美國合眾銀行 (USB) 2005 Q1 法說會逐字稿

Welcome to the U.S.

Bancorp's first quarter, 2005 earnings conference call.

Following a review of the results by Jerry Grundhofer, Chairman and Chief Executive Officer, and David Moffett, U.S.

Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. [OPERATOR INSTRUCTIONS]

This call will be recorded and available for replay beginning today at approximately 5 pm Eastern through Tuesday, April 26, at midnight Eastern time.

I will turn the call over to Mr. Mac McCullough, Senior Vice President of Investor Relations.

Please go ahead, sir.

Thank you Operator, and thanks to everyone for joining our call this afternoon.

If you have not received a copy of our earnings release and supplemental analyst schedules, they are available on our website at USBank.com.

Jerry Grundhofer and David Moffett are here today to discuss our results.

But before they 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 current forward-looking assumptions are detailed in our press release.

I will turn the call over to Jerry.

Good afternoon.

We have many positive developments to discuss.

I'll start with the highlights and David will provide more detail in his commentary.

Today we reported record quarterly net income of $1 billion 71 million, or $0.57 per diluted share, resulting in a 9.6% increase in diluted earnings per share when compared to the first quarter of 2004.

We continue to report high quality earnings, driven by strong, underlying fundamentals.

Excluding security losses, revenue per share increased 6.4% over the same time frame.

Due to our aggressive share repurchase program, we believe that revenue per share is the best measure to consider when discussing revenue growth.

We spent $3.6 billion to repurchase our stocks since the fourth quarter of 2003, when we first announced our intention to return 80% or more earnings to our shareholders.

As you know, there is a revenue cost to giving up equity which, of course, is a zero cost source of funding.

The net interest margin for the first quarter was 4.8 -- .08%.

A reduction of 12 basis points from the fourth quarter of '04, and a reduction of 21 basis points from the first quarter of 2004.

While David will discuss it this in more detail later, I have a few comments.

I know that we are not the first to say this, but loan pricing is very competitive.

Tightening credit spreads accounted for 6 of the 12 basis points reduction in the margin on a linked quarter basis, and 14 of the 21 basis point reduction compared to the first quarter of last year.

As we said in the past , we are willing to get beat on price.

Our cost structure, expense discipline, and extensive fee based product and service offerings, allow us to compete on loan pricing very effectively.

Looking at commercial loan growth in the quarter, you'll see we continue to show progress.

Average commercial loans increased 7.3% from last year and an annualized 8.4% over the fourth quarter of '04.

Period end commercial loans increased an annualized 16.1% from December 31, 2004, driven by annualized growth of almost 24% in our commercial banking business unit, which is entirely focused on the middle market.

But there is another aspect to competition for loan growth what compromise is not an option for us.

I'm talking about credit structure.

To illustrate my point, let me discuss our commercial real estate business, an area where we have recognized expertise in lending to professional builders and developers throughout the country.

Average loan balances in the first quarter of approximately $28 billion were up modestly year-over-year and down on a linked quarter basis.

Why only modest growth?

Because we are not willing to compromise in the terms and conditions that we believe are necessary to avoid unacceptable losses in the future.

Turning to fee revenue.

Excluding security gains and losses, noninterest income increased 9.3% from last year.

The payment fee categories increased 15.7%, reflecting recent investments and increased customer penetration, with merchant processing increasing 26.2%, credit and debit card revenues increasing 8.5%, and corporate payments increasing 12.6%.

Mortgage banking revenues increased 8.5% compared to last year, driven primarily by higher servicing revenue.

We expect to continue -- you expect to continue to show growth in this line in 2005, as we have good balance between revenue and servicing revenue.

Deposit service charges increased 13.5% over the first quarter of 2004, driven primarily by net new account growth.

First quarter deposit service charges were essentially flat, compared to the fourth quarter of 2004, despite the fact that the fourth quarter is typically higher due to seasonal factor.

We expect double -- we expect the deposit service charges to continue to show double digit growth in 2005.

The primary reason for this, is that we are growing net new checking accounts.

Here are five ascending numbers that I would like you to remember -- 1.5%, 3.4%, 4.7%, 6% and 6.5%.

These are the growth rates that we have achieved in net new checking accounts starting with 1.5% in 2001, and ending with an annualized 6.5% in the first quarter of 2005.

Net new account growth is not a new concept to us.

In fact, we have been focusing on net new account growth long before it has become fashionable.

It is real simple.

Grow net new checking accounts and you will grow deposit service charges.

We are growing net new checking accounts, and we are telling you every quarter how we are progressing.

We added 300,000 net new checking accounts in 2004 and another 86,000 in the first quarter of '05, with the first quarter typically being a slower quarter.

As you would expect from the leader in efficiency, expenses were well-controlled in the first quarter, declining by approximately $25 million from the fourth quarter of 2004, after adjusting for mortgage servicing rights impairment and repairment, and the debt prepayment expense that was incurred in the fourth quarter.

Our tangible efficiency ratio in the first quarter was 39.7%.

Average retail loans grew 9.5% from last year, driven by double digit growth in leasing and home equity, and over 9% growth in credit card balances.

