Andrew Cecere:

Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on Slide 3. In the first quarter, we reported earnings per share of $0.78, which included $0.12 per share of notable items. Excluding notables, earnings per share totaled $0.90.

John Stern:

Thanks, Andy. On Slide 8, we provide an earnings summary. This quarter, we reported diluted earnings per share of $0.78 or $0.90 per share after adjusting for notable items, including the last of merger and integration costs of $155 million following our acquisition of Union Bank and $110 million related to an anticipated increase in the FDIC special assessment.

Andrew Cecere:

Thanks, John. We have been preparing for a wide range of economic scenarios for some time now, and we continue to deliver industry-leading returns despite the current industry stress. Our diverse business mix is allowing us to differentiate in a competitive market, and we are seeing the benefit of the investments we've made and continue to make in our digital capabilities, our technology modernization and our payments ecosystem.

Operator:

[Operator Instructions] Your first question comes from the line of Scott Siefers with Piper Sandler.

Andrew Cecere:

Thanks, John. And Scott, I'd just add that we continue to look for opportunities to improve efficiencies, particularly in this higher-for-longer rate environment. So we benefited from the $900 million of cost takeouts from the Union Bank transaction. And we continue to focus on additional efficiencies in areas like procurement and third-party spend, our workplace management and our properties and real estate.

Operator:

Your next question comes from the line of Ebrahim Poonawala with Bank of America.

John Stern:

Yes, sure. So I mean, overall, we feel very -- we're pleased with the quarter 1 results. We saw good account growth. We're deepening relationships. We continue to see progress on Union and the growth opportunities that we see there. Consumer spending metrics, all the underlying metrics are strong, capital markets activities are strong. And that is supportive of our continued view on the single-digit growth on the fee aspect of things.

John McDonald:

We're wondering about how are you thinking about the outlook for net charge-offs and provision and just kind of the credit trends you saw this quarter. John, you mentioned there was the one idiosyncratic commercial. Other than that, kind of what are you seeing? And are you still kind of thinking about a mid-50s kind of net charge-off outlook for this year? That would be helpful.

John McDonald:

Okay. Got it. And then for the overall company, kind of still kind of trending to that mid-50s perhaps on the charge-offs?

John McDonald:

Got it. Okay. Great. And then, Andy, how are you thinking about the expense flex? You mentioned offsetting the NII. I guess, within reason, you're going to flex the expenses depending on the revenue environment plays out through the year?

Andrew Cecere:

Welcome back, Betsy.

Betsy Graseck:

Thanks so much. So I had a follow-up on the comments around corporate behavior and the deposit shift from NIB. I want to understand two things. One is it should -- do you see your corporate deposits shifting from NIB to IB? Or is it more NIB to MMS?

John Stern:

Betsy, it's John. Thanks for that. So in terms of the behavior, I think what we're seeing is the trends are slowing. The rotation is going, maybe first to answer your question, more from NIB into more IB. And it's more of the -- it's the trade-off for the client.

John Stern:

It's possible. But again, the dynamic's pretty fluid is kind of how I would describe it.

John Stern:

That's right. Yes. A lot of this is defending clients and making sure we're there for them. Again, we view this as a temporary phenomenon. This is just a timing thing. It's really just -- the churn here is continuing. It's just being -- the pace of it is taking a little bit longer for it to stabilize than what we would have anticipated. And that's really what's going on here. We want to make sure we're here for the long run for our clients and serving them as we kind of transition through this rate environment.

John Stern:

Yes, sure. So I think in terms of asset sensitivity from a risk management perspective, we are as neutral as you can be. We've taken a lot of different actions to make sure -- because we just don't know where the rate environment is. I mean, it was 7 cuts at the beginning of the year, the market had. Now it's closer to 0. So we just want to make sure we are prepared for different type of rate environments. And so I think as we think about the asset sensitivity, that is really how we're positioning ourselves.

Andrew Cecere:

So Betsy, as John said -- this is Andy. We've tried to narrow the corridor of volatility given the uncertainty in the outlook. And so we are about as neutral as we can be given all the puts and takes John talked about.

Kenneth Usdin:

If I could ask a couple of questions on the fee side. One, can we just talk a little bit through the payments businesses? It looks like the overall year-over-year growth rate was 4%. I think you're aspiring for upper single digits. It looks like corporate was down year-over-year and maybe the rate in merchant slowed a little bit. So can you just talk us through some of those dynamics and then how you'd expect that traject going forward?

Kenneth Usdin:

Okay. Got it. And then just in terms of some of the other lines, corporate services and mortgage did a lot better. I think you mentioned DCM and corporate and better gain on sale. Just wondering, are those both sustainable? Or was there any pull-forward on both of those areas this quarter?

Kenneth Usdin:

Okay. Great. And last cleanup one. Just the ATM business, it didn't look like service charges changed. Did that close at -- and I know it's not a net profit. I know it's neutral net profit, but can you just update us on that?

Kenneth Usdin:

With an offsetting cost?

Operator:

Your next question comes from the line of Mike Mayo with Wells Fargo.

Andrew Cecere:

So what we're saying, Mike, is that this pressure that, as John described, we believe, is going to dissipate and has dissipated. It's just dissipating slower than we thought. And we expect a relatively stable into the second quarter and then growth in the back half of '24. So that's what I meant by temporary.

Andrew Cecere:

So I would expect that '25 would continue the momentum that we see in the second half of '24. We're not going to give a '25 guide right now because it's so volatile in terms of what rates could be. But importantly, Mike, we see the second half of '24, even in a lower rate cut environment and higher for longer, to start to go up.

Operator:

Your next question comes from the line of John Pancari with Evercore.

John Pancari:

Okay. And then separately, on the expense efforts where you're taking a closer look, and you mentioned some of the areas, are those measures that you've taken fully reflected in that updated expense outlook of $16.8 billion for the year? Or could your efforts drive a somewhat lower number as you evaluate the opportunity?

Operator:

Your next question comes from the line of Vivek Juneja with JPMorgan.

Andrew Cecere:

I'm going to let John start, and I'll add on.

Vivek Juneja:

And the hedge that you did, which you said was an anomaly this quarter, could you talk a little bit about that? Was that for -- that's not going to have an ongoing impact? Was that just something that you put on for capital protection? Or what was it?

Vivek Juneja:

Got it. Because you already said you were neutral, so that's what I was trying to understand, what sort of change to make that you had to do to make it go to neutral.

Vivek Juneja:

Okay. And is that what? Just received fixed swaps you added or terminated? Or what did you do?

Operator:

Your next question comes from the line of Gerard Cassidy with RBC Capital Markets.

Gerard Cassidy:

Very good. And coming back to -- stepping back for a moment. Now the Union Bank, I assume is fully integrated. Obviously, that has been your focus since that acquisition. Can you share with us your thoughts about de novo expansion? You had that expand down in the Charlotte area. Is there more to come now that, again, the acquisition is behind you? What's your thoughts there as you look out over the next 12 to 24 months?

Andrew Cecere:

It's significantly higher. The more relationships, the higher the return, the more revenue, certainly. So if they have a loan only versus a loan plus deposit, plus treasury management, plus commercial products, plus payments, it all adds up.

Operator:

[Operator Instructions] Your next question comes from Matt O'Connor with Deutsche Bank.

John Stern:

Yes. I'll start here. Matt, in terms of the net interest margin, it's going to obviously track net interest income over time, but it may bounce around. Some of the drivers of that, obviously, could be some of the things you just mentioned, the asset churn on the investment portfolio, the creep and -- on deposit costs and things like that. The cash levels and liquidity mix and things of that variety can also drive it as well. So we don't really have a call or a base of here's where our net interest margin. We're more focused on net interest income.

John Stern:

I'm sorry, Matt, I didn't...

John Stern:

The swap activity that we have. Yes. So just as a -- our hedging -- while we're very active in our hedging activities, we -- there's really no fundamental change. We continue to focus on pay-fixed swaps that have -- that hedge the investment portfolio. Obviously, we took some off that impacted, but it's a temporary thing. We still have well over 30% -- or well over 1/3 actually, of our risk hedged on the securities book.

Operator:

Your next question comes from the line of Saul Martinez with HSBC.

Saul Martinez:

Okay. And in terms of noninterest bearing, the total liability or total deposits, where does...

Saul Martinez:

Okay. Great. And I guess a follow-up on -- just a clarification on the deposits surge, your response to an earlier question on the deposit surge, Forgive me if I missed this, but the $15 billion to $20 billion surge, that's a normal surge in noninterest-bearing deposits? But I guess the question is, what's sort of the incremental to the normal surge? What was incremental this quarter to what you normally see? I'm just trying to get a base on which to forecast noninterest-bearing deposits going forward.

Operator:

Your next question comes from Mike Mayo with Wells Fargo.

John Stern:

Yes. Sure. Mike, it's John. So the -- yes, we are neutral, to answer your question, to shocks to interest rates. I think what we're explaining is the behavioral aspect of it, which sometimes can be a little more challenging to judge at that point in time. And so again, it's a little bit -- the pace of rotation is a little bit. It's slowing down, just not as much as what we had anticipated. So again, rate shocks moving up and down, we continue to feel very good from a neutral standpoint. It's just that behavioral aspect that we've been talking about here.

John Stern:

Well, I think the way I would think about it is about half of our loan book is fixed rate component. The other half is floating rate component and spreads are widening. So you can see some of the floating rate components perhaps improve over time. We're seeing decent growth in payments -- or excuse me, credit card. And so some of the mix is also working at play here. And so commercial loans are coming on. They're coming on at wider spreads. So that's kind of how I think about that from a big picture perspective.

John Stern:

Yes. So I think it's just different markets. So I think some of the drag you're seeing in the commercial volume side is capital markets. Spreads have been -- and the access has been very good. We saw that reflected in our fixed income capital market fees and things of that variety. And so -- but I think that has taken away volume to a certain extent. In other areas where access to capital markets isn't as pronounced, I would say there has been a decent opportunity for spreads there.

Ebrahim Poonawala:

John, just a quick follow-up to make sure we get this right. The surge deposits that came in, I think you mentioned you expect about $15 billion to leave. Am I -- is all of that going out of noninterest-bearing? So the $91 billion number, does that go into the mid-70s as we think about the second quarter?

Ebrahim Poonawala:

Mix of both. And so you do expect, just from a very -- dollar balance standpoint, NIB staying north of $80 billion. Is that fair?

Ebrahim Poonawala:

And just a separate question. Given all these questions on NII, I think, would love to hear the degree of conservatism baked into your NII outlook. Because I guess the concern you're hearing is whether we see another downward guide 3 months from now. And yes, so in terms of what would go wrong in order for us to see another guide down on NII and for you to be surprised?

Operator:

There are no further questions at this time. Mr. Andersen, I turn the call back over to you.

Operator:

Thank you. This concludes today's conference call. You may now disconnect.

George Andersen:

Thank you, Sarah, and good morning, everyone. Today, I'm joined by our Chairman, President and Chief Executive Officer, Andy Cecere; our Vice Chair and Chief Administration Officer, Terry Dolan; and our Senior Executive Vice President and Chief Financial Officer, John Stern. With their prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation, our earnings release, our Form 10-K and its subsequent reports on file with the Securities and Exchange Commission. Following our prepared remarks, Andy, Terry and John will take any questions that you have. I will now turn the call over to Andy.

John Stern:

Thanks, Andy. Turning to Slide 6, we reported diluted earnings per share of $0.49 for the quarter, or $0.99 per share after adjusting for notable items. Notable items totaled $1.1 billion on a pre-tax basis or $780 million net of tax, representing a $0.50 reduction per diluted common share, including an FDIC special assessment charge of $734 million, offset by a benefit from tax settlements in the quarter. Other notable items this quarter included, merger and integration costs of $171 million, a charitable contribution to fund our community benefits plan of $110 million, and a balance sheet optimization charge of $118 million. This quarter, we opportunistically restructured a portion of our investment securities portfolio, which we expect will enhance our net interest income trajectory, while also strengthening our capital and liquidity positioning. Slide 7 provides a more detailed earnings summary for the quarter. Turning to Slide 8, we continue to manage the balance sheet prudently as we saw reduced loan demand this quarter and the competition for deposits remained heightened as system-wide liquidity declined. Total assets ended the year at $663 billion. Average loans declined 1.1% on a linked-quarter basis, as growth in credit card loans supported by consumer spending and low payment rates was more than offset by weaker commercial loan demand. Average deposits declined 1.9% linked quarter. Given our strong deposit balances in the third quarter, we moderated our deposit pricing somewhat in the fourth quarter even as we grew consumer deposits by 1%. During the quarter, we rebalanced a portion of our securities portfolio, which provided risk-weighted asset relief and improved our overall earnings trajectory. The average yield on total investment securities portfolio increased to 2.97% for the fourth quarter, a 55 basis point increase compared to a year earlier. As of December 31, the ending balance on the total investment securities portfolio was $161 billion. During the quarter, effective duration on the available for sale portfolio declined to less than three years as unrealized losses, net of tax, improved by approximately $2 billion given the movement in rates and repositioning. Turning to Slide 9, net interest income on a fully-taxable equivalent basis declined 3.0% linked quarter, driven by a modest decline in the net interest margin of 2.78%. The 3 basis point decline in the net interest margin reflected market dynamics including deposit pricing pressure and unfavorable shifts in the deposit mix, partially offset by better earning asset spreads and improved total funding mix. In the first quarter of 2024, we expect net interest income on a fully-taxable equivalent basis to be in the range of $4.0 billion to $4.1 billion. For the full year 2024, we expect net interest income on a fully-taxable equivalent basis to be consistent with our annualized fourth quarter 2023 net interest income level of approximately $4.14 billion to up slightly. Slide 10 highlights trends in noninterest income. Noninterest income, as adjusted, increased 12.1% on a year-over-year basis, driven by new account growth and deepening relationships across the business. Year-over-year payment service revenue benefited by continued strength in consumer and business spending activities, while increases in trust and investment management fees and commercial product revenue were driven by underlying market activity, a full fourth quarter with Union Bank, and core growth. Turning to Slide 11, noninterest expenses, as adjusted, decreased by 1.0% on a linked-quarter basis, driven by lower compensation-related expense that was partially offset by strategic investments in marketing and business development. Slide 12 highlights our credit quality performance. Asset quality metrics trended in-line with expectations, and key metrics continue to normalize toward pre-pandemic levels. Our ratio of non-performing assets to loans and other real estate was 0.40% at December 31 compared with 0.35% at September 30 and 0.26% a year ago. The fourth quarter net charge-off ratio of 0.49% increased 5 basis points from a third quarter level of 0.44% and was higher when compared to a fourth quarter 2022 level of 0.23%, as adjusted. Turning to Slide 13, we increased our common equity tier 1 ratio to 9.9% as of December 31. The combination of earnings accretion, net of distributions, and balance sheet optimization actions resulted in a 20 basis point increase linked quarter. Balance sheet optimization activities continue to have a low to neutral impact on earnings and provided additional risk transfer benefits. As we move into 2024, we expect earnings to be the primary driver of capital accretion with limited reliance on balance sheet capital-related actions. As of December 31, 2023, our common equity tier 1 capital ratio remains above our regulatory capital minimum by 290 basis points. Let me now hand it back to Andy for closing remarks.

