美國合眾銀行 (USB) 2004 Q2 法說會逐字稿

Very good. [OPERATOR INSTRUCTIONS] We'll move first to the line of John McDonald with Bank of America. Please go ahead.

Hi, good afternoon.

Hi.

Hi, John.

David, could you give us color on the net interest income outlook for the second half? And do you still expect to fund commercial loan growths from the bond portfolio and what do you expect from the margin in the second half?

Well, John, based on our expectations for loan growth, which we think is pretty solid, we would expect, and depending on whether it comes in the third or fourth quarter, we will expect improvement in net interest income across the remainder of the year. And it's going to be driven almost entirely by the loan growth. We see our deposits still remaining stable, and in some cases we see improvements there. On the margin side, as you know, we felt like we would see a margin reduction in the quarter of somewhere around three basis points when we were looking at it about a quarter ago. The margin was down one basis point. I still believe we'll get some margin compression into the third quarter with possibly becoming more stable and rising in the fourth quarter based - really based on loan demand, but I still think there's some small margin erosion. I would call it very modest, but I think it's a little too early to expect an upturn yet.

Okay but volume driving the NII higher in the second half?

Yes. Yes.

Okay and can you update us on the interest rate positioning? What was the impact of the securities that you sold? How did that leave your duration looking and the unrealized losses in the bond portfolio?

Yeah. As you know, the unrealized losses, the bond portfolio, basically had an unrealized loss of about a billion dollars. Since that time, since the end of the quarter, obviously rates have fallen so it's more on the order of $650 million. The sale of the bond portfolio, we sold basically $4 billion of security that had a yield of about 350, and as a result, the interest rate position is - there are two things. We reduced the interest rate risk position or improved this by selling the securities but on the other hand we had some extension in the portfolio at the same time. So net-net we're really sort of off, but we are sort of in the same position we were, which I would describe as still relatively neutral.

Okay. Thanks. My last question is on reserve levels, your reserves are starting to look quite high with the improvement in credit, and you've resisted letting them out. Can you give us a update on where you stand on that?

Yeah. John, as you know, we look at our reserve levels every quarter. We are -- we believe that the reserves are adequate to the exposures that we have, and again we'll continually assess it as we do every quarter, and I think that's really the most appropriate stance we can take.

Okay, thanks.

We'll move next to the line of Lori Applebaum with Goldman Sachs. Please go ahead.

Good afternoon. While payment trends accelerated in the quarter to double-digit rates broadly, if you could give us your outlook for growth in the various businesses in that retail sales slowed as the quarter progressed and seem to be slowing so far into July. So maybe if you could give us a sense of your expectations and how volumes trended as the quarter progressed from April to June, and so far into July.

This is Jerry. The trends in all those businesses you just mentioned, really continued to accelerate. We're basically better every -- darn near every month during the quarter. And we would expect to see certainly on the merchant processing side, no question, that we'll get double-digit growth again and the corporate cards and corporate payments and overall we are going to be, but I would expect in the double-digit area as well.

Let me address it a little bit differently Lori. During the quarter, as you know, the second quarter is always the strongest quarter for all these payment businesses, larger because the volume is up and the usage is up. But I think Jerry's characterization of the momentum going forward is going to be driven not only by volume, but we're seeing a lot of new account growth both in corporate payments and in the merchant processing side. So we not only have the volume going in our direction and the usage, but we also are seeing improvements in new customers and new accounts.

And especially on -- and then, Lori, an important aspect of it is the retail banking side, fees on deposits, and with the growth in net -- the net DDA, which is really, really critical, to growing that, the expectation would be that we would come in strong as well for the third quarter.

But your trends and payment activities through the month that have mirrored some of the revenue, the same-store sales disappointments that we saw that the larger retailers in June like Target and Walmart, is that what you're saying?

Well, no we didn't. June was a good month, Lori. I mean, and so, I did see that from target and the others, but we're you know, there's a little bit of a slow-down the first two weeks, but I think that doesn't make a trend. So at least our expectations still are for decent growth in those. I don't see -- we certainly don't see those declining. Operator.

Yes, we will move next to the line of Nancy Bush with NAB Research. Please go ahead.

Hi, good afternoon guys.

Hi, Nancy.

Could you just speak to sort of the operating leverage trends going forward, and I know that your overhead ratio got a little strange this quarter because of all the various things going on, but where you saw the overhead ratio this quarter and sort of how low can it stay or go?

