美國合眾銀行 (USB) 2017 Q2 法說會逐字稿

Welcome to U.S. Bancorp's second-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, July 26 at 12 p.m.

midnight Eastern Daylight Time.

I will now turn the conference call over to Jen Thompson 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 second-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.

Thanks, Jen.

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

I'm going to start off by discussing a few highlights from our second-quarter earnings results.

Terry will then fill in some details and also provide you with forward-looking guidance.

After that we will take your questions.

I will start on slide 3 of the presentation.

In the second quarter we reported net income of $1.5 billion, or $0.85 per diluted share.

You will see on this slide that our balance sheet is strong and growing.

Sequential loan growth came in at the high-end of our guidance range at 0.9%.

As expected, C&I loan growth picked up after a sluggish start to the year and gained momentum towards the end of the second quarter.

Based on current trends we expect that by the third quarter total loan growth will be back to the 1% to 1.5% range we think of as more normalized.

Credit quality remains excellent and we feel good about the risk profile of the loan portfolio.

Our net charge-off ratio was stable in the second quarter and our nonperforming asset ratio improved on both a linked-quarter and year-over-year basis.

Shifting to capital management, our book value per share ended the quarter at $25.55, which was up 4.8% from a year ago.

Our Common Equity Tier 1 ratio estimated for the Basel III fully implemented standardized approach was 9.3% at 6/30, a level which is sufficient to support growth, effectively managed through periods of economic stress and return capital to shareholders.

In June the Federal Reserve Bank notified us that they did not object to our capital plan submitted during the CCAR process.

We subsequently announced a dividend increase of 7.1% and a new share repurchase program for the year.

Now let me touch on our key performance ratios.

If you turn to slide 4, our return on average assets for the second quarter was 1.35%.

Our return on common equity was 13.4% and our efficiency ratio was 55.2%.

We are proud of our industry-leading profitability metrics, but we are always striving to improve.

Although consistently best-in-class, our efficiency ratio has been at the higher end of its historical range in the past few quarters, primarily reflecting increased personnel and technology costs related to the regulatory compliance programs.

However, we are nearing the end of the build out of these programs and believe the growth rates of these costs will begin to moderate.

We expect compliance cost to grow at a pace more in line with the Company's core expense base in late 2017 and into 2018.

When we look out to the remainder of the year we expect to deliver positive operating leverage in both the third and fourth quarters of 2017 on a year-over-year basis.

We further expect that the year-over-year noninterest expense growth will be in line with our long-term target range of 3% to 5%.

We believe that our strong balance sheet, diversified revenue mix and our focus on expense management, combined with the dissipation of some significant expense headwinds, provides momentum for the second half of this year and into 2018.

Let me stop there and turn it over to Terry.

Thank you, Andy.

If you turn to slide 5, I will start with a balance sheet review and follow-up with a discussion of second-quarter earnings trends.

In the second quarter, average loans increased 0.9% on a linked-quarter basis and grew 3.4% from a year ago.

Commercial loan growth rebounded from the first quarter, increasing 2.0% sequentially.

Line utilization has not increased materially, however deal activity has strengthened and we continue to gain market share.

As Andy mentioned large corporate lending developed momentum in the latter part of the quarter.

Additionally, throughout the quarter we continued to see strong growth in middle-market lending across many geographies.

Commercial real estate lending reflects our prudent approach to certain CRE segments such as multi-family and retail given current market conditions.

We did have opportunities for growth in construction lending, however we remain cautious in commercial mortgage markets where the competitive environment has created unfavorable conditions from a risk and return standpoint.

In addition, customers continue to refinance commercial mortgages in the capital markets given the rising rate environment and opportunity to extend maturities.

We had particularly strong growth in retail lease in this quarter, up 11.0% linked quarter.

We are both a prime lender and a lessor in the auto segment and our well-established market position, full product offering and strong dealer relationships have provided strong growth in both lending and leasing.

We have made significant investment in this business over the past few years, which is coming to fruition in the form of increased market penetration with both dealers and manufacturers.

We expect growth will remain healthy for the next few quarters as we continue to penetrate this market.

I want to emphasize that leasing growth is not coming at the expense of increased risk.

If you look at slide 6, credit metrics remain very stable in our retail leasing portfolio.

We have not changed our underwriting in this business and are not enhancing residual values.

I would also highlight that in the second quarter, the weighted average FICO score on originations for our auto leases was 782.

Turning to slide 7, total average deposits increased 0.8% compared with the first quarter of 2017 and 7.7% on a year-over-year basis.

Following the June interest rate hike our total interest-bearing deposit beta is in the mid-20% range.

If future rate hikes occur, we would expect the beta will gradually trend towards 50% level.

