美國合眾銀行 (USB) 2005 Q2 法說會逐字稿

Good day, and welcome to today's teleconference call.

All participants are on the line in a listen-only mode.

At this time I would like to turn the call over to your host, Mr. Mac McCullough.

Go ahead, sir.

Thank you, operator, and thanks to everyone for joining our call this morning.

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

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

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 now turn the call over to Jerry.

Good morning.

Thank you for joining us today.

We have had many positive developments and have many positive developments to discuss this morning, so I'll start with the highlights and David will provide more detail in his his commentary.

Today we reported record quarterly net income of $1,000,000,121 or $0.60 per diluted share, resulting in an 11.1% increase in the diluted earnings per share when compared to the second quarter of 2004.

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

Excluding securities, gains and losses, total revenues increased 3.4% from the second quarter of '04 and an annualized 13.6% over the first quarter of 2005.

Revenue per share, again, excluding securities gains and losses, increased 6.5% from the second quarter of 2004.

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

Since the fourth quarter of 2003, we have returned 104% of earnings to shareholders in the form of dividends and share repurchases, with the share repurchases resulting in a significant 5.1% reduction in common shares outstanding.

We repurchased 17 million shares in the second quarter, and this combined with our normal quarterly dividend resulted in a 92% return of earnings to our shareholders.

We're going to continue to aggressively repurchase our stock going forward, which will continue to result in a smaller number of common shares outstanding, but as you saw in the second quarter, we may need to retain some earnings in order to support the strong balance sheet growth that we are seeing.

Just to be clear, though, we are still targeting a minimum 80% return of earnings to our shareholders.

The net interest margin for the first quarter was 3.99%, a reduction of 9 basis points from the first quarter of 2005 and a reduction of 29 basis points from the second quarter of 2004.

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

Tighter credit spreads continued to have a significant impact on the reduction in our net interest margin, accounting for 4 of the 9 basis points reduction in the margin on a linked quarter basis and 18 of the 29 basis points reduction compared to the second quarter of last year.

As we have said in the past, we're willing to compete on price, but let me be very clear about what this means.

We are not leading the market in pricing; we are meeting the market in pricing.

We feel very comfortable doing this because of our cost structure, our expense discipline, and in particular, our extensive fee-based product and service offerings which allow us to compete on loan pricing very effectively and still drive net income growth with high returns on equity.

As I alluded to earlier, commercial loan growth continues to show excellent progress.

Average commercial loans increased 9% over last year at an annualized 16.8% over the first quarter of 2005.

Period end commercial loans increased an annualized 17.3% from March 31, 2005, indicating that recent strength in commercial lending is continuing.

Average retail loans grew 8.2% over last year, driven by 12.9% growth in leasing, 8.9% growth in home equity and 9% growth in credit card balances.

Turning to fee revenue, excluding security gains and losses, non-interest income increased 8.9% from last year and 6.9% on a linked quarter basis, which is an annualized 27.6%.

The payments fee categories increased 16.9% over last year, year-over-year reflecting recent investments and increased customer penetration with merchant processing increasing 20%, credit and debit card revenue increasing 11.3%, corporate payments increasing 16.5%, and ATM processing services increasing 26.7%, reflecting strong year-over-year results and growth.

Mortgage banking revenue was flat year-over-year but increased 7.8% compared to the prior quarter, driven by higher origination and servicing revenue.

We expect to continue to show growth in this line in 2005 as we have very good balance between origination and service revenues.

Deposit service charges increased 15.8% over the second quarter of 2004, driven primarily by net new account growth.

Deposit service charges continue to show strong momentum as second quarter deposit service charges increased by $24 million or 11.4% relative to the first quarter in 2005, an annualized 45% increase over the first quarter.

We expect deposit service charges to continue to show strong growth in '05.

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

Through the first six months of 2005 we have increased net new checking accounts by an annualized 6.4%.

And in the second quarter grew net new checking accounts 83,000 over the first quarter.

It's really pretty simple: If you grow net new checking accounts, you'll grow deposit service charges.

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 for our company.

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

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

Looking at these three categories for our branch network, the second quarter average was just over $34.7 billion, a 5% increase from the second quarter of 2004 and an annualized 7% increase from the first quarter of 2005.

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 service that our employees give, the breadth of product offerings that we have.

