Oct 21, 2009
Executives
Judy Murphy – Director, IR Richard Davis – Chairman, President and CEO Andy Cecere – Vice Chairman and CFO Bill Parker – EVP and Chief Credit Officer
Analysts
Matt O'Connor – Deutsche Bank Betsy Graseck – Morgan Stanley Nancy Bush – NAB Research, LLC John McDonald – Sanford Bernstein Mike Mayo – CLSA Ed Najarian – ISI Group Heather Wolf – UBS Carole Berger – Soleil Securities Chris Kotowski – Oppenheimer David Konrad – KBW Moshe Orenbuch – Credit Suisse
Operator
Welcome to U.S. Bancorp’s third quarter 2009 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 a replay beginning today at approximately noon through Wednesday, October 28th at midnight. I would now like to turn the call over to Judy Murphy, Director of Investor Relations for U.S.
Bancorp.
Judy Murphy
Thank you Christie and good morning to everyone who has joined our call today. Richard Davis, Andy Cecere, and Bill Parker are here with me today to review U.S.
Bancorp’s third quarter 2009 results and to answer your questions. If you have not received a copy of our earnings release and supplemental analysts 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 uncertainties, factors that could materially change our current forward-looking assumptions are detailed in our press release and in our Form 10-K and subsequent reports on file with the SEC. I will now turn the call over to Richard.
Richard Davis
Thank you Judy. Good morning everyone and thank you for joining us.
Andy and I will begin the call today with a short review of U.S. Bancorp’s third quarter earnings results.
After we’ve completed our formal remarks, we will open the line to questions from the audience. U.S.
Bancorp recorded net income of $603 million for the third quarter of 2009. Diluted earnings per common share were $0.30 compared with $0.32 per diluted common share in the same quarter of last year, a $0.02 or 6.3% decrease year-over-year and compared with $0.12 per diluted common share in the second quarter of 2009.
Solid third quarter operating earnings defined as income before provision and taxes were higher than both the third quarter of 2008 and in the prior quarter, and importantly kept pace with the increased costs of credit, including the cost of building the allowance for future credit losses to reflect the current economic conditions. In total, a number of significant items reduced diluted earnings per common share in the third quarter by approximately $0.19, and Andy will provide more detail on those items in a moment.
Our performance metrics were impacted by the significant items with return on average assets in the current quarter of 0.9% and return on average common equity of 10%. Excluding significant items, return on average assets and return on average common equity would have been approximately 1.46% and 16.3% respectively.
As I stated, our company continue to perform very well this quarter on an operating basis. Once again, we achieved record total net revenue this quarter, driven by growth in both net interest income and fee revenue.
A few of this quarter’s financial highlights included an increase in total average loans outstanding of $15.4 billion or 9.3% year-over-year, with growth in all major categories except commercial. Growth in total average loans was impacted by recent acquisitions.
Without acquisitions, total average loans grew by 2.6% year-over-year. On a linked quarter basis, total average loans decreased by 1%, driven mainly by a 5.2% decrease in average total commercial loans outstanding.
Similar to last quarter, the decrease in average loans outstanding was largely due to lower usage of outstanding commitment by our commercial customers. Specifically, the average rate of commitment utilization by our corporate and commercial borrowers declined from an average of about 35% in the second quarter of 2009 to approximately 32% in the third quarter.
The decline in average balance is also reflected in overall softening of demand for our new loans by our customers both commercial and consumer as they remain cautious and are waiting to see concrete signs of an improving economy before investing and extending our businesses and their debt obligations. That being said, we are continuing to originate and renew lines and loans for our customers who want and need credit.
In fact, during the third quarter of 2009, U.S. Bank originated almost $15 billion of new residential mortgages, and over $32 billion of other loans, plus new and renewed commitment for our consumer small business commercial and commercial real estate customers, essentially equal to the previous quarter’s total.
We remain responsive to the credit needs of our current and new creditworthy borrowers and continue to strongly support the government’s efforts to maintain the flow of credit necessary to stimulate and strengthen the economy. Growth in average deposits was another highlight of our third quarter results.
Total average deposits increased by $32.8 billion or 24.6% over the same quarter of last year, and $3.1 billion or 1.9% on annualized – on a linked quarter basis. Without acquisitions, the year-over-year growth rate was an exceptionally strong 16.1%.
This growth clearly indicates that our company is continuing to benefit from a “flight to quality.” As one of the highest rated financial institutions in the country, our lease bank, U.S.
Bank National Association has a significant advantage over the competition. Consumers and businesses are looking for a safe, stable and sound financial institution, and U.S.
Bank ranks at the top of that list when measured against those fundamental criteria. As I previously mentioned, the company reported record total net revenue in the third quarter.
A major contributor to the success was mortgage banking related revenue, which grew year-over-year by $215 million. Total mortgage banking revenue however was lower on a linked quarter basis as it fell back about 10% from the record-setting revenue posted in the second quarter of this year.
Mortgage production of $14.8 billion were significantly higher than the $7.6 billion recorded in the same quarter of 2008 and modestly below the record-setting $16.3 billion in production completed in the prior quarter. The growth in mortgage banking revenue and production is another example of the flight to quality and our company’s ability to capitalize on its unique position in this market.
We have moved from being one of the top 25 mortgage banking providers in the country to being one of the top 7, as many of our competitors are either no longer in the business or they are pulling back while we continue to support our customers’ mortgage needs, with high quality mortgage products and underwriting processes. In addition to mortgage banking, commercial products revenue and treasury management fees also showed solid double-digit growth year-over-year.
I call out these two categories in particular as they most clearly illustrate how the investments we have made over the past two years, specifically in our corporate banking expansion and in building deeper relationship initiatives had now translated into positive and tangible results. With an efficiency ratio of 47.5% in the third quarter, our company has a distinction of being one of the most efficient financial institutions in the country, and I am pleased to say that we achieved positive core operating leverage this quarter on both year-over-year and linked quarter basis.
We are managing our operating expenses at a level appropriate for the current environment, while prudently investing in our businesses and our employees to ensure future growth. And now moving on to credit.
