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

Good morning. Thanks for joining us on our last day of the Strategic Decisions Conference. We're very happy to have U.S. Bancorp returning this year. They've been a consistent supporter of this conference for the last 10 years plus, and we appreciate it very much. Andy and Terry, welcome. We've got Andy Cecere, the CEO; and Terry Dolan, Chief Financial Officer of U.S. Bank. Thank you both for joining us again today.

Good morning, John. Thanks for having us.

Thanks, John, for the opportunity.

Andy, I thought we'd just get a little perspective from last year. Things have changed dramatically since you appeared at this conference a year ago. Maybe you could give us your overview of U.S. Bank's performance over the past year and how you feel you're positioned as the economy continues to recover.

Sure. Thanks, John, and thanks for hosting this conference. This is always one of our favorite times of the year to talk about the company. So I appreciate the invitation. As you said, if I think back a year ago, when we had this conversation, things have certainly changed a lot. And at that time, we were facing pretty significant headwinds and particularly in our payments business. As you know, we have a heavy exposure to airlines and travel and hospitality and entertainment, and all those areas plus consumer spend overall were pretty significantly down. And as we move a year forward, those headwinds have absolutely become tailwinds. We're seeing a very strong recovery. In fact, ex airlines and hospitality, spend levels are above 2019 levels already, and we would expect overall to come back to normal levels towards the end of this year into 2021. So things are certainly rebounding from a cyclical perspective. Credit, as you know, for us and for most banks is very good right now, all-time low charge-off levels. We're releasing a lot of the reserves that we built in 2020. And so those are all positives. But I think what I'm most fired up about is the secular growth story that we have. We've been investing a lot in digital activities over the past many years, which really showed its worth in the pandemic and the changes in consumer behaviors. But if I summarize into 2 things, it's, number one, really being great at digital capabilities for all our customers; and secondly is this ecosystem we talk about, which is that combination of banking and payments activities for small and midsized businesses. And that's where we're seeing a lot of traction and we believe, a lot of opportunity for growth, both from a perspective of deeper relationships with current customers as well as acquiring additional customers. So that's sort of the big picture.

Great, great. Well, I think we'll dive into a lot of those issues.

Sure.

Maybe we could start off talking a little bit about the environment. Commercial loan growth continues to be largely elusive for the banking industry so far. What are you guys seeing in terms of commercial loan demand? And what metrics are you watching to gauge a potential pickup?

Yes. John, let me take that question. And I would agree, I think across the industry, loan growth has been difficult to kind of come by, at least in the last couple of quarters. And we're continuing to see that as well. And obviously, loan growth was impacted by the lower rate environment that exists and the ability for companies to be able to go out to the capital markets in order to be able to finance some of their -- at least their longer-term expenditures. As a result, paydowns have been relatively elevated, at least when you compare to historical levels. And that probably will continue at least for some period of time. And then when you think about working capital, utilization levels are really, again, very low for us, kind of in that 19%, 20% range when historically, it's -- or what's more normalized is maybe 30%, 32%, kind of in that ballpark. So it will take a little bit of time for that ship to turn. But I think that when we think about kind of the future opportunity from a loan growth perspective, our expectations really haven't changed from when we talked at the end of the first quarter. We felt like the first quarter was kind of the bottom or the low point, that second quarter would be fairly flattish and then, as we got into the second half of the year, we would start to see loan growth to occur. And that will be driven by a couple of different things. I mean GDP is expected to be very strong. And while it will take a little bit of time for that loan growth to develop simply because of the amount of excess liquidity that exists out there for commercial customers, I do expect -- or we do expect that with consumer spend getting stronger, there'll be a need to replenish inventories. Those working capital requirements will get stronger, and I think that, that will drive some of the utilization rates up. And I think that's important. We are starting to see a little bit stronger M&A activity. I think that's one of the future opportunities that exist. And then I think that just confidence among the corporate customers, I think, is much stronger today and continues to improve. We see that not only in the large corporate but in the middle market. It's kind of fairly broad-based and across industry sectors as well as geographies. So I think that those are all good signs. Maybe one area where we are seeing strength is in ABS lending. We saw some positive movement in the first quarter. We continue to see that strengthening in the second and going into the second half of the year. So we do think that when we get into the second half of the year, that loan growth will develop, but it will take some time. It will take the -- having to get some of that excess liquidity out of the system.

In addition to the liquidity, Terry, it seems like supply chain issues are causing additional problems. If folks can't build inventory because they can't get it, they don't need to finance it. Is that another factor that's playing in?

That certainly is coming into play and particularly in some areas. For example, in the auto lending space, we are seeing good strength in that particular area. But one of the things we're watching is just the chip shortage. It takes something like 1,000 chips to make an F-150 Ford truck. It's -- so that can be pretty impactful. But supply chain across kind of corporate America, I think, is one of the challenges that exist right now. But I do also see that as being more of a transitional view as opposed to a longer-term issue.

