Apr 15, 2008
Executives
Judy Murphy - Director of Investor Relations Richard Davis – Chief Executive Officer Andy Cecere – Chief Financial Officer Bill Parker - Chief Credit Officer
Analysts
Jon G. Arfstrom - RBC Capital Markets Chris Farr - Deutsche Bank Nancy Bush – NAB Research, LLC Matthew O’Connor – UBS Edward Najarian – Merrill Lynch Betsy Graseck - Morgan Stanley Theodore M.
Groesbeck - Groesbeck Investments David Knutson - LGIMA Brock Vandervliet - Galleon Group Gregory G. Guenther - Garden State Kevin St.
Pierre - Sanford Bernstein & Co. [Tom Purcell] - Viking Investors Tom Doheny - Decade Capital
Operator
Welcome to U.S. Bancorp's first quarter 2008 earnings conference call.
Following a review of the results by Richard Davis, Chairman, President and Chief Executive Officer and Andy Cecere, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session.
(Operator Instructions) This call will be recorded and available for replay beginning today at approximately 11:00 a.m. Eastern Time through Tuesday, April 22 at 12:00 midnight Eastern Time.
I will now turn the conference over to Judy Murphy, Director of Investor Relations for U.S. Bancorp.
Judy Murphy
Thank you, [Christie], and good morning to everyone on the call today. Richard Davis, Andy Cecere, and Bill Parker are here with me to review U.S.
Bancorp's first quarter 2008 results and answer your questions. If you have not received a copy of our earnings release and supplemental analyst schedules, they are available on our website at USBank.com.
I would like to remind you that any forward-looking statements made during today's call are subject to risks and uncertainty. Factors that could materially change our current forward-looking assumptions are detailed in our press release and in our Form 10K report on file with the SEC.
I will now turn the call over to Richard.
Richard Davis
Thank you, Judy. Good morning, and thank you for joining us this morning.
I'd like to begin today's call with an overview of our first quarter results and then turn the call to Andy, who will provide you with additional comments about our earnings. After we've completed our formal remarks, we will open up the line to questions from our audience.
The company's first quarter results reflected the disciplined approach we've taken over the past number of years toward managing credit and operating risk while prudently investing for growth. Our company recorded net income of $1.09 billion for the first quarter of 2008.
Reported earnings per diluted common share are $0.62, or $0.01 lower than the earnings per share in the same period of 2007 but $0.09 higher than the prior quarter. The first quarter results included several significant items that combined reduce earnings per common diluted share by $0.02.
Briefly, they included a $492 million gain related to the Visa IPO, a $253 million impairment of certain structured investment securities, a $62 million reduction in trading account income related to the adoption of the new accounting standard, a $192 million incremental provision for credit losses, a $25 million contribution to the U.S. Bancorp Foundation, and a $22 million accrual for litigation matters.
Andy will provide more detail on these items in a few minutes. We achieved a return on average assets of 1.85% and a return on average common equity of 21.3% for the first quarter.
Excluding the net unfavorable impact of the significant items I briefly mentioned, our return on average assets and our return on average common equity would have been 1.92% and 22.1% respectively. Our first quarter net interest margin of 3.55% was higher than the 3.51% net interest margin we recorded in both the first and fourth quarters of 2007.
This 4 basis point improvement in our margin, in addition to the strong growth in average earning assets, resulted in an increase in net interest income of 9.8% year-over-year and 3.8% unannualized on a linked-quarter basis. As we have said in the past, a stable margin is one of the key components to our long-term revenue growth assumptions.
At 3.55%, the margin is slightly higher than we'd anticipated at the start of the year, primarily due to the decline in the fed funds rate, growing and higher spread earning assets, and our ability to capitalize on lower short-term funding costs. Our fee-based businesses continue to show excellent growth year-over-year, with payments-related categories, Treasury management fees, commercial products revenue and mortgage banking all increasing by more than 11%.
Trust and investment management fees grew but at a lower rate of 4% as positive growth in transactions and new customers were partially offset by unfavorable changes in the equity market valuations. Linked-quarter revenue growth for the first quarter of the year is historically the slowest for our company.
This year was no exception, as the majority of our fee categories were lower this quarter than last. The Treasury management and mortgage banking revenue lines were exceptions, as both posted strong linked-quarter increases.
Mortgage banking revenue in the first quarter benefited from strong growth in origination and servicing income in addition to favorable changes in accounting, the MSR valuation and economic hedging activity. Bottom line, our mortgage banking division continues to benefit from the current market conditions, enjoying a flight to quality in both the production and servicing aspects of that business.
The growth in total revenue - net interest income plus fees - was 14.3% year-over-year. More importantly, revenue growth, excluding the net impact of the Visa gain, asset valuation loss and accounting changes was more than 8% year-over-year.
This is significantly higher than our company has experienced in the past few years, demonstrating the powerful impact that a stable margin, coupled with our strong fee-based businesses, can have on overall revenue growth. Non-interest expense in the current quarter was $224 million higher than the first quarter of last year but $172 million lower than the previous quarter.
A large portion of the increase in expense year-over-year can be attributed to core growth and our continued investment in both fee-based businesses and our banking franchise. In addition, this quarter's contribution to the Foundation, litigation expense, investments in tax-advantaged projects and credit-related costs for other real estate owned and collection activities accounted for most of the remaining variance.
On a linked-quarter basis, total non-interest expense was lower. Although certain expense categories tend to be seasonally lower in the first quarter of each year, the majority of the positive dollar variance from the previous quarter was due to the $215 million Visa litigation charge taken in the fourth quarter, partially offset by the current quarter's two special items - the Foundation contribution and the litigation expense.
