Executives: Jen Thompson - Director, Investor Relations Andy Cecere - President and Chief Executive Officer Terry Dolan - Vice Chairman and Chief Financial Officer Bill Parker - Vice Chairman and Chief Risk

Officer
Analysts: John Pancari - Evercore Betsy Graseck - Morgan Stanley Erika Najarian - Bank of America/Merrill Lynch Ricky Dodds - Deutsche Bank Vivek Juneja - JPMorgan Brian Klock - Keith, Bruyette, & Woods Saul Martinez - UBS Kevin Barker - Piper Jaffray Gerard Cassidy -

RBC
Operator: Welcome to U.S. Bancorp's Second Quarter 2017 Earnings Conference Call. Following a review of the results by Andy Cecere, President and Chief Executive Officer; and Terry Dolan, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session. [Operator Instructions] This call will be recorded and available for replay beginning today at approximately noon, Eastern Daylight Time, through Wednesday, July 26 at 12 o'clock midnight Eastern Daylight Time.

I will now turn the conference call over to Jen Thompson of Investor Relations for U.S. Bancorp.

Jen Thompson: Thank you, Melissa and good morning to everyone who has joined our call. Andy Cecere, Terry Dolan and Bill Parker are here with me today to review U.S. Bancorp's second quarter results and to answer your questions.

Andy and Terry will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I would like to remind you that any forward-looking statements made during today's call are subject to risks and uncertainties. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation in our press release and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Andy.

Andy Cecere: Thanks, Jen. Good morning, everyone and thank you for joining our call. I am going to start off by discussing a few highlights from our second quarter earnings results. Terry will then go into some details and also provide you with forward-looking guidance, and after that, we'll take your questions. I'll start with Slide 3 of the presentation.

In the second quarter, we reported net income of $1.5 billion or $0.85 per diluted share. You will see on the slide that our balance sheet is strong and growing, sequential loan growth came in at the high end of our guidance range at 0.9%. As expected, C&I loan growth picked up after a sluggish start to the year and gained momentum towards the end of the second quarter. Based on current trends we expect that by the third quarter total loan growth will be back to the 1% to 1.5% range we think that is more normalized. Credit quality remains excellent and we feel good about the risk profile of the loan portfolio.

The net charge-off ratio was stable in the second quarter and our non-performing asset ratio improved on both, the linked quarter and year-over-year basis. Shifting to capital management; our book value per share ended the quarter at $25.55 which was up 4.8% from a year ago. Our common equity Tier 1 ratio estimated for the Basel III fully implemented standardized approach was 9.3% at 6.30 [ph], the level which is sufficient to support growth effectively managed through periods of economic stress and returned capital to our shareholders. In June, the Federal Reserve Bank notified us that they did not object to our capital plans submitted during the CCAR process. We subsequently announced the dividend increase of 7.1% and a new share repurchase program for the year.

Now let me touch on our key performance ratios. We turn to Slide 4, our return on average assets for the second quarter was 1.35%, our return on common equity was 13.4%, and our efficiency ratio was 55.2%. We're proud of our industry cleaning profitability metrics that we're always striving to improve. Although consistently best-in-class, our efficiency ratio has been at the higher end of its historical range in the past few quarters, primarily reflecting increased personnel and technology cost related to the regulatory compliance programs. However, we are nearing the end of the build out of these programs and believe the growth rates of these costs will begin to moderate.

We expect compliance costs to grow at a pace more in-line with the company's core expense space in late 2017 and into 2018. When we look out through the remainder of the year we expect to deliver positive operating leverage in both the third and fourth quarters of 2017 on a year-over-year basis. We further expect that the year-over-year non-interest expense growth will be in-line with our long-term target range of 3% to 5%. We believe that our strong balance sheet, diversified revenue mix and our focus on expense management combined with participation in some significant expense headwinds provides momentum for the second half for this year and into 2018. Let me stop there and turn it over to Terry.

Terry Dolan: Thank you, Andy. If you turn to Slide 5, I'll start with the balancing review and follow-up with the discussion of second quarter earnings trends. In the second quarter average loans increased 0.9% on a linked quarter basis and grew 3.4% from a year ago. Commercial loan growth rebounded from the first quarter increasing 2% sequentially. Line utilization has not increased materially, however, deal activity has strengthened and we continue to gain market share.

As Andy mentioned, large corporate lending, there are momentum in the latter part of the quarter. Additionally, throughout the quarter we continue to see strong growth in middle market lending across many geographies. Commercial real estate lending reflects our prudent approach to certain CRE segments such as multi-family and retail given current market conditions. We did have opportunities for growth in construction lending. However, remain cautious in commercial mortgage markets where the competitive environment has created unfavorable conditions from a risk and return standpoint.

