美國合眾銀行 (USB) 2006 Q4 法說會逐字稿

Welcome to the U.S.

Bancorp's fourth quarter 2006 earnings conference call.

Following a review of the results by Richard Davis, President, 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 4:00 p.m.

Eastern time through Tuesday, January 23, at 12:00 midnight Eastern time.

I'll now turn the conference call over to Judy Murphy, Senior Vice President.

Thank you for joining us.

This is Judy Murphy, Director of Investor Relations at U.S. Bancorp.

Richard Davis and David Moffett are here with me today to review U.S.

Bancorp's fourth quarter and full year 2006 results.

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.

I would like to remind you that any forward-looking statements made during today's call are subject to risks and uncertainty.

Factors that could materially change our current forward-looking assumptions are detailed in our press release and in our Form 10-K report on file with the SEC.

I will now turn the call over to Richard.

Thank you, Judy, and thank you for joining us today.

I'd like to start the call by talking a few minutes about our highlights for the fourth quarter and for the full year 2006.

I'll then turn over the call to David who will provide you with additional details about our earnings.

After we've completed our formal remarks we would be happy to entertain questions from the audience.

We achieved earnings of $1.194 billion, in the fourth quarter of 2006.

That would be earnings per diluted common share for the fourth quarter of $0.66 or a 6.5% increase over fourth quarter 2005.

Net income for the full year 2006 was $4.751 billion, or $2.61 per diluted common share.

This represents a 7.9% increase in earnings per diluted common share year-over-year.

Although the growth in earnings per diluted common share for the fourth quarter and for the full year 2006 was lower than it has been over the past few years, I'm satisfied with our results given the challenging economic environment that our company and the banking industry as a whole has faced during the past year.

I believe that the investments we've made in our fee based businesses, our high credit quality standards, and our disciplined expense control have helped to mitigate the impact of this less than favorable environment.

That being said let's review some of the highlights of our fourth quarter results.

First, we achieved a return on average assets of 2.18% and a return on average common equity of 23.2% in the fourth quarter.

These profitability metrics continue to be among the best in our industry.

Second, our fourth quarter net interest margin of 3.56% was equal to the net interest margin we reported in the third quarter of 2006.

The stabilization of the margin combined with the fourth quarter annualized growth and average earning assets of 5.2% resulted in a a $22 million increase in net interest income over the prior quarter.

Significantly, this is the first time since the third quarter of 2005 that we have seen our linked quarter increase in net interest income.

This is an important inflection point because going forward, as the net interest margin stabilizes and our fee based revenue grows, we'll be creating operating leverage for our company.

The net interest margin was, however, 32 basis points lower than in the fourth quarter of 2005.

David will discuss the reasons for the margin changes year-over-year in more detail later, but I'd like to note the credit spreads are tighter than they were a year ago and accounted for 15 of the 32 basis point drop year-over-year.

Although credit spreads appear to have stabilized for both commercial and retail loans over the past number of months we continue to see aggressive competition.

We expect to be challenged going forward to grow credit products at a reasonable spread, a spread that is no less than what we need to win the business and still compensates us for the risk and given our efficiency we can afford to be competitive to win the business and that also gives us the opportunity to cross sell our fee based products.

Fee revenue, particularly the trust and payments processing related revenue, was another highlight this quarter.

Year-over-year, our payments grew through fee revenue by over 15%, while the wealth management business, line grew fee income by almost 20%.

Both business lines benefited from acquisitions that experienced excellent organic growth as well of approximately 10 and 7% respectively.

In addition to the trust and payments processing related fees, deposit service charges posted a solid increase of 8.8 % in the fourth quarter of 2006 over the same quarter of 2005 driven primarily by net new account growth and transaction related fees.

As many of you know, growth in net new checking accounts is the only non-financial measure for which I hold our branches accountable.

In the fourth quarter of 2006, excluding our new branch acquisitions, we added 36,000 net new checking accounts for a total of 281,000 net new accounts for the year.

This represents an annualized growth rate of 5% from our January starting point of 5.6 million checking accounts.

We continued to demonstrate our expense discipline this quarter while investing capital in a prudent manner.

Although total operating expenses increased by 148 million or 10.1% year-over-year, the majority of that change can be attributed to our recent acquisitions and integration related expenses as well as tax credit investment amortization and a few unusual items that David will discuss in more detail later.

This was also true for the change in expense on a linked quarter basis.

Because of this disciplined approach to expense control, our tangible efficiency ratio for the fourth quarter of 2006 was 44.5%.

Although higher than the recent past due to the franchise investments and those few unusual items, we still remain one of the most efficient financial institutions in the industry.

One of the balance sheet highlights for the quarter was solid year-over-year growth in average total commercial loans and total retail loans of 6.6% and 6.5% respectively.

Going forward, we expect that our company's growth in commercial and commercial real estate loans will be slightly lower than the industry average as we continue to concentrate on originating high quality credits.

Moving on to credit, once again our credit quality metrics were excellent.

