美國合眾銀行 (USB) 2018 Q2 法說會逐字稿

Welcome to U.S. Bancorp's Second Quarter 2018 Earnings Conference Call.

Following a review of the results by Andy Cecere, Chairman, 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, EDT, through Wednesday, July 25 at 12 midnight EDT.

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

Thank you, Jack, and good morning to everyone who's 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'd 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'll now turn the call over to Andy.

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

Following our prepared remarks, Terry and I will open the call up to Q&A.

I'll start on Slide 3. In the second quarter, we reported record net income and record earnings per share driven by record revenue and positive operating leverage.

Excluding the impact of our student loan sale, loan growth picked up compared with last quarter even as we remain disciplined in our commercial real estate underwriting.

On the right side of Slide 3, you can see that credit quality improved in the second quarter and our book value per share increased by 5.8% from a year ago.

During the quarter, we returned 69% of our earnings to shareholders through dividends and share buybacks.

In the second quarter, the Federal Reserve completed its annual stress test.

And once again, the results confirmed our ability to withstand and remain profitable in severely adverse economic conditions.

Based on the stress test results, our Board of Directors approved a 23% increase in our quarterly dividend to $0.37 per common share beginning in the third quarter as well as a 15% increase in our stock repurchase authorization.

Slide 4 highlights our best-in-class performance metrics, including a 19.8% return on tangible common equity.

Our efficiency ratio, return on average assets and return on average common equity all improved sequentially and on a year-over-year basis.

Now let me turn the call over to Terry, who'll provide more detail on the quarter as well as forward-looking guidance.

Thanks, Andy.

If you turn to Slide 5, I'll start with a balance sheet review and follow up with a discussion of earnings trends.

Excluding the student loans sold this quarter, average loans grew 0.3% on a linked-quarter basis and increased 1.8% compared with the second quarter of 2017.

We saw continued strength in retail portfolios, such as mortgage and retail leasing.

Credit card transaction volume grew, and the growth was strong and supportive of a robust fee growth.

However, revolve rates have been declining, reflective of a strong economy and the strong credit quality of our customer base, which is muting balance growth.

Commercial middle-market loan growth accelerated to 2.2% sequentially in the second quarter.

However, paydown activity among large corporate customers continued to be a headwind to total commercial loan growth.

Line utilization remains at historical lows.

However, pipelines continued to improve, and commitments grew.

Clients are optimistic, and we are starting to see customers deploy deposit balances to fund business investment.

While the timing of more robust CapEx activity is uncertain, we continue to expect that moderating paydowns and increased M&A closings will support improved commercial loan growth in the second half of the year.

Commercial real estate loans declined in the second quarter, reflecting our decisions not to extend credit at unfavorable terms and elevating paydowns as customers seek alternative financing.

This quarter, commercial real estate contributed a 20 basis point drag to linked-quarter growth and a 140 basis point reduction to year-over-year average loan growth.

Turning to Slide 6. Lower deposit growth relative to prior periods was driven by stronger economic conditions.

Business customers are beginning to deploy balances to fund capital investments.

Also, the impact of rising interest rates on deposit earnings credits have reduced their need to maintain noninterest-bearing deposits.

Finally, there are some -- there is some migration of balances to interest-bearing deposits or alternative investment vehicles as customers seek higher yields.

These deposit flows are consistent with our asset liability modeling expectations.

Slide 7 indicates that credit quality improved in the second quarter due to improving economic conditions, with customer paydowns resulting in pressure on loan balances but an improved credit profile.

Notably, our nonperforming assets declined 9.4% compared to the first quarter and decreased 19.1% compared with the second quarter of 2017.

Slide 8 provides highlights of second quarter earnings results, including a 7.5% sequential increase in pretax income and a 5.1% increase in net income available to common.

On Slide 9, linked-quarter and year-over-year net interest income growth was supported by higher interest rates and earning asset growth, which was partially offset by a shift in deposit and funding mix.

Additionally, year-over-year growth was negatively impacted by tax reform, which reduced the taxable-equivalent adjustment benefit related to tax exempt assets.

In the second quarter, the net interest margin was 3.13%, flat with the linked quarter but higher by 5 basis points compared with the year -- a year ago.

The impact of tax reform on taxable-equivalent earning assets hurt year-over-year net interest margin expansion by 2 basis points.

Our interest-bearing deposit betas continued to perform in line with our expectations during the last few rate hikes.

