U.S. Bancorp's Management Presents at Barclay's Americas Select Franchise Conference (Transcript)

Seeking Alpha

U.S. Bancorp (USB)

Barclay's Americas Select Franchise Conference

May 22, 2013 3:15 am ET

Executives

Andrew Cecere - Vice Chairman and Chief Financial Officer

Analysts

Jason M. Goldberg - Barclays Capital, Research Division

Presentation

Jason M. Goldberg - Barclays Capital, Research Division

Great, if everyone could settle down. Starbucks supposed to wake you up. And now for the rest of the day in this room, I think we have financial services companies. And I cannot think of a better company to kick off a U.S. financial services track than U.S. Bancorp. U.S. Bancorp has consistently put up some of the best profitability ROA, ROE, efficiency ratio and net interest margin metrics in our coverage universe over many, many years, in addition to keeping a very nice balance revenue mix and consistent growth on average over time.

From the company, very pleased to have Andy Cecere, Vice Chairman and Chief Financial Officer; and Judith Murphy, Director of Investor Relations. With that, I'll turn it over to Andy.

Andrew Cecere

Thank you, Jason. Good morning, everyone. Thanks for your interest in the company. I may be referring to some forward-looking statements this morning, so if you could refer to Page 2 about the risks and uncertainties, I'd appreciate it.

Okay. I'm going to do 5 things today. I know many of you know a lot about the company, but I'm going to give a brief overview, talk about the certain aspects of the company. I'm going to talk a little bit about our capital management, our philosophy and the process we use; give a business plan update and dig a little bit in the 2 businesses that really differentiate our company; talk a little bit about the second quarter and what we're seeing; and then give an overview of our summary and our long-term objectives.

So let me start with an overview of the company. You can think about the company 3 ways. First of all, from a traditional retail branch, ATM network standpoint, we're in 25 states, half of the United States, principally in the Midwest to the West and the Southeast. And that is also where we have our Wealth Management private client group officers. However, from a national corporate banking perspective, from the business side of the equation, we are a national company. We are in almost in every state. And that's also true of our Corporate Trust business, which is #1 in the U.S. And then finally, from an international perspective, we are a large player in merchant processing and recently expanded our presence globally in Corporate Trust. And I'll talk a little bit about Corporate Trust and merchant.

Let me tell you first about merchant. So Elavon, which is our brand for our merchant processing is a very large player in Europe. We're #5 in the U.S., #6 in Europe. We have about 10 countries that we have offices in. We have a great platform and have expanded recently to also Brazil and Mexico with that capability.

Let me give you dimensions of the company, talk a little bit about that. From the perspective of our size, $355 billion now. So if you compare in the U.S., $250 billion, you just under $250 billion in deposits. We serve about 17 million customers and a $62 billion market cap, over 3,000 branches in the U.S. and 5,000 ATMs. So how do we rank in terms of the U.S.?

So you can see on this chart, $355 billion in assets puts us at #6 in the U.S.;#5 commercial traditional commercial bank. Two things, I'll highlight for you. Number 1 is we're well below the trillion dollar players, and we'll probably never get -- we will never get that day. But we're in a good spot. We're big enough to have the efficiencies and the scale economies, particularly in this environment of high compliance costs and regulation, but not too big to get some of the attention that some of the bigger players are getting. From a deposit standpoint and the market value standpoint, we're #5, $62 billion. We're in the same range here in U.S. with Barclays and Standard Chartered.

These are the banks we compare ourselves to. These are the 10 largest banks in the U.S., including ourselves, excluding Citi. And we don't put Citi in our peer group because they have a little bit of a different model, which much more of an international presence. But these are the banks we compare ourselves to, and I'm going to give you some reference those banks in terms of returns. One of the great benefits of our company is diversification. And I think about diversification 2 ways. First of all, in terms of our revenue of the business mix on the left-hand side of the chart, we have 4 very simple businesses: Consumer, Payments, Wealth Management and Wholesale Banking. And you can see Consumer's the largest component. But those mix of businesses have been fairly consistent over the last 7 years. And I would expect those mix of businesses to be consistent over the next 7 years. The other benefit that we have is we derive about half of our revenue from the balance sheet, from net interest income and about half from fee income. So any point in time, you start a 45-55, the mix between those 2 sources of revenue. And that's helped us a lot because the different points in the cycle, for example, right now where margin is challenged, the balance sheet side of the question helps a lot -- the fee income state of the equation helps a lot. In other types where fees are challenged, the balance sheet side helps.

