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U.S. Bancorp (NYSE:USB)

Q4 2010 Earnings Call

January 19, 2011 8:30 am ET

Executives

Richard Davis - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Risk Management Committee

Andrew Cecere - Vice Chairman and Chief Financial Officer

P. Parker - Chief Credit Officer and Executive Vice President

Judith Murphy - Senior Vice President, Director of Investor Relations and Analyst

Analysts

Jon Arfstrom - RBC Capital Markets, LLC

Matthew Burnell - Wells Fargo Securities, LLC

David George - Robert W. Baird & Co. Incorporated

John McDonald - Bernstein Research

Christopher Gamaitoni

Paul Miller - FBR Capital Markets & Co.

Betsy Graseck - Morgan Stanley

Brian Foran - Goldman Sachs

Edward Najarian - ISI Group Inc.

Keith Horowitz - Citigroup Inc

Michael Mayo - Credit Agricole Securities (NYSE:USA) Inc.

Matthew O'Connor - Deutsche Bank AG

Operator

Welcome to U.S. Bancorp's Fourth Quarter 2010 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] I will now turn the conference call over to Judy Murphy, Director of Investor Relations for U.S. Bancorp.

Judith Murphy

Thank you, Brooke, and good morning to everyone who has joined our call. Richard Davis, Andy Cecere and Bill Parker are here with me today to review U.S. Bancorp's fourth quarter 2010 results and to answer your questions. Richard and Andy will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analysts' schedules are available on our website at usbank.com.

I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation, in our press release and in our Form 10-K and subsequent reports on file with the SEC.

I will now turn the call over to Richard.

Richard Davis

Thank you, Judy, and good morning, everyone. Thank you for joining us.

I'd like to begin on Page 3 of the presentation and point out a few of the highlights from our fourth quarter results. U.S. Bancorp reported net income of $974 million for the fourth quarter of 2010 or $0.49 per diluted common share. Earnings were $0.19 higher than the same quarter of last year and $0.04 higher than the third quarter of 2010. Included in this quarter's results were a few significant items that positively impacted earnings per diluted common share by $0.03. We will discuss them more in detail later on the call.

We achieved record total net revenue of $4.7 billion in the fourth quarter. This represented a 7.9% increase over the same quarter of 2009 and a 2.9% increase over the prior quarter.

Total average loans grew year-over-year by 2%, about half of which can be attributed to recent acquisitions. Importantly, for the second quarter in a row, we achieved linked-quarter loan growth as total average loans grew by 1.5% over the third quarter, the majority of which represented organic growth, as this growth occurred despite a slight reduction in wholesale line utilization.

We achieved a strong 9.5% growth year-over-year in average low-cost deposits and 6.4% growth unannualized on a linked-quarter basis. The low-cost categories include noninterest bearing, interest checking, money market and savings accounts, and represent a solid and growing core customer base. As expected, credit quality improved as the net charge-offs and nonperforming assets, excluding covered assets, declined by 5.8% and 6%, respectively, from the third quarter.

Further, this improvement supported a reduction in the allowance for credit losses, as the company recorded a provision for credit losses that was $25 million less than the net charge-offs in the fourth quarter. Our company continues to generate significant capital each quarter, and our capital position remains strong with the Tier 1 common and Tier 1 capital ratios increasing to 7.8% and 10.5%, respectively, at December 31.

Slide 4 displays our consistent performance metrics over the past five quarters. Return on average assets in the fourth quarter was 1.31%, and return on average common equity was 13.7%. The five-quarter trends of our net interest margin and efficiency ratio are shown in the graph on the right-hand side of Slide 4. This quarter's net interest margin of 3.83% was equal to the net interest margin in the fourth quarter of 2009 and, as we predicted, was lower than the previous quarter's net interest margin of 3.91%. Our fourth quarter efficiency ratio was 52.5%, slightly higher than the prior quarter and above the same quarter of last year.

We remain the best among our peers in terms of efficiency, and the increase in this ratio reflects both the ongoing investments and the impact of recent legislative and regulatory actions on revenue and on expense.

Turning to Slide 5. As previously noted, our capital position remained strong and continues to grow. In fact, our Tier 1 common ratio under the Basel III guidelines at December 31 was 7.3%, above the 7% Basel III level required in 2019. We will continue to generate significant capital through earnings each quarter going forward, even if the economy, which is now showing more signs of a recovery, begins to slow.

As I have said before, our company can support a dividend increase for our shareholders while still meeting or exceeding any new capital requirements that may be forthcoming. Increasing the dividend remains the top priority for our management team and the Board of Directors. And, as you know, we are one of 19 large banks that was required to submit a comprehensive capital plan to the Federal Reserve System. We have submitted our plan, and we expect to receive a response in late March.

Moving on to Slide 6. Average total loans outstanding increased by $3.9 billion, or 2% year-over-year. As noted on the slide, excluding acquisitions, total average loans grew by 0.9% year-over-year, as the commitment utilization rate of our commercial and corporate borrowers declined from 30% in the fourth quarter of 2009 to 26% in the fourth quarter of last year. The decline in the utilization rate was significant enough to offset much of the new loan origination business we experienced over the past year.

On a linked-quarter basis, however, total average loans increased by 1.5%, as the demand for new loans from credit-worthy borrowers was more than enough to offset a nominal decrease in the average utilization rate on commercial commitments. In fact, we recorded an increase in average commercial loans outstanding quarter-over-quarter. This is the second quarter in a row that we have shown linked-quarter increases, something we hadn't seen since the fourth quarter of 2008.

In total, new loan originations, excluding mortgage production, plus new and renewed commitments, totaled approximately $46 billion in the fourth quarter, about $8 billion higher than the previous quarter's total and the highest level recorded since before the fourth quarter of 2008.

New lending activity for the full year of 2010, excluding mortgage production, was over $147 billion, approximately 14% higher than 2009. Total average deposits increased by $9.4 billion or 5.2% over the same quarter of last year. As you can see from the slide, a very small portion of that increase came from acquisitions.

Total average deposits also grew by $7.6 billion on a linked-quarter basis, primarily due to the higher corporate trust and institutional deposits as well as growth in the Consumer and Small Business area. On December 30, we acquired approximately $8 billion in deposits related to the acquisition of a securitization trust administration business. This acquisition had a minimal impact on this quarter's average balances, but will have a positive impact on the first quarter of 2011.

