U.S. Bancorp (USB) Earnings Call Transcript & Summary

Well, thanks, everyone. We've got U.S. Bancorp up next. Joining us again is CEO, Andy Cecere; CFO, Terry Dolan. Thank you, both, for coming back. It's great to see you guys in person.

Thank you. Good to be here, John. Thank you.

Nice to see you, John.

Andy, let's maybe start off talking about the big picture, how you're thinking about the economic backdrop, what you're doing in terms of planning for different scenarios and just overall kind of what you're seeing right now and then how that defines your outlook.

Sure. Yes. It's an interesting time, John. So I would say as we look at the here and now, the consumer and businesses are in very good shape. They continue to have strong deposit balances and liquidity. Productivity is high, and spend levels are really good, and I'll come back to that in a little bit. But certainly, there are inflationary pressures, the war in Ukraine and what's happening with COVID and unemployment. All those things are just causing a lot of uncertainty. And what I would say is we all have our base case, but I think we're in an environment that the range around that base case is as wide as we've ever seen it, and the probabilities of many different scenarios occurring are out there. And at U.S. Bank, we're planning for all those scenarios. And we typically do well in a more defensive structure, and that's demonstrated by our stress test results and our credit through the cycle. But we're ready for any of those potential scenarios because I think the range is wide. If I dive just a little bit deeper into this, it is interesting that the deposit levels have been growing throughout, and you hear about this $2.5 million or $2.7 million excess savings. What I would say is the trend has flattened, so the deposits are not yet coming down, and that's across all categories. They're still 2 to 4x pre-pandemic levels, but they're flattened. Spend is still strong, but it's changing. So spend levels, up 30-plus percent versus pre-pandemic levels. But where spending is occurring is changing, more services versus goods and more nondiscretionary versus discretionary. So for example, May versus May of last year, spending on furniture, equipment, sports activities, things that are more discretionary are down 20-plus percent. Spending on fuel, discount stores and food is up a fair bit, so there's a shift occurring. So there's a lot of -- again, back to this uncertainty. Things are good right now, a lot of uncertainty in the future. And the fed, I think, is going to do everything that they can to control inflation. I'm confident of that, but there are things that are out of their control. So they're going to need a little help with some of that, things like supply chain, workforce participation and such. So again, we're ready for all the scenarios, John, but it's a pretty uncertain environment as you look longer term.

And it sounds like inflation is already working its way into influencing the mix.

It is. It is. And certainly, I think of that as particularly true. The higher-end individuals are spending more on travel, entertainment and hospitality. I think the medium and low are spending more on the nondiscretionary things and just shifting spending behaviors.

And, Andy, let's drill into U.S. Bancorp. There is a little bit of a report card over the past year. What would you say about the kind of hits and misses for the company?

Sure. So if we think about a year ago when we were talking virtually at that time, we were just coming out of the pandemic. We had some pressures that impacted us because of our large payments business and lower spend activities. That's all recovered. So spend levels across all categories are above pre-pandemic levels, which is a positive. Certainly, we also saw a change in loan growth. So loan growth started to strengthen in the fourth quarter and came even stronger in the first quarter as people started to utilize more of their outstanding commitments, and those are positives. I think importantly, some of the investments that we've been making on technology are starting to pay off, and so we're seeing higher takedown in our digital processes. 2/3 of loan applications, they've all been done digitally. We've expanded our capabilities with a couple of acquisitions, TravelBank and PFM, which is expanding both our wealth management group as well as our capabilities around providing a payments ecosystem. But probably the most important thing that we've done is announce Union Bank. And we announced in September, we have teams working on it on successful integration. And that's going to be a terrific deal because it's -- by most measures, it increases our scale by about 20%. If you think about deposits or loans, it adds nearly 200,000 business banking customers in an important market in California makes us a big player, and it's a very positive financial transaction. So that's probably the most significant outcome in the last 12 months.

And where did you say to the team, "We got to do better this year than last year?"

I think we're hitting on a lot of cylinders. I think we're just being prepared for these potential wide outcomes of scenarios and making sure that we're very good defensively, and we always have been, and we want to continue to be. But we have this focus on growing on the offense side of the equation, particularly in our payments ecosystem. We have a terrific payments business. We have a terrific banking business, and weaving this together into a comprehensive offering for business banking and commercial customers is a particular focus.

Okay. So let's drill down into a couple of those strengths. Loan growth has been good for the industry. You guys had a very strong loan growth quarter in the first quarter. How broad-based is that? What's driving it? And is it continuing into the second quarter?

Sure. Terry, why don't you comment on that.

