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U.S. Bancorp (NYSE:USB)

Q4 2007 Earnings Call

January 15, 2008 1:00 pm ET

Executives

Judy Murphy - Director of Investor Relations

Richard Davis – Chief Executive Officer

Andy Cecere – Chief Financial Officer

Bill Parker - Chief Credit Officer

Analysts

Edward Najarian – Merrill Lynch

Nancy Bush – NAB Research, LLC

Matthew O’Connor – UBS

Chris Mutascio – Stifel Nicolaus

Todd Hagerman – Credit Suisse

Mike Mayo – Deutsche Bank

Brock Vandervliet - Galleon Group

Operator

Good afternoon and welcome to the U.S. Bancorp’s Fourth Quarter 2007 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 Ms. Judy Murphy, Director of Investor Relations. Please go ahead, madam.

Judy Murphy

Thank you for joining us today. This is Judy Murphy, Director of Investor Relations at U.S. Bancorp. Richard Davis, Andy Cecere, and Bill Parker, our Chief Credit Officer, are here with me to review U.S. Bancorp’s fourth quarter 2007 results and answer your questions.

If you have not received a copy of our earnings release and supplemental analyst schedules, they are available on our website at USBanc.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 report on file with the SEC.

I will now turn the call over to Richard.

Richard Davis

Thank you, Judy and good afternoon to all of you joining us today. I’d like to begin today’s call with an overview of our fourth quarter results and a review of some of the highlights. I’ll then turn the call over to Andy, who will provide you with additional comments about the earnings. After we’ve completed our brief formal remarks, we’ll open the line to questions from our audience.

U.S. Bancorp reported net income of $942 million for the fourth quarter of 2007. Earnings per diluted common share for the fourth quarter of $0.53 were $0.13 lower than the earnings per share in the same period of 2006, and $0.09 lower than the third quarter of 2007.

As we announced in December, the fourth quarter results included two items that in total reduced the earnings per common diluted share by $0.13. The first was a pre-tax charge of $215 million or $0.09 per diluted common share representing our proportionate share of certain litigation involving Visa and a number of Visa banks.

The second item was a pre-tax market valuation loss of $107 million or $0.04 per common diluted share related to the purchase of certain asset-backed commercial paper holdings from certain money market funds managed by a subsidiary, FAF Advisors.

Excluding these two one-time items, our earnings per share for the fourth quarter of 2007 would have approximated $0.66 per diluted common share. We achieved a return on average assets of 1.63% and a return on average common equity of 18.3% in the fourth quarter. Excluding the Visa charge and the market valuation loss, our return on average assets and return on average common equity would have been 2.01% and 22.6% respectively.

Our fourth quarter net interest margin improved from 3.44% in the third to 3.51% in the fourth quarter, a 7 basis point increase. This improvement in our margin, in addition to good quality growth in average earning assets, resulted in an increase in net interest income on a linked-quarter basis as well as on a year-over-year basis.

As we have said in the past, a stable margin is a key component of our long-term revenue growth assumptions. Our assumption going forward is that given the current rate environment, yield curve and our balance sheet mix, the margin in 2008 should settle in the mid 340s range comparable to that of 2007. Andy will discuss our rationale for these expectations in greater detail in a moment.

Once again our fee-based businesses exhibited excellent momentum. Payments-related fees were very strong this quarter, recording year-over-year core growth in the high teens. Trust and investment management fees increased by almost 8%, while treasury management fees, commercial product revenue and mortgage banking revenue also improved over the prior year.

As we discussed at our September investor conference, treasury management and commercial product sales have been specifically targeted for improvement via several revenue growth initiatives. This quarter’s results demonstrate that these initiatives have begun to gain attraction.

Although revenue growth in the fourth quarter is seasonally not as robust as in the second or third quarters for our company, payments, trust, and investment management fees along with commercial revenue all posted solid core growth over the prior quarter.

Mortgage banking revenue was lower on a linked basis by quarter by $28 million as an unfavorable change in the valuation of mortgage servicing rights and related economic hedging activity was partially offset by higher servicing revenue and production gains.

Our mortgage banking division continues to benefit from the recent market conditions with what we would call a flight to quality. Our mortgage products and service are first rate and our customers and business partners know that we are committed to originating and servicing high quality credit.

The growth in total revenue, net interest income and fees was 3.4% year over year. However, revenue growth, excluding the $107 million money market related asset valuation loss in the current quarter and a previously reported $52 million gain from the sale of the 401(NYSE:K) business posted in the fourth quarter of last year, would yield more than an 8% year-over-year increase in total revenue. The growth in total revenue on a linked-quarter basis was approximately 1% annualized. Excluding the money market-related asset valuation loss, total revenue grew by over 13% on an annualized basis demonstrating the powerful impact that a stable margin, coupled with our strong fee-based business, can have on our overall revenue growth.

