U.S. Bancorp (USB) Earnings Call Transcript & Summary

I'm Jason Goldberg, U.S. large cap bank analyst at Barclays and continuing with our afternoon session, very pleased to have U.S. Bancorp up next. Before we kick off, just keep in mind, on the left -- top left-hand corner of your screen, there is a button to click, you can ask Q&A. You can submit them. We've been doing a decent job of asking those questions. So feel free towards the end of Andy and Terry's prepared remarks. We'll have some time for Q&A. Also there are some audience dated -- audience polling system questions. We may or may not have time to get to them today, but we will certainly publish results tonight. If we don't do that, so take -- free to answer those. There's about 4 questions. As I noted, next up, we have U.S. Bancorp. From the company, very pleased to have Andy Cecere, Chairman, President and CEO. We also have Terry Dolan on the line, Chief Financial Officer. With that, I want to turn it over to Andy.

Thanks, Jason, and thanks for hosting us in a virtual way, and good afternoon, everyone. Terry and I will give a short presentation. That will leave plenty of time for any questions you may have. And I want to remind you that on Page 2, we may be making some forward-looking statements, which are subject to risk and uncertainty, and you could refer to that document. I would appreciate it. Thank you. We go to Page 3. We will talk about the company. I know a lot of you are familiar with the company, but just as a brief overview, we are the fifth largest bank in the United States with just under $550 billion in assets and a market cap of about $55 billion. We operate across 3 sort of geographic concepts. One is regional, which we have our consumer businesses. Our branches are in 26 states. We just entered our 26th state last year by entering Charlotte, North Carolina and what we're calling a branch like digital-first strategy. We have national businesses in commercial and corporate banking as well as wealth and institutional groups. And finally, globally, we have 3 business lines: Elavon merchant processing, Corporate Trust, and Fund Services. I know the slides are just catching up with us. We're having a little bit of a technical issue here, but I will keep going. If we go to the next slide, as I mentioned, we're the fifth largest bank in the country. And what's unique about us is we are the largest non-GSIB, and why that's important is because we have the scale to be able to spend about $2.5 billion a year in technology and innovation. But at the same time, we don't have some of the capital and liquidity requirements that the GSIBs do, so we feel we're optimally sized from that perspective. The other item that you would notice from this slide is that we are more valuable than we are big. You see on the left-hand side we're about 1/4 of the size of the bank above us, but on the right, more than half in terms of value. Now we've always been valued at a very high price-to-book value, and I want to explain a little bit why that is. And just to keep it simple on the next page, it starts with having a very long history of delivering above-average return on equities through the cycle. So you can see here, at the last 5, 10 and 15 years, we've performed the best in the peer group. And the reason for that, on the next slide, is twofold. Importantly, it's driven by a superior PPNR, which is driven by our very best-in-class efficiency ratio and strong top line growth, and at the same time, we have a strong defense. You can see on the bottom, our charge-off rate is pretty close to our peer group in normal times, but in times of stress, you can see we well outperform and having a lot lower increase in charge-offs in those more stress cycles. If we think about what are -- what's driving all this, I want to focus on 3 things today: differentiated business mix, through the cycle underwriting discipline and finally talking a little bit about our culture. I'm going to start on business mix, which is described on Page 9. We have 4 pretty simple businesses with the company. About 42% of our company is Consumer and Business Banking, and 21% Corporate and Commercial Banking. Now many banks have those businesses as we do as well and performed very well on those. We also have a couple of unique sets of -- a couple of sets of unique businesses that are very capital efficient, fee oriented and have large scale across the board. And those include our Payment Services business, which represents about 24% of the company as well as Wealth Management and Investment Services, which is about 13%. I'm going to dive into a few of those businesses a little bit more, and I'm going to start with payments. Payments has been a great for us. It's actually 3 businesses: merchant acquiring, retail card issuing and corporate payments. I would highlight that the retail card issuing has a very large white label business where we do the underwriting and back-office processing for a number of smaller financial institutions. And then within corporate payments, we have both the large corporates as well as a government relationship that drives that revenue. Now we've talked about this in a number of calls this year, but the COVID-19 situation as well as the shelter-in-place orders have certainly impacted these businesses as spend volume has decreased and that's pressured the revenue here. And while that was certainly true in the second quarter, I think what we're seeing is that spend activity is starting to recover as economies have started to open up. And since bottoming out in April, you can see that they're starting to see it come back almost to normal levels. Now it's certainly true that some industries like airline, travel and hospitality continue to be stressed, but given the diverse nature of our portfolio overall, that's starting to come back. And Terry will talk a little bit more about that when he gives third quarter guidance. The other thing that is very important about our payments business is this combination of banking and payments into our total ecosystem. We feel as migration occurs from paper to digital and more and more business activity moves to a digital platform and payments becomes as important as the banking components, merging those into a comprehensive product set and capabilities is going to be hugely important. And we're very focused on that across the bank, particularly in the B2B market, which is a huge market and represents a huge opportunity. The next business I want to talk a little bit about is mortgage banking. So this has been a long-term business for us, and it's a very balanced business. We're both a large originator as well as a large servicer. And we are active both in the refinancing market but importantly, also in the new purchase market. And that's important because refinancing will wear down over time, but the core new purchase activity is important to us. And it's a business we've invested in. We talk about digital and human, and this is a great example of this business. Right now, through our partnership with Blend, about 90% of mortgage activity