Operator:

Thank you. [Operator Instructions] Your first question comes from the line of Scott Siefers with Piper Sandler. Your line is open.

Andy Cecere:

Good morning, Scott.

Scott Siefers:

Hey. John, I was hoping you could maybe provide a little more context around the NII thoughts for the full year. It sounds like if I did the math correctly, we're expecting somewhere between $16.5 billion and $16.6 billion for the full year. Maybe just some thoughts on how the margin and NII should traject. I would presume maybe a little more downward pressure on NII given day count in the first quarter, but does it trough there and then sort of grow throughout the year, or would there be other factors that would cause NII maybe to bleed through, say, middle of the year and then start to inflect back up or maybe just any thoughts there?

Scott Siefers:

Okay. Perfect. Thank you. And then maybe just a quick question on capital. Glad to hear that some of those balance sheet optimization efforts are beginning to sunset. Maybe one, do you have what you all estimate the sort of fully loaded common equity tier 1 ratio to be now and maybe the balance between just building and potentially returning capital going forward?

Scott Siefers:

Okay. Perfect. All right. Thank you very much.

Operator:

Your next question comes from the line of Ebrahim Poonawala of Bank of America. Your line is open.

John Stern:

Good morning.

John Stern:

Sure. Absolutely. So, in terms of our current projections, we have four interest rate cuts by the Fed starting in the second quarter of this year. Now, whether or not that's two cuts or six cuts, it's not going to be a material driver to our outlook. We have worked hard to get our net interest income sensitivity to be more or less in a neutral position. And so, we feel like whether the cuts are -- how they are positioned are not going to be a material driver to the change of the outlook, excuse me.

John Stern:

Sure. Yeah, I'll call a couple of things on payments and some of the other fee categories. So, as we think about payments, certainly, in terms of merchant processing, we've put a lot of investment in there. There's a lot of technology-led advancements that we've made in terms of connections and certainly some MUB synergies. And so, we continue to expect high-single digits in terms of revenue growth there. The same would be said for corporate payments, we think high-single digits, given the amount of T&E growth and client growth and all that sort of thing that we see. And then, on the card side of things, we've seen a very nice margin expansion. MUB certainly helps. And holiday sales have been -- were certainly helpful this past quarter, but we see that extending, and so we think mid-single digits from that standpoint. I would also reiterate, we've had really very nice growth in the commercial product side. We've had -- particularly in 2023. We would expect high-single digits there, given strength we've had in foreign exchange, derivatives, the fixed income, capital markets, loan syndication has all been performing very well for us. Our trust investment management fee also should experience growth led by our institutional service businesses and Corporate Trust and Fund Services, and certainly in wealth management, some of the fees associated with that. But one thing I would point out though in terms of service charges, we have exited our ATM cash servicing business and that was a business we decided to exit just given the high level of capital related to it in terms of intensity and investment. And so, that will impact us by about $30 million to $35 million per quarter, starting in the first quarter.

Operator:

Your next question comes from the line of John Pancari with Evercore ISI. Your line is open.

John Stern:

Good morning.

John Stern:

Sure. So, a couple of things there. So, I'll start on the loan growth side. I do believe our expectation is that we will see growth in the commercial side. Of course, that was a little bit weaker this last quarter as we experienced pay downs, particularly as clients were accessing capital markets and things of that nature. But we've seen really a good pipeline build in that. We expect utilization to pick up and things of that variety. So, we feel like that, along with credit cards, will be good sources of growth for us, as we think about loan growth going forward. On the deposit side, as a reminder, we'll probably be lower in the first quarter. We seasonally lose deposits just as we kind of go through the year-end process and just given the mix of our businesses, deposits end up being a little bit lower in the first quarter, but then we see more or less stabilization. But there might be some headwind there, particularly depending on QT and how the Fed draining of liquidity out of the system will impact the numbers there. And then, going into your NIB comment, we've seen, of course, rotation out of NIB into other interest-bearing products. That continues but starts to wane as we go throughout the year. And again, as I mentioned, we're going to be nine months by the end of this quarter past the last Fed hike, and that gives us some signal that that will begin to abate.

Andy Cecere:

Good morning, John. This is Andy. So, let me start with this and John can add on. So, as I said in my prepared remarks, we're going to benefit from the cost efficiencies of the Union deal to total $900 million, and that is fully reflected now and into the run rate starting this quarter. So, we're achieving those benefits because of the benefits of technology investments we've made, digital investments, operational investments, our risk platform. And so that is the benefit of the investments we've made, and we would expect to continue to invest in the business, in those capabilities and payments and technology modernization. So, we are also very cognizant in managing expenses very closely. We still have opportunities in terms of efficiencies in personnel and operations and activities around technology that will allow us to more efficiently deliver the services we have. So, I would expect as we get towards the second half of the year that when we start to see that margin growth that John talked about as well as the fee normalization, that we would have opportunity for positive operating leverage and we're going to -- again, that is our long-term objective as always and we have levers to pull.

Andy Cecere:

You bet.

Andy Cecere:

Good morning, John.

Terry Dolan:

Yeah. Good morning, John. This is Terry Dolan. So, I'm going to take this question related to credit quality. Your first one is really related to non-performing assets and some of the things that we saw in the fourth quarter. If you end up going across the portfolio, generally pretty stable. We did see a couple of idiosyncratic loans that went into non-performing status. Both of those were kind of Union legacy sort of credits, so continue to kind of work through that. But I would also say that both of those are fairly well collateralized. So, we don't necessarily see a lot of charge-off content related to those idiosyncratic credits. When we look at net charge-offs and the trajectory, I would expect that -- we would expect that it will continue to kind of normalize. Credit card is kind of getting closer to pre-pandemic levels, but that will continue to move up a little bit. Our expectation is that for full year 2024, we'll probably be in kind of in the mid-50s in terms of the net charge-off rate.

John Stern:

Yeah. So I mean, we had, as you mentioned, some of the fee numbers there. From a core fee perspective, we do expect to grow. I ticked off some of the areas in terms of payments, commercial products, trust and all sort of thing. Other -- and some of the service charges components there. Of course, in terms of mortgage, that will be probably somewhat in the flat range. And in terms of other, we had a little bit of a high number in terms of the fourth quarter related to tax credit, related impact finance, syndication fees and things like that. So, all those things in, we expect kind of that mid-single in terms of the fee components going forward for this year.

John Stern:

Hmm.

Operator:

Your next question comes from the line of Erika Najarian of UBS. Your line is open.

Andy Cecere:

Good morning, Erika.

Andy Cecere:

Yeah, Erika, as John mentioned, I think our balance sheet optimization efforts are behind us. Our focus on capital accretion will be from earnings as we go into 2024 and forward. As we talked about, we are at a 9.9% CET1 ratio today. A couple of years ago, our target was between 8.5% and 9%. So, we're above that target. But we're also cognizant of the rules that are coming, both from the perspective of Basel III endgame, which is still uncertain, as you talked about, as well as CCAR and how that will evolve over time. So, we will continue to accrete the 20 to 25. We'll continue to burn down the AOCI. When we get clarity on the capital rules, both Basel III and CCAR, we'll then determine what the proper capital target will be. My expectation is we'll be above the 9% that we were a few years ago. But we'll define that, refine that, and then we'll get into what the math is around buybacks at that time.

John Stern:

Sure. In terms of -- the first part of your question in terms of QT, we do anticipate QT to be throughout the year. And so that's going to, on whole, put pressure on deposits throughout the year in terms of balances. And so, we don't expect a lot of growth overall in deposits, but we'll -- we have ways to manage through that. Of course, they're talking through various ways to change the QT, but that just remains to be seen. In terms of deposits performance on the way down, I anticipate commercial and wholesale type balances will go down just as fast as they would come up. On the retail side, it's going to be more of an arc. It'll take some time for that to turn. But those are our expectations.

Operator:

Your next question comes from the line of Mike Mayo with Wells Fargo. Your line is open.

Mike Mayo:

Hi. So, I wasn't clear, are you guiding for flat, positive or negative operating leverage or none of the above for 2024? And more generally, I mean, the real question is, when do you get back to your historical efficiency ratio? I think you talked about this at a presentation in December. I mean, 61% core efficiency in the fourth quarter isn't exactly like legacy U.S. Bancorp, and that's up 300 basis points year-over-year. And earlier last decade, you were 55%. Going back further, you were the low 50%s. Is that just the aspirational target now? Or is that a real target over the next two years or so? And along those lines, I guess, you have all the savings you're going to get from Union Bank. So, where does the risk come from here?

Mike Mayo:

When you say into the 50%s, I mean, is it something -- can you get back to 55%? Is that in your planning horizon, even going out a few more years? And it looks like the payments business is recatching its stride here. And along those lines, I didn't see the slide anymore on the payments business combined with small business banking. You're going to grow small business relationship like 15% to 20% and the revenues by 25% to 30%. I don't see any slide for that. And I know you got -- look, you got Union Bank deal, you had the issues of last March and April, and it's okay. Your capital is back, the deal is done, and now we're back to kind of U.S. Bancorp business as usual. So, I'm just trying to look for some color on that if you're going to become the square of banking or if that's still a goal, and how those revenues might help you improve that efficiency?

Mike Mayo:

All right. Thank you.

Andy Cecere:

Good morning, Matt.

Andy Cecere:

That's correct.

Andy Cecere:

Correct.

Matt O'Connor:

Okay. And then just stepping back, like any other kind of small businesses or segments that you're kind of reevaluating for, not so much kind of the regulatory proposals, which we'll see how they may finalize, but just other areas that you're stepping back and whether it's in mortgage, given the smaller market there, or other parts of the business portfolio that you're looking either to exit or to potentially lean into, that's a bit different than you were thinking, say, six months ago?

Andy Cecere:

I think I agree, John. And the only thing I'd add is that the environment and the competitive dynamic is something that causes us to be more aggressive or less aggressive in certain categories. And maybe the example I'll give you is auto lending, which is, for us is not growing right now. And that's because of the spreads and the returns are just not at our levels that we want to put on the books. So, those are areas that we're going to not get out of or close down, but just not emphasize in terms of growth at the levels of returns that we're seeing right now.

Terry Dolan:

Yeah. Well, I mean, it is an area, Matt, that we think that there continues to be a nice growth in that particular space. It is an area, though, that certainly as we have looked at the economic uncertainties and all sorts of things, the pressure on consumers, especially given the inflationary sort of pressure. We -- on the margin around the edges, we do make adjustments to underwriting and tighten that up where we need to. But when you end up kind of thinking about the overall credit performance of credit card business, we still think it's a very nice business. We focus on prime, super prime sort of customers. And even through this cycle, I think it's going to perform very well.

Operator:

Your next question comes from the line of Gerard Cassidy with RBC Capital Markets. Your line is open.

Andy Cecere:

Good morning, Gerard.

Gerard Cassidy:

John, you touched on, in answering a question about commercial loan growth that some of your customers were accessing in capital markets and things of that nature. Can you guys share with us -- we read a lot and see a lot about the private credit markets have really become quite active and aggressive in making loans to corporate and commercial customers. Are you guys seeing that competition, number one? And also, is it any different than past years? Or has it intensified? And then, simultaneously, are any of these private -- Apollo, Blackstone, et cetera, are these customers of yours? And if they are, how do you balance the competition versus handling their needs?

Andy Cecere:

Yeah. Our Corporate Trust and Global Fund Services, Gerard, as John mentioned, businesses, they support a number of large private credit funds in the industry and, well, they are customers and clients of ours that we continue to serve.