Okay. Yeah, you're right, but we still are probably the low cost producer in the business. We've invested in a lot of areas marketing out the lease this quarter. But we would expect that operating leverage will get back to what our normal operating leverage has been, and we'll grow revenues as fast as expenses and you can count on us managing the expenses and you can book that one, Nancy.

Okay thanks. In the second half of the year, can I sort of look at a flat expense level or can you just kind of give us sort of a high view of that?

Well yeah, some of it is related, as you know, to activity. For example, merchant processing and the other expenses was -- there was an up-tick just because of merchant processing activity, and in bonuses, and I hope those go up. So you know, you're going to see more positive operating leverage than you saw this quarter, but you know, it's not going to be flat. It will be up modestly.

Great, thank you.

Thank you

We'll move next to the line of Olivia Asher (ph) with Mitsubishi Trust. Please go ahead.

Thank you good afternoon. Two unrelated if I may. First, just sort of generally, we've always been told that the first sign that commercial loan growth will accelerate is the fact that commercial deposits will start being drawn down. And at least looking at the wholesale line of business, it looks like deposits continue to grow. So what's going on there? Are companies just borrowing, beginning to borrow, beginning to borrow and not drawing down their cash, or what's going on there?

Olivia this Jerry. I think you have -- there are two phenomena's going on. You're accurate in the way you described it. Commercial deposits continue to grow. I would -- the mood of my corporate executive is much better, and I think commercial borrowing and utilization, which for us still is at a very, very low rate, that has not come back, it is still much, much -- it is much better. And if you look it's sort of interesting. Large corporate -- our large corporate piece is showing much more modest growth over the last few months, than it had in the past six months, where it had accelerated a little bit. But we're looking to large corporate over the next six months to be up maybe, you know, 3-6%, 4-5%, some place in that area, whereas, our commercial middle market and you don't know our company, we've invested a lot of money in retooling that, and really bringing the right people in, replacing people, managing it, and focusing on it, we think that that can grow in the next six months, some, you know, in that 8 to 10% range, which is perfect for us. We need to build that book in particular in that commercial middle market because we've got a big investment out there. And that's pretty good growth and we think we've inflected and we are starting to show some good progress there, and that's going to be a bright spot I think going forward. And then total loans for our company, you know somewhere around 8% overall. So, you're right, people have really not started borrowing yet, utilization rates are still at all-time low there, and there's been a little switch in that, the commercial middle market is showing a little better trend and we forecast it to be a little better, whereas large corporate again has sort of dropped off and there's alternative financing out there, lots of places where large corporate can -- companies can go to finance and refinance. So that's still a little weak. So, all of your perceptions that you see about deposits and the fact that they're still growing is accurate, it's factual, and in fact we haven't seen that robust increase that you normally see. David.

Yeah, the only other thing I would add, Nancy, also keep in mind --

(inaudible) Olivia with volumes in the treasury management area, you're also seeing increased compensating balances from activity and volumes as well. So you're also getting that phenomenon as well.

Okay great. And then just to follow up on the question on the reserving. I'm curious, do you have a target for unallocated reserve and where does that stand at right now?

No, we don't have a target for unallocated reserve. As David had said, we have a very involved process for reserving, these reserves are adequate, and I think our -- what is our - analog is right around 35, 36%.

Okay, thanks so much.

Thank you.

Our next question comes from the line of Mike Mayo, with Prudential. Please go ahead.

Hi.

Hi, Mike.

I had a follow-up to the offering leverage question, specifically on expenses. You gave a little laundry list of the reason the expenses increased, incentive benefit, insurance. I wasn't sure about the fourth one, charge back exposure --

Yeah. Let me --.

Is that something - if you could elaborate about that, and also expenses did go up more than revenues, link quarter, so how much of that is discretionary, what's happening with marketing, just give more color, if you would?

Well Mike the item that we were talking about was the reserve for merchant payment processing for the airlines. And we have a reserve, because we do so much airline processing, we have to have a reserve and we evaluate the reserve relative to our exposure on processing airline tickets. And as you know, the volume passenger load across the country has increased and therefore the volume of ticket processing has also risen, and we have a reserving process that I won't get into the details of it¸ that basically suggest that as the volume grows, our exposure grows and therefore in assessing our reserve, we felt like we needed additional reserves against those processing volumes. And that was a significant part of the expense increase during the quarter.

How much was that, or what was the increase link quarter?

That was a little under 30 million.

