U.S. Bancorp. (USB) — Q2 2016 Earnings Call Transcript

Thank you, Mellissa. And good morning to everyone who has joined our call. Richard Davis, Kathy Rogers, Andy Cecere, Terry Dolan, and Bill Parker are here with me today to review U.S. Bancorp’s second quarter results and to answer your questions. Richard and Kathy will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules are available on our website at usbanc.com. I would like to remind you that any forward-looking statements made during today’s call are subject to risk and uncertainty. Factors that could materially change our current forward-looking statements are described on page two of today’s presentation and our press release and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Richard.

Thanks, Jen, and good morning, everyone. Thank you for joining our call. I’ll begin our review of U.S. Bank’s results with the summary of reported highlights on slide three of the presentation. I’m pleased to report that U.S. Bank reported record net income of $1.5 billion for the second quarter of 2016 or $0.83 per diluted common share. The second quarter results include several notable items that together increased earnings per share by $0.01. These notable items include $180 million of equity investment income, primarily the result of our membership in Visa Europe, which was recently sold to Visa Incorporated. Additionally, we recognized $110 million in accruals related to legal and regulatory matters and a $40 million charitable contribution. I’m very pleased with our second quarter results where we once again delivered industry-leading profitability and posted record results for revenue, net income, and earnings per share on both a reported as well as a core basis. Record revenues were driven by growth in average linked quarter loans of 1.6% as expected and continued strength in our fee businesses. While we saw a reduction in our linked quarter net interest margin as expected, we did report modest linked quarter growth in net interest income and strong growth in net interest income on a year-over-year basis. Total average deposit growth also remained strong at 7.6% versus the previous year and included net new income account growth of 2.8%. Credit quality was stable for the second quarter as expected. The net charge-off ratio was unchanged at 48 basis points compared to the previous quarter and the previous year. And we recognized a modest improvement in non-performing assets, which was driven mainly by improvements in the energy credits. Slide five provides you with a five-quarter history of our profitability metrics, which continue to be among the best in the industry. Moving to the graph on the right, you will see that this quarter’s net interest margin was 3.02%, four basis points lower than the prior quarter, which was in line with our expectations. The industry continues to face headwinds from a low interest rate environment and the flatter yield curve, which became more pronounced at the end of the second quarter and continues as we begin the third quarter. The lower long-term rates will have an impact on our second half results if the rates remain at these low historic levels. Given the current yield curve and expectations that the short-term rates will remain flat for the near-term, we expect the net interest margin to decline on a linked basis in the range of three to four basis points. However, we also expect net interest income to increase on a linked quarter basis, principally driven by an increase in earning assets. Expenses excluding the notable items increased 3.4% at the bottom end of our expected range. Our efficiency ratio improved to 54% versus 54.6% in the prior fiscal quarter. As projected, quarter two expenses included a linked quarter increase in marketing expense related to the investment in our brand advertising and also reflect the expected peak in our compliance-related costs. As we look out to the second half of the year, we’d expect expenses to grow; however, the rate of growth will be lower than the 3.4% linked quarter growth reported in the second quarter. Turning to slide six, the company reported record net revenue of $5.4 million in the second quarter. Excluding the Visa Europe sales, revenue increased $226 million or 4.5% from the prior year. Our revenue growth was primarily driven by core loan growth as well as strength in several of our fee-based businesses, including our payments, mortgage, and wealth management businesses. We also saw strong results from our capital markets business, as we were well positioned to provide products and services to customers as they navigated through the recent market volatility. Kathy will now provide you with more details about our second quarter results.