We continue to be very disciplined in our approach to pricing deposits.

Our focus continues to be on growing net new checking accounts and the corresponding deposit balances that are more likely to create long-term value.

I mentioned earlier the success we are having in growing net new checking accounts, as evidenced by the continued strength in deposit services charges.

Another indication of the success that we've had in growing net new checking accounts, the raw material per share of wallet, is a continued growth that we are seeing in the three deposit categories that directly related to checking account growth -- noninterest bearing deposit s, interest checking deposits, and savings deposits.

Looking at these three categories for our branch network, the first quarter average was just over $34 billion, a 7% increase from the first quarter of 2004 and an annualized 3% increase from the fourth quarter of '04.

We are very pleased with the growth of these high value deposits that are less sensitive to rate, and more dependent on the convenience of the branch network, the breadth of product offerings, and the level of customer service.

Net charge-offs increased modestly in the first quarter to 55 basis points of average loans, compared to 52 basis points in the fourth quarter.

This increase was due entirely to loan recoveries and to lower recoveries, as gross charge-offs actually declined in the quarter.

Nonperforming assets declined 11% from December 31, 2004.

We continue to aggressively repurchase our stock, buying back 20 million shares in the quarter.

This, combined with our normal quarterly dividend, resulted in 108% return of earnings to shareholders.

As we enter the second quarter, a quarter in which we historically produce annualized double digit revenue growth, when compared to the first quarter, we expect to achieve our target of 10% EPS growth for full year 2005.

We continue to build momentum in the first quarter as evidenced by growing earnings per share 9.6%; by growing revenue per share of 6.4%; by growing fee revenue 9.3%; by the continued acceleration in the growth rate of net new checking accounts, a concept that is not new to us, and our raw material for future revenue growth; by the acceleration and the growth rate of commercial loans to an annualized 16.1% on a period-end basis; by the achievement of a 39.7% tangible efficiency ratio in the first quarter, a significant advantage as we compete on price and exercise expense discipline in times when the environment makes revenue growth more difficult to achieve; and finally, by concluding our 6th consecutive quarter of returning 87% plus of earnings to shareholders.

Conclusion -- this company is executing on the fundamentals, building on our promises, and producing the high quality earnings that you and we expect.

Now, I will turn it over to David to give you more details on the quarter.

Thanks, Jerry.

Today we reported first quarter earnings of $1 billion 71 million, or $0.57 per share on a diluted basis.

This was a 9.6% increase in diluted earnings per share over the first quarter of 2004.

The quarter was relatively straight forward and the earnings quality was high.

During the quarter, we rode our mortgage servicing rights up $54 million due to increases in the yield on both the 10-year treasury notes and 30-year Fannie Mae commitments.

We focused repariment as a reduction in the intangible amortization expense, and we more than offset the benefit with $59 million of investment portfolio security losses.

Our balance sheet growth strategy remains unchanged.

We will continue to drive earning asset growth by keeping the investment security portfolio flat and by competing on price as necessary, to grow both commercial and retail loans.

Average earning assets grew $6.9 billion or 4.2% over the first quarter of 2004 as commercial loans increased 7.3%, and retail loans increased 9.5%.

These positive growth trends were somewhat offset by a $1.9 billion reduction in the investment portfolio, flat commercial leases, and a very modest increase in commercial real estate loans.

Despite the growth in earning assets, net interest income declined $28 million from the first quarter of 2004, due to tighter credit spreads, asset-liability management actions designed to maintain a neutral rate risk position -- including a 40% reduction in the net received fixed swap position.

The first quarter net interest margin of 4.08% declined 21 basis points from the first quarter of 2004 and a 12 basis point reduction from the fourth quarter of '04.

Compared to the first quarter of 2004, tighter credit spreads, driven by increased competition and a higher proportion of lower spread credit products, accounted for 14 of the 21 basis points decline.

The remaining decline primarily reflected a preference to acquire lower-yielding, floating-rate securities; lower loan payment prepayment fees; and higher rates paid on wholesale funding; due to the impact of rising short-term interest rates.

These negative factors were partially offset by the higher value of net-free funds.

To follow up on Jerry's point earlier regarding the cost of the share repurchase program, approximately 4 basis points of the year-over-year decline in the margin can be attributed to share repurchases.

One final note on this topic.

We have one of the highest net interest margins in the industry among banks of similar size.

The 21 basis point decline from the first quarter of 2004 is only a 4.9% reduction.

Compare that to our peers and you will see that our margin is holding up quite well.

We expect the net interest margin to decline only a modest amount in the second quarter, but the outcome is going to be dependent upon the strength of commercial loan growth and the related pricing dynamics.

We ended the quarter neutral from a rate risk perspective.

Mortgage servicing rights repairment provided additional flexibility in the quarter to continue to position the balance sheet for higher rates.

At March 31, 2005, approximately 40% of the investment portfolio was variable rate.

We also continue the process of extending the maturity of wholesale funding during the quarter.

Taking a quick look at business year results compared to the first quarter of last year; wholesale banking increased net operating earnings by 12.5%, driven by improved credit quality and a 3.9% increase in total revenue.

Average balances increased 4.7%, driven by an 8.3% increase in total commercial loans.