Credit costs in the third quarter, including the costs of building the allowance for credit losses were higher than the same quarter of 2008 and the prior quarter. But as expected, the rate of increase moderated on a linked quarter basis.
Third quarter net charge-offs of $1.041 billion [ph] were 12.1% higher than the second quarter of 2009. This percentage increase was lower than the 17.9% increase reported between the first and second quarters of this year.
Also and as expected, non-performing assets increased again this quarter. The $376 million or 9.4% increase was lower than last quarter’s linked quarter growth rate of 17.8%, another indication of the credit quality although not yet improving, it’s deteriorating at a slower pace.
Accruing loans 90 days or more past due excluding covered assets increased by 8% over the prior period. The increase was largely related to the higher residential mortgages and a seasonal increase in credit card delinquencies, plus the impact of recent prior portfolio purchases.
With regard to early stage delinquencies, total 30 to 89 days past due loans at September 30th, which is slightly higher than June 30th. Our C&I commercial real estate and small business portfolios all experienced declines in early stage delinquencies relative to the second quarter.
Offsetting the positive variance in commercial related categories, the increases in early-staged delinquencies and retail lending, led by higher credit cards, first mortgages and home equity loans. The increase in early-staged delinquencies and credit cards reflected a normal seasonal pattern in the recent portfolio of purchases.
Early-stage delinquencies in residential mortgages and home equity loans have been steadily increasing over the past number of quarters, but the growth rate is slowing. Our auto loans and lease portfolios were the exception in the retail category this quarter, with early-stage delinquencies improving linked quarter as the value of used cars continues to recover.
Overall, these trends in our early-stage delinquencies further support our view that the pace of deterioration in credit quality is decelerating. Restructured loans that continue to accrue interest rose by 7% this quarter.
Our company began actively working with customers to renegotiate loan terms late in 2007, enabling many of them to keep their homes. Since 2008, including loan service for others, we have modified over 21,000 residential mortgage loans, totaling approximately $3.6 billion.
Additionally, we began participating in the – that government’s mortgage modification program in August of this year and have since begun trial modification on over 3,500 loans or 12% of eligible loans. Going forward, we will continue to actively assist our customers and support the government’s objectives to restore the housing markets.
As expected, given the upward trends in both net charge-offs and non-performing assets, in addition to the uncertain and soft economy, we increased the allowance for credit losses this quarter by recording a $415 million incremental provision for loan losses. This represented approximately 40% of the current quarter’s total net charge-offs of slightly over $1 billion.
This compares with an incremental provision equal to 50% of net charge-offs in both the second quarter of 2009 and the third quarter of 2008. This incremental provision raise the company’s allowance for credit losses to period in-loans excluding covered assets to 2.88% from 2.66% at June 30th.
The ratio of allowance to non-performing loans excluding covered assets in this quarter to 158% [ph], while the allowance to non-performing loans plus 90 days past due loans excluding covered assets remained unchanged from the prior quarter at 107%. As we look ahead 90 days, we anticipate continued growth in both net charge-offs and non-performing assets.
However, we expect the rate of growth to once again trend lower. Consequently, we expect further increases to the allowance for credit losses, as credit quality stabilize and have consistent evidence of the net charge-offs are leveling off or declining.
We will continue to assess the adequacy of our allowance for credit losses and provide for credit losses at a level that reflects changes in the credit risk of the portfolio and current economic conditions. Finally, and importantly, our capital position remains strong.
Our Tier 1 and total capital ratios were 9.5% and 13% respectively at September 30th, both very comfortably above the well capitalized level as defined by the regulators, and following our repayment of the preferred stock issued under U.S. Treasury Capital Purchase Program.
Additionally, our Tier 1 common equity ratio increased to 6.8% and our tangible common equity tangible assets ratio rose to 5.4% at the end of the third quarter. All of our capital ratios benefited from the $2.7 billion capital issuance last night and continued positive earnings.
I will now turn the call over to Andy.
Andy Cecere
Thanks Richard. Once again our third quarter results demonstrated our company’s ability to produce quality core earnings, while managing through a difficult economic cycle.
And we would like to provide you a few details about the results. I will begin with a quick summary of the significant items that impact the comparison of our third quarter’s results to prior periods.
First, third quarter non interest income included $76 million of securities losses, representing impairment charges on perpetual preferred securities, our SID exposure and non-agency mortgage-backed securities. Second, other non-interest income included a $39 million gain related to our investment in Visa, and third, we recorded a $450 million provision for credit losses in excess of net charge-offs.
These three significant items reduced diluted earnings per common share in the third quarter by approximately $0.19. For comparison purposes, during the third quarter of 2008, the company recorded $411 million of securities losses as well as $39 million of market disruption related losses.
Additionally, results in the third quarter of 2008 included an incremental provision for credit losses of $250 million. These three significant items reduced diluted earnings per common share in the third quarter of 2008 by approximately $0.28.
Significant items in the second quarter of 2009 included $19 million of security losses, $123 million related to a special FDIC assessment, and $466 million provision for credit losses in excess of net charge-offs. In addition, diluted earnings per share in the second quarter were reduced by the impact of the $154 million deemed dividend associated with the repayment of the TARP funds.
Together, these significant items reduced second quarter 2009 diluted earnings per common share by approximately $0.34. Finally, as a reminder, we purchased the warrant issued as part of the TARP program for $139 million on July 15th.
This payment did not have an impact on earnings in the third quarter, as the payment represented a direct reduction to equity. Now, a few comments about operating earnings.
Net interest income in the third quarter was 9.7% higher in the third quarter of 2008, primarily due to the $19 billion or 8.9% increase in average earning assets. Net interest income was 2.5% higher than the previous quarter, largely due to favorable funding rates, as average earning assets were essentially flat on a linked quarter basis.
The favorable change in the company’s funding costs driven by both an increase in low cost deposit balances and lower rates paid on those balances led to an increase in net interest margin, which was 3.67% in the third quarter versus 3.60% in the second quarter of 2009. Assuming the current rate environment in yield curve, we expect the net interest margin to remain relatively stable, with a slightly bias towards improvement in the fourth quarter.
