U.S. Bancorp (NYSE:USB) Q2 2022 Earnings Conference Call July 15, 2022 9:00 AM ET
Company Participants
Jen Thompson – Head, Corporate Finance and Investor Relations
Andy Cecere – Chairman, President and Chief Executive Officer
Terry Dolan – Vice Chair and Chief Financial Officer
Conference Call Participants
Scott Siefers – Piper Sandler
John Pancari – Evercore
Gerard Cassidy – RBC
Erika Najarian – UBS
Mike Mayo – Wells Fargo Securities
Matt O’Connor – Deutsche Bank
Bill Carcache – Wolfe Research
Ebrahim Poonawala – Bank of America
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. [Operator Instructions] 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
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
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, 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 the midyear 2022 are 10x 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 – but one area I’d like to highlight on Slide 7 is our business banking initiative, which is really starting to gain traction. On the left chart, you will see that the opportunity we have previously discussed to connect our banking customers with our payments, products and services and our payments 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 has meaningfully outpaced growth in total relationships over the past 12 months. And it’s worth noting, 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
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.
We provide detail on prepaid card revenue over the past five quarters in the upper right hand quadrant. While prepaid card revenue is approaching a run-rate on a linked quarter basis, it will impact year-over-year credit and debit card revenue comparisons through the end of 2022. 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 last 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 that 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 1.6x 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 1 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
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.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Scott Siefers from Piper Sandler. Your line is now open.
Scott Siefers
Good morning, guys. Thanks for taking the question.
Terry Dolan
Good morning, Scott.
Scott Siefers
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
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 our – 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 sort of categories as people are looking at seeking sort of yield. And then when we think about deposit pricing, it’s been relatively low for the first rate cycle or rate hikes that we have seen. And in fact, it’s – for us, we have actually outperformed our expectations, which is good to see and which is a reflection in part, because we have higher level of consumer balances today than we did, for example, 4 or 5 years ago, etcetera. But when we get into the next 125 basis points, so if you think about the next two rate hikes that the market is expecting, our expectations, deposit betas will probably be in that low to mid-30s kind of in that ballpark.
Scott Siefers
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? I guess just a lot has changed in terms of both possible credit and certainly rate environment. Just curious to hear any thoughts that you have in so far as you’re able to given while it’s still pending.
Terry Dolan
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 accreted 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
The only thing I’d add, Terry, is that – as you talked about in your comments, we’re making significant process in planning for the closing of the deal, which we – as we talked about, and now expect in the second half. We targeted a second half conversion last time we talked and now – and it was going to be Veterans Day. Given now that we’re coming upon 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 3-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
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. And so of the $900 million that Andy talked about, our expectation is we will probably achieve 50% to 60% of that next year. But 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
Great. That’s perfect. Andy and Terry, thank you very much.
Andy Cecere
Thanks, Scott.
Terry Dolan
Thanks, Scott.
Operator
Thank you. Our next question comes from John Pancari from Evercore. Your line is now open.
Andy Cecere
Good morning, John.
John Pancari
Good morning. On the payments revenues 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 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
Yes. So our expectation when we get to more of a normal environment is that payments would have the high single digits sort of growth rate. So it’s a continuation of the business. The growth rates that we’re talking about in terms of moderating year-over-year 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
Okay. So – got it. So then in the moderation, is there a way you can maybe help characterize what type of level do you think is reasonable in the coming quarters as the moderation takes hold?
Terry Dolan
Yes. I think part of it in terms of moderating the growth rates, part of it is we will start to see from ‘22 to ‘23 kind of getting into a more normal environment. So I think that 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 that high single digits.
John Pancari
Okay. I got it. 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 and given the CECL requirements?
Terry Dolan
Yes. Maybe as a reminder, when we end up looking at scenarios, we look at 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. So I think about that range. For some time, there is been an uncertainty if you think about Ukraine now. And when we end up looking at the different economic and we weight those assumptions, we’re really waiting to a little bit more of a downside scenario. Relative to that baseline, we are trying to take the economic situation into consideration. So I feel like we’re in a pretty good spot in terms of how we are thinking about it. And 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
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
I think it will be more driven by loan growth than our scenario weightings getting worse, at least not measurably worse.