As rate -- as future rate hikes occur, we continue to expect our deposit beta will trend toward a 50% level, which compares with the current level of about 45%.

The betas on our commercial and trust deposit bases, which represent about half of our total deposits, are in line with their estimated terminal betas.

We expect that movement in the overall beta going forward will primarily be driven by our consumer deposit base.

Slide 10 highlights trends in noninterest income.

On a year-over-year basis, we had strong growth in payments revenue and trust and investment management revenue, partially offset by a decrease in commercial product revenue and mortgage banking revenue.

Mortgage revenue was affected by lower refinancing activity and lower gain on sale margins.

Treasury management fees declined, reflecting the impact of changes in earnings credit, which is typical in a rising rate environment.

Looking closer at our payments business.

On a year-over-year basis, we had strong growth in credit and debit card revenue and double-digit growth in our corporate payments -- corporate payment products revenue, each reflecting higher sales volumes.

It's noteworthy -- it's worth noting that this quarter marked the best revenue growth performance in corporate payments in over 7 years.

Merchant processing revenue growth continued to be impacted by our exits from 2 joint ventures last year, but we continue to expect that it will return to a mid-single-digit growth pace by the third quarter of 2018.

Merchant acquiring sales volumes continue to support our expectations.

Trust and investment management growth -- fee growth was driven by business growth and favorable market conditions.

Turning to Slide 11.

Noninterest expense increased 1% on a linked-quarter basis and 3.4% on a year-over-year basis, in line with our expectation.

Compensation expense increased principally due to the impact of hiring to support business growth and compliance programs, merit increases and higher variable compensation related to business production.

Notably, within nonpersonnel expenses, professional service expense declined from a year ago primarily due to fewer consulting services as compliance programs near maturity.

We expect compliance-related costs to continue to moderate through the year.

In addition, mortgage service and related costs are declining due to favorable economic conditions.

Slide 12 highlights our capital position.

At June 30, our Common Equity Tier 1 capital ratio, estimated using the Basel III standardized approach, was 9.1%.

This compares to our capital target of 8.5%.

I will now provide some forward-looking guidance.

For the third quarter, we expect fully taxable equivalent net interest income to increase in the low single-digit range on a year-over-year basis.

We expect fee revenue to increase in the low single-digit range year-over-year.

On a year-over-year basis, we expect to deliver positive operating leverage in the third quarter and for the full year of 2018.

We expect credit quality to remain relatively stable compared with the second quarter.

Our year-over-year tax rate on a taxable-equivalent basis is estimated to be 21%.

I'll hand it back to Andy for closing remarks.

Thanks, Terry.

We are building on a firm foundation, and I'll leave you with 2 goals our entire management team is focused on as we head into the second half of 2018.

Number one, growing revenues while maintaining our credit discipline.

We are willing to forego growth in areas where the risk/reward dynamics don't make sense, like certain areas in commercial real estate or higher risk leverage lending in the corporate space.

Risk management is a core competency, but it does not mean we will forego revenue growth.

We have a broad enough set of businesses that enable us to efficiently and dynamically allocate capital to areas where we expect the best growth and risk-adjusted returns.

We are optimistic about our ability to continue to gain share in both retail lending and commercial lending.

And as paydown pressures subside and existing pipelines are funded, that market share growth will be evident.

I feel very good about the outlook for our fee businesses.

Momentum is building in retail and corporate payment services, wealth management and trust and investment services, and we expect the third quarter to mark an inflection point in merchant servicing revenue.

Cyclical headwinds facing mortgage will abate over time, and we are positioning that business to thrive in the purchase mortgage market.

Number two, our management team is focused on investing for the future while delivering positive operating leverage.

As we discussed previously, we are stepping up our business investment in digital-first capabilities, revenue-enhancing initiatives and business automation as we position this company for the future.

These investments enable us to stay at the forefront in banking and will drive improving operating leverage over the next several years.

However, we are mindful that we need to manage expenses for whatever revenue environment we are operating in, and we remain committed to delivering positive operating leverage this year and going forward.

In closing, I'm pleased with our second quarter results, and I'm optimistic as I look out to the remainder of this year and beyond.

I want to thank our employees for their hard work and commitment to serving our customers and earning their trust every day.

That concludes our formal remarks.

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

(Operator Instructions) Your first question comes from the line of John McDonald with Bernstein.

I wanted to ask a little bit about expenses and operating leverage.