Total noninterest income in the third quarter was higher year-over-year by $681 million, partially due to the favorable impact of the significant items, most notably lower security clauses. However, core noninterest income including significant items and acquisitions grew by over 13% year-over-year, driven by mortgage banking revenue, commercial product revenue, treasury and management fees, ATM servicing fees and lower residual losses.
Partially offsetting these positive variances were trust and investment management fees, deposit service charges and investment product fees and commissions, which declined year-over-year, adversely impacted by the slow economy and equity market conditions. Payment related fees, which were flat year-over-year, despite a meaningful job in same-store sales, as well as trust and investment management fees continue to be well positioned to rebound once the economy strengthens and the equity market stabilize.
This position is in part the result of a number of recent attractive strategic acquisitions, including the bond trustee business of First Citizens Bank, the mutual funds administration and accounting service division of Fiduciary Management, the Diners Club Merchant Portfolio from Citibank, the credit card issuing programs for KeyBanc and associated bank, and a new merchant processing alliance relationship with Santander in the UK. In late July, we also announced the creation of Syncada, a B2B joint venture with Visa.
As Richard mentioned, mortgage banking revenue in the third quarter was higher than the same quarter of last year, but lower on a linked quarter basis, largely due to production volume. Included in the mortgage banking revenue this quarter was a benefit from a net impact of the change in fair value of mortgage servicing rights and the associated hedge.
The net amount of the gain was $67 million in the third quarter compared with a net loss of $32 million in the third quarter of 2008 and a gain of $45 million in the second quarter of 2009. Within non interest income, the other income category was higher year-over-year, primarily due to lower end of term lease residual losses as well as the Visa gain.
As we have noted during previous quarterly calls, end of term lease residual losses peaked in the latter half of 2008. The end of term losses in the current quarter were $3 million compared with losses of $84 million in the third quarter of 2008, and $14 million in the second quarter of this year.
On a linked quarter basis, seasonally higher payments related revenue as well as higher commercial products revenue, deposits service charges, equity investment income and the Visa gain more than offset the declines in trust and investment management fees in mortgage banking and securities losses. Total noninterest expense in the current quarter was $240 million or 13.2% higher than the same quarter of last year.
The variance was largely due to acquisitions, higher FDIC insurance premiums, marketing and business development expense related to our new FlexPerks credit card program, increased costs related to investments in tax advantage projects, which create an offsetting benefit in income tax expense and costs associated with mortgage servicing and other real estate. Noninterest expense was lower on a linked quarter basis by $76 million, as the favorable variance resulting from the second quarter special FDIC assessment was partially offset by an increase in marketing expense for the FlexPerks and higher costs related to our investment in tax advantage projects.
Finally, the tax rate in the third quarter of 2009 on a taxable equivalent basis was 18.4%. This rate was lower than the previous comparable periods and reflected the marginal impact of tax exempt income, investments in affordable housing and other tax advantage projects combined with a lower pre-tax earnings year-over-year.
The tax rate on a taxable equivalent basis in the fourth quarter is expected to stay relatively flat to the current quarter. I will now turn the call back to Richard.
Richard Davis
Thanks Andy. During our second quarter earnings call, I said that the first half of 2009 had been anything but ordinary for our company as we concluded and passed the regulatory stress test, placed $2.7 billion of new common equity, paid back TARP and finally completed the repurchase of the related warrant.
Although we continue to operate in a challenging and uncertain economy, our vision into the future is clearer today than it was three months ago. These past three months brought us the beginning signs of stabilization and even some improvement in the markets we serve.
While unemployment remains high, an indication that does not peak, the rate of sales have moderated. The housing sector remains weak, but the pressure on housing prices have lessened and we have seen sales activity pick up in some of our most effective markets.
Our commercial customers are still decreased in the usage of their outstanding lines of credit, and overall demand for new credit is not robust, but our customers are efficiently managing their businesses and prudently saving for their future. In the third quarter, our company posted record net revenues, achieved positive core operating leverage, continue to lend and gather deposits and preserve the strength of our credit rating and capital.
I would consider this quarter to be much closer to business as usual than we have seen in quite some time. Our senior management team just finished participating in an extended Board of Directors meeting.
During our time together, we reviewed the company’s business line initiatives and overall strategic direction with the Board. After this review, the Board and the management team reaffirmed the strategic direction of our company, and we now continue to move forward building our high quality franchise, enhancing our products and service delivery, engaging and developing our employees and capitalizing on our unique position of strength and independence to differentiate just from our competition.
Our third quarter results once again validated the strengths of our diverse business lines and effectively demonstrated that the momentum we have created has and will continue to effectively carry through the current cycle, while positioning us to capitalize coming [ph] to recover. U.S.
Bank remains open for business and we are managing this company for the long term. As we continue to prudently lend to creditworthy borrowers, we judiciously invest in and grow our franchise.
We support our community. We provide best-in-class customer service and importantly we create for our shareholders by sustaining our earnings power, high quality balance sheet and capital strength.
That concludes our formal remarks. Andy, Bill and I would now be happy to answer questions from the audience.
Christie?
Operator
(Operator instructions) Your first question comes from the line of Matt O'Connor of Deutsche Bank.
Matt O'Connor – Deutsche Bank
Richard Davis
Good morning Matt.
Matt O'Connor – Deutsche Bank
You point to a lot of small acquisitions that you have done this quarter. And just in general since the crisis began, you have done a number of deals, I was wondering if you had the total revenue pickup that you have gotten from those deals and what the earnings opportunity might be overtime, because I feel like it’s hard to keep track of each one, but it’s starting to add up?
Andy Cecere
Matt, this is Andy. What we tried to do because each individual acquisition is relatively small, but when you add them up, they do become a little bit bigger number, we tried to do as we did in this call, demonstrate the earnings growth, the revenue growth or the balance growth related to acquisitions.
