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

Good morning, everyone. Thank you for joining us for our second company fireside chat. We have U.S. Bancorp here today. As many of you know, U.S. Bancorp has about $500 billion in total assets. It's one of the premier banks in the United States with consistently the highest levels of return on equity and the strongest stock valuations. And with us today, we have Terry Dolan, Vice Chair and Chief Financial Officer. But also we have Mark Runkel, Chief Credit Officer. And gentlemen, thank you for joining us.

Good morning, Gerard, thanks for having us. We very much appreciate it.

Good morning.

Very good. We're going to start off for the audience to talk about credit. Obviously, credit's front and center and everybody's minds. And maybe Mark, you can address where do we stand today on the credit front from an industry perspective, would you say, but also specifically for U.S. Bancorp? And then second, can you also share with us what has surprised you so far in this cycle?

Yes, sure. I'd be happy to do that. So let me just start off with kind of where we're at. I think over the last couple of quarters, we've seen deterioration across the industry from a credit perspective. And I think as we moved into third quarter, for us, specifically, we did see increase in our charge-off levels, which was in line with our expectations. If you look at the different industries, and I'll start with the commercial side of the balance sheet, and specifically, that's where the area of stress for us. And I think the industry has really heard up to this point is, we've seen stress in certain COVID-related industries that we've highlighted. So think of the airline industry, think of some of the other lodging, transportation and some of the retail and entertainment sectors of the business, that's where we've seen distress. On the commercial real estate side, it's really been focused in on lodging and retail and specifically some of the mall and closed mall is where the stress has occurred. So as we think about us and the industry, I think, broadly speaking, some of the high-risk industries have been identified, and I think are pretty manageable for us to be able to work our way through it. We're actually starting to see the exposure level starting to come down as we begin to work through some of those more distressed credits. In terms of your other question around surprises, I've kind of highlight a couple of key areas. The first is on the consumer side. The consumer has been very resilient so far throughout this economic downturn. We've seen strong payment rates and strong amount of liquidity that borrowers have had. And a lot of that has to do with the amount of fiscal stimulus that have been provided to the customers. The other area that I would highlight would be an area of surprises, just residential real estate values on the consumer side and auto values have been very strong as well. And then finally, on the commercial side, there's been some industries that have done quite well as a result of COVID, so think home improvement, think some of the online retail businesses, we've seen some really strong recovery, especially as we've gone through third quarter, and we've seen businesses shift kind of to more -- some of that online activity has served us well. So I think you put all that together, I think we're in a good position. I think you'll see charge-offs on nonperforming assets broadly across the industry continue to increase, especially as we get into next year.

But how do you think coming into this downturn, it was a surprise. This one, obviously, I know each downturn is different than the prior ones. But this one was a surprise for all of us because of COVID. And so Mark, when you look at your customers, were they less levered coming into the downturn versus -- if you look at '06, '07 or '89, '90 in those downturns, it seemed like many of the customers were over-levered. The banks may have been over extended And it didn't seem that way this time. Or am I wrong and even...

No. I think you're exactly right. I think that's true both in the commercial as well as even in the consumer world. I think there's just a lower amount of leverage coming into this. I think people learned from the last downturn, and they've been more judicious and prudent. And I think that's going to serve the banking system well as well as the customers, frankly, as we move forward.

Good. And as a reminder to the participants, again, the dashboard is open. If you'd like to ask questions throughout the presentation, please send them my way, and we'll try to get to as many as we can. Mark, when you look at how you outperformed during the financial crisis back in '08, '09, what differentiated you from you think, your peers? And should we expect that likely to happen again this time?

