美國合眾銀行 (USB) 2017 Q1 法說會逐字稿

Welcome to U.S. Bancorp's First Quarter 2017 Earnings Conference Call.

Following a review of the results by Andy Cecere, President and Chief Executive Officer; and Terry Dolan, 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 Wednesday, April 26, at midnight, Eastern daylight time.

I will now turn the conference call 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.

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

Andy and Terry 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 Andy.

Thank you, Jen.

Good morning, everyone, and thank you for joining our call.

I'm going to start off by giving you some high-level commentary.

Terry will then provide more detail on the first quarter results and some forward-looking guidance.

And after that, we'll take your questions.

In the first quarter, we reported net income of $1.5 billion or $0.82 per diluted share.

Slide 3 of our presentation provides a summary on the quarter.

As is typical of the first quarter, seasonal factors impacted sequential results.

However, on a year-over-year basis, we reported solid growth in revenues, earnings, loans and deposits.

Turning to Slide 4. I'd like you to focus your attention on profitability and returns.

In the first quarter, our return on average assets was 1.35%, our return on common equity was 13.3%, and our efficiency ratio was 55.6%.

We are proud of these industry-leading results, and we continue to focus on enhancing our performance.

We expect our return to shareholders and our efficiency ratio to improve throughout the year as we gain market share in core business lines and benefit from the funding advantage afforded by our high debt ratings and superior deposit franchise.

We expect to do this while maintaining the same expense and credit risk discipline our shareholders have come to expect from us.

The U.S. economy continues to improve.

Interest rates are finally on an upward trajectory, and customer sentiment reflects optimism for potential actions by the new administration.

So there is a lot of change and potential opportunity on the macro front, much of which could be to the benefit of the banking industry.

I believe we are well positioned for this next phase of the cycle.

During the first quarter of 2017, commercial loan growth was sluggish across the industry.

Our large corporate customers tell us that they are optimistic about the future but are awaiting more clarity regarding potential changes in tax and regulatory reform, infrastructure spend and trade policies.

Additionally, some of our clients are actively accessing the capital markets, which pull some financing from the bank lending arena or result in a reduced line utilization.

However, we expect commercial loan growth to be better in the second quarter versus the first, and we expect more robust commercial loan growth in the second half of the year.

Let me talk more about profitability and returns.

We are not interested in growing just to get bigger; we are focused on profitable growth.

And that mindset is deeply ingrained in our culture.

As a result, we are willing to forego volume growth to maintain an appropriate level of profitability.

We've been doing this for years in our company.

In the wholesale bank, we often acquire new customers by allowing them to utilize their balance sheet for some amount of time, but if we can't transition that into a more profitable relationship, we cull the relationship.

That strategy has translated into client growth, higher revenue per client and better profitability.

We apply this same logic in our payments business and every business line for that matter.

High-volume, low-margin business can impair profits.

So as an example, we are purposely allowing less profitable business in Elavon to run off.

In the near term, that's a headwind to top line merchant acquiring services sales and revenue growth, but those clients are being replaced by more profitable relationships.

And that transition is setting us up well for the future.

Terry will give more detail on merchant processing revenue during his remarks.

Turning to expenses.

Our efficiency ratio remains best in class, but it's higher than we would like it to be.

As we said last quarter, we expected expense growth to moderate as certain risk management programs are fully implemented later this year.

We are committed to delivering positive operating leverage for the full year 2017 with the support of top line revenue growth, careful management of expense and reduced cost pressures from compliance programs.

And we will deliver that positive operating leverage without pulling back on prudent investment spending.

We remain diligent on the topic of risk management.

We feel very good about our credit quality and the overall credit environment.

Our net charge-off ratio continues to be stable, and the nonperforming asset ratio improved on both the linked quarter and year-over-year basis in the first quarter.

But we will never take our eye off the ball or fool ourselves into thinking we'll be able to predict when the churn in the business cycle will come.

Finally, our capital position remains solid.

We haven't been burdened by an excessive amount of capital that has weighed on the returns.

That said, we have sufficient capital to support growth, effectively manage through periods of economic stress and continue to return capital to our shareholders.

Our tangible book value per share of $19.13 at March 31 was up 6.6% versus a year ago.

With that, let me turn it over to Terry to provide details on the quarter.

Thank you, Andy.

I'll start with a balance sheet review and then discuss first quarter earnings trends.

Slide 5 shows our loan growth trends.

Average total loans outstanding increased 0.2% on a linked-quarter basis and grew 4.1% compared to the first quarter of 2016.

Strong linked-quarter growth in retail leasing and residential mortgages was essentially offset by modest declines in commercial loans, commercial real estate loans and home equity lending.

As mentioned earlier, the commercial loan growth was sluggish across the industry during the first quarter.

Our commercial loans declined slightly compared with the fourth quarter of 2016.

Excluding the seasonal decline of corporate card balances, which are included in our commercial loans, our commercial loan growth was positive 0.2%.

Somewhat offsetting this headwind in the first quarter was strong growth in middle-market lending across many geographies.

Loan growth in commercial real estate reflects our own prudent approach in lending to certain CRE segments, such as multifamily and retail, given current market conditions.

