Earnings Call Transcript
US BANCORP DE (USB)
Earnings Call Transcript - USB Q3 2023
Operator, Operator
Welcome to the U.S. Bancorp Third Quarter 2023 Earnings Conference Call. Following review of the results, there will be a question-and-answer session. This call will be recorded and available for replay beginning today at approximately 9:00 a.m. Central Time. I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for U.S. Bancorp.
George Andersen, Senior Vice President and Director of Investor Relations
Thank you, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; Terry Dolan, Vice Chair and Chief Administration Officer; and John Stern, Senior Executive Vice President and Chief Financial Officer. During their initial prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that may materially change our current forward-looking assumptions are described in today's presentation, our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry, and John will take any questions that you have. I will now turn the call over to Andy.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on Slide 3. In the third quarter, we reported earnings per share of $0.91, which included $0.14 per share of notable items related to merger and integration charges. Excluding those notable items, we delivered earnings per share of $1.05 for the quarter. Third-quarter results were highlighted by linked-quarter and year-over-year fee revenue growth that benefited from our acquisition of Union Bank, deepening client relationships, and strong underlying business activity. We are achieving the cost synergies we anticipated from Union Bank and continue to prudently manage core expenses as we identify operational efficiencies across the business. As of September 30, our Common Equity Tier 1 capital ratio was 9.7%, an increase of 60 basis points this quarter. This is the same level that it was prior to our acquisition of Union Bank. Total average deposits increased 3% or $15 billion on a linked-quarter basis. Credit quality continues to normalize this quarter, in line with expectations, and we further strengthened the balance sheet by adding $95 million to our loan loss reserve, reflective of an evolving credit environment. On October 16, the Federal Reserve granted us full relief from certain Category II commitments made in connection with the Union Bank acquisition given our balance sheet reduction and capital actions. As a result, we are now subject to existing capital rules or, if adopted, the same transition rules as all other Category III banks related to enhanced capital requirements under the Basel III proposal. As proposed, this would include a three-year transition period for the expanded risk-based approach and AOCI regulatory capital adjustment starting in the third quarter of 2025. I will discuss the impacts of these decisions further in my closing remarks. Slide 4 provides income statement results as reported and on an adjusted basis, ending balances, and other key metrics. Slide 5 provides key performance metrics. Excluding notable volumes, our return on average assets was 1.04%, and our return on tangible common equity was 21%. While net interest margin declined 9 basis points to 2.81% this quarter, in line with our expectations, we continue to expect the NIM to bottom in the fourth quarter as we reach the end of the current rate hiking cycle. Turning to Slide 6. A great benefit of our business model includes a balance between our spread and fee income businesses that helps us reduce earnings volatility through a business cycle. On a year-over-year basis, noninterest income grew approximately 12%. Within Payment Services, we continue to invest in our digital capabilities, expanding our payments ecosystem, and optimizing our distribution. Emphasis on expanded partners and integrated capabilities will continue to support tech-led growth across merchant processing and increased opportunities across other areas of payment services businesses. Additionally, we are continuing to make investments that leverage our scale and strategic market positioning across our corporate trust, mortgage banking, and capital markets businesses, which should enhance our already strong annualized growth trajectories. Slide 7 highlights a few of our many post-conversion revenue opportunities and expected synergies with Union Bank. Early indications of the potential to deepen relationships with the legacy Union Bank loyal, affluent, and diversified client base are promising, and we continue to be on track to realize approximately $900 million in cost synergies, which we expect to be fully reflected in our run rate as we head into the year 2024. Let me now turn the call over to John, who will provide more details on the balance sheet and results for the quarter.