Total net charge-off and wholesale banking declined approximately $31 million, coming in at 3 basis points of average loans in the first quarter of 2005, compared to 33 basis points in the first quarter of 2004.

Excluding the impact of mortgage servicing right impairment and repairment, and securities gains, consumer banking increased net operating earnings by 23.1%, compared to the first quarter of 2004.

Revenue increased 8.4%, primarily due to a 9.5% increase in net interest income that was driven by a 9.5% increase in total loans, and higher earning credit on deposits.

Fee revenue increased 6.2%, driven by continued strength in deposit service charges and mortgage banking.

Noninterest expense increased 2.6%, due to primarily to higher compensation and benefits expense, driven by an addition of 102 branches compared to the first quarter of 2004.

Total net charge-offs declined from 70 basis points in the first quarter of 2004, to 48 basis points in the first quarter of 2005.

Private Client Trust and Asset Management recorded a 9.6% increase in net operating earnings from last year, driven by a 6.3% increase in revenue.

Net interest income increased 26.8%, driven primarily by 7.7% increase in total deposits, and higher earnings credit for deposits.

Finally, Payment Services increased net operating earnings by 7.9% from last year, driven by fee growth of 16.2% and a 4.3% decline in net charge-offs.

Total revenue grew 11.1% as tighter credit spreads on credit card receivables reduced net interest income 3.4% from last year.

The 16.2% increase in fee revenue was driven by a 26.2% increase in merchant processing fees, a 12.6% increase in corporate payment fees, and a 9.2% increase in retail credit and debit card fees.

Total net charge-offs declined from 366 basis points in the first quarter of 2004, to 327 basis points in the first quarter of 2005.

Turning back to consolidated results for a moment.

Our capital position remains strong.

We are comfortably above the minimum regulatory capital targets to achieve well- capitalized status, with a Tier 1capital ration of 8.6%, and total capital ratio of 13.3%.

Tangible common ratio ended the quarter at 6.2%.

In conclusion, we continue to make good progress in the quarter and the quality of our earnings remains high.

Our high value of fee-generating businesses continue to show strong growth.

We are adding distribution and high growth markets, and investing our capital efficient payments businesses.

We have invested over $1.8 billion in the franchise over the last four years, and this does not include the value of acquisitions or integrations.

We believe that our balanced business mix, our advantage scale, our reduced risk profile, our low-cost leadership position, and our emphasis on customer service; will allow us to achieve our long-term goal of 10% plus earnings per share growth.

This concludes our prepared comments, we will now take questions from institutional investors and analysts.

[OPERATOR INSTRUCTIONS] First we will move to Laurie Applebaum with Goldman Sachs.

Please go ahead.

My question relates to the Company's deposit pricing philosophy.

And Jerry, I suppose you were pretty specific about your views on pricing commercial loans and wanting to be competitive there, and I just wanted to know your thoughts on deposit pricing, especially, I guess, the Company's focus is on lower-cost deposits, not so much on money markets, because the Company has been consistently paying under other banks on money market rates.

Is that a fair assessment?

I want to know your overall strategy -- pricing deposits.

Yes, Laurie, that is a fair assessment.

As you know, we price in over 150 markets every Friday morning, both assets and liabilities.

And since you're talking about deposits, talk about the liabilities side obviously, and some markets we do pay up and others where we don't feel it is necessary we don't.

But we manage it and we've done a very decent job at it.

The strategy, basically, is to look at each one of these markets and see what is happening in it and where we need to -- we feel it is appropriate to pay up we will, where we don't feel it is in our best interest to do that, we will not, and so that is how we focus on it, and we do that every Friday.

What is the philosophy toward money markets, though, because the money market deposits have been falling consistently every quarter for about a year, and the yield on your portfolio is about 93 basis points and that is the lowest I have seen of any of the banks this quarter.

Yes, Laurie, we're not going to pay up.

We -- money market is one account.

And we are not going to pay up for any of those, and we are going to compete on price where we need to, but overall, we are not going to just be the lowest cost to get deposits.

We base it on other things like customer service and convenience and all the other areas where we are doing a heck of a job, as you can see from the net new account growth.

Which by the way, for us, is a new -- ever since I have been in the consumer banking business that is what I focused on and what we are focusing in on our company.

We know it and that is a raw material for the -- the -- the very good growth in deposit service charges this quarter, which I think bucks a little bit of the trend overall in the industry.

Thank you.

Thank you.

Thank you, next we will move to John McDonald with Banc of America Securities.

Please go ahead.

Hi, good afternoon.

Good afternoon.

Hi, John.

The efficiency ratio improved a lot this quarter, just wondering if you guys see this level -- 41, 42 -- as sustainable.

And if you can comment on whether you are doing the right level of investment spending and where investment spending is being directed right now.

Yes, John, one of the premises of the Company throughout each operating division and throughout our entire company is, in order to be competitive we need to drive down the efficiency ratio over time.

We particularly focus on the tangible efficiency ratio, because it takes out the impact of acquisition and repairment and impairment of mortgage servicing rights, so we tend to focus on the tangible piece of it.