Turning to Slide 6. Total average deposits declined 0.2% compared with the fourth quarter of 2016, reflecting typical seasonal trends and lower funding requirements given the slower loan growth in the quarter.

On a year-over-year basis, average deposits increased 11.0%.

Following the first -- the March interest rate hike, our total interest-bearing deposit beta is about 20%.

As future rate hikes occur, we model that the beta will gradually trend toward a 50% level.

On Slide 7, you can see the credit quality remained relatively stable in the first quarter.

Net charge-offs as a percentage of average loans were 50 basis points in the first quarter, up slightly by 3 basis points compared to the fourth quarter and 2 basis points higher than a year ago.

Nonperforming assets declined by 6.7% compared with the fourth quarter, and NPAs as a percentage of loans plus other real estate decreased 4 basis points to 55 basis points at March 31.

Improvement was driven by commercial loans, commercial real estate, residential mortgages and other real estate.

Slide 8 represents some information on 2 areas that have received a lot of attention lately by the investment community: auto lending and retail industry exposure.

First, on auto.

We are a prime lender in this space, and we do not originate subprime auto loans.

The average FICO score for originations in 2016 was over 770.

Our credit metrics remain very stable in auto lending.

The second area is the retail industry segment given recent pressure as consumers alter their buying habits.

Commitments related to the retail industry totaled 3.4% at year-end 2016.

A little over half of that is direct C&I exposure to retailers, 2/3 of which are to investment-grade or equivalent clients.

We have minimal exposure to retailers who anchor malls.

We are watching this retail segment and are comfortable with our portfolio given the relative small exposure, geographic diversity and high quality of customers.

I'll now move on to earnings results.

Slide 9 provides highlights of first quarter results versus comparable periods.

First quarter net income of $1.5 billion was essentially flat compared to the fourth quarter but was up 6.3% versus the first quarter of 2016.

The first quarter is impacted seasonally each year, and this quarter was no different.

Turning to Slide 10.

Total revenue declined by 2.0% on a linked-quarter basis and grew 5.7% compared with the year earlier.

The year-over-year revenue growth was primarily driven by solid loan growth funded by strong deposit growth and strength across our fee businesses.

Turning to Slide 11.

Net interest income on a fully taxable equivalent basis was $3.0 billion in the first quarter, essentially stable with the fourth quarter despite fewer -- 2 fewer days in the quarter.

Net interest income was up 3.7% compared with the prior year, reflecting earning asset growth from a year ago.

Slide 12 highlights trends in noninterest income, which decreased by 4.2% versus the fourth quarter, reflecting typical seasonal patterns and a decrease in mortgage banking revenue of 14%.

The mortgage revenue decline was in line with our guidance and reflects both seasonality and a drop in refinancing activity due to higher interest rates.

On a year-over-year basis, noninterest income increased by 8.4%, driven by strength in payment services revenue, trust and investment management fees and mortgage banking revenue.

I'll highlight a couple of items within noninterest income.

Trust and investment fees increased 8.6% year-over-year, reflecting new account growth and improved market conditions, along with lower money market fee waivers.

Credit and debit card revenue increased 9.8% on higher credit card sales of 8.5% and total card sales volumes of 6.2%.

Credit and debit card revenue increased 6.8%, excluding the impact of an acquired portfolio.

The increase in other income was primarily due to higher equity investment income.

Merchant processing revenue grew 2.7% on a year-over-year basis, adjusted for the impact of currency rate changes.

This is a slower pace than we've seen in previous quarters and reflects several factors, including the impact of higher EMV-related equipment sales revenue in the first quarter of 2016; the margin impact of certain interchange caps implemented in Europe in late 2015; and our decision to exit certain high-volume, low-margin merchant relationships last year.

We are growing merchant relationships in this business, but the impact to volumes and revenue is being muted somewhat by these factors.

We expect this masking effect will begin to dissipate in the second quarter.

By the third quarter, merchant acquiring revenue is expected to return to a more normal rate of growth, a trajectory of same-store sales plus about 2%, excluding the impact of foreign currency changes.

Turning to Slide 13.

Noninterest expense decreased 2.0% compared with the fourth quarter, primarily reflecting seasonally lower costs related to investments in tax-advantaged projects, professional services expense and marketing and business development.

On a year-over-year basis, noninterest expense increased 7.1%.

Growth was driven by higher compensation and employee benefits expenses, reflecting the impact of merit increases; higher variable compensation, including performance-based incentives and stock-based compensation; and hiring to support business growth and risk management programs.

The increase in marketing and development expense reflected investment in the brand and various business initiatives.

Other expense was up 6.2%, reflecting the impact of the FDIC surcharge, which began in the third quarter of 2016 and an insurance recovery last year.

Slide 14 highlights our capital position.

At March 31, our common equity Tier 1 capital ratio, estimated using the Basel III standardized approach as if fully implemented, was 9.2%, which is well above the 7% Basel III minimum requirement and our internal target of 8.5%.

In the first quarter, we returned 78% of our earnings to shareholders through dividends and share buybacks.

We expect to remain in our targeted payout ratio of 60% to 80% going forward.

I'll now provide some forward-looking guidance.

In the second quarter, we look for modest growth in net interest income on a tax -- fully taxable equivalent basis, driven by improved loan growth compared with the first quarter and slightly higher net interest margin.