Net charge-offs were 47 basis points of average loans for the fourth quarter of 2006.

Higher than the 38 basis points in the third quarter of 2006 but below the 62 basis points in the fourth quarter of 2005.

The increase over the prior quarter was primarily the result of an expected increase in retail bankruptcy related charge-offs, slightly higher commercial charge-offs, and a reduction in commercial and other retail loan recoveries.

Going forward, we expect that both commercial and retail net charge-offs will increase moderately due to the normalization of bankruptcy related charge-offs, slightly higher commercial charge-offs, and continuing lower recoveries.

Non-performing assets increased to to $587 million at December 31, 2006 from from $575 million at September 30, 2006.

They were, however, approximately 9% below the the $644 million balance at December 31, 2005.

At this time, looking forward into 2007, we would expect any increase in non-performing assets to be fairly modest.

Finally, one of the most significant highlights of the quarter, the Company announced a 21% increase in the dividend rate on U.S.

Bancorp common stock.

This increase is an important part of our strategy to continue to commit to return 80% of our earnings to our shareholders through both dividends and stock buybacks.

In terms of buybacks, we repurchased approximately 90 million shares of stock in 2006, and this combined with our quarterly dividends has resulted in a 112% return of earnings to our shareholders for 2006.

Our continued emphasis on returning 80% of our capital to shareholders does not diminish the growth prospects of this company.

We feel strongly that 20% of earnings that we can retain is more than enough to support the growth in our balance sheet, capital expenditures and cash acquisitions.

The higher dividend payout is consistent with our strategy of low risk, dependable earnings and financial discipline.

Before turning the call over to David, I'd like to share a few highlights from our business line results.

The payment services groups net income for the fourth quarter rose by 39.4% over last year.

This business lines results were primarily driven by a 13.9% increase in total net revenue and a 27.4% decrease in the provision for credit losses.

Major fourth quarter accomplishments included--an impressive 13% increase in average loan outstandings year-over-year; the sale of the 12 millionth gift card in December; and the approval of the European Bank Charter for the Elevon Financial Services by the Irish regulators.

This bank will help us to cost effectively manage our expansion of the payment services businesses in Europe.

The wealth management team recorded a 20% increase in net income over the last year, driven by a 16.1% increase in total net revenue.

Major fourth quarter accomplishments included--the successful completion of the Wachovia Trust and Custody Systems conversion and integration; continued progress on the SunTrust Corporate Trust Systems conversion and integration which is scheduled to be completed next month; the acquisition of LaSalle Corporate Trust business in December; the sale of our 401(k) record keeping business; and finally, the achievement of best-in-class client satisfaction ratings for the private client group with a composite rating of 97 versus an industry benchmark of 85.

Our consumer banking groups net income was lower year-over-year by 2.1%, however, excluding mortgage banking, the groups net income increased by 4.8% driven by a 2.9% increase in net revenue and a 14.3% decrease in the provision for credit losses.

Major fourth quarter accomplishments included--the successful conversion of the Vail Banks; the announcement of the acquisition of Heritage Bank in Montana; and the opening of 15 new in store branches.

Finally, our wholesale banking teams fourth quarter net income declined by 9% year-over-year.

The result of a 4.7% decrease in total net revenue essentially by expenses and a $10 million unfavorable variance in the provision for credit losses.

Highlights for these business lines included--continued progress on the reorganization of our wholesale group into three distinct lines of business.

Corporate banking, commercial banking, and commercial Real Estate.

Under the leadership of Dick Payne, who is new to our company since July, Joseph Otting, and Joe Hoesley, respectively.

We introduced formal training to all of our wholesale lenders in fourth quarter 2006 and we also introduced new more formal prospecting protocols, enhanced calling and collateral material and we created new sales incentives for our merging payments and processing capabilities.

I'll now turn the call over to David to give you more details on the quarter.

Thanks, Richard.

Net income in the fourth quarter of 2006 was 51 million or 4.5% higher than the fourth quarter of 2005 and just slightly lower than the third quarter of 2006.

At this time I'd like to take a few minutes to point out a number of items that effected the comparison of fourth quarter results to prior quarters.

First, mortgage banking revenue in the fourth quarter 2006 was lower than both the same quarter of 2005 and the prior quarter of 2006 by $84 million and and $43 million respectively.

The variance was primarily due to the adoption of FAS 156, the fair value method of accounting for mortgage servicing rights, during the first quarter of 2006.

In addition, MSR economic hedging results in the fourth quarter 2006, the outcome of an adverse relative change in interest rates at year-end contributed to the decline in mortgage banking revenue from both time periods.

Second, other non-interest income in the fourth quarter included a $52 million gain from the sale of the Company's 401(k) retirement plan record keeping business, and a $6 million trading gain related to a certain interest rate swap while the third quarter of 2006 included a $32 million gain related to the sale of equity interest in a card association.

Non-interest expense in the fourth quarter of 2006 included a $22 million charge related to the pre-payment of certain trust preferred debt securities.

