U.S. Bancorp (USB) Q3 2023 Earnings Call
U.S. Bancorp (NYSE:USB) Q3 2023 Results Conference Call October 18, 2023 8:00 AM ET
Company Participants
George Andersen - Investor Relations
Andy Cecere - Chairman, President & CEO
Terry Dolan - Vice Chair & CFO
John Stern - SVP & Head of Finance
Conference Call Participants
Ebrahim Poonawala - Bank of America
John McDonald - Autonomous Research
Mike Mayo - Wells Fargo Security
John Pancari - Evercore
Scott Siefers - Piper Sandler
Erika Najarian - UBS
Gerard Cassidy - RBC
Vivek Juneja - JPMorgan
Matt O'Connor - Deutsche Bank
Ken Usdin - Jefferies
Operator
Welcome to the U.S. Bancorp Third Quarter 2023 Earnings Conference Call. Following review of the results, there will be a question-and-answer session. [Operator Instructions] This call will be recorded and available for replay beginning today at approximately 9:00 a.m. Central Time.
I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for U.S. Bancorp.
George Andersen
Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; Terry Dolan, Vice Chair and Chief Administration Officer; and John Stern, Senior Executive Vice President and Chief Financial Officer. During their initial prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation, our earnings release and supplemental analyst schedules are available on our website at usbank.com.
Please note that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors materially change our current forward-looking assumptions are described on Page 2 of today's presentation, our press release, our Form 10-K and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry and John will take any questions that you have.
I will now turn the call over to Andy.
Andy Cecere
Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on Slide 3. In the third quarter, we reported earnings per share of $0.91, which included $0.14 per share of notable items related to merger and integration charges. Excluding those notable items, we delivered earnings per share of $1.05 for the quarter. Third quarter results were highlighted by linked quarter and year-over-year fee revenue growth that benefited from our acquisition of Union Bank, deepening client relationships and strong underlying business activity.
We are achieving the cost synergies we anticipated from Union Bank and continue to prudently manage core expense as we identify operational efficiencies across the business. As of September 30, our Common Equity Tier 1 capital ratio was 9.7%, an increase of 60 basis points this quarter. This is the same level that it was prior to our acquisition of Union Bank. Total average deposits increased 3% or $15 billion on a linked-quarter basis.
Credit quality continues to normalize this quarter, in line with expectations, and we further strengthened the balance sheet by adding $95 million to our loan loss reserve, reflective of an evolving credit environment. On October 16, the Federal Reserve granted us full relief from certain Category II commitments made in connection with the Union Bank acquisition given our balance sheet reduction and capital actions.
As a result, we are now subject to existing capital rules or, if adopted, the same transition rules as all other Category III banks related to enhanced capital requirements under the Basel III and game proposal. As proposed, this would include a three-year transition period for the expanded risk-based approach and AOCI regulatory capital adjustment starting in the third quarter of 2025. I will discuss the impacts of these decisions further in my closing remarks.
Slide 4 provides income statement results as reported and on an adjusted basis, ending in balances and other key metrics. Slide 5 provides key performance metrics. Excluding notable volumes, our return on average assets was 1.04% and our return on tangible common equity was 21%. While net interest margin declined 9 basis points to 2.81% this quarter, in line with our expectations, we continue to expect the NIM to bottom in the fourth quarter as we reach the end of the current rate hiking cycle.
Turning to Slide 6. A great benefit of our business model includes a balance between our spread and fee income businesses that helps us reduce earnings volatility through a business cycle. On a year-over-year basis, noninterest income grew approximately 12%. Within Payment Services, we continue to invest in our digital capabilities, expanding our payments ecosystem and optimizing our distribution.
Emphasis on expanded partners and integrated capabilities will continue to support tech-led growth across merchant processing and increased opportunities across other areas of payment services businesses. Additionally, we are continuing to make investments that leverage our scale and strategic market positioning across our corporate trust, mortgage banking and capital markets businesses, which should enhance our already strong annualized growth trajectories.
Slide 7 highlights a few of our many post-conversion revenue opportunities and expected energies with Union Bank. Early indications of the potential to deepen relationships with legacy Union Bank loyal, affluent and diversified client base are promising, and we continue to be on track to realize approximately $900 million in cost synergies, which we expect to be fully reflected in our run rate as we head into the year 2024.
Let me now turn the call over to John, who will provide more details on the balance sheet and results for the quarter.
John Stern
Thanks, Andy. Turning to Slide 8, we ended the quarter with total average assets of $664 billion and total average loans of $377 million, down $9 billion and $12 billion, respectively, on a linked-quarter basis as we prudently managed and optimized our balance sheet given the current macroeconomic and regulatory environment. Average total deposits were $512 billion, representing a 3% increase linked quarter, driven by expected seasonality and growth in money market and time deposit accounts.