On slide 8 you will see the credit quality was relatively stable in the quarter.

Net charge-offs as a percentage of average loans was 49 basis points in the second quarter and nonperforming assets declined by 9.8% on a linked-quarter basis.

I will now move on to earnings results.

Slide 9 provides highlights of second-quarter results versus comparable periods.

Second-quarter net income of $1.5 billion was up 1.8% compared with the first quarter, but was down 1.4% versus the second quarter of 2016.

As a reminder, the second quarter of 2016 included two notable items, a $180 million Visa Europe gain in noninterest income and a $150 million noninterest expense related to interest accruals and a charitable contribution.

Excluding these items, net income increased slightly year over year.

I will exclude the impact of these notable items when I discuss revenue and expense comparison versus the second quarter of 2016.

Turning to slide 10, revenue totaled a record $5.5 billion, up 3.1% on a linked-quarter basis and 4.2% higher compared with the same quarter a year ago.

Turning to slide 11, net interest income on a fully taxable equivalent basis was $3.0 billion in the second quarter, up 2.4% compared with the first quarter and 5.9% higher than the second quarter of 2016.

Comparisons in both quarters benefited from earning asset growth and higher interest rates.

In the second quarter, the net interest margin increased 1 basis point to 3.04%, in line with our guidance.

The increase was primarily driven by rising interest rates partially offset by the impact of a flatter yield curve, and higher cash balances which increased to meet certain regulatory expectations related to liquidity.

We do not expect average cash balances to increase meaningfully from current levels.

Slide 12 highlights trends in noninterest income which increased 3.9% versus the first quarter reflecting seasonally higher fee revenue, particularly in the payment services business.

On a year-over-year basis noninterest income increased 2.0% excluding notable items.

Credit and debit card revenue increased 7.8% from a year ago on higher sales volumes.

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

In the second quarter, we exited two merchant acquiring joint ventures which did not have a material impact on the second results but will mute revenue growth comparisons for the next few quarters.

The divestitures were due in part to changing priorities of the joint venture partners that were impacting future growth and profitability of the portfolios for us.

Mortgage revenue grew about 2.4% on a linked-quarter basis but declined 10.9% year over year, in line with our expectations.

Turning to slide 13, noninterest expense increased 2.7% compared with the first quarter of 2017 primarily reflecting higher compensation expense and marketing and business development expense, partially offset by seasonally lower employee benefit expenses.

On a year-over-year basis noninterest expense increased 6.4% excluding notable items.

Growth was driven by higher compensation and other noninterest expense.

Compensation expense grew mainly due to the impact of hiring to support business growth and compliance programs, as well as seasonal merit increases and higher variable compensation related to production.

Other expenses increased primarily due to the impact of the FDIC insurance surcharge which began in the third quarter of 2016.

Slide 14 highlights our capital position.

At June 30 our Common Equity Tier 1 capital ratio, estimated using the Basel III standardized approach, as if fully implemented was 9.3%.

This compares to our capital target of 8.5%.

I will now provide some forward-looking guidance for the third quarter.

Given recent trends we expect linked quarter total loan growth to be in the 1.0% to 1.5% range.

Average earning asset growth will track with loan growth.

We expect the linked quarter net interest margin to increase in a manner similar to the first quarter of 2017, which is within a range of 4 to 5 basis points.

Let me take a minute to talk about merchant-acquiring revenue.

Last quarter we indicated that during the third quarter merchant-acquiring revenue was expected to return to a more normal growth trajectory of same-store sales plus 1% to 2%, excluding the impact of foreign currency changes.

The adverse impact on sales volumes from exiting certain large volume customers is beginning to dissipate with reported sales volumes increasing 3.3% on a linked-quarter basis.

Given the anticipated revenue impact from exiting the joint ventures, we expect year-over-year merchant-acquiring revenue will be essentially flat in the third quarter.

Growth will begin to normalize in the fourth quarter and then heading into 2018.

As Andy discussed, we expect to deliver positive operating leverage in each of the next two quarters supported by year-over-year expense growth of 3% to 5%, a level we target as more normalized on a long-term basis.

Finally, we expect the taxable equivalent tax rate to approximate 29% in the third quarter.

Let me hand it back to Andy for closing comments.

Thanks, Terry.

Our financial performance gained momentum in the second quarter and we expect to continue to improve profitability and returns as we look into the second half of this year and head into 2018.

From a macro perspective corporate balance sheets are strong, consumer confidence is increasing and the evolving economic and regulatory backdrop has the promise to be conducive to growth.

I just spent time in Washington last week and left very encouraged by the open and productive dialogue that is taking place.

Nonetheless progress has been slower than many had hoped.

