Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

U.S. Bancorp (NYSE:USB)
Q2 2018 Earnings Conference Call
July 18, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to U.S. Bancorp's second quarter 2018 earnings conference call. Following a review of the results by Andy Cecere, Chairman, President and Chief Executive Officer, and Terry Dolan, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session. If you would like to ask a question, please press *1 on your touchtone phone and press # to withdraw.

This call will be recorded and available for replay beginning today at approximately 12:00 noon EDT through Wednesday, July 25th at 12:00 midnight EDT. I will now turn the conference call over to Jen Thompson, Director of Investor Relations for U.S. Bancorp.

Jennifer Thompson -- Director Vice President of Investor Relations

Thank you, Jack, and good morning to everyone who has joined our call. Andy Cecere, Terry Dolan, and Bill Parker are here with me today to review U.S. Bancorp's second quarter results and to answer your questions. Andy and Terry will be referencing a slide presentation during their prepared remarks. 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 would 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.

Andrew Cecere -- Chairman, President and Chief Executive Officer

Good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will open the call up to Q&A.

I'll start with Slide 3. In the second quarter, we reported record net income and record earnings per share driven by record revenue and positive operating leverage. Excluding the impact of our student loan sale, loan growth picked up compared with last quarter, even as we remain disciplined in our commercial real estate underwriting. On the right side of Slide 3, you can see that credit quality improved in the second quarter and our book value per share increased by 5.8% from a year ago. During the quarter, we returned 69% of our earnings to shareholders through dividends and share buy-backs.

In the second quarter, the Federal Reserve completed its annual stress test and once again, the results confirmed our ability to withstand and remain profitable in severely adverse economic conditions. Based on the stress test results, our Board of Directors approved a 23% increase in our quarterly dividend to $0.37 per common share beginning in the third quarter, as well as a 15% increase in our stock repurchase authorization.

Slide 4 highlights our best-in-class performance metrics, including a 19.8% return on tangible common equity. Our efficiency ratio, return on average assets, and return on average common equity all improved sequentially and on a year-over-year basis.

Now, let me turn the call over to Terry, who will provide more detail on the quarter, as well as forward-looking guidance.

Terrance R. Dolan -- Chief Financial Officer

Thanks, Andy. If you turn to Slide 5, I'll start with the balance sheet review and follow up with a discussion on earnings trends. Excluding the student loans sold this quarter, average loans grew 0.3% on a linked quarter basis and increased 1.8% compared with the second quarter of 2017.

We saw continued strength in retail portfolios, such as mortgage and retail leasing. Credit card transaction volume grew and the growth was strong and supportive of robust fee growth. However, revolve rates have been declining, reflective of strong economy and the strong credit quality of our customer base, which is muting balance growth.

Commercial middle market loan growth accelerated to 2.2% sequentially in the second quarter. However, paydown activity among large corporate customers continued to be a headwind to total commercial loan growth. Line utilization remains at historical lows. However, pipelines continue to improve and commitments grew. Clients are optimistic and we are starting to see customers deploy deposit balances to fund business investments. While the timing of more robust capex activity is uncertain, we continue to expect that moderating paydowns and increased M&A closings will support improved commercial loan growth in the second half of the year.

Commercial real estate loans declined in the second quarter, reflecting our decisions not to extend credit at unfavorable terms and elevating paydowns as customers seek alternative financing. This quarter, commercial real estate contributed to a 20 basis point drag to linked quarter growth and a 140 basis point reduction to year-over-year average loan growth.

Turning to Slide 6, lower deposit growth relative to prior periods was driven by stronger economic conditions. Business customers are beginning to deploy balances to fund capital investments. Also, the impact of rising interest rates on deposit earnings credits have reduced their need to maintain non-interest-bearing deposits. Finally, there is some migration of balances to interest-bearing deposits for alternative investment vehicles as customers seek higher yields. These deposit flows are consistent with our asset liability modeling expectations.

Slide 7 indicates that credit quality improved in the second quarter due to improving economic conditions, with customer paydowns resulting in pressure on loan balances, but an improved credit profile. Notably, our non-performing assets declined 9.4% compared to the first quarter and decreased 19.1% compared to the second quarter of 2017.

Slide 8 provides highlights of second quarter earnings results, including a 7.5% sequential increase in pre-tax income and a 5.1% increase in net income available to common. On Slide 9, linked quarter and year-over-year net interest income growth was supported by higher interest rates, earning asset growth, which was partially offset by a shift in deposit and funding mix. Additionally, year-over-year growth was negatively impacted by tax reform which reduced the taxable equivalent adjustment benefit related to tax-exempt assets.

In the second quarter, the net interest margin was 3.13%, flat with the linked quarter, by higher by 5 basis points compared with the year ago. The impact of tax form on taxable equivalent earning assets hurt year-over-year net interest margin expansion by 2 basis points. Our interest-bearing deposit betas continue to perform in line with our expectations during the last few rate hikes. As future rate hikes occur, we continue to expect our deposit beta will trend toward a 50% level, which compares with the current level of about 45%.