I'm particularly proud of the exceptional improvement we've seen in the Company's credit quality.

Net charge offs fell to 44 basis points of average loans in the second quarter compared to 55 basis points in the first quarter.

This decrease reflects both lower gross charge-offs and higher recoveries in the quarter.

In addition and importantly, non-performing assets also declined 8.3% from March 31, 2005 and were 33% below the level of non-performing assets at June 30, 2004.

We continue to place great attention and energy on the quality of service we provide our customers.

The tracking of our customer service efforts focuses on the customers' overall satisfaction, likelier to continue banking with us and the likelihood of recommending friends and family to U.S. Bank.

We have consistently increased the percentage of our core customer base that ranks us very high in all three of these very important measures.

Finally, we continue to build momentum from across -- across the franchise on a number of fronts in the second quarter, as evidenced by earnings per share growth of 11.1%, revenue per share growth of 6.5%, fee revenue growth of 8.9%, continued acceleration in the growth rate of net new checking accounts, a concept that is not new to us and is our raw material for future revenue growth.

And acceleration in the growth of commercial loans, continued improvement in customer satisfaction with 91.1% of our customers responding as satisfied in the second quarter.

The achievement of a 42.8% tangible efficiency ratio in the quarter and by concluding our seventh consecutive quarter of returning 80% plus of earnings to shareholder.

In conclusion, this company is executing on the fundamentals, delivering on our promises and producing the high-quality earnings that you expect us to deliver.

Now let me turn it over to David to give you more details on the quarter.

Thanks, Jerry.

Today we reported second quarter earnings of $1,000,000,121 or $0.60 per share on a diluted basis.

This was 11.1% increase in diluted earnings per share over the second quarter of 2004 and an annualized 21.1% over the first quarter of 2005.

Earnings quality was high this quarter but did include a few notable items: First, during the quarter we wrote our mortgage servicing rights down by $53 million, due to decreases in the yields on both the 10 year treasury note and 30 year Fannie Mae commitments.

We booked this impairment as an increase in intangible amortization expense.

This was a $224 million unfavorable change from the second quarter of 2004 when the Company wrote up the MSR valuation by 171 million and 107 million unfavorable change from the first quarter of 2005 when the Company wrote up the MSR valuation by $54 million.

Second, we incurred a 54 million charge related to a completed tender offer for certain subordinated and trust preferred debt securities.

Finally, the Company resolved all federal tax examinations covering all years through 2002, which resulted in a $94 million reduction in the Company's income tax expense.

Average earning assets grew $9.7 billion or 5.8% over the second quarter of 2004 as total commercial loans, which includes lease financing increased by 8.1%, commercial real estate loans rose a modest 1.7%, and retail loans increased 8.2%.

In addition, residential mortgages rose by 22.4% year-over-year.

These positive growth trends were somewhat offset by a reduction in the investment securities and loans held for sale.

Despite the growth in earning assets, net interest income declined $18 million from the second quarter of 2004 due to tighter credit spreads and asset liability management actions designed to maintain a relatively neutral rate risk position, including a 56% reduction in the net receives fixed swap position.

Going forward assuming we continue to see strong loan growth, we are going to partially fund loan growth by reducing the investment securities portfolio.

This will allow for continued growth in earning assets as loan growth volume will always be higher than the decline in the investment security volume.

We believe that this strategy will allow net interest income to grow and result in a more efficient use of equity capital.

The second quarter net interest margin of 3.99% declined 29 basis points from the second quarter of 2004 and 9 basis points from the first quarter of 2005.

Compared to the second quarter of 2004, tighter credit spreads, driven by increased competition and a higher proportion of low-spread credit products accounted for 18 of the 29 basis points decline.

The remaining decline for primarily reflects a preference to acquire low-yielding, floating-rate securities and higher rates pay 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.

We expect the net interest margin to stabilize in the third or fourth quarter of 2005 with the largest reductions behind us at this point.

We ended the quarter relatively neutral from a rate risk perspective.

At June 30, 2005, approximately 39% of the investment portfolio was variable rate and the duration of the portfolio was approximately 2.7 years.

We also continued the process of extending the maturity of wholesale funding during the quarter as well as completing a debt tender offer that would reduce our long -- our cost of our long-term funding as it is replaced with lower-rate borrowings.