Turning to Slide 7. The company reported record total net revenue in the fourth quarter of $4.7 billion. The increase in revenue year-over-year was driven by earning asset growth, strength in our fee-based businesses, organic growth initiatives and acquisitions, muted somewhat by the impact of recent legislative actions.

Turning to Slide 8 and credit quality. Fourth quarter total net charge-offs of $937 million were 5.8% lower than the third quarter of 2010. Nonperforming asset, excluding covered assets, decreased by $212 million or 6%. As you can see from the graphs, this represents the third consecutive quarter of declining net charge-offs and nonperforming assets, giving us further confidence that these trends will continue.

On Slide 9, the graph on the left shows continue improvement in late-stage delinquencies, excluding covered assets, in the fourth quarter and a slight increase in early stage delinquencies, primarily driven by commercial real estate loans, a category that continues to be under stress.

On the right-hand side of Slide 9, the continuing favorable trend in criticized assets again gives us further indication that we have reached the inflection point in credit quality. Accordingly, we expect the level of both net charge-offs and nonperforming assets, excluding covered assets, to trend lower in the first quarter of 2011.

Turning to Slide 10. You can see that for the first time since this credit cycle began, we recorded a provision for credit losses less than the total net charge-offs. Specifically, we released $25 million of reserves. Comparatively, the provision for credit losses equaled net charge-offs in the third quarter, while an incremental provision equal to approximately 25% of net charge-offs was recorded in the fourth quarter of 2009. The reserve release was primarily driven by improvement in credit quality of the commercial and retail loan portfolios.

I will now turn the call over to Andy.

Andrew Cecere

Thanks, Richard. I'll take a few minutes to provide you with more details about the results.

I turn your attention to Slide 11, which gives a full view of the fourth quarter of 2010 results compared to those recorded in the third quarter of 2010 and the fourth quarter of 2009.

Earnings per diluted common share were $0.49 for the fourth quarter of 2010, $0.04 higher than the prior quarter and $0.19 higher than the fourth quarter of 2009. The key drivers of the company's fourth quarter results are detailed on Slide 12.

The $372 million or 61.8% increase in net income year-over-year was primarily the result of a 7.9% increase in net revenue and a $476 million decrease in the provision for credit losses, which included the $303 million favorable change in excess provision expense. These favorable changes in total net revenue and the provision were partially offset by 11.5% increase in non-interest expense year-over-year.

Net income was $66 million or 7.3% higher on a linked-quarter basis. A 2.9% growth in total net revenue and a favorable variance of $83 million in the provision for loan losses more than offset the 4.2% increase in non-interest expense quarter-over-quarter.

A summary of the significant items that impact the comparison of our fourth quarter results to prior periods are detailed on Slide 13. The significant items called out for the fourth quarter of 2010 were a $103 million gain equal to $41 million after-tax related to the exchange of the long-term Asset Management business of FAF Advisors for an equity interest in Nuveen Investments, net securities losses of $40 million and a $25 million reserve release.

The two significant items impacting the fourth quarter of 2009 are also highlighted on Slide 13, and include $158 million of security losses and a $278 million incremental provision expense.

Turning to Slide 14. Net interest income decreased year-over-year by $139 million or 5.9% due to a $14.5 billion increase in average earning assets. The increase in average earning assets was driven by growth in the securities portfolio, loans held for sale, loans and acquisitions. The net interest margin of 3.83% was equal to the net interest margin of the fourth quarter of 2009, primarily due to lower funding costs, offset by growth in lower-yielding assets, particularly residential mortgages and investment securities, as we build our balance sheet liquidity and the impact of CARD Act.

On a linked-quarter basis, net interest income was higher by $22 million, the result of a $7.9 billion increase in average earning assets, offset by an eight basis point decline in net interest margin. The net interest margin was lower than the prior quarter due to the growth in lower-yielding assets and the impact of CARD Act.

Assuming the current rate environment and yield curve, we expect the net interest margin will decline in the first quarter by an amount similar to the decline we experienced between the third and fourth quarters as we continue to add to our securities portfolio.

Slide 15 provides you with more detail on the change in average total loans outstanding. Average total loans grew by $3.9 billion or 2% year-over-year. Excluding acquisitions, average total loans increased by 0.9%. And as you can see from the chart on the left, this increase was principally driven by a 15.8% increase in residential mortgages, partially offset by a 4.5% year-over-year decline in average commercial loans outstanding.

As Richard pointed out, the reduction in wholesale lending year-over-year is primarily due to the lower commitment utilization by our commercial customers, which has declined from 30% in the fourth quarter of 2009 to 26% in the current quarter, representing a decrease of approximately $2.7 billion of outstandings.

On a linked-quarter basis, the 1.5% increase in average loans outstanding was driven by increases in all major loan categories, as the demand for credit from both our new and existing business and consumer customers continues to trend higher.

Moving to Slide 16. You can see the growth to total low-cost core deposits over the past five quarters. Average total deposits grew by $9.5 billion or 5.2% year-over-year. Significantly, low-cost core deposits, non-interest bearing, interest checking money market and savings grew by 9.5%. On a linked-quarter basis, average deposits increased by 4.2%, while average low-cost deposits increased by 6.4%, principally due to corporate trust and broker/dealer activity as well as growth in Consumer and Small Business Banking business line.

Slide 17 represent in more detail of the changes in noninterest income on a year-over-year and linked-quarter basis. Non-interest income in the fourth quarter of 2010 was $206 million or 10.2% higher than the fourth quarter of 2009. This variance was driven by growth in payments, commercial products and mortgage banking revenue and the positive change in net securities losses as well as the FAF-Nuveen transaction gain. These favorable variances were partially offset by lower deposit service charges, which reflected the legislative and bank-developed pricing changes.

On a linked-quarter basis, non-interest income was higher by $112 million or 5.3%. This positive variance was primarily the result of higher trust and investment management fees, commercial product fees, payments-related revenue and other income, which was higher principally due to the FAF-Nuveen Gain on sale and again on the company's investment in Visa Inc. Offsetting these positive variances were mortgage banking revenue, which declined by $60 million primarily due to a reduction in application volume and lower deposit service charges reflecting the impact of legislative changes.

