Earnings Call Transcript
US BANCORP DE (USB)
Earnings Call Transcript - USB Q3 2022
Operator, Operator
Welcome to the U.S. Bancorp’s Third 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 conference over to George Andersen, Director of Investor Relations for U.S. Bancorp.
George Andersen, Director of Investor Relations
Thank you, Allan, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and CEO; and Terry Dolan, our Vice Chair and 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, CEO
Thanks, George. Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will take any questions you have. I'll begin on Slide 3. In the third quarter, we reported earnings per share of $1.16, which included $0.02 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 $1.18 for the quarter. During the third quarter, we achieved record net revenue totaling $6.3 billion. The third quarter results were highlighted by strong revenue growth, well-controlled expenses, and stable credit quality. This quarter, we added $200 million to our loan loss reserve, reflecting loan growth and a consistent through-the-cycle underwriting approach to risk management. At September 30, our CET1 capital ratio was 9.7%. Our tangible book value per share totaled $20.73 at September 30, or 3.2% lower than the prior quarter, driven by the impact of rising interest rates on our available-for-sale securities. Slide 4 provides key performance metrics. Excluding notable items, we delivered a return on average assets of 1.24% and a return on average common equity of 16.2%. Our return on tangible common equity was 21.4% on a core basis. Slide 5 highlights continued positive trends in digital engagement as consumer and business customers gain a deeper understanding of our digital capabilities and benefit from our digital-plus-human approach. Slide 6 shows progress across our digital and payments initiatives that are both deepening our core competencies and expanding our competitive advantage, which we believe will drive meaningful profit and return penetration to our company. One example of our digital initiatives is our launch of Talech Register, a next-generation all-in-one payment and business analytics platform that is helping to bring greater simplicity, convenience, and efficiencies to the point-of-sale for our business banking customers. On the right side of the slide, you can see the continued momentum we are gaining in real-time payments transactions. Year-to-date through September 30, the total number of transactions is 17 times higher than the full year of 2020. Recently, we introduced an innovative real-time payment solution to auto dealers where we provide loan funds instantly after a loan contract is finalized. This gives our participating dealer clients greater control over cash flow and helps to improve their day-to-day operational efficiency. Turning to Slide 7, our business banking initiative continues to gain traction, with steady progress in both growing accounts and expanding wallet share. Growth in relationships with both banking and payments products has continued to meaningfully outpace growth in total relationships over the past 12 months. Looking ahead, we expect that our recently launched innovative offerings and developments will help further deepen our existing relationships between business banking and payments customers. Now let me turn the call over to Terry, who will provide more detail on the quarter.
Terry Dolan, CFO
Thanks, Andy. If you look at Slide 8, I will begin with a review of the balance sheet, followed by a look at third quarter earnings trends. Average loans rose by 3.9% compared to the second quarter, led by a 6.5% increase in commercial loans, a 4.7% rise in mortgage loans, and a 6.0% growth in credit card balances. The growth in commercial loans was due to increased business activity and higher utilization rates in both large corporate and middle-market segments. Demand remains strong as we pursue suitable return opportunities to wisely allocate our capital. In the retail segment, we experienced solid growth in credit card balances both quarter over quarter and year over year, fueled by strong spending and lower payment rates. Gains in purchase mortgage market share and reduced prepayment activity continued to support the growth in residential mortgage balances. Moving to Slide 9, total average deposits saw a slight increase compared to the second quarter. Growth in total interest-bearing deposits outweighed the decline in non-interest-bearing deposits as customers reacted to the rising interest rate climate. Total average deposits went up by 5.9% from a year ago. Slide 10 illustrates credit quality trends, which remained strong throughout our loan portfolio. The ratio of nonperforming assets to loans and other real estate stood at 0.20% on September 30, down from 0.23% in June and 0.32% a year ago. Our third quarter charge-off ratio of 0.19% showed a slight improvement compared to the second quarter of 2022 and the third quarter of 2021. The allowance for credit losses as of September 30 was $6.5 billion, or 1.88% of period-end loans. The $200 million increase in our reserve this quarter primarily reflected loan growth and, to a lesser extent, uncertainties in the economic outlook. Slide 11 presents an earnings summary. For the third quarter, we reported earnings of $1.18 per share, excluding $0.02 per share of merger and integration charges tied to the pending acquisition of MUFG Union Bank. Turning to Slide 12, net interest income on a fully taxable equivalent basis reached $3.9 billion, marking an 11.3% rise compared with the second quarter and a 20.6% increase from last year. This quarter's linked growth was driven by strong earning asset growth and a 24 basis point rise in the net interest margin, which