actually goes through a digital process. And that's allowed us to be more efficient, quicker to market and faster with our customers. That is also offering higher levels of service to the customers as they go through the mortgage application process. We've also invested in mortgage originators across the territory, which has allowed us to increase our market share. And this is going to be a business that we continue to focus on in whatever rate environment we see. The last business I want to talk about is our Corporate Trust and Fund Services business. This is rather unique. And this is a business that is -- as I mentioned before, it's a very capital efficient business. Scale is important, and you can see from the market shares on the right that we have more than sufficient scale. And it is a great source of both deposits as well as fees, and we built these businesses through about 20 acquisitions over the last 15 years and have a very dominant market share, as you can see on the right. This is another business that we're very focused on. And what's interesting about all these businesses is that they are very diverse in terms of when they perform in different market conditions. So in scenarios where rates are low like they are today and maybe lending or margin might be challenged, businesses like Corporate Trust and Mortgage do very well. So that diversity also helps us in this through-the-cycle comparison. Let me shift a little bit and talk about underwriting. One of the standards of U.S. Bancorp that has been and will continue to be is our disciplined and consistent underwriting as it comes to through the cycle. So we don't adjust down nor adjust up our credit standards. We keep them very consistent. And that has served us well, as I showed you through that chart. You can see on the upper left, some of the areas of our focus and a couple of highlights. We're a prime base lender on the retail side, and we're very investment grade on the corporate and commercial side. We have a very limited leverage lending portfolio. The other thing is we try to look at hotspots before they become too hot. And I think that the best example of that is our commercial real estate portfolio, which we recognized a few years ago, was an area that we wanted to make sure we had controlled growth. And you can see the growth versus our peer group was actually a fair bit less, but that was intentional. And that was intentional because we wanted to make sure we had that right balance of risk and growth and try to optimize across that equation. On the lower right on that slide, you'll also notice that we performed very well in the capital -- from a stress capital buffer perspective from the fast stress test. And again, that reflects that view of our portfolio, both on PPNR as well as our credit underwriting being best in class. Let's move to the next slide on credit. You'll see on the upper left the commercial exposures by industry. Certainly a couple of industries that are stressed in this environment are lodging and airlines and some mall activity. As you can see, it's a relatively small component of our portfolio overall. On the upper right, you can see the payment relief activity that's occurred. I will tell you that, that is all -- those are all cumulative numbers as of September 10, so just a few days ago. About 84% of all non-mortgage accounts have exited relief programs, and just under 1% of non-real estate consumer are still on a deferral plan. 1.2% are commercial and about 6.5% of real estate ex Ginnie Mae buybacks. I'll also note that about 35% to 40% of those who are in some sort of forbearance are still making payments while in that relief plan. And then finally, on the lower right chart, we've talked about this before, but the loss mitigation activity, as you can see, on a 5-day moving average has slowed considerably. Let me then move to our culture a little bit. What we've talked about is the culture of innovation, and this really harkens back to our core payments businesses over the last decade or 2. Payments has always been a technology and innovation-driven business, and that now is true across the bank overall. While we talked about the fact that about 75% of our transaction activity already occurs in a digital fashion, I think there's a tremendous opportunity to continue to focus on the sales component, as you can see on the lower left. It has been increasing tremendously, but I think we have even more opportunity. And what's important about digital is always open. It's more efficient. It's a higher customer satisfaction, and we also have opportunity for savings, what we call below the glass or in the back room. The other component of our optimization is the expense component. And for those of us -- for those of you who have been following the bank, you know that we were on a consent order from 2015 through '18, which caused us to increase investment on some compliance-related matters as well as really slowed our optimization of the branches. The good news is, on both of those fronts, we're past this. We're in a more normalized investment mode right now, and we're now able to optimize the branches. And while it's true that branches will always be important and really be a key component of how we deliver our services to the customer, the fact is that we have opportunity to decrease the number of as well as the square footage of the branch system overall. We talked about the fact already that we articulated 10% to 15% branch closures and we expect actually to come in above that. We're working through the final numbers that we'll update you on in the next couple of months, but I think that'll also represent an opportunity to both to cost save as well as to continue to invest on the digital front. Another component of this that's important is our alliance with State Farm. We have an opportunity here to expand our distribution through the 19,000 State Farm agents across the company. Again, taking the best of the relationship that they have and the digital products we have and really merging those to an opportunity for both companies. In the third quarter, we will add about $1.2 billion in credit card loans that Terry will talk a little bit more about in a moment. And in the fourth quarter, we're going to add -- about the middle of the fourth quarter, about $10 billion of deposits as a result of the State Farm alliance. So it's a terrific opportunity to, again, expand our presence through a very efficient distribution model. Finally, one of the components of our culture is doing the right thing. And I'm not going to go through all the components on this slide, but this has been an area of focus for us in the past. But we really ratcheted up the area of focus on this on a go-forward basis in terms of financial inclusion, supporting our communities and making sure our workplace allows for everyone to be -- the opportunities that they can get. So this is -- continues to be an area of focus and emphasis across the company. I'm going to now turn it over to Terry, who's going to give a little bit of an update on the third quarter. Terry?