As we have discussed in the past, legislative changes have and will continue to impact revenue going forward. We have estimated that the impact of Reg E, along with the bank-initiated pricing and policy changes on our deposit charge service revenue, without mitigating actions, would be approximately $440 million to $480 million on a full run rate basis.

The German amendment and the recently issued guidelines for debit card interchange group proposed by the Federal Reserve will also have an impact on our revenue going forward. Our company's debit and prepaid card interchange revenue in 2010 was approximately $515 million. The proposed changes to debit card interchange, as they currently stand, will reduce that revenue by approximately 75% beginning in the second half of 2011. We estimate that in 2011 and 2012, our company will recapture approximately half of the revenue loss from the changes in both demand deposit service charges and debit interchange through product feature and pricing changes.

Slide 18 highlights non-interest expense, which was higher year-over-year by $257 million or 11.5%. The majority of the increase can be attributed to higher compensation and benefits driven by incentives and commissions, additional staffing for branch expansion and business line initiatives, as well as merit increases. An increase in professional service expense and technology and communication expense related to investment product and projects and acquisitions, which accounted for approximately $25 million of the increase.

On a linked-quarter basis, non-interest expense was higher by $100 million or 4.2% due to an increase in compensation related to additional staffing and commissions; higher professional services expense related to technology projects and some seasonality; and seasonally higher investments in affordable housing and other tax-advantaged projects.

Finally, the tax rate on a taxable equivalent basis was 27.8% in the fourth quarter of 2010, compared with 25.9% in the third quarter of 2010 and 20.8% in the fourth quarter of 2009.

Slide 19 provides updated detail on the company's mortgage repurchase-related expense and reserve for expected losses on repurchases and make-whole payments.

Our company's conservative credit and underwriting culture, as well as our very disciplined loan origination process has resulted in a lower mortgage origination repurchase volumes and expense relative to our peers. Given the current environment, we expect mortgage repurchase activity to remain slightly elevated over the next few quarters before beginning to moderate downward, with quarterly repurchase expense of $50 million to $70 million per quarter.

Before leaving the mortgage topic, I’d like to turn to Slide 20 and review U.S. Bank's role as trustee for residential mortgage-backed securities. We are one of the largest Corporate Trustees in the U.S, so our name has and will continue to come up in news reports regarding foreclosures on mortgages held and securitizations, for which we are the appointed trustee. As trustee, U.S. Bank is not the originator, owner or servicer of these loans nor is it the sponsor or depositor for the securitization trust. Our role is to follow very specific administrative duties as outlined in the documents that establish the trust. As trustee, U.S. Bank does not have a role in the servicing of the mortgages that are used as collateral in the trust. As trustee, we do not select the servicer of the mortgages or have a role in the actions the servicer takes in the foreclosure process. We do not hire or direct the lawyers to bring foreclosure disputes to court. Further, as trustee and/or custodian, we do not have responsibility for determining the validity or enforceability of the underlying mortgage documents.

We are named in these suits simply because we hold the security interest in mortgage in our name as trustee for the securitization trust. It is important for all of our constituents to know that the actions of the servicers and the courts decisions have no financial impact on our company, nor do they imply that we have, in any way, not fulfilled our responsibilities as trustee. However, these incorrect portrayals of our roles or responsibilities as a corporate trustee create reputation risk, and we are fully prepared to defend the accuracy of our actions and to educate the media about the role of corporate trust custodians and trustees.

I will now turn the call back to Richard.

Richard Davis

Thanks, Andy. To conclude our formal remarks, I'll turn your attention to Slide 21.

2010 was a year filled with challenges for all of us in the banking industry. The industry faced and has yet to fully absorb unprecedented legislative and regulatory changes; an uncertain and slow-to-recover economy; and the need to regain the public's confidence and trust. Despite this environment, U.S. Bank's performance this quarter and in 2010 was strong. For U.S. Bank, it was a year filled with opportunities; opportunities to acquire new customers, to improve our processes, to expand our franchise and to build upon a reputation as a trusted provider of financial products and services. We are larger and stronger than we were at the beginning of the year and at the beginning of this cycle.

We are well prepared to adapt to the changing legislative, regulatory and economic environment. We have a strong foundation in place. We have a proven track record of success. We have launched many new initiatives and made the strategic investments necessary to provide our customers of the highest-quality experience and to maintain our highly engaged employee base. U.S. Bancorp is positioned to win and perform for the benefit of our customers, our employees, our communities and importantly, for our shareholders.

That concludes our formal remarks. Andy, Bill Parker and I would now be happy to answer questions from the audience.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley

Basic question around the balance sheet and moving the balance sheet into a little bit more of an efficient set of earning assets, getting the loan growth. Have you outlined significant increase in commitments? Could you just talk through how you are hoping to change those commitments into lines? Because in the slow industry environment, that seems like what you need in order to get to NIM up a little bit?

Andrew Cecere

This is Richard. I don't know that we know how to incentivize people to draw in their line except the first and most important step is to get them to line. So I think in the order of things, I'm not surprised that people are either husbanding deposits or getting credit lines for their options that they're going to need as things start to change. And you're seeing some of the larger corporations now moving into more M&A and acquisition space. So I think it makes sense to me that the commitments are moving up. I'm looking forward to the day that the usage will move up. And as you heard us say, it's at record lows now in the wholesale side down to -- actually, just slightly below 26%. But that's the -- I think that in order of things, if we just keep becoming more important to more of our customers and be invited to more of these credit positions that we're now seeing and hold the open-to-buy larger and larger, eventually, based on the needs of our customers, I think we'll benefit from having seen the usage go up. That will just be a bonus when part of it starts to happen. And the fact that we're still growing with -- that going the other direction, I think, reflects the fact we are getting some of the market share growth.

Betsy Graseck - Morgan Stanley

Could you just give us a sense of how typical it is to have an increase in commitments as a borrower? Have an increase in commitments but not take action on those commitments over the course of a year's timeframe?