In addition, compensation and benefits were higher this quarter, reflecting annual merit increases and incentive accruals. Our efficiency ratio as reported for the first quarter of 2008 was 43.5%.
Excluding the significant items I detailed earlier, the ratio was more comparable to past quarters, at 47.1%. Importantly, excluding the significant items, we achieved positive operating leverage on a linked-quarter basis.
We are one of the most efficient financial institutions in the industry, and as a company, we will continue with our disciplined approach to expense control while making prudent investments in our products, services, employees and franchise. Turning to the balance sheet, total average loans grew by 7.3% year-over-year, led by solid growth in average total commercial loans of 10%, retail loans of 7.4%, and residential mortgages of 6.5%.
On a linked-quarter basis, total average loans increased by $3.8 billion, or 10% on an annualized basis. This increase was led by a $2.1 billion increase in total average commercial loans, representing the extension of credit to both current and to new customers.
We are finding that our company is benefiting from the uncertainty and volatility in the financial markets as customers seek stability in their financial services provider. We have the capital to lend, and we're in the position to provide the high quality banking products and services our customers seek.
That said, be assured that we will continue to concentrate on originating principally high quality credits. We can and will compete on price for the best customers.
We saw very favorable deposit trends this quarter. Average total deposits increased by 8.4% in the first quarter over the same quarter of last year and more than 4% unannualized over the prior quarter.
This deposit growth is in part seasonal, driven by higher broker-dealer, government and institutional trust balances and the company's ability to attract low-cost wholesale funding in a somewhat volatile market. In addition, the growth in deposits reflected our continued focus on our revenue initiatives, particularly in the corporate banking business line.
Finally moving on to credit, our first quarter credit results remained manageable. As predicted, net charge-offs and non-performing assets were higher this quarter and somewhat higher than we expected 90 days ago.
Net charge-offs were 76 basis points of average loans for the first quarter of 2008, above the 59 basis points and 50 basis points of average loans in the fourth and first quarters of 2007 respectively. The increase over both the prior quarter and the first quarter of 2007 was the result of continued stress in the residential home and mortgage-related industries as well as the growth of our consumer loan portfolio.
Within the consumer loan portfolio, credit card loan net charge-offs accounted for the majority of the linked-quarter and year-over-year increase. The credit card net charge-off ratio of 3.93% this quarter, however, still remains below our expected rate for this loan category.
We now anticipate this ratio will climb above its pre-bankruptcy reform rate of 4% plus. Given the high quality of this prime portfolio, we still expect that our net charge-off ratio will be lower than industry standards but higher than we anticipated at the beginning of the year.
Residential real estate-related charge-offs, including consumer first and second liens, also increased at a faster rate last quarter following the recent trend in the industry. We expect the growth in total net charge-offs to continue through the balance of the year due to general economic conditions, continued stress in the homebuilding and related industries, and the upward trends in delinquencies in the consumer and residential real estate-related categories.
The increase in net charge-offs is expected to be manageable and within our through the cycle range of 60 to 80 basis points on average and may approach 100 basis points at the high end during this economic slowdown. This represents a slight revision upward from our prior forecast of 90 days ago.
Also as expected, non-performing assets increased during the quarter to $845 million at March 31 from $690 million at December 31, a 22.5% increase. We anticipate that our non-performing assets will continue to increase as a result of the current economic conditions and portfolio trends.
The first quarter results included an incremental provision for credit losses of $192 million. With this addition to the reserve for loan losses, the company's coverage ratios remain adequate.
The allowance to period-end loans at March 31 was 1.54% while the allowance to non-performing loans was 358%. Before I turn the call over to Andy, I'd like to say a few words about our recently announced agreement to purchase Mellon 1st Business Bank in Los Angeles, California.
This acquisition will more than double U.S. Banc's deposit market share as well as significantly expand our middle market customer base in the Los Angeles area.
Mellon 1st Business Bank is an excellent example of the type of acquisitions we are searching for, acquisitions that fill in and expand our presence in faster-growing markets within our 24state footprint, particularly when the price is right and the risks are manageable. I will now turn the call over to Andy, who will make a few more comments about this quarter.
Andy Cecere
Thanks, Richard. I'd like to begin by summarizing the significant items that have impacted the comparison of our first quarter results to prior periods.
Other fee income in the first quarter included a $492 million gain related to the Visa initial public offering. The other fee income line was also impacted by the adoption of FAS 157 fair value measurements, which decreased trading revenue by $62 million.
Recall that we discussed the impact of the adoption of this standard in our January earnings call. For comparison purposes, the other fee income line in the first quarter of 2007 included $107 million mark to market on approximately $3 billion of assets purchased from certain FAF Advisor money market funds.
During the current quarter, an additional impairment charge of $253 million was recognized on these structured investment securities as they are now part of the company's investment portfolio. The impairment charge was booked as a securities loss.
As most of you are aware, spreads widened during the first quarter. As a result, about two-thirds of the write-down on these structured investments was related to changes in market-related credit spreads, while the remaining third was due to potential credit loss and fee payment changes.
Non-interest expense also included two significant items: first, marketing and business development expense included a $25 million contribution to the company's charitable foundation, while other expense was higher due to the $22 million litigation accrual. For comparison purposes, recall that the fourth quarter of 2007 also included a significant expense item, a $215 million Visa litigation charge.
Finally, the adoption of FAS 157 resulted in an increase of $19 million in the compensation expense line. This was offset, however, by a similar increase in the mortgage banking revenue line as the standard eliminates the deferral of compensation expense related to the closing of mortgage loans held for sale.