Thanks, Richard. Average loan and deposit growth is summarized on slide seven. Average total loans outstanding grew 1.6% on a linked quarter basis and increased by over $20 billion or 8.1% compared with the second quarter of 2015. Excluding the recent retail card portfolio acquisition and student loans that were carried in the held for sale in the second quarter of 2015, loans grew by 6.5% compared to the prior year. In the second quarter, the year-over-year increase in average loans outstanding was led by strong growth in average total commercial loans of 10.7% and improved residential mortgage loan growth of 8.6%. Other consumer loans continue to show positive momentum, led by credit card growth of 14.3%, which included the retail card acquisition. Finally, home equity loan growth continued reflecting the year-over-year increase of 2.7%. On a linked quarter basis, our core loan growth of 1.6% met our expectation and was driven by total commercial loan growth of $2.3 billion or 2.6%, and growth in residential mortgages of $1.3 billion or 2.4%. We currently project linked quarter average loan growth in quarter three to be similar to the growth reported in prior quarters. Total average deposits increased $22 billion or 7.6% compared with the second quarter of 2015, and were up 3.9% on a linked quarter basis. On a year-over-year basis, the trend continues to reflect strong growth of 9.5% in our low-cost deposits, which includes our non-interest bearing and low-cost interest checking deposits and more than offset the run-off in higher cost time deposits. Turning to Slide eight, as Richard mentioned, credit quality remains relatively stable in the second quarter. Second quarter net charge-offs increased $21 million or 7.1% compared with the prior year, and reflected a modest increase of $2 million or 0.6% on a linked quarter basis. Net charge-offs as a percentage of average loans were 48 basis points in the second quarter, unchanged from the prior quarter and the prior year. Compared with a year ago, non-performing assets increased $95 million or 6% mostly due to the downgrade that occurred in the prior quarter due to recent energy credits. Linked quarter non-performing assets improved 3% or $47 million driven mainly from improvements in our energy credits. Slide nine provides an update of our energy exposure. At the end of the second quarter, $3 billion of our commercial loans and $11.3 billion of our commitments were to customers in the energy portfolio, which was down from the previous quarter. The decline was primarily driven by the completion of our spring borrowing base redetermination on reserve-based loans within our energy portfolio. During the second quarter, criticized commitments within this portfolio decreased $509 million while non-performing loans decreased $54 million principally driven by paydown. Finally, credit reserve associated with the energy portfolio declined by $45 million, reflective of reduced loans, which resulted in an 8.8% credit reserve for our energy portfolio compared to 9.1% in the previous quarter. Given the underlying mix in quality of the overall portfolio, we expect linked net charge-off and total provision expense to be relatively stable in the third quarter of 2016. Slide 10 gives you a view of our second quarter results versus comparable periods. Second quarter net income excluding notable items increased by $17 million or 1.1% on a year-over-year basis. Higher operating income was partially offset by higher provision expense. On a linked quarter basis, net income excluding notable items decreased by $114 million or 8.2% mainly due to the seasonality in certain fee businesses, partially offset by higher non-interest expense related to expected increases in compliance cost and marketing expense. The marketing expense represents our brand advertising. Turning to slide 11, net interest income increased by $126 million or 4.5% on a year-over-year basis. Strong average earning asset growth was slightly offset by the impact of a one basis point decline in net interest margin to 3.02%. The modest year-over-year decline in net interest margin primarily reflected the impact of higher short-term rates offset by lower reinvestment rates in the security portfolio. Net interest income increased by $8 million or 0.3% on a linked quarter basis. Strong growth in average loans was offset by a four basis point reduction in net interest margin. The decline in the margin was principally due to the loan portfolio mix as well as lower average rates on the investment securities portfolio, which is principally due to flatter yield curves.

Thanks, Kathy. I am proud of our record second quarter results. We maintained our industry-leading performance measures and we reported an 18.7% return on tangible common equity in the quarter. Our industry continues to face challenges from the low interest rate environment; however, we remain confident that we’ll continue to grow revenue and prudently manage expenses while strategically investing in our business to create value for our shareholders. That concludes our formal remarks. Andy, Kathy, Terry, Bill, and I will now be happy to answer your questions.

Hi, good morning guys. Richard, I was hoping if you could provide a little bit of color on loan growth. What’s gotten better and what keeps you confident that the expected trend will continue? It sounds like you might expect more of the same; maybe a little more color there.

Sure, happy to do it. And we’re expecting more of the same, pretty much what we’ve seen for the last two quarters. I’ll have Andy give a little color on the detail as he oversees all of those revenue businesses. But I will say it continues to be a theme of repetitive quarter-after-quarter. On the wholesale side, you’re seeing increased capital markets activity that, in fact, move up and trigger loan repayments and lower line utilization and M&A related activity. So on the wholesale side, we’re not still not seeing the kind of organic growth we’d like to see, but we are pleased as we said in our comments that we have a fully capable capital markets business in order to take the benefit of what would otherwise be some activities we didn’t use to have in the company when customers moved outside of the lending market and into the capital markets. On the consumer side, we’re seeing all areas moving slowly but surely and nicely, favorably from autos, to RVs, to credit cards, to home equity. And then we particularly have a good story to tell in the mortgage business as we continue to be a bigger player in that area. So it’s a lot of the same, John, but everything has got a generally positive, slightly positive bias, but a lot of the opportunity that the wholesale market is yet to be the kind of organic growth that we all want to see that gets evidenced in a more healthy and robust economic environment. Andy, do you want to add some color there?

Richard, I’d add in that. So we did see record revenue in our commercial products groups and you saw that our credit fixed income, or FX, or municipal products all were up at record levels, somewhere between 40% and 50% on a year-over-year basis. And again, that’s reflective of a tremendous bond issuance that was occurring here in the second quarter. We did continue to see strength in auto lending as well as residential mortgages again principally due to the rise in the jump in the market and commercial real estate also grew a bit this quarter, which is a little bit of a reversal of the trend.

And maybe Bill can follow up. You had good credit results this quarter; I think the outlook was for a relatively stable. I was just wondering if you might need to build some reserves, if the loan growth remains healthy here?

