美國合眾銀行 (USB) 2021 Q2 法說會逐字稿

Welcome to U.S. Bancorp's Second Quarter 2021 Earnings Conference Call. Following a review of the results by Andy Cecere, Chairman, President and Chief Executive Officer; and Terry Dolan, Vice Chair 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 11:00 a.m. Central Time through Thursday, July 22, 2021, at 10:59 p.m. Central Time.

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

Thank you, Ashley, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and CEO; and Terry Dolan, our Chief Financial Officer. Also joining us on the call are our Chief Risk Officer, Jodi Richard; and our Chief Credit Officer, Mark Runkel. During their prepared remarks, Andy and Terry will be referencing a slide presentation. 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.

Thanks, Jen. Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry, Jodi, Mark and I will take any questions you have.

I'll begin on Slide 3. In the second quarter, we reported earnings per share of $1.28. We released $350 million in loan loss reserves this quarter, supported by our outlook on the economy and continued improvement in credit quality metrics, the pace of which has been better than expected. Net revenue totaled $5.8 billion in the second quarter. As expected, net interest income grew in the second quarter, while our fee businesses benefited from improving consumer and business spending trends.

Notably, as of late June, total sales volumes for each of our 3 payments businesses, credit and debit card, merchant acquiring and corporate payment systems, were above 2019 levels for the first time since the beginning of the pandemic. Our expenses were relatively stable compared with the first quarter.

Turning to capital. Our book value per share totaled $31.74 at June 30, which was 4% higher than March 31. During the quarter, we returned 79% of our earnings to shareholders in the forms of dividends and share buybacks. Following the results of the Federal Reserve stress test in late June, we announced that management will recommend that our Board of Directors approved a 9.5% increase in our common dividend in the third quarter payable on October.

Slide 4 provides key metrics, including a return on tangible common equity of 20.9%.

Slide 5 highlights continued strong trends in digital activity.

Now let me turn the call over to Terry who will provide more detail on the quarter.

Thanks, Andy. If you turn to Slide 6, I'll start with the balance sheet review followed by a discussion of second quarter earnings trends. Average loans were stable compared with the first quarter in line with our expectations. Strong demand for installment loans drove other retail loan growth, while C&I loans increased 0.9% supported by strong growth in asset-backed lending, partly offset by continued paydown activity in other C&I categories. We saw a decline in residential mortgage loans

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increased paydowns.

Average credit card loan balances were stable compared with the first quarter as the payment rates remained high at 38%, reflecting the significant level of consumer liquidity. However, period-end balances increased 4.5% on a linked quarter basis as we saw some pickup in activity toward the end of the quarter.

Turning to Slide 7. Average deposits increased 0.7% compared with the first quarter and grew by 6.4% compared with the year ago, reflecting the significant level of liquidity in the financial system. Our overall deposit mix continues to be favorable. In the second quarter, our noninterest-bearing deposits grew 5.9% linked quarter, while time deposits declined by 8.1%. Time deposits now account for 6% of total deposits compared with 11% a year ago.

Slide 8 shows credit quality trends, which continue to be better than expectations. Our net charge-off ratio totaled 0.25% in the second quarter compared with 0.31% in the first quarter. The ratio of nonperforming assets to loans and other real estate was 0.36% at the end of the second quarter compared with 0.41% at the end of the first quarter.

We released reserves of $350 million this quarter, reflective of better-than-expected credit trends and a continued constructive outlook on the economy. Our allowance for credit losses as of June 30 totaled $6.6 billion or 2.23% of loans. The allowance level reflected our best estimate of the impact of improving economic growth and changing credit quality within the portfolios.

Slide 9 provides an earnings summary. In the second quarter of 2021, we earned $1.28 per diluted share. These results include the reserve release of $350 million.

Slide 10. Net interest income on a fully taxable equivalent basis of $3.2 billion increased 2.4% compared with the first quarter, primarily driven by higher yields and volumes in our investment securities portfolio and favorable earning asset and funding mix shifts, partly offset by lower loan yields. Our net interest margin increased 3 basis points to 2.53%. The impact of lower loan yields was more than offset by a favorable mix shift in both our investment portfolio and funding composition as well as lower premium amortization expense.