So as Richard mentioned, the 9% loan growth plus was about 2.8% without acquisitions and net earnings from – net interest income flows around the same level. The fee income growth was less so, because that was driven by core mortgage growth and the expense growth as we said, about $88 million of our increase year-over-year was related to acquisition.
We will continue to describe the growth both with and without acquisition in future periods, because again no one individual acquisition is big, but when you add them all up, they become a number that was mentioned.
Richard Davis
And Matt, it’s Richard, we haven’t changed our philosophy that we won’t do diluted transactions. So, you will find that everyone of them does that up, but what they might think is a little longer to be highly accretive, but they will start out being non dilutive and anything we have done in the last 12 months is just starting to hit some point of benefit and I think we will just see is over the course of time, they will start to add up and given your question, we will do a better job of, maybe isolating those for future calls and giving you a guidance of what we said 12-month acquisitions is really done for earnings.
Matt O'Connor – Deutsche Bank
Okay, great. And then just separately, you know, Wells Fargo came out today and provided a number of outlook comment regarding credit.
They talked about consumer losses, potentially peaking first half in next year and commercial losses in the back half of next year, just wondering if you have any time frame on when you think your loss rates might peak in here, portfolio or overall?
Richard Davis
Yes, I read those, too. I will tell you.
Stick to my voice that we can see 90 days really clearly, and I think we have been able to prove that at the beginning of each new quarter, we have been pretty close to right at the end of that quarter. So, I am going to stick first of all to saying we can see it at the end of the year pretty clearly and I will remind that we do see the increase of both charge-offs and non performs continuing to go upwards but at a decelerating rate, which means we are getting close to the point where we are going to hit that version, because we don’t have much left to keep reducing on an increasing rate.
I won’t say we do see the consumers are more predictable, because it’s more of an annuity business, we can track their behavior and assuming seasonality, it ticks up back into historical patterns. We have a pretty good idea that the consumer won’t track with unemployment, I think we see that sometime in next year, but I don’t know what part of next year.
On the commercial side, based on the quality of our book, I think we will emerge faster from any problems from most of our peers, but it’s a little less even because it’s more customer related than it is group or category related. So, I would also say that next year, we expect those to peak, but I wouldn’t be so precise to when or which part of 2010, because we just can’t see that farther.
Matt O'Connor – Deutsche Bank
Okay, fair enough. Thank you very much.
Richard Davis
Yes.
Operator
Your next question comes from the line of Betsy Graseck of Morgan Stanley.
Richard Davis
Hi Betsy.
Betsy Graseck – Morgan Stanley
Hi good morning, thanks. Couple of questions, one is on the footprint in how you are thinking about capital usage for extending your footprint.
You indicated that the Board confirmed the strategic plan for U.S. Bancorp, could you just help me understand what that means for capital usage and extending or enhancing the current footprint?
Richard Davis
I can, thank you. First of all, the headline was organic load at an aggressive level, and M&As will be opportunistic if and when they come along.
So, what we wanted to make sure the Board is aware of this, we are going to continue to pursue what we have done in the last two years, in investing more heavily in our franchise and technology to employ engagement to some of the products and services that you will start to see more of as we build deeper relationships. That’s quite important because if we weren’t just start forward an M&A strategy as our future, that will be a different approach to things.
Andy Cecere
Further I would say that we talked about deepening our investment in our 24 state franchise where you would see the consumer and small business bank as opposed to trying to expand it and perhaps dilute ourselves over more locations. At the same time, we are going to spend those same energies organically on taking the commercial real estate, commercial and corporate bank more at the national level along with the trust business to expand where we have already been playing effectively.
So, I think it’s a little (inaudible), but we basically are confirming doing more what we have done over the last couple of years allowing M&A to be an infill and depth building as opposed to expansion areas and allowing M&A to be additional to our success, but spending a fair amount of our capital in the organic measures of old fashioned banking to get long term gains.
Betsy Graseck – Morgan Stanley
And at some point, you will be hitting the density of presence in your current footprint, at levels that perhaps you are targeting already, my point is, at point do you start seeing the ROIC in expansion at a better return and potentially increasing density of presence in your current program?
Richard Davis
That’s a great point. We have further to go probably than you think, and I am not disappointed to say that.
We have come to conclude like a good retailer that when we have a market position either in deposits or branch and they can be combined, of one, two or three position and 168 MSAs that we consider ourselves involve in. When we are one, two or three, it’s incremental and it’s accretive, your investments are more than one for one, where your four or five or six something below that, you will find that your investments are not as well returned and your goal would be to get up into the top three if you can in order to leverage your investments.
Of those 168 markets, slightly more than half of those, we are in that one, two, three position, but inside that, which is whole lot of markets, we are not. So, there’s plenty of time and energy to be placed, and there’s some really good growth markets where our positions are very strong.
Andy Cecere
(inaudible) helps, well let that be a jumpstart, strategically decided to go after it directly and just start building our infrastructure in places where we are not going to get it otherwise.
Betsy Graseck – Morgan Stanley
Okay, and then lastly on capital usage, the dividend, what are the key things you are looking for to yield the conclusion that you were on to increase the dividend?
Richard Davis
I will move to question two without the dividend question. We are – and exactly we have done in all the years, very predictable, and by that I mean that it’s been historically, this company is routine to look at the dividend December of every year, and we will do that again in December of this year.
We will make a recommendation to the Board to evaluate in December based fully on our ability to have confidence in the next one and two-year earnings results for this company. Once we get our line of sight and we have a pretty good idea where that would be, we will trust asset for regulatory policy and economic circumstances.
If we like where that number comes even in the worst part of the stress test and we feel that there’s ample room to begin with dividend, then that will be the moment, we will do it. At December, well, you will see it in December, if not, then that indicates that we are going to wait a little longer to see our line of sight that gives us that confidence.
Betsy Graseck – Morgan Stanley
The regulators aren’t going to be coming out with their capital requirements until the beginning of the year probably so, is there an opportunity for you to read, think the dividend, not just in December, but another quarterly –?
