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

Good morning. Next up is U.S. Bancorp. We have CEO, Andy Cecere; CFO, Terry Dolan. Thank you, guys, for joining us. I appreciate you being here.

And we'll kick off talking about your big weekend. Last weekend, you had the big conversion of Union Bank onto U.S. Bank's platform.

We did. Thank you, and good morning, everyone. John, as you said, Memorial Day weekend, we successfully converted and integrated Union Bank onto the U.S. Bank system. That included about $1.2 million consumer and small business customers, about 3,000 commercial customers. And importantly, to date, we've already enrolled in our digital capabilities about 300,000 of those customers. As you might expect with any large conversion, we prepared for and we're ready for any unknowns, which always happen in the conversion. And we had a couple of technical slowdowns related to customer behaviors and activities and trends, but I couldn't be more proud of the way the banking group, our bank branch employees, our 24-hour banking, our call centers and particularly our technology group, resolve the issues very rapidly to make sure there was minimal customer disruption. So we're in a good spot. We're not completely down. We still have Trust and Investment this weekend. And then Card at the end of the month, and then we'll be completely integrated on all systems across the board.

Great. Terry, maybe from the financial angle, how does that set you up in terms of near-term merger integration expenses and then later in the year, merger saves? Just remind us of that time line.

Yes. So from -- maybe from a merger-related cost perspective, second quarter and the third quarter will be probably the highest simply because you're going through the severance costs and all sort of things that are part of it. But then that starts to wane as we get into the end of the year, and certainly, by 2024, the vast majority of merger-related costs are done, which is good. So from a year-over-year perspective, that will be nice. From a cost synergy standpoint, now we modeled and included in our estimates about $900 million with the cost synergies. Once we are now through the system conversion, we can start to implement that. About 2/3 of it is personnel-related type of costs. 1/3 of it is contracts and operational sort of aspects. Our expectation is that we'll be kind of at the full run rate of the cost synergies by the end of the year. So when we get into 2024, we'll be in good shape.

Great. Great. And Andy, bigger picture, just remind us what's exciting about this acquisition for you?

Yes. So first of all, scale has never been more important in banking, and this gives us a step function in terms of scale increases, 15% to 20%, depending upon the business for the segment. So that's terrific, number one. Secondly, it makes us a player in California. We go from a #10 market share to #5. California has more small businesses than any other state, a very affluent customer base. And we have tremendous opportunity to also provide more products and services and capabilities to the customer base because of our digital capabilities, our payments activities that Union Bank didn't have. So we have a lot of opportunities there. We didn't model any as revenue synergies, but I think they're very real. And then importantly, in this environment, it's a very large stable deposit base. We're exceeding the [ PPNR ] expectations we initially modeled because of that deposit base. So it is a very positive transaction financially and strategically.

One other thing, John, I would just add with respect to the revenue synergies. While we didn't model any other then, we certainly expect now that we're behind -- the conversion is behind us, we'll now start to be able to pay more attention to that in the second half of 2023. And certainly as we get into 2024, there's real opportunity there.

Sure. Sure. So let's talk a bit about capital and your path to build. So the way we look at it and doing the acquisition, you traded some capital for future enhanced earnings profile.

Correct.

And given the timing of the deal, you had to take a bigger capital hit because of the marks and where rates were closed. I guess, Andy, is that a fair way of looking at it? And then what's the plan for growing capital? I know you're at the way you report capital today, about 8.5% CET1, not including the OCI, which you don't have to growing at above 10%. I think it's part of your plan over the next 2 years. So maybe walk us through that...

Sure. I'll start and then Terry will add on. And I think the way you portrayed it, John, is appropriate. There's future earnings potential that we traded off with capital at time 0. We expected to close the deal at about 9% CET1, but the extended nature of the approval and the increase in rates caused us to be about 8.4%, as you said, we're 8.5%. We expect to get back to 9 very rapidly, and Terry will go through that walk, but it -- and it was a very good trade-off and when I would do again for sure. Terry?