Now as we think about the diversification of revenue mix, I'd highlight 2 points for you on Page 10. First, what we are big in; and secondly, what we are not so big in. So you see on this chart on the blue slice of the pie, 15% of our revenue mix comes from Payments. It's a big business for us. It's a very capital efficient business for us, very steady, very annuity based, much bigger than our peer group. I would also highlight to you the small piece of the pie is investment banking. We're not really into trading and investment banking. That's not a big business for us. So the more volatile component, the higher beta component of the business is not big for us.

So how did we do? You can see on the left-hand side of the chart, if you look at the 3 key ratios in banking: return on assets, return on equity and efficiency ratio, you can see we're #1, #1 and #1. We were #1 in first quarter of '13. We were #1 in 2012 all year. And we, in fact, have been #1 since this downturn occurred beginning in the first quarter of '08. And you can see we continue to enjoy a very strong return even in a sort of challenging time for revenue with 16-plus percent ROE and 1.65 ROA.

Now, it's interesting if you look at this chart, Page 12 and look at our prior year revenue growth. Most would say that years 2008 through 2012 have been one of the most challenging times for financial services in the U.S. probably for 80 years. If you look at this chart, you really wouldn't see this, because through that period of difficulty and headwind, we've been able to grow revenue each and every year, double digits in some years, but 4% to 6% if you go to the beginning to the end. So we've been able to grow in the face of a headwind, and I'll talk about why we've been able to do that, but the principal reason is investments we've made to build market share.

If you look at the last 5 quarters, you see the first quarter of 2013, we actually had negative revenue growth. Now that was principally due to 2 reasons. Number 1 is Mortgage Banking came down, and I'll tell you what my view is for that in the second quarter. And the second component is loan growth was challenged in the first quarter for us and for the industry overall, and I'll talk about that also. But importantly, while we have negative 1% revenue growth, we had negative 3% expense growth or a decline in expense, so we continue to enjoy positive operating leverage.

If I look at balances over the last 5 years, you see a nice steady stream. On the left are both loans and deposit and on the right over the last 5 quarters. I will tell you that while the last 5 years have shown much stronger deposit growth, you see that 16%, 10%, 11% in the blue chart on the left, in the first quarter, deposit growth and loan growth were much more matched up. Loan growth being about 1%; deposit just over 1%. So that acceleration that occurred in those prior years is starting to slow, which could be a good sign because some of that would indicate that perhaps that corporates are starting to use their own balance sheet -- balances for investment.

I would also highlight to you that, that left-hand side of the chart, we benefited greatly for the fight to equality. We're the #1 rated bank in the U.S., and you would make sense that if you think about that, that people would want to put deposits with the #1 rated bank and very strong bank. But that's also true of the lending side of the equation. And that's true because during the downturn, some of the banks that didn't have perhaps, the strong ratings, the strong capital position, would retract from commitments or lower them or not be able to continue the commitments. And that is something that the CFOs and CEOs of large corporates remember. And we've been able to get a lot of business because of that and getting deals because of the strength of our company.

Credit quality. For us and for most banks, it's getting better. You can see this nice trend downward. Net charge-offs on the left and nonperforming assets on the right. And I will tell you that one of the things we talked about in our first quarter earnings call is that we expected relative stability in net charge-offs in the second quarter. And I will tell you today there's an update that we expected that to improve a bit. So we expect charge-offs to be down in quarter 2 relative to quarter 1 and nonperforming assets also to continue to improve.

Let's talk about capital management. This is an important topic in this environment, a lot of news and stories about what could change here. But as we think about the company today, I'm going to start with that, middle light blue box on the right-hand side. And this is our binding constraint, the way we manage capital. We manage against the Tier 1 common target under the Basel III fully implemented standard of 8%. And the way we get there is the minimum capital level for all large banks is 7%.

We estimate our SIFI. We are not a global SIB. We are not a global SIB. We are not a global systemically important bank, but we estimate our SIFI at 50 basis points. And on the top of that, we put in our own capital buffer for the volatility that occurs, principally around OCI with another 50. So our target is 7 plus 50 plus 50 or 8%, and we are there. We are at 8.2%. We've been there for a few quarters, which means 2 things. We don't need to build capital and let the right capital level to be able to distribute to a normal level, which is sort of about 60% to 80% of our earnings, which is what we're doing.