We have initiated that process. We are now focused on adding to our reserve. As I've mentioned for some time, there is still likely room within our existing portfolios, particularly in residential home equity, where we continue to observe improvements in home values. This situation could enable us to release some funds from those portfolios, which would help balance out some of the loan growth. However, we believe it is wise to continue increasing our overall reserves.

And is this quarter a pretty good indicative pace for now Bill?

For now.

Okay. And in terms of the NPAs and charge-offs, can you just repeat what your outlook is there?

It's quite stable across the board. If you examine each of the asset classes, commercial and industrial is surprisingly low this quarter. We believe we proactively addressed the energy issues in the first quarter, and this quarter we experienced no significant energy charge-offs. In fact, we had a positive recovery on one of our credits. We feel that with energy prices around $50 a barrel, the energy concerns are behind us. Overall, the stability in the other asset classes is notable.

Just add to that, Bill. I would add, we marked our portfolio at $35 a barrel for the second quarter. And we have no intention of releasing that reserve for some time, and we see sustained higher levels of value on oil, but we do have at 8.8%, we think sufficient coverage and provision, and we’re quite pleased with how that portfolio is behaving at this point.

Okay, thanks.

Thanks, John.

Hey, Jon. Hey, thanks. Good morning. Maybe Richard, a question for you, expenses. Maybe about a year ago, you gave the chin-up bar analogy on rates remain low; you might have to be tougher on expenses. I appreciate all the guidance, it looks like maybe professional services can start to moderate a bit, or maybe marketing too. Maybe there are some other offsets, but maybe your latest thoughts on long-term expense management, efficiency if the rate environment remains challenging.

I appreciate your question. As I look ahead, I want to share that for the second half of the year, we plan to maintain our efficiency ratio in the range of 54% to 54.9%. This outlook is based on the current interest rate environment, which is notably stable, but can shift quickly and unpredictably. While we aim for positive operating leverage, achieving that is becoming increasingly difficult. Therefore, I want to be transparent and say we intend to keep our efficiency levels consistent with what we've demonstrated over the past few quarters. Our expense control program is steady and focused. We have not increased our workforce since February of last year and are vigilantly monitoring non-essential and discretionary expenses to ensure we don't hinder our growth. Our investors are looking for long-term value, so we'll be cautious in our approach. As for expenses, we anticipate an increase of less than 3.4% linked to the previous quarter, with projections for next quarter being between 2.5% and 3%. A significant portion of this increase will be associated with FDIC premiums and compliance costs, which usually rise in the latter half of the year. Additionally, we are adding personnel for portfolio management and compliance. The costs related to professional services are expected to peak this quarter and then begin to decline.

Okay, that’s helpful. And then maybe quickly just an update on the consent order and once lifted, what really changes in your mind?

Sure. So the consent order, as you know, precludes us from whole bank transactions, particularly things with branch banking. And as we go through this consent order, it takes quite some time not only to get things where they need to be, but to sustain and improve that they stay there, and we are in those processes now. So I have no idea what the exit time will be, but we are working closely with our regulators to make sure that we have permissions, particularly to be released from any part of the consent order first if that’s helpful to us to get back into the traditional M&A business. However, I remind you that our M&A in the area of merchant portfolios, credit card portfolios, mortgage business activities, trust activities, none of those are precluded under that order. And those have been exactly the things we have done in the last five years consistently as part of our M&A. So we haven’t been precluded from doing what we wanted to do and as I said before, there hasn’t been a bank deal or a branch deal that we wanted since the Citizens Chicago deal that we’ve included from. So our goal is to get out of it as soon as possible so we don’t have any barriers on our options. But for now it’s not impairing any of our ability to run the company or find opportunities to acquire.

Okay, great. Thank you.

Thanks, Jon.

Hey, guys. This is actually Tim Hayes for Paul Miller. What is your view for mortgage revenues in the second half of the year, given where interest rates are today? Are you guys seeing any pickup in resize yet? And do you think that’s a tailwind to fee income from lower rates could offset the detriment to margin?

This is Andrew replying. So our second quarter mix was about 65% new purchases and 35% refinancing. So I would expect that to go closer to 60-40 in the second quarter and given that coupled with the normal seasonality I would expect mortgage fees to continue to increase in that 20% to 30% range.

Okay, great. Thank you.

Sure.

Good morning. I wonder if you can give us a little bit more color on the merchant processing revenue. It looks like it was a little bit light from where I was looking for this quarter. I just want to see if we can get some of your updated trends that you are seeing on the merchant side? And then separately, for the payments business, just overall revenue trends that you can expect here. I know we’ve seen a pretty good rebound in that business, but wanted to get some color on your outlook. Thanks.

