Welcome to the U.S. Bancorp Q3 2023 earnings conference call. Following a review of the results, there will be a formal question-and-answer session. If you would like to ask a question, please press one, then zero on your phone. If you'd like to withdraw, please press one, then zero again. This call will be recorded and available for replay beginning today at approximately 9:00 A.M. Central Time. I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for U.S. Bancorp.
Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President, and Chief Executive Officer; Terry Dolan, Vice Chair and Chief Administration Officer; and John Stern, Senior Executive Vice President and Chief Financial Officer. During their initial prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that can materially change our current forward-looking assumptions are described on page two of today's presentation, our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry, and John will take any questions that you have. I will now turn the call over to Andy.
Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on slide three. In the Q3, we reported earnings per share of $0.91, which included $0.14 per share of notable items related to merger and integration charges. Excluding those notable items, we delivered earnings per share of $1.05 for the quarter. Q3 results were highlighted by linked quarter and year-over-year fee revenue growth that benefited from our acquisition of Union Bank, deepening client relationships, and strong underlying business activity. We are achieving the cost synergies we anticipated from Union Bank and continue to prudently manage core expense as we identify operational efficiencies across the business. As of 30 September , our Common Equity Tier one capital ratio was 9.7%, an increase of 60 basis points this quarter.
This is the same level it was prior to our acquisition of Union Bank. Total average deposits increased 3% or $15 billion on a linked-quarter basis. Credit quality continues to normalize this quarter in line with expectations, and we further strengthen the balance sheet by adding $95 million to our loan loss reserve, reflective of an evolving credit environment. On 16 October , the Federal Reserve granted us full relief from certain Category Two commitments made in connection with the Union Bank acquisition, given our balance sheet reduction and capital actions. As a result, we are now subject to existing capital rules or, if adopted, the same transition rules as all other Category Three banks related to enhanced capital requirements under the Basel III Endgame proposal.
As proposed, this would include a three-year transition period for the expanded risk-based approach and AOCI regulatory capital adjustments starting in the Q3 of 2025. I will discuss the impacts of these decisions further in my closing remarks. Slide four provides income statement results as reported and on an adjusted basis, ending in average balances and other key metrics. Slide five provides key performance metrics. Excluding notable items, our return on average assets was 1.04%, and our return on tangible common equity was 21%. While net interest margin declined 9 basis points to 2.81% this quarter, in line with our expectations, we continue to expect the NIM to bottom in the Q4 as we reach the end of the current rate hiking cycle. Turning to Slide six.
A great benefit of our business model includes a balance between our spread and fee income businesses that helps us reduce earnings volatility through a business cycle. On a year-over-year basis, non-interest income grew approximately 12%. Within payment services, we continue to invest in our digital capabilities, expanding our payments ecosystem, and optimizing our distribution. Emphasis on expanded partnerships and integrated capabilities will continue to support tech-led growth across merchant processing and increase opportunities across other areas of our payment services businesses. Additionally, we are continuing to make investments that leverage our scale and strategic market positioning across our corporate trust, mortgage banking, and capital markets businesses, which should enhance our already strong annualized growth trajectories. Slide seven highlights a few of our many post-conversion revenue opportunities and expected cost synergies with Union Bank.
Early indications of the potential to deepen relationships with legacy Union Bank loyal, affluent, and diversified client base are promising, and we continue to be on track to realize approximately $900 million in cost synergies, which we expect to be fully reflected in our run rate as we head into the year 2024. Let me now turn the call over to John, who will provide more details on the balance sheet and results for the quarter.
Thanks, Andy. Turning to slide eight, we ended the quarter with total average assets of $664 billion and total average loans of $377 billion, down $9 billion and $12 billion, respectively, on a linked quarter basis, as we prudently managed and optimized our balance sheet given the current macroeconomic and regulatory environment. Average total deposits were $512 billion, representing a 3% increase linked quarter, driven by expected seasonality and growth in money market and time deposits, time deposit accounts. Specifically, average non-interest-bearing deposits decreased $16.2 billion this quarter, primarily driven by our Union Bank retail customer upgrade at conversion from non-interest-bearing checking accounts to our interest-bearing Bank Smartly product. Excluding this reclassification, the decrease would have been $6.2 billion.
Our mix of non-interest bearing to interest-bearing deposits was approximately 19%, consistent with where we expect the mix shift to stabilize based on historical performance and the operational nature of our core deposit base. Slide nine provides an update on the investment securities portfolio. As of 30 September , our available-for-sale securities were 97% of our total securities. We continue to reduce the effective duration of the AFS portfolio, which is now less than 3.5 years. On slide 10, we provide a detailed earnings summary for the quarter. This quarter, we reported diluted earnings per share of $0.91, or $1.50 per share, after adjusting for merger and integration charges of $213 million net of tax, or $0.14 per diluted common share. Turning to slide 11.