Taking a quick look at business unit results compared to the second quarter of last year, we'll begin with wholesale banking, which increased net income by 9.9%, driven by improved credit quality and a 2.8% increase in total revenue.

Average loan balances increased 5.5%, driven by 9.1% increase in total commercial loans.

The business line posted net recoveries of 16 million in the second quarter, compared with 8 million or 8 basis points of net charge-offs in the second quarter of 2005.

Consumer banking increased net operating earnings by 22.5% compared to the second quarter of 2004.

Revenue increased 9.1%, primarily due to a 10.8% increase in net interest income that was driven by a 10.8% increase in total loans and higher earnings credit on deposits.

Total consumer loan origination volume was $6.5 billion in the second quarter, a 6.5% increase over the second quarter of 2004 and an annualized 32.7% increase over the first quarter of 2005.

Fee revenue increased 6.1%, driven by continued strength in deposit service charges.

Debit card transaction volume increased 22.3% over the second quarter of 2004 and an annualized 39.5% over the first quarter of 2005.

Non-interest expense increased 2.9% due primarily to higher compensation and benefits expense, driven by the addition of 68 branches compared to the second quarter of 2004.

Total net charge-offs declined 59 basis points in the second quarter of 2004 to 39 basis points in the second quarter of 2005.

Private client trust and asset management recorded a 22.1% increase in net operating earnings from last year, driven by a 7.9% increase in revenue in flat expenses.

Net interest income increased 29.1%, driven primarily by a 5.7% increase in total deposits and higher earnings credit for those deposits.

Long-term assets under management, which includes all equity and fixed-income assets increased 2.8% over the second quarter of 2004 and an annualized 9.9% over the first quarter of 2005.

Finally, payment services increased net operating earnings by 10.6% from last year, driven by fee income growth of 17.1% and a 2.1% decline in net charge-offs.

Total revenue grew by 11.6% as tighter spreads on credit card receivables and higher non-interest bearing corporate card balances and rebates reduced net interest income 7.2% from last year.

The 17.1% increase in fee revenue was driven by a 20% increase in merchant processing fees, a 16.5% increase in corporate payment fees, and a 12% increase in retail credit and debit card fees and a 40% increase in ATM processing services, which benefited from the expansion of our ATM business.

Credit card transaction volumes continue to show strong growth on both the consumer and the corporate sides of the business.

Our consumer card transaction volumes were up 9.3% compared to the second quarter of 2004 and an annualized 42% increase, compared to the first quarter of 2005.

Our corporate card transaction volumes were 21.2% over the second quarter of 2004 and an annualized 46.5% over the first quarter of 2005.

Total net charge-offs declined from 360 basis points in the second quarter of 2004 to 325 basis points in the second quarter of 2005.

Turning back to consolidated results, our capital ratios remain strong, we are comfortably above the minimum regulatory targets to achieve well capitalized status with a tier-1 capital ratio of 8.1% and a total capital ratio of 12.5%.

The tangible common ratio ended the quarter at 6.1%.

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

Our high-value, fee-generating businesses continued to show strong growth.

We're adding distribution in high-growth markets and investing in our capital efficient payment businesses.

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

Now I'd like to turn it over to Jerry for some closing remarks before we open it up for questions.

David, thank you.

I'd like to close by making a few comments about investing for the future of U.S. Bancorp.

First, as I reported to you in the past, we have invested approximately $2 billion in this franchise over the last four years with approximately 10% of the 2 billion invested in the retail branch distribution.

I would also like to point out that the 2 billion does not include capital that we've invested in acquisitions and increases in non-interest expense due to the addition of front-line sales personnel.

Last week, we brought 54 of our most senior business leaders together to discuss the actions that we must take to keep the long-term health of our individual businesses on the right track.

This was our third consecutive year of engaging our business leaders in this process and every year I walk away feeling more positive about the future of this great company.

Let me share a few thoughts with you.

First, I want to remind everyone that we have a very unique business mix.

A number of our payments and fiduciary businesses, which account for 25 to 45% of our company, depending on what you classify as payments, have very low equity capital requirements.

These same businesses also have highly-leverageable cost structures.

These facts, combined with our disciplined approach to expense control, have a lot to do with our high return on equity and industry-leading efficiency ratio.

Going forward, we see significant opportunities to invest in our payment businesses.

In fact, we expect to double $2.5 billion of 2005 revenue in certain of our payment businesses by 2009.

