U.S. Bancorp. (USB) — Q2 2019 Earnings Call Transcript

Thank you, Jack, and good morning to everyone who's joined our call. Andy Cecere and Terry Dolan are here with me today to review U.S. Bancorp's second quarter results and to answer your questions. Andy and Terry 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 usbank.com. I'd 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 assumptions are described on Page 2 of today's presentation in our press release and in our Form 10-K and subsequent reports on file with the SEC. I'll now turn the call over to Andy.

Thanks, Jen, and good morning, everyone. Thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on Slide 3. In the second quarter, we reported earnings per share of $1.09. Despite the more challenging interest rate environment for the banking industry that we have seen for some time, we delivered strong financial results supported by top-line revenue growth and positive operating leverage of 1%. Loan and deposit trends improved compared with the first quarter, and we saw broad-based momentum across our key businesses driven by account and volume growth. Credit quality remained stable, and we continue to prudently manage operating expenses while appropriately investing for the future. Turning to capital management, our book value per share increased by 9.7% from a year ago. During the quarter, we returned 79% of our earnings to shareholders through dividends and share buybacks. In June, we received the results of our CCAR submission, and the Federal Reserve did not object to our capital plan, which included a dividend increase of 13.5%. Slide 4 provides key performance metrics. In the second quarter, we delivered a return on average common equity of 15% and a return on average assets of 1.55%. Our return on tangible common equity was 19.2%. Our efficiency ratio improved both on a linked-quarter and year-over-year basis. Now let me turn the call over to Terry who will provide more detail on the quarter as well as forward-looking guidance.

Thanks, Andy. If you turn to Slide 5, I'll start with the balance sheet review and follow up with the discussion of second quarter earnings trends. Average loans grew 1.1% on a linked-quarter basis and increased 4.5% year-over-year, excluding the fourth quarter 2018 sale of FDIC-covered loans that had reached the end of the loss coverage period. Solid year-over-year growth in mortgages, credit cards, and installment loans supported solid consumer loan trends, while commercial loan growth reflected strength in both large corporate and middle-market lending, partly offset by paydowns related to active capital markets. New business pipelines remained healthy, although paydown activity is likely to remain elevated and choppy in the near term. Commercial Real Estate loans decreased on a sequential and year-over-year basis. This quarter, Commercial Real Estate contributed a 20 basis point drag to linked-quarter average loan growth and an 80 basis point drag to year-over-year average loan growth. Given what we consider to be unfavorable risk/reward dynamics in certain areas of Commercial Real Estate lending, we expect paydown pressure to continue to restrict growth in this portfolio. Turning to Slide 6, deposits increased 2.9% on a linked-quarter basis and 3.1% year-over-year. Compared with the prior year period, growth in consumer wealth management and corporate trust balances was offset by lower Corporate and Commercial customer balances. Balances continued to migrate to higher yielding savings and time deposits from noninterest-bearing deposits. The decline in Corporate and Commercial banking balances were also affected in part by migration related to the business merger of a large financial client. This migration has stabilized and will be less impactful in future quarters. Slide 7 indicates that credit quality was relatively stable in the second quarter. Nonperforming assets decreased 5.2% versus the first quarter and were down 12.6% in the same period a year ago. Commercial loan 90-day delinquencies were elevated this quarter as a result of an administrative matter related to a single customer and is expected to be resolved in the third quarter without a credit loss. Slide 8 highlights the second quarter earnings results. We reported earnings of $1.09 per share in the second quarter of 2019 compared with earnings per share of $1.02 a year ago. Turning to Slide 9, net interest income on a fully taxable equivalent basis grew by 1.4% compared with the first quarter and increased by 3.3% year-over-year, which was in line with our expectations. Both linked quarter and year-over-year comparisons benefited from loan growth, offset by the impact of a flatter yield curve. Linked quarter growth also reflected an additional day in the quarter and higher interest recoveries. Slide 10 highlights trends in noninterest income. On a year-over-year basis, we saw mid-single-digit growth in credit and debit card revenue, corporate payments revenue, and merchant processing revenue driven by higher sales volume in each category. Trust and investment management fees grew 3.5% due to business growth and favorable market conditions. And 6.4% growth in commercial product revenue was driven by higher corporate bond fees and trading revenue, partly offset by lower syndication fees. Mortgage origination revenue decreased on a year-over-year basis. Strong origination and sales volumes were offset by an unfavorable change in the valuation of mortgage servicing rights, net of the hedging activity. The year-over-year decline in deposit service charges reflected the impact of the sale of our third-party ATM servicing business in the fourth quarter of 2018. The increase in other income was partly driven by the inclusion of the related transition services revenue from this sale, which will decline over time as well as higher tax credit syndications and equity investment revenue. Turning to Slide 11. The year-over-year increase in noninterest expense reflected higher personnel costs and professional services and technology expense tied to business growth initiatives. This was partially offset by a decrease in other expenses primarily reflecting lower costs related to tax-advantaged projects and lower FDIC assessment costs. Slide 12 highlights our capital position. At June 30, our common equity Tier 1 capital ratio, estimated using the Basel III Standardized approach, was 9.5%. This compares to our target of 8.5%. I will now provide some forward-looking guidance. For the third quarter, we expect fully taxable equivalent net interest income to increase in the low single digits on a year-over-year basis. We expect fee revenue to increase in the mid-single digits on a year-over-year basis. We expect to deliver positive operating leverage of 100 to 150 basis points for the full year 2019, in line with our previous guidance. We continue to expect our taxable equivalent tax rate to be approximately 20% on a full year basis. Credit quality in the third quarter is expected to remain relatively stable compared with the second quarter. Loan loss provision expense growth will continue to be reflective of loan growth. Now I'll hand it back to Andy for closing remarks.