Slide 11 highlights trends in noninterest income. Compared with a year ago, noninterest income was relatively stable as the expected decline in mortgage banking revenue and commercial product revenue was offset by higher payments revenue, trust and investment management revenue, treasury management fees and deposit service charges. On a linked quarter basis, noninterest income increased 10.0% driven by higher business and consumer spending activity, reflecting broad-based reopenings of local economies.

Both year-over-year and linked quarter mortgage banking revenues were negatively impacted by slower -- slowing refinancing activity and reduced gain on sale margins. Linked quarter mortgage revenue growth of 15.7% was primarily driven by the favorable linked quarter impact of a change in fair value of mortgage servicing rights net of hedging activities.

Slide 12 provides information on our Payment Services business. In the second quarter, total payments revenues increased 39.5% versus a year ago and was higher by 16.4% compared with the first quarter. Each of our 3 payments businesses saw strong revenue growth on both a linked quarter and a year-over-year basis, reflective of the strengthening economy and the increased spend activity.

Credit and debit card revenue increased 39.4% on a year-over-year basis driven by stronger credit card sales volumes and higher prepaid card processing activities related to government stimulus programs. Sales volume trends, which are the primary driver of payments revenues, are encouraging.

The bottom charts on Slide 12 indicate that as of the end of June, total sales volumes across each of the 3 payments businesses exceeded comparable 2019 levels. Certain pandemic-impacted spend categories continued to lag, in particular corporate T&E. However, consumer travel and hospitality spend volumes are rebounding faster than we expected, and the pace of improvement in recent weeks has accelerated a bit.

Turning to Slide 13. Noninterest expenses was relatively stable on a linked quarter basis as expected.

Slide 14 highlights our capital position. Our common equity Tier 1 capital ratio at June 30 was 9.9% compared with our target CET1 ratio of 8.5%. Given improving economic conditions in the second quarter, we bought back $886 million of common stock as part of our previously announced $3.0 billion repurchase program.

I'll provide some forward-looking guidance. For the third quarter of 2021, we expect fully taxable equivalent net interest income to be relatively stable compared to the second quarter. We expect total payments revenues to be relatively stable compared to the second quarter but will continue to track favorably on a year-over-year basis. While we expect sales volumes growth in each of our 3 payments businesses to continue to improve sequentially, prepaid card volumes are expected to decline toward prepandemic levels as the impact of government stimulus dissipates.

We expect noninterest expenses to be relatively stable compared to the second quarter. Credit quality remains strong. Over the next few quarters, we expect the net charge-off ratio to remain lower than normal. For the full year of 2021, we expect -- we currently expect our taxable equivalent tax rate to be approximately 22%.

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

Thanks, Terry. Our second quarter results came in as expected, and there are many reasons we are optimistic as we head into the second half of the year. The economy continues to recover towards prepandemic activity levels, and the consumer and business spending activity continues to improve. Credit quality trends have been a positive surprise. And our payments volumes have come back a bit faster than we expected as recently as a few months ago.

We are well positioned for the cyclical recovery that we expect to play out over the next several quarters. More importantly, we are well positioned to deliver on superior growth and industry-leading returns on equity over the next several quarters given our business mix, our comprehensive and holistic payments and banking capabilities and our expansive distribution model supported by world-class digital capabilities. I'd like to thank our employees for their hard work and dedication throughout the year.

We will now open up the call to Q&A.

(Operator Instructions) And your first question comes from Betsy Graseck with Morgan Stanley.

I just wanted to dig in a little bit to the guidance and some of the discussion there around the payments business. I think you mentioned that payments came in a little faster than expected. I know you were expecting that the payments revenues would accelerate in 2Q. So it came in a little faster than you're expecting, but then I think you're mentioning that you've got it flat -- expecting it to be flat Q-on-Q. But I just want to dig into that. Is that because the acceleration rate you think is slowing down here? Or are you being conservative with the guide for 3Q?

Yes. I think it's a combination of things, Betsy. And maybe just if I kind of talk a little bit about payments again overall, I think 3 things to kind of keep in mind in terms of the payments businesses in total. And that is the sales volume momentum continues to be very strong, especially when you exclude the airline and T&E sort of activities. Airlines and T&E continue to be lagging but are getting stronger.

In fact, if you listen to any of the airline sort of quarterly results, the leisure travel is really back to prepandemic levels, and business travel is starting to pick up pretty nicely. The other thing I would just say is that corporate T&E continues to be the one area that is still down quite a bit, but it is improving a little bit faster than maybe what we had expected.