Gerard Cassidy:

Thank you, Terry. Just if we step back for a moment and look at beyond Basel III endgame, maybe we do get the final proposal in the middle of this year or later this year. We get through the next DFAST. U.S. Bancorp has always had a hallmark of having one of the highest ROTCEs amongst the regional banks. Obviously, you're probably going to maintain that. But you also were very disciplined in giving back the excess capital every year to shareholders in buybacks and dividends. Generally, if I recall correctly, around 75% to 80% of total earnings in a combination of both. Andy, do you see that coming on the horizon, maybe 2025, once we get all the rules that we know where you see CET1 ratio needs to be? What's your outlook there?

Gerard Cassidy:

Very good. Appreciate it. Thank you.

Operator:

Your next question comes from the line of Ken Usdin with Jefferies. Your line is open.

John Stern:

Sure. Thanks, Ken. My -- the comment was really around in terms of the fourth quarter in just what we saw. Maybe just stepping back a bit. In the third quarter, we grew deposits quite a bit. And part of that was we were just getting through the Union Bank acquisition. We wanted to make sure we were maintaining strong relationships with those clients and really all clients as we're going through those times. In the fourth quarter, given where loan demand went and where we had a little bit of excess deposits, so we've made decisions really just tactically to go away from non-deposit -- or non-relationship or less relationship-based and specifically on time deposits declining and things of that nature. So, I think that's just going to be the ebb and flow of things of just how we manage it going forward depending on loan growth, depending on our profile and depending on the relationship. So that's really what that comment was intended for.

John Stern:

Yeah. We continue to expect core deposit growth in the consumer side, and that has been something we've been -- the team has been very focused on, and we feel we've had great success there.

John Stern:

Yes.

John Stern:

Exactly. It's all in the core now, yeah.

Saul Martinez:

Hey, good morning, guys. Maybe on the payment side, if you just add a little bit more detail about how you're feeling about your payment strategy, how you're doing and how much -- how big the upside opportunity is there? Obviously, you're growing nicely on the issuing side, the merchant acquiring side, sort of mid-single-digit growth in revenues and volumes. I think you said high-single digit next year. I mean, as you guys know, the banks have ceded a lot of share to software companies, integrated service providers. And just how do you feel it's going in terms of integrating your commercial banking in payments offering? And it does seem like you have a major advantage in terms of having relationships, both on the retail and commercial side. And then, obviously, you kind of have that two-sided network that a lot of the fintechs want. But obviously, banks have struggled in this area. So, just maybe if you could just give us sort of an overview of how you're doing and how you feel the opportunity set is evolving?

Saul Martinez:

Okay. Got it. That's helpful. Maybe I'll just follow-up on deposits. You mentioned the migration, you expect the migration out of noninterest-bearing deposits to sort of run its course. Just when and where do you see that? I think noninterest-bearing was about 17.5% of total deposits. How much more room is there? And just on deposit cost, I think the cumulative beta, if my calculations right, is around 49%. How much more room is there for that to increase? Sort of what's embedded in your guidance for NII?

Saul Martinez:

Okay. Got it. Thanks.

George Andersen:

Thanks, Sarah, and thank you for listening to our earnings call. Please contact the Investor Relations department if you have any follow-up questions.

George Andersen:

Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; Terry Dolan, Vice Chair and Chief Administration Officer; and John Stern, Senior Executive Vice President and Chief Financial Officer. During their initial prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation, our earnings release and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors materially change our current forward-looking assumptions are described on Page 2 of today's presentation, our press release, our Form 10-K and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry and John will take any questions that you have. I will now turn the call over to Andy.

John Stern:

Thanks, Andy. Turning to Slide 8, we ended the quarter with total average assets of $664 billion and total average loans of $377 million, down $9 billion and $12 billion, respectively, on a linked-quarter basis as we prudently managed and optimized our balance sheet given the current macroeconomic and regulatory environment. Average total deposits were $512 billion, representing a 3% increase linked quarter, driven by expected seasonality and growth in money market and time deposit accounts. Specifically, average noninterest-bearing deposits decreased $16.2 billion this quarter, primarily driven by our Union Bank retail customer upgrade at conversion from noninterest-bearing checking accounts to our interest-bearing Bank Smartly product. Excluding this reclassification, the decrease would have been $6.2 billion. Our mix of noninterest-bearing to interest-bearing deposits was approximately 19%, consistent with where we expect the mix shift to stabilize based on historical performance and the operational nature of our core deposit base. Slide 9 provides an update on the investment securities portfolio. As of September 30, our available for sale securities were 97% of our total securities. We continue to reduce the effective duration of the AFS portfolio, which is now less than 3.5 years. On Slide 10, we provide a detailed earnings summary for the quarter. This quarter, we reported diluted earnings per share of $0.91 or $1.05 per share after adjusting for merger and integration charges of $213 million net of tax or $0.14 per diluted common share. Turning to Slide 11. Net interest income on a fully taxable equivalent basis totaled approximately $4.3 billion, which represented a 4.1% decrease on a linked-quarter basis and a 10.7% increase from a year ago due to the impact of rising rates and the acquisition of Union Bank. Our net interest margin declined 9 basis points to 2.81% in the third quarter. The linked quarter decline was primarily due to the impact of lower earning assets, deposit pricing and mix shift, offset somewhat by better loan spreads and funding mix. Slide 12 highlights trends in noninterest income. Fee income increased 11.9% or $295 million on a year-over-year basis, driven by higher payment service revenue, trust and investment management fees, virtual products and mortgage banking revenues. On a linked-quarter basis, fee income increased 1.4% or $38 million, driven by other revenues, which included servicing revenue from previously executed balance sheet optimization actions. Turning to Slide 13. Reported noninterest expense for the quarter totaled $4.5 billion, which included $284 million of merger and integration-related charges. Noninterest expense, as adjusted, decreased $13 million or 0.3% on a linked-quarter basis driven by lower compensation expense that was somewhat offset by our investments in marketing and business development. Slide 14 shows our credit quality performance this quarter. While asset quality metrics reflecting changing conditions in the commercial real estate office segment, results this quarter continue to trend in line with our expectations, and key metrics remain below pre-pandemic levels. Importantly, given the higher interest rate environment as well as other portfolio considerations, we increased our reserve ratio for commercial real estate office loans to 10%. Our ratio of nonperforming assets to loans and other real estate was 0.35% at September 30 compared with 0.29% at June 30 and 0.20% a year ago. Our third quarter net charge-off ratio of 0.44% increased 9 basis points from a second quarter level of 0.35% as adjusted, and was higher when compared to a third quarter 2022 level of 0.19%. Our allowance credit losses as of September 30 totaled $7.8 billion or 2.08% of period-end loans. Turning to Slide 15. We continue to take action to improve our capital ratios this quarter, increasing our CET1 ratio to 9.7% as of September 30. The combination of our debt-to-equity conversion with MUFG, earnings accretion net of distributions and balance sheet optimization actions resulted in a 60 basis point increase from last quarter. Importantly, our CET1 capital ratio is now 270 basis points above our regulatory capital minimum. I will now provide fourth quarter forward-looking guidance on Slide 16. In the fourth quarter, we expect net interest income of between $4.1 billion and $4.2 billion. Total revenue, as adjusted, is estimated to be in the range of $6.8 billion to $6.9 billion, including approximately $65 million of purchase accounting accretion. Total noninterest expense, as adjusted, is expected to be approximately $4.2 billion, inclusive of approximately $115 million of core deposit intangible amortization related to Union Bank acquisition. On a core basis, we expect full year 2024 expenses to be flat with 2023. Our income tax rate is expected to be approximately 23% on a taxable equivalent basis. We expect merger and integration charges of between $250 million to $300 million in the fourth quarter. I'll now hand it back to Andy for closing remarks.

Operator:

[Operator Instructions] And we'll go to Ebrahim Poonawala with Bank of America. Please go ahead.

John Stern:

Sure. Thanks, Ebrahim. So -- this is John. As a way of background, the Fed granted us as we -- as you mentioned, full relief from our Category II commitments, and that's because of the action, Andy mentioned this, of our actions to reduce risk as well as our ability to strengthen our capital position. So importantly, this is going to provide us additional time and flexibility to meet those new regulatory requirements and do so in the same timeframe as our Category III peers. And additionally, we think it's going to reduce the downside given the challenging rate environment. But nothing really changes in terms of how we're fundamentally managing the balance sheet going forward. We're still committed to building regulatory capital. We're still expecting to increase and accrete capital at a 20 to 25 basis points on average per quarter. And our expectation is to accelerate that as we get through the merger-related costs or be in the high end of that range, I should say, as we get through the merger-related costs and start to realize the full Union Bank synergies. And we're still going to be executing risk-weighted asset optimization transactions. But now we have the time and flexibility to do that over in a way that is low to neutral in terms of our earnings impact. And so for all those reasons, we feel like we have the flexibility in our balance sheet to do those sorts of things.

Ebrahim Poonawala:

That's good color. And just another question, John, I think I heard you correctly -- if I heard you correctly, you mentioned you expect the NIM to draw off, and I'm assuming NIM equals the trough in the fourth quarter. Maybe just that assumption in terms of does a steeper yield curve or widening in just the curve. So is -- that assumption around troughing of NII or NIM? And what gives you confidence around mix change consumer behavior to feel good about that?

Operator:

Next, we go with John McDonald with Autonomous Research. Please go ahead.

John Stern:

Yes. Maybe just to go to the last couple of questions you mentioned. So from a noninterest bearing, yes, we do expect that mix, we're at about 19%. That's about where we will be -- we expect that to be in that range. And from a beta perspective, we are in the mid-40s right now. It's possible it could creep up higher depending on where the Fed goes from here, but we feel good about that. And then in terms of the net interest margin and things like that, we do anticipate a little bit more pressure here in the fourth quarter, but then that really is the point where we feel that it'll bottom out based on my comments I just made a previous question?

John Stern:

Yes.

John Stern:

Yes. So I think all in, it's about -- AOCI is about 250 basis points of impact. So I would say 7.2% is roughly kind of where I would think about it. In terms of the change in the AFS, obviously, rates backed up on the long end of the curve, 75 to 90 basis points, depending on treasuries or mortgages that you're looking at. And that had an impact of about $1.4 billion in our -- on an after-tax basis on our AFS securities book, which we would have expected and is consistent with the duration of our book, which we have continued to wind down, as I mentioned in our comments about -- less than 3.5 years is our current duration. So that's the effect of that. We are continuing to see -- we will continue to see pay downs in that book, whether it's the HTM or AFS. We have about approximately $3 billion or so per quarter that rolls off that book, and we'll reinvest in the AFS side of things over time.

Mike Mayo:

Just to be clear, how much of the $900 million merger savings were recognized in the third quarter results?

Mike Mayo:

So relative to the third quarter, the first quarter of 2025 could see $800 million of additional expense savings?

Mike Mayo:

So what's the cumulative merger savings? I guess how much more expense savings should there be when they're fully realized in the first quarter relative to the third quarter?

Andy Cecere:

So Mike, the way I think about it, this is Andy, by the end of the fourth quarter, we will be on a run rate recognizing $900 million of savings, which will be fully reflected in 2024 in our expense base. And that is consistent with how we think about a relatively flat 23% to 24% expense base, including those savings plus investments we'll continue to make in the business.

Andy Cecere:

It is a sweet spot, Mike, you're absolutely right. And the savings are great. The opportunities to deepen relationships on the Union Bank customer base, I mentioned that in my comments, I think that is terrific. Our fee businesses are doing extremely well. On a year-over-year basis, it was up 12% across almost every category. And frankly, very little of that was related to Union Bank. That was just core improvement across a number of categories, capital markets, our corporate and trust, our fee businesses, our payments businesses. The challenge for us and for the entire industry is net interest income and margin. And in this environment, that's the one that I -- there's a lot of moving pieces, as you say. Loan growth is relatively tepid as we speak for us and for the industry overall. So it will be dependent upon that in terms of positive operating leverage, and I would say it's too early to call.

John Stern:

Yes. We have flexibility now in terms of the transactions that we do to optimize. And we still have plans to do those sorts of things. We've identified some things that are going to be relatively neutral and a little bit on the low end of earnings impact. And of course, you saw some of those transactions in the second quarter flow through in terms of provision and things like that. And that did lower our earning assets, as you mentioned, about $8 billion or thereabouts this quarter.

John Pancari:

I know despite the regulatory change around the Cat II requirement, you maintain the 20 to 25 bps generation in CET1 quarterly. Why no change there? Can you just talk to us maybe about the give and takes in that expectation as the need to meet the Category II shifted to Category III, why no change there?

John Pancari:

Okay. So the less BSO activities didn't materially benefit that expectation?

John Pancari:

The less risk-weighted asset optimization that would be needed now under the -- need to meet Category III did not materially impact the 20 to 25 basis points of earnings generation expected?

John Pancari:

Okay. And then separately, is there any OpEx impact of the -- of now needing to conform to the Category III versus the more immediate requirements of Category II? Anything on the expense side, and then separately, on the -- on your margin bottoming comment, anything in terms of the trajectory in the margin that you would expect after you see this bottoming as we head into 2024?

Operator:

And next, we’ll go over to John McDonald with Autonomous Research. Please go ahead. Oh, one moment here. We'll go to Scott Siefers with Piper Sandler. Please go ahead.