While we have not yet seen evidence of a resurgence in the CapEx cycle, consumers are spending and businesses are active and we continue to win share across our geographic markets and business lines.

We have a solid and growing revenue base and we believe we have reached an inflection point in expense growth.

Importantly, the profit improvement that we expect will drive improving returns will not be achieved at the expense of the cost of credit quality.

Nor will it be achieved at the cost of delaying prudent business investment, which will be increasingly focused on technology and innovation.

Finally, I want to thank our dedicated employees who work hard every day to be our customers' and communities' trusted financial partner.

That concludes our formal remarks.

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

(Operator Instructions).

Ken Usdin, Jefferies.

Thanks, good morning.

Just following up on the expense rate of change, it's good to hear and good to hear that it's anticipated that quickly.

So I just wonder if you can help us understand, when you are talking about both 3Q and 4Q getting back down into that 3% to 5%, what things are getting better and what things are you still having any inflation in underneath the surface?

So Ken, let me take that question.

So I think there is three broad things.

From a compensation standpoint we expect that that will begin to moderate and continue to moderate third, fourth and into 2018.

And that will be driven by the fact that we are getting close to the end of building out those risk and compliance programs.

So that is number one.

Then costs related to risk and compliance, such as consulting activities that are really -- have been helping us support some of those programs, has been moderating and will continue to moderate as we go into the next few quarters and also into 2018.

So those would be the biggest things.

And then a year ago FDIC implemented a surcharge and so we are starting to lap that.

And the year-over-year effect associated with the FDIC insurance will start to moderate too.

And I will keep my follow-up to expenses then.

Can you just help us understand the tax advantage investments and what does that mean for sequential growth as we go third into fourth as well?

It seems like you also had a bunch of that more in the Other line this quarter.

So can you just help us understand what that means for sequential growth as well?

Thanks.

Yes, so we don't necessarily talk about that specifically, but we do typically see the tax-credit amortization expense start to move up in the third and then the fourth quarter.

I think last year from third to fourth, an example, it was up about $40 million to $50 million, in that ballpark.

So that should give you some sort of a range with respect to how that's going to change.

Okay, thanks, guys.

Appreciate it.

John Pancari, Evercore.

Good morning.

Just around the deposit balances again for the end of period, I just want to get a little bit of color on what drove that -- the end of period coming in above the average and some of the volatility there and how we should look at the deposit flows going forward.

Yes, so on a linked-quarter basis -- again, I'm looking at just averages -- we saw growth in deposits both in our consumer business and then also in our corporate trust business.

When you end up looking at the ending cash balances, keep in mind that one of the things we were doing is we were building cash balances in order to meet some of those liquidity requirements.

And in order to be able to do that one of the things that we did is a little bit of a pricing change related to some sort of deposits in order to bring some dollars in near the end of the quarter, and so that's why you see that.

Kind of on a go-forward basis when you think about cash balances, we don't expect the average balances to change much from current levels.

That's right, Terry.

And I would add in any particular day that cash balance can be up or down, there's a lot of volatility particularly within the corporate trust business with flows that occur there.

So one day I think doesn't designate a trend or anything like that.

Okay, so the average should remain where it is, so therefore the [EOP] is probably going to head back towards the level where it was.

Yes, I'd focus on average balances.

Yes.

Got it.

Okay, and then on the margin, in terms of your expectation could you remind me again -- you had mentioned 4 to 5 basis points?

Yes, so our guidance for the -- going into the third quarter is we expected to expand 4 to 5 basis points from here.

And one of the things just when you end up looking at the 1 basis point movement in the second quarter, we had guided that it would be lower.

One of the big reasons for that is really building the higher cash balances.

That cost us about 2 basis points during the quarter and the flatter yield curve cost us a little bit.

But when we look at third quarter we feel pretty comfortable with that range of 4 to 5 basis points.

Okay.

And then jumping off from that point into fourth quarter, how much beyond that would you think barring incremental hikes and then into 2018 if you can give us a little color.

Thanks.

Yes, when we look into the fourth quarter, at least right now we would expect that the margin increase may not be at the 4 to 5, but it's still going to be in that range of 3 to 4, somewhere in that ballpark.

And we try to stay within 90 days because so much can change with the yield curve in particular.

So we will continue to give guidance as we go into the next 90 days.

Got it.

Thanks, Andy; thanks, Terry.

Betsy Graseck, Morgan Stanley.

Hi, good morning, how are you?

I just had a couple of questions a little more on the strategic side.

Just wanted to get your thoughts on some of the consolidation that's going on with merchant acquiring over in Europe and how that plays into your business over there.

And any thoughts on incremental investments that you would be looking to make as a result?

Right, so as you know, Betsy, we are five or six both in North America as well as Europe.

