美國合眾銀行 (USB) 2002 Q4 法說會逐字稿

Good day.

Welcome to U.S.

Bancorp fourth quarter 2002 earnings call.

Following a review of results by David Moffett, US Bancorp's chief financial officer, there will be a formal question-and-answer session.

At that time, if you would like to ask a question, please press the star and 1 on your touch-tone phone, and you may withdraw that question by pressing the pound key.

This call will be recorded and available for replay beginning today at 6:00 p.m. eastern time through Tuesday January 28th at 12:00 p.m. eastern standard time.

I will now turn the call over to Mack (ph) McCullough, senior vice president of investor relations.

Please go ahead.

Good afternoon.

Thanks for joining us today.

We have David Moffett here who will be discussing our fourth quarter results.

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

But before we begin I would like to remind you that any forward-looking statements made during today's conference call are subject to risk and uncertainty.

Factors that could materially change our forward-looking assumptions are detailed in our press release.

Now I'll turn the conference over to David.

Welcome.

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

Before I get into the details of the fourth quarter, I want to take a few minutes and talk about the full year of 2002.

We entered 2002 with three primary objectives.

First and foremost, we wanted to complete the integration of Firststar Corporation with no customer disruption.

Second, we wanted to continue to reduce the risk profile of the organization.

And finally, we wanted to continue to emphasis to our employees the importance of providing superior customer service.

I am happy to report that we surpassed our expectations on all three counts.

First, the integration was flawless.

We accomplished the task on schedule and now have the entire 24-state franchise on one technology platform.

We believe this provides tremendous advantages in terms of cost structure, customer convenience, and information availability.

Second, while credit costs were higher than we would have liked in 2002, we were able to achieve the consensus earnings estimate for the full year of $1.84 and continue to make progress in reducing the risk profile of the organization.

We have seen adversely rated credits decline each of the last five quarters including a 20 percent reduction from the level at which we began 2002.

Finally, our employees across the entire organization have enthusiastically embraced the Five-Star Service Guarantee, providing great customer service is what this company is all about.

Perhaps more importantly, our Five-Star Service Guarantee provides common language for us to talk about customer service across the entire company.

The employees know it is important because we talk about it all the time, and part of their compensation is based on customer service levels.

Let me leave you with this one fact.

In markets where the five-service star guarantee has been in place the longest, customer retention rates are 15 percent better than our average market.

Full year operating income was $3.5 billion or 1.84 per share.

Full year revenue growth per share excluding the securities gains was 9.6 percent.

And on a core basis we increased operating leverage at every quarter of 2002.

Full year operating ROA was 2.06 percent and full year operating ROE was 20.9 percent.

Finally, let me congratulate our employees for their tremendous accomplishments in 2002 and for the dedication that was required to make the integration an unqualified success.

We're one company operating from a position of strength poised to take advantage with what we hope is an improving economy in 2003.

Now moving on to the fourth quarter.

We reported fourth quarter operating earnings of $921 million or 48 cent per share on a diluted basis, a 20 percent increase from the fourth quarter of 2001.

During the quarter, we recognized $161 million of significant non-core expense items and asset writedowns including 54 million of mortgage servicing rights impairments, a 50 million litigation charge which included the costs of settling certain investment banking regulatory matters at US Bank Piper Jaffray, a 31.4 million of incremental personnel expense related to the rationalization of the company's post integration technology operations and support functions and 25.5 million of commercial and retail leasing residual and impairment.

Partially offsetting these charges was $152 million of significant income items including investment portfolio gains of 106.2 million and a 46.5 million gain on the sale of a co-branded credit card portfolio.

Excluding the significant non-core items, that I just mentioned and adjusted for acquisitions, fourth quarter pre-provision operating income grew 4 percent from the third quarter of 2002 as total revenue grew by a little less than 1 percent and non-interest expense declined by 3.2 percent.

Net interest income increased 2 percent, primarily due to earning asset growth driven by higher levels of residential mortgage loans held for sale.

Fourth quarter average loans adjusted for acquisitions in the loan conduit remained at third quarter levels as commercial loans declined approximately $550 million and retail loans increased approximately $640 million.