Okay this is Andy again. Let me start with merchant, and you are right, there are a few moving pieces in merchant I want to explain. So first, one of the principal drivers of merchant fee revenue is same-store sales. Same-store sales in North America were up just under 2%, 1.8%, and in Europe they were up about 5%. So globally up about 2.6%, and what you typically see from us is same-store sales plus 1% to 2% is total merchant revenue growth. What happened this quarter is while we were up 2% on a year-over-year basis, if you exclude FX, that’s up 3%. That is also now flattening now revenue related to equipment sales. So we were up higher in prior quarters because equipment sales were going up, and they are sort of leveled up. We’ve lapped that so to speak. The other things you will see are transaction volume is down and that was intentional. We exited some low margin business, so it did have an impact on transaction volume, but as you saw, not a tremendous impact on fee income. So as we look forward to the next few quarters, I would expect again same store sales plus 1% to 2% in terms of our fee growth in merchant volume. You asked about the other payments business, so let me comment on that. Credit card is very strong. Excluding fidelity, we were up about 6%, and that’s driven by card transaction volume growth of about 7%, and I would expect that to continue in future quarters. And then finally, on corporate payment systems, there is a very good story there is that we are seeing growth in the corporate side of the equation. While government is continuing to be flat, our corporate fee income is growing, transaction volume, and sales volumes are up about 6%, and that’s a function of the investments we made in virtual pay and product activity, which is very positive. So T&E continues to be weak or level or down a bit, but payables and virtual pay is up strong.

I’ll add to that, this is Richard. Just if you’re going to bring up proxy questions I’ll help you out here. For Brexit, first of all, it’s not material and it’s pretty neutral to the bank. But if it shows up anywhere, it shows up in our European businesses, which is merchant acquiring. You may recall those of you who followed us for a decade, we started our business merchant acquiring business in the UK that’s where it’s actually headquartered. So a disproportionate amount of business is in the UK. And actually, if there is a lot of prognosis, I believe there will be a lot of travel and visits and spending over the UK, which is net positive for us. And given our portfolio mix being heavy on hotels, retail, hoteliers, and airlines, that could be quite positive as well, offsetting any variances that may occur in the rest of the European market through this disruption. So we’re seeing Brexit as fairly neutral to not material to maybe even a little bit positive. As it relates to our employees, we have a few hundred employees that are working in the UK and/or in around Europe that would either have to have past reporting circumstances change for them because they’re either UK employees working in Europe or European employees working in the UK; that’s something that will roll over the next couple of years. There is no rush to it and there has been no reaction there; we’re not changing any of our strategies as a result of that.

Okay great. Thanks for all that color, it’s helpful. And then just separately on the commercial real estate portfolio, pretty good growth this quarter and looking actually at the construction piece saw a pretty good jump there. So wanted to see what you’re seeing on the commercial real estate side in terms of where the growth is coming from? And do you expect any moderation from regulatory scrutiny around CRE trends right now at all? And then lastly, any credit concerns on that front because we’re hearing a little of that too? Thanks.

Yeah, I will go first, I want to go first on that. CRE has, as you know, for our company, is one of the areas we want to be particularly conservative in much as we love it and we’re very big in it. And so the scrutiny is high in the industry I’m quite comfortable that the scrutiny will not be placed here because we’ve been conservative for a decade and we continue to be underwriting. I’ll also remind you that commercial real estate has a CMBS market where there is a lot of activity. And our guys are filling it with a lack of buyers coming particularly from the life insurers; that has affected the refinance and purchase activity, which only serves to say that there is a reduced pace to payoffs. So part of the increase is actually good news. We’re keeping the customers we have. But we’re not striving to get new customers at any kind of risk of underwriting or pricing change. I think the portfolio will prove itself more over time. Andy and Bill can add a little color about where the growth is and where we see the pockets of strength. But we love this business; we’re very good at it. But I promise you we’re just not going to get greedy at a time like this in the marketplace on terms or underwriting. Because it’s easy to do and it’s not going to happen here. So Andy you might go first.

Well to follow up on Richard’s point. If you look at our construction loan activity, you see that that’s been increasing fairly consistently over the last five or more quarters. What’s changed is that commercial mortgage or standing loan permanent loan where the attrition has declined and actually reversed this quarter, a very slight increase. And that was what Richard was highlighting. I mean, the strength has been, it continues to be on the coast especially the West Coast for us and through a lot of our REIT clients they have been very active.

And that's what I was going to say. California, Pacific Northwest is where we’re seeing insurance activity.

Great, all right. Thank you.

You’re welcome.

Good morning, everybody. Richard, I was hoping either you or Kathy could extend upon your comments on the margin from the beginning of the call. First, I want to make sure I understood it correctly. I think when you characterized they’re down 3 to 4 basis points, I think you were talking about the second half, but is that three to four basis points per quarter in the second half or in the aggregate for the second half? And then I guess the broader question there is, at what point would you guess that margin compression would stop in this kind of pressure grade environment? Because I guess there are two big issues with the securities portfolio reinvestment risk and then there is still kind of a wide gap between your loan and deposit growth. But just curious to hear your thoughts on both of those phenomena.