Thanks, Terry. The U.S. economy remains healthy, the jobs market is robust, and business and consumer confidence remains supportive of favorable consumer spending as well as related business investment. While the flattening yield curve has created a more challenging interest rate environment, our core deposit franchise, interest deposit mix, and consistent risk management philosophy put us in a strong relative position from which we will navigate. Fundamental trends for our major key businesses are healthy and significantly, are being fueled by growth in new accounts and expansion of existing relationships, which in turn is driving strong volume growth. Our loan growth came in a little better than we had anticipated in the second quarter, and we are confident in our ability to win market share across our consumer and commercial portfolios. We are investing in the future with digital initiatives being a key focus. As you can see on Slide 13, loan sales are increasingly being sourced through our digital channels. We expect this trend to continue with the expected outcome being a better customer experience, higher account and volume growth, and improved operational efficiency. The success of our digital mortgage program continues to meet or exceed our expectations. Currently, over 80% of all mortgage loan applications are completed digitally. Small business lending is another area where meaningful digital migration is occurring. As a reminder, last fall we launched a portal that allows small business customers to apply for and fund a loan up to $250,000 entirely digitally, and the customer reaction has been extremely positive. In June, about 25% of applications for loans of this size used our digital portal. And year-to-date, book loan volume in this category is up 7% versus the same period a year ago. To summarize, the second quarter came in as we expected, and we are well positioned as we head into the second half of the year. I'd like to thank our employees for their hard work and dedication, which drove these results. That concludes our formal remarks. We will now open up the call for Q&A.

I'm sorry if I missed this, we've just been jumping around here. But the margin was a little more resilient this quarter than I would have thought, given some of the growth and things like securities and other earning assets, but basically lower-yielding asset bucket. So even though the NIM was in line with what you guys had said, it just seemed a little more resilient and was wondering what drove that and then if you gave any NIM outlook.

Yes, this is Terry. I believe part of that resilience comes from loan growth and the mix we are seeing. That has been a significant driver for us. We are also experiencing some accretion in the investment portfolio, and the changes in the yield curve occurred quite late in the quarter. There are multiple factors at play. Looking ahead to our net interest margin for the third quarter, our current forecast anticipates a two-rate decline for the remainder of 2019, one at the end of July and another in September, with the long end of the curve remaining relatively stable. Consequently, we expect some pressure on the net interest margin in the second half of the year. Specifically, we project a high single-digit decline in the third quarter due to two main reasons. The first factor does not impact net interest income. Half of this impact is related to a change in European regulatory policy that restricts our ability to include certain balances in the Liquidity Coverage Ratio. This change is industry-wide, but since the LCR is a significant constraint for us, we will need to enhance our liquidity position by acquiring high-quality liquid assets and funding this through borrowings at similar rates. This growth in earning assets will offset the impact on net interest margin by about half. The other half of the expected decline in net interest margin is linked directly to our anticipated decrease in rates and the current long-term yields.