Yes. So if you end up looking at loan growth, for example, in the first quarter, the C&I side, it was about 8% on a linked-quarter basis. So it was very strong. And we saw -- then in the fourth quarter, not quite at that level, very strong in the first quarter. While it's probably not going to be quite at that level, it's still going to be quite strong in the second quarter. Where we are seeing it, so if you end up looking at where it's occurring, it's really pretty broad-based across most of our markets. And many of the different, what I would say, industry sectors, particularly in industries where they're trying to build inventory, where they're trying to make a capital investment in order to be able to automate their business activities, all sorts of things. From an inventory build standpoint, part of it is just getting back to pre-pandemic levels, and part of it is also what I would say just-in-case sort of investment in inventory. So we're seeing nice utilization with respect to our lines from a year ago. Roughly, it's gone from about 19% to 23%. So it's not only drawing down those lines, but also just new strong pipeline as well.

What's normal, Terry, for utilization if you think about longer term average relative to that 19% to 23%?

Yes. Just before pandemic, it was about 23%, so it's kind of back to pre-pandemic levels. But I would say more normal, it's 25%, 25-plus, kind of in that range. And one of the things, John, for us, we end up banking typically high investment-grade type of clients, and so having that type of utilization rate is pretty standard for us.

How about on the commercial side -- sorry, on the consumer side? Are high payment rates still kind of holding back credit card revolve...

They are. Spend levels are great. We talk about credit card spends 35% up versus pre-pandemic levels, but the payment rate continues to be high. 37%, I think, Terry, versus a normal in the low 30s. So people are spending a lot, but they're paying it down very quickly.

Yes. And one of the things, John, that I would expect is that while we're not seeing it yet, it has stabilized at that 37% because it was climbing for a while. And while it's stabilized, our expectation is it does start to come down as government stimulus dissipates and people start to burn through some of their savings.

I want you to just fix your mic, Terry. Andy, can you remind us how you choose to compete in credit cards and how U.S. Bank is a little differentiated in how it chooses to compete in card which is a very competitive space?

Right. Card's a big business for us. It's our largest component of our payments business. I'd highlight 3 things. One is we are very flexible and recognize what is important to the consumer and change our reward processes. For example, we change it from travel to takeout in food during the pandemic, and we can do that in a very quick fashion. Second is we have a very solid platform that our technology is on that allows for very unique characteristics for our partners. So we have a lot of co-brand partners as well as other banks that we provide credit card processing for, and that is terrific for 2 reasons. One, there's great diversification around that. There isn't one big player that we're the co-brand partner with, but also that -- those co-brands could have their own servicing and own customer experience because of the technology platform. So that capability being flexible as well as the technology that we have allows us to grow and effectively serve the customers that we're serving.

Okay. Just sticking to consumer, could you touch on auto? You're big as an auto business company and a lender. What do you like about the auto business? And how are you thinking about that in potentially a tougher economic environment?

Yes. So one of the characteristics that is positive is that we are a big lender as well as lessor. So having that optionality around loans for leases, particularly in an environment where rates are changing rapidly, is important. We have great dealer relationships and a big indirect business, and it's one we've been consistent in. It's a great area for growth in loan activity, positive returns. And we also are benefiting right now from the high values of used cars returning from lease, and that is also a positive from a fee generation standpoint.

Yes. And, John, one of the things I would just say is when you have both the lending and the leasing business, when rates are in a rising rate environment, the customer is looking more so at their cash flow ability to pay, and the leasing option becomes much more attractive to them. And so having that differentiated sort of balance within the business, I think, is very important. It's been a part of our success.

And how about mortgage? Industry volumes have been dropping. How are you dealing with that? And what are you seeing in your own business on the mortgage side?

Yes. Our leaders in mortgage a couple of years ago decided 2 things. One is we're going to make sure we're investing in technology, so 95% of our margin activity right now is in a digital fashion. It's a complicated process. So to the extent you can take paper out makes it better for the customer, and it makes it better for our efficiency. The second thing is we shifted and put much more emphasis and focus on new purchase activity as opposed to refinance. So we, like the industry, are seeing a much lower volume in refinance. But we're -- because of that focus on new market, new purchase, that's helped us out a lot. So it is going to be a positive going forward as well.

Yes. One of the things I would say, John, is that from a volume standpoint, we're tracking consistent with kind of industry trends. Across the industry, the volumes are down. I think the other thing that's affecting the industry right now is just gain on sale margins in terms of your production, and they're fairly tight today. We have a stronger focus around retail, as Andy said. So those margins are better than, for example, the correspondent channel. And the primary reason why the gain-on-sale margins are where they're at is because there's still a pretty significant amount of capacity in the system, and so the industry is kind of working through that. And you're going to see -- and we are seeing that capacity is starting to come down, which should help to stabilize those gain-on-sale margins and actually cause them to expand. And that's kind of our expectation.

