Good morning. Next up is U.S. Bancorp. We have CEO, Andy Cecere, CFO, Terry Dolan. Thank you, guys, for joining us. Appreciate you being here, and we'll kick off talking about your big weekend. Last weekend, you had the big conversion of Union Bank onto U.S. Bank's platform.
We did. Thank you, and good morning, everyone. John, as you said, Memorial Day weekend, we successfully converted and integrated Union Bank into the U.S. Bank system. That included about $1.2 million consumer and small business customers, about 3,000 commercial customers. And i mportantly, to date, we've already enrolled in our digital capabilities about 300,000 of those customers. As you might expect, with any large conversion, we prepared for and were ready for any unknowns, which always happen in a conversion.
And we had a couple of technical slowdowns related to customer behaviors and activities and trends, but I couldn't be more proud of the way the banking group, our bank branch employees, our 24-hour banking, our call centers, and particularly our technology group, resolved the issues very rapidly to make sure there was minimal customer disruption. So, we're in a good spot. We're not completely done. We still have trust and investment this weekend, and then card at the end of the month, and then we'll be completely integrated on all systems across the board.
Mm-hmm.
Great. Terry, maybe from the financial angle, how does that set you up, in terms of, you know, near-term merger integration expenses and then later in the year, merger saves? Just remind us of that timeline.
Yeah. So, you know, from maybe from a merger-related cost perspective, you know, Q2 and Q3 will be probably the highest, simply because you're going through the severance costs and all sorts of things that are a part of it. And then that starts to wane as we get into the end of the year, and certainly by 2024, the vast majority of merger-related costs are done, which is good. From a year-over-year perspective, that'll be nice. You know, from a cost synergy standpoint, you know, we modeled and included in our estimates about $900 million worth of cost synergies. You know, once we are now through the system conversion, we can start to implement that. You know, about two-thirds of it is personnel-related type of costs.
A third of it is contracts and operational sort of, aspects. You know, our expectation is that, you know, we'll be kind of at the full run rate of the cost synergies by the end of the year, so when we get into 2024, we'll be in good shape.
Great. Great. And Andy, bigger picture, just remind us what's exciting about this acquisition for you?
You know, first of all, scale's never been more important in banking, and this gives us a step function in terms of scale increases, 15%-20%, depending upon the business or the segment. That's terrific, number one. And secondly, it makes us a player in California. We go from a number 10 market share to number five. California has more small businesses than any other state, a very affluent customer base. And we have tremendous opportunity to also provide more products and services and capabilities to the customer base because of our digital capabilities, our payments activities, that Union Bank didn't have. So we have a lot of opportunities there. We didn't model any of those revenue synergies, I think they're very real.
And then, you know, importantly, in this environment, it's a very large, stable deposit base. We're exceeding the PB and our expectations we initially modeled because of that deposit base. It, it is a very positive transaction, financially and strategically.
Yeah. One of the things, John, I would just add with respect to the revenue synergies, while we didn't model any of it then, you know, we certainly expect now that the conversion is behind us, we'll now start to be able to pay more attention to that in the second half of 2023, and certainly as we get into 2024, there's real opportunity there.
Sure. Sure. Let's talk a bit about capital and your path to build. The way we look at it, in doing the acquisition, you traded some capital for future enhanced earnings profile.
Correct.
And, you know, given the timing of the deal, you had to take a bigger capital hit because of the marks and where rates were when you closed.
Right.
I guess, Andy, is that a fair way of looking at it? And then what's the plan for growing capital? I know you're at, the way you report capital today, about 8.5%?
Right.
In Q1, you know, not including the OCI, which you don't have to. Growing at above 10, I think, is part of your plan over the next, you know, two years. Maybe you could walk through that capital?
Sure. I'll let Terry add on. I think the way you portrayed it, John, is appropriate. We, there's future earnings potential that we traded off with capital at time zero. We expected to close the deal at about 9% CET1, but the extended nature of the approval and the increase in rates caused us to be about 8.4%, as you said, we're 8.5%. We expect to get back to 9% very rapidly. Terry will go through that walk, but it was a very good trade-off, and one I would do again, for sure. Terry?
Yeah, maybe to kind of give people some perspective, and we talked a little bit about this, but, you know, we expect to get from that 8.5%, where we're at today, to, you know, well over 10% by the time we get to the end of 2024. And there's really three major components that are part of that. The first one is really the earnings accretion. Our expectation, especially with the scale of Union Bank and some of the things that will come on and the cost synergies we talked about, you know, that we will average over the next seven quarters, somewhere between 20 and 25 basis points of accretion of capital. And that really kind of is a, is a significant component.
If you think about it, Q2 probably will be a little bit below that, simply because of the merger-related charges and things like that that occur. But then as we get into the second half of the year and into 2024, that strengthens. So we feel really good about that. The second component is really related to risk-weighted asset optimization or balance sheet optimization, and we did some of that in the Q4 . And, you know, we have at least 50 basis points of actions or activities that will enable us to be able to kind of get there.
