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

Good afternoon. This is Gerard Cassidy from RBC Capital Markets. Welcome to our 25th Annual Financial Institutions Conference. This fireside chat is with U.S. Bancorp. As many of you know, U.S. Bancorp is the fifth largest bank in the United States, has about $554 billion in assets, operates in 26 states, has about 68,000 employees and close to 23 -- 2,375 branches. The market cap is an impressive $79 billion and the stock trades at about 1.6x book value, has a dividend yield of close to 3.3% and their CET1 ratio is 9.7%. And then lastly, they have been able to -- or announce, I should say, $2.7 billion buyback for 2021. Joining us today from U.S. Bancorp is Terry Dolan, Vice Chair and CFO. Terry has been in this position since 2016, and he's been with the company, as many of you know, since the late 1990s. We also are very fortunate today to have Jeff von Gillen -- or Gillern, I apologize, Jeff, Vice Chair of Technology and Operations Services. And he has been with U.S. Bancorp since 2001. They have a presentation. Jeff will start it off with a presentation. But first, I want to just thank both Jeff, you and Terry, for joining us today and we really appreciate it. And Jeff, take it away.

Gerard, thank you, and good afternoon, everyone. I appreciate the chance to present here today. I take you to Slide 2. Just remind you that we may make some forward-looking statements that are subject to risk and uncertainty, and I'll refer you to our safe harbor statements for further information. On Slide 3, and Gerard covered some of this, but with $554 billion in assets and a market cap of $79 billion, we operate businesses that are regional, national and international in scope. And in the red on the left is where you'll see our physical retail branches as well as ATMs, and we're over -- in over half the states in the United States. Our Corporate and Commercial as well as our Wealth Management and Institutional Services businesses are national businesses, and we serve customers across the country. And then finally, internationally, we have 3 business lines: Elavon merchant processing, Corporate Trust as well as Fund Services. On Slide 4, we think we're well positioned in terms of our size. While we are large in size, we're not a complex organization. And therefore, we don't have some of the additional capital requirements and liquidity requirements that some of the G-SIBs have. On the other hand, we have the scale to compete effectively against both larger and smaller peers. We spend about $2.5 billion a year on technology and innovation, which we'll talk about in a little bit. On Slide 5, we really have 4 simple businesses. As you look at the left side of the slide there, Consumer and Business Banking, along with Corporate and Commercial Banking, they really make up about half the company. And on the right side, you'll see our fee-based businesses, such as payments, along with Wealth Management and Investment Services. And it's this balanced approach of spread and fee-based businesses that really help support consistent results through the cycle. As you'll see on Slide 6, we believe we've consistently been rewarded a higher relative valuation by the market. It's really by a history of delivering above-average returns on average common equity through the cycle. This slide illustrates that consistency of industry-leading returns on both the 5-, 10- and 15-year period. I take you to Slide 7. Importantly, these industry-leading returns have been driven by both industry-leading PPNR performance and our credit quality performance. And we don't focus exclusively on either growth or risk. We focus on a balanced approach to growth and risk, which leads to superior returns through the cycle. Moving you to Slide 8. Our best-in-class financial results over time have been supported by our differentiated business mix, our through-the-cycle underwriting discipline and a strong and nimble culture. And those things aren't going to change. However, we haven't been standing still, and we recognize that as technology and consumer behavior evolves, we have to continue to evolve as well. Consumer [ preference ] towards digital and business payments are moving from paper to check -- are moving from paper check to digital fairly rapidly. And we're investing in people and technology with the goal of really improving growth and efficiency. So let's move to Slide 9 and talk a little bit further about technology. In the current environment, a variety of factors has accelerated modernization at U.S. Bank. Our investments over the years have helped us position to meet the demands of today's world. And as the pandemic ensued, we saw a tremendous shift towards digital banking. With our technology, we were really ready to deal with it. And just to give you some examples. With this shift, we were able to capitalize on this opportunity. 77% of our customers are now digitally active, and 78% of our transactions are digital. And we believe the digital trends are here to stay. Let me move you to Slide 10. As we think about technology today, we're going to spend $2.5 billion, and those investments are going to shift towards 60% offense and 40% defense capabilities. Our current capabilities allow us to have a best-in-class app. We have strong do-it-yourself, do-it-together, DIY, DIT, services and while also migrating more of our enterprise applications to the cloud. We also make sure all our acquisitions are brought to our tech platform in a standardized way for simplicity and easier upgrades in the future. That drives efficiency. As we look forward, we'll continue to have a tech strategy focused on continued modernization across a variety of areas. Just to give you some examples, we anticipate this strategy will allow us to continue to make efficiencies across the organization. More specifically, 20% lower incremental costs for new digital feature function, 60% of our digital consumer touchpoints will be serviced by the cloud, and we'll reduce back-end mainframe usage by 20%. Let me take you to Slide 11, and let's talk about our biggest change and driver of modernization. And it's going to be the new tech stack. We're going through -- we're going really from a monolithic core system to a unified data platform. And basically, this is going to allow us to simplify our systems in a very reliable infrastructure. This new tech has many positive impacts across all business lines to allow us to be more flexible and agile. So upgrades and new systems can be implemented literally in a matter of weeks versus traditionally months on end. As you'll see here, we're looking to reduce cost to not just the technology, but across our business lines. So within Consumer and Business Banking, we're focused on improving our branch and call center systems while also simplifying our customer touchpoints. Examples in Corporate and Commercial Banking, you're going to see an acceleration of capital markets capabilities. While in Wealth Management, we'll be able to implement acquisition strategies much faster. In the payments business, we're looking at reducing cost further, but also looking to use technology to enhance our payments ecosystem. So in summary, we're creating a fully modernized, scalable technology platform, greater reliability and lower run cost. Let me take you to Slide 12. And let's talk about our payments ecosystem a little bit. We're going to use technology to help connect banking and payment services. And this is really exciting for U.S. Bank as we leverage our bank capabilities and our payment capabilities to meet the growing demand of businesses. Technology has allowed us to create ecosystem, and we're starting to see the investments bear fruit in this digital evolution. I'll just give you an example. We've focused our investment into the tech-led area, which is now our fastest-growing segment within the merchant services area. And if you can see on the bottom of the chart here, we've seen over 100% growth in new tech-led partnerships in the past couple of years. Let me move you to Slide 13. And we wanted to highlight talech as a use case within our payments and as part of our tech-led focus. talech was a recent acquisition that allows us to be a bigger player in consumer payments. That's a market of over $18 trillion. And not only did we get capabilities with talech, we also got a tremendous talent force that came and joined our team as well. talech currently focuses on helping small businesses, such as restaurants, retail and services, manage their payments and businesses better. And part of our technology strategy, we're going to create an integrated dashboard to help these businesses manage both payments and banking activities in one place. And as we continue to invest in tech-led, we anticipate growth in digitally acquired customers and in digital product usage by our current banking customers. And as you can see, we're excited about our technology modernization strategy, not only within payments, but across the whole organization. And our investments in people and technology will continue to help improve both growth and efficiency at U.S. Bank. And with that, let me turn it over to Terry to talk about how the quarter is shaping up. Terry?