Yes. But that will take a little bit of time.

Yes. It takes -- I think we're starting to see -- we're certainly starting to see capacity coming out of the system in the fourth and first quarter, and I think that -- in the second quarter as well. Gain-on-sale margins usually start to stabilize and come up a quarter or 2 after that. So in second half of the year, we would expect the margin starting to get a little bit better.

Okay. So over the past year, you've highlighted an opportunity to achieve better growth in small business. You made some investments and acquisitions there. Can you talk a little bit about that, Andy?

Yes. So this is one of our key focus areas, John. So we have over 1 million business banking customers. And part of those customers have a payments relationship, so merchant, but only about 1/3 of the merchants have a banking relationship. And about half of them have a banking relationship. And of the banking customers, only about 1/3 have a merchant relationship. And what -- our objective is, as you're running a business, there are many things you need and information and products and services. And what we're trying to do is bring them all together in a comprehensive component. So managing their receivables, managing their payables, managing their cash flow, managing their payments activity, looking for lending opportunities when they need cash flow surplus or supplement. So -- and that goes along with the investments we made, John, as well as the acquisitions. So talech really focuses on the receivables, Bento is on the payables, TravelBank for the travel activity. That, combined with our merchant and banking capabilities, provides us comprehensive set. And I think it's a great opportunity to acquire new banking customers as well as fill out the services that the current bank customers need. So my objective is and our objective is to have a tool that a business owner uses on a daily basis to help them run their business, and it's not so much just a banking tool. It's a business assistance that has banking and payments products, and I think we have a tremendous amount of opportunity here in the tune of 20% to 25% growth in revenue and business banking activity.

You've really spruced up the lineup of products and services and offerings. And how -- you've gotten some traction already. How would you describe the progress there?

We've got -- this is something we focus on. Terry and I meet with the team on a monthly basis. Two focus areas: acquiring new customers as well as extending the relationship with current customers, and we're making great traction on both. And it's interesting. I think we have all the components. What we need to continue to focus on is simplifying the offering and the navigation and the usage, which is what we're doing and we're making great progress.

Yes. A couple of things, John, I would just add to that. Andy talked about talech being at the center and helping customers, small business to be able to manage their business. We're really creating kind of a dashboard to enable them to be able to connect all the dots, so to speak, because that really makes our tools and our capabilities kind of central to how they manage their business, which I think is very important. The other thing is that Andy talked about the number of small businesses that we have. Union Bank adds about almost 200,000 more small business customers to that equation, and so we think that there's real opportunity with respect to that as well.

Back to the 20%, so as our small business banking group, a number of customers by 20%, just like deposits 20%. Scale is really important, and to have that step function with Union Bank of 20% is critical.

You guys are excited about the small business opportunity in its early innings.

Yes, yes.

Yes, very much so.

Okay. So let's talk a little bit about net interest income and the environment with rates, Terry. Just remind us, what is your outlook for net interest income this year? It feels like your NIM and your NII have kind of bottomed, and you've talked about that. But what are you looking at for this year?

Yes. I certainly think the environment has changed with a rising rate environment. Maybe to kind of give -- to ground a little bit, we had given guidance. And consistent with that guidance, we still expect net interest income to expand 8% to 11% in 2022. So that will be some very nice growth. The overall fee -- excuse me, the overall revenue guidance, again, consistent with what we said, somewhere between 5% and 6% because the mortgage banking revenue drag that exists will kind of bring that down a bit. But when we did kind of the March forecast with you all and when we were giving guidance at that point in time, we assumed about 9 rate hikes. And the fed funds rate getting to about 2.50%, it's probably a little bit stronger than that if you end up looking at market implies today. So that's the positive, but there's just a lot of uncertainty out there. The other thing is that kind of on top of that forecast and that guidance, our asset sensitivity is about 2% to a 50 basis point move up. So there's certainly opportunity to be able to expand upon even that strong net interest income guidance from here.

And, Terry, you might want to comment on Union Bank and how that...

Yes. So Union Bank, another thing that is kind of beneficial about it is that, from an asset sensitivity, it will be accretive to us. So it will increase that asset sensitivity. But I think the positive thing is that it really brings a nice core deposit base, very similar to our own sort of customers with consumer and small business, C&I. So the stability of that particular deposit base is really good and nice low-cost deposits as well. So I think that that's a real positive when we think about both from an asset sensitivity standpoint as well as the overall kind of balance sheet.

And then maybe just on that topic, you could talk a little bit about what you think for industry deposit growth as the fed continues to tighten. And what are some of the unique aspects of U.S. Bank's deposit mix that might influence your behavior relative to peers?