Net interest income on a fully taxable equivalent basis totaled approximately $4.3 billion, which represented a 4.1% decrease on a linked-quarter basis and a 10.7% increase from a year ago due to the impact of rising rates and the acquisition of Union Bank. Our net interest margin declined 9 basis points to 2.81% in the Q3. The linked-quarter decline was primarily due to the impact of lower earning assets, deposit pricing and mix shift, offset somewhat by better loan spreads and funding mix. Slide 12 highlights trends in noninterest income. Fee income increased 11.9%, or $295 million, on a year-over-year basis, driven by higher payment service revenue, trust and investment management fees, commercial products, and mortgage banking revenues.
On a linked-quarter basis, fee income increased 1.4%, or $38 million, driven by other revenues, which included servicing revenue from previously executed balance sheet optimization actions. Turning to slide 13. Reported non-interest expense for the quarter totaled $4.5 billion, which included $284 million of merger and integration-related charges. Non-interest expense, as adjusted, decreased $13 million, or 0.3% on a linked-quarter basis, driven by lower compensation expense that was somewhat offset by our investments in marketing and business development. Slide 14 shows our credit quality performance this quarter. While asset quality metrics reflecting changing conditions in the commercial real estate office segment, results this quarter continued to trend in line with our expectations, and key metrics remained below pre-pandemic levels.
Importantly, given the higher interest rate environment, as well as other portfolio considerations, we increased our reserve ratio for commercial real estate office loans to 10%. Our ratio of nonperforming assets to loans and other real estate was 0.35% at 30 September , compared with 0.29% at 30 June and 0.20% a year ago. Our Q3 net charge-off ratio of 0.44% increased nine basis points from a Q2 level of 0.35%, as adjusted, and was higher when compared to a Q3 2022 level of 0.19%. Our allowance for credit losses as of 30 September totaled $7.8 billion or 2.08% of period end loans. Turning to slide 15.
We continued to take action to improve our capital ratios this quarter, increasing our CET1 ratio to 9.7% as of 30 September . The combination of our debt-to-equity conversion with MUFG, earnings accretion net of distributions, and balance sheet optimization actions resulted in a 60 basis point increase from last quarter. Importantly, our CET1 capital ratio is now 270 basis points above our regulatory capital minimum. I will now provide Q4 forward-looking guidance on slide 16. In the Q4, we expect net interest income of between $4.1 billion and $4.2 billion. Total revenue, as adjusted, is estimated to be in the range of $6.8 billion to $6.9 billion, including approximately $65 million of purchase accounting accretion.
Total non-interest expense, as adjusted, is expected to be approximately $4.2 billion, inclusive of approximately $115 million of core deposit intangible amortization related to Union Bank acquisition. On a core basis, we expect full year 2024 expenses to be flat with 2023. Our income tax rate is expected to be approximately 23% on a taxable equivalent basis. We expect merger and integration charges of between $250 million to $300 million in the Q4. I'll now hand it back to Andy for closing remarks.
Thanks, John. Turning to slide 17. The Federal Reserve notified us on 16 October that they have granted us full relief from Category Two commitments made in conjunction with the Union Bank acquisition, after considering several factors, including actions to reduce our risk profile, strengthen our capital position, and provisions related to Category Three rules made after we received approval on the Union Bank acquisition. This important decision now subjects us to the same enhanced capital requirements as all other Category Three banks, including a three-year phase-in of AOCI into regulatory capital starting in the Q3 of 2025. As expected, we will continue to carefully balance the need to accrete capital with any potential impact to earnings from further balance sheet optimization activities. Measures to manage the interest rate sensitivity and duration of our available-for-sale securities will continue....
Since before our acquisition of Union Bank, our priority has been, and will continue to be, the strategic execution of capital-efficient growth opportunities across each of our business lines. As a result of the Fed's decision, we are now well positioned with our enhanced earnings profile and diversified business mix to increase our capital levels, continue our disciplined lending activities, and further strengthen our balance sheet. Let me close by thanking our more than 75,000 employees for their dedication to supporting the needs of our clients, communities, and shareholders. We'll now open up the call to Q&A.
Thank you. We will now begin the question-and-answer session. If you have a question, please press one, then zero on your phone. If you wish to be removed from the queue, please press one, then zero again. Once again, if you have a question, please press one and then zero on your phone. We go to Ebrahim Poonawala with Bank of America. Please go ahead.
Hey, good morning.
Good morning.
Good morning.