We have a great platform our dynamic currency conversion capabilities, our international payment platform.

So I think we are well-positioned in both places.

Merchant acquiring is an area that we will continue to look for incremental acquisitions; I would call them were bolt-on or add on as opposed to major deals.

We don't need to really expand or start in Europe because we already have a very strong presence.

But it is an area of focus for us and one that continues to grow and one we continue to invest in.

Okay.

And then on the corporate trust side, could you give us some more updated comments there?

So, corporate trust is having a good year.

We continue to be leading market share across all three categories: muni, corporate as well as structured.

We have again a good platform and good technology which I think is key to that business and we have been very consistent in terms of our commitment to that.

So, our opportunity is to continue to expand in the US, but also we have a foothold in Europe and our opportunity to expand there I think is comparable to where it was in the US about 20 years ago.

And then just lastly, you talked a bit about deposit betas and how they have been trajecting.

Just wanted to get a sense from you on how close to run rate you are on the corporate side of your business.

So, I think when you end up looking at deposit betas overall, I talked a little bit about that, I do think that one of the things you're seeing on the wholesale side is that the deposit pricing is getting a little bit more competitive.

So we do see that ticking up both in the June hike and as rate hikes continue into the future.

I think that that is going to continue to move up and that's part of what we assume when we think about deposit betas overall, moving up closer to that 50 basis points.

You are going to see more pressure on the wholesale side and on the corporate trust side.

Okay.

But it feels like we are two-thirds of the way through or a third of the way through?

With respect to this rate hike?

I think we are probably further along on the wholesale side of the equation getting to normalized betas.

And we have more space to go on the retail side which the beta there has been very low and will continue to go up as the next rate increases come forward.

Okay.

It was interesting just -- I asked the question because obviously we had a rate hike, but yet you did a great job on non-interest-bearing deposits growth in the quarter.

And so, it kind of suggested to me that maybe you were done on the corporate deposit beta side.

I don't know if we are done.

I think that's all going to be really driven based upon what we see from a competitive standpoint.

But I don't think, based upon the fact that we have cash balances where we are at, we don't necessarily see a need to drive deposits in where -- I would agree with you, I don't think that there is a lot of upward pressure with respect to it.

Deposit betas both, whether it's retail or wholesale, etc., is really tracking pretty similar to what we've seen in the past, maybe just a little bit higher.

All right, thanks so much.

Scott Siefers, Sandler O'Neill & Partners.

Good morning, guys.

First question just on loan growth.

It sounds like in the aggregate stuff is pretty much tracking as you would have thought through the course of the year where it indeed will accelerate back into your targeted range in the back half.

So that's all good, but it is kind of running a little contrary to the weakness we still see in the [H8].

Just curious if you can spend another moment or so just talking about exactly where it ends up coming from, how much of it is market share versus incremental growth, etc.?

So, I will start, then I will ask Bill to add on.

The areas of growth continue to be in a few -- middle-market is doing exceptionally well.

That's in excess of 2% on a linked quarter basis and we continue to see that accelerating or being above that level in future quarters.

It's doing well.

As Terry and I both mentioned, we saw some growth in the second half of the second quarter in the large corporate wholesale part of the category.

And then our auto leasing, as Terry mentioned, it's very high quality, but given the great platform and relationships we have that has shown some growth.

So those are areas that I would say are principal areas of focus.

Bill, what would you add?

Yes, that pretty much hit on them -- I mean the consumer we expect to remain fairly strong for the latter half of the year.

So we continue to see good demand in auto loans and leases.

And again, that's a very prime portfolio for us.

We have always done it that way and we have stayed consistent in that area.

We also do see some demand in home equity.

That's a tough market but we haven't seen the big decreases.

We do still have strong originations there.

Andy talked about the commercial side.

I will say on the commercial real estate side, although we do see some roll off of what we call our mortgage portfolio or standing loan portfolio, because there is very aggressive terms by the life companies and the CMBS market.

We are still an active construction lender, so we have seen growth there.

And we also -- our client base is a lot of REITs and much of that actually shows up in the C&I line.

And we have seen good growth quarter over quarter and year over year there.

So there is a lot of spaces where we are continuing to see good demand.

Okay, that's perfect.

I appreciate the color.

Then just separately on -- just the idea of positive operating leverage, it looks like both the quarters in the back half of the year we should get it, which is good.

Just curious about your updated thoughts on positive operating leverage for the full year and when you would expect to see that.

I think you had previously been hoping to generate positive operating leverage for the full year 2017.

I guess just my rough cut on the updated guidance suggests that will still be a little bit of a challenge.

But just would be curious to hear your thoughts.

Scott, we will get it third quarter and fourth quarter and we will be very close, if not on, for the full year.