In addition, the amortization of tax advantage investments was approximately $26 million higher in the fourth quarter of 2006 when compared to the same quarter of 2005 and $43 million higher than the third quarter of 2006, the result of an expansion of investment in these tax advantaged projects.

There is seasonality to the amortization and the fourth quarter does reflect the highest level of amortization.

As Richard indicated, with the exception of these items, the majority of the increase in the expense year-over-year and on a linked quarter basis can be attributed to acquisitions and their related integration cost.

The effective tax rate in the fourth quarter of 2006 was 26.7% lower than the tax rate in the prior quarter of 30.7% and lower than the 30.8% effective tax rate in the fourth quarter of 2005.

The change in the effective tax rate was due to the increase in the investments and the tax advantage projects as well as the resolution of federal income tax examinations through 2004 and certain other state tax examinations.

We anticipate that the effective tax rate in the future periods should approximate 32%.

Moving on to the balance sheet.

Average earning assets rose $6.6 billion or 3.6% over the fourth quarter of 2005 as total commercial loans increased by 6.6%, commercial real estate loans rose by 1.3%, and retail loans increased 6.5%.

In addition, residential mortgage loans increased by 4.5% on a year-over-year basis.

Loans held for sale and other earning assets also increased year-over-year.

On a linked quarter basis, total retail loans recorded the strongest growth with an annualized growth rate of 11.2% while total commercial loans grew at an annualized 5.2%.

Residential mortgages were up just slightly from the third quarter reflecting the Company's decision to sell an increased proportion of the residential loan production.

Average investment securities declined year-over-year by 3%.

The reduction in the investment securities portfolio from a year ago primarily reflected asset liability management decisions to reduce some of the Company's exposure to residential mortgage assets.

In addition to a reclassification of $460 million of principal only securities to the trading account in connection with the adoption of FAS 156.

Average investment securities were just slightly higher on a linked quarter basis.

Going forward, we would expect the investment securities portfolio to remain fairly close to its current balance of approximately $40 billion.

Despite the 3.6% growth in earning assets, net interest income declined by $90 million or 5% from the fourth quarter of 2005 as the net interest margin declined to 3.56% from 3.88% during the same period.

Compared to the fourth quarter of 2005, tighter credit spreads driven by increased competition and a higher proportion of low spread credit products, including growth in non-interest bearing corporate and purchasing card balances accounted for 15 of the 32 basis point decline.

The remaining decline primarily reflected the impact of funding incremental growth with higher cost wholesale funding, share repurchases, and asset liability management decisions designed to minimize the Company's rate sensitivity position.

These negative factors were partially offset by the higher value of net free funds and loan fees.

On a linked quarter basis, net interest income increased by $22 million or 1.3%, which was the result of a stable margin and a $2.5 billion increase in average earning assets quarter-over-quarter.

Based on the results of the fourth quarter, our current balance sheet position, and assuming the Fed has quit tightening, we would expect our margin to continue to remain relatively stable.

Total average deposits in the fourth quarter of 2006 were $1.3 billion or 1.1% lower than the fourth quarter of 2005.

The decline in average non-interest bearing deposits year-over-year reflected reductions in business demand deposits as our customers reduced excess liquidity.

Deposit balances and lower rate money-market and savings accounts continued to migrate to higher rate time certificates of deposit in both the wholesale and the consumer business line.

This migration reflected the Company's deposit pricing decision for money-market deposits in relation to other fixed rate deposit products.

Total average deposits in the fourth quarter were 1 billion higher than the prior quarter with the largest increase coming in non-interest bearing deposits and interest checking, primarily reflecting the growth in corporate trust and the government banking areas.

Finally, as Richard mentioned earlier, we returned 112% of earnings to shareholders in the form of dividends and buybacks in the fourth quarter of 2006.

Even with this return of capital to shareholders, we remained well capitalized and exceeded our capital targets with Tier 1 and total capital ratios of 8.8% and 12.6% at December 31, respectively.

I would now like to turn the call back to Richard for his closing remarks.

Thanks, David.

In conclusion, we'll continue to focus on organic growth and investment of businesses that will enhance our product and service offerings.

We'll also continue to add distribution in high growth markets through in store expansion and select de novo branch editions.

I'm personally honored to have this opportunity to lead this U.S.

Bancorp into the future.

Our long term goals have not changed.

I believe we are positioned to produce a consistent, predictable and repeatable earnings stream which will make our company an attractive partner for our customers, communities, employees, and shareholders.

David and I would now be happy to answer any questions from the audience and Operator, we're ready to take the calls.

Yes, sir. [OPERATOR INSTRUCTIONS] We'll take our first question from the site of Jason Goldberg with Lehman Brothers.

Please go ahead.

Thank you, good afternoon.

Hi, Jason.

One, or both of you commented that you expect MPAs to only increase modestly as we kind of look around some of the other banks have reported we've seen much more significant increases in MPAs this quarter with actually a slant to more of the increase actually coming in the Midwest.

