Earnings Call Transcript
US BANCORP \DE\ (USB)
Earnings Call Transcript - USB Q2 2022
Operator, Operator
Welcome to the U.S. Bancorp’s Second Quarter 2022 Earnings Conference Call. Following a review of the results by Andy Cecere, Chairman, President and Chief Executive Officer; and Terry Dolan, Vice Chair and Chief Financial Officer, there will be a formal question-and-answer session. This call will be recorded and available for replay beginning today at approximately 11:00 a.m. Central Time. I will now turn the call over to Jen Thompson, Head of Corporate Finance and Investor Relations for U.S. Bancorp. You may go ahead, Jen.
Jen Thompson, Head of Corporate Finance and Investor Relations
Thank you, Cheryl, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and CEO and Terry Dolan, our Chief Financial Officer. During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the slide presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I’d 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 Andy.
Andy Cecere, Chairman, President and CEO
Thanks, Jen. Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will take any questions you have. I will begin on Slide 3. In the second quarter, we reported earnings per share of $0.99, which included $0.10 per share of merger and integration charges related to the planned acquisition of MUFG Union Bank. Excluding these notable items, we reported earnings per share of $1.09. We achieved record net revenue this quarter totaling $6 billion. Second quarter results were highlighted by strong revenue growth driven by robust net interest income and fee revenue and stable credit quality. Revenue growth was driven by strong growth in earning assets and the benefit of rising rates as well as good underlying business activity and customer acquisition trends across our fee businesses. Additionally, our multiyear investments in digital payments and technology are paying off in the form of strong top line growth and enhanced efficiency. This quarter, we added $150 million to our loan loss reserve, reflecting strong loan growth and our consistent through-the-cycle approach to risk management. Our credit quality remains strong and we are not seeing any trends in early-stage metrics that cause us concern. At June 30, our CET1 capital ratio was 9.7%. Based on the results of the Federal Reserve’s 2022 stress test that were published in June, we announced that we expect to be subject to a preliminary stress capital buffer of 2.5%, unchanged from the current level. We believe our industry-leading results demonstrate our ability to withstand a severe economic downturn, which is a testament to the strength, quality, and diversity of our balance sheet and our prudent approach to managing risk. Slide 4 provides key performance metrics. Excluding notable items, our return on average assets was 1.16% and our return on average common equity was 15.3%. Our return on tangible common equity was 20.5% on a core basis. Slide 5 highlights digital trends and engagement. I will now turn to Slide 6. We believe our digital capabilities and our complete payments ecosystem are competitive advantages that will drive meaningful profit and return differentiation for our company over the next several years. Our state-of-the-art digital capabilities have not only created a more effective and valuable experience for our customers, but they have allowed us to expand our distribution reach beyond our physical infrastructure while optimizing our existing branch network. On the left side, you will see that the success we are having with our State Farm partnership, which is driving more customers, more loans, and more deposits to our platform in a cost-effective way. The chart in the middle highlights the strong trends in the uptake of our talech point-of-sale functionality, which allows small business customers to manage their banking and payments needs in a simple, easy-to-use format that we provide in the form of a dashboard. And on the right, you will see the momentum we are gaining in real-time payments transactions, which, through midyear 2022, are 10 times higher than the total number of transactions we saw for the entirety of 2020. We are excited about the secular growth opportunities we see across all of our business lines, but I’d like to highlight one area on Slide 7—our business banking initiative—which is really starting to gain traction. On the left chart, you will see the opportunity we have previously discussed to connect our banking customers with our payment products and services and our payment customers with our banking products and services. The chart on the right shows the progress we are making in growing accounts and expanding wallet share. Growth and relationships with both banking and payments products have meaningfully outpaced growth in total relationships over the past 12 months. And it’s worth noting that we are still in the early innings. Now, let me turn the call over to Terry who will provide more detail on the quarter.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks, Andy. If you turn to Slide 8, I will start with a balance sheet review followed by a discussion of second quarter earnings trends. Average loans increased 3.6% compared to the first quarter, driven by 6.9% growth in commercial loans, 4.1% growth in credit card, and 3.6% growth in mortgage loans. Commercial loan growth reflected increased business activity and higher utilization rates across both large corporate and middle-market portfolios. Pipelines are strong going into the third quarter and working capital needs remain elevated. In the retail portfolio, we saw good growth in credit card balances, reflecting strong spending activity and typical seasonal trends. Purchase mortgage market share gains and lower prepayment activity continue to support residential mortgage balance growth. Turning to Slide 9, total average deposits increased by 0.5% compared with the first quarter. Growth in interest-bearing deposits more than offset the impact of lower balances of non-interest-bearing deposits, reflecting the rising interest rate environment. Total average deposits increased by 6.4% compared with a year ago. Slide 10 shows credit quality trends, which continued to be strong across our loan portfolios. The ratio of non-performing assets to loans and other real estate was 0.23% at June 30 compared with 0.25% at March 31 and 0.36% a year ago. Our second quarter net charge-off ratio of 0.20% improved slightly versus the first-quarter level of 0.21% and was lower compared with the second quarter of 2021 level of 0.25%. Credit performance across our commercial and retail portfolios continues to be strong. On a linked-quarter basis, both early and late-stage delinquencies decreased for the total portfolio. Our allowance for credit losses as of June 30 totaled $6.3 billion or 1.88% of period-end loans. Slide 11 provides an earnings summary. In the second quarter, we