Yes. Thanks, Gerard. Yes, I would just say there's 2 key principles as we think about how we manage credit at this company. And I think I'd highlight our underwriting discipline and the second would really be our proactive approach to risk management. So let me start with the underwriting aspects. We've always taken the through the cycle view of our underwriting. So you're not going to see us making significant tightening and loosening throughout time, right? So we're going to be very consistent. We've always been a relationship-based lender. Third is that we've always been a cash flow lender. What all of that's translated into is on the consumer portfolios, we've always been a prime, super-prime lender. In the commercial space, we are a middle market lender through this economic expansion. We've gone up market actually and have more large corporate borrowers, which I think we've strengthened the portfolio. So I think that's positioned us well. And then on the commercial real estate side, we've been in that business for a long time, have really strong relationships. And we've underwritten prudently throughout time in that kind of, I'd say, 55%, 65% loan-to-value, which sets us up extremely well. So we stay very disciplined and consistent in our underwriting. That's number one. Number two is around, again, being proactive from a risk management perspective. We'll identify where we see risk in the portfolio. And for example, we'll migrate those credits down in terms of downgrading those. And you'll see that especially if you look back to first quarter, we were proactive at downgrading the portfolio and our criticized commitments increased faster that there's sooner than the rest of the industry. And I think that's has served us well, and we'll see the charge-offs maybe come through a little bit sooner. And so it's really a timing issue. So as I sit and look at both where we sit today from an underwriting and a credit perspective, I feel very good where we sit here today, and I think we're well positioned to continue to outperform as we move through the rest of this downturn.

It's interesting, cycles have a lot of similarities. And have you -- can you share with us in the cases where you had -- have had to go in maybe repossess a piece of real estate or you have had to write something down, is it -- are you seeing the same types of characteristics or trends in that activity today that you saw in previous downturns? Or is that different as well?

Well, I think for the most, it's pretty early, right, because we're just on the front end of this. So it's a little too early to say that anything is materially different. I'd say it's pretty consistent. I think we're being very proactive at trying to reduce some of our exposure in some of those higher-risk sectors and managing through that and being proactive on that. It's been really our approach, which was very consistent with how we approach things during the last down turn, which served us well.

Gerard, one of the things that I would maybe just add to that, if you're looking for differences between this cycle and maybe the last cycle is that The Federal Reserve Bank really jumped in with a lot of different programs, very early in order to provide the liquidity necessary, and I think that, that was important given the nature of this downturn, the pandemic sort of environment. And then in addition, you had a very significant stimulus. So I think one of the things that's different is that we're seeing performance within the portfolio that's been surprisingly good during this time frame. And a big part of it will be, is the stimulus and the programs that they put into place a long enough bridge for us to be able to get through to the other side without having significant losses? Or does the duration of the pandemic continue, and from a timing standpoint, we start to see those losses develop later in the cycle than we normally would. And there's just a lot of uncertainty. But those 2 things are very different than what you typically see in a recessionary environment.

No. You're absolutely right, Terry, and we've heard from your peers and others that the opening of the capital markets was -- has been a real success for the banks where they have had troubled customer's access to capital markets and take the banks out. And so it lowers the risk on your balance sheet, which is quite good. Moving on to -- speaking of the portfolios, Mark, if you look at the portfolio today, how different is it than what it was going into the financial crisis? And have you also adjusted your underwriting standards now in light of the more challenging environment we're in?

Yes. I thin as kind of Terry noted that this downturn is different. Obviously, that was a housing-driven crisis and consumer-driven recession, whereas this is a pandemic situation. But I think when I look back to our strong disciplined underwriting, I think that served us well during the last economic downturn, which will serve us well here as well, Gerard. And so if you look at over the last couple of years, especially in our commercial real estate portfolio, we've been kind of signaling that we've seen the market starting to get a little bit too aggressive, and we stay consistent in our underwriting approach there. And you see that our growth rates maybe lagged a little bit from the market. It wasn't maybe as high, and I think that will serve us well as we move into this. So I think it's that -- goes back to that consistent underwriting that we've had historically that will serve us well throughout this downturn. The other thing is, have we made some tweaks? What I would say is, like anything, we've made some tweaks on the margin on the consumer portfolios. And then in the commercial, and commercial real estate portfolio is obviously in some of these COVID-impacted industries, we're being very cautious at the moment in terms of additional exposure that we're willing to take on, and we're actually trying to bring that down a little bit here at the moment. So I think we're well positioned as we move forward, Gerard.