The betas on our commercial and trust deposit bases, which represent about half of our total deposits, are in line with their estimated terminal betas. We expect that movement in the overall beta going forward will primarily by driven by our consumer deposit base.

Slide 10 highlights trends in non-interest income. On a year-over-year basis, we had strong growth in payments revenue and trust and investment management revenue, partially offset by a decrease in commercial product revenue and mortgage banking revenue. Mortgage revenue was affected by lower refinancing activity and lower gain on sale margins. Treasury management fees declined, reflecting the impact of changes in earnings credit, which is typical in a rising rate environment.

Looking closer at our payments business on a year-over-year basis, we had strong growth in credit and debit card revenue and double-digit growth in our corporate payment products revenue, each reflecting higher sales volumes. It's worth noting that this quarter marked the best revenue growth performance in corporate payments in over 7 years.

Merchant processing revenue growth continued to be impacted by our exit from two joint ventures last year, but we continue to expect that it will return to a mid-single digit growth pace by the third quarter of 2018. Merchant acquiring sales volumes continue to support our expectations. Trust and investment management fee growth was driven by business growth and favorable market conditions.

Turning to Slide 11, non-interest expense increased 1% on a linked quarter basis and 3.4% on a year-over-year basis, in line with our expectation. Compensation expense increased, principally due to the impact of hiring to support business growth and compliance programs, merit increases, and higher variable compensation related to business production. Notably, within non-personnel expenses, professional service expense declined from a year ago, primarily due to fewer consulting services as compliance programs near maturity. We expect compliance-related cost to continue to moderate through the year. In addition, mortgage servicing related costs are declining due to favorable economic conditions.

Slide 12 highlights our capital position. At June 30th, our common equity tier 1 capital ratio estimated using the Basel III standardized approach was 9.1%. This compares to our capital target of 8.5%. I will now provide some forward-looking guidance. For the third quarter, we expect fully taxable equivalent net interest income to increase in the low single-digit range on a year-over-year basis. We expect fee revenue to increase in the low single-digit range year-over-year. On a year-over-year basis, we expect to deliver positive operating leverage in the third quarter and for the full year of 2018. We expect credit quality to remain relatively stable compared with the second quarter. Our year-over-year tax rate on a taxable equivalent basis is estimated to be 21%. I'll hand it back to Andy for closing remarks.

Andrew Cecere -- Chairman, President and Chief Executive Officer

Thanks, Terry. We are building on a firm foundation and I'll leave you with two goals our entire management team is focused on as we head into the second half of 2018. No. 1, growing revenues will maintaining our credit discipline. We are willing to forego growth in areas where the risk/reward dynamics don't make sense, like certain areas of commercial real estate or higher risk leverage lending in the corporate space. Risk management is a core competency, but it does not mean we will forego revenue growth. We have a broad enough set of businesses that enable us to efficiently and dynamically allocate capital to areas where we expect the best growth and risk-adjusted returns.

We are optimistic about our ability to continue to gain share in both retail lending and commercial lending. As paydown pressures subside and existing pipelines are funded, that market share growth will be evident. I feel very growth about the outlook for our fee businesses. Momentum is building in the retail and corporate payments services, wealth management, and trust and investment services. We expect the third quarter [inaudible] inflection point in merchant servicing revenue. Cyclical headwinds facing mortgage will abate over time and we are positioning that business to thrive in the purchase mortgage market.

No. 2. Our management team is focused on investing for the future will delivering positive operating leverage. As we discussed previously, we are stepping up our business investment in digital-first capabilities, revenue enhancing initiatives, and business automation as we position this company for the future. These investments enable us to stay at the forefront in banking and will drive improving operating leverage over the next several years. However, we are mindful that we need to manage expenses for whatever revenue environment we are operating in. We remain committed to delivering positive operating leverage this year and going forward.

In closing, I'm pleased with our second quarter results and I'm optimistic and I look out to the remainder of this year and beyond. I want to thank our employees for their hard work and commitment to serving our customers and earning their trust every day. That concludes our formal remarks. Terry, Bill, and I will now be happy to answer your questions.

Questions and Answers:

Operator

If you'd like to ask a question, please press *1 on your touchtone phone. Press the # key to withdraw. Your first question comes from the line of John McDonald with Bernstein. Your line is open.

John McDonald -- Bernstein -- Analyst

Good morning, guys. I wanted to ask a little bit about expenses and operating leverage. It looks like you delivered about 10 basis points of positive operating leverage this quarter, which is an improvement. I was just wondering when you look ahead to the third and fourth quarter, would you expect an increased magnitude of operating leverage? Do you expect that to widen out? If so, what would be the drivers?

Terrance R. Dolan -- Chief Financial Officer

John, this is Terry Dolan. Thanks for the question. When we end up looking for the third and fourth quarter, I think that we will deliver positive operating leverage, although I think it will still be relatively narrow. We do expect that as we kind of get into 2019 and into 2020 that wedge of revenue growth versus expenses will start to widen. Toward that 2% to 3%, which is a part of our long-term growth expectations, but for the balance of 2018, we would expect it to be fairly narrow.