Non-interest expense in the current quarter was $322 million higher than the fourth quarter of last year and $191 million higher than the previous quarter. Although certain expense categories tend to be seasonally higher in the fourth quarter, the majority of the dollar variance from both time periods was due to the $215 million Visa litigation charge taken in fourth quarter. A large part of the remaining increase in expense year-over-year and on a linked-quarter basis can be attributed to core growth and continued investment in both our fee-based businesses and our banking franchise.

Our efficiency ratio as reported for the fourth quarter was 54.7%. That declines to a more comparable 47.2% when adjusted for the fourth quarter Visa litigation charge and market valuation loss. We are one of the most efficient financial institutions in the industry.

As a company, we will continue to have a disciplined approach to expense control. It is our efficiency, after all, that allows us to continue to invest and maintain our industry-leading profitability metrics.

Turning to the balance sheet, total average loans grew by 5.4% year over year, led by solid growth in average total retail loans of 7.5% and commercial loans of 6.4%. As we indicated last quarter, commercial loan growth began to pick up during the latter half of the third quarter. Our fourth quarter results reflect that activity as average commercial loans grew by almost $3 billion or 6.4% year over year and over 18% on an annualized linked-quarter basis.

A significant portion of this growth came from the corporate banking and business equipment leasing groups and represented growth in both current and new relationships, again demonstrating that our growth initiatives are beginning to have an impact on our overall results.

Going forward, we expect that our company’s growth in both commercial and commercial real estate loans will be slightly lower than the industry average as we continue to concentrate on originating principally high quality credits and compete on price for the best customers.

We saw a very favorable change in our deposit trends this quarter. Average total deposits increased by 3.7% in the fourth quarter over the same quarter of last year and by more than 5% on an unannualized basis over the prior quarter. This deposit growth is, in part, the result of our company’s continued focus on and execution of our revenue initiatives.

Our credit quality metrics remained very manageable. As predicted, net charge-offs and non-performing assets rose moderately this quarter. Net charge-offs were 59 basis points of average loans for the fourth quarter of 2007, above the 54 basis points in the third quarter of this last year and higher than 47 basis points of average loans in the fourth quarter of 2006. These ratios represented a $26 million increase in net charge-offs on a linked-quarter basis and a $56 million increase year over year.

The increases over both the prior quarter and the fourth quarter of 2006 were expected. On the commercial side, stress in the homebuilding and mortgage industry led to an increase in net charge-offs, albeit small, at just $8 million. The most significant increase year over year on the consumer side was in the credit card loans net charge-offs, as growth in outstandings and a return to normalized net charge-off ratios led to this increase.

The credit card net charge-off ratio of 3.29% this quarter remains below our expected rate for this loan category as we anticipate this ratio to climb over time to its pre-bankruptcy reform rate of slightly over 4%, which will be still very low by industry standards.

Residential real estate related charge-offs, including consumer first and second liens, grew modestly over the same period of last year and over the prior quarter. We anticipated the growth in total net charge-offs to accelerate as we move into 2008 as stress in the commercial mortgage and homebuilding industries continue and the upward trends in delinquencies and the consumer residential real estate-related categories migrate to charge-off status. The increase in net charge-offs is expected to be manageable and within the expected through the cycle range.

As expected, non-performing assets also increased during the quarter to $690 million at December 31 from $641 million at September 30, a 7.6% increase. Given the current economic environment, we anticipate that our non-performing assets will continue to move higher but this increase will be very manageable.

I will now turn the call over to Andy who will make a few more comments about the quarter.

Andrew Cecere

Thanks Richard. I would like to begin by summarizing the significant items that have impacted the comparison of our fourth quarter results to prior periods. As Richard discussed, the current quarter included two significant items: first, the $107 million asset valuation loss; and secondly, the $215 million Visa litigation charge. Earnings per diluted common share without these items would have been $0.66.

The third quarter of 2007 also included a charge of $115 million related to Visa litigation. This charge represented the company’s proportionate share of the litigation settlement between Visa and American Express. Third quarter earnings per diluted common share without this charge would have been $0.67.

Finally, the fourth quarter of 2006 benefited from three notable items, including a $52 million gain on the sale of the company’s 401 recordkeeping business; a $22 million charge to prepay certain debt; and a reduction in tax liabilities related to the resolution of certain state and federal tax examination.

After consideration of these items, the fourth quarter 2006 earnings per diluted common share would have been approximately $0.61. Hopefully this gives a little clearer view of our earnings moving into 2008.

Net interest income in the fourth quarter was higher on both the year over year and linked-quarter basis. The $68 million increase in net interest income over the fourth quarter of 2006 was the result of a $10.6 billion increase in average earning assets which was enough to more than offset the 5 basis point drop in the margin.