Richard Davis

Yes. So first of all, it's kind of like the, it's the corollary to just holding more deposits, right? So if you're just composite-rich and you see that now, that one is just holding onto their balance sheet for -- their options and their choices, even if it's not efficient for them to do that. If, in fact, they want to have an additional level of safety and comfort, they'll take an extension line of credit, which they'll pay for. The issue is, as and over the course of time, it becomes more expensive to hold an unused line of credit. That might be the next thing we'll see where people start to use it because they've got to get value for it, or they'll stop having either the need or pay for the cost of having the abundance of caution by having the open-to-buy, which they may never use. Now, Bill, I've gone as far as I can in terms of behaviors. You want to add it up in the credit card?

P. Parker

Yes, I think coming through this recession, people are looking to have a fortress balance sheet. So they're very interested in having sources of capital for when the economy really begins to move.

Richard Davis

I'll add one more thing. We also track the percentage of customers who haven't -- don't use it at all, zero usage. And that's just shy of 50%, which is also a record high as usage of 20% is record low. So there are at least half of our customers that are using our balance sheet as an alternative option without having any use of that line.

Betsy Graseck - Morgan Stanley

It's just interesting, because clearly drawing or having more commitments during the stress period of the cycle made a lot of sense at this stage. I'm wondering if it's any indication of interest by your customers to actually begin to invest with some of the tax policies that went through recently in accelerated depreciation. Did that spark any incremental commitment generation?

Andrew Cecere

Betsy, this is Andy. I think it's as Bill described. There is signs of a recovery. Companies are preparing for further investment and taking out lines, and having that ready and available is one of those actions for preparedness.

Operator

Your next question comes from the line of Ed Najarian with ISI Group.

Edward Najarian - ISI Group Inc.

A question with respect to growing the securities portfolio. So you grew it on an average basis by about $2 billion this quarter and indicated you're going to continue to grow it in the first quarter. So I guess two questions: Number one, maybe you could provide us a sense of how much you expect to grow the securities portfolio looking out, maybe in 2011? And then secondarily, what types of securities are you buying in terms of a type and duration? And can you give us a sense of how you're managing that interest rate risk?

Richard Davis

Ed, I'm going to give that to Andy. This is Richard. But let me talk about motivation first. Some of our most important actions as management is to protect the shareholders. And in doing so, we were very careful of the cycle not to introduce more capital than the company needed and to not balloon the balance sheet any more than we needed to. And in both cases, we're trying to be as precise as we can by not overreaching. In capital, I think you'd agree we have a sufficiently strong capital base and a great quarterly growth of capital. On the liquidity side, as we start looking at the capital assessments and the requirements being placed on us, we wanted to respond to what needed to be a higher more liquid balance sheet on balance sheet. And yet, not having done it ahead of time and wishing we had. So you're watching us now move back into a more kind of the median space of banks that have appropriate liquidity at their beckoned call and what Andy and I are doing now is starting to build that up as carefully and slowly over the course of time, and still waiting for more guidance so that we don't overreach and have an excessively large balance sheet like we didn't want to do with capital. So you're seeing that process, and it is a journey and it is going to be a 2011 event.

And now, let me give it Andy to answer the specific questions you gave.

Andrew Cecere

Sure. So Ed, first let me tell you, our liquidity has never been stronger. We have tremendous loan borrowing capacity. And what we're doing is to put some of that loan borrowing capacity on the balance sheet to meet some of the requirements of liquidity coverage ratio. So that's why we're doing this. Further, I will tell you that the assets that we're putting on the balance sheet are partly Ginnie Mae Securities and partly Treasury securities. So they have zero impact to risk-weighted assets. I will also tell you they have zero or very close to zero impact to net interest income. What they will do, however, is lower the margin a bit, and that's what you saw this quarter and you'll see next quarter. We would expect to add a few $3 billion to $5 billion of securities per quarter this year to again meet some of the requirements in the liquidity coverage ratio. But again, I'll highlight no impact to net interest income and no impact to risk-weighted assets.

Edward Najarian - ISI Group Inc.

So in that regard, you would say they're pretty well match funded with longer duration liabilities, and that's why they're not really providing much incremental NII?

Andrew Cecere

That's correct. We're putting those on in an interest rate-neutral sense, not increasing nor decreasing our sensible liquidity position.

Operator

Your next question comes from the line of Jon Arfstrom with RBC Capital Markets.

Jon Arfstrom - RBC Capital Markets, LLC

A question for you, Andy. Your comment on the potential to recapture half of the lost revenue on Durbin and Reg E. Did I hear that correctly?

Andrew Cecere

That's correct.

Jon Arfstrom - RBC Capital Markets, LLC

Can you talk a little bit about what you're planning to do in that regard and how maybe your philosophy on Retail Banking would have changed a bit as this has all come through?

Andrew Cecere

I'll start, then I'll hand it to Richard. First of all, let me be clear that remember, our Reg E legislative changes and pricing impacts are in the neighborhood of $450 million. And our impact to the Durbin, as currently highlighted, would be about 75% of revenue, so just over $400 million. So out of the combination of both of those, we would expect to recapture approximately half through a combination of a number of action plans, including changes to our checking, account pricing, changes to our merchant pricing, changes to our debit interchange, reduction in rewards, perhaps a fee. We have a number of action items in place that will do that, and we'll be introducing those throughout 2011 to offset some of the impacts we talked about.

Richard Davis

So John, let me add to that. It's Richard. First of all, I said up until the last call that we will be a laggard in taking action, the kind that Andy mentioned, because of our strong position and because we wanted to watch and see what happens to the marketplace. I'm going to update that and tell you we're not going to be a late follower anymore. We're going to be right in the game. And I'll tell you why. The decision by the Fed to respond to the Congress' question that was asked of them for the Durbin amendment at 12 basis points maximum is so sufficiently and absolutely below the cost of doing business, we no longer have the luxury of waiting, not for our shareholders anyway. Just so you know, I think U.S. bank, Elavon, is probably the low-cost provider in that whole space and we can talk about that another time. But for us, it's anywhere from 40 to 50 basis points for those transactions, which includes improving the transaction of the card, embossing the card, sending the card, managing the relationship, paying for their fraud, all of those things, all of which, by the way, were not part of the question that the Congress asked the Fed to answer. So I take a sidebar here. Many of us in the industry are going to be going back, working with the Congress to explain to them what the unintended consequences will be of this decision. But also we're going to go back and ask them to ask a better question. I think the Fed did a great job of asking the question they were asked, but the question was wrong and it was incomplete, and that's why you have this disconnect between getting recaptured at least the cost of doing business. All of that said means that we, as a bank, will no longer lag. We will see sometime in the early or middle part of this year our own actions and making sure that we have fair pricing for checking products, which are part of what debit includes. We'll be working behind the scenes to see if we can get a better answer out of both the Congress and the Fed. And to answer your most important question, the long-term ramifications of branch banking are now in question. We're not closing any branches. We have over 3,000. We are the most likely purveyor of non-traditional branches in the industry now with about 1,000 of those 3,000 in corporate sites, universities, airports and grocery stores. Those are definitely going to make more sense now than they ever did based on their cost of operation. But a more traditional brick-and-mortar branch on the corner of a very expensive parcel of a shopping center that's not being built anymore, those are going to be rethought as we evaluate really what is the breakeven of a branch when it's not just a deposit-gatherer and a loan-maker, but it's also a fee-provider and I think that is the question that the industry should stop and pause to evaluate. And we won't have those answers until later this year when we see both what the competition does and what our consumers are willing to accept as a price to have a checking account, a debit card or some of the ancillary products that go along with it.

