美國合眾銀行 (USB) 0 Q0 法說會逐字稿

Welcome to the U.S.

Bancorp second quarter 2002 earnings conference call.

Following a review of the results by David Moffett, vice chairman and chief financial officer, there will be a formal question and answer session.

If you would like to ask a question, press the 1 and pound to withdraw.

This call will be recorded and available for replay at 6 p.m. today, eastern time, through Tuesday, July 23rd at midnight, eastern time.

I will turn over to Mack McCullough.

Good afternoon and thank you for calling in.

Today David Moffett will be discussing second quarter results.

If you have not yet received a copy of our earnings release and analyst schedules, they are available under the news release section of our website at www.usbank.com.

Before we begin, I would like to remind you forward-looking statements made during today's conference call are subject to risks and uncertainty. Factors that could change our forward-looking assumptions are detailed in our press release.

I will turn the conference over to David.

Welcome.

This is David Moffett, vice chairman and chief financial officer of U.S. Bancorp.

Today we reported earnings of 869.8 million or 45 cents per share on a diluted basis, up from 44 cents a share in the first quarter of 2002.

The 44 cents for the second quarter of 2002 meets first call consensus estimates.

And remain confident with the $1.84.

Second quarter provision operating income grew approximately 11% from the second quarter of 2001. Excluding the impact of acquisitions of nonrecurring items and the adoption of SFAS 142, second quarter operating income grew approximately 8% f the second quarter of 2001.

As revenue grew by approximately 6% and expenses increased by 3%.

On a lead quarter basis, revenue increased 4.3% for annualized 17.2%, with all business units and nearly all noninterest income categories contributing to the increase.

Even excluding the impact of Leader Mortgage which closed, revenue increased by 3.7%.

This is the largest lean quarter revenue increase we have had in the past 13 quarters. However, to put in perspective, keep in mind, on lead quarter basis, the second quarter is the strongest revenue growth quarter of the year.

The net interest margin declined 3 basis points from the first quarter of 2002, to 4.59%, high level of lower yielding investment securities and increases in the rates paid on money market accounts were the primary drivers behind the decline.

We believe that higher interest bearing rates and modest growth in total loans will result in continued declines in net interest margin as 2002 progresses. Second quarter noninterest income increased approximately 110 million or 8.3% f the first quarter of 2002.

Leader Mortgage accounted for 14 million of the increase.

Credit and debt card processing fees increased 22 million.

Merchant processing fees increased 11 million.

Corporate payment product fees increased 7 million.

All these increases were due to higher transaction volumes in organic growth. Deposit service charges increased 18 million, due to increase in revenue from existing customers, as well as new accounted growth.

Investment banking fees increased 17 million due to increased MNA at Piper Jaffray.

Trust and asset management fees increased 11 million due to finance in growth in corporate trust and client services. Second quarter noninterest expense increased approximately 86 million from the first quarter of 2002. 11 million of the increase was related to acquisition of Leader Mortgage.

We also incurred mortgage servicing right impairment in the quarter of approximately 14 million, offset through recognition of security gains.

Next, higher revenues at U.S.

Bancorp Piper Jaffray was due to salary expense and (inaudible) travel, entertainment and occupancy accounted for 20 million of the increase. Retail loan growth remains strong as average balances for the second quarter increased annualized 11% the first quarter of 2002, due to continued growth in home equity lines and retail leasing.

Adjusting for loan that is moved into conduit, commercial loans declined 1.7 billion from the first quarter.

Commercial real estate was essentially flat.

Excluding the impact of acquisitions, second quarter of 2002, average noninterest bearing deposits increased 11% f 2001, reflecting the current rate environment and successful business initiatives from integration of the two companies.

Savings on money market accounts, excluding acquisitions, increased 3% f the first quarter of 2001.

In addition, higher rates certificates of deposits continue to be replaced with lower cost wholesale funding.

Net charge-offs total 330 million or 1.1 6% in the quarter, as continued deterioration in commercial lease financing and seasonal increase in credit card charge-offs were more than offset by commercial loans and commercial real estate.

While business conditions in the manufacturing sector have shown some improvement, net charge-offs are expected to remain at elevated levels, but are expected to trim lower by the end of the year. Not nonperforming assets at June 30, 2002 increased 37 million from march 31, 2002, remains at high level at 1.1 billion or 1% of loans.

Nonperforming assets are expected to remain at elevated levels for the remaining of the year and expected to increase in the third quarter.