I guess what do you see or experiencing that maybe others aren't, to give you the confidence to I guess make that claim.

Thank you, Jason.

This is Richard.

I'm not sure what others are saying or what their balance sheet would portend, but I will say that we have a very good forecasting acumen in our company for non-performs and at this point in time we do think that those are fairly stable and the numbers that you see and have seen in the most recent past are very much what we expect in the future.

We would not, in terms of the commercial business, see that marked by any geographic uncertainty one way or another across the marketplace; however we do see some of the Midwest areas of stress on credit quality and the consumer portfolios.

We don't really see anything geographically based on the commercial side.

And non-performs for us are as you would expect a very good bellwether for the quality of our portfolio and as we've been saying for quite some time, while we may not be taking some of the same growth opportunities that our peers have been taking over the last couple of years, likewise we don't expect to be taking some of the same credit decrements over the future quarters as we might expect some of our peers.

So for us it's a consistent outcome.

Sounds good.

And then secondly, on the consumer chargeoffs as we kind of return to I guess bankruptcy normality or however you want to phrase it, I guess how much more room do we have, do you think, to kind of continue to go up with respect to kind of the bankruptcy piece and I guess over what time frame do you think that occurs?

Well, I will tell you, and I'm sure you've heard this from others, we haven't seen the normalization to the pre- bankruptcy levels yet in the industry and I'm not so sure that we will.

We think that maybe some consumers may be deciding just to walk away in the future as opposed to going through the bankruptcy protocol, but I will say that we do think based on the quality of our portfolio, again a high percentage of it being credit cards and consumer direct, we don't expect that number to be materially different in the future coming quarters with the exception of just a small and slight retreat back to some bankruptcy levels.

So I don't think in this Company we'll get back to pre- bankruptcy.

If you remember where we were, we were actually one of the best in our peer groups as well because of the quality of our underwriting and as I see the next couple of quarters you'll see a very modest increase, as much driven by the size of our portfolio growth as you will by any credit dimensions that are relevant to a decrease in quality.

Sounds great.

Thank you.

Our next question comes from the site of John McDonald with Banc of America.

Please go ahead.

Hi, good afternoon.

Hi, John.

Question for David on the tax advantage investments.

David, do I understand that the tax credits will go away in the form of the tax rate this quarter as the tax rate will come up?

Will the amortization expense go away or will that continue to be higher in the other non-interest expense?

Yes, John.

Let me explain it.

The way these programs work, the -- most of the volume always comes in the fourth quarter, and along with that comes an increase in the amortization of the tax credit investment, an offset to that then, therefore, is essentially a lower tax rate, and you saw that in the fourth quarter.

Now, the tax rate was also impacted by the tax settlement that we had with the IRS and also the state, but to answer your question specifically, you would expect to see much lower tax rate amortization in the first three quarters of next year and then again probably a seasonal increase in the fourth quarter with the related reduction of the tax rate.

That's why we provided you some guidance with regard to the overall tax rate of 32%.

That takes into account what we would expect to be a normal production of investment tax credits along with the other factors like the growth in taxable income and so fourth.

And can you help us on the other side with quantifying the increase in amortization expense?

I don't, at this time, I don't really have an estimate.

I can tell you that I think it would be relatively -- it would be lower in the first quarter and begin to creep up but nothing that's going to be a material change, the results like maybe in the fourth quarter.

So lower in the first than it was in the fourth?

Yes, definitely.

Okay.

And on credit, just following up on Jason's question, any updated thoughts on what normalized your mid cycle net chargeoff ratio might look like for you guys?

Well, I'd say -- this is Richard.

I would say that you've seen us as high as the 80 basis points at the peak of the cycle last time and this company has really I think corrected it's credit dimensions over the last couple of years, so I mean, John, as a real guess, I would say that we would be looking in the mid 50s to mid 60s kind of chargeoff ratio over the long period.

Okay.

Thanks very much.

Okay.

Our next question comes from the site of Ed Najarian with Merrill Lynch.

Please go ahead.

Hi.

First question is related to capital management.

Obviously, got the big dividend increase announcement a little while ago, but we saw much less stock repurchase this quarter.

Can you dimension now with a higher payout ratio how you're thinking about capital ratios and stock buybacks for '07?

Sure.

Ed?

Let me just describe it this way.

We have in our plan continued to target a return of earnings of 80% in '07.

Based on dividend payout, we would assume that the payout ratio is going to be somewhere in the order of 47%.

The result, and the remaining difference would be the buyback, assuming we don't have any other cash acquisition.

So, I would expect that the buyback would be higher going into the first quarter and higher for the year than what you saw in the fourth quarter largely because we have more capacity and we don't have the acquisitions in the forefront.

That still retains 20% of it for balance sheet growth and other potential acquisitions.

Okay.

So you're feeling like you're going to get much closer to that 80% number?

Yes.

This year rather than surpassing it by a great deal as you have in prior years?

Yes.