Specifically, average noninterest-bearing deposits decreased $16.2 billion this quarter, primarily driven by our Union Bank retail customer upgrade at conversion from noninterest-bearing checking accounts to our interest-bearing Bank Smartly product. Excluding this reclassification, the decrease would have been $6.2 billion. Our mix of noninterest-bearing to interest-bearing deposits was approximately 19%, consistent with where we expect the mix shift to stabilize based on historical performance and the operational nature of our core deposit base.
Slide 9 provides an update on the investment securities portfolio. As of September 30, our available for sale securities were 97% of our total securities. We continue to reduce the effective duration of the AFS portfolio, which is now less than 3.5 years.
On Slide 10, we provide a detailed earnings summary for the quarter. This quarter, we reported diluted earnings per share of $0.91 or $1.05 per share after adjusting for merger and integration charges of $213 million net of tax or $0.14 per diluted common share.
Turning to Slide 11. Net interest income on a fully taxable equivalent basis totaled approximately $4.3 billion, which represented a 4.1% decrease on a linked-quarter basis and a 10.7% increase from a year ago due to the impact of rising rates and the acquisition of Union Bank. Our net interest margin declined 9 basis points to 2.81% in the third quarter. The linked quarter decline was primarily due to the impact of lower earning assets, deposit pricing and mix shift, offset somewhat by better loan spreads and funding mix.
Slide 12 highlights trends in noninterest income. Fee income increased 11.9% or $295 million on a year-over-year basis, driven by higher payment service revenue, trust and investment management fees, virtual products and mortgage banking revenues. On a linked-quarter basis, fee income increased 1.4% or $38 million, driven by other revenues, which included servicing revenue from previously executed balance sheet optimization actions.
Turning to Slide 13. Reported noninterest expense for the quarter totaled $4.5 billion, which included $284 million of merger and integration-related charges. Noninterest expense, as adjusted, decreased $13 million or 0.3% on a linked-quarter basis driven by lower compensation expense that was somewhat offset by our investments in marketing and business development.
Slide 14 shows our credit quality performance this quarter. While asset quality metrics reflecting changing conditions in the commercial real estate office segment, results this quarter continue to trend in line with our expectations, and key metrics remain below pre-pandemic levels. Importantly, given the higher interest rate environment as well as other portfolio considerations, we increased our reserve ratio for commercial real estate office loans to 10%.
Our ratio of nonperforming assets to loans and other real estate was 0.35% at September 30 compared with 0.29% at June 30 and 0.20% a year ago. Our third quarter net charge-off ratio of 0.44% increased 9 basis points from a second quarter level of 0.35% as adjusted, and was higher when compared to a third quarter 2022 level of 0.19%. Our allowance credit losses as of September 30 totaled $7.8 billion or 2.08% of period-end loans.
Turning to Slide 15. We continue to take action to improve our capital ratios this quarter, increasing our CET1 ratio to 9.7% as of September 30. The combination of our debt-to-equity conversion with MUFG, earnings accretion net of distributions and balance sheet optimization actions resulted in a 60 basis point increase from last quarter. Importantly, our CET1 capital ratio is now 270 basis points above our regulatory capital minimum.
I will now provide fourth quarter forward-looking guidance on Slide 16. In the fourth quarter, we expect net interest income of between $4.1 billion and $4.2 billion. Total revenue, as adjusted, is estimated to be in the range of $6.8 billion to $6.9 billion, including approximately $65 million of purchase accounting accretion. Total noninterest expense, as adjusted, is expected to be approximately $4.2 billion, inclusive of approximately $115 million of core deposit intangible amortization related to Union Bank acquisition.
On a core basis, we expect full year 2024 expenses to be flat with 2023. Our income tax rate is expected to be approximately 23% on a taxable equivalent basis. We expect merger and integration charges of between $250 million to $300 million in the fourth quarter.
I'll now hand it back to Andy for closing remarks.
Andy Cecere
Thanks, John. Turning to Slide 17. The Federal Reserve notified us on October 16 that they have granted us full relief from Category II commitments made in conjunction with the Union Bank acquisition after considering several factors, including actions to reduce our risk profile, strengthen our capital position and provisions related to Category III rules made after we received approval on the Union Bank acquisition.
This important decision now subjects us to the same enhanced capital requirements as all other Category III banks, including a three-year phase-in of AOCI into regulatory capital starting in the third quarter of 2025. As expected, we will continue to carefully balance the need to accrete capital with any potential impact to earnings from further balance sheet optimization activities. Measures to manage the interest rate sensitivity and duration of our available-for-sale securities will continue.