Credit card, mortgage and auto loan growth are seasonally stronger in the second quarter.

Additionally, we look for improved commercial loan growth in the second quarter as well.

However, the timing of anticipated policy changes are difficult to predict.

Also, given the current yield curve and rate expectations, corporate clients are continuing to access the capital markets, which may impact that growth in commercial loans in the short term.

Therefore, we think meaningful acceleration in commercial loan growth is more likely to occur in the second half of 2017.

Finally, we remain disciplined in lending to the CRE market, and growth in that category will likely remain muted in the near term.

We look for mortgage revenue to increase compared with the first quarter.

The second quarter is seasonally stronger as home sales strengthen in the spring, and we are well positioned to gain share in the purchase market over time.

Industry refinancing activity is projected to continue at lower levels, reflecting the higher mortgage rates.

Expenses will be seasonally higher in the second quarter, but as previously mentioned, we expect to deliver positive operating leverage for the full year.

Given the underlying mix and quality of our loan portfolio, we expect credit quality to remain relatively stable in the second quarter, and we expect the loan loss provision to increase in line with loan growth.

The taxable equivalent income tax rate was 27.0% in the first quarter compared with 28.1% in the fourth quarter of 2016.

The decrease reflected the impact of new accounting guidelines related to stock-based compensation effective for the first quarter of 2017.

We estimate the taxable equivalent income tax rate in the second quarter of 2017 will be approximately 28%.

Finally, in the first quarter, we provided notice to redeem all of our Series G preferred stock and issuing $1 billion of Series J preferred stock.

The total quarterly dividend -- preferred dividend for the -- the total quarterly preferred dividend for the quarter was $69 million.

Included in the determination of diluted earnings per share for the first quarter of 2017 was an additional charge of $10 million related to the Series G issuance cost.

Looking to future quarters, given our current capital structure, the level of preferred dividends will be about $63 million in the second and fourth quarters of each year and $70 million in the first and third quarters of each year.

Of course, the $10 million issuance charge will not reoccur.

Let me hand it back to Andy for closing comments.

Thanks, Terry.

So to summarize, we feel good about where we are and our position and even better about where we're headed.

I look forward to leading this company through the next phase of its evolution.

Our Chairman and former CEO, Richard Davis', leadership has set us up well for the future, and I'm grateful for his guidance and partnership over the last 10 years that we've worked together.

Our businesses are strong, and our culture of innovation is intact.

So as I transition into my new role, you should not expect major changes to the strategic direction of this company given our industry-leading performance.

You should expect an ongoing focus on innovation, continuous improvement and our customers and employees.

That concludes our formal remarks.

Terry, Bill and I will now be happy to answer your questions.

(Operator Instructions) Your first question is from John McDonald with Bernstein.

Wondering about the expenses.

Terry, what kind of step-up in expenses should we kind of be thinking about for the second quarter?

And just remind us, where does that seasonality occur, which lines?

Yes.

So if you end up thinking about the second quarter, we're going to typically see it growing probably 3% to 4% in the second quarter relative to first quarter.

As, John, we have talked in some of our investor conferences, we still expect pressure with respect to risk programs, at least through the end of the second quarter, with the trajectory of that growth starting to slow as we get later into the year.

So when we think about positive operating leverage as far as expenses are concerned, we're pretty confident that we're going to deliver on positive operating leverage for the full year.

Okay.

But maybe we shouldn't expect efficiency ratio improvement in the second quarter, and it probably gets better late in the second half?

That's the way that we're thinking about it.

I think it's going to probably start to plateau, and then as it gets later into the year, it's going to start to come down.

So John, I do -- this is Andy.

I do think we're sort of at a high level, it'll be flattish in the second quarter and then start to come down as we achieve that positive operating leverage in quarters 3 and 4.

Okay.

And Andy, what kind of loan growth outlook do you have nearer term?

How much do you think that we can get better in the second quarter?

And what drives your confidence that we could accelerate further in the back half of the year?

Sure.

So first of all, our starting point's a little higher versus where we ended at fourth quarter.

Secondly, our pipelines are stronger.

As Terry mentioned, a lot of our corporate clients were accessing the capital markets, so that did put a bit of a damper on loan growth.

But the seasonality on home equity, what we're seeing on auto and what's going on with the corporate loan growth tells me that the second quarter is going to be stronger than the first quarter but probably not as strong as what we achieved some quarters last year.

But I do see acceleration here in quarter 2.

Okay.

And then last thing, Terry, can you just give us some thoughts on the net interest margin?

What are the puts and takes going forward for next quarter?

And how much improvement can you see?

We got the March hike.

And what do you think for the second quarter NIM?

Yes.

I think net interest margin, as we said, is -- it's going to end up expanding, but it's going to end up expanding slightly, I think, in the second quarter.

We do see growth in the net interest margin as we get into the third and fourth quarter.

Part of the growth in the first quarter of 5 basis points -- some of the factors that will help us as we go into second quarter is we're starting to see that inflection point in terms of the investment security portfolio, so that will help us a little bit.

Cash balances will be a little bit higher, which will put some pressure on it.