The $78 million increase in net interest income on a linked-quarter basis was the result of a 7 basis point increase in the margin and a $5.4 billion increase in average earning assets.

The margin contraction year over year can be attributed to slightly tighter credit spreads, primarily due to competitive loan pricing and a decline in net refunds relative to a year ago. An increase in loan fees and a relative improvement in wholesale funding rates partially offset these negative factors.

As Richard mentioned, we are comfortable with the expectations that our net interest margin will settle in the mid 340s in 2008 which would be comparable to the full year margin in 2007.

The fourth quarter margin was slightly higher due to a number of positive events, including a lag in the repricing of a portion of our consumer products in conjunction with the last rate decrease; higher yield-related fees; our ability to garner favorable short-term funding rates during the current market turmoil; and an increase in EFI funds due to the absence of share repurchases in the fourth quarter.

Going forward, our expectation for a stable net interest margin is based on steady to slightly improving credit spreads, continued growth in higher spread products, including credit card and other retail loans, and normalization of funding and liquidity in the overnight markets and the resumption of our share repurchase program.

Our capital position remains strong. In anticipation of the need to purchase certain securities from the rated money market funds managed by FAF Advisors, the company did not buyback shares of stock in the fourth quarter of 2007. For the full year 2007 however, 58 million shares were repurchased. These repurchases, combined with our quarterly dividend, resulted in 111% return of earnings to shareholders for the full year 2007, well above our 80% goal. We remain well capitalized at quarter end with a tier one capital ratio of 8.3%, just slightly below our target ratio of 8.5%, and a total capital ratio of 12.2%. We anticipate that we will return our target tier one capital ratio by March 31st 2008.

Richard will cover the highlights of our credit quality statistics for the quarter, but I wanted to update our exposure to sub-prime lending. Our exposure to sub-prime residential loans is minimal and very little has changed from the end of the third quarter of 2007.

As of the end of this quarter, we had $4.2 billion of residential real estate loans and home equity and second mortgage loans outstanding to customers that could be considered sub-prime. Those two portfolios represent 2.7% of total loans outstanding as of December 31. Although the percentage of sub-prime loans is very small, we have taken steps to address concerns related to the repricing of the adjustable rate mortgages and the impact that may have on our current customers. This program was instituted in the spirit of the model introduced by the federal government, but we feel that it contains additional flexibility. The result of this program will be an increase in the total of restructured loans reported by the company as we move into 2008.

My final comment relates to an accounting change that will impact the results in 2008. Effective January 1, 2008 the company will adopt Financial Accounting Standards 157, Fair Value Measurements and 159, Fair Value Options as required by the Financial Accounting Standards Board. The impact to our financial statements from the adoption of these accounting standards will be an expected reduction in earnings per common diluted share of approximately $0.02 at the time of adoption in the first quarter of 2008 and approximately $0.03 for the full year 2008.

I would now like to turn the call back to Richard for his closing remarks.

Richard Davis

Thank you, Andy. Last September at our investor day meeting I announced the formation of a new division in our company focused on revenue growth. We are calling this new division the Enterprise Revenue Office, the ERO, and appointed [Mac McCulla], a name familiar to many of you, to lead this effort.

As you might also remember, I discussed the first group of activities the Enterprise Revenue Office will focus on. A set of 15 initiatives focused on building deeper relationships with our customers. These 15 initiatives are expected to generate between $500 million and $750 million of incremental annual revenue beginning in 2009. I am very pleased to report that we will have six or seven of these initiatives up and running in pilot form in the first quarter, including three of the largest opportunities.

In addition, we are finalizing a number of activities that will allow us to become more proactive and disciplined in the pursuit of new sources of revenue; in particular, as it relates to leveraging our broad payments capabilities. I will continue to keep you updated on the progress we are making as these important activities begin to gain traction.

December marks my one-year anniversary as CEO of this company. Although the first year of my tenure proved to be anything but business as usual, for us and the others in the financial services industry, I am very pleased with the strides we have made in positioning of this company for the challenges that lie ahead

As you can see from the quarter’s results, we have managed through this environment well. Our management team is focused on the future and working on initiatives that will capitalize on current products, services and our geographic reach while working with our new ERO to innovate and deliver new products and services for our current and our future customers.

As a company, we will continue to utilize our core financial strength including our profitability, efficiency, prudent credit culture, capital management, and customer service while selectively investing in growth of our businesses and people, both organically or via small strategic acquisitions to lead our long-term goals without taking risks that could jeopardize our future.

This company is well positioned to produce a consistent, predictable and repeatable earnings stream going forward for the benefit of our customers, our community, our employees and our shareholders.

That concludes our formal remarks. Andy, Bill and I will now be happy to answer any questions from the audience. Operator, we’re ready.