In addition customers continue to refinance commercial mortgages in the capital markets given the rising rate environment and opportunity to extend maturities. We had particularly strong growth in retail leases as far as up 11% linked quarter where both a prime lender and a less or in the auto segment and our well established market position, full product offering and a strong dealer relationships that provided strong growth in both lending and leasing. We have made significant investments in this business over the past few years which is coming to fruition in the form of increased market penetration with both dealers and manufacturers. We expect growth will remain healthy for the next few quarters as we continue to penetrate market. I want to emphasize that leasing growth is not coming at the expense of increased risk.

If you look at Slide 6, credit metrics remain very stable in our retail leasing portfolio. We have not changed our underwriting in this business and are not enhancing residual values. I would also highlight that in the second quarter the weighted average cycle score on originations for auto leases was 782. Turning to Slide 7, total average deposits increased 0.8% compared with the first quarter of 2017 and 7.7% on the year-over-year basis. Following the June interest rate hike, our total interest bearing deposit is in the mid 20% range.

As future rate hikes occur we would expect the beta will gradually trend towards 50% level. On Slide 8 you will see the credit quality was relatively stable in the quarter, net charge-offs as a percentage of average loans was 49 basis points in the second quarter and non-performing assets declined by 9.8% on the linked quarter basis. I will now move on to earnings results. Slide 9 provides highlights of second quarter results versus comparable periods. Second quarter net income of $1.5 billion was up 1.8% compared with the first quarter but was down 1.4% versus the second quarter of 2016.

As a reminder, the second quarter of 2016 including two notable items; a $180 million Visa Europe gain in non-interest income and a $150 million non-interest expense related to interest accruals and a charitable contribution. Excluding these items net income increased slightly year-over-year. I will exclude the impact of these notable items when I discuss revenue and expense comparison versus the second quarter of 2016. Turning to Slide 10, revenue totaled a record $5.5 billion, up 3.1% on a linked quarter basis and 4.2% higher compared with the same quarter a year ago. Turning to Slide 11, net interest income on a fully taxable equivalent basis was $3 billion in the second quarter, up 2.4% compared with the first quarter and 5.9% higher than the second quarter of 2016.

Comparisons in both quarters benefited from earning asset growth and higher interest rates. In the second quarter the net interest margin increased one basis point to 3.04% in-line with our guidance. The increase was primarily driven by rising interest rates partially offset by the impact of a flatter yield curve and higher cash balances which increased to meet certain regulatory expectations related to liquidity. We do not expect average cash balances to increase meaningfully from current levels. Slide 12 highlights trends in non-interest income which increased 3.9% versus the first quarter reflecting seasonally higher revenue, particularly in the payment services business.

On the year-over-year basis, non-interest income increased 2% excluding notable items. Credit and debit card revenue increased 7.8% from a year ago on higher sales volumes. Merchant acquiring revenue grew 2.7% on a year-over-year basis adjusted for the impact of currency rate changes. In the second quarter we exited two merchant acquiring joint ventures which did not have a material impact on the second quarter results but will mute revenue growth comparisons for the next few quarters. Divestitures were in part -- due in part to changing priorities of the joint venture partners that were impacting future growth and profitability portfolios for us.

Mortgage revenue grew about 2.4% on a linked quarter basis but declined 10.9% year-over-year, in-line with our expectations. Turning to Slide 13, non-interest expense increased 2.7% compared with the first quarter of 2017, primarily reflecting higher compensation expense and marketing and business development expense, partially offset by seasonally lower employee benefit expenses. On a year-over-year basis non-interest expense increased 6.4% excluding notable items, were also driven by higher compensation and other non-interest expense. Compensation expense grew mainly due to the impact of hiring to support business growth and compliance programs, as well as seasonal merit increases in higher variable compensation related to production. Other expenses increased primarily due to be impact of the FDIC insurance surcharge which began in the third quarter of 2016.

Slide 14 highlights our capital position. At June 30, our common equity Tier 1 capital ratio estimated using the Basel III standardized approach as if fully implemented was 9.3%. This compares to our capital target of 8.5%. I will now provide some forward-looking guidance for the third quarter. Given recent trends, we expect linked quarter total loan growth to be in the 1% to 1.5% range.

Average earning asset growth will track with loan growth. We expect the linked quarter net interest margin to increase in a manner similar to the first quarter of 2017 which is within a range of four to five basis points. Let me take a minute to talk about merchant acquiring revenue. Last quarter we indicated that during the third quarter merchant acquiring revenue was expected to return to a more normal growth trajectory of same-store sales plus 1% to 2% excluding the impact of foreign currency changes. The adverse impact on sales volumes from exiting certain large volume customers is beginning to dissipate with reported sales volumes increasing 3.3% on a linked quarter basis.

Given the anticipated revenue impact from exiting the joint ventures, we expect year-over-year merchant acquiring revenue will be essentially flat in the third quarter. Growth will begin to normalize in the fourth quarter and then heading into 2018. As Andy discussed, we expect to deliver positive operating leverage in each of the next two quarters supported by year-over-year expense growth of 3% to 5%, a level we target as more normalized on a long-term basis. Finally, we expect the taxable equivalent tax rate to approximate 29% in the third quarter. Let me hand it back to Andy for closing comments.