John Stern:

It is. As Andy mentioned, there's asset cap so that we have complete flexibility here on our balance sheet going forward. So if we elect to grow or want to grow, and we do want to grow in a capital-efficient manner, we will do so. What I would say, though, is that we're going to be emphasizing higher return loans and deemphasizing lower return type of assets. And I think that will manifest itself as the balance sheet churns. And in addition to that, I would just highlight that in this environment right now, the loan outlook is pretty is pretty low. The demand for loans is quite low, given a number of different reasons out there. But that gives us kind of the confidence that we have a lot -- have more time and flexibility here.

John Stern:

Sure. So in terms of the AFS and HTM, we're at about -- in terms of balances, about $162 billion or so, and it's about a 50-50 mix as we mentioned on the call, in terms of AFS and HTM. So, we have about, as I mentioned, $3 billion of runoff per quarter on average just given the current interest rate environment and things of that variety. In terms of our profile, we've been able to hedge about 30% of the fixed rate portion of the AFS book. And so that's what has driven the duration of that particular book in the 3.5 -- less than 3.5 years as we have. That HTM book is principally all agency mortgage-backed securities, which have longer lives. And so, it's more in the six or so range in terms of the duration of that book.

Erika Najarian:

Andy, my first question is for you. Specifically yesterday's announcement is a big win for the Company. And as we think about combining that relief with a generally tighter regulatory environment, what CET1 are you looking at -- and what level are you looking at in terms of, okay, now I'm at the right level, this is now my target in the new world. And now in an environment where balance sheet growth is minimal at best, right, I can now return capital back to shareholders through buybacks. I guess I'm just wondering because there's printed -- your GAAP CET1, there's the adjusted that John gave, right? But then you only have to take into account 25% of that 250 by July 1, 2025, if we get to a final date by then. So, there's a lot of moving pieces. So as your investors think about all the parts that you've made plus this relief, what is your new target? Is that transitional or fully phased in? And what's the bogey that investors could look forward to that you would hit before returning capital through buybacks?

Erika Najarian:

And so just to follow up here. At least until June 2024 CCAR results, regardless of how quickly you build the capital, either on an adjusted or on a GAAP basis, you're going to continue to be at pause on the buyback until at least the until we see the CCAR and the SEB?

Erika Najarian:

Got it. That's very clear. And just one more for John, if I may. In terms of the net interest income trajectory, I think the fourth quarter is good news, especially relative to what we thought two days ago, which would be more RWA mitigation. As we think about the RWA mitigation ahead that's less impactful to EPS, should we think about it similar to what we saw early in the year in terms of securitization? Are you more actively -- are you going to continue to use credit linked notes, which I assume has cost you 12.5% or so of the pool, plus SOFR and the spread. And as we think about those dynamics, do you feel like you have to warehouse more liquidity as we anticipate LCR rules for regional banks? Because we're also hearing that there could be pretty significant haircuts on how they're thinking about HTM as HQLA.

Erika Najarian:

Got it. And congratulations on the release of commitments.

Operator:

And next, we'll go to Gerard Cassidy with RBC. Please go ahead.

Andy Cecere:

Let me give you the big picture, and I'm going to ask Terry to highlight some specifics. I would say the consumer is entering this cycle in very strong shape from a balance standpoint, from the perspective of savings accounts that they have, the spend activity, I think they're all starting to normalize, but normalized to a pre-pandemic what I'd say, normal level. The companies and small businesses are also in very good shape. The one area that we're all very focused on is commercial real estate office, which is one of the areas that we increased our reserve to. As you know, it's at 10% in this quarter. So maybe, Terry, you can give some specifics.

Gerard Cassidy:

Very good. Good to hear your voice, Terry. Just to follow up on what you were saying from a competitive standpoint, do you sense -- the extreme, of course, was '05, '06 when all of the crazy lending is being done by some banks, but also the nonbanks. When you guys look at the nonbank competitors, are there rogue players out there that are just doing crazy things so that the second derivative impacts the banks, not because any of the banks, yourself included, made a poor underwriting decision, but it was the competitors that really did something foolish and now the banks are suffering a bit? Or again, not like '06, I'm not suggesting we're there, but just from a comparison standpoint.

Gerard Cassidy:

Great. And then as my second follow-up question, Andy, it was obviously great news that you guys had yesterday about the release. Is there any read-through? Obviously, you sat down with the regulators to get that release and they seem to be fairly rational in their decision to make that change. There's been a lot of hope and criticism that the Basel III end game proposals are pretty darn strict. Do you think -- is there any read-through where we may actually see some rationality with the regulators and they may compare back some of those requirements? Or is that too far of a stretch?

Gerard Cassidy:

I think -- go ahead. I'm sorry.

Operator:

Next, we'll go to Vivek Juneja with JPMorgan.

Andy Cecere:

I'm going to ask John to start then I'll add in.

Andy Cecere:

And I think two of those important investments, Vivek, our tech-led initiative, which is about 1/3 of our revenue base right now is tech lead from a perspective of new activity. And secondly is that what we've talked a lot about, which is this business payments ecosystem, which continues to be a top priority for the Company, because I think it's a huge opportunity for our business banking customer base as well as our commercial customer base. And then you add in what we're getting from Union Bank, I think that's why we're confident in that higher single-digit increase.

John Stern:

Sure. This is John. So, the -- we -- this is another area where we have continued to make investments in back-end systems and the frontline, and acquiring talent and all these sorts of things, and it's been a great story for us, and we continue to invest in this going forward. And along with high-grade and underwriting, there's high yield as well as what other areas that have been very strong is in the derivative market, providing interest rate. Hedging products for our clients, especially in this time where interest rates are moving around quite a bit as a service that has been highly needed. Foreign exchange has been a growing component here as well. And particularly now with Union Bank, we have more of a West Coast customer base and more foreign exchange need. In addition to some of the businesses that we work with in the Corporate Trust side, we have -- as you know, we have businesses in Europe as well. So there's always some form of foreign exchange, and so we've seen a lot of growth there. In addition to that, we've been gaining market share in the investment-grade business and high yield. Over the coming days, I think we've had an investment grade in the top 10 now in terms of market share. So that has been a business that has continued to advance slow and steady, and it's been a good item for us business for us.

Matt O’Connor:

I was wondering -- Slide 7 that shows some of the revenue opportunities. I was wondering if you could size that. The UB deal, the revenue synergies related to the UB deal that you outlined on Slide 7, is there any way to frame how big that might be or what timeframe?

Matt O’Connor:

Okay. And then separately, a little bit of a technical question, I forgot some of CFA materials. But when we look at the securities book of a duration of less than 3.5 years, but you're only burning down 25% through '25. Remind me how that math works? And does the burn-down kind of step up as we think about '26, right? Because the duration is pretty short and the burn-down is not all that much in the first couple of years.

Matt O’Connor:

Okay. That's helpful. Obviously, less relevant now given the Fed's decision, but still something we're all tracking.

John Stern:

Thanks, Matt.

Ken Usdin:

So just one more follow-up on the Category II news, I just want to make sure we're super clear. So this $700 billion stop being a bind forever? Or obviously, you don't have to cross on the prior potential timeframe. But to the prior question, just wondering, you said there's -- you don't have an asset cap. So does that mean that Category II is now a non-thing for U.S. Bank going forward in any time period? Or when you cross naturally, do you still get on the natural clock of having to comply? Just wondering how that fits in with the news you got yesterday.

Ken Usdin:

Understood. Okay. That's what I wanted to clarify.

Operator:

And with no further questions, I'll hand the call back over to George Andersen.

Operator:

This does conclude the conference for today. Thank you for participating. You may now disconnect.

George Anderson:

Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; Terry Dolan, our Vice Chair and Chief Financial Officer; and John Stern, Senior Executive Vice President and Head of Finance. During initial prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today's call are subject to risk and uncertainties. Factors that can materially change our current forward-looking assumptions are described on Page 2 of today's presentation, our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry, and John will take any questions that you have. I will now turn the call over to Andy.

Terry Dolan:

Thanks, Andy. Turning to Slide 7, our balanced mix of consumer, corporate and commercial deposits continues to be a key source of strength for the bank. As Andy highlighted, while average total deposits declined 2.6% or $13.1 billion on a linked-quarter basis, we ended the period with $522 billion of deposits, representing a 3.2% increase in ending balances on a linked-quarter. This quarter, our end of period percent of non-interest bearing deposits declined to approximately 20% from 25% in the first quarter, due to both industry dynamics and a change we made to Union Bank retail accounts at conversion. Specifically, about half of the decline was related to an increase in deposit volumes and mix shift, while the other half was primarily driven by a customer-friendly product conversion decision by us. To create a more positive customer experience, we upgraded Union Bank customers to our interest-bearing Bank Smartly checking product, which offers a better checking solution, as well as other benefits. This change will provide customer retention benefits without a material impact on our net interest margin. Given current interest rate volatility and the significant competition for deposits across the industry, we now expect our cumulative deposit beta to be in the mid 40% range by the end of this rate cycle, slightly higher than our previous expectation, but consistent with the deposit pricing dynamics in the industry. On Slide 8, average total loans this quarter were $389 billion, which was flat on a linked-quarter basis, and up 19.9% year-over-year. Commercial real estate loans represent approximately 14% of our total average loan portfolio, with commercial real estate office exposure representing only 2% of total loans, and 1% of total commitments. Our office exposure is well balanced amongst suburban, specialty, and central business districts, and had a weighted average loan-to-value ratio of approximately 55% at initial underwriting. Given current macro factors, as well as other portfolio considerations, we increased the reserve ratio for commercial real estate office loans to 8.5%. Turning to Slide 9, we reported diluted earnings per share of $0.84 for the quarter, or $1.12 per share after adjusting for notable items in the amount of $575 million or $0.28 per diluted common share. Notable items this quarter included $310 million of merger and integration-related charges associated with the acquisition of Union Bank, as well as $265 million related to balance sheet optimization and capital management actions, largely driven by a provision charge of $243 million related to the securitization of approximately $4.4 billion of indirect auto loans, as well as an additional $4.2 billion sale of Union Bank mortgage loans. These moves enable us to more effectively position the balance sheet for profitable growth and optimize returns. Slide 10 provides a more detailed earnings summary for the quarter. Turning to Slide 11, net interest income on a fully taxable equivalent basis totaled approximately $4.4 billion, which represented a 4.7% decrease on a linked-quarter basis, and a 28.4% increase from a year ago due to the impact of rising rates in the acquisition of Union Bank. Our net interest margin declined from 3.10% in the first quarter to 2.9% in the second quarter, which is somewhat lower than expected. The linked-quarter decline was primarily due to the impact of maintaining higher cash levels given the debt ceiling concerns and deposit pricing pressures, partially offset by higher rates on earning assets. Slide 12 highlights trends in non-interest income. Non-interest income increased 8.7% or $219 million on a linked-quarter basis, driven by higher payment services revenue, trust and investment management fees, and commercial product revenues. Within payment services, revenue increased $112 million on a linked-quarter basis, reflecting credit card revenue growth of $62 million or 17.2%, driven by higher margins and sales volume, and an increase in merchant processing revenue of $49 million or 12.7%, driven by pricing. Also noteworthy were increases in trust and investment management fees of $31 million or 5.3%, driven by core business growth and commercial product revenue of $24 million or 7.2%, driven by strong debt capital markets activity in the quarter. Compared with a year ago, non-interest income for the company increased $178 million or 7.0%, largely driven by higher core fee income. Turning to Slide 13, reported non-interest expense for the company totaled $4.6 billion in the second quarter, which included $310 million of merger and integration-related charges. Non-Interest expense, as adjusted, decreased $52 million, or 1.2% on a linked-quarter basis. Slide 14 shows credit quality trends, which continue to be strong from a historical perspective, but are normalizing as expected. The ratio of non-performing assets to loans and other real estate was 0.29% at June 30, compared to 0.3% at March 31, and 0.23% a year ago. Our second quarter net charge-off ratio of 0.35%, as adjusted, increased five basis points from a first quarter level of 0.3%, as adjusted, and was higher when compared to the second quarter 2022 level 0.2%. Our allowance for credit losses as of June 30, totaled $7.7 billion or 2.03% of period end loans. Turning to Slide 15, we accelerated our capital actions and ended the quarter with a CET1 capital ratio of 9.1%. The 60 basis points linked-quarter increase in the CET1 ratio, reflected 20 basis points of earnings accretion net of distributions, and an additional 40 basis points attributable to risk-weighted asset and other balance sheet optimization initiatives, with low to neutral earnings impact. During the quarter, we received the results of the Federal Reserve’s 2023 stress test, and we expect to be subject to the minimum stress capital buffer requirement of 2.5%, which is unchanged from last year. Despite this year's more stressful economic scenario and an additional $1.4 billion of merger-related charges, with limited recognition of cost synergies related to Union Bank. I will provide third quarter and updated full year 2023 forward-looking guidance on Slide 16. Starting with third quarter 2023 guidance, we expect net interest income of between $4.2 billion and $4.4 billion in the third quarter. Total revenue as adjusted is estimated to be in the range of $6.9 billion to $7.1 billion, including approximately $75 million of purchase accounting accretion. Total non-interest expense as adjusted is expected to be approximately $4.3 billion, inclusive of approximately $120 million of core deposit intangible amortization related to the Union Bank acquisition. Our income tax rate as adjusted is expected to be approximately 23% to 24% on a taxable equivalent basis. We expect merger and integration charges of between $150 million to $200 million in the third quarter. I will now provide updated guidance for the full year. For 2023, net interest income is expected to be in the range of $17.5 billion to $18.0 billion. Total revenue as adjusted is now expected to be in the range of $28.0 billion to $29.0 billion, inclusive of approximately $330 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be approximately $17 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis, as adjusted, is expected to be approximately 23% to 24%. We continue to expect to have $900 million to $1 billion of merger and integration charges in 2023, and total merger and integration cost of approximately $1.4 billion, consistent with earlier guidance. I will now hand it back to Andy for closing remarks.