Talking about the consumer credit. Obviously, Terry touched on it with the fiscal programs where many Americans received $1,200, as we all know, in their checking accounts right after the CARES Act was signed and then the unemployed received the additional $600 a week until sometime early August. So certainly, that's benefited consumer credit. I like to have Terry phrase the bridge, is that bridge long enough to get us to other side. What are you guys watching to -- because consumer credits held up so well for you and others, what are you watching now as we go forward to see if it's going to maintain this outperformance?

Yes. I would kind of highlight a couple of things to your point is, is that consumers pulled back significantly when the environment shut down, call it, in April time frame, Gerard. And I think that did provide additional savings. We did see that. The second is the government stimulus, as you noted. And then I think the banks did a great job of stepping forward to help provide deferment forbearance program. So you put all of that together, and I think that is increased liquidity, which has allowed people to continue to service their debt. So that's kind of the where we were at this point, right? So as we look forward, I think what we're focusing in on is, what is the -- how long is that bridge? And is it sturdy enough? And I think what's the real question will be is how long is it until we see some kind of vaccination or herd immunity so that people get comfortable and the economy starts to open up a little bit moving forward. And then the other key piece is, obviously, those deferment forbearance programs in terms of how they may come off and the subsequent performance of those. Today, what we've observed, we had in our forbearance, about 5% of our portfolio at the end of June, that went down to about 2%. So we've seen a fair amount of customers coming out of those programs. And what we've observed up to this point is about 96% of those at the end of third quarter were current, which is really strong from my perspective because these are customers that proactively reached out to us saying, "Hey, you know what, I need some help." We were able to help them. And then after that period of time, we've actually started seeing them making their payments, which I think is a real positive.

And I haven't heard any of your peers say this to me either. Any word from the Federal Reserve on when maybe these deferment programs may end or when they may require the banks to treat a TDR like a real TDR?

Yes. I think most of that expires at kind of the end of the year. And I think the banks -- most of the banks -- we just haven't seen the demand from the consumer or even the commercial customers, right? I mean most of that activity peaked back in the April time frame. And since then, we've really seen the demand, if you will, from a borrower perspective, significantly decline, right? So we're, like I said, at 2% at the end of third quarter and what remains is really the residential real estate portfolio. And those are typically a little bit longer in nature. We get 180 days and you could go up to 360 days. So I think as we get into the end of this year into next year, you're going to really start to see us as well as the industry significantly reduce the amount of customers on those programs, and that's what we're watching closely in terms of impact that may have on some of the consumer portfolios.

Yes. And on this consumer subject, you've talked about the bridge and some people are expecting a second stimulus plan, which may even extend it out further. I guess if we do get a second stimulus plan and some of your peers and others have talked about the net charge-off pickup could come in the second half of '21. If we do get a stimulus plan, let's say, in the next 8 weeks, does that push out charge-offs even further, do you think? Or on the consumer side, and assuming it's consumer oriented?

Yes. I mean I think we, along with the industry, Gerard, have been thinking about it the same way, which is at this point, delinquencies are kind of at a low point, right? We haven't seen those come through on the consumer side. Typically, it takes 180 days after you become delinquent before we'll start to recognize the losses, especially on the unsecured portfolio. So I think to your point, if there's additional stimulus, we could see that continuing to push that off into the future. I think at this stage, we would think some of those consumer portfolios, we'd start to see increasing levels of charge-offs in the back half of 2021, given the current environment if additional stimulus, you're right, it may change some of the timing of that.

And coming back to the commercial side of the portfolio, you touched on it. Maybe we could go a little deeper around, within the commercial and commercial real estate area, where are you seeing the biggest issues? And I suspect it's the travel, entertainment, the COVID, but are you also seeing any evidence of, what I would call, non-COVID-related industries that were starting to show some signs of stress?

Yes. The only area that I would say is non-COVID might be some of the energy portfolio, some of the oil and gas. And that was a little bit stress kind of coming into this downturn, Gerard. And I think, obviously, that we've been watching closely. Outside of that, I would say the surprise for me in third quarter really was, again, certain industries trying to pick back up as the economy and the environment started to pick back up, we're actually starting to see a lot of the customers starting to perform extremely well. And so I think it will be interesting, there's still a lot of uncertainty in the environment as we move forward. But I think so far, things have held up pretty strong. And on the commercial real estate side, if you look at the other -- the sectors, industry sectors, if you think of some of the multifamily office, that's continued to be very strong, and we've seen high payment rates and collection rates from our customers, and that's been really resilient as well so far.