That'll be a combination of different things like portfolio sales, MSR sales, just being very prudent with respect to and thinking about, you know, our focus around profitable relationships and working unfunded commitments that aren't being used down, you know, things like that. Those 50 basis points are really what I would call kind of low impact sort of strategies that really won't affect the accretion that I just talked about earlier. And the third component is just what happens with respect to AOCI during the time between now and the end of 2024. And on our expectations is, you know, obviously it's a, it's a function of what the investment portfolio looks like and interest rates and that sort of thing.
But, you know, our base case, that we're incorporating into that plan is assuming rates stay flat. So, rather than, you know, the market implied coming down. You know, if rates stay kind of where they're at, that 200 basis points of drag that exists today or at the end of the Q1 is about 150 basis points. It comes down to about 50 basis. The combination of accretion, risk-weighted asset adjustments, and balance sheet optimization, as well as the AOCI burn down, gets us to about 10.5%.
Yeah. Ans so, just looking at that, because the market for you and others, looking at kind of this fully loaded with AOCI in there, and this expectation that regulatory rules will require that, you moving into category, which would require that. On that basis, with the 200, your 8.5 goes to about 6.5.
Mm-hmm.
I guess the idea would be building up towards about.
9%.
Nine all in. You know, to that point, John, when we signed the deal, we started planning for all this because we had the expectation we were going to Category II. Now, as you fast forward, it's not just us who are going to face this AOCI, it's a broader group of banks, given the new regulatory framework that we expect to come down. So, the good part of this is we were planning for this well in advance.
Yes. If you did enter Category II, you would take the full AOCI-
Right.
Yep.
At the time, right?
Yep, we'd be in position. Of course, you know, there's a lot of uncertainty yet with respect to what the future capital rules are going to be.
Sure, sure.
As Andy said, everybody will be all the regional banks will be kind of subject to that. But, you know, we have other things that we can implement beyond the 50 basis points of risk-weighted asset optimization that I talked about, that we can continue. One of those things, which, again, we've been kind of putting into place, we haven't necessarily tapped into, would be, you know, securitization sort of structures and that sort of thing.
Yep
That we think would allow us to be able to get there.
Just, just one follow-up on the AOCI, Terry. Just remind us what you've done in terms of hedging. I think you put some hedges on.
Mm-hmm
Avoid the night sweats if rates go up too much.
Yes
Minimize increased AOCI.
Yes.
What's the trade-off then? Just slower burn off if rates.
It's a little bit, yeah. I mean, you give up, you give up on the downside a bit, but you also protect yourself on the upside. So, you know, we've put into place some pay fixed swaps. You know, that probably equates to about 20%-25% of the overall portfolio. So what it does is it dampens the effect of rising rates and helps to protect us from that standpoint.
That the AOCI grow-
Yep.
from here, yeah.
The other thing that we're, you know, actively doing is we're working the duration of the AFS portfolio down over time. You know, kind of picking our points when rates move around to, you know, we can be able to shorten that as much as we can.
You have a history, Andy, of running with high capital relative to your minimums and to peers. SoI guess there'll probably be a path to grow even further beyond 9%, I guess, in 2025 and beyond, given wherever the rules.
I would expect that, John, but I would also expect a transition period to get there. Given our strong accretion and profitability, I'm comfortable we'll get to wherever we need to be in the timeframe defined.
Okay.
Yeah, maybe to give some context, Typically, when they have had capital rule changes like that, you know, they give you a, probably a minimum of 3-5-year sort of a transition window in order to be able to get there.
Mm-hmm.
That gives us plenty of time. Very manageable.
Sure. So, Andy, how are you thinking about the dividend, that you use up about 15 basis points a quarter?
Right
On your dividends, important to your shareholders, you've got a good yield. How are you thinking about that in the context of this plan to grow capital?
So, the dividend is included in all the numbers that, Terry articulated. The dividend continues to be important to us. If we think about investment in the company, you know, first of all, it's investment in growth initiatives. The dividend would be second, and buybacks or M&A would be third or fourth. So, that continues to be a priority and will not change.
Mm-hmm.
The other thing I would just say, John, is that, you know, CCAR will be coming out pretty soon. We'll see new capital rules, all sorts of things. Those will all be things that we'll take into consideration, but again, the dividend is a very high priority for us.
Yep. One last question on the capital build. There's not a lot of growth in the industry right now, but, I'm just also assuming that you're not planning on a lot of RWA growth even before the mitigation.
Yeah. So, you know, before all of this, even, you know, across the industry, I think what we're seeing and what the industry's seeing is very tepid loan growth. Demand is down for sure. I think we and all banks are also being very prudent around capital utilization. So, g iven all that, I would expect loan growth, all things being equal, to be very flattish to up just a little bit.
Yeah
Not where we were about a year ago, for sure.
Yeah. That capital walk assumes a pretty flat balance-
Flattish.