It looks like you delivered about 10 basis points of positive operating leverage this quarter, which is an improvement.

And I was just wondering, when you look ahead to the third and fourth quarter, would you expect increased magnitude of operating leverage?

Do you expect that to widen out?

And if so, what would be the drivers?

Yes.

John, this is Terry Dolan.

Thanks for the question.

When we end up looking for the third and fourth quarter, I think that we will deliver positive operating leverage, although I think it'll still be relatively narrow.

We do expect that as we kind of get into 2019 and into 2020, that that wedge of revenue growth versus expenses will start to widen and toward that 2% to 3%, which is a part of our long-term growth expectations.

But for the balance of 2018, we would expect it to be fairly narrow.

Okay.

And just on that point, Terry, for this year, the expenses this quarter came in a little better than expected.

Does that help you get in a little closer to the lower end of the 3% to 5% expense range for this year?

Or are you still expecting the high end?

And does that forecast for this year include any change in the FDIC surcharge for the end of this year?

Yes.

With respect to the FDIC charge, we're really expecting that we're going to have to continue to pay that through the balance of the year.

But, I mean, coming back to expenses, we recognize, just like the rest of the industry, that we're kind of in a transitional period with respect to tax reform.

And I would say that just has put some challenges with respect to loan growth and, as a result, revenue growth.

And as Andy and I have said, we're always balancing short term versus long term.

And I would say with respect to the second quarter and the balance of the year, while we're going to continue to make investments in those long-term digital capabilities and strategic areas of focus, we're going to be very disciplined with respect to looking at discretionary spend and areas where we can cut back.

And so we are definitely going to be managed to the lower end and with respect to our expectations of revenue growth at that point.

Okay.

So this year is still looking at kind of upper end of the 3% to 5% expense range and then next year...

No, John, it will be at the lower end.

No, lower end of the range.

Lower end.

Got it.

Okay, good.

Yes, this trend -- this quarter comes in better, so you're looking at lower end this year and then next year as well.

Yes.

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

Just to follow up on the expenses.

Obviously, a positive messaging on slowing the growth, and you mentioned working towards the 2% to 3% operating leverage in 2019 and '20.

Is that -- when you say working towards, are you hoping to be in that range next year?

If I can try and pinpoint you on that.

Or is that something that's going to take a couple of years to get to, the 2% to 3% operating leverage?

Yes, I think that that is -- we're starting from something that's very narrow, so it's going to take some time in order for us to be able to get there.

But I would expect continued improvement in the quarters as we go sequentially throughout '19, Matt.

Okay.

So maybe like a 1% to 2% operating leverage next year, and then in 2020, you're thinking the 2% to 3%.

Is that a reasonable thought process?

We'll continue to make improvements.

A lot's going to depend on the revenue outlook, which is going to be very dependent upon loan growth and the economy overall.

We're going to manage that positive.

We're going to manage to expanding that positive.

Okay.

And then just separately on the net interest margin.

Obviously, flat NIM linked quarter.

Is there still leverage to rates going up?

The curve isn't helping.

But just talk about kind of the NIM trajectory not just next quarter, but as we think through the next few quarters, what some of the puts and takes are there and if there's an upward bias or think about it being flat.

Yes.

So again, for the second quarter, we were flat to first quarter at 3.13%.

But all else being equal, we would have expected that to expand by a couple of basis points during the quarter.

But there are a couple of different things that I would just point out.

First is in the credit card space, and it tends to fluctuate.

But revolve rates were a little lower during the quarter, and that ended up impacting NIM relative to kind of what we were expecting.

Second is that we sold the student loan portfolio, and that had an effect.

And then the third is that we took the opportunity early in the quarter to hedge some of our LIBOR-based long-term debt and fix it, and that had a x0 hit or impact to us, but it should help us a little bit as we think about the future.

Those 3 things really represent 2 basis points, and so that, hopefully, helps kind of frame it.

We think about the third quarter and into the fourth quarter, we do expect and believe there's opportunity for NIM expansion.

Our securities portfolio continues to be accretive, in that 100 to 125 basis points, as we're replacing securities.

As loans grow and we have an outlook that loan -- that our loan outlook is that loans will grow.

And with that and the right mix of loans, we would expect to see margin expansion as well.

So we do think there's opportunity for that.

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

A couple of questions, one on the loan growth outlook.

I'm hearing that you are very clearly retaining credit quality.