So good summary, Terry. And just to reiterate, about half of that decline in net interest margin is not impactful at all to net interest income. It's just a little higher asset offset by a little lower rate due to that regulatory change that you talked about. And I think when we're all set and done, we expect on a year-over-year basis, net interest income to be up in that very low single-digit range, given the rate declines that we expect here, and as Terry talked about, in the second half of the year.

Okay. There are clearly some variables regarding rates between now and the October call. As we consider the fourth quarter net interest margin, will the effect of increasing liquidity be fully reflected in the third quarter? Or will there be some residual impact in the fourth quarter? Additionally, should we anticipate a similar decline in core net interest margin in the fourth quarter if there is another rate cut in September?

Yes, let me address the first question. Regarding the fourth quarter and the increase in liquidity, that will be fully reflected in the run rate because it becomes effective for us on July 1. We are already working on that. As we consider the fourth quarter, we expect to see a rate cut at the end of July and again in September. As a result, asset pricing will start to decline immediately and deposit pricing will decrease over time. Therefore, I anticipate that in the fourth quarter, we will continue to experience pressure on the net interest margin, which reflects the dynamics of the balance sheet.

Okay, I have one last question to fit in. Some banks are indicating that if rates remain stable, the net interest margin excluding liquidity might be flat or decrease slightly. Can you comment on how a stable rate environment could impact this? That’s all from me.

It's good to hear. Yes, I think that essentially we consider net interest income to be relatively stable compared to where it was in the second quarter, remaining relatively flat.

Given your outlook for two cuts before the end of the year, how does that impact your expectation for expense growth at all? Does that impact how you're thinking about expenses? I know you had expected full year expenses to be flat to up 1% or so for the full year '19. And then also, I know you saw a little bit of pressure this quarter on expenses. So curious how that growth expectation has changed. And then separately, about operating leverage as you look for 2020, how are you thinking about that?

Yes. So John, again, this is Terry. So when we think about the second half of the year, clearly there’s going to be pressure on net interest income, but one of the things I think we're seeing is good momentum on the fee income side of the equation, which I think will help to offset some of that, at least a fair amount of that. So if you think about it, we are seeing acceleration or momentum growing in our payments businesses. The consumer spend issues that were occurring in the early half of the year, they really kind of normalized. You’re seeing good momentum with respect to our mortgage banking revenue, and while it was down about 1 percentage point year-over-year this quarter, we would expect that to have hit that inflection point and start to grow in the third quarter. I think that will help. We're seeing good momentum, continuing momentum, with respect to trust and investment securities, and I think with the decline in the rate environment, I think you'll see more fund formation in the third quarter with respect to corporate trust. So my point is that when you look across all of our fee categories, we see some pretty nice strength in that. I think that’s kind of one of the benefits of our business model. And the diversification that we have on the revenue side of the equation is that fee income tends to help offset some of that pressure on the net interest margin side of the question. Andy?

And John, specifically to your question, we'll continue to manage expense reflected of the revenue environment. And we still continue to expect that full year operating leverage in that 1% to 1.5%. The revenues will be at the lower end of that range.

That's helpful. I have one more question. How do you view operating leverage for 2020? I'm assuming that's still a significant factor. However, we might face a challenging environment as we consider the top line. What do you think is achievable in 2020?

Yes. So our goal, I think, in 2020 continues to be that 100 to 150 basis points. We’ll end up having to manage through the rate environment, of course, making decisions short term versus long-term investments that we end up needing to make. But as we think about 2020, we'll continue to have that as our goal that we expect to achieve. Where we might have saw more expansion based upon what conditions were at the beginning of this year, that may continue to stay more at the lower end of the range. But we'll have to just see how revenues develop.

I wanted to follow up on John's question, Terry. For the operating leverage for this year, you came in the first half of the year towards the lower end of the 1%. Just kind of wondering, I think you mentioned some things that get better in the second half, what are the puts and takes towards maybe we're getting to the middle of the range in the second half of the year, maybe closer to the 1.5%?

Yes. I think for us, in the second half of the year, given the revenue environment regarding net interest income, it may be more challenging to achieve our goals. However, it will depend on the strength of fee income growth as we move into that period. We are seeing solid acceleration in our payments and mortgage banking businesses, which could play a significant role.