benefited from increasing interest rates, despite some offset from deposit pricing and short-term borrowing costs. Slide 13 discusses trends in non-interest income. Non-interest income fell by 3.1% on a linked quarter basis, as decreases in mortgage banking and treasury management revenues were partially mitigated by stronger corporate payments revenue and an uptick in other non-interest revenue. Year over year, non-interest income decreased by 8.3%, mainly due to lower mortgage banking revenue, reduced deposit service charges from policy changes, and decreased treasury management fees from rising rates, partially offset by higher payments revenue and trust and investment management fees. The drop in mortgage revenue chiefly stemmed from reduced refinancing activity, which continued to affect overall application volumes and associated gain on sale margins due to excess industry capacity. In the third quarter, total payments revenue rose by 4.9% compared to a year earlier. Slide 14 highlights revenue growth trends for our three payments businesses on both a linked quarter and year-over-year basis. Given the cyclical nature of our payments businesses, we believe that year-over-year trends offer a clearer view of underlying business performance in a normal environment. Credit and debit card fee revenue changed minimally by 0.5% year-over-year, as higher volumes were overshadowed by reduced prepaid card activity. Excluding prepaid cards, which were especially high last year due to unemployment support, credit and debit card fee revenue would have risen by 3.0% compared to the third quarter of 2021. The bottom part of the slide shows year-over-year growth rates in merchant processing and corporate payments fee revenue over the past several quarters. In the third quarter, merchant processing revenue increased by 3.6% year-over-year. However, growth was negatively affected by unfavorable foreign currency exchange rates amid volatility in Europe, particularly in the U.K. If we exclude the FX impact, the year-over-year growth in merchant fee revenue would have been around 9.4%. Slide 15 offers additional insights into our payment services business. On the right side of the slide, you'll note the ongoing strong momentum in our tech-led revenue from partnerships in our merchant acquiring business. A key driver of this growth has been the significant increase in new tech-led partnerships, which, year-to-date, are 2.5 times the total number we achieved throughout all of 2019. These partnerships continue to expand. Moving to Slide 16, non-interest expense rose by 1.9% on a linked quarter basis, excluding merger and integration expenses associated with the Union Bank acquisition. This increase was primarily due to higher compensation, professional services, and marketing and business development expenditures. Slide 17 highlights our capital position. Our common equity Tier 1 capital ratio was 9.7% as of September 30. On Slide 18, I will share forward-looking guidance for U.S. Bank on a standalone basis, which does not factor in the potential effects of Union Bank. For full year 2022 guidance, we remain consistent with our earlier expectations, anticipating total net revenue growth of 5.5% to 6% compared to 2021. We expect mid-teen growth in taxable equivalent net interest income, slightly improved from our previous low to mid-teens growth outlook. We continue to project a decline in fee revenue for the entire year, largely due to the impact of rising interest rates on mortgage revenue from decreased refinancing, lower deposit service charges resulting from pricing changes, and reduced other non-interest income. We also expect to maintain positive operating leverage of at least 200 basis points in 2022, excluding the effects of merger and integration costs tied to the Union Bank acquisition. For the full year of 2022, our expected taxable equivalent tax rate is roughly 22%. Now, let’s discuss guidance for the fourth quarter. We predict both total revenue and total core expenses, excluding merger and integration costs, to rise by about 2% from the previous quarter. Net interest income will continue to benefit from earning asset growth and higher rates. However, our fee revenue is expected to decline due to typical seasonal trends and some of our fee-based businesses. Credit quality remains robust. In the coming quarters, we expect the net charge-off ratio to stay below historical norms, but we anticipate it will normalize over time. Changes in the allowance for credit losses in the near term will mainly reflect loan growth and shifts in the economic landscape. Turning to Slide 19, I will update you on our previously announced acquisition of Union Bank. In September 2021, we announced our definitive agreement to acquire the core regional banking franchise of MUFG Union Bank. We are making notable progress in planning for the deal's closing, expected in the fourth quarter of 2022, pending regulatory approval. As always, regulatory approvals are beyond the company's control and may affect the timing of closing the transaction. We estimate that we will finalize the deal approximately 45 days after receiving U.S. regulatory approval. As stated before, we anticipate the conversion date will occur in the first half of 2023. The financial benefits of the deal remain solid. Our EPS accretion estimates remain unchanged, and we foresee the acquisition delivering an internal rate of return of about 20%, well above our cost of capital. The company's target CET1 capital ratio stands at 8.5%. Based on interest rates as of October 13, our CET1 capital ratio at the time of closing is projected to be around 8.3%. We expect the CET ratio to rise toward 9% as purchase accounting valuation adjustments are recognized in capital through earnings.
