美國合眾銀行 (USB) 2003 Q1 法說會逐字稿

Hello and welcome to US Bancorp's third quarter 2003 earnings conference call.

Following the results by David Moffett, there will be a formal question and answer session.

If you would like to ask a question, please press the star-1 on your touch-tone phone and press the pound key to withdrawal.

This call will be order recorded and available for replay beginning today at 6 P.M.

EST through Tuesday, April 22, at 12 midnight EST.

I'd now turn the conference over to Matt McCullough (ph), SVP of Investor Relations.

Please go ahead, sir.

Good afternoon and thank you for joining us today.

We have David Moffett here with us who will be discussing first quarter results.

If you've not yet received a copy of our earnings release and supplemental analyst’s schedules, they are available under the financial and news release section of our Website at www.U.S.bank.com.

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

I will now turn the conference over to David.

Welcome, this is David Moffett, vice chairman and Chief Financial Officer of US Bancorp.

Before I start to discuss the quarter, I want to remind everyone on this call of an important change in our financial reporting.

In accordance with the new SEC rules required by the Sarbanes Oxley Act of 2002 regarding the use of non-GAAP financial measures, our earnings press release has been redesigned to eliminate the discussion of non-GAAP financial measures including operating earnings and per share information that excludes the impact of merger and restructuring-related items.

However, we will continue to talk about operating earnings on this and future conference calls because we do believe that operating measures of profitability provide more transparent financial information about the company and highlight important trends in the company's core financial results.

So now let's turn to the quarter.

Today we reported first quarter operating earnings of $922.7m, or 48 cents per share on a diluted basis, 1 cent better than first call consensus estimate.

We remain comfortable with our target of $2 for the full year 2003, which is slightly higher than the current first call consensus estimate.

In summary, we saw good core revenue growth that met our expectations despite continued weakness in the economy.

I will talk more about this later, but as a reminder, our revenue trends are highly seasonal.

Revenues typically decline in the first quarter relative to the fourth quarter.

This year was so exception.

And then show considerable strength in the second quarter which we believe will hold true this year as well.

Core expenses were tightly controlled on a link quarter basis and year over year basis.

Credit quality continues to show improvement, meeting or our expectations for the quarter, and business conditions are best characterized as stable with some incremental improvement as the quarter progressed.

First, first quarter operating earnings increased 9.6% from the same period of last year, while diluted earnings per share on an operating basis increased 9.1% over the same period.

During the quarter, we recognized approximately $121m in mortgage servicing-right impairment, primarily due to the low environment rate in December.

As a reminder, we value our servicing asset on a 15-day lag.

As has been our practice in the past, the impairment charge which we book as intangible amortization expense was offset with investment portfolio security gains.

I want to call your attention to a new discloser we've added to the press release that provides the information necessary to understand the valuation of our mortgage servicing asset.

At March 31 2003, they were valued at 1.23% of mortgage services for others.

However, what this ratio fails to explain is the unique composition of our mortgage servicing portfolio.

Approximately 21% of our mortgages services for others are loans made under state and local housing authority programs.

Loans made under these programs are made to low and moderate income borrowers and generally under government-insured programs with some sort of down payment or closing cost assistance.

The majority of this business came to us in our April 2002 acquisition of a company by the name of Leader Mortgage.

The prepayment speed of this portfolio has been extremely slow relative to other servicing at similar rates.

The actual prepayment speeds for this portfolio were 17% for the first quarter of 2003, 15% for all of 2002, and 10% for all of 2001.

The mortgage servicing right for Leader’s portfolio were valued at approximately 1.84% at March 31, 2003, the mortgage servicing rights for the remainder of the portfolio were valued at 1.09% at March 31, 2003.

Relative to our peers, the reminder of our portfolio excluding here is newer, has a lower weighted average note rate and a higher percentage of government loans.

Take a look at this information in the press release.

I think you'll find it helpful in better understanding the valuation of our mortgage servicing asset.

Now, other items to note include first quarter revenue excluding acquisitions and securities gain increased approximately 5% from the same quarter of last year as double-digit growth and mortgage banking revenue, ATM processing services, credit and debit card revenue and corporate payment products offset weakness in investment banking fees, trusts and investment management and investment product fees.

If you exclude these market-sensitive categories, total revenue increased 7.2% from the same quarter of 2002.