As Richard discussed, the provision for credit losses recorded this quarter was $192 million in excess of net charge-offs. The incremental provision was made in recognition of the current economic conditions, stress in the residential real estate industry, and the growth of our consumer loan portfolio.
Earnings per diluted common share for the current quarter without these significant items would have been approximately $0.64. For comparison purposes, fourth quarter 2007 earnings per diluted share without the impairment charge in the structured investment securities and the Visa litigation charge would have been approximately $0.66.
As Richard discussed, net interest income in the first quarter was higher on both a year-over-year and linked-quarter basis due to strong earning asset growth and an expanding margin. The margin expansion year-over-year and on a linked-quarter basis can be attributed to growth in higher spread assets and the benefit from being liability sensitive in a declining rate environment.
Our company has also benefited from the ability to secure favorable short-term funding rates given the volatility in market conditions. Going forward, given the current rate environment and yield curve, we expect a stable interest margin based on steady to slightly improving credit spreads, continued growth in higher-spread products, including credit cards and other retail loans, and a normalization of funding and liquidity in the overnight markets.
Our capital position remains strong. As you may recall, we indicated in January that we would not buy back stock in the first quarter of 2008 in order to ensure that our tier one capital ratio returned to our target level of 8.5% from the 8.3% we posted at December 31.
Our tier one and total capital ratios were 8.6% and 12.6% respectively at March 31, both slightly exceeding our own target levels. As Richard mentioned, we announced an agreement to purchase Mellon 1st Business Bank in March with an anticipated close by the end of the second quarter.
Because of this acquisition, we expect to delay the buyback program during the second quarter in order to maintain our tier one capital ratio near target at June 30. Richard covered the highlights of our credit quality statistics for the quarter, but I want to update you on our exposure to subprime lending.
Our exposure to subprime residential loans remains minimal, and very little has changed from the end of the fourth quarter of 2007. As of the end of the quarter, we had $4 billion of residential real estate loans and home equity and second mortgage loans outstanding to customers that could be considered subprime.
These two portfolios represented 2.6% of total loans outstanding as of March 31. Given the current credit environment, we have published additional schedules this quarter as part of our earnings release package with more details on the credit performance of this portfolio.
In summary, we are pleased with our first quarter results. The company posted a solid loan growth on both a year-over-year and linked-quarter basis, a 9.8% increase in net interest income year-over-year, and a higher net interest margin, excluding significant items, total revenue growth of over 8% year-over-year and positive operating leverage on a linked-quarter basis.
We had manageable increases in net charge-offs and non-performing assets, and finally, we ended the quarter as we began - with a strong capital base and liquidity position. I will now turn the call back to Richard.
Richard Davis
Thanks, Andy. Our Board of Directors and management team are here today with me in Portland, Oregon to host our 2008 annual meeting, where I'll be very proud to share our full year 2007 and first quarter 2008 results.
As our shareholders leave the meeting today, I want them to recognize that this management team and our 54,000 employees are focused on the future, not on repairing problems from the past. We're focused on business growth initiatives and on our customers, not on downsizing businesses or eliminating positions.
In other words, U.S. Bank is open for business.
As we successfully close the books on the first quarter of 2008, I'm confident that our company will continue to perform and prosper despite the challenges we face in the current economic environment. This company will continue to invest in new and existing products and services, in our communities and in our employees, while focusing on our responsibility to produce consistent, predictable and repeatable results for our shareholders.
That concludes our formal remarks. Andy, Bill and I would now be happy to answer questions from the audience.
Operator
(Operator Instructions) Your first question comes from the line of Jon Arfstrom of RBC Capital Markets.
Jon G. Arfstrom - RBC Capital Markets
Good morning.
Richard Davis
Hi, Jon.
Andy Cecere
Good morning, Jon.
Jon G. Arfstrom - RBC Capital Markets
Richard used the term "incremental provision" in terms of the large increase sequentially, and you guided to some modestly higher losses in the future. And I guess the question is: How much of that is truly incremental, and do you think that the provision will fall back to that $200 million-type quarterly run rate?
Bill Parker
This is Bill Parker. The incremental provision Richard referred to was, you know, to increase the allowance, so that was the $192 million.
The core run rates [inaudible] for the quarter were 293, but we do anticipate those levels of losses to continue to increase during the balance of the year.
Jon G. Arfstrom - RBC Capital Markets
Okay.
Richard Davis
So, Jon, we - you know, this company is going to be adequately protected over the long course, so you can count on the fact that - I said this last time, and I'll say it again - we can see pretty clearly 30 days out, we can see marginally 90 days out, and after that we really can't see what's going to happen in credit any further than that because there's just too much volatility and there's a lot of seasonality as well. So we felt very good about being able to add that $192 million to bulk up our provision to be as strong, in fact, even stronger than before, and we will watch each quarter to see that we are adequately reserved.
And should we need to add to reserves, we will. But at this point in time, we don't see that.
Jon G. Arfstrom - RBC Capital Markets
Okay. Just two other quick questions.
Richard Davis
Yeah.
Jon G. Arfstrom - RBC Capital Markets
In light of the Mellon 1st Business Bank acquisition - it's obviously a hot topic - but can you talk about what does and what does not make sense in terms of M&A for your company?
Richard Davis
Sure. In M&A, I'll start by saying we will always take a look at anything that comes in front of us to be opportunistic and to make sure we don't pass on opportunities that might otherwise not at first glance look attractive.