And so my question is, is that -- does that drive to a slightly slower outlook than you've been delivering?

In other words, is there a narrowing of the credit box that has an impact?

Or is there a narrowing of the credit box that has potentially runoff increasing in the loan book?

Betsy, this is Andy.

And the short answer to your question is no.

We're not narrowing the credit box.

We're remaining disciplined as we always have been.

And in fact, we have confidence that loan growth will accelerate.

Our pipelines are as strong as they've been in a long time.

The impacts that we think from a tax reform are starting to dissipate.

The consumer spend numbers are high.

Corporate payments spend activity is high, payables and T&E.

So there's a lot of confidence out there, and I think, actually, loan growth will accelerate.

Okay.

So the NII, up low single-digit year-on-year, is more about NIM as opposed to loan growth.

Is that accurate?

No.

I mean, I think that it's kind of a combination of both.

I mean, if you remember, in the first quarter, we were growing at 0.1%.

Now we're at 0.3%.

And we're going to continue to see that expand and improve, but it's not going to go hog wild in the third quarter.

I mean, we would say that it's going to be moderately growing in the third quarter.

So that's kind of our expectation.

Okay, got it.

So some of the trimming of -- around the edges, like in the student loan book or -- I mean, we saw some shrinkage in CRE.

Is that pretty much over at this stage?

Well, the student loan book is no longer in the numbers, obviously.

The CRE probably will continue to lag because of what we're seeing in the marketplace.

And that's an area that we're not becoming more disciplined or tightening the credit box, but we have been more disciplined historically.

And we'll continue to maintain that.

Yes.

No, I get that, Andy.

And on the student loan piece, my question was really more about are there other portfolios that you would be looking to trim?

Or are you finished with...

Yes.

I mean, yes, Betsy, we're -- obviously, we're always looking at different alternatives and different things to look at, especially portfolios that might be in a runoff status and don't have any long-term strategic benefit to the company.

But there's nothing that is on the immediate horizon that we would point to, right?

Okay.

And the faster growth in C&I that you've got this quarter is part of the optimism on the loan growth from here.

Yes.

And that's particularly true, Betsy, in the middle market which, as Terry mentioned in his remarks, was up 2.2% on a linked-quarter growth.

We're seeing strong activity there.

Yes.

And then I think the other positive thing about that is that that growth we're seeing really across many markets, it's fairly broad based at this particular point in time, and the effect of paydowns has dissipated in that particular space as well.

The other thing I would add is that our community banking markets saw some nice growth in the second quarter.

We would expect that to continue in the third.

Your next question comes from the line of John Pancari with Evercore.

On the loan growth side, the -- back to commercial, I know the end of period balance came in above the average balance.

Is that a better number to work off of?

Is that level sustainable in terms of where we'll grow it off of?

Yes.

I mean, what I would say, John, is that, certainly, when you end up looking at ending versus average, we started to see strength in the latter half of the second quarter.

And in all the different factors that we ended up talking about, we also saw paydowns starting to dissipate a little bit more in the second half of the second quarter.

So I think that that is a good way of looking at the loan growth outlook.

Okay, good.

And then any impact that you're seeing on the -- from tariffs on commercial demand?

Not on demand.

This is Bill.

If you can read in the papers the specific companies here that may be impacted, but we have not seen that in any kind of -- even at an industry level, we really have not seen any impact of the tariffs.

So obviously, we continue to monitor it closely.

But if it stays at this level, we don't really anticipate any impact.

Okay, all right.

And then lastly, on the deposit side.

I just want to get a little bit more color on the deposit moves in the quarter that you saw.

I know end-of-period balance is down 1%, flat on an average basis.

Is there -- are you starting to see a pickup in the shift in deposits and anything else that's impacting the growth?

And what your outlook would be there as well would be helpful.

Yes.

On the deposit side, again, what I would say is that whether it's betas or whether it's just the flow of deposits, it's very much in line with the way we have been modeling our asset liability sensitivities.

So there really hasn't been any unusual expectations.

We've always said that corporate or commercial deposits would -- we would start to see outflows, one, when the economy gets stronger, and I think we're seeing that.

We're not seeing a lot of rotation.

In fact, we're seeing growth in the consumer side, which is good to see.

And then our corporate trust balances, especially in the second quarter because of timing of bond payments and that sort of thing, tends to fluctuate a lot.

So I would -- I guess where I'd leave it is that everything is really on track with respect to our expectations.