Ed, also just to remind you, last year in '06, one of the things that we did starting in March of last year was we basically switched from targeting a tangible common ratio to a Tier 1 capital ratio.

The result of that was to essentially buyback a fair amount of stock and replace it with capital securities.

That's why you saw such a higher increase in '06.

I would expect in '07, targeting the 8.5% Tier 1 capital ratio that the buyback would be more consistent with the 80%.

Okay.

Thanks.

And then second question, you mentioned with respect to the lower mortgage banking fee income number.

Yes.

Some negative impact from some hedging activity for the MSR.

Can you quantify that for us or how much was that pulled down because of MSR extra -- extra MSR amortization or some negative hedging impact?

Let me just describe it this way.

During the quarter, actually, at the very end of the quarter, we use Treasury securities and options to hedge the mortgage servicing rights.

During the very end of the quarter when we're doing our valuation, that spread narrowed dramatically.

As a result of that, two things happened.

Our mortgage servicing right asset actually declined in value and then the other thing that happened is actually our hedge also declined in value which had not happened since we've been doing the hedge.

Now, since that time, a fair amount of that has already been reversed in the first few weeks of January, so that's primarily principally the reason, but of of the 43 million that you're looking at between the third and the fourth quarter, 41 of that is essentially those two components, the hedge itself and the MSR.

The other part of it was a mix between lower originations but higher servicing income, but 41 of the 43 was really the hedge.

Okay, that's helpful.

Thank you.

Yes.

Thanks, Ed.

Our next question comes from the site of Tony Davis with Ryan Beck.

Please go ahead.

Hi, Richard, Dave.

I wonder if you could talk a little bit about the margins in the wealth management and your corporate trust business because last quarter I think payment services were pre-tax margin like 55 and wealth management was 48, it really hadn't changed a lot over the last year and I guess the question is--at what point should we expect some diminished conversion, integration, and other cost up front expenses, if you will, to see some improvement in the margins in those businesses, and then are you going to slow the acquisition pace enough to let that happen?

Well, let me tackle both of them for a second.

Tony, in the payments business, one of the things that we have going on next year are some fairly very important changes over in Europe.

One, we have basically part of the European payment process that we've acquired or the merchant funds we have acquired over the course of the year, they will be assimilated on to a global platform.

There will be some conversion costs related to that in '07; however, along with that, we would expect a continued growth in revenue and some cost reductions and the reason the cost reduction is because we've just been approved to establish a bank in Ireland to basically reduce some costs that we have across the platform in Europe.

So I would expect the margins actually in the overall payments area to actually improve slightly into '07.

One is because some of the diminished conversion costs, but also we're getting some cost benefits from the consolidation into the bank in Ireland.

With regard to the wealth management business, for the most part , their conversion activities are really over in the first quarter, so I would expect their margins particularly in the corporate trust side to also show some improvement as well, so I'm pretty positive both of them will show improvement.

Okay, good.

Richard, can you give us anymore color on Powerbank?

I guess any comment on household or revenue lift you're seeing, where you're going after Portland in May and just your take on how it's progressing?

Thank you, Tony.

Yes, Powerbank for everybody on the call is our approach to our large legacy markets where we're going in and taking one market at a time and basically owning our position as a market leader, and we're not doing it just through price.

We're not rate mongers where we run out and throw a rate at a customer and hope that we grow the business.

We did this in St. Louis earlier this year and Tony, I will say that the progress has been greater than we had hoped, Rick Hartnack, as you know, had tested this model in Fresno, California, at a prior bank and we've exceeded I think all of the benchmarks he may have set for us and in accordance with that, we are taking this to Portland in early spring and what we'll see next is one of our large legacy markets later in 2007, and when I say legacy markets, U.S.

Bank is comprised of really six very large old headquarters markets and a seventh large market, those six being Cincinnati, Milwaukee, Minneapolis, St. Louis, Denver, and Portland, the seventh being Seattle by virtue of the old U.S.

Bank growing north of Portland.

Those seven markets are the candidates for Powerbank and I would suggest to you that between now and the end of '08 we will have launched our Powerbank initiative through those large markets completely.

I'll also take you to the small community markets where we have over 1,000 of our branches and there are opportunities to do what I'll call mini Powerbanks in smaller markets where it won't get the notoriety, but the approach we will take by taking a higher perspective on convenience, more hours, aggressive posturing in the marketplace through advertising, improved interest rates on certain key products, children's banking, super savings accounts and things like that.

You will see those quietly introduced throughout the next couple of years and then I might add the other side of our equation has the many many branches in the larger cities where we have a growing position like the Phoenix, Las Vegas , Southern California, Nashville markets where we have a small presence but nothing but upward opportunity.

We have not named this approach but it's a predatory approach where we're going to go in and be much more aggressive against those peers that are longer, older, and more staid and to give ourselves a chance to be competitive on a fairly different basis and that we will launch this year as well, probably need to name it so we can all call it something, but it does kind of parallel the same path of taking our markets one at a time, testing things, and then taking what works and moving it to the next market.