On a link quarter basis, first quarter revenue excluding acquisitions and securities gains fell 1.4%, approximating the median reduction of 1% for the same period of the last four years.

Perhaps the best example of this seasonality would be our payment services fee categories, which declined 6.1% on a link quarter basis, again, approximating the median reduction of 5.7% for the same period of the last four years.

First quarter non-interest expense excluding acquisitions and mortgage service and impairment increased $13m or less than 1% from the same period of last year due primarily to higher benefit costs.

During the quarter, we decreased the assumed long term rate of return on our pension plan assets to 8.9%.

Increasing expense by approximately $15m compared to the first quarter of 2002.

Based on what has been reported in 2002 annual reports and 10-Ks our new assumed long-term rate of return puts at the median of the top 20 banks.

You also need to keep in mind that our pension plan assets are 100% vested in equities.

On a link quarter basis, first quarter non-interest expense excluding acquisitions and mortgage servicing impairment and certain unusual items in the fourth quarter of 2002 declined approximately $6m, as higher payroll taxes and an increase of $5m related to the change in the assumed long-term rate of return on the pension plan assets were more than offset by seasonally lower expenses across the board.

Net interest margin decreased 7 basis points from the fourth quarter of 2002 to 4.56%.

Approximately 6 basis points in the decline can be attributed to higher levels of lower yielding investment securities in the first quarter, also impacting the margin was a $25m reduction in net-interest income due to two fewer days in the first quarter relative to the fourth quarter.

Adjusted for the sale the co-branded credit card portfolio in the fourth quarter, first quarter average retail loans grew at an annualized rate of approximately 7% compared to the fourth quarter.

Home equity loans continued to experience higher payoffs driven by consumers who refinanced their first mortgages and rolled home equity loans into the refinancing.

This trend reversed late in the quarter with origination volumes in most retail categories including home equity loans, gaining strength as the month of March progressed and has continued in into April.

Adjusted for portfolio sales and acquisitions, adjusted first quarter retail loans increased approximately 9% compared to the same quarter of last year.

First quarter average commercial loan volume continues to be weak with seasonal declines and loans in financial institutions and overdrafts.

Declines in CNI and corporate card-related economic conditions and other continued runoff and disposal of certain commercial and leased assets.

We continue to believe that commercial lending has stabilized and outstanding should show modest growth as the year progresses.

Our commercial commitment utilization is still approximately 45% versus a more normal rate of 55%, which should provide lift in an improving economy.

Excluding the impact of acquisitions and reflecting in part the benefit of being on one technology platform across all 24 states, first quarter average non-interest bearing deposits increased an annualized 17% from the fourth quarter of 2002.

Net demand deposit account growth in the consumer bank exceeded expectations in the first quarter providing excellent momentum as we enter the seasonally strong second and third quarters.

Compared to the first quarter of 2002, average non-interest bearing deposits excluding the impact of acquisitions increased approximately 17% with all business units contributing to the growth.

Savings now and money market accounts, again, excluding the impact of acquisitions, also displayed good growth in the quarter, increasing an annualized 15% from the fourth quarter.

Compared to the first quarter of 2002, average savings now and money market accounts, again, excluding the impact of acquisitions, increased approximately 10% with all businesses contributing to the growth.

Non-performing assets declined $11m during the quarter to $1.36b at March 31, 2003, or 1.16% of loans in orio (ph).

Assuming no further deterioration in the economy, we expect non-performing assets to remain flat.

Net charge-offs fell on a link quarter basis to $334m, the dollar amount of retail net charge-offs declined for the third consecutive quarter despite higher loan balances.

Retail delinquencies remain stable and have declined significantly from the same quarter -- same quarter of 2002, reflecting improvements in underwriting and enhanced collection efforts.

Total commercial net charge-offs including CNI, commercial leasing and commercial real estate also fell on a link quarter basis but do remain high.

The CNI and commercial lease portfolios continued to be impacted in weakness in communication, transportation, and manufacturing sectors as well as the impact on the economy on highly leveraged enterprise value financing.

Again, assuming no further deterioration in the economy, we expect net charge-offs to trend lower.

Our asset coverage ratios remain strong.

The allowance for credit losses to non-performing loans was 194% at March 31, and the allowance for credit losses to period end loans at March 31 was 2.06%.

Our capital ratios remain strong as well.

We are comfortably above the minimum regulatory targets to achieve well capitalized status with a tier one capital ratio of 8% and a total capital ratio of 12.4%.