I guess, maybe, the first question, just around the Fed decision. In its letter, the Fed said, I guess, the bank anticipates taking further actions to reduce risk profile and reduce assets and increase capital. So if you don't mind talking about just what additional actions we should expect. I think you mentioned that the EPS, in fact, could be neutral from here. But just how should we think about what else the Fed expects from you on the risk mitigation side as we move forward into next year? Thank you.
Sure. Thanks, Ebrahim. Good morning. You know, so as a way of background, this is John, you know, the Fed granted us, as we, as you mentioned, full relief from our Category Two commitments, and that's because of the actions, and Andy mentioned this, of our actions to reduce risk, as well as our ability to strengthen our capital position. So importantly, this is going to provide us additional time and flexibility to meet those new regulatory requirements and do so in the same time frame as our Category Three peers. And additionally, we think it's going to reduce the downside risk, given that, given the challenging rate environment. But, you know, nothing really changes in terms of how we're fundamentally managing the balance sheet going forward. We're still committed to building regulatory capital.
We're still expecting to increase and accrete capital at a 20 basis points to 25 basis points on average per quarter. Our expectation is to accelerate that as we get through the merger-related costs, or be on the high end of that range, I should say, as we get through the merger-related costs and start to realize the full Union Bank synergies. And we're still going to be executing risk-weighted asset optimization transactions, but now we have the time and flexibility to do that over in a way that is low to neutral in terms of our earnings impact. And so, you know, all those reasons, we feel like we have the flexibility in our balance sheet to do those sorts of things.
I think that's exactly right, John, and the only thing I'd add is, you know, part of this decision is reflective of what we've already done for the last 12 months in terms of reducing the risk profile, building capital, optimizing the balance sheet. And I want to be clear, Ebrahim, we are not under an asset cap at all. We are maintaining flexibility in managing the balance sheet and capital, and we'll continue to remain focused on capital-efficient growth. And that includes focusing in the high margin, high return businesses that exceed our cost of capital, while deepening relationships from our most profitable clients. And that has been and will continue to be our focus.
That's good color. Thank you. And just a separate question, John. I think I heard you correctly. If I heard you correctly, you mentioned you expect the NIM to drop, and I'm assuming NIM equals NII to drop in the Q4. Maybe just change that assumption in terms of does a steeper yield curve or a widening in just the curve, it will risk that assumption around dropping of NII or NIM? And what gives you confidence around mix shift, consumer behavior, to feel good about that?
Yeah. So I think in terms of, you know, the guidance we provided, you know, we have embedded in there, you know, our rate forecast, which includes a rate increase in December. Whether or not that happens or not is relatively immaterial since we're fairly neutral from an interest rate risk positioning standpoint. I guess what I would say is, you know, as the Fed is whether they're done or not, in terms of the rate hiking, you know, you know, we start to see a lot of the things on the deposit side slow down, so our non-interest-bearing balances will be relatively stable here at this level.
You know, the deposit betas will, and the rate paid will start to slow down, and then on the other side, your assets will start to reprice, whether that's the securities book, the loan book, and all those sorts of things. So that's what gives us the confidence, really, that we will bottom out here in the Q4 from a NIM and a net interest income perspective.
Got it. Thanks for taking my questions.
Thank you.
Thank you.
Next, we'll go to John McDonald with Autonomous Research. Please go ahead.
Morning, John.
Hi, good morning. John, could I just follow up on what you were just talking about? What are you looking at in terms of the NIM for the Q4, roughly? And did I hear correctly, you think the deposit mix kind of settles out, you know, around 19, 20, where you are here, and beta kind of in the mid-40s? You still have those expectations?
Yeah, maybe just to go off the last couple of questions you mentioned. So, from a non-interest bearing, yes, we do expect that mix. We're at about 19%. That's about where we will be. We expect that to be in that range. And from a beta perspective, we are in the mid-40s right now. It's possible it could creep up higher, depending on where the Fed goes from here, but you know, we feel good about that.
Then in terms of your, you know, your, the net interest margin and things like that, we do anticipate a little bit more pressure here in the Q4, but then that, that really is the, the point where we, we feel that it'll bottom out, based on my comments I just made, previous question.
That's reflected in our revenue and interest income guidance.
Yeah.
Okay. And then, you know, recognizing with the Fed decision, you've obviously got a lot more time to phase in the AOCI now. John, could you just give us a little more color on what happened in terms of the trend in AOCI this quarter? What are the pieces there? You know, and how do the swaps affect your burn down timeline? And just also, if you could add on, what do you how do you calculate the capital with AOCI today? Looks like maybe around 7%, something like that.
Yeah. So I think all in, you know, it's about AOCI is about 250 basis point of impact. So I would say 7.2 is probably, you know, roughly kind of where I would, I think about it. You know, in terms of the change in the AFS, obviously, rates backed up on the long end of the curve, you know, 75 basis points to 90 basis points, depending on Treasuries or mortgages that you're looking at.