John McDonald -- Bernstein -- Analyst

Okay. Just on that point, Terry, for this year, the expenses this quarter came in a little better than expected. Does that help you get in a little closer to the lower end of the 3% to 5% expense range for this year or are you still expecting the high end and does that forecast for this year include any change in the FDIC surcharge for the end of this year?

Terrance R. Dolan -- Chief Financial Officer

Yeah, with respect to the FDIC charge, we're really expecting that we're going to have to continue to pay that through the balance of the year. But coming back to expenses, we recognize, just like the rest of the industry, that we're kind of in a transitional period with respect to tax reform. I would say that has put some challenges with respect to loan growth and as a result, revenue growth. As Andy and I have said, we are always balancing short-term versus long-term.

I would say with respect to the second quarter and the balance of the year, while we're going to continue to make investments in those long-term digital capabilities and strategic areas of focus, we're going to be very disciplined with respect to looking at discretionary spend in areas where we could cut back. We're definitely going to be managed to the lower end and with respect to our expectations of revenue growth at that point.

John McDonald -- Bernstein -- Analyst

Okay, so this year is still looking at the upper end of the 3% to 5% expense range and then next year --

Terrance R. Dolan -- Chief Financial Officer

No, it will be at the lower end of the range.

John McDonald -- Bernstein -- Analyst

Got it, OK, good. Yeah, this quarter comes in better, so you're looking at lower end this year and then next year as well.

Terrance R. Dolan -- Chief Financial Officer

Yes.

John McDonald -- Bernstein -- Analyst

Okay, got it. Thanks, guys.

Terrance R. Dolan -- Chief Financial Officer

Thanks, John.

Operator

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

Matt O'Connor -- Deutsche Bank -- Analyst

Good morning. Just to follow up on the expenses, obviously a positive messaging on slowing the growth and you mentioned working toward the 2% to 3% operating leverage in 2019 and '20. When you say working toward, are you hoping to be in that range next year? If I can try and pinpoint you on that range, or is that something that's going to take a couple years to get to? The 2% to 3% operating leverage.

Andrew Cecere -- Chairman, President and Chief Executive Officer

Yeah, I think we're starting from something that is very narrow, so it's going to take some time in order for us to be able to get to. But I would expect continued improvement in quarters as we go sequentially throughout '19, Matt.

Matt O'Connor -- Deutsche Bank -- Analyst

Okay. So maybe like a 1% to 2% operating leverage next year and then in 2020 you're the 2% to 3%? Is that a reasonable thought process?

Andrew Cecere -- Chairman, President and Chief Executive Officer

We continue to make improvements. A lot's going to depend on the revenue outlook, which is going to be very dependent on loan growth and the economy overall. But we're going to manage that positive or we're going to manage to expanding that positive.

Matt O'Connor -- Deutsche Bank -- Analyst

Okay. Then separately in the net interest margin, obviously slack NIM going into quarter. Is there still leverage to rates going up? The curve isn't helping, but just talk about the NIM trajectory, not just next quarter, but as we think through the next few questions, what some of the puts and takes are there and if there's an upward bias or do you think about it being flat?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Yeah, so again, for the second quarter, we were flat first quarter at 3.13%, but all else being equal, we would've expected that to expand by a couple of basis points during the quarter, but there are a couple different things that I would just point out. First is in the credit card space, it tends to fluctuate, but revolve rates were a little lower during the quarter and that ended up impacting NIM relative to what we were expecting. Second is that we sold the student loan portfolio and that had an a effect. And then the third is that we top the opportunity early in the quarter to hedge some of our LIBOR-based long-term debt and fix it, and that had a time zero hit or impact to us, but it should help us a little bit as we think about the future.

Those three things really represent two basis points. That hopefully helps frame it. When we think about the third quarter and into the fourth quarter, we do expect and believe there's opportunity for NIM expansion. Our securities portfolio continues to be accretive in that 100 to 125 basis points as we're replacing securities. As loans grow and we have an outlook that our loan outlook is that loans will grow and with that and the right mix of loans, we would expect to see margin expansion as well. We do think there's opportunity for that.

Matt O'Connor -- Deutsche Bank -- Analyst

Okay, thank you.

Operator

Your next question comes from the line of Betsy Graseck with Morgan Stanley. Your line is open.

Betsy Graseck -- Morgan Stanley -- Analyst

Good morning. A couple questions. One on the loan growth outlook. I'm hearing that you are very clearly retaining credit quality and so my question is, does that drive to slightly slower outlook than you've been delivering? In other words, is there are a narrowing of the credit box that has an impact or is there a narrowing of the credit box that has potentially run-offs increasing in the loan book?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Betsy, this is Andy. The short answer to your question is no, we're not narrowing the credit box. We're remaining disciplined as we always have been and, in fact, we have confidence that loan growth will accelerate. Our pipelines here are as strong as they've been in a long time. The impacts that we've seen from tax reform are starting to dissipate. Consumer spend numbers are high. Corporate payments spend activity is high, payables and T&E. So, there's a lot of confidence out there. I think actually loan growth will accelerate.

Betsy Graseck -- Morgan Stanley -- Analyst

Okay. So, the NII up low single digit year-on-year is more about NIM as opposed to loan growth? Is that accurate?