Andy Cecere, CEO
Thanks, Terry. The investments we have made and continue to make across our business lines are paying off in terms of improved customer experience, new customer acquisition, and deeper relationships. Expense management is a priority, and we continue to target positive operating leverage in 2022 and beyond. We look forward to closing on the Union Bank acquisition, pending regulatory approval. This is a unique opportunity at scale in one of our core markets, and we remain confident in the strategic and financial merits of the deal. The current credit environment is benign. In fact, our net charge-off ratio in the third quarter remains near historic lows, and we are not seeing any meaningful early stage metrics that cause concern. That being said, we recognize the pressure points are building in several areas of the economy that could lead to stress in the future. Borrowing costs are increasing, inflation is high, savings rates are starting to decline, and the stock market is well off its highs. So while the backdrop is favorable today, it would not be surprising to us to see an economic slowdown develop at some point driven by lower confidence levels, which may lead to reduced spending and business investment. There are a number of scenarios that may play out over the next several quarters. We are preparing for a range of possible outcomes by prudently managing credit, liquidity, and capital, so that we continue to grow within our through-the-cycle risk management framework and deliver industry leading returns. In summary, our investments are paying off. We remain diligent stewards of capital. Our balance sheet is strong, and our focus is firmly fixed on managing the company for the long-term. I'll close by saying thank you to our employees. Your hard work and focus on doing the right thing for our customers and communities every day is recognized and appreciated. We'll now open it up to Q&A.
Operator, Operator
Operator Instructions. John Pancari with Evercore is online for a question. Go ahead.
John Pancari, Analyst
Good morning.
Andy Cecere, CEO
Good morning, John.
John Pancari, Analyst
On your commentary around the CET1, falling to 8.3% at close, but needing to get back up to the 9% before you resume buybacks. Can you give us a little more color on that in terms of timing around when you think you can reach that 9% with the PA accretion, and how we should think about the magnitude of buybacks at that time? Thanks.
Terry Dolan, CFO
Yes, thanks, John. So again, our expectation is a closing of 8.3%. But we do expect that we will get to roughly 9% within about four quarters. A big part of that will be, obviously, earnings growth driven by the accretion of the mark-to-market that will end up impacting earnings during that particular timeframe. Our expectation and what we have been signaling in the past is that we would start our share buyback program once we get to that 9%. So, about four quarters.
John Pancari, Analyst
Okay, all right. Thank you. That's helpful. And then just separately, can you just give more color on the payments trends that you're seeing both in the merchant processing and corporate payments businesses? And maybe if you could just talk about the potential moderation in activity there you could see as the economy reacts to the Fed action?
Andy Cecere, CEO
Yes, this is Andy. It's interesting to note that while spending categories have shifted somewhat, overall spending remains strong, up about 10% year-over-year and approximately 30% above pre-COVID levels. As Terry mentioned earlier, our revenues were affected by the pound's exchange rate in merchant processing. However, without that impact, our revenues would have increased by just over 9%. Additionally, for the past two years, we've observed an increase in consumer deposit levels per account. As we highlighted last quarter, those levels have been flat for the second quarter and are relatively flat, showing only a slight decrease in the third quarter. We anticipate some moderation in spending, but we haven't observed that yet.
John Pancari, Analyst
Okay. Thanks for taking my questions.
Andy Cecere, CEO
Thank you.
Operator, Operator
Matt O'Connor with Deutsche Bank is online with a question.
Andy Cecere, CEO
Hi, Matt. How are you this morning?