Some mitigation.
Yeah.
Yeah, I think that that'll be pretty consistent with what we're going to see in the industry as well, you know, so I don't think that we would stand out one way or the other.
Right
Relative to that.
On the other aspects of Category II.
Mm-hmm
Being prepared, just remind folks, what are the other aspects of Category II?
Yeah. So, you know, again, as Andy said, we've been working on Category II for the last 18 months. You know, when we went through the tailoring process that took place in 2019, we were already, you know, compliant with respect to the advanced approaches and all sorts of things. We didn't, we did not unwind a lot of those activities because, you know, we knew ultimately we would kind of get there. We just didn't know exactly what the timing of the path was going to be. You know, a lot of those mechanisms and processes are still in place, or we have the, you know, the capability to do that. I would say, you know, from the other aspect that kind of comes into play is just the LCR and liquidity management.
You know, I think we have, if you end up looking at our, total available liquidity and kind of how we're positioned, I think we'll be able to manage that very well. So from a process perspective, from a liquidity perspective, I think capital, we have a clear path to be able to get there.
Great. And he last aspect on the regulatory side, it seems like banks your size and lower will have to do some version of TLAC and debt issuance.
Mm-hmm.
Terry, how do you put that in context of incremental cost or debt burden that you might have to bear?
Yeah, great question. Again, that's one of those things that's, there's just a high level of uncertainty associated with it. maybe to kind of give people a perspective, you know, the expectation is that, you know, by the time the rulemaking gets completed and then the transition period, you're probably talking minimum of three, again, probably five years. So, from an issuance perspective and the market being able to absorb that, I think it's very, very manageable from that standpoint. What everybody's trying to do is to kind of get some perspective in terms of the sizing of TLAC. You know, if you had to adopt the GSIB rules, you're talking kind of mid-twenties in terms of the amount of issuance. You know, we're a lot less complex.
The calibration, I think, that will go through. What we are looking at, for example, applying the framework that we use for foreign bank operations and that sort of thing, you know, we think the impact of what would have to be issued is kind of in that $10 billion-$15 billion range. There's a little bit of a drag associated with that, associated with, you know, the issuance and then your ability to reinvest it. You're probably talking 50 basis points ±50-100 basis points, kind of in that ballpark. But again, over a long period of time, very manageable, and certainly when you think about our earnings power and sustainability, we're going to be able to absorb that.
Yeah. Before we dive into credit quality, Andy, maybe just get your broader views on the current macro environment? You touched on loan growth, but just maybe the broader view on the economy here?
Yeah. So, you know, we have a big payments business, John, as you know, issuing as well as acquiring. What we're seeing is a bit of a slowdown in consumer spend. So, travel, hospitality, grocery, those are still continuing to be strong. But, large ticket, discretionary, retail, slowing down a bit. Still above levels that we've seen historically, but certainly slowing down. We're also seeing balances moderating and coming down. You know, six months ago, we were maybe 2-4x , depending upon the segmentation of the customer base, above. The deposit levels were two to four times above pre-COVID levels. Now, that's one to two times, and probably going to get back to flattish pre-COVID levels later in this year. The spend is slowing a bit.
Deposit balances are coming down a bit per customer, and that is all factored into our modeling, which we expect a set shallow recession later this year or early 2024. Moderating growth, as we talked about, and that is all factored in together with the flat rate scenario that Terry described.
Mm-hmm.
Mm-hmm.
So on credit, U.S. Bank has traditionally outperformed during credit cycles. How are you positioned today for a more challenging environment?
Mm-hmm.
You know, where are you seeing risk for the industry and yourselves?
Yeah. I'll start with the big picture, and then, Terry will go in a little bit more detail on that, John. First of all, we always been very prudent about our credit guidelines and our processes. We don't soften or weaken, you know, lengthen or extend. We don't tighten. We sort of very consistent through the cycle. That's always been our case. We are a super prime portfolio. We don't have any subprime card issuance or anything of that sort. So, it always does well. In the toughest environments, we do the best, and that I would expect to continue. The area of particular focus for right now is commercial real estate, like it is for most banks. Maybe, Terry, you can provide some details.
Yeah. We talked a little bit earlier, we provided some of this information at the end of the Q1 If you think about commercial real estate overall represents about 14% of our overall book of business or loan book of business. So again, that's a very manageable size. The vast majority of that, a lot of that is, you know, multifamily, industrial, you know, those types of asset classes that are going to perform fine or at least very consistently with how they've performed in the past and how we've underwritten them. We feel pretty good about that. You know, the one sector I think that people are most worried about is commercial real estate office space.
And maybe to kind of put some color or context around that, you know, that represents, you know, 1% of our commitments, 2% of our loans outstanding. You know, it's a very small, kind of manageable, book of business for us. And then it's really important to kind of understand, you know, what does the office space look like and kind of where is it, how is it concentrated? Well, you know, we have A, B class sort of office space. About 65% of it is A class, 35% of it is B class, so high quality. We've always underwritten that or done those projects with strong sponsors, you know, that's going to be important when you go through a cycle like this.