Your next question comes from the line of Ken Usdin with Jefferies.

A couple of small ones.

Can you help us understand how much NII went away with the student loan sale?

And how much was in that other fee line related to the gain?

Yes.

I would say that the gain impact is very insignificant.

If you've seen other student loan portfolio sales, you don't see a significant premium with respect to that.

So the gain was very small.

The -- and from a net interest income standpoint, again, kind of coming back to my point, around 2 basis points, I mean, you can kind of back into that being about 1/3 of that overall equation.

Okay.

And then so that means in other fees then that you had -- was the VC/PE stuff pretty big again, outsized would you say?

Well, that category tends to be pretty lumpy.

I mean, there's a lot of different things that end up going into it in terms of retail product revenue, insurance sales, all -- insurance products sales, everything.

So there's not any one particular item in the second quarter that really has caused that to move.

Okay, got it.

And on the expense side, just one question about the third quarter comps.

Now that we've gotten a couple of quarters into the post tax reform changes, do you expect the seasonal upward trend in the tax benefit-related expenses and that's included in your kind of operating leverage guide?

Because I'm just trying to understand if you're saying low single-digit NII and low single-digit fees, that kind of means low single-digit expenses, and that's inclusive of any bump-up in the tax advantage expense.

Absolutely.

There will be a bump-up.

There always is because of the seasonality of that particular business and a lot of tax credit projects being completed in the third and fourth quarter, particularly late in the fourth quarter.

But yes, it absolutely includes everything.

Okay.

And last one, do you -- are you expecting the -- in terms of the year operating leverage, are you expecting the FDIC to go out by year-end?

If so, can you help us size what you think it'll be?

Well, the FDIC surcharge, we expect that it's going to continue through at least the end of the year.

And as I look into 2019, they say they're going to pull it back.

But at this particular point in time, who knows?

But the guidance we've been giving is not assuming any change to the FDIC.

Right.

Okay.

So there's a positive operating leverage even with that staying in there.

Got it.

Yes.

Your next question comes from the line of Erika Najarian with Bank of America.

I just wanted to ask a little bit more about your comments on corporate payments and one of the strongest quarters you've observed.

Is that a leading indicator for the rest of the year?

And sort of what's the lag in terms of that being a potential leading indicator for corporate activity on the financing side?

Erika, that's a great question.

And we look at that corporate payments spend, especially on the commercial side, as a leading indicator with respect to basically corporate confidence and their willingness to spend on both discretionary items as well as capital expenditure.

And so the fact that that is growing gives us more confidence that when we look into the future, that they have confidence that business continues to expand and grow.

And that's part of the calculus as we kind of think about the loan outlook.

And Erika, just to give you some numbers.

The sales volume growth spend volumes, so to speak, this quarter versus a year ago were up 11.7%.

And a year ago, those numbers were 6.4%.

So it's almost doubled in terms of the activity from a corporate spend perspective.

That was helpful.

On the consumer side, Andy, you talked about confidence in terms of growing both corporate and consumer.

Could you remind us a little bit about your offering in the premium card space?

I know one of your larger peers has introduced a premium card that's available outside of their deposit network, which is unusual for them.

But just wondering sort of what you're observing about competitive dynamics and how you think your premium card is positioned and what the take-up has been with your customer base.

We have a full array of card products, including a premium card that we call the Altitude card.

The Altitude card is principally for core customers already of U.S. Bank, and the uptake has been tremendous.

It's a great card.

And one of the attributes of that card is the mobile component, and it has multiple points or rewards.

And so it is really intended to be the choice to be first in your mobile or digital wallet, and the uptake has been very positive.

And just lastly, on the comments earlier about the consumer deposit pricing really driving deposit rates from here.

I'm wondering if you could give us an update on potentially launching a national product.

What products would you lead with and sort of what you've observed with regards to competition picking up or not picking up on the retail side?

Yes.

We have a number of initiatives underway, Erika.

But the one I'd highlight is really trying to extend beyond our current branch geographic, 25-state positioning beyond that where we already have a customer base.

So we are a national player in both our mortgage lending as well as our auto lending through our indirect network.

And our opportunity is to expand the relationship with those customers who already have a relationship with U.S. Bank through mortgage or indirect, to include depository and other opportunities in terms of bank products, and then that's where our focus is.

Just to clarify.

I would have to -- you're marketing directly to your national clients or outside of the 25-state geography that already have a product.