Yeah, thanks, Scott. I think we got to question five before we got to NIM; that’s pretty good. I’ll be very clear, what we said was in quarter three which is all we can see into. We have a 3 to 4 basis point prediction of NIM decrease. I have no idea what quarter four would be. As we woke up this morning, you know that the call for interest rate increases is 21% for September, 36% for December. Better than zero worse than it was when we talked last time. So we’re not going to bet on any of that, but to the extent that any of it comes back would be terrific. Also, the 10 years above 150 again thank God. That is helpful to us as interest rate increases. And you know there is an equal impact on the income statement based on that. So if we can manage through these very worst times which is continued zero interest rate increases and very, very low tenure, we can manage through just about anything which is how we’re building the lower for longer kind of term around the company. So for one quarter we can see that pressure. We can’t predict beyond that. I’ll have Kathy talk a bit more about the sequencing and the importance of the refinancing that occurs in the securities. And the fact that we’re actually seeing stable performance in most margin areas for compression as it relates to competitors.

Yes, he is correct. As we look into the third quarter, we anticipate a decline in the range of 3 to 4. However, I believe it will resemble more of what we have previously observed. The flattening of the rate curve, despite some recent signs of improvement, will continue to affect our securities portfolio, leading to an ongoing decline. Additionally, our focus on loan growth indicates that if we continue to slightly outperform in wholesale loans compared to retail loans, this will also create some compression moving forward.

So Scott, let it be said at the end. We remind you that net interest income will increase in quarter three. So we can out on this in the outset growth, but it’s going to be continued more challenging until we get interest rate increases around that.

Hey, good morning everyone. Just as a follow-up on just the balance sheet mix, we still have a really good loan-to-deposit ratio. You’re still growing deposits and I see you’re able to remix from the short-term borrowings this quarter. Given that low rate scenario we’re dealing with, at what point do you decide to just try to remix just more into loans and less into securities, understanding that you need to keep LCR? But does anything structural change with that thought process around just asset liability management?

No, it doesn’t Ken. We’re not close to those levels. We take what the market offers and ensure it's applied properly to the balance sheet and the income statement. We're not evaluating the value of deposits; we're self-collecting them and are glad to have them as they'll be more important in the future. We’re pricing loans properly to attract high-quality customers, and the securities portfolio is a consequence of that. However, it wouldn't drive our strategy; it would follow it. There’s nothing in our strategy that will change at this point, and we’re not approaching a threshold that would require us to reassess our balance sheet mix or any part of our appetite that we haven’t already demonstrated.

Understood. And then on the deposit side, I think a lot of banks are starting to still see modest tick-ups on the deposit pricing side. What are you guys just seeing in terms of customer behavior in terms of product choice and any cost that you have to hand along even though we’re not really getting it on the left side of the balance sheet?

Yeah, we really haven’t seen a whole lot of shift. Really the consumer has really no rate change whatsoever on the consumer. We talked previously that we did have some repricing on our wholesale side; some of that was just contractual that happened to other if we work with our customers. But I’ll tell you it’s been relatively stable as we look into this quarter.

Okay. Last one real quick one, the preferred dividend Kathy, does it go back to the first quarter 57 in the third quarter?

Yeah. So it’s a quarterly payment. So first and third quarter will be at the lower rate, second and fourth quarter will be at the higher. Yeah about 60 I would say, 60 in the third quarter, about 80 in the fourth quarter.

Okay, thank you.

I am glad you asked that because that gotten just neither didn’t telegraph well or just gotten missed in a lot of the models. And it’s real money and it's also real value. So I’m glad to have that clarity. Thanks for asking it.

You bet.

Good morning, Richard. So in the battle, Richard Davis, first the tenure I think you’re kind of getting obliterated.

I think so. They are definitely winning, I’ll tell you that.

On the other hand, you do have some accelerating loan growth. I know you talked about loan growth here. So originally you’ve mentioned economic growth couple of years ago accelerating, improving and then tenure goes down and that’s why I brought the comment initially. So if you look at the tenure you’re really loosing; if you look at your accelerating loan growth, maybe you’re winning a little bit more. So I’m just trying to make sense of as the markets for you do business improving or not?