reported $1.09 per diluted share, excluding $0.10 per share of merger and integration charges related to the planned acquisition of MUFG Union Bank. Turning to Slide 12, net interest income on a fully taxable equivalent basis totaled $3.5 billion, representing an 8.3% increase compared with the first quarter and a 9.5% increase from a year ago. Linked quarter growth was driven by strong earning asset growth and a 15 basis point increase in the net interest margin. Slide 13 highlights trends in non-interest income. Non-interest income grew 6.3% on a linked-quarter basis but declined by 2.7% from a year ago as lower mortgage banking revenue more than offset strong performance in other fee businesses. The decline in mortgage banking revenue primarily reflected lower refinancing activity in the market, which continues to pressure total application volumes and related gain-on-sale margins. In the second quarter, total payment fee revenue increased by 9.7% compared with the year earlier, reflecting strong underlying business trends supported by investments we are making. Slide 14 provides linked quarter and year-over-year revenue growth trends for our three payments businesses. Because of the cyclical nature of our payments businesses, we believe year-over-year trends are a better indicator of underlying business performance in a normal environment. Credit and debit card revenue increased 0.8% on a year-over-year basis as the impact of higher credit and debit card volume was offset by lower prepaid card activity. Excluding prepaid card revenue, credit and debit card revenue fee revenue would have increased 10.1% compared with the second quarter of 2021. Year-over-year credit and debit card revenue growth rates continue to be negatively impacted by the decline in prepaid card revenue as the benefit of government stimulus has dissipated. The bottom half of the slide illustrates the strong year-over-year growth rates in both merchant processing and corporate payment fee revenue over the past several quarters. While we expect the year-over-year growth rates to moderate from current levels, we continue to believe that both merchant processing and credit and corporate payment fee revenue can grow at a high single-digit pace on a year-over-year basis in a post-pandemic environment. Slide 15 provides some additional information on our payment services businesses. On the right side of the slide, you can see the strong momentum we are seeing in tech-led revenue growth within our merchant acquiring business. In the second quarter, tech-led merchant revenue, which accounted for 27% of the total merchant acquiring revenue, was 13% higher than a year ago and 43% higher than the comparable 2019 period. A key to that trajectory is the strong growth we have seen in new tech-led partnerships. In the second quarter, new tech-led partnerships totaled 1.6 times the number of new partnerships we acquired for the entire year of 2019, and we continue to add to that customer distribution baseline. Turning to Slide 16, non-interest expense increased by 0.7% on a linked-quarter basis, excluding merger and integration costs associated with the pending acquisition of Union Bank. The change in expense was driven by higher compensation expense, marketing, and business development expense and other non-interest expenses, partially offset by lower employee benefit expense and other expense categories. The higher compensation expense was driven by the impact of seasonal merit increases and one additional day in the quarter as well as variable compensation tied to revenue growth. Slide 17 highlights our capital position. Our common equity Tier 1 capital ratio at June 30 was 9.7%. As a reminder, at the beginning of the third quarter of 2021, we suspended our share buyback program due to the pending acquisition of Union Bank. After the closing of the acquisition, we expect to operate at a CET1 capital ratio of approximately 8.5%. We continue to expect that our share repurchase program will be deferred until our CET1 ratio reaches 9.0% following the pending deal close. On Slide 18, I will now provide some forward-looking guidance for U.S. Bank on a standalone basis. This guidance does not include any potential impact from Union Bank. Let me start with the full year 2022 guidance. We have updated our interest rate expectations to be consistent with the market expectations. We continue to expect total net revenue to increase 5.6% compared with 2021. Given our revised interest rate assumptions, we now expect low to mid-teen growth in taxable equivalent net interest income compared with our previous estimate of 8% to 11%. We expect higher rates to pressure mortgage application volumes more than previously anticipated, which will negatively impact our mortgage banking revenue. We now expect fee income to be slightly lower for the full year of 2022 compared with our previous expectation that fee revenue would be stable. We continue to expect positive operating leverage of at least 200 basis points in 2022, excluding the impact of merger and integration-related costs associated with the Union Bank transaction. For the full year of 2022, we expect our taxable equivalent tax rate to be approximately 22%. Now, I will provide guidance for the third quarter. We expect total revenue to grow 3% to 5% on a linked-quarter basis. In the third quarter, we expect linked quarter non-interest expense growth of 2.3%, excluding merger and integration-related costs as we prepare for the Union Bank transaction. Credit quality remains strong. Over the next few quarters, we expect the net charge-off ratio to remain lower than historical levels, but will continue to normalize over time. Adjustments to our loan loss reserve in the near term will primarily reflect loan growth and changes in the economic outlook. If you turn to Slide 19, I will provide an update on our previously announced pending acquisition of Union Bank. In September of 2021, we announced that we had entered into a definitive agreement to acquire the core regional banking franchise of MUFG Union Bank. We continue to make significant progress in planning for closing the deal in the second half of 2022, while we await regulatory approval. As you know, regulatory approvals are not within the company’s control and may impact the timing of the closing of the deal. As a reminder, we expect to close on the deal approximately 45 days after being granted U.S. regulatory approval. Because this timing would likely indicate a late third quarter or early fourth quarter close, we believe it is prudent to shift the system conversion date to the first half of 2023. The financial merits of the deal remain intact. Our original EPS accretion estimates are unchanged, and we continue to estimate the acquisition will generate an internal rate of return of approximately 20%, which is well above our cost of capital. I will hand it back to Andy for closing remarks.