Andy Cecere
Absolutely. Always we think that and if we don’t take action in December, we will continue to evaluate it until we do.
I would also indicate that when I say stress test, I include what could be possible outcomes that they could place on us under those scenarios, too.
Betsy Graseck – Morgan Stanley
Got it, thanks.
Andy Cecere
Yes.
Operator
Your next question comes from the line of Nancy Bush of NAB Research, LLC.
Nancy Bush – NAB Research, LLC
Good morning guys.
Andy Cecere
Good morning Nancy.
Nancy Bush – NAB Research, LLC
Richard Davis
Correct.
Nancy Bush – NAB Research, LLC
How do you see that going forward? And that’s a very healthy ROE given the sort of zero interest rate environment, is that a sustainable number, is that a number that you can build upon and quote normal times, if you could just give your thoughts there?
Richard Davis
I will. I will have Andy give you some color around it.
First of all, I think that banking in general because of the higher new bars that will be placed on all of us going forward, namely higher loan loss provisions or likely, and they were before the downturn. Higher capital requirement so likely.
And now we are all seeing insurance and (inaudible) actually getting credits for. I think all three of those are natural negative vices for the ROA and ROE of the long term banks than the after versus the before scenario.
But I also attempted in your question that the increasing old-fashioned banking on benefits, yield curve and the flight to quality that banks won’t have in being able to be the place where our capital well recognized and we get paid for risk, I think that’s a positive vibe. So, I think that net-net, you can expect things to go close to, maybe frankly under where they were before.
This bank was typically in the 21% to 22% ROE, today we are talking about a normalized 16, and I think you will see it somewhere between those two numbers as things start to settle. Having said that, we also do though enjoy a strong balance sheet management and this company does on interest rate, but we have guidance based on the way we are constructing on having it, you talked about that just briefly.
Andy Cecere
Yes, we are slightly asset sensitive, as you know, Nancy. So, to the extent rates go up, and or the yield curve steep will help us.
As Richard mentioned, the key variable to get back to normalized will be the charge-off level on reserve bill. And you know, two years ago, three years ago when we were earning under 20%, we had a charge-off level below 1%, we are now well about 2%, to the extent we get back to those levels is when we will get back to our normal ROE levels.
Nancy Bush – NAB Research, LLC
Yes, and I would ask a similar question about sort of normalized mortgage banking, as you look at the mortgage market going forward, I think there’s fair amount of confusion about what a real mortgage market is going to look like in the future. Could you just speak to your outlook there?
Richard Davis
We will, actually, I will have Andy give you – we studied in that in our strategy session, but as I will also say, I don’t think you could plan to expect – we sort of pass to increase our mortgage business by over a third from where it was a year ago. So, we have now added hundreds of new mortgage originators, we have created new operating centers in more states and you will see it to be a more robust player in the market even with the market shrinking.
We have gotten bigger and trying to grab more market share as well. As you know by our size, and our composition of other earnings, we are not going to be a one trip pony of anyone’s category, but I thought that mortgage to be a substantially higher, given what we do think is a long-term good and effectively, one day we will be a very predictable earnings, we want to be a bigger part of that.
So, our investments will reflect that, and Andy might talk about how we see into.
Andy Cecere
I think that’s exactly why you told – about this quarter, Nancy, we had production of about $14.8 billion and that compares to a year ago about half that level of $7.6 billion. The $14.8 billion is probably higher than what would be normal run rate because of refinancing activity and the level of interest rates, but I would expect and we are also done into fourth quarter of next year, will still be 25% to 40% higher than we were a year ago, but probably on a 100% margin.
Richard Davis
We think it’s going to be volatile, but it’s still especially in old-fashioned quarter what banking does and so people will eventually need, it would be a good place for them to get their mortgages and we want to be a bigger player in that.
Nancy Bush – NAB Research, LLC
All right. Thank you.
Operator
Your next question comes from the line of John McDonald of Sanford Bernstein.
Richard Davis
Hi John, how are you?
John McDonald – Sanford Bernstein
Hi, good morning. I was wondering, if Andy, you could give us a little color on the puts and takes in your margin and NII outlook?
Andy Cecere
Yes, what’s happened this quarter is similar to what’s happened in the prior quarters, John. The loan rates, the loan yields have improved a bit principally on the wholesale commercial side.
Earnings assets are relatively flat, but the big help, the big positive is our growth in core deposits, both demand deposits and interest-bearing deposits and the mix in that shift has helped our margin a bit as we talked about 367 for the quarter, I would expect to continue to slight modest positive because of that fact and we see some of the same trends that relate here in the fourth quarter.
John McDonald – Sanford Bernstein
And in terms of your positioning with the securities portfolio, I guess two questions, do you see any remaining risks in the securities product and what’s your possibility about kind of growing the securities portfolio given your rate outlook?
Richard Davis
Right, we are worried about $43 billion, John. You know, our risks in the future quarters are similar to what we experienced this quarter, but albeit at a diminishing level, they are in the SIV exposure, which is down to just about $1 billion now.
They are in the non-agency mortgage backed and slightly in some smaller perpetual preferring, those would be our key areas. In terms of the future, you know, the $43 billion I would expect to be relatively stable, perhaps slightly higher in future quarters.
John McDonald – Sanford Bernstein
Okay, and last question on credit, do you also expect, you mentioned slowing space of NPA growth and charge-offs growth, do you also expect a magnitude of reserve though to continue to moderate?
Bill Parker
Yes, this is Bill, John. Yes, if you look back at over the past couple of quarters, I mean fourth quarter last year, we were at 100% of charge-offs on reserve billed, 167 [ph], 50 [ph] in this quarter, 40% though.
Again, we evaluated at the end of each quarter and it’s highly dependent on our economic outlook at that time, yes we do anticipate that, that assuming of losses continue to moderate, which we believe they will go in the fourth quarter, that will come down to.
John McDonald – Sanford Bernstein
Okay, and Billy, I knew you just started to have modification program, but just a general comment about how modifications even beyond have and restructurings might be impacting your NPAs and delinquencies?
