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

Great. Thanks, Colin, and hello, everyone. My name is Ben Bubeck, and I head up the U.S. and Canada Financial Services, Sovereign and International Public Finance Ratings Department at S&P Global. Our final panel will be a fireside chat, and I'm pleased to introduce Andy Cecere, Chairman, President and CEO of U.S. Bancorp. Andy, thanks very much for joining us today.

Thank you, Ben. It's my pleasure.

So let's start with COVID as it's undeniably had the largest impact on the economy and will certainly have lingering effects well into 2021. Perhaps, first, at a high level, Andy, what has surprised you most about the impact of COVID on your business? And can you describe the economic outlook that you have in mind as you plan for 2021?

Sure, Ben. So first, COVID for me started on March 11 when I was returning back to the office and a lot of activity occurred that day. The first thing, and a lot of companies have said this, a lot of leaders have said this is how rapidly we were able to move from a work in office to work at home platform in just a matter of a couple of weeks. If you thought about that being a project, it would probably be years in duration, and we were able to do it in just a couple of weeks, going from about 10% work-from-home to about 75%. Secondly is the resilience of the employee base. We went into a work-from-home sustainable bottle, and been in it ever since. And I think we're performing very well. I don't think it's exactly the same as working in the office. I think we're missing something from a collaboration, training and particularly for new employees, there's an impact for sure. And then finally, and we've talked about this before as well, is the resiliency of the consumer in this environment. And I think we're going to come back to some credit questions, but given the fact of where unemployment was in GDP and the loss of jobs and bankruptcies and business pressures, the fact that the consumer is performing so well in this environment is quite surprising. What we planned for in 2021 is a slow, consistent moderate recovery. So we are projecting to end this year just over 9% of unemployment, so up a little bit in the fourth quarter. And ending 2021 in the high 7s, 7.8, 7.9, plus or minus percent GDP growth. Modest improvement in the S&P in the market. And interest rate is pretty much where they are today, so continuing low on the short end and maybe a little bit of an increase on the 10-year perhaps to 1% or so.

Great. Thanks, Andy. And that economic backdrop is certainly similar to the base case we at S&P have, and we just heard our U.S. Chief Economist, Beth Ann Bovino, lay out our thoughts in the prior panel. Digging maybe a bit deep here.

I heard him talk about it. I heard her talk about a more accelerated B recovery. I hope she's right.

Likewise. Just thinking a bit more into the operating trends, U.S. Bancorp, like most banks took a healthy provision in the first half of the year. But there was a noticeable pause in the third quarter as loans entering forbearance declined and the charge-offs have remained relatively benign. That said, we're hearing a lot about another wave of virus building across the U.S. Do you believe that U.S. Bancorp's allowance will need to be built further? And over what time frame do you believe charge-offs will ultimately be realized?

Yes. So let me step back and just talk about the scenario that we're seeing. So as I mentioned, the consumer side is really good. The combination of the stimulus programs, which have created a bridge over these very troubled waters, the forbearance programs that we and many banks have in place, and the final -- the consumer spend being lower and coming in at a lower leverage level, all those things add up to the consumer actually being in a very strong position. And if you look at all the facts from an economic standpoint and look at consumer delinquencies, you would say you are in 2 different environments. It just doesn't add up. And then on the commercial side, it's actually a tale of 2 cities. We have a number of companies that are struggling in a very significant way. Certainly, the airlines and hospitality, lodging, all those malls are struggling because of all the impacts that we know about. But at the same time, there are a number of companies that are doing very well, in some cases, having record profits and record revenue. So you add all that up, and we project using the CECL methodology, as you know, given the scenarios that we talked about, a loan loss reserve level that we think is -- we believe, is sufficient at the end of the third quarter. And unless the economic scenario deteriorates significantly from where we see it, we would not expect to put in more reserve. And given the delays that we're talking about with the forbearance programs as well as the stimulus, I don't think charge-offs are going to actually peak until the second half of 2021.

