tsunami effect of people acting quickly. I am going to stick to what I said before and I think it is next year. And when it does it happens fast.

I don't have any evidence that says otherwise. And I am not responding to the vagaries of two weeks of either 10-year interest rates or stock market variances, I am just going to stick with it.

All right, thank you.

That was our final question. Presenters, do you have any closing remarks?

Well, thank you for listening to our call and please call me this afternoon if you have any further questions. Thanks.

Thank you. This concludes U.S. Bancorp's third-quarter 2014 earnings conference call. You may now disconnect.