John Pancari
Right, right. Okay. And then one more related to that. I guess just as economic scenarios do intensify and you think if a build does begin to moderate, I mean, 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
Yes. It was as you kind of went through the pandemic, it was hard to know exactly where the economy was going. So I do think that the level of reserve builds were pretty aggressive and rightfully so at that particular point in time based upon, what we knew. I think that as we see the next economic recession kind of develop, again, John, we try to manage through the cycle. And our underwriting is strong and all those sorts of things. So while there will be reserve build 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
Got it. Thank you so much, Terry. It’s helpful.
Operator
Thank you. Our next question comes from Gerard Cassidy from RBC. Your line is now open.
Gerard Cassidy
Good morning, Terry. Good morning, Andy.
Andy Cecere
Hi, Gerard.
Gerard Cassidy
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
Yes, I don’t know if you have…
Andy Cecere
I think what drives loan activity more than anything is the economic growth and GDP. And I think from a rate scenario standpoint, in terms of credit risk, if you think about the defense side, Gerard, I think we underwrite to a higher rate environment for variable rate loans. So I think we’ve already taken that into account. And we look at cash flows under different rate scenarios as we think about putting those loans on the book. So we’re less – I’m less concerned about rising rates impacting credit. I do think rising rates as that impacts the economy will impact loan growth at some point.
Gerard Cassidy
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 seen 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. So can you guys – I don’t know if you can give us any further color on what is it that the market is – so it seems like so concerned about what 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 there?
Andy Cecere
Yes. I do think it’s the – banks are a reflection of all the customers that we serve and to the extent the recession impacts those customers that will impact us. And I think that’s why you’re seeing bank stocks, usually when rates go up, bank stocks outperform. Bank rates – we’ve been waiting for a while for rates to go up. They are probably going up and bank stocks are going the other way. And I think it’s that fear of recession for all the reasons we’ve talked about. And as I’ve talked about, Gerard, I think we are preparing for any scenario because the range of scenarios, and I talked about this before, he says, wide as I’ve ever seen it in my career. The probability of different events occurring, there is a lot of uncertainty out there, a lot of inputs into things that we’ve never had before. And I think all that uncertainty just translates into people being careful and a little prudent in terms of their investments.
Gerard Cassidy
And with that, are your customers seeing any clear evidence of the slowdown from the tightening that’s already gone on? Or is it still – are the customer is still in pretty good shape in terms of their businesses, generally speaking?
Terry Dolan
Yes. Maybe a couple of different things that certainly we watch, I mean from a consumer spend standpoint, it continues to be very strong. From a – and that obviously is what businesses are seeing now that consumer spend is shifting a bit in terms of where it’s 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 type of 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. I think in part, that’s allowing at least on the average for that consumer to spend to continue. And then they are willing to draw down on their credit card lines as well. On the business side, the way that I would characterize it as we’re continuing to see inventory builds. I think that part of the loan growth that we’re seeing or experiencing maybe businesses trying to get ahead of inflation a bit in terms of acquiring inventory today as opposed to something that might have a 10%, 20%, 30% rate increase. The one thing I would say though, Gerard, is that I think that business owners, especially in the middle market space, are just more cautious today. And it comes back to what Andy said, it seems like a strong economy today, but the range of possibilities is very wide. And so people are trying to take that into consideration when they think about running their business.
Gerard Cassidy
Fellas, thank you very much as always and good luck on closing the deal in the second half.
Andy Cecere
Thanks, Gerard. Appreciate it.
Operator
Thank you. Our next question comes from Erika Najarian from UBS. Your line is now open.
Andy Cecere
Good morning, Erika.
Terry Dolan
Good morning, Erika.
Erika Najarian
Just a new clarification questions 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
It would be lower. I mean, the average obviously will be less. So 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, so…
Erika Najarian
Got it. I’m just comparing it to appear that reported also today, I think they mentioned that the cumulative beta would be in the low 30s by year-end. And it sounds like based on the math, you could outperform that.
Terry Dolan
Certainly, in terms of what we are experiencing, the deposit betas in the first rate hikes has been lower than what we had expected. I think from just in terms of the industry and where we were starting from the betas for us, at least, have been lower.