The other thing to kind of keep in mind is, you know, where that office space is. You know, the majority of it is either medical or specialty type, is about 10% of the portfolio. About 45% of the portfolio, roughly, is in suburban areas, which are going to hold up better just because of the workplace dynamics and all sorts of things, the free parking, all sorts of things that kind of go along with it. The rest of it is what I would call central business districts, which are going to be a little bit more, but again, a higher percentage of A class sort of space in there. So, if we end up looking at the overall kind of mix of our business, we feel pretty good about that.
The reserves we have on commercial real estate overall is about 6%, 6.1%. And, you know, when we think about that's going to be principally focused around the office space as we go through this next cycle. So, the other thing I would just say is that, you know, with, you know, an expectation of a mild or modest sort of recession, you know, we are going to see as an industry, you know, non-performing assets starting to tick up. Net charge-offs will start to normalize, you know, to pre-pandemic levels over the next several quarters. You know, for us, that was about 50 basis points. You know, we're kind of in a 30-34 basis point sort of range at this particular point in time.
That'll continue to migrate up.
Mm-hmm. And what about the quality of the Union book, Terry? How much have you done or finished scrubbing that reserving for that?
Yeah. You know, we have really kind of spent a lot of time with respect to due diligence, especially after closing. You know, you don't have visibility with respect to all the information when you go through the closing process, after closing, we've gone through that entire book of business. You know, through the end of the Q1 , you know, we have done the loan marks, we feel like we're in a really good spot with respect to the Union Bank book of business. The other thing I would just say is that, you know, the underwriting, you know, of that book of business is fairly consistent with how we think about our own business as well.
And the performance that they saw, for example, in the last recession, was quite strong, so we feel pretty good about it.
Our credit processes and guidelines and, and you know, risk-taking was very comparable.
Mm-hmm.
The last two quarters, the credit metrics were a little noisy, as always.
Yep
A merger with different, will that get cleaned up, and you'll kind of have more of just a U.S. Bank, you know, line in terms of on nonperformers.
Yeah. There's two things that have been affecting that in the past. Some of it was just the unusual CECL sort of adjustments that you end up making. We saw that in the Q4 and then a bit more in the Q1 . The other thing that affected the Q4 predominantly was just balance sheet optimization strategies. You know, so as we think about our risk-weighted asset strategies, you know, where you might securitize or repack an auto loan portfolio, which we did in the Q4 , you have some losses that go along with that. You'll probably see that in the Q2 as well, as we kind of go through some of these things.
But again, when you take all of that into consideration, the impact from a capital standpoint is still very accretive.
The Union Bank started, side of it is all done.
Yeah.
Yeah.
And that auto securitization, that noise comes through in charge-offs, or?
Usually comes through in charge-offs. If you have a gain or loss associated with it gets factored into the charge-offs. That's the way the accounting works.
Sure, sure. Just maybe a comment on your credit card book and kind of what kind of normal seasoning and normalization of credit loss.
So, the credit card book, as I mentioned, John, is prime, super prime. That consistently performs very well in stressed periods, and it's showing the same today. And, y ou know, we will migrate towards normal, like Terry said. That component of the 30 basis point is a little higher, and it'll continue to go towards pre-pandemic levels as we move through the year into next year.
Okay.
Mm-hmm.
Yeah, so let's talk a little bit about earnings. You mentioned, you know, we traded capital for earnings. You'll get to that 20-25 basis point maybe after this quarter and to kind of pace. Terry, any update on the near-term environment regarding Q2 , how that's shaping up relative to your expectations?
Yeah. So, we still have months to go. You know, right now, based upon kind of our forecast or our expectations, still very much in line with the PPR guidance that we gave with respect to revenue expenses, total PPR tax rate, et cetera. So we don't have any real change to that guidance at this particular point in time.
Consistent.
How about on deposits? Obviously, we've been talking to folks this week about deposits. We're seeing NIB, you know, showing deposits down 2% or so for the quarter.
Mm-hmm.
You gave a little bit of an update.
Mm
In April, you've had some moving parts. Maybe you could just walk us through-
Yeah
What you're seeing.
We're, we're following the same NIB data. The industry overall, given the tightening in the Fed, will show some modest decline in deposits, but we're showing the same, relatively stable. As a reminder, John, we have about 50/50 insured, uninsured, but I think more importantly, about 80% of the uninsured are operational. We have a couple of big business lines, corporate trust being the best example, which are a tremendous provider of operational deposits. And those also have volatile flows up and down, you know, bond payments in, bond payments out. So we'll see any time, any day, $ billions come in and out. But on a relative basis, in tuning seasonality, relatively stable, down modestly. Yeah.