That's helpful.

Thanks, Rich.

Thanks, Tony.

Our next question comes from the site of Gary Townsend with Friedman Billings Ramsey.

Please go ahead.

Good afternoon, Richard, David.

Hi.

I'd like to thank you for moving to this format.

I think it's been very very helpful.

Thanks, glad to hear it.

Just following on on the Powerbank initiative, could you talk about exactly the, or as precisely as you can, the types of goals that you would have for how would we know you're achieving successes?

How do you know it?

Sure.

Well, Gary, Powerbank for us starts and ends with really two things.

We measure net growth of checking accounts as you heard earlier on the call as a key metric for success.

We have a saying here from all good things emanate from a checking account and that does qualify for opportunities for fee based businesses and cross selling.

So first and foremost, our net checking growth in the companies I said was 5% last year.

I would say in these older legacy markets, that number is more like 3 to 5%, in the higher growth, more youthful markets for us, they were more like 6 to 8%.

So our number one goal would be to get our net growth of checking accounts in these very large markets from a very large based growth at 5% level.

The second and related tangent is the quality of customer service that we measure and have now for over six years.

For the last two years, Gary, we've been evaluating branch performance of customer service at a branch level that is sufficient sampling size to actually pay incentives or decrease incentive payouts based on performance.

I can say St. Louis as a measure has moved from the middle of the pack to our most highly impressive and highest performing customer service satisfied market in all of our large markets and we do hold Powerbank accountable for that.

Of course that's nice to have but only good if retention improves and attraction of new customers goes up which it did and so we will measure those as our two baseline initiatives because in fact, there will be an investment curve ahead of it through advertising, additional hours, more FTE investment in certain technology that must be paid back over the course of time which we have the patience to do but is exactly why we're not doing it across the bank all at once because that would be too big to bite off without knowing how the story ends.

So I would give you those kind of dimensions and Rick Hartnack, I think is very -- not only optimistic about the success we've had in St. Louis and we're already seeing a halo effect in Portland before we launch the very first initiative which I think says a lot to the employees excitement for getting something like that.

Very interesting.

Yes.

Your held for sale loans grew the most low in ten quarters.

Does that reflect your decision to originate and sell or how should we think about that?

Well, I think that's exactly what we're doing.

We are -- made a shift to originate and sell more of the mortgage production, particularly the fixed, which we have been doing for a long time, but we also have made the decision to sell a lot of the production of both the five year arms and the seven year arms as well.

What about the Corporate portfolio?

We have nothing in the Corporate portfolio at all in the held for sale.

Okay.

This is the all single family with some student lending loans, but it would not be any corporate.

Yes, okay.

I understand, thank you.

Thanks, Gary.

Our next question comes from the site of Michael Mayo with Prudential Equity Group.

Good afternoon.

Richard, since this is the first chance we had to talk to you in your new CEO role, a couple general questions.

Any changes to the financial targets or what are the targets ahead?

Sure.

I'll start there.

No.

We're not making changes over the long view of this company.

I would tell you, we will make slight adjustments according to what opportunities come about in this marketplace, number one.

Number two, it's going to be my job to call to your all attention, the continued diversification of earnings we're starting to achieve through our recent couple of year ago decision to move into the payments and processing businesses, but we will stay true to our 80% return to shareholders as Dave and I have focused on in this call.

We'll stay true to our 10% earnings per share over the long term and long term is three, four, five years, I'm not smart enough to know which one it is but I'll tell you this company will not promise you 10% every year regardless of the environment because that would be imprudent and frankly missing opportunities as the environment changes.

But I will tell you that we plan to be better than our peers every one of those years no matter what the moving environment calls for and over the course of time you can expect 10% or more earnings per share.

And then finally, Michael, I think the effort of our dividend decision last month reflects our strong value in trying to transfer ownership of the growth of this company's profit to our shareholders by way of both the buyback and stock dividend.

Namely, our ability to return and generate capital is very very unique to this company, vis-a-vis our peers, and that capital generation is an advantage that we feel we should take advantage of, pass along to our shareholders and that along in accordance with the 80% return and the 10% long term EPS growth we think has been a solid platform we've been operating on for at least the last three years and I don't see any change in that in the future.

Any tweeks into compensation?

I mean what drives your compensation the rest of executive management?

The reason I say that, it sounds like on a year to year basis you compare yourselves to how you do versus peer and I look at the organic growth by business line and wholesale, 1 to 2%, consumer 6%, and you mentioned earlier, I thought you said wealth 10%, and payment services 7% and if you compare that to certain peers it doesn't look right.

Sure.

By the way those are sound bites from like organic pieces and things like that, so the payments group and the wealth management group last year in net income were both 20% or 25%.

So when I was answering those questions earlier, they were meant to be organic.

But to the point that you really asked, we do hold ourselves very accountable for pay for performance around this company.