That had an impact of about $1.4 billion on an after-tax basis on our AFS securities book, which we would have expected, and is consistent with the duration of our book, which we have continued to wind down, as I mentioned in our comments. Less than three and a half years is our current duration. So, that's the effect of that. You know, we are continuing to see, you know, we will continue to see pay downs in that book, whether it's HTM or AFS. We have about approximately $3 billion or so per quarter that rolls off that book, and, you know, we'll reinvest in the AFS side of things over time.
Okay. Thank you.
Thanks, John.
Next, we'll go to Mike Mayo with Wells Fargo Securities. Please go ahead.
Hi.
Morning. Morning, Mike.
Just to be clear, how much of the $900 million merger savings were recognized in the Q3 results?
Well, in terms of, we will get to a full run rate of $900 million. You know, it's probably, you know, $100 million or so is kind of the, in that range is probably what we were seeing. But, you know, it, it's been a growing in terms of the amount, and we'll see that full benefit full through in the Q4.
Relative to the Q3, the Q1 of 2025 could see $800 million of additional expense savings?
No, because the savings have been generated all throughout the course of the year. And they accelerate, you know, Q3 into Q4 and all that, you know, Q2, Q3 into Q4.
What's the cumulative merger savings? I guess, how much more expense savings should there be when they're fully realized in the Q1 relative to the Q3?
When we have the savings, you know, we'll have, you know, approximately, you know, $400 million or so that has gone through this full year, and then we'll expect to see that in the next coming year. But that's embedded into our full year guidance of flat expenses between 2023 and 2024. So, Mike, the way I think about it, this is Andy. By the end of the Q4, we will be on a run rate, recognizing $900 million of savings, which will be fully reflected in 2024 in our expense base. And that is consistent with how we think about a relatively flat 2023 to 2024 expense base, including those savings plus investments we'll continue to make in the business.
And then the big question then is, so if you have flat 2024 expenses, do you think you can get to positive operating leverage, or is it too early or too many moving parts? Because this is the sweet spot of the merger savings coming up, right? By the next quarter.
It is a sweet spot, Mike. You're absolutely right, and the savings are great. The opportunities to deepen relationships on the Union Bank customer base, I mentioned that in my comments. I think that is terrific. Our fee businesses are doing extremely well. You know, on a year-over-year basis, it was up 12% across almost every category. And frankly, very little of that was related to Union Bank. That was just core improvement across a number of categories, capital markets, our corporate trust, our fee businesses, our payments businesses. You know, the challenge for us and for the entire industry is net interest income and margin. And you know, in this environment, that's the one that I, you know, there's a lot of moving pieces, as you say.
Loan growth is relatively tepid as we speak for us and for the industry overall. So it'll be dependent upon that in terms of positive operating leverage, and I would say it's too early to call.
Okay, and last follow-up. Your increase in CET1 ratio, due to a lot of balance sheet optimization, did come at a cost of less assets, less loan growth, less earnings, right? There's a, there's a trade-off in that. So now that you're under kind of less pressure and have so much more flexibility, do you think you can be a little bit more, lax in terms of your growth and in turn, that may help NII, or is that too much of a stretch?
Yeah, we have flexibility now in terms of the transactions that we do to optimize. And, you know, we still have plans to do those sorts of things. We've identified some things that are going to be relatively neutral, and a little bit on the low end of earnings impact. And, of course, you saw some of those transactions in the Q2, you know, flow through in terms of provision and things like that, and that did lower our earning assets, as you mentioned, about $8 billion or thereabouts this quarter.
Great. Thank you.
Thanks, Mike.
Thanks, Mike.
Next, we'll go to John Pancari with Evercore. Please go ahead.
Morning, John.
Morning. I know despite the regulatory change around the Category 2 requirement, you maintain the 20 basis points to 25 basis points generation in CET1 quarterly. You know, why no change there? Can you just talk to us maybe about the give and takes in that expectation as the need to meet the Category two shifted to Category three? Why no change there?
Well, I think, you know, there's no change because we feel like, you know, given the new rule set and things like that, over time, we'll have to transition into the new regime, which will include AOCI, and so all the other rules. And so we're going to be in a mode to continue to accrete that capital, and that 20 basis points to 25 basis points is our earnings stream that we will accrete. And right, you know, like this quarter, for example, is 20 basis points, but we anticipate going to 25 basis points or on the higher end of that range, you know, as we get through the merger-related costs and we have the Union synergies.
Okay. So the less BSO activity didn't materially benefit that expectation?
I'm sorry. Can you say that more? I couldn't hear you.