Erika Najarian
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. And 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 sort of lost market share to non-banks, do you see some of that coming back to – that market share 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
It’s a good question, Erika. I think there is a little bit of a shift already occurring and what 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. And you saw our results of the stress test, which showed us performing very well in a very stressful environment. And I think that’s a reflection of all those things, including our diversity in our credit underwriting discipline. I do think traditional credit models work through cycles, sometimes new credit models work when things are going well and are a little more challenged when things aren’t going so well. And so we will see how those new credit models and new ways of doing underwriting will work in this downturn. But I do think that banks and certainly U.S. Bank’s models have been proven through multiple cycles.
Erika Najarian
And my third question is, I think that most of the Street subscribes to the idea that payments, is going to be a secular winner for U.S. Bank. And there is clearly a debate right now on how weak does the consumer get in a downturn. Nobody is worried really 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
Yes. Erika, it depends how severe that recession is, certainly. But as Terry alluded to, what we are seeing is 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 3x deposit level. So they are still spending dollars that they have not spent over the past few years. And as you know, the unemployment numbers are very good. So I think there is enough cushion. And I do think that at least for the near-term, that cushion will allow continued spend activity, albeit, as Terry mentioned, in a little 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. And again, how that ultimately comes out will depend upon those that range of outcomes that I talked about that’s pretty wide.
Erika Najarian
And just one last one on the fee income guide, you said lower than 2021. Did you quantify how much?
Terry Dolan
I am sorry, related to what?
Andy Cecere
So Terry, she is asking if we quantify the fee income guide, and we quantified total revenue in that 5% to 6%.
Terry Dolan
We did – yes, exactly.
Erika Najarian
Sorry, I am too much going. Okay.
Andy Cecere
No problem.
Operator
Thank you. Our next question comes from Mike Mayo from Wells Fargo Securities. Your line is now open.
Andy Cecere
Hi Mike. Good morning.
Mike Mayo
Hi. Good morning. So, I look at Slide 7, I am trying to look at – I am squinting on that, and that’s the number of joint business banking and payment customer relationship growth, and you have that indexed at 100, starting at March 2021. And by looking at a blue line versus the green line, and this is your big effort. And so I guess you are up, with my splinting here, you are up 5% year-over-year from the growth in accounts that you use both banking and payments. Is that correct?
Andy Cecere
That’s right, Mike. Sorry for the squinting, but yes. So, if you index back to 100, we are up just under 6% on those combined relationships that have both banking and payments products and that’s almost 2x what just the total relationships, which would imply just single service relationships are below that green line.
Mike Mayo
Okay. And 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? Like 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
I think it’s a little bit of both. We are still, as I mentioned, in the early innings of all this. But I will tell you, Mike, that we have a tremendous focus on this on both the Business Banking segment as well as the Commercial segment. And I think 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. And it is one of my top priorities. It’s one of the company’s top priorities across many business lines. And I do think it’s driving the growth that you are seeing in both business activity as well as corporate activity.
Mike Mayo
And then an unrelated question. I mean commercial loan growth is growing very strong. And what’s the pricing like on commercial loans? It just seems like there is such a disconnect between the capital markets, which is charging so much more for credit and the bank lending markets, which might be charging more but not nearly as much.
Terry Dolan
Yes. I think that, Mike, in the commercial side, corporate loan side of the equation, the – it’s still pretty competitive from a pricing point of view. And so I would tend to agree in the sense that credit spreads haven’t widened maybe as much as we might have expected at this particular point in time. And I think part of that kind of comes back to what economy are we looking at? I mean it’s – again, today, it looks pretty good. But my expectation is if you have this type of loan growth and the economic outlook people are kind of expecting, you would expect those credit spreads to be widening and spreads to be widening our loans more, not seen it yet though.
Mike Mayo
So, does that – I mean you are the most conservative bank in the industry based on several metrics, bond spreads, credit rating agencies, all that sort of thing. So, as the most conservative bank in the industry, among the largest, does that mean do 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
Mike, it’s a good question as well. So, Terry and myself and our leaders are being very disciplined about what we are putting on our balance sheet. And I will tell you that while we had strong loan growth, it could have been a heck of a lot stronger, but it wasn’t because we are not putting those deals that are either not appropriate from a credit standpoint, certainly or from a spread standpoint or a return standpoint. So, we are growing good loans, we could have grown more, but we didn’t.