But we will do due diligence at a very thorough level, and in many cases find that it doesn't pass our test, which in our minds, it needs to be accretive, it needs to be focused on revenue growth not on expense benefits, and it needs to be relevant to our long-term future growth, where we're trying to build a wonderfully balanced diversification of revenue based on a core in-footprint banking business, a national wholesale business, and an international payments business. So you'll find us looking at payment companies, trust companies and traditional banks.
But I'm not looking for that transformation deal unless it were so advantaged that it would be crazy to pass and we haven't seen anything like that in this period of time, so it's kind of the old-fashioned, small, sensible, accretive and revenue focused.
Jon G. Arfstrom - RBC Capital Markets
Okay. That's helpful.
And then just early thoughts on the Northwest-Delta merger and what kind of impact that might have on your payments business.
Richard Davis
Sure. It's too early to know exactly except to say that we're the merchant acquirer for both of those companies, which is positive.
I think that the merger makes sense and is good for the new company, the largest airline, I guess, in the world. We are the merchant issuer - or, I'm sorry, the card issuer for Northwest through our WorldPerks, and we have a very good relationship with them.
We also have a great relationship with the current head of Delta Airlines, who used to be the head of Northwest, and we've been the bank for Northwest, I think, for as many years as people can remember. So I'm expecting that our relationship and the great partnership we've had with that organization will carry us forward into the next stage, and we're looking forward, frankly, to having more business from the largest bank in the world - or largest airline in the world.
Jon G. Arfstrom - RBC Capital Markets
Okay, thank you.
Richard Davis
Yep.
Operator
Your next question comes from the line of Chris Farr of Deutsche Bank.
Richard Davis
Hi, Chris.
Andy Cecere
Hi, Chris.
Chris Farr - Deutsche Bank
Good morning. I'm just wondering if you can give me a sense of the economic outlook for the potential 100 basis points increase in charge-offs - like unemployment, GDP growth - and what geographies are you seeing the greatest stress?
Bill Parker
This is Bill Parker again. Clearly, the geographies with the greatest stress are the Southwest, specifically California markets, Arizona, Nevada, and then also Florida.
And then for really different reasons, the upper Midwest of Michigan and Ohio, with the [inaudible] industry. So those areas, I mean, you've seen the softening in employment over the last few months, and if that, you know, if that continues, I mean, that's the kind of thing that will drive our losses towards that peak loss rate that Richard mentioned.
Richard Davis
Yeah, Chris, this is Richard. I'll add to that.
I want to make it clear - we're not at a 100 basis point increase nor at that level. But I think last time when we spoke to this group we said that at the high end of the cycle we'd be in the mid-90s and, if nothing else, I want you all to be very comfortable that the three of us will tell you what we think and what we know, and we're thinking that that's probably a little low now.
At the high end of the cycle, we could approach 100 basis points. It will be - as we got there, right now, if you'll look at our current situation - it will be just as the 76 basis points today is spread pretty much across all categories - commercial, commercial real estate, residential, credit cards and other retail.
We don't see any particular area suffering any more of a consequence to go from 76 to something higher; we simply more of the same. And I think you know that in every one of those categories, we are primarily prime, and to the extent that that has been the outcome that's occurred with this current economic downturn, I think it would be prudent for us to expect that it will get worse across the entire categories.
But we don't see anything necessarily beyond 30 or 90 days to say that it's Armageddon. It just says that it's continuing to get worse, and the stresses appear in all categories.
Chris Farr - Deutsche Bank
Sure. And then beyond homebuilding and commercial, I mean, what other areas or pockets are you focusing on right now in terms of weakness?
Bill Parker
As Richard said, I mean, it's really across the board. I mean, we're a significant auto lender.
We've seen higher delinquencies in our auto portfolio. It's still manageable, but the loss per vehicle when we do have to repossess a car is higher than it was 90 days ago.
Richard Davis
Yeah, Chris, anything related to the homebuilding starts to show stress at this point in time. So, you know, I don't know, let's say it's a small business that manufactures faucets, they're stressed now, or companies that manufacture door bells; they're stressed.
And so most of the domestic providers of mortgage-related business are going to find stress in this cycle, and some of them show up as commercial loans, some of them show up as small business loans. It's actually quite predictable when you think about it.
It's just a matter of how long this downturn might take people and how long they can hold on through these difficult times. We are seeing that stress, and we're managing it.
Chris Farr - Deutsche Bank
Thank you very much.
Richard Davis
Yep.
Operator
Your next question comes from the line of Nancy Bush of NAB Research, LLC.
Richard Davis
Good morning, Nancy.
Nancy Bush – NAB Research, LLC
Good morning, guys. Richard, we're hearing from others who have capital and are steady in this market that they're seeing, you know, tremendous potential for earning asset growth and taking share, et cetera, et cetera.
Could you just comment to this whole phenomenon? I mean, are you seeing clients coming to you?
Are you seeing new clients? Are you moving market share?
You know, what's going on?
Richard Davis
We are, Nancy, and in fact this might be the time, I think, when there's permanent shifts in market share. It's, I think, quite logical.
It's surprising to me how pervasive it is, but we are seeing customers coming to the company - we call it a flight to quality - customers that are coming with a bigger position, customers who we perhaps had before and now want to come back. It works both ways, too.
People want to get their lending relationship with you because they're confident that you're not going to change your level of interest in supporting them. They want to give you their deposit because they want to be comfortable that the company's going to be able to support those deposits, especially above FDIC levels.
So it is across the board, it is complete, and it is from every single category. And so what I need to make sure is that this company remains prudent and that we neither get greedy at a time just because we can have more business.