Andrew Cecere -- Chairman, President and Chief Executive Officer

No, I think that is kind of an accommodation of both. If you remember, in the first quarter we were growing at 0.1%. Now we're are 0.3% and we're going to continue to see that expand and improve, but it's not going to go hog wild in the third quarter. I mean, we would say that it's going to be moderately growing in the third quarter. That's kind of our expectation.

Betsy Graseck -- Morgan Stanley -- Analyst

Okay, got it. So, some of the trimming around the edges, line in the student loan book, I mean we saw some shrinkage in CRE, is that pretty much over at this stage?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Well, the student loan book is no longer in the numbers, obviously. The CRE probably will continue to lag because of what we're seeing in the marketplace. That's an area that we're not becoming more disciplined or tightening the credit box, but we have been more disciplined historically and we'll continue to maintain that.

Betsy Graseck -- Morgan Stanley -- Analyst

Yeah, no, I get that, Andy. On the student loan piece, my question was really more about are there other portfolios that you would be looking to trim or are you finished with that?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Yeah, Betsy, obviously we're always looking at different alternatives and different things to look at, especially portfolios that might be in a run-off status and don't have any long-term strategic benefit to the company, but there's nothing that is on the immediate horizon that we would point to.

Betsy Graseck -- Morgan Stanley -- Analyst

Okay. And the faster growth in C&I that you got this quarter is part of the optimism on the loan growth from here?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Yeah, that's particularly true, Betsy, in the middle market, which as Terry mentioned in his remarks was up 2.2% on a linked quarter growth. We're seeing strong activity there.

Terrance R. Dolan -- Chief Financial Officer

Yeah. I think the other positive thing about that is that growth we're seeing really across many markets. It's fairly broad based at this point in time. The effect of paydowns has dissipated in that space as well. The only thing I would add is that our community banking markets saw some nice growth in the second quarter. We would expect that to continue in the third.

Betsy Graseck -- Morgan Stanley -- Analyst

Okay. Thanks so much.

Operator

Your next question comes from the line of John Pancari with Evercore. Your line is open.

John Pancari -- Evercore ISI -- Analyst

Good morning. On the loan growth side, back to commercial and the period balance came in above the average balance. Is that a better number to work off of? Is that level sustainable in terms of where you can grow it off of?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Yeah, I mean, what I would say John is that certainly when you end up looking at ending versus average, we started to see strength in the latter half of the second quarter. In all of the different factors that we ended up talking about, we also saw paydowns starting to dissipate a little more in the second half of the second quarter. I think that is a good way of looking at the loan growth outlook.

John Pancari -- Evercore ISI -- Analyst

Okay, good. Then impact that you're seeing from tariffs on commercial demand?

P.W. Parker -- Vice Chairman and Chief Risk Officer

Not on demand. This is Bill. You can read in the papers the specific companies that may be impacted, but we have not seen that in any kind of, even at an industry level. We really have not seen any impact of the tariffs. Obviously, we continue to monitor closely. But if it stays at this level, we don't really anticipate any impact.

John Pancari -- Evercore ISI -- Analyst

Okay, all right. Then lastly, on the deposit side, just want to get a little bit more color on the deposit moves in the quarter that you saw. I know end of period balance is down 1%, flat on an average basis. Are you starting to see a pick-up in the shifts in deposits and anything else that's impacting the growth and what your outlook would be there as well would be helpful.

Terrance R. Dolan -- Chief Financial Officer

Yeah, on the deposit side again, what I would say that whether it's betas or whether it's just the flow of deposits, it's very much in line with what we have been modeling our asset liability sensitivities. So, there really hasn't been any unusual expectations. We've always said that corporate or commercial deposits we would start to see outflows when the economy got stronger and I think we're seeing that. We're not seeing a lot of rotation and, in fact, we are seeing growth on the consumer side, which is good to see.

Then our corporate trust balances, especially in the second quarter, because of timing of bond payments and that sort of thing, tends to fluctuate a lot. So, I guess where I'd leave it is that everything is really on track with our expectations.

John Pancari -- Evercore ISI -- Analyst

Okay, got it. Thanks, Terry.

Operator

Your next question comes from the line of Ken Usdin with Jefferies. Your line is open.

Ken Usdin -- Jefferies -- Analyst

Thanks a lot. Hey guys, a couple small ones. Can you help us understand how much NII went away with the student loan sale and how much was in that other fee line related to the gain?

Terrance R. Dolan -- Chief Financial Officer

Yeah, I would say that the gain impact is very insignificant. If you've seen other student loan portfolio sales, you don't see a significant premium with respect to that, so the gain was very small. From a net interest income standpoint, again, coming back to my point around 2 basis points, you can back into that being about a third of that overall equation.

Ken Usdin -- Jefferies -- Analyst

Okay. So that means in other fees then, was the VCPE stuff pretty big again, outsize, would you say?

Terrance R. Dolan -- Chief Financial Officer

Well, that category tends to be pretty lumpy. There's a lot of different things that end up going into it in terms of retail product revenue, insurance product sales, everything. So, it's not any one particular item in the second quarter that really has caused that to move.