We do not expect to see significant reduction in nonperforming assets until the economy improves. Our asset ratios remain strong.

They allowed for credit losses and was 241% at June 30.

It allows for credit losses (inaudible) 2.15%.

The company booked approximately 72 million of free tax merger and restructuring expense in the second quarter of 2002, 60.5 million related to Firstar Corporation. 8.6 to the integration of NOVA and prior acquisitions.

We remain comfortable with our estimate of 1.6 billion in total merger and restructuring expense to integrate all current acquisitions, including Firstar, Banc of America Securities and pacific (inaudible).

The integration is still on track to be complete by the end of the third quarter.

We have converted deposit and commercial loan systems in Arizona, Arkansas, Kansas, Missouri, Iowa, Minnesota and Wisconsin. 85 percent of our customers are on common deposit system and 82 percent of our commercial loan customers are now on the same commercial loan system. By the end of July, one hundred percent of the Firstar branches will be rebranded U.S.

Bank and customers will be doing business as U.S. Bank.

I am pleased to report last Friday, Moody's recognized the progress on our integration and improving asset quality, discipline and liquidity position by upgrading the debt ratings of U.S.

Bancorp and its rated subsidiaries to double a 3 and ratings of U.S.

Bank to double a 2.

Finally, I want to give you a few examples of the success we have had taking advantage of the business opportunities as we bring the two companies together. The first is small business lending.

This is an old U.S.

Bancorp business.

Sba loans grew 28% in 2002.

Next is our finance company.

This was primarily a Firstar business.

Again, by expanding the product offering to the entire franchise, company loans have rose 29% in 2002.

Finally, we begin more aggressive promotion of our checking product feature, consumer debit card option to provide rebates for card usage in 2002, we add 148,000 pay customers and received penetration of consumer checking accounts.

This has contributed to 32% increase in debit card transactions for the first month of 2002, compared to the same period in 2001. These are a few examples of the illustration of the progress we have made to date.

Further execution, combined with customer service are already in place, will allow us to continue to build in the revenue momentum evident in the first quarter results.

This concludes my prepared comments.

I will take questions from institutional investors and analysts.

If you would like to ask a question, please press 1 on your touchtone phone at this time.

Pressing pound will withdraw you from the queue.

Once again, to ask a question, please press 1 now.

Our first question is from Judith Crushire of Merrill Lynch.

Hi.

How you doing?

Couple of questions.

I want more color on the card-related merchant process related strains this quarter. (inaudible) I heard you mention seasonality and organic growth.

Can you give us more reflection on what is going on?

Three points.

One, the fourth quarter was weak after September 11th period.

And we always had expected improvement in the volume, but we bank in the first quarter, it was still delayed because of economic activity and principally travel.

In the second quarter, literally, in the merchant business or the corporate payments business, - the number of merchant transactions rose from 249 million transactions to 283 million. Merchant volume on the acquiring side went from 22 to 24.

So, we had just overall increases.

I will tell you, tracking back over the course of several years, you normally get higher volumes in the second quarter, than you do the first quarter.

I think part of the increase we had is a little delayed reaction from the fourth quarter and the first quarter.

(inaudible) outsourcing for any banks.

How much?

That has some impact, but quite frankly will not impact until (inaudible).

We are rolling out a lot of the equipment in some of the new alliances and some has to be replaced.

Again, some of this is related to that.

We have just acquired a lot of accounts.

For instance, we have acquired in the last - or signed new merchants of 8 merchants, some of which are quite newly renewed relationships with a couple of banks. I would say a third of the increase is related from some of those bank relationships, but one is new direct merchants we have been signing and have signed in the fourth quarter.

I think it is beginning to show up in the first and second quarter.

(inaudible) think about the second half of the year for the fee lines?

I would hate to forecast that.

I think again, the second quarter growth is unusually high.

I think growth rate that is more in line with more sort of high single digits is probably the best guess at this point in time.

But, quarterly, with the new business initiatives we had, for instance, in rolling out NOVA's merchant processing in the old U.S.

Bank west and also the east, has helped.

Quite frankly, we are seeing more and more debit card volume and more corporate payment volume. Literally, across the board, that is what revenue numbers show.

Look at the break-outs.

We are seeing improvement across the board, which I think reflects core growth than we have had.

Again, as I said, it is delayed in the fourth quarter.

Totally different issue on deposits and margins.

I am curious where you stand with the (inaudible) and what impact the run-off of CDs has had on the margin in the last couple of quarters.