Since before our acquisition of Union Bank, our priority has been and will continue to be the strategic execution of capital-efficient growth opportunities across each of our business lines. As a result of the Fed's decision, we are now well positioned with our enhanced earnings profile and diversified business mix to increase our capital levels, continue our disciplined lending activities and further strengthen our balance sheet.
Let me close by thanking our more than 75,000 employees for their dedication to supporting the needs of our clients, communities and shareholders. We'll now open up the call to Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] And we'll go to Ebrahim Poonawala with Bank of America. Please go ahead.
Ebrahim Poonawala
I guess maybe the first question, just around the Fed decision. In its letter, the Fed said, I guess the bank anticipates taking further actions to reduce risk profile and reduce assets and increase capital. So if you don't mind talking about just what additional actions we should expect. I think you mentioned that the EPS impact could be neutral from here. But just how should we think about what else the Fed expects from you on the risk mitigation side as we move forward into next year?
John Stern
Sure. Thanks, Ebrahim. So -- this is John. As a way of background, the Fed granted us as we -- as you mentioned, full relief from our Category II commitments, and that's because of the action, Andy mentioned this, of our actions to reduce risk as well as our ability to strengthen our capital position. So importantly, this is going to provide us additional time and flexibility to meet those new regulatory requirements and do so in the same timeframe as our Category III peers. And additionally, we think it's going to reduce the downside given the challenging rate environment.
But nothing really changes in terms of how we're fundamentally managing the balance sheet going forward. We're still committed to building regulatory capital. We're still expecting to increase and accrete capital at a 20 to 25 basis points on average per quarter. And our expectation is to accelerate that as we get through the merger-related costs or be in the high end of that range, I should say, as we get through the merger-related costs and start to realize the full Union Bank synergies.
And we're still going to be executing risk-weighted asset optimization transactions. But now we have the time and flexibility to do that over in a way that is low to neutral in terms of our earnings impact. And so for all those reasons, we feel like we have the flexibility in our balance sheet to do those sorts of things.
Andy Cecere
I think that's exact, John. And the only thing I'd add is that part of the decision is reflective of what we've already done for the last 12 months in terms of reducing the risk profile, building capital, optimizing the balance sheet. And I want to be clear, Ebrahim, we are not under an asset cap at all. We are maintaining flexibility and managing the balance sheet and capital, and we'll continue to remain focused on capital-efficient growth. And that includes focusing the high-margin, high-return businesses that exceed our cost of capital, while deepening relationships from our most profitable clients. And that has been and will continue to be our focus.
Ebrahim Poonawala
That's good color. And just another question, John, I think I heard you correctly -- if I heard you correctly, you mentioned you expect the NIM to draw off, and I'm assuming NIM equals the trough in the fourth quarter. Maybe just that assumption in terms of does a steeper yield curve or widening in just the curve. So is -- that assumption around troughing of NII or NIM? And what gives you confidence around mix change consumer behavior to feel good about that?
John Stern
Yes. So I think in terms of the guidance we provided, we have embedded in there our rate forecast, which includes a rate increase in December. Whether or not that happens or not is relatively immaterial since we're fairly neutral from an interest rate risk positioning standpoint.
I guess what I would say is as the Fed is -- whether they're done or not in terms of the rate hiking, we start to see a lot of things on the deposit side slowdown, so our noninterest-bearing balances will be relatively stable here at this level. The deposit betas will -- rate paid will start to slow down.
And then on the other side, your assets will start to reprice, whether that's the securities book, the loan book and all those sort of things. So that's what gives us the confidence really that we will bottom out here in the fourth quarter from a NIM and net interest income perspective.
Operator
Next, we go with John McDonald with Autonomous Research. Please go ahead.
John cDonald
John, can I just follow up on what you're just talking about. What are you looking at in terms of the NIM for the fourth quarter roughly? And did I hear correctly, you think the deposit mix kind of settles out around 19%, 20%, where you are here in beta kind of in the mid-40s, you still have those expectations?
John Stern
Yes. Maybe just to go to the last couple of questions you mentioned. So from a noninterest bearing, yes, we do expect that mix, we're at about 19%. That's about where we will be -- we expect that to be in that range. And from a beta perspective, we are in the mid-40s right now. It's possible it could creep up higher depending on where the Fed goes from here, but we feel good about that. And then in terms of the net interest margin and things like that, we do anticipate a little bit more pressure here in the fourth quarter, but then that really is the point where we feel that it'll bottom out based on my comments I just made a previous question?