Bill Parker
Yes, as you know, we just did start – and I will point out that we actually – when they published a 3% effective rate or 3% of those that were eligible at (inaudible) actual number was 12% and we anticipate that will improve over the next quarter or two as we stabilize the program. If we look at our total restructured loan book, we have about $1.3 billion in restructured mortgages, we look at the AA as one, which is the way regulators often report that the two payment default, the re-default rate for our overall book, that’s about 25%, and we also look at it for those that go into the program but then eventually close, and that’s about 25%.
Those are the two key metrics that we launched.
Richard Davis
John, this is Richard. We don’t get too many chances to offer to carry on things.
But the participation has a lot to do with quality. So, we may never get to the high end of that number, and I am not going to apologize for it, we don’t have a portfolio that warns that, but we will be as everybody else’s best practice in terms of doing the right job of restructuring mortgages and helping people, stay in their homes.
So, I would caution all of you that it’s not the only modifications we do, and it probably has a lot more to do with the quality that we start within the facility.
John McDonald – Sanford Bernstein
Okay, thank you.
Operator
Your next question comes from the line of Mike Mayo of CLSA.
Richard Davis
Good morning Mike.
Mike Mayo – CLSA
Good morning. My questions are really on kind of what’s normal, so starting with the loan utilization, down from 35% in the second quarter to 32% in the third quarter.
Is this is an all-time low, what’s the long-term average, what do you think about that?
Richard Davis
Yes, this is Richard. It’s a record low for as long as we have been tracking in this management team, but I know they are going to spend in the 30% range as well.
I think what I would tell you over the normal course is when you take the mix of our business is we are probably in the 35% to 40% range of utilization, and you know, pretty well diversified across commercial and consumer and that’s probably the better place to market. So, it doesn’t sound like a lot, but when you take it on a 100-plus billion dollars and you lose a couple of percentage points, it’s meaningful and I think moving from 32 back up into that mid-30s, and maybe high 30s will be as impressive as just making loans the old fashioned life.
I will also offer to you all as evidenced that that it will appear that banks are not participating in the recovery of the economy because our loan books are shrinking and in some cases, that may be accurate, but for this bank, it’s certainly isn’t accurate to say that. I think the reflection of customers’ usage, these are people that already have loans approved, clients approved, probably it’s pretty preferred rate, and they are choosing not only to not use in more of it, they are actually choosing to pay it down, which is about (inaudible) for new demand being people given the circumstances and people’s tolerance right now to extend their balance sheet.
Mike Mayo – CLSA
So, pay downs are influencing the bottom line number there?
Richard Davis
Most of it, in fact, for our 1% linked quarter of decrease, the majority of it is coming from the decrease in the utilization.
Mike Mayo – CLSA
And are you also seeing a switch back to the capital markets from bank financing?
Andy Cecere
That is also a factor, Mike, that’s a good point, and you know, that has opened up and loosened quite a bit in the last couple of quarters, and that has helped some of the higher graded companies alternative sources of capital.
Mike Mayo – CLSA
So, you should be helping things recover on the negative side though, the overdraft charges with the big banks indicated that this was going to impact them starting with fourth quarter, how much should a reduction in overdraft fees impact you and when do you think it might impact you?
Richard Davis
First of all, the newest item is coming out of the (inaudible) with a very aggressive position. I am not going to justify that I am going to count on the fact that we will have plenty of time to get that into committee and come up with a solution in the expense, but in the meantime, we along with others made comments 30 or 40 days ago that ours would begin in the first quarter of 2010, nothing in 2009 – fourth quarter of this year, and in accordance with that, you can size it for yourself, but I think the best estimates have been the fact that it would be a couple of hundred million dollars in reduced fees, and depending on how the customer behavior moves forward, how they decide to opt out, whether or not their behaviors are as we predict them to be, that’s a pretty wide swing, Mike.
For us, it’s going to move the needle, it’s not going to change the way we run the company, but it’s something to watch for, and I would say, as I said it has nothing but negative bias for long-term fee businesses the banks are in, but I am not ready to size it, as I just don’t know what the final rules would be.
Mike Mayo – CLSA
Okay, I am sorry. When you said a couple of hundred million in less fees, that’s what some people have estimated and that might not be a crazy estimate?
Richard Davis
That’s right.
Mike Mayo – CLSA
Okay, and then last question, just a follow-up to the mortgage banking question, is there any way to kind of give a rough estimate, how much your mortgage banking fees this quarter, for example would do to refi versus people buying new homes?
Richard Davis
About 80% refinancing, Mike.
Mike Mayo – CLSA
And I heard recently, someone said starting in a year or so for the next several years, the only mortgage banking business you will see is due to the purchase of new homes, is that just a stupid statement or is there some truth to that?
Richard Davis
Andy Cecere
The quality of the GAAP period – I don’t know how long or when, but when rates start to go back up, they will be that last flash of people who think, My God, I will have to refinance go forward, and then as rates start to come up, and I think that will be faster than new volume will get to the old days, so probably it will be net negative to overall mortgage banking income in that window, it could be 90 days, It could be six months, I don’t know, but whenever that happens, it will probably a small fold in the earnings continuity, but on the other side of this – houses are fairly priced, people are getting new homes, and they will start to refinancing because they have to and not because it’s rate driven, and I think it will be an old-fashioned business in a couple of years.
Mike Mayo – CLSA
All right, that’s helpful, thank you.
Andy Cecere
Thanks Mike.
Operator
Your next question comes from the line of Ed Najarian of ISI Group.
Ed Najarian – ISI Group
Good morning guys. Hello?
Andy Cecere
Yes, hi Ed.
Ed Najarian – ISI Group
Hi, most of my questions have been answered, but just one more on the tax rate, you have been running with these below normal tax rates for the last several quarters, you indicated that’s going to stay low in the fourth quarter. Can you talk about the pace that, that might normalize in 2010 into 2011?
Andy Cecere
So, the tax rate at 18.3% [ph] this quarter is down because of two reasons, principally the increase in tax credit related business which causes an increase in expense. So, you see our expense going up about $41 million both on a linked quarter and on a year-over-year basis.
