美國合眾銀行 (USB) 2016 Q2 法說會逐字稿

Welcome to U.S. Bancorp's second-quarter 2016 earnings conference call. Following a review of the results by Richard Davis, Chairman and Chief Executive Officer, and Kathy Rogers, 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 Friday, July 22 at 12 midnight Eastern Daylight Time.

I will now turn the conference over to Jen Thompson, Director of Investor Relations for U.S. Bancorp.

Thank you, Melissa, and good morning to everyone who has joined our call. Richard Davis, Kathy Rogers, Andy Cecere, Terry Dolan and Bill Parker are here with me today to review U.S. Bancorp's second-quarter results and to answer your questions. Richard and Kathy 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, Jen, and good morning everyone. Thank you for joining our call. I will begin our review of U.S. Bank's results with a summary of this quarter's highlights on slide three of the presentation.

I am pleased to report that U.S. Bank reported record net income of $1.5 billion for the second quarter of 2016, or $0.83 per diluted common share. The second-quarter results include several notable items that together increased earnings per share by $0.01. These notable items include $180 million of equity investment income, primarily the result of our membership in Visa Europe which has recently sold to Visa Incorporated. Additionally, we recognized $110 million in accruals related to legal and regulatory matters and a $40 million charitable contribution.

I am very pleased with our second-quarter results where we once again delivered industry-leading profitability and posted record results for revenue, net income and earnings per share on both a reported as well as a core basis.

Record revenues were driven by growth in average linked quarter loans of 1.6% as expected and continued strength in our fee businesses. While we saw a reduction in our linked-quarter net interest margin as expected, we did report modestly quarter growth in net interest income and strong growth in net interest income on a year-over-year basis.

Total average deposit growth also remained strong at 7.6% versus the previous year and included net new income account growth of 2.8%. Credit quality was stable for the second quarter as expected. The net charge-off ratio was unchanged at 48 basis points compared to the previous quarter and the previous year, and we recognized a modest improvement in nonperforming assets, which was driven mainly by improvements in the energy credits.

Slide 5 provides you with a five-quarter history of our profitability metrics which continue to be among the best in the industry.

Moving to the graph on the right, you will see that this quarter's net interest margin was 3.02%, 4 basis points lower than the prior quarter which was in line with our expectations. The industry continues to face headwinds from the low interest rate environment and the flatter yield curve, which became more pronounced at the end of the second quarter and continues as we begin the third quarter. The lower long-term rates will have an impact on our second-half results if the rates remain at these low historic levels.

We would expect that given the current yield curve and expectations that the short-term rates will remain flat for the near term, that the net interest margin will decline on a linked basis in the range of 3 to 4 basis points. However, we also expect net interest income to increase on a linked-quarter basis, principally driven by increase in earning assets.

Expenses, excluding the notable items, increased 3.4% at the bottom end of our expected range and our efficiency ratio improved to 54% versus 54.6% in the previous quarter. As projected quarter two expenses included a linked-quarter increase in marketing expense related to the investment in our brand advertising and also reflect the expected peak in our compliance-related costs.

As we look out to the second half of the year, we would expect expenses to grow; however, the rate of growth will be lower than the 3.4% linked quarter growth reported in the second quarter.

Turning to slide 6, the Company reported record net revenue of $5.4 billion in the second quarter. Excluding the Visa Europe sale, revenue increased $226 million or 4.5% from the prior year. Our revenue growth was primarily driven by core loan growth as well as strength in a number of our fee-based businesses including our payments, mortgage and wealth management businesses. We also saw strong results from our capital markets business as we were well-positioned to provide product and services to our customers as they navigated through the recent market volatility.

Kathy will now provide you with more details about our second-quarter results.

Thanks, Richard. Average loan and deposit growth is summarized on slide 7. Average total loans outstanding grew 1.6% on a linked quarter basis and increased by over $20 billion or 8.1% compared with the second quarter of 2015. Excluding the recent retail card portfolio acquisition and student loans that were carried and held for sale in the second quarter of 2015, loans grew by 6.5% compared to the prior year.

In the second quarter, the year-over-year increase in average loans outstanding was led by strong growth in average total commercial loans of 10.7% and improved residential mortgage loan growth of 8.6%. Other consumer loans continued to show positive momentum led by credit card growth of 14.3% which included the retail card acquisition.

Finally, home equity loan growth continued reflecting a year-over-year increase of 2.7%.

On a linked-quarter basis, our loan growth was 1.6% meeting our expectations and was driven by total commercial loan growth of $2.3 billion or 2.6% and growth in residential mortgage of $1.3 billion or 2.4%. We currently project linked-quarter average loan growth in quarter three to be similar to the growth reported in prior quarters.

Total average deposits increased $22 billion or 7.6% compared with the second quarter of 2015 and were up 3.9% on a linked-quarter basis. On a year-over-year basis, the trend continues to reflect strong growth of 9.5% in our low-cost deposits which includes our non-interest-bearing and low-cost interest checking deposits and more than offset the run-off in higher cost time deposits.

Turning to slide 8, as Richard mentioned, credit quality remained relatively stable in the second quarter. Second-quarter net charge-offs increased $21 million or 7.1% compared with the prior year and reflected a modest increase of $2 million or 0.6% on a linked-quarter basis. Net charge-offs as a percent of average loans were 48 basis points in the second quarter unchanged from the prior quarter and the prior year. Compared with the year ago, nonperforming assets increased $95 million or 6% mostly due to downgrades that occurred in prior quarters related to energy credits.

Linked-quarter nonperforming assets improved 3% or $47 million driven mainly from improvements in our energy credits.