Now the other factor in capital distribution is stress test, and this is the result from Page 17 of the most recent stress test that's produced by the Fed. And I will tell you that the test numbers are very close to our numbers, so we were very tied in these results. But you can see from this page that from a pre-provisioned net revenue on the left and from a net income on the right, we did very well. In fact, the best in our peer group. In fact, if you look on the right, under this scenario -- it was a very dire scenario that we had a plan under. It was housing down 20%; equity markets down 50%; GDP negative 6%; and unemployment, over negative 11%. And under that very stressed scenario, we made 1.1% on assets per the Fed, for that independent model. So we have a very strong company to go back to, that's diversification our sources of revenue. And again, this is the independent model that's derived by the Fed. So we're at the capital level that we need to be. We did well on the stress, which leads us to a normal capital distribution model that we're in right now as highlighted on Page 18.

Our objective is to return 60% to 80% of our earnings back to shareholders, half in the form of dividends, 30 to 40; and half in the form of buybacks. You can see that in the first quarter, we're right in the middle of that target at 69%. So you translate what does that mean. So if we're returning 70% to the shareholders, we are reinvesting in the company 30%. Our tangible return's just over 20%, so that allows for earnings asset growth or investment in the company of somewhere in that 5% to 6% range, which is what we're in. That's the mode we're in today. So we're not building capital, we're not trying to get rid of excess capital. We're in a normal mode, earning what we're earning, returning 70%, reinvesting 30% and allowing for the balance sheet growth that we're seeing.

Now, what are we doing with that capital? This is a very important page because it demonstrates some of the strength that we have had during this downturn. So you say, why is that? Why is he busy building market share? Why has he been doing well? Because we invested in the face of this headwind. If you a look at the periods of through 2003 to 2007, a very strong period for banking in the U.S. And then you look at the periods of '08 through '12, we actually increased our investments by 44% during that downturn, still earning those ratios that I talked about in the earlier pages. We invested in Mortgage Banking. We went from number 22 to number 5 in the U.S. We improved our in-stores. We expanded Wholesale Banking, building capabilities we did not have before, high-grade underwriting, municipal underwriting, expanded our loan trading. We built greatly our asset -- our capital management or private capital -- Ascent Private Capital Management group, international payments expansion. So in the face of this headwind, we're coming out of this, 7 years after the downturn or from the beginning of the downturn, a much better company, more capabilities, more people, more offices, more products and services. And that's helped us greatly.

We've also done acquisitions. So first of all, in the middle of the box, you'll see that over this pie-type period, we've increased loans and deposits by about $30 billion through acquisitions. And those will principally be FDIC transactions. We're one of the first to be involved in some of the guaranteed transactions from the FDIC, but I will tell you that, that list now is really short and unlikely to be further expand -- expanded. So what are we doing more recently are in 2 categories: Payments and Trust. And I will tell you that the 2 highlighted names are great examples of what you might see us doing in the future periods. First of all, on the left on the Payment side, we just signed a joint venture with Santander in Spain to do the merchant price processing for their branches in Spain. That's a classic example of how we enter a new territory with our merchant processes. We recently did the same thing with regard to Brazil with Citi and in Mexico with Santander.

On the right-hand side, you see that we bought the U.S. bank -- our U.S. processing, municipal, corporate trust business at Deutsche Bank. Another great example, Corporate Trust is a big business for us. We made a number of acquisitions. We're a very capital efficient business, and I would expect that you would see us continue to do that. So I would expect in the future periods, fewer banks, probably more in the payment space and the trust space as we move forward in terms of M&A.

I talked about our debt ratings. We enjoy the #1 debt rating. I talked about the importance of that from a deposit standpoint, as well as on loan standpoint. I'd highlight we're #1 across all categories, and I'd also highlight the fact that we're stable across all 4 of those rating agencies.