The amount of the increase was 30 million?

Yes. We also had marketing of 9 -- increase about 9 or $10 million. We had a true-up of FAS-142 for expense option -- or option expensing, which was about $16 million, $17 million in the quarter. True-up was up -- that was from the stock option, that we granted in the -- at the end of the -- middle of the first quarter of last year.

And then we also had just increased expenses from merchant processing volume. We had cost related to that volume and that was up that was about $5 million of the increase.

So in your mind, what percentage of the expense increase was discretionary versus something you just had to do?

Well you know, I'd say the core expense rate was probably almost 1%.

So maybe expect something closer to that in the second half of the year?

Yeah.

Okay. Thank you.

Our next question comes from the line of Tom McCandless with Deutsche Securities. Please go ahead.

Hi. Good afternoon.

Hi Tom.

A couple of smaller type of questions, I suppose. In the past I think maybe perhaps some presentations maybe (inaudible) U.S. bank and others, but they have shared line utilizations overall and I think Jerry said they're not up yet. Are they moving at all?

Our community banking line utilization, which is basically, as you know, in our urban markets, which is a big part of our company, 1000 branches, and we have seen some uptick there which I think is a good sign. Our large corporate was up a bit for two quarters, and now has flattened and is down a bit. Our commercial middle market is about flat, a little uptick, but then just sort of flattish. So those are -- commercial real estate is about flat. So that's sort of the story, Tom. You know, still we're not seeing utilization rates. I think overall utilization is somewhere around 32 to 33%, which as you know is just historically low.

Do you -- sorry, I got sidetracked -- but do you have some elaboration as to why you've got so much confidence in the middle market, is it about to accelerate strongly in the second half? Or is it just you have a bunch of new customers that are coming on?.

Well, as I said, we've retooled a lot of that, and we have a very, very -- we think sophisticated way of going out there and looking at forecasting and these people are getting better at it. We have better management in there under Richard and we've made a lot of changes and we think we've inflected and we're starting to turn.

Yeah, also every two weeks we have a sales meeting with all the commercial heads throughout the company for two hours, and it's principally designed to get sort of anecdotal feedback about what the customers are saying, well, how the pipelines look, where the volumes increased, where the industry is. And I think the -- my read of the discussion is that across all the markets we're seeing more confidence, more likelihood of borrowing, higher probability that the pipeline is continuing to improve and be enhanced, and probability of closing and in using lines is increasing. So I think that's a pretty good barometer that from this point forward and really through the second quarter, we're beginning to hear much more positive signs out of the commercial side and again we have a barometer every two weeks that I think is pretty true. And Tom, we have replaced a lot of people there.

Yeah.

We have some fighter pilots now, and they're out there making progress.

Could I ask one or two other small faint questions?

Sure.

You cited in the discussion earlier in the Q & A, about your payments business and that you're seeing basically account growth in the corporate side as well as the merchant processing side. Could you drill a little deeper into sort of why and wherefore, you know, what's driving that new account growth. Is it just natural economic demand, have you bolstered your sales force, have you beat them mercilessly to get the growth?

Well, a little bit of all of that.

Good work.

No, hey look, I mean, we've got world class products on our corporate card and debit card and purchase card and out of sale, where we have really professional people and a fellow named Rob Hobley (ph) who runs it and we're world-recognized and it's showing -- it's really the economic activity, you know, I mean it's related to the business we're bringing in, as you probably saw, we announced five or six, seven months ago, the Homeland Security is now a customer, and all those -- you know, we send those announcements out a lot, in transaction process, excuse me, in merchant processing, it's new business, you know, focusing on the fundamentals, I mean we...

And acquisitions?

I am sorry?

And acquisitions?

Well, we have some acquisitions in there too, but you know, that's their business, buying portfolios, but yeah, all those. But we are seeing volume increases as well. And Tom, one thing I'd also say, we have since the middle of last year, and it's been a long time coming, we have a tremendous effort under way to educate and to develop programs and put programs in place to cross-sell these across both the commercial and small business lines. And as NOVA became part of the company, we really felt like we have a great opportunity to sell the correspondent banks, governments, state, local, and federal governments and that is beginning to pay-off, and there's a recognition in the company that we have great products and the middle market is a tremendous opportunity to cross-sell, and I think that's beginning to take hold. So not only do we have what I'd call external sales by the sales force in the unit, but inside U.S. Banc in the different lines of business, we're developing momentum on the cross-sell side, and I think that's going to be very, very profitable for us going forward.