Ken Usdin -- Jefferies -- Analyst

Okay, got it. On the expense side, just one question about the third quarter comps. Now that we've gotten a couple quarters into the post-tax reform changes, do you expect the seasonal upward trend in the tax-benefit related expenses and that's included in your operating leverage guide? I'm just trying to understand if you're saying low single-digit NII, low single-digit fees that kind of means low single-digit expenses and that's inclusive of any bump-up in the tax advantage expense?

Terrance R. Dolan -- Chief Financial Officer

Absolutely. There will be a bump up. There always is because of the seasonality of that particular business and a lot of tax credit projects being completed in third and fourth quarter, particularly late in the fourth quarter, but yes, it absolutely includes everything.

Ken Usdin -- Jefferies -- Analyst

Okay. Last one, are you expecting in terms of the year operating leverage, are you expecting the FDIC to go out by year end? If so, can you help us size what you think it will be?

Terrance R. Dolan -- Chief Financial Officer

Well, the FDIC surcharge, we expect that it's going to continue at least through the end of the year. As I look into 2019, they say they're going to pull it back, but at this particular point in time, who knows?

Andrew Cecere -- Chairman, President and Chief Executive Officer

The guidance we've been giving is not assuming any change in the FDIC.

Ken Usdin -- Jefferies -- Analyst

Okay. So, there's the positive operating leverage even with that staying in there. Got it. Thank you.

Operator

Your next question comes from the line of Erika Najarian with Bank of America. Your line is open.

Erika Najarian -- Bank of America -- Analyst

Good morning. I just wanted to ask a little bit more about your comments on corporate payments. One of the strongest quarters you've observed. Is that a leading indicator for the rest of the year? Sort of that's the lag in terms of that being a potential leading indicator for corporate activity on the financing side?

Andrew Cecere -- Chairman, President and Chief Executive Officer

Erika, great question. We look at that corporate payment spend, especially on the commercial side, as a leading indicator with respect to basically corporate confidence and their willingness to spend on both discretionary items, as well as capital expenditure. The fact that is growing gives us more confidence that when we look into the future that they have confidence that business continues to expand and grow. That's part of the calculus as we think about the loan outlook.

Terrance R. Dolan -- Chief Financial Officer

Erika, just to give you some numbers. The sales volume growth spend volume, so to speak, this quarter versus a year ago, we're up 11.7%. A year ago, those numbers were 6.4%, so it's almost doubled in terms of the activity from a corporate spend perspective.

Erika Najarian -- Bank of America -- Analyst

That was helpful. Thank you. On the consumer side, Andy, you talked about confidence in terms of growing both corporate and consumer. Could you remind us a little bit about offering in the premium card space? I know one of your larger peers just introduced a premium card that's available outside of their deposit network, which is unusual for them. But I'm just wondering what you're observing about competitive dynamics and how you think your premium card is positioned and what the take-up has been with your customer base?

Andrew Cecere -- Chairman, President and Chief Executive Officer

We have a full array of card products, including a premium card that we call the Altitude Card. The Altitude Card is principally for our core customers already with U.S. Bank and the uptake has been tremendous. It's a great card. One of the attributes of that card is the mobile component has multiple points or rewards. It really is intended to be the choice to be first in your mobile or in your wallet. The uptake has been very positive.

Erika Najarian -- Bank of America -- Analyst

Just lastly on the comments earlier about the consumer deposit pricing really driving deposit rates from here. I wonder if you could give us an update on potentially launching a national product? What products would you lead in and what you've observed with regard to competition picking up or not picking up on the retail side?

Andrew Cecere -- Chairman, President and Chief Executive Officer

We have a number of initiatives under way, but the one I'd highlight is really trying to extend beyond our current branch geographic 25-state positioning beyond that where we already have a customer base. So, we are a national player in both our mortgage lending, as well as our auto lending through our indirect network. Our opportunity is to expand the relationship with those customers who already have a relationship with U.S. Bank through mortgage or indirect to include depository and other opportunities in terms of bank products. That's where our focus is.

Erika Najarian -- Bank of America -- Analyst

Just to clarify, I would have to -- you're marketing directly to your national clients, or outside of the 25-state geography that already have a product. So, similar to card, this is something that four-year current client base is not necessarily available to somebody that was just going on bankrate.com and shopping for a money market account or CD?

Andrew Cecere -- Chairman, President and Chief Executive Officer

They certainly could do that but our focus in terms of leveraging growth is against the current customer base because, again, they already have a relationship with U.S. Bank. It's not a full bank relationship. It's typically a single-product relationship, typically a mortgage or an auto loan and our opportunities to expand upon that relationship.

Erika Najarian -- Bank of America -- Analyst

Got it. Thank you.

Operator

Your next question comes from the line of Mike Mayo with Wells Fargo Securities. Your line is open.

Mike Mayo -- Wells Fargo Securities -- Analyst

I have one cyclical question and one structural question. The cyclical question, you seen to be very positive about the economy. I think I heard you correctly. "Accelerating loan growth and corporate spend and payments as twice as fast as a year ago." So, given that view, do you think that the yield curve will steepen and do you back up that view with how you position the balance sheet? The big debate about the [inaudible] yield curve does it foreshadow a downturn? But it seems like you're saying the opposite, you said that you've got to make investments to go against the recent movement in the yield curve.