And, as you know, our mantra is we have to grow revenue faster than expenses and if we do that, we're going to continue to gain operating efficiency.

On the investment side, John, we have invested over $1.8 billion in the franchise over the last four years.

We continue to invest every quarter we have.

Cap Ex meetings every other month and we focus on initiatives to reduce cost permanently, to enhance revenue, to expand distribution; and we are constantly looking at that and I think that rigorous process helps us sort out those projects that are going to be the most productive and use the shareholder dollars over a long period of time.

And that is the way we manage it, and all good companies invest and we -- we do tha,t and we are -- again, we are focused on long-term results for those investments.

And John, this is Jerry.

Whereas our major focus and investments in our shareholders and in the term in the form of buyback and dividends, and we certainly have done that, but we are not skimping on what we need to make this company grow.

We feel very confident about that.

In the first quarter, we invested another $100 million in different kinds of investments to grow revenues.

A major portion of those to grow revenues.

Some are regulatory and some are others, obviously.

But as David said, we've invested in excess of 1 billion 8 over the last 18 months -- excuse me, over the last four years, and we are starting to see the benefit of that; certainly in the payment side, and we're going to see it on the commercial loan side over time, I believe.

John, this is David.

Investing is not an excuse or prohibiter from us making our long-term goals.

We have the capacity to invest, we create the greatest amount of tangible common capital, and we can invest in that, so we are not -- that is not a constraint to this company.

And we going to be a low -cost provider.

It is effective, especially in today's time of the challenges of banking industry faces with decreasing margins.

This is where we can just do better than anybody else.

For any loan that's out there we -- we can make more on it than anyone because of our efficiency ratio.

We going to use that.

Okay.

And just on -- the reported numbers really dropped a lot from, like, a 47,48 efficiency ratio down to 42 this quarter.

Is that sustainable, and could you also comment on where you see ROE and ROA going over the next year?

Well, John, here's the way I would think about it.

Our target is to maintain, obviously, a 20% return on equity.

We are in excess of that.

I would expect to see the ROA and ROEs continue to be at the current levels they are with maybe some slight improvement on ROE.

The other area that I think the efficiency ratio has come down, measured on a gross basis, down in the 42 range, but if we are doing our job that is going to migrate down over the course of the year.

Now, one quarter it might be up, and one quarter it might be down.

The way we judge it is, we look at the efficiency ratio on both basis year-over-year, one of our scorecards is we want it to be lower year-over-year.

Also the 47% that we had included impairment.

So, take that out and it's 44, 43 --

That is why we look at the tangible because it really looks at the pure operating leverage that we're getting in the Company.

So, we are in the right ballpark right now, of efficiency ratio?

Okay.

Yes, the first quarter is always a little lower, I would say, John.

But, again, we're going to be the low cost provider, and you can see, we're relatively consistent, when you take out repairment or impairment.

Relatively consistent.

We've invested a lot of money in the franchise over the last 18 months in particular, which has driven some of our expense numbers up a bit, but that's -- the fruit of that is being born right now in EuroConex and other investments we've made.

And in the -- in grocery store branch expansion that we have invested a lot of money in, not only just plain capital, but in operating expenses as they get up to speed.

But those will start to bear fruit in a the months to come.

One quick follow up, David, how much was the private equity contribution this quarter compared to last?

The comparative number is about a $14 million increase quarter to quarter.

The overall number is less than $50 million.

But I will remind you that we have had venture capital gains, as other banks have for the last five quarters.

Now, I will tell you, however, it will diminish in the second and third quarters.

We just had an unusually high amount in both fourth and first, but it will begin to come down.

Again, that is the result of a lot of the venture funds recognizing and having liquidity events that have created those gains, but it won't be material to the results of the Company and it has -- and it will be coming down over the next 3-4 quarters.

Okay, thanks.

Next we'll move to the site of Mike Mayo calling from Prudential.

Please go ahead.

Hi, it's Prudential Equity Group.

Hi, how are you doing?

Good.

Jumbo CDs were up one-fifth linked quarter, and if you strip that out, I guess, the other core deposits were kind of flat, so if you could talk about what is going on with your jumbo CD strategy And also, how the increase in checking accounts -- what your model is, really, because the deposits aren't necessarily going up, but you're getting more deposit service fees, so if you can just kind of reconcile these thoughts?

Well, first of all, David can talk about the jumbo CDs.

Let me talk to about our basic transaction accounts -- if you look at consumer bank , those deposits are growing about 6.5% in deposit increases.

So, that's exactly reflective of the -- our focus on net new checking accounts, Mike.

It is very -- it is very -- associate the two very easily.

That is in fact happening, and we have been growing our consumer banking deposits in those very important high quality categories at that 6.5% to 7% for the last three years.

Mike, with regard to the CD strategy, during the end of fourth quarter and the end of the early part of first quarter, one of the things that we've noticed in different markets -- as you know we price in a lot of different markets -- one thing that we saw was that the lack of loan demand -- there were a lot of banks in the markets lowering their CD rates.

We took the opportunity, in some selected markets, to raise both small CD and large CD rates, and that was accomplished in a multitude of markets where we are able to see a pricing advantage.