Yeah and another thing Tom, and you know, we're not perfect, that's for sure, but we are making really good progress in these businesses because we have been able, for the last, you know, almost two years, to focus on these businesses. You know, our credit issues overall in the company are squared away, and you know, and we don't have to focus entirely on those, which we did for the first two years of the combination of this company. And number two we don't have the conversions. And that took up a heck of a lot of time. We can now focus on running these businesses, and we are starting to see the benefit of it. Our issue for our company is going out and growing loans. We need net interest margin. We know what we have to do. Our fee-based businesses are as you see them, I mean very strong. We know what we have to do, and we're going to make that happen. And we happen to be in a cycle, just like the rest of the banking industry, we're coming off a loan growth that was higher last year, which is causing net interest margin, gross net interest margin to be less, okay and that is net interest income, because balances were higher. But we are going to build that with quality loans, and that's the way you run a bank, and I think we know how to do that. And so that's what we're going to do. We know what our challenges are.

One tiny follow-up. It looks like the fees within -- related to corporate trust are not exactly growing like a weed. Can you elaborate as to sort of what's going on there?

Go ahead Dave.

Yeah, I think what you're seeing, and if you could can also see it, if you look at the private client depository, the deposit side, a lot of these groups are paying us not in fees, but in balances, somewhat akin to the corporate side. And when you saw the big growth in the fiduciary balances, that's largely what it is. But it is paid other ways.

$2.3 billion increase in deposits in that group, a lot of that is on the fiduciary side. Really it's doing very, very well. That was a 35% increase in that group in demand deposit.

But that's related to your.

Corporate trust business.

Corporate trust business, okay, all right.

And yeah that's the issue.

Thank you very much. Congratulations.

Thank you.

Our next question comes from the line of Jason Goldberg with Lehman Brothers. Please go ahead.

Hi, Jason.

Yeah, good afternoon. I guess, do you have the MSR recapture this quarter. I guess where does that MSR allowance stand?

At 90 million.

Okay. And then, I guess secondly, you mentioned you had unrealized loss at the end of the quarter. How should we think about that in terms of your targeted tangible equity shows six and a quarter, should we include that, exclude that?

Well, we absolutely exclude it. You're probably talking about comprehensive income, and we -- when we calculate tangible comment, we exclude any interim issues like the securities portfolio. Our logic is managing capital is a long run issue, and a very complex issue with regard to business mix and everything else. Interim changes in the valuation of bond portfolio, we exclude from that. So it has no impact from a Capital Management point of view whatsoever.

Okay. And lastly, did you say how much in I guess revenues the two European acquisitions added?

yeah, it is about 7 million.

Great, perfect, thank you.

Our next question comes from the line of Ben Crabtree with Piper Jaffray, please go ahead.

All right, thank you. Just a couple of quick expense line item questions. It looks as though the occupancy and equipment line you've had two sequential declines here, and especially given your build out on the retail side I'm a little surprised at that, just wondered if you could explain what's at work there and whether we're going to start going back up modestly from here?

Well, Ben, a couple of things. One is keep in mind the occupancy costs related to those end-stores is very, very small. They're a quarter of the size and quarter of the cost of a regular branch. Number two is we are continuing to go throughout the company and identify areas where we can eliminate real estate, whether we have leases coming due or we have some property that we're fully not occupying, where we can move one group to another group. So the challenge in our corporate real estate group is always looking for opportunities to reduce our occupancy cost over a long period of time, and I -- that's really the efforts of just being more efficient at what we're doing.

Yes.

You also have the first quarter, which has weather-related factors involved there, which is worth you know, for our company, and our franchise Midwest, a couple of million bucks probably. And then we just, we really do focus on this stuff. Also, we're the benefactor and certainly, you know, not Class A space, but Class B space, where our branches are, of the weakness in commercial real estate market and we're taking advantage of those lower prices, and our real estate group is doing a very good job at it and we focus on this stuff

Okay then a quick question on the MSR amortization. If I add back in the 171 to the net amortization you show in the supplemental data would indicate that you know maybe I'm drawing the wrong conclusion here but the core amortization might be 45 to 50 million a quarter. Am I doing it right, and is that a reasonable number going forward, assuming no more adjustments to MSR valuation?

Well, I think -- you're referring to page 42.

Yeah.