If it doesn't fit our model of prime-related and high-end customer, I assure you we're going to pass on it. Just because we could do more doesn't mean we should, and in fact the more good prime stuff that comes to us, frankly, we can price for it now because risk has been added back into the equation and because it's a buyer's market for us as regards to customers.
So it's quite positive for us, and I believe it will give us a long-lasting benefit over the course of the next couple quarters.
Nancy Bush - NAB Research, LLC
Is this being seen - I mean, this phenomenon - being seen throughout the franchise or are there regions where you would say that you're claiming greater share than others?
Richard Davis
I'd say it's everywhere, but I would say in terms of line of business it's probably showing up in corporate and middle market banking the most. Consumer not as much; I don't think those customers are as keened in on what's happening.
But I will say on the corporate and middle market side, those are customers - CFOs, treasurers, controllers they understand the difference, and they are coming to us at higher levels.
Nancy Bush - NAB Research, LLC
Thank you very much.
Richard Davis
Yeah, thank you.
Operator
Your next question comes from the line of Matthew O'Connor of UBS.
Matthew O’Connor – UBS
Good morning.
Richard Davis
Hi, Matt.
Matthew O'Connor - UBS
I thought it was an interesting comment about the small business that makes the doorbells and the faucets and things like that, the spillover impact, and I'm just wondering, of your $46 billion of C&I, you know, how much would be kind of quasi-tied to housing, if you had to estimate?
Bill Parker
Yeah, we actually track it. We have about $5 billion in commitments.
So that $40 billion of C&I really grosses up to, you know, $100 or so billion of commitment. So about $5 billion in commitments is in one way, shape or form suppliers to the homebuilding industry.
Richard Davis
So 5% to 10%, Matt, would be really kind of what we're looking at. And I'd say that it's [inaudible] because you don't - it can keep going and going, and if you work really hard, everything has something to do with a house, if you try too hard.
But Bill's right, we've been tracking housing-related now for over a year. As we can see - you know, loans and downturns are pretty much like annuities; you can see them coming.
They're like a slow flood. But you can predict.
You just can't exactly see where it's going to end. And so in our case, we don't have a material concentration across any of our portfolios, either on geography or product or customer type, but we do have our fair share of related businesses in this area which we're watching closely.
Matthew O'Connor - UBS
Okay. And any sense on how that 5% to 10% compares for the overall industry?
Andy Cecere
That would be consistent with - if you looked at, you know, industry distributions of the economy, that would be consistent.
Matthew O'Connor - UBS
Okay. And then just, Richard, a question here.
You know, we're seeing a lot of banks - some could argue are the weaker players - getting capital without needing to restructure in a meaningful way, and I guess some could argue that it's healthy that they're getting capital or some could argue it's not healthy because they're not taking out capacity. I'm just wondering kind of big picture what your thoughts are on that.
And, you know, is it a little frustrating that you're sitting here with capital and a multiple and maybe not having, you know, the unbelievable distress opportunities that we might have thought we would have at this point in the cycle?
Richard Davis
Right. Thanks, Matt.
It's a good question. I'm not frustrated by it because I actually understand it, and so the frustration would be if it didn't make sense to me.
I'm not surprised how this process is rolling out in that I think nobody wants the industry to be stressed. Capital is a good solution to keep the entire greater good theory alive, and I don't think any bailouts are positive for anyone.
And so I think that based on Nancy's question and what we are seeing across the board, we're getting benefited in the long term by this flight to quality and the benefits that accrue to a company's reputation for not having been through this stress. Capital can often be diluted, as you know, as well, so I'm looking forward to a shareholder meeting today where I at least, of other things, don't have to face shareholders who have felt a precipitous drop in their value or wonder if we're going to harm them by diluting their investment or by cutting their dividends.
So I think we're getting our share of benefits. It's our job to leverage that benefit and take advantage of it while not making mistakes, and you have my word we will do that.
But we can live with that discord, and the fact is that not being distracted is probably the biggest value I can offer you. And I won't be able to prove that to you for probably a year from now, but a year from now when things are maybe settled down, I hopefully will be talking about a very well-oiled revenue company here that made its change in course during this period of time when we weren't focused on retrofitting or downsizing or reconstructing the company.
So I'm actually quite positive about it.
Matthew O'Connor - UBS
Okay. Thank you very much.
Richard Davis
Yep. Thanks, Matt.
Operator
Your next question comes from the line of Ed Najarian of Merrill Lynch.
Richard Davis
Good morning, Ed.
Edward Najarian – Merrill Lynch
Good morning, Richard. How are you?
Richard Davis
Good.
Edward Najarian - Merrill Lynch
Good. Could you just go into a little more detail about your capital management outlook?
You mentioned, you know, no buybacks related to Mellon 1st Business Bank, I guess, in the second quarter. Could you just remind us of a couple of things, number one, what amount of cash you're paying for that and, number, two, does that mean we should expect some resumption of buybacks in the second half of the year?
Andy Cecere
Ed, this is Andy. Thanks for the question.
We did not disclose the financial details of that transaction, but suffice it to say that we will not be in the buyback market in the second quarter due to that. We expect that to close June or so of the second quarter, and that essentially takes the capacity for buybacks in Q2.
Given everything we see thus far, we would expect to be back in the buyback market in the second half of the year.
Edward Najarian - Merrill Lynch
So I'm guessing, then, from those comments that you're expecting that that - and maybe you haven't disclosed this - that that's a 100% cash deal in terms of structure?
Andy Cecere
Yes, it is 100% cash.
Edward Najarian - Merrill Lynch
Okay, thanks.
Andy Cecere
You bet.