John Stern, Senior Executive Vice President and Chief Financial Officer
Thanks, Andy. Turning to Slide 8, we ended the quarter with total average assets of $664 billion and total average loans of $377 million, down $9 billion and $12 billion, respectively, on a linked-quarter basis as we prudently managed and optimized our balance sheet given the current macroeconomic and regulatory environment. Average total deposits were $512 billion, representing a 3% increase linked quarter, driven by expected seasonality and growth in money market and time deposit accounts. Specifically, average noninterest-bearing deposits decreased $16.2 billion this quarter, primarily driven by our Union Bank retail customer upgrade at conversion from noninterest-bearing checking accounts to our interest-bearing Bank Smartly product. Excluding this reclassification, the decrease would have been $6.2 billion. Our mix of noninterest-bearing to interest-bearing deposits was approximately 19%, consistent with where we expect the mix shift to stabilize based on historical performance and the operational nature of our core deposit base. Slide 9 provides an update on the investment securities portfolio. As of September 30, our available-for-sale securities were 97% of our total securities. We continue to reduce the effective duration of the AFS portfolio, which is now less than 3.5 years. On Slide 10, we provide a detailed earnings summary for the quarter. This quarter, we reported diluted earnings per share of $0.91 or $1.05 per share after adjusting for merger and integration charges. Turning to Slide 11. Net interest income on a fully taxable equivalent basis totaled approximately $4.3 billion, representing a 4.1% decrease on a linked-quarter basis and a 10.7% increase from a year ago due to the impact of rising rates and the acquisition of Union Bank. Our net interest margin declined 9 basis points to 2.81% in the third quarter. The linked quarter decline was primarily due to the impact of lower earning assets, deposit pricing, and mix shift, offset somewhat by better loan spreads and funding mix. Slide 12 highlights trends in noninterest income. Fee income increased 11.9% or $295 million on a year-over-year basis, driven by higher payment service revenue, trust and investment management fees, virtual products, and mortgage banking revenues. On a linked-quarter basis, fee income increased 1.4% or $38 million, driven by other revenues, which included servicing revenue from previously executed balance sheet optimization actions. Turning to Slide 13. Reported noninterest expense for the quarter totaled $4.5 billion, which included $284 million of merger and integration-related charges. Noninterest expense, as adjusted, decreased $13 million or 0.3% on a linked-quarter basis driven by lower compensation expense that was somewhat offset by our investments in marketing and business development. Slide 14 shows our credit quality performance this quarter. While asset quality metrics reflecting changing conditions in the commercial real estate office segment, results this quarter continue to trend in line with our expectations, and key metrics remain below pre-pandemic levels. Importantly, given the higher interest rate environment as well as other portfolio considerations, we increased our reserve ratio for commercial real estate office loans to 10%. Our ratio of nonperforming assets to loans and other real estate was 0.35% at September 30 compared with 0.29% at June 30 and 0.20% a year ago. Our third-quarter net charge-off ratio of 0.44% increased 9 basis points from a second quarter level of 0.35% as adjusted and was higher when compared to a third quarter 2022 level of 0.19%. Our allowance credit losses as of September 30 totaled $7.8 billion or 2.08% of period-end loans. Turning to Slide 15. We continue to take action to improve our capital ratios this quarter, increasing our CET1 ratio to 9.7% as of September 30. The combination of our debt-to-equity conversion with MUFG, earnings accretion net of distributions, and balance sheet optimization actions resulted in a 60 basis point increase from last quarter. Importantly, our CET1 capital ratio is now 270 basis points above our regulatory capital minimum. I will now provide fourth quarter forward-looking guidance on Slide 16. In the fourth quarter, we expect net interest income of between $4.1 billion and $4.2 billion. Total revenue, as adjusted, is estimated to be in the range of $6.8 billion to $6.9 billion, including approximately $65 million of purchase accounting accretion. Total noninterest expense, as adjusted, is expected to be approximately $4.2 billion, inclusive of approximately $115 million of core deposit intangible amortization related to the Union Bank acquisition. On a core basis, we expect full year 2024 expenses to be flat with 2023. Our income tax rate is expected to be approximately 23% on a taxable equivalent basis. We expect merger and integration charges of between $250 million to $300 million in the fourth quarter. I'll now hand it back to Andy for closing remarks.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, John. Turning to Slide 17. The Federal Reserve notified us on October 16 that they have granted us full relief from Category II commitments made in conjunction with the Union Bank acquisition after considering several factors, including actions to reduce our risk profile, strengthen our capital position, and provisions related to Category III rules made after we received approval on the Union Bank acquisition. This important decision now subjects us to the same enhanced capital requirements as all other Category III banks, including a three-year phase-in of AOCI into regulatory capital starting in the third quarter of 2025. As expected, we will continue to carefully balance the need to accrete capital with any potential impact to earnings from further balance sheet optimization activities. Measures to manage the interest rate sensitivity and duration of our available-for-sale securities will continue. Since before our acquisition of Union Bank, our priority has been and will continue to be the strategic execution of capital-efficient growth opportunities across each of our business lines. As a result of the Fed's decision, we are now well positioned with our enhanced earnings profile and diversified business mix to increase our capital levels, continue our disciplined lending activities, and further strengthen our balance sheet. Let me close by thanking our more than 75,000 employees for their dedication to supporting the needs of our clients, communities, and shareholders. We'll now open up the call to Q&A.