Slide 9 provides an update of our energy exposure. At the end of the second quarter, $3 billion of our commercial loans and $11.3 billion of our commitments were to customers in the energy portfolio which was down from the previous quarter. The decline was primarily driven by the completion of our spring borrowing base redetermination on reserves based loans within our energy portfolio. During the second quarter, criticized commitments within this portfolio decreased $509 million while nonperforming loans decreased $54 million principally driven by pay downs.

Finally, credit reserves associated with the energy portfolio declined by $45 million reflective of reduced loans which resulted in an 8.8% credit reserve for our energy portfolio compared to 9.1% in the previous quarter. Given the underlying mix and quality of the overall portfolio, we expect linked net charge-offs and total provision expense to be relatively stable in the third quarter of 2016.

Slide 10 gives you a view of our second-quarter results versus comparable periods. Second-quarter net income excluding notable items, increased by $17 million or 1.1% on a year-over-year basis. Higher operating income was partially offset by higher provision expense. On a linked-quarter basis, net income excluding notable items decreased by $114 million or 8.2% mainly due to the seasonality in certain fee businesses partially offset by higher non-interest expense related to expected increases in compliance costs and marketing expense. The marketing expense represents our brand advertising.

Turning to slide 11, net interest income increased by $126 million or 4.5% on a year-over-year basis. Strong average earning asset growth was slightly offset by the impact of a 1 basis point decline in net interest margin to 3.02%. The modest year-over-year decline in net interest margin primarily reflected the impact of higher short-term rate offset by lower reinvestment rates in the security portfolio.

Net interest income increased by $8 million or 0.3% on a linked-quarter basis. Strong growth in average loans was offset by a 4 basis point reduction in net interest margin. The decline in the margin was principally due to the loan portfolio mix as well as lower average rates on the investment securities portfolio which is principally due to the flatter yield curve.

Slide 12 highlights non-interest income which increased $100 million or 4.4% year-over-year, excluding the Visa Europe sale. The year-over-year increase in non-interest income was primarily due to increases in payments revenue, trust and investment management fees, mortgage banking fees and commercial products fees, which is mainly due to the increased capital market fee -- which was mainly due to increased capital market fees resulting from the recent market volatility.

Credit and debit card fees grew by $30 million or 11.3% reflecting higher transaction volumes including acquired portfolios. Corporate payment products revenue grew 1.7% reversing a negative growth trend recognized during the previous year and this was driven mostly by market share gains resulting from prior year investments made within our middle-market, virtual payment and commercial [products] platform.

Merchant processing services increased 2.0% year-over-year or 3% excluding the impact of foreign currency rate changes. Commercial product revenue increased $24 million or 11.2% driven by higher bond underwriting fees and other capital market activities as our customers responded to the recent market volatility. On a linked-quarter basis, non-interest income excluding the Visa Europe sale increased $223 million or 10.4% principally due to seasonally higher fees within our payments, mortgage banking and deposit service charge fee categories.

Credit and debit card fees increased $30 million or 11.3% and merchant processing fees increased $30 million or 8.0% primarily due to seasonally higher transaction volume. Commercial product fees increased $41 million or 21%.

Mortgage banking fees increased $51 million or 27% which was in line with our previous guidance of 20% to 30%. Growth in mortgage banking revenues primarily reflected seasonally higher production volume. We currently expect linked-quarter mortgage fees to increase 20% to 30% again in quarter three.

Moving to slide 13, non-interest expense excluding notable items increased $160 million or 6% on a year-over-year basis. Higher compensation expense mostly due to the impact of merit increases and variable compensation, higher professional service expense principally related to compliance activity and higher marketing and business development expense related to the investment in our brand advertising were partially offset by lower employee benefit expense.

On a linked quarter basis, non-interest expense excluding notable items increased by $93 million or 3.4%. Linked-quarter expense growth was driven by higher marketing and business development costs again reflective of the investment and brand advertising, higher professional service fees expenses principally due to compliance and an increase in compensation expense mostly due to merit increases. These increased costs were partially offset by seasonally lower employee benefits expense.

As Richard mentioned, we expect expenses to grow in the second half of the year, however, at a lower rate of growth versus the 3.4% excluding notable items that we reported for the second quarter.

Our current expectation is for linked expenses to increase 2.5% to 3% in the third quarter, but let me provide some additional detail. We anticipate that the FDIC surcharge assessment for larger banks will begin in the third quarter which will increase our expenses by approximately $20 million. Additionally, expenses related to our tax credit business are seasonally higher as we move into the third quarter. These two items account for more than half of the expected quarterly expense growth.

In the second quarter, preferred dividends totaled $80 million which compared with $51 million in the first quarter of 2016. The linked-quarter increase is reflective of a recent preferred stock issuance with a semi-annual dividend payment that will repeat again in quarter four.

Turning to slide 14, our capital position remains strong and in the second quarter, we returned 77% of our earnings to shareholders through dividends and share buyback. On June 29, we announced that the Federal Reserve did not object to our capital plan. As a result, we announced a $2.6 billion stock buyback program that commenced on July 1 and announced an expected increase in our third-quarter common dividend of 9.8%. We would expect to remain in our targeted payout range of 60% to 80% going forward.

Our common equity Tier 1 capital ratio estimated using the Basel III standardized approach as if fully implemented at June 30 was 9.3% which is well above the 7% Basel III minimum requirement. Our tangible book value per share rose to 18.46% at June 30 representing a 10% increase over the same quarter of last year and a 3% increase over the prior quarter.

I will now turn the call back to Richard.