The net interest margin increased two basis points from the third quarter to 4.63 percent, driven primarily by the ability to re-price interest bearing liabilities faster than interest earning assets after the most recent rate cut.

This benefit was partially offset by lower loan fees in the fourth quarter.

In keeping with historical trends, fourth quarter income was flat to the third quarter.

Factors contributed to this included higher retail credit card revenue offset by reduced spending on corporate and government card programs and stable performance in deposit service charges and cash management fees.

Market-sensitive revenues for the quarter were mixed as investment banking revenue increased $12.3 million from the third quarter and while trust and investment management fees fell $10.5 million, trading and invest product fees were flat.

Fourth quarter non-interest expense, excluding the significant non-core items that I mentioned earlier, declined $46 million or 3.2 percent from the third quarter, reflecting continued cost savings from the integration activities.

Retail loan growth decelerated in the quarter as home equity loans experienced higher payoffs, driven by consumers who refinanced their first mortgages and rolled home equity loans into the refinancing.

Excluding home equity loans and adjusted for acquisitions, average retail loans in the third quarter increased approximately $800 million or 10.3 percent annualized compared to the third quarter.

Home equity lines of credit, installment and retail leases drove this growth.

Excluding the impact of acquisitions and reflecting in part of the benefit of being on one technology platform across all 24 states, fourth quarter average non-interest bearing deposits increased an annualized 36 percent from the third quarter of 2002.

All business units participated in the increase, with wholesale banking up an annualized 42 percent, private client trust and asset management up an annualized 31 percent and consumer banking up an annualized 22 percent.

Savings, NOW and money market accounts excluding the impact of acquisitions also displayed good growth not quarter increasing 23 percent from the third quarter.

Non-performing assets at December 31, 2002, were $1.4 billion, or 1.18 percent of loans and Oreo (ph), a 2 percent increase from September 30, 2002.

We expect non-performing assets to stabilize at this level, assuming the economy does not deteriorate further, significant reductions in the level of non-performing assets will not occur until the economy rebounds.

Net chargeoffs total $379 million or 1.3 percent of average loans in the third quarter, included in the $379 million was a $36 million chargeoff of a leveraged lease to a US airline entering bankruptcy in the third quarter.

We did not provide for this chargeoff during the fourth quarter of 2002 due to the reserves established in 2001 to reflect continuing weakness in the airline transportation and manufacturing industry.

Retail net chargeoffs as a percent of average loans declined for the fourth consecutive quarter.

Retail delinquencies increased slightly in the quarter due to seasonal factors that are down significantly compared with the fourth quarter of 2001.

This reflects improvements in underwriting and enhanced collection efforts.

Commercial net chargeoffs continue to reflect current economic conditions and weakness in the communications, transportation and manufacturing sectors, as well as the impact of the economy on highly leveraged enterprise value financing. .

Assuming no further deterioration in the economy, net chargeoffs in the first quarter of 2003 should approximate the level in the fourth quarter of 2002, excluding the impact of the airline related leveraged lease write off, and remain fairly stable throughout the remainder of the year.

We view this outlook as being very manageable within the context of our earnings power.

Our asset coverage ratios remain strong.

The allowance of credit losses to NPL's is 196 at 12/31 the allowance of credit losses to pure (ph) loans at December 31 was 2.08 percent and capital ratios remain strong as well.

We are comfortably above the minimum regulatory targets to achieve well capitalized status with tier 1 capital ratios at 7.8 percent and total capital ratio at 12.2 percent.

As expected the tangible capital ratio ended the quarter at 5.6 percent due to the close of two acquisitions during the quarter.

The 57 Bay View branches which closed on November 1 and the corporate trust business of State Street which closed on December 31.

We expect the tangible common ratio to approach the 6 percent level by the end of the first quarter of 2003.

In addition, our profitability measures remain at the top of our peer group with an operating ROA of 2.05 and an operating ROE of 20.4.

The company booked approximately $108 million of pre-tax merger and restructuring expense in the fourth quarter of 2002. $88 million relate to the Firstar - US Bancorp merger representing the final charge for this integration. $13.2 million related the integration of NOVA and 6.7 million related to other smaller acquisitions.