Nathan Stein, Analyst
Hello, this is Nathan Stein on behalf of Matt O'Connor. I just want to follow up quickly on the payments outlook. I think previously you've talked about higher than normal year-over-year growth in the second half of this year before moderating to high single digits next year. Just to follow up on what you were just talking about. Does that guidance still make sense in this environment?
Terry Dolan, CFO
Our expectation for payments revenue is in the high single digits, which we believe remains realistic given current consumer spending trends. As Andy mentioned, transaction volumes continue to be strong compared to pre-COVID levels, despite some shifts in where spending is happening. Additionally, if transaction levels begin to decline, we anticipate that inflation will help buffer the impact. Overall, we remain confident in our outlook.
Nathan Stein, Analyst
Okay, great. Thank you so much. That's helpful. And then one quick follow-up question. Can you just touch on the plan to manage the balance sheet post the deal closing whenever that is? I think total assets were just above $600 billion at the end of this quarter. And with Union Bank, it'll push you above the $700 billion threshold. So how are you thinking about that going forward?
Andy Cecere, CEO
Yes, we expect to continue managing the balance sheet carefully, focusing on supporting more profitable relationships. Regarding CAT II, we believe that the earliest we might enter that category is the end of 2024. However, our ability to manage risk-weighted assets and balance sheet levels might extend that timeline slightly.
Operator, Operator
Mike Mayo with Wells Fargo is online with a question.
Andy Cecere, CEO
Good morning, Mike.
Mike Mayo, Analyst
Hi. I think at a recent conference, you said that you will not achieve as much synergies from Union Bank next year as you originally thought, but no change in EPS guidance. Did I hear that correctly?
Andy Cecere, CEO
Yes, that is correct. And if you think about the dynamics, Mike, while the timing has changed and the synergies associated with the $900 million of synergies that we expect to achieve when fully implemented, the timing will be offset to some extent by the accretion of the mark-to-market will be a little bit stronger. So we still feel pretty confident with respect to the accretion levels that we have guided in the past.
Mike Mayo, Analyst
Right. So instead of 75%, you said 40% to 45%?
Andy Cecere, CEO
Yes, 40% to 50%.
Mike Mayo, Analyst
40% to 50% and 6% EPS accretive. So if you're getting less merger synergies next year than you originally thought and you have the same EPS guidance, are you de facto increasing the end result of expected accretion from Union Bank?
Andy Cecere, CEO
Yes, I don't believe we are changing the estimates we provided earlier at this time. We need to get past the approval and closing before we would consider making any significant changes to those estimates.
Mike Mayo, Analyst
Okay. And any early guidance for next year? Some other banks are giving some general kind of guideposts for 2023 in terms of operating leverage. And your guidance is saying this would be some of the best operating leverage in over five years, I guess. And just trying to figure out how confident you are in that continuing. I know you invested for a number of years in the tech infrastructure. And now you hope to capitalize on that at a time when business is coming back. But how much follow-through should investors expect for this positive operating leverage?
Andy Cecere, CEO
Yes, Mike, we're focused on positive operating leverage on a core basis and we'll continue to achieve that. Next year has a fairly large moving part with Union Bank coming on. So that is going to be our top priority is to make sure we successfully convert and integrate that into this company, which will allow for more positive operating leverage, but that we haven't provided any guidance updates on that yet.
Mike Mayo, Analyst
All right. Thank you.
Andy Cecere, CEO
Thanks, Mike.
Operator, Operator
Erika Najarian from UBS is online with a question.
Andy Cecere, CEO
Good morning, Erika.
Erika Najarian, Analyst
Hi. Good morning. Terry, I'm going to have to ask you about the 8.3% pro forma CET1 that you mentioned. You’re estimating at close. I think I didn't realize that there has been a significant conversation in the market that perhaps it has contributed to the three months underperformance with concern about the widening of the interest rate marks. So I think that announcement you were looking at a 50 basis point loan markup on UB's loan portfolio that you're bringing over, given that a significant portion in that portfolio is residential. I think there was a lot of math being done in the buy side, that was, let's say, a 100 basis points lower than what you were giving us. So I guess my question here is, how is the Street getting the math wrong? Or are there protections that are built into the deal? Or are there hedges on UB's balance sheet that seems to be protecting your pro forma CET1 from a greater day one mark relative to how interest rates have moved since the announcement?