When we end up looking at kind of all of those, the growth quarter-over-quarter is going to be in the basis point or so.

Your next question is from John Pancari with Evercore.

On the -- back to the loan growth expectation, I know you indicated that as -- the capital markets weighed near term, but you expect that could be strengthening.

What type of annual growth rate do you expect for this year in overall loan growth?

And then as you look into a more normalized macro improving type of environment, what is the go-forward loan growth that you think USB is capable of for next year, for example?

Right.

So one of the things that we talked about last quarter is that we thought that loan growth for the year would probably be in the 6% to 8% sort of range.

And certainly, as we look at where the first quarter has occurred, that's going to be hard to achieve.

But we think it's going to be middle single digits, if you will, for the year.

We also do believe that second quarter is going to start to get stronger, and then it's going to start to accelerate as the year progresses.

And so as we think about 2018, we certainly believe that, that 6% to 8% is very reasonable as we think about the future.

Okay, great.

And then back to the expense topic, appreciate the color you gave.

But just looking at the efficiency ratio, more of on a long-term basis as well.

I know you're sitting there at 55.5% for the quarter.

How can we expect that that'll trend as we look into '18?

If you can give a little bit of color.

So John, I mean, as we've said, we expect our efficiency ratio to be in the low 50s.

And that's still our goal and our target, and that's what we're planning to.

I would say, again, that this quarter was at our highest level, our high point, and we are going to start to achieve a downward trend, particularly in the second half of this year.

And I would expect the same trend next year as we achieve positive operating leverage.

Okay, great.

And then lastly, on the credit side, I know you indicated you don't originate subprime auto, but do you have a component of your auto book that is subprime that is migrated that way?

No.

I mean, obviously, if somebody goes delinquent and they get scored out, they'll wind up in a -- with a FICO below 620, but that's just normal migration.

So -- but I mean, we have a very high-quality auto loan book.

The origination FICOs are 770 plus.

On the leasing side, it's even a higher credit quality portfolio.

FICOs are over 780.

So anybody that winds up with a 620 or less FICO is just somebody that's probably lost their job and has payment issues.

The next question is from Matt O'Connor with Deutsche Bank.

This is actually Ricky Dodds from Matt's team.

Just a quick question on the professional services line.

Down quite a bit on a linked-quarter basis.

I was just wondering how we should be thinking about that line going forward and if the first quarter number is a good starting point to sort of model off of.

And then maybe another question on the other fees line item.

Obviously, that line item is a little lumpy historically.

Wondering if you could remind us maybe what is in that line item that makes it so lumpy and then perhaps provide a good run rate going forward.

Yes.

So let me take the professional services fee -- fees first, Ricky.

And if you end up thinking about that, that is an area where a lot of business initiatives come through and a lot of expense related, too, for example, some of the risk compliance programs.

It's also very seasonal.

It's very -- it's seasonally high in the fourth quarter.

First quarter comes down to levels that you're seeing, and then it starts to ratchet up as business initiatives are put into place and as the year kind of progresses.

So we do expect that it's going to be a line category that is going to go up.

As we get later into the year and especially as we kind of start getting into 2018, though, I think some of the pressure related to professional fees, as it's related to risk management compliance programs, is going to start to alleviate.

And so I think that is an area for opportunity as we start looking at next year.

But second quarter definitely is going to be seasonally up.

Third quarter and then fourth quarter is usually the high watermark for professional services fees.

In terms of other revenue, other revenue is a combination of a whole variety of different things.

It ends up including equity investment income, some trading income, sometimes syndications is a part -- loan syndications is a part of that, retail product revenue, insurance product revenue.

And so it can be very lumpy depending upon what's happening that particular quarter.

Year-over-year, it's up a little bit, but relative to the fourth quarter, we had some CDC syndication fees that were a part of that.

So it tends to be a little bit lumpy.

Your next question is from Saul Martinez with UBS.

A couple of questions.

First, sort of a bigger-picture strategy question.

I know, Andy, you mentioned that you shouldn't expect any meaningful change in strategy, but wanted to ask about your branch strategy specifically.

You haven't, since the crisis, really changed your branch count that much, especially relative to peers.

You've also had very strong deposit growth over this time period and continue to.

So maybe that's playing a role.

But going forward, how do you think about the ideal network size especially given changes in consumer behavior and, frankly, some pressure to achieve positive operating leverage?

So Saul, you're right.

The branches are a great source of deposits.

We recognize that.

I think that'll become even more important as we move into a higher interest rate scenario.

At the same time, you're also right that transactions in our branch are reducing.

So 60% of transactions today are done digitally outside of the branch.

So what we've done and we will continue to do is change the footprint of the branch in terms of reducing the square footage, and we've done that for the past few years, and we continue to focus on that.

We've also had some reductions in the number of branches, and I would expect that to continue.

So overall, the footprint space, so to speak, in our branch network will come down.

The number of people handling transactions will come down.

But it does continue to be an important source of deposit growth, and for that reason, we'll have branches as we do but fewer square footage, fewer branches, less space.

Okay.

So -- okay.

Did you give any sort of magnitude or sense of the magnitude of how much you're reducing square footage or the proportion of branches that are being refurbished or remodeled?

Yes.