Yes. Maybe to kind of give people some perspective and we talk a little bit about this, but we expect to get from that 8.5% where we're at today to well over 10% by the time we get to the end of 2024. And there's really 3 major components that are part of that. The first one is really the earnings accretion. And our expectation, especially with the scale of Union Bank and some of the things that will come on and the cost synergies we talked about that we will average over the next 7 quarters, somewhere between 20 and 25 basis points of accretion of capital, and that really kind of is a significant component. If you think about it, second quarter probably will be a little bit below that simply because of the merger-related charges and things like that, that occur. But then as we get into the second half of the year and into 2024, that strengthens. So we feel really good about that. The second component is really related to risk-weighted asset optimization or balance sheet optimization. And we did some of that in the fourth quarter. And we have at least 50 basis points of actions or activities that will enable us to be able to kind of get there. And that will be a combination of different things like portfolio sales, MSR sales. just being very prudent with respect to -- in thinking about our focus around profitable relationships and working -- unfunded commitments that aren't being used down, going to be things like that. Those 50 basis points really, what I would call kind of low impact sort of strategies that really won't affect the accretion that I just talked about earlier. And then the third component is just what happens with respect to AOCI during the time between now and the end of 2024. And on our expectations is, obviously, it's a function of what the investment portfolio looks like and interest rates and that sort of thing. But our base case that we're incorporating into that plan is assuming rates stayed flat, so rather than the market implied coming down. So if rates stay kind of where they're at, that 200 basis points of drag that exists today or at the end of the first quarter is about 150 basis points. So it comes down about 50 basis. So the combination of accretion, risk-weighted asset adjustments and balance sheet optimization as well as the AOCI burn down gets us to about 10.5%.

Yes. So -- and just looking at that because the market for you and others, looking at kind of this fully loaded with AOCI in there and this expectation that regulatory rules will require that you moving into category, which should require that. So on that basis, the $200 million, your 8.5% goes to about 6.5%. So I guess the idea would be building up towards about 9%.

9%, yes, I know, all in. And to that point, John, when we signed a deal, we started planning for all this because we had the expectation we're going to Cat II. Now as you fast forward, it's not just us who are going to face this AOCI. It's a broader group of banks given the new regulatory framework that we expect to come down. So the good part of this is we were planning for this one.

Yes. And if you did CAT II, you would take the full AOCI.

Yes. But we'd be in a position. Of course, there's a lot of uncertainty with respect to what the future capital rules are going to be. And as Andy said, everybody will be -- all the regional banks will be kind of subject to that. But we have other things that we can implement beyond the 50 basis points of risk-weighted asset optimization that I talked about that we can continue one of those things, which, again, we've been kind of putting into place. We haven't necessarily tapped into it with the securitization sort of structures and that sort of thing that we think would allow us to get there.

Just one follow-up on the AOCI, Terry. Just remind us what you've done in terms of hedging. I think you put some hedges on to avoid the night sweats, if rates go up too much, minimize increased AOCI. And what's the tradeoff then just slower burn off if rates went up?

Well, it's a little bit -- yes, we -- you give up, you give up on the downside a bit, but you also protect yourself on the upside. So we put into place some pay-fixed swaps. That probably equates to about 20%, 25% of the overall portfolio. So what it does is it dampens the effect of rising rates and helps to protect us from that standpoint.

So that the AOCI will grow from there.

Yes. The other thing that we're actively doing is we're working the duration of the AFS portfolio down over time, kind of picking our points when rates move around to be able to shorten that as much as we can.

And you have a history, Andy, of running with a high capital relative to your minimums and to peers. So I guess there'll probably be a path to grow even further beyond 9%, I guess, in 2025 and beyond depending where rates...

I would expect that, John, but I would also expect the transition period to get there. And given our strong accretion and profitability, I'm comfortable with it to wherever we need to be in the time frame defined.

Yes. And maybe to give some context. And typically, when they have had capital rule changes like that, they give you probably a minimum of 3- to 5-year sort of a transition window in order to be able to get there. So that gives us plenty of time, very manageable.

Sure. So Andy, how are you thinking about the dividend, that you use up about 15 basis points a quarter on your dividends? Important to your shareholders. You've got a good yield. How are you thinking about that in the context of this plan to grow capital?

So the dividend is included in all the numbers that Terry articulated. The dividend continues to be important to us. If we think about investment in the company, first of all, it's investment in growth and initiatives. The dividend would be second and buybacks or M&A would be third or fourth. So that continues to be a priority and will not change.

Now the other thing I would just say, John, is that CCAR will be coming out pretty soon. We'll see new capital rules, all sorts of things. Those will all be things that we'll take into consideration. But again, the dividend is a very high priority for us.

Yes. And one last question on the capital build. There's not a lot of growth in the industry right now, but I'm also assuming that you're not planning on a lot of RWA growth even before the mitigation.

Yes. So before all of this, even across the industry, I think what we're seeing and what the industry is seeing is very tepid loan growth. Demand is down for sure. And I think we and all banks are also being very prudent around capital utilization. So given all that, I would expect loan growth often being equal to be very flattish to up just a little bit, but not where we were about a year ago.