Another thing we did is -- related to that -- is we began, as you know, began to focus on lengthening the liabilities and we have done it on the debt side in the capital markets, but we also employed that same strategy in the consumer deposit side.

So, where we found opportunities to price CDs at lower than the capital market's equivalent, we took the opportunity to raise the rates to extend the liabilities and extend the maturities, and that is really what caused that, but it was in both large CDs and small CDs, as well as -- particularly in the government banking area.

What would you highlight to be the mitigating factor, and again, if you take out the CDs over $100,000, the other core deposits are down year-over-year despite this nice increase in checking account growth?

Well, one that you have got to remember is -- I think we've mentioned this before.

There were several accounts, large corporate accounts, that we've elected not to compete on price on those money market accounts.

We mentioned two of them last quarter and those were all in excess of maybe a billion or billion dollar -- billion dollars in accounts, and so, in many cases, some of those money market accounts, particularly in some of the government and the corporate area, they were -- they were requesting rates at LIBOR plus a quarter, LIBOR plus three-eighths.

And we just chose not to compete on that.

We didn't lose a relationship or operating business or any credit relationship.

We just chose that we would rather spend our money some place else, and not compete at those levels of rates.

We don't need to, we have a lot of liquidity and we can get those deposits at -- really, at any time.

And Mike, maybe I didn't make myself clear, but, in the consumer bank with the high value DDA interest checking and savings, those grew in the quarter at an annualized 7.5% and that has -- that's been very consistent.

That is the raw material for our company, and it has been very stable.

Running right around that every quarter.

Mike, I think maybe later on, if you would like, we can get in contact with Mac and we can go through those numbers.

Okay.

And one just completely separate question.

You said you are not looking to do a big bank acquisition.

I was wondering if you are still holding to that.

And given the efficiency ratio where it is, I always thought the low cost provider is the one that should be doing the buying.

Well, that's -- you can say that.

I didn't say we wouldn't do a big bank acquisition.

I said we wouldn't do any acquisition that was big.

They are just not high priorities for us.

Let me include anything else that you might have interpreted in that.

That is still the posture of the Company.

We do believe that focusing on our -- our -- our company is the best thing to do to give it back to our shareholders, and with the prices of -- of -- of what is out there we are not going to participate at these levels.

And you are right, but when it is -- when -- when you -- you look at the economics you are just -- I'm just -- we're not going to pay for banks and other companies at those kind of multiples.

Thank you.

Thank you.

Next we'll move to John Balkind calling from Fox-Pitt Kelton.

Please go ahead.

Good afternoon everybody.

Hi, John.

Just a couple of quick questions.

One, when I look at your rates and yields table, it looked like commercial loan yields were only up a nominal amount.

Is there a repricing issue there, or is that simply reflective of the current competitive conditions?

And then second question, besides venture capital or private equity, was there any other unusual items in the other income line?

No, there were not any unusual items.

John, really, the facts are as I was talking about the margin, we are down 21 basis point year-over-year. 14 of that is price compression, that is the yield between the loan to the customer and the cost of funds.

And notice that between the 4th and 1st, that that 12 basis point drop, 6 of that is relating to pricing compression.

And, obviously, that basically indicates some sort of continued compression in the margin from competition and we have been very straightforward in saying, "you can expect that to happen."

We are going to compete on price.

If our margin is lower, that is the result of competition and the result of growing earning assets, and particularly loans, and we've had -- had some -- we are having continued success; and we are seeing more success in the commercial side and the margin compression is going be a factor related to one, loan growth on the commercial side, and two, pricing dynamics that we expect to continue.

And that is -- I mean we are -- we see price but we're going to meet it.

Sounds good.

Just a quick follow-up.

Do you think in general, is the industry getting paid for the credit risk it is taking right now?

And how do you guys weigh deploying your capital right now in a loan market that seems overheated versus buying back your stock.

Let me make it real clear.

There are two ways to compete in this business.

One is structure and terms, and the other is price.

We have absolutely decided that we are not going to compete on structure and term, because those -- lack of those conditions will create future losses in the future.

We would prefer, with good credit quality and customers in our markets that we know, we're going go ahead and compete on price if the terms are acceptable to us, and we are going to continue to compete like that.

And we think that although there is heavy price competition and a diversification in our portfolio and a granular nature of our overall credits, we think it will payoff long-term, both when you look from profitability and also charge-offs.

Let me add one other piece to this.

We are competing and we going to compete on price.

But it is only to customers where we can sell our other products and services which are really robust.

So, we are going to compete on price, assuming the structure is something which is satisfactory to us.

And I mentioned in my comments, the fact that we thought the commercial real estate business overall, where the structure was deteriorating and we are not going to compete on that.

So, we're not only -- we are competing on price but you see it in our fee-based businesses, the corporate payments businesses, and the other businesses where we are getting additional revenues, almost 10% in the quarter annual increase on the payments side.

This is driven a lot by going out and not losing business, even though pricing is really competitive, and in my 39 years I don't think I have ever seen it so competitive, but only to those customers where we are servicing them in some other manner so we can sell our suites of products and services to them.

John, another way I could describe this.