Operator:

[Operator Instructions] We’ll first go to Scott Siefers with Piper Sandler. Please go ahead.

Terry Dolan:

Yes, thanks, Scott. I think that we ended up at 9.1% CET1 at the end of the second quarter. Our expectation now through the rest of this year is that we'll be at least at 9.5% by the end of the year, and that's going to be a function of earnings accretion net of distributions, as well as some continued actions from a risk-weighted asset perspective. We had originally articulated about 50 basis points of risk-weighted asset optimization over kind of the two-year time horizon. We felt like we could accelerate that a lot because the vast majority of them were what I would call low to neutral impact on earnings accretion. We still have a number of different levers that we can pull, some of which we’ll be able to execute on this year, some of which is in preparation for 2024, but we feel very confident that we have a game plan in order to be able to get to at least 9.5% by the end of this year, and to be in a position to be able to fully adopt Category II by the end of 2024, if necessary.

John Stern:

Hey, Scott, this is John. So, in terms of the DDA mix, you illustrated that correctly. We moved about $15 billion of deposits over into that Bank Smartly interest checking product. And so, that gets us to about a 20% ratio. We think that that's about where we land here. It'll be plus or minus of course, as we kind of go through the quarters, but we think that we're at a low point here.

Operator:

And next, we'll go to John Pancari with Evercore. Please go ahead.

John Stern:

Sure. This is John again. So, a couple of things I would say maybe just to provide additional context. As you saw in our results, we saw a big increase in our deposits, up 3% on a period ending basis to $522 billion. And then we had with - as Terry mentioned about our capital actions, we had loans drop as a start point of about 2% given the auto and the mortgage sale that we talked about within our comments. And so, as I think about those things, we will have the ability to be a little bit more disciplined and moderate in our deposit pricing as we go forward, given that line of thinking. And in addition, I think that as we bring on new loans, those loans are coming in at wider spreads, although loan growth is a little bit stalled as there's a little bit less demand for that in the near term here. And the mix here of loans should be more favorable as we're bringing on cards and less in mortgage and auto. So, those are kind of the puts and takes to how we came up with the net interest income guidance. And then I think you made a comment about deposits there as well, and I can just touch on that. I think on deposit side, we would - even though we had a large seasonal uplift, as typical in the second quarter from our corporate trust and commercial businesses that bring in deposit balances, as that begins to normalize, we think we're probably in line with the industry, which we anticipate being more of a decline given the quantitative tightening and all the other sorts of things that are headwinds for deposits in the industry.

John Pancari:

Got it. No, thank you. That's very helpful. And just lastly, the confidence in your through-cycle deposit beta of about 40%, looks like we have a number of banks that are turning to the high 40s and into the 50s. just what gives you the confidence in that through-cycle beta expectation of around 40?

John Pancari:

Okay, great. Thank you.

Terry Dolan:

Morning, Ebrahim. How are you?

Terry Dolan:

Yes, great question Ebrahim. And so, let me maybe unpack it a little bit in terms of the different types of actions that we are likely to take. One, as an example is, we're going to be kind of winding down a cash provisioning of business. So, that'll have very minimal impact from an earnings perspective because it's not that big of a business, but it is a pretty significant user of capital in terms of risk-weighted assets. So, that's one area and one example of how we still think that there is low to neutral sort of opportunity in terms of enhancing or improving the risk-weighted asset position. We'll continue to be focused on reducing our MSR, our mortgage servicing right portfolio over the course of the next several quarters. That's an area that again it has some impact, but it's not significant. And probably more importantly, it allows us to rebalance the size of the mortgage exposure, mortgage portfolio relative to the overall size of the business. We'll continue to look at kind of similarly mortgage loan sales out of the Union Bank portfolio. Again, that reduces our concentration in California and should have minimal sort of impact kind of on a go-forward basis. And then there's just a number of other things, similar sort of structures that we've done. But the other thing that we're working on between now and the end of the year, which will kind of position us well to be able to continue to improve on a risk-weighted asset basis is setting up some securitization programs related to some of our other balance sheet asset positions.

Terry Dolan:

Yes, go ahead Andy.

Terry Dolan:

Yes. And many of those single service on our balance sheet today, deepening the relationship will be as much focused on fee-based sort of businesses, which are capital efficient, as Andy said.

Operator:

And next, we'll move to Ken Usdin with Jefferies. Please go ahead.

Terry Dolan:

Yes, and of course that's the $100,000 question, is whether or not we actually move into a recession or not. But I think broadly from a macro perspective, some of the things that we're seeing is that some of the excess savings that consumers have held in the past has come down to really pre-pandemic levels at this particular point in time. So, I think that manifests itself in kind of a normalization of consumer spend. So, we are seeing what was very strong consumer spend starting to normalize and soften, if you will. I mean, yesterday was retail sales information that came out a little bit softer than maybe expected. We're seeing some of those same dynamics in the payments business where sales, for example in the merchant side of the equation, slower, softer sort of retail sales, but there's still a fair amount of travel expenditure that's taking place. So, customers are certainly choosing and maybe being a little more choosy as to where they're spending their dollars. Some of the dynamics that we're seeing is while sales have softened maybe a bit, the margins in some of the businesses have actually improved. So, on the credit card side of the equation where sales have come down a little bit, the margins are actually a little stronger. On the corporate payment side of the equation, margins continue to get stronger because T&E spend at the corporate - in the commercial corporate sectors, has continued to be reasonably strong. So, we continue to kind of look out the rest of the year on the merchant acquiring side of the equation of revenue kind of in that high single digits sort of range, on the credit card fee revenue still in that mid-single digits, and on the corporate payment side equation. It'll normalize, but it'll kind of normalize in that high single digits range. That's kind of what we're seeing, what we're kind of forecasting at this particular point in time based upon consumer behavior.

Terry Dolan:

Yes. So, if you were to embed the AOCI into the CET1 calculation under Category II, it'd been at 6.9%. And we expect that, based upon all of our capital actions, to get to kind of our target levels by the end of 2024. We have the game plan in order to be able to get there. So, we feel confident about that.

Terry Dolan:

Yes. Do you have that, John?

Terry Dolan:

Yes.

Operator:

Next, we can go to Erika Najarian with UBS. Please go ahead.

Terry Dolan:

Yes, so maybe just kind of unpacking a little bit. We still expect Erika, that the benefit from capital accretion or earnings accretion is going to be somewhere in that 20 to 25 basis points on average. And a couple of different things to kind of keep in mind. While there's a little more pressure on the revenue side of the equation, the things that will start to come into the equation is a lot lower merger and integration charges next year. We’ll be substantially done with that, as well as the fact that by the end of the year, we will really be at kind of full run rate from a cost synergy standpoint. So, I think that there's a number of things just in terms of why we feel confident that that accretion level starts to accelerate or creep up from where we're at today. And then I think when you end up going through - John talked a little bit about the burndown being at about 25% between now and the end of the year, and that's based upon market implied. But also keep in mind, as we have said is, we have put into place some hedging strategies to protect us from the upside risk that might exist if rates were to move up. So, we feel pretty good about where that is going to come in. And then the rest of it is really tied to risk-weighted asset actions, many of which I ended up talking about. And again, we have a pretty confident game plan with respect to our ability to reduce risk-weighted assets in order to be able to achieve the targets that we need to hit.

Terry Dolan:

Yes, absolutely.

Operator:

And next, we can go to John McDonald with Autonomous Research. Please go ahead.

Terry Dolan:

Yes.

Terry Dolan:

Yes.

Terry Dolan:

Yes, it's going to continue to normalize for all the different things we have been talking about and that I think the industry has been talking about. Our expectation is that that 35 creeps up into the kind of mid-40s by maybe the end of the year, early next year. And then it kind of normalizes around 50 basis points once we get into 2024.

Terry Dolan:

In terms of cost synergies or…?

Terry Dolan:

Yes, absolutely. Gets us to the run rate, John of the full 900 by the end of the quarter. So, when we get into 2024, we will have achieved a full run rate of $900 million of cost synergies,

Terry Dolan:

By the end of the fourth quarter. Yep.

Terry Dolan:

Yes.

Operator:

And we can go to Chris Kotowski with Oppenheimer. Please go ahead.

Terry Dolan:

Yes. The duration that we had talked about with respect to the AFS portfolio was 3.8 years and has continued to come down a little bit, not measurably, but down a little bit from there. Our game plan, I guess, is that we're going to continue to work on shortening the duration of the AFS portfolio. Again, it kind of helps us de-risk that, meaning we'll keep more in short term sort of securities, whether it's that or cash, but it'll be kind of a combination.

Terry Dolan:

Yes. Well, with respect to the HTM portfolio, that's just kind of going to run down over time or burn down over time. We're not adding to the HTM portfolio at this particular point.

Operator:

And we'll move to Vivek Juneja with JPMorgan. Please go ahead.

Terry Dolan:

Yes, some of it is year-over-year comp and how it'll kind of play out. But the biggest driver, Vivek, in the merchant processing at this particular point is the fact that the travel, airline specifically, is continuing to become a higher portion of the overall mix that we think is starting to stabilize. In other words, most of the - much of that growth has been in the airline space, but we think that that kind of stabilizes. Airline happens to have a lower margin. And so, that's the dynamic that you're seeing.

Terry Dolan:

Yes. Go ahead, John.

Vivek Juneja:

Thank you.

Gerard Cassidy:

Good morning, gentlemen. Terry, you talked a bit about a normalization in net charge-offs moving into 2024. Can you share with us what kind of assumptions you're using to get to that normalization rate in charge-offs, both economic and just the way the customer base may behave?

Andy Cecere:

From an economic standpoint - Gerard, I'll start. This is Andy. We think there's probably a fairly equal weight probability that we'll either see a soft landing or a mild recession. And if we do get a recession, our models would indicate it would be short and shallow either late this year or early in 2024. You know there's still pricing pressure and the inflation's not solved. So, we have one more rate hike by the end of the year modeled in. And then - but on the other hand, as Terry mentioned, excess savings has come down significantly, and consumer spending is slowing. So, the Fed is getting its desired outcomes. So, big picture, we think the Fed's close to being done. And as I said, sort of this probability of either shallow and soft or mild recession and or a soft landing is what we've modeled in to get to those assumptions Terry has articulated

Gerard Cassidy:

Very good. And then I apologize if you addressed this question, but with the expectation of the Basel III end gain capital requirements coming shortly in this week, the disclosures, that it seems like residential mortgages may be exposed to higher risk-weighted assets. How are you guys thinking about that in terms of risk of RWA strategies, if mortgages do get a bigger weight and other areas are greater than expected?

Gerard Cassidy:

Thank you, Terry. Thank you, Andy.

Betsy Graseck:

Hi, good morning. Just a couple of quick follow-ups. One, the asset sales that you did this quarter, was that at the beginning of the quarter or the end? I'm just trying to understand how much like revenue from that portfolio you have in 2Q.

Betsy Graseck:

Okay. And then the revenue outlook for the full year, is that based on June 30 balance sheet or is that also including the RWA actions you're planning on taking between now and year end?

Betsy Graseck:

Okay. Got it. All right. Okay. Thank you. That's it.

Mike Mayo:

Hi. Well, on the capital issue I asked last quarter, do you think there's any chance that you need to raise capital or cut the dividend? And I’ll just to ask again, or what - I mean, people were doing these mechanistic analyses where they would take the underlying securities losses, reduce that from tangible equity, give you no credit, and then say you would need to raise capital. So, now that you've met your year-end capital target, I guess would you reiterate, or to what degree would you reiterate no capital increase, no dividend cut. And in addition, if you could put in a broader context, the vice chair of the Fed, Barr, last week said that actually the economic value of equity at banks goes up because of higher value of deposits. So, it seems like he signs on to a lot of the analysis that we analyst do. So, just if you could comment on the bigger picture about your capital and the flexibility there.

Mike Mayo:

And then on the negative side, you and a lot of regional banks have continued to lower guidance on NII, and here we go again with that. And look, I mean, rates went up faster than you or anyone had expected. The yield curve is a lot more inverted. I guess competition has picked up more than expected. What inning do you think you're in terms of this downward revision for NII? Do you think you're kind of there now? You said third quarter could be down a little bit. And as you exit the year, do you think you maintain that third quarter level or what - I think you said NIM would be flat after that, but I'm not sure if you mentioned NII. So, is the downward revision for NII done, or eighth inning, seventh inning, and what does that mean for kind of run rate going to next year?

Andy Cecere:

Mike, the other thing I'd add is, I think one of the benefits of our business model is the diversity of revenue. So, even in a stressed environment on deposits, which you're absolutely right about, we have the payments revenue, the trust revenue, the commercial products revenue, and on top of all that, $900 million of cost synergies that we're going to act on. So, we're pulling lots of levers, not just on margin.