We also have plans to pilot investment centers in certain of our branches in order to increase our capacity to distribute investment and insurance products.

This may sound familiar, but the approach that we're considering has some unique features in terms of product and delivery and most importantly meets the needs of the market and our customers.

Finally, we're considering numerous business unit specific initiatives around improving sales effectiveness and increasing deposit growth.

Let me add one thought about deposit growth.

While we are developing new deposit-related initiatives for the future, the idea of developing deposit-related initiatives is not new for U.S. Bank.

Growing high-value, relationship-oriented deposit accounts is part of our DNA, always has been, always will be.

We've consistently reported the progress that we have made in growing net demand deposit accounts, and based on the growth that we've experienced in interest checking balances and deposit service charges, we are doing something very right.

You should also expect to see and hear more about the investments that I just mentioned as well as others that I did mention -- or did not mention, in the near future.

In closing, we've always believed that the actions we take to ensure the long-term health of our company need to be balanced with delivering short-term results.

We are confident that we are making the right long-term investments to keep this company healthy, and that our proven ability to execute will allow us to meet expectations over all time horizons.

This does conclude our prepared comments, operator, we'd be happy to take questions from institutional investors and analysts.

[OPERATOR INSTRUCTIONS] We'll go first to the site of John McDonald with BOA Securities.

Go ahead.

Hi, good morning.

Good morning, John.

I was wondering, with the seasonal uptick in the payments businesses, you had good performance there, how much of that is seasonal and how much of it is getting traction on the investments that you've been making in those payments businesses?

I'd say, John, if you look at it again, you're right, the seasonality is -- really does come to bear versus the first quarter, in the second quarter, but those business are growing double digits.

That would probably be the growth rate in those businesses, double-digit, low double-digit.

Jerry, maybe a little bit more color on where you have been investing in the payments businesses and the kinds of things that will drive the increasing revenues over the next couple of years that you just talked about in your strategic outlook?

Sure, I mean, the most obvious one, the one where we've -- excuse me-- had very visible investment, obviously, is in euroConex and NOVA, our processing business, which has just been -- has had spectacular results under Pam Joseph and her team.

That, obviously, is the number one area.

But also in our ATM processing business and our ATM acquiring business with the acquisition of Genpass was very, very important to us and also in our corporate payments business with the acquisition of, as you know, Multiserv in Houston.

So those are good examples of the continued investment that we've made over the last four years, in particular over the last year and a half in the payments businesses.

Also, in our credit card businesses, the substantial investment we've made to get into the Affinity business, which has been recognized by competitors.

We've made great progress, and that's an area that we're going to continue to focus on.

Then, John, it's just basic blocking and tackling on the other credit card business or what we call payment services business.

We still have a tremendous opportunity with our own customer base to deliver our card product, which is showing results now, and one of the great benefits of not having the distraction of large acquisitions is that we can focus on our business.

I did mention to you that this is the third time that we have met together in strategic planning over three days, the top 54 people in our company, and focusing internally on our businesses is going to really show benefits in the future for our company.

Okay, thanks, Jerry.

One question for David.

What is the impact on margin beginning to fund some of the loan growth from the bond portfolio and what's driving the outlook for margin to stabilize in the third or fourth quarter?

John, I think there's a couple of factors, I think, coming into play.

Number one is the loan growth that we're seeing is again fueling the earning asset growth, and we've concluded that we're going to fund that earning asset growth by really two major factors, one is as Jerry mentioned, we are planning some deposit initiatives, which will also, one both improve margin and second will also provide funding for the additional earning asset growth, the loan growth.

The second form of funding will be the reduction in the bond portfolio, and I believe that will also help improve margin.

And third, as you can see in our current earnings, our bond portfolio yield continues to improve, and that's the result of many quarters of migrating the portfolio from a fixed or a longer duration to a floating and shorter duration and the reinvestment of that cash flow will also help, and then finally, we've had, we're going to get some benefit from the debt tender program that we put in place in the quarter and we tendered to bonds.

So that will lower the overall funding cost for the Company as well.

So I think it's going to be both on the funding side and the asset side, which is why we expect margin to stabilize, either in the third or the fourth quarter, but we do expect by far most of the margin compression is behind us.

Okay.

That's helpful, David.