We are literally making a tradeoff between much higher credit quality, lower credit spreads, which end up in lower margins; in lieu of future credit losses, and that is the tradeoff we are making and we think that is the appropriate tradeoff long-term.

Great, thanks, guys.

[ OPERATOR INSTRUCTIONS] We will move to Ben Crabtree with Piper Jaffray.

Please go ahead.

Yes, thank you.

Couple of more questions about the whole pricing competition.

I guess one would be, is that competition concentrated -- I assume it is within the commercial side, maybe not.

But is it concentrated more heavily in one part of your geography than the other?

And is it concentrated more heavily in a certain, let's say, category of loan sizes, or is it kind of across your whole commercial area? .

Well, actually, Ben, let me be real clear.

It is happening, and is probably more intense on the retail side, of late, than it has been -- than I have seen since -- really, 1995.

The retail side whether it be home equity pricing, leasing, auto paper, whatever; it is clearly much more intense.

In 1995 the same thing happened.

We plowed through it, and we were able to compete on that basis and we came out through that quite well.

On the commercial side, clearly middle market is under, what I would call the most intense pricing pressure.

If you are talking about credit, and you really got to think about credit grades at the higher end of the credit spectrum, where you have past-rated credits that it would maybe be investment grade or slightly below investment grade.

You are seeing intense pressure on renewals when customers renew commitments, or on discrete transactions for specific investment across the board, regardless of territory.

It is very, very expensive.

On the area of the corporate, we are also seeing competition from the capital markets.

Capital markets pricing by players who traditionally are not in the lending side, some of the investment banks.

Some of the hedge funds are particularly active in the high grade area, and they were doing transactions and spreads that we think are extraordinarily tight, and the other thing is, we want to do business with people who are going to do other kinds of noncredit business with us, and we are going to -- are going to continue to focus on those customers where we can build more relationship.

But I think it is really across the board.

It is not in my own thinking, this is very similar to 1995.

I mean this is what happens.

Rates rise and you are going get, especially at these lower rates, and there is a lot of competition and banks are screaming for assets, and now you see in structure at least we are seeing structure compromised and we are not going to participate in that.

And in a some what analogous question -- if I look at this and think about aggressive price competition, in a way, as being an investment in greater revenue.

If I look at your long growth -- it was good but doesn't show a lot of acceleration over what you have been recently doing.

I'm just wondering, if the return on investment is satisfactory here, given what you are giving up on the front end in terms of spread, are we going to see an acceleration of loan growth as a result of that?

Well, remember, Ben, there is two aspects to this.

There is a whole segment of opportunities that we get a chance to look at, where the terms and conditions we are not willing to match no matter what price.

But, I would say that on the commercial side we have made progress this quarter.

We had nice growth on a late quarter and year-over-year, and I think you're going to see that begin to accelerate even more in the second quarter.

As you know, we made a lot of changes at the leadership in a lot of these markets, and that is beginning to pay off, and we are seeing the results of that.

But again, we are not going to compromise terms, so we may very well not have the highest loan growth in the commercial side.

That is going to reflect not a desire not to compete on price, but a desire not to compete on terms.

And if that lowers our growth rate vis-a-vis our peers, than that -that's the way it's going to be.

Thank you.

Next we will move to Dennis Laplante with KBW.

Please go ahead.

Thank you very much.

Since a big part of the -- your margin compression has been due to loan spread compression, and you continue to want to compete on price, what else is happening in your balance sheet that suggests you won't see the kind of the margin compression we have seen here linked quarter, and year-over-year, over the next three, four quarters.

A couple of things are going on.

In the bond portfolio, as you know, we have been investing more and more in floating rate and that's beginning to inch its way up, in terms of improved asset yields.

On the funding side, we have bitten the bullet over the last several quarters and lengthened our debt maturities, which we've had to pay up for initially, to continually reduce our overall rate risk, and try to stay ahead of the game with regard to that.

I think also is as we -- as rates rise, we've had this repairment.

We have been able to offset that repairment by selling securities, taking losses and reinvest those in higher yields.

So, we're going to see it on that side of the coin -- on the portfolio side.

Also, if you look at overall deposit rates.

Several people pointed out that people are competing on deposits.

We have probably been in some categories, particularly the CDs, we have not been as aggressive, but we are seeing opportunities to compete on price on the deposit side on the CD side, where we think there is some opportunity to gain deposits, and also grow earnings.

And so that is the sort of sweet spot at present in the CD market.

So it is going to be a combination of a lot of those factors, but I think over the course of the year, as time goes on, experience shows that that pricing compression begins to let up over time and we will maybe see more -- a little more normal spreads, but as I said, we're willing to complete, and as we said before we expect to grow 10%, and that is in the face of compressions.

And the reason we think that is because we have a great set of fee businesses that are growing double digit, and that is going help us, also set some of that compression.

So you're thinking margin compression of 1 to 2 basis points a quarter, rather than 6, 7, 8, 9 basis points a quarter.

I would say it is on the lower end but it is too early to tell.

Again, the credit compression is there.

We are seeing it on deals every day, and we do expect long growth to help us on the net interest income side.

But it is probably too early to say, but we think there is more compression just by virtue of loan pricing.