So that capital walk us seems a pretty flat [indiscernible] in terms of mitigation.

Flattish, yes.

Yes. And I think that, that will be pretty consistent with what we're going to see in the industry as well. So I don't think that we would stand out one way or the other relative to that.

On the other aspects of Category II, you mentioned being prepared. Just remind folks, what are the other aspects of [indiscernible].

Yes. So again, as Andy said, we've been working on Category II for the last 18 months. And when we went through the tailoring process that took place in 2019, we were already compliant with respect to the advanced approaches and all sorts of things. We did not unwind a lot of those activities because we knew ultimately, we would kind of get there. We just didn't know exactly what the timing of the path was going to be. So a lot of those mechanisms and processes are still in place or we have the capability to do that. I would say from -- the other aspect that kind of comes into play is just the LCR and liquidity management. I think we have -- what we end up -- we'll get our total available liquidity and kind of how we're positioned. I think we'll be able to manage that very well. So from a process perspective, from a liquidity perspective, I think capital, we have a clear path to be able to get there.

Great. And the last aspect on the regulatory side, it seems like banks your size and lower will have to do some version of TLAC and [ GSIB ]. How do you put that in context of incremental cost or debt burden that you might have to bear?

Yes, great question. And again, that's one of those things that there's just a high level of uncertainty associated with it. Maybe to kind of give people a perspective, the expectation is that by the time the rule-making gets completed and then the transition period, you're probably talking a minimum of 3 again, probably 5 years. So from an issuance perspective in the market and being able to absorb that, I think it's very, very manageable from that standpoint. What we're -- what everybody is trying to do is to kind of get some perspective in terms of the sizing of TLAC. And if you had to adopt the GSIB rules, you're talking kind of mid-20s in terms of the amount of issuance. But we're a lot less complex. The calibration, I think, that will go through. What we are looking at, for example, applying the framework that we use for foreign bank operations and that sort of thing. We think that the impact of what would have to be issued is you kind of in that $10 billion to $15 billion range. There's a little bit of a drag associated with that -- associated with the issuance and then your ability to reinvest it. You're probably talking 50 basis points plus or minus -- 50 to 100 basis points kind of in that ballpark. But again, over a long period of time, very manageable. And certainly, when you think about our earnings power and sustainability, we're going to be able to absorb that.

Yes. So before we dive into credit quality, Andy, maybe just get your broader views on the current macro environment. You touched on loan growth, but just maybe the broader view on the economy here.

Yes. So we have a big payments business, John, as you know, issuing as well as acquiring. And what we're seeing is a bit of a slowdown in consumer spend. So travel, hospitality, grocery, those are still continuing to be strong, but large ticket discretionary retail slowing down a bit, still above levels that we've seen historically but certainly slowing down. We're also seeing balances moderating, coming down. 6 months ago, we were maybe 2x to 4x depending upon the segmentation of the customer base, above -- their positive levels were 2x to 4x above pre-COVID levels. Now that's 1x to 2x and probably going to get back to flattish pre-COVID levels later in this year. So the spend is slowing a bit. Deposit balances are coming down a bit per customer, and that is all factored into our modeling, which we expect is shallow recession later this year, early '24, moderating growth, as we talked about. And that is all factored in, together with the flat rate scenario that Terry described.

So on credit, U.S. Bancorp has traditionally outperformed during credit cycles. How are you positioned today for a more challenging environment? And where are you seeing risk for the industry and yourselves?

Yes, I'll start with the big picture, and then Terry will go in a little bit more detail on that, John. So first of all, we always have been very prudent about our credit guidelines and our processes. We don't soften or weaken -- lengthen or extend if we don't tighten. We're sort of very consistent through the cycle, and that's always been our case. We are a super prime portfolio. We don't have any sub prime card issuance or anything of that sort. So it always does well. In the toughest environments, we do the best, and that I would expect to continue. The area of particular focus for, right now is commercial real estate like it is for most banks and maybe Terry can provide some details.