So similar to card, this is something that's for your current client base and is not necessarily available to somebody that was just going on bankrate.com and shopping for a money market account or CD.

They certainly could do that.

But our focus in terms of leveraging growth is against the current customer base because, again, they already have a relationship with U.S. Bank.

It's not a full bank relationship.

It's typically a single product relationship, typically a mortgage or an auto loan, and there are opportunities to expand upon that relationship.

Your next question comes from the line of Mike Mayo with Wells Fargo Securities.

I have one cyclical question, one structural question.

The cyclical question, you seem to be very positive about the economy.

I guess -- I think I heard you correctly, accelerating loan growth and corporate spend and payments that's twice as fast as a year ago.

So given that view, do you think that the yield curve will steepen?

And do you back up that view with how you position the balance sheet?

Or the big debate about the flatter yield curve, does it foreshadow a downturn?

But it seems like you're saying the opposite, so do you kind of make investments to go against the recent movement in the yield curve?

So Mike, I'm going to start and then ask Terry to add on.

I do think we do have confidence in the economy.

From small business to middle market to large corporate, confidence is up.

Activity is up.

On the consumer side of the equation, spend is up and activity's up there, too.

So we do have confidence.

Pipelines are strong.

We talk to our leaders and our lenders, and they're talking to their customers.

Things are very positive.

Credit is very good, as you know.

So those are all positive indicators.

The yield curve does say something different today, and there could be other components of that that's driving that differential.

And Terry, from a positioning standpoint, we're not assuming that there's going to be a steepening in the short term.

Right.

That's exactly right.

So when we're looking at our interest rate modeling and are looking at our forecasts with respect to revenue growth, et cetera, we are continuing to assume that the yield curve remains fairly flat as the short end rises.

And if you end up looking at the spread between 2- and 10-year treasury, we're kind of expecting that it's going to stay in that ballpark and not really change in that perspective.

Well, isn't that a disconnect.

I mean, you seem pretty bulled up on the economy, which would imply a steeper yield curve.

Or are you just being conservative?

Or are you assuming tactical QE factors still stay in place?

Well, I think that until we actually see the yield curve steepening, I think we're going to be -- the way we model and the way we think about forecasting, we're just going to be conservative and take that point of view.

Okay.

And then the structural question, to follow up on the last line of discussion.

So this strategy to expand outside of your 25-state network to cross-sell to mortgage and auto customers, that could potentially take you to all 50 states or most of the states.

And what gives you confidence that that strategy will succeed?

And the opposite of that strategy, it seems like everyone's doing a national digital bank now, from Citigroup, PNC, Goldman Sachs, JPMorgan, and we tend to hear Minneapolis pop up every now and then.

So these competitors from 1,000 miles away are coming into Minneapolis trying to cross-sell to customers in your backyard.

So I guess the question is how do you defend against those other banks that are coming to your backyard to try to steal away your customers?

And how do you think you can go ahead and cross-sell to your customers where you don't have a branch presence?

So Mike, I will tell you, in Minneapolis and in our core markets, we have not seen movement or lost customer base, either on the wholesale or on the consumer side, from some of these new entrants.

So I'll start there.

Secondly, while you can enter all the states, we're going to focus on a few, and we're going to continue to test and learn and try different things.

Number three is I think if you go into a market without a customer base and you either compete on price or product, you could get negative selection.

So that's why we're focused on current customers who already have a relationship with the bank, who we can expand that relationship with other products and services because they already have U.S. Bank as part of their wallet, so to speak, part of their relationship.

We think that's the way to do it.

And again, we're focused on a few markets as we start it out, and we'll continue to update you on the results as we go forward.

Great.

And when did you start this recent initiative?

Is it like...

This year.

We're starting it this year.

Your next question comes from the line of Kevin Barker with Piper Jaffray.

In regards to some of the outlook for revenue growth, and obviously, you expect a flattening yield curve, is there any acceleration of deposit betas beyond what you've already seen within your numbers?

And do you expect asset yields to continue to move higher despite the flattening yield curve?

Yes.

So on the deposit side, as we said in the -- some of the remarks, when you end up looking at the commercial, corporate world and you look at corporate trust sort of deposits, we really feel that those are at kind of their terminal betas.

And so as rates move up, we would move kind of lockstep with it, but we wouldn't necessarily see an expansion or narrowing of that.

The real question is more on the consumer side of the equation.

Consumer betas, they're kind of in that 15% range, and they will typically migrate toward 30%.