The one area I would just say or highlight is -- let me talk a little bit about maybe the 3 components. If we first take a look at credit and debit card revenue, again, sales volumes are particularly strong in that area as an example. Credit sales in the second quarter -- and we would expect it to continue maybe a slightly lower rate. But credit sales in -- are about 20% when you exclude travel and entertainment. Debit card sales are about 27%. So the second quarter was particularly strong, and we expect that type of momentum to continue.

The one thing that I would say, though, is that third quarter of last year was the peak with respect to prepaid card processing revenue. And that has been slowly normalizing, but we really kind of expect third quarter to be back closer to what would be a normal level.

The second thing that is going to end up impacting credit and debit card revenue for the third quarter is that we are taking the opportunity to invest in growth. So we're giving up some near-term growth opportunity in order to be able to generate customer account acquisition.

The other thing that I would just mention maybe from a prepaid card perspective, on a normal basis, it represents about 10% to 11% of that overall credit and debit card revenue category. And it's that factor of it normalizing plus the investment that's really going to cause the overall payment revenues to be fairly stable relative to the second quarter.

Okay. So even though you've got T&E that is ramping, the prepaid is really offsetting that as you go into 3Q. That's really the conclusion.

Yes. That's right.

Okay. All right. Got it. And then maybe you could talk a little bit about the credit box and how you're thinking about that with regard to not only the card space, but the overall loan book.

Yes. So I think we mentioned this last quarter, but we're now back to fundamentally the credit box that we had on a prepandemic level really across all the product categories.

And your C&I was good, especially if I consider the PPP. So just wondering what's going on there to generate the strength that you saw in the quarter.

Yes. There's a couple of different things. We mentioned that asset-backed securitization lending has been strong, and it's been continuing to improve. I think that's one of the things that we are seeing in that particular category.

The one thing, though, that we're continuing to watch is that the payoffs -- or paydowns continue to occur. And that's simply because the rate environment, the capital markets activities continue to be fairly strong. And I also think it's going to take a little bit of time for our C&I to develop simply because the amount of liquidity that customers have and are continuing to generate.

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

So good to see costs flat linked quarter, even though you had the beat in fees and you guided to kind of similar in the third quarter. But I asked last quarter, as the fees pick up, hopefully driven by payments, and if rates rise and loan growth picks up, can you get outsized operating leverage? And last quarter, you thought you could, and that was the plan, the hope. I know you don't give kind of formal guidance beyond one quarter out, but thematically, is that still the case that while there's investments to make, you would hope for outsized operating leverage as the revenues pick up?

Yes. I mean we certainly have that expectation. I mean we've made some very nice investments across many different categories within our business, whether it's in the mortgage business. We see the benefit, especially as that starts to shift toward -- away from refinancing toward the purchase mortgage. Our digital capabilities there will be very beneficial.

I think that we continue to see strong growth with respect to auto end-of-term gains. The payments businesses where we've made investments, for example, in treasury management sort of capabilities and things like that, that is starting to pay off. So the answer is yes, I think we feel very confident that the investments that we have been making are going to allow us to generate some nice fee growth as we think about the future.

And Matt, we're going to continue to manage expenses relatively stable with the headwinds we have in revenue. Like you talked about the flat yield curve and margin and loan growth being a little bit challenged. But we'll manage flat in this environment and then positive operating leverage in a more normal revenue environment.

Okay. And then just separately, you recently announced a deal to acquire part of this PFM. Maybe just what is that exactly? How does it fit into USB? And I had to remind myself, I think you had owned an asset management company that you sold about 10 years ago, FAF. So is this kind of get back into a certain business that you exit or a different part of the investment in wealth management segment?

Yes, Matt. So like you referenced, a few years ago, we did sell, but that was equities and bond business. We continue to retain the money market business and, in fact, have about $161 billion of assets under management. And so this essentially doubles that base with a particular focus on government, which is the space around government investment pools. And it fits very nicely into our government banking business, our treasury management and particularly our corporate trust business. So it's a nice add-on to a business we're already in, but gives us additional scale on customer acquisition.

Your next question comes from John Pancari with Evercore ISI.

On -- back on the payments side, just as we continue to see the rebound that you're flagging play out, I guess, can you help us think about how you view the long-term growth potential business perhaps beyond this year? What is a reasonable growth rate to expect out of the various payments business?