Question-and-Answer Session

Operator

Your first question will come from Ed Najarian - Merrill Lynch.

Ed Najarian - Merrill Lynch

Good afternoon Richard. Just two quick questions. It sounded like from Andy’s remarks that you would not be repurchasing stock in the first quarter, but would expect to resume repurchasing stock in the second quarter and beyond, is that the right read?

Andrew Cecere

Hi Ed, we did not repurchase in the fourth quarter, this is Andy, we did not repurchase in the fourth quarter in anticipation of the FAF transaction. We will start to repurchase late in the first quarter. Our first objective is to retain, get back to the 8.5% tier one ratio, but we do expect some, albeit a low level of purchases in the first quarter and back to a normalized level in future quarters.

Edward Najarian – Merrill Lynch

It looked like operating costs, even after backing out the Visa litigation charges, were stepped up pretty noticeably. I guess obviously related to a number of the revenue growth initiatives that you touched upon. Is that sort of core expense level sort of a base level now from which we can think about sustaining or growing from given the fact that you’re moving forward with power banking and a number of other revenue initiatives that you discussed or would you expect a step down a little bit from the fourth quarter level?

Richard Davis

You know Ed, the answer is I believe that represents the direction I’d like to go in having a higher expense base but offset when the revenues starts to show, so let’s agree that we’re starting to move that number up, we still speak and will have positive operating leverage for the year of 2008, but in the beginning stages of an investment curve that we’re in, I suspect that will probably be a bit of the expenses ahead of some of the revenue and at this point I hesitate to cut back on that to the point that I’ll either delay or lose the benefits that we’re creating now and the momentum.

So from the near term I think you’re seeing us at a new run rate base, but as we deliver the revenue that I’m expecting that will continue to keep the positive operating leverage and the industry leading efficiency ratio that you’ve come to expect and you can have my word that should we not find the revenue coming about we have all kinds of opportunities to reduce the expense flow to make sure that we protect our ratios.

Edward Najarian – Merrill Lynch

Okay thank you, that’s very helpful and very good quarter, especially relative to what we’re seeing from peers.

Operator

Your next question will come from the line of Nancy Bush with NAB Research, LLC.

Nancy Bush – NAB Research, LLC.

Also known as Nancy Bush. Could you just speak to the deposit growth, is this coming in a particular geographic area or product because it’s rather startling to see so much deposit growth in such a short period of time and is there something here that has kicked in and should we expect more going forward?

Andrew Cecere

Nancy, two things, I would say part of the deposit growth was unique to the fourth quarter, we have some acceleration of broker dealer growth and activity that I would call more temporary in nature, but even peeling that back we are starting to see growth in our core consumer deposit products. We are adapting a number of new products and a couple of pricing strategies. Still within our constraints and range but we are seeing some core growth in consumer deposits on the savings and checking side so I think we are starting to see a turn to the curve that we’ve experienced the last couple of years.

Richard Davis

So Nancy, you’re right, it is a meaningful change in the past and I think it’s one that a lot of people hopefully would do someday. It’s not at the cost of the increment of our margins but we are taking advantage of some of the margin attributes that allow us to firm up and at the same time start being more competitive in some of these markets.

Power base, to Ed’s earlier question is one of those areas but you will see us take different approaches in our community markets or in the markets that we have low market share which we’re calling a program called Self Banking where we will be more aggressive in markets where the disintermediation risk is so much lower, so if we do our job well you will see a slight increase in the cost of deposits managed against the overall margin remain flat and the growth of core relationships which is something we’ve been long coveting for many years.

Nancy Bush – NAB Research, LLC.

Great and secondly if you could just speak to the profitability of mortgage banking right now, I mean there’s been a great deal of hope that the remaining players would see better quality loans, better profitability, increase market share, if you could just speak to whether that is yet being seen?

Richard Davis

You know Nancy it is for us, I’m happy to report, didn’t have to change any of our protocols, our products, our broker stream, we were doing exactly the business a year ago that we’re doing today. We’re seeing a highlight now of the flight to quality that we call that in our notes, it’s a funny way to say it but we do have customers and partners wanting to do business with us because we haven’t changed our products that we haven’t changed our return on the focus of customer service and under the leadership of Danny [Orgoniya], our first mortgage business, you know we’re in the high teens as a national ranked mortgage provider and mortgage servicer, that’s a great place for us to be because it’s a great business.

Our own customers get our own business, we do a lot of business for others, but it is for us a high quality business and actually the margins have improved because of the flight to quality. That along with the hedging acumen that Andy has to bring to the table to make sure that the business is managed in this difficult time has given us a very robust view of the future of mortgage banking. It’s one of our growth initiatives based on the size that it has in the company. Andy, did you want to add to that?