With the Firstar US Bancorp integration out of the way, we expect to incur approximately $70 million of pre-tax merger and restructuring expense in 2003 for all of the remaining, much smaller integration.

Finally, turning to 2003, our focus will be on organic growth, the continued right sizing of the organization and the creation of operating leverage.

We will also continue to be diligent in improving credit quality and further reducing the risk profile of the organization.

At this time we are comfortable with 2003 consensus earnings per share estimates of $2, as 2003 progresses and the economic conditions unfold, we will continue to update you on how we are viewing this target.

This concludes my prepared comments, and I will now take questions from institutional investors and analysts.

Very good.

At this time, once again, if you would like toe ask a question, please press the star 1 on your touch done phone.

You may withdraw your question at any time by pressing the pound key.

We will take our first question from John McDonald of UBS Warburg.

Go ahead, please.

Hey, David.

Hey, John, how are you?.

Good, thanks.

Wondering if you could comment a little on the margin out look for 2003 and talk about whether you're still doing the repricing on the targets or is that a one time event after the fed rate cut last quarter?.

I think we have been consistent in our view that we thought the margin would fall throughout the year and I was consistently wrong.

Right.

I think what's happened is several factors.

One is, the retail side has done an extraordinarily great job in revising all of our pricing in all the new markets, particularly in the west, and that has helped frankly keep up with the asset repricing.

They've have done an extraordinary job.

Second is the demand deposit in-flow was really very invest strong.

And quite frankly, we expect the deposit in-flow to continue to hold into the first quarter.

So I would have to say the effects of the rate drop, I think, are pretty much behind us, and I would have to maybe restate my view that I started with last year, is that I still believe that the margin would continue to decline throughout next year but I don't think it's going to be as material as I -- as I originally thought it was going to be but I think it would be best to expect some sort of decline.

I think maybe the first quarter would be the least decline and then maybe pick up in the second, third, and fourth quarters, but I don't -- I think it will be sort of mid, single- digit decline.

I'm not as bearish as I used to be on this.

Okay.

And then also on the expenses, could you give us little more color on the realignment, the $31 million realignment post integration that you did this quarter?.

Yeah.

What we did, as you may know, John, we started going through our budgeting process for the 2003 plan and, inevitably, there are business units that still trying to reconcile the size of their unit relative to a post integration period.

With this budgeting process, we identified several opportunities to continue to reduce costs.

For instance, the biggest area was in the technology area, the development area, where we have been spending a lot of resources revamping and revising the systems for the integration.

And we found a lot of opportunities to reduce resources in that area.

As well as combining some back office in the transaction processing area, there were also some opportunities to consolidate in the asset management side and then finally Piper also found some opportunities to downsize.

Basically, it was across the board but it was really the result of the 2003 budget planning process and a lot of people just decided to go ahead and act on it and our view was let's go ahead and do that in the fourth quarter, if we identify it and know what it is, let's just do it

Can you give us a sense of what you're expecting in terms of expense growth for the year?.

Next year we're not expecting a lot, if any.

Quite frankly, John.

We're going to hold tight.

This is the kind of environment where we basically told people, look, revenue is going to be tough next year as it is probably for everybody.

We've got, I think, a reasonable revenue plan for next year.

But we will wait until we see that revenue until we allow any expense growth.

So we're going in the year with the attitude we're not going to grow expenses and in fact will have an opportunity to reduce some expenses in the first quarter and we will wait and see if the economy improves, we won't be as tough on it but we're clearly going into it with a view that we're not going to have any increase.

Okay, thanks, David.

We will take our next question from Betsy Graseck of Morgan Stanley.

Hi, how are you.

Just a quick question on the mortgage business.

I know in the past you had been indicating that you're not going to be investing a lot of incremental assets in the mortgage business.

Obviously the origination flow right now is quite high.

In looking out towards next year I would expect it as refinancings do decelerate, you know, the amount of earning assets you have invested in mortgage would decline as hold for sales turns down, is that right?.

That's exactly right.

Our view and our plan is we're assuming lower mortgage banking revenue overall.