The question is over what period of time.

We haven't seen a lot of pressure.

The pressure is there, it's more on the affluent side, which we've been responsive to.

And we price in a lot of different markets, and so we keep our ear to the ground, so to speak.

But it will really come down to how quickly consumer deposits move.

On the asset side, as we have talked in the past, our -- if you end up looking at our balance sheet, we benefit both on the short end and on the long end, about 50-50.

As rates continue to move up, I think that there's opportunity there.

The other thing I would say is, again, coming back to -- our securities portfolio will continue to be accretive for several quarters, many quarters.

And as the residential mortgage portfolio rotates and some of our longer-term assets rotate, we'll see accretive benefit associated with that as well.

Right.

And in regards to mortgage banking question, I noticed that the origination numbers quarter-over-quarter appear to show that you've let market share go.

Are you making a conscious decision to pull back from the market, given the competitive dynamics that are occurring right now in the mortgage space?

Yes.

In the mortgage space, our app volume on a linked-quarter basis was actually up about 8%.

And so we continue to, I think, feel like we're in a pretty good spot in taking market share.

I will tell you that it's very competitive.

The margins are thin.

There's a lot of capacity that's out there.

But we have shifted our focus more toward purchase mortgage.

We started that about 2 years ago, 2, 3 years ago.

We also focused on the retail channel.

The margins tend to be better in the retail channel.

I think what you are seeing in the industry is really more on the correspondence side, where the margins have been very thin and people have been kind of pulling back.

And we're -- from a pricing standpoint, we're remaining competitive.

But just given where margins are, we're being prudent about that as well.

Your next question comes from the line of Vivek Juneja with JPMorgan.

A couple of questions here.

Corporate payments, I wanted to get a little more granularity.

How's government spend been doing, Andy, Terry?

I know you've talked about it in the past.

Yes, government spend is also up, Vivek, as same -- spend year-over-year was up 9.8% in the second quarter of 2018.

That compares to relatively flat or even down 1% last year.

So that is also strengthening.

Okay.

And how does the fee rate on that, Andy, compare with the rest of corporate payments?

The fees on both are substantial -- are fine.

There hasn't been a decline in those.

So you can see that the revenue for both have also increased in the same relative vein.

So commercial spend volumes were up 11.7%, and the revenue was up 12%.

The government spend was up 9.8%, and revenue was up 11.8%.

Yes.

On the government side, Vivek, remember that those contracts tend to be very long term.

And so from a pricing perspective, you see the pressure when the contracts get renegotiated.

But generally, during the term, they stay pretty consistent.

And they're relatively comparable, Vivek, between the 2.

Okay.

Another one, cards.

You talked about the decrease in revolvers.

How much of that do you think is coming from just this increased price competition in the industry from promotional balances?

I wouldn't necessarily attribute it as much to that.

I mean, I think that what we end up seeing when the economy gets stronger and consumer confidence goes up, you tend to see more spend.

But balances, the revolve rate actually comes down a little bit simply because people have the capacity to be able to make those payments.

And then I think the other thing that we're seeing right now is just with tax reform, there's a little more cash in people's pockets and they're taking that opportunity to reduce the revolving part of their balances.

So I think it's probably more so that than anything.

And Terry, I'd add the high quality nature of our portfolio.

Yes.

For us, yes.

Your next question comes from the line of Saul Martinez with UBS.

A couple of questions, first, clarification on your comments on deposit betas.

So Terry, you mentioned that going forward, that you'd expect around 50%.

It was around 45%, I think, this quarter.

So should we take that as meaning the 12 basis point increase in deposit costs you saw this quarter, more or less with future hikes, that's sort of the magnitude we should be thinking about in terms of increased deposit costs?

It's a reasonable assumption, yes.

Okay.

And that bakes in -- that already bakes in the increase in the consumer deposit beta you mentioned from 15% to 30%?

I mean, you mentioned the commercial and, I guess, trust are already -- the corporate trust is already at terminal beta.

Yes.

I would say that currently, it's at 15% and it's going to continue.

The question is over what period of time.

I don't know if it'll be in the next rate hike or the rate hike after that.

So it's kind of from a timing standpoint, those betas will move up a little bit, so 12 may go to 13 basis points for a 25 basis point movement, et cetera.

But it's not going to be dramatic anymore, I don't think.

Okay.

So -- okay.

But you don't think it's a big meaningful move-up from here, from this starting point?