And real quickly, you still think --if I heard you right, you basically think your pipelines now are better than they were going into the year.

They are better across the board.

They are better by geography and they are better by product line.

No question about that.

And one last question if I may.

Where is the pressure on structure coming from?

Is is coming from the small community banks?

Or is it coming from the large competitors, like yourselves.

It is coming from all over, it really is.

The smaller banks that sell principally credit and don't have a suite of other products, are being very aggressive if only if our -- our -- our rural markets, which is a big business for us.

And then on the larger side -- the large corporate side, you have people that are in the capital markets that have lots of liquidity that aren't banks, as well, and some banks are being very competitive.

You are seeing some competition there, but from other sources like hedge funds and all the rests, the investment banks are being very, very competitive.

It is really coming from all over.

Thank you.

Next we move to Matt O'Connor with UBS.

Please go ahead.

Give us a sense of your expense outlook for the remainder of the year?

I'm sorry, Matt, we didn't hear that.

Can you give us a sense of what you expect expenses to do for the remainder of the year?

I suspect we will have some expense increase based on some of the initiatives we see, but we will hold the growth to a very minimal amount.

And again, as you know, if our own expectations for revenue growth don't materialize, we can, if needed be, we can reduce costs.

As you know, every year when we put together a plan, we have a 5% reduction plan that is built into the business lines, and if the revenue doesn't materialize, we will take action.

So, I don't think you need to worry about the expense growth in the Company.

If we find opportunities to invest, we're going to.

We are not going to avoid them because of short-term needs.

We're going to invest because we have long-term opportunities to either reduce costs or increase revenue, but I don't think that is going to be a determining factor to meet our 10% growth rate.

So when you think increasing -- going forward, is that versus 1Q or kind of on a year-over-year core basis and the revenues there?

I would say it is first quarter.

First quarter.

Okay.

You mentioned about extending out the duration of some of your funding, the large CD side.

Where can we see it in terms of some of the other deb,t like long-term debt seems to have declined a bit while short-term funding increased a bit?

Yes, a couple of things.

One is, during the quarter you are right, the borrowings actually came down, CDs came up, and as I pointed out there were some opportunities in the markets, some very specific markets, where we did raise price, but the pricing was less than the overall capital markets would have provided to us.

I think what you'll see this quarter, Matt, is a return or in increase in the overall borrowing levels, but you will see it in the longer term debt categories, during this next quarter.

Cause we will take some opportunities that we're seeing beginning to materialize -- longer rates as you know have begun to drop.

I think the 10-year is now down in the four and a quarter range, so we are going to see opportunities to do longer term pricing, longer term debt, where we think it is attractive.

So, we will move from the shorter term out to the longer term this quarter.

Okay.

And just last question.

It's not that material, but the commercial products revenue dipped down a little bit.

Yeah.

That is really in really three area.

International foreign exchange trading was lower, LC fees, there was not as much volume in the LC area.

And also, commercial leasing had less residual gains during the quarter, so it came really from those three.

All right, thank you.

Thank you.

Next we will move Nancy Bush with NAB research.

Please go ahead.

Good afternoon, guys.

Good afternoon.

I promise this question doesn't have the words "pricing competition" in it anywhere.

Kind of a free-floating and multipart question, and I guess it concerns your stock price, and concerns that investors have, and when I talk to people there are a couple of issues that continue to come up.

The embedded loss in the bond portfolio.

This issue of over-earning as it relates to low expenses, deposit pricing, et cetera.

Can you just address how you think about these things, and why people shouldn't be as worried as they are?

Let me describe it, as you sort of coined it, sort of free flowing.

Essentially, as you know, management of all banks are constantly trading off different aspects of their business and the certain variables that drive the business.

You have pricing considerations vis-a-vis volume, and you have volume considerations vis-a-vis credit structure.

You have deposit issues, where you're trying to fund the assets with the cheapest cost of funds, but also, trying to grow the deposits because they are relationship driven, and you are investing.

I think Nancy, I think, you have to look at this over time, has this management team been able to make all those tradeoffs over a long period of time, such that the investment in the Company is realized by the shareholders, as opposed to try and please each individual shareholder quarter to quarter?

I think you can say over the 13 years that this management team has been in practice we have made those tradeoffs.

Sometimes we have to tradeoff short-term earnings for long-term gains, because it is in the best interest of the shareholder.

We are making investments long-term.

It going to cost us in the current quarter.

It is going to cost us in the next quarter, but we have to make investments long-term to grow the Company.

The loss in the bond portfolio is not a concern to me.

I'm not going to sell the whole bond portfolio.

On the other hand, you can also say that we have an embedded gain in our deposit portfolio.

So, it is not a consideration because in structuring the bond portfolio, we consider liquidity, credit quality, valuation risk, earnings, earnings volatility; and so there is a number of factors that go into that.

Overall, we do look at the value of the Company's assets and liabilities on a market- to-market basis.

That valuation we report, and it is consistently -- it is not very volatile, and it's consistently been relatively neutral over the last many, many quarters.

I think we are making all the right tradeoffs.

Again, the tradeoffs can change quarter to quarter, but long-term we are committed to delivering 10% growth in earnings per share, and a high return on equity, and a distribution of those earnings to our shareholders.