The other thing that I would just say is that, you know, in addition to our, for example, our corporate trust business, we have a very large money market fund business. And, you know, the positive of that is it gives us the flexibility to work with those clients to bring money market funds on and off balance sheet, depending upon, you know, what sort of deposit flows we're looking for. So, you know, there's just a lot of flexibility with respect to that business, and it's a good one to be in.
Sure. There's maybe a little bit of, transitional issues this quarter. I think you're, you know, closing PurePoint, a high yield, savings-.
Right
From Union, that didn't fit your strategy, I guess.
Right.
Is that having a slight impact this quarter?
So that's all part of the numbers, John, that we've articulated. Again, I think if you think about ending balance to ending balance, it's going to be down modestly, flattish, similar to the industry. Average balances will be the same. you know, if you look at any particular day, it'll be more up and down because of those corporate trust flows.
Yeah.
Sure. Fair enough. And Terry, just remind us what you're seeing in terms of deposit beta reprice and how you're deciding to, you know, keep deposits versus repricing.
Yeah, it's a great question. You know, certainly in the industry, because of, you know, quantitative tightening and just, you know, Fed policy, those sorts of things, you know, deposits are, you know, very, very valuable. There's a lot of competition that kind of goes along with that. You throw some maybe some of the disruption in the banking industry on top of that. You know, so our expectation at the end of the Q1 was that we would see cumulative deposit betas through the end of this year of about 40%. It's probably going to be a little bit higher than that in the low forties, but not measurably different than what we have been seeing. So t hat's all kind of in that guidance that we ended up giving.
In terms of leading for the year or just kind of near term?
Both for the Q2 .
Yeah
As well as the range that we established for the year as well.
Right. In terms of mix shift, can you talk about where your noninterest-bearing as a total and where you see that kind of remixing to?
Yeah. So, you know, noninterest-bearing represent, at the end of the Q1 , about 25% of overall deposits. And, you know, our expectation over time is that will migrate to what I would call pre-pandemic levels, which was kind of in the low 20s, you know, the 21%, 22%, 23% sort of percent. So, you know, that's kind of what our expectation is at this particular point in time in terms of how deposits will remix.
Just a bigger picture, obviously, everyone's focused on net interest income. How does that wrap up into an outlook for net interest income? Can you just talk about the, you know, good guys, bad guys, and what you're dealing with, the flat balance sheet, and some of these dynamics?
Yeah. Well, I think that, you know, the positive things, again, will be very focused on, you know, our profitable relationships and enhancing the profitability of those relationships. You know, credit spreads are widening, and I think things like that will be some of the positives that will end up taking place. You know, the deposit betas will be a little bit of a pressure point. But again, at the end, I'm thinking about kind of flattish with the widening of credit spreads and, you know, also the deposit betas. I think, you know, we still feel like the guidance that we've given is pretty good.
You know, one of the important aspects of U.S. Bank is the diversification of our income stream. A lot of it comes from fee income as well as net interest income. We have a, you know, a number of unique, terrific businesses, our corporate trust business, our payments businesses, our mortgage, our commercial products businesses, treasury management, that allow us a lot of diversification in different environments, up and down in rates and so on. That's served us well in the past.
Yeah.
Yeah.
Maybe one of the things to highlight with respect to capital markets, you know, I mean, our fixed income capital markets business is doing really well. We've had a very strong Q1 . You know, 2022 was a very volatile time, and so that was an area that kind of underperformed. You know, typically, what we see when loan growth is relatively flattish, you know, the capital markets are getting stronger. And so, you know, I think that we're going to see some good opportunity with respect to fee income in that space, and that would be a good example.
Mm-hmm. And Andy, payments is a differentiator for you. Maybe you could just kind of give us an update strategically, and remind folks just kind of the broad contour.
Right. So, about just under 30% of our revenue stream comes from payments. That's merchant acquiring, card issuing, and corporate trust, corporate payments. And all those businesses are doing very well. You know, they, depending upon the business, mid-single digit to high single digit year-over-year growth is what we would expect. The merchant acquiring and the card issuing, in particular, are really focused on integrating the banking and the payments businesses, particularly for small businesses. I think we have a tremendous opportunity to more fully serve small businesses and gain more small business customers by integrating payments with banking. Oftentimes, in the past, this was a sort of a separate activity. I'm going to choose a payments provider. I'm going to choose a banking provider.
In this world, where digital activity and payments are all integrated into banking, having that in our sort of product set is critically important, and our focus is on integrating this in a simple way, helping companies run their business, and helping them achieve their goals, using payments and banking as a mechanism to get there . So, all those businesses are critically important. And again, what's interesting is that they have different impacts to different economic cycles, and that's also true of corporate trust. So, that diversification of revenue streams, the big part of payments, really helps us in different environments.
Yeah, John, maybe one of the things I would just add to that, you know, we've made some very nice investments over the last two or three years. You know, we invested in a fintech called Bento. We invested in a fintech called talech, as well as TravelBank. You know, each one of those focuses on a little bit different, some on the receivable side of the equation, some of them on the payable side of the equation, both small business as well as kind of middle market commercial banking. You know, in this particular space, with respect to that payments ecosystem, you know, the competition is as much on the fintech side of the equation.