The tangible capital ratio ended the quarter at 5.8%.

We expect to believe our targeted tangible capital ratio of 6.25% by the end of third quarter.

In addition, our profitability measures remained at top of our pier group with an operating ROA of 2.04% and an operating ROE of 20.3%.

The company booked approximately $18m pretax merger and restructuring expense in the quarter, most of it relating to the integration of the Bay View branches and the State Street corporate trust acquisition.

Both integrations were completed during the first quarter.

In closing, let me say that we are pleased with first quarter results.

The momentum that developed during the quarter and the progress that we have already made in achieving our 2003 financial goals is encouraging.

Cost control remains strong.

Revenue growth met our expectations.

And taking into consideration current and economic realities and the credit quality continues to show improvement.

As 2003 progresses, our objectives remain clear.

First, we will continue to focus on organic growth and the creation of operating leverage.

Second, we will continue to enhance our already high levels of customer service, and finally we'll remain disciplined in our desire to reduce volatility and improve the risk profile of the organization.

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

Very good.

At this time if you'd like to ask a question, please press the star-1 on your touch-tone telephone.

You may withdraw by pressing the pound key.

Again, to register for why a question, press the star-1 on your touch-tone telephone.

First to Betsy Graseck with Morgan Stanley.

Go ahead, please.

Oh, thanks.

Sorry.

I was on speaker.

How you doing?

Hi, Betsy.

Just would like to understand what you're seeing in demand for credit and its particular from the corporate sector per both at a large corporate basis as well as a mid-size corporate basis.

Are you seeing any changes in utilization rates and pipelines, et cetera?

Yeah, Betsy, from the perspective of really looking at sort of beginning at March and end of April, we are beginning to see some sign of improved borrowing patterns.

We're seeing it both in the middle market and on the large corporate side, as well as small business.

The utilization rates, I think, will improve as the quarter progresses.

As I've said, we've seen signs, in fact, in cross -- essentially all the regions of the company, but particularly in the middle market area.

So I think we're seeing some optimism on the business environment.

And we hope that that continues.

But really, as March progressed and now into April, we're beginning to see the turn in lending.

And you talked about the improvement in credit quality likely to improve, if not accelerate during the year.

Well, I think what we're -- our view is that we believe that the charge-offs are going to continue to decline.

And we believe at this time that the non-performers are going to be stable.

And we're hopeful that over time we'll see some reduction in that but I think we have more confidence that the absolute levels of charge-offs are coming down.

What you may take away from that which I think is true, is that the quality of the non-performers that we have today versus maybe a year or so ago are actually improving.

And there's more demand for the assets that are backing them?

Exactly.

Okay.

Thank you.

Next to the line of Lori Appelbaum with Goldman Sachs.

Go ahead, please.

Just a question on your merchant processing operation.

It seems trends are weaker than the underlying market in competitors in that revenues were down 5% year for year and the seasonal Q4 to Q1 decline was worst than it was last year.

If you could outline the pressures and whether you see them alleviating anytime soon.

In the merger processing area I think there's a couple of trends that are going on.

Number one, it is clear that the volumes are still weak across the entire franchise.

And that's whether you're looking at fourth to first or year over year.

That's number one.

On the other side of it, also, is the profit margins particularly in some of the -- in some of the areas have become more competitive.

And they've become more competitive vis-à-vis some of the non-bank processors.

However, we believe, as spring unfolds and as the economy begins to improve, we think the volumes and the revenue will improve.

And the reason we feel that the revenue will improve is one, there's a -- usually a seasonally increase in second quarter in merchant processing.

We fully expect that to happen.

And we fully expect that to happen for the other payments businesses as well.

But in the case of merchant processing particularly, we are expecting basically an increase in the volumes and the associating increase in revenue because we don't believe -- we believe the shift will be more towards the smaller merchant in the volumes and as a result, that will keep our margins more intact than we've seen maybe in the last couple quarters.

Thank you.

Oh, thank you, Lori.

Our next question comes from the line of Nancy Bush with NAB Research.

Go ahead, please.

Hello?

Hello.

Hi.

Listen, could you just give us some further color on the margin what you expect the margin patterns to be in the next quarter or so and how you're positioned right now should, indeed, we get rising rates in the second half of the year?

Nancy, at this point in time, we're pretty well neutral to any rate range -- change really at the present.