Got it. That's really interesting. And then I guess, if you add on to that, the weight of a lower for longer, which may have helped on the consumer side a bit that you alluded to, but even a lower forever potential outlook for interest rates. What do you think that means for profitability in the banking sector and for U.S. banks specifically over the next couple of years?

Yes. So as your audience knows, low interest rates, fairly flat yield curve is a challenge for banking. So the interest rate scenario, coupled with the economic scenario. And perhaps a little lower spend level, all add up to some headwinds from a profitability standpoint for baking. So it is -- it demonstrates the importance of a diverse model. So in U.S. bank's case, about 45% of our revenue derives from fee income from the likes of mortgage banking, which is having a record year in capital markets, our trust businesses and our payments businesses. So having a diverse revenue stream is very important in this environment because, certainly, interest rates are going to be a headwind for the foreseeable future.

And I guess sticking with interest rates, do you think we'll ever see negative interest rates in the U.S.? And if we did, what could that mean for U.S. Bancorp?

Yes. I would assign a low probability to that for a couple of reasons. First of all, the commentary from the Fed about that not being at the top of their list in terms of actions. The second is the efficacy of what has happened in Europe in terms of the outcomes of negative interest rates. So again, I would assign a low probability to that. We actually have a project in place, though, in the event that it does occur to make sure we have the steps in place to make sure it works correctly. We've already faced that in Europe, as you know. And so low probability, but will be ready if it does occur.

Great. Shifting gears a bit and looking a little bit more broadly at the banking business model. COVID also seems to have accelerated some secular changes we were seeing over the past several years. U.S. Bancorp has certainly been investing heavily into technology, tightening its branch footprint in recent years as the bank's customers have increasingly adopted digital products. U.S. Bancorp also presented updated plans to remove another 15% of its branches on the third quarter earnings call. I'm just wondering if you could maybe highlight some of the key investments you have been making, and describe your vision for the customer experience in banking in the future, perhaps, 2025 versus today?

Right, Ben. So this goes back a little bit. So a few years ago, we actually -- we're very focused on digital capabilities. Under the belief that while branches will still be important in the future, they are becoming less of a transaction location and more of an advice and council location. And more and more activity is migrating to digital devices. So for example, in the third quarter at the bank, and at many banks, 76% of transactions occur in a digital device. And because of that, you don't need as many branches and you don't need them as compacted in terms of location as they once were. And the function of a branch will, again, migrate from that transaction location and sales to more advice and counsel. Over 50% of our lending activity, our lending sales activity occurred digitally as well in the third quarter. So there is a tremendous migration occurring. And one thing that COVID did was accelerate that. So we have been focused on this for a couple of years. And I would say, in the 8 or 9 months of COVID that, if anything, it accelerated tremendously and probably in months what would have otherwise have taken years in terms of behavior changes from a consumer standpoint. So our digital initiatives around do-it-yourself, do-it-together, in other words, co-browsing or meeting on topics in a co-browsing situation and ensuring that we have speed, convenience, ease of navigation and all the capabilities in all of our channels is only going to become more important and is more important. So we shifted and we've accelerated our digital initiatives because of that change. And the other component of all this is my competition is not just the other banks anymore. It's the digital platforms and some of the fintech capabilities that we're facing off against. And I need to make sure that I have the capabilities that are consistent and can compete with those other factors.

Got it. Great. One other asset class, we're discussing a lot with investors, and it was raised this morning on our first panel that covered asset quality is CRE. And some of the subsectors within it that are quite vulnerable, and you alluded to these a bit earlier on, vulnerable to accelerating secular changes. Can you share your thoughts on how vulnerable U.S. Bancorp's CRE exposure is to these secular changes? And how you will manage lending to this sector going forward?