Andy Cecere
And that's reflected in our revenue and net interest income guidance.
John Stern
Yes.
John cDonald
Okay. And then recognizing with the Fed decision, you've obviously got a lot more time to phase in the AOCI now. John, can you just give us a little more color on what happened in terms of the trend in AOCI this quarter? What are the pieces there? How do the swaps affect your burn-down time line? And just also if you could add on, what do you -- how do you calculate the capital with AOCI today? It looks like maybe around 7%, something like that.
John Stern
Yes. So I think all in, it's about -- AOCI is about 250 basis points of impact. So I would say 7.2% is roughly kind of where I would think about it. In terms of the change in the AFS, obviously, rates backed up on the long end of the curve, 75 to 90 basis points, depending on treasuries or mortgages that you're looking at.
And that had an impact of about $1.4 billion in our -- on an after-tax basis on our AFS securities book, which we would have expected and is consistent with the duration of our book, which we have continued to wind down, as I mentioned in our comments about -- less than 3.5 years is our current duration.
So that's the effect of that. We are continuing to see -- we will continue to see pay downs in that book, whether it's the HTM or AFS. We have about approximately $3 billion or so per quarter that rolls off that book, and we'll reinvest in the AFS side of things over time.
Operator
Next, we'll go to Mike Mayo with Wells Fargo Securities. Please go ahead.
Mike Mayo
Just to be clear, how much of the $900 million merger savings were recognized in the third quarter results?
John Stern
Well, in terms of -- we will get to a full run rate of $900 million, it's probably $100 million or so is kind of the -- in that range is probably what we were seeing. But it's been growing in terms of the amount, and we'll see that full benefit fall through in the fourth quarter.
Mike Mayo
So relative to the third quarter, the first quarter of 2025 could see $800 million of additional expense savings?
John Stern
No, because we've been -- the savings have been generated all throughout the course of the year, and they have -- they accelerate third quarter into fourth quarter, and second quarter, third quarter and the fourth quarter.
Mike Mayo
So what's the cumulative merger savings? I guess how much more expense savings should there be when they're fully realized in the first quarter relative to the third quarter?
John Stern
When we have the savings, we'll have approximately $400-or-so million that has gone through this full year, and then we'll expect to see that in the next coming year. But that's embedded into our full year guidance of flat expenses between 2023 and 2024.
Andy Cecere
So Mike, the way I think about it, this is Andy, by the end of the fourth quarter, we will be on a run rate recognizing $900 million of savings, which will be fully reflected in 2024 in our expense base. And that is consistent with how we think about a relatively flat 23% to 24% expense base, including those savings plus investments we'll continue to make in the business.
Mike Mayo
And then the big question then is, so if you have flat 2024 expenses, do you think you can get to positive operating leverage? Or is it too early or too many moving parts? Because this is the sweet spot of the merger savings coming up, right, by the next quarter.
Andy Cecere
It is a sweet spot, Mike, you're absolutely right. And the savings are great. The opportunities to deepen relationships on the Union Bank customer base, I mentioned that in my comments, I think that is terrific. Our fee businesses are doing extremely well. On a year-over-year basis, it was up 12% across almost every category. And frankly, very little of that was related to Union Bank. That was just core improvement across a number of categories, capital markets, our corporate and trust, our fee businesses, our payments businesses.
The challenge for us and for the entire industry is net interest income and margin. And in this environment, that's the one that I -- there's a lot of moving pieces, as you say. Loan growth is relatively tepid as we speak for us and for the industry overall. So it will be dependent upon that in terms of positive operating leverage, and I would say it's too early to call.
Mike Mayo
Okay. And last follow-up, your increase in CET1 ratio due to a lot of balance sheet optimization did come at a cost of less assets, less loan growth, less earnings, right? There's a trade-off in that. So now that you're under kind of less pressure and have so much more flexibility, do you think you can be a little bit more lax in terms of your growth and in turn, that may help NII? Or is that too much of a stretch?
John Stern
Yes. We have flexibility now in terms of the transactions that we do to optimize. And we still have plans to do those sorts of things. We've identified some things that are going to be relatively neutral and a little bit on the low end of earnings impact. And of course, you saw some of those transactions in the second quarter flow through in terms of provision and things like that. And that did lower our earning assets, as you mentioned, about $8 billion or thereabouts this quarter.
Operator
And next, we'll go to John Pancari with Evercore. Please go ahead.
John Pancari
I know despite the regulatory change around the Cat II requirement, you maintain the 20 to 25 bps generation in CET1 quarterly. Why no change there? Can you just talk to us maybe about the give and takes in that expectation as the need to meet the Category II shifted to Category III, why no change there?