Let's talk about the business lines. There are 4 pretty simple major categories. I talked about those: Consumer, Payments, Wealth and Wholesale. And with that, within that are the 5 or 6 categories of each of the business lines. They're all doing well. A couple of them are doing exceptionally well, and I want to dive into those a little bit more. But all of them are building market share. So how did we get that revenue growth in this downturn? Because revenue for the industry is not growing that rapidly. How did we get that loan growth? We got it by building market share. I go back to the investment slide that we did, investing in the face of the headwind in the years 2008 through 2012. But you can see across this slide, mortgage originations, 0.7% in 2007, 4.6% today. We're in that 5% to 6% range. I expect us to continue to be there.

You can see our CRE loans doubling, almost doubling, our presence there, consumer loans growing greatly. Middle market and investment grade loan book runner, we didn't really have a presence there in investment grade by an underwriting. And now we're #8. Again, these are businesses that are at the beginning of their investment cycle. We built them during the downturn, and we're starting to pay off right now.

And then Corporate Trust, I'll talk more about right now. So if you look at Corporate Trust on Page 25, this is a great business for us. We built this business back starting in 1990. There are series of acquisitions in the U.S. And this is the classic scale business. And let me give you an idea how this works when we buy something. When we go buy a corporate trust business, we're able to typically put it on our platform, add an efficiency ratio in the 30s. And it's coming off a platform typically in an efficiency ratio in the 60s because we're able to put it on with very little additional cost. It's a very capital-efficient business. It generates both tremendous fees, as well as low-cost deposits. And it offers opportunities for to cross-sell. And for the first time in our history, we are actually #1 across all 3 categories of Corporate Trust, the municipal side of the question, the structure side, as well as the corporate side. And you can see the structure side is actually the biggest piece of that business with our recent acquisition of the BofA Corporate Trust business about 2 years ago.

And I will tell you that this is a business that now has tailwind. The structured component of the business is growing rapidly. The number of structured issues out there, CDOs, CLLs [ph] is growing and we generate tremendous fees from that activity. And it's one of the businesses, as I talked about further, the diversity that occurs when margin's challenged, other businesses are doing well. This is one that's doing very, very well, right now.

Payments is another one of our unique businesses, another capital efficient business, generates tremendous fees. We have 3 businesses within payments, the first and the biggest slice of the pie, lower right is the payments, retail payment solutions. Card issuing business, where we make money both on the credit card, on the balance sheet about $16 billion, as well as the revenue generated from interchange.

Global Merchant Acquiring, I talked about that. That's Elavon. Again, that is the 1 business that U.S. Bank that we would continue to expand globally. We don't take loans. We don't make deposits, but we do, do the processing, lower-risk business for us, generates tremendous fees.

And then corporate payment solutions is the third slice of the bucket. Corporate payment solutions is providing cards for corporations, for purchasing and C&E as well as the government. Now that was one of the areas in the first quarter that was down on a linked and year-over-year basis. And I'll tell you the reason it was down is principally because 30% of our business in the corporate payment space is with the U.S. Government. And the largest component of that 30% is the Department of Defense. And then the U.S. in the first quarter, the Department of Defense spending was down around 20%. Part of that has to do with the budget, the sequester and other things. We don't expect that to continue, but that is one of the factors that led to our decline in fees in the first quarter, and we talked about that in the call. This is a great business for us again and another very capital-efficient business, strong fee generation and strong cross-sell opportunity.

We talk about the second quarter a little bit. If I give you an update from what we talked about on the call, I will tell you that generally, things are pretty similar to what we said back in January. First of all, from a business-climate perspective, companies are still growing, but very slowly. The economy is still growing, but very slowly. And things are not going negatively, but they're going positive in a very slow fashion. So from a loan-growth perspective, we talked about the fact that we expected 1% to 1.5% loan growth in the second quarter, up from the basically 1% in the first quarter. And that continues to be our expectation.

Secondly, we talked about the fact that we expect mortgage activity to increase in the second quarter. The first quarter was down on a linked basis, about 15%; and on a year-over-year basis, about 12%. That was due to 2 reasons: length because of seasonality. First quarter is typically low weather. And then finally, there was an increase in rates in the U.S. in the middle of the second quarter, that's slowed application volume. I would tell you that the second quarter, we expect growth in application volume, growth in revenue. And that is still our expectation.

And then finally, net interest margin. Our net interest margin of the first quarter was down 7 basis points. We expected and we talked about 4% to 6% in the second quarter, and that continues to be our expectation. I continue to believe that the first quarter will be the low point in terms of the decline because of partly seasonality in loan fees. 4% to 6% is our expectation for the second quarter. Our principal headwind is the securities portfolio repricing, and that will begin to dissipate over time.