You know, we acquired some great talent in that particular space, and I think it's going to really make a difference for us as we kind of move forward.
And it helps the business run their business, manage the payments, manage the receivables, manage the payables, manage their cash flows, manage their lending needs. It's the entirety of the ecosystem.
On the issuing side, Andy, just remind us, what are the spaces that you're playing in?
Mm-hmm.
What are your strategies for growing the issuing?
On the issuing side, we have a big core of it is our retail issuing to U.S. Bank customers. We have a great opportunity to expand that to the Union Bank customer base. The penetration there was not nearly the same as it was for U.S. Bank customers. That's a revenue opportunity that, while not modeled in, I think is real. We also are a partner to both third parties, white label card activity, as well as other banks, where we issue for those banks, provide the service and the balance sheet for that. So those three components allow us to have this great sort of mix of customer base for retail card issuing, as well as partnerships, as well as other banks. And p art of that is the system we're on.
The system allows us to have bank partners who have their own sort of room within the house that is very specific to their customer servicing activity and their balance sheet activity, differentiated bank by bank. And that system capability differentiates us.
Yeah. In that particular space, you know, we provide that service for about 1,500 different financial institutions across the country, which so it's a very nice business for us, and it's one of those businesses that ends up differentiating us relative to our competitors. The other thing I would just say, John, is that over the last two or three years, we've been making significant amount of investment in our partner platform, which both helps with respect to this Elan or financial institutions business, as well as our co-branding business. I believe it's going to set us up for some sort of, some significant success in those particular spaces over the next couple of years.
So when you make an investment in our card issuing platform, it impacts our retail customer base, it impacts our partnerships, and it impacts that bank group that we talked about, that 1,300 or 1,500. So, it is great leverage by having that set of customers.
Mm-hmm.
On the platform.
Maybe just a quick update on the merchant processing side of.
Merchant processing, you know, it's interesting. There are two things. One is this combination of banking and payments has really been integrated over the last few years for the bank, for the banking industry and for U.S. Bank specifically. We're one of the unique banks that have this merchant processing capability in-house. The second thing is we've made a lot of investments in tech-led capability.
Mm-hmm.
So, it used to be, John, that you would sell merchant processing by going to merchant by merchant and selling that component. Now you're really integrating into the software that runs their business, and that's where we've made most of our investments, which is integrating our merchant capabilities into the software that runs the business. We call that tech-led, and that's been the predominant growth area and the sale area for us in the past few years.
Yeah, better margins. You know, I think this is a great example, again, where, you know, the investment that we made now is kind of fully in, into kind of our run rate with respect to the merchant acquiring space. But, you know, where this was a, what I would say, low to moderate single-digit, you know, business is we think it's a kind of a high single-digit business kind of going forward. And so, we're starting to see that revenue acceleration.
Andy, let's talk a little bit about tech investments.
Sure.
Where you're on the cycle there. You know, you've mentioned that the company's kind of through the heavy spend phase.
We are.
Is a bit more of a, on a flat line. Maybe just kind of explain, what you mean by that?
So maybe, five or six years ago, we were spending a little less than we are today. We're spending about $2.5 billion, about $1.5 billion in CapEx, $1 billion in OpEx. And we're spending that level of spend is flattened. It's higher than it was five years ago, but it's moderated, and we would expect it flat going forward. We've greatly improved and enhanced our digital capabilities, our payments capabilities.
Mm-hmm.
Our technology capabilities. You know what, John, if I just reflect on this, that is one of the most positive aspects of the Union Bank transaction.
Mm-hmm.
The investments we made in those digital capabilities allow us to leverage the Union Bank customer base, the 15% or 20% increase in our customers, with very little additional technical spend. That's the value of scale.
Mm-hmm.
That's the value of technology investment, and that's the value of customer interaction and customer capabilities. Because we're going to have a product set that's broader, more robust, and more digitally capable than what Union Bank had before. So, it's going to be a better customer experience. It's going to be a better financial experience for us, and it's going to be leveraging that tech investment we made. It's in the run rate now. So now, we're seeing the returns of those investments on a go-forward basis. The other thing that the tech investments allow us to do is to operationally become more efficient in the way we service customers and operationalize our expenses. And That is also going to be part of the projections that we talked about and part of the run rate and expense growth going forward.
Mm-hmm. The incremental areas of investment today, there's a combination of front end, back end?
Yeah. We were maybe, 40/60 on offense versus defense. We've shifted that to 60/40 offense.
Mm-hmm.
And so, most of our activities right now are around customer capabilities, digital capabilities, payments, and operational excellence, as opposed to, you know, regulatory components, which was the case maybe five or six years ago.