Thanks, Kathy. I'm proud of our record second-quarter results. We maintained our industry-leading performance measures and we reported an 18.7% return on tangible common equity in the quarter.

Our industry continues to face challenges from the low-interest rate environment; however, we remain confident that we will continue to grow revenue and prudently manage expenses while strategically investing in our business to create value for our shareholders.

That concludes our formal remarks. Andy, Kathy, Terry, Bill and I will now be happy to answer your questions.

(Operator Instructions). John McDonald, Bernstein.

Richard, I was hoping you could provide a little bit of color on loan growth. What's gotten better and what's giving you the confidence to expect the trend to continue? It sounds like you might expect more of the same? Maybe a little more color there.

Sure. Happy to do it. Yes, we are expecting more of the same, pretty much what we've seen for the last two quarters. I will have Andy give you a little color on the detail as he oversees all of those revenue businesses. But I will say it continues to be a theme of repetitive quarter after quarter where on the wholesale side you are seeing increased capital markets activity that in fact move up and trigger loan repayments and lower line utilization and M&A-related activity. So on the wholesale side, we are still not seeing the kind of organic growth we'd like to see but we are pleased as we said in our comments that we have a fully capable capital markets business in order to take the benefit of what would otherwise be some activities we didn't used to have in the Company when customers moved outside of the lending market and into the capital markets.

On the consumer side, we are seeing all areas moving slowly but surely and nicely favorably from autos, to RVs, to credit card, to home equity, and then we particularly have a good story to tell in the mortgage business as we continue to be a bigger player in that area.

So it's a lot of the same, John, but everything has got a generally positive, slightly positive bias but a lot of the opportunity in the wholesale market is yet to be the kind of organic growth that we all want to see that gets evidenced in a more healthy and robust economic environment.

Andy, do you want to (inaudible)?

Richard, I would add in that that we did see record revenue in our commercial products groups and you saw that our credit fixed income, our FX, our municipal products all were up at record levels somewhere between 40% and 50% on a year-over-year basis, and again that's reflective of the tremendous bond issuance that was occurring here in the second quarter.

We did continue to see strength in auto lending as well as residential mortgages, again principally due to (technical difficulty).

(technical difficulty)

(technical difficulty)

Say that last part again.

And commercial real estate also grew a bit this quarter also which is a little bit of a reversal of a trend.

Great. And maybe Bill could follow up. You had good credit results this quarter. I think the outlook was for relatively stable. Just wondering if you might need to build some reserves if loan growth remains healthy here?

Well, we've started that. So we are adding. We are done with the days of releasing and we are adding to our reserve, so we are mindful of that. As I've said for quite a period, there's still probably room in the existing portfolios, specifically residential/home equity, where we do have -- we continue to see improvements in home values, etc., so that could allow for releases out of those portfolios which does help offset some of the loan growth. We are in a position where we feel it's prudent to be adding to our overall reserves.

Is this quarter a pretty good indicative pace for now, Bill?

For now.

Okay. And in terms of the NPAs and the charge-offs, could you just repeat what your outlook is there?

Yes, it's very stable really across the board. If you look at each of the asset classes, C&I is surprisingly low and this quarter we thought we were very -- got out ahead of the energy issues first quarter and this quarter we had no material energy charge-offs. In fact, we had a nice recovery on one of our credits. So we feel like we've got the energy -- at $50 a barrel anyway -- that we have the energy issue behind us. And if you look at the other asset classes, it's all very stable.

Just to add to that, Bill, I would add we marked our portfolio at $35 a barrel for the second quarter and we have no intention of releasing that reserve for some time until we see sustained higher levels of value on oil. But we do have at 8.8%, we think sufficient coverage and provision and we are quite pleased with how that portfolio is behaving at this point.

Okay. Thanks.

Jon Arfstrom, RBC.

Maybe, Richard, a question for you on expenses. Maybe about a year ago you gave the chin-up bar analogy on if rates remain low, you might have to be tougher on expenses. Appreciate all the guidance. It looks like maybe professional services can start to moderate a bit, maybe marketing and maybe there's some other offsets, but maybe your latest thoughts long-term expense management efficiency if the rate environment remains challenging?

Yes, appreciate that. So picture the bar still up there (inaudible) like crazy, knuckles are white but we are hanging in there.

A couple of thoughts, John. I want to start by saying, I will give you guys a forward-looking view that we intend at this point at least for the second half of the year to stay in the 54% range, 54.0% to 54.9% kind of a range in our efficiency ratio and I'm giving you that because I don't know exactly with no interest rates, flat, very flat yield curve and that can move, either of them can move at any time and they seem to be very volatile. We are not giving up on positive operating leverage but it's getting a lot harder and I'd rather just tell you guys that we are going to stay at this same current level, and we've been there for a couple of quarters now, of efficiency.

Because what I am saying is, we already are under a pretty steady and measured expense control program. We've got an FTE hold in the Company that before any growth items in areas for compliance we haven't added those now since February of last year. And we continue to watch all the non-critical expenses, the discretionary expenses to a point that we think is right up the line where it would start to impair our new growth.

And you guys invest in us not just for this quarter or next quarter but for the long-term, and we are going to be very careful not to overreact, and we have been careful so far not to do that. So our expenses will go up as we said less than the 3.4% linked-quarter. Next quarter will be 2.5% to 3%, and as Kathy mentioned, half of that will be in the FDIC premium cost and in the CDC, which typically has higher expenses in the second half.

The rest is just core part of adding people for our portfolios, adding to compliance and as you said, professional services starts -- it did peak this quarter -- starts to come down. I will tell you it comes down very slowly. So it's not a big measured improvement, but it is at least a point in fact that this will be our highest quarter, I hope, on record.