Andy Cecere, Chairman, President and CEO
Thanks, Terry. Our second quarter results were supported by solid account growth, deepening of existing relationships, and strong business activity across our banking and fee business lines and we are well positioned as we head into the second half of the year. Credit quality remains strong, and we continue to prudently manage operating expenses even as we invest in our digital initiatives, our payments capabilities, and in our technology modernization. In closing, I’d like to thank our employees for all they do, and we look forward to welcoming Union Bank employees to our company. I remain confident in the strategic and financial merits of this transaction and the meaningful benefits that will accrue to our customers, our communities, as well as our shareholders. We will now open up the call to Q&A.
Operator, Operator
Thank you. Our first question comes from Scott Siefers from Piper Sandler. Your line is now open.
Scott Siefers, Analyst
Good morning, guys. Thanks for taking the question.
Terry Dolan, Vice Chair and Chief Financial Officer
Good morning, Scott.
Scott Siefers, Analyst
I was hoping – apologies if I missed any of this in the prepared remarks, but – so it was nice to see overall deposits up a bit. The mix is changing just a bit as you go forward, I guess, but maybe thoughts on major sort of what you would expect in overall deposit balances as we go forward, how the mix might change and any thoughts on what you are seeing with pricing pressures on funding costs?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, Scott. Certainly, with the quantitative tightening that’s taken place, I think the growth rates with respect to deposits in the industry will be relatively stable or maybe even down a little bit. But our expectation, at least in the near term, is that overall deposit balances will be fairly stable for us. We have a lot of sources of deposits, including our corporate trust and the mix between our money market funds and our on-balance sheet. From a mix standpoint, as you would expect and what we have seen both for us and in the industry is that the mix starts to change when rates rise. And so we are starting to see the mix between non-interest-bearing and interest-bearing start to change with a shift out of non-interest-bearing balances into interest-bearing categories as people are looking at seeking yield. When we think about deposit pricing, it’s been relatively low for the first rate cycle or rate hikes that we have seen. In our case, we have outperformed our expectations, which is good to see, a reflection in part because we have a higher level of consumer balances today than we did, for example, four or five years ago, etc. But when we get into the next 125 basis points, if you think about the next two rate hikes that the market is expecting, our expectations are that deposit betas will probably be in that low to mid-30s kind of ballpark.
Scott Siefers, Analyst
Okay, that’s terrific color. And I appreciate that. Thank you very much, Terry. Maybe a separate question, can you walk through any updated thoughts on sort of the capital ramifications from the pending transaction? A lot has changed in terms of both possible credit and certainly rate environment. Just curious to hear any thoughts that you have insofar as you’re able to given while it’s still pending.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I think that right now, the capital implications are in line, certainly, with a rising rate environment, the mark-to-market is a little bit more than what we maybe had modeled in the original deal. But once you close that transaction, it accretes back into income pretty fast. Our expectation, as I said, is that CET1 will be somewhere around 8.5% at the time of closing. Of course, that will be dependent upon where rates are at that particular point in time. But the transaction accretes pretty quickly. So we do expect capital to continue to grow and accrete after the transaction. Andy, what would you add?
Andy Cecere, Chairman, President and CEO
The only thing I’d add, Terry, is that – as you talked about in your comments, we’re making significant progress in planning for the closing of the deal, which we now expect in the second half of the year. We targeted a second half conversion last time we talked and it was going to be Veterans Day. Given now that we’re coming upon a little later close, we’re moving the conversion date to President's Day weekend. So that’s what our planning assumption is for all the teams working on this. That’s that next three-day weekend. And as Terry mentioned, our financial targets that we initially articulated are still intact, although the timing of the cost savings might be a little different, the synergies are still $900 million. And Terry, maybe you can talk about, given the rate environment, the accretion dilution per earnings share.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. Again, the accretion, when you think about the earnings per share accretion, we still feel very comfortable with respect to the 6% accretion in 2023. A couple of different things. Obviously, the timing will affect our ability to achieve all of the cost synergies that we expected in 2023. Of the $900 million that Andy talked about, our expectation is that we will probably achieve 50% to 60% of that next year. What’s offsetting that is with the rising rate environment, we’re going to see stronger revenue that will help to offset that.