Yes. And we talked a little bit or we provided some of this information at the end of the first quarter. But if you think about commercial real estate overall, represents about 14% of our overall book of business or loan book of business. So again, that's a very manageable size. The vast majority of that, a lot of that is multifamily, industrial, those types of asset classes that are going to perform fine, or at least, very consistently with what -- how they perform in the past and how we've underwritten them. So we feel pretty good about that. The one sector, I think that people are most worried about is commercial real estate office space. And maybe to kind of put some color or context around that. That represents 1% of our commitments, 2% of our loans outstanding. So it's a very small kind of manageable book of business for us. And then it's really important to kind of understand what does the office space look like and kind of where is or how is it concentrated. Well, we have A, B-class sort of office space. About 65% of it is A-class, 35% of it is B-class, so high quality. We've always underwritten that or done those projects with strong sponsors, and that's going to be important when you go through a cycle like this. The other thing to kind of keep in mind is where that office space is. The majority of it is either medical or specialty type is about 10% of the portfolio. About 45% of the portfolio roughly is in suburban areas, which are going to hold up better just because of the workplace dynamics and all sorts of things, the free parking holes or something that kind of go along with it. And the rest of it is what I would call central business districts, which are going to be a little bit more. But again, a higher percentage of A-class sort of space in there. So if we end up looking at the overall kind of mix of our business, we feel pretty good about that. The reserves we have on commercial real estate overall is about 6%, 6.1%. And when we think about that, that's going to be principally focused around the office space as we go through this next cycle. So the other thing that I would just say is that with an expectation of a mild or modest sort of recession, we are going to see, as an industry, nonperforming assets starting to tick up. Net charge-offs will start to normalize to pre-pandemic levels over the next several quarters. For us, that was about 50 basis points. We're kind of in the 30, 34 basis point sort of range at this particular point in time. So that will continue to migrate up.

And what about the quality of the union book, Terry? And how much have you done or finished scrubbing that and [indiscernible] for that?

Yes. We have really kind of spent a lot of time with respect to deals and especially after closing. You don't have visibility with respect to all the information when you go through the closing process. But after closing, we've gone through that entire book of business. Through the end of the first quarter, we have done the loan marks. So we feel like we're in a really good spot with respect to the Union Bank book of business. The other thing I would just say is that the underwriting of that book of business is fairly consistent with how we think about our own business as well. And the performance that they saw, for example, in the last recession was quite strong. So we feel pretty good about it.

Our credit processes and guidelines and risk taking was very comparable.

The last 2 quarters, the credit metrics are a little noisy, as always, after a merger with different -- will that get cleaned up and you'll kind of have more of just a U.S. Bank line in terms of nonperformers? And...

Yes. There's 2 things that have been affecting it in the past. Some of it was just the unusual CECL sort of adjustments that you end up making. We saw that in the fourth quarter and then a bit more in the first quarter. The other thing that affected the fourth quarter predominantly was just balance sheet optimization strategies. So as we think about our risk-weighted asset strategies where you might securitize or repack an auto loan portfolio, which we did in the fourth quarter, you have some losses that go along with that. You'll probably see that in the second quarter as well as we kind of go through some of these things. But again, when you take all of that into consideration, the impact from a capital standpoint is still very accretive so.

And the Union Bank's side of it is all done.

Yes.

And that auto securitization, that noise comes through in charge-offs or...

It usually comes through in charge-offs if you have a gain or loss associated with that, it gets factored in the charge-offs. That's the way the accounting works.

Sure, sure. And just maybe a comment on your credit card book and kind of what kind of normal seasoning in normalization of...

So the credit card buckets I mentioned, John, is prime, super prime. That consistently performs very well in stressed periods and it's showing the same today. And we will migrate towards normal, like Terry said. So that component of the 30 basis points is a little higher and it will continue to go towards prepandemic levels as we move through the year into next year.

Okay. So yes, let's talk a little bit about earnings. You mentioned we created capital for earnings. You're building -- you get to that 20 to 25 basis point maybe after this quarter forward kind of pace. Terry, any update on the near-term environment regarding second quarter? How that's shaping up relative to your expectations?

Yes. So we still have a month to go. But right now, based upon kind of our forecast or our expectations, still very much in line with the PPNR guidance that we gave with respect to revenue expenses, total PPR, tax rate, et cetera. So we don't have any real change to that guidance at this particular point in time.

Consistent.

How about on deposits? Obviously, we've been talking to folks this week about deposits. You're seeing H.8 showing deposits down 2% or so for the quarter. You gave a little bit of update in April, and you had some moving parts. Maybe you can just walk us through what you're saying.

Yes. So we're following the same H.8 data and the industry overall, given the tightening of the Fed will show some modest decline in deposits, but we're showing the same relatively stable. As a reminder, John, we have about 50-50 insured, uninsured. But I think, more importantly, about 80% of the uninsured are operational. We have a couple of big business lines, Corporate Trust being the best example, which are a tremendous provider of operational deposits. And those also have volatile flows up and down, bond payments in, bond payments out. So we'll see any day, billions of dollars come in and out. But on a relative basis, including seasonality, relatively stable, down modestly.