Yes. So Ben, we've been fairly careful in CRE for the past couple of years. If you looked at our loan growth in that category versus many of our peers, we were far lower because we did sense some overbuild in multifamily and some other pressures that we were actually being a little bit more conservative on. But as we sit today, it's different in different classes. So first, you have the hospitality, which is certainly feeling the pressures as well as certain malls that were already pressured before COVID, but it just accelerated like many of the things I talked about the impacts that were occurring, particularly those with the lower class malls. And then you have the multifamily, which is holding up, but partly, it's holding up because of that -- those bridges and those programs that I talked about. And probably the one that's the most interesting in my mind is office. So office is pressured for sure. And we would expect that there will be a continued migration away from the city, the metro areas and more into the suburban areas in terms of office space and building, but also less space overall. If I use U.S. Bank as the example, a year ago, Ben, we were contemplating about having to add capacity in our office space across much of our footprint. And as I sit today, in my expectation that we'll have more of a hybrid model when we come through this COVID experience. We probably have more capacity that we need, not just in branches, but in office space overall because we expect a hybrid workforce in the long term. So those things will add up to continued pressure, which is one of the reasons we're being very careful about what we're putting on and how we're managing our CRE portfolio.

Great. Office space is certainly something that hits home for us, too, not beyond just the fact that everyone at S&P that works in New York has not been in the office, I don't think since March 10, with very few exceptions. We're certainly looking at office consolidation as well. We're something like 90% working from home, and it's worked well, and the IT has hung in for us, but we're certainly rethinking our footprint and how we're structuring our offices. Let's move into the election results and regulation, maybe as a tie-in there. And while the dust hasn't settled 100% yet, at least in the senate race, would you please share some thoughts on any potential changes in regulation and the competitive dynamics you expect from the Biden administration?

Well, let me first say, I think the Fed and the treasury and a lot of government agencies did a terrific job in moving very quickly at the beginning of this COVID crisis in terms of supplementing liquidity, putting in programs, the stimulus, all those things were so important. And really, when I talk about the strength of the consumer, they're really a function of those programs and activities that really calm the waters and created this bridge. So that was critically important, and they did a terrific job in doing it rapidly. I think it's critically important that we have a second stimulus program because, as I said, we're not over this completed yet, and we need to extend the bridge. Otherwise, we're going to fall, we're all going to fall, and I don't want that to happen. So having that second stimulus, in my view, is critically important. I think the other thing that the regulators have done on the past number of years has been very much working together with banks in terms of listening and creating programs and processes that, while ensuring safety and soundness, also making sure that we can serve our customers in the most effective manner. And I would expect that to continue. There might be a little bit of a different focus in certain areas. We may have some changes with the CRA that was just put in place with a change that is expected. But I think many of the programs that have been put in place will continue, perhaps a little bit more focused, as I said, on CRA, Fair Lending and what ultimately happens with the Basel and the capital rules would be 3 areas that we're focused on.

It will be interesting to see how much banking is in the spotlight. And we had a capital markets panel yesterday where Rich Handler, who's the CEO of Jefferies, made some interesting observations regarding several unique aspects of this recession versus the past several. One of them was the fact that the financial sector entered this period from a position of strength. And so far, at least, it's been part of the solution rather than part of the problem. And so perhaps that will bump transformative banking regulation a bit down the list of President-elect Biden's top priorities. But I guess only time will tell on that. As it pertains to direct competition from the banking...

I agree, completely, Ben. As you said, versus the last financial crisis, banks are much better capitalized, higher liquidity, we're able to serve our customers or creating forbearance forgiveness programs. In March, when some of the pressures occurred, we had a U.S. bank a high $20 billion of drawdowns that occurred within a matter of weeks from companies trying to build liquidity and their balance sheet protection for their business model. We were able to accommodate that very quickly. Now most of that has been paid back. But really, banks have been helping customers get through this in a much more specific fashion than the last crisis. That is absolutely correct.

And I guess, maybe extending that just a little bit further. I mean how -- the performance the last couple of years and heading into this crisis, how much of that do you chalk up to some of the regulations that were put into place 10, 12 years ago?