John Stern
Well, I think there's no change because we feel like given the new rule set and things like that, over time, we'll have to transition into the new regime, which will include AOCI and so all the other rules. And so, we're going to be in a mode to continue to accrete that capital and 20 to 25 basis points is our earnings stream that we will accrete. And like this quarter, for example, it was 20 basis points, but we anticipate going to 25 on the higher end of that range as we get through the merger-related costs and we have the Union synergies.
John Pancari
Okay. So the less BSO activities didn't materially benefit that expectation?
John Stern
I'm sorry. Can you say that? I couldn't hear you.
John Pancari
The less risk-weighted asset optimization that would be needed now under the -- need to meet Category III did not materially impact the 20 to 25 basis points of earnings generation expected?
John Stern
No, that did not. No, that did not. Like for example, this quarter, we had 20 basis points of RWA actions, which included some of the asset reduction you saw our earning assets lower, for example, as well as some other transactions embedded. So, we separate out core earnings -- when we were talking about 20 to 25 basis points, core earnings from other RWA optimization transactions that we have the ability to do.
John Pancari
Okay. And then separately, is there any OpEx impact of the -- of now needing to conform to the Category III versus the more immediate requirements of Category II? Anything on the expense side, and then separately, on the -- on your margin bottoming comment, anything in terms of the trajectory in the margin that you would expect after you see this bottoming as we head into 2024?
John Stern
Yes. So in terms of OpEx, no, there's no further investment. You may recall before tailoring, we had many of the same rules and standards that we had in terms of liquidity rules and reporting and all those sorts of things. So, we have all the capabilities built up or can quickly get to that level from an operational standpoint. So, there's no worries there. In terms of the net interest margin, we mentioned just a little bit of pressure in the fourth quarter and then bottoming out, likely stable. But still dependent on interest rates, quite frankly, at that particular time.
Operator
And next, we’ll go over to John McDonald with Autonomous Research. Please go ahead. Oh, one moment here. We'll go to Scott Siefers with Piper Sandler. Please go ahead.
Scott Siefers
Just as it relates to sort of the balance sheet growth dynamic. So great to see you out of the Fed restriction. Do you see any risk that you'd exceed $700 billion in assets organically, or come into contact with any of the other Cat II restrictions organically in a timeframe that would inject you to Cat II rules before your peers would have to get there under new levels? In other words, I'm just trying to kind of make sure that this is indeed just a full free -- so just curious of your thoughts there.
John Stern
It is. As Andy mentioned, there's asset cap so that we have complete flexibility here on our balance sheet going forward. So if we elect to grow or want to grow, and we do want to grow in a capital-efficient manner, we will do so. What I would say, though, is that we're going to be emphasizing higher return loans and deemphasizing lower return type of assets. And I think that will manifest itself as the balance sheet churns. And in addition to that, I would just highlight that in this environment right now, the loan outlook is pretty is pretty low. The demand for loans is quite low, given a number of different reasons out there. But that gives us kind of the confidence that we have a lot -- have more time and flexibility here.
Scott Siefers
Yes. Perfect. Okay. And then I think you might have touched on this in an earlier question, but maybe if you can sort of re-walk us through the sort of AOCI burn-down and cash flow expectations coming off the -- both the AFS and HTM books. And then, I think you might have given the duration of the AFS book, but do you have that for the HTM book as well?
John Stern
Sure. So in terms of the AFS and HTM, we're at about -- in terms of balances, about $162 billion or so, and it's about a 50-50 mix as we mentioned on the call, in terms of AFS and HTM. So, we have about, as I mentioned, $3 billion of runoff per quarter on average just given the current interest rate environment and things of that variety.
In terms of our profile, we've been able to hedge about 30% of the fixed rate portion of the AFS book. And so that's what has driven the duration of that particular book in the 3.5 -- less than 3.5 years as we have. That HTM book is principally all agency mortgage-backed securities, which have longer lives. And so, it's more in the six or so range in terms of the duration of that book.
Operator
And next, we'll go to Erika Najarian with UBS. Please go ahead.
Erika Najarian
Andy, my first question is for you. Specifically yesterday's announcement is a big win for the Company. And as we think about combining that relief with a generally tighter regulatory environment, what CET1 are you looking at -- and what level are you looking at in terms of, okay, now I'm at the right level, this is now my target in the new world. And now in an environment where balance sheet growth is minimal at best, right, I can now return capital back to shareholders through buybacks.