Operator, Operator
This concludes the prepared remarks. And we'll go to Ebrahim Poonawala with Bank of America. Please go ahead.
Ebrahim Poonawala, Analyst
I guess maybe the first question, just around the Fed decision. In its letter, the Fed said, I guess, the bank anticipates taking further actions to reduce risk profile and reduce assets and increase capital. So if you don't mind talking about just what additional actions we should expect. I think you mentioned that the EPS impact could be neutral from here. But just how should we think about what else the Fed expects from you on the risk mitigation side as we move forward into next year?
John Stern, Senior Executive Vice President and Chief Financial Officer
Sure, thanks, Ebrahim. This is John. As background, the Fed has granted us full relief from our Category II commitments due to our actions in reducing risk and strengthening our capital position. This relief will give us more time and flexibility to meet new regulatory requirements on the same schedule as our Category III peers. We believe this will also help mitigate risks given the current challenging interest rate environment. However, our approach to managing the balance sheet remains unchanged. We remain focused on building regulatory capital and aim to increase our capital by 20 to 25 basis points on average each quarter. We expect to accelerate this as we move beyond merger-related costs and fully realize the synergies from Union Bank. We will continue with risk-weighted asset optimization transactions, but now we have the time and flexibility to do so with minimal impact on our earnings. For these reasons, we feel confident in our balance sheet's ability to support these initiatives.
Andy Cecere, Chairman, President and Chief Executive Officer
I think that's exactly right, John. The only thing I'd add is that part of the decision is reflective of what we've already done for the last 12 months in terms of reducing the risk profile, building capital, optimizing the balance sheet. And I want to be clear, Ebrahim, we are not under an asset cap at all. We are maintaining flexibility and managing the balance sheet and capital, and we'll continue to remain focused on capital-efficient growth. That includes focusing on high-margin, high-return businesses that exceed our cost of capital while deepening relationships with our most profitable clients. That has been and will continue to be our focus.
Ebrahim Poonawala, Analyst
That's good information. John, I believe I heard you say that you expect the net interest margin to decline, and I'm assuming that means the lowest point will be in the fourth quarter. Can you clarify if this is based on a steeper yield curve or a widening of the curve? Is that assumption regarding the lowest point in net interest income or net interest margin? What makes you confident in the changes in consumer behavior that support this?
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes. In the guidance we provided, we included our rate forecast, which anticipates a rate increase in December. However, whether that increase occurs is not very significant as we maintain a neutral position regarding interest rate risk. As the Federal Reserve concludes its rate hikes, we are observing a slowdown in various areas related to deposits, indicating that our noninterest-bearing balances will remain stable at their current levels. Additionally, the rates we pay on deposits will start to decrease. Concurrently, our assets will begin to reprice, including our securities and loans. This gives us confidence that we will reach a low point in the fourth quarter concerning net interest margin and net interest income.
Operator, Operator
Next, we go with John McDonald with Autonomous Research. Please go ahead.
John McDonald, Analyst
John, can I just follow up on what you're just talking about? What are you looking at in terms of the NIM for the fourth quarter roughly? And did I hear correctly, you think the deposit mix kind of settles out around 19%, 20%, where you are here in beta kind of in the mid-40s, you still have those expectations?
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes. Maybe just to go to the last couple of questions you mentioned. From a noninterest-bearing, yes, we do expect that mix; we're at about 19%. That's about where we expect that to be in that range. And from a beta perspective, we are in the mid-40s right now. It's possible it could creep up higher depending on where the Fed goes from here, but we feel good about that. And then in terms of the net interest margin and things like that, we do anticipate a little bit more pressure here in the fourth quarter, but then that really is the point where we feel that it'll bottom out based on my comments I just made to a previous question.
Andy Cecere, Chairman, President and Chief Executive Officer
And that's reflected in our revenue and net interest income guidance.
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes.