Andrew Cecere

The only thing I’d add Nancy is in the fourth quarter, given the dramatic change in interest rates day to day and the turbulence that occurred our head results were a little less than the third quarter and that’s some of the decline you’re seeing on the [link] quarter basis but the core underlying servicing and production revenue is very strong.

Nancy Bush – NAB Research, LLC.

Great, thank you.

Operator

Your next question will come from the line of Matthew O’Connor with UBS.

Matthew O’Connor – UBS

Richard, can you talk a little bit about how you can take advantage of the current downturn? Obviously you’ve held up a lot better than others from an earnings point of view, your capital is intact, there’s [Overlay: Thank you] set up better, you mentioned some opportunities in the commercial lending side but are you looking at other opportunities in this downturn?

Richard Davis

I understand where the question said is let me answer in two parts. The first one, not exactly what you meant but, while a majority of our peers I believe are focused on internal action, not the least of which would be capital preservation, dividend reviews, line of business reductions and perhaps contraction of employees. We’re not working on any of those things and so issue number one is we have the ability to be focused on continuing to power through on the initiatives that this company has long been focused on which is to be as great an offensive stock as you’ve known us to be for years as a defensive stock. And we would be doing that anyway but given that our peers might be focusing on other things, that’s the distinct advantage.

Follow up to that is we have made that, I think, very clear to our 54,000 employees by emboldening them to be all the more advantageous in dealing with the very best customers and prospects we may heretofore not seen and take advantage of our window of opportunity and be very aggressive in the pride that they should feel about the company that they keep. So we’re getting a lot of the, I’ll call it the 12th man on the team kind of benefit, we’re not shrinking away from that advantage.

In terms of the real technical and financial advantage, let’s agree that to have a distinct PE advantage to your peers is something to understand and to manage. In this case we just finished our board meeting here this morning, we’re off-site today in Atlanta where you know Novus is headquartered and during the board meeting we discussed issues about being very prudent with our advantages, keeping our powder dry to make sure we understand what material items in the next quarter or two in this great environment and let me say for anybody who wants to not be confused, we have no desires or need to do any transactional event or transformational event to keep this company moving forward as well as it can.

And yes, we have advantages you must understand them, evaluate them and make sure you don’t leave them unfettered and we will continue to look at those advantages and make sure that we don’t miss the chance where something may come along but we are not seeking it, we are not looking for it, we like who we are, where we’re headed, I love the fact that we’re not under any disruption, but I’m not going to look a blind eye to opportunities if something comes along. So, it’s not a goal but we’re not going to overlook an opportunity if something comes along but it would certainly have to present itself and it hasn’t yet.

Matthew O’Connor – UBS

And Richard just a follow up on that last point, I mean you might be in a position where you’re in the driver’s seat where there’s a lot of potential sellers just a few potential buyers, are you looking at is, just prioritize just in terms of what’s most important from a financial point of view, strategic new business lines, seems like you might have your pick to those new places or new geographies.

Richard Davis

Right, I would say to order things number one, number two and number three is financial. This has just got to make sense for our company in the near term and the long term. You’re not going to hear us consider deals and wile away the issues of two years of dilution or marginally accretive, that’s not smart. This company is in a great position and in fact arguably at the sixth largest sized, maybe at the last point, large enough to be able to understand and manage without being too big to be complex. So, I’m going to be very prudent with the use of our capital and our position and not dilute what got us here.

And then if that financially made sense then strategically it would have to fit, that would be the second gateway because we literally do things that make sense and as I know it today, Matt, we’re still focused on small in-market acquisitions that make sense in the deepening of the markets that we’re in. Small but meaningful and perhaps strategic payment opportunities anywhere on the globe that makes sense and continue to look at that trust and wealth management business where there are businesses that I think will come to us in the next quarter or two from some companies downstream that say I really think I don’t want to get in this business anymore, I want someone else to do it for me and you guys have a track record.

So financial first, strategic second and both are required before we go to any third of fourth considerations.

Matthew O’Connor – UBS

Okay, thank you very much.

Operator

Your next question will come from the line of Chris Mutascio with Stifel Nicolaus.

Chris Mutascio – Stifel Nicolaus

Good afternoon all. I think first question, Andy could you itemize the things that caused the benefit to the fourth quarter margin again, went kind of fast and I could write them down and then maybe provide how much each of those items benefited the margin?

Andrew Cecere

Sure, there are three principle reasons for the margin improvement. Number one is that we did not purchase stock in the fourth quarter so our free funds were actually higher because of that lack of repurchase.

Number two is that we did benefit from the downward trend in rates, as you know we are liability sensitive and as we projected in the downturn in rates we benefit and that helped us out in margin.

And then finally as you also probably know, the last month of the year and principally the last half of the last month there was a lot of turbulence in the financial markets which allowed us to actually benefit quite substantially in terms of our wholesale funding cost day to day. There is a bit of a flight to quality and we had some days there where on an overnight basis we were borrowing at a low rate.