Yes. Thanks, Andy. And just kind of going through some of the things that we talked about in the second quarter and our guidance for the third quarter is very consistent with the guidance that we provided in July. So with respect to net interest income in the third quarter, we expect it to be essentially flat relative to the second quarter. And that'll be driven by loan growth on a year-over-year basis, but we do expect loans to be down relative in the second quarter. Net interest margin is expected to be relatively stable relative to the second quarter. Although as we think about fourth quarter and end of 2021, there will be pressure on the net interest margin as we continue to move forward. And that'll be tied to things like the reinvestment on the securities portfolio, et cetera. As I said, loan growth, we do expect to be up on a year-over-year basis but down relative to the second quarter. Deposit growth continues to be strong. It will be certainly strong relative to the third quarter of last year, relatively flat to up a little bit relative to the second quarter. But we do expect deposit growth to continue through the end of the year, and that's really tied to a lot of the Fed actions that are taking place. Turn to fee income or noninterest income, and I'll talk about some specific areas. The mortgage banking continues to be very strong. And while it -- while we do expect it to be down slightly from the second quarter, it will be strong in terms of on a year-over-year basis, and that's driven by refinancing activities, good home sales and gain on sale margins. Payment revenues, as you know, are highly correlated to some of the sales volumes that Andy talked about earlier. And it has rebounded very nicely and very consistent with what we had been expecting for the third quarter. It'll still be lower than it was on a year-over-year basis but continuing to rebound on a linked-quarter basis. And that is continuing to improve very nicely with respect to really all 3 categories. We do expect deposit service charges to be down on a year-over-year basis. But again, because it's tied to consumer spend, we do expect it to be stronger in the third quarter relative to the second quarter. In terms of expenses, we expect noninterest expense to be relatively stable or flat relative to the second quarter. And then with respect to credit quality, talk about a couple of different things. The credit quality trends continue to be at or better than what we had expected. The economic outlook that we see today is very consistent with what we had expected at the end of the second quarter. We do continue to believe that net charge-offs and nonperforming assets will continue to move up, and in the third quarter, we would expect net charge-offs to increase by somewhere between 10 and 15 basis points, again, relative to the second quarter. And that will be driven by some of the higher risk industries, including hotels and lodging and retail malls. As Andy mentioned, in the third quarter, we did acquire about $1.2 billion credit card portfolio from State Farm as part of entering into that alliance. There will be an impact to the reserve of about $120 million tied to the CECL requirement to provide for those loans when you acquire them. And so that $120 million will be a part of our reserve build. As you know, when you look at the reserve adequacy at the end of each quarter and while I would say, on a quantitative basis, everything seems to be on track, one of the qualitative assessments we will look at is really the impact of both the timing and the extent of the stimulus that most of the economic outlooks had incorporated into their assessment. So when we think about the third quarter, we will have the reserve build of $120 million related to State Farm. And if we have a reserve build, it will be more on a qualitative assessment, and it would be meaningfully lower than what we saw in the second quarter. And then finally, in terms of the tax rate, we continue to think that the tax rate -- our expected tax rate on a full year basis to be around 15%. So Andy, with that, I'll turn it back to you, Jason.