The less risk-weighted asset, you know, optimization efforts that would be needed now under the need to meet Category Three did not materially impact the 20 basis points to 25 basis points of earnings generation expected.
No, that did not. And, you know, you know, like, for example, this quarter, we had 20 basis points of RWA actions, which included some of the asset reduction. You saw our earning assets lower, for example, as well as some other transactions embedded. So, you know, we separate out the core earnings when we were talking about 20 basis points to 25 basis points, core earnings from other RWA optimization transactions that we have the ability to do.
Okay. And then separately, is there any OpEx impact of the, of now needing to conform to, to the Category three versus the more immediate requirements of Category two? Anything on the expense side, and then separately on the, on your margin bottoming comment, anything on, in terms of the trajectory in the margin that you would expect after you see this bottoming, as we head into 2024? Thanks.
Yeah. So in terms of OpEx, no, there's no further investment. You may recall before tailoring, we had many of the same rules and standards that we had in terms of liquidity rules and reporting and all those sorts of things. So we have all the capabilities built up or can quickly get to that level from an operational standpoint, so there's no worries there. In terms of the net interest margin, you know, we mentioned just a little bit of pressure in the Q4 and then bottoming out, likely stable, but it'll depend on interest rates, quite frankly, at that particular point in time.
Okay. Thank you. Thanks, John.
Thank you.
Next, we'll go to John McDonald with Autonomous Research. Please go ahead. Oh, one moment here. We'll move past that. Pardon me. We'll go to Scott Siefers with Piper Sandler. Please go ahead.
Morning, Scott.
Morning, guys.
Hey, thanks for taking the question. Just as it relates to sort of the balance sheet growth dynamic, so great, great to see you out of that Fed restriction. Do you see any risk that you'd exceed $700 billion in assets organically, or, you know, come into contact with any of the other Cat or Cat two restrictions organically in a time frame that would subject you to Cat two rules before your peers would have to get there under new levels? In other words, I'm just trying to kind of make sure that this is indeed just a full, free, and clear. So just curious your thoughts there.
It is, as Andy mentioned, there's no asset cap, so that we have complete flexibility here on our balance sheet going forward. So if we elect to grow or want to grow, and we do want to grow in a capital efficient manner, we will do so. What I would say, though, is that we're going to be emphasizing higher return loans and de-emphasizing lower return type of assets, and I think that will manifest itself in, as the balance sheet churns. And in addition to that, I would just highlight that in this environment right now, the loan outlook is pretty low. The demand for loans is quite low, given a number of different reasons out there.
But that gives us kind of the confidence that we have a lot more time and flexibility here.
Yeah. Perfect. Okay, thank you. And then, I think you might have touched on this in an earlier question, but maybe if you can sort of re-walk us through the sort of the AOCI burn down and cash flow expectations coming off the both the AFS and and HTM books. And then, I think you might have given the duration of the AFS book, but do you do you have that for the HTM book as well?
Sure. So in terms of the AFS and HTM, you know, we're at about, you know, in terms of balances, about $162 billion or so, and it's about a 50/50 mix, as we've mentioned on the call, in terms of AFS and HTM. So we have about, as I mentioned, $3 billion of runoff per quarter on average, just given the current interest rate environment and things of that variety. You know, in terms of our profile, we've been able to hedge about 30% of the fixed rate portion of the AFS book. And you know, and so that's what has driven the duration of that particular book in the less than three point five years as we have.
You know, the HTM book is principally all, you know, agency mortgage-backed securities, which have longer lives, and so it's more in the 6 or so, 6.5 range in terms of the duration of that book.
Perfect. All right, wonderful. Thank you guys for taking the question.
Thanks, Scott.
Next, we'll go to Erika Najarian with UBS. Please go ahead.
Hi, good morning.
Morning, Erika.
Morning.
Andy, my first question is for you. You know, quickly, yesterday's announcement, you know, is a big win for the company. And as we think about, you know, you know, combining that relief with a generally tighter regulatory environment, you know, what, what CET1 are you looking at, and what level are you looking at in terms of, okay, now I'm at the right level. This is now my, my, my target in the new world, and now in an environment where balance sheet growth is, you know, minimal at best, right? I, can now return capital back to shareholders through buybacks. I guess I'm just wondering cause, you know, there's your printed CET1, your GAAP CET1, there's the adjusted that John gave, right?
But then you only have to, you know, take into account 25% of that 250 by, you know, 1 July , 2025, if we get to a final date by then. So there's a lot of moving pieces. So as your investors think about all this progress that you've made, plus this relief, what is your new-- what is your new target? Is that transitional or fully phased in? And what's the bogey that investors could look forward to, you know, that you're, you would hit before returning capital through buybacks?