My expectation is all three of those things will begin to normalize and as we talked about, our expectation for ’08 is to get back to that mid 340 margin for the full year.

Chris Mutascio – Stifel Nicolaus

You say those three items provide you seven basis points, ten basis points of margin?

Andrew Cecere

You know, again, I don’t have each one itemized specifically but a combination of all of those things are sort of the seven basis points.

Chris Mutascio – Stifel Nicolaus

Okay, if the Fed keeps cutting interest rates as aggressively as some may suggest wouldn’t you still benefit from at least the trend in rates going down further?

Andrew Cecere

You are correct we are still liability sensitive but I will also say that given that where rates are today on some deposit products, we are going to start to reach a floor on our downward pricing, so that the benefit, while still there, will begin to diminish as rates continue to go down.

Chris Mutascio – Stifel Nicolaus

Okay and I can ask one follow up question, on the actual qualities, clearly is going to look better than most are going to report over the next couple days but I guess the one that you could look at is the 90 day past due was up 30% sequentially, is there any concern there that it’s a harbinger of things to come in terms of inflows and NPAs at some point?

Richard Davis

Chris this is Richard and I want Bill to answer that but yes, that is a concern and yes so is the fact that 30, [80 and] 90 continue to be finding themselves back down to a more normalized level, so if anyone in the next couple weeks tells any of you differently, we have a pretty good view of the next 90 days in banking, we have a very blurry view after that. I mean you just can’t really possibly predict much beyond your delinquencies and your charge off routines.

Bankruptcies can come in faster from the sides than they used to be and the valuation losses, not dependent on how predictable you are on your loss by customer’s ability to repay, the actual loss for instance this case autos or homes or other things are much more difficult to predict than they used to be because the market has so many moving dynamics, so we are concerned about that, we did plan as you know, we’ve telegraphed that our net charge offs and our non-performers will grow over the course of the year. We expect that, if it changes the trajectory we will telegraph that to all of you. At this point it’s definitely as we expected it to be and we’re not immune but we don’t see any reason to pull the trigger or call in for any kind of onetime event in order to account for any surprises that we didn’t see at this point. That would be the CEOs approach, but let the chief credit officer give you their real facts that might make more sense.

Bill Parker

Yeah we did see some stickiness in the 90 days over the holiday season that was probably a little more than we normally see, but as Richard said, the good news was on our residential mortgages portfolio, including home equity, we were actually flat to down on our 30 to 89 day delinquencies. So that was a positive development for us.

Chris Mutascio – Stifel Nicolaus

Thanks for the candor.

Operator

Your next question will come from the line of Todd Hagerman with Credit Suisse.

Todd Hagerman – Credit Suisse

Good afternoon everybody. A couple questions, just a follow up along those lines, just in terms of the comments that you made before just in terms of expectation for accelerating delinquencies and so forth and higher charge offs, Richard I think you mentioned that the expectation is that it will still remain within through cycle type of a range, could you just kind of frame that out for us in terms of how you’re thinking right now and whether or not the Board and Senior management has kind of thought through the potential in terms of recession scenario and how that may impact those figures?

Richard Davis

I think I’ll have Bill answer the first question, but Todd let me go with the last one. You might expect that we’re fairly good students of our own numbers and we have a recession scenario that we’ve built in our profit plan which is particularly watching for these signals, the early indicators and then reacting if need be on the expense side of the equation to respond to that so we protect our original commitments.

We’re not seeing these events yet that would cause us to trigger our recession scenarios neither at the company level or at an individual line of business level, but you can rest assured we have done our homework, we know exactly what that looks like. For US Bank we’re a fairly large consumer based company, so should there be a recession or a technical slowdown either way, it effects us on the credit side, it also effects us in the customer demand side and it effects our payment businesses both on the acquired and issuing side. So yes we and the Board have talked about that and we’re good stewards of what’s possible, but we’re also operating in what we know today which itself fairly decent growth, albeit a bit slowing, it’s manageable for us and based on the mix of businesses there are some counter-intuitive activity that goes on where some areas are actually strengthening at times and others are weakening.

So on the recessionary preparations, we are prepared for that and have looked at our moving parts. Regards the rest of it in terms of actual credit performance, let me have Bill add that.

Bill Parker

Yeah you referred to the through the cycle comments and we defined that before as between 60 and 80 basis points, if you look at our balance sheet we do have a fairly sizable credit card portfolio relative to the size of our balance sheet and as we’ve stated we do expect those losses to move up into the low 4% range and as it does that we will move up in that range of that through the cycle.