Andy Cecere: Thanks, Terry. Our financial performance gained momentum in the second quarter and we expect to continue to improve profitability and returns as we look in the second half of this year and head into 2018. From a macro perspective, corporate balance sheets are strong, consumer confidence is increasing and the evolving economic and regulatory backdrop has to promise to be conducive to growth. I just spent time in Washington last week and was very encouraged by the open and productive dialogue that has taken place; nonetheless, progress has been slower than any had hoped. While we have not yet seen evidence of a resurgence in the CapEx cycle, consumers are spending and businesses are active, and we continue to ensure across our geographic markets and business lines.

We have a solid and growing revenue base and we believe we have reached an inflection point in expense growth. Importantly, the profit improvement that we expect will drive improving returns will not be achieved as the expense but at the cost of credit quality nor will be achieved at the cost of delaying prudent business investment which will be increasingly focused on technology and innovation. Finally, I want to thank our dedicated employees who work hard every day to be our customers and communities trusted financial partner. That concludes our formal remarks. Terry, Bill and I will now be happy to answer your questions.

Operator: [Operator Instructions] And your first question is from [indiscernible].

Unidentified Analyst: Thanks, good morning. Just following up on the expense, rate of change; it's good to hear that it's anticipated that quickly. So I just wonder if you can help us just to understand -- when you're talking about both, 3Q and 4Q getting back down into that three to five; what things are getting better and what things are you still having any inflation underneath the surface?

Terry Dolan: Yes, so let me take that question. I think there is three broad things.

From a compensation standpoint we expect that that will begin to moderate and continue to moderate third, fourth and into 2018 and that will be driven by the fact that we're getting close to the end of building out those risk and compliance programs, so that is kind of number one. Then cost related to risk and compliance such as like consulting activities; that are really have been helping us support some of those programs, has been moderating, it will continue to moderate as we go into the next few quarters and also into 2018. So those would be the biggest things and then a year ago FDIC implemented a surcharge and so we're starting to lap that and the year-over-year effect associated with the FDIC insurance will start to moderate.

Unidentified Analyst: And I'll keep my follow-up to expenses; and can you just help us understand the tax advantage investments and what does that mean for sequential growth as we go third, into fourth as well; it seems like you also had a bunch of that more in the other line this quarter. So can you just help us understand what that means for sequential growth as well? Thanks.

Terry Dolan: We don't necessarily talk about that specifically but we do typically see the tax credit amortization expense start to move up in the third and then the fourth quarter. I think last year from third to fourth as an example it was up about $40 million to $50 million kind of a net ballpark. So that should give you kind of some sort of a range with respect to how that's going to change.

Unidentified Analyst: Okay, thanks guys, appreciate it.

Operator: Your next question is from John Pancari with Evercore.

John Pancari: Good morning. Just around the deposit balance sheet again for the ended period, just want to get a little bit color on what drove that -- the end of period coming in above the average and some of the volatility there and how we should look at the deposit flows going forward?

Terry Dolan: Yes, so on a linked quarter basis if you're going to look at just averages, we saw growth in deposits, both in our consumer business and then also in our corporate trust business. We end up looking at the ending cash balances, keep in mind that one of the things we were doing as we were building cash balances in order to meet some of those liquidity requirements; and in order to be able to do that one of the things that we did is a little bit of a pricing change related to some sort of deposits in order to bring some dollars in near the end of the quarter, and so that's why you see that. Kind of on a go forward basis when you think about cash balances, we don't expect the average balances to change much from current levels.

Andy Cecere: That's right, Terry.

And I'd add in any particular day that cash balance can be up or down, there is a lot about that particularly within the corporate trust business with flows that are there, so one day I think there is a designated trend during my [indiscernible].

John Pancari: Okay, so the average should remain where it is, so therefore the EOP is probably going to head back towards the level where it was?

Andy Cecere: Yes, it's an average balances.

John Pancari: Yes, got it, okay. And then on the margin, in terms of your expectation, could you remind me again, you had mentioned four to five basis points?

Terry Dolan: Yes. You know, our guidance for the -- going into the third quarter we expected to spend -- expand four to five basis points from here.

And one of the things, just -- when we end up looking at the one basis point movement in the second quarter, we had guided that it would be lower. One of the big reasons for that is really building the higher cash balance as that cost has got two basis points during that quarter and the flatter yield curve cost us a little bit but when we look at third quarter we feel pretty comfortable with that range of four to five basis points.

John Pancari: Okay. And then jumping off from that point into fourth quarter, how much beyond that would you think barring incremental hikes then into '18 can be a good color? Thanks.

Terry Dolan: When we look into the fourth quarter, at least right now, we would expect that the margin increase may not be at the four to five but it's still going to be kind of in that range of three to four, some and above.

Andy Cecere: And we try this thing with the 90 days because so much can change with the yield curve in particular, so we'll continue to give guidance as we go to the next 90 days.

John Pancari: Yes, got it. Thanks, Andy. Thanks, Terry.

Operator: The next question is from Betsy Graseck.