From the number perspective, we've been culling branches in the neighborhood of 50 to 100 the last few years, and we expect us to continue for the next couple of years.

Got it.

And then a more specific question on credit quality, credit cards specifically.

The charge-off rates did move up, 3.7%.

I think a year ago, it's 3.26%.

So obviously, there's some seasonality component quarter-on-quarter.

But the year-on-year, there is some increase, and I know you talked about retail and subprime auto.

But anything there?

What's driving that?

Anything to be worried about in terms of the trajectory on your credit card book?

Short answer, nothing to be worried about.

As you recall, we have grown our -- all of our loan portfolios throughout this cycle.

So we do have seasoning (sic) [ seasonal ] impact there.

We've had good net acquisitions.

We've had good organic growth, especially out of the branches.

So there's nothing there that -- we saw the same seasonal patterns in delinquencies, so we see nothing that concerns us.

It's all within expectations.

We expect the -- that the latter half of the year, [ the house ] rates will come back down depending upon the balance.

Yes?

Got it.

Right, okay.

And can you remind me what you -- I think you mentioned it on -- in your Investor Day, but what the through-the-cycle charge-offs are for your card book?

Yes.

I think we tagged that.

It's either, like, 4.75% or 5%, somewhere in that range, yes.

Okay.

So you're still well within that?

Yes.

Your next question is from Ken Usdin with Jefferies.

This is Amanda Larsen on for Ken.

Can you talk about the push and pulls on balance sheet growth?

Average earning assets were down quarter-over-quarter for the first time in many years.

And I guess that balance sheet size is a product of deposit growth and the opportunity set in growing loans.

But you remixed out of cash into loans, and securities are all shrinking the balance sheet this quarter.

And I'm wondering if this is -- if this will be more indicative of your future plans in a lower-deposit, lower-growth quarter as you focus on profitability over volume.

Yes.

I mean, so if you end up looking at just kind of the shifting of earning assets, I mean, we are holding a little bit more cash balances than what we have in the past.

And that's for things like liquidity purposes, et cetera, and the fact that we've had stronger deposit growth over the course of the last couple of quarters.

In terms of loan growth, I think we've kind of talked about the mechanics of that.

Our investment securities is really going to grow in line with what our liquidity requirements are at any particular point in time.

From a deposit standpoint, in terms of pricing, we're just really looking at being very competitive with respect to deposit pricing.

But right now, deposit beta has been fairly inelastic.

So we don't see a lot of changes relative to where we're at, and I think it is fairly indicative in what -- in terms of what you're going to see going forward.

And Terry, I'd say most of the fluctuation that occurred in the fourth quarter was a function of cash flows.

Yes.

And that can be volatile given deposit flows and given the loan growth.

So if you look at our loan portfolio, that was up, as we said, 0.2%.

Our securities were relatively stable.

And cash will move around a bit.

We'll probably have a little bit more cash as we move forward.

Yes.

Okay, great.

And then fees were good across the board.

Can you talk about pipelines and commercial product revenue and also some of the headwinds and tailwinds in the payments line?

It looks like corporate payments products may have turned the corner on growth but that merchant processing slowed.

Yes, no, I think that, that is true.

I mean, we did see really nice growth with respect to credit cards.

One of the areas I would also kind of focus on is in the commercial payments space.

We saw some very nice growth.

Linked quarter, it's about 4.7%.

On a year-over-year basis, it's about 5.3%.

It's one of the things that we're seeing, and we started making some business investment in that a little over a year ago in terms of technology.

We rolled out kind of virtual card offerings and innovations.

And we're also seeing a little bit of a tailwind as a result of fuel prices getting a little stronger.

So that's some of the things that are benefiting us in terms of commercial business sort of spend in that particular category.

And then in the first quarter, we're starting to see government spend expanding a little bit up, which is a little bit unusual for the first quarter.

It was up about 2.2% year-over-year.

And we're seeing stronger defense spending since the election because maybe we haven't categorized it.

On the merchant acquiring and merchant processing revenue, I did talk a little bit about it.

But again, the drivers behind the 1.3%, part of that is the foreign currency.

So that gets you to about 2.7%.

We -- as part of the kind of chip and PIN sort of rollout in the whole -- in that whole topic, our EMV equipment sales were strong at the end of 2015 and the first quarter of 2016.

But relative to the industry, we're more penetrated in terms of chip technology with about 66%, 67% penetration at this particular point in time relative to the industry, which is closer to about 40%.

And so in the first quarter of this year, we're kind of just continuing to see that.

Now that will abate as we get into the second quarter and then the third quarter as well.

And then I think the other thing that's been -- the other 2 things that's been impacting that is that we just have margin compression that's been occurring in Europe because of the interchange caps that were put into place in late 2015.

That's getting close to the end, which is good to see.

And then as we said, we've been exiting some high-volume, low-margin sort of merchants.

And so that has impacted revenue a little bit, but it certainly has impacted volumes.

And so when we think about merchant acquiring revenue for the second quarter, we do believe that, that is going to get stronger as some of these factors start to abate, and it's going to become more normalized in the third quarter.

And when we think about that, we usually think about it in terms of same-store sales plus 1% to 2% in terms of what the revenue should look like.

And Terry, let me reemphasize something you said.