Yeah, I think the way you need to interpret that is the mortgage servicing right impairments that you're seeing on the table it includes the 171, so I think what you can do is just really adjust that out.

Right. Right.

I mean, you're looking at it right.

Okay. Thanks.

Thank you, Ben

We will move next to the line of Stephen Wharton (ph) with Morgan Stanley. Please go ahead.

Hello.

Hi, Steve

Yeah I just had a couple follow-up questions, first of all for David. Could you give the exact number for the bond portfolio duration at the end of the quarter?

Sure. 3.9.

Okay. Was there any material change to your swap (ph) position?

No, no not at all. Our swap position pretty much stands -- we had a little bit of runoff but not a lot.

So are you still in a net receive (ph) picks (ph) position?

Yes, we are.

And what's the dollar amount on that, initial amount?

I think it's net -- let me think. Let me get back to you, because we've got -- you know we have got some received picks (ph) and pay picks (ph) and I'm not sure of the net position. Let me -- I'll call you back on that and let you know.

Okay. And just on the share repurchase side you guys have been pretty active in the last two quarters and I saw your tangible capital ratio came down just a little bit, 20 basis points since year end. I think, can you just refresh my memory on what comfort level in terms of like what range you want?

Yes. We have targeted it at 6.25 tangible common and that is sort of been in place for a long time and over time, Steve, you can expect us to gradually, in very small increments to increase the tangible common over time. As you know, when we came together and we put together our plan to return earnings back to shareholders, we said 80%.

Right.

Well, obviously this quarter we did 97%, and that still remains a little bit of capital basically for that. So you know, my point is that unless we have a use for it, we'll return it to the shareholders. And we'll try to build a little bit of common equity as we go along, but quite frankly, it's hard for to us see any reason, really to do that at this point in time. By the way, Steve?

Yeah.

Matt helped me out of this but I net received fixed position is about $17.8 billion, as of the end of the period. That's netting out the fixed received and floating received.

I got you. And then on -- okay, so as it relates to the securities portfolio, then, I think I saw that the period end was down, that you said you sold 4 billion total.

Yes

So we would expect maybe a little bit further reduction in the average security portfolio in the third quarter and then maybe beyond that are you feeling like you're kind of finished in the bond portfolio restructuring at this point? Or if you get the opportunity to further write up the MSR, would you -- although it probably won't be in the third quarter, would you consider doing more bond sales?

Yeah, I mean the answer to your last question is yes, if we get a write-up or reversal of the reserve, yeah, we would offset that with securities losses, but Steve, beyond that, we're not going to do -- have any action with regard to the bond portfolio. I mean, depending on loan growth, we will just basically take the cash flows in the bond portfolio and reinvest it in floating rate or very short-term (ph) CMOs. I mean, our goal is obviously to continue to reduce the duration of that over time without actually increasing the exposure. And we'll continue to basically evaluate that quarter-to-quarter, based on loan growth and based on, as we've said, maintaining equity to asset ratio of right around 10. So it's the same game plan.

Alright. Okay thanks.

Thanks, Steve

We will move next to the line of John Balken (ph) with Fox-Pitt Kelton.

Good afternoon, everybody.

Hi, John

Just a few quick questions, one, service charge growth was significant in the quarter. Is that a function of any fee changes or is that just account growth and then I will have a couple of follow ups.

Well there's two things. It's largely account growth, and a part of that account growth is on the existing retail system, but keep in mind we're also expanding stores in and the in-store as well. But it's really, I think it is three things, retaining business, and then growing business and then adding business as a result of expanding our in-store operation.

Okay and then just to follow-up on that. Could you discuss your strategy on the wholesale funding side, you have some moving parts in between short-term borrowings and the CD books so, I'm interested in that. And then lastly, the consumer finance business had pretty good originations in the quarter, any changes in underwriting criteria, et cetera?

Well, first of all, on the underwriting, there have been no changes in underwriting criteria. That volume really reflects true demand on the consumer side for what I would call near prime credit and a little bit of sub prime credit. Mainly first mortgages and second mortgages is primarily the businesses that that we're primarily seeing.

Okay.

Restate your other question.

Just your strategy on the wholesale funding side because you had things moving in different dockets and I was just wondering what your thought process is.