You pointed out that loan sell for sale were the biggest increase in earning assets in the quarter but I will say however that if there is an environment of rising rates, obviously the other side is true, the actual servicing rights become more valuable, servicing revenue actually increases, but I don't believe it will be enough to offset the reductions that we saw, that we would likely see in the gain on sales from the origination.

I think if we can get through the year with maybe being slightly down in mortgage banking revenue, that would be a success, but I think you're right.

Then own the hold for investment portfolio; is there any change on thought there or is that just holding steady?.

That's just holding steady.

Okay, thanks.

We will take our next question from Lori Appelbaum of Goldman Sachs.

David, my question relates to revenue trends from the wholesale bank which have been pretty tepid over the last several quarters, clearly given some amount of risk reduction on your part and pay downs among your customers.

Is there any an anecdotal evidence that the pay down trend would be ending and if you can talk about any internal initiatives that you may have to improve revenue trends in wholesale banking?

Let me take this in two pieces.

One, on the commercial side, in the wholesale banking area, it is -- it has been fairly clear to us that the -- the potential growth in outstandings is probably going to be low single digits from the perspective we have now.

It's interesting to note that the corporate side has been the weakest this year and we've had a significant decline, one partly related to initiatives that we have to reduce classified assets.

But also borrowings at larger corporate end were -- had declined the most, and the middle market remained steady.

What we're seeing today, however, is maybe improved borrowings on the corporate side and weakness in the commercial -- in sort of the middle market side.

So from that perspective, we don't see a lot of improvement in borrowings.

Another bit of information that would be helpful is the commitment levels really have not changed.

The amount of commitments we have made throughout the year on the commercial side has actually grown, but the amount of borrowing under that line has dropped about 10 percent.

And when you take that into consideration, that's about $6 billion of loans.

So if we got a 10 percent increase in utilization of these lines, our loans would go up $6 billion.

So the lines are in place, the utilization is just not there.

Then if you combine the fact that we reduced classified assets on the commercial side by $2 billion, we're really at a point where all of that work has pretty much been done.

I think we're reasonably saving -- about the volume but the opportunity is there if the economy picks up.

On the revenue side, we think we are going to have a good year in the treasury management and cash management area so I think you will see improvements in revenue there.

As you know we also had strong growth in deposit side.

We probably won't get that kind of growth next year.

So we're thinking that overall revenue growth in wholesale banking would be single digits to slightly higher fueled primarily by better loan growth and I might also add that also I think -- also as lower loan growth, the margins in the business have actually improved.

We have noticed -- we track it by product, by region, that our margins are slowly but surely improving.

That partly reflects the rating, the downgrade in the ratings, which basically causes influence increases in pricing.

But we have also seen just overall spreads improve.

So I'm sort of guardedly optimistic about it.

I think they will have a much better year this year than they did last year but we don't see any rebound in the double digit range at all for next year.

We will take our next question from Mike Mayo of Prudential.

Did ahead, please.

Hey, David.

High hey, Mike.

It seems like you recently came up with some additional expense savings in the budgeting process-- you rattled off four areas.

How much will those initiatives save in 2003?.

Somewhere on the order of probably 35 to 40 million, somewhere in that range.

So it's not that much?.

No, it's not that much.

It really is not.

But in this environment, anything helps.

Sure.

But, I mean, post merger savings, what do you have planned, if revenues are weaker than you expect and you get these $35 million, you might need to go after some more.

What are your contingency plans?.

Our plan, we're expecting single digit, mid, single digit revenue growth and we're planning a flat expense growth base.

However, knowing that, you know, the revenues are always on the [inaudible]-- we recognize that, is we have in place, a plan to cut an additional 5 percent of expenses if we need to.

So, in other words, if the revenues are not there, we have a plan down to business unit, down to expense item, down to the timing of when we would invoke that.

So we're ready to go.

We have a plan.

We're optimistic we're going to make the revenue goals but if we don't, we have backup plans.

We will hear more about that contingency plan if and when you need it.

That's right.

Thanks a lot.

We will take our next question from Chris Merinac from SunTrust Robinson Humphreys.

Go ahead.

On acquisitions in general in the environment, are you more or less willing to do them?.

Less willing.

Quite frankly.

For a lot of different reasons.