Mike it’s a great question. They are improving slowly, but I’ll tell you what, I wish I’ll be here 10 years from now to prove that, but we are taking market share, swear to God, honest Injun. We are taking market share. We have been for years. Think of our home equity portfolio it’s still growing, albeit slightly, but that’s been shrinking across the industry. Auto loans we’ve never got not of it, so we’re selling it big, leasing or now one of the few players literally quite capable of it; we’ve been doubling down on credit cards and you are seeing some of our recent portfolio and partnerships. So it’s mostly in market share, there is not a market that’s actually weaker than it was a year ago, but for intents and purposes there is not a market much stronger than it was either. And what I think really turns on the dial for banks is when corporate America is more confident and I don’t mean the original old unconfident; we’re always uncertain. But things with a presidential election in the offering, things like Brexit uncertainties, we don’t need any of the things like that to continue to give corporate America a reason to just wait and but for M&A and for restructuring their balance sheet corporate America is not organically doing big things, at least not needing banks in that process. So that’s when the thing really starts to take off. But in the meantime, we are all getting it out in the trenches, trying to keep more customers and do more with the ones we have. And I just think the right answer, as much as it’s hard to prove, is that we are doing it in our case with market share growth.

So the answer to my question is useful. But if you look beyond that, do you believe things are generally improving or are they pretty much the same?

I think I meant to say every market is a little stronger than it was last year. So yes, but not very much.

Okay. All right, great. Thanks a lot.

Thanks.

Good morning, Erika. Good morning. I was wondering if you could share a little bit of color on the CCAR results. I was a little bit surprised how the regional banks fared in terms of their stress ratios or PPNR assumptions relative to last year. I am wondering if there is any color that you could share with your investor base on that? And also Richard, I’m wondering if the CCAR results and how acquirers were treated in this year’s results at all impact your thinking about future acquisitions?

Let me say first of all we were very pleased with our CCAR results. I always joke at the stress test and it’s effective because we are stressed the whole time. Also be reminded we haven’t had the final exit exams on all the details, and you also know we’ll never know exactly how the model works. But I’ll remind you that in this particular cycle the negative interest rate scenario was added and that’s hard for any of us to predict exactly how that fares for each bank. But I know that that had an impact on what was likely the PPNR for every bank. As you know, we continue to be at the top on the PPNR; barely in this case we are slightly below break even, but in the years past we’ve always been above, and I think on a relative basis we even performed better. So I’m not concerned about trying to predict that, and I think that the test continues to be effective in helping us all understand whether or not in the most stressed scenario we would be okay. Acquirers had more limited capital distribution, and so we don’t think that’s a factor for us because it’s not as relevant to us as it will be for some others. But I think as you look at the stress test results and you apply it across different kinds of companies, it’s not unusual to see different distribution models based on both what we are starting from, what the stress test would do to us, and where we would end.

So essentially it doesn’t impact how you are thinking about understanding that you have a consent order in place. But it doesn’t impact your thinking about how to manage capital for future acquisitions.

No, I mean emphatically no; in fact, it doesn’t have any impact on it at all. What we wanted to do is we want to continue to understand the best methodologies that they use in stress testing the loan portfolio. So we can better understand what mechanics are in there so we can predict those better than we have in the past. But we also continue to outperform on the PPNR as it relates to their satisfaction in the model with how much money we’ll make. So it works both ways, but every year we get smarter every year we go back and do our best to evaluate it and as I said, we are a little bit early on getting any formal feedback which we’ll be getting in the next couple of weeks between this and the next time we talk.

Got it. And just as a follow-up question. Really appreciate the color on how to think about payments revenues as we think about forecasting. Could you give us a sense of how much of your payments revenues are generated in pounds so we can think about translation risk?

The translation is rather limited. So if you think about every 1% change it’s about $1 million; it’s not a big number, Erika.

Got it, thank you.

Thanks.

Hi, Vivek. Hi. Couple of follow-ups. Firstly on CCAR, your current costs are at the high end compared to last year. Can you comment on your thoughts on the results that are showing up there?

Yes. I believe this is especially evident in our wholesale portfolio, which we have been developing for several years. We have generally operated at a higher level, similar to the Fed. However, we lack detailed insight into their modeling processes, which can be quite opaque. That said, we suspect that our relatively low utilization rates might influence the situation. Despite this, we anticipate lower risk in a downturn compared to the Fed, and we will continue to analyze and understand the reasons behind the differences in our assessments.

So Vivek, this is a point of frustration for me because we in the first couple of years, I was really worried if we were different than them how bigger deal could that be. I will say that history is probably now better dictate than testing itself. And if you look in the last seven years, which is the exact timeframe that we’ve got the stress test our commercial portfolios outperformed almost everybody and done very, very well. And so, I’m not challenging the test; I’m just challenging that we’re never going to figure out what they put in, Kathy gave you a hint. We think our commitments have been growing faster than anybody, well in addition to our loan growth. And I think if they take a model where all the commitments go to 100%, and they go to charge-off that could be it. We have a big government portfolio in our corporate business, which if they take a 90-day late pay and take the whole portfolio to charge-off, maybe that could be it. And as simple as it sounds, we’ll never get the answer, even to those questions I just offered. So what we will do is continue to watch our own performance as you should measure the dictate on how well we’ve actually done in charge-offs and non-performs over the course of time. So we’ll just do our best to get closer on that test. But we don’t understand exactly ourselves how it test like it does, when the results themselves show that way.