And, again, the individual quarter to quarter changes don't concern me.

Again Nancy, as far as over earning, this Company has always earned since 1994.

We got here in '93, and we have been over earners in the sense that you said every year.

We know how to control expenses.

We have always been tough on deposit pricing.

That is just the way we do business.

So I, in a free flow conversation, that is the way we run our bank.

And every one in our company understands that they going to control expenses.

That we are going to compete on convenience, on product, on service.

And so, I don't know how there is to view it, but if we are over earners, that is what we have done for ten years.

And we are going to continue to be, as you quoted, over earners, because we will continue to focus on the things that we know how to do.

Do you feel like, Jerry or David, or both, that you kind of made an inflection point here as far as growth goes?

Are we going to see, sort of accelerating loan growth and all those things.

Or do we kind of stay at this 7%, which is fine, if you do it year in and year out, but for some reason, the market doesn't seem to be satisfied with that.

Let me just tell you, Nancy, we are going to do as much as we can do that fits our credit standards.

And our credit standards are, I think, they will only when shown when we get into the next challenging time, and we will do very well.

I know that our backlogs are the highest they have ever been.

We are focusing on commercial loan growth and variable rate commercial loan growth in all of our businesses that make commercial loans and if we focus on something over time, this company executes.

Now, there is some vagaries and some economic things we have nothing to do with.

If the economy completely tanks, than we all have issues.

You can see higher growth there certainly.

But the way it looks now, I think that you could see higher growth there, certainly.

But as David said, too, I think with our credit standards, that you probably won't see us be the highest growth in commercial loans, or any others in the industry vis-a-vis our peers.

But I -- I -- I hope it is an inflection point.

I think we made great progress.

We are starting to see the rebuild of a commercial loan portfolio that dropped $14 billion, Nancy.

Right.

And that is big.

I mean, the banking business is pretty much fun.

It is a lot easier when you don't go back five years on your commercial loan book, which pays for salary increases and everything else.

We have been able to make up for that by very robust payments businesses that we invested in that are doing very well.

So, our job is to get and to move our commercial loan book up, and get it bigger to cover things.

To cover overhead.

To cover earnings.

To cover everything else, and we are making progress.

If you look compared to the first quarter of last year -- commercial loans, we are growing them again.

This is really, very good news for US Banc.

Nancy, we know what we have to do, and what our challenge is.

And we are focusing every minute of every day, on growing quality commercial loans in this company, and growing net DDA and net transaction accounts and we will succeed in that.

It is just -- and we are making progress.

Is this -- is this the transitional point when -- when it changes?

I hope it is.

I think we have a very good chance at growing faster than we grew this quarter.

And that is still yet to be seen, but the backlogs are there.

Thank you.

Thank you.

Thank you.

The final question will come from Carol Berger calling from Cres Investments.

Please go ahead.

Hi, guys.

Hi, Carol.

Would you -- your fee income, as you said, was up 9% year-over-year.

Which seems really good.

Didn't seem to me to go down as much seasonally as it usually does, nor relative to some of your peers, particularly on the service charge areas.

Could you help us in terms of the areas that really accelerate into the second quarter and why shouldn't fee revenues be up more than 10% year-over-year for the full year?

I'll just tell you that you are right, and I will have David talk about some more of the details, but our second quarter as you know, historically is very strong.

And frankly, I don't see a reason, assuming that the seasonality doesn't change, and we don't see any reason that it will that that won't take place this quarter.

But really, and in the second quarter, it is across all businesses.

Carol, let me address the question.

One is, the payments business is in total, if you take all five of them, they are all very strong in going from the first to the second quarter.

I think what you are focused on, is there is a particular category where your expectations were that we would have had lower actually growth from fourth to first, and really that is in the merchants side.

As you know, we have expanded our operation in Europe.

We have had some relatively small acquisitions with the acquisition of the Norway portfolio, as well as the one in Poland, and also we have had a great deal of success in the UK.

That is probably a piece of it, which is the expansion Euro connects, that is to some degree, has helped alleviate some of that near-term reduction usually that you see from fourth -- from fourth to first.

I think that is -- that is an element of it.

The other area that I think that we are used to seeing is because merchant processing has been such a dominant piece of it, and that's the most seasonal piece.

We had great success in growing the corporate payments business, both at the government sector as well as adding new corporations, particularly in the middle markets.

That has been a little bit of offset, but there is no doubt that you will see much stronger growth in the payments businesses from first -- from first to second.

And there is nothing about those acquisitions that would mute the seasonality?

No, not really.

No, no, Carol.

So even with those acquisitions, we should expect even a much stronger second quarter?

Yes, yes.

Now, is there any reason that we shouldn't be looking for the double digit fee revenues this year?

We should produce double digit fee growth, Carol.

Yes.

Okey dokey.

Thank you.

Thank you.

Thank you.

At this time we have no further questions.

I would like to turn the program back over to management for any closing comments or remarks.

I would just like to say thank you for joining us today and please give me a call if you have any questions.

Thank you.

This does conclude today's program. [OPERATOR INSTRUCTIONS] And have a great day.