Do you think that some of the securities you'll be getting rid of to fund loan growth will be the lower-yielding assets?

Well, John, probably what we'll do as we have done in the past, we'll just allow the natural runoff of the securities portfolio, the cash flow coming from the bond portfolio, because it's so short, which is really by design, and that heavy cash flow will be the source of the funding.

I don't expect us to be selling securities as a result of that.

Got it.

That's great.

We haven't in the past.

We've looked at that securities portfolio as a securities portfolio, and we've not take actions to sell those.

John?

Yes?

We're very comfortable with the bond portfolio, both the duration as well the makeup and then the cash flow from that portfolio is really, I think, going to help us fund that loan growth and keep the margin intact and hopefully grow in '06.

Okay.

Great, thanks, guys.

Thank you.

Thank you.

We'll go next to the site of Mike Mayo with Prudential Equity Group.

Go ahead.

Good morning.

Good morning.

Your outlook for earning asset growth I guess would be flattish, if I interpret that correctly?

No, John.

No, I think we were clear, at least in my comments.

We do expect earning asset growth, and as I said, we expect the bond portfolio to partially fund the loan growth, but we do expect the loan growth to exceed the bond portfolio runoff, so we do expect earning asset growth.

And your comment about 2009, you want to double which area?

Well, I just gave you one example of our strategic planning that in the payments area -- and that would be basically in Pam Joseph's world, which includes NOVA, euroConex, our ATM business and our retail credit card business, we call it our payment services business, we would expect that that would be a goal that we want to accomplish, Mike.

And would that be also with acquisitions?

It could be a little acquisition, yes, but it's principally, there is some acquisition, but the vast majority is really from internally-generated.

And you addressed some of this, but Jerry, you've always said when revenues grow faster than expenses, great things happen, and that hasn't been the case as much recently.

If you could just discuss a little bit of this philosophical change between investing for long-term growth and meeting short-term targets?

I think that's a great question, Mike.

Number one, it reflects the investments we have made in this franchise from retail banking to (Expletive) near every business, and you will start seeing revenue growth exceeding expense growth, and I'd expect in the next quarter or two, but it really does reflect a substantial investment you have to make in the franchise, which we have been making really over the last four quarters in particular, and so you've got to bear the expenses of that, as you know, and we'll get back to that.

I mean, if you look at it, we grew revenue some $110 million in the quarter compared to the first quarter.

Expenses grew 103, something like that, and again, I think you'll start seeing the benefit of -- or going back to our growing expenses -- growing revenues faster than expenses, unless we decide to invest more, and we have been investing a lot of money in this franchise.

It grows, earnings per share, there is some catch-up, though, in particular in the investments we've made in the retail bank, which as you know takes about 18 to 35 months to come to fruition with a substantial investment in branches.

Also on the NOVA and euroConex side, takes, it takes 9 to 12 months to get that moving as we buy these portfolios, get them integrated.

So it's just a reflection, Mike, of our investment in this company and the fact that we're not starving investments or the future.

So we can make our earnings and still ensure that we have solid growth going forward in '06, '07, and '08.

Last question, as far as acquisitions, you've kind of sworn-off bank deals.

Is that still the case and what's your attitude towards selling to a larger firm?

The only reason I ask that last question is because I get so many questions about it.

Well, Mike, obviously, our Board of Directors would do what's absolutely right for the shareholders of this company.

To answer that last question.

But we have an extremely bright future, as you can see.

This is in my opinion the best quarter that we have had overall since we put these two great companies together.

I'm very pleased with our progress there.

As far as acquisitions, Mike, the prices for smaller deals, that would -- we would as you know consider are just too high.

We have too many options to invest in payments and other businesses, and so what we've done, which has lead to our expenses out-pacing our revenues as far as a percent of growth, which you've started your questioning of us about, is really the investment in building the retail franchise from scratch, instead of paying somebody else the entire premium for that and not getting a lot for it.

So that's our attitude, Mike.

And until prices stabilize, and do I think that will happen?

I think over the next two or three years that could, because there is going to be, I believe, a continued pressure on the assets side of the balance sheet, the banks that don't have fee income to offset that margin compression.

There's just a lot of money out there that's going to continue, and there's going to be a lot of pressure and I think prices might come down.