Yes. Thanks, Jeff. And what I want to do is just give a little bit of guidance with respect to the first quarter. So our outlook for the first quarter is very consistent with what we talked about during the January earnings, but maybe with just a couple of clarifications. Currently, we expect net interest income to be down about 3% to 4% compared to the fourth quarter. About 1/3 of that is related to just fewer days than the fourth quarter, and the rest of it is really going to be driven by a little bit of softness with respect to loan growth relative to what we had expected. We're also seeing a little bit more pressure with respect to net interest margin than we had anticipated. And those 2 factors are really about 50-50 in terms of the remaining portion. So think about it in terms of 1/3, 1/3, 1/3. Compared to the guidance that we gave in January, premium amortization expense is a little bit higher than what we had anticipated. And then loan fees associated with the PPP program were delayed. So that's really kind of a timing between first and second quarter. And that delay is because of the fact that the window for submission of forgiveness of loans was closed by the SBA for about a month. And then when we think about the first quarter and then moving into the second quarter, we really think the first quarter is kind of an inflection point for both net interest income as well as net interest margin, given the steepening yield curve as well as kind of our expectations around loan growth. In our previous outlook, when we had talked about loan balances going into the second quarter, we do continue to expect the second quarter is going to -- we're going to start to see growth in terms of loan balances. More of that growth, I think, will come in terms of commercial, C&I. And consumer may continue to be somewhat flat because of the stimulus programs that currently are out there. So kind of in summary, we think that the first quarter is an inflection point, second quarter starts to get better. With respect to our outlook regarding fees, generally unchanged. Total payments revenue is going to be very consistent with what we had communicated at the -- in January, probably with a little bit of a shift in mix. We are seeing strength in merchant acquiring, so it's a little bit stronger than what we had anticipated in January. But credit and debit card revenue is going to be a little bit softer than what we had expected. And that is principally because of the timing of the stimulus program and the impact that it has on pre-card processing revenue. So that is really more of a shift in timing from first quarter to second or third quarter as depending upon the timing of the stimulus program. So generally, very much in line. And then finally, I'd just like to remind people that when we evaluate the allowance for credit losses, we do that at the end of the quarter. However, I would say that the credit trends that we are seeing have been very favorable. The economic outlook is currently trending better, and all of those things will be incorporated into our reserve estimate for the first quarter. So with that, Gerard, why don't I turn it back to you?