Are they embedded here, sort of a positive in rate of change that could end?

When you look at money market pricing, versus market rates, you have been sluggish here.

Yeah.

I think there are two things going on.

Number one is during last quarter, we net opened about 46,000 new DDA accounts.

Our focus has clearly been in the noninterest bearing checking account.

That is where we are spending 95 percent of marketing efforts in that area.

We have a lot of opportunities.

One is the product I just talked about before, which is the product that pays, which is a checking account focused on the debit side.

We are focused there. The other phenomenon that I think the benefit has diminished, that is as rates fell in the fourth quarter, we took advantage of basically rolling off some of our higher cost CDs for lower cost funding.

Quite frankly, in the money markets, our credit spread improved dramatically t. made sense to do that. you are right in pointing out there is diminished benefit from that given that rates have bottomed.

That is why I have been certainly clear a decline in the margins should be expected.

We expected a four or five basis point drop this quarter in the margin and we - it wasn't that extensive.

Again, in the third quarter, we expect some decline in margin.

But, I think if you look at the improvement, I think that improvement from last year will stay with us.

Part of that is loan repricing, part is better pricing on the retail side.

Part is better pricing in the commercial side, as well.

Good day.

Thank you.

Our next question from the site of chip Dixon of Lehman Brothers.

You expect nonperformers to remain fairly high until the economy rebounds, this seems to be a little bit of change in sentiment.

It is negative.

I would like you to address that in terms of credit outlook and what has changed first.

Chip, there has been a couple of things.

Our view is that I think we are being extraordinarily conservative.

Our view is, as we noted, nonperformers will probably be higher in the third quarter and largely that is reflecting the fact we still quite frankly, don't see a lot of improvement in the economy that would warrant a change in view.

And I think our view is that we, want to be extraordinarily conservative and not expect or have any expectations there will be much improvement.

On the charge-off side, I think that is a little bit different story.

I think what we will see is improvements in the charge-offs throughout the year.

But, in the nonperformers, I think there is going to be, because of deteriorating business conditions, at least in our market, it is going to warrant that.

Keep in mind, a lot of expectation, even though the fact that nonperformers may go up or continue to be high, we think a lot of these are going to continue to pay and pay as expected. But, the risk rating will warrant an increase or movement from performing status to non-performing, despite the fact that we believe almost all, if not a high percentage of any increase we might see is going to continue to be paid.

It is back to the performing sort of performing and nonperforming loan categorization we had back in the '80s.

I think what we are seeing, we are not seeing a lot of improvement in credit of the company, which warrants downgrade of the classification.

In our case, causes it to move to a nonperformer.

I don't think it will affect the financials or the performance of the company.

Okay.

Is - has the snake had any impact on your outlook?

How did that go?

As far as I know it hasn't had an impact at all.

I think it is our own assessment.

I don't think our assessment has been different than the exam.

I think we are being very cautious.

I don't think it will impact charge-offs.

But, I do believe that the credit deterioration and additional credits could and more likely require to go on nonperforming status.

No, there is no differences in the way that we view that versus any of the exams.

(inaudible) trends right now?

What is that?

Again, it has been very stable, Chip.

It has not changed at all.

We are just being very cautious.

Last question.

Which business units do you have the best prospects for the remainder of the year

I would say it is going to be all the payments businesses, merchant, corporate card and credit and ATM processing, I think are clearly going to be that.

Retail will continue to improve, Chip.

I believe quite frankly, the commercial side is probably is - worst times are behind it.

We are seeing improvement in commercial leasing.

They are beginning trends in that area are improving.

I think we are making a lot of headway on both the corporate side and the commercial side.

They are probably going to improve more in the last half of the year than so far. Asset management, although the business trends are extraordinarily good and institutional trusts and mutual fund servicing in terms of number of accounts, I am not hopeful given the fact the market overall market values are going to be down.

That will impact business in the third and fourth quarter.

Unfortunately, that will be the case.

The overall business trends in terms of new business growth have been really very good in that private client in capital markets, I don't expect much improvement for the remainder of the year.

We continue to have fairly good success in fixed income.

I will tell you the brokerage business, as well as the equity capital markets, we don't think will improve.

We had business improvement this quarter because of transactions we participated in, which gave revenue, but I don't find that extremely helpful. I think it will be led bay the payments business, retail and improvement in the commercial side.

Thanks a lot.

If you would like to ask a question, press the 1 on your touchtone telephone.