Betsy Graseck: Hi, good morning. I just had a couple of questions, little more on the strategic side. I just wanted to get your thoughts on some of the consolidation that's going on with merchant acquiring over in Europe and how that plays into your business over there, any thoughts on incremental investments that you would be looking to make as a result?

Andy Cecere: Right. So as you know Betsy, we're five or six both in North America, as well as Europe, we have a great platform, our dynamic currency conversion capabilities, our international payment platform; so I think we're well positioned in both places. Merchant acquiring is an area that we will continue to look for incremental acquisitions, I would call it more open bolt-on or add-on as opposed to major deals.

We don't need to really expand or start in Europe because we already have a very strong presence, so -- but it is in an area of focused rest and one that continues to grow along, we continue to invest in.

Betsy Graseck: Okay. And then on the corporate trust side, could you give us some more updated comments there?

Andy Cecere: So corporate trust is having a good year, we continue to be leading market share across all three categories, muni, corporate, as well structured; we have again a good platform and good technology which I think is key to that business and we've been very consistent in terms of our commitment to that. So our opportunity is to continue to expand in the U.S. but also we have a foothold in Europe and our opportunity to expand there I think is comparable to where it was in the U.S.

about 20 years ago.

Betsy Graseck: And then just lastly, you talked a bit about deposit betas and how they've been projecting; I just wanted to get a sense from you on how close to run rate you are on the corporate side of your business?

Terry Dolan: I think when you end up looking at deposit bidders overall, they talked a little bit about that. I do think that one of the things you're seeing on the wholesale side is that the deposit prices gain a little bit more competitive; and so we do see that picking up both in the June hike and as rate hikes continued in the future. And you know, I think that is going to continue to move up and as part of what we are so when we think about the positive bid as overall moving up closer to that 50 basis points, we're going to see more pressure on the wholesale side and on the corporate trust side.

Betsy Graseck: Okay.

But it feels like we are two-thirds the way through or a third of the way through.

Terry Dolan: With respect to this rate hike?

Betsy Graseck: Yes.

Terry Dolan: I think we're probably further along on the wholesale side of the equation getting normalized betas and we have more space to go on the retail side which the beta there has been very low and we'll continue to go up as the next rate increases come forward.

Betsy Graseck: Okay. No, it was interesting just -- I asked the question because obviously we had a rate hike but yet you did a great job on non-sparing deposits growth in the quarter, and so it kind of suggested to me that maybe you were done on the corporate deposit beta side.

Terry Dolan: No, I don't know if we're done. I think that's all that we can really driven based upon what we see from a competitive standpoint but I don't think based upon the fact that we have cash balances where we're at, we don't necessarily see a need to drive deposits in. We're -- I would agree with you, I don't think there is a lot of upward pressure with respect to it. Deposit beta is both -- whether it's retail or wholesale etcetera, it's really tracking pretty similar to what we've seen in the past, maybe just a little bit higher.

Betsy Graseck: Okay.

Alright, thanks so much.

Operator: The next question is from [indiscernible].

Unidentified Analyst: Good morning. My first question is on loan growth, it sounds like the aggregate stuff is pretty much tracking as you would have thought that through the course that you're already indeed will accelerate back in your targeted range in the back half. So that's all good but it is kind of running a little contrary to the weakness we still see in the HA [ph].

Just curious if you can spend another moment or so just talking about exactly where it ends up coming from how much of it is market share versus [indiscernible]?

Andy Cecere: So I'll start and then I'll ask Bill to add on. You know the areas of growth continue to be in few -- middle market is doing exceptionally well, that's in excess of 2% on a linked quarter basis and we continue to see that accelerating or being about that level in future quarters, that's doing well. As Terry and I both mentioned, we saw some growth in the second half of the second quarter in the large corporate wholesale part of the category. And then a lot of leasing as Terry mentioned, very high quality but given the great platform relationships we had that shows some growth. So those are areas that I would say are our principal areas of focus.

Bill Parker: Yes, that pretty much hit on the consumer, we expect it to remain fairly strong through the latter half of the year, so we continue to see good demand in auto loans and leases; and again, that's very prime portfolio for us, we've always done it that way and we've stayed consistent in that area. We also using some demand on home equity, that's a tough market but we haven't seen the big increases, we do still have strong originations there. Andy talked about the commercial side; I will stay on the commercial real estate side although we do see some roll-off of our -- what we call our mortgage portfolio or standing loan portfolio, I guess it's very aggressive terms and by the life companies in the VS market. We are still an active construction lender, so we've seen growth there and we also -- our client base is a lot of reaps [ph] and much of that actually shows up in the C&I line and we're seeing good growth quarter-over-quarter and year-over-year there. So there is a lot of space where we're continuing to see good demand.

Unidentified Analyst: Okay, that's perfect. I appreciate the color. And then just separately on -- just the idea of positive operating leverage; it looks like both the quarters in the back half of the year, we should get was just good. Just curious about your updated thoughts on positive frame leverage for the full year and sort of when you would expect to see that? I think you've previously been hoping to generate positive operating leverage for the full year '17; I guess just my rough cut on the updated guidance -- just now, it will still be a little bit of a challenge but just would be curious to hear your thoughts.