Thank you, Terry, for the update, and thank you, Jeff. Maybe starting off with some questions for Jeff. Jeff, we know that technology is critical for banks, and banks have been investing in it for quite some time. But if you had a whiteboard and you were asked to set up the technology for a cutting-edge bank, how does that differ, if at all, from the current banking system? Not just U.S. Bancorp, of legacy IT systems, brick-and-mortar, how do those 2 paths kind of converge?

Yes, Gerard, what I'd say is the end state would be -- we would build to the end state of what I described on our modernization trip. The reality is we do have legacy that we're migrating from. And so I use an analogy, we're flying the airplane while we're changing the engines, and we don't want the passengers to have a bad experience, in our case, the customers. So that's the challenge. If you're building it new and from scratch, you wouldn't have that legacy transition challenge to make sure that you're balancing risk and security and pace of change. But it would very much be the target end state that I described that we're migrating towards.

Very good. You mentioned in one of your slides, you showed the overlap between banking and payments, and that seems to us to be one of the advantages U.S. Bank -- U.S. Bancorp has in its payments business because of the banking overlap. Can you give us some color on just how you see that enhancing, winning new customers, whether it's in the merchant acquiring business or other businesses with payments and having that banking overlap?

I think I mentioned it in the presentation. It's actually something we're really excited about because we have all the parts. We have all the pieces. We have what's necessary, and we're knitting that together right now. The key is going to be a seamless, frictionless, simple-to-use customer experience. And that's what we're really, really focused on. And I talked about talech helping knit some of that together for us and bringing in some new capabilities. But that is going to be in our sweet spot, and that's why we're excited about it.

Very good. Many investors always ask the question to myself and, obviously, Terry gets it as well, about these financial disruptors, the fintech companies coming in and disrupting the business for banks. And it appears to us that the banks are holding their own. Do you have a view on the advantages or disadvantages that fintechs may have? And what you're seeing from your vantage point as from a technological standpoint?

Yes, Gerard. I've got a couple of point of views relative to that. First, I'll just start with competition is healthy for all of us. And I got to tell you that some of these fintechs are really good at what they do. They are customer-centric, they create simplicity for the user experience, and that's healthy competition. I would also say that we have very successfully partnered with several fintechs in how we deliver our service [Audio Gap] all is and at the end of the day, we own that customer relationship. But it's brought a better experience to our customer in a lot faster way than we would have been able to do it on our own. And then I'd tell you the third point of view would be, we do need to be paying attention to our customers' information, security of that information. That's probably one of the key things that I focus on with some of these fintechs just to make sure that our customers understand where their information is and how it's protected. And I think that's an important thing for us to keep eye on as well.

Very good. Obviously, one of the greatest risks the banking industry confronts is obviously in cybersecurity. If we just put that off to the side for a moment, Jeff, can you share with us what would the other -- or what are the greatest technology risks that a company confronts aside from the cyber risk?

We constantly challenge ourselves to go fast, right? And that's the key. It's innovate, to go fast and to have a culture to learn and fail fast and fix, correct, learn and so forth. And that's a balancing act like we talked about before, balancing growth and risk together. So that's one, and that's important that we're moving fast, but we're doing it in a responsible way. The second thing that I put in the category of either a threat or a focus area is just the war on talent. People are what make a lot of this happen. And by area, we're actually doing things with less people over time, and some of those people are at a higher pay grade that we are hiring because of the shift and the technology mix is changing. But talent acquisition, not just acquisition, but motivating, retaining and keeping them as part of the culture is something that I focus on quite a bit. And then you already covered cybersecurity. That's obviously our #1 focus.