One is, you know, when you look at acquisitions, there's a degree of confidence you have in the numbers and the outlook, and in this environment it's hard to develop what I would call a high probability you can get high levels of comfort in the target you're acquiring.

So hence you would obviously discount that and, frankly the prices that would be attractive would not be attractive to a seller.

That's number one.

Number two is, quite frankly, we're -- we're going to dedicate 95 percent of our time this year to growing the company organically.

We have a great line of businesses, we're finished with the integration.

We have built the whole infrastructure and we really need to focus our time and attention on growing the company organically and that's what we're going to do.

Right.

Understand.

Is this true, just also for the -- acquisitions like Bay View and Tennessee a couple years ago.

If those things come along, they would be attractive in the markets we're in but they usually don't come along very often.

You're right.

You see them once a year.

But if those kinds of opportunities come along, we will certainly take the opportunity to look and see if we can increase our penetration of a certain area or save some costs through consolidation but we're not going to be looking for them.

Thanks.

We will take our next question from Brad Vander Ploeg of Raymond James.

It's the piggy back question on a couple that were asked earlier, the mortgage portfolio you mentioned with lower origination volume and perhaps a smaller held for sale portfolio, I would think that could help the margin in upcoming periods, is that right?.

Help net interest margin?

Yeah.

On that piece of the portfolio.

Well, in the sense of the way we're thinking about it, you're carrying in the held for sale current mortgage production and you are funding it at fed funds, so that's a pretty wide margin.

Certainly if the yield curve flattens that would cause a compression.

But I don't think there will be a lot of improvement in the margin from this fi any.

I'm not expecting it because I think there would be offsetting factors.

So we're not counting on that sort of Carey.

Our earnings assets were considerably higher because of it.

We won't have the balances and we're not receiving the balances now.

But I don't think it's really going to help us much.

Okay.

Can you talk a little about Piper Jaffray?

Have you had any change in thinking there or are you letting them run semi-autonomously as you have for the recent past?

Is there any changes there?.

No, Brad, we have come to a very good operating agreement with the management of Piper Jaffray.

It's been in place for the last several quarters.

We have finalized it and we have put together all of the necessary infrastructure to support it.

They had, I think, some reasonably good revenue this quarter.

They're optimistic.

They're going to begin to see some more volume, better volume on the brokerage side.

This is the record year in the fixed income area.

So, you know, the volumes of business are obviously low and they haven't improved that much.

But, no, there's nothing changed.

We're happy with Piper and they are -- they're doing a great job.

All right, thanks, David.

We will take our next question from David Hilder of Bear Stearns.

Go ahead, please.

Good afternoon, David.

Something in the press release just intrigued me.

In the non-interest income section, it talked about growth in core banking product revenues of a little over $60 million YOY in Q4 and it wasn't immediately obvious to me what you were excluding or including to get that to figure?.

Well, what we're taking out is any acquisitions, any divestitures, any asset sales that occurred during the year.

So we really wanted -- we really wanted to provide you with what we call a core number.

And we could give you the numbers to support that, if you mean to -- if you want to call Mack, he would be happy to do that.

We're trying to take out any activity that occurred in the quarter that would not be repeatable or poor.

That's where that came from.

Mack would be happy to get that to you.

But there was no particular business line that you were including?.

No.

Thanks very much.

We will take our next question from Nancy Bush of NAB Research.

Go ahead.

Good afternoon.

Hi, Nancy.

Hi, David.

Can you just expand zero little on the deposit growth that you saw in the quarter.

I think you said that you believed that it would stick.

Do you have any indications that you are taking market share or, you know, where is all of this stuff coming from, I guess, is the big question.

Well, I think there's a couple of things.

One is, we have had some promotion of some new products into the old US Bank West.

One is related to a fairly significant debit card promotion that has been quite successful where we're doing free checking and also paying people for using debit cards attached to their checking.

That has been, frankly, an overwhelming success.

The second thing, I think, is quite frankly, this continued push and emphasis on service quality.

I think that has helped retain and grow deposits.

And we've been add it for now a good 18 months, not only in the old U.S.

Bank but the new company and that has been a significant factor.

Number three, quite frankly, companies are basically storing cash.