Andy Cecere: Scott, we'll get in third quarter and fourth quarter and we'll be very close if not on for the full year.

Unidentified Analyst: Okay, sounds good. Thank you.

Operator: The next question is from Erika Najarian with Bank of America.

Erika Najarian: Hi, good morning. Just a follow-up to Scott's question; as we look on longer term in terms of the progression of your efficiency ratio, if we presume this with either forward curve today; could we see U.S.

Bancorp exit 2018 with an efficiency ratio in the low 50s?

Andy Cecere: Yes, it's a short answer to that question. We would expect to have positive operating leverage and closer to our long-term growth projections as move into '18 and that is what we talked about at Investor Day and that expense ratio in the 3% to 5% and revenue growth above that. Now that's assuming sort of a normal yield curve, economic growth is abnormally lower or anything like that but we would expect to continue to have that into '18.

Erika Najarian: That was very clear, thank you. The follow-up on some of the deposit question, some of your peers have noted that if the SAD [ph] does reduce its balance sheet or begin reducing its balance sheet by September, they believe that the outflows will be most vulnerable in wholesale deposits and I'm wondering what your color is on that -- your take is on that and whether or not that could potentially accelerate beta's even further for U.S.

bank?

Terry Dolan: Yes, so let me take that. And so -- you know, the Fed is still kind of in the process defining what the level of balance sheet reduction and the pace of that overtime; and our expectation is that first of all, they're going to be very transparent as they go through that process and the pace is going to be very gradual, most likely several years. So we do believe that as -- kind of excess liquidity comes out of the market, we would expect there to be more competition for deposits and that is going to end up impacting pricing; I do believe that just because of the nature of the deposits on the wholesale side you're going to see more competitive and -- more of a competitive environment associated with that. Whether I'd be surprised if it's going to significantly impact 2017, and I do believe that just because it's going to be very gradual, it's going to also be very manageable and the market is going to respond accordingly.

Erika Najarian: Thank you.

And just one last follow-up question; I know you always get asked on this call about an update for with the consent order and I'm wondering if I could ask a more technical question; is the consent order for OCC applicable to the holding company? And I'm just wondering whether or not there is a way to isolate the consent order to sort of unshackle it more strategically?

Andy Cecere: OCC obviously regulates our national banks, so that's where it is. But our national bank is essentially the holding company, I mean I think it's over 99% of the entire banks; so all the operations occur within that national bank. So what the OCC -- it really applies across the board.

Terry Dolan: Erika, we continue to expect to have our people in process who are in place, their technology will be completed by the end of the third, into the fourth quarter and then it gets to the sustainability and part of the equation and that goes into early '18.

Erika Najarian: Thank you.

Operator: Your next question is Matt Connor [ph] with Deutsche Bank.

Ricky Dodds: This is actually Ricky from Matt's team. I'm wondering if I could just do a bigger picture question first. I wonder if you can touch on some of items on the growth front that you mentioned in the past, maybe it's in payments or in wealth penetration; maybe frame out what those could mean to revenue as we think about both, the rest of this year and into 2018 and beyond?

Andy Cecere: So I think our -- let me just sort of go across the business lines, yes, for high level; our wholesale continues to be an opportunity to expand our dominance in terms of being the bank of choice for large corporate customers. We have a number of capabilities we've built over the years and we continue to take market share in different categories, particularly in the commercial group as we move up the league tables.

On the wealth management side, I do think the extension of corporate trust, as well as the wealth management piece of the pie, particularly were focused on the emerging [ph], that represents a great opportunity. Payments across all three categories, merchant acquiring, card issuing, as well as corporate payment systems; I think we have the technology and leaders to continue to grow that. I think particularly in regard to Elvan [ph], I think the opportunity is both here, as well as in Europe. And then finally retail, we're doing very well in terms of small business as well as retail core customer growth. And so I think across all of our business lines as we've said many times before, I think we're in a strong position, and we're not really seeking to have major adjustments and just taking advantage of the opportunities we have in front of us.

Ricky Dodds: Okay, great. And the maybe separately, it seems like energy and maybe oil prices are starting to come back in the conversation a bit more; some analysts are calling for sun $40 oil prices by 2018. I'm just wondering if you can remind us again what your exposure in that space and does it seem like there is any real signs of deterioration in your portfolio? I'm wondering if you could talk again maybe about the quality.

Andy Cecere: Sure. Yes, I mean our book has been relatively modest in size, we do finance the energy sector but we're below 2% of our commitment level and less than 1% of our loans within that sector.

When the original price decline took place we obviously did see some impact. This quarter NPAs were down in part because of some of the resolution of those original non-performing loans but we've been bringing our reserve levels down but it's not -- it's just not a material impact to our overall performance but we think the -- were at -- going to a $40 price tag, we think that's a comfortable place to be, so we expect to continue to see improvement in that portfolio.