John McDonald, Analyst
Okay. In light of the Fed's decision, you've clearly got more time to gradually incorporate the AOCI now. John, could you provide more details on the trend in AOCI this quarter? What are the components? How do the swaps influence your burn-down timeline? Also, how do you calculate the capital with AOCI currently? It appears to be around 7%, approximately.
John Stern, Senior Executive Vice President and Chief Financial Officer
I believe the impact on AOCI is about 250 basis points. Therefore, I would estimate it to be around 7.2%. Regarding the change in AFS, interest rates on the long end of the curve increased by 75 to 90 basis points, depending on whether you're looking at treasuries or mortgages. This resulted in an impact of approximately $1.4 billion on an after-tax basis on our AFS securities book, which aligns with our expectations given the duration of our portfolio. We have continued to decrease that duration, and it is currently below 3.5 years. We will keep seeing paydowns in that portfolio, whether it's for HTM or AFS, with about $3 billion rolling off each quarter, which we will reinvest on the AFS side over time.
Operator, Operator
Next, we'll go to Mike Mayo with Wells Fargo Securities. Please go ahead.
Mike Mayo, Analyst
Just to be clear, how much of the $900 million merger savings were recognized in the third quarter results?
John Stern, Senior Executive Vice President and Chief Financial Officer
We expect to reach a full run rate of $900 million, with approximately $100 million in that range being what we anticipate. The amount has been increasing, and we expect to see the full benefit in the fourth quarter.
Mike Mayo, Analyst
So relative to the third quarter, the first quarter of 2025 could see $800 million of additional expense savings?
John Stern, Senior Executive Vice President and Chief Financial Officer
No, because the savings have been generated throughout the year, and they accelerated from the third quarter into the fourth quarter, as well as from the second quarter and third quarter to the fourth quarter.
Mike Mayo, Analyst
So what's the cumulative merger savings? I guess how much more expense savings should there be when they're fully realized in the first quarter relative to the third quarter?
John Stern, Senior Executive Vice President and Chief Financial Officer
When we have the savings, we'll have approximately $400 million that has gone through this full year, and then we'll expect to see that in the next coming year. But that's embedded into our full-year guidance of flat expenses between 2023 and 2024.
Andy Cecere, Chairman, President and Chief Executive Officer
So Mike, the way I think about it, this is Andy, by the end of the fourth quarter, we will be on a run rate recognizing $900 million of savings, which will be fully reflected in 2024 in our expense base. That is consistent with how we think about a relatively flat 23% to 24% expense base, including those savings plus investments we'll continue to make in the business.
Mike Mayo, Analyst
And then the big question then is, so if you have flat 2024 expenses, do you think you can get to positive operating leverage? Or is it too early or too many moving parts? Because this is the sweet spot of the merger savings coming up, right, by the next quarter.
Andy Cecere, Chairman, President and Chief Executive Officer
It is indeed a sweet spot, and you're absolutely correct. The savings are significant, and the potential to strengthen our relationships with the Union Bank customer base is impressive, as I noted earlier. Our fee businesses are performing exceptionally well, showing a 12% increase year over year across nearly all categories. Importantly, this growth is largely due to core improvements in various areas, including capital markets, corporate and trust services, and our payments businesses, rather than being tied to Union Bank specifically. However, the main challenge we and the industry face is net interest income and margin. In the current environment, that aspect has many factors at play. Loan growth is relatively slow for both us and the broader industry. Therefore, achieving positive operating leverage will depend on this situation, and I think it's too early to make a definitive call.
Mike Mayo, Analyst
Okay. And last follow-up, your increase in CET1 ratio due to a lot of balance sheet optimization did come at a cost of less assets, less loan growth, less earnings, right? There's a trade-off in that. So now that you're under kind of less pressure and have so much more flexibility, do you think you can be a little bit more lax in terms of your growth and in turn, that may help NII? Or is that too much of a stretch?
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes. We have flexibility now in terms of the transactions that we do to optimize. And we still have plans to do those sorts of things. We've identified some things that are going to be relatively neutral and a little bit on the low end of earnings impact. Of course, you saw some of those transactions in the second quarter flow through in terms of provision and things like that. And that did lower our earning assets, as you mentioned, about $8 billion this quarter.
Operator, Operator
And next, we'll go to John Pancari with Evercore. Please go ahead.