Great. Terry, thanks for that. I guess a lot to digest. Maybe we'll go through some of that. Terry, you talked to kind of loan growth down quarter-on-quarter. It feels like on the commercial segment's under pressure, part of it driven by continued pay downs. There has been some, I guess, pockets of strength on the consumer side. Just maybe talk to kind of what you're seeing, at what point do you think commercial loan growth can inflect and just how you kind of think about loan expectations into next year.

Terry, I think you're on mute.

Sorry. As we said, we do expect that, on a linked-quarter basis, to be down. A lot of that is driven based upon the amount of corporate pay downs that are occurring. There continues to be a lot of liquidity in the capital markets, and just the access by many of our corporate customers to the capital markets have enabled them to be able to pay it down. About half of the decline is really related to capital markets. The other half is really based upon their own cash flows. So that continues to be relative -- that continues to be strong. I would say corporate America continues to be very cautious. We see that not only in terms of the spend but also in terms of loan demand, which tends to be soft right now. I think the things that will cause an inflection is if they continue to see the consumer spend growing as we have over the last quarter and through the end of the year, I think that, that will help. And then I do believe that there probably will be some M&A activity that starts to pick up as we get later into the year and into 2021. On the consumer side, as you said, loan growth has been particularly strong in terms of mortgage loans. Credit cards have been a little bit hurt by the lower consumer spend. In the third quarter, we will see a little bit of an uptick simply because of the acquisition associated with the State Farm credit card portfolio. And auto lending has also been very strong over the last 120 days, both in terms of production volumes as customers have come back online, and then the spreads have been particularly strong in the auto lending area as well.

Got it. And stable name is something you talked about on the earnings call for Q3. I guess this low interest rate environment causing some pressure for Q4 and potentially into next year. I guess how do you manage the balance sheet in this persistency low -- persistent low interest rate environment? And are there any kind of things you could do differently? Obviously, deposit growth has been really strong as your ability to kind of reinvest that outside of cash, the higher-yielding assets and just your overall approach to managing the balance sheet.

Yes. As you know, Jason, in the marketplace today, the yields with respect to treasuries, mortgage-backed securities, et cetera, are really at kind of all-time lows. So in terms of being able to identify opportunities, we'll continue to look for loan growth, opportunities to be able to focus on the auto lending, some of those things from a balance sheet perspective. But a lot of the excess liquidity that's going to come on balance sheet will end up either putting into the investment portfolio or cash. So those factors are really going to be drivers with respect to pressure on NIM as we think about the next several quarters.

And I guess, with the pressure on NIM, U.S. Bank's always been good about managing its cost base. But I guess are there additional opportunities for you guys to look at that, ways to be more efficient? Has COVID-19 impacted you? I know you talked about accelerating branch closures. Is that stuff that falls to the bottom line or has to get reinvested back into other initiatives?