And I think, given the fact that the interest rate environment is so low, they're tending to pay for services through balances.

So you see on a commercial side, we see that.

We also see, quite frankly, a lot of people out of the markets, out of the equity markets, with money and money markets and checking accounts not knowing quite what to do with it.

And then finally, we have had some great promotions in the money market account area in the government services area in city, state, local governments which we found to be very attractive.

And we've also found, I think, a significant interest in the small business area where we have been growing a lot of small business accounts and with that comes a fair amount of growth in checking.

And finally, just the mere inertia is business today, a lot of companies are downsizing.

They're saving cash and reducing inventories and we tend to be the recipient of that.

As we saw in the press release, every business line increased their deposits and literally every region.

It's hard to pinpoint a specific region or a specific market but they all did.

It's all of those factors that I named contributed to it.

Any projections at this point, David, about when you do start to see a little bit of, you know, pressure come off the margin?

I mean, you're pretty bearish, I think, through this year?

And I wasn't right at all.

But my own view is, if rates stay at the level they are, and even the yield curve stays where they are, there's very little liability re-pricing available, and the assets tend to re-price slightly at a slower pace than the liabilities.

And the only thing that could change that, I think, are two things.

One is, reduction in demand deposits, and I think that's going to require a significant sustained improvement in the equity markets, number one.

And the second issue is, I think what businesses will do first is they will draw down on their balances for purposes of spending and then draw on their lines for borrowing.

And I think that will be probably the biggest factors, companies will start using their balances to spend for inventory and expansion, if that time comes.

If the environment, the economic environment continues on as it is, I don't see much change in these balances at all.

Now, certainly, we're not going to get to the kind of growth we had but I think they will be around until one of those factors influence a change.

But other than that, it seems to be a safe place to put the money.

Thanks very much.

Thank you.

We will take our next question from Stephen Whorton (ph) of Loomis Sales (ph).

Go ahead.

Hey David.

Hi, Steve.

I just had a couple brief questions.

Of the first one is that it looks like your home equity loan growth is lagging that of the industry as a whole.

And I was wondering if that was because you had not been focusing on that in the sales --.

No, I tell you, Steve, what has happened is, we -- you know, we've had a lot of mortgage origination and refinancing.

And we have refinanced a lot of our own home equity quite frankly, and these are mainly the loan side.

We have been careful to distinguish the two.

We seem to have had people who say had a loan outstanding for a project, say an addition.

What's happened is, they are disproportionately paying off their first, rolling it and refinancing the first and the second one, and then on the margin, opening a new line.

That seems to be what's happening.

And it's partly also related to the fact that a lot of these loans also have been refinancing because lower rates.

Because keep in mind, a lot of these home equity loans would be fixed.

So if rates dropped, they've also been out trying to refinance the loans to lines, which would be cheaper, almost like the same thing that's going on with first is the same thing going on with second.

So it's not for lack of an -- not for lack of effort.

And we have had good growth in the lines, which I think will continue.

So we're not ignoring it and we're not promoting it.

We've just had a lot of payoff on the fixed-rate side of this on the home equity market that is part of the first but also just refinancing the second.

Okay.

And then just a brief follow-up on the deposits, and it's pretty impressive, the growth you showed this quarter after a couple of quarters where the growth was not as dramatic.

The thing I thought that was most interesting, if you look at the average balance sheet it doesn't like you paid up for the deposit growth.

Now we didn't and that's one of the things I think I said early on last year, and I know I did this in the first quarter, was when we were having the same conversation about margin, I basically said that one of the reasons that I felt like it was going to decline was we were going to need to start paying for deposits.

We started an initiative with Richard and they actually did that.

Along the way quite frankly though we didn't really have to use pricing as the principle reason for getting the deposits.

Part of that is the promotion and part of that is the new product they developed on the money market side and also the checking side.

But we didn't give up much at all.

That was partly the fact that rates dropped and we took advantage of it without hurting the volume.

But I think, Steve, the overall factors is just the environment and the uncertainty of the environment and companies and consumers just leaving the money and checking accounts until they see which way things are going to go.

I think that's part of it.