And the investment in the back office, you know, we have kind of brought our operational functions together under kind of a single leadership. You know, we really believe that we're going to have the opportunity to be able to automate, incorporate things like artificial intelligence and things like that into the operational process in order to be able to drive costs out of the equation on a go-forward basis as well. So, w're very excited about it. That's a part of whether you call it offense or defense, I don't know, but it's kind of one of those applications of technology in the back office that's going to allow us to provide some dividend to the.
Mm-hmm
To the bottom line as we go forward.
Great. I'm going to go through a couple of audience questions here.
Sure. Mm-hmm.
You know, where are you in terms of branch optimization across your broader footprint?
So, when we're all said and done, we have about 2,300 branches, which is down from about 3,200, maybe five years ago. Now, that includes the addition of the Union Bank branches. In California, we're going to have about 600 branches to serve the customers. Importantly, you know, while we had some branch closures, they were typically within a mile of each other. We went to the best location, the optimal location from a customer standpoint. I would say that we'll have some moderate up and down, modest up and down, but nothing material. On a go-forward basis, 2,300-2,200 is about the level we would expect to see in the next few years.
Yeah. And part of the, part of the investment that Andy talked about from a CapEx standpoint is really around our branch infrastructure as well. Always looking for opportunities to be able to open new branches where it makes sense, but also remodel branches and, you know, to kind of redesign them to be more digitally oriented.
And that redesign is important, John, because for us and for all banks, the branch went from a place where transaction occurred to a place now where technology, education, and consultation, and advice is given. So, the role of a branch has changed dramatically. It's still really important, still very important, still need to have them in the right locations, but what happens within those four walls is quite different, and we've modeled and structured the facility to accommodate the new purpose.
In terms of consolidating in the Union footprint, what's the timeframe over which that happens?
All done. Down to time zero.
Yep. All done with that?
All done. What opened up on Tuesday morning, this last Tuesday morning, is the new branch footprint.
Yeah.
With the new signage, with the ATMs and branches, all U.S. Bank. It was a combination of consolidating some U.S. Bank branches and some Union Bank branches. But again, the footprint that we have there, 600 branches or so across California, is optimal given the combined Union Bank-U.S. Bank platform.
Got it.
About two-thirds of the branches that we ended up optimizing or closing at the time of the conversion were U.S. Bank branches, as an example.
Right.
Yeah. again, those benefits on the cost side will flow through.
That's part of the cost, benefit that Terry articulated, $100 million.
Yeah. Now, also on cost, Terry, obviously, you and other banks will have some higher FDIC expenses.
Mm-hmm.
Can you just contextualize that in terms of your earnings and maybe the capital walk?
Yeah, maybe to kind of speak to that, so there's different components, and the Union Bank maybe clouds that a little bit. You know, our legacy FDIC assessment last year was a little under $200 million. You know, that'll increase in 2023, about $30 million a quarter on a pre-tax basis. Now, that is already in the Q1 run rate, you know, so relative to Q1 , we don't see any step up relative to the FDIC assessment that's moving forward. Second component of that is Union Bank. Union Bank adds about $50 million on a annual basis. You know, the $200 goes to about $375, and again, all of that in the Q1 run rate. Then, the other component of that is the special assessment.
On a, after-tax basis, the impact of that is gonna be about $500 million or about 10 basis points of capital, and again, taking that into consideration.
Sure, sure. And Terry, can you just repeat what you said about the capital markets opportunity that might show up as loan growth slows? Which, which area are you talking about there?
Yeah. You know, in the revenue line, it's our commercial product revenues, but, it primarily is our fixed income capital markets space. So whether it's, derivative eco, FX trading, loan, you know, the loan capital markets, et cetera, you know, those are the categories. And again, 2022 was an area that there was a timeframe in which the markets were very volatile. You didn't see a lot of capital markets activity. That's now starting to take off, and that's one of the things that we would expect, you know, when you're in kind of a flattish loan, you know, environment. You know, the capital markets will play a very important role.
And the benefit to us is, you know, we have a great, fixed income capital markets business, and, you know, we're able to capture some of that in fee revenue.
Mm-hmm.
That's a business that we've invested over the last 10 years in, John, and fixed, high-grade fixed income is the best example, but it's derivatives and FX and all that. I look at, you know, 7-10 years ago, that was a $100 million business or so, now it's a $1 billion business.
Yeah. And Andy, on the loan growth front, where are you seeing loan growth demand slow? And also, you mentioned wider spreads. We've heard a little bit about that this week?
Right.
Like, recently, maybe banks are seeing wider spreads.
I think banks are seeing wider spreads because they're sort of pursuing wider spreads.
Uh-huh.
Because of, you know, the capital. Everyone's being very conservative with capital, making sure they're taking care of their current customer base and making sure we're getting profitable returns. Even prior to the sort of the disruption in the banking system, demand started to diminish. That's part of the slowdown that's occurring, the uncertainty with the economy. I think some CapEx projects for companies and so forth are slowing. Inventories are starting to normalize. That all led to a little bit of slowdown in demand, and that, coupled with, looking to make sure that you are achieving the returns that we need to at U.S. Bank and as an industry, is slowing a little on the supply side. So, the combination of those things, those two things, are basically flattish, very modest loan growth, and it's across all categories.