Scott Siefers, Analyst
Great. That’s perfect. Andy and Terry, thank you very much.
Andy Cecere, Chairman, President and CEO
Thanks, Scott.
Terry Dolan, Vice Chair and Chief Financial Officer
Thanks, Scott.
Operator, Operator
Thank you. Our next question comes from John Pancari from Evercore. Your line is now open.
Andy Cecere, Chairman, President and CEO
Good morning, John.
John Pancari, Analyst
Good morning. On the payments revenue and the merchant revenue, I know you had indicated that you do expect those revenues on a year-over-year basis to moderate here, but as you see high single-digit year-over-year growth is reasonable post pandemic. So just to understand that a little more in terms of the coming quarters over the next several quarters, that moderation that you see, is that going to put you in that high single-digit range? Or do you expect growth to be lower than that high single-digit year-over-year range in coming quarters as payments volumes moderate?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. So our expectation when we get to more of a normal environment is that payments would have a high single-digit growth rate. The moderation we’re talking about is really from the very high growth rates that we saw post-pandemic as the cyclical recovery occurred. But think of payments in the single – high single digits.
John Pancari, Analyst
Okay. So – got it. So then in the moderation, is there a way you can maybe help characterize what type of level you think is reasonable in the coming quarters as the moderation takes hold?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I think part of moderating the growth rates will be getting us into more of a normal environment from ’22 to ’23. I think it’s still probably a little bit of a higher level when we think about the third quarter or in the near quarters, but certainly, as we get into 2023, I think it moderates to high single digits.
John Pancari, Analyst
Okay. I gotcha. Got it. And then just on the credit front, clearly, you guys are certainly were generally historically more conservative standpoint. How – can you maybe talk a little bit more on how you’re thinking about the loan loss reserve here particularly from a CECL perspective? As you’re dialing in the scenarios, you have to assume the economic scenarios are going to get worse incrementally here given the Fed actions. So how do you see that impacting your reserving here just from a scenario standpoint given the CECL requirements?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. Maybe as a reminder, when we look at scenarios, we consider five different potential scenarios from a baseline to something that’s slightly better to something that’s worse and as severe, maybe as a more severe recession. For some time, there has been uncertainty if you think about Ukraine now. When we weigh those assumptions, we’re really waiting a little bit more on a downside scenario. Relative to that baseline, we are trying to account for the economic situation. I feel like we’re in a pretty good spot in terms of how we are thinking about it. What I would say, John, is that at least in the near-term, think about the second half of this year, growth in – or changes, I think, in the loan loss reserve will probably be driven more by loan growth than anything else.
John Pancari, Analyst
Okay. Got it. So you don’t necessarily, over the next couple of quarters, see an outright build related to the economic backdrop based upon the forecast that you’re looking at now?
Terry Dolan, Vice Chair and Chief Financial Officer
I think it will be more driven by loan growth than our scenario weightings getting worse, at least not measurably worse.
John Pancari, Analyst
Right, right. Okay. And then one more related to that. I guess just as economic scenarios do intensify and you think a build does begin to moderate, any way to just longer-term help us think about the magnitude? I mean we just had another – one of your competitors talk about how the pandemic-related reserve levels may not be applicable to where the banks built the pandemic-related reserves to. Would you agree with that, that the pandemic-related reserve levels were probably overly draconian?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. As you went through the pandemic, it was hard to know exactly where the economy was going. I do think that the level of reserve builds were pretty aggressive and rightfully so at that time based upon our knowledge then. As we see the next economic recession emerge, again, John, we try to manage through the cycle. Our underwriting is strong and all those sorts of things. While there will be reserve builds certainly from an economic outlook point of view, I don’t think it’s going to be anywhere near what it was as a result of the pandemic.
John Pancari, Analyst
Got it. Thank you so much, Terry. It’s helpful.
Operator, Operator
Thank you. Our next question comes from Gerard Cassidy from RBC. Your line is now open.
Andy Cecere, Chairman, President and CEO
Good morning, Terry. Good morning, Andy.