And then separately, are you viewing competition in the space any differently today than a couple of years ago? It certainly seems like it's intensifying and -- so how do you view that as a dynamic as well?

Yes. So let me just talk about maybe how we think about it on a longer-term basis. Certainly, when we think about the payments businesses, we believe that mid-single digits is a good target for us to be able to achieve in that particular space. We have been making some, as I said, some really nice investments. The tech-led fees, for example, within Elavon, our merchant acquiring space, today represent about 28% of the overall Elavon revenue or merchant acquiring revenue. And it's growing at about that pace as well. So it's a nice business investment that we've made and tech-led will contribute to the overall investment as we go.

And then I do think that our investments in the RPS digital account acquisition and in our treasury management space, all those different types of investments on the B2B real-time payments are going to have a real opportunity for growth. In treasury management, as an example, about half of that revenue today represents what I would call digital or forward-leaning type of revenue products as opposed to legacy products. And they grow at about a 10% to 11% clip. So I think that there's some real opportunity for mid-single digits or in that ballpark anyway. Andy?

I agree, Terry. And I think in addition to what you said, which is sort of the current case, I would point to our focus on business banking and this weaving together of the banking and payments capabilities into a comprehensive product set. And as a reminder, we have just over 1 million business banking customers with less than a 40% penetration. I think it presents a lot of opportunity. And we've talked about the fact that we expect to grow that revenue base 25% to 30% over the next few years. So I think that's an additional opportunity in addition to what Terry talked about.

All right. Great. That's helpful. Then separately on the capital front, the CET ratio at 9.9%. Your internal target still sits at 8.5%. And how should we think about migration down towards that level in terms of timing? What type of factors are influencing the pace that you migrate back or towards that target?

It -- yes. Great question. And currently, I think we have capacity under our buyback program. It's about a $3 billion program, and we have purchased about half of that thus far. So we'll continue to purchase under that buyback program. And then we certainly have the opportunity to be able to expand that or replace it in the future.

We think about deploying or utilizing capital and kind of along the various priorities, organic growth being the -- really the top priority and the dividend, as Andy talked about earlier. Then we look at inorganic sort of opportunities to the extent that they might present themselves or product sort of capabilities and then the buyback program. So that's kind of how we end up prioritizing it. From a timing standpoint, I think we're going to continue to watch both from an economic standpoint. But we're just going to be opportunistic in the market when it makes sense to be buying back shares.

Your next question comes from Scott Siefers with Piper Sandler.

I was hoping to sort of revisit this notion of the sort of competitive positioning in payments. I think one of the big things that I hear on USB is that the payments business is just such a wonderful differentiator vis-à-vis other banks. But the -- sort of the volume trends versus some of your fintech competitors aren't as striking now. A lot of them are much newer companies and stuff like that, so it makes sense. But would just be curious to hear your thoughts on sort of competitive positioning overall and where you think you're doing especially well but would -- might need some work conversely as well.

So Scott, this is Andy. We -- as Terry talked about the investments we're making on the digital front and the capabilities around software and tech-led. And I think that is -- really put us in a great spot. But I think even more important is this weaving together, like I referenced earlier, of the banking and the payments into a comprehensive product set to help these companies run their businesses.

So that banking-payments combination, I think, is particularly important. And the fact that we have strong banking capabilities and strong payments capabilities is, I think, how we're going to differentiate ourselves. And it's on 2 fronts: one is to extend the current capabilities to current customers; but more importantly, to achieve customer acquisition at a higher growth rate. So that's where we're focused on.

Okay. All right. Perfect. And then maybe separately, Terry, can you talk about maybe the degree to which you're seeing sort of institutional deposit inflows related, if at all, to like the largest banks may be turning them away given their own sort of thresholds and [purchases]. And so what's the way you're thinking about the potential for sort of kind of customer acquisition on the deposit side there in the institutional area, but particularly when there's not necessarily a ton of robust loan growth to immediately kind of utilize those funds with?

Yes. Great question. It's a little hard to know exactly what the implications are of other actions that it has on us. But maybe when I end up looking at where our growth is occurring, that the strongest growth is really coming from our Consumer and Business Banking segment rather than on the institutional side. The institutional has actually probably been staying relatively flat or even coming down based upon rates that are being offered, et cetera. But the strong growth is really on the consumer side, and we think that that's because of our digital capabilities and customer acquisition sort of strategies and then the liquidity that customers have.