So that gives you a little more color and I think in the 54% range that gives us enough room to have some [prices] during the quarter but also protect the knowledge for you that we are not going to do something to get to 52% and I don't see this thing moving into the 55%s or 56%s.

Okay. That's helpful. And then maybe quickly just an update on the consent order. Once lifted, what really changes in your mind?

Sure. So the consent order, as you know, precludes us from [whole] bank transactions, particularly things with branch banking. And as we go through this consent order, it takes quite some time not only to get things where they need to be but to sustain them and prove that they stay there. And we are in those processes now.

So I have no idea what the exit time will be but we are working closely with our regulators to make sure that we have permissions, particularly to be released from any part of the consent order first if that's helpful to us to get back into the traditional M&A business.

However, I will remind you that our M&A in the area of merchant portfolios, credit card portfolios, mortgage business activities, trust activities, none of those are precluded under that order and those have been exactly the things we have in the last five years consistently as part of our M&A.

So we haven't been precluded from doing what we've wanted to do. And as I said before, there hasn't been a bank deal or a branch deal that we've wanted since the Citizens Chicago deal that we've been precluded from, so our goal is to get out of it as soon as possible so we don't have any barriers on our options, but for now it's not impairing any of our ability to run the Company or find opportunities to acquire.

Okay. Great. Thank you.

Paul Miller, FBR & Co.

It's actually Tim Hayes for Paul Miller. What is your view for mortgage revenues in the second half of the year given where interest rates are today? Are you guys seeing any pickup in refis yet and do you think that the tailwind to fee income from lower rates could offset the detriment to margin?

This is Andy replying. So our second-quarter mix was about 65% new purchases and 35% refinancings. I would expect that to go closer to 60%/40% in the second quarter, and given that coupled with the normal seasonality I would expect mortgage fees to continue to increase in that 20% to 30% range.

Okay. Great. Thank you.

John Pancari, Evercore ISI.

Want to see if you can give us a little bit more color on the merchant processing revenue. Looks like it came in a little bit light from where I was looking for it for this quarter. I just want to see if we can get some of your updated trends that you are seeing on the merchant side?

And then separately for the payments business, just overall revenue trends that you can expect here. I know we've seen a pretty good rebound in that business but want to get some color on your outlook. Thanks.

Okay, this is Andy again. Let me start with merchant. You are right, there are a few moving pieces to merchant I want to explain. So first, one of the principal drivers of merchant fee revenue is same-store sales. And same-store sales in North America were up just under 2%, 1.8%. And in Europe, they were up about 5%, so globally up about 2.6%. And what you typically see from us is same-store sales plus 1% to 2% is total merchant revenue growth.

What happened this quarter is, while we were up 2% on a year-over-year basis, if you exclude FX that's up 3%. That is also now flattening out revenue related to equipment sales, so we were up higher in prior quarters because equipment sales were going up. They are sort of leveled off. We have lapped that, so to speak.

The other thing you will see is our transaction volume is down, and that was intentional. We exited some low-margin business so it had impact on transaction volume but as you saw not a tremendous impact on fee income.

So as we look forward to the next few quarters, I would expect again same-store sales plus 1% to 2% in terms of our fee growth in merchant volume.

You asked about the other payments business and let me comment on that. Credit card is very strong. Excluding Fidelity, we were up about 6% and that's driven by card transaction volume growth of about 7%, and I would expect that to continue in the future quarters.

And then finally on corporate payment systems, the very good story there is that we are seeing growth in the corporate side of the equation. While government is continuing to be flat, our corporate fee income is growing. Transaction volume, sales volumes is up about 6% and that's a function of the investments we've made in virtual pay and product activity which is very positive. So T&E continues to be weak or level or down a bit but payables and virtual pay is up strong.

And I will add to that, this is Richard. Just if you are going to bring up a Brexit question, I will help you out here. For Brexit first of all, it's not material and it's pretty neutral to the bank, but if it shows up anywhere it shows up in our European businesses, which is merchant acquiring. You may recall those of you who have followed us for a decade, we started our business, merchant-acquiring business, in the UK. That's where it's actually headquartered. So a disproportionate amount of business is in the UK and actually there's a lot of prognosis that believes there will be a lot more travel and visits and spending over in the UK, which is net positive for us.

And given our portfolio mix being heavy on hotels, retail hoteliers and airlines, that could be quite positive as well offsetting any variances that may occur in the rest of the European market through this disruption. So we are seeing Brexit as fairly neutral, to nonmaterial, to maybe even a little bit more positive.

As it relates to our employees, we have a few hundred employees that are working in the UK and/or around Europe that would either have to have passporting circumstances change for them because they are either UK employees working in Europe, or European employees working in the UK. That's something that we will learn over the next couple of years. There's no rush to it and there's been no reaction and we are not changing any of our strategies as a result of that.

Okay, great. Thanks for all that color. That's helpful. Now just separately on the commercial real estate portfolio, pretty good growth this quarter and looking actually at the construction piece saw pretty good jump there. So I wanted to see what you are seeing on the commercial real estate side in terms of where the growth is coming from? And do you expect any moderation from regulatory scrutiny around CRE trends right now at all?

And then lastly, any credit concerns on that front because we are hearing a little bit of that too? Thanks.

Yes, I will go first. I want to go first on this. CRE has got, as you know, for our Company is one of the areas we want to be particularly conservative in, as much as we love it and we are very big in it. And so the scrutiny is high in the industry. I'm quite comfortable that the scrutiny will not be placed here because we've been conservative for a decade and we continue to be in our underwriting.