John Pancari, Analyst
I know despite the regulatory change around the Cat II requirement, you maintain the 20 to 25 bps generation in CET1 quarterly. Why no change there? Can you just talk to us maybe about the give and takes in that expectation as the need to meet the Category II shifted to Category III, why no change there?
John Stern, Senior Executive Vice President and Chief Financial Officer
Well, I think there's no change because we feel like given the new rule set and things like that, over time, we'll have to transition into the new regime, which will include AOCI, and all the other rules. So, we're going to be in a mode to continue to accrete that capital, and 20 to 25 basis points is our earnings stream that we will accrete. And as you saw, this quarter, for example, it was 20 basis points, but we anticipate going to 25 on the higher end of that range as we get through the merger-related costs and we have the Union synergies.
John Pancari, Analyst
Okay. So the less RWA activities didn't materially benefit that expectation?
John Stern, Senior Executive Vice President and Chief Financial Officer
I'm sorry. Can you say that? I couldn't hear you.
John Pancari, Analyst
The less risk-weighted asset optimization required to meet Category III did not significantly affect the 20 to 25 basis points of earnings generation expected.
John Stern, Senior Executive Vice President and Chief Financial Officer
No, that did not. For instance, this quarter, we had 20 basis points of risk-weighted asset actions, which included some of the asset reductions you observed, resulting in lower earning assets, along with some other transactions involved. Therefore, we distinguish core earnings when discussing the 20 to 25 basis points of core earnings from other risk-weighted asset optimization transactions that we can execute.
John Pancari, Analyst
Okay. Is there any impact on operating expenses from needing to conform to Category III compared to the more immediate requirements of Category II? Is there anything on the expense side? Additionally, concerning your comment about margins reaching their lowest point, what do you expect regarding the trajectory of margins after this bottoming as we move into 2024?
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes. So in terms of OpEx, no, there's no further investment. You may recall before tailoring, we had many of the same rules and standards that we had in terms of liquidity rules and reporting and all those sorts of things. So, we have all the capabilities built up or can quickly get to that level from an operational standpoint. So, there's no worries there. In terms of the net interest margin, we mentioned just a little bit of pressure in the fourth quarter and then bottoming out, likely stable. But still dependent on interest rates, quite frankly, at that particular time.
Operator, Operator
And next, we'll go to John McDonald with Autonomous Research. Please go ahead.
Scott Siefers, Analyst
It’s great to see you no longer facing Fed restrictions. Are you concerned about the possibility of exceeding $700 billion in assets organically or encountering any Category II restrictions that could push you into those rules before your peers? I’m trying to understand if this situation is completely free of risks.
John Stern, Senior Executive Vice President and Chief Financial Officer
As Andy noted, there is no asset cap, so we have full flexibility with our balance sheet moving forward. If we decide to expand, we intend to do so in a capital-efficient way. However, we will focus on higher return loans and reduce our emphasis on lower return assets. This shift will be visible as our balance sheet evolves. Additionally, I want to point out that the current loan outlook is quite low, with reduced demand for loans due to various factors. This situation gives us the assurance that we have ample time and flexibility.
Scott Siefers, Analyst
Yes. Perfect. Okay. And then I think you might have touched on this in an earlier question, but maybe if you can sort of re-walk us through the sort of AOCI burn-down and cash flow expectations coming off both the AFS and HTM books. And then, I think you might have given the duration of the AFS book, but do you have that for the HTM book as well?
John Stern, Senior Executive Vice President and Chief Financial Officer
In terms of the AFS and HTM, we're at about $162 billion in total balances, split evenly between AFS and HTM. We experience approximately $3 billion of runoff each quarter due to the current interest rate environment. We've managed to hedge around 30% of the fixed-rate portion of the AFS book, which has resulted in a duration of less than 3.5 years for that book. The HTM book mainly consists of agency mortgage-backed securities, which have longer durations, typically around six years.
Operator, Operator
And next, we'll go to Erika Najarian with UBS. Please go ahead.
Erika Najarian, Analyst
Andy, my first question is for you. Yesterday's announcement represents a significant achievement for the Company. As we consider this relief alongside a generally tighter regulatory environment, what CET1 level are you targeting now? In an environment where balance sheet growth is minimal, I can look to return capital to shareholders through buybacks. I'm curious about your GAAP CET1 and the adjusted figure that John provided. We need to factor in that by July 1, 2025, only 25% of that 250 will need consideration, assuming we have clarity by then. There are many variables at play. As your investors evaluate the various components you've implemented along with this relief, what is your new target? Is it a transitional target or fully phased in? What benchmarks can investors anticipate that you would meet before initiating capital returns through buybacks?