Richard Davis

So Todd, I think we are making clear to you guys we tell you what we know. We said 60 to 80 over the cycle and in our minds that would be the range in a more traditional time, post this bankruptcy reform and all the other things. These numbers could move on the high end or slightly above that range that we just said depending on how the performance of credit cards and the real estate businesses perform.

We’re not seeing it go above that yet, we’re definitely seeing in that range at the high end and we’ll telegraph that to you as quickly as we see anything otherwise, but we would not as I said be immune and at this point we did not add to provision, we don’t feel we need to, we’re adequately provided for, we’re going to watch the earnings of the other banks and see that they’re addition to provisions might place us in a relative ranking, on an absolute basis we’re very well provided and we want to make sure on a comparative basis we are as well so we’ll continue to visit that but at this point in time I think you would agree if you looked at our numbers that we’re in a good position and a strong healthy balance sheet right now.

Todd Hagerman – Credit Suisse

I appreciate those comments and if I could just add a follow up, just again along the lines on the mortgage side, the reference to the increase in the restructured loans this quarter, could you just provide a little bit more color around that, specifically, you made reference to the sub-prime piece and being a driver of that increase, could you just talk a little bit more about what exactly kind of proportionally the composition there and any other, whether it’s accounting changes or I should say policy changes that may have been made within the residential mortgage portfolio that allows you to become a little bit more proactive in terms of managing these elevated delinquency levels?

Bill Parker

What we looked at in our sub-prime first residential mortgages and what we looked at was a pool of customers in our sub-prime portfolio that have always made their payments as agreed at a certain level for two to three years and they were facing interest rate resets which would cause a higher payment level and what we did was chose to provide relief to them in the form of allowing them to maintain their current level of payment. So it’s still a performing mortgage, but accounting treatment would say you have to report it as a restructured loan.

Richard Davis

Todd, this is Richard, I’m actually quite proud of that action, we’ve contemplated and built the rules before the President’s recommendation and while it may not be five years as was recognized by the President’s commission, it’s an extensively larger set of customers based on a different measure of need and in our case let it be said that US Bank doesn’t want to own a house. We don’t want to put people out of their houses and we want to do what’s right. Our profit plan predicted that we would not enjoy those increases for the next couple of years and it’s to that extent of the protection people and protect our assets that makes a lot of sense to us and for our shareholders.

Bill Parker

Okay and again just any policy changes to speak to in terms of with the mortgage portfolio specifically in terms of how you’re recognizing either the charge off or foreclosure process?

Richard Davis

No, none.

Bill Parker

Okay, terrific, thank you.

Operator

Your next question will come from the line of Mike Mayo - Deutsche Bank.

Mike Mayo – Deutsche Bank

I know we talked before about competitive pressures and I thought you said it’s easing up some on mortgage. But more generally, are you seeing the competitive conditions getting better, worse or are they the same?

Richard Davis

I’m seeing them to be the same, may be a little different variation on things but for us, pricing is not quite as aggressive as it’s been, in part because I think it is just the inward focus a lot of companies are looking at. When you are inwardly focused you try to shave off the edges on everything, in this case it might be shaving down some of the pricing comparisons.

So for us, we’ve always been a low-cost provider and a challenger in the market for price for the very top customers. That is a little better than it’s been in times past, in part because I think we are leading with a certain level of certainty that we may not have had on a relative basis before.

On the positive pricing side, the actions -- not the least of which that were taken yesterday -- do assist us in some of the less rationale deposit pricers moving away from the competitive view; and that’s not to say we don’t give our customers what they deserve, but it is nice to have less pressure on some of these unrealistic deposit gatherers with the FDI fee insurance that’s been provided to them, it’s very hard to compete.

So I think there is current and will be a slightly beneficial deposit pricing going forward. Absent that, everyone is out there clawing for the next customer and doing what they can to make sure that they offset some of these pressures with decent revenue growth; so on that side, it is as competitive as it has ever been and I think in our case we just have a slight few advantages that we’re seeing.

Mike Mayo – Deutsche Bank

What about your willingness to extend credit? Have you pulled back even just a tiny bit based on what you are seeing with your credit losses for the industry?

Richard Davis

I’ll let Bill answer that technically, but the answer is in certain things, yes; but for the most part no, because this is my moment to say to you all we weren’t doing most of this for the last few years and many folks criticized us for not growing our assets more robustly and now that we haven’t changed our formats we are still growing at about the same levels we were, but it appears to be a little more core than maybe it was known to be before.

So for us overall no, we are not changing our approach or our policies but on the other hand there were a couple of categories –

Bill Parker

Really the only category that we are not originating out of anymore -- which was never that significant -- is the sub-prime home equity. We have less than a $1 billion, we still have less than $1 billion and it’s running off right now.

Richard Davis

That’s about it.

Operator

Your next question comes from Brock Vandervliet - Galleon Group.