So I don't expect us to really receive any benefit, really, one way or the other either from falling rates or rising rates.

I would say, over time, the thing that's important for us is that we do have a very large consumer deposit base.

And that, quite frankly, gives us some flexibility and some cushion against any immediate rise in rates or a very rapid rise in rates either one way or the other.

So I feel pretty good about where we stand relative to overall increases affecting our income.

On the margin side, I think, as I said last year, I do expect some margin compression, not in any way like we saw in the first quarter.

I think second quarter's reductions will be a lot less than we saw in the first quarter in terms of margin.

That's really reflecting, I think, two things.

One is, as interest rates -- short-term rates stay flat and down as they are, the obviously the asset side will ultimately re-price towards lower rates.

That's number one.

And number two, is the fact that we've been reinvesting the cash flow from our bond portfolio, and as a result, we're reinvesting at lower rates.

And that has, in and of itself, had more of an impact, quite frankly on the margin than anything else.

But I'm hopeful that the margin reduction won't be impactful enough to change our outlook for earnings or for revenue.

David, could you also give us some color on -- you did say that you see middle market large corporate and small business, signs of improved borrowing patterns.

And you're one of the few who's mentioned large corporate along those lines.

Is there any industry particularly that's accounting for this, or if you could just give us sort of some insight a little bit more into that?

Well, I think instead of the industry, I think the pattern that we are -- that we are beginning to note is, really improvement in inventories.

And some CAPEX spending, I think, is largely the source of the borrowing.

And I think it's very typical for when business environments -- or the outlook from business environment is improving.

I think those are typically the first two that you're seeing.

I think that's the areas that we're seeing.

But I wouldn't say it's anything particularly except probably the most that we're seeing is obviously in the industrial side.

So would there be any geographic -- I mean, we've gotten a lot of conflicting signals here about whether the Midwest is indeed getting better or worse.

Well, I would say in our case it's the west that we're seeing the improvement as opposed to the Midwest.

So I think the western side of the franchise is really -- when I'm talking about improving business borrowing, that's really the areas, California, Nevada, places like that.

The Midwest is still relatively soft.

But quite frankly, I don't think it's going to get worse.

I think it's definitely stabilized, and we're hopeful that we'll see some improving borrowings in the Midwest as well.

Thank you.

Our next question comes from the line of John McDonald with UBS Warburg.

Go ahead, please.

Hey, David.

Hi, John.

Wondering about expenses.

What kind of non-interest expense growth are you budgeting for '03 and wondering if you're close to pulling the switch on the kind of contingency plan that you laid out, if necessary, to cut 5% additional expenses.

Yeah.

John, I think the way to answer that is, we built in, and we started from the very beginning in knowing that the economy was going to be weak.

We built a plan that basically has no increase in expenses.

I will say, however, on the other hand, our revenue expectations, actually met actual results for the first quarter.

So we're always going to be diligent in reducing costs.

But we're quite frankly on plan both with regard to revenue and cost.

And as a result, we'll keep the notebook handy and available.

But obviously, we're always looking for opportunities to reduce costs, which is what we would normally do anyway.

But so far so good.

Okay.

And then on the capital levels, you get the tangible equity up a bit to 5.8%, wondering if you're still targeting 6.25% for the quarter?

Yes, and we're on track to meet 6.25% by the time we reach September.

And that would factor in both FIN 46 and then the Piper?

Yep.

Okay.

Thanks.

Our next question comes from the line of Steve Warton with Loomis Sales (ph).

Please go ahead.

Hi, David.

Hi.

Yeah, just a couple follow-ups on things already mentioned.

First of all, can you provide a little bit more color on the home equity loan growth in the quarter?

You had mentioned it was getting seasonally stronger late in the quarter.

But if I look at some of the peer banks in your footprint, it looks like they saw some stronger metrics.

And I wondered, do you feel like, you know, up to now there were maybe some share shift going on or do you see some of your competitors doing things that you view as not compelling in terms of price, et cetera.

No, Steve.

I think the pattern we're seeing is not necessarily related to the competitors.

But I do think we have the -- we've had an impact, as I know others have, on terms of refinancing first and rolling the seconds in the first, that's definitely hurt our specific loans.

But I think what we're referring to is the lines; we continue to build home equity lines in terms of commitments.

I think what we're seeing is the utilization of those commitments in sort of towards the late March and into April.

So think it's lines that were already there being utilized, and I know we're busy opening new accounts.