Your next question comes from Bill Carcache with Wolfe Research.

I wanted to follow up on the comments you just made and ask maybe a little bit more specifically. If you could sort of juxtapose for us the growth outlooks in consumer and commercial and talk a little bit about maybe where you see the greater potential for inflection given all the moving parts that we're seeing around the supply chain dynamics and pent-up demand and all the liquidity and all of that. Would love to hear your thoughts as you kind of look at those businesses next to each other.

Yes. So Bill, the opportunity on the consumer side, I think, continues to be the economic recovery that's occurring and the strength in payments. And Terry talked about the trends across all 3 of the payments categories, particularly card spend. And even things like travel and entertainment, while still lower or weaker than prepandemic levels, coming back strong and rapidly. So that's a positive.

And then we have sort of the secular trend that I talked about which was in the business banking side, which is this combination of payments and business. And so those -- the economic recovery on the consumer side and the secular focus on the business side would be the 2 areas I would emphasize.

Got it. And then I was hoping that you could give your thoughts on the open banking aspect of Biden's executive order, making it easier and cheaper to switch banks by requiring banks to allow customers to take their financial transaction data with them to a competitor. Just curious if you had any broad, high-level thoughts on that?

Yes. One of the reasons we're investing in all these digital capabilities is because we want to be the very best in terms of digital and have great capabilities to serve our customers. And that, combined with the human element -- finance is complicated and having people in addition to digital, I think, is critically important. So that's how we think we're going to effectively compete in the long run, and that's what we're focused on.

Got it. And if I could squeeze in one last one. Is there any concern around the child tax credits? And I guess you talked about the improving -- payments revenues sort of stable but improving. And like there's been this whole dynamic with payment rates being elevated but hope that they get better. Do the child tax credit sort of extend the recovery, push it further out? Or maybe any thoughts on how you guys are viewing that?

Yes. I think maybe one of the ways to think about it is you know that the child tax credit, they typically end up getting a great big lump sum. And now when you spread it out kind of on a quarterly basis or more throughout the year, I think it just gives people the opportunity to be able to utilize that maybe a little bit more effectively in terms of paying their lifestyle sort of bills. So I don't think -- I don't -- it might change in terms of timing as much as anything, but I don't think it's necessarily a major driver. Andy, do you have a different perspective?

I agree, Terry. We actually -- we’ve talked about the payment rate being high 30s. It was 38% in the second quarter, but it's also stabilized. It was growing for a number of quarters, which has put pressure, obviously, on the card balances. But stabilization on that payment rate combined with increased spend, I think, will perhaps lead to growth in the next few quarters on the card side.

Your next question comes from John McDonald with Autonomous Research.

Terry, was wondering if you could unpack a little bit the outlook for next quarter NII. Just kind of thoughts on puts and takes on margin versus volume as you look at the stable outlook for net interest income.

Yes. I mean a big part of that is just what rates have done. But let me kind of step back. I mean we had a really nice quarter in terms of the growth. That was driven in part by the investment portfolio growth that we had in the second quarter. We were opportunistic in investing when the 10-year was kind of in that 1.75% range. And we put some cash to work at that particular point in time. We also saw some benefit associated with the premium amortization expense being a little bit lower.

When we think about the second -- or the next quarter, I think maybe the puts and takes are going to be -- we expect loan growth to be relatively flat but modestly stronger than what we saw on a linked quarter basis in the second quarter. We -- our expectation is that the long end of the curve comes up a little bit but is not much. And then I think that the margin is relatively stable. So I think when we end up looking at the various components of it, that's kind of how we think about it.

Loan growth, we are seeing it in that asset-backed securitization lending. We do expect consumer lending to get a little bit stronger because of the consumer spend activities are taking place. Andy talked about the payments rates have kind of hit, we think, a high in the credit card space. We saw some nice growth right at the end of the June time frame. And while they'll continue to be at elevated levels, I think that the fact they're not increasing, they may be coming down a little bit will help credit card balances as well.

And then maybe when we also think about loan growth, auto lending continues to be very strong. And I think it's really kind of a combination of all those different types of things.

Okay. And not sure if you touched on it yet, but any thoughts on the outlook for mortgage banking volumes and revenues in the near term, Terry?