Terry Dolan
Yes. And a perfect example, if you end up looking at the growth in auto lending for us over the last quarter or two quarters, although spreads have been very competitive, they have not been responsive to the rising rate environment. And we are willing to give up some of the volume there, simply because of the fact that returns are not as strong as they should be, given the current environment. So, that would be an example of the discipline we are talking about.
Mike Mayo
Okay. Thank you.
Andy Cecere
Thanks Mike.
Operator
Thank you. Our next question comes from Matt O’Connor from Deutsche Bank. Your line is now open.
Matt O’Connor
Good morning.
Andy Cecere
Good morning Matt.
Matt O’Connor
I wanted to ask about the credit marks related to the pending UB deal. Obviously, spreads have widened as was just discussed. And just 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%? And then of course, on the flip side, if you are marking that book down a little bit more aggressively, maybe you are essentially done building reserves in that portfolio even if we do get the hard landing.
Terry Dolan
Yes. Well, maybe from a credit mark standpoint, I think it’s pretty consistent with what we had expected. I mean that portfolio performs pretty strong. In terms of the mark-to-market from a rate point of view, it 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 – or a little higher. It kind of just depends upon where rates are at that point in time. But as you say, it accretes back into income pretty quickly. And, so it’s not really a significant concern at this particular point in time for us. I do think, Matt, also, we talked a little bit about the timing of synergies related to the cost synergies, maybe with the system conversion moving back being a little bit lower than what we had modeled, but the benefit of the mark-to-market will offset that. So, from an overall earnings accretion point of view, we still very – still feel very comfortable with 6% in 2023.
Matt O’Connor
And then just to summarize, so the credit markets aren’t really impacted by kind of 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
Yes. I mean obviously, we have to take into consideration what our assumptions are from an economic outlook point of view. But as I mentioned earlier, those haven’t changed a lot yet at this particular point in time. And so again, it depends upon the timing of the closing and what happens between here and then. But at least at this particular point in time is the quality of the portfolio is good. It’s performing well, etcetera, so…
Matt O’Connor
Okay. And then 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. But 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 as we look across some of the banks, we are not seeing that. Is there still some benefit from the servicing book to kick in?
Terry Dolan
Yes. So, 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. But that’s going to be a combination of things, Matt. I do think that there continues to be a little bit of pressure on the volume side of the equation simply because of rising rates. We are seeing, at least for us, 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 certainly into 2023. There is a fair amount of capacity that’s coming out of the system, out of the industry. And so I think that, that will help in terms of gain on sale. From the servicing standpoint, at least from our point of – in terms of how we end up management and we try to hedge MSR valuations pretty tightly. Obviously, the values of MSRs are improving because of that – because of rates. And I do expect there is probably opportunity from a servicing income point of view.
Matt O’Connor
Great. Thank you.
Andy Cecere
Thanks Matt.
Operator
Thank you. Our next question comes from Bill Carcache from Wolfe Research. Your line is now open.
Andy Cecere
Thanks. Good morning Bill.
Bill Carcache
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
Yes. I think there is a lot of uncertainty out there in which direction it’s actually going to go. I think there just needs to be more certainty around what that economic outlook is. Again, kind of coming back to what I mentioned earlier, Bill, we look at a whole variety of different economic outlooks and then we weight them and we have been, for some period of time, kind of waiting them a little bit more on the downside, expecting because of the uncertainty that we have been talking about in the past. So, if a recession hits, we will have to adjust it, but that’s something we’ll have to take into consideration at that time.
Bill Carcache
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. And 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 overheads are being used to the extent to which you consider using them?
Terry Dolan
Yes. I mean I can’t speak for what other people are doing. What I will speak to is that if you end up looking at the reserve rate on day one versus today, the change in that is really probably a couple of different factors, but it’s principally the mix of the portfolio today versus what it was 2 years ago, both in terms of the quality of the asset, but also where we have seen growth over the last couple of years. ABS Securities, as an example, security lending, as an example, is very high quality. That’s where we have seen quite a bit of growth over the last couple of years. And so a lot of it’s mix for us as much as anything. I would say from an economic perspective, relative to certainly day one, it’s probably more on the downside than it was then. So, it’s – I mean again, I can’t speak to what other people are doing, but it’s really mix driven by for us.
Bill Carcache
Understood. That’s helpful. And if I can squeeze in one last one. You guys have unique view given the depth of your consumer and commercial businesses. Maybe could you price out for us what a mild recession you think would look like maybe where you see the greatest risk on both the commercial and consumer side and then specifically within USB?