Terry Dolan, CFO
Yes, I think it could be a combination of different things. For example, there is an expectation that they will deliver a certain level of tangible book value and to the extent that their available-for-sale portfolio is impacted. Prior to the acquisition, there is kind of a make-whole provision within the agreement related to the available-for-sale securities, so that is part of it. I think some of it could be just what the assumptions are related to the duration of the residential portfolio. And then again, we'll end up looking at and managing in this rate environment the balance sheet as prudently as we can to ensure that we're allocating capital to the appropriate businesses during this timeframe. So it's a combination of a variety of different things, Erika.
Erika Najarian, Analyst
Got it. So I guess that's the question. As a follow-up question, that $6.25 billion they need to deliver, there's a make-whole provision on the AFS portfolio, but not on the loan portfolio, I'm presuming, is what you're saying, Terry?
Terry Dolan, CFO
That is true. Yes.
Erika Najarian, Analyst
Got it. I'm assuming there could be a potential CDI offset at close that might help balance things out. However, that would likely lead to a higher amortization cost in the following period.
Terry Dolan, CFO
Yes, I mean, it's a combination of a whole variety of things. I mean, it's not only the interest rate marks, but it's what does the loan portfolio look like in terms of overall quality relative to kind of what our original estimates were, we think that that is slightly better, the CDI. I mean you have to look at all of the different moving parts in terms of coming up with what we think the final impact of the mark-to-market is going to be.
Erika Najarian, Analyst
Got it. Thank you so much.
Operator, Operator
Bill Carcache with Wolfe Research is online with a question.
Andy Cecere, CEO
Thank you. Good morning, Andy and Terry. How are you?
Bill Carcache, Analyst
Hi. So we started nice remixing out of available for sale and held to maturity. I wanted to follow up on that and more specifically whether there's room for you to take the mix of available for sale higher? It'd be helpful if you could just give some color on what guides your decision on how high the HTM mix can go?
Andy Cecere, CEO
Yes, great question, Bill. So, today we're currently at about 53% held to maturity versus available for sale. And we moved some securities in early July, when rates dipped, that allowed us to be able to kind of increase that percentage. The other thing that we take into consideration is the fact that with respect to the AFS portfolio, there are also floating rate securities that have very little impact with respect to AOCI. So when you end up combining that together, it's about 60% that is protected, substantially protected for movements in interest rates. So think about it almost as a 60-40 sort of split in terms of the sensitivity to interest rates. And is there opportunity? I mean, we'll continue to look at whether that makes sense, relative to our balance sheet positioning. But at least right now we feel pretty comfortable with that mix. It gives us the AOCI protection as well as some flexibility with respect to managing the balance sheet. And then the other thing you have to kind of think about is that we have Union Bank that hopefully we'll be closing on here in the fourth quarter. And that ends up influencing decisions that we make with respect to the positioning of the balance sheet and excuse me, of the securities portfolio, and then also with respect to deposits, we're going to have a significant amount of deposits coming on and that's going to help us as well.
Bill Carcache, Analyst
Very helpful. And separately, I wanted to follow up on funding and more specifically, the decrease in non-interest bearing deposits. Is it reasonable to expect that your mix of non-interest bearing deposits is going to gradually revert to pre-COVID levels as the Fed proceeds with QT? Maybe if you could address that, if you have any views sort of at the industry level and then specifically for USB?
Andy Cecere, CEO
Yes, I believe that quantitative tightening will impact deposits overall. As interest rates increase, there will be a movement from non-interest bearing deposits to interest-bearing ones. Depending on how much the balance sheet is reduced and the level of liquidity maintained in the system, the assumption regarding pre-COVID may hold true. For us, I estimate that our situation will likely remain a bit stronger than pre-pandemic levels, mainly due to the growth in our consumer portfolio, which helps mitigate that shift. Additionally, we've made significant efforts to retain operational deposits within our corporate trust business, which tend to be non-interest bearing rather than interest-bearing.
Bill Carcache, Analyst
That makes sense. Regarding the mix of debt relative to your overall funding, it's still well below the levels seen in the fourth quarter of 2019. Can you discuss the likelihood that we should anticipate a gradual return to pre-COVID levels?