Yes. The other thing that I would just say is that in addition to our -- for example, our Corporate Trust business, we have a very large money market fund business. And the positive of that is that gives us the flexibility to work with those clients to bring money market funds on and off balance sheet depending upon what sort of deposit flows we're looking for. So there's just a lot of flexibility with respect to that business, and that's a good one to be in.

Sure. And there's maybe a little bit of transitional issues this quarter. I think you're closing PurePoint a high yield savings that didn't really -- from Union that didn't fit your strategy, I guess. Is that having a slight impact this quarter?

Right, right. So that's part of the numbers, John, that we've articulated. And again, I think if you think about ending balance to ending balance, it's going to be down modestly, flattish, similar to the industry. Average balances will be same. If you look at any particular day, it will be more up and down because of those corporate trust flows.

Yes, sure. Fair enough. And Terry, just remind us what you're seeing in terms of deposit beta reprice and how you're deciding to keep deposits versus repricing?

Yes, it's a great question. Certainly, in the industry because of quantitative tightening and just Fed policy, those sort of things, deposits are very, very valuable. There's a lot of competition that kind of goes along. Throw maybe some of the disruption in the banking industry on top of that. So our expectation at the end of the first quarter was that we would see cumulative deposit betas through the end of this year of about 40%. And we're -- it's probably going to be a little bit higher than that in the whole 40s but not measurably different than what we have been seeing. So and that's all kind of in that guidance that we ended up giving.

And in terms of the need for the year or just kind of near term kind of?

Both for the second quarter as well as the range that we established for the year as well.

Yes, and in terms of mix shift, can talk about where you're noninterest-bearing total and where you see that kind of remixing, too?

Yes. So noninterest-bearing represent, at the end of the first quarter, about 25% of overall deposits. And our expectation over time is that, that will migrate to what I would call prepandemic levels, which was kind of in the low 20s, 21%, 22%, 23%. So that's kind of what our expectation is at this particular point, in time in terms of how deposits will remix.

So just a bigger picture. Obviously, everyone's focused on net interest income. How does that wrap up into an outlook for net interest income? And can you just talk about the good guys, bad guys and what you're dealing with a flat balance sheet and some of these dynamics for...

Yes. Well, I think the positive things, again, will be very focused on our profitable relationships and enhancing the profitability of those relationships. Credit spreads are widening, and I think things like that will be some of the positives that will end up taking place. The deposit betas will be a little bit of a pressure point. But again, we end up thinking about kind of flattish with the widening of credit spreads and also deposit betas. We still feel like the guidance that we've given is pretty good.

And one of the important aspects of U.S. Bank is the diversification of our income stream. So a lot of it comes from fee income as well as net interest income. And we have a number of unique terrific businesses, our Corporate Trust business, our payments businesses, mortgage, our commercial products businesses, treasury management. That allow us a lot of diversification in different environments up and down the rates and so on. And that served us well in the past.

Yes. Maybe one of the things to highlight with respect to capital markets and our fixed income capital markets business is doing really well. We just had a very strong first quarter. 2022 is a very volatile time. And so that was an area that kind of underperformed. Typically, what we see when loan growth is relatively flattish. The capital markets are getting stronger. And so I think that we're going to see some good opportunity with respect to fee income in that space, and that would be a good example.

And Andy, payments is a differentiator for you. Maybe you could just kind of give us an update strategically and remind folks just kind of the broad context.

Right. So about just under 30% of our revenue stream comes from payments. That's merchant-acquiring, card-issuing and corporate trust -- corporate payments. And all of those businesses are doing very well. They -- depending upon the business, mid-single-digit to high single-digit year-over-year growth is what we would expect. The merchant-acquiring and the card-issuing, in particular, are really focused on integrating the banking and the payments businesses, particularly for small businesses. I think we have a tremendous opportunity to more fully serve small businesses and gain more small business customers by integrating payments with banking. Oftentimes in the past, this was sort of a separate activity. I'm going to choose a payments provider. I'm going to choose a banking provider. In this world where digital activity and payments are all integrated into banking, having that in our sort of product set is critically important. And our focus is on integrating this in a simple way, helping companies run their business and helping them achieve their goals using payments and banking as a mechanism to get there. So all those businesses are critically important. And again, what's interesting is that they have different impacts to different economic cycles, and that's also true Corporate Trust. So that diversification of revenue streams, the big part payments really helps us in different environments.