Yes, Erika, I understand the question. And, you know, first of all, I just want to highlight we're back to 9.7 basis points, which is where we started before the deal, and we're able to build. We went from 9.7 basis points to 8.4 basis points and build 130 basis points in a basically less than a year, which I thought was a great effort across the company. In terms of what our new target is, I think our short-term target is to continue to build, as we talked about. Remember, there's two sets of rules that are yet to be finalized and coming down. Number one, are the Basel III endgame finalization of rules, which will, in one shape, one way, shape, or form, increase capital levels, and the second is clarity on CCAR.
We'll set those targets once we have clarity on those two items.
So just to follow up here, you know, at least until June 2020 for CCAR results, regardless of how quickly you build the capital, either on an adjusted or on a GAAP basis, you know, you're going to continue to be at pause on the buyback until at least then, until we see the CCAR and the SCB.
That's my expectation, Erika. We want clarity on the finalization of the Basel III and then CCAR, importantly. So we'll be continuing to build capital and determine our capital targets and buffers and all that activity once we have more clarity in the finalization of the rules.
Got it. That's very clear. And just one more for John, if I may.
Sure.
In terms of the net interest income trajectory, I think, you know, the Q4 bottom is good news, especially relative to, you know, what we thought two days ago, which would be more RWA mitigation. You know, as we think about the RWA mitigation ahead, that's less impactful to EPS. Should we think about it similar to what we saw early in the year in terms of, you know, securitizations? Are you more actively going to continue to use credit-linked notes, which I assume is, you know, cost you 12.5% or so of the pool, plus SOFR and a spread? And as we think about those dynamics, do you feel like you have to, you know, warehouse more liquidity as we anticipate LCR rules for regional banks?
Because we're also hearing that there could be pretty significant haircuts on, how they're thinking about HTM as HQLA.
Sure. Erika, so maybe I'll, start with your, your last point. You know, on LCR, we, we will, as in addition to what Andy said on the capital side, we're going to have to wait and see what it is on the liquidity side, in terms of any potential changes that come out of LCR. We feel very comfortable, that we'll be able to achieve whatever that change is and, and feel, that, that we'll be able to, to achieve that, whatever that scenario is. We'll work into it. You know, in terms of, you know, you talked about the, the net interest income.
You know, we feel like it, again, just to kind of reiterate, we are looking for that to bottom at this particular point in time, in the Q4, and where it kind of goes from there, post it will depend in part by interest rates.
Got it. Congratulations on the release of commitment.
Thanks, Erika.
Thank you.
Next, we'll go to Gerard Cassidy with RBC. Please go ahead.
Morning, Gerard.
Hi, Andy. How are you?
Good.
Andy, obviously, you as Bancorp, has developed a reputation of being a strong underwriter, and we've talked about this in the past with you folks. And I was wondering if you could frame out the environment, because every bank is talking about credit normalization, as you guys did, because we had such great numbers coming out of the pandemic on credit. And if you just exclude for a moment the economy, because you're obviously, none of us can control that, but I'd really be interested in what you guys are seeing from a competitive standpoint in terms of underwriting. And if you could compare it to past cycles. Obviously, we've been around for a few cycles and can compare, but I'm curious from your guys' vantage point, is it as risky today as it may have been in 2005, 2006 or 1999, 2000?
Any color there that you can share with us?
Well, let me give you the big picture, and I'm going to ask Terry to highlight some specifics. You know, I would say the consumer is entering this cycle in very strong shape, from a balance standpoint, from the perspective of savings accounts that they have, the spend activity, I think are all starting to normalize, but normalize to a pre-pandemic, what I would say, normal level. The companies and small businesses are also in very good shape. You know, the one area that we're all very focused on is commercial real estate office, which is one of the areas that we increased our reserve to. As you know, it's at 10% in this quarter. So maybe, Terry, you can go into some specifics.
Yeah, what I would add to that, Gerard, is, as you know, you know, when we think about underwriting, we really underwrite through a cycle. You know, we try to take into consideration and stress from an underwriting perspective, you know, what could happen in terms of rising interest rates or, you know, other economic factors that could come into play. You know, so, you know, we haven't adjusted our underwriting standards a lot as we have been thinking about this particular cycle. I do think that, you know, when you end up looking at the industry, I think there is some tightening that's going on out there. You know, certainly from a competitive standpoint, you know, we are seeing that to some extent.
But, you know, we, we feel like we're in pretty good shape. You know, if you end up looking at, yeah, you know, our situation, as Andy said, you know, probably the area that we're monitoring the most is commercial real estate office space, specifically. You know, we have a reserve that's about 10% of the overall balance there. We have been increasing that, and we're likely to continue to increase that because that's gonna be a pressure point. But, but we're starting from... you know, if you think about the overall portfolio, we're starting at fairly low points. You know, our nonaccrual loans is only 35 basis points of total loans. Our allowance is strong at 208. You know, delinquencies are, you know, still at relatively low levels, although increasing.