So it's pretty much as we told you about 2 months ago in terms of as we think about the second quarter. And I will also tell you, as I mentioned, that the third part of the equation, credit, which we thought was going to be stable is going to improve a little bit in terms of charge-offs.

So in summary, we have 4 fairly simple long-term goals. First of all, optimal business mix. Let me tell you the businesses that we're in are the ones we want to be in. There isn't that part of that pie that we want to get rid of, divest or shrink. We're in the businesses we want. And secondly, there isn't any business that we seek to be in that we're trying to build or continue. The last business that we built in a positive way is Ascent Capital Management within our private client group. And we're passed the investment stage there. So we are in the businesses we want to be in.

They are generating positive returns. We are building market share. I showed you those slides, you see our returns, 16 plus percent ROE, 22% tangible return. From a profitability standpoint, our ROE [indiscernible] 16% and 19%. First quarter was 16%, and we expect to continue to be in that range. ROA, 160 to 190, our first quarter was 165. And efficiency ratio, #1 in our peer group by a long lane in the low 50s, and we're at 50.7%.

Finally, from a capital distribution, I talked about that. Our objective is to return 60% to 80% to shareholders. We're right in the middle of that range. We're in a good spot in terms of being able to return from the stress test standpoint, from the strength of earning standpoint, from our capital position standpoint, and at the same time, fund the growth that we're seeing in this environment.

So with that, I'd be happy to take any questions. Yes?

Question-and-Answer Session

Unknown Analyst

I mean you've always done the same way, but because you trade at such a high, or higher price to tangible NAV, you still think that 50 dividend, 50 buyback is the right mix? Or is there any circumstances when the economy grows that maybe you're more tilted towards distributing more in terms of dividends versus buyback?

Andrew Cecere

Right. So the reason we trade at a high price to buckets is because of our strong return, our 22% return, so that's how I look at it. I mean what is important is the cash flow that we generate and the return that we generate for the next dollar you put in our company. All things being equal, I would like the dividend to be, perhaps, be a little higher. We were constrained a little bit by the stress test and that 30% additional scrutiny comment. It wouldn't need to be wildly higher, maybe in the mid-30s, but that would be the one thing that we would want to moderate a little bit. And we'll see where we are next year in the stress test. We're sort of fixed with it for the next 4 quarters. We do expect the dividend increase consistent with what we talked about on CCAR here in the second quarter for $0.23. But then that will be fixed until the end of the first quarter of '14, and we'll see what we do in the stress test next year.

Unknown Analyst

[indiscernible] Do you have any views on sort of the new sort of leverage ratios, whether that's going to be the ultimate outcome? It's just 1 ratio, or is it combination of ratios? I mean what's your view on that?

Andrew Cecere

Sure. So with regard to capital, a lot of things going on in the U.S. right now. I'm sure you're aware of the Brown-Vitter proposal. I would assign a lower probability to that occurring as currently defined. However, I would not be surprised by our leverage ratio being part of the final Basel III proposal at a higher level than it is today. As you know, there's already a supplementary Basel III leverage ratio at 3%. That could perhaps be increased. I would expect, however, that our binding constraint will continue to be Tier 1 common for 2 reasons. We have a very simple balance sheet. Our risk-weighted assets, the total assets under a Basel III scenario is 88%. So we're at 8.2%. And unless the leverage ratio goes up dramatically, I think we'll still be bound by the 2 uncommon ratio. Yes?

Unknown Analyst

I wonder whether you could just tell us how your net interest margin compares to the competition? I'm looking at net interest income to risk-weighted assets, and it seems to be higher and why?

Andrew Cecere

So our net interest income, I would say from our peer group is probably in the top quartile. And a lot of that is a function of our own mix that we have. We have about a 9% total loans, a better credit card related [ph], which have a little higher rate; and on the mix of businesses, consumer versus wholesale. As I mentioned, it has come down from where it was a few years ago, but I expect it to decline, again to stabilize over time. The principal headwind that we have today in the margin is the securities portfolio. Every month, I have about $2 billion that pay us down and runs off. In the securities portfolio, we have about $75 billion securities portfolio. That security that I'm putting on to replace that is coming on at 60 to 70 basis points lower than that, which is rolling off. I'm trying to stay short. I'm saying it has a sensitive amount of taking an extension of the duration risk, so that continues to be a principal headwind. Loan margins are actually relatively stable.