Okay, sounds good.

Thank you, guys.

Erika Najarian, Bank of America.

Hi, good morning.

Just a follow up to Scott's question.

As we look longer-term in terms of the progression of your efficiency ratio, if we presume either forward curve today, could we see U.S. Bancorp exit 2018 with an efficiency ratio in the low 50s?

Yes is the short answer to that question.

We would expect to have positive operating leverage closer to our long-term growth projections as we move into 2018.

And that is what we talked about at the Investor Day and that expense ratio in the 3% to 5% and revenue growth above that.

Now that is assuming sort of a normal yield curve, economic growth that isn't abnormally low or anything like that, but we would expect to continue to have that into 2018.

That was very clear.

Thank you.

To follow-up on some of the deposit questions, some of your peers have noted that if the Fed does reduce its balance sheet or begin reducing its balance sheet by September, they believe that the outflows will be most vulnerable in wholesale deposits.

And I'm wondering what your color is on that -- your take is on that and whether or not that could potentially accelerate betas even further for U.S. Bank?

Yes, so let me take that.

And so, the Fed is still kind of in the process of defining what the level of balance sheet reduction and the pace of that over time.

And our expectation is that first of all they are going to be very transparent as they go through that process and the pace is going to be very gradual, most likely over several years.

So we do believe that as excess liquidity comes out of the market we would expect there to be more competition for deposits and that is going to end up impacting pricing.

I do believe that just because of the nature of the deposits on the wholesale side you are going to see more of a competitive environment associated with that.

Whether -- I'd be surprised if it's going to significantly impact 2017.

And I do believe that just because it's going to be very gradual it's also going to be very manageable and the market is going to respond accordingly.

Thank you.

Just one last follow-up question.

I know you always get asked on this call about an update with the consent order and I'm wondering if I can ask a more technical question.

Is the consent order from the OCC applicable to the holding Company?

And I'm just wondering whether or not there is a way to isolate the consent order to unshackle you more strategically?

The OCC obviously regulates our national bank, so that's where it is but our national bank is essentially the holding Company.

I think it's over 99% of the entire bank.

So, all the operations occur within that national bank.

So what the OCC -- it really applies across the board.

And Erika, we continue to expect to have our -- the people and processes are in place, our technology will be complete by the end of the third into the fourth quarter, then it gets to the sustainability part of the equation and that goes into early 2018.

Thank you.

Matt O'Connor, Deutsche Bank.

Hey guys, this is actually Ricky from Matt's team.

I'm wondering if I could just do a bigger picture question first.

I wonder if you can touch on some of the items on the growth front that you mentioned in the past, maybe it's in payments or in wealth penetration, maybe frame out what those could mean to revenue as we think about both the rest of this year and into 2018 and beyond.

Let me just go across the business lines, you asked for a high level.

Wholesale continues to be an opportunity to expand our dominance in terms of being the bank of choice for large corporate customers.

We have a number of capabilities that we have built over the years and we continue to take market share in different categories, particularly in the commercial products group, as we move up the league tables.

On the wealth management side I do think the extension of corporate trust as well as the wealth management piece of the pie, particularly focused on the emerging affluent, that represents a great opportunity.

Payments across all three categories: merchant acquiring, card issuing as well as corporate payment systems, I think we have the technology and (inaudible) to continue to grow that.

I think particularly in regard to Elavon I think the opportunity is both here as well as in Europe.

And then finally retail, we are doing very well in terms of small business as well as retail core customer growth.

And so, I think across all of our business lines, as we've said many times before, I think we are in a strong position.

And we are not really seeking to have major adjustments, it's just taking advantage of the opportunities we have in front of us.

Okay great.

And then maybe separately, it seems like energy and maybe oil prices are starting to come back into the conversation a bit more.

Some analysts are calling for sub $40 oil prices by 2018.

Just wondering if you can remind us again what your exposure is to that space.

And it doesn't seem like there is any real signs of deterioration in your portfolio, but wondering if you could talk again maybe about the quality.

Sure.

Our book is relatively modest in size.

We do finance the energy sector, but we are below 2% of our commitment level and less than 1% of our loans is in that sector.

When the original price decline took place we obviously did see some impact.

This quarter our NPAs were down in part because of some of the resolution of those original nonperforming loans.

But we've been but we've been bringing our reserve levels down, but it's not -- it's just not a material impact to our overall performance.

We think the -- we are going to a $40 price deck, we think that's a comfortable place to be.

So we expect -- continue to see improvements in that portfolio.

Okay, thanks, guys.

Vivek Juneja, JPMorgan.

Hi, a couple of questions.

And maybe this one goes to Bill.

Credit card net charge-offs up 58 basis points year on year, it's running a little higher than your peers.