I mean our job in treasury is every day evaluate how we fund the company on a short-term basis. We utilize the fed funds market, the CD market, Eurodollar market, term debt market and so it's a constant re-jiggering and re-looking at markets. And our view has been, over time we have seen on the CD side, quite frankly and the retail system, deposit rates that are just too high relative to our cost of funding in the wholesale markets. So what we tend to do is be opportunistic. Where there's an opportunity to increase our fixed rate funding, in the capital markets where we have attractive spreads, the LIBOR or sub LIBOR pricing, we will take advantage of that and do that. And the Eurodollar market, it comes and goes, and sometimes we can get sub par, sub LIBOR pricing, but our goal is in the wholesale is to consistently have below LIBOR funding and I think our ratings and the fact that we don't have that much paper outstanding, quite frankly, is a big help to us and it's -- but if we do a great job in treasury evaluating those alternatives and taking advantage of the markets when they're there, but we're not sitting around thinking that we have got to have x amount of CDs or x amount of Eurodollar deposits or x amount of - we're just taking advantage of all the markets when they are on an opportunistic basis. We don't pay a lot of attention to the movement in those accounts.

Thanks, David.

Our next question comes from the line of Dennis LaPlante (ph) with KBW. Please go ahead.

Great, thank you. Two things. Two items in your balance sheet sort of buck the trend a little bit, and that was your non-DDA deposit growth wasn't particularly robust, and I've seen a number of companies see a resurgence in growth this quarter and they can talk about pricing there, and how that's affecting your growth. And then two, is home equity, if I look at your supplementary tables and consumer banking, your growth looks about 5 or 6% annualized link quarter which is well below kind of the industry norms and if you maybe talk a little bit about that as well.

Yeah. Now, keep in mind when we talk about home equity, we sort of have two categories. One is we have home equity in seconds and we have first-lien home equity and that total portfolio in the quarter is $90.5 billion. Quarter-to-quarter link quarter basis, we grew about 1.6%. The home equity and the seconds piece grew around 3% on link quarter basis, and the first lien portfolio came down that actually declined 1.5%, so what you're seeing is a dispersion difference between the home equity seconds and the first-lien home equity. All that's being said is what we're seeing is true growth in the seconds, and that's driven from the branch system and also to some degree from the finance company, where on the first-lien side we're not seeing as much growth.. That product is not as popular as people are switching from fixed to variable rate as a result of the rising rate environment. But overall if you put those two together it's about 1.6%. But again part of it is a drag because of the first-lien declined.

Where was the funding? The non-DD, I think David answered that for John. I mean basically we look at alternative sources of funding at the cheapest rates and we can borrow in the other markets cheaper than we can do through our branch system and CDs. We have never been you know a big CD shop.

Yeah if you look at the under 100,000 - over 100,000, one thing you will notice over the last several quarters is we just refused to go out and bid against some of the competitors in the local markets to raise money. What we are focused on is non-interest bearing DDA as well as money market and savings account. So we are just not going to take those accounts and if you think about like this, the last thing that we need to do is get more liquidity. We have a lot of liquidity, we have a big bond portfolio, we have growth in demand deposits accounts and that is where we are going to choose the grow on. And so I think that's our game plan.

And Dennis, we look to that net DDA account rather than a CD account. CD accounts and that hotter money, when you are out there trying to buy time deposits just doesn't fit and so that doesn't fit into our wheelhouse.

I guess I should have been more specific with my question. I was looking at your interest checking money market savings accounts, the non-CD parts of the portfolio. If you look on an average basis, they are actually down link quarter, which is a little contrary to what's going on in the industry. Is there anything related to pricing? Are you deliberating trying to under price that as well?

I don't think so no.

Okay.

Now, the only thing I can suggest is part -- -- there are parts of those accounts are linked to governments, local and city and state governments, and those are very volatile accounts.

Okay.

And I think you're going to see it. If you look at metropolitan community banking, you're going to see an improvement, which is the consumer, essentially, and small business. But the government piece is going to be volatile quarter-on-quarter.

One last question related to the recent prime increase, or the move by the fed. Did you move your deposit rates at all, and have you taken any of that 25 basis point and moving them into the marketplace?

No.

Great, thank you.

We'll move next to the line of Betsy Grasik (ph) with Morgan Stanley. Please go ahead.

Thanks. When I look at the business mix and the opportunities for potential reinvestment, it seems like you might actually have a few, including the retail branches and some of the new locations where you're putting the in-stores, I would think would be enhanced by some traditional branch investments in those areas as well. And then in the merchant processing business, I would think you might need some incremental capital there, given some of the things that have gone on vis-à-vis the industry structure over the past couple of days or weeks, I guess I should I say. I'm wondering why we should still be expecting to have such a high level of earnings return to shareholders over the next several quarters?