Unknown Analyst

I know you talked about acquisitions and the payments on the trust space and kind of, you mentioned the FDIC assisted the deal coming to an end. But what about more traditional bank acquisitions. U.S. Banc has obviously, been a lot of those over the years and kind of still way below kind of the mega banks. Could you just talk to the landscape interviews around more traditional bank M&A?

Andrew Cecere

Yes. So first, I do not expect and we're not seeking a large bank deal or even a medium-sized bank deal. The regulatory hurdles are very high, first of all. The uncertainty with regard to what has happened in that company in terms of regulation that you're effectively buying, that's very difficult to judge during the due-diligent progress. Mix is very weary in terms of -- wary in terms of going after a good, good deal. However, to the extent that we're looking at smaller deals, and I would define smaller sort of as that 100 branch deal, we would look in market in areas that would go by market share to number 1, 2 or 3, not likely to extend out of market, and again, building our capabilities or our distribution in our current markets. I will tell you how adjacent [ph] that is. The current bid ask expectation is still pretty wide between what a bank expects or perceives the value to be in, what we perceive the value to be. So until that narrows, I don't think you're going to see a lot of activity there. I do expect over time that smaller and midsized banks will come together, partly because of the revenue headwinds that we're all facing, probably because of the compliance cost. But in terms of our activity there, the bid ask is still wider than what created deal opportunity. Somebody have a question back there. Yes?

Unknown Analyst

[indiscernible]

Andrew Cecere

Sure, the question is, as we expand our payments businesses internationally, what is our key differentiator and how we're doing that? A typical process is to go in with a bank in that country that has merchant relationships. In a joint venture, typically, we're at the 51%, 49% on the other side. The key differentiator is our payment platform, IPP, international payment platform, multicurrency, very dependable, very rapid, strong technology, strong service. And that's why we're able to go in with some of these banks who have the merchant relationships. We provide the platform and the technology. They provide the relationships, and we share the revenue. That's our typical platform. That's how we started Elavon many years ago here in Europe with Bank of Ireland. The key to their success, I believe, is our technology. And the stability of that technology is relative speed. Right here, there's a question. Yes?

Unknown Analyst

I was just wondering if you look at the spread business on its own, which is probably impossible to do. But if you look at the spread businesses, and is that a business that covers the cost of equity?

Andrew Cecere

Yes.

Unknown Analyst

By how much?

Andrew Cecere

Depends on what category that we're looking at. But I would say the return on equity of our spread business ranges from 11% to 20% depending upon the category.

Unknown Analyst

And that's excluding fees?

Andrew Cecere

That's excluding fees. Now within that category, I will tell you that there are some that -- to answer your question directly, if I go to the large corporate side of the question, those are going to be right at, or perhaps, a little bit below the cost of equity. However, there is other generation of fees and other components of the business. If you think about a large bank like us in the U.S., we're typically doing a large corporate lending to get other sorts of business. And we have actually a very disciplined process to do that. If we're going to go in a deal that is below for a period of time, let's say 1 year, we actually track and make sure we're getting that other business to make sure that we're covering the cost of equity all in from the relationship standpoint. One other point I'd make is on the flip side, on the right side of the question, deposits today, deposit gathering is not probably ruining the cost of capital. It's at an all-time low in terms of the value to deposits. So you might say well, should you be shrinking branches more rapidly, and we're not. We're just building fewer. We're building slower, so we really -- perhaps, we're expanding 50 to 75 a year, we're now 10 to 20 a year. Because deposit gathering will be valuable again. It's an important component of building relationships, and branches are still a key part of that equation. So if we did it -- if we made our decisions based on the very short-term basis today, deposits don't look so good, but they will look good again soon.

Unknown Analyst

[indiscernible]

Andrew Cecere

Well, our banks overall, we're earning 16%. Our peer group averages about 10%, so...

Unknown Analyst

[indiscernible]

Andrew Cecere

Yes, I can't judge that. And again, our return on intangibles is about 20%, so we're #1. We're high, well above most of the peers, all of the peers. So I can't judge the others.