But you're right, we didn't have to pay what we thought we were going to pay when I was sitting at the -- here at the same time last year.

It just didn't happen.

You're right.

I know you have that Checking That Pays product.

Do you have a new product on the money market side?.

Yeah, we do.

We have one that we designed for principally city, state, local, county government areas, where we've developed -- or actually we have expanded a whole government banking area.

And it was originally designed to go out and develop the same program we have with the Federal Government, the corporate payment business and the procurement card.

But along the way, we have also found through the small business area and also through merchant processing, we have been able to grow the money market accounts at the same time.

And it's largely just focused on -- focusing on growing the deposits, mainly in the government side which has really helped us.

It was sort of an untapped area that we didn't, quite frankly, get to until towards the end of the integration.

Thanks.

We will take our next question from Carol Berger (ph) from Crest Investments.

Go right ahead dude.

Hi, David.

Hi, Carol.

First I would just like a small clarification.

When you started to talk about a $31.4 million personnel charge, that's the same charge you call re-alignment of companies, businesses post integration?.

That's exactly right.

And that's in other expenses.

Correct.

Beyond that, can you talk a little about revenue and expense expectations for State Street for this year and does that fit into your sort of hardly any increase for expenses statement from before?.

Yes.

That was already included, Carol, in that statement.

We knew that that was going to come when we did the plan for 2003.

That's already in that number.

So I would include that in that sort of no-expense growth rule.

You know, the earnings from State Street this year are going to be less than a penny from this acquisition.

We really won't get the big earnings until the next year, and that's when almost all of the cost savings are going to come out.

The way this business works is, as opposed to a bank, where you get a fair amount of cost out early, in this case, the integration and conversion of the system won't happen until early 2004.

So it's going take some time to get the costs out and that won't be, again, until 2004.

So that's when we will get a pretty nice increase from the earnings out of that.

It would be 2004.

Thanks.

We will take our next question from Brian Hagler of Bank of America Capital Management.

Go ahead, please.

Good afternoon, David.

Hi, Brian.

I was just wondering if you could tell us historically how long it's taken the improving trend and adversely rated credits to translate into, you know, better trends and chargeoffs?

I think you said that the balance in the adversely rated credits were down 20 percent year over year.

Just wondering when you get a little more optimistic on credit.

Well, I tell you, we -- you know, part of the way a lot of those loans go off the books is they're partly in the chargeoffs.

That's number one.

And they're partly in asset sales.

But I -- here is the best way for me to characterize our view on credit.

We really believe with respect to both non-performing assets and chargeoffs that the company is pretty well stabilized now.

And we don't expect them to deteriorate in either case from here, which would basically imply that over the next several quarters they will either be flat, you know, to slightly down, and I think that's a reasonable view.

Now, it's all predicated on what we see today and the impact today's economy is having on our customers.

Again, we don't expect any more deterioration, either in our credit or the economy, but we're just going have to wait and see.

But I think we're pretty comfortable with the level of NPA's that we have today and the level of chargeoffs that we see today, and assuming that 2003 improves, then we would expect some improvement in both.

Is that mainly based on the trend in this metric?.

That's -- no, that's partly it.

And that's -- that certainly is going to make a big contribution to it, but -- let me give you an example.

In the middle market area, where you don't see -- you receive classified assets but you don't see the deterioration like you might have had in the other market, in the corporate market, so that would basically say that in the middle market, we would tend to get fewer increases in NPA's and they tend to go directly to chargeoffs let's say, but I think we think all of those portfolios are pretty stable.

One of the areas that is has contributed to our increase in NPA's and chargeoffs last year was leasing.

And now leasing has actually improved and actually -- is actually improving in the NPA area and the chargeoff level.

So the area we had the most problem with are actually improving, with regard to the adversely rated credits, so the credit -- the direction of risk ratings has actually continued to improve.

Are you seeing more credits being worked out?.

Yes.

We're actually seeing two things.

We're seeing new money coming in for refinance.

That's both other lenders and equity.

We're seeing some acquisition activity of companies, albeit at charge down prices but nonetheless, there are some sales.

You're right.

We've seen a little more activity in that area than we did the last two or three-quarters, but it wouldn't be anywhere near the period prior to 2001, let's say.