Yes. No doubt. There's been, again, a lot of talk amongst investors of what companies are keeping up with their technology in terms of spending and do they have a cutting-edge technology. Aside from the actual dollar amount -- and obviously, it's not fair to compare. You mentioned $2.5 billion and it looks like U.S. Bancorp will likely spend versus $10 billion that a Bank of America may spend. That's kind of apples to oranges. So we take it, like many people, as relative to assets or revenues as a way of looking at how much banks are spending on technology. Do you have any observations on what you would share with us on what are good metrics that outsiders -- we don't have access to the inside information, that outsiders can use to measure if a company is really keeping up with the technology spending they need to keep up with?

One of the metrics that's important, I think, is your run cost versus change cost for the bank, right? You want to be efficient. And so as you look at the $2.5 billion, making sure that you're efficient in those terms and there's benchmarks out there for those kind of things as well. But I think what's important for us is there's a fundamental level of investment that I call responsible investment that's necessary for capacity, for controls, for security, and you can't cut corners on that, even cutting corners in the current year because you're going to have implications of that legacy technology. It's very easy to defer a legacy technology upgrade for a revenue-enhancing thing. But you've got to protect the things that are core to keeping the business stable and reliable, protect that and know that it's important to do. And then we're very deliberate, and we've got a very deliberate process of how we allocate capital outside of those regulatory or those foundational things. And foundational being information security, regulatory requirements, the resiliency of the architecture and so forth. And we're very deliberate, and we're not going to invest in probably as many areas as the larger banks are, but where we invest, we're going to be deliberate and we're going to deliver.

Very true. And obviously, you don't have the asset size of some of the larger banks so there's no need to spend, obviously, as much as those larger banks. Maybe pivoting over to you, Terry. Obviously, last year was an incredible year. It's an overused word, but it was unprecedented in our lifetimes, of course. And aside from the obvious pandemic and COVID, what were some of the surprises that you saw for U.S. Bancorp? And what did you take away from that for the future?

Yes. Thanks, Gerard. I think there's a number of different things. First of all, I would just kind of point to the agility and the resiliency of our employee base. I was really amazed at how quickly they were able to change and adapt from a -- in-the-office sort of environment to a work-from-home environment. Second thing that I would just say is really around our technology from a number of different perspectives. One is the ability for us to be able to shift the -- to that work-from-home environment to be able to support that from a technology perspective. I think Jeff and his team did a great job, and many of the investments that we had made kind of set us up for success for that. And technology also ended up playing an important role with respect to our ability to service clients and customers during that time frame and to do it very effectively as their behaviors were changing. And I think a lot of the investment that we made on the digital side of the equation over the last several years really set us up for success associated with that. And then maybe the last thing that I would say, just especially in the early stages of it, is the government response, how quickly they were able to support the capital markets and to be able to kind of take a number of different things off of the shelf, so to speak, out of the playbook and put it into play to enable to support the economy during a very difficult time. I think that those are all things that went very well, and I think that were surprising to many of us as we kind of went through it.

No, no. I couldn't agree with you more on the government, not only the Federal Reserve, but the U.S. government's ability to react so quickly. I can't remember a time when a stimulus plan was put in place and Americans had cash in their pockets within 3 weeks of the President signing the bill last spring. So I totally agree with you. It was truly remarkable to say the least. You showed on the slides about your profitability through the cycle. It's one of the hallmarks of U.S. Bancorp as having industry-leading profitability as measured by return on equity, return on tangible common equity. Can you share with us, Terry, what's the optimal -- if all the cylinders are firing together, what's the optimal level of return on equity? And then tying to that, what kind of macro environment do we need to see so that you get to that optimal level?

Yes. Well, in our Investor Day, we had laid out a number of different profitability goals. In terms of return on tangible common equity, that goal is 17.5% to 20%. And quite honestly, we have not moved away from that objective on a long-term basis. Now in the fourth quarter, I think our return on tangible common equity is about 15.6%. And so while it was lower, it's kind of on the track back, so to speak, to be able to do that. And in all respects, we feel like we can operate within that range in more of a more normalized sort of environment. Now -- okay -- which kind of gets to your second question. I do think that there has to be some more normalization. I think we can operate that at that level if GDP was quite in that 2% sort of range, plus or minus a little bit because that gives you the opportunity to be able to grow. I think that what we need to be able to see from here is consumer spend continuing to kind of get back to normal and to strengthen, which it has been doing very nicely. So I think that, that is starting to come back. And then I would just say kind of a stable credit environment where you're not either releasing or building reserves because of credit concerns. And again, I think that based upon what we are seeing right now, we're moving in that direction, which is all good. So I think we're pretty confident that we can operate in that level of profitability on a long-term basis.