Operator
Your next question comes from the line of Betsy Graseck of Morgan Stanley.
Richard Davis
Hi, Betsy.
Betsy Graseck - Morgan Stanley
Hi. A couple questions.
One, just finishing up on the capital question, how do you think about the capital levels in an economy that is deteriorating, as you point out? I guess I'm wondering if, you know, as credit deteriorates does that lead you to a need to increase capital to deal with that?
Andy Cecere
Betsy, this is Andy. You know, we've targeted our capital levels at the 8.5% tier one, and we will continue to maintain that target level.
Capital is very important in this environment, you're right, but we're 250 basis points above what would be defined as well-capitalized, and we're very comfortable with that position. And that, together with our strong liquidity and our earnings power and our relatively speaking strong credit position all makes us comfortable with our targets at 8.5.
Betsy Graseck - Morgan Stanley
Right. So you would say that today you're in an overcapitalized position expecting a deterioration in the credit outlook?
Andy Cecere
I would say we're at the target levels that we've set for ourselves, and we'll continue to maintain that target.
Betsy Graseck - Morgan Stanley
Okay. And then on the margin side, just looking, you know, forward, as you were looking at the forward yield curve and some improvement expected there, at least at the long end of the curve, how can you take advantage of that?
And how do you plan to take advantage of the steepness in sort of the 210 portion of the curve?
Andy Cecere
Right. Thank you.
You know, we did come up in margin a bit more than we expected. If you recall back in our January earnings call, we thought we would be flattish to what we experienced in the first quarter of '07 in the low 350s and we were at 355.
I think there are three things that are causing that increase. Number one is some of the loan volume that we're getting, as Richard and Bill both mentioned, the flight to quality offers this opportunity with the spread coming back into the equation, and we'll be able to compete very effectively.
And we have the capital and we have the funds to lend, so that's helping us. Secondly, there has been a flight to quality on the deposit side of the balance sheet which is offering us opportunities to grow deposits, and our national market funding is also very favorable in this environment.
And then finally, as you know, we're a bit liability sensitive so the fact that rates came down 125 basis points in the first quarter helped us out a bit. We continue to be liability sensitive, albeit at a little lower level, because we're hitting some deposit floors.
So to the extent we see a further drop in rates and a steepening of the yield curve, that'll benefit us a bit. But as we talked about in the call, given today's yield curve and today's rate scenario, we expect a relatively stable margin.
Betsy Graseck - Morgan Stanley
Okay, there's nothing that you would plan to do on, you know, with swaps and trying to capture some incremental and II from the 210 portion of the curve?
Andy Cecere
You know, what we try to do is manage our interest rate risk within the constraints of our policies, and we'll continue to do that.
Betsy Graseck - Morgan Stanley
Okay. All right, thanks.
Richard Davis
Betsy, it's Richard. One more thing.
Betsy Graseck - Morgan Stanley
Yeah?
Richard Davis
Capital is king right now. We get that, and we're going to protect it as maybe our most precious asset.
I will also remind you that our ability to generate capital is far and away ahead of our peers based on both the business mix, the quality of our assets and our efficiency. So our ability to generate return on tangible common of 42% a year is also probably the gift that keeps giving.
So in our case, we are focused on protecting those capital levels. We also know we can generate it pretty quickly.
And at least at this point in time, I still don't feel so bad and I said this 90 days ago - that the buyback is the first thing to give up right now, because I'm not sure with the volatility of the stock market that a correlation of a buyback is as high as it would be in more normal cases, and the dividend must be protected and is very important to us, having increased it 6.25% back in December, and protecting it going forward. That's my first and foremost concern for the shareholders.
So that all kind of comes together in the focus we put on capital protection and generation.
Betsy Graseck - Morgan Stanley
Okay, thanks.
Richard Davis
Thanks.
Operator
Your next question comes from the line of Ted Groesbeck of Groesbeck Investments.
Richard Davis
Hi, Ted. Good morning.
Theodore M. Groesbeck - Groesbeck Investments
Yes, good morning. Thank you.
A question for you. In the mortgage business, what percentage of originations were refinances?
Bill Parker
Our non-purchase money, you mean?
Theodore M. Groesbeck - Groesbeck Investments
No, in the regular mortgage originations, how much was refinancings of mortgages?
Bill Parker
Oh. That's probably about 50%.
Theodore M. Groesbeck - Groesbeck Investments
Fifty percent, okay. And in the charge-offs, were there any commercial loan charge-offs in the quarter?
Bill Parker
Yes, there were.
Theodore M. Groesbeck - Groesbeck Investments
Okay. About how much?
Bill Parker
I think it was - let's see.
Andy Cecere
It was 55.
Bill Parker
Fifty-five?
Andy Cecere
Yeah.
Theodore M. Groesbeck - Groesbeck Investments
Fifty-five, okay. And also, a question - if there were no buybacks during the quarter, it looked like the weighted average share count was down?
Andy Cecere
It was about flat.
Theodore M. Groesbeck - Groesbeck Investments
It was about flat. Okay.
Thank you.
Operator
Your next question comes from the line of David Knutson of LGIMA.
David Knutson - LGIMA
Hi. I had a couple of quick questions, one in regards to the, I guess, the latter part of the first quarter.
Did you see a change in the payment profile of your clients? Did you see any credit deterioration?
Was the weakness backend loaded, I guess?
Richard Davis
Yeah, this is Richard. In fact, I think we've said that March should be the month we'll learn a lot.
We did. We saw some additional stress in the ability to repay, both on the credit card side and some of the auto categories, primarily.