But I don't think the competitive landscape has necessarily shifted one way ort other.

I think it's the large extent who got impacted the most with regard to refinancing with regard to the loan side and then obviously the name of the game is home equity lines that you can underwrite according to your own standards and then it's really the borrowing patterns of the consumers that that's going to be make the difference in the outstandings.

I think our price is competitive but I also think the competition's pricing is competitive, too.

And then the other question, just briefly, was on Bay View, the deposit dollars that were actually added in the quarter from that acquisition, do you have that?

Well, we added about $3b in deposits.

Now, keep in mind, Bay View had a fairly -- they obviously had large transaction volumes, but they also had a fair amount of CDs.

And you'll note that we had some small CDs reduction runoff.

That's because we're basically running down the deposit -- the high-priced deposits.

And then replacing it with lower levels.

Okay.

And then the final question on deposits, if I look at the consumer bank line of business.

Yep.

And I look at the non-interest bearing were very good, but the interest bearing continued to be a little bit sluggish year over year just in the consumer bank.

Yeah, if you look at -- yeah, if you look at the -- it's sort of the savings products and -- in the consumer area, if you go to the -- you see the savings products went from around $35b to $39b, and I think what you're referring to is the time deposit piece.

And I think, Steve, what we've been doing is focusing entirely on the money markets.

We have new focus on new products.

And we're almost largely focused on that.

So you're one, you're going to see some cannibalization out of the time in the positive category out of the money market but you've also had net growth in the money market.

And, again, our whole marketing plan is really; let's focus our resources on growing accounts.

In fact, in the first quarter, this year, we opened net new checking accounts by 50,000.

A year ago we only opened 11,000.

So our efforts have been on checking and money market and savings.

And quite frankly, we have not again -- been willing to increase and be as competitive in the CD area.

It doesn't mean we won't, but, again, our focus has been on building the lower cost more stable, more long-term deposit base.

And that's, quite frankly, where we've been spending our dollars.

Thank you.

Next from the line of Jennifer Thompson with Putnam.

Hi, David.

I was wondering if you could give us the gross inflows into non-performing loans this quarter.

Did you have any sales and how much?

Yeah, we did have some sales in the MPA area.

We had -- in total, in total loan sales, we had $167m.

Of that $167m, around $119m were in the MPA area.

So you could basically assume we had about $115m go into the category.

Another thing I could note is about 30% of the MPAs are performing.

Okay.

And just as a follow-up to a previous question, you said the net interest margin or talking about the net interest margin, could you just give us the trend over the three months or at least the margin going into the second quarter?

The trend, really, the decline during the quarter was really pretty equally impacted during each and every month.

And I would say that sort of March was what I would say is sort of took a lull in March.

And, again, as I said, I think we'll see it a little bit lower in the second quarter.

But I don't think it's going to be materially lower than the second quarter.

Okay.

Thank you.

We'll go next to the line of Kris Mataushio with Legg Mason.

Hey, David, hey, Mac.

Quick question, with the potential merger between First Data and Concord, could you give us comments on either positive or negative ramifications that could have on your processing arm?

Well, you know, this is -- these are two companies that are obviously involved in some cases similar businesses, but in some cases separate businesses.

As you know they have the debit card processing on the one side and the merchant on the other.

I think it's too early to tell what impact it's going to have.

I think they're going to have to go through a long period of consolidation, which I think, quite frankly, could be difficult to do.

And I think it could open up some opportunity for us during that time where they're trying to merge companies.

So I think it's too early to tell.

I think it could represent an opportunity for us.

I don't believe that it's necessarily a threat because I think when we stack our operations, our processing speed, our capabilities, and our service, I think we're good or better in many, many cases than they are, and I think we have -- they have to be focused on the integration where we can focus our time and attention on getting more clients.

So I sort of see it as an opportunity.

Thank you.

Next question comes from the line of Brad VanderPloeg with Raymond James.

Go ahead, please.

Thanks.

Good afternoon.

Just a couple questions.

First, on the mortgage servicing right valuation, David, on the non-leader part of the portfolio I think you said it was 1.09%, is that right?

That's right.

And that still seems a little higher than some of the others out there.

And I'm wondering if you're -- and obviously you're comfortable with the valuation you've had now, but maybe just some of the factors that maybe warrant a slightly higher valuation on those rights.

Well, I think the best factor you can look at, which -- that's why we provided the data for you.