Andy Cecere, Chairman, President and Chief Executive Officer
Yes, Erika, I understand the question. And first of all, I just want to highlight, we're back to 9.7, which is where we started before the deal and we're able to build. We went from 9.7 to 8.4 and build 130 basis points in basically less than a year, which I thought was a great effort across the Company. In terms of what our new target is, our short-term target is to continue to build, as we talked about. Remember, there are two sets of rules that are yet to be finalized and coming down. Number one, are the Basel III end game finalization of rules, which will, in one way or another, increase capital levels. And the second is clarity on CCAR. We'll set those targets once we have clarity on those two items.
Erika Najarian, Analyst
And so just to follow up here. At least until June 2024 CCAR results, regardless of how quickly you build the capital, either on an adjusted or on a GAAP basis, you're going to continue to be at pause on the buyback until we see the CCAR and the SEB?
Andy Cecere, Chairman, President and Chief Executive Officer
That's my expectation, Erika. We want clarity on the finalization of the Basel III and the CCAR importantly. So, we'll be continuing to build capital and determine our capital targets and buffers and all that activity once we have more clear clarity in the finalization of the rules.
Erika Najarian, Analyst
Got it, that's very clear. Just one more for John, if I may. Regarding the net interest income trajectory, the fourth quarter looks promising, especially compared to our thoughts from two days ago, which suggested more RWA mitigation. As we look ahead to RWA mitigation, which has less impact on EPS, should we consider it similar to what we observed earlier in the year regarding securitization? Will you continue to use credit linked notes, which I assume has cost you around 12.5% of the pool, plus SOFR and the spread? Additionally, do you feel the need to hold more liquidity in anticipation of LCR rules for regional banks? We are also hearing there could be significant haircuts regarding how they view HTM as HQLA.
John Stern, Senior Executive Vice President and Chief Financial Officer
Sure, Erika, I will start with your point. Regarding LCR, in addition to what Andy mentioned about the capital side, we will need to wait and see what happens with liquidity concerning any potential changes from LCR. We are confident in our ability to meet whatever those changes may be and believe we can adapt to any scenarios that arise. As for net interest income, we expect it to bottom out in the fourth quarter. Its direction afterward will depend, in part, on interest rates.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Erika.
Operator, Operator
And next, we’ll go to Gerard Cassidy with RBC. Please go ahead.
Gerard Cassidy, Analyst
Andy, obviously, U.S. Bancorp has developed a reputation of being a strong underwriter and we talked about this in the past with you folks. And I was wondering if you could frame out the environment because every bank is talking about credit normalization as you guys did because we had such great numbers coming out of the pandemic on credit. And if you just exclude for a moment the economy because obviously, none of us can control that, but I'd really be interested in what you guys are seeing from a competitive standpoint in terms of underwriting. And if you could compare it to past cycles, obviously, we've been around for a few cycles and can't compare. But I'm curious, from your guy's vantage point, is it as risky today as it may have been in '05, '06 or '99, 2000. Any color there that you can share with us?
Andy Cecere, Chairman, President and Chief Executive Officer
Let me give you the big picture, and I'm going to ask Terry to highlight some specifics. I would say the consumer is entering this cycle in very strong shape from a balance standpoint, from the perspective of savings accounts that they have, the spending activity, I think they're all starting to normalize, but normalized to a pre-pandemic what I'd say, normal level. The companies and small businesses are also in very good shape. The one area that we're all very focused on is commercial real estate office, which is one of the areas that we increased our reserve to. As you know, it's at 10% in this quarter. Maybe, Terry, you can give some specifics.
Terry Dolan, Vice Chair and Chief Administration Officer
Yes. I would like to add that when we consider underwriting, we approach it with a long-term perspective, taking into account potential stressors such as rising interest rates and other economic influences. We haven't made significant changes to our underwriting standards and are mindful of the current cycle. In the industry, there seems to be some tightening, particularly from a competitive standpoint, but we believe we're in a strong position. As Andy mentioned, the area we are watching most closely is commercial real estate, specifically office space. We have a reserve that constitutes about 10% of the total balance in that area, and we plan to continue increasing it as it poses a potential risk. However, starting from a broader portfolio perspective, our starting point is fairly strong. Our non-accrual loans account for only 35 basis points of total loans, and our allowance stands at 2.08%. While delinquencies are rising, they remain low overall. As we approach 2024, we expect normalization to persist, with both delinquencies and nonperforming assets likely to increase. Nevertheless, we feel confident about our allowance coverage and our overall position.