Thank you. One more question about capital markets. You've experienced significant growth, Richard. As you continue to expand, does that change your perspective in terms of fee growth drivers this quarter, particularly regarding underwriting? Does this influence your capital strategy, especially in comparison to your peers?

Vivek, I would say it doesn’t shift; it’s a reflection of what’s occurring in the market. We’ve had traditionally two strong growth areas in fees, trust and our payments group, and it’s great to have this third area come in and started taking what the market gives us. And given this low rate environment and the volatility, things like credit fixed income FX are very strong as well as derivatives. So it’s great that we have these businesses, which in fact 10 years ago we didn’t have. So it’s a positive add to the fee businesses that we have.

Right. But given that it’s a higher volatility business, would that not mean that as you think about economic capital, when you’ve talked about 8% or 8.5% in the past, that that starts to migrate slightly upwards?

No. I wouldn’t expect that to have any impact on our capital ratio at all.

Okay, thanks.

Sure.

Thank you. Good morning. Richard, I had a question on your P2P money transfer product. How are you thinking about the potential disintermediation risk that clear exchange could pose to the revenues that you generate on the card issuing side of your business? Or are there any restrictions that you could put in place to prevent potential disintermediation?

Good question, Bill. First of all, we are clear exchanges. So we’re going to be on either side of that transaction. But I’ll tell you it’s the same answer I gave three years ago with Square, when Square started coming out big with Starbucks, and at least for now, not for long-term but for now, most of these transactions are taking money out of the cash out of the system, not other card debit or credit transactions. There is still so much cash in our system, in our society; there is plenty of disintermediation of cash a long before it starts to tap up against the other card businesses, and that’s what we are all planning for in the near-term. and that could be a couple of years. But short beyond that period of time, we all have to be very thoughtful, and your question is right on the money as it relates to what’s the evolving relationships between real-time pay-to-pay, card, card not present, and the mobility of people moving money about in the different environment. Remember we’re still under a Federal Reserve circumstance that settles overnight and not over the weekend. So there is still a big disconnect and we have those things to fix systemically before we get to a real-time payment. But for now, disintermediation is mostly seen on cash, and that’s a net positive for us and the other banks because we have no benefit in cash moving about for the most part; we do when it starts to monetize itself in the form of the payment.

Right. But maybe just as a follow-up, I guess the nature of that product is really for clear exchange where P2P money transfer between individuals not necessarily to conduct a payment transaction. But I guess to the extent that you were, and given your position as both acquirer and issuer, you would be in a very good position to see to the extent to which people who are using the product to actually conduct payment transactions in lieu of USB credit card. And if that were the case, is that something that you would expect to be monitoring and react to as appropriate to the extent that we’re having a revenue impact?

I think the main focus today is cash and individual-to-individual checks, as Richard mentioned. The second area that will emerge is bill payments, which will serve as a substitute for checks and online checking. So, we are looking at bill payments in that context. In the short term, I don't anticipate any negative impacts, and we will continue to monitor the situation as Richard pointed out over the long term. Additionally, we need to consider how this evolves on the wholesale side of the business, which is something we are also closely observing.

Yeah, that's right. So think about this is P2P, right? Then there is P2B where people are paying their bills and there is a B2P where people are trying to business are reaching out to you and giving you reason to buy things and send money back. And then there is B2B which we’re all working on including block chain. And then we’re working on all of those alternatives; most of those are so nascent. I think as a banking category those are just all upside for us, because there is so much opportunity and much less to see remediation. But you’re on to something, Bill, and there will be a time. Right now babysitters, you go home and you pay him cash, you write them a check. Now you’re going to start doing it in real-time between you and the 17-year-old and the money moves. We’re assuming remediating something that’s right now not a debit or credit card. But over time, this is something we have to put the whole universe together and figure it out. And I’ve said this before; I’ll say it again. The banks as a collaborative are working better together than we ever have to make sure we work together and create a better circumstance for all of our clients. And I think that’s a big plus in the last couple of years if we see payments emerge as a real-time issue.

That’s great color. Thanks gentlemen.

Thanks.

Thank you very much. Good morning. In regards to your commentary around the Brexit and your real positive commentary around that. Could you dig in a little bit on the impact of the Brexit in regards to your payments business in particular?

Yeah, that’s generally where it’s going to be. Because we’ve got the merchant acquiring activity, which we’ve talked about a little bit here before. So I think we’ll call it neutral for now based on what you can, Kevin, just because we have such a UK influence. I think there is a positive in UK enter UK, and there is probably side negative enter Continental Europe. But we’re going to say that to be net to favorably positive on the payment side. Terry, you got the trust side, you got a lot of employees in the Brexit impact there; you might talk about that.