Again, within the context, Mike, of what we said, that are manageable for us and then we take advantage of it, but right now we'll build it organically and take the expenses that we have and have to absorb during the period of start-up rather than take our shareholders' money and spend it on things that are diluted.

Thank you.

Thank you.

We'll go next to the site of Lori Appelbaum with Goldman Sachs.

Jerry, you mentioned the strategic conference that you had with senior management of U.S.

Bank last week.

If you could be more specific about some of the initiatives that came out of it, whether it addressed strategies to improve growth in the consumer bank or better leverage, the payments activities across the broad customer base of U.S. Bank?

Yes.

Lori, I'm not going to get into the specifics of all of them.

I've alluded to some.

One, from a higher level, which I mentioned increasing our payments business revenues and doubling them almost $2.5 billion over the next five years, four years, five years.

That's one.

But we went through a deep dive on four strategic areas in particular, and every business in our company, and the ones that were obviously very important to us, which is the payments business, our community banking strategy, which is really starting to take hold, it's taking a long time, we've got a lot of money, or a lot of shareholders' capital invested in our community bank.

That is important.

We talked about that, including growing in certain markets of community banking, which you would look at as really, you probably -- many of you would think is not fast growing.

We have many markets of community banking that are fast growing and -- including markets throughout the west in particular, so we will be looking at additional branches in community banking and we're starting to see the benefits of that.

Also, obviously, we took deep dives in government banking, which as you know, government tends to continue to grow regardless of the economy, and we are a big player in government banking, not only federally, but also in municipalities.

That's an area that we think we have tremendous opportunity.

Lori, you know that we do business with half the banks in the United States.

We have a very, very strong correspondent banking division, and so that's an area of opportunity.

And obviously, the last one is private client -- not the last one, but private client we took deep dives there.

Private client, asset management and trust, as you know, our asset management business and our asset management company, First American Funds was awarded the Lipper Award last year, a few months ago, which was an incredible achievement by our company for our bank to receive that.

And so we've got -- we need to distribute more.

We know that.

We've got the performance now, as we've really turned over and changed the majority of people in asset management, and that is starting to show its results, but we need to distribute more.

Finally, small business.

Small business is an area that we've done okay in, but we are going to really focus on it.

We've got the branch structure, we've got the people.

Now it's just a matter of making it easier for our business people to sell small business.

We've done fine in it, but we can do a (Expletive) of a lot better, so we are going to really focus on that, Lori.

Okay, thanks.

Thank you.

Thank you.

We'll go next to the site of Fred Cummings with KeyBanc Capital Markets.

Go ahead.

Yes, good morning.

A couple questions.

David, is it worth quantifying the charitable contribution you made in the quarter as well as the integration costs and the write-down of the co-branding and the lease arrangements?

No, I mean, they're not material either way, Fred.

So I don't think it would make any difference to the quarter.

Okay, and then secondly, can you give us a breakout of the merchant business between the revenues coming from the U.S. and the revenues coming from Europe and then related to that, does the strengthening or weakening of the dollar have an impact on that business?

Well, first of all, with regard to the revenue, really the European operation is really a small portion of the total revenue of the payments business, and it's somewhere around less than 1%, quite frankly.

Oh, okay.

So it's a small piece, but I will tell you, Fred, it is the fastest growing piece because as you know, the domestic merchant processing business has largely consolidated in the U.S. and there are additional opportunities, but the investment that Jerry referred to is largely over the European area.

Now, our view is long-term trade, both as you know across Europe and we also haven't mentioned Canada, where we have a considerable expansion going on in Canada -- we believe would trade flows both ways.

It will help our business, and it will also add to the volume, but what's even more critical, Fred, is that we're operating this off one global platform, and that global platform really gives us the leverage as we grow revenues to incrementally add more profit because of this one platform.

Also, Fred, we also, again, are expanding in opportunities not only in Europe, but in Eastern European countries as well where we see tremendous opportunities to gain market share.

So our view is both trade flows and both consumer flows between the two parts of the world as well as quite frankly the leverage from our one single platform is really going to make a huge difference in our ability to compete, and again, in that business you're competing basically on down time and service and recoverability when you're downtime.

And that's what's critical and that's why the big investment we've made in the platform is going to make a really big difference.

Fred, if you look at the percent of revenues that Europe would be of total NOVA, it's somewhere around 14, 15, 16%, but it will be growing.