And then, John, this is Andy. On the expense side of the equation importantly, we continue to invest in a number of our technology and digital initiatives while at the same time optimizing the current business structure, and I think that put-and-take of those 2 things will drive the expense growth to the low side, so that we're managing consistent with the revenue environment.

Okay. And then just a follow-up on some of the NII questions, Terry. Is there a way to size how much 125 basis point cut hurts in terms of NII or NIM, everything else equal?

Yes. If you consider our asset liability disclosures, a 25 basis point cut on the short end likely impacts us by around $40 million to $45 million. That's how we've quantified it. If we were to look at it in a more extreme scenario, it could reach $80 million to $90 million across the curve.

Okay. $80 million would be like a parallel?

Yes.

Okay. So, are the current investment yields at the long end accretive, dilutive, or roughly break-even?

Yes. So our expectation, when we think about the third quarter, is that it certainly has come down in terms of the amount of accretion that you have. We still think there's opportunity for 20 to 25 basis points of accretion on the investment portfolio. I think in the short term, though, we're going to see some pressure with respect to premium amortization that may offset that.

Okay. Got it. But those securities that you plan to introduce in relation to the pressure you mentioned for the next quarter, are you considering those to be accretive to net interest income?

We're thinking of those as in terms of the liquidity position and the regulatory issue, specifically?

Yes.

We believe that it is neutral from a net interest income perspective.

Got it, got it. And a little bit hurtful to the NIM percent.

So just to make sure, I understand it's neutral for the coming quarter, but does it flip positive when premium amortization goes away?

You mean in terms of the investment portfolio?

Yes.

Yes. And again, it kind of depends on what ends up happening with respect to yield curve. So if premium amortization starts to neutralize, it would have a little bit of a positive impact.

I wanted to ask about the mortgage business. It had a strong quarter. Can you share your thoughts on how you see this developing for the rest of the year? Does this quarter show a significant increase in applications, and is there just a small remaining impact when you close? Or do you think this will keep growing through the rest of the year?

Yes. I believe it will remain advantageous for the rest of the year for several reasons. Part of the benefit is due to refinancing activity related to changes in the longer end of the yield curve. However, refinancings still account for only about 30% of our total volume. Much of the increase in volume for us is more influenced by our investments in the digital channel and retail operations compared to the corresponding areas. Additionally, because of our investment in the retail side, we expect margins to begin improving. Consequently, we anticipate benefiting from higher margins due to this business mix, alongside robust volumes on the purchase side. Therefore, we expect to see an increase in the second half and a continuation of this trend.

Okay. And then could you talk a little bit about consumer spending? And how that impacted you in the quarter?

So Betsy, this is Andy. That's starting to come back. As we talked about late in 2018 into the first quarter of '19, that started to weaken a little bit. But we've seen sequential improvement in each month, and now it's closer to that 5%, 5.5%, 6% range which is still a little bit below early last year, but starting to get back to normal levels.

And if you think about our payments base, that 5% and 5.5%, which Andy talked about, but on the merchant side, that's closer to about 9%.

Merchant acquiring volumes.

Merchant acquiring volumes. And again, I think that is tied to some of the investments that we've been making in the business on the integrated software solutions, et cetera. And then the sales volumes on the corporate payment side of the equation continue to hold up. That's really more kind of in the 6% range, so it's lower than it was a year ago, but it's still quite strong. And those types of things give us some confidence with respect to where the economy is as well.

That's interesting. Just linking that to Commercial loan growth, you had a nice pickup Q-on-Q. I know you mentioned that the forward look will have some impact from paydowns, and I guess the question I have here is, have you seen paydowns accelerate at all in 2Q?

Yes. I would say that with respect to loan growth in the second quarter, not a lot of acceleration in terms of paydowns. We continue to see it in the Commercial Real Estate side of the equation. And so where we say that there's going to be pressure, I think it's really more in Commercial Real Estate. And I guess based upon where we're at in the economic cycle, I think we’re fine with that. And those paydowns will come because of increased capital market activity based upon where Commercial Real Estate developers can't refinance their projects. But when we think about kind of our outlook from a loan standpoint, again, I think consumer spending continues to be strong. GDP is holding up okay, unemployment is just fine. We're seeing good growth in terms of the middle market space and really kind of across most regions in the country. So we just think that there's a lot of signs that would suggest that that loan growth is going to continue, M&A activity pipeline, et cetera. So we feel fairly confident about where we're at right now.