I will also remind you that commercial real estate has a CMBS market where there's a lot of activity and our guys are telling us that the lack of buyers coming, particularly from the life insurers, has affected the refinance and purchase activity, which only serves to say that there is a reduced pace of payoffs, so part of the increase is actually good news. We are keeping the customers we have.

But we are not striving to get new customers at any kind of risk of underwriting or at pricing change and I think the portfolio will prove itself more over time.

Andy and Bill can add a little color about where the growth is and where we see pockets of strength, but we love this business. We are very good at it, but I promise you we are just not going to get greedy at a time like this in the marketplace on terms or underwriting because it's easy to do and it's not going to happen here.

So Andy, do you want to go first?

Well, to follow up on Richard's point, if you look at our construction loan activity, you see that that's been increasing fairly consistently over the last five or more quarters. What's changed is that commercial mortgage or standing loan/permanent loan, whereas the attrition has declined and actually reversed this quarter, very slight increase -- that was what Richard was highlighting.

The strength has been -- it continues to be on the coast, especially West Coast for us, and through a lot of our REIT clients they've been very active.

And that's what I was going to say. California and Pacific Northwest is where we are seeing the strongest activity.

Great. All right. Thank you.

Scott Siefers, Sandler O'Neill.

Good morning, everybody. Richard, I was hoping either you or Kathy could expand upon your comments on the margin from the beginning of the call. First, I want to make sure I understood it correctly. I think when you characterized it down 3 to 4 basis points, I think you were talking about the second half, but is that 3 to 4 basis points per quarter in the second half, or in the aggregate for the second half?

And then I guess the broader question there is, at what point would you guess that margin compression would stop in this pressured-rate environment because I guess the two big issues would be securities portfolio reinvestment risk and then the still wide gap between your loan and deposit growth. But just curious to hear your thoughts on both those phenomenon.

We got to question five before we got to NIM. That's pretty good. I will be very clear. What we said was, in quarter three, which is all we can see into, we have a 3 to 4 basis point prediction of NIM decrease. Have no idea what quarter four would be. As we woke up this morning, you know that the call for interest rate increases is 21% for September, 36% for December. Better than zero; worse than it was when we talked last time. So we are not going to bet on any of that but to the extent that any of it comes back would be terrific.

Also the 10-year is above 150 again, thank God. That's as helpful to us as interest-rate increases, and you know there's an equal impact on the income statement based on that. So if we can manage through these very worst times, which is continued zero interest-rate increases and very, very low 10-year, we can manage through just about anything, which is how we are building the lower-for-longer kind of term around the country.

So for one quarter we can see that pressure. We can't predict beyond that. I will have Kathy talk a little bit more about the sequencing and the importance of the refinancing that occurs in the securities and the fact that we are actually seeing stable performance in most margin areas for compression as it relates to competitors.

Yes. So, Richard is exactly right. We are looking at it as third-quarter and we are down about -- we are projecting that we are going to be down to in that range of 3 to 4 but I'm going to say it is going to be a lot more of what you've seen. So as the rate curve has kind of flattened, although some signs of improvement here most recently, that's going to continue to have an impact on our securities portfolio, so we will continue to see a decline in that.

And then the rest really you have to look to our loan growth. To the extent that we continue to grow our wholesale loans a little bit stronger than our retail loan, that's also going to put a little bit of compression going forward.

So, Scott, let it be said at the end, remind you that net interest income will increase in quarter three. So we can now fund this in the asset growth but it's going to be continued more challenging until we get interest-rate increases or (technical difficulty). Okay?

Okay. Terrific. Thank you guys very much.

Ken Usdin, Jefferies.

Just as a follow-up on the balance sheet mix, still have a really good loan-to-deposit ratio. You are still growing deposits and I see you are able to remix from the short-term borrowings this quarter. Given that low-rate scenario we are dealing with, at what point do you decide to just try to remix more into loans, less into securities given an understanding that you need to keep LCR? But does anything structural change with that thought process around just asset liability management?

No, it doesn't, Ken. We are nowhere near those lines. We take what the market gives us and then make sure that we apply it appropriately to the balance sheet and therefore the income statement, but we are not near any line where we are evaluating the value of even deposits. We are still collecting deposits and happy to take them because they will be more necessary in the future, and we are pricing loans at the right level to win the high quality, and the securities portfolio is a result of all of that.

But it wouldn't be a driver, it would be a follower and there's nothing in our strategy that's going to change at this stage and there's nothing that's getting as close to the edge where we'd have to sit down and strategize on our balance sheet as a relates to a mix or an area, an appetite that we haven't already demonstrated.

Understood. And then on the deposit side, I think a lot of banks are starting to still see modest hiccups on the deposit pricing side. What are you guys seeing in terms of customer behavior in terms of product choice and any costs that you have to hand along even though we are not really getting it on the left side of the balance sheet?

We really haven't seen a whole lot of shift. Really the consumer has really no rate change whatsoever on the consumer. We talked previously that we did have some repricing on our wholesale side. Some of that was just contractual that happened. The other is as we work with our customer. I will tell you it's been relatively stable as we looked into this quarter.

Okay. Last one, real quick one. The preferred dividend, Kathy, does it go back to the first quarter [57] in the third quarter?

So it's a quarterly payment, so first and third quarter will be at the lower rate; second and fourth quarter will be at the higher.

Probably around 60 (multiple speakers)

So about 60 I would say, 60 in the third quarter, about 80 in the fourth quarter.

Okay. Thank you.

I'm glad you asked that because that got missed -- either didn't telegraph it well or it just got missed in a lot of the models and it's real money and it's also real value, so I'm glad to have that clarity. Thanks for asking it.