Ricky Dodds: Okay, thanks.

Operator: And the next question is from Vivek Juneja with JPMorgan.

Vivek Juneja: Hi, couple of questions, and maybe this one goes to Bill.

Credit card net charge-offs up 58 basis points year-over-year, turning a little higher than your peers; can you talk a little bit about what's going on there?

Bill Parker: Yes, sure. I mean I think that I'll start within -- the forward look is lower than that, right, it will come back down, it will be below 4%; so it's not a trajectory thing. I think what we see is that we have continued to grow that portfolio both with acquisitions and internally through our branches, it's been solid growth; so there is a seasoning impact and if you've probably seen that across the industry but we have -- we do have a seasoning impact there but our outlook is very solid, we haven't -- we've seen our underwriting to begin that growth.

Andy Cecere: And it's a crime portfolio across the board, there is no sub-prime activity there and we're not -- that's not something we're worried about.

Vivek Juneja: Okay, alright.

Second topic, mortgage banking, you talked about that on last quarter's call. Terry, Andy in terms of -- your applications are pretty sharply, seems like gain on sale margins were down; can you give some color as to what's going on and what you expect to see on that?

Andy Cecere: Yes, so maybe just to talk about the second quarter first, mortgage applications on a year-over-year basis we're down about 16% for us and that's pretty much in line with what the market was experience and that's driven in large part by the right refinancing. Second quarter mortgage applications, we did see a nice movement up on a linked quarter basis; we end up looking into the third quarter, we would expect mortgage applications to continue to move higher, that is kind of seasonal effect and we also have a nice mix of retail and on the purchase mortgage side, so that seasonal impact will continue to see in the third quarter. Gain out of sale margins in the second quarter did come down, I think you saw that kind of in the industry, our expectation or outlook is that they will be relatively stable going into the third quarter.

Vivek Juneja: Okay, great, thank you.

Operator: [Operator Instructions] Next question is from Brian Klock with Keith, Bruyette, & Woods.

Brian Klock: Good morning. I wanted to just follow-up maybe a little finer tooth on the expense guidance. On the year-over-year basis, I mean would you think that anyway if we look at the 3% to 5% range, do you think that sequentially we're looking at expenses; especially I think Terry if you mentioned the impact of the amortization of -- well income housing tax credits, so should we be up most single digits on a sequential basis, third versus second?

Terry Dolan: Yes. I mean usually there is a little bit of a seasonal effect that comes into play with respect to the third quarter but I think that's a reasonable assumption when you think about the third quarter.

Brian Klock: Okay. And I now you talked about earlier the deposits and you know the expectation around just the seasonal, there is a season of run-off that comes back in the second half of the year; so cash balances on average you think will be unchanged. So with the recent issuances of some longer term debt are you planning to add anything else to the investment securities portfolio? Are you planning to keep the securities portfolio relatively flat?

Terry Dolan: Yes. We end up increasing the securities portfolio really kind of in-line with the overall balance sheet growth; so if you think about what average loan growth is going to look like -- our average earning assets really kind of tracks in a very similar manner, so we would be adding to the investment portfolio in order to be able to do that but that's kind of one way to think about.

Brian Klock: Alright, thanks for your time.

Operator: The next question is from Saul Martinez with UBS.

Saul Martinez: Good morning, everybody, couple of questions. Just sort of closing the loop a little bit on the net interest margin in NII guide; the NIM guidance four to five basis points average loan growth, 1%, 1.5%; I guess this should -- you know, triangulating that into NII growth of getting the numbers of around -- I guess 3% to 4% sequential growth is -- it's a little bit higher than I thought but I just want to make sure I'm not missing something in terms of triangulating NIM into NII growth?

Andy Cecere: Yes. I know that you can do the math based on what we ended up laying out but I think that's a reasonable assumption.

Saul Martinez: Got it.

Okay, perfect. Now I guess a little bit of a bigger picture question on [indiscernible] merchant acquiring business, sort of a follow-up to an earlier question; especially in light of some of the consolidation you're seeing in Europe. But we have heard and feel free to disagree with this but we have heard that from some that it feels like you're subscale in the acquiring business in both, the U.S. and Europe, and obviously you've exited some low MDR relationships, you've exited some JVs, but can you talk a little bit more about the business strategically in terms of where you see the opportunities and how you capitalize on those opportunities? Where do you see [indiscernible] getting into the entire payment space in the merchant acquiring space and how do you differentiate yourself and drive better growth on an ongoing basis?

Andy Cecere: So I think first on your scale question, I think we have sufficient scale to be very competitive. I think we've had that for a number of years.

We're focused on the few areas, number one is verticals, I think as you think about the merchant processing business, it's migrating from a natural transaction business to an information business and being very focused on verticals and providing that information, it's usually important and we have a number of verticals; the travel industry, hotels, small realty retailers that I think we're very good at, healthcare is another one; so our focus is in that information and in terms of innovation and technology providing beyond the financial transaction, and as well as the expansion of our sales force, both domestically, as well as Europe. And then finally, the e-commerce side of the equation is another area of focus for us in terms of investment and growth.