Operator:

And next, we have a follow up from John McDonald with Autonomous Research. Please go ahead.

Terry Dolan:

Yes. Again, the 50 that we were targeting, we knew we had a high level of confidence in terms of being able to achieve it because there were low to kind of neutral impact and they were things that we could kind of execute on the - we definitely believe that as we get into 2024, the standing up, which obviously takes a little longer, standing up of securitization programs and many of the actions that I talked about earlier, gets us to where we need to be from a capital perspective when you take into consideration the burndown, et cetera. So, that opportunity I think is certainly - probably in line with another 50 basis points, would be my guess.

Terry Dolan:

Yes, absolutely. We'll continue to see that as we reposition the balance sheet. But again, those impacts are all taken into consideration when we think about the net RWA impacts.

Terry Dolan:

Yes. Well, it'll be - fully adopted, it'd be roughly 8.5%, 9%.

Operator:

And we have no further questions at this time, and I'll turn it back to George Anderson. Please continue.

Operator:

And this concludes today’s conference. Thank you for participating. You may now disconnect.

George Anderson:

Thank you, Brad. Good morning everyone. With me today are Andy Cecere, our Chairman, President, and Chief Executive Officer; and Terry Dolan, our Vice Chair and Chief Financial Officer. During the prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation a s 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 risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, our Form 10-K and its subsequent reports on file with the SEC. Following their prepared remarks, Andy and Terry will take any questions that you have. I will now turn the call over to Andy.

Terry Dolan:

Thanks Andy. Turning to slide eight, a key strength of the bank is our well- -diversified deposit base, which remains a stable source of low-cost funding. As a reminder, following the completion of our acquisition of Union Bank last quarter, our end-of-period deposits totaled $525 billion, including approximately $80 billion of deposits from Union Bank. As we discussed last quarter, $9 billion of Union Bank acquired deposits were transitory in nature, with $4 billion returned to MUFG in the fourth quarter and additional $4.7 billion that moved back to MUFG in the first quarter of this year. In addition, $1.1 billion of acquired deposits were included in the branch sale or related to PurePoint, a broker deposit gathering mechanism that we discontinued. Importantly, prior to the events of March 8, we saw expected deposit outflow largely consistent with seasonal patterns, reflective of our business mix, including our large trust business. From March 8 through the end of the quarter, deposit balances were relatively stable, down only 0.6% as inflows from new customers were slightly offset by the impact of clients diversifying their deposits and seeking yield and money market funds consistent with broader industry trends. During this period, we saw an increase in money market funds of approximately $10 billion within our wealth management and investment services businesses. We expect the competition for deposits to remain high for the industry in 2023. Our cumulative deposit beta through the first quarter was approximately 34% and we expect that to increase to about 40% by the end of this rate cycle, generally in line with our previous expectations. Slide nine provides additional detail on the composition of our highly diversified deposit base. As the slide shows, our deposit balances are composed of a broad mix of consumer, corporate and commercial customers that we support with an expansive branch distribution network and mobile capabilities across our national footprint. Our deposit base reflects the wide range of customers and industries that our companies serve. At March 31, our percent of insured deposits to total deposits was 51%. Approximately 80% of our uninsured deposits are composed of operational wholesale trust and retail deposits that are stickier, either because they are contractually bound or tied to treasury management services and trust activities provided to corporate and institutional clients. Combined with our consumer-based deposits, the stability of our funding source is sound. Moving to slide 10. U.S. Bank's total available liquidity as of March 31 was $315 billion, representing 126% of our uninsured deposits. As of March -- as of December 31, our liquidity coverage ratio was 122%. As mentioned, our strong debt ratings reflect our diversified business profile, well-collateralized credit exposure, healthy capital and liquidity profiles and disciplined asset liability management framework. These attributes work in concert with our strong balance sheet optimization and management practices to ensure strength and stability of our balance sheet. Slide 11 provides details on the composition of our investment securities portfolio. Over the last five quarters and well ahead of the most recent banking disruption, we reduced the size of our investment securities portfolio from 30% to 25% of total assets while increasing cash levels. In preparation for and as part of the completion of our acquisition of Union Bank, we repositioned our balance sheet by selling fixed rate loans and investment securities, paid off borrowings and increased cash balances in response to economic uncertainty, industry dynamics, rising interest rates and increased market volatility. At March 31, approximately 90% of the securities in our investment portfolio are backed and are sponsored by the US federal government with 55% of securities designated as held to maturity and 45% designated as available for sale. Further, available for sale unrealized losses as a percentage of our investment securities portfolio improved in the first quarter and total AOCI improved by 11% on a linked-quarter basis. Turning to slide 12. As a reminder, following the completion of our acquisition of Union Bank, our CET1 capital ratio declined from 9.7% at the end of the third quarter of 2022 to 8.4% as of December 31st, which reflected the impact of balance sheet optimization and purchase accounting adjustments that will accrete back into capital over the next few years. Strategically, we continue to be encouraged about the financial merits of this deal and the synergistic benefits we expect to realize as a combined institution. As Andy mentioned earlier, our CET1 capital ratio at March 31st was 8.5%, a 10 basis point increase from year-end reflected 20 basis points of capital accretion, offset by the transitional impact of CECL of 10 basis points. As of March 31st, we expect to accrete approximately 20 to 25 basis points of capital per quarter as we complete the Union Bank integration and realize cost synergies. Importantly, this does not include the impacts of planned RWA optimization initiatives mentioned earlier. Turning to slide 13. Total end-of-period loans were $388 billion, which was flat on a linked-quarter basis and up 21.6% year-over-year. Commercial real estate loans represent approximately 14% of our total loan portfolio with CRE office exposure representing approximately 2% of total loans and only 1% of total commitments. Leverage lending balances are not a significant component of the loan portfolio. Slide 14 shows credit quality trends, which continue to be strong, but as expected, are started -- are starting to normalize across the portfolio. The ratio of nonperforming assets to loans and other real estate was 0.3% at March 31st compared with 0.26% at December 31st and 0.25% a year ago. Our first quarter net charge-offs of 0.30% as adjusted, increased seven basis points versus the fourth quarter level of 0.23% as adjusted and was higher when compared to the first quarter of 2022, which was a level of 0.21%. Our allowance for credit losses as of March 31st totaled $7.5 billion or 1.94% of period-end loans. As the chart on the upper right side of this slide demonstrates, our credit performance through the cycle serves as a key differentiator for the bank. Slide 15 provides a detailed earnings summary for the quarter. In the first quarter, we earned $1.16 per diluted share, excluding $0.12 of notable items related to the recent acquisition of Union Bank. Slide 16 highlights revenue trends for the quarter. Net revenue totaled $7.2 billion in the first quarter, which included a full quarter of revenue contribution from Union Bank of $832 million, primarily representing net interest income. Net interest income grew 7.9% on a linked quarter basis and 45.9% year-over-year, driven by earning asset growth and continued net interest margin expansion, which benefited from rising interest rates. Non-interest income as adjusted increased 2.7% compared to the fourth quarter, driven by higher commercial product revenue, mortgage banking revenue and trust and investment management fees, partially offset by losses of $32 million from securities sales. Turning to Slide 17. Adjusted non-interest expense for the company totaled $4.3 billion in the first quarter, including $546 million from Union Bank. Non-interest expense as adjusted increased 9.1% on a linked-quarter basis largely driven by the impact of two additional months of Union Bank's operating expenses, core deposit intangible amortization and higher compensation and other non-interest expenses. I will now provide second quarter and updated full year 2023 forward-looking guidance on Slide 18. Starting with the second quarter of 2013 guidance, we expect average earning assets of between $600 billion and $605 billion in the second quarter and a net interest margin of approximately 3%. Total revenue, as adjusted, is estimated to be in the range of $7.1 billion to $7.3 billion, including approximately $85 million of purchase accounting accretion. Total non-interest expense as adjusted is expected to be in the range of $4.3 billion to $4.4 billion, inclusive of approximately $120 million of core deposit intangible amortization related to Union Bank. Our tax rate is expected to be approximately 23% on a taxable equivalent basis. To date, we have incurred $573 million in merger and integration costs and anticipated charges of between -- and anticipate charges of between $250 million and $300 million for the second quarter. We continue to estimate total merger and integration costs of approximately $1.4 billion, consistent with earlier guidance. I will now provide updated guidance for the full year. For 2023, average earning assets are now expected to be in the range of $600 billion to $610 billion. We expect the net interest margin to be between 3.0% to 3.05% for the full year. Total revenue as adjusted is now expected to be in the range of $28.5 million to $30.5 billion, inclusive of approximately $350 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be in the range of $17.0 billion to $17.5 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis is now expected to be approximately 23.0%. We continue to expect to have $900 million to $1 billion of merger and integration charges in 2023. I will now hand it back to Andy for closing remarks.

Operator:

Thank you. We will now begin the question-and-answer session. [Operator Instructions] We'll go to Scott Siefers, Piper Sandler. Please go ahead.

Andy Cecere:

Hi Scott.

Terry Dolan:

Yes. Our expectation is that if you end up just looking at the industry, there's going to be pressure on deposits and high competition. We think will fare quite well with respect to that. To the extent that we see changes in deposits, it will be kind of based upon that competition. So, -- but I would say relatively stable. And then coming to your second question, the mix of NIBs as an example in roughly the fourth quarter was about 25%, 26% in that ballpark. It's 25%. We think it's kind of hitting that kind of stable level, keeping in mind that we have a lot of operational deposits tied to our -- both our Corporate and our Corporate Trust businesses, and that kind of helps to sustain it. So, it's a combination of things, Scott.

Terry Dolan:

Yes. Our trajectory with respect to Category 2 is no earlier than the end of 2024. And that will be -- I think that will be more driven by whether the Fed makes that decision or not rather than asset size. Again, as we kind of manage the company, we're going to be -- continue to be very focused on profitable loan growth and things like that. So we get there when we get there. But that -- in our expectation right now is no sooner than the end of 2024.

Terry Dolan:

Yes. It will be a combination of a couple of things we talked about, the -- just the capital generation from earnings and of course, that is helped by the Union Bank transaction. And then, we're very focused on capital management. We have to be just -- because of the Category II. And we'll be very focused on risk-weighted asset optimization and making sure that we're focused on profitable growth.

Operator:

Next, we'll go to Erika Najarian with UBS. Please go ahead.

Terry Dolan:

Good morning, Erika.

Andy Cecere:

So, Erika, good question. And so, I'm just going to go from the beginning. I think that would be helpful. So, as you know, we were well above 9% and came down to 8.4% as a result of the Union Bank transaction. The Union Bank transaction is a terrific transaction. We're exceeding our revenue expectations. We are coming under on our expense expectations. The accretion is greater than we expected. So the value of the franchise is positive for sure. As we think about the Category II, I have three or four factors, I think about. Number one is the earnings accretion that we talked about, which is strong and growing, and will become even more accretive as we get through the cost takeout component of the Union Bank integration. Number two is, we have a number of initiatives across the board for risk-weighted asset optimization. Those are things like credit transfers, risk transfers, a number of things to optimize the balance sheet that I think we ought to be focused on and are very focused on to your question. And I think, with those two things, as I mentioned, we expect to exceed 9% by the end of this year. That, coupled with our AOC burn down and additional accretion as we go into 2024, makes me comfortable that we are prepared with whatever event occurs as it relates to Category II in the timing, as Terry mentioned, no later -- no earlier than the end of 2024.

Erika Najarian:

And is 9.5%, 10% an appropriate new bogey as we think about the shift change for next year on Cat II?

Erika Najarian:

Go ahead.

Erika Najarian:

And just if I could sneak in one last one in. One of your peers closest to you in size at the TLAC was pretty much done investing. I noticed that you mentioned your superior debt rating several times. Clearly, the debt markets are still a little bit dislocated. But how should we think about the wholesale funding stack from here. I noticed on a period-end basis, short-term borrowings went up by $25 billion. Terry, as you potentially anticipate TLAC, how should we think about your senior debt issuance plans or really hold that level of borrowings until there's a little bit more less dislocation in the senior debt market?

Erika Najarian:

Thank you.

Operator:

And next, we can go to Mike Mayo with Wells Fargo Securities. Please go ahead.

Mike Mayo:

Hi. Well, your PE, I believe consensus is close to seven and the market is around 20. So your relative PE is one of the lowest in history. So I would pause it, that the market is concerned about something other than earnings. So going back, I guess the simple question for you, Andy, is will U.S. Bancorp need to issue capital? And how confident are you about that? And on the other side, are buybacks potentially an option once you get to 9% CET1? And the reason I bring that up is you've seen the front page articles and papers, if you're forced to recognize the unrealized securities losses and you do a burn down and then people come up with all sorts of numbers. And would you be forced to realize that? You heard Congress talk about these issues. Could you be forced to incorporate that as part of the current stress test? Could the Fed force your hand sooner? Any color you can give. What's your confidence that you might need to issue capital over the next year or so?