You know, mortgage is down because of refinancings, as you know, and the slowdown in the new home activity. Auto is up and down, but that one is more a focus for us on making sure we have profitable returns, and that's part of what Terry talked about. And commercial corporate activity is moderated as well, partly because people preparing for a slowdown.
Mm-hmm.
Yeah. One of the areas that we are seeing growth in is in the, credit card space.
Yeah.
You know, payment rates were particularly high during the pandemic. You know, those -- and you had, you had the stimulus effects and all sorts of things, payments were relatively high. Those are now starting to kind of normalize. As they normalize, people will start to revolve on their credit card a little bit more. So we'll see nice growth there, and that'll help the margins. That'll be one of those positives from a margin standpoint.
Mm-hmm. And one follow-up, Terry, on deposits. We talk about deposits as if they're all the same in terms of data as a reprice, but you've obviously got a mix of deposits, different types, very granular. Just remind us, where are you thinking remix and reprices largely happen, and which parts may be retail, where there's still some upward pressure?
Yes. I mean, it's helpful maybe to kind of understand the composition of the deposit base. First of all, over 50% of it is consumer, you know, and that'll be very sticky from a pricing perspective. It is moving up, but it's moving up at a much slower pace. And certainly, if the Fed pauses, you know, that'll even kind of, you know, start to stop. You know, about 15%, 20% of the deposits are, you know, in the corporate trust or the institutional services sort of business. You know, that, I think there's kind of two components to that.
A very high percentage of those deposits are operational deposits, you know, so they're deposits that are related to payment, payments on bonds and the paying agency sort of capabilities and those sorts of things. So very sticky, but, you know, from a pricing perspective, it tends to get priced more similar to kind of a money market type of fund. And we've been keeping pace with respect to that, so our deposit betas that I've been talking about, you know, reflect that as well. And then the rest of it is in our corporate and commercial, and again, very high percentage of that is operational in nature, supporting cash management, treasury management sort of activities, and just the, you know, the payroll and all sorts of things that corporations need to do.
So, you know, the other thing I would just say is that, you know, we have, as Andy said, a very extensive branch network, and we generate deposits across that entire network. A significant number of those are in community markets, and those tend to be nice, sticky deposits as well. And then, you know, I'll come back to State Farm. You know, we entered into a partnership or alliance with them, and so our ability to generate deposits through that alliance, you know, has been, I think, an area of focus for us as well.
Just to reiterate, because I think there's so much focus, John, on this insured/uninsured. I would argue that a lot of the uninsured is as stable as the insured, particularly those that are operating in nature. So, the corporate trust business, you know, that flows in and out, happen because we have a corporate trust relationship, but we're serving the bond issuers and the bond holders. And those are sticky because we are the corporate trustee, and the issuance around the fund services business and the treasury management, those are part of helping those companies run their day-to-day cash flows and part of the deeper relationship. They're not capital investment or customer seeking yield, and, you know, flighty at the, you know, two basis point level. They're part of our operation of running their business.
That's a great point, and, you know, we've heard that from others.
Yeah.
It's a really important point.
Yeah.
Just one more for Terry. Just remind us, Terry, we talked about rate sensitivity from the capital standpoint, but from the earnings standpoint, obviously, we're not sure if the Fed's done here or not, but, where are you positioned from an earnings rate sensitivity standpoint? If we get another Fed hike or not, depending which part of the curve?
Yeah. If you end up looking at assets, the sensitivity, we're a little bit asset sensitive, about 1%, to, you know, a 50 basis point movement. So, you know, still a little bit asset sensitive, but, you know, that obviously has narrowed quite a bit over the last year or so.
Yeah. More important to the net interest income outlook now is about the reprice of deposits.
Yeah, and actually, yeah, exactly. So, you know, if the Fed does end up pausing, you know, that pressure that we are seeing on terms of deposit betas, you'll probably continue to see that for maybe a quarter, and then it starts to alleviate itself. That's typically what the pattern is. So, y ou know, if the Fed moves up, you know, 25 basis points again, you'll continue to see a little bit of pressure in terms of deposit betas, but again, for about a quarter after, you know, that rate hike. So, if they, if they, if they hold stable, it'll start to alleviate.
Great. And Andy, any final comments or thoughts for...
No, I, again, I want to just say thank you to the team. We had over 7,000 people, John, for 18 months working on this integration. And the success is due to them and the hard work and the planning, the due diligence. That was a team of both MUFG Union Bank employees as well as U.S. Bank employees, and they just did a tremendous job. It's complicated, but they did a wonderful job. You know, the other thing is, you never expect it to be perfect, and what's important is how you react to the issues as they occur, and they did a terrific job with that.
Great. Well, thank you both for joining us.
Thank you.
Thanks, John. Appreciate it.