John, maybe one of the things I would just add to that, we've made some very nice investments over the last 2 or 3 years. We invested in fintech called Bento. We invested in a fintech called talech as well as Travel Bank. Each one of those focuses on a little bit different, some on the receivable side of the equation, some of it on the payable side of the equation, both small business as well as kind of middle market commercial banking. So in this particular space with respect to that payments ecosystem, the competition is as much on the fintech side of the equation. And we acquired some great talent in that particular space. And I think it's going to really make a difference for us as we kind of move forward.

And it helps the business run their business, manage the payments, manage the receivables, manage payables, manage their cash flows, manage their lending needs. It's the entirety of the ecosystem.

And on the issuing side, Andy, just remind us what are the spaces that you're playing in? And then what's your strategy for growing the issuing?

So on the issuing side, we have a big core of it is our retail issuing to U.S. Bank customers. We have a great opportunity to expand that to the Union Bank customer base. The penetration there was not merely the same as it was for U.S. Bank customers. So that's a revenue opportunity that, while not modeled in, I think, is real. We also are a partner to both third-parties, white label card activity as well as other banks where we issued for those banks, provide the service and the balance sheet for that. So those 3 components allow us to have this great sort of mix of customer base for retail card issuing as well as partnerships as well as other banks. And part of that is the system we're on. The system allows us to have bank partners who have their own sort of room within the house that is very specific to their customer servicing activity and their balance sheet activity, differentiated bank by bank. And that system capabilities differentiates us.

Yes. In that particular space, we provide that service for about 1,500 different financial institutions across the country, which is it's a very nice business for us. And it's one of those businesses that ends up differentiating us relative to our competitors. The other thing I would just say, John, is that over the last 2 or 3 years, we've been making a significant amount of investment in our partner platform, which both helps with respect to this -- financial institutions business as well as our co-branding business. And I believe it's going to set us up for some significant success in those particular spaces over the next couple of years.

So when you're making an investment in our card issuing platform, it impacts our retail customer base impacts our partnerships, and it impacts that bank group that we talked about, that 1,300 or 1,500. So it is great leverage by having that set of customers on the platform.

And maybe just a quick update on the merchant processing side of the...

Merchant processing, it's interesting there. Two things. One is this combination of banking and payments has really been integrated over the last few years for the banking industry and for U.S. Bank specifically. We're one of the unique banks that have this merchant processing capability in-house. The second thing is we've made a lot of investments in tech-led capabilities. So it used to be, John, that you would sell merchant processing by going to merchant by merchant and selling that component. Now you're really integrating them the software that runs their business. And that's where we made most suburban investments, which is integrating our merchant capabilities into the software that runs the business. We call that tech-led, and that's been the predominant growth area and the sale area for us in the past few years.

Yes, better margins. I think this is a great example, again, where the investment that we made was kind of fully into kind of our run rate with respect to the merchant acquiring space. But where this was a, what I would say, low to moderate single-digit business is we think it's a kind of a high single-digit business kind of going forward. And so we're starting to see that revenue acceleration.

So Andy, let's talk a little bit about tech investments and whether you're on the cycle there. You've mentioned that the company has kind of threw the heavy spend phase.

We are.

And it's a bit more on a flat line. Maybe just kind of explain what do you mean by that?

So maybe 5 or 6 years ago, we were spending a little less than we are today. So we're spending about $2.5 billion, about $1.5 billion in CapEx, $1 billion in operating x. And we're spending -- that level of spend is flattened. It's higher than it was 5 years ago, but it's moderated, and we would expect a flat going forward. We've greatly improved and enhanced our digital capabilities, our payments capabilities, our technology capabilities. And you know what, John, if I just reflect on this, that is one of the most positive aspects of the Union Bank transaction. The investments we made in those digital capabilities allow us to leverage the Union Bank customer base, the 15% or 20% increase in our customers, with very little additional technical spend. So that's the value of scale, and that's the value of technology investment. And that's the value of customer interaction and customer capabilities because we're going to have a product set that's broader, more robust and more digitally capable than what Union Bank had before. So it's going to be a better customer experience. It's going to be a better financial experience for us, and it's going to be leveraging that tech investment we made, and it's in the run rate now. So now we're seeing the returns of those investments on a go-forward basis. The other thing that the tech investments allowed us to do is to operationally become more efficient in the way we service customers and operationalize our expenses. And that is also going to be part of the projections that we talked about and part of the run rate and expense growth going forward.

So the incremental areas of investment today, there's a combination of front end, back end.

Yes. So we were maybe 40-60 on offense versus defense. We've shifted that to 60-40 offense. And so most of our activities right now are around customer capabilities, digital capabilities, payments and operational excellence as opposed to regulatory components, which was the case maybe 5 or 6 years ago.