How about on the consumer side? We've got consumers flushed with cash, and high payment rates haven't been helpful to building loan balances. Any change in dynamics there from what we've seen in the first quarter?

Yes. I think that it's maybe a little bit of a continuation with respect to the first quarter. One of the areas that we have seen challenged are really more on the credit card side of the equation. Payment rates on credit cards are in large part being driven by the amount of government stimulus that has come into the system and the amount of liquidity that consumers have as a result, and they're using that to pay down debt. To kind of give you some perspective, payment rates on credit cards are usually in that 30% range, 35% range, kind of in that ballpark, and we would expect in the second quarter it will be as high as 40%. So that has an impact with respect to just credit card balances. Now when consumer spend -- as consumer spend is taking off and that momentum is growing, we do again expect that second quarter payment rate to be probably at the peak and then start to come down. As that comes down, credit card balances will start to grow, and I think that that's the positive. Now the flip side on the credit card in terms of the payment rates and things like that is that the credit charge-off story is particularly strong. And so we saw relatively low net charge-offs in the first quarter, and we would expect that as we go into the second quarter and probably the better part of the year, at least at this particular point in time. The other thing I would just mention, I come back to auto. And we have a pretty significant auto lending business, leasing business. We've seen very strong loan balance growth through the latter half of last year and certainly through the first quarter, and we're seeing that continuing into the second quarter. We're watching the supply chain issues, which I have mentioned earlier. But one of the things that, that has caused is the captives and financing from captives have actually kind of pulled back. So that gives some of the bank -- us, from a banking perspective, the opportunity to be able to finance more of it. So I think that is part of the opportunity. As well as on the used car side, as you know, asset values have been particularly strong because of the lack of supply in the new car or new vehicle side of the equation. And those help in terms of end-of-term lease gains from us or the extension of leases. So I think that there's a couple of positive dynamics with respect to auto as well.

Great. That's all super helpful. Maybe just to clarify, Terry. That's a great perspective on the payment rates in card. Is the 30% type of a long-term average number that you're referencing and that's kind of gone to 40%? Or is that -- was that where they were kind of pre pandemic?

Yes. Well, pre pandemic, but historically, that's kind of where it has held. It's kind of in that 30, 31, 32 sort of percentage points. And so when it moves up to 40%, that's fairly impactful. And of course, the entire industry is seeing that happening right now.

Yes. And your view, and we've heard this from others, that payment rates should come down in the second half, what drives that view that -- your expectation that these could come down and drive some revolve later in the year?

Yes. The -- probably one of the biggest things is that as consumer spend continues to gain momentum, we're seeing that and just a lot of pent-up demand. As economies are opening up and consumers are getting out and spending more, they're burning through that government stimulus, which will eventually start to come to an end, and then any of the excess liquidity that they have. And because of that, we do expect those payment rates to start to come down. It will take a little bit of a while for it to normalize, but it should come down over time.

Great. Let's talk a little bit about some of your growth initiatives, particularly on the consumer and small business side. Andy, maybe we could start with small business. You've highlighted that as an opportunity on your recent earnings call. Can you elaborate a bit on that?

Sure, John. So we've had a payments business for decades that has served small businesses, and we have a set of banking products and services that have also served small businesses. And in the current environment and as behaviors have changed, the integration of payments together with banking has become much more comprehensive. So as you think about offering services to small businesses, it's not individual products. It's really a set of products to help them run their business, manage payables and receivables and payroll and their daily cash flow activity. And so we have an initiative really to weave together payments and banking into a comprehensive set of products. We, as you know, purchased talech a few years ago, which provides a dashboard, again, to help the business run their business. And all of that will, I believe, help us both increase the penetration of sales activity to customers. The fact is that less than 40% of the customer base has both sets of products today. And so we have an opportunity to offer this comprehensive set and in addition, grow the customer base. So we have just about -- just over 1 million customers in what we're defining as small business, which is $25 million or less in revenue. And we believe we can grow the customer base somewhere in that 15% to 20% and total revenue 25-plus percent for both of those actions by that comprehensive view and product offering to help them run their business. And it's a very high focus for us. We have a great set of products and services. We've made investments in those areas and we will continue to. And that's one of our key initiatives and one -- I believe, one of our key opportunities going forward.

And the talech platform provides a cloud-based payment software for the small businesses, correct? And it seems like you've had good uptake on that.