Terry, why don't I start and then you add on, okay? I think, Jason, yes to all those. So first of all, I think we have an opportunity in the branches as we said, and that's just driven by customer behavior. Customer behavior before COVID was already migrating to digital channels, and that has only accelerated during the last 6 months. So as I mentioned, while branches are still important, the number of them and the square footage opportunity is there. I think we also have an opportunity in other physical assets. And just the way we think about the workforce and the return to work and how that might look and the number of offices we need and the size of those offices, I also think represents an opportunity. And we're going to continue to optimize across the company, the structures. And as we move to digital in more and more ways, I think that offers an opportunity, sort of what is we call below the glass in terms of operations and technology and the tech stack overall. As you think about how we would utilize that savings, I would say some of it absolutely will fall to the bottom line, and some of it will continue to be invested. So we can continue to make those improvements on a go-forward basis. So it's a mix of all. Terry, what would you add?

Yes. I would just -- coming back to the digital initiatives that we have been really investing in over the last several years. I do think that we're starting to see the opportunity in terms of digital sales, and Andy talked a little bit about that. So I think when we think about our digital investments, we have the opportunity to increase the wedge in terms of driving revenue growth as well as optimizing on the expense side of the equation.

Helpful. Andy, you talked about the Charlotte initiative. You talked about the State Farm initiative. I guess, in Charlotte, that was kind of one market. I guess what's your appetite for additional markets? And has COVID-19 kind of impacted that strategy at all? And then on the State Farm front, are there other kind of avenues of distribution that you're exploring kind of away from the more traditional approach?

Yes. So Charlotte has been -- first of all, I would tell you that the results, thus far, and it's about 1.5 years been -- exceeded our expectations in terms of new customer growth, extension of more banking products and services to current customers and the overall traffic activity and appointment. So it's been a positive from that perspective. COVID did slow us down a little bit. We are going to open up our second branch, and our intent is still to open up 10 to 12 branches. But COVID did slow us down a little bit. I think we'll continue to study the impacts and look at how the outcomes in terms of how fast we can grow in markets like that before we move on to other markets. But thus far, it's been consistent, positive and exceeded our expectations. In terms of the State Farm alliance, I do expect us to look at other opportunities like that. And the opportunity will be where we have a partner, [ without ] relationships, who either need or utilize banking products, and we could utilize that distribution with our digital capabilities. And State Farm is a great example of that. I think we have aligned cultures from a business perspective, and we would look for other opportunities like that.

And Andy, the thing that I would add with respect to this that with respect to the State Farm alliance, you think about the 19,000 agents across the country in many -- in markets that we're not in. So we really do believe that, that's a great opportunity for us to leverage our digital-first sort of capabilities. And then if you think about State Farm, they have a great franchise that's focused on a lot of small businesses across America, and that is one of our kind of strategic focuses as we think about the future. So we talked about bringing merchant acquiring and banking products and services to those small businesses. Now we also have the opportunity to be able to leverage that with our State Farm alliance. So I think there's just a lot of opportunity with respect to things like that.

And just to remind...

One of the things we learned through PPP, Jason, was that small businesses really are very digitally focused. And the whole concept of bundling together payments capabilities and banking in a digital offering is a tremendous opportunity across the franchise as well as through other alliances.

No, that makes sense. Just a reminder to those in the audience, if you want to submit a question, off the left-hand corner of your screen. Last and also below that is some of the audience polling questions. If you haven't done so, please take a moment to do that. We do have a question from the audience, so I'll read it. It's how does merchant acquiring business compete against the likes of Worldpay, Square, et cetera? What are any strategic, both organic and inorganic, moves the business needs to make to be more competitive in its offering?

Yes. So I'll start, and Terry, if you want to add. So first of all, we have been building capabilities on the omnichannel, so looking at both digital channels as well as the physical channels and really the combination of both. And so you -- I had a page earlier on, on some of the acquisitions we made, including talech and CenPOS. And that would be an example of extending capabilities. That, coupled with merging the banking products together with the payments, I think is really the secret to the success in this because I think the distinction between banking and payments is going to continue to break down. And what customers are looking for, particularly small business in middle market are a comprehensive offering that combines their banking needs and their money movement and payment needs. And we have all of that within the four walls of U.S. Bank, and that's how I think we successfully went on a go-forward basis.