You bet.

Mike Mayo, CLSA.

So in the battle of Richard Davis versus the 10-year, I think you are getting obliterated.

I think so too. They are definitely winning, I will tell you that.

On the other hand, you do have some accelerating loan growth. I know you talked about loan growth here, so originally you mentioned economic growth a couple of years ago accelerating, improving and then the 10-year goes down and that's why I brought the comment initially.

So if you look at the 10-year, you are really losing. If you look at your accelerating loan growth, maybe you are winning a little bit more, so I'm just trying to make sense of, are the markets where you do business improving or not?

Mike, it's a great question. They are improving slowly; but I will tell you what, I wish I will be here 10 years from now to prove it, but we are taking market share. Swear to God, honest Injun. We are taking market share. We have been for years.

Think of our home equity portfolio. It's still growing, albeit slightly. But that's been shrinking across the industry. Auto loans, we've never gotten out of it so we are still in it big. Leasing, we are now one and the few players that are really quite capable at it. We've been doubling down on credit cards and you've seen some of our recent portfolio and partnerships. So it's mostly in market share. There's not a market that's actually weaker than it was a year ago, but for all intents and purposes, there is not a market much stronger than it was either and what I think really turns on the dial for banks is when corporate America is more confident, and I don't mean the original old unconfident -- we are always uncertain -- but things with a presidential election in the offering, things like Brexit uncertainties, we don't need any things like that to continue to give corporate America reason to just wait.

And but for M&A and for restructuring their balance sheet, corporate America is not organically doing big things, at least not needing banks in that process. So that's when the thing really starts to take off.

But in the meantime, we are all gutting it out in the trenches trying to keep more customers and do more with the ones we have, and I just think the right answer and as much as it's hard to prove is that we are doing it, in our case, with market share growth.

I'm sorry, the answer to my question? That is helpful, but if you strip all that away, do you think things are improving, generally or not, or it's just kind of the same old?

Yes, I meant to say every market is a little stronger than it was last year, so, yes. But not very much.

Okay. All right, great. Thanks a lot.

Erika Najarian, Bank of America.

Good morning. I Was wondering if you could share a little bit of color on the CCAR results? I was a little bit surprised at how the regional banks fared in terms of their stressed ratios or PP&R assumptions relative to last year. I'm wondering if there is any color that you could share with your investor base on that?

And also, Richard, I'm wondering if the CCAR results and how acquirers were treated in this year's results at all impact your thinking about future acquisitions?

Let me just say first off, we were very pleased with our CCAR results. I always joke, it's a stress test and its effective because we are stressed the whole time. You will also be reminded, we haven't had the final exit exams on all the details, and you also know we will never know exactly how the model works. But I will remind you that in this particular cycle the negative interest rate scenario was added, and that's hard for any of us to predict exactly how that fared for each bank. But I know that that had an impact on what was likely the PP&R for every bank.

As you know, we continue to be at the top on the PP&R, barely in this case, we were slightly below breakeven, but in years past we've always been above. And I think on a relative basis, we even perform better. So I'm not concerned about trying to predict that and I think that the test continues to be effective in helping us all understand whether or not under most of the stress scenarios we would be okay.

Acquirers had more limited capital distribution, and so we don't think that's a factor to us because it's not as relevant to us as it would be some others. But I think as you look at the stress test results and you apply it across different kinds of companies it's not unusual to see a different distribution model based on both what we are starting from, what the stress test would do to us and where we would end.

So essentially it doesn't impact how you are thinking about -- understanding that you have a consent order in place -- but it doesn't impact your thinking about how to manage capital for future acquisitions?

No, emphatically, no. In fact, it doesn't have any impact on it at all. What we want to do is we want to continue to understand the best methodologies that they use in stress testing the loan portfolio so we can better understand what mechanics are in there so we can predict those better than we have in the past. But we also continue to outperform on the PP&R as it relates to their satisfaction in the model with how much money we will make.

So it works both ways, but every year we get smarter. Every year we go back and do our best to evaluate it. And as I said, we are a little bit early on getting any formal feedback, which we will be getting in the next couple of weeks, between this and the next time we talk.

Got it. And just as a follow-up question, really appreciate the color on how to think about payments revenues as we think about forecasting. Could you give us a sense of how much of your payments revenues are generated in pounds so we can think about translation risk?

The translation risk is rather limited, so if you think about every 1% change is about $1 million. It's not a big number, Erika.

Got it. Thank you.

Vivek Juneja, JPMorgan.

A couple of follow-ups. Firstly on CCAR, your credit costs are at the high-end compared with a lot of peers. Can you comment on your thoughts on the results that are showing up there?

Yes, and I think really where you see that is particularly within our wholesale portfolio, and that's been something we've been working on for quite a few years. I think we have tended to be on the higher side -- the Fed has been a little bit on the higher side. We don't have a whole lot of input into or insight into what some of their modeling routines are. As you know it's relatively a black box.

But perhaps we are thinking perhaps that if you think about where our utilization rates and so forth that could have a play. We're relatively low on our utilization side, but we are actually, as you notice, we project a lot lower risk in a downturn environment then the Fed and we are just going to continue this year to try to work through that and try to figure out where the differences lie.

So, Vivek, this is a point of frustration for me because in the first couple of years, I was really worried if we were different than them how big a deal could that be. I will say that history is probably now a better dictate than testing itself, and if you look in the last seven years, which is the exact time frame that we've had the stress test, our commercial portfolio has outperformed most everybody and done very, very well.