Terry Dolan
Yes. I think the greatest impacts will be on the low and moderate income customers base starting there and that’s where inflation impacts the most, and that’s where we are already starting to see some shift in spend as we talked about from discretionary and nondiscretionary. And I think as that continues that will – you will see more of an impact there. But the spend levels continue to be good as we talked about. I will tell you, one change that we are seeing for the last 2.5 years, every month, consumer balances, what our checking and savings account balances have risen every single month. We did see sort of a flattening in the last 2 months. So, that’s moderating for sure. So some of that excess savings certainly is not growing, but it’s flattening and starting to be spent. So, I think as that continues, that provides a cushion as we go into the next few months, but that cushion is starting to at least flatten out. So, those are the things we are seeing. And again, as a reminder, we don’t have – 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
Yes. And then on the corporate side, we have very little leverage lending. That’s just not an area that we get into. Our corporate customers are good investment-grade customers. So, they have certainly the ability to withstand especially a mild recession.
Bill Carcache
That’s super helpful. And Andy, maybe going back to your comment around the significant liquidity that the consumers have and how that’s kind of coming down a little bit, but it’s still high, is that something that you think perhaps is maybe contributing to the strength in the spending and potentially could be sort of inflationary in and of itself and lead the Fed to have to do more in terms of hiking, just curious just your high level thoughts on that?
Andy Cecere
Yes. I think that’s one of the wildcards or factors that we talked about. We are seeing things in today’s environment that we haven’t seen in other downturns or recessionary impacts. And I think this is one of them. So, we had trillions of dollars of government stimulus, unemployment, and the fact that people weren’t spending given the pandemic for a number of quarters and years and that built up a cushion. And that cushion certainly is impacting spend levels because now they are using it. And that’s that $2.5 trillion of excess savings. And for us, it is that high balance that we are seeing 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. And I think that cushion provides a little bit of time, certainly before you start to see some of the impacts from this higher rate environment because people are spending money they already have.
Bill Carcache
Thank you so much.
Andy Cecere
Thank you.
Terry Dolan
Yes. Thanks Bill.
Operator
Thank you. And our final question comes from Ebrahim Poonawala from Bank of America. Your line is now open,
Andy Cecere
Good morning Ebrahim.
Ebrahim Poonawala
Good morning. Just one quick question on Slide 15, on the payments business, Andy and Terry, so, 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 this means 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? And then just how that business should evolve relative in the pie chart and the breakdown you provided on Slide 15? I would love to hear your thoughts. Thank you.
Andy Cecere
So, I think what we talked about is building this capability, this ecosystem, banking and payments. And we have already made a number of smaller acquisitions, talech being one of them, TravelBank being another that have built our capabilities and thinking about helping companies manage their entire business from a receivables, a payable standpoint, money movement, lending activity cash flows and such. So, the acquisitions that you have seen us make us to do exactly that, that coupled with the investments we have made is what’s driving that, what we think is a great opportunity to build relationships and build revenue within those relationships, and that’s driving to Terry’s articulation of that high-single digit growth.
Terry Dolan
Yes. And Ebrahim, I would say that if we have a focus from an acquisition point of view, in the near-term, it will be something that’s very specific to a product or a capability that we are trying to fill in. But quite honestly, we feel pretty good in terms of where we are at right now.
Ebrahim Poonawala
And then would you expect that over the next year or 2 years, you are gaining market share in the business? And what I am trying to do is just handicap disruption risk to that business. It’s something that’s on the mind of investors. And it seems like you are making good progress, but 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
Yes, I do think we have the opportunity. I think we have two great opportunities. One is we have a big slew of banking customers. That’s on another chart. We don’t have our payments capabilities yet, and we have – half of our payments customers don’t have our banking. So, we have a great opportunity to provide more products and services to those customers. That’s number one. And number two is, given the capabilities in this ecosystem we are building, we have the opportunity to acquire more customers, which we believe will take share.
Ebrahim Poonawala
Thanks.
Andy Cecere
Thank you.
Operator
And speakers, we have no further questions at this time. I will turn the call back to Jen Thompson.
Jen Thompson
Thanks everyone for listening to our earnings call today. Please contact the Investor Relations department if you have any follow-up questions.
Operator
Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.
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