Gerard Cassidy, Analyst
Terry, to follow up on credit quality, can you share with us, certainly, I’m with you, I don’t see the reserves needing ever to get close to what you guys had to do during the pandemic when unemployment went to 14.5%, and we had an annualized rate of decline in the second quarter GDP in 2020 of over 35%. But can you share with us in the rate stress testing for your commercial customers or anybody on variable rate loans, at what point do rising rates really start to give you guys a little discomfort? Is it 200 or 300 basis points higher? Any color there?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes, I don’t know if you have the…
Andy Cecere, Chairman, President and CEO
I think what drives loan activity more than anything is the economic growth and GDP. From a rate scenario standpoint regarding credit risk, if you think about the defense side, Gerard, I think we underwrite to a higher rate environment for variable rate loans. We’ve already taken that into account. We look at cash flows under different rate scenarios as we think about putting those loans on the book. We are less concerned about rising rates impacting credit. I do think rising rates as they impact the economy will eventually affect loan growth at some point.
Gerard Cassidy, Analyst
No. Okay. Very fair. And then, I guess, as a follow-up, sticking with credit, it seems like in past cycles, excluding 2020, there was a gradual lead into the downturns, and we – I think many of us could have foreseen what was going on in the aggressive lending of ‘06 going into ‘08, ‘09 or ‘88, ‘89 going into ‘90. We don’t seem to have that this time. Can you give us any further color on that? What is it that the market is… so it seems like so concerned about banks that were going to hit a brick wall or go off a cliff on credit possibly in 6 to 12 months? Any further thoughts?
Andy Cecere, Chairman, President and CEO
Yes. I do think it’s that – banks are a reflection of all the customers that we serve, and to the extent the recession impacts those customers, that will impact us. That’s why you’re seeing bank stocks, usually when rates go up, outperform, but now with the fear of recession, you’re seeing a different trend. I think all that uncertainty just translates into people being careful and a little prudent about their investments.
Gerard Cassidy, Analyst
With that, are your customers seeing any clear evidence of the slowdown from the tightening that’s already gone on? Or are they still in pretty good shape generally speaking?
Terry Dolan, Vice Chair and Chief Financial Officer
Maybe a couple of different things that certainly we watch. From a consumer spending standpoint, it continues to be very strong. Businesses are seeing now that consumer spend is shifting a bit in terms of where it is occurring. It’s less discretionary, certainly more non-discretionary on food and fuel and those types of things. It is probably shifting away from a lot of the retail purchases toward service-related activities. But the overall level of spend is still pretty strong. I would also say that the consumer balance sheet is strong. They still have deposit balances that are in excess of where they were pre-pandemic. That’s allowing consumers to continue spending. They are willing to draw down on their credit card lines as well. On the business side, we’re continuing to see inventory builds. Part of the loan growth we are seeing or experiencing may have businesses trying to get ahead of inflation by acquiring inventory today as opposed to something that might have a 10%, 20%, or 30% rate increase. Business owners, especially in the middle market space, are just more cautious today. It seems like a strong economy today, but the range of possibilities is very wide. Business owners are trying to take that into consideration when they think about running their business.
Gerard Cassidy, Analyst
Fellas, thank you very much as always, and good luck on closing the deal in the second half.
Andy Cecere, Chairman, President and CEO
Thanks, Gerard. Appreciate it.
Operator, Operator
Thank you. Our next question comes from Erika Najarian from UBS. Your line is now open.
Andy Cecere, Chairman, President and CEO
Good morning, Erika.
Terry Dolan, Vice Chair and Chief Financial Officer
Good morning, Erika.
Erika Najarian, Analyst
Just a clarification question for my first one. Terry, you mentioned that deposit beta could be in the low to mid-30s for the next 125. Can we interpret that in terms of the cumulative beta by fourth quarter? Does that mean that we will be the cumulative beta by the fourth quarter? Or does that mean that the cumulative beta would be lower than that range by fourth quarter because we have to take into account the first 100?
Terry Dolan, Vice Chair and Chief Financial Officer
It would be lower. The average will be less. What I’m really talking about is the next two rate hikes and what we would see in terms of deposit betas in reaction to that.
Erika Najarian, Analyst
Got it. I’m just comparing it to a peer that reported also today, I think they mentioned that the cumulative beta would be in the low 30s by year-end. It sounds like, based on the math, you could outperform that.
Terry Dolan, Vice Chair and Chief Financial Officer
Certainly, in terms of what we are experiencing, the deposit betas in the first rate hikes have been lower than what we had expected. From just in terms of the industry and where we were starting from, the betas for us have been lower.
Erika Najarian, Analyst
Got it. Okay. And Andy, maybe taking a step back and asking more of an industry question. Clearly, the market is very worried about a recession. Clearly, the market accepts that U.S. Bank has one of the best quality balance sheets out there. The bank has spent a lot of time building their corporate market share. I guess my first question to you is, as you think about the relative resilience of banks potentially in a recession like Gerard alluded to, and the amount of lost market share to non-banks, do you see some of that coming back to the industry, generally in U.S. Bank specifically? Or was some of that credit quality never something that you wanted to underwrite and put on the books to begin with?