I guess I'm just wondering because there's printed -- your GAAP CET1, there's the adjusted that John gave, right? But then you only have to take into account 25% of that 250 by July 1, 2025, if we get to a final date by then. So, there's a lot of moving pieces. So as your investors think about all the parts that you've made plus this relief, what is your new target? Is that transitional or fully phased in? And what's the bogey that investors could look forward to that you would hit before returning capital through buybacks?
Andy Cecere
Yes, Erika, understand the question. And first of all, I just want to highlight, we're back to 9 7, which is where we started before the deal and we're able to build. We went from 9 7 to 8 4 and build 130 basis points in basically less than a year, which I thought was a great effort across the Company.
In terms of what our new target is, short-term target is to continue to build, as we talked about. Remember, there's two sets of rules that are yet to be finalized and coming down. Number one, are the Basel III end game finalization of rules, which will, in one shape -- one way shape or form increased capital levels. And the second is clarity on CCAR. We'll set those targets once we have clarity on those two items.
Erika Najarian
And so just to follow up here. At least until June 2024 CCAR results, regardless of how quickly you build the capital, either on an adjusted or on a GAAP basis, you're going to continue to be at pause on the buyback until at least the until we see the CCAR and the SEB?
Andy Cecere
That's my expectation, Erika. We want clarity on the finalization of the Basel III and the CCAR importantly. So, we'll be continuing to build capital and determine our capital targets and buffers and all that activity once we have more clear clarity in the finalization of the rules.
Erika Najarian
Got it. That's very clear. And just one more for John, if I may. In terms of the net interest income trajectory, I think the fourth quarter is good news, especially relative to what we thought two days ago, which would be more RWA mitigation. As we think about the RWA mitigation ahead that's less impactful to EPS, should we think about it similar to what we saw early in the year in terms of securitization?
Are you more actively -- are you going to continue to use credit linked notes, which I assume has cost you 12.5% or so of the pool, plus SOFR and the spread. And as we think about those dynamics, do you feel like you have to warehouse more liquidity as we anticipate LCR rules for regional banks? Because we're also hearing that there could be pretty significant haircuts on how they're thinking about HTM as HQLA.
John Stern
Sure. Erika, so maybe I'll start with your point. On LCR, we will -- in addition to what Andy said on the capital side, we're going to have to wait and see what it is on the liquidity side in terms of any potential changes that come out of LCR. We feel very comfortable that we'll be able to achieve whatever that change is and feel that we'll be able to achieve that whatever that scenario is we'll work into it. In terms of -- you talked about the net interest income. We feel like it's -- again, just to kind of reiterate, we are looking for that to bottom at this particular point in time in the fourth quarter. And where it kind of goes from there post -- will depend in part of interest rates.
Erika Najarian
Got it. And congratulations on the release of commitments.
Andy Cecere
Thanks, Erika.
Operator
And next, we'll go to Gerard Cassidy with RBC. Please go ahead.
Gerard Cassidy
Andy, obviously, U.S. Bancorp has developed a reputation of being a strong underwriter and we talked about this in the past with you folks. And I was wondering if you could frame out the environment because every bank is talking about credit normalization as you guys did because we had such great numbers coming out of the pandemic on credit.
And if you just exclude for a moment the economy because obviously, none of us can control that, but I'd really be interested in what you guys are seeing from a competitive standpoint in terms of underwriting. And if you could compare it to past cycles, obviously, we've been around for a few cycles and can't compare. But I'm curious, from your guy's vantage point, is it as risky today as it may have been in '05, '06 or '99, 2000. Any color there that you can share with us?
Andy Cecere
Let me give you the big picture, and I'm going to ask Terry to highlight some specifics. I would say the consumer is entering this cycle in very strong shape from a balance standpoint, from the perspective of savings accounts that they have, the spend activity, I think they're all starting to normalize, but normalized to a pre-pandemic what I'd say, normal level. The companies and small businesses are also in very good shape. The one area that we're all very focused on is commercial real estate office, which is one of the areas that we increased our reserve to. As you know, it's at 10% in this quarter. So maybe, Terry, you can give some specifics.
Terry Dolan
Yes. And what I would add to that, Gerard, as you know, when we think about underwriting, we really underwrite through a cycle. We try to take into consideration in the stress from an underwriting perspective, what could happen in terms of rising interest rates or other economic factors that could come into play. So, we haven't adjusted our underwriting standards a lot. We have been thinking about this particular cycle. I do think that when you end up looking at the industry, I think there is some tightening that's going out there. Certainly, from a competitive standpoint, we are seeing that to some extent.
But we feel like we're in pretty good shape. If you end up looking at our situation, as Andy said, probably the area that we're monitoring the most is commercial real estate office space specifically. We have a reserve that's about 10% of the overall balance there. We have been increasing that, and we're likely to continue to increase that because that's going to be a pressure point. But we're starting from -- if you think about the overall portfolio, we're starting at fairly low points.