Gerard Cassidy, Analyst
Very good. It's nice to hear from you, Terry. Following up on your comments about competition, do you notice any extreme behaviors from nonbank competitors, similar to what we saw in 2005 and 2006 when various banks and nonbanks engaged in risky lending? Are there any players out there taking significant risks that might negatively affect the banks, not due to poor underwriting decisions on our part, but rather because those competitors are acting irresponsibly, leading to some consequences for the banks? I'm not implying that we are in a situation like 2006, just looking for a comparison.
Terry Dolan, Vice Chair and Chief Administration Officer
I think both in the bank and in the nonbank space, I think that people are being fairly rational. Part of the issue is that it's maybe more so on the demand side of the equation as much as anything. I think corporate America is being relatively cautious out there. They're still waiting to see where interest rates settle in. Until they see more certainty regarding what the interest rate inflationary environment looks like, I think corporate America has been relatively cautious. Therefore, demand is relatively soft. But we're not seeing, what I would say crazy things either on the bank or on the nonbank side at this particular point in time. In fact, we're probably seeing a pullback across the board in commercial real estate.
Gerard Cassidy, Analyst
Great. As a follow-up, Andy, it was fantastic news about the relief you announced yesterday. Is there any insight into this? You met with the regulators to secure that release, and they seem to have been reasonable in their decision to make that change. There's been a lot of speculation and criticism regarding the stringent Basel III end game proposals. Do you think we might see some rationality from the regulators in potentially revisiting those requirements, or is that too optimistic?
Andy Cecere, Chairman, President and Chief Executive Officer
I think the regulators have asked for feedback. The banks will provide feedback, both collectively and individually. I think a lot of the feedback is good feedback because of the consequences to our customers. And I think that's the area of focus that we're going to be very pointed on in terms of our feedback. We want to make sure that from a banking standpoint we are able to serve our customers, and the rule set will create some friction around that in certain categories, and that's where we're going to focus. My anticipation is that the Fed will listen to our perspectives, and that's my hope.
Operator, Operator
Next, we'll go to Vivek Juneja with JPMorgan.
Vivek Juneja, Analyst
Shifting gears from capital, you have made significant progress in your core business. Andy, you mentioned your goal of growing merchant processing in the mid- to high single digits, particularly aiming for the high single digits, while some areas like corporate payments are expected to grow in the low double digits. Can you provide any insights or thoughts on how you plan to reach those targets? This has not been the trend in the last few quarters, so what changes or actions would be necessary to achieve that growth?
Andy Cecere, Chairman, President and Chief Executive Officer
I'm going to ask John to start then I'll add in.
John Stern, Senior Executive Vice President and Chief Financial Officer
Sure. In terms of merchant processing, we have been making a number of investments over the years and continue to expect that high single-digit growth in that area. The numbers have been strong this quarter, but there's normalization that has been happening. Over the last several quarters, there have been nuances coming out of COVID and all those sorts of things. If you think about airline tickets and hotels and corporate T&E, those have been very strong, but they are normalizing. That said, services and retail have been strong. The retail print that we saw yesterday was very constructive. So we feel like there are good underpinnings there in addition to the investments that we make to continue to believe and give confidence in those projections.
Andy Cecere, Chairman, President and Chief Executive Officer
And I think two of those important investments, Vivek, are our tech-led initiative, which is about one-third of our revenue base right now is tech lead from a perspective of new activity. Secondly, it’s the business payments ecosystem, which continues to be a top priority for the Company because I think it's a huge opportunity for our business banking customer base as well as our commercial customer base. Then you add in what we're getting from Union Bank; I think that's why we're confident in that higher single-digit increase.
Vivek Juneja, Analyst
Okay. And then another key business that you mentioned, you're expanding capital markets since you're not doing your investors anymore. Any color on what you're doing there to expand that? You've always had the loan syndications and debt capital market. What else are you doing to step that up in terms of the level of revenues from that?