No, we don't think so.

Okay.

And then a follow-up on the discussion on sustainable positive operating leverage of 200 to 300 basis points.

I know it's -- takes some time to get there.

But your long -- I think that's based on the assumption of 6% to 8% revenue growth, long term, 3% to 5% cost growth, and that's how you get to the 200 to 300 basis points.

But to the extent revenue growth doesn't materialize in that fashion, how much room do you have to manage expenses down below that 3% to 5% range and keep that 200 to 300 basis points?

Yes.

Saul, the way I would kind of think about it is not only from a revenue standpoint.

But as we continue to make investments in digital capabilities, those digital capabilities are going to offer us opportunities to be able to streamline or improve our cost basis, our cost structure as well.

So I think it's really kind of -- you have to think about it from both sides of the equation, I think, as much as anything over the next 3 years or so.

Got it.

But -- so does that mean if the revenue backdrop doesn't materialize -- because I think most of us probably don't have 6% to 8% revenue growth in our model for most banks, should I take that answer as saying -- as meaning you can manage it down below that or that you just have investments you need to make and cost growth is going to be sort of within that range regardless of the revenue environment?

So I think, Saul, the easy way to think about it is the higher the revenue growth, the wider that wedge between revenue and expense will be.

To the extent the revenue growth is narrow, that wedge will be more narrow because it's just going to be a function a bit about revenue growth in the long term.

Your next question comes from the line of Gerard Cassidy with RBC Capital Markets.

Can you kind of just give us a little more color on the commercial loan book?

Obviously, you pointed out that the commercial real estate outstandings came down due to paydowns, but also underwriting standards that are not up to your standard.

If you look at it carefully, how much, one, -- the decline, how much was due to the paydown versus underwriting standards?

And then in commercial lending, C&I lending, I think you said you also had some paydowns.

Where is the outside money coming?

Is it other banks taking those loans?

Or is it the private equity market shadow banking industry?

Yes.

So this is Bill.

So on commercial real estate, where we lose balances is in what we call the standing loans or longer-term mortgages, and that's the area that's gotten aggressive, really, in terms of terms and rate.

Many of that's outside the banking community.

And so that's where we've seen the runoff.

On the -- the other big portion in CRE is construction lending.

We remain very, very active there.

We haven't seen -- it's been relatively stable.

It hasn't really seen a runoff.

But that's an area that we remain very active, very -- add great value to clients.

We watch the markets carefully.

But for our good clients, we'll continue to do the construction lending.

And then on the C&I side, that's really more a function of some of the larger M&A deals, but we've seen good pipeline growth coming into the end of the quarter and into this quarter.

So we anticipate that that paydown activity should subside as we see more M&A transactions closed in addition to, as was previously mentioned, some of the kind of core growth in our community and middle-market books.

Bill, as a follow-up to that, your comments about the term commercial real estate mortgage market, can you compare it today, the terms that are being used, to 2005, 2006?

Is it that stretched or we're not there yet in those types of (inaudible)?

No, I think it's -- I would say it's not that stretched, but it's more a function of the length of term and rate that people are offering.

I think our bank -- and specifically, we're not interested in doing fixed rate 15-year loans.

That just does not fit well with our model.

So -- but there are -- whether it's the securitization market that can accommodate that or insurance companies can accommodate that.

Great.

And then as a general question, Terry, you touched upon the operating expense growth being at the lower end of the 3% to 5% range that you gave us.

Have you guys seen any -- we hear a lot nationally about the employment situation, very strong, there's maybe a labor shortage in certain markets and certain industries.

Do you guys see any of that in your commercial bank with office -- loan officers or branch managers?

And if you don't see it, is there something on the horizon that makes you a little nervous that you could see it in 12 months if the economy turns out to be as strong as we all hope?

I think -- this is Andy.

I think what we are seeing is it's taking longer to fill positions.

And so I would say that there's a bit of a tightening in the labor market, and that's impacting our hiring.

It's not substantially increasing pay yet, but I do think that could happen.

But right now, it's just taking longer to fill positions.

There are no further questions at this time.

I would now like to turn the call back over to Jen Thompson.

Thank you for listening to our earnings call.

Please contact us if you have any further questions.

Thank you.

Thanks.

Thanks, everybody.

This concludes U.S. Bancorp's Second Quarter 2018 Earnings Conference Call.

We thank you for your participation.

You may now disconnect.