Our non-accrual loans is only 35 basis points of total loans. Our allowance is strong at 208. Delinquencies are still at relatively low levels although increasing. And our expectation as we go into 2024 is that that normalization will continue. Delinquencies will continue to kind of move up and nonperforming assets will continue to move up. But I think we're in a really good position in terms of the allowance coverage that we have, and we feel pretty good about that.
Gerard Cassidy
Very good. Good to hear your voice, Terry. Just to follow up on what you were saying from a competitive standpoint, do you sense -- the extreme, of course, was '05, '06 when all of the crazy lending is being done by some banks, but also the nonbanks. When you guys look at the nonbank competitors, are there rogue players out there that are just doing crazy things so that the second derivative impacts the banks, not because any of the banks, yourself included, made a poor underwriting decision, but it was the competitors that really did something foolish and now the banks are suffering a bit? Or again, not like '06, I'm not suggesting we're there, but just from a comparison standpoint.
Terry Dolan
I think both in the bank and in the nonbank space, I think that people are being fairly rational. Part of the issue is that it's maybe more so on the demand side of the equation as much as anything. I think corporate America is being relatively cautious out there. They're still waiting to see where interest rates settle in at. And until they see more certainty with respect to what the interest rate inflationary environment looks like.
I think corporate America has been relatively cautious. And therefore, demand is relatively soft. But we're not seeing, what I would say crazy things either on the bank or on the nonbank side at this particular point in time. In fact, we're probably seeing -- if you end up looking at commercial real estate, probably a pullback across the board.
Gerard Cassidy
Great. And then as my second follow-up question, Andy, it was obviously great news that you guys had yesterday about the release. Is there any read-through? Obviously, you sat down with the regulators to get that release and they seem to be fairly rational in their decision to make that change. There's been a lot of hope and criticism that the Basel III end game proposals are pretty darn strict. Do you think -- is there any read-through where we may actually see some rationality with the regulators and they may compare back some of those requirements? Or is that too far of a stretch?
Andy Cecere
I think the regulators have asked for feedback. The banks will provide feedback, both collectively and individually. I think a lot of the feedback is good feedback because of the consequences to our customers. And I think that's the area of focus that we're going to be very pointed on in terms of our feedback. And we want to make sure that from a banking standpoint, we're able to serve our customers and the rule set will create some friction around that in certain categories, and that's where we're going to focus. And my anticipation is that the Fed will listen to our perspectives. And then that's my hope.
Gerard Cassidy
I think -- go ahead. I'm sorry.
Terry Dolan
I was just going to say in -- particularly it can be punitive with respect to low moderate income customer base. You see some capital rules related to renewable energy tax credits that don't make -- that seem punitive at this point in time. So, I do think there's a number of different areas where there's opportunity for adjustment.
Operator
Next, we'll go to Vivek Juneja with JPMorgan.
Vivek Juneja
Shifting gears from capital, given that you made a lot of progress to just your normal business. Payments, you've talked, Andy, about wanting to grow merchant processing high -- mid- to high single digits, really more in the high single digits, and some of the others in the low double digits, like corporate payments. Any color on -- any thoughts on how you get back up there because that hasn't been the case the last couple of quarters, what you need to do or change or what would help you get that?
Andy Cecere
I'm going to ask John to start then I'll add in.
John Stern
Sure. So in terms of merchant processing, we have been making a number of investments over the years and continue to expect that high single digit in terms of that sort of thing. The numbers are have been have been strong this quarter, but there's normalization that has been happening. And so in the quarter -- the quarter-to-quarter here, the last several quarters, there's been a lot of the nuances coming out of the COVID and all those sorts of things.
So, if you think about airline tickets and hotels and corporate T&E, those have been very strong, but they are normalizing. That said, services and retail have been strong. And so -- and the retail print that we saw yesterday was very constructive. So we feel like there's good underpinnings there in addition to the investments that we make to continue to believe and give confidence in that -- in our projections there.
Andy Cecere
And I think two of those important investments, Vivek, our tech-led initiative, which is about 1/3 of our revenue base right now is tech lead from a perspective of new activity. And secondly is that what we've talked a lot about, which is this business payments ecosystem, which continues to be a top priority for the Company, because I think it's a huge opportunity for our business banking customer base as well as our commercial customer base. And then you add in what we're getting from Union Bank, I think that's why we're confident in that higher single-digit increase.