And just one last question for me on the middle-market side in those regions doing better. I'm wondering if you're seeing any particular industries accelerate because as we look at the macro data, we've had some pullback in some of the manufacturing areas, trade, ag or transportation, I should say, agriculture. So one of the things that I've been getting from folks is, 'Hey, where's this strength in C&I coming from?' I don't know if you have any things you can share with us on that.

Yes. On the middle-market side, our growth in core commercial C&I was over 2 percent on a linked-quarter basis. There was a slight offset due to agricultural lending, which reflects the current state of the farming economy. We primarily focus on farm operations rather than land financing, so our exposure to agriculture is relatively minimal. Manufacturing seems to be holding up reasonably well, though it may be slightly lower than in the past. Our middle-market business is quite diversified across various industries and across our entire footprint. Based on our current observations, we anticipate this trend will continue.

Thank you so much for the detail on net interest margin sensitivity to rate cuts. I'm wondering if could give us some insight on how you're thinking about deposit repricing in terms of both lag and a magnitude of repricing relative to each 25 basis points?

Yes. So again, just to kind of give a reminder. If you think about our deposit base, about half of it is retail and about half of it is corporate and trust. And the retail deposit betas in the movement up was fairly inelastic, so you didn’t see a lot of movement with respect to deposit pricing there. But our corporate trust and our wholesale deposits tended to be much more sensitive, as you can imagine. So when you think about a declining rate environment, we believe that deposit betas are going to come down in the corporate trust world reasonably fast as rate cuts are occurring, but you're just not going to see as much with respect to retail.

Perfectly fair, but the betas in corporate and trust were I think higher than expected. So as I think about full year 2020, it seems like there's an opportunity for actually net interest margin either stability or accretion relative to 4Q '19 even in the face of rate cuts, if we assume rate pricing on just 50% of that book and assuming the curve stays where it is. Is that too optimistic of a conclusion?

Yes. I think if you end up looking out to 2020 and you're assuming the rate cuts are occurring, I think that because of our mix of corporate trust and wholesale, that we, on a comparative basis, are going to perform pretty well. So that's going to be more sensitive and deposit price is going to come down more quickly.

I think, Terry, what you said was the betas for corporate trust and wholesale will continue to be high if they come down, something like that.

Yes. Absolutely, absolutely.

Got it. I noticed that compensation expenses only increased by 2% year-over-year. Previously, they had been trending in the 8% to 9% range annually, and I'm curious if this represents the opportunity that has always existed despite changes in the rate environment. As we consider those compensation levels or the growth rate of compensation, should we expect it to be between 2% and 8%? How should we view the slowdown in that growth rate?

Yes. When you consider the compensation in the 8% range, that was a period when we were enhancing our risk and compliance in various investment areas, making it unusually high. As mentioned, this began to moderate in late 2017 and continued into 2018. By 2019, things have normalized. Regarding a compensation range of 2% to 3%, we believe we can maintain that level for an extended period, which should be beneficial. Some of that compensation is linked to revenue, particularly in the capital markets and wealth management sectors. Therefore, it will depend somewhat on the revenue streams we observe on the P side, but that would be a positive outcome.

So I'm just going to ask a couple of clean up ones. Can you help us understand the magnitude of the interest recoveries that came through the NIM this quarter relative to last?

Yes, Ken, we consistently experience interest recoveries. The reason we want to draw attention to this is that we are nearing the later stages of the business cycle, and given the prolonged nature of credit conditions, we are uncertain if this trend will persist. It's important to highlight this factor in light of our current position in the business cycle.

Okay. So was it above normal? I mean, was it above normal even?

I would say it was kind of normalized, but maybe a little bit high given where we're at in the business cycle.

Got it. You mentioned that you've been successfully realizing some gains. Do you see many opportunities in that area, especially considering the current equity cycle? Should that continue to remain relatively strong regarding the other income line?

Yes. Other income consists of various elements, including tax indication revenues and some transition revenue related to our ATM sales as we lead the sale of our ATM business. This will continue through 2020 but will start to lessen as we progress through that conversion. On the equity investment side, we still see opportunities there.