Well, first of all, you're right on. We are investing in traditional branches and areas where we have principally entered markets, all of Phoenix, Scottsdale, some other markets, where we've entered in the grocery store business in a big way. We will supplant and that with traditional branches that ensure that are if anything were to happen to any of these alliances that we have, which we don't expect to happen, of course, but you have to plan for that, you need real brick and mortar to offset that, should that occur, which we don't expect to happen. So yes, so you can expect that and you can expect us to grow, Betsy, a little more in traditional in-stores. What's driving that as well is a price for franchises, which you've seen, we have not participated in. We can grow with the tremendous amount of capital that we generate, we can grow by building branches in areas where we may need them, and getting returns much greater than paying premiums for institutions that we think don't give our shareholders any return. As far as merchant processing side, you mentioned the NPC; I think you were alluding to the NPC sale. That was done, and I'm sure that Bank America feels that's an opportunity for them. But we compete against them every day and are doing very, very well against them, and do not need more scale from the standpoint of additional infrastructure. It's just you will see more -- you can see more capital, standpoint of systems and all the rest of that, in that enterprise, and we are, as you can see, producing very good results, and our expectation is that we will continue to see that.

Betsy, the other place, I think you focused on the domestic merger processing but we've had a number of announcements on our efforts to expand our merchant processing business in Europe. We have added a couple of operations and portfolios, and in the UK, and in Poland, and also we bought out our other 50% partner, Bank of Ireland, we bought back their 50% interest; so we own the Euro Connect Operation. We are investing in merchant processing. We think investing in processing businesses are attractive. We already have the scale, but we could add features and function and capability through acquisitions. They're going to be relatively small as they have been, but you're right, we do an opportunity, as you know, we generate a lot of capital, but our thinking is that you know, there will be some quarters where we may basically through a buyback and dividends return all of it and there would be some quarters where we may not do that much. But we think we can generate enough capital to make the kind of investment that we think are going to pay off in the long run for the shareholders.

We are now withstanding that, you know, we said on average about 80% of the target you should look at.

Right, okay thanks.

Our next question comes from Fred Cummings with Key Bank Capital. Please go ahead.

Yes. Good afternoon.

Hi, Fred.

Hi, Fred.

Just a quick follow-up question on the mortgage banking business, David. You had a pretty good quarter of originations and how does the pipeline stand at the end of the second quarter, and assuming this tenure say holds below 460 or so, what's your outlook for originations in the second half? I know you've entered into some joint ventures and you talked about having expanded your origination capabilities out west. So what's kind of, what is your outlook on the mortgage banking side?

Fred, there are several moving parts here. Number one, you're right, rates have been high and they have fallen and you did see an increase in originations, number one. Number two; we have an expansion of offices in other markets where the prior old U.S. bank did not have production offices. So, that is aiding to the origination. Number three is, as you know, when we originate, we retain our servicing. And servicing asset and income, improves as rates rise, so we would expect to see an improvement in servicing. So essentially, the way I would think about it, I would think conservatively as the revenue would be largely flat, or flat-to-down over second-to-third, but you would see changes in the origination income falling and some improvement in the servicing income. But I think it's fair to say that our own expectations you would have lower mortgage banking revenue, but I don't think it's going to be such that it has any material impact on us making our numbers.

And David, do you have the -- or Matt, do you have the mortgage pipeline at the end of the second quarter in front of you?

No, we don't have any information in front of us.

Okay.

It has declined.

It has declined, although there's been a little bit of an up-tick, so as soon as we say it declined, you know, we get lower rates, Fred, this is Jerry, there's a little bit of an up-tick, so it's going a little back and forth, frankly. And the last two weeks have been pretty strong.

And Fred, you know, there are a lot of predictions that it was going to fall off a cliff, and it hasn't done that. But you know, nonetheless it's going against us.

And but we have a mortgage banking operation that as you know, is right size for our company.

Yes.

And but, having said that, these are really pros and you're not going to see big fluctuations, where if they make $250 million in one year, they're not going to make 80 the next. You might see them make -- if they made 300, they might make 250 in the next year. So we have sort of positioned this so that it doesn't substantially affect the predictability of our earnings.

Okay, thanks, Jerry.

Thank you.

If you please, we have no further questions at this time.

Great, thanks for joining us today, please call with questions.