Okay, thanks a lot.

At this time I would like to remind everyone that if you would like to ask a question, you may press the star and one on your touch-tone phone.

We take our next question from Fred Cummings of McDonald investments.

Go ahead, please.

Good afternoon, David.

Hello, Fred.

Two quick questions, David.

First as it relates to it merchant processing business, were you surprised that you didn't see any seasonal pick-up?.

No.

There are a couple of things going on in merchant processing.

One is, the volume, just a pure volume of the business has increased quarter-to-quarter.

What we did notice in the fourth quarter is a shift from small merchant activity to the larger merchants during the holiday season.

When that happens, we're actually -- the pricing in the larger end of the market is thinner than it is in the smaller merchant.

So we had a volume shift from small to big, which basically had the impact of reducing the revenues.

Now, keep in mind, if you look at the third quarter, it was extraordinarily high as well.

So it's a little bit of a shift in business.

And in the -- the third reason is there were too fewer processing days actually in the quarter in the fourth than there was in the third quarter.

So that also had an impact as well.

So I would say it's really those three factors.

And, David, can you give us -- I appreciate that update on the business mix.

But can you talk about that business mix with respect to how successful NOVA has been in moving up market -- I don't know if you can give us rough feel for revenues coming from the smaller traditional merchants that they served and some of the middle market customers that you've added over the last year or so?.

Well, I tell you, Fred, the best way I can describe it is, all of the marketing emphasis that has been direct, there's really sort of three channels, one through the bank branches, is generally small business and that has been their efforts and we've been able to maintain the margins on that.

The second area where we're expecting a lot of growth, particularly in 2004; coming from our bank alliance group, where we've been able to roll out through a number of the large regional banks, our whole merchant banking platform, and that is going to real pay -- really see a lot more improvement in 2004 as a result of just that.

And then finally, the other area that has been sort of a stable of NOVA's merchant business is the marketing from the independent sales organization group, where they're having a tremendous amount of success in different markets, which is the way they marketed traditionally in the past.

So we're pretty optimistic we're going to see some nice growth out of NOVA in 2004.

But it will be principally based on their marketing efforts, principally driven out of the small business side.

And lastly, David, on the credit side, can you talk about, of your current non-performing commercial and lease financing loans, can you talk about what portion would be comprised of aircraft?.

In the non-performing?.

Yeah, what is currently non-performing, or even in this situation.

I also want to get a feel for, given the situation of the chargeoff of the $36 million, was that a non-accrual or did you, at the time of the bankruptcy, simply charge it off?.

Fred, it's the latter.

It was charged off.

And we have no airline exposure in non-performing.

Okay.

Thanks, David.

We will take our next question from Sally Pope Davis of Goldman Sachs.

Go ahead, please.

Hey, David, who you are you doing?.

Good.

Quick question on asset quality.

We have seen a steady deterioration in commercial real estate, in mortgages and in construction and development.

Just wondering, are you seeing that in any particular product or geographic region and what do you think as we get into 2003, stable or continued depreciation?.

Sally, our view is there's probably going to be some small deterioration, but we've just done a fairly significant amount of work in looking at all of the real estate projects.

And when we look at the -- -- you know when you look at the larger credits, and it doesn't matter what part of the country, the only thing we're really seeing is that vacancy rates are changing but the cash flow of the borrowers which are largely very, very solid borrowers with a lot of equity, their cash flow is still very, very intact and very capable of servicing these projects.

So to some extent, the borrower has less cash flow to them but they don't have any problem servicing these projects.

Now, I don't know how much worse it has to get before it begins to be a problem.

But our expectation is real estate on the margin may have a little bit more deterioration.

But from our point of view, we don't see that it would change our credit outlook at all for next year.

Just as a quick follow up, when you see the deterioration in commercial mortgages is that more a reflection of kind of C&I just secured by commercial mortgages as opposed to really real estate?.

That's exactly what it is.

It's more owner occupied than it is in the investor real estate.

That's exactly right.

Okay, thanks.

There are no further questions.

I would like to turn it back over to the management for any closing remarks.

Thank you for joining us today.

And please call with questions.