Do you think -- are there any -- in talking to your frontline guys and gals, I guess, do you see any sectors or industries that maybe in permanent impairment or just going to take a real long time to recover, possibly the hotel sector?

Yes. I think you're exactly spot on. I think it's going to be -- those impacted industries are just going to have a longer recovery period, right? So until people can get comfortable or until there's vaccination, right, I think it's going to take a while for the travel industry and the lodging industry to recover in a meaningful fashion. So I think that's just a longer time horizon to recovery is how we're thinking about it.

Speaking of -- we were talking about the net charge-offs and how they may play out going into 2021. When do you think we'll see the highest levels of credit losses? Is it a middle of next year? And assuming we don't do a double dip in the economy so we [indiscernible] steady growth. Obviously, not quite recently in the third quarter, but just steady growth, what do you think maybe net charge-offs peak at what level if you could make that kind of estimate? And just when it may happen?

Yes. I think in terms of the peak, we -- again, we're thinking that's probably in the second half of 2021 and based on what we're looking at today. And again, that's really going to be driven from, again, those consumer portfolios that we haven't seen the risk emerge, if you will, from a delinquency perspective. And so we're watching that closely. I do think there's a tremendous amount of uncertainty. You kind of highlighted that in terms of what type of additional government stimulus, what's the timing of that? So it's really hard to gauge exactly where is that peak going to actually occur at this point in time. But we do think in the back half of next year, losses will increase.

Yes. I think, Gerard, one of the things I would just say regarding that is that if we were looking at a typical recession, when we started this process, we would have probably said early to mid next year is kind of when the peak would occur, can be fairly significant and then you'd start to see improvement from there. But I think, again, because of the stimulus program, the accommodation by the Fed, et cetera, it's really hard to figure out what the timing of that looks like and even how it ends up developing. So I do think, as Mark said, second half of next year is when we would expect those losses to start to increase. Where that peak is may end up even getting a little bit deferred beyond that. So again, there's just a lot of uncertainty at this particular point in time.

Right. We've got a question coming in on the dashboard of the consumer, and it's asking that you've got about 2% of the consumer borrowers and TDRs or some type of regulatory accounting forbearance. And the question is, does this mean that the consumer delinquency numbers are understated somewhat by this amount?

Yes. I mean I think those are customers that have reached out proactively to us, right? So I wouldn't say they necessarily should be counted into delinquency, as I kind of noted, which is those customers that we have seen come off, it was about 5% in the end of second quarter, and that's now 2%. So about 3% of the balances have kind of rolled off of those programs. And today, 96% of those are current. So I think we've seen strong payment performance. And again, the whole idea of those programs was to create that bridge and support to be able to help people get through this scenario. And I think so far, we've found those to be quite effective.

Yes. And Mark, even when they were in the forbearance programs, many of those customers continue to make payments, so I don't think it's a situation where you can easily translate it into, those are delinquent accounts simply because the customer behavior is such that they're continuing to make payments. And again, the part of that is because [indiscernible] because of the stimulus.

That's right.

The -- when you look back at the people that asked for forbearance, do you think many of them were doing -- obviously, we didn't know how severe this downturn was going to be back in April, COVID was running ramping. Was it more as a safety measure, even though, to your point, Terry, a lot of people were making those payments, and people just want to make sure that in case they did get into trouble, they had some flexibility?

I think absolutely, that was it. I mean I think a lot of customers through the last economic downturn, recognized if they reached out to the bank proactively, the bank would work with them. And I think the banking industry was much better positioned, I would say, this downturn to be able to reach out and help borrowers. And we made it known that we are here to help, and we put it on our websites in any of our -- any place you logged in digitally, we connected with you to say, we're here to help. And I think that was where people were proactively reaching out to us and said, "Hey, if there is an opportunity, I don't know how this is going to play out, so I'm going to reach out to my bank and figure out if there is an opportunity." And then back to Terry's point, that's what I think we believe we saw such a high payment rate of those customers that were on these active forbearance programs.