But I think it's important that you have to look at the fact that our servicing portfolio, we believe, has lower interest rate lower note rates.

And quite frankly, our mortgage services is relatively new.

Newer than most of our peers.

So I think the aging of the servicing has one thing to do, the note rate, I think, has another impact on it.

So I -- we're very comfortable with it.

Hopefully, if you've had time to review the data, and think track to over time, I think it will make a lot more sense to you, recognizing this is the first time we've provided the data to you so you don't really have a basis of comparison.

But I think we're right in line.

And I think the fact that our portfolio's relatively new and our servicing in the rates -- the coupon rates that we're servicing are lower;

I think that has something to do with it.

Okay.

Thanks.

And I was wondering if you could touch on the valuation work you're doing to on Piper and how that's coming and if you have any thoughts you might want to add there.

No.

We are still in the process of putting together the Form 10 information.

We really don't have any information that can be provided available to you with the valuation side.

But, again, our deadline that we've stated, we expect to spend occur no later than September 30 and we hopefully will have the Form 10 out by May 1.

I think that's going to be the best source of information for that.

All right.

Thanks very much.

Our next question comes from the line of David Hilder with Bear Stearns.

Go ahead, please.

Good afternoon.

Just two questions.

First, on the seasonality of fees, your seasonality especially save deposit service charges seems to be greater than some of your competitors.

Is there anything either in the way you assess fees or the way you run the business or your customer base that might explain that?

Yeah.

David, I think the offsetting factor is -- and, again, I haven't seen the releases of our other peers, but we're making the fee reduction is being more than offset in the balances.

And that's particularly more true this quarter than we've seen in the past.

And I think that's going to have a definitely impact on it.

I don't know what other banks have experienced in terms of non-interest bearing growth, but we've had significant growth in that.

And it's also been not only at the commercial side, but the consumer side.

We have a lot of DDA products where customers can maintain balances in lieu of fees.

I think the balances that growth occurred in the first quarter have definitely impacted that piece of it.

That's, I think, what's going on.

Okay.

And then a separate question, I think you just mentioned that you had about $119m of sales of non-performing loans.

Were there any incremental Charge-offs at the time of those sales?

On the MPA side?

No.

Okay.

No, those are already valued at market..

Great.

Thanks very much.

Thank you.

We'll go next to the line of Casey Ambrekt with Millennium Partners.

Go ahead, please.

Hey, David.

Mac, thanks for taking the call.

Quick question, can you talk kind of what trends you're seeing at retail bank and what the team is seeing in terms of account growth and attrition and so forth?

On the account growth, as I stated, we had -- probably the best quarter we've ever had with net demand deposit balance -- or account growth. 50,000 versus 10,000 last year.

But when we look at the results for the consumer bank and, again consumer bank is affected somewhat by the securities gains in the MSR impairment, but I think the best indications of success we're having is when you look at either revenue growth, non-interest income growth, we just -- we're back to the double-digit revenue growth that we've seen and experienced over the last several quarters before the mergers.

So I think, Richard and his team are back, they're doing a great job.

The fundamentals are improving.

Commercial loan balances were affecting -- or excuse me, consumer loan balances were affected by the fact that we had a credit card sale in the fourth quarter, and that somewhat affects that.

But I'm very optimistic that the retail side is in the process of delivering.

And I think they've got a lot of momentum behind them.

And going into the spring, I think the loan balances will improve.

And I think the income side will improve as well.

So when I look at their numbers, year over year, if I exclude the securities gains and the impairment, they're growing double digit.

Okay.

Thank you.

Our next question comes from the line of Adam Hurwitch with Hewlett Management.

Go ahead, please.

Thank you.

My questions were asked.

Thanks, Adam.

We will go next to the line of Richard Manuel with American Express.

Go ahead, please.

Hi.

I was wondering if you guys could comment on what has happened with the duration of the securities portfolio in the quarter.

And then if you could just comment in general with respect to your philosophy on how you're going to manage in a rising rate environment or a falling rate environment?

Yeah.

The securities portfolio has a duration of 2.4 years.

So it's a very, very, very short portfolio made largely of mortgage securities with the preponderance in floating rate or very, very short-term fixed rate CMO.

So it's designed for purposes of being very short.

With regard to interest rate management, our essential view is always start with from a relatively balanced position, which is where we are.