That has a direct relation to a lower tax rate, that combined with the fact that our income levels are just lower than it would be normal. So, as I talked about in the last call, we think our full year number is about 20%, we still think that.
The first half of the year is just above 20%, the second half is just below 20%. We would expect the activities related to CDC to continue to be strong as we go into the rest of this year and next year.
And you know, overtime when we get back to our normalized level, our tax rate will begin to increase from the 20s approaching the 30s, but it will take a while to get to normalized revenue levels.
Ed Najarian – ISI Group
Okay, so really that move from 20 to 30 is mostly a function of getting, of the earnings normalizing?
Andy Cecere
That is correct.
Ed Najarian – ISI Group
Okay, great. Thanks.
Operator
Your next question comes from the line of Heather Wolf of UBS.
Andy Cecere
Good morning Heather.
Heather Wolf – UBS
Hi good morning. Just a quick follow-up on your outlook, the one to two year view of earnings and the stress test for capital levels and reserve levels, would you be willing to share with us what some of those stress tests are?
Andy Cecere
Categorically, the stress test will be first and foremost to the economy, starting with unemployment rates and how they affect our portfolios and which parts, expected usage of lines, remember we talked about earlier about our commercial customers. Then I would move to regulatory and political and they are different, they are both very different, these stress tests would cause us to be pretty wide on our variance just in terms of what we think can happen in both law policy, the new consumer protection agencies from those activities are certainly new variables that weren’t there before.
And then finally, I add back all of the momentum that this company is having today on its organic, well invested organic initiatives over the last couple of years, supply to quality and then getting things to that point is normal. I believe flight to quality is even bigger than it was a few months for this company, and frankly, the longer the down turn, its presence the more benefit on a relative basis, it traps to you.
As Frank said, it’s not good for all of us to be in this circumstance. So, we are building a circumstance where eventually the flight of quality is neutralized and we are not getting gains from that, we are getting it from just being a provider of more services to more people with more relationships in more places and carrying that momentum with the kind of normalcy that you come to expect years before.
So, the flight to quality is a great opportunity for us to use this to reinvest in the bank while we are gaining those benefits, but really to not rely on it for too long. So, put all of that in the mix, Heather, and I think this area – they are provocative and the statistics that we have signed to them and the Board was interested in seeing how we would align the risks and the rewards, but net-net, we feel very positive that the old-fashioned way of banking for a company like ours which is big but pretty simple has been pretty positive, that’s a very nice positive vibes through over the next couple of years.
Heather Wolf – UBS
And more specifically on the regulatory stress test, what kind of capital levels and reserve levels will you be stressing for?
Andy Cecere
Now, that’s the art of it, not the time. So, that I am not going to disclose to you, because that’s proprietary, the lesser degree that what you see in the last couple of quarters, namely raise $2.7 million in May to get to a point that we thought was more than sufficient to accept a supportive balance sheet with a good capital position, able to withstand any of the – continuing decreasing economy and hopefully enough to be a place for the regulators under any circumstances would say, you are well capitalized and we are satisfied with where you are, but that’s the art of it, and so, our efficiency were made our own best estimates, and we continue to be that and the fact that this company – (inaudible) decent run of money every quarter, we believe gives us an ability to feel all the more confident at where we are, isn’t good enough, we are going to be there very shortly no matter what the rules are.
So, we put that out there is not a high risk for this company, but one just a pretext.
Heather Wolf – UBS
Okay, and then just the $1.3 billion in mortgage PRs, can you just give us dollar value that’s in non-accrual versus the dollar value on performing?
Andy Cecere
Well, the ones that are reported, the $1.3 million is all performing.
Heather Wolf – UBS
Okay, wonderful, thank you very much.
Andy Cecere
Thanks Heather.
Operator
Your next question comes from the line of Carole Berger of Soleil Securities.
Andy Cecere
Hello Carole.
Richard Davis
Carole, you there?
Carole Berger – Soleil Securities
Yes, good morning guys.
Richard Davis
Good morning.
Carole Berger – Soleil Securities
All right, I had my mute on. Most of my questions have been asked and answered.
I was just wondering, you have a figure for tangible book value per share?
Richard Davis
11.04 [ph].
Carole Berger – Soleil Securities
11.04?
Richard Davis
Right.
Carole Berger – Soleil Securities
Thank you.
Richard Davis
You bet.
Andy Cecere
Thanks Carole. Nice to hear from you.
Operator
Your next question comes from the line of Chris Kotowski of Oppenheimer.
Chris Kotowski – Oppenheimer
Hi, if I compare you to most regional banks, I guess I would say your mix of business is very much a regional bank kind of mix of business, one of the things that’s really different about you is that you have held your margin very well where it’s been under severe pressure for most of the rest of the industry, and most of the other companies are now kind of guiding to the incremental reprising of loans and deposits adding a couple of basis points a quarter maybe, but then you know, should rates ever go up, then we will get a benefit and see margins going back to where they were or a while back. And I am just kind of curious, you are kind of guiding to flat to slightly up margins.
I mean, if the industry, if the regional banking industry generalized recaptures, you know, 30, 40, 50 basis points that they lost over the last two years, how much of a benefit would you anticipate getting from that?
Andy Cecere
So, Chris, when I talked about a relatively flat with a positive bias, I prefaced it with given the current rate environment in yield curve, and we continue to expect and we have been pretty close to our expectations with regard to margin and perhaps at beating in each of the quarters. So, we expect it to migrate up a little bit, but not a lot.
To the extent rates increase and more importantly the yield curve steepens, that will be a positive bias to us and I would imagine to many banks, partly because we are asset sensitive and partly because that was (inaudible).
Richard Davis
Hi Chris, it’s Richard. If you look back a couple of years, in the 420s or 430s [ph], I wouldn’t guide you to that number again.