Keith Horowitz - Citigroup Inc

Just one follow up from a competitive point of view. Does it make you nervous at all to be in the middle of the pack? Or do you expect competitors to really react in a similar fashion as you're talking?

Richard Davis

Yes, I don't think, in the scheme of things, there won't be a middle of the pack. It's all going to happen this year. And I don't think a few months doesn't matter. What we'll all learn is what each other is doing, we'll watch our own customers' tolerance. I was actually hoping that we would have a couple of quarters to watch everybody else's actions and learn from them on the other side to see if it was sending business our way or to see what their tolerance was. I no longer want to take that luxury, because I think that's now taking risk. But we'll be right in the game. We won't be behind or below. What you'll see is banks coming up with different ways of characterizing the cost of a checking account, all of which will be slightly different variants, but they will at the end of the day be -- debit card is no longer a free product. There will no longer be rewards to speak of, because it's certainly a loss leader. And debit belongs to checking, so checking will now need to have some level of cost recovery to provide the service that we all have been providing for years. So I think the paradigm will change quickly and it will be this year. And I don't think there will be many behind or ahead because it's just something won't be that long of a window.

Operator

Your next question comes from the line of David George with Baird.

David George - Robert W. Baird & Co. Incorporated

A follow-up on the margin commentary and your comments toward the first quarter margin. How much of the eight basis point decline is kind of the remixing of the balance sheet towards resi mortgage and a little bit more securities? And how much is just strict kind of loan-price competition? Because if you look at both commercial and retail yield or on a loan side are under a little bit of pressure sequentially. So just trying to get a sense as to price competition, what's happening in the market and how are loan spreads today versus, say, three, six and nine months ago?

Andrew Cecere

David, this is Andy. I would say the great majority of that decline is due to the securities component of what we talked about. While loan spreads are not as strong as they were perhaps six months ago, they are still significantly stronger than they were two years ago. And we're seeing some moderation in those loan spreads and new originations, but not a significant level. So I would say the great majority is due to securities portfolio addition.

Operator

Your next question comes from the line of John McDonald with Sanford Bernstein.

John McDonald - Bernstein Research

One quick follow-up on the margin to David's question. So Andy, understanding that the securities purchases will not have an effect on NII. Just on the margin uptick, if you're buying $3 billion to $5 billion or so per quarter, will that continue to have each quarter, that effect on the margin sequentially in the second and third quarter?

Andrew Cecere

Yes, John, it will, in the neighborhood of five to eight basis points a quarter.

John McDonald - Bernstein Research

Richard, question on the capital management. Just on the dividend amount, can you just remind us would you like to move right up to a 30% type payout ratio on the dividend? And what's your sense of the higher bar that the Fed might require for payouts higher than 30%? And then just between buybacks and dividends, is the old 80% payout still a reasonable target for you guys on kind of total capital management?

Richard Davis

First of all, I just want out the gate. This is me sitting in the pit, being held waiting and waiting, and I want to get back on the track. So we're going to stay below the 30%, not very far, but we leave ourselves room because there's also the cost of the preferred dividends and some other things. So our goal is to be somewhere in that 25% to 30% range and expecting that, that will meet with the favor of the Fed, because we don't want to push any limits or envelopes. There's just no reason to, just let us move forward. And so I think that's more likely what most other companies should do. And we've got no guidance on what would be required to go over 30%. And this management team isn't going to test those limits. Secondly, as 80% was an old phraseology we used that 75% to 80% of our returns would be given back to shareholders in the form of dividends and in buybacks, and that is still accurate. As you know, we won't get there right away because of the limitation that we just spoke of as part and in the buybacks, of course, we'll have some equally limited expectation, I think, as people slowly recover and get back to something normal. But whatever normal is, you can expect us to be back to the same normal of returning 75% to 80% of what we make to the shareholders, leaving the rest to us to reinvest and to grow the company.

John McDonald - Bernstein Research

And maybe you or Bill could share some thoughts even at a high level on the credit improvement cycle and what you think you might see in terms of the pace of improvement, at least relative between various loan categories.

P. Parker

Yes, on the commercial. So excluding commercial real estate, but the general commercial corporate doing very strong, seeing continued improvement across the board there. Commercial real estate, I just have to characterize, is still extremely stressed. I think it will remain extremely stressed for another 12 to 18 months. There has been a little sign of life in multifamily product, medical office product. So there is some demand out there. But obviously, residential construction is not coming back anytime soon. On the Consumer side, other than residential mortgages, the consumer performance continues to get better. And so as long as unemployment improves slightly or at least stays stable, that's good news for the company.

Operator

Your next question comes from Matt Burnell with Wells Fargo Securities.

Matthew Burnell - Wells Fargo Securities, LLC

Just a couple of quick questions. In terms of the very solid loan growth that you show, not only on a year-over-year basis but what appears to be maybe a slight acceleration of loan growth in fourth quarter, is there a specific geography where that's occurring? Or is that occurring largely on roughly an equal basis across the franchise?