And then I think the second most important thing is to allow essentially the loan growth that usually occurs in a rising rate environment to be financed by existing cash flow from the bond portfolio, which is what we expect to happen as the economy improves, we expect that cash flow to be employed into the loan portfolio which will improve and immediately the overall asset mix and the yield on the overall assets.

The second strategy that we employ is, as we do every Friday we become much more sensitive by market.

And as you know, we price deposits in each and every market well over 100 markets.

And we want to make sure that we protect our margin by selectively taking interest rates up in products where we need to and not just wholesale raise them across the board.

So we're very reflective in how we respond on a consumer side.

We start out with a very balanced position.

And, again, usually rising rates means improving loan growth, which means we'll get the improvement in the asset side.

At the same time, we continue to keep our pricing in deposit side although competitive, but very selective.

And that's worked quite well for us over other interest rate cycles, and I feel certain, starting where we are with a relatively balanced position, we'll be able to manage that.

Okay.

That's helpful.

Another question, David, once you get to the 6.25%, what is your thinking about what you're going to do with capital?

Because you're generating it, obviously, at a pretty good clip between now and then.

Yeah.

I mean, obviously what we're trying to do is one, first, reach the target, and then obviously, two, we obviously have to assess the overall risk profile of the company and the needs.

But at this juncture, we don't see any needs other than to support, you know, borrowing growth.

So given that, we'll dedicate a lot more of our excess capital to buy back our stock.

Richard Manuel Okay.

Thank you.

Our next question comes from the line of Leo Harman with Allstate Investments.

Hi, good afternoon, David.

Hi, Leo.

Could you talk a little about the composition of new net non-performers in the quarter especially on the commercial side, a lot of competitive banks that we've seen are reporting flat to down MPAs on a commercial line.

I was wondering if you guys were seeing anything in a particular area or industry that's causing it to move up this quarter.

Well, ours actually is down in terms of MPAs, but it was down a little bit.

I think there's two comments I would say about it.

One is, keep in mind that MPA portfolio largest is about $20m.

You start with the point of view that it's very granular.

Most of these loans don't have ready markets for them with regard to sales.

So they tend to be middle market companies where we tend to have to work through the credits with the customer, try to provide some equity support, try to find some restructuring opportunities try to find other sources of financing.

So quite frankly, they're just not going to be -- they're not going to trend lower at a very rapid rate largely by the nature of the loan.

However, what I will say is the overall mix is moving from what I'd call larger credits, or corporate credits to much more middle market credits, smaller credits and credits that, quite frankly, are still, in many cases, performing well.

In fact, I tried to describe them.

If you can describe MPAs, I'd say the quality we're dealing with today are much better with a lot less loss content in the credit.

So although the balance is, say, the outlook for loss is a lot lower, and quite frankly, it's just going to take some time to work through some of these credits with the borrowers.

We're the kind of company that we try to work with a company as best we can and try to find the best alternative for them to work out from under the troubles.

And we're going to stick as best we can with the borrowers and work with them.

Okay.

Can I have a quick follow-up?

You talked about maybe seeing credit costs trend down over the next -- over the year if the economy stays where it is.

What kind of assumptions are you making for GDP or growth or that sort of thing?

Yeah, we're assuming GDP this quarter is going to end up around 2% and probably improve to something better than that in the third and fourth quarter.

Okay.

Thank you, sir.

Um-hm.

Our next question comes from the line of Mike Mayo with Prudential.

Hi, Mike, how are you.

Just a couple questions.

Just following up on Leo's question.

I guess MPAs link quarter were up 8% if you didn't sell the loans, just if you add back the $119m of MPAs that you sold, would that be mostly those middle market credits you were just talking about?

Well, keep in mind, Mike, we basically sell credits to one degree or another every quarter.

The quarter before we sold 135.

So I mean, we're constantly trying to find opportunities to sell credits.

So I mean, we've been doing that every quarter for four or five quarters.

So I don't -- I think our view is that the MPAs are going to be harder to get down.

Now, there are going to be opportunities to sell, but they're harder to work down because just the nature of the credits themselves.

But we will continue to look for opportunities to sell MPAs at reasonable values where we think the valuations make sense.

It's not necessarily going to be the same amount every quarter.

And, again, we carry the MPAs at market when they go into MPAs.

So when we can find opportunities, we will.

We, no doubt, have inflows.

The inflows are mainly in the middle market area.

They're mainly smaller credits.