Yes. Well, one of the things that Andy talked about is that when you end up looking at the growth in deposits, it's kind of stabilized. And I think that that's fundamentally what we're seeing and what the industry, I think, is going to see. Certainly, when you end up looking at our mix of business, about 50% of it's consumer-based, and 50% of it's institutional. Now the consumer percentage is a little bit higher than it was for the last time we went through this. And so from a rate sensitivity standpoint, we actually think it's a little -- it's going to be a little bit lower as we go through this particular cycle.

The beta will be lower.

The beta should be a little bit lower, simply because of the mix of the business. The other thing that we ended up doing is a lot of the institutional deposits that we might have had on balance sheet the last cycle, a lot of that is a part of our money market fund today as opposed to on balance sheet. And so that ends up influencing and bringing down the deposit betas a bit. So our expectation is that actually it's a little bit slower deposit beta than what we saw the last time.

And anything, Terry, to talk about in terms of the investment portfolio, just kind of what you're seeing in front book/back book dynamics? And remind us how you're protecting against AOCI challenges?

Yes. So we've been very active from a balance sheet perspective in terms of managing the investment portfolio. In the first quarter, we saw the overall yield of the portfolio come up about 8 basis points. We would continue to expect to see that sort of a benefit growing as we go in the second quarter and through the year, part because when you end up looking at the reinvestment rate, the reinvestment rate today is pretty strong relative to the back book that's coming off. From an AOCI perspective, we moved about $43 billion of investments to held-to-maturity back in the fourth quarter, so we were a little bit ahead of that. And today, we have probably about 36% of the overall portfolios in the HTM category, which will help us in terms of being able to manage some of the implications associated with the rising interest rates. With Union Bank, we have the opportunity to be able to increase that HTM, the held-to-maturity category, some more. Our overall goal is probably to be at about 50-50 so that HTM is about 50% of the overall portfolio.

Got it. But you're waiting to the deal to...

Well, we're waiting for the deal, and then we typically have about $5 billion worth of investments that are rolling off in any one quarter. And so we have the opportunity to be able to shift more and more of that into the held-to-maturity category as we make that reinvestment and to do it when we're investing at higher rates, and it will give us some opportunity from that standpoint.

Okay, got it. So, Andy, maybe you can give us an update on the 3 parts of your payments business and what you're focusing on with each of those.

Yes. So if you think about the 3 parts, we talked a little bit about retail issuing the card business. Card spend is 35%. The spend categories are changing a little bit but certainly the post-pandemic levels across the board is above pre-pandemic levels in terms of spend. The partnerships are working well, and we would expect growth consistent with what we've seen in the last few quarters. Merchant processing, our big opportunity there, John, is on this banking payments ecosystem. We have a tremendous payments business. Merchant processing is critical from many businesses capabilities, and we made it together with the business banking side. And across all those categories, spend is above pre-pandemic levels also. So we're back on a normal track. And then in CPS, our corporate payment systems, there's 2 components there. One is a government business, which has been doing well. The second, which is coming back strong, it's not yet 100%, is corporate travel and entertainment. And that is coming back, though. That's about 10% below pre-pandemic levels but growing rapidly, getting back to it normally. So across the board, the payments business is back, let me just keep it simple. And I think it has tremendous opportunity to grow, not only with the economic activity and spend, but with some of the initiatives that we're focused on in terms of the ecosystem.

Yes. One of the things I would just add, John, and Andy talked about the merchant acquiring business. We made some very significant investment in that over the last several years. The book of business has slowly transitioned from one that was really built based upon buying portfolios from banks to more tech-led. So today, almost 30%, I think 29% of the revenue within that business is tech-led sort of revenue. So it's very tied to integrated software solutions and activities that people use to run their personal life or their business life, and that's really important because that is higher growth and good margins in that particular space. The other thing is that we've been very focused on investment in areas like health care or certain specific industry sectors that are higher growth, and that is going to give us the opportunity to be able to not only take advantage of the cyclical improvement in terms of consumer spend but to be able to really drive market share growth within the merchant acquiring space into the future.

And some of those verticals are exactly where -- what's coming back strong right now: travel, entertainment, hospitality and health care.

So I think in -- for investors, one of the questions has been how do we gauge how U.S. Bank is doing in payments. I think you've been willing to cede share in certain areas to protect profitability. So sometimes it looks like, hey, you're losing share, and some of that might be delivered, some of that not. So how do you, Andy, measure your success in payments? What should we look at to evaluate how you're doing across those businesses?