We hold off on our concerns until we see the stimulus refund and what happens in April and May when the refund checks come in in normal situations. So before we get too concerned, we'll let March be a slight decrease to prior periods, but we'll wait and maybe call the decision in May or next month when we get a sense for how the stimulus and the money back into the markets come to bear.
We've also been very careful to watch our forward-looking delinquencies, and they are fairly predictable. They're not stressing a great deal.
Bankruptcy is a little higher, but everything is just incremental. It's a very slow incremental continuation of downturn in the prime businesses, where I think it's reflective of this economic downturn and the duration now.
Whether we're in a recession or not, call it what you will, we've been in a slowdown for awhile. So I think, David, that's really the cost that we're seeing on the consumer side.
David Knutson - LGIMA
One follow-up question to that. The last time that we had a stimulus package similar to the one we're expecting, what area did it benefit?
Did it beneficial the consumer credit card business the best, the auto business, or the small owners? Or what was the meaningful - or can you try and quantify it for us?
Richard Davis
It went two places - actually, we saw it three places. It went into deposits, more like the money markets and checking accounts.
It went into credit card paydowns, because it's the most fluid item for people. And it affected, the two together affected a lower NSF-OD fee business because people were bringing themselves current on their checking account side.
So we kind of see the effects on both sides. Deposits balloon up, fees go down a bit, and credit card payments are higher and charge-offs are lower.
So it's kind of where you'd expect it to go, to more of the daytoday kind of stuff.
David Knutson - LGIMA
There hasn't been any increased speed in the roll rate of delinquencies over the quarter, people moving from 30 days to just simply going no more payments, or has there been?
Bill Parker
Yeah, this is Bill Parker. No, the thing that has occurred in the last, you know, 90, 120 days is really those that do go delinquent go seriously delinquent - 90 plus - have a much more difficult time getting out of that situation.
That's the pattern that's changed during this slowdown.
David Knutson - LGIMA
Thank you very much.
Richard Davis
Thanks, David.
Bill Parker
Thank you.
Operator
Your next question comes from the line of Brock Vandervliet of Galleon.
Richard Davis
Hi, Brock.
Brock Vandervliet - Galleon Group
Hi. Thanks very much for taking the call.
I just wanted to get some color on the book of Mellon Business Bank. I remember that bank from years ago, but just kind of - just wanted to freshen up on size and what's under the covers there a little bit.
Richard Davis
Sure.
Andy Cecere
Okay. Brock, this is Andy Cecere speaking.
It is principally a deposit-gathering bank, and from a size perspective it is much more deposit versus the loan. We have a book of about $1 billion on the loan front, and about $2.8 billion on the deposit front; very little in securities, and so that'll be incremental to our balance sheet.
We also see a lot of opportunity here to continue to extend the deposit side of the balance sheet and the loan side with the products and services that we're able to offer, particularly on the payments and Treasury management side.
Brock Vandervliet - Galleon Group
And what kind of reserves were they running?
Andy Cecere
Their reserve level is about 10%.
Brock Vandervliet - Galleon Group
Okay. And what had been their historical credit experience?
Andy Cecere
Pardon me?
Brock Vandervliet - Galleon Group
What had been their historical credit experience?
Bill Parker
It was very strong. We did a thorough due diligence of their loan portfolio, and they're primarily a middle market lender.
They're not in the investor real estate business, so it's a pretty solid credit.
Brock Vandervliet - Galleon Group
Got it. Okay.
Thank you.
Richard Davis
Thanks, Brock.
Andy Cecere
Thank you.
Operator
Your next question comes from the line of Greg Guenther of Garden State.
Gregory G. Guenther - Garden State
Good morning, Richard.
Richard Davis
Hi, Greg.
Gregory G. Guenther - Garden State
I know you mentioned that due to declining home prices in many of your exposed markets that net charge-offs and nonperforming assets increased in the first quarter?
Richard Davis
Right.
Gregory G. Guenther - Garden State
And going forward, you forecast that these charge-offs will continue to be increasing, but at a manageable clip.
Richard Davis
Right.
Gregory G. Guenther - Garden State
So my question is: What's the watermark we'd really need to see that would concern management as far as net charge-offs going forward?
Richard Davis
Well, you know, when we said 60 to 80 in the range, you know, we're at 76 today, so we're in the range. If this range gets longer or more steep, then I would say once we get to that 100 basis points or the 1% that we operate up here, that would be a point of worry for me.
You know, I'll mention that - I said that our charge-offs were higher than we thought they'd be 90 days ago. In order of magnitude, this company made, you know, over $0.60 earnings per share this quarter, and the difference between what would have been an amazingly great quarter and one that disappointed me because it was worse was less than one penny.
So this isn't going to take us from, you know, profit to loss, but it's going to just be a lag on the ability to let the pre-provision earnings of this company not be erased by some of the after-provision. And so it's not going to be Armageddon under any scenarios I can see, Greg, under any circumstances.
But I do think that once we approach that 100 basis points, then we're at a point of stress that is both probably going to continue for somewhat longer than we would have thought, and it starts to erase some of the great things we're seeing above the line that I was hoping that would shine through earlier. So I think in the next 90 days we will learn a great deal on the trajectory of the rest of the year.
Gregory G. Guenther - Garden State
Will there be a bit more clarity in the next quarter?
Richard Davis
Right.
Gregory G. Guenther - Garden State
Thank you.
Richard Davis
Right.
Operator
Your next question comes from the line of Kevin St. Pierre of Sanford Bernstein.
Richard Davis
Hi, Kevin.
Kevin St. Pierre - Sanford Bernstein & Co.
Good morning, gentlemen. Good morning.