You know, our expectation as we go into 2024 is that, you know, that normalization will continue. Delinquencies will continue to kind of move up, and nonperforming assets will continue to move up. You know, but I think we're in a really good position in terms of the allowance coverage that we have, and we feel pretty good about that.
Very good. Good to hear your voice, Terry. Just to follow up on what you were saying, from a competitive standpoint, do you sense... You know, the extreme, of course, was 2005, 2006, when all of the crazy lending was being done by, you know, some banks, but also the non-banks. When you guys look at the non-bank competitors, are there rogue players out there that are just doing crazy things so that the second derivative impacts the banks, not because any of the banks, yourself included, made a poor underwriting decision, but it was the competitors that really did something foolish, and now the banks are suffering a bit?
Yeah, I think
Or, again, not, not like 2006, I'm not suggesting we're there, but
Yeah.
Just, yeah, from a comparison standpoint.
I think both in the bank and in the non-bank space, I think that, you know, people are being fairly rational. A part of the issue is that it's, maybe more so on the demand side of the equation as much as anything. I think, corporate America, is being relatively cautious out there. They're still waiting to see where interest rates, you know, settle in at, and, you know, until they see more certainty with respect to what the interest rate and inflationary environment looks like, you know, I think, corporate America is being relatively, relatively cautious, and therefore, demand is relatively soft. But, we're not seeing, what I would say, crazy things, either on the bank or on the non-bank side at this particular point in time.
In fact, we're probably seeing, if you end up looking at commercial real estate, probably a pullback across the board.
Great. And then, as my second follow-up question, Andy, it was obviously great news that you guys had yesterday about the release. Is there any read-through? Obviously, you sat down with the regulators to get that release, and they seem to be fairly rational in their decision to make that change. There's been a lot of hope and criticism that the Basel III endgame proposals are pretty darn strict. Is there any read-through where we may actually see some rationality with the regulators, and they may kind of pare back some of those requirements, or is that too far of a stretch?
You know, I think the regulators have asked for feedback. The banks will provide feedback both collectively and individually. I think a lot of the feedback is good feedback because of the consequences to our customers. And I think that's the area of focus that we're gonna be very pointed on in terms of our feedback. And we wanna make sure that from a banking standpoint, we're able to serve our customers, and the rule set will create some friction around that in certain categories, and that's where we're gonna focus. And my anticipation is that the Fed will listen to our perspectives, and that's my hope.
Good. Thank you.
Yeah, and I would
Yeah, go ahead. I'm sorry, go.
You know, I was just gonna say, you know, particularly it can be punitive with respect to low and moderate income customer base. You see some capital rules related to renewable energy tax credits that don't make that seem punitive at this particular point in time. So I do think there's a number of different areas where, you know, there's opportunity for adjustment.
Great. Thank you, guys.
Thanks, Gerard.
Next, we'll go to Vivek Juneja with JP Morgan. Please go ahead.
Morning, Vivek.
Morning. Shifting gears from capital, given that you've made a lot of progress to just your normal business. Payments, you've talked, Andy, about wanting to grow merchant processing, mid to high-single digits, really more in the high single digits, and some of the others in the low double digits, like corporate payments. Any color on, any thoughts on how you get back up there? Because that hasn't been the case last couple of quarters. What do you need to do or change, or what would help you get there?
I'm going to ask John to start, then I'll add in.
Sure. So, you know, in terms of merchant processing, we, you know, have been making a number of investments over the years and, and continue to expect, you know, that, that high single digit in terms of the merchant sort of thing. You know, the numbers are, have been, you know, have been strong this quarter, but there, there's normalization that has been happening. And so in the quarters that, the quarter to quarter here, the last, several quarters, there's been a lot of, of the nuances coming out of the COVID and all those sorts of things. So if you think about airline tickets and hotels and corporations, those have been very strong, but they're normalizing. That said, services and retail have been strong.
And so the retail print that we saw yesterday, you know, was very constructive. So we feel like there's good underpinnings there, in addition to the investments that we make to continue to believe and give us confidence in that, in our projections there.
I think two of those most important investments, Vivek, are our tech-led initiative, which is about a third of our revenue base right now, is tech-led from a perspective of new activity. And secondly, is that what we've talked a lot about, which is this business payments ecosystem, which continues to be a top priority for the company, because I think it's a huge opportunity for our business banking customer base as well as our commercial customer base. And then you add in what we're getting from Union Bank. I think that's why we're confident in that higher single digit increase.