Andrew Cecere -- Chairman, President and Chief Executive Officer

Mike, I'm going to start and then ask Terry to add on. I think we do have confidence in the economy. From small business to middle market to large corporate, confidence is up, activity is up. On the consumer side of the equation, spend is up and activity is up there too. So, we do have confidence. Pipelines are strong. We talked to our leaders and our lenders. They're talking to their customers. Things are very positive. Credit is very good, as you know. So, those are all positive indicators. The yield curve does say something different today and there could be other components to that that's driving that differential. Terry, from a positioning standpoint, we're not assuming that there's going to be a steepening in the short term.

Terrance R. Dolan -- Chief Financial Officer

Right, that's exactly right. So, when we're looking at our interest rate modeling and looking at our forecast with respect to revenue growth, etc., we are continuing to assume that the yield curve remains fairly flat, as the short end rises. If you end up looking at the spread between 2 and 10-year treasury, we're kind of expecting that it's going to stay in that ballpark and not really change in that perspective.

Mike Mayo -- Wells Fargo Securities -- Analyst

Isn't that a disconnect? You see pretty bulled up on the economy, which would imply a steeper yield curve. Or are you just being conservative or are you assuming technical QE factors still stay in place?

Terrance R. Dolan -- Chief Financial Officer

Well, I think that until we actually see the yield curve steepening, I think we're going to be -- the way we model and the way we think about forecasting, we're just going to be conservative and take that point of view.

Mike Mayo -- Wells Fargo Securities -- Analyst

Okay. And then the structural question, to follow up on the last line of discussion. So, this strategy to expand outside of your 25-state network to cross-sell to mortgage and auto customers, that could potentially take you to all 50 states or most of the states? What gives you confidence that strategy will succeed? The opposite strategy, it seems like everyone's doing a national, digital bank now, from Citigroup, PNC, Goldman Sachs, JP Morgan. We tend to hear Minneapolis pop up every now and then. So, these competitors from 1,000 miles away are coming into Minneapolis, try to cross-sell to customers in your backyard. So, I guess the question is, how do you defend against those other banks that are coming into your backyard to try to steal away your customers and how do you think you can go ahead and cross-sell to your customers where you don't have a branch present?

Andrew Cecere -- Chairman, President and Chief Executive Officer

No, Mike, I will tell you in Minneapolis and in our core markets, we have not seen movement or lost customer base, either on the wholesale or in the consumer side from some of these new entrants, so I'll start there. Secondly, while you can enter all the states, we're going to focus on a few and we're going to continue to test and learn and to try different things. No. 3, I think if you go into a market without a customer base and you either compete on price or product, you could get negative selection. So, that's why we're focused on current customers who already have a relationship with the bank, who we can expand that relationship with other products and services, because they already have U.S. Bank as part of their wallet, so to speak, part of their relationship. We think that's the way to do it and, again, we're focused on a few markets as we start it out and we'll continue to update you on the results as we go forward.

Mike Mayo -- Wells Fargo Securities -- Analyst

Great. When did you start this recent initiative?

Andrew Cecere -- Chairman, President and Chief Executive Officer

This year. We're starting it this year.

Mike Mayo -- Wells Fargo Securities -- Analyst

Okay, great. Thanks a lot.

Operator

Your next question comes form the line of Kevin Barker with Piper Jaffray. Your line is open.

Kevin Barker -- Piper Jaffray -- Analyst

Good morning. In results to some of the outlook for revenue growth and obviously you expect a flattening yield curve, but is there any acceleration of deposit betas beyond what you've already seen within your numbers? Do you expect asset yields to continue to move higher despite the flattening yield curve?

Terrance R. Dolan -- Chief Financial Officer

On the deposit side, as we said in some of the remarks, when you end up looking at the commercial corporate world and you look at corporate trust deposits, we really feel those are at their terminal betas. So, as rates move up, we would move lockstep with it, but we wouldn't necessarily see an expansion or a narrowing of that. The real question is more on the consumer side of the equation. Consumer betas there are kind of in that 15% range and they will typically migrate toward 30%. The question is over what period of time? We haven't seen a lot of pressure. The pressure is there. It's more on the affluent side, which we've been responsive to. We price in a lot of different markets, so we keep our ear to the ground, so to speak. But it will really come down to how quickly consumer deposits move.

On the asset side, as we have talked in the past, if you end up looking at our balance sheet, we benefit both on the short end and on the long end, about 50/50. As rates continue to move up, I think there's opportunity there. The other thing I would say is, again, coming back to our securities portfolio will continue to be accretive for several quarters, many quarters. As the residential mortgage portfolio rotates and some of our longer-term assets rotate, we'll see accretive benefit associated with that as well.

Kevin Barker -- Piper Jaffray -- Analyst

Okay, thank you. In regards to mortgage banking, I notice that the origination numbers quarter-over-quarter appear to show that you've let market share go. Are you making a conscious decision to pull back from the market given the competitive dynamics that are occurring right now in the mortgage space?