Okay. And then last one, just as we get hopefully closer to the Feds making some of the rules finalized at some point on the tailoring front, can you just talk through where you're seeing or anticipating to be the potentially business opportunity sets? And can you get ahead of any those at all? Or do you have to wait till they get formalized?

Yes. From a capital management perspective, there will be advantages due to the AOCI, and on the liquidity side, that will also assist us. We will wait for clarity regarding the adoption of that before making decisions related to capital management and LCR. In the past, we mentioned the potential to reduce HQLA by about $10 billion to $15 billion, either to redeploy it or reconsider the investment security portfolio. Currently, our capital management stands at 9.5%. Once we have clarity on CECL and the tailoring rules, we expect to manage that down closer to our 8.5% target.

Had one big strategic question and a very specific accounting question. We'll start with the accounting side. When you talked about premium amortization, you talked about maybe a headwind, you kind of said well there's some headwind coming. What I was curious about is most of the other calls we've actually heard management's talking about how they had accelerated. So I know you can, from an accounting standpoint, estimate amortization and so when rates move, you get kind of whipsawed around or you can kind of pay as you go. I was just curious in the sense of how you're amortizing that premium. Are you really more kind of a pay as you go or are you estimating what you think the rates are going to do to you?

We are definitely taking into account our expectations for how rates will affect premium amortization. For us, there is a slight delay. The most significant change occurred very late in June. As a result, the accounting impact will be more evident in the third quarter than it was in the second quarter, based on how we will account for it.

So it's just a quarter lag more than anything else, and that's it?

Yes. And again, that's assuming that the rate curve kind of stays where it is in terms of what the impact's going to be going forward.

And that happens in the third quarter and then if rates stay where they're at, that's kind of behind you and you go into the fourth quarter's end with no impact in the sense that rates don't change anymore?

That's what we're hoping.

All right. All right. And then the other thing I was trying to get at was merchant processing. You were talking about growth in the 8% or 9% when revenues are kind of growing in the 4% to 6%. How is the competitive environment for merchant processing? It seems like you've been picking some momentum back up there, but do you feel like you're going to be growing with kind of the same-store sales and maybe a little bit of market share gain? How do you envision that merchant processing as you're looking at the competitive environment right now?

Yes. The difference lies in the churn within the business. I believe our growth rate, currently around 4.5%, will continue to pick up as new business comes in. Additionally, factors such as foreign exchange impacts are affecting the revenue growth rate. There are several dynamics at play. However, when evaluating the core business, we believe it is gaining momentum and remains robust.

And I'd add, I think the team has done a terrific job of accelerating our greatest software vendor capabilities as well as our omnichannel capabilities and importantly, integrating with the other banking components so that we have a full set of products and capabilities that we can offer our middle-market and small business customers. So those activities are, I think, also driving the growth in a very positive way.

This is Saul Martinez at UBS. I have a couple of questions. First, I wanted to follow up on Erika's question regarding the trend in deposit costs and to clarify the differences between retail and corporate and trust deposits. Considering all of this, how should we view the overall trend of your interest-bearing deposit costs? Historically, there tends to be a lag of about one to two quarters between a decline in deposit costs and when the Federal Reserve begins to lower rates. As we look ahead to the third and fourth quarters, should we expect immediate benefits from the cut in July, or will it take a couple of quarters for that to reflect in the interest-bearing costs of deposits, possibly later in 2019 or in the first quarter? Or should we anticipate seeing these changes starting in the third quarter?

Yes. Regarding corporate trust or the wholesale side of the equation, the impact of the July rate cut will be relatively quick. Since the cut would likely occur at the end of the month, we will have opportunities to integrate that into our process. However, there is usually a slight delay in how quickly it gets incorporated. Therefore, the benefits will be more pronounced in the fourth quarter compared to the third.

In your guidance, are you assuming that the overall cost deposits will come in at levels similar to those in the second quarter?

Yes. Yes.

In the third quarter, I’d like to shift focus to your branch strategy. You've mentioned a reduction of 10% to 15% in branches over the next few years. While 3,000 branches may not seem like a significant number at first glance, that translates to about 300 to 450 branches. From what you’ve previously stated, your community bank branches, which number just over 1,000, and in-store branches, which bring the total close to about 2,000, are not likely to be affected by these cuts. Therefore, the substantial reductions appear to be occurring primarily in your urban market branches, which total around 1,000. My question is, am I understanding this correctly? Are the cuts predominantly in the Metro markets, and what is driving this change? It appears to be a significant restructuring of your branch network.