The corporate payment systems in the past few years have -- seems to have had a headwind either in the government side because of lower government spend or on the corporate side as some large corporations slow down their expense spending.

This was a quarter that we actually saw growth at both.

And that was very positive on the corporate side [ because ] some of that innovation on the government side because of some of the increased spend.

And we continue to expect growth in both of those.

So that's an important turn in terms of the growth trajectory for corporate payment systems.

Okay.

And just one last one on the commercial product revenue, thinking about pipelines into 2Q.

I know you had a good quarter this 1Q, but then also last year, 2Q, it seems like a tough comp.

So what you're seeing on DCM and loan syndications activity.

Is it possible you can post year-over-year growth in that category?

Yes.

Well, certainly, on a year-over-year basis, we do believe that.

The second quarter tended to be a little bit stronger last year because of some of the Brexit things in terms of the second quarter.

But the pipeline, in terms of syndication and fixed income capital markets, continues to be strong.

We do expect, given the current rate environment and just kind of some of the things our large corporate customers are doing, that they'll continue to access the capital markets.

Our capital market revenue was up very strong in the first quarter.

We would expect it to stay at higher levels going into the second quarter.

So we think that that's a pretty good outlook.

And of course, by those large corporate customers accessing the capital markets, that has been impacting our loan growth to some extent.

But we do see that continuing.

And the next question is from Erika Najarian with Bank of America.

So just wanted to ask a question on the trajectory of deposit costs from here.

As you mentioned, deposit beta has remained quite low.

I did notice that there was a 10 basis point quarterly uptick in money market savings.

And I was wondering if you could give us a little bit more color on perhaps the different competitive dynamics of different deposit products.

And also, you mentioned an eventual 50% deposit beta.

But what is a realistic trajectory in 2017 if we only get 1 or 2 more rate hikes?

Yes.

So let me kind of talk about it.

Again, betas overall, if we end up looking at December '15, December '16, March '17, typically, what we have seen, and we're pretty much on track on this as well in terms of the March hike, is that deposit betas have been up about 20%, 20% to 25%, kind of in that ballpark.

We have a strong retail deposit base that represents about 50% of our overall deposits.

And the pricing from that particular standpoint has been pretty inelastic thus far.

So we haven't seen a lot of movement in terms of retail deposits.

And certainly, for the next rate hike, I don't expect that we're going to see a lot of movement.

There may be a little bit more pressure, but we still think there is room and opportunity there.

On the wholesale side, which represents about 30% of our overall deposits, we are seeing kind of what I would say selective competitive pressure.

And the deposit betas with respect to that are closer to the kind of the 25% to 30%, kind of in that ballpark.

And then our corporate trust business, which will be unique to us, represents about 18% of our overall deposits.

That tends to be a little bit more sensitive to interest rates.

And so if we're seeing pressure in terms of movement of interest rates, it's going to be in that particular space.

As we think about kind of the rest of the year and certainly the next rate hike or so, that 20% to 25% deposit beta probably starts to migrate to 30%, 35%.

And that would be -- what I would think we would see kind of through this year.

It's really going to depend upon how many rate hikes and how quickly they come.

I just want to point out is that when we model a rate hike movement, certainly as we get a few rate hikes out, we are going to see deposit betas.

There's going to be just more competitive pressure there in the future.

So that's kind of how -- the way I would think about it.

And just as a second question.

Andy, we totally get the message as the marketplace that it's going to be business as usual and no large change in strategy.

I'm wondering if you can remind us on how U.S. Bancorp, over the next 2 or 3 years, is thinking about inorganic growth in terms of use of its excess capital, especially in a world where your consent order is lifted or you don't have any regulatory restrictions in terms of inorganic growth.

Right.

So we have -- as you know, Erika, we have been doing some portfolio deals, credit card transactions, some payments transactions as well as trust and fund services.

So those types of things, we're not precluded from doing.

They are high-return, low-capital usage businesses, and we'll continue to focus on them.

We are precluded from branch transactions until we are out of the consent order.

And we'll look at opportunities there to increase market share or depth of participation in the market as that presents itself.

But we are well positioned with both organic growth that we have today and our opportunities for acquisition with the current model.

So we're not really prohibited from what we want to do.

Your next question is from Vivek Juneja with JPMorgan.

A couple of follow-ups on those questions that have come up.

Andy, can you remind us where you are in terms of your expectations for timing on when you get out of that anti-money-laundering issue?

So there are 3 components that they can center, and I'm going to ask Bill to fill in the details.

But the way I think about it, simply, there's the people process side, and then we're done with that.

The second is the technology component, which will be done this summer.

And the third is the sustainability component, which is really a function of the regulators approving the sustainability.

And that one has a little bit more in terms of uncertainty of timing.

Bill?

So Andy hit on it right.

Vivek, we got it late 2015.

We'd already been working on it for well over a year.

So last year was a year of build.

This year is the year of installing some of the new technology enhancements.

We're pretty much at a full staffing level.

So towards the end of the year, we expect to be able to demonstrate sustainability.

And then from there, it's getting all the external parties comfortable with validations and et cetera.

So that's how we think about the timing.

Do you think you'd get out of the whole thing from the regulators by end of this year, early next year?