Yes. You're right, John. We have ceded share in certain categories that have low, very low margin for some larger customers, and that was intentional. At the same time, we've been making investments to make sure that we're not thinking about the old way of selling payments, but the new way, which is the tech-led, that component, and then weaving it together with the banking component. I would maintain that payments has never been more important to be part of a bank product offering as it is today because individuals don't think about banking and payments separately. They think about them combined. So to the extent we have that as a component, that's how we're thinking about it and our focus areas on acquiring customers and extending the relationships with current customers across all those categories. And I think we've made a lot of investments. We've made a lot of acquisitions to extend the capabilities, and we're in a very good place now versus where we were 4 or 5 years ago.

Okay. Terry, beyond payments in mortgage, just wondering if you have -- wanted to highlight any other key trends in fee businesses across your company?

Yes. We've -- obviously, we talked about payments. On the trust and investment business, we have really been going gangbusters. I mean, that, from a core perspective, has been growing very nicely. And both on the wealth management side in the equation, we're seeing nice assets under management growth but we're also seeing in terms of assets under administration within our corporate trust and our fund administration business. So good core growth in that particular space. Now that will be pressured a little bit simply because of the equity market dynamics. But only about 15% or so of those revenues are really tied to the S&P. Everything else is much more broad-based. So I still expect that the trust and investment management business is going to do very well. The other thing that I would just end up highlighting, which is already in our forecast, and that's part of what we gave guidance on is really related to overdraft fees and deposit service charges. We do expect that, that will be fairly stable, maybe coming down a little bit, simply because of the fact that we made some decisions to change some of the pricing on deposit overdrafts. And we talked about that as part of the first quarter. But everything else is holding up pretty well.

We have an exceptionally large money market business. We don't have long assets in terms of equities or fixed income, so we're a big money market business, which is only extended with the PFM acquisition. And the other offset to the deposit service charge is waivers which start to go away. That totals about $70 million a quarter that will dissipate. And basically, if there are 2 more rate hikes, we'll be back to 100%.

Okay. So let's talk a little bit about efficiency, improving efficiency, managing expenses. You're targeting at least 200 basis points of positive operating leverage this year. It's a good outlook, yet that goal of positive operating leverage has been an elusive one for you. It's been difficult. Why now, Andy, why you feel good about it this year?

It's a good question, John. There's 2 components to the efficiency ratio; one is revenue, one is expense. Let me start on revenue. I think we're past the downfall, the negative impacts of COVID and what it -- particularly that impacted payments. We're starting on the upward trend, like I talked about. Margins starting to come back. We're seeing both loan growth as well as increases in rates, which helps the NIM component. So we're seeing good growth and opportunity on the revenue side and getting back to what I would call a normal environment. On the expense side, a couple of things I'd mention there. Number one is we've made a lot of investments to strengthen our digital capabilities and technology over the last many years. We're past that. We've lapped that expense growth that occurred, so we've lapped the expense growth. And also the opportunity that comes from it is starting to reflect in the expenses because it's not just growth in customers and digital capabilities. It's the ability to do it in a more efficient way. We've been able to reduce our branch count by 25%, but still growing the same amount of customers and loans and deposits in a different way. And then finally, I think the Union Bank acquisition adds a tremendous revenue base at a very efficient platform. We're able to increase our -- decrease our efficiency ratio by about 100 basis points by putting them on our tech platform, our tangible return by 150 basis points. So the combination of strength in revenue, getting past the investment spend, which is now starting to pay off, and the combination of Union Bank gives me comfort that we'll get to that 50s.

Yes. That low 50s has kind of been the efficiency ratio you've targeted from...

Yes, it's our objective.

Feels realistic?

Feels realistic, yes, for all those reasons.

Yes. And just remind us, your tech spend, you've talked about that shifting, and you started defense to offense...

Yes. So we -- it's $2.5 billion a year, which actually increased to that level. In the last 4 or 5 years, it's been steady. It will be in a steady state going forward. Five years ago, it was probably 60-40 defense, strengthening some of our defensive capabilities. I would say it's 60-40 offense right now. A lot of digital capabilities. We have a top-rated app. We have capabilities to mortgage. I talked about the payments activities, tech-led. All those things that are our focus now is where our spend is occurring, and we're -- it's in the run rate, and it's starting to pay off.

The other thing I would say, John, just around the mix of where we're spending. For the last several years, we've been very focused on enhancing the digital capabilities from -- in terms of product capability, feature functionality and all sorts of things. And as Andy said, I think we're in front of that curve now. I think we're in pretty good shape. It gives us the opportunity to be able to take that 60% that's offensive-led and focus now on sales effectiveness and business automation and some of those sorts of things. And so while the investment, I think, is in terms of the investment build is behind us, where we can now dedicate those resources in the future is probably going to shift a little bit more, which is also going to help, not only on the revenue side, but also on the cost efficiency side.