To withdraw press pound. We will take our next question from Brian Hagley Bank of America.

Go ahead.

Good afternoon, David.

Just to drill on the MPA question from earlier.

You said it was based on recovery in the economy.

I was just wondering if you could drill down a little more and let us know if any regions across your franchise are showing better promise than others?

Brian, let's start with the west coast .

California and Nevada are doing extraordinarily well.

We see good credit quality with good loan demand.

In Oregon and Washington, it is very weak.

We don't see much improvement in there.

We probably see some diminished increases and mpa are likely to come in that area.

Third, the midwest, which is Minnesota down through Illinois and over in Wisconsin and Ohio.

We think conditions are really fairly weak, in particularly in parts of the manufacturing areas.

They just don't seem to be getting better.

In the ad markets, we are seeing improvement in all aspects of the agricultural markets.

Things seem to be improving.

That is somewhat seasonal.

It seems to be improving.

In the small business area, we are seeing continued growth, as noted before.

Small business loan growth is solid and credit quality is quite good. I still think the - I still believe we are seeing some problems in really the midwest manufacturing.

They are still lingering.

That is why I noted I think when the economy improves and if it improves, which we believe it will, we will get some relief on the nonperforming side.

Again, our nonperforming portfolio, I think our largest is about 22 to 23 million dollars.

It is a granular portfolio, but we need to see improvement in financial statements before we are prepared to move off nonperforming status.

Okay.

Thanks.

Our next question comes from Mr. John Coffee of Citi Group.

Yeah.

I will take that question a different way.

If you look at the Legacy companies, are the credit problems coming from Legacy companies?

John, no, not really.

I guess the best way to think about it if you look at sort of the old star franchise, it is heavily manufacturing based.

We have also asset-based lending in that market, as well as the old Firstar market.

Basically, it is really hard to say whether it is at any one market.

I would say the West, where we have had good loan growth in California and Nevada and quite frankly, the credit quality has improved substantially in the western franchise.

I would guess and say it is centered around pretty much in the midwest.

That is a little bit - all three or four franchises have a fair core base in the midwest.

It is hard to distinguish.

It is the midwest driven.

Thank you.

Our next question comes from John Falcon Fox Pit.

Three questions on deposit growth.

One, could you segment geographically where it is coming from and update us on Mercantile two.

Your average (inaudible) you seem to have spikes on end of period.

Is there anything going on there we need to know about?

On the spikes, you might recall in the old Mercantile, they were the largest processor for the IRS.

We continued to grow the business and gotten new regions.

Those balances tend to build up at period end.

That is always the case, particularly in the second quarter and somewhat the first quarter.

Mainly in the second quarter.

It is primarily the tax processing business for the internal revenue.

Okay.

In terms of overall deposit trends, I think we are growing net new accounts across the consumer side, but we are also growing the cash management businesses.

Growth of cash management volume ends up in higher balances.

The final issue, I think, is probably true for us and most, the uncertainty in the economic environment, plus corporate cash flow practices are keeping deposits in the banks.

I think that has helped us to a great degree, in particular Mercantile, where the old Firstar had, we are seeing growth in the overall consumer and commercial business in that area.

One of the things you might recall in Mercantile is the community banking.

Community banking is getting a lot better, particularly in that market.

We have had major changes with practices and management.

We are seeing improvement. It is not where we need to be, but it is getting a lot better.

The West, is absolutely embraced the old community banking concept and really have gone - taken it to the next level and has done a great job implementing all the practices and all the strategies of that whole community banking model.

Richard and has team has done an outstanding job.

The West franchise has embraced it.

Take one in Idaho, Boise, Idaho, has embrace today and made a major change in customer service and autonomy in the market.

That would replicate true in most of the West.

Great.

Thanks.

Our next question is from Dianne Golfman, UBS Warburg.

It is John McDonold.

One, could you comment on the commercial lease charge-off ratio?

That seems to be an area you had problems.

Is that trucking portfolio there?

John, it is.

We have had problems with it, but it is improving.

We have had the trucking business has been really in the duldrums since the third and fourth quarter, quite frankly.

It is getting better.

We are seeing more sales of trucks that have been parked.

We are seeing improved credit quality in the trucking companies. I think that area is getting better.

That is principally what is driving that.

As you know, we have small business leasing, we have tech leasing and major equipment leasing, transportation, but most of the issues have been centered, as I said, in the truck.

That is definitely getting better.

I am looking forward to improvement there.

I think we will get that

Okay.