Any sense of where you think the timing lands?

Yes.

Again, towards the end -- this -- the end of this year is when we will be demonstrating sustainability.

So that's -- after that, it's up to the auditors and regulators.

Okay.

Okay, great.

Separate question.

Other income, which is up 16% year-on-year, you mentioned in the release that's higher equity investment gains.

Can you give us some perspective -- that's a pretty nice jump in other income.

How -- what is the run rate of equity investment income?

And what is the dollar amount of equity investments?

I've never gotten into the dollar amount associated with equity investments simply because other revenue represents the whole bunch of different categories.

I will tell you that as we think about the second quarter, Vivek, that we do believe that the equity investment income is going to be pretty consistent -- based upon anything that we see right now, pretty consistent with the first quarter.

So we wouldn't expect to see a lot of movement upward, down in terms of equity investment.

Okay, okay.

Lastly, auto lease residuals, can you talk a little bit about that?

There's been some concerns about that item given concerns about lower [ fleeces ] coming off in the next couple of years.

So Vivek, this is Andy.

That has come back.

So as you know, that was in the $700 to $800 level last year, migrated down to about $200 of gain in the first quarter.

But I will tell you, in April, it's back up to the $800 to $900 level.

So it's bounced back.

Part of that is because of a slowdown in production, which has eased the pressure on used car prices.

So that has bounced back.

Your next question is from Betsy Graseck with Morgan Stanley.

A couple of questions and follow-ups.

One is on the deposit rates that you showed on your slide deck where, for time deposits, you did increase this past quarter, but there was some outflow.

And I'm just wondering, I know, for quite a while, you've been shrinking time deposits, not necessarily most efficient way of gathering deposits.

But I'm wondering, from here on in, does that strategy still hold?

Or should we expect that you're going to try to regain some activity there?

Yes.

From a time deposit standpoint, we're -- that's really kind of a function of what sort of funding we need in order to be able to support loan growth.

So in some respects, it's kind of a function of how much loan growth we end up seeing.

If we do continue to see rising rates, that we may kind of change our pricing strategy a little bit with respect to time deposits, especially as we get into a period of time as -- I don't know whether it'll be the next rate hike or the following where retail deposits become more sensitive to rising rates, then you may see us kind of shifting that strategy in order to kind of lock in some of the deposit pricing associated with time deposits.

But for right now, based upon what we're seeing in the relatively inelastic retail deposits, I don't anticipate that we would change a lot.

Okay.

And then my other follow-up is on the commercial real estate.

You mentioned in the prepared remarks not really looking to grow that line item and, in fact, shrink a bit, being conservative.

Maybe just speak to some of the reasons why and touch on if any of that has to do with regulatory reviews or CCAR process, [SNCCs], et cetera.

Betsy, this is Bill.

Last part first.

None of it has to do with regulatory or CCAR process.

If you look at the CRE line and you look at the 2 pieces, the piece that's been declining is the standing loan or mortgage loan part.

So that's -- as other banks have offered long-term fixed rates, we're not interested in doing that.

We'll have a nonrecourse.

We're not -- we have our set appetite for that.

And then just the insurance markets, et cetera.

So that's the piece that's been declining.

On the construction, we enjoyed fairly rapid growth there for a while.

That has slowed, but that's in part because of our own client base.

They're getting more cautious on the multifamily side, and obviously, we follow our clients.

And so we do look at the high asset values in some of the CRE markets right now, some of the different metropolitan markets.

So our borrowers are cautious -- our customers are cautious.

We're cautious.

But we still anticipate the construction book to grow, just not at the same rates as it used to.

Okay.

And then just lastly on the C&I, in -- saw the comments around how large corporates are refinancing in the capital markets, driving paydowns, a little bit of pressure there on the C&I loan balance.

But what about the mid-market side?

Is that -- are you seeing the same thing there?

And what degree of interest do you think there is in increasing loan utilizations, just separating out large versus mid?

Yes.

So when we end up looking at loan growth, C&I loan growth, we did see good growth in the middle market space.

And so on a year-over-year basis, middle market was actually up about 8.7%, and on a linked-quarter basis, it was up about 2.5% and represents about 13% to 15% of our overall portfolio.

We are seeing it -- that type of growth across the whole variety of different markets.

We've seen good growth in places like Nevada, Utah, Colorado, here in the Twin Cities, Kansas City, Wisconsin, just kind of across the board.

So -- and as we kind of talk to our folks and we talk to our clients, we're not seeing the same level of access to the capital markets.

So that impact is really more in the large corporate space.

And we would expect the middle market to continue to grow.

The other thing I would say is as we look into the second quarter, part of the middle market is our community banking space, and we typically see lift in the second quarter as the ag lending starts to kick in.

And so both of those would be areas that we would look for opportunity as we think about the second quarter.

Yes.

And Betsy, I'm just going to add one other thing, that in the first quarter, we did see several hundred million of paydowns in our energy portfolio, and we don't expect that to repeat as the portfolio is stabilizing and improving.

But we did have a large number of paydowns in the first quarter.

So...

Okay, no, that's very helpful.

And just lastly, the definition between middle market and large corporate for you?

Yes.

Well, it's kind of based upon size.

It's about $10 million.