Andy Cecere, Chairman, President and CEO
It’s a good question, Erika. I think there is a little bit of a shift already occurring as you’re seeing in some of the non-bank competitors. First of all, the banking industry is in terrific shape from a capital liquidity just from a defensive standpoint, much better than we were during the last downturn, and that includes U.S. Bank. We had our results of the stress test, which showed us performing very well in a very stressful environment. I think that’s a reflection of all those things, including our diversity in our credit underwriting discipline. Traditional credit models work through cycles, while sometimes new credit models work when things are going well and are a little more challenged when things aren’t going as well. We will see how those new credit models and new ways of doing underwriting will work in this downturn. I do believe banks and certainly U.S. Bank’s models have proven their worth through multiple cycles.
Erika Najarian, Analyst
And my third question is, I think that most of the Street subscribes to the idea that payments are going to be a secular winner for U.S. Bank. There’s clearly a debate right now on how weak the consumer gets in a downturn. Nobody is really worried about credit surprises in the consumer with U.S. Bank. But how should we think about the range of outcomes in payment activity and spend if we do have a recession?
Andy Cecere, Chairman, President and CEO
Yes. Erika, it depends on how severe that recession is, certainly. The consumer is still in a very good position. They have a lot of cushion; we have $2.5 trillion of excess savings versus pre-pandemic levels. For U.S. Bank, we’re still at 2 to 3 times deposit levels. They are spending dollars they have not spent over the past few years. As you know, the unemployment numbers are very good. I think there is enough cushion. For the near-term, that cushion will allow continued spending activity, albeit, as Terry mentioned, in a bit different categories, certainly from goods to services and a little bit more in terms of non-discretionary, but we’re still seeing strength there. Again, how that ultimately comes out will depend upon the range of outcomes that I talked about that’s pretty wide.
Erika Najarian, Analyst
And just one last one on the fee income guide, you said lower than 2021. Did you quantify how much?
Terry Dolan, Vice Chair and Chief Financial Officer
We did – yes, exactly.
Erika Najarian, Analyst
Sorry, I am too much going. Okay.
Andy Cecere, Chairman, President and CEO
No problem.
Operator, Operator
Thank you. Our next question comes from Mike Mayo from Wells Fargo Securities. Your line is now open.
Andy Cecere, Chairman, President and CEO
Hi Mike. Good morning.
Mike Mayo, Analyst
Good morning. I look at Slide 7, I’m trying to look at – I’m squinting on that, and that’s the number of joint business banking and payment customer relationship growth. You have that indexed at 100, starting at March 2021. It seems you’re up, with my squinting here, you’re up 5% year-over-year from the growth in accounts that you use both banking and payments. Is that correct?
Andy Cecere, Chairman, President and CEO
That’s right, Mike. Sorry for the squinting, but yes. If you index back to 100, we’re up just under 6% on those combined relationships that have both banking and payments products, which is almost 2 times what just the total relationships represent, which would imply that single service relationships are below that green line.
Mike Mayo, Analyst
Okay. How much is this contributing to your growth? I mean you had outsized growth in payments, Slide 14. You have had outsized growth in commercial loans, Slide 8. So, can you kind of disassemble this? What percent of the growth is due to this business banking and payment initiative? And how much is just due to the environment, the onboarding of the economy post-pandemic?
Andy Cecere, Chairman, President and CEO
I think it’s a bit of both. We are still, as I mentioned, in the early innings of all this. We have a tremendous focus on this in both the Business Banking segment as well as the Commercial segment. This concept of weaving together banking and payment services into a comprehensive offering is going to be meaningfully important to our growth rates, both acquiring customers and providing more products and services to the current customers. This is one of my top priorities, and it’s one of the company’s top priorities across many business lines. I think it’s driving the growth you are seeing in both business activity as well as corporate activity.
Mike Mayo, Analyst
And then an unrelated question. I mean, commercial loan growth is growing very strong. What’s the pricing like on commercial loans? It just seems there is such a disconnect between the capital markets, which are charging so much more for credit, versus the bank lending markets, which might be charging more but not nearly as much.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I think that, Mike, in the commercial side, corporate loan side of the equation, it’s still pretty competitive from a pricing point of view. I’d tend to agree in the sense that credit spreads haven’t widened as much as we might have expected at this particular point in time. Part of that comes back to what economy we’re looking at? I mean today, it looks pretty good. My expectation is if you have this type of loan growth with the economic outlook people are expecting, you’d expect those credit spreads to be widening and spreads to be widening on loans more; but we just haven’t seen it yet.
Mike Mayo, Analyst
So, does that mean, as the most conservative bank in the industry based on several metrics, bond spreads, credit rating agencies, all that sort of thing. Does that mean you forgo some of this lending, or do you just plow ahead with the assumption that we are not going into any sort of hard landing?