Richard Davis

So Matt, that's your first question. I'll stop there. It's across the board, and it's partly because we've added our number of people doing loans, making loans across the board. All parts of our business we've been investing for the last couple of years, and I know that's kind of a hollow promise to all of you when there was nothing to show for it, but it's starting to show up now. From the very top and large corporate, we're invited now to participate in a number of new syndicated deals and/or lead a certain number of deals which we didn't lead before, all the way down to small business and having literally added 50% more Small Business originators in the last year and a half, at a time that's just perfectly positioned for us to go after the strengthening Small Business. I'll also say that the loan growth is coming across more area than it did a few quarters ago. Two quarters ago, I would have told you that corporate customers, large corporate were the strongest. They had already done their good work of restructuring their balance sheet and their earnings based on the recovery of the recessions linked. They had capital markets alternatives, and we saw them first. Last quarter I would have brought in, and I did bring in, middle-market is starting to show some signs of strength. And the fact is that they don't have the Capital Market as often, so banks reaping the benefit of that. Now I'll explain it and say that middle-market, across from large cities to community, as well as Small Business from the SBA to the small-ticket leasing to just traditional C&I small business are all showing equally strengthening capability and making themselves more worthwhile for a bank to make loans too. So it's not just across the types of loans or geography, it's also because we have more people in all of those places receiving stronger customers.

Matthew Burnell - Wells Fargo Securities, LLC

And then a quick follow-up on the mortgage banking trends. I'm presuming, given the relatively strong growth in the mortgage banking revenues -- or quarter-over-quarter, they were relatively weak despite solid growth in the origination volume. Should we expect continued declines into the first quarter in mortgage banking?

Richard Davis

Right. So Matt, this is Andy. As you know, what drives the mortgage revenue is net application volume, and net application volume is actually down on a linked-quarter basis in the neighborhood of 30%. We would expect that to continue to trend down moderately to the first and second quarter of 2011.

Betsy Graseck - Morgan Stanley

But you still stand by your earlier statement that you think you're taking market share in that specific business?

Andrew Cecere

We are. Absolutely. What drove application volume down for us, as all of our competitors, was a high rate scenario or a high rate environment in that month of December. So that still is the case.

Richard Davis

And seasonality too. This is the time of the year where the originations are slow. But I think you'll see on a relative basis, we'll continue to keep it nice and are growing market position.

Operator

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

Matthew O'Connor - Deutsche Bank AG

I guess my first question is on the underlying expense growth. You've done a good job at stripping out some of the revenue items. But I think on the expenses, the growth was being distorted from both acquisitions, some of the tax credits. I'm just trying to get a sense of maybe what a more normal run rate is or what the run rate has been versus the, I recall, 11%, 12% year-over-year on a reported basis?

Andrew Cecere

Right, Matt, you're absolutely right. The fourth quarter seasonally is higher and also has the impact of the tax credit amortization being significantly higher than any other quarter of the year. I would say on a normal run rate basis, our expense growth is more in the neighborhood of 5% to 6%.

Matthew O'Connor - Deutsche Bank AG

And as you look into next year, I can appreciate there is some regulatory headwinds. But do you think you'll be able to start exceeding some of the expense growth? And I guess what I'm getting at is there's been lot of investment in the business. I think it's very clear from some of the metrics that you are getting share in a number of areas. But at some point, when you see it filter down on the revenue and obviously the operating leverage, I'm just trying to get a sense of when we might start seeing that a little more transparent?

Richard Davis

Yes. And Matt, I think that's a 2012 moment in time, even 2011. We peaked in 2010. Just looking at this year, we peaked in our capital investments. We peaked in what will be the cumulative depreciation effect of all of these investments we've made in the last few years. I think you know we have a lot of catch-up to do from everything from just basic technology to customer research and data, to things like mobile banking and things. We've invested in all of those things, they're all coming to fruition this year. And the cost of them will start to be cumulative in 2011, because we're not having those large investments ahead of us that will start to trend back down. So that's actually a fairly big part of our expense delta. And certainly, what's taking us from where we used to be years ago to where we are today. But I also expect, at the same time, this remuneration that we'll figure out on how to offset some of the headwinds of legislative. We're at the worse moment right now as we could be. Everything's been levied against us. We haven't had time or the ability to solve all of that in some other forms of fees and charges. So I think that will also help. And then finally, this year, just so you know, the bank in 2010 performed much better than we thought it would, not just on loan losses, and by loan provision, but overall, we exceeded virtually every performance metric that we had expected in an awfully difficult year. As part of that, the incentive plans for the nearly 20,000 of employees who get paid on an annual basis of the company and their own line of business, those incentives are higher than they've been in the last two years. So there's a meaningful difference in 2010 for incentive compensation for the people who work on the front line for having done a very good job, and much significantly higher than it was in 2009 and even higher than it was in 2008. So if we continue to do well, that will in there, but we'll also have the offsets, like we had this year. If not, then the incentive compensation will come back down, and that will be a muting effect. So we don't mean to be anything less transparent about our expenses than we are on revenue, so I'm glad for the question. But I think Andy said it best, 5% and 6% over the long-term. And you can count us to be in the low-50% efficiency. I promise you it was never a target, but it kind of is now. Because you need to know, we're not headed to 52.5% on our way to 55%. But I also must tell you, we're not headed to 52% back down to 48%. We're probably going to be right around that 50% to low 50s. It seems to be the right place for us to have enough to invest and keep investing in new revenue so we can start being received by you guys as a revenue company with expense controls as opposed to expense company with flat revenue.

Matthew O'Connor - Deutsche Bank AG

We've seen a couple of acquisitions out there priced probably a little bit higher than what many people would have expected. And I guess just how you think about acquisition opportunities within the traditional bank space going forward, opportunities for your company and what pricing might look like and some of markets you're interested in.

Richard Davis

Yes, so opportunity is a good word. Because I've said it before, we won't let an opportunity be missed. If there is a good deal out there at the right price, we will be part of that. And if we get it, we'll be satisfied, and you won't be writing about how we overpaid. That's a fact. On the other hand, if we don't get a deal because we needed to overpay to get it, then I hope you'll appreciate that discipline, because we don't anything as an acquisition to make this company stronger and better because we're on our way to that just doing what we're doing. So having said that, we'll look for opportunities and all spaces, including traditional bank spaces. I think there will be some. We will be in those. We'll be looking at them. We'll price them to be exactly right for ourselves, but we will not get greedy and try to price them if we think we're in a pricing war just to win one, because that would be a mistake that this management team is not going to make. And I'd rather you were disappointed we didn't win something than to be disappointed than we won it at the wrong price. But we won't hesitate to look. It's just not a core strategy. M&A doesn't change our future. It just has to be a deal that makes it stronger than it was without it.