Brock Vandervliet - Galleon Group

I just wanted to confirm your over the cycle comment. I am assuming that’s an average number, 60-80 basis points over a cycle, correct?

Richard Davis

That’s correct.

Brock Vandervliet - Galleon Group

So at a peak period of losses, what would that imply, 100?

Richard Davis

In our mind, the 90 to 95 is on the high end of that range and the 55 to 60 is on the low end so when we get to the core that 60 to 80 is right in the center of that curve.

Brock Vandervliet - Galleon Group

I am relatively new to this story; if you could just review your home equity exposure?

Andrew Cecere

90% of our home equity portfolio is originated out of our branches. That’s all prime and it has a weighted average loan-to-value of 71%. Then there is the only other piece, which is this less than a $1 billion I referred to that’s in the finance company. That’s it.

Brock Vandervliet - Galleon Group

Of the home equity paper, what percent do you have the first mortgage in front of it?

Andrew Cecere

I think about 20 to 25% where we have the first mortgage held.

Richard Davis

Brock, welcome to the story. If we had an hour, I’d tell you the rest of it but I will say that our finance company is a wholly owned startup from 1995; it was started from the old Star Bank in Cincinnati. It has always been a homegrown product that has been led by a guy named Randy Griffith who has led us through all of these difficult times with no remorse and no regret as to the kind of businesses we offered our customers.

Sub-prime for us has always has been first and foremost customers who qualified at a different price point and in this case, they are stressed for sure, but there’s never been a single point of failure for our company nor has it been a major earnings stream. It’s just been part of the composition of building customer relationships. By the way, as they graduate to prime they have been welcomed into the bank at the prime level and have been part of our long-term growth; you just couldn’t see it over the years.

Andrew Cecere

I will just add on the prime portfolio that this branch portfolio which is 90% of the business, the net loss rate on that in the fourth quarter was 21 basis points.

Brock Vandervliet - Galleon Group

Finally on the 90-day past due, is that mostly a seasonal impact that you would expect to settle back down here in Q1?

Andrew Cecere

It should come back down and there is a seasonality to it, but as I said earlier, there was some stickiness that we did not see in previous holiday season.

Brock Vandervliet - Galleon Group

Thanks for taking all the questions.

Richard Davis

Brock, to follow-up on that for everyone’s sake, as I said earlier, we do operate under the traditional old fashioned banking knowledge that 90-day delinquencies are a predictor of future charge-offs; 30 day delinquencies are predictors of potential problems. Bankruptcy is a kind of out of the sight, comes out as a surprise sometimes but you get that information and all of a sudden it is your new bankruptcy.

The valuation of both homes and automobiles is probably the one thing that’s most volatile now because our predictability has been proven to be absolutely on point. We have a really good idea of who is going to go delinquent or who is going to have a charge-off. What we don’t know as well as we used to, by no fault of our own, is the amount of that loss, until which time the valuations are clear and either deals are settled in the marketplace or we get the results after the fact.

So, I think it’s important. We are one of the first banks to report that as you look at this course of the credit, most banks are quite good at understanding risk of charge-off or risk of default and loss for commercial and consumers; but the ability to size the absolute loss is probably more difficult than it’s been.

So, we are not hedging, we are not trying to act like we don’t know, and we are also not sitting on something we know that’s bad either because we simply can’t see much beyond 90 days probably most certainly within 45 and after that we just watch the signals and we will adjust to it as we learn.

For me, as the head of a company that’s got its basis on risk management and understanding customer relationships, it is not only what happens but it’s how we treat our customers for the period, it’s how we manage with them to try to help them get through this time that will forever build relationship that will go generations forward. If we’re there to help them when the times are tough and that is our number one objective -- not at the cost of the shareholder, but at the benefit of the shareholder -- and that’s the art of the science here.

Operator

We have no further questions at this time. Are there any closing remarks?

Richard Davis

There are, thank you operator. Thank you, Tina. I just want to thank you all once again for following this company and showing an interest if you’re an investor, thank you for that.

I’ve always closed my presentations -- and I won’t hesitate today -- to close with a commitment that this company focuses on being among the very best banks in the country in every measure; to be consistent, predictable, and repeatable. I can’t think of a time that that will mean more than it does in this very volatile time.

We are not the savants, we are not mind readers, we don’t know exactly what’s going to happen in the future, but we know our company very well. We know everything going on inside of it and we are quite pleased to present to you these results for Q4 and for 2007, despite my chagrin that the shareholder did not gain a return last year from U.S. Bancorp, over the long course of time they have and it’s our hope that over the long course of the future they will again as well.

So, we look forward to continuing to communicate with you, especially during the quarter as we progress through this challenging time. If there is any news to tell you we’ll be the first to tell you. Thanks operator.

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Source: U.S. Bancorp Q4 2007 Earnings Call Transcript
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