Could you comment on outlook for consumer loan growth in the second half of the year?

It has been consistent for the last several quarters of double digit growth.

I don't see that changing.

We are having a lot of success in the retail side, particularly on the West, where we rolled out community banking and the Metro market banking.

We are seeing improvements, as you can see in home equity loans and retail leasing.

We are seeing improvement in credit card and installments.

I don't anticipate any changes in that growth rate throughout the remainder of the year.

It is strong.

Okay.

Thanks.

Our next question comes from Steven Warton.

Hi, David.

Couple of quick questions.

The first one, I want to go back to the MPA guidance again.

I am a little confused.

I mean, correct me if I am wrong, but isn't it usually the case you have watch list credits you see that are deteriorating and they go into the MPA bucket and you write down the MPA on the charge-offs.

Aren't MPAs a (inaudible).

Not necessarily, Steve.

Some is credit condition deterioration that has changed its risk rating.

We don't believe that there is necessarily any loss content in any of these credits.

For the most part, we believe they will all be paying as agreed.

We don't see loss content.

We are seeing the financial statement conditions would dictate in our own system, they should go to nonperforming.

We don't necessarily believe it is going to increase charge-offs.

Or necessarily write-downs.

Is that similar to your experience in prior economic cycles?

No.

In the last several quarters, we think the conditions have dictated some portion of credit to be written off.

We don't think that is necessarily true in the third quarter.

Or the fourth quarter.

Keep in mind, the consumer side is actually improving, Steve.

The commercial side, look at the commercial charge-offs.

They actually came down this quarter.

The actual leasing is getting better.

In some cases there are offsets on one and improvements in the other.

I don't think necessarily this increase in MPAs will lead to loss content.

That is our expectation at this point.

The other question on deposits.

You referenced year over year trends.

Sequentially, the trends are left positive.

Is that just due to seasonality?

Partly due to seasonality.

Look back at the first quarter.

I am sure you had.

We had good deposit growth in the first quarter.

Second quarter is quite frankly, usually down.

It has been better.

I think it is the fact cash management business is pretty good and people are leaving more balances.

On the consumer side, we have actually had improvement in DDA and consumer accounts for the first quarter.

The other side, Steve, I will tell you.

The money market accounts and now accounts, we have been focused on as much as the DDA side.

A lot is product initiatives, product opportunity and product - part is competitive pricing.

We are just not going to raise rates to get more balances.

I would rather focus on growing household accounts and allow the interest bearing to come as it does.

So, part is our own focus to grow.

We do expect and have seen account growth and expect deposit growth in the third and fourth quarter, as you have seen, we had a spike at the end of the quarter and that is partly through the processing of the IRS payments. I think we will continue to see good deposit growth, particularly in the checking side. Okay.

Final question.

Your comment is 5.7%.

You announced share repurchase program last year.

Where do you stand on that in terms of what is left and what is your targeted capital ratio?

We are going to target 6% tangible by the end of the year.

So, therefore, we have not been very active at all, Steve, in the buy back.

We think it is critical to build the capital back up to the 6% level.

We have a lot of initiatives to do that.

We are pretty comfortable with being at that level.

I am 5.7 or 5.8 is not that far from some of the piers, particularly look at the ratios.

Totals are quite high.

I would prefer to have higher tangible numbers.

Okay.

Thanks.

Our next question comes from Fred Cummings of McDonald Investments.

Good afternoon.

First, what are you guys doing on the Brant system?

We are hearing a lot about banks opening up NOVA branches.

What is your strategy in California branches?

Fred, one of the things we have been doing, our pattern hasn't changed much.

We are opening a few branches of NOVA in existing markets, not really new markets.

In California, we are - we have opportunities and have been taking advantage of them in the in-store operations.

As you know, we have been doing a fair amount of at-work branching, but it hasn't been very extensive.

We are very careful not to expand.

There are opportunities to consolidate old branches or not very attractive, into in-stores and opening new full service branches.

But, it really - we haven't done a lot of that.

In California, we are going to tend to focus more on the in-store because we do have some opportunities with some of the supermarket chains where we have experience with them in the midwest and they have operations in California.

We will take advantage of those, but I don't - we are not doing a lot in that area.

Okay.

Secondly, David, as it relates to normalized charge-off ratio, how realistic is it for you all to get down to say 80 to 85 basis points and charge-offs for 2003, assuming modest economic recovery where we get 2 or 3% gep growth?

Fred, I think it is very realistic.