And they're smaller credits, quite frankly, with less loss content.

So I feel pretty good with about the quality of them.

I, like you, would like to see a faster reduction.

But I think given the circumstances and given the opportunities, we're going to continue to work and do the best job we can for the borrower and company to get them down.

Again, does it cost us a lot in earnings to carry them?

We've already written them down, so we don't think there's a lot of financial impact on the company.

I think we gain a lot trying to work through the customer base with the customer.

Any way to size it up, in other words, what percent of your MPAs were corporate-repeated in the past and that's -- what's that% now?

I would say in the past your and a half, I would say it's probably 60% corporate.

It's probably reversed itself to maybe 40% corporate now and maybe 60% middle market.

Okay.

I think is pretty much been the switch.

Okay.

And then lastly, Bank of America sat on their earnings call earlier this week said the whole country is doing fine except for the Northwest, you said the west is doing well, Midwest isn't, and you didn't comment on the northwest.

I'd say the Northwest is no change.

For us.

It's slow.

But I wouldn't say we're a particular concern about the Pacific Northwest.

They may compete in different areas of the commercial side, but we've seen good improvement in retail banking in the Pacific Northwest.

As you know, we have a very high market share position in Washington and Oregon as a result of obviously the old US Bank but I wouldn't say it's any more -- I don't think we're more concerned about that than we would be maybe anyplace else, Mike.

Okay.

Thanks a lot.

Our next question comes from the line of Jon Balkind with Fox Pitt Kelton.

Hey, guys.

Could you let us know what the size of the leverage loan book is currently.

And then secondly, the other non-performing assets category was about 20m linked quarter and I was wondering if there was anything going there.

I know it's small.

And then retail leasing Charge-offs are up.

Anything particular there?

No.

Let me start with the retail leasing for a second.

We're not seeing anything particularly unusual about charge-offs in retail leasing.

I would say that the increases really related to a really specific portfolio that quite frankly it's relatively small.

And it has a disproportion of loss content in it.

I think that's pretty much the difference.

I wouldn't say it's symptomatic of any problems.

As you know, we've grown retail leasing quite a bit.

And if you look at the overall charge-offs, it's not -- it's, quite frankly, not very high, so obviously it's coming off a small base.

But I don't think it's a particular concern one way or the other.

Your question about leveraged lease valuation is about $3.9b in commitments is what we have on the books today, on the leverage transactions, and about $2.8m in loans.

And how has the churn been?

Is it basically you're cleaning up some stuff and having more customers draw down on their lines?

In that area?

Yeah.

Yeah, I just think the volume's coming down.

Okay.

In terms of borrowings.

If you think about that sector, if you think about that sector, obviously those are the most stressed customers.

And they're going to do a lot better job as preserving cash in arranging other financing.

So they're just -- their needs are less.

Okay.

And then lastly, just that other non-performing assets drop in the quarter.

Yeah.

That's really associated in some cases in the leasing area where we have assets where we've written down basically assets in the leasing area where we've owned the property.

Okay.

So that's mainly the change.

If you look at the loan categories, it's pretty well flat.

That's why we characterize it as basically flat, stable.

Gotcha.

Thanks, David.

Next to Alan Tingy with Cannon Tingy Investment.

Thank you.

Could you just comment, gentlemen on your dividend strategy going forward and specifically will there come a time when dividend growth mirrors growth of operating profits?

Well, I think our dividend strategy is going to be obviously dictated by a number of factors.

And obviously, it's where can we best utilize the capital.

I would say if you look at our dividend pattern, we have traditionally paid out, prior to maybe the last four years, in around 30% to 33%.

We would like to migrate, quite frankly, that payout down to that range again, which would mean we would probably, for the foreseeable future, have the dividend growth at probably half the growth rate of earnings largely to return ourselves back to a lower payout ratio.

And basically end up with a better balance of dividends, buybacks and retention to be more 1/3, 1/3, 1/3 is where we'd like to get to.

It's going to take a long time to get there at that rate, but that's generally what we've tried to do.

Fight quite frankly, that's what we did do.

Thank you.

Our next question comes from the line of Barry Cohen with Maverick Capital.

My question was answered.

Thanks, Barry.

At this time we have no further questions.

I'll go ahead and turn the call back over to negotiate.

Thank you for listening.

If you have any questions, please give me a call.

Thank you.

That does conclude today's audio conference.

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