And I noticed that you have a cloud-based partnership with Microsoft. Where are you on that kind of cloud journey?

So we announced that a few months ago. That's going to be a big deal for a couple of reasons. One is it increases the capacity and the rapid nature of that capacity to build for technology needed at any point in time. Secondly, I think it improves the security because we're doing it in a way to make sure that we have not only the Microsoft security but our own security. But what's important on this one, John, is it's not just a lift and shift. We're not just taking what we do on our own in-house technology and putting it on the cloud. We're simplifying it before we do that. We're modernizing the tech stack. We're going from vertical structures to horizontal and serving the customer across on a much more consistent basis. And I think that's an important first step. So you don't just take what you have and go to the cloud. We're taking what we have. We're simplifying and modernizing and going to the cloud. And we're in the middle -- we're just starting that adventure. It's probably a 3-year process.

Okay. So let's talk a little bit more about the Union Bank deal. You're obviously excited about that, and you touched on why that's the right deal for U.S. Bancorp. How would you attach the kind of degree of difficulty on integration? It's been a while for both of you, but you both have experience in your early executive days doing big integrations. How do you stack this up and what it looks like compared to what you've seen in the past?

Yes. I think between the 2 of us, we've done nearly 100 acquisitions, I think, over the years. So, John, first of all, it's a great transaction because scale is important. We do have a step function of scale, as I said, by any measure, 20%. Number two, it's a -- makes us a much larger and key component player in California, which is from about 10th market share to 5th. And it's a great customer base that I think we can do more, too. We didn't put that in the model, but we are going to be able -- we have a much broader product set, more payments capabilities, more commercial banking activities, more business banking activities, and we're adding 1 million customers and nearly 200,000 business customers. So it's a good positive there. We're able to do that because of the investments we've made. And to keep it simple, we're not going through a process of deciding what technology to use between the 2. It will all go to our platforms, so it's a pure lift and shift. And in that regard, it's easier. And we'll be able to do it because we know exactly what deposit system, what loan system, what technology we're going to. The complexity is moving the data from Union Bank to us, which we have a great team working on it. But the systems part of it, I think we're very comfortable with. And if we think about the cost benefit of doing that, the Union Bank transaction results in about $900 million of cost savings, about 40%, the great majority of which comes from the technology component and moving it from there, oftentimes partnered or purchased or outsourced systems, to our core systems at a very low cost.

Yes. And I think you've ultimately talked about this deal being 6% to 8% accretive to earnings, and that's really on the cost side. And the revenue would be upside to that.

The revenue does not model in that 6% to 8%, and I'm very encouraged. And the more I get into it with the teams, the more opportunity I think we have from a revenue standpoint.

Yes. So if you think about our different businesses, they have a nice mortgage business, and it all fit right into ours. So the products and services and capabilities are pretty similar. But I think with our digital capabilities and some of those types of abilities, our opportunity from a revenue synergy standpoint is strong. It's an affluent customer base. And so from a wealth management perspective, we're very excited about that in terms of being able to bring our automated lending or automated investing sort of capabilities to that. If you think about from a consumer customer base, they will really go after the conversion from having, what I would say, more limited digital capabilities to very strong digital capabilities. So when we look across all the different customer categories, fee categories, we do think that there is opportunity that exists there.

And in terms of closing the deal, you're obviously waiting for regulatory approval, and I'm sure there's some limitations on what you can say here, Andy. But you did kind of push out the expectations. You hope to close it by midyear, and you kind of said mid -- second half of the year. Do you have visibility on that process? Or is it you do your work and then you kind of wait?

Well, we -- first of all, we have about 1,000 people at U.S. Bank and about 1,000 people at Union Bank working on this. And across all the integration activities, we're on track. From a process standpoint, organizational structure, technology, data, on track, and it's great progress. We've also been working with both of our principal regulators, the fed as well as the OCC and responding to their questions. So that's going well. And importantly, we signed a community benefits plan, which actually was signed by both the NCRC, CRC, the Californian specific, which is a real positive, too. So the communities are on board. The teams are on board. The regulators have what they need, and it's just a matter of getting that approval right now, which we expect in the second half.

Okay. Yes. And part of that plan is you made commitments in terms of keeping people on investing community...

Retaining all branch employees, which in this environment is the right thing to do because of the turnover and the difficulty in finding branch employees, making sure that we continue to serve low-, moderate-income communities and particularly -- and focusing on providing mortgage activity and capital for small businesses.