Operator

Your next question comes from the line of Paul Miller with FBR Capital Markets.

Paul Miller - FBR Capital Markets & Co.

Your cash went up almost $10 billion followed mainly driven I guess because your deposits were up so strong. Is there a point that you're growing your deposits too fast to put it to work effectively?

Andrew Cecere

You've highlighted a good point, Paul. What happened there was, towards the last few days of December, we closed on our Corporate Trust acquisition and in conjunction with that, we had about $8 billion of deposits come in the house immediately. And what that will do for us is allow us to continue to build out the left-hand side of the balance sheet in terms of both our securities portfolio and our loans, but it's purely timing. So it was a phenomenon of the year end and will be rectified in the first quarter.

Richard Davis

It's a broader question, Paul. We're not at a point yet where we think that we are so deposit-rich that we cannot afford to go after and grow our loan book. I mean it's quite the opposite. I welcome all of the loan growth we can. I'm expecting it not only because we're doing well, but as to my first question to Betsy, I think when the economy turns and those lines of credit start to get used, we'll be really glad we're core deposit-funded. And we just don't see a scenario where we have a circumstance where we're worried about the balance sheet getting out of balance because deposits are too fast or too strong. That will be, I think, -- the bank with the strongest core deposits going into the recovery will be the strongest bank, period.

Operator

Your next question comes from the line of Brian Foran with Nomura.

Brian Foran - Goldman Sachs

I guess I put everything you said together for both you and the industry. I mean, is it fair to say pre-provision earnings growth is going to be difficult, maybe impossible in 2011 just given all of the confluence of regulatory reform and higher expenses and asset yields resetting down, and to the extent there's earnings growth that's going to be credit-driven and then 2012 is the year where hopefully we get the handoff back from credit driven to pre-provision driven?

Richard Davis

Brian, no. That's an absolutely no. That's not what I meant at all. It might be more of an industry byline. But for us, PPI, pre-provision is going to grow, it has been growing. We're going to expect probably significantly less credit reserve recapture than you guys do. If it happens, it will happen because amass there, not because we're going to try to curry favor with higher numbers. It will just happen because our credit quality just keeps getting better. But PPI, God, we expect that to grow quite a bit this year. Our balance sheet will grow. Our margins may shrink but as Andy said, it's not a function of losing money. So we'll still have the loan growth, the good spreads growing deposit growth of core levels is a great core funding. Our fees are going to be quite strong because we're a lot more than just a retail bank. We've got a lot of payments and a lot of corporate trust, and wholesale new businesses and wholesale bank that are generating fees. So I'm quite involved in it. We are going to -- I want you to think about this as one of the most close to normal operating companies separate to finality of the last of credit quality getting better, of any bank you follow and I think PPI for us will be the way that will determine whether or not we're the real deal. And it has to be this year. It can't be 2012.

Brian Foran - Goldman Sachs

And just to be clear, pre-pre grows even when you factor in Durbin in the back half of the year?

Richard Davis

It does.

Brian Foran - Goldman Sachs

And then a follow-up. You've talked a little bit about the Brazil and India payments JVs in the past. I guess, for those of us who don't know those markets well, should we think about it as something that supports the overall growth rate of the payments business? Or are those big enough opportunities that this could be a level of change in the total revenues and earnings for the payments business over the next couple of years?

Richard Davis

It's the former, because they'll both be slow to start. So the JV in Brazil, as I think we told you, when we did it, won't really start to point money for -- until the second year and beyond. And so that, and it's going to get to a level even in a few years that will be significant to the payments group, but not huge to the bank. It will just be another contributor to our global payments. India, as we have said before, we've got this lock-down commitment to be the partner with the bank, State Bank of India, eventually to be the bank that works with them on the processing side of all merchant acquiring. But India will move slowly, but this will be very, very long and coming. That's probably a 2012 start, with a few years [indiscernible] benefit. So both of those are indications that we intend to continue to expand globally, but neither of those will grow near as much as just the core European, Central America, Mexico and domestic payments that we have today. It would just be nice to have them, but they're not going to affect or move numbers for a couple of years.

Operator

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

Michael Mayo - Credit Agricole Securities (USA) Inc.

I wanted to follow up on the loan growth and loan commitments. So first, what was the wholesale line utilization in the third quarter? You said it was 26% this quarter.

Andrew Cecere

It's 26.5% in the third quarter, 26.1% this quarter, Mike.

Michael Mayo - Credit Agricole Securities (USA) Inc.

And that would be calculated off the base of the $82 billion of wholesale loans?

Andrew Cecere

Closer to $66 billion.

Richard Davis

Both revolving loans. A number of guys was in quarter four of last year. Well, 28.8%. So Mike, that's 2.5% on almost $70 billion.

Michael Mayo - Credit Agricole Securities (USA) Inc.

And then, what's the dollar amount of the loan commitments in the fourth quarter versus the third quarter?

P. Parker

For the revolving, it went up about $2 billion. It went up from about $65 billion to $67.5 billion.

Michael Mayo - Credit Agricole Securities (USA) Inc.

And that would be the loan commitments?

Richard Davis

Those are revolving commitments. Commitments that are used for revolving purposes.

Richard Davis

So just under 4%, Mike, linked quarter.

Michael Mayo - Credit Agricole Securities (USA) Inc.

So what I'm trying to reconcile as you had the 1.5% linked-quarter wholesale loan growth and then...

Richard Davis

Total loan growth. They're funded loans. They're term loans.

Andrew Cecere

And it includes retail.

Richard Davis

So it's just a slice of it. The wholesale-only lines of credit only. Not credit card, not consumer, none of that.

Michael Mayo - Credit Agricole Securities (USA) Inc.

So that's up? And the loan utilization is down?

Richard Davis

Right.

Michael Mayo - Credit Agricole Securities (USA) Inc.

So why is that? Are you giving commitments to new borrowers? Or what's going on there?