Andy Cecere, Chairman, President and CEO
Mike, it’s a good question as well. Terry and myself and our leaders are being very disciplined about putting loans onto our balance sheets. While we had strong loan growth, it could have been stronger because we are not putting on deals that are either not appropriate from a credit standpoint or from a spread standpoint or return standpoint. We are growing good loans, we could have grown more, but we didn’t.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. A perfect example is the growth in auto lending for us over the last few quarters; although spreads have been very competitive, they have not been responsive to the rising rate environment. We are willing to give up some of the volume there simply because returns are not as strong as they should be in the current environment. That’s an example of the discipline we are talking about.
Mike Mayo, Analyst
Okay. Thank you.
Andy Cecere, Chairman, President and CEO
Thanks Mike.
Operator, Operator
Thank you. Our next question comes from Matt O’Connor from Deutsche Bank. Your line is now open.
Andy Cecere, Chairman, President and CEO
Good morning.
Matt O’Connor, Analyst
Good morning. I wanted to ask about the credit marks related to the pending UB deal. Obviously, spreads have widened as was just discussed. I would think that means kind of more marks and maybe just frame how meaningful that might be? Is there a risk that the CET1 is below 8.5%? On the flip side, if you are marking that book down a little more aggressively, maybe you are essentially done building reserves in that portfolio even if we do get the hard landing.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. From a credit mark standpoint, I think it’s pretty consistent with what we had expected. That portfolio performs pretty strongly. The mark-to-market from a rate point of view certainly is higher than what we had originally modeled out. That will put a little bit of pressure, as I mentioned earlier on, the day one closing CET1 ratio which we still expect to be around 8.5%. It might be a little bit lower than that, but it could also be a little higher; it just depends upon where rates are at that point in time. The transaction accretes back into income pretty quickly. So, it’s not really a significant concern at this particular point in time for us.
Matt O’Connor, Analyst
And then just to summarize, so the credit markets aren’t really impacted by the macro forecast and what we are seeing in public markets; it’s more what you are seeing in the actual portfolio as we think about the credit marks themselves?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. We have to take into consideration our assumptions from an economic outlook standpoint. But those haven’t changed a lot yet at this point. So the quality of the portfolio is good, and it’s performing well, etc.
Matt O’Connor, Analyst
Okay. Just separately, you talked about mortgage fees being weaker than expected in your full-year guidance. Obviously, we are seeing that for the industry overall. Any signs of the gain on sale margin stabilizing? And then in the servicing book, it doesn’t feel like we are getting the full benefit of the slower prepayments. I know there can be a little bit of a delay across some of the banks; we’re not seeing that. Is there still some benefit from the servicing book to kick in?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. A couple of different things. As we talked earlier, there will continue to be pressure on mortgage banking revenue. We think about it on a linked-quarter basis, third quarter fee revenue in that area is probably going to be pretty similar to the second quarter. However, that’s going to be a combination of things. I do think that there continues to be a little pressure on the volume side simply because of rising rates. We are seeing the gain on sale starting to stabilize and improve a little bit. Our expectation is that it improves as we go through the rest of the year and into 2023. There’s a fair amount of capacity that’s coming out of the industry. I think that will help in terms of gain on sale. There’s opportunity from a servicing income point of view.
Matt O’Connor, Analyst
Great. Thank you.
Andy Cecere, Chairman, President and CEO
Thanks, Matt.
Operator, Operator
Thank you. Our next question comes from Bill Carcache from Wolfe Research. Your line is now open.
Andy Cecere, Chairman, President and CEO
Thanks. Good morning, Bill.
Bill Carcache, Analyst
Yes. Good morning. Assuming the Fed hikes eventually lead to slower growth and higher unemployment as many hiking cycles have historically, could you help us understand at what point you would be required to increase your reserve rate because that increase in unemployment would fall under your reasonable and supportable forecast period under CECL? Does it just need to be more visible before you can act on it?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I think there is a lot of uncertainty out there in which direction it’s actually going to go. It just needs to be more certainty around what that economic outlook is. We have been weighing a little bit more on the downside, expecting because of the uncertainty we’ve been talking about. If a recession hits, we will have to adjust it, but we will take that into consideration at that time.
Bill Carcache, Analyst
Understood. And maybe following up on that, how much of an impact would you say management overlays are having currently? Many banks have had their reserve rates fall below their day one levels already. There is a view that the macro outlook today is not as favorable as it was on January 1, 2020. Just curious to what extent overlays are being used to the extent to which you consider using them?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. I can’t speak for what other people are doing. From what I will speak to is what the reserve rate on day one versus today, the change is really probably a couple of different factors but it’s principally the mix of the portfolio today versus what it was two years ago, both in terms of the quality of the asset but also where we have seen growth over the past couple of years. ABS securities, as an example, security lending for example is very high quality. That’s where we have seen a lot of growth over the past few years. A lot of it’s mix for us as much as anything. I would say from an economic perspective, relative to day one, it’s probably more on the downside than it was then.