Yes. No. That's very good to hear. And I know investors today, one of their themes of why they want to buy bank stocks is this improvement in credit and potential for loan loss reserve releases, maybe even negative loan loss provisions. With that in mind, is there a scenario, Terry, that we look back to the CECL day 1 reserves for you and the industry? Obviously, we're well above those levels. Is there a day that we could ever get back to those levels? Not this year, of course, but at some point in the relatively intermediate future?

To pre-COVID sort of reserve levels?

Yes. But including -- yes, that's correct, but the CECL day 1. So the January 1, 2020, reserves. Correct.

Yes. No, absolutely. I think that if you end up looking at the economic outlook right now, it continues to get better or improve both from a GDP perspective as well as unemployment. I think there are still a number of uncertainties that are out there related to things like commercial real estate and some industry sectors as well as maybe some of the small business that is still struggling out there. But I do think that if we start to look into the second half of 2021 and into 2022, I do think that the GDP growth is going to be pretty robust. You have a fair amount of stimulus that's going to focus around infrastructure, putting money into people's pockets, possibly also creating a little bit of inflation. And so I think all those things get you to a point where we're back to kind of pre-COVID levels. I think part of it is just what is the timing of it. I'm not sure that it's there by the end of the year, but certainly, when we get into 2022, I think that there's the opportunity to do that.

Yes. No, very insightful. I appreciate that. We're running out of time here, unfortunately. But you touched on something about economic growth, maybe some inflation. The yield curve in your opening remarks, you did talk about the steepening of the curve. If we were to see the curve steepen further, and I'm not asking for a crystal ball on rates, but if we were to get to a 2% 10-year, are the forward curve right now is calling for fed fund rate increases in 2023, maybe that gets pulled forward into 2022. So could you just share with us what you would see or expect to see if the yield curve steepen further. And if we did see maybe short-term rates come up earlier than expected sometime in 2022, what that might -- what the impact might be for U.S. Bancorp?

Yes. Great question, Gerard. And let me give you a little bit of context. So we've talked about the fact that our balance sheet and the benefit we get in terms of rising interest rates is about half of it is on the short end of the curve and about half of it is on the long end of the curve. And if you end up looking at our disclosures around asset sensitivity, we are fairly asset-sensitive right now, certainly much more asset-sensitive than we were, let's say, a year ago pre-COVID. And I think at the end of the year, to a 50 basis point shock, it was about 4.5% benefit in terms of year 1. Well, we've seen that on the long end. And so if you think about maybe half of that. And then to the extent that the short end starts to move up or we see those continuing to move up, you can see some pretty nice opportunity in terms of net interest income going forward. But I would kind of point to some of the disclosures that we've made, and people can do a little bit of the math and kind of get there.

Yes. No, we've noticed that a number of banks have a big -- have had an increase in net asset sensitivity that you just described. And just maybe wrapping it up, we got 1 last minute here, Terry. Just capital management, you guys have always been very good at it. Any color or thoughts? I know the buyback is reinstated because the fed has allowed you. But any thoughts on that as you look out into the future?

Yes. Again, maybe for context, our target is about 8.5% CET1, and we have operated somewhere between 8.5% and 9%. And as you said in the opening remarks, we're at about 9.7% right now. So from a capital management standpoint, we do think that there's -- we have the capacity, and we think we have the ability to be able to start bringing that capital ratio down. I think the economic outlook would suggest that now would be an appropriate time. The way that I would prioritize it is we'd certainly love to be able to put that capital to use by focusing on customer demand for loans. That would be my first priority. But we'll continue to look at dividend opportunities to be able to expand that in the future. And then the buyback program, as you said, we authorized a $3 billion buyback over a period of time. There's a little bit of restriction from the fed standpoint at this particular point in time in terms of how much capital distribution you can do. But we do think we have the capacity and the ability to be able to bring those ratios back down to what is more normal for us, which is kind of between that 8.5% and 9%.

No. Very good. A very thorough answer, very good answer. And I want to thank you and Jeff for joining us this year. I really appreciate you guys being part of our conference, and it really has enhanced the quality of the conference. So thank you very much.

Thank you for the opportunity. We appreciate it.

Thank you.

Okay. Take care. Bye.

Bye-bye.