Andy Cecere, CEO
Yes, I think the broad assumption is reasonable, but it's important to remember that Union Bank will be joining us. They have a significant portion of their deposits coming from consumers, so it’s essential to consider the overall mix. I believe U.S. Bank will be in a stronger position than we were before the pandemic.
Bill Carcache, Analyst
That's great. Finally, if I could squeeze in one last one. Could you speak to your ability to bring off-balance sheet money market funds back on balance sheet, maybe some of the dynamics surrounding that?
Terry Dolan, CFO
Yes, great question. So, currently, we have about $130 billion in money market funds. And that is a business that's very tied to our Institutional Investor Services business. Based upon what we need to do from a funding perspective, we have the ability from a pricing point of view to bring that back on balance sheet, or off-balance sheet, but it's pricing decisions that then influence customer behavior. And it is a great source for us from a funding standpoint as there is more pressure in deposits going forward.
Bill Carcache, Analyst
Great. Thank you for taking my questions.
Operator, Operator
Gerard Cassidy with RBC is online with a question.
Andy Cecere, CEO
Hey, good morning, Gerard.
Terry Dolan, CFO
Hi, Gerard.
Gerard Cassidy, Analyst
Hi, Terry. Hi, Andy. Terry, I think in your comments, you talked about the residential mortgage business and the gain on sale margins were lower. And I think you referenced, there's still excess capacity in that line of business. Can you share what’s your outlook? You've seen some of that capacity coming out in the fourth quarter, if rates remain elevated for the purge over the refi activity, of course, being negatively affected by elevated long-term rates?
Terry Dolan, CFO
Yes, we certainly are seeing capacity come down in the industry. I think you'd seen various announcements of bank and non-bank mortgage operations kind of pulling back or reducing capacity. I think it probably still needs to reset to some extent, what's happening with rising rates and the impact that it might have on both refinancing as well as home sales. But we do see it coming down. Our expectation is that gain on sale margins stabilize and probably for us improve a bit. In the third quarter, our gain on sale was down maybe a little bit more than what we had anticipated. But about half of that, excuse me, about half of that is really driven by the mix between correspondent and retail, and the other half of it, which is really more revenue recognition, some timing issues and some secondary kind of market valuation issues, which we think will reverse a bit.
Gerard Cassidy, Analyst
Very good. I saw when we looked at your average loan portfolio, obviously, you've had some very nice growth and seen a very strong growth year-over-year. We're hearing some market chatter and I don't know if it's just the equity REITs are squawking, but apparently, the commercial real estate mortgage business might be a little more or less liquid today. Any color that you guys can offer on what you're seeing in commercial mortgage real estate? Is it an area that you're pulling back some? I know you had growth, but maybe some color and insights on what you're hearing, and seeing and what your views are for that business?
Terry Dolan, CFO
Yes. Certainly with respect to commercial real estate, it's an important business for us and one that will continue to be very focused. And I think part of it is just dynamics in the marketplace. If you end up looking at large corporate REITs sort of financing, we continue to lend in that particular space; we actually probably saw some growth in the third quarter. But we do know homebuilders are starting to pull back, and even making decisions to maybe pull out of potential projects they were planning on doing. And then in the middle market space, in terms of commercial real estate, it is actually still from a pricing standpoint pretty competitive. And people extending terms associated with that, and that's the space that we're not comfortable with at this particular point in the cycle. So we're seeing a little bit of pressure maybe in the middle market space, but we're fine with that.
Gerard Cassidy, Analyst
Very good. Thank you.
Terry Dolan, CFO
Thanks, Gerard.
Operator, Operator
Ken Usdin with Jefferies is online with a question.
Andy Cecere, CEO
Good morning, Ken.
Ken Usdin, Analyst
Hey, good morning, Terry. Thanks. I want to just ask a little bit more on the whole outlook for deposits. I know you talked about the mix. Just wondering just what you guys are seeing given the fact that you have a little bit of a different mix versus most of the peers in terms of any updates and what you're thinking about where betas eventually go to, just given that we're in a completely different rate regime than we might have all thought six months ago?