A couple of things will drive that.

One, we are exiting the leverage lending business.

That by itself will help.

Number two, we are making tremendous improvements in the home equity charge-offs, which we think are too high.

There are a lot of things we can do in that area.

Three, we will have more emphasis on the middle market, rather than the large corporate.

Larger credit positions we have already reduced and are continuing to reduce single exposure we have in the large corporate areas.

So, I think it is pretty realistic.

Whether we get there sort of mid-year, will depend on the economy improving.

I believe that if we get a 3% growth economy, we ought to have charge-off s in the around the 85 basis point level. That is what we are targeting and that is where our expectation is.

That is what we want to work toward.

One last question, David.

I know it is interesting you guys are focused more on demand accounts, as opposed to interest bearing checking and now.

In Ohio, you have certain competitors pricing the products aggressively.

Are you all somewhat limited by your dominant market share minimarkets from competing more on the base of price for certain products?

No, I don't think so.

Sometimes we hear that internally, we don't believe that.

We think if you have a high market share position, that gives you a lot of opportunity to begin to price very competitively and we also believe that even if you have a low market share position, you can still make a lot of progress in growing accounts.

We have 10 people in an area and we only have 1, that means we have a opportunity to get 9 more.

So, we don't - our own philosophy, we don't think it has to do with price.

We think convenience has a lot to do with it, bill payment has a lot to do with it.

We think electronic or banking electronically provides convenience.

We think it is about convenience on location. Also, price has some to do with it.

We prefer to address the convenience and value added to the consumer as opposed to getting more for price.

We don't think long-term that is the right way to grow the business. Thanks.

r next question comes from 00:59:27 Mike Mayo of Prudential Securities. 00:59:29 00:59:30 >> ANALYST: Good afternoon.

If you could 00:59:31 comment on expenses and efficiency, you are in a good 00:59:36 range.

It went up a little bit this quarter.

How 00:59:39 much expense savings do you have?

What is left and 00:59:42 where do you think the efficiency ratio goes over the 00:59:45 next year? 00:59:46 00:59:48 >> DAVID MOFFETT: First of all, Mike, 00:59:49 as you know, we are in the most important part of the 00:59:56 conversion is really this next quarter, which is the Ohio conversion.

So, it is really, really critical.

We have not been really pressing on the expenses, as you would think we would and largely it is we want to make sure the service follows through, integration follows through.

Because that will service quite well.

Our total expense savings were 325 million.

We have 60 to 70 million left to go.

That will occur more in the fourth quarter and into the first quarter of next year, as the conversion teams begin to peel away and the continued elimination of systems begins to free up costs. Our own view is, as you know, we will press the company.

Once we get passed the conversion, to continue to be more and more efficient.

One time our company got down as low as 36 or 37 or 38%.

Quite frankly, we don't know any other strategy, except if we are doing this right, we will grow revenue faster than expenses.

That will drive that rate down.

But, we have a lot of opportunity in the end of the year of 2003, to begin to not only reduce the cost relative to conversion, but quite frankly will streamline the company.

We will focus on layers of management.

We will focus on basically looking at the organization from the perspective of what does it take to run a company this size on a run rate basis with quality service led by revenue growth and reducing nonessential costs.

I assure you, we will drive the efficiency ratio down. Again, we have an abundance of caution to make sure we integrate and to the highest level of customer service and at the same time, grow revenue and grow through it.

So, that is sort of our view and we are not far from that at this point.

Okay.

Appreciate that.

One follow-up on the MPA trends.

I guess the chief credit officer is leaving the company.

Do you have a replacement for him?

Is this connected with the shared national credit exam?

The timing at least, raises questions.

No.

Actually it is not.

Actually, at the time of the merger and even right after that, Bob Hoffman, who has been the leader for the new company and the former U.S.

Bank, has been working toward retirement at the end of 2002 long before the merger had even transpired.

Mike Doyle, leads the team (inaudible) U.S.

Bank was at Star Bank.

Under that credit philosophy and credit regime and Mike is well suited and well able to lead the overall credit.

He will be working with Bob through six months to transition from Bob's very able leadership to Mike.

I think that will serve the company well. Bob has done a tremendous job of pulling the company together and really instituting a conservative and disciplined credit process in the new company.

Mike is very accustomed to that and obviously very comfortable with that.

It is totally unrelated at all to any exam or any other matter.

It has been in the works for a while.

Thanks a lot.