Saul Martinez: Got it. And how do you feel like your e-commerce capabilities are now versus where you want them to be?

Andy Cecere: I think they are fine, I want them to be better.

Saul Martinez: Okay, alright, fair enough.

Thanks a lot.

Operator: Your next question is from Kevin Barker with Piper Jaffray.

Kevin Barker: Good morning. I just had a quick question on tax rate; you mentioned it was going to 29%, I'm right there on the third quarter, so it's been quite volatile over the last few quarters. Are you still sticking with the 27% to 28%, give or take range for this year and maybe longer term?

Terry Dolan: I think that when we end up looking at the tax rate on a tax equivalent basis on a long-term basis, you know just because of growth it's going to -- because of the marginal effect it's going to drift upwards, so when I end up looking at certainly the next few quarters and going into 2018, the 29% is certainly more reasonable.

Kevin Barker: Okay. And then in regards to growth, obviously commercial mortgage -- C&I has been the main driver of growth as we've seen in the last few years, it slowed recently here. When you look out the next one or two years do you feel like the consumer and retail lending will start to take the lead or do you feel like commercial lend -- C&I lending will continue to be strong over the next couple of years?

Terry Dolan: I think wholesale will continue growing as it is and I think we'll start to see a turnaround in retail; so we've had strong growth, we've seen another portfolio that we talked about, a little bit less in terms of the home equity in traditional retail loan areas but I think we'll start to accelerate in future periods and I think that's how we get to the more normalized long-term growth rates.

Kevin Barker: Okay, thank you.

Operator: Your next question is from Betsy Graseck with Morgan Stanley.

Betsy Graseck: Hi, I just had a follow-up question. It's around the CCAR process and the ask and -- you know, really the question is around the dividend. I thought you had a nice increase in the dividend but yet you have one of the lowest volatility earning streams of the group and it feels like there might be some room to boost up the dividend component of the capital return. Just wondering how you're thinking through that.

Andy Cecere: Betsy, that's a fair question.

So I think first of all, we're starting from one of the lower capital ratios; you're right that we have the lowest volatility and the lowest downturn in the stress environment, in fact, we still make money as you say but we're starting from a point that's not far away from what we think is our optimal capital structure, the 8.5% versus the just over 9% we are today, that's number one. Number two is, we're always wanting to make sure that we do -- that we are successful in the outcome of the CCAR process and then finally balancing between the buyback side of the equation and the dividend. What we've done is, what I would call continue -- very predictable continually steady growth and we would expect to continue that in the future. We might balance a little bit more but we will balance a little bit more towards increasing the dividend probably more than a buyback in future periods.

Betsy Graseck: Okay, alright, thank you.

Operator: Your next question is from Gerard Cassidy with RBC.

Gerard Cassidy: Good morning, thank you. Can you guys give us some additional color -- you touched on in your opening remarks about the commercial real estate markets, you're seeing possibly some weakness in the multi-family space; can you share with us is there any geographical areas that you see as more concerning for you at this time?

Andy Cecere: Well, I mean there are certainly some of the cities that have very strong multi-family growth and if you look at some of the rent forecast and there is plenty of companies to do this. They will see there are markets, some of the coastal markets of Boston, DC; where the forecasts are for either no or slightly decline in rent growth; and that doesn't mean we won't do projects there, we follow our client base and if they like the project, we like the project, we both will do something but some of the markets have seen a lot of multi-family, Minneapolis is another one where you got to be cautious about it.

Gerard Cassidy: Thank you.

The second question was and I think you may have touched upon this and I apologize if you did; can you kind of give us your view of -- obviously, the Federal Reserve has made it clear that they're going to start unwinding their balance sheet and it will go into full speed operation in 2018. How are you guys looking at that and the impact it may have on deposits in the banking system and then for USP as well?

Terry Dolan: Gerard, thank you. We talked a little bit about that earlier but you know, when you end up looking at what the Feds -- the Fed still needs to kind of define a level of reduction in the balance sheet and really the pace of it and I think that they've been really transparent that that pace is really going to be gradual over several years and I think that that will cause any impacts of it to be very manageable on the banking industry. And as the market adjusts, I do think that as -- or we think as excess liquidity comes out of the market you could expect to see and you will expect to see more competition with respect to deposits, I would also expect that the long end of the curve on a relative basis would be a little bit higher; as a result some of their activities -- that have [indiscernible] from a deposit standpoint is most likely to come on the wholesale side of the equation.

Gerard Cassidy: Very good.

And then just lastly, you know, obviously you guys have industry leading profitability with your ROA and your ROE at the present levels. What -- is it going to be more the net interest margin improvement or the efficiency ratio when you look at how you're going to or could drive that higher? As you know in the past, your numbers were higher but is it more of a margin issue or is it more efficiency ratio or leverage; what are you guys looking out for the levers? Do you even take it higher than where it is today?