Terry Dolan, CFO
Yes. Well, maybe I'll kind of start just by reiterating if we end up looking at the mix of our deposit base, it has changed a little bit relative to maybe what we were three or four years ago, et cetera. Certainly, we went through the last rate rising cycle with a little stronger consumer, a little more focus around operational deposits within our trust business, et cetera. Trust is also, on a relative basis, represents only about 15% of our deposit base today. And then again, think about Union Bank coming on and you know some of the dynamics that that will bring. But coming back to deposit betas then maybe with that context, we're actually performing probably better than what we might have expected. I think deposit betas were about in the second quarter about 20%, coming up from about 10%. We would expect that to be maybe in the high 30s as we get into the fourth quarter. But certainly as rates continue to rise and the Fed continues to be very aggressive, it's going to migrate to higher percentages. Our through the cycle estimate right now is still kind of mid-30s, though, we kind of think about the entire rate cycle that we're going through.
Ken Usdin, Analyst
Okay. And then as a follow-up to that, so as that plays forward, you're still expecting good NII growth into the fourth quarter. I know you're giving '23 guidance, but just can you help us understand like what are the gives and takes to make? Can you still grow NII post the fourth quarter sequentially? Or is it just a reality check about some of these mix and beta functions that make that tougher?
Terry Dolan, CFO
Yes, I believe we can continue to grow net interest income as we move past the fourth quarter. However, the rate of growth may vary across the industry, influenced by changes in deposit betas. The loan growth that the industry has seen is quite strong, but it's uncertain whether that growth will maintain its current pace as we progress.
Ken Usdin, Analyst
All right. Understood. Thank you, Terry.
Operator, Operator
Betsy Graseck with Morgan Stanley is online with a question.
Betsy Graseck, Analyst
Hi, good morning.
Andy Cecere, CEO
Hey, Betsy.
Betsy Graseck, Analyst
It would be helpful if you could provide insight into how we should consider the pull to par in the AFS book. Specifically, it would be great to understand if we assume rates will remain the same from this point forward, and how many quarters or years we should incorporate into our models.
Terry Dolan, CFO
Yes, we have mentioned that the duration of the portfolio is just over 5 years. Considering that, it likely provides some guidance on how AOCI factors into the capital equation.
Betsy Graseck, Analyst
Okay. So it should be longer than a 5-year period?
Terry Dolan, CFO
Yes, a little bit longer, but not much.
Betsy Graseck, Analyst
Okay. And is there anything you're thinking about with regard to restructuring the books once Union Bank comes on?
Terry Dolan, CFO
Yes, we will review the balance sheet to determine what makes the most sense. We anticipate that we might adjust the securities portfolio when it arrives. As a result of the transition, we may increase held-to-maturity securities. This is certainly something we will examine.
Betsy Graseck, Analyst
And then just separately on the consumer lens that you have in the payment side, could you just give us a sense as to what you saw on 3Q? I know 3Q tends to be a relatively strong quarter for you. Any changes in behavior, any insights as to how you think 4Q will end up shaping up?
Andy Cecere, CEO
So, Betsy, the consumer spend levels overall continue to be strong, they were up and credit card spend about 10% on a year-over-year basis, about 30% above pre-COVID levels. The mix of categories has changed a bit consistent with what we've talked about before, a little bit away from hard goods to more services and a little bit away from non-discretionary to non-discretionary from discretionary. So that shift in spend that we have been discussing continues, but the overall levels are still very strong.
Betsy Graseck, Analyst
And the savings levels of the consumers are hanging in there?
Andy Cecere, CEO
Yes, Betsy. So I mentioned that we saw increases across all strata of balances for about two years, but the last two quarters have been stable across all categories. So not growing anymore, but not shrinking dramatically as well.
Betsy Graseck, Analyst
All right. Thanks so much.
Andy Cecere, CEO
You bet.
Terry Dolan, CFO
Hey, Ken, I want to clarify something regarding deposit betas to ensure I have the correct percentages. The deposit betas for the second quarter were around 20%. In the third quarter, they were nearly 30%. We expect this increase to continue as rates rise and to accelerate a bit, likely reaching the high 30s by the fourth quarter.
Operator, Operator
We have no further questions at this time. I will now turn it back to George Andersen. Please continue.
George Andersen, Director of Investor Relations
Thank you for listening to our earnings call. Please contact the Investor Relations department if you have any follow-up questions.
Operator, Operator
This concludes today's conference. Thank you for participating. You may now disconnect.