Bill Carcache, Analyst
Understood. That’s helpful. If I could squeeze in one last one. You guys have a unique view given the depth of your consumer and commercial businesses. Maybe could you price out for us what a mild recession would look like; maybe where you see the greatest risk on both the commercial and consumer side and then specifically within USB?
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. The greatest impacts will be on the low and moderate income customers base starting there, and inflation impacts the most. That’s where we are already seeing some shift in spend from discretionary to non-discretionary. It is probably shifting away from a lot of retail purchases toward service-related activities. The overall level of spend is still pretty strong. I will tell you, one change we are seeing is that over the last 2.5 years, every month, consumer balances, checking and savings account balances have risen every single month. We did see flattening in the last two months. That’s moderating for sure. Those excess savings are starting to be spent. That provides cushion into the next few months but that cushion is starting to flatten out. Those are the things we are seeing. Our portfolio is prime only, our customer base is high quality, so I think some of those early indicators or early impacts will not be seen in our balance sheet.
Andy Cecere, Chairman, President and CEO
On the corporate side, we have very little leverage lending; we just don’t get into that area. Our corporate customers are good investment-grade customers. They have the ability to withstand especially a mild recession.
Bill Carcache, Analyst
That’s super helpful. And Andy, going back to your comment on significant liquidity that the consumers have and how that’s flattening a little bit but it’s still high; is that something you think perhaps is maybe contributing to the strength in the spending and potentially could be inflationary in and of itself and lead the Fed to have to do more in terms of hiking? Just curious about your high-level thoughts on that?
Andy Cecere, Chairman, President and CEO
Yes, I think that’s one of the wildcards or factors we talked about. We are seeing things in today’s environment that we haven’t seen in previous downturns or recession impacts. This is one of them. We had trillions of dollars of government stimulus, unemployment, and people weren’t spending given the pandemic for a number of quarters and now that built a cushion. It’s impacting spending levels because they are spending money now. That’s that $2.5 trillion of excess savings. We still see high balances across every level of deposits, zero to $500, $500 to $1,000, up to $10,000, so still well above pre-pandemic levels but certainly flattening out. This cushion provides a bit of time before you start to see some impacts from this higher rate environment since consumers are spending money they already have.
Bill Carcache, Analyst
Thank you so much.
Andy Cecere, Chairman, President and CEO
Thank you.
Terry Dolan, Vice Chair and Chief Financial Officer
Yes. Thanks Bill.
Operator, Operator
Thank you. Our final question comes from Ebrahim Poonawala from Bank of America. Your line is now open.
Andy Cecere, Chairman, President and CEO
Good morning, Ebrahim.
Ebrahim Poonawala, Analyst
Good morning. Just one quick question on Slide 15, on the payments business, Andy and Terry, you talked about just what might happen in the next few quarters. But talk to us, when we think about the business in the medium to longer term, a lot of the digital native companies are struggling right now. What does this mean in terms of the investments you have made over the last few years to gain market share? Should we anticipate any kind of strategic M&A that helps you further your footprint within the payments business? How should that business evolve relative to the pie chart breakdown you provided on Slide 15? I would love to hear your thoughts.
Andy Cecere, Chairman, President and CEO
What we talked about is building this capability, this ecosystem of banking and payments. We have already made several smaller acquisitions, talech being one of them, TravelBank being another. These acquisitions build our capabilities in helping companies manage their entire business regarding receivables, payables, money movement, lending activity, and cash flows. The acquisitions we have made are to do exactly that, coupled with the investments we have made is what’s driving what we think is a great opportunity to build relationships and drive revenue within those relationships. That’s driving Terry’s articulation of that high-single-digit growth.
Terry Dolan, Vice Chair and Chief Financial Officer
Ebrahim, I would say that if we have a focus on acquisition from a product or capability that fills in. That said, we feel pretty good in terms of where we are right now.
Ebrahim Poonawala, Analyst
Would you expect that over the next year or two, you are gaining market share in the business? What I’m trying to do is just handicap disruption risk to that business. It’s something that’s on the mind of investors. It seems like you are making good progress, but I would love to hear how you think about where your market share would be if you had to draw out over the medium-term relative to today.
Andy Cecere, Chairman, President and CEO
Yes, I do think we have that opportunity. We have two great opportunities. Firstly, we have a big slew of banking customers that don’t yet have our payments capabilities. Secondly, we have half of our payments customers that don’t currently have our banking offerings. This gives us a great opportunity to provide more products and services to those customers. That's number one. Number two, given the capabilities in this ecosystem we are building, we also have the opportunity to acquire more customers, which we believe will help take share.
Ebrahim Poonawala, Analyst
Thanks.
Andy Cecere, Chairman, President and CEO
Thank you.
Jen Thompson, Head of Corporate Finance and Investor Relations
Thanks, everyone, for listening to our earnings call today. Please contact the Investor Relations department if you have any follow-up questions.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.