Having just finished a Board meeting today that's been reflected again as we share with our Board our performance, not only against our profit plan which we set with them each year, before the year begins but, and our performance against our peer groups in the marketplace.

I'm happy to report that this company is also one to recognize performance where we see it and we have a very high uncapped incentive performance opportunity for our top performers and when groups struggle they will also be rewarded with a lesser level of bonus until which time they come back to perform.

So, we are what we say we are and we put our money where our mouth is.

Having said all of that in terms of performance against our peers, we do set ourselves a peer group for our Board of 13 other peer banks.

Those are banks that you could guess who they are, they are the banks that we consider our peers.

We do expect ourselves to outperform them in each and every quarter and each and every year and in accordance with that the Board expects that of us as well.

In terms of the highest level incentive programs, as a matter of fact it is one of the short list of things that I do want to adjust in this company as we go forward.

We have some 6,000 employees of our top management team that are in line with a discretionary bonus plan that is paid once a year, and while I think it's tremendously important that the senior people are tied to the performance of the overall Company, I do think that further down the organization, we probably need an adjustment, and some more formulaic evaluations of performance and the further down you go, the more opportunity you have to perform first and foremost on your own success and couple that with the bank's overall performance but not necessarily waiting for that one magical moment at the end of each year to see how you did based on a large incentive accrual.

So I do see that as an '07 activity and in '08 this time next year, I'd be happy to tell you about the new incentive plans we've hopefully adopted and tested in order to create a little more cause and effect for performance at the individual level.

Last follow-up.

You also have an ROE target of 20%.

Right.

Last year, you earned 300 to 400 basis points above that so does that mean you're willing to perhaps price more competitively?

It does.

Let me start though, our target of 20 is a very, I think lofty goal for any company and we will stay there because we believe that that's been a good place for us to operate.

I'll remind you that our capital generation in part has the corollary to our ability to grow revenues and earnings without having to use as much of the balance sheet as some of our peers may have in the old fashioned way of banking, but I'm glad for the question because while I've said to any audience that will listen, we will not compete on structure on the credit market, we simply don't think that that's a good use of our balance sheet, We will compete on price.

And in my comments I mentioned to a point that's reasonable not to point that hurts us or the industry but if we need to get down to a point where a very high quality customer has an opportunity for us to extend further credit or other relationships to them, based on a low cost providing capability, we have the ability to be competitive on price and we will use it.

Thank you.

Yes.

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

Please go ahead.

Good afternoon.

Hi, Nancy.

David, could you just update us on where you stand from an asset liability, asset management standpoint right now and just what the cash flows are you're receiving from the securities portfolio, et cetera, et cetera, and what your plans are?

Sure.

Today, at the end of the year, we were liability sensitive, just essentially where we were at the end of last year and actually the end of September, so we are right in that line.

It's been actually very consistently in the same position for over five quarters.

With regard to overall balance sheet strategy, on the bond portfolio side, we have continued to hold the $40 billion.

We have continued to buy basically short duration mortgage backed securities.

We have supplemented the cash flow which is about $400 million a quarter with municipal securities and to some degree trust preferred securities from some of the high quality banks.

So we have changed the mix slightly.

The duration of the portfolio is still about the same at around four years.

That hasn't changed a lot.

On the funding side, most of the structural things on the funding side we did in '06 by changing the mix of our Tier 1 capital and using more trust preferred securities and less common equity, so most to all of that work was done.

The other part of the asset liability management actually was our derivative portfolio has shrunk a lot over the course of '06 and today, we're actually in a pay fixed basis and that portfolio will continue to run-off over the course of the year, so the impact of margin or income from derivatives is almost zero at this point.

So I would suggest that going forward what you'll see is for all practical purposes, earning assets are going to be driven by loan growth, with the bond portfolio being flat, funded by both deposit growth and borrowings largely in either the overnight market or in the senior debt market.

Is that decision pretty much neutral to whatever the Fed might do this year as we sort of start thinking more about perhaps the Fed not cutting rates and perhaps even raising them?

Yes.

I think, Nancy, our view is this strategy is sufficiently protective enough that if rates rise say another 50 basis points, we'll still be in pretty good shape or if it falls.

Our anticipation is the Fed won't change and -- but even if it does, I don't think it's going to materially change our view of our balance sheet position one way or the other.

And if I could also ask, Richard, when you're talking about your loan growth being less than some of your peers because of your willingness to compete on price but not on structure, can you just tell us a little bit about what you're seeing, what kind of loans you're seeing at this point that you might be rejecting?

I sure can, thanks, Nancy.

First of all, there's an emerging kind of leveraged credit out there, leveraged lending is becoming more pervasive as people go into deals with a different kind of a structure and as a lender when you look at your primary point of repayment, you always look at your secondary as well and I think probably the best way to characterize our company is we simply don't rely on a secondary source repayment to be this very hot market with liquidity out there today and you can make a lot of deals and you can say to yourself, boy, my worst case scenario, someone is going to buy this because the money is out there everywhere and to the extent that that is probably true at any given moment, that's probably not a bad bet but we're not going to get practiced at that because we simply don't know when that ends.