Can you talk a little bit about what's going on there?

Yes, sure.

I think I will start with saying that the forward look is lower than that.

It will come back down; it will be below 4%.

So it's not a trajectory thing.

I think what you see is that we have continued to grow that portfolio both with acquisitions and internally and through our branches.

It's been solid growth so there is a seasoning impact.

I think you have probably seen that across the industry.

But we have -- we do have a seasoning impact there, but our outlook is very solid.

We haven't loosened our underwriting standards to gain that growth.

And it's a prime portfolio across the board.

So there is no subprime activity in there and we are not -- that is not something we are worried about.

All right.

Second topic, mortgage banking, you talked about that on last quarter's call, Terry, Andy.

And in terms of -- your applications are up pretty sharply, seems like gain on sale margins were down.

Can you give some color as to what is going on and what you expect to see on that?

Yes, so maybe just to talk about the second quarter first.

Mortgage applications on a year-over-year basis were down about 16% for us, and that's pretty much in line with what the market was experiencing and that's driven in large part by the [right] refinancing.

Second quarter mortgage applications we did see a nice movement up on a linked-quarter basis.

But we end up looking into the third quarter, we would expect mortgage applications to continue to move higher, that is seasonal effect.

And we also have a nice mix of retail and on the purchase mortgage side.

So that seasonal effect we'll continue to see in the third quarter.

Gain on sale margins in the second quarter did come down.

I think you saw that in the industry.

Our expectation or outlook is that they will be relatively stable going into the third quarter.

Great, thank you.

(Operator Instructions).

Brian Klock, Keefe, Bruyette & Woods.

Good morning, gentlemen.

I wanted to just follow up maybe a little finer tooth on the expense guidance.

On the year-over-year basis, would you think that -- maybe if we look at the 3% to 5% range, do you think that sequentially we are looking at expenses?

Especially I think, Terry, if you mentioned the impact of the amortization of the low income housing tax credits, should we be up low-single-digits on a sequential basis third versus second?

Yes.

Usually there is a little bit of a seasonal effect that comes into play with respect to the third quarter.

But I think that that's a reasonable assumption when you think about the third quarter.

Okay.

And I know you talked about earlier the deposits and the expectation around just the seasonal -- there's the seasonal runoff that comes back in the second half of the year.

So cash balances on average you think will be unchanged, so with the recent issuances of some longer-term debt are you planning to add anything else to the investment securities portfolio?

Or are you planning to keep the securities portfolio relatively flat?

Yes, we end up increasing the securities portfolio really in line with the overall balance sheet growth.

So if you think about what average loan growth is going to look like -- our average earning assets really tracks in a very similar manner.

So we would be adding to the investment portfolio in order to be able to do that.

But that's one way to think about it.

All right.

Thanks for your time.

Saul Martinez, UBS.

Hi, good morning, everybody.

A couple questions.

Just closing the loop a little bit on the net interest margin and NII guide.

The NIM guidance, 4 to 5 basis points, average loan growth 1%, 1.5%.

I guess triangulating that into NII growth of getting the numbers of around I guess 3%, 4% sequential growth and is -- it's a little bit higher than I thought, but I just want to make sure I'm not missing something in terms of triangulating NIM into NII growth.

I know you can do the math based on kind of what we ended up laying out, but I think that's a reasonable assumption.

Got it.

Okay, perfect.

Now I guess a little bit of a bigger picture question on Elavon merchant acquiring business, sort of a follow-up to an earlier question, especially in light of some of the consolidation you are seeing in Europe.

But we have heard -- and feel free to disagree with this -- but we have heard from some that you feel like you are subscale in the acquiring business in both US and Europe.

And obviously you've exited some low MDR relationships, you have exited some JVs.

But can you talk a little bit more about the business strategically in terms of where you see the opportunities and how Elavon -- how you capitalize on those opportunities?

Where do you see Elavon fitting into the entire payment space and the merchant acquiring space?

And how do you differentiate yourself and drive better growth on an ongoing basis?

So, I think first from your scale question, I think we have sufficient scale to be very competitive and I think we have had that for a number of years.

We are focused on a few areas, number one is verticals.

I think as you think about the merchant processing business, it's migrating from a financial transaction business to an information business.

And being very focused on verticals and providing that information is hugely important.

And we have a number of verticals, the travel industry, hotels, small retailers that I think we are very good at.

Healthcare is another one.

So our focus is in that information and, in terms of innovation and technology, providing beyond the financial transaction as well as the expansion of our sales force both domestically as well as Europe.

And then finally, the whole e-commerce side of the equation is another area of focus for us in terms of investment and growth.

Got it.

How do you feel like your e-commerce capabilities are now versus where you want them to be?