And so I'm not challenging the test, I'm just challenged that we are never going to figure out what they put in. Kathy gave you a hint. We think our commitments have been growing faster than anybody's well in addition to our loan growth, and I think if they take a model where all the commitments go to 100% and then go to charge off, that could be it. We have a big government portfolio in our corporate business, which if they take a 90-day late pay and take the whole portfolio to charge off, maybe that could be it.

And as simple as it sounds, we will never get the answer even to those questions I just offered. But what we will do is continue to watch our own performance as you should measure the dictate on how well we've actually done in charge-offs and non-performs over the course of time. And we will just do our best to get closer on that test, but we don't understand exactly ourselves how it tests like it does when the results themselves don't show that way.

Okay. Thanks. One more. Capital markets, you've grown very strongly, Richard. As you continue to do that, does that shift what you are thinking in terms of -- so that's been one of the strongest fee growth drivers this quarter and you are trying to grow underwriting, does that shift what you are thinking from a capital standpoint where especially when you look at peers, etc.?

Vivek, I would say it doesn't shift. It's a function of what's occurring in the market. We've had traditionally two strong growth areas in fees, trust and our payments group, and it's great to have this third area come in, and we are taking what the market gives us and given this low-rate environment and the volatility, things like credit, fixed income, FX are very strong as well as derivatives. So it's great that we have these businesses, which in fact, 10 years ago we didn't have. So it's a positive add to the fee businesses that we have.

Right. But given that it's a higher volatility business, would that not mean that as you think about economic capital that when you've talked about 8% or 8.5% in the past that that starts to migrate slightly upwards?

No, I wouldn't expect that to have any impact on our capital ratio at all.

Okay. Thanks.

Bill Carcache, Nomura.

Richard, I had a question on your P2P money transfer product. How are you thinking about the potential disintermediation risk that clearXchange could pose to the revenues that you generate on the card issuing side of your business, or are there any restrictions that you could put in place to prevent potential disintermediation?

Good question, Bill. First of all, we are clearXchange, so we are going to be on either side of that transaction. What I will tell you -- same answer I gave three years ago with Square, when Square started coming out big with Starbucks, and at least for now, not for the long-term, but for now, most of these transactions are taking cash out of the system, not other card, debit or credit transactions. There's still so much cash in our system and our society, there's plenty of disintermediation of cash long before it starts to tap up against the other card businesses and that's what we are all planning for in the near term and that could be a couple of years.

But beyond that period of time, we all have to be very thoughtful, and your question is right on the money as it relates to what's the evolving relationship between real-time, pay to pay, card, card not present and the mobility of people moving money about in a different environment. Remember, we are still under a Federal Reserve circumstance that settles overnight and not over the weekend, so there's still a big disconnect and we have those things to fix systemically before we get to a real real-time payment.

But for now the disintermediation is mostly seen on cash and that's a net positive for us and the other banks because we have no benefit in cash moving about, for the most part. We do when it starts to monetize itself in the form of a payment.

Right. But maybe just as a follow-up, the nature of that product is really for clearXchange for P2P money transfer between individuals, not necessarily to conduct a payment transaction. But I guess to the extent that you were -- and given your position as both acquirer and issuer -- you would be in a very good position to see the extent to which people were using the product to actually conduct payment transactions in lieu of a USB credit card.

And if that were the case, is that something that you would expect to be monitoring and react to as appropriate to the extent that we are having a revenue impact?

I think the principle activity today is, as Richard mentioned, cash and it's also check, individual to individual. I think the second category that will occur is for people to pay bills, and the bill payment, again, is going to be a replacement for check and/or online checking.

So it is -- bill pay, so to speak -- so in the interim, or in the immediate time frame, I don't think there's any negative at all and we will continue to monitor it, as Richard said, over the long-term. I think the other thing to consider is how this migrates to the wholesale side of the equation and the business. And that's also something we are very aware of.

(multiple speakers) So think about it. This is P2P, right. Then there's P2B, people are paying their bills. And there is B2P where people are trying to -- businesses are reaching out to you and giving you a reason to buy things and send money back. And then there's B2B, which we are all working on, including blockchain, and we are working on all those alternatives.

Most of those are so nascent, I think as a banking category those are just all upside for us because there's so much opportunity and much less disintermediation. But you are onto something, Bill, and there will be a time -- right now babysitters you go home and you pay them cash or you write them a check. Now you are going to start doing it in real time between you and the 17-year-old and the money moves.

We are disintermediating something that's right now not a debit or credit card. But over time this is something we have to put the whole universe together and figure it out. And I've said this before I will say it again, the banks as a collaborative are working better together than we ever have to make sure we work together and create a better circumstance for all of our clients. And I think that's a big plus in the last couple of years as we've seen payments emerge as a real-time issue.

That's great color. Thanks, gentlemen.

Kevin Barker, Piper Jaffrey.

Thank you very much. Good morning. In regards to your commentary around the Brexit and the overall positive commentary around that, could you dig in a little bit on the impact of the Brexit in regards to our payments business in particular?

Yes, in fact that's generally where it's going to be because we've got the merchant acquiring activity which we've talked about a little bit here before. So we will call it neutral for now based on what we can see, Kevin, just because we have such a UK influence. I think there is a positive in UK, intra-UK and there's probably a slight negative inter-continental Europe. But we are going to say that to be net to favorably positive on the payment side.

Terry, you've got the trust side and you have a lot of employees and the Brexit impact there. You might talk about that.

Yes, in our corporate trust business that we have in Europe, at least recently we've seen just a little bit of a tick down with respect to deals that are being done as people pause during that time frame. But the impact that it's had on the long rate of the curve, so the 10-year actually is probably going to stimulate the deal flow in terms of debt issuances, so the overall net impact of that over the next quarter or two I would actually anticipate would probably be positive.