Vivek Juneja
Okay. And then another key business that you mentioned, you're expanding capital markets since you're not doing your investors anymore. Any color on what you're doing there to expand that? You've always had the loan syndications and debt capital market. What else are you doing to step that up in terms of the level of revenues from that?
John Stern
Sure. This is John. So, the -- we -- this is another area where we have continued to make investments in back-end systems and the frontline, and acquiring talent and all these sorts of things, and it's been a great story for us, and we continue to invest in this going forward. And along with high-grade and underwriting, there's high yield as well as what other areas that have been very strong is in the derivative market, providing interest rate. Hedging products for our clients, especially in this time where interest rates are moving around quite a bit as a service that has been highly needed.
Foreign exchange has been a growing component here as well. And particularly now with Union Bank, we have more of a West Coast customer base and more foreign exchange need. In addition to some of the businesses that we work with in the Corporate Trust side, we have -- as you know, we have businesses in Europe as well. So there's always some form of foreign exchange, and so we've seen a lot of growth there.
In addition to that, we've been gaining market share in the investment-grade business and high yield. Over the coming days, I think we've had an investment grade in the top 10 now in terms of market share. So that has been a business that has continued to advance slow and steady, and it's been a good item for us business for us.
Operator
[Operator Instructions] And next, we'll go to Matt O'Connor with Deutsche Bank. Please go ahead.
Matt O’Connor
I was wondering -- Slide 7 that shows some of the revenue opportunities. I was wondering if you could size that. The UB deal, the revenue synergies related to the UB deal that you outlined on Slide 7, is there any way to frame how big that might be or what timeframe?
Andy Cecere
It is a high priority for each of our businesses. Probably the greatest priority is that first one we highlight, which is our credit card opportunity. The payments business is a strength of U.S. Bank. Our card offering is terrific, and we've already had a penetration increase from where we started, and that continues to be a focus. And then you think about that with the business clients as well. I think it is a material impact. But we're still working through exactly the sizing and timing, and we'll continue to update on that. But it is a priority and a focus area for each of our businesses.
Matt O’Connor
Okay. And then separately, a little bit of a technical question, I forgot some of CFA materials. But when we look at the securities book of a duration of less than 3.5 years, but you're only burning down 25% through '25. Remind me how that math works? And does the burn-down kind of step up as we think about '26, right? Because the duration is pretty short and the burn-down is not all that much in the first couple of years.
John Stern
Yes. The function of the curve really changed as the -- we saw the curve flatten out quite a bit this quarter. What I'd say on that is we have a number of securities that obviously are fixed rate that have longer durations to them or longer average lives. And so -- and then we have a number of -- with our -- the security portion of swaps, that has very, very low duration. It's three months or so because of how it's swapped the floating rate index.
So in addition to that, we've -- as we've added on, some of the security book, we have about $8 billion or so of -- when we did some of the auto repack transaction in the fourth quarter of last year as well as the second quarter of this year. That is very short as well in addition to some of the floating rate securities within that book. So, that -- it's kind of more of a barbell approach, which gives you the duration of it, which just gives us a value change for a move in interest rates. But in terms of the burn-down, that will depend in part about how the shape and the type of securities that are within the book.
Matt O’Connor
Okay. That's helpful. Obviously, less relevant now given the Fed's decision, but still something we're all tracking.
Andy Cecere
Thanks, Matt.
John Stern
Thanks, Matt.
Operator
And next, we can go to Ken Usdin with Jefferies. Please go ahead.
Ken Usdin
So just one more follow-up on the Category II news, I just want to make sure we're super clear. So this $700 billion stop being a bind forever? Or obviously, you don't have to cross on the prior potential timeframe. But to the prior question, just wondering, you said there's -- you don't have an asset cap. So does that mean that Category II is now a non-thing for U.S. Bank going forward in any time period? Or when you cross naturally, do you still get on the natural clock of having to comply? Just wondering how that fits in with the news you got yesterday.
Andy Cecere
So, we're bound, Ken, by the current rule set, which is after four quarters of an average of $700 billion then you would go to Category II, or the new Basel III rule set, which is yet to be finalized, as you said. But the current rule set is what we're bound on. So $700 million still is important, but what we're seeing is given where we think asset growth will be, given our continued optimization in certain categories, given our focus on high-return businesses, we do not see that as a hurdle to growth.
Ken Usdin
Understood. Okay. That's what I wanted to clarify.
Andy Cecere
You bet.
Operator
And with no further questions, I'll hand the call back over to George Andersen.
George Andersen
Thanks Brad. Thank you, everyone, for listening to our earnings call. Please contact the Investor Relations department, if you have any follow-up questions.
Operator
This does conclude the conference for today. Thank you for participating. You may now disconnect.