Okay. So when you close that deal, it will put you close to a new category of regulation, a category 2 bank when you hit $700 billion in assets. What are the implications of that, I guess, technically and practically? And how do you think about those?

Yes. Well, first of all, from a timing standpoint, again, the threshold was $700 billion, but you have to average $700 billion over 4 quarters. So if you think about it, you have to be in that -- you have to kind of be in that space for a period of time. So it gives us time and flexibility to be able to kind of work through that. The big kind of areas or implications is really around the capital and liquidity. And with respect to capital, probably the big thing that -- and we're already thinking about this and working through it is really the fact that you have to consider AOCI as part of your investment portfolio in the capital calculation, which is, in part, why we started moving to a higher level of HTM and why we're starting to kind of manage that. From a liquidity standpoint, we have a lot of liquidity. So I don't see that as being a major issue, and then it's really not something that we need to do too much in order to be able to be in compliance with that. The other thing is that you have to be able to move to the advanced approach, and so we used to do this already. We have all the plumbing and the capabilities. So really, it's a big part of this kind of switching it back on as much as anything. So our thought process right now is that while there will be work to do, we're already prepositioning ourselves in order to be able to manage that. From a timing standpoint, when we do the deal, we'll still be below the $700 billion level. And our expectation, at least right now, is it's probably early to mid 2024 before we would start to hit that trigger. So we have time to be able to manage through that.

But it's not a constraint for us, John. We have all the components to manage this, and it's not a worry for me. And particularly the advanced approaches, we've been there and done that. And it...

Right. And it sounds you have to build these teams that don't exist already, and more complicated stress test or liquidity test or...

No. We don't.

We fundamentally continue to do all the stress testing we needed to do under the old approach, anyway. From a capital management standpoint, we used to be subject to AOCI, our target at that particular point in time was 8.5%, and our operating range was somewhere between 8.5% and 9%. That's kind of our expectation as we move forward as well. And if you think about it, your capital level that you established or your targets that you set is really a function of the risk in your balance sheet and the risk profile of your company. And when we think about bringing Union Bank on, it has a very similar sort of risk profile in terms of the balance sheet and the business activities. And so we still feel that 8.5% to 9% is the right level for us to be able to operate within.

Okay. Got it. And you mentioned that your buybacks are on hold until you get the deal approved because I guess you'd expect to end the deal somewhere in that 8.5% to 9%, Terry, and then you like to build up.

Get back to the 9%. We'll have -- at close, it will go down, and we'll hold off on the buybacks until we get back to that 9% or so in a couple of quarters.

And what level it goes to at the day of closing will be a function of where interest rates are and what the mark-to-market is at that point in time. Again, we've modeled a lot of different scenarios, and it's very manageable.

Yes. So with AOCI being an issue for banks recently, the debates come up among investors how much the tangible common equity ratio matters? So you've got very healthy on the CET1, very healthy on tangible. But you're kind of in the mid-5s or so on that tangible. Terry, how much do you think about that as a constraint? Does it affect the rating indices, how they look at you? Or regulators, do they ask about this? Or is it really the regulatory only?

Yes. No. It's kind of a combination. Certainly, it's one of the things we end up looking at, watching and managing, the -- certainly, from a rating agency standpoint, it's important. It's one of the things that they end up taking into consideration. But again, where it's at and where we would expect it to go, again, we think is just fine.

So our binding constraint is CET1.

Yes.

Yes. Okay. So you've got the Union Bank deal in the wings. Is there still capacity for U.S. Bank to look at bolt-on deals that are non-bank kind of things?

Yes. I think the things that we've done, we'll continue to look at. So examples like Bento and talech and PFM and TravelBank, which is again extending the capabilities, that's things we'll continue to look at. Partnerships to do things like that as well as increased distribution, State Farm is a great example of that, where we also -- we've created a partnership where we had 19,000 agents across the country that are selling U.S. Bank products and services. Deposits are the effect of one large new MSA; and credit cards, 3 new large MSA. Another way that through -- in different methods, you can expand distribution, we'll look at that as well. So I would expect both opportunities for bolt-ons for capabilities and technology and opportunities for partnerships from distribution.

Okay. We haven't talked about credit cycles much in the last couple of years in bank discussions. But as we look ahead to potentially some turbulence in the macro, how do you feel the banking industry is prepared for a credit cycle? Where might the risk be in the system? And then maybe just talk a little bit if there's more risk outside the banking system.