Yeah, in our corporate trust business, which is that we have in Europe at least recently, we’ve seen just a little bit of a tick down with respect to deals that are being done as people kind of pause during that timeframe. But the impact that it had on the long rate of a curve so the tenure actually is probably going to stimulate the deal flow in terms of debt issuances. So the overall net impact of that over the next quarter or two, I would actually anticipate would probably be positive.

Yeah, deals aren’t getting allowed; they’re just being come in the new ones...

In Europe they’re being deferred, but in the United States, the yield curve impact is actually stimulating some growth.

Is that helpful, Kevin?

Yeah, that’s very helpful. And then in regards to your marketing spend and professional services spend, obviously that can be volatile quarter-to-quarter depending on the business conditions and what you’re planning for the future. But given the uptick you’re seeing there, would you expect that to decline over the next few quarters just because of the spend we saw in the second quarter?

Yeah, good question. In my 54% range of efficiency we’re holding steady to finish what we start this year on our marketing and branding campaign because there is a value and stability and sustainability in messaging. As you know, people have to do things seven times to remember them once. So we’re not going to give up on that and then the cost of third-party assistance on compliance as I said starts to tick down slowly. So those are both sustainable for the rest of this year. But trust me, everything we can control continues to be in our gun sights. And marketing is one of those things that if it has to go, it has to go, but I’d love very much to not cut it off just a bit too soon if in fact we’re on the advent of some times here what we can afford to do what we want to do and grow the company greatly.

Thank you for taking my questions.

Yeah, thanks.

Good morning, Richard, how are you?

How are you?

A couple of questions. The first one is about economic growth. You mentioned the Fed being, to your knowledge, adverse to stimulus. But we are seeing there is a response to weakness in the economy. What do you think about the financial stability provided by the Fed at some point?

Yeah. Well, first of all, I’m going to join you more than because I agree with you. But I will tell you, we are what we see. And I’m going to say two things that Fed has, it has a different lens on this. They are looking at different things and looking usually later than we are. But on a real-time basis, which we live in every day, we are seeing a slow recovery. And it’s a small nuance on a word, but a recession is things are going backwards where people are starting to feel worse and not taking actions that they might otherwise have taken before. We are not seeing that. On the other hand, because we’re balance sheet companies and because we're highly levered and because half of what we do is in the wholesale business, we’re all, I think, spending a lot of energy talking about how we’re waiting for the wholesale side of the balance sheet to pick up in a real organic, old-fashioned way, and we’re also not seeing that. But they’re not going backwards, so just taking this long, long, long period of time to restructure, evaluate their best options when things do pick up. And there’s nothing wrong with that, but that’s why we have all these unused commitments and continue to grow the balance sheet. About the business side, they’ve got reasons and they’re informed and they’re waiting. But on the consumer side, it’s a little bit better every quarter and it’s not a recession. And I would disagree if someone is saying that at Fed level. And in fact, I think you can see consumers are starting to spend again. They’re savings is at a level that they are comfortable. They’re using their credit cards and they’re paying it back on time and getting rewards for it. But I would say it actually makes sense to me. But for the words recession being standard about lately by a lot of parties, we don't see it.

Okay. Secondly, I have a question regarding the consent order. You mentioned that it limits branch acquisitions. Does it also restrict you from opening new loan production offices? Is that something you're considering? Are there any markets you feel you need to be in that you're currently not?

Good question. The answer is no. It doesn’t impair our ability to open loan production markets. And the answer is we don’t have any new markets to get into, but I’ve never had the chance to show you guys just how many markets we are in out of our footprint. So a 25 state footprint where you see us on the street and you drive by us every day. And the other 25 states, for the most part, for commercial real estate, corporate trusts, middle market, and large corporate, we’re in all of those states. We just really have never taken the time to show you that. So I’ll make this a note to do that at the Investor Day in September 15th to make sure we show you where all of our loan production offices are outside of what would be the footprint. Because when I show you, you’ll see wherever we want to be, and so the answer to the expansion is no because we’re already there.

Okay, thank you.

Yes, thanks.

Hi, thanks for taking my questions. Trust and investment management fees looked to be up 6% or 7% if I just based off the trailing four-quarter average. In the release, you talked about account growth. Could you give a little bit more color about that business in 2Q as well as maybe the outlook for the back half of the year?

Yes. So if you ended up looking at the second quarter or if you look at the first half, the first quarter was a little bit slower simply because of the market spend. But in the second quarter where the market started to recover, we’re starting to see nice growth again with respect to new accounts, both on the corporate institutional side as well as within wealth management itself. So we end up looking into the second half of the year. We would anticipate that that sort of growth would continue just given the rebound, for example, in the markets where they are at today.

Perfect. Thanks so much.

Thanks, Terry.

Thank you for listening to our view of our second quarter 2016 results. Please contact us if you have any follow-up questions.

Thanks, everybody.