Terry Dolan: Gerard, I think it's both parts of the equation, it's accelerating revenue growth and moderating expense growth; positive operating leverage which will improve the efficiency ratio and ultimately improve ROA and ROE.

Gerard Cassidy: Great, thank you.

Operator: Your next question is from [indiscernible].

Unidentified Analyst: Good morning.

Just one question, the bottom of Slide 8 really stands out; and that U.S. bank has built reserves for the last six quarters whereas your peers even through 2Q for those that have reported continue to release those reserves. So could you talk about it as something in terms of the mix shift or the loan portfolio that's driving your ability to grow reserves, again when your peers are just not in that same position?

Andy Cecere: Well, one of the things you're looking at is that lot of the peers have larger energy exposure so they added more and like us, we can see improvement in this quarter so they may have released more reserves out of their energy book. And we're pretty much steady as she goes from a credit standpoint; so at this point in the cycle we have a very stable credit environment and we're still growing loans, so that's what we look at and we will add to reserves to support loan growth if you think about what they are for and they are for potential future losses out of your loan book and as you grow the loan book, that's what the reserve is for. So if we don't have big upswings, we're needing to add to reserves in a downturn like the energy portfolio.

Then we're going to be adding for loan growth.

Bill Parker: Sorry about that, it's been a lot lower than everyone else and so simply stated if we're not adding a lot, we're also tracking a lot.

Unidentified Analyst: Great. Then just a follow-up question for me. Andy, this concept of one U.S.

bank which you've talked about I believe is in the annual report; as you think about the second half of this year there are any areas within your core businesses that stand out in terms of benefiting from this strategy as you work together under this one U.S. bank kind of a strategy?

Andy Cecere: Terry, has a long list, there are a number of initiatives across the company from the way we handle our call centers, the way we do innovation and the way we communicate with our customers, to how we share information among the business lines. So there are a number of initiatives and I would say it's probably our number one focus of the company right now.

Unidentified Analyst: Thank you.

Operator: The final question is from [indiscernible].

Unidentified Analyst: Hi, I just had a couple of small ones on the -- making sure we're getting the payment -- merchant cost JV, it's right in the model; so were there any pain associated with the exit either in 2Q or back half of the year? And then the second just in terms of the guide, I think you said your 3% FX adjusted growth now in merchant processing and you see that flat in 3Q; was that -- how -- is it the earnings -- is it like equity method accounting that was being booked or is there revenue and then we should think about some expense coming out also in P&L? And I guess last, maybe just curiosity -- which JVs are you exiting? I saw something about [indiscernible] but couldn't find the other.

Andy Cecere: So first I'm going to ask Terry to go on the other details, there was no material gain or loss in the second quarter as a result.

Terry Dolan: Yes, so if you just end up looking at and trying to think about the growth rates over the next couple quarters, certainly reported growth rate is about 2.7% excluding the foreign currency as we said. I'd also say that same-store sales percentages and organic business growth has generally been quite strong which I think is good to see, that gives us insights with respect to the future. Reporting growth sales have been impacted by three factors; we talked last quarter about exiting some large volume low margin customers, that's been muting sales volumes and that has been dissipating and it's getting behind us, and certainly will be behind us as we get into the end of the third quarter; and so we're starting to see sales volume starting to grow.

We are experiencing some margin compression in Europe because of interchange caps that were put into place late 2015, and that has continued to impact our year-over-year sort of growth rates and will continue to do impact at least through the third quarter if that will start to dissipate in the fourth quarter and then really be behind us as we get into 2018. And then the impact of exiting the two joint ventures will have an impact on merchant acquiring, really for the next several quarters as we think about the year. To kind of give us some, maybe specifics; when we look at the third quarter, we do expect the year-over-year growth rate for the third quarter to be essentially flat and that's essentially what we said. As I look into the fourth quarter, I do expect the fourth quarter year-over-year growth rate to be similar to what we saw in the second quarter of this current quarter. And then as we continue to see organic growth that we are experiencing, you know that will start to benefit us as we go into 2018.

Unidentified Analyst: Great. And are you able to disclose which JVs are not at this time?

Terry Dolan: Yes. I mean the one joint venture is related to our joint venture in Spain with Santander. And you know really, they've had changing priorities with respect to what they want to focus on; and as we think about Spain, it continues to be an area that has some economic challenges. So from our standpoint we really do believe that we have the opportunity to continue to grow in that market on our own with a focus on the right customers and I'd be very clear we're not exiting the market.

With respect to the second joint venture, that is the joint venture with KeyCorp [ph], so we thought key merchant services; and in that situation our partner really wanted to focus on a third-party servicing arrangements and we respect that decision on their particular part. And we also say that we're retaining the clients that we believe will create the best growth opportunity for us as we move into the future.

Unidentified Analyst: Thank you, that was very detailed and I appreciate the answers.

Operator: There are no further questions. I would like to turn the call back over to you for closing remarks.

Jen Thompson: Thank you for listening to this review of our second quarter results. Please contact us if you have any follow-up questions.

Operator: This concludes today's conference call. You may now disconnect.