Yes. I think the banking system, and I think U.S. Bank, in particular, is well prepared for a downturn in the cycle. I mean, we have more capital liquidity than we've ever had. We've been very consistent in our underwriting. We don't increase or decrease our box. We've been consistent, and that was true during the last downturn in the 2008 to 2012 time frame. And I would say, if anything, we're in a better position today. So CECL creates all this volatility, John, that I think throws things off a bit, which -- models that we're using for CECL weren't constructed with this in mind. And we -- if you look at the history that the models are based on, we've never had this. So that's why you have these billions of dollars of reserve build and billions of dollars of reserve for lease, and the volatility is quite significant. But if I take that away and just look at the core charge-off levels, I'm confident that we'll be able to accommodate the next cycle.

Well, the one other thing I would just maybe add as background, if you end up looking at the type of customer we end up booking or banking, if you will, on the commercial side, it tends to be investment-grade customers, high-quality, whether it is in the C&I portfolio or in the commercial real estate portfolios. We're typically dealing with the top quartile or percentage of developers, those sorts of things. So the quality of the customer is very good. We do very limited leverage lending. So those areas that typically gets you into trouble when you go through an economic downturn, we usually do quite well because of that. On the consumer side, our focus is really around prime, super prime type of customer. And again, those customers typically have the wherewithal, the capacity in order to be able to manage through a recessionary sort of environment. So we have typically performed well through the cycle, and I feel based upon the customer base that we have that we'll do quite well. I do think that one of the things that's interesting when we talk about the banking industry is there's a nonbank industry that has been disintermediating some of the -- on the lending side, especially on the consumer side. I think time will tell as to how that performs as it goes through the cycle, and -- but that's not where we play.

Okay. So with a few minutes left, I just have to do a couple of lightning round questions that have came in on the Pigeonhole here. So just what's your sense of how things might evolve on the bank regulation front? Obviously, we've got to get some appointments done. But what are the most important areas that might be on the agenda for U.S. Bank that you guys think about as being regulatory?

So I think, certainly, there's a greater emphasis and focus on ESG, and that is consistent with some of the announcements that we've made. We have a focus on it within the bank. It impacts every business line in one way, shape or form. We have a large tax credit business that I think helps us in this regard. We've made commitments in terms of net zero as well. So I think ESG focus, number one. I do think the certain fees that we've adjusted already will continue to be focused, and that's why we made some of the changes. And it was also the right thing to do on deposit service charge and overdraft fees and so forth, and I think that will continue to be a focus. An area that we're all very -- looking at very closely is cybersecurity. I think it's one of the greater risks in banking right now because it has long tails. Credit is always -- we always told credit is the #1 risk in banking. I would argue that it's a known risk. It's a defined risk, cyber tail events that you don't know enough about. So strengthening your cyber and the ability to do that. And then finally, this focus on crypto and the regulation that occurs and what banks -- what roles banks play in that will be something that I think regulators are focused on, on a go-forward basis.

Good. Maybe we'll do this one as the last one, Andy. Do you think the payments businesses that U.S. Bank has, do they have the right growth culture necessary when they're in a bank?

Yes, because the bank has the right growth culture, so yes. It's a good question. It's interesting, John. We've migrated a lot of the things that we measure to talk about what would be traditional growth measures of other industries, customer acquisition, depth of relationship. And so it's not just the bottom line we're focused on. We're focused on the growth component and acquiring new customers, and there are things that we're measuring on a regular basis. And again, that combination of banking and payments is, I think, how we're going to be successful there. So the payments mentality, I'll call it, has always been on growth. That, combined with the way we're measuring and tracking and the partnership with business, I think, will allow us to get to that growth that we're talking about.

Yes. And one of the -- couple of other things I would just add, if you think about the merchant acquiring space, our expectation is that that's high single-digit sort of growth over an extended period of time. I think that's really nice growth within the context of not only the payments industry but also in the banking space. And so I think that, that is one of the places that will differentiate us. And then if you think about corporate payments and real-time payments, that is still in the early stages in terms of where that growth opportunity goes and our focus around those capabilities but also having the corporate payments capabilities that already exist. And that culture -- sales culture within that, I think, is going to be very positive and very strong.

And you did touch on this, but I guess it's worth repeating. In terms of the Union Bank deal, how does it enhance your future growth? Obviously, we've got the cost saves, but just maybe reiterate that, Andy?

Three things, bigger player in California, number one; 1 million customers, 190,000 businesses, increases our opportunity to provide more products and services to those customers in a meaningful way that's not part of the model. And it's a very efficient transaction. I think, again, 40% cost takeout principally due to the technology. This is a great example of why scale is important. We're able to acquire this large customer base, put them on our technology platform at very little cost and generate the revenue from those customers at a very efficient ratio because of the technology investments we've made.

Got you. Great. Well, thank you, both, for joining us. We covered a lot of ground. Appreciate it.

Our pleasure.

Thanks, John.