I think they are fine.

I want them to be better.

All right.

Fair enough.

Thanks a lot.

Kevin Barker, Piper Jaffray.

Good morning.

I just had a quick question on the tax rate.

You mentioned it was going up to 29%, if I'm right there, in the third quarter.

It's been quite volatile over the last few quarters.

Are you still sticking with the 27% to 28%, give or take, range for this year and maybe longer-term?

Yes, I think that when we end up looking at the tax rate on a tax equivalent basis on a long-term basis, just because of growth it's going to -- because of the marginal effect it's going to drift upward.

So when I end up looking at certainly the next few quarters and going into 2018, that 29% is probably more reasonable.

Okay, and then in regards to growth, obviously commercial mortgage -- C&I has been the main driver of growth that we've seen in the last few years; it slowed recently here.

When you look out the next one or two years do you feel like the consumer and retail lending will start to take the lead?

Or do you feel like commercial and -- C&I lending will continue to be strong over the next couple of years?

I think wholesale will continue growing as is and I think we will start to see a turnaround in the retail.

So we've had strong growth on the leasing and auto portfolio.

We've talked about a little bit less in terms of the home equity and traditional retail loan areas.

But I think we will start to accelerate in future periods and I think that's how we get to the more normalized long-term growth rates.

Okay, thank you.

Betsy Graseck, Morgan Stanley.

Hi, I just had a follow-up question.

Just it's around the CCAR process and the ask and really the question is around the dividend.

I saw you had a nice increase in the dividend, but yet you have one of the lowest volatility earnings streams of the group.

And it feels like there might be some room to boost up the dividend component of the capital return.

Just wondering how you are thinking through that?

Yes, Betsy, that's a fair question.

So I think first of all we are starting from one of the lower capital ratios.

You are right that we have the lowest volatility and the lowest downturn in the stress environment.

In fact we still make money, as you saw.

But we are starting from a point that is not far away from what we think is our optimal capital structure, the 8.5% versus the just over 9% we are today.

That's number one.

Number two is we are always wanting to make sure that we are successful in the outcome of the CCAR process.

And then finally balancing between the buyback side of the equation and the dividend.

What we've done is what I would call very predictable, continually steady growth and we would expect to continue that in the future.

We might balance a little bit more and we will balance a little bit more towards increasing the dividend probably more than the buyback in future periods.

Okay, all right, thank you.

Gerard Cassidy, RBC.

Good morning.

Thank you.

Can you guys give us -- for some additional color?

You touched on in your opening remarks about the commercial real estate markets, you are seeing possibly some weakness in the multi-family space.

Can you share with us is there any geographical areas that you see it more concerning for you at this time?

Well, there are certainly some of the cities that have had very strong multi-family growth.

And if you look at some of the rent forecasts, and this is -- there is plenty of companies that do this -- you will see there are markets, some of the coastal markets of Boston and DC, where the forecasts are for either no or slightly decline in rent growth.

Now that doesn't mean we won't do projects there.

We follow our client base and if they like the project, we like the project, we will still do something.

But some of the markets have seen a lot of multi-family, Minneapolis is another one, where you've got to be cautious about it.

Thank you.

The second question was -- and I think you may have touched upon this and I apologize if you did.

Can you guys give us your view of -- obviously the Federal Reserve has made it clear that they are going to start unwinding their balance sheet and it will go into full speed operation in 2018.

How are you guys looking at that and the impact it may have on deposits in the banking system and then for USB as well?

Yes, Gerard, thank you.

We talked a little bit about that earlier, but when you end up looking at what the Fed -- the Fed still needs to define the level of reduction in the balance sheet and really the pace of it.

And I think that they have been really transparent that that pace is really going to be gradual over several years.

And I think that will cause any impacts of it to be very manageable on the banking industry and as the market adjusts.

I do think that as -- or we think as excess liquidity comes out of the market you could expect to see, and you will expect to see, more competition with respect to deposits.

I would also expect that the long end of the curve on a relative basis would be a little bit higher as a result of some of their activities.

That competition from a deposit standpoint is most likely to come on the wholesale side of the equation.

Very good.

Then just lastly, obviously you guys have industry-leading profitability with your ROA and your ROE at the present levels.

What -- is it going to be more the net interest margin improvement or the efficiency ratio when you look at how you are going to or could drive that higher?

As you know, in the past your numbers were higher.

Is it more of a margin issue or is it more an efficiency ratio or leverage?

What are you guys looking at for the levers to even take it higher than where it is today?

I think it's both parts of the equation.

It's accelerating revenue growth and moderating expense growth.

Positive operating leverage which will improve the efficiency ratio and ultimately improve ROA and ROE.

Great, thank you.