Just to follow up on that, I just want to get a little more into your - how you're thinking about reserving here. And Richard, you've remained at the high end of the industry in terms of reserve adequacy and that's still the case, but how should we be thinking about reserves now?
And when you think about remaining adequately reserved, are you thinking about reserves to annualized charge-offs, reserves to NPAs, or is it that if things worsen, we bump up reserve to loans? How are you thinking about that?
Richard Davis
Kevin, thank you. There's a lot of allowance, you know, coverage ratios, but I look at two, and primarily two of the most important.
One is total allowance to total loans, and that's a bit of a misnomer if you don't understand the business mix you have in the portfolio, but in our case that's very important to us and our allowance to total loans is 1.54%, which at least last quarter would have put us in the very top of our peer group, near the top, and I think it will stay there. The next thing I look at and equally important is allowance to total nonperforming loans because, as logic would prevail, those are the loans that are having some form of stress.
This particularly quarter we will be at 288%, which is almost three times coverage. I feel very comfortable with that, especially compared to our peer group.
And while will keep our eye on nonperforms, perhaps one of the most instructive things I can offer you all is both based on regulator concerns and needs to be aggressive in downgrading at this point in the cycle, I don't think that necessarily nonperforming loans mean the risk of total loss as they may have meant in some of the more traditional days. They're simply a recognition of a higher stress and potential loss.
So I like to look at both because NPAs might be an overkill, but allowance, either way, in my mind has got to be at the high end of our peer group and well within what we'll call adequate to satisfy the regulators. And in both cases, I think our actions this quarter to add that $192 million as part of the benefit was to bulk that up [strictly] and give us plenty of time to watch the next couple of quarters and see if we have a need to do that again.
Kevin St. Pierre - Sanford Bernstein & Co.
Right. Thank you, that's helpful.
And you mentioned in there to satisfy the regulators. Is it your sense that the regulators, the safety and soundness regulators, are a bit more - are paying closer attention to the levels of reserves at your bank and at your competitors?
Richard Davis
Well, I know they're satisfied with our bank. I suppose they're watching closely because that's certainly an area of concern for them.
I will say that particularly the regulators have been very aggressive in making sure that stressed credits are recognized quickly, downgrades are recognized quickly, and benefit of the doubt goes to the downside. And that doesn't surprise me.
That's probably prudent at a time like this, and the regulators have a lot of concern that banks don't take too long to recognize problems or don't look for a Pollyanna outcome when in fact they'd be better served to be prepared for the worst. So we see it as a little bit of that, but we've seen it every cycle and it's not unusual.
Kevin St. Pierre - Sanford Bernstein & Co.
Thanks very much.
Richard Davis
Yep.
Operator
Your next question comes from the line of [Jeff Viscone] of Viking Investors.
Richard Davis
Hi, Jeff.
Tom Purcell - Viking Investors
Hi. This is [Tom Purcell].
Thanks for taking the call. Just a follow-up on Kevin's question earlier.
When you guys look at the NPAs, do you exclude the 90plus accruing in restructured? If you do, what's the thought process?
Thanks.
Bill Parker
They are excluded from the NPA totals, however there's also a table that includes the 90plus, so you can look at it both ways. So it's however you choose to look at it.
Tom Purcell - Viking Investors
I guess I was wondering from the reserve adequacy standpoint, Richard said you look at reserve to loans and reserve to NPAs. For yourselves, when you're looking at it, do you include those or do you exclude them?
Bill Parker
Well, effectively you include it. But the ratios Richard was citing exclude it.
It's just the NPAs without the 90 days. But when you actually do the reserve methodology, since it's mostly the consumer assets that are more than 90 days, it does factor into the allowance methodology and analysis.
The nomenclature people use [inaudible] externally reported numbers is often just an allowance that NPLs or NPAs without the 90 days.
Tom Purcell - Viking Investors
Okay. When Richard said just staying, you know, at the top of the peer group on the 150 to total loans and watching that, do you want to keep the reserve above the combination of NPLs plus restructured plus 90day plus or is that not actually - should I not think about it that way?
Bill Parker
I wouldn't think about it that way. I mean, there's two things.
One, we obviously look at how we believe we should be well-capitalized and adequately served relative to our peers. And we are a highly rated bank, and those are important measures.
But then we also have the internal methodology to calculate the allowance, and that's where you get into the delinquencies and the underlying ratings of commercial credits, et cetera, which Richard was also talking about.
Tom Purcell - Viking Investors
Okay. Thanks a lot.
Bill Parker
Yep.
Operator
Your next question comes from the line of Tom Doheny of Decade Capital.
Richard Davis
Good morning, Tom.
Tom Doheny - Decade Capital
Good morning. Just a quick question.
I apologize if you hit on this, but the decline in credit and debit card revenue from the fourth quarter, I realize there's a lot of seasonality in that line but anything else you can, you know, hit on in terms of the decline on a linked-quarter basis or is that just purely seasonality?
Richard Davis
It's purely seasonality. In fact, it's even got the increase in fuel prices offsetting that, so it's absolutely and only seasonality.
There's nothing remarkable in there at all.
Tom Doheny - Decade Capital
Okay, great. Thanks a lot.
Richard Davis
Yep.
Operator
(Operator Instructions) There are no further questions at this time.
Richard Davis
Thanks, Christie. Judy, wrap it up.
Judy Murphy
Thanks, everybody, for joining us. If you have any follow-up questions or need hard copies of our press release and supplemental schedules, please feel free to contact me at 6123030783.
Richard Davis
Thanks.
Operator
This does conclude today's conference call. You may now disconnect.