One of the reasons you were there is because we were fairly uncompetitive in deposit pricing, in fact, many of you who have followed us for a long time know that we are in the bottom depth in most of the marketplace – look at that earlier, we are not there anymore. We are competitive, we are in the middle of the pack, in places we want to win, we will go out even higher – discussion on being a market leader, it can afford you more leverage when you do change rates.
So, on the deposit side, I think loans will give stronger overtime to the industry, because we will continue to have more opportunity. We will get more of the (inaudible) and we will be able to have a risk premium that we did have going into that downturn.
On the deposit side for U.S. Bank, it’s probably closer to where it’s going to be now than it will be either a risk or reward going forward.
So, we are pleased with where we are and we have given some of that margin – I don’t write it even in higher back in the form of deposits.
Chris Kotowski – Oppenheimer
Okay, thank you.
Richard Davis
Thanks Chris.
Operator
Your next question comes from the line of David Konrad of KBW.
Richard Davis
Hi David.
David Konrad – KBW
Hi good morning. I was wondering if you could talk a little bit more about the processing company, overall processing revenues were flat year-over-year, but linked quarter up quite a bit, and really the run rate from this year, it’s up quite a bit.
So, I don’t know, it seems a little bit more than seasonal based on looking at last year, but and perhaps it had something to do with the recent acquisitions, but just – and it looks like pretty good growth rate. Just wondering if you could comment that on your outlook for revenues there?
Richard Davis
David, thank you. One of the things I would have hung up and just point and talk about.
The fact that it’s left and the portfolios that we do processing for our 8% – (inaudible) down over the same period. Probably that number taught anything else on the – it doesn’t get a lot of visibility and thank you for calling it out.
Yes, a little bit to do with acquisitions, but it has a lot more to do with our European and our international processing coming in this quarter now. Remember a year ago, right now, we are talking about a big investment in an international payment platform that would be scaleable and useable in all over the world.
That was installed about a year ago, to start about this year, it’s changed greatly the ability for us to be scalable and some of these acquired properties outside of the base. And in this face, we just continue to have a better benefit on renegotiating some of our terms with our merchants, having a much better retention than we have had in years past, the attritions laydown and frankly a lot of our competitors in the merchant acquiring space are very disrupted or been disrupted action to their customers and we have been completely steady state – but overall making a lot more money on it.
So, when that sooner comes back, I always talk about this bank – the corporate trust affected by primarily the markets and the payment business affected by the economy. When those two hit back, force some their companies with kind of a aid [ph] underneath themselves or we are satisfied that is a grip beginning to show that we see some improvement in the economy and we are going to call that out as one of the positive finds.
David Konrad – KBW
Great, thank you.
Richard Davis
Yes.
Operator
Your next question comes from the line of Moshe Orenbuch of Credit Suisse.
Richard Davis
Good morning.
Moshe Orenbuch – Credit Suisse
Hi, thanks. Was hoping you could expand a little bit, within the expenses, it seems like the increase was heavily concentrated in marketing and this is development you alluded in the text of the press release, too, card products and things, could you just expand a little more on what your plans might be going forward in that area?
Richard Davis
Yes, so we talked a lot on FlexPerks and just to be specific there, FlexPerks as you recall was our solution to the decision when the WorldPerks card portfolio was taken by AmEx when Delta [ph] was merged. The portfolio that was ours, we never gave up the portfolio to keep, and so we decided to invest heavily in the portfolio to recreate different rewards program for those customers.
I wouldn’t tell exactly the numbers, but I will say that our early results have been significantly better than we hoped in terms of retention of customers to keep their WorldPerks card now called FlexPerks, the challenge we have now, Moshe, is to make sure that, that turns into spending behaviors not just card retention, and while we are – it comes in that order, by the way, we have plenty more cards than we thought we would have in our original expectations. So, the advertising seems to have worked.
Now, we need to create a rewards program routine and their behavior that helps people say I really want to use this card. So, ask me again in 90 days, we will see how that’s going, but the investment of advertising which is also marketing and collateral and all the things that go along with creating the rewards and rewards themselves been part of that cost.
The other thing in that category expense as you will see will be just overall brand development advertising and some collateral that we have been doing with our clients, and also underneath that as part of our corporate bank and wealth management restructurings that we have been talking about for a couple of quarters. We are getting more national view on the corporate side and doing a better job at the higher end wealth management clients that we have done in the past, creating a new brand called private client reserve and setting a lot of energy, bringing a lot of new employees with those kinds of talent to amend what we have not had here in years past which is a very high wealth management capability.
So, those expenses are both noninterest expense and personnel expense and they are all aligned with that organic investment I have been talking about during the call, all of which will probably yield benefits in the future quarters more than they have now. That’s all, it’s pretty much the real delta between the variance of the prior period and current period, it’s been marketing in people.
Moshe Orenbuch – Credit Suisse
Great, thanks very much.
Andy Cecere
Thank you.
Operator
And we have reached the allotted time for the question-and-answer session. Are there any closing remarks?
Richard Davis
Thank you Christie. First of all, I thank you enough for your interest in our company and I mean that.
I will tell you, with a very good strategic meeting that we just came back from actually yesterday. We have been gone over the weekend, and I must say when you put it on paper to explain to your Board of Directors where your opportunities lie, where your weaknesses are, and where your future is going, it gives us great celebration to pause and say simple and basic is good, and you are going to see more of that from us.
We will continue to protect our prudent, our risk and credit underwriting philosophies, you will see us to be a watchful on the expenses, but we are also making a lot more revenues, so we will reinvest that. And while whereas the dividend is an important step in our shareholders’ focus, and finally I can’t put words around at the momentum we are feeling in the company by the employee engagement and their pride of being part of this company is probable, you can’t taste it.
And I am excited to show it off to you over the coming quarters. So, thanks for your interest in our company and if you have any others questions, Judy, Andy, Bill and I are happy all day long to answer those questions.
Judy?
Judy Murphy
Absolutely. Thank you for listening to our call and absolutely feel free to call me if you do have questions later today.
Thank you.
Richard Davis
Thanks Christie.
Andy Cecere
Thank you.
Operator
This concludes today’s conference call. You may now disconnect.