Terry McEvoy, Stephens.

Hi, good morning.

One question, the bottom of slide 8 really stands out in that U.S. Bank has built reserves for the last six quarters, whereas your peers, even through 2Q for those that have reported, continue to release those reserves.

So could you talk about it as something in terms of the mix shift of the loan portfolio that's driving your ability to grow reserves again when your peers are just not in that same position?

Well, one of the things you are looking at is a lot of the peers have larger energy exposure so they added more.

And like us, we did see improvement this quarter so they may have released more reserves out of their energy book.

And we are pretty much steady as she goes from a credit standpoint.

So at this point in the cycle we have a very stable credit environment and we are still growing loans.

So that's what we look at and we will add to reserves to support loan growth.

If you think about what they are for, they are for potential future losses out of your loan book as you grow the loan book.

That is what the reserve is for.

So if we don't have big upswings with needing to add to reserves in a downturn like the energy portfolio took, then we are going to be adding for loan growth.

So our volatility, Bill, has been a lot lower than everyone else and (multiple speakers).

Simply stated, if we are not adding a lot, we are not subtracting a lot (inaudible) we can do it.

Great.

And then just a follow-up question for maybe Andy.

This concept of One U.S. Bank, which you've talked about, I believe it was in the annual report.

As you think about the second half of this year are there any areas within your core businesses that stand out in terms of benefiting from this strategy as you work together under this One U.S. Bank kind of strategy?

Yes, Terry, that's a long list.

There are a number of initiatives across the Company from the way we handle our call centers to the way we do innovation to the way we communicate with our customers to how we share information among the business lines.

So there are a number of initiatives and I would say it's probably our number one focus at the Company right now.

Thank you.

Brian Foran, Autonomous.

Hi, I just had a couple of small ones on the -- making sure we are getting the payment -- merchant processing JV exits right in the model.

So was there any gain associated with the exit either in 2Q or back half of the year?

And then the second just in terms of the guide, I think you said you are at 3% FX-adjusted growth now in merchant processing and you'd see that flat in 3Q.

Was that -- is it the earnings?

Is it like equity method accounting that was being booked or is there revenue and then we should think about some expense coming out elsewhere in the P&L?

And then I guess last -- mainly just curiosity, which JVs are you exiting?

I saw something about Santander but couldn't find the other.

So first I'm going to ask Terry to fill in the other details.

There was no material gain or loss in the second quarter as a result of these exits.

Terry, take the others.

Yes, so if you just end up looking at and trying to think about the growth rates over the next couple quarters, certainly reported growth rate is about 2.7 excluding the foreign currency, as we said.

I would also say that same-store sales percentages and organic business growth has generally been quite strong, which I think is good to see.

That gives us good insights with respect to the future.

Reported growth sales have been impacted by three factors.

We talked last quarter about exiting some large volume low margin customers and that has been muting sales volumes.

That has been dissipating and it's getting behind us.

It certainly will be behind us as we get into the end of the third quarter.

And so we are starting to see sales volume starting to grow.

We are experiencing some margin compression in Europe because of interchanged caps that were put into place late 2015.

And that has continued to impact our year-over-year growth rates and will continue to impact at least through the third quarter.

That will start to dissipate in the fourth quarter and then really be behind us as we get into 2018.

And then the impact of exiting the two joint ventures will have an impact on merchant acquiring really for the next several quarters as we think about [your] --.

To kind of give you some maybe specifics, when we look at the third quarter, we do expect the year-over-year growth rate for the third quarter to be essentially flat and that's essentially what we said.

As I look into the fourth quarter, I do expect the fourth-quarter year-over-year growth rate to be similar to what we saw in the second quarter or this current quarter.

And then as we continue to see organic growth that we are experiencing, that will start to benefit us as we go into 2018.

Great.

And are you able to disclose which JVs or not at this time?

Yes, I mean the -- one joint venture is related to our joint venture in Spain with Santander.

And really they've had changing priorities with respect to what they want to focus on.

And as we think about Spain, it continues to be an area that has some economic challenges.

So from our standpoint we really do believe that we have the opportunity to continue to grow in that market on our own with a focus on the right customers.

And I would be very clear we are not exiting the market.

With respect to the second joint venture, that is the joint venture with KeyCorp, so we call it Key Merchant Services.

And in that particular situation our partner really wanted to focus on a third-party servicing arrangement and we respect that decision on their particular part.

I would also say that we are retaining the clients that we believe create the best growth opportunity for us as we move into the future.

Thank you.

That was very detailed and I appreciate the answers.

There are no further questions.

I will turn the call back over to you for closing remarks.

Thank you for listening to this review of our second-quarter results.

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

This concludes today's conference call.

You may now disconnect.