Okay. And then, another fee business that you mentioned, you're expanding capital markets. Since you're not doing your investor days anymore, any color on what you're doing there to expand that? You've always had the loan syndications and debt capital markets. What else are you doing to step that up in terms of the level of revenues from that?
Sure. This is John. So, you know, this is another area where we have continued to make investments in back-end systems and the frontline and acquiring talent and all these sorts of things. And it's been a great story for us, and we continue to invest in this going forward. And along with, you know, high grade and underwriting, there's high yield, as well as what other areas that have been very strong is in the derivative market, providing interest rate hedging products for our clients, especially in this time where, you know, interest rates are moving around quite a bit. That's a service that has been highly needed. Foreign exchange has been a growing component here as well.
And, you know, particularly now with Union Bank, we have more of a West Coast customer base and more of a foreign exchange need. In addition to some of the businesses that we work with in the corporate trust side, we have, as you know, we have businesses in Europe as well. So there, there's always some form of foreign exchange, and so we've seen a lot of growth there. In addition to that, we've been gaining market share in the investment grade business and high yield over the, you know, the coming days. I think we've had an investment grade in the top 10 now in terms of market share.
So that has been a business that has continued to advance, slow and steady, and it's been a good business for us.
Thanks.
Before we take our next question, I'd like to remind everybody it is 10 to ask a question. Next, we'll go to Matt O'Connor with Deutsche Bank.
Morning, Matt.
Morning.
Morning. I was wondering, slide seven, that shows some of the revenue opportunities. I was wondering if you could size that.
If you could what?
Sorry, related to the UB deal. The revenue synergies related to the UB deal that you outlined in slide seven. Is there any way to frame how big that might be or what timeframe?
It is a high priority for each of our businesses. Probably the greatest priority is that first one we highlight, which is our credit card opportunity. You know, the payments business is a strength of U.S. Bank. Our card offering is terrific, and we've already had a penetration increase from where we started, and that continues to be a focus. And then you think about that with the business clients as well. I think it is a material impact, but we're still working through exactly the sizing and timing, and we'll continue to update on that. But it is a priority and a focus area for each of our businesses.
Okay. And then separately, a little bit of a technical question. I actually get some of my CFA materials. But when we look at the securities book of a duration of less than 3.5 years, but you're only burning down 25% through 2025, remind me how that math works, and does it, does the burn down kind of step up as we think about 2026, right? Because the duration is pretty short, and the burn down is not all that much in the first couple of years.
Yeah, you know, the function of the curve really changed, you know, as the, you know, we saw the curve flatten out quite a bit this quarter. You know, what I'd say on that is we have a number of securities that, you know, obviously are fixed rate, that have longer durations to them or longer average lives. And so. And then we have a number of with our the security portion, where we have swaps, that is very, very low duration. You know, it's, you know, three months or so because of how it swapped to floating rate index.
So in addition to that, we've as we've added on some of the security book, we have about $8 billion or so of, you know, when we did some of the auto repack transactions in the Q4 of last year, as well as the Q2 of this year, you know, that, that is very short, as well, in addition to some of the floating rate securities within that book. So that it's kind of more of a barbell approach, which gives you the duration of it, which is, you know, just, it gives us a value change for a move in interest rates.
But in terms of the burn down, that will depend in part about how the shape and the type of securities that are in the book.
... Okay, helpful. Obviously, less relevant now given the Fed's decision, but still something we're all tracking. So thank you.
Thanks, Matt.
Thanks, Matt.
Next, we can go to Ken Usdin with Jefferies. Please go ahead.
Hey, guys, thanks. So just one more follow-up on the Category Two news. I just want to make sure we're super clear. So does $700 billion stop being a bind forever? Or, obviously, you don't have to cross on the prior potential time frame, but to the prior question, just wondering, you said there's you don't have an asset cap, so does that mean that Category Two is now a non-thing for U.S. Bank going forward in any time period? Or when you cross naturally, do you still get on the natural clock of having to event, you know, to comply? Just wondering how that fits in with the news you got yesterday.
So, we're bound, Ken, by the current rule set, which is, after four quarters of an average of $700 billion, then you would go to Category Two, or the new Basel III rule set, which is yet to be finalized, as you said. But the current rule set is what we're bound on. So 700 still is important, but what we're saying is, given where we think asset growth will be, given our continued optimization in certain categories, given our focus on high return businesses, we do not see that as a hurdle to growth.
Understood. Okay, that's what I wanted to clarify. Thank you, Andy.
You bet.
With no further questions, I'll hand the call back over to George Andersen.
Thanks, Brad. Thank you, everyone, for listening to our earnings call. Please contact the investor relations department if you have any follow-up questions.
This does conclude the conference for today. Thank you for participating. You may now disconnect.