John Stern, Senior Executive Vice President and Chief Financial Officer
Sure. This is John. We have continued to invest in back-end systems and our frontline by acquiring talent, which has been a great story for us, and we plan to keep investing in this area moving forward. Alongside high-grade underwriting, there is high yield. One strong area has been the derivative market, where we provide interest rate hedging products for our clients, especially during this period of fluctuating interest rates, as this service has been in high demand. Foreign exchange has also been growing, particularly with Union Bank, as we now have a stronger West Coast customer base and increased foreign exchange needs. Additionally, we work with several businesses in the Corporate Trust sector, including those in Europe, so there is always a need for foreign exchange, and we have experienced significant growth there. Furthermore, we have been increasing our market share in the investment-grade and high-yield sectors. In the coming days, I believe we will rank in the top 10 for investment grade in terms of market share. This business has steadily advanced and has been a strong contributor for us.
Operator, Operator
And next, we'll go to Matt O'Connor with Deutsche Bank. Please go ahead.
Matt O’Connor, Analyst
I was wondering if you could provide some insight on the revenue opportunities shown on Slide 7. Specifically, regarding the UB deal and the revenue synergies outlined, can you give any indication of how substantial that might be or the timeframe for it?
Andy Cecere, Chairman, President and Chief Executive Officer
It is a high priority for each of our businesses. Probably the greatest priority is that first one we highlight, which is our credit card opportunity. The payments business is a strength of U.S. Bank. Our card offering is terrific, and we've already had a penetration increase from where we started, and that continues to be a focus. And then you think about that with the business clients as well. I think it is a material impact. But we're still working through exactly the sizing and timing, and we'll continue to update on that. But it is a priority and a focus area for each of our businesses.
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes, just to jump in, Matt, just to reinforce that. The credit card opportunity is a significant area of focus for us, and we see meaningful synergies there based on customer base and cross-selling opportunities.
Matt O’Connor, Analyst
Okay. And then separately, a little bit of a technical question, I forgot some of CFA materials. But when we look at the securities book of a duration of less than 3.5 years, but you're only burning down 25% through '25. Remind me how that math works? And does the burn-down kind of step up as we think about '26, right? Because the duration is pretty short and the burn-down is not all that much in the first couple of years.
John Stern, Senior Executive Vice President and Chief Financial Officer
Yes. The function of the curve really changed as we observed it flatten considerably this quarter. I would note that we hold several fixed-rate securities with longer durations or average lives. We also have a portion of our swaps with very low duration, around three months, due to the nature of the floating rate index. Additionally, we've added approximately $8 billion to our security book through auto repack transactions in the fourth quarter of last year and the second quarter of this year, which is also quite short alongside some floating rate securities in that book. This creates a barbell approach, providing duration and allowing us to see value changes with shifts in interest rates. However, the burn-down will be influenced in part by the shape and type of securities included in the book.
Andy Cecere, Chairman, President and Chief Executive Officer
Thanks, Matt.
John Stern, Senior Executive Vice President and Chief Financial Officer
Thanks, Matt.
Operator, Operator
And next, we can go to Ken Usdin with Jefferies. Please go ahead.
Ken Usdin, Analyst
I have a follow-up regarding the Category II news to ensure clarity. Is the $700 billion no longer a binding issue? While I understand that you don't need to adhere to the previous timeframe, I'm curious about your earlier statement indicating that there's no asset cap. Does this imply that Category II is no longer a concern for U.S. Bank moving forward? Or when you reach certain thresholds, do you still need to comply with regulations? I'm looking to understand how this aligns with the recent news.
Andy Cecere, Chairman, President and Chief Executive Officer
So, we're bound, Ken, by the current rule set, which is after four quarters of an average of $700 billion then you would go to Category II, or the new Basel III rule set, which is yet to be finalized, as you said. But the current rule set is what we're bound on. So $700 billion still is important, but what we're seeing is given where we think asset growth will be, given our continued optimization in certain categories, given our focus on high-return businesses, we do not see that as a hurdle to growth.
Operator, Operator
And with no further questions, I'll hand the call back over to George Andersen.
George Andersen, Senior Vice President and Director of Investor Relations
Thanks, everyone, for listening to our earnings call. Please contact the Investor Relations department if you have any follow-up questions.
Operator, Operator
This does conclude the conference for today. Thank you for participating. You may now disconnect.