Yes. We have three sort of segments or branches, 1,000 in community, just under 1,000 in-store and outside and just over 1,000 in Metro. What we said is we're not going to exit communities. So we are not going to exit and have no branch standing in the community market we're currently in, but we do have some opportunity in community markets to rationalize or consolidate branches particularly, those that are close together, and that's also true for the in-store. So it is not only focused in Metro. The other thing I mentioned to you is that, that 10% to 15% is a net number. That includes optimization, moving branches to a better location, entering new markets like we've announced in Charlotte, so forth. So that's a net number across all categories.

Should we assume that most of the branch rationalization takes place in metropolitan areas? Even if there is some rationalization in community banking and in-store branches, it seems that, especially considering the net number of branches you'll open in locations like Charlotte, Atlanta, and Dallas, a significant portion of your existing branch network is being rationalized in urban markets.

Yes, we are focusing on optimizing our branch network across all three categories. We see opportunities in each category. For instance, when we consider community branches, we are talking about significant markets like Omaha, where we already have a strong branch presence. Our strategy will involve adjustments in metro markets, but will also encompass all types of markets.

This is a follow-up to the last question, but I wanted to ask about the areas where you're planning to add branches and how the current interest rate environment affects your approach to that strategy.

I don't think the rate backdrop is directly impactful to it. I think what we're trying to do is enter new markets where we already have a large employee base, a customer base that have 1 or 2 or 3 other products that, that U.S. Bank in their wallet, but don't have a full banking relationship and trying to extend that relationship using the data and things that would be valuable to that customer, regardless of the rate environment.

Yes. And so it's about building the overall relationship with the customer and then when you think about it, I mean this is really a long-term strategy. So the current rate environment is only one consideration on a data point.

Got it. And then second question I had was related to CECL and the impact that may have. Are you guys at a point where you can talk about what the impact may be on your overall reserve levels and also your appetite to make loans into certain categories?

Yes. We have previously discussed a potential increase of 20% to 40%. In the third quarter, we plan to conduct a more thorough parallel run, which will provide us with better insights regarding the implications at that time. We estimate a reserve increase likely in the 20% to 40% range, leaning closer to around 30%. However, we will wait until the third quarter assessment is complete. Additionally, we expect to gain better visibility into economic conditions, which certainly influences this process. When considering the different products to emphasize or deemphasize, our decisions are primarily based on product profitability rather than letting the accounting model dictate those choices. At this moment, we have not indicated any changes to that strategy.

Can you provide some insight into payments, which is a crucial aspect of your business model? Considering the announcement regarding Libra and their intentions, have you had a chance to review the white paper, and what are your thoughts on it?

We have reviewed the white paper and engaged in several discussions about it. I believe it is still in the early stages, so I don’t anticipate any immediate impact. However, we are launching various initiatives related to our payments. We are working to understand the implications, as well as optimizing the new real-time capabilities that have been developed and are currently in use across the company. This includes the transition of treasury management to corporate payments and its effects on consumer-related real-time activities. It is just one aspect of the broader changes happening in the payments landscape, which is significant and a key area of focus for us.

Very good. And then coming back, over the years, obviously, you guys have been very successful in making depository acquisitions as well as other nondepository acquisitions. Can you give us your view on what you're thinking over the next maybe 12, 24 months on depository transactions as well as nondepository transactions? Are you interested or is that something that could happen if the right opportunities came up?

Yes. So as you know, most of our recent transactions have been nondepository. They've been either current portfolio's payments capabilities, trust, things of that sort, technology capabilities. And I think that will continue to be a focus for us. As we talked about, we are working on entering new markets without an acquisition, but in it's concept of a digital-first branch-light strategy. So I think that is a new way to enter a market. It might be more efficiently and effectively without paying a big premium and having attrition that occurs after the back. So if we were looking at anything larger, and we'll look at all opportunities, it would have to be substantial, it would have to be meaningful. And we'd also have to wait that transaction against the great momentum that we have across the company right now across many of the businesses and think about it from a long-term perspective. So we'll consider all those things, but I wouldn't expect us to enter a new market with a small depository acquisition, given our other opportunities to do that. It's just starting, Gerard. In fact, next month we will have the first branch there, and the others will follow after that, so it's too early to provide any detailed information.

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