Yes. Mortgage banking, obviously, it hit its high in the second quarter of last year. And then it's been coming down simply because the refinancing activities have been slowing over time.

When we think about the mortgage banking business, it has been influenced by that refinancing. But today, the mix of purchase versus refinancing is about 60% purchase, 40% refinance. Mortgage banking revenues are kind of back to what I would call prepandemic sort of level that we saw in the fourth quarter of 2019, first quarter of 2020 kind of in that ballpark.

So I actually think that mortgage banking is kind of back to that prepandemic level. And the investments that we've made in our digital capabilities, our retail mortgage business and all sorts of things will help us compete. We have been taking market share especially in the purchase mortgage side of the equation. I think that's all kind of beneficial.

Your next question comes from Ken Usdin with Jefferies.

I was wondering if I could follow up on PFM. And I know details weren't released in the press release, but can you help us think about just what the type of contribution it might bring to revenues, pretax income, earnings, et cetera, and use of capital?

Yes. Again, we haven't necessarily disclosed all of that. I mean from a capital usage perspective, it would be relatively insignificant. I think that one of the benefits maybe of acquiring at this particular point in time is that if we do start to see rise in rates, the benefit of recapturing some of the fee waivers that, that business has been experiencing and that's all upside to how we were thinking about the business when we ended up acquiring it.

So again, a nice acquisition for us because it gets us into that local government investment pool market. We will have a #1 market share in that particular space. But overall, from a company perspective, it's just complementary to the money market asset management business that we have.

And on that point, Terry, do you know what your second quarter fee waivers were in the core trust and investment management business? And how much that might have changed sequentially and should improve?

$73 million was Q2, up a little bit from Q1, and I think $73 million is going to be the peak.

Right. Okay. Last one. You mentioned in the press release that the first quarter NII -- second quarter NII was helped by higher loan fees. I'm just wondering, how much was that of a helper? And also, if you have any color on what the delta in just PPP loans was as you exit the quarter?

Yes. I mean the delta, first to second quarter, wasn't significant. And when we think about second to third quarter, we don't think that, that is going to be significant in terms of, for example, fee recognition.

For PPP specifically?

For PPP specifically, yes.

Okay. And were loan fees meaningful in the second quarter?

Not really. I mean no. I mean any time you have recoveries, you have a little bit of a benefit associated with that, but nothing of significance.

Your next question comes from David Long with Raymond James.

The loan growth for your auto portfolio has been pretty strong. I just wondered if you can provide some color on the split between growth in making loans to new vehicles versus used vehicles.

Most of our activity is from our dealer finance business, and it's mostly new activity. There is some used in there, but I would say the majority is new.

Got it. Got it. Okay. And then as it relates to the mortgage banking, do you have the dollar amount of the favorable impact from the MSR valuation adjustment in the second quarter?

Yes. I'm trying to remember. In the first quarter, I think the net impact was about $140 million kind of in that ballpark. So that would be kind of the benefit that we end up seeing. So in the first quarter, it was $120 million, and it was -- it's probably about $100 million of differential.

Yes. I think that's right, Terry. It's about $120 million in the first quarter, negative, and about $28 million in the second quarter here.

Your next question comes from Vivek Juneja with JPMorgan.

A couple of questions. First one, you mentioned you'd be giving up some near-term growth on the card side due to investments. Can you talk a little bit about what investments? And for how long? And why that would slow down your card growth?

Yes. Well, anytime you're going through both the customer account acquisition as well as the volumes are expanding, et cetera, your rebates, residuals, your card acquisition costs, all those sorts of things are part of that revenue line. And so the extent that, that is ramping up, it's going to moderate the quarter-over-quarter sort of growth.

I mean, Vivek, we're always constantly sort of investing in that business. It's just kind of relative from one quarter to the next how much we’re investing at any particular point in time. We just think that given the strong sales momentum and the opportunity at this particular point in time to make those investments, we just think it's the right thing to do.

And then that would hurt third quarter, but then that should, from a comparison standpoint, not be a drag or flip the other way in the fourth quarter. Is that how we should think about that, Terry, from a timing standpoint as we model out quarter-to-quarter?

Yes. I don't think that the amount of the drag increases in the fourth quarter relative to the third quarter, but that's right.