Unknown Analyst

I was just amazed by that 30% efficiency ratio versus 60% efficiency ratio for any kind of trust or kind of payment deals. Surely, that would suggest that you should just go out there buy everyone and put it out of your platform?

Andrew Cecere

We pretty much did. So when we started -- and it's in the high 30s on the marginal basis, just to be clear on that, 39% or so. We started -- I actually ran the Corporate Trust business at that time. We decided that it is a great business, very capital efficient and a classic scale business. And we started building -- we did around 20 acquisitions in the '90s through the middle of 2000, building that book of business and went to #1. And there are a couple of large players in the U.S. that are handful, and we're #1 across all 3 categories. The remaining acquisitions that are available are smaller in nature in the U.S. There maybe more opportunities in Europe, but in the U.S., we already bid down in that market share.

Unknown Analyst

[indiscernible]

Andrew Cecere

Yes, our market share across different categories are in the mid-20s already across most categories in the U.S.

Unknown Analyst

Sticking with the payments theme, you guys are obviously a large merchant acquirer, you're a decent-sized credit card issuer. I guess early this year, Chase came out with an agreement with Visa. They're trying to leverage their issuing in the merchant-acquiring size with this Chase working services joint venture announcement. Let me just -- in terms of your -- talk about how you kind of think about how the network plays in kind of the future payments, and is there more you can do to marry those businesses together?

Andrew Cecere

Yes, so that ability to differentiate on the discount depending upon the retailer exists for all Visa partners. So that is -- we would have that same capability -- let me shortcut the answer on that Jason [ph], so that is not that unique. We're pursuing a number of different activities. I will tell you the one thing in payments that is changing and will be different 5 years from now versus today is the vehicle that you use for the payment processing, so be it square or the wallet. And I don't know what the final solution will be, but what we're trying to do is to stay in all parts of the game. So we're on the Google Wallet. We have our own square device. It's also important to note that even -- regardless of what device you use, there's always a bank behind it. And we are typically part of that bank, but the technology is going to change there. And our strategy is to try to play in all aspects of the potential solutions there, because it's likely that some will be successful and some will not. But it's not certain yet which are those are going into category. Yes?

Unknown Analyst

[Indiscernible]

Andrew Cecere

Yes, the question is, what is our interest rate sensitivity. We are asset sensitive. I talked the fact -- about the fact that as I'm putting on securities, I'm trying to keep the duration fairly low. Our interest rate sensitivity, depending on the 50 or 200 basis point increase, is somewhere about 1.5% of our net interest income. So we are biased to an increase in rates, and we're going to continue to maintain that position. We'll also tell you, excluded from that equation, is we have a $36 billion money market mutual fund that is almost entirely in waivers right now. So that's a fee income component that is also biased to an increase in rates that will come through fees.

Unknown Analyst

[indiscernible]

Andrew Cecere

Our waivers, you can sort of do the math on $36 billion, but it's in that $90 million to $100 million range. Yes?

Unknown Analyst

With all your peers, so you focus on cost cuts going forward and sort of trying to get down to efficiency ratio similar to yours. What opportunities does that give you going forward? And also, I mean is 50 the sort of the very top of the efficiency ratio over the next sort of 5, 10 years?

Andrew Cecere

Right. So we're at 50.7%. Our goal long term on an efficiency ratio standpoint is to continue to be in the low 50s. And we want to keep our positive operating margin -- leverage, excuse me. Here's how we manage our expenses. We manage it business line by business line. Richard Davis, our CEO, and myself meet with about 60 business lines each month. And we go through just like you would go through with your businesses. What is the revenue opportunity, what's the competition, what's the expense that's going with that revenue opportunity, what investment did we have? And we're managing those businesses, business by business. So we don't have an overall cost program. It's a business-by-business initiative, and it's worked very well for us. The other thing I highlight, what are the keys to our efficiency ratio, 2 other keys. One is our platform. We have 1 deposit system. We have 1 consumer loan system, 1 trust system. So every time we do one of those acquisitions, we completely integrate it. So when we're changing the product or a pricing component, we're not changing it on 15 or 20 different system, we're changing it on one. And the final component, key to our success, I believe, is our culture. We are really good at managing expenses. And I think we have the ability to see what's coming. So if you go back to December of this last 2012, we saw a slow first quarter. In fact, we talked about it at another conference. We were one of the few banks that talked about it. And we planned under that scenario. We cut back on our merit increases for the senior-most folks in our company. We cut back on some of T&E activity, anticipating the slow revenue growth that did occur. So we're pretty good at seeing out and managing against that.