Once again, if you would like to ask a question, press 1 on your touchtone telephone. We will take our next question from the site of Tom Fersale of Viking Global Asset Management.

One other question.

Is there a particular industry that will cause nonperformance to be up in the third quarter as large corp rot or commercial mortgages or what is it?

It is not in real estate.

It is in regular commercial.

It is not commercial mortgage or real estate.

It is just sort of a middle market, mainly large corporate, that we are expecting it to be.

It is not in no particular industry, as such.

Okay.

One follow-up on cost trends.

You just talked about costs for the year in '02?

It is really hard to say.

Right now, year to date, we are sort of running 3 or 4%.

I would expect cost - I don't think we will have the kind of cost increase we had in the third quarter, we had in the second quarter.

But, I don't know, for the rest of the year, sort of be up 1 or 2%, would be my guess.

Great.

Thanks.

Our next question comes from the site of Jim Aga of Millennium

This is actually Keith. (inaudible) was related to the airline lease loan portfolio?

If I remember correctly you set up reserve based on credit ratings of the airlines versus the airline losses.

Since then, the airlines have been downgraded another 5 to 8 notches, depending on the credit company you use.

That is correct.

Can you update the size of the portfolio, what kind of reserves you have taken?

Are you building reserves?

Are the reserve levels built into mpa guidance?

Our own view is relative to what we expected at the time we took that reserve, they have actually improved.

But, again, we haven't changed our risk ratings or our evaluation of the overall airlines specifically.

We would note, they have improved.

Now, what I mean by that is cash flow is improving.

Loans are improving.

That is true really across the board.

We are reluctant any time soon to change our view and overall change in our risk profile of those. We have about 700 million.

Half is in loans and half of it is in leases.

It has actually been reduced since the time that we looked at it in the third quarter.

You might know we have also have been actively working with the other airlines in terms of other corporate business versus the payments businesses.

We are working with Delta.

We continue to have a strong relationship weapon northwest.

Quite frankly, we are still reluctant to change our own view until overall conditions improve.

Again, the fundamentals of them have improved in our opinion, particularly on the cash flow side.

Okay.

One last follow-up.

Are you going to have (inaudible) day in the fall again?

No, I don't think so.

I think we will wait until the following year.

Okay.

Thank you.

Our next question comes from Eric Connerly upon Boston Partners.

(inaudible) square your comments with decrease in loss of severity with the character of the changes that are going on in nonperformers.

The categories going up the most tend to be the higher loss content loans.

How can the charge-offs remain flat or go down if higher loss content categories are going up in nonperformers?

Well, I don't think - I guess I don't think the statement is necessarily true.

In terms of commercial, you will note commercial charge-offs have improved, all be it slight.

They have improved.

Overall consumer product quality charge-offs are actually improving.

If you - the delinquency in consumer are improving, collection rates are improving.

The overall Fica scores are improving across the board on the consumer side. The real estate side, again, we don't think there is any issues in that.

Usually you get fairly significant - if you have problems in real estate, they are usually fairly significant.

We don't expect to see that at all.

What we are seeing is although a loan may go to nonperforming status, it will probably - it will most likely we believe, continue to pay interest as agreed upon.

It is only financial condition that cause its to move to nonperforming, hence, we don't really expect much loss content.

If there is, we think that will be offset by lower consumer losses.

All right.

Thanks.

Our final question comes from the site of Barry Cowen of Maverick Capital.

Couple of questions.

I know this is being a dead horse.

I get the sense from the fact people keep on asking the questions over and over again.

I don't know whether it makes sense to dwell on it and contemplate coming back and discussing it or whether you think there is a better way right now.

There seems to be a general disconnect in people's mind between what we see in terms of the general credit stats and some of the discussions in nonperforming direction that you spoke about.

Then, trying to get comfort with the concept of lower loss rate guidance as time goes on over the next several quarters.

I don't really want to get into a beating the dead horse kind of talk, but I think every third question seems to be - we don't understand why this is happening.

Maybe there is a better way to explain it and maybe it requires better thought.

Barry, let me give you some - the best way to think about this.

Back in the 1980s, through the retraining process, most banks had loan for nonperforming loan categories, as represented on the balance sheet.

They had a fair amount of loans that were accruing and really had no loss possibility in there.

They were in there because their financial conditions were weak.

As a result of that, they were placed in nonperforming status category.

What I am describing is really a situation where a loan can for purposes because of financial condition, move to nonperforming status, but literally have no loss content in it.