Terrance R. Dolan -- Chief Financial Officer

Yeah, in the mortgage space, our add volume on a linked quarter basis was actually up about 8%. We do feel like we're in a pretty good spot and taking market share. I will tell you that it's very competitive. The margins are thin. There's a lot of capacity and it's out there. But we have shifted our focus more toward purchase mortgage. We started that about two years ago, two, three years ago. We also focused on the retail channel. The margins tend to be better in the retail channel. I think what you are seeing in the industry is really more on the correspondence side, where the margins have been very thin and people have been kind of pulling back. From a pricing standpoint, we're remaining competitive, but just given where margins are, we're being prudent about that as well.

Kevin Barker -- Piper Jaffray -- Analyst

Okay. Thank you very much.

Operator

Your next question comes from the line of Vivek Juneja with JP Morgan. Your line is open.

Vivek Juneja -- JP Morgan -- Analyst

Hi and thanks for taking the questions. A couple of questions here. Corporate payments. I wanted to get a little more granularity. How has government spend been doing, Andy, Terry? I know you talked about --

Andrew Cecere -- Chairman, President and Chief Executive Officer

Government spend is also up. In fact, spend year-over-year was up 9.8% in the second quarter of 2018. That compares to relatively flat or even down 1% last year. That is also strengthening.

Vivek Juneja -- JP Morgan -- Analyst

And how does that fee rate on that, Andy, compare with the rest of corporate payments?

Andrew Cecere -- Chairman, President and Chief Executive Officer

The fees on both are fine. There hasn't been a decline in those. So, you can see that the revenue for both also increased in the same relative vein. So, commercial spend volumes are up 11.7% and the revenue is up 12%. The government spend was up 9.8% and revenue was up 11.8%.

Terrance R. Dolan -- Chief Financial Officer

Yeah, on the government side of that, remember that those contracts tend to be very long term, and so from a pricing perspective, you see the pressure when the contracts get renegotiated, but generally during the term they stay pretty consistent.

Andrew Cecere -- Chairman, President and Chief Executive Officer

And they're relatively comparable, Vivek, between the two.

Vivek Juneja -- JP Morgan -- Analyst

Okay. Another one -- cards. You talked about the decrease in revolvers. How much of that do you think is coming just from this increased price competition in the industry from promotional relatives?

Terrance R. Dolan -- Chief Financial Officer

I wouldn't necessarily attribute it as much to that. I think that what we end up seeing when the economy gets stronger and consumer confidence goes up, you tend to see more spend but balances, the revolve rate actually comes down a little bit, simply because people have the capacity to be able to make those payments. I think the other thing that we're seeing right now is just with tax reform, there's a little more cash in people's pockets. They're taking that opportunity to reduce the revolving part of their balances. I think it's probably more so that than anything.

Andrew Cecere -- Chairman, President and Chief Executive Officer

Terry, I'd add the high-quality nature of our portfolio, right?

Terrance R. Dolan -- Chief Financial Officer

For us, yes.

Vivek Juneja -- JP Morgan -- Analyst

Okay, thank you.

Operator

Your next question comes from the line of Saul Martinez with UBS. Your line is open.

Saul Martinez -- UBS Securities -- Analyst

Good morning, guys. A couple questions. First, clarification on your comments on deposit betas. So, Terry, you mentioned that going forward you'd expect around 50%. It was around 45% I think this quarter. So, should we take that as meaning the 12 basis points increase in deposit costs you saw this quarter more or less with future hikes, that's sort of the magnitude we should be thinking about in terms of increased deposit costs?

Terrance R. Dolan -- Chief Financial Officer

It's a reasonable assumption, yeah.

Saul Martinez -- UBS Securities -- Analyst

Okay. And that already bakes in the increase in the consumer deposit betas you mentioned from 15% to 30%? You mentioned the commercial and I guess corporate trust is already at terminal beta.

Terrance R. Dolan -- Chief Financial Officer

Yeah, I would say that current is at 15% and it's going to continue. The question is, over what period of time. I don't know if it'll be in the next rate hike or the rate hike after that. So it's kind of, from a timing standpoint, those betas will move up a little bit. So 12 may go to 13 basis points for a 25 basis point movement, etc. But it's not going to be dramatic anymore, I don't think.

Saul Martinez -- UBS Securities -- Analyst

Okay. But you don't think it's a big meaningful move-up from here, from this starting point?

Terrance R. Dolan -- Chief Financial Officer

No, we don't think so.

Saul Martinez -- UBS Securities -- Analyst

And then a follow-up on the discussion on sustainable positive operating leverage of 200 to 300 basis points. I know it takes some time to get there, but I think that's based on the assumption of 6% to 8% revenue growth long-term, 3% to 5% cost growth and that's how you get to the 200 to 300 basis points. But to the extent revenue growth doesn't materialize in that fashion, how much room do you have to manage expenses down below that 3% to 5% range and keep that 200 to 300 basis points?