Okay. Different topic. You said lower MBS premium amortization helped a little in the second quarter. Any color on what it was? And how we can compare where you are versus prepandemic? So how much more room for that to come down?

Yes. I mean I would expect that the reduction in premium amortization in third quarter will be kind of similar to what we saw in the second quarter. And the margin impact over time, as it was going up, was somewhere between 2 and 4 basis points kind of on a linked quarter basis. So I think that you could kind of expect that same sort of benefit in, for example, the third quarter. It starts to dissipate or moderate as we kind of get out into late fourth and into 2022.

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

Your tech spend is up 20% year-over-year, if you look at the year-to-date numbers. So the question is, how much do you think you'll spend this year? What percent increase do you expect? What are you spending it on? And any more meat on the bones you can give on combining the banking and payment businesses?

Yes. So maybe from an overall tech spend, we talked about the fact that we make investment of about $2.5 billion in technology kind of broadly. About half of that is capital expenditure. About half of that is what I would call kind of run rate, if you will. We have been running at that level for some period of time. And the increase that you're seeing, Mike, is really, as you're making those investments, it takes a little bit of a time for it to kind of get into the run rate, if you will.

The -- I would expect that -- we don't anticipate when we think about going forward that, that tech spend amount will change a lot. I think the -- what we end up focusing on, I think, has been changing over time. For example, if I were to step back 3, 4 years ago, it was less offense, more defense. And today, it's probably 60%, 65% offense related around our digital initiatives, tech stack modernization, those sorts of things as opposed to playing -- having to play defense. So I think the shift is good because it's more forward-leaning and more revenue-generating sort of activities as opposed to defense. And I think key -- go ahead, I'm sorry.

Just to -- so run the bank, change the bank. You'd say now change the bank is like 60% versus 40% run the bank?

Yes. I think that's a good way of describing it.

Okay. And then you guys -- I ask this question every quarter, and you seem to be playing it very close to the vest. You clearly have been investing a lot in combining the payments and the banking businesses to give -- I think you said on one call to be more Chime-like or go after Chime, not them specifically but the concept. Can you give us any more meat on the bones as far as what the strategy is? When we're going to see it? You said you want to serve existing clients better but also capture a lot more new customers. And I don't know where to look for that in the external releases or when we should look for it.

Yes. Mike, it's Andy. We're spending a lot of time on that internally, and I'll tell you what, we're going to put something in the earnings release and deck by the end of the year to give you more information on this. We are looking at it on a regular basis. It's one of our top priorities. I think it's a huge opportunity both from an increased penetration to current customers as well as customer acquisition. And we'll give you more on this before the end of the year.

Your next question comes from Scott Siefers with Piper Sandler.

Just curious, in the -- in President Biden's executive order last week, some language regarding increased scrutiny on bank transactions. Just curious if you have any sort of early thoughts on kind of ramifications or how it might or might not change your calculus on thinking about any opportunities that might come up.

Sure, Scott. So as we've talked about, we want to be disciplined, and have been -- and opportunistic when it comes to M&A. And any deal that we would look at would need to make strategic and financial sense and consistent with our guidelines. And I think the executive order will mean there will be additional attention for bank M&A. But we believe ultimately, decisions will be driven by what's best for all stakeholders, and that's how we're thinking about it.

Your next question comes from Gerard Cassidy with RBC.

Terry, you touched on in your opening comments about loan growth. And you mentioned about the C&I growth increased slightly driven by asset-backed type of lending, but it was partially offset by the continued paydown activity in other C&I categories. The question is on the paydown activity. We know that many of the commercial borrowers have elevated liquidity levels, which may be contributing to this.

But can you maybe further elaborate on what your customers are telling you? Is it the supply chain problem where they just -- like your auto dealers, for example, just don't have the inventory? Therefore, they have this extra cash flow and they're able to pay down? And would this then change as the supply chain issues for all companies, not just auto, starts to get ironed out in the next 6 to 12 months, which could lead to maybe an accelerated commercial loan demand?

Yes. I mean I do think that the commercial loan demand will start to pick up. I think it's just -- it's a matter of timing when does that actually occur. And I do think that they have to get through that excess liquidity or at least some of it. And they also -- I think that they need to start making those capital expenditures. And we're starting to see that.