Our U.S. business continues to grow as we add value to the customers that we are acquiring here, but also -- but the growth rate in Europe will be faster.

This year it might be in the 14, 15, 16% of total NOVA revenues.

And then the impact of exchange rates on that revenue, is that meaningful?

No, it's not, Fred.

Okay, then one last question, if I may.

This seems like a major infection point on commercial loan growth this quarter.

Can you give us some sense of by geography which areas really showed strong growth?

Fred, the Midwest showed very good growth and the west as well.

We have lower market shares in the west, as you know, but we're starting to see -- but that gives us opportunities.

So it really was across the board.

I mean, as we've talked about a few years ago, that was an area of concern for us and we've made the changes, so it really was principally across the board, but if you look at Ohio and St. Louis was very strong, Chicago was very good, Nevada, Arizona, and Utah really good.

So it was really across the board for the most part.

Colorado, it was really all over, Portland, Oregon, Portland and the Oregon group was very good.

So we're making really good progress there.

Midwest, though, did fine.

Okay.

Thank you.

Yes.

Thank you.

We'll go next to the site of Ben Crabtree with Piper Jaffrey.

Go ahead.

Yes, thank you.

Maybe just a couple more points on the margin.

Couple of things that you highlighted in your release was obviously the pricing pressure on loans.

I'm presuming, I guess, given the forecast. of stable margins that maybe that is not getting worse?

Ben, I think that's right.

I mean, as you know, we spend a lot of time understanding our spreads by product, by market, month-to-month, and we're seeing, although the pressure is still there, we don't see it getting worse, and that's implied in our margin statement.

So I think that's a good conclusion.

And the other -- one of the other points you talk about, the loan mix changing, you can't help noticing the big jump in residential mortgages.

Obviously, those are not the highest yielding loans in the portfolio.

I'm just wondering kind of what's behind that growth and what the outlook might be there and are those in fact loans that might be sold in the future or anything like that?

Really, Ben, at this point in time we don't expect to be selling any loans.

As you know, in our mortgage banking operation, we originate both fixed and variable, and we're retaining the variable and we are selling the fixed, and the variable side, as you know, will adjust to higher interest rates and we expect improvement in the overall yield in the portfolio over time.

There may be a -- come a point in time, as we've had in the past, where we will begin to sell more of the variable rate, but we don't intend to in the near-term, but there could become a point in time where we begin to ratchet the growth from that portfolio back.

So over the near-term, the relative waiting of residential will probably stay about the same in the portfolio?

Yes, it will stay the same or maybe slightly higher.

Okay, then one very small point.

But you mentioned in the text higher pension costs from a year ago and I'm just wondering, I guess, I'm wondering if there were any changes in assumptions or anything like that or wha that's all about?

Mostly, you don't have a defined benefit, or you do have a defined benefit plan, don't you?

Yes, and, Ben, what we're referring to, is we made those changes back at the beginning of the year to reflect both a lower assumed investment rate and then also a lower discount rate reflecting the fact that interest rates were lower.

Those two combined as well as some other small changes reflected a higher pension costs, but those higher pension costs were also in the first quarter results as well.

Oh, okay, thank you.

Thank you.

We'll go next to the site of Meredith Whitney with CIBC World Markets.

Good morning.

I just wanted to ask two questions please.

First, can you explicitly go over your rate outlook for the remainder of the year?

And then also, I don't know if Pam's available, but discuss what is going on in the payment processing industry and what are some of the margin pressures we all hear about?

Let me deal with the rate forecast.

This is David.

Our view is we take the Fed at his word, and based on the statements we've seen and based on the pattern of the economic events that have unfolded so far, we believe that the Fed would really continue to increase interest rates, both in August and November, so we think it's safe to assume another 50 basis points, if not 75 basis points, and at that point, we would assume the Fed would then reassess the overall impact that not only oil, but interest rates are having on the U.S. economy.

Let me, Meredith, this is Jerry.

Let me address your question related to Pam's business.

She is not on the phone.

But, again, remember, we have a different product, a different customer mix than the large competitors, or our competitors in the processing business that deal principally with larger merchants.

So our spreads, although under some pressure are not at all under the pressure of the large retailers that basically have to process for teenies and tenths, so it is a big difference in the customer base that we both -- that we have.

So although we have some pressure, it is not meaningful for us, and Pam would say that obviously it's -- we always have to sharpen our pencil, it isn't -- we don't have a big impact in that today.