We don't exactly understand what's bulking it up even now and so to the extent that our clients have got to have the primary and secondary source repayment and the old fashioned way of earnings, that's probably the best way to characterize the difference in our philosophy.

I'm not saying that our peers are making mistakes or doing anything that they shouldn't do and I would hope they are getting paid for it.

In our case given the flat yield curve in the current environment, we just don't think that there's really an ability to take an extended risk over time or type and get paid for that in this environment without taking a risk that's undue and probably would show up in future quarters.

So if anything, I said this before, if I lose any sleep at night, it's not about credit quality or the risk of that.

It's whether or not we're taking enough risk in our portfolio, but given the risk adjusted premiums that you get in this kind of a marketplace I think our positioning is probably pretty smart.

Thanks very much.

Yes.

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

Please go ahead.

Good afternoon and again, Richard, congratulations and thanks for doing this call.

Hate to ask about such small items, but in the payment services business which has grown nicely as a proportion of your earnings, it seems the merchant processing revenues were actually down from the third quarter which surprised me and there was a pretty substantial sequential quarter increase in other expenses.

Is there anything unusual going on there or anything we need to think about going forward?

Great question, David.

Thank you.

Let me just mention, on our payments group if I had to keep that high level, 50% of the payments group is our issuing business and the issuing card side. 30% would be our acquiring side which would be the Nova and now the euroConex extensions under Europe and 20% would be the corporate payments business and the transaction services.

So we're honing in here on the 30% of payment.

I'm happy for the question because myself, as we continue to add portfolios and learn over the course of time our merchant behavior, we now have about a third of our merchant acquiring business is retail, and two-thirds is not, and so oddly enough you might think that we're primarily retailers, and quarter four should have been a peak.

Quarter four is actually not at all a peak for our merchant acquiring business and in fact, quarters three and one are typically stronger.

I'll remind you that during 2006 we purchased the portfolio from First Horizon which was kind of the last category of core merchants that we did not enjoy which was mid sized merchants in resort and travel categories and they particularly have now rounded out our full composition of merchants both small and large from airlines down to florists and geographically all over the country.

So a third of the portfolio would have been affect the by the fourth quarter and that would have only been a third of the 30% or obviously that would be about 9% of the total payments businesses.

So I think you'll find our cyclicality is not based as you might think, it's a little more counterintuitive.

Quarter three is very strong for the corporate business, quarter one is very strong for the issuing business, quarters four and quarters two are just typically strong because of holiday, but I would say the seasonality is very very flat when you add all of those together and this is a business that grows strongly, pretty much each of the four quarters for varying reasons.

And on the expense side, anything unusual there?

Yes.

David, it's essentially all conversion costs and integration costs, primarily the result of the formation of the bank in Ireland, as well as converting some of the platforms and some of the merchant processing businesses in Europe on to our platform, but essentially those integration cost.

That's very helpful and again nice to see that segment becoming a bigger proportion of earnings.

I agree with you.

Thank you, David.

Our final question comes from the site of Ed Najarian with Merrill Lynch.

Please go ahead.

Good afternoon, guys.

Just a quick follow-up question.

When I asked about capital and you mentioned the dividend payout ratio, I think you referred to a 47% payout ratio?

I'm guessing you meant to say 57%?

I did mean 57, sorry.

Thanks for bringing that back up.

Okay, thanks.

Yes.

Operator, any other questions?

It appears that we have no further questions at this time.

All right let me close.

Thank you for your help, Operator.

First of all, thank you for joining this call and thank you for letting us know that you value it because we've certainly enjoyed a chance to tell you about our company and I appreciate your following.

Let me just close with this.

We are, you'll continue to see, you didn't ask about M&A, but you'll continue to see us take opportunities where they come about in small bites, primarily in the payment businesses, in the trust businesses, or in the branch banking businesses, but nothing different than you've seen in the past and only if they make sense and I for one and David for two are not seeking M&A as a growth engine for this company.

If it comes along we'll be opportunistic but for the most part you can expect us to hone in on what we do best which is take care of what we have.

I give you my word that our focus is definitely on revenue growth.

I know from you, and I know from the marketplace, that that's the highest value have in growing revenue in a very predictable, repeatable way, and I want to make sure that you help us tell our story about this distinction we're making in the Company's earning stream and it's revenue stream by virtue of this core bank that we're building and making stronger aligned with this processing payments and trust businesses that we're continuing to be opportunistic and build scale.

And finally, I think you'll agree that both of those activities when you look at HSA businesses and emerging card paradigms and payment businesses that that's not only good for the near term but in the long term, it's relevant to the future of our industry and what's changing in our customers expectations so I hope that that resonates with you over the course of time and once again, thanks for joining us on this call.

Yes, thank you, and if you do have any follow-up questions please feel free to give me a call.

I am at 612-303-0783, Judy Murphy.

So thanks again.

Thanks, Operator.