And the investment in the back office, we have kind of brought our operational functions together under kind of a single leadership. We really believe that we're going to have the opportunity to be able to automate, incorporate things like artificial intelligence and things like that into the operational process, in order to be able to drive costs out of the equation on a go-forward basis as well. So we're very excited about it, but that's a part of -- whether you call it offense or defense, I don't know, but it's kind of one of those applications of technology in the back office that's going to allow us to provide some dividend to the bottom line as we go forward.

Great. We're going to go through a couple of audience questions here. Where are you in terms of branch optimization across your broader footprint?

So what we're all said and done, we have about 2,300 branches, which is down from about 3,200 maybe 5 years ago. Now that includes the addition of the Union Bank branches. In California, we're going to have about 600 branches to serve the customers. And importantly, while we have some branch closures, they were typically within a mile of each other. We went to the best location, the optimal location from a customer standpoint. I would say that we'll have some moderate up and down, modest up and down, but nothing material on a go-forward basis, 2,300 -- 2,200 is about the level we would expect to see in the next few years.

And part of the investment that Andy talked about from a CapEx standpoint is really around our branch infrastructure as well. So always looking for opportunities to be able to open new branches where it makes sense, but also remodel branches and to kind of redesign them to be more digitally oriented.

And that redesign is important, John, because for us and for all banks, the branch went from a place where a transaction occurred to a place now where technology, education and consultation and advice is given. So the role of a branch has changed dramatically. It's still really important, still very important, still need to happen in the right locations. But what happens within those 4 walls is quite different. And we've modeled and structure the facility to accommodate the new purpose.

In terms of consolidating in the Union footprint, what's the time frame over which that's happened?

All done.

All the time, 0.

So all done with that.

What opened up on Tuesday morning, this last Tuesday morning is a new branch footprint with the new signage with the ATMs and branches, all U.S. Bank. And it was a combination of consolidating some U.S. Bank branches and some Union Bank branches. But again, the footprint that we have there, 600 branches or so across California, is optimal given the combined Union Bank U.S. Bank platform.

About 2/3 of the branches that we ended up optimizing the closing at the time of the conversion were U.S. Bank branches as a right example.

Yes. And again, those benefits on the cost side will flow through.

That's part of the cost benefit that Terry articulated, the $900 million.

Yes. Also on cost, Terry, obviously, you and other banks will have some higher FDIC expenses. Can you just contextualize that in terms of your earnings and maybe the capital work?

Yes. Maybe to kind of speak to that. So there's different components in the Union Bank maybe cause that a little bit. Our legacy FDIC assessment last year was a little under $200 million. That will increase in 2023, about $30 million a quarter on a pretax basis. Now that is already in the first quarter run rate. So relative to first quarter, we don't see any step-up relative to the FDIC assessment that's moving forward. Second component of that is Union Bank. Union Bank adds about $50 million on an annual basis. And so the $200 million goes to about $375 million. And again, all of that in the first quarter run rate. Then the other component of that is the special assessment. On an after-tax basis, the impact of that is going to be about $500 million or about 10 basis points of capital. And again, taking that into consideration.

Sure, sure. And Terry, can you just repeat we said about the capital markets opportunity that might show up as loan growth slows. So which area are you talking about there?

Yes. So in the revenue line, it's our commercial product revenues, but it primarily is our fixed income capital market space. So whether it's derivative FX trading, the loan capital markets, et cetera. Those are the categories. And again, 2022 is an area that -- or was a time frame in which the markets were very volatile. You didn't see a lot of capital markets activity. That's now starting to take off. And that's one of the things that we would expect. When you're in kind of a flattish loan environment, the capital markets will play a very important role. And the benefit to us is we have a great fixed income capital markets business, and we're able to capture some of that in fee revenue.

That's a business that we've invested over the last 10 years in, John, and fixed -- high-grade fixed income is the best example, but it's derivatives and FX and all that. If I look at 7 to 10 years ago, that was a $100 million business or so, and now it's $1 billion basis.

Yes. And Andy, on the loan growth front, where are you seeing loan growth demand slow? And then also, are you seeing -- you mentioned wider spreads. We've heard a little bit of that this week. Like recently, maybe banks are seeing wider spreads.