Terry Dolan:

Yes. And Mike, the thing that I would add to that, we're going to learn with respect to exactly how -- moving to category two and the inclusion in unrealized losses gets incorporated into the CCAR process. But just as a reminder, we have a pretty significant amount of buffer that already exists just based upon our credit performance and our PPNR performance because of the earnings capacity. We continue to reduce the volatility of AOCI to rising interest rates. We're doing that through pay-fixed hedges and just shortening the duration and things that I talked about earlier. I think there's very likely that they will incorporate a higher rate environment into the CCAR process. I will tell you that we've done lots of scenarios that look at a stagflation sort of environment and we actually perform better in that environment because the revenue streams tend to hold up given our mix of business, et cetera. So we're taking a lot of that into consideration. And like Andy said, we feel pretty confident that we don't have to go through a capital raise.

Terry Dolan:

No. That is not required in the CCAR analysis as a condition of the way the deal was structured.

Terry Dolan:

Yes. It's a couple of different things. One is, again, if you end up just looking at the mix of total deposits, we again think that total deposits will be relatively stable and that the mix of NIB will be relatively stable around that 25% up or down. Part of the decline in this particular quarter ties back to some of the seasonal flows, which are part of our trust business, but also the deposits that we knew were going to go out the door to MUFG because of closing down the PurePoint, et cetera. All of those things kind of tie in to the reason why we saw the decline this quarter.

Operator:

Next, we go to John McDonald with Autonomous Research. Please go ahead.

John McDonald:

Yes, hi. Good morning, guys. Wanted to ask on the idea of getting above 9% by the end of the year on CET1. Does that rely on the RWA mitigation opportunities, or is that just kind of the 20 to 25 basis points that Terry mentioned before the RWA benefit? Is that something that will help you next year? Can you talk a little bit about that?

John McDonald:

The benefits of that should happen and help you towards the end of this year, maybe into next year as you work towards end of 2024 capital target?

John McDonald:

Yes. And just to clarify, Terry, this hasn't happened prior to the end of 2024, even with the Fed, right? The Fed would tell you on January 2024 that it would take effect by the end of 2024, right? So, it's not like they're going to tell you any color there, correct?

John McDonald:

Okay. And then any idea of the pace of AOCI burn down? Obviously, the AOCI came down 11% this quarter with the help of rates. But in a world where rates are not coming down, what's the natural kind of burn-off pace that you might expect for that over a year or two? Any help on that? And just kind of reminding us of the duration again.

John McDonald:

Okay. Thanks.

Operator:

Next we go to John Pancari with Evercore. Please go ahead.

Andy Cecere:

Good morning John.

John Pancari:

On the -- back to the RWA optimization, can you maybe give us a little more color on what you're looking at there? I know you mentioned credit transfers and risk transfers. But maybe if you can kind of flesh that out a little bit and maybe just an idea of the magnitude of the benefit that you see potentially materializing as a result of the RWA actions? And then lastly, is other business or portfolio sales or divestitures considered within that? Thanks.

Andy Cecere:

Their business sales.

John Pancari:

And do you have a way to help us estimate the magnitude in terms of how you're thinking about that targeted contribution from the RWA optimization strategies?

John Pancari:

Got it. And then, just one more for me. And I know you mentioned in terms of other regulatory potentially coming down the pipe. You're already in the advanced phase of proposed rulemaking on the TLAC. And can you just talk about the other potential regulatory changes you see coming down the down the pipe? I know you had mentioned the AOCI efforts, but can you talk about potentially around FDIC or stress capital buffer, liquidity rules, anything on that front worth commenting on?

John Pancari:

Got it. Okay. Thanks, Terry.

Terry Dolan:

Hey, Gerard. Good morning.

Gerard Cassidy:

Good morning, Terry. Good morning, Andy. I have a narrower question. I think it was on slide eight. You guys talked about the impacts of deposits following March 8. The inflows that you referenced, did that come primarily in the Union Bank franchise? Because, obviously, it was located in California. I know you guys have been in California as well. And then second, was it more commercial versus consumer or more interest-bearing versus non-interest-bearing?

Gerard Cassidy:

Thank you. And then over the years, you guys have always done quite well and underwriting your loan portfolio, you show up well in the CCAR tests over the years on credit. And so you don't have a very big exposure to commercial real estate. And I always find it interesting to talk to banks that don't have big exposures to a potential credit area that could be problem. What are you guys seeing in that commercial real estate area, particularly in the office portfolio? Any color would be helpful.

Gerard Cassidy:

Thank you.

Terry Dolan:

Good morning, Ebrahim.

Terry Dolan:

Yeah. So again, we've been taking a number of different actions in order to dampen the effect. As I said, selling securities were appropriate, shortening the duration, which we did very nicely, I guess, in the first quarter. And then putting in place pay fixed swaps against the long end of the curve. So dampening the effect of a move -- I meant up of rates in both -- for example, in the five and 10-year sort of space. We -- if rates moved up 50 basis points, obviously, AOCI would be impacted to some extent, but we've dampened that quite a bit over the course of the last couple of quarters.

Terry Dolan:

Yeah. We've done a lot of different analysis. And I mean, you are right. The competition for deposits is getting stronger. We've taken that into consideration. We're seeing over 5% in some markets. Generally, it is smaller banks where that is occurring, community markets, those sorts of things. And that's because for those entities, that's their primary source of funding. And so that's going to occur. But all of that has been kind of taken into consideration in terms of looking at that 40% deposit beta. If you end up looking at our business, again, in terms of who we end up competing against, et cetera. But while we end up looking at and tracking is, especially on the institutional corporate side of the equation is money market rates and those sorts of things. Right now, that's kind of in the high fours. And our deposit pricing is very competitive with that, which is why it gives us confidence with respect to both flows and the deposit betas that we've articulated.

Terry Dolan:

Yes. It's going to depend. I mean, obviously, it depends upon the rate environment. I mean, if the Fed, for example, goes up another 50 or 100 basis points from here, that would put more pressure on deposit betas. But if you end up looking at the market implied or even up a bit, I still feel pretty comfortable with where we're at.

Operator:

And next, we can go to Matt O'Connor with [indiscernible] Bank. Please go ahead.

Matt O'Connor:

It's Deutsche Bank. You've got very strong reserves to loans on a stated basis. I guess, first, can you remind us what the impact is if you adjust it for the Union Bank loans that were marked at fair value when you took them on? -- if you have that handy?

Andy Cecere:

I think, Mike, you're trying to understand -- or Matt, you're trying to understand the -- if Union Bank has an impact on our reserve to loans ratio and what it is. I don't think it has a major impact.

Matt O'Connor:

Okay. And then just broadly speaking like as you think about the rest of the year, I mean, you're obviously taking your best guess on reserves at the current period at your thoughts on.

Matt O'Connor:

Sorry, can you hear me better now?

Matt O'Connor:

Okay. Sorry about that. I was just asking about the outlook for the loan loss reserves from here in your base case.

Matt O'Connor:

Okay. Great. And then maybe if I could just squeeze in on spending trends throughout 1Q, you guys, through your payments business, obviously see a lot. Just any observations on kind of trends throughout the quarter? And maybe any comments so far in April? Thank you.

Andy Cecere:

Yes. And that is still growing to math, but it's just growing at a lower rate, particularly in retail. Airline spend continues to be very, very high, which is a little bit of the reason that we have a differential between sales growth and in revenue growth because the airline spread is a little thinner. So, travel continues to be strong. Retail came down a bit, but still growing.

Andy Cecere:

Sure.

Andy Cecere:

Yes, good morning Chris.

Terry Dolan:

Yes. Yes. I mean, obviously, we look at both sides of the equation. The burn down on the HTM side simply because of the nature of it is really more tied to how quickly you see payoffs and what the duration of that ends up looking at. I think as we look at the size of the investment portfolio, et cetera, will take into consideration what level of duration we want to have in that -- in the HTM portfolio, but that's going to be more a function of just pay downs and payoffs over time.

Terry Dolan:

Yes. Yes. Absolutely. Yes.

Terry Dolan:

Thanks Chris.

Ken Usdin:

Hey guys. Good morning. First question, I just want to ask you on credit. On an adjusted basis, your charge-offs were 30 basis points this quarter. And per the comments you made earlier, about CRE and some of the data we see in the release about delinquencies and NPAs increasing. What's your outlook for charge-offs as we go forward versus the 30 basis points that we saw in the first?

Ken Usdin:

Yeah. Understood on that. Okay. And then just coming back to the full year guide. Obviously, you made a modest adjustment which is well expected given the change in the rate outlook. We can back into that, I think it's mostly on the NII side, just given that that's where seemingly some of the changes were versus the prior outlook. But can you just kind of refresh us and just give us kind of just some underlying thoughts of NII growth versus fee growth and any changes you had on, if any, on the fee side versus your prior outlook? Thank you.

Ken Usdin:

Okay. And then so just last follow-up. So then embedded in your fee outlook for the year is pretty decent growth, it would seem then. And are you expecting that to still be mostly driven by the payments business, or are there other areas that you're expecting to see some good growth in?

Ken Usdin:

Got it. Understood. Thanks, guys.

Operator:

Next we go to Vivek Juneja with JPMorgan.

Vivek Juneja:

Hi, Andy. Hi, Terry. A couple of just clarifications, I think you all mentioned that accretion from the deal, Andy, is going better than you had expected any. I know you've talked a lot, just trying to pull this all together, where are you seeing it better thus far?

Terry Dolan:

Net higher accretion in the net purchase accounting is actually negative given the car deposit intangibles. So it's very strong.

Terry Dolan:

Yeah.

Terry Dolan:

That's correct.

Operator:

Next, we can go to Erika Najarian with UBS.

Andy Cecere:

Dividend growth continues to be a priority, Erika. So our expectation is we would have continued growth in the dividend. The dividend growth numbers not hugely material to the capital accretion math. If you go through the numbers on that, that is a relatively small component of a negative downturn in capital. So that expectation that I talked about includes the expectation of a strong dividend.

Operator:

And next over to Mike Mayo with Wells Fargo Securities.

Mike Mayo :

Hi. Hey, last quarter, you mentioned your reserves were for an environment with 6% unemployment. I was wondering if you had an update for that. And given CECL accounting, does that mean you're reserving done before the recession has even started, or how do you think about that? And what about the release of reserves the extent you stay down this low charge-off range even with some of the normalization?

Mike Mayo :

Okay. And your outlook for the economy, soft recession, hard landing, kind of what you're thinking?

Mike Mayo :

Okay. Thank you.

Operator:

And we have no further questions at this time. I will now turn it back to George Anderson. Please continue.

Operator:

And this concludes today's conference. Thanks for participating. You may now disconnect.

George Andersen:

Thank you, Brad and good morning everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; and Terry Dolan, our Vice Chair and Chief Financial Officer. During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the 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 risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following their prepared remarks, Andy and Terry will take any questions that you have. I will now turn the call over to Andy.

Terry Dolan:

Thanks, Andy. If you turn to slide 7, as Andy mentioned, we reported diluted earnings per share of $0.57 for the quarter or $1.20 per share after adjusting for notable items related to the acquisition. Notable items related to Union Bank acquisition are comprised of three primary elements that reduced earnings per share by $0.63 related to balance sheet optimization, merger and integration costs, and the impacts of -- on provision expense related to acquired loans and actions taken to optimize the balance sheet. During the fourth quarter, the company recognized a one-time $399 million pre-tax loss on a net basis related to several actions taken to optimize the balance sheet, manage the interest rate volatility impact on capital levels and position the company for future growth. Subsequent to obtaining regulatory approval for the transaction, we entered into interest rate hedges to manage rate volatility and its related impact on regulatory capital from the date of approval through the closing of the transaction in December. During that time frame, long-term interest rates increased nearly 50 basis points before declining approximately 65 basis points. The interest rate swaps were terminated at the time of closing, and the losses recognized through earnings largely offset the interest rate marks recorded into the balance sheet through purchase accounting. In addition, the company optimized its balance sheet by selling certain loans and repositioning its investment portfolio on certain equity investments. Within non-interest expenses, we incurred merger and integration related charges of $90 million that primarily included the impact of specific deal closing costs, professional services and employee related expenses. We also incurred a $791 million charge to the provision for credit losses, which reflects an initial provision impacted by the acquisition of $662 million and a net loss of $129 million related to the securitization of approximately $4 billion of legacy indirect auto loans. Again, these moves enabled us to more effectively position the balance sheet for profitable growth and optimize returns. Slide 8 provides a more detailed earnings summary. Union Bank, which was included in our consolidated results for one month, contributed $302 million of revenue, $221 million of non-interest expenses, $81 million of operating income and $44 million of net income to the company, representing $0.03 per diluted share. On slide 9, end of period loans increased 13.3% on a linked-quarter basis to $388 billion, which included core loan growth and acquired loans from Union Bank. Union Bank contributed ending loan balances of $54 billion net of purchase accounting adjustments, partly offset by a reduction in balances of $15 billion related to balance sheet optimization actions, including loan sales and securitizations. Slide 10 provides end-of-period deposit balance composition. End-of-period deposits increased 11.4% on a linked-quarter basis to $525 billion driven by the acquisition, which contributed $86 billion of lower-cost deposits, and actions taken as a result of the deal to optimize our funding sources. On a core basis, we saw deposit balances decline slightly this quarter. Turning to slide 11. The investment securities portfolio grew 4.2% linked quarter to $170 billion. The addition of securities from Union Bank were offset by balance sheet optimization actions. Slide 12 highlights revenue trends. Adjusted net revenue totaled $6.8 billion in the fourth quarter, which included revenue contribution of $302 million from Union Bank, primarily representing net interest income. For legacy US Bancorp, net interest income grew 5.5% on a linked-quarter basis and 29.2% year-over-year driven by strong earning asset growth and net interest margin expansion, which benefited from rising interest rates. Results were partially offset by higher deposit pricing and short-term borrowing costs. Non-interest income, as adjusted for the legacy company, declined 3.0% compared to the third quarter driven by seasonally lower payment service revenue and lower commercial product revenue, offset by stronger mortgage banking revenue. Year-over-year, legacy adjusted non-interest income declined 5.5% driven by lower mortgage banking revenue from reduced refinancing activity and lower servicing charges, offset by stronger payment services revenue and trust and investment management fees. Turning to slide 13. Adjusted non-interest expense totaled $4.0 billion in the fourth quarter, including $221 million from Union Bank. Included in expenses was approximately $42 million of intangible amortization due to core deposit intangibles established at the time of the acquisition. Legacy non-interest expense, as adjusted, increased 3.8% on a linked-quarter basis largely driven by higher compensation-related expenses as well as higher expenses related to professional services, marketing, technology and tax credit amortization. Slide 14 shows credit quality trends. We reported total net charge-offs for the quarter of $578 million. After adjusting for acquisition impacts and the balance sheet optimization activities, net charge-offs totaled $210 million or 0.23% of average loans, up from 0.19% in the third quarter, which reflected the continuing normalization of credit losses. Non-performing assets for the legacy bank increased slightly, while Union Bank contributed $329 million to the total. On a combined basis, the reported ratio of non-performing assets to loans and other real estate was 0.26% at December 31, compared with 0.20% at September 30, and 0.28% a year ago, reflecting a continued strong credit quality. The provision for credit losses was $1.19 billion, which included a provision of $791 million related to the acquisition and balance sheet optimization activities. This provision includes an initial provision impacted by the acquisition of $662 million and $129 million related to our balance sheet optimization activities. The allowance for credit losses as of December 31st totaled $7.4 billion or 1.91% of period-end loans, which reflects increased economic uncertainty and the incorporation of the Union Bank portfolio. Slide 15 highlights the drivers of our linked-quarter common equity Tier 1 capital position. As of December 31st, our CET1 capital ratio was 8.4%. Acquisition impacts of 180 basis points included an increase in goodwill and other intangible assets that reflected the impact of credit and interest rate marks, the initial provision for credit losses, balance sheet optimization actions, as well as the increase in risk-weighted assets with the addition of Union Bank. These impacts were partially offset by an increase to equity related to shares issued to MUFG as part of the purchase price of Union Bank. Slide 16 provides our current expectations of certain financial metrics related to the transaction. The financial and strategic merits of the deal remain intact and are very attractive. Earnings per share accretion is now expected to be 8% to 9% in 2023, which is higher than originally estimated. While our tangible book value per share dilution is higher than initially estimated due to the significant impact of rising interest rates on the interest rate marks at close, our estimated earn-back period is only slightly longer than our original estimate at two years versus our original estimate of 1.5 years. Slide 17 provides a comparison of credit and net fair value marks from the time of our announcement to closing. Credit marks are lower due to favorable changes in portfolio composition and credit quality, partially offset by economic deterioration. Interest rate marks, inclusive of loans, securities net of sales, and debt, are higher than anticipated at announcement due to higher interest rates, but we expect that to accrete quickly back through earnings. The core deposit intangible is also higher than originally estimated, reflecting the increased value of lower-cost core deposits in a higher rate environment. I will now provide first quarter and full year 2023 forward-looking guidance, which is provided on slide 18, starting with the first quarter 2023 guidance. We expect average earning assets of between $605 million and $610 billion in the first quarter and the net interest margin that is five to 10 basis points higher than the fourth quarter level. Total revenue is estimated to be in a range of $7.1 billion to $7.3 billion, including approximately $100 million of purchase accounting accretion during the quarter. Total non-interest expense as adjusted is expected to be in the range of $4.3 billion to $4.4 billion, inclusive of approximately $125 million of core deposit intangible amortization related to Union Bank. Our income tax rate as adjusted is expected to be approximately 22% to 23% on a taxable-equivalent basis. We anticipate merger and integration charges of between $200 million and $250 million for the quarter. I will now provide guidance for the full year. For 2023, average earning assets are expected to be in the range of $610 billion to $620 billion with net interest margin expansion of between five to 10 basis points compared with the fourth quarter of 2022. Total revenue is expected to be in the range of $29 billion to $31 billion, inclusive of between $350 million to $400 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be in the range of $17 billion to $17.5 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis as adjusted will be approximately 22% to 23%. We expect to have $900 million to $1 billion of merger and integration charges in 2023. I will now hand it back to Andy for closing remarks.

Operator:

We will now begin the question-and-answer session. [Operator Instructions] And we can first go to Scott Siefers with Piper Sandler. Please go ahead.

Terry Dolan:

Hi, Scott.

Andy Cecere:

Scott, I'll start. This is Andy and Terry will add in. So first of all, we're not limiting growth in the company. We – one of the reasons we positioned the balance sheet and took the optimization actions we talked about, Terry went through, was to allow for profitable growth. It also was related to the credit box that we manage within as well as the returns that some of those categories of assets that we securitized were returning. So those are all allowing us to grow in a profitable way in the future. As we talked about before, we not expect to cross the threshold of a Cat II until the earliest at the end of 2024, and that's into the new category at that time. And if we have any further balance sheet optimization actions in securitizations, they would be very nominal and not material in nature. Terry, what would you add?

Scott Siefers:

Wonderful. And then just sort of thoughts on repurchase as well? I know, we're on pause for now, but it's still sort of a crush mark, so would be curious to your thoughts?

Scott Siefers:

Wonderful. All right. Appreciate all the thought. Thank you.

Operator:

Next, we can go to Erika Najarian with UBS. Please go ahead.

Terry Dolan:

Good morning.

Terry Dolan:

Yeah, Erika, great question. And just to confirm, our expectation is that of the $900 million of cost synergies, we'll see about 35% of that next year in 2023. And so from a cadence standpoint, with the Memorial Day conversion, the vast majority of those cost synergies will start to really kick in subsequent to that system conversion. So smaller during the first half of the year much more significant of that 35% in the second half of the year.

Terry Dolan:

Yes. By the time we get to the end of the fourth quarter, we will have incorporated the vast majority of the cost synergies such that by the time we get to 2024, we will be in a good position to have achieved 100%.

Terry Dolan:

Yes, I would say that our expectations are probably consistent with that sort of a thought process. When we are thinking about the reserve, our base case is that there is a mild recession probably in the second half of the year and that unemployment ticks up and GDP is either relatively flat or down a bit. When we go through the reserving process, as we've said in the past, we end up looking at five different potential scenarios all the way from a base case to a severe sort of recession. And I would say that from a reserving perspective, we're a little bit weighted towards that downside scenario, so a little bit more conservative. From a charge-off perspective, our expectation kind of using the baseline of about 23 basis points in the fourth quarter that, that will continue to normalize throughout the year. We'll see both the delinquencies and charge-offs moving up. But to kind of give you some perspective, our pre-pandemic was at 50 basis points. We probably don't see that until sometime into 2024.

Terry Dolan:

Thanks Erika.

Terry Dolan:

Good morning Mike.

Andy Cecere:

I'll start on a couple of things and then Terry will add in. So, let me sort of go backwards on your questions. The margin is increasing principally because of the value of the low-cost deposits that Union Bank brings on. We talked about that a lot, Mike, and $85 billion of principally consumer low-cost, stable deposits in this environment is very valuable in driving up that margin on a quarterly basis. And that's reflected in that five to 10 basis points. We did achieve 230 basis points of positive operating leverage in 2020 -- hearing a little bit of background.

Andy Cecere:

We did achieve 230 basis points of positive operating leverage in 2022. We would expect to achieve continued positive operating leverage into 2023. But 2023 is going to have the merger-related charges in it as well. So I'm looking at it on a core basis. And Terry, what would you add?

Mike Mayo:

And as a follow-up, look, U.S. Bancorp had been a low cost producer for a long time. It looks like you're going to trend back in that direction. So it sounds like you still have no change in expected synergies. I get it, Union Bank is performing better, and that's why the accretion you had brought higher, the 8% to 9%. But still no change in expected synergies from the acquisition? And then separate from that, Andy, you mentioned in December that the big tech investment cycle is now turning positive versus being a drag the last five-or-so years. If you could elaborate on that? Thank you.

Mike Mayo:

Thank you.

Operator:

And now we'll go to John Pancari with Evercore ISI. Please go ahead.

Terry Dolan:

Hi John.

Terry Dolan:

Yeah. I mean I -- this is Terry. So maybe to address your first question in terms of where we're seeing it and maybe as a reminder, from an underwriting perspective, we focus on prime, super prime really in all of our consumer portfolios. To the extent that we're seeing delinquencies starting to tick up, it's more so in the credit card space. And you're right; it would be probably on the lower bands as opposed to the upper bands at this particular point in time. But one of the things we talked about is that when you look at savings or excess savings from a consumer perspective, they're fairly significant. That is coming down as that's coming down; people are revolving more on their credit cards. And I think it's just kind of a natural progression that we are seeing. And again, starting more with the unsecured and the credit card portfolio, not as much with respect to the other portfolios yet. But as things continue to normalize, we would expect that too.

Andy Cecere:

Yeah. So the payments revenues, you saw, still is well above pre-COVID levels. The card spend is 25% above. On a year-over-year basis, we're plus 5%. So spend continues to be strong. The categories of spend are shifting a little bit. And we would expect continued strong spend, but moderating a bit as we go into the rest of 2023 for the reasons that Terry mentioned. But still expect growth but again, probably more moderate in nature as we go forward and the savings level start to normalize and the consumer behavior starts to change.

John Pancari:

Great. Thank you, Terry. Appreciate it.

Operator:

Next, we go to Ebrahim Poonawala with Bank of America. Please go ahead.

Terry Dolan:

Good morning, Ebrahim.

Terry Dolan:

Yeah. I mean, maybe at a high level, certainly from a CRE perspective, valuations, I think, are moderating to some extent. The areas that we have had probably the greatest focus on if you will, is really office space. And that is really probably as much tied to return-to-office sort of behaviors or patterns. And I think that, that is probably a longer-term sort of structural adjustment that's going to end up happening. We're just going to have to watch it over time. But when we just kind of look at the core CRE portfolio, it continues to perform pretty well from a credit perspective at this particular point.

Andy Cecere:

Yeah. As you mentioned, we've made a lot of investments in tech-led activity, and our tech-led investments have led to that being the principal area of growth for the merchant processing categories. And then on the card side, the partnership's component continues to be an important strength for us and a point of growth as we look forward. So those two areas, tech-led on merchant and partnerships on card, are doing well and it's partly due to the investments we've made over the past few years.

Andy Cecere:

Many of the investments we made are internal investments that we've developed our capabilities and our platforms to allow for different activities and allow for integration with some of the software that the company has used to run their business. We've added as well, as you know, miscellaneous M&A acquisitions that -- you said bolt-ons like Atellic or Bento that add capabilities around the edges. And I think we'll continue to do a little of both as we look forward.

Andy Cecere:

Sure.

Terry Dolan:

Morning Gerard.

Gerard Cassidy:

Hi Andy, hi Terry, congratulations on closing the deal. Question for you, Terry, on the balance sheet optimization where you guys decided to sell off certain loans that were acquired. Can you give us some color on types of credits were in those sales? And why would they chose -- I know they didn't meet your credit profile, but what was the driver of that -- I mean some of the details of the credit profiles?

Gerard Cassidy:

Terry, where there -- in the corporate loans, were there any shared relationships, meaning you had an exposure to XYZ company as the Union Bank and the total was maybe too much and you guys decided to take that down as well?

Gerard Cassidy:

Very good. And then just as a follow-up, you guys obviously gave us very good detail on your slides. And on the credit quality, slide 14, you give us the breakout in the net charge-offs, and you show us the reported number at 64 bps versus your core legacy number of 23 basis points. If I pull out the $189 million from the optimization, it looks like the net charge-off ratio is around 43 basis points, including the Union Bank numbers. Is that the level we should gear ourselves to for 2023 now that Union will be fully implemented into your business?

Gerard Cassidy:

Thank you for clearing that up. I appreciate it.

Operator:

And next, we can go to Betsy Graseck with Morgan Stanley. Please go ahead.

Terry Dolan:

Hi, Betsy.

Terry Dolan:

Yeah. I mean, obviously, it is impacted by a lot of different things in terms of how economic uncertainty ends up changing and the mix of the portfolio, how it might change. But as we think about 2023, I think that, that 191 basis points is probably a good -- is a good metric throughout the year. It might inch down a little bit. But I think that, by and large, we feel pretty comfortable with that as we think about 2023 based upon our base case, so to speak.

Andy Cecere:

Sure. Betsy, this is Andy. So first, on the growth rate, I think 2022 had exceptional loan growth across many categories, led by commercial as well as CRE. So what we would see is that more normalizing. You're starting to see that in the fourth quarter. And I think the other fact is that, the growth rates are impacted by average balances and some of the optimization activity that we took down in the fourth quarter. It was a partial quarter in the fourth quarter, full quarter in the first quarter and the rest of 2023. But the principal driver is a function of loan demand, which is moderating a bit across most categories. So it's still growing but a less than what we saw in 2022.