Yes, deals aren't getting lost they are just being held and the new ones (multiple speakers).

Yes, in Europe they are being deferred but in the United States the yield curve impact is actually stimulating some growth.

Was that helpful, Kevin?

It is very helpful. And then in regards to your marketing and spend and the professional services spend, obviously that can be volatile quarter to quarter depending on the business conditions and what you are planning for the future. But given the uptick you've seen there, would you expect that to decline over the next few quarters just because of the spend we saw in the second quarter?

Yes, good question. I'm in my 54% range of efficiency. We are holding steady to finish what we started this year on our marketing and branding campaign because there is a lot of value and stability and sustainability and messaging. As you know, people have to hear things seven times to remember them once. So we are not going to give up on that and then the cost of third-party assistance on compliance, as I said, starts to tick down slowly, so those are both sustainable for the rest of this year. But trust me, everything we can control continues to be in our gun sights and marketing is one of those things that if it has to go it has to go. But I'd love very much to not cut it off just a bit too soon, if in fact we are on the advent of some times here where we can afford to do what we want to do and grow the Company greatly.

Thank you for taking my questions.

Nancy Bush, NAB Research.

Good morning, Richard. I have a question that encompasses a number of these interest-rate questions that have been asked before. If you looked at the JPMorgan Chase results yesterday, there is nothing in those results that says recession. If you look at your results, there is nothing that says recession. I'm about to go on the Wells Fargo call. I assume there's nothing there that says recession.

But the talk is about recession. And when you listen to Janet Yellen speak, it's about global softness, and there is just a massive disconnect now between what we are seeing at the micro level and the banks and what the experts are talking about at the macro level. Can you help me reconcile this before I bang my head into the wall?

First of all, I'm going to join you more than not because I agree with you, but I will tell you we are what we see and I'm going to say two things. The Fed has a different lens on this. They are looking at different things and they are looking usually later than we are. But on a real-time basis which we live in every day, we are seeing a slow recovery. And it's a small nuance on a word but a recession says things are going backwards or people are starting to feel worse and not taking actions that they might otherwise have taken before. We are not seeing that.

On the other hand, because we are balance sheet companies and because we are highly levered and because half of what we do is in the wholesale business, we are all, I think, spending a lot of energy talking about how we are waiting for the wholesale side of the balance sheet to pick up in a real organic old-fashioned way, and we are also not seeing that.

But they are not going backwards. They are just taking this long, long, long period of time to restructure, evaluate their best options when things do pick up, and there's nothing wrong with that, but that's why we all have these unused commitments and continue to grow the balance sheet.

But on the business side, they've got reasons and they are informed and they are waiting. But on the consumer side, it's a little bit better every quarter, and it's not a recession, and I would disagree if someone saying that at the Fed level. And in fact, I think you can see consumers are now starting to spend again. Their savings has hit a level that they are comfortable. They are using their credit cards and they are paying them back on time and getting rewards for it.

But I would say it actually makes sense to me but for the word recession being bandied about lately by a lot of parties, we don't see it.

Okay. Secondly, I have a question related to the consent order. You mentioned that it prevents you from doing branch acquisitions, basically branch institutions. Does it also prevent you from opening any new loan production offices? Is that something you are thinking about? And which markets do you -- are there any markets that you need to be in that you are not in right now?

Good question. The answer is no. It doesn't impair our ability to open loan production markets. And the answer is, we don't have any new markets to get into, but I've never had the chance to show you guys just how many markets we are in our of our footprint. So 25 state footprint where you see us on the street and you drive by us every day. In the other 25 states, for the most part, for commercial real estate, corporate trust, middle market and large corporate, we are in all those states. We just really have never taken the time to show you that.

So I will make this a note to do that at the Investor Day on September 15 and make sure we show you where all of our loan production offices are outside of what would be the footprint because when I show you, you will see we are everywhere we want to be. And so the answer to expansion is no because we are already there.

Okay. Thank you.

Terry McEvoy, Stephens.

Hi, thanks for taking my questions. Trust and investment management fees look to be up 6% or 7% if I just base it off the trailing four-quarter average. In the release you talk about account growth. Could you give a little bit more color about that business in 2Q as well as maybe the outlook for the back half of the year?

Yes, so if you end up looking at the second quarter -- you look at the first half -- the first quarter was a little bit slower simply because of the markets, but in the second quarter with the market starting to recover, we are starting to see nice growth again with respect to new accounts both on the corporate, the institutional side, as well as within wealth management itself. So when we end up looking into the second half of the year, we would anticipate that that sort of growth would continue just given the rebound, for example, in the markets and where they are at today.

And then just a quick question for Kathy. Could you run through your mortgage banking outlook for Q3 and then just so I'm clear, does that include your best guess on hedging gains/losses and MSR changes in fair value?

Yes, so for mortgage fees, we are anticipating that that will have a linked-quarter increase of about 20% to 30%. That does include all of our assumptions around hedging and so forth, so that's all in. And as Andy indicated earlier, I do think that we going to see a little bit of a shift in our application base from purchased -- between the purchase and refi. As he indicated, we are kind of 65%/35% this quarter. I think that that's likely to go more towards the 60% purchase, 40% refi as we move forward.

Perfect. Thanks so much.

I will now turn the call over for closing remarks.

Thank you for listening to the review of our second-quarter 2016 results. Please contact us if you have any follow-up questions.

Thanks, everybody.

This concludes today's conference call. You may now disconnect.