I think banks are seeing wider spreads because they're sort of pursuing wider spreads because of the capital. Everyone is being very conservative capital and making sure they're taking care of their current customer base and making sure we're getting profitable returns. Even prior to the sort of disruption in the banking system, demand started to diminish. That's part of the slowdown that's occurring, the uncertainty with the economy. I think some CapEx projects for companies and so forth are slowing. Inventories are starting to normalize. That all led to a little bit of slowdown in demand. And that, coupled with looking to make sure that you are achieving the returns that we need to at U.S. Bank and as an industry is slowing a little on the supply side. So the combination of those 2 things are basically flattish, very modest loan growth, and it's across all categories. Mortgage is down because of refinancings, as you know, and the slowdown in the new home activity. Auto is up and down, but that one is more a focus for us on making sure we have profitable returns, and that's part of what Terry talked about. And commercial corporate activity has moderated as well, partly because people preparing for a slowdown.

Yes. One of the areas that we are seeing growth in is in the credit card space, and payment rates were particularly high during the pandemic. Those -- and then you had the stimulus effects and all sorts of things. So payments were relatively high. Those are now starting to kind of normalize. As they normalize, people will start to revolve on their credit card a little bit more. And so we'll see nice growth there, and that will help the margins. That will be one of those positives from a margin standpoint.

And one follow-up, Terry, on deposits. We talk about deposits as that they're all the same in terms of data as a reprice. You've obviously got a mix of deposits different types, very granular. Just remind us where are you thinking remix and reprices largely happen? And which parts may be retail where there's still some upward pressure?

Yes. I mean -- so it's helpful maybe to kind of understand the composition of the deposit base. First of all, over 50% of it is consumer, and that will be very sticky from a pricing perspective. It is moving up, but it's moving up at a much slower pace. And certainly, if the Fed pauses, that will even kind of start to stop. About 15%, 20% of the deposits are in the Corporate Trust or the institutional services sort of business. That -- I think there's kind of 2 components to that. A very high percentage of those deposits are operational deposits. So they're deposits that are related to payments on bonds and the paying agency sort of capabilities and those sorts of things. So very sticky, but from a pricing perspective, it tends to get price more similar to kind of a money market type of fund. And we've been keeping pace with respect to that. So our deposit betas that I've been talking about reflect that as well. And then the rest of it is in our corporate and commercial. Again, a very high percentage of that is operational in nature, supporting cash management, treasury management sort of activities and just the payroll and all sorts of things that corporations need to do. So the other thing I would just say is that we have, as Andy said, a very extensive branch network. And so we generate deposits across that entire network. A significant number of those are in community markets, and those tend to be nice, sticky deposits as well. And then I'll come back to State Farm. We entered into a partnership or alliance with them. So our ability to generate deposits through that alliance has been, I think, an area of focus for us as well.

Just to reiterate because I think there's so much focus, John, on this insured, uninsured. I would argue that a lot of the uninsured is as stable as the insured, particularly those that are operating in nature. So the Corporate Trust business, that flows in and out happened because we have a Corporate Trust relationship, but we're serving the bond issuers and the bondholders. And those are sticky because we are the corporate trustee, and the issue is around the fund services business and the treasury management. Those are part of helping those companies run their day-to-day cash flows and part of the deeper relationship. They're not capital investment or customers seeking yield and flighty at the 2 basis point level. They're part of our operation of running their business.

It's a great point. And we've heard that from others. It's a really important point. Just one more for Terry. Just remind us, Terry, we talked about rate sensitivity from the capital standpoint. But from an earnings standpoint, obviously, we're not sure that that's done here or not. But where are you positioned from an earnings rate sensitivity standpoint? If you could now have a Fed hike or not, depending which part of the curve?

Yes. So at the end of looking at assets, the sensitivity, we're a little bit asset-sensitive about 1% to a 50 basis point movement. So still a little bit asset-sensitive. But that obviously has narrowed quite a bit over the last year or so.

Yes. More important to the -- income outlook now is about the reprice of deposits.

Yes, exactly. So if the Fed does end up pausing that pressure that we are seeing in terms of deposit betas, you'll probably continue to see that from maybe a quarter, and then it starts to alleviate itself. That's typically what the pattern is. So if the Fed moves up 25 basis points, again, you'll continue to see a little bit of pressure in terms of deposit betas but, again, for about a quarter after that rate hike. So if they hold stable, it will be -- it'll start to alleviate.

Great. Andy, any final comments or thoughts to...

No. Again, I want to just say thank you to the team. We had over 7,000 people, John, for 18 months working on this integration, and the success is due to them and the hard work and the planning and the due diligence. And that was a team of both Union Bank employees as well as U.S. Bank employees, and they just did a tremendous job and it's complicated, but they did a wonderful job. And the other thing is you never expect it to be perfect. And what's important is how you react to the issues as they occur, and they did a terrific job with that.

Great. Well, thank you all for joining us.

Thank you.

Thanks, John. Appreciate it.