Unknown Analyst

[indiscernible]

Andrew Cecere

Our opportunity is to gain market share, which is what we have done through the investments we have made. So I showed you that investment growth curve that we did through 2008 through 2012. And in that period, we retained a slow efficiency ratio. So we pick our spots to build where we think the return is sufficient, and we've been able to grow market share. So I think the opportunity is to build the market share, while others are cutting back. And that certainly was the case in 2008 through 2012. Yes, you're going to have another margin question, I bet?

--

Unknown Analyst

Yes, that sort of thing. You look at the industry with 10% ROE, okay? And that's in -- when provisions are low, so you are barely covering the cost of capital as an industry, when things are okay, which kind of to me -- and I may be completely wrong. But it seems like a kind of troubled industry. So what do you do about it as an industry? Is there a chance that you could price up? Doesn't sound like it, maybe you can bring cost down, or maybe there should be huge consolidation. I suspect that a lot of banks being started every year, so I don't quite know how you square all these things?

Andrew Cecere

So it's a good question. It's not as relevant to us because we're running well above our cost of capital at 16%, 20% tangible. I do think that is a question that you should ask of banks that's earning below their cost of capital. And so we're doing what we're doing, and it's working very well for us. And our capital model, as a shareholder, it works. I guess that's all I could say. Because we're earning the 20% tangible. We're retaining enough to continue the growth that we're seeing in the slow-growth scenario. To the extent, revenue opportunities or growth increases, I will dial back on the buybacks, invest more in the company and offer more risk-weighted or balance sheet growth and return a little less. But right now, the 70%, the 30% and the 20% return is looking very well for us.

Unknown Analyst

Andy, you talked about a little bit of pickup in loan growth in 2Q versus relatively slower Q1. Can we just talk about what pockets of strength you're seeing, being both from a geographic standpoint, as well as just a business line standpoint?

Andrew Cecere

Sure, Jason. So first of all, I think part of the slowness in the first quarter was -- is slow for us and for the industry overall. It was a bit related to what happened in the fourth quarter. There was a little bit of an acceleration in activity, partly due to tax policy and some other things that accelerated loans in the fourth quarter. What we're seeing strength is in small business. That's a particular area of focus for us. Rick Hartnack, who is our Vice Chairman of Consumer, put a great focus on that through our branches, and small business continues to grow nicely. Auto lending and leasing continues to be an area of opportunity and growth, and we're seeing a nice increase in volume there. We have dealer relationships as well as direct relationships, and that works well. And then finally, on a home mortgage side, we do sell all of our GSE production, but we have a branch based, high-quality product that we sell to our branches called, Smart Refinance, that's a lower dock for high-quality customers, and that is also growing nicely. So the mortgage, home mortgage side, auto lending, as well as small business are areas of strength right now. One more. Sure.

Unknown Analyst

You mentioned the slug of your corporate payment business tied to the government and the average impact you saw on Q1 that holds sequestration issue. Can you talk about, in terms of how that plays out kind of 2Q, 3Q? And there were some seasonality that sometimes helps you in 3Q, and what to expect there going forward.

Andrew Cecere

Right. There is seasonality in our company, not only in corporate payments, but across our company. And the way I think about our company is 3, 4, 2, 1. 3, 4, 2, 1, the strongest to the weakest quarter. So 1 is typically the weakest. And the government kind of, part of the spend is a bit uncertain, to tell you the truth, because we're uncertain. We're not certain how the sequester's going to play out. And we do have that exposure to the Department of Defense and the Government. So I don't expect it to be a long-term phenomenon, but in terms of quarter-to-quarter, I don't know how that's going to play out. We'll also tell you on the corporate -- on the company side of the question, the 70% strength in purchasing card, a little weakness in TV card. So companies, many companies, you're doing exactly what we're doing, which is cutting back on the travel and entertainment and the slow-growth environment, but continue to purchase what they need to, to run their company. But the government side of the equation remains a bit of an open issue until that's determined, but I don't think it's a long-term issue.

Jason M. Goldberg - Barclays Capital, Research Division

[indiscernible]

Andrew Cecere

All right. Thank you very much.



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