For instance, right now, roughly, 30 or 40 percent of loans are nonperforming loans are paying as agreed.

There was a concept back in the 80s, which would basically be performing nonperforming status.

That is really what I am describing is that although they may be higher nonperformers, one, there may not be any loss content.

What that really translates to is - what I am try tog describe is total charge-offs going forward for the year, we don't expect to increase.

In fact, probably latter part of the year, we expect them to climb. Again, part of that is the fact consumer charge-offs will be lower, which you will accommodate any increase at all in the commercial.

So, you can have net charge-off s down because one category, consumers, lower than any increase you might have in commercial on top of that, you do have loans.

Which, we expect 30 to 40% of them will not have any loss content.

Now, there is stress.

They have characteristics of diminished cash flow and other, but they very well may be self correcting and not have any loss content whatsoever.

I don't know any other way to explain it.

You can't have offsetting lower consumer charge-offs with slightly higher commercial charge-off and still be down in total.

But, still have higher nonperformers, but yet the nonperformers are paying as agreed upon, therefore, less charge-off.

Okay.

Couple of questions to help put this in perspective.

Look at the dollars of nonperforming that you have, how many of them are actually cash pay on contractual basis?

Right now 30% of the existing ones.

How has that changed?

Not much at all.

It has probably increased.

Higher perpercentage of nonperforme rs are paying on contractual basis.

Yes.

This is a tough question to ask because you don't spend a lot of time listening to other conference calls.

One question is you really are the only person I heard about the last two days that talked about the concept of nonperformers going up and charges going down, but the nonperformers that are going into the bucket of nonperformers are actually paying us.

It is a weird concept.

I am trying to figure out are you giving us more insight than other people or is there something you need?

I am trying to give you the best of the most current thinking.

I think from our perspective, if you think about charge-offs in total, again, retail and commercial, it is fairly straight forward and looking at what we expect on the consumer side, to make progress on charge-offs.

Although you could have commercial charge-offs increase, you could net have the total charge-offs come down.

Right?

I mean that is basically what we are expecting.

On the other hand, you can have the increase nonperforming assets simultaneously with that with no loss content, yet, and paying as agreed, but their financial condition warrants quite frankly, they be in nonperforming status.

Could you give us better sense going forward over the next two quarters, I think people will focus on this issue going forward.

You know, when we take a look at things, could you give us a better sense of the charge-off rate necessary commercial and consumer and not necessarily a total number?

I guess my sense is consumer I think will continue to trend lower, as we have.

The reason - let me tell you why do I believe that.

The reason I believe that is delinquency trends are definitely improving.

Our collection processes are improving.

Our underwriting is getting better.

And we are beginning to see the impact of consolidating that, along with very strong retail growth that we have had in higher quality. So, I directionally we believe the consumer is getting better and charge-offs are getting better.

Commercial, I can't say that for sure.

I can say we don't think there will be much deterioration in commercial charge-offs if they are, I would expect them to be offset by the lower consumer charge-offs.

I don't think you are going to get any material change in either direction before - by the end of the year.

By the end of the year, you will begin to see improvement in the direction of charge-offs, but I think they will be counter balancing with more consumer and if there are higher commercial, it will pretty much be offset.

Again, I am not describin g a very material change for the charge-offs in either direction.

We will continue to provide equal to the charge-offs. What I am describing is really increase in MPAs that again, we don't think had much loss content at all.

But, deserves to be on non-performing status, despite the fact it is paying.

I don't know how to describe it better than that.

From the comments, do you feel that people just are completely misunderstanding what you are trying to get across or an issue people are focusing on?

I think a lot is differential is not paying.

That is not necessarily true.

We had the same phenomenon in the '80s.

We had high levels of nonperformers and high levels of paying.

You can have that.

I think that is maybe a confusing term, having a loan that is on nonperforming because your immediate reaction is it is not paying, when it is paying.

Not all of them, but a certain percentage of them are.

I think that is maybe the concept.

How much flexibility with the rating agents do you think you have in terms of the book value, if you wanted to clean up your book further so people wouldn't have to listen to this?

We don't think we need to.

If we needed to, we would.

You feel strongly about the balance sheet, then?

Absolutely.

I will note Moody's has been in and reviewed an enormous amount of detail.

All of our credit statistics in our portfolio and I think they see the same thing we see.

Great.

I appreciate your time.

There are no further questions.

I would like to turn the program over to the host

Thanks for joining us today.

Please call with questions.

Goodbye.

This does conclude our conference call for today.

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