Richard Davis

Yes, both. So the best way to think about it is we've got on the corporate side on all of these investments we're making, we are now in a lot of deals we weren't in before. So you're a Fortune 100 company, you want to renew your line, you want three or four banks in the credit. We weren't in it at all two years ago. We're now one of those banks. And those particularly strong companies just have a line of credit for the availability, they typically don't draw on it. They you get the middle market, and we've increased the number of middle-market lenders substantially. We've gone now national more than we did before, where we have availability to customers who have need outside of our footprint. And we're getting those lines of credit, but not necessarily usage. And then finally, if you look at our Community Bank, which is also present in here, we continue to be very strong in those thousand branches where we have community customers who are actually more likely to use their lines than most. But also invited some because the small community banks they've been relying on have been now as some form of a stress, and in fact, have not been lending or they have been reducing their line capabilities. So we're inviting those deals too. So we're kind of a barbell, where we've been invited into the large deals and into the very small deals that we were neither part of in the past. So if it works, then the line of credit is a proxy for eventually an outstanding use of the credit. But we agree that having it outstanding has held use of small value, but it's better than the other direction.

Michael Mayo - Credit Agricole Securities (USA) Inc.

I don't want to put words in your mouth. I just wanted if can validate what I think I hear you saying. So loan demand is not improving based on the utilization of existing loans, but you're expanding your footprint to some Fortune 100 companies and outside of your traditional footprint? Is that fair?

Richard Davis

So loan demand is probably at the national level not growing. But by the fact that we've got more commitments and growth for the lines and our loans at our present year, means we are growing in this shrinking environment. So I think we must be thinking market share, that's kind of my hypothesis theory. But I don't think it would be right to say that loan demand has gone up. But the willingness for customers to want to engage in an open line of credit, and because they're more qualified than they were and because they want to be abundantly cautious, that's a fact.

Michael Mayo - Credit Agricole Securities (USA) Inc.

And then, to what degree are you seeing a substitution to the Capital Markets? You're seeing bond issuance going gangbusters when you don't have this loan demand going up at the bank level.

Richard Davis

Yes, I mean, clearly, that's part of it. We open our Capital Markets. We get to participate in those underwritings now, but that's for the investment grade companies, obviously, a great substitute for bank loans. And I'll comment one thing on the demand. I mean with the pickup in M&A activity that we've seen a little bit more in the latter half of the year, that generates loan demand that's generally funded. So not under a revolver. So there is a little bit of a loan demand that's coming through on the wholesale side on the funded side for M&A activity. Might be part bank, but bank debt, part bonds.

Operator

Your next question comes from the line of Chris Gamaitoni with Compass Point.

Christopher Gamaitoni

Do you guys have any interest in expanding into other types of fee businesses or adding on to current fee businesses? Just looking at M&A in that area, and if there's any concentrations maybe moving forward.

Richard Davis

So nothing new. But I'd like to be deeper in everything we're in. So what you see is what we like. Our last effort by partnering with Nuveen was probably a reflection of the fact we want to keep the bank fairly simple. We don't have an investment bank and we don't now have the asset management at that level. We're not an insurance distributor or an insurance creator. And we don't get into businesses that we don't understand well. But we get better in the ones we're in. So, Chris, I would say that you'll see more and more acquisition opportunity that's non-traditional in corporate trust and in the payments business. And when I say payments, I don't mean just card business. I mean mobile banking and some of the more innovative things that you're starting to read about because I think that will indicate an innovative company and one that can bring things to its customers earlier to market. So you'll see that kind of stuff in traditional banks, but nothing new. There's no space right now that we think we have uncovered. There's nothing we're doing now that we don't want to be doing. I don't think we've ever been more exacting to having the composition of earnings in revenue from the different places than we are right now. So if you like what we see, we're in a good position. We just like to be better at all of it.

Christopher Gamaitoni

And as far as on the credit side, are there any specific regions or MSAs or some MSAs where you're seeing particular weakness on the residential mortgage side or commercial real estate side?

Andrew Cecere

Yes, I mean, it is more regionally or really MSA-based now. And for us, the markets we're in, clearly, the most stressed remain the Southwest. So in and out of Las Vegas, both on the investor and residential side. Some of the markets in California, generally the further you are from the coast, living in the high desert or some of the central Valley markets are still very weak.

Christopher Gamaitoni

And then on the trust side, we saw a suit from Wells Fargo on EMC mortgage requesting files. That was yesterday. I know you're not, you don't usually trust deals. I was wondering if you received those types of requests. How many are proceeding? And just who bears the legal expense for that type of issue? Is that you or the trust?

Andrew Cecere

We do not bear the legal expense. Some of the rulings that you're seeing from the courts, again, we are in those as named only because we are the trustee. As we talked about in the script of the call, we do not hire the lawyers. We do not bear the legal expense. We do not bear the financial risk. We're not responsible for the foreclosure activity. We have a very specific role that we think we fulfill very well. And unfortunately, right now, that is not completely understood. It's complicated, I will give you that. But our role is very limited. And we do not bear the financial risk.

Christopher Gamaitoni

I wasn't talking about the foreclosure side. I meant more as trustee for private label where an investor instructs the trustee to issue a request for loan files.

Andrew Cecere

Yes. Our role on the private label is very similar to what I just described. So again, we have a very limited specific role that we fulfill. And to the extent there is expense related to that role, it is either borne by the servicer of the trust itself.

Richard Davis

It will be built in the contracts in the beginning as our duties and remuneration for handling the requirements of the trust.

Operator

I will now turn the conference back over to the presenters for closing remarks.

Richard Davis

Well, thank you, everybody. Thanks for staying past the hour. We're always at your beckoned call if you have any further questions.

I'd like to just say that, in following up on the last questions, I think we're getting to a pretty normalized predictable pattern here, where you can appreciate the revenue contributors, the expense discipline, the economy that will recover will help all of that. And our improvement in credit quality is now getting closer and closer, and we hope it will be over the long term. So we're not through this cycle yet, but I don't see any reason to think we'll falter at this stage, but to continue a slow methodical report -- peak back to something more normal. And our number one goal really is to get the dividends started again and begin to show the investors that we intend to give them back what they've earned over these years. We're looking forward to having that to talk about the next call. So Judy?

Judith Murphy

Thank you, all, for listening to our review of the fourth quarter. And please just always give us a call if you have additional questions. Thank you, Brooke.

Operator

Thank you. This concludes the conference. You may now disconnect.

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