I mean when we talk across our markets, I think that the, for example, middle-market customers are certainly much more optimistic today than they were even a quarter or 2 quarters ago. And that usually translates into making longer-term sort of business investment. And so I think that we'll continue to kind of see that.

I do think that we're -- so I do think that supply chain is impacting it to some extent, but I think that that's more transitory. I think that, that will dissipate over time in terms of the impact.

Terry, I agree. And the only other key factor, I think, is many companies are awash in liquidity. They have strong balance sheets. They've been becoming more efficient and their balance sheets are strong, which is reflected in our deposits on the left -- on the right side of the balance sheet. So I think that's another factor.

And just as a follow-up on this commercial customer discussions that you've been having with these customers. What's their view about inflation? Are they concerned that they're not going to be able to pass on higher prices to their customers? Or any color that you guys are picking up in your discussions with these customers about the outlook for inflation and what it means to them?

Yes. I think, Gerard, a number of our manufacturing companies in particular are passing on some of the increased supply costs that they're recognizing. And it is a factor in their pricing as well. So I do think some of it is being passed on -- a lot of it's being passed on. And I think this question around how transitory this is, is one that is often debated. But I can tell you right now, it's impactful. How long it lasts, I'm not sure.

Very good. And then just as a follow-up. Andy, you touched about the liquidity helping on the deposit side. We also all understand what quantitative easing has done to the deposits of the banking system. Do you think that when tapering takes place probably end of the year, let's say, that there may be some pressure on deposit growth for you folks? Or that you really haven't been impacted that materially by the quantitative easing by the fed because that's more wholesale-oriented and maybe hitting the money center banks maybe more so than you folks?

So I think we, U.S. Bank, and we, the industry, have certainly benefited from a deposit growth standpoint because of the fed balance sheet. I don't think there's any dispute around that.

I do think as that starts to diminish, you'll see some impact in deposits. But I also would point out that some deposits have also -- or some funds have also moved off balance sheet to money market funds. This is, again, this mix we have and this opportunity to go either on balance sheet or off balance sheet. Some might migrate more to the on-balance sheet component in that environment.

Your next question is from Mike Mayo with Wells Fargo Securities.

Just a follow-up. A big picture question, Andy. You had 6 years of negative operating leverage, and we all know the reasons for that, from the regulatory to the investing to the pandemic and everything else. And I guess, technically, year-over-year, it's still a little negative. But quarter-over-quarter, this is some of the best positive operating leverage you've had in a while. And it seems like it's not going negative ahead, it seems.

So are you willing to call a turn in that 6 years of negative operating leverage? Or is it too early? Or is that kind of a next year event? I know I'm getting ahead of where you maybe want to go, but it's been a long wait for the revenues growing faster than expenses. It seems like you might be there, but I'm not sure.

Yes, Mike. So I think like I mentioned before, we're going to manage expenses flat in this challenging revenue environment. And the challenging revenue environment is a function of the things we've talked about, which is this lower-than-normal loan growth, this flat and low yield curve and the function of still returning to normalization on things like travel and entertainment and so forth. So flat until we get normal and then positive operating leverage when we start to get to a more normalized revenue environment. That's how we're managing the company.

Your next question is from Bill Carcache with Wolfe Research.

I just wanted to ask one follow-up. You guys have historically been very deliberate about your use of M&A to create value. As you look ahead, is there an opportunity to think differently, for example, by taking the strength of your existing franchise to expand into new markets and win customers without having to acquire legacy branch infrastructure? Or is sort of bank M&A likely to look the same as it has traditionally? Any thoughts around that topic would be helpful.

Yes, Bill. So we talked about the factors. There's a few ways that we continue to grow and expand from a consumer and retail and business standpoint. One is continued acquisition with our core organic initiatives around digital acquisition and focusing on that, which we're making great progress on. The second is this concept of digital first branch light expansion like we were doing in Charlotte, North Carolina, where we have fewer branches and really leveraging data and digital capabilities.

The third is partnerships like what we've done with State Farm, 19,000 agents who are really working to refer our card and deposit products. It's just an extension nationwide of our capabilities. And the fourth would be more traditional M&A. And we look at all those opportunities depending upon what's in front of us.

At this time, there are no further questions. I will now hand the call back for closing remarks.

Thanks for listening to our earnings call this morning. Please contact the Investor Relations department if you have any follow-up questions.

That concludes today's conference call. Thank you for your participation. You may now disconnect.