Could I just ask one more follow-up?

On your fee component of the business, how far can you take that?

That's come so far so fast anyway at least in the last two and a half years.

Where does that get in terms of percentage of total revenue?

Yes.

Meredith, I hold -- I want it to be as much as it can absolutely, but what's really important to our company is that we inflect on the net interest income side and that's hard to do when margins are under pressure, but I believe we're getting close to that infection, that is very meaningful for our company, when we can begin to grow net interest income, and so when you ask that question, I'd love it to be higher, but in my -- I mean -- but I want net interest income to grow, and I think it will, and in particular beginning at the beginning of next year, because if you look at just net interest income, you'll see that last year, this year beginning in the first quarter, there was a significant drop off.

We're starting to build that back.

Where would I like to see it?

We're in the 45% range, just as a -- in a general marker.

I'd like it to become more, but I want it to become more as we grow net interest income, and we are making progress at that.

Okay.

So again, you've seen our investments.

You know our company very well.

We have invested in the payments business over the last four years, in particular over the last two and a half years and you'll continue to see us invest there, certainly in the acquisition side, but again, I think that 45, 46, 47% range is probably the area we're looking at over the next few years, understanding that we are going to hit that inflection point on net interest income as margin stabilizes and we continue to grow our loans.

Got it.

Great.

Thanks so much.

Thank you.

Thank you.

We'll take our last question from Stephen Wharton with Morgan Stanley.

Go ahead.

Hi, guys.

Good morning.

Good quarter.

Thank you.

Thank you.

My question involved the deposit initiatives you've made reference to.

I know that Jerry, when you were talking about deposit growth and the good type of deposit growth that comes from the branches and that's non-interest bearing interest checking and savings, that's 37 billion, which represents about 42% of the traditional definition of core deposits and about 31% of your total deposits, so while it's good that's growing, obviously I think all of us would like to see greater overall deposit growth.

And I was just curious specifically what you're talking about with these deposit initiatives because yet again, quarter-to-quarter when I look at the rates you're offering on your average balance sheet, they look like they're not moving much.

Well, number one, I think we should be applauded for that to some extent because we've been able to keep our customers and grow what we think are quality deposits, but to answer your question, we'll have to see some movement I think in rates.

That is one area.

But again, rates -- and there have just been recent analysis done that the correlation or the relationship between rates and deposit growth, there is little correlation.

It's really service, the location of your branches, how you product -- how you package your products.

But I think, Steve, overall what you're going to see is some increase certainly in certain markets of interest rates to better compete with some of the competitors out there in markets that we think we can add values to.

And then we're just going to focus on it.

And when we focus on something, we typically get it.

So I think you'll start to see some progress there.

So I think in certain areas like small business is an area that we're going to see substantial growth because we're going to focus on it.

Government, the government area is an area that we have tremendous raw material to do more.

We're a big enough business to date, but we're going to become bigger, both Federal -- both on the Federal side and on the municipal side because of our large as you know, community banking structure, we have people in-country in all of these community markets and we're going to really focus on those, Steve.

And I think you'll start seeing the benefits of that in quarters to come.

David?

If I can just follow-up.

I think we've talked in the past about how much you want to spend, so to speak, on deposits, by pricing up, versus the offset, which was you could get very good rates on long-term debt, and the medium-term debt.

When you forecast your margin then going forward, you said you thought the worst was behind you, have you then factored in like maybe pricing up a little bit more on deposits to be closer to the market rate, like money markets?

Let me describe.

We factored in a number of things.

One, we factored in the rate increases I just spoke about before that are expected to come from the Fed.

We have built in higher cost on the retail and commercial side of the depository side, but as Jerry mentioned, we've been very judicious in where we applied those increased deposit rates across markets and across products, so it's not one rate across the whole franchise, so we've been very judicious in that aspect of it.

So yes, it does allow for that, it does allow for increases in the federal funds rate and essentially, the same yield curve that exists actually today.

Okay.

Thanks.

Thanks, David.

That concludes the question and answer session.

I'll turn it back over to your hosts.

Thank you.

Before we sign off today, I would like to announce that going forward our earnings calls will be pre-recorded and available at the same time as our earnings press release.

Thank you for joining us on the call today.

And as always, please call if you have any questions.