$10 million in sales, Betsy.

Up to -- yes, the middle market is the $500 million.

Above that's the corp -- large corporate.

Yes.

Your next question is from Kevin Barker with Piper Jaffray.

Just a quick follow-up on the auto side.

Given the decline we've seen in used car prices, I was wondering how you're thinking about the residuals on your auto lease book and how they might be performing relative to your expectations.

In particular, just the -- maybe you've increased the depreciation rate on those leases and just really how you're mitigating the residual risk on that book.

So Kevin, I mentioned before that the residuals have actually come back here in early second quarter, back to normalized levels, I would say.

They dipped down in the first quarter, you're absolutely correct, but they did come back.

We are already very conservative in the way we think about residuals and the way we book them.

So we're not changing anything there, and the market has come back.

The next question is from Gerard Cassidy with RBC.

Can you guys share with us the HA data, as recently as this past Friday, showed the home equity loans continue to shrink for the industry.

Yours have pretty much held in flat now for a year.

Can you tell us what your guys are seeing on the front lines, why this portfolio is not growing faster since housing prices have obviously come back quite a bit from the lows of the crisis?

Well, a couple -- I mean, we still -- we've actively originated our product out of our branches throughout this whole cycle.

So we still have $1.5 billion, $2 billion of originations every quarter.

And we do poll our folks on what their intended uses are.

And it is -- as you would expect on a traditional home equity, people want to improve the kitchen or whatever.

But as home prices have really rebounded, a lot of folks are able to refinance out both our old first mortgage and our home equity line, lock in a new lower fixed rate.

So I think that's what we're seeing right now is a refinancing of all -- both the first and second loan.

But our origination volume has held in there very steady.

And the growth in utilization, I think, will drive growth.

Yes, right.

Very good.

You guys have been very steady and predictable on the amount of capital you return to shareholders.

What kind of environment would have to develop where you may lift that number closer to 100% of earnings or slightly above it?

Well, Gerald (sic) [ Gerard ], we're in a good spot right now.

Our capital levels are such that -- and our returns are such that our capital formula works.

In other words, we're able to generate enough to return that 60% to 80%, we're at the high 70s right now, and still accommodate balance sheet growth.

So I don't see a scenario that we're getting to that 100% as far as the near term as long as we continue to achieve balance sheet growth, which is what I expect.

And again, we're in a good spot.

We're not sitting in a big excess position today.

Yes.

No, no, agreed.

I totally agree.

And then finally, when you guys are talking about the inorganic growth, acquisitions, obviously, depositories are off the table for the time being.

Are you -- would you consider -- or can you purchase a wealth manager if you felt that would fit into your current wealth management strategies?

Components of the wealth business, we could do that, and it is a level -- area of interest for us.

Wealth is one of our growth businesses.

We're doing a great job organically already, but if there are opportunities that present themselves, we would take a look.

Yes.

And Gerard, what I would say is that in that particular space, we're not interested in what I would call traditional asset managers.

But where we found a good fit in terms of a real wealth manager, I think those are things we would take a look at because culturally, that would be a better fit for us.

Right, exactly.

Your final question is from Brian Klock with Keefe, Bruyette & Woods.

So it's a follow-up question.

And actually, I missed -- I had to jump off a little bit, so I might have -- I apologize if you answered this already.

On the loan growth side and thinking about the NII growth for the second quarter versus the first quarter, I mean, should we be thinking about -- last year second quarter, you had a really strong 1.5% on annualized growth in total loans.

Like, with the commentary about maybe some -- maybe slower rebound for the second half of the year in commercial, should we be thinking about, overall, 1%-ish maybe loan growth into the second quarter on a linked-quarter basis?

And does that sort of drive the NII growth quarter-over-quarter?

So Brian, we achieved 2 -- 0.2% in the first quarter.

And what we said is given the pipelines, the expectations of some seasonality, we expect that to accelerate into the second quarter but not likely to get to that 1% and 1.5%.

So the way you can think about it is sort of 0.2% to the mid 0.5%, somewhere in that area.

Okay, great.

And I guess kind of following up on the auto leasing side, there's been some pretty strong growth year-over-year.

Just thinking about if there's the issues around the residuals and how that may impact the amount that's financed by the purchaser, I guess do you guys think that you may see some slowing in growth in that -- the auto leasing book?

Our leasing group is doing a great job.

They're taking share.

They have a great product.

They've been consistent in the marketplace.

Good turnaround time.

So I think that continues to be an area of opportunity for us.

And as a reminder, everything we're doing there is prime.

So it's good business, and it's good correct volumes.

Brian, the other thing that I would end up saying is that if you end up looking at the competitive landscape, we offer both retail leasing as well as the auto lending.

And so when customers come into the dealership -- and then we also have very strong relationships with the dealerships.

So when they're coming into the dealer and make a decision upon -- about buying a loan or buying a car or leasing that car, we have the ability in that prime space to be able to go either way.

And I think that's, from a competitive standpoint, one of the reasons why we see the growth...

Long-standing relationships.

Yes.

You're exactly right, Terry.

Okay.

Well, thank you for listening to this review of our first quarter results.

Please contact us if you have any follow-up questions.

This concludes today's conference call.

You may now disconnect.