Terrance R. Dolan -- Chief Financial Officer

Yeah, Saul, the way I would kind of think about it is not only from a revenue standpoint, but as we continue to make investments in digital capabilities, those digital capabilities are going to offer us opportunities to be able to streamline or improve our cost structure, as well. I think you have to think about it from both sides of the equation, I think, as much as anything, over the next three years or so.

Saul Martinez -- UBS Securities -- Analyst

Got it. So, does that mean if the revenue back-drop doesn't materialize, because I think most of us probably don't have 6% to 8% revenue growth in our model for most banks, should I take that answer as meaning you can manage it down below that or that you just have investments you need to make and cost growth is going to be sort of within that range regardless of the revenue environment?

Terrance R. Dolan -- Chief Financial Officer

I think, Saul, the easy way to think about it is the higher the revenue growth, the wider that wedge between revenue and expense will be. To the extent the revenue growth is narrow, that wedge will be even more narrow because it's just going to be a function of better revenue growth in the long term.

Saul Martinez -- UBS Securities -- Analyst

Okay, all right. Got it. Thanks so much.

Operator

Your next question comes from the line of Gerard Cassidy with RBC Capital Markets. Your line is open.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Good morning, Terry. Good morning, Andy. Can you guys give us a little more color on the commercial loan book? Obviously, you pointed out that the commercial real estate outstandings came down due to paydowns, but also underwriting standards that are not up to your standard. If you look at it carefully, the decline, how much was due to the paydown versus underwriting standards? Then in commercial lending, C&I lending, I think you said you also had some paydowns. Where is the outcoming money coming? Is it other banks taking those loans or is it the private equity market, shadow banking industry?

P.W. Parker -- Vice Chairman and Chief Risk Officer

This is Bill. On commercial real estate, where we lose balances is in what we call the standing loans or longer-term mortgages. That's the area that's gotten aggressive really in terms of terms and rate. Many of that's outside the banking community. So, that's where we've seen the runoff. The other big portion in CRE is construction lending. We remain very active there. We haven't seen, it's been relatively stable. It hasn't really seen a runoff. But that's an area that we remain very active. It adds great value to clients. We watch the markets carefully, but for our good clients, we'll continue to do the construction lending.

Then on the C&I side, that's really more a function of some of the larger M&A deals, but we've seen good pipeline growth coming in to the end of the quarter and into this quarter. So, we anticipate that paydown activity should subside as we see more M&A transactions closed. In addition to, as was previously mentioned, some of the core growth in our community and middle market books.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Bill, as a follow-up to that, your comments about the term commercial real estate mortgage market, can you compare it to the terms that are being used in 2005, 2006? Is it that stretched or we're not there in those types of numbers?

P.W. Parker -- Vice Chairman and Chief Risk Officer

No, I think I would say it's not that stretched, but it's more a function of the length of term and rate that people are offering. I think our bank and specifically, we're not interested in going fixed-rate, 15-year loans. That just does not fit well with our model. But whether it's the securitization market that can accommodate that or insurance companies can accommodate that.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Great. Then as a general question, Terry, you touched upon the operating expense growth being at he lower end of the 3% to 5% range that you gave us. Have you guys seen any -- we hear a lot nationally about the employment situation. Very strong. There may be a labor shortage in certain markets, in certain industries. Do you guys see any of that in your commercial bank with loan officers or branch managers? If you don't see it, is there something on the horizon that makes you a little nervous that you could see it in 12 months if the economy turns out to be as strong as we all hope?

Andrew Cecere -- Chairman, President and Chief Executive Officer

This is Andy. I think what we are seeing is it's taking longer to fill positions. I would say that there is a bit of a tightening in the labor market and that's impacting our hiring. It's not substantially increasing pay yet, but I do think that could happen. But right now, it's just taking longer to fill positions.

Gerard Cassidy -- RBC Capital Markets -- Analyst

I appreciate that. Thank you, Andy.

Operator

There are no further questions at this time. I would now like to turn the call back over to Jen Thompson.

Jennifer Thompson -- Director of Investor Relations

Thank you for listening to our earnings call. Please contact us if you have any further questions.

Operator

This concludes U.S. Bancorp's second quarter 2018 earnings conference call. We thank you for your participation. You may now disconnect.

Duration: 49 minutes

Call participants:

Andrew Cecere -- Chairman, President and Chief Executive Officer

Terrance R. Dolan -- Chief Financial Officer

P W. Parker -- Vice Chairman and Chief Risk Officer

Jennifer Thompson -- Director of Investor Relations

John McDonald -- Bernstein -- Analyst

Matt O'Connor -- Deutsche Bank -- Analyst

Betsy Graseck -- Morgan Stanley -- Analyst

Ken Usdin -- Jefferies -- Analyst

Erika Najarian -- Bank of America -- Analyst

Mike Mayo -- Wells Fargo Securities -- Analyst

Kevin Barker -- Piper Jaffray -- Analyst

Vivek Juneja -- JP Morgan -- Analyst

Saul Martinez -- UBS Securities -- Analyst

Gerard Cassidy -- RBC Capital Markets -- Analyst

More USB analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than US Bancorp
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and US Bancorp wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of June 4, 2018

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.