We have, and it does provide a comprehensive -- yes, you could think about it as a dashboard that you might want to look at on a regular basis during the day, what are my cash flows. And there are other components that feed into this. So if you think about real-time payments, that allows those merchants to get their cash flow more quickly, either that day or more immediately so that they don't have to wait for the batch process. So it all sort of works together. Again, the bottom line is a comprehensive set of products to help them run their business and add value to what we offer to them.

How about on the consumer side of things? You've had a branch-light expansion strategy into Charlotte where you're looking at 10 or 12, I think, branches ultimately, and then you've talked about some additional states you might have your eye on. Maybe you could talk about that.

Yes. So I think about -- so as we talked about and for us and for all banks, consumer behaviors have changed. 80% of transactions now happen in a digital way. The branch -- the purpose of a branch has changed a lot from a place where transactions took place to one where it's sales, consultation and really, advice is given. So as a result of that, we need fewer branches. So we went from just over 3,000 to just over 2,300, so we're down about 25%. And what happens in a branch that's very different is that advice and consultation. So as you think about how we grow the customer base, it's really -- there's 3 or 4 activities. Number one is using the branches and the productivity and the sales activity that I talked about. Number two is digital marketing and the use of data analytics to create offerings for customers that would be their next best option in terms of things that will add value to their financial objectives. Number three is what we're calling this branch-light digital-first strategy, and Charlotte is a great example. We don't need the same coverage of branches to serve our metropolitan market and might need a dozen branches versus in the Twin Cities where we have 80 to serve the Twin Cities market. And then finally is partnerships. And I think our best example there is State Farm, where we create a partnership with 19,000 agents who are offering our products and services throughout the United States through a referral process. And just to maybe give you some sizing, that partnership already has created the effect of 1 additional large (sic) [ small ] MSA in terms of deposit activity and 2 large MSAs in terms of credit card activity. So those 4 sort of paths are how we're thinking about growing our consumer base.

What have you learned from the expansion into Charlotte? And how are you thinking about new potential states?

Yes. So it is -- the theory about Charlotte was we have a lot of customers already in Charlotte who either have a credit card, a mortgage or an auto loan in their pocket from U.S. Bank. So our objective was to use that data and analytics to expand the relationship, number one; and secondly, to grow customers -- new customers to U.S. Bank through the branch presence. Now the pandemic slowed it down a little bit because we had to put a little bit of a slowdown in terms of the branch expansion for obvious reasons. But it is -- given the number of branches we have there, is exceeding our expectations, which is a positive. But it isn't as rapid. It will take a little while. So it's not an immediate overnight build. It takes a while, but it's consistent with what we thought would happen.

Yes. And additional areas, you've talked about, I guess, Georgia, Florida, Texas as potential regions. And these are not underbanked areas, they're attractive geographies, but I guess neither is Charlotte.

Yes. A couple of criteria that we think about, John. And number one is high growth. Number two is where we already have a presence, either with an employee presence or some sort of office that has one of the other products or services, and an area where we have some -- already a pretty good set of U.S. Bank customers and some of those other national products that we offer.

Got you. Terry, maybe we could talk a little bit about managing through a challenging interest rate environment. On the earnings call in April, you talked about net interest income and net interest margin being a potential inflection point. Can you give us an update on the near-term trajectory for those items, both the NIM and the net interest income?

Yes, John. And as you said, at the end of the first quarter, we felt like NIM and interest income was kind of at the low point and starting to grow from there. And our expectations there have not changed. We do expect to see expansion of the margin beginning and the net interest income starting to expand. So no real change there. As we kind of think about the second half of the year, again, the thought process around loan growth, and those will be things that will end up driving it. But certainly, for second quarter, loan growth is expected to be relatively flattish but then starting to expand. In terms of whether it's net interest margin or whether it's net interest income, we really focus more on net interest income. But we have been certainly seeing some of those dynamics I talked about in terms of the loan growth, but the credit card mix will also have a positive impact as we're starting to get into the second half of the year, as we talked a little bit about earlier. And then maybe some of the things that we're just focused on right now is with respect to the investment portfolio. We took the opportunity when rates popped up to 1.75%, 1.76% to deploy some cash in the investment portfolio. We did that kind of earlier in the second quarter. That is what was a part of kind of our game plan. Reinvestment rates -- even with rates today at 1.60% or so, reinvestment rates are positive relative to kind of where they were. So that is accretive in terms of the investment portfolio. What that does do in the short term, it extends our duration a bit. We're kind of in that 4, 4.5 years now in terms of the investment portfolio. And with rates moving up on the long end as well as some of the deployment of cash, that did bring our asset sensitivity down a little bit. But I think we're really kind of thinking about the trade-off of interest carry in the short term and thinking about long term -- rates moving up on a longer-term basis. So just -- what we're really trying to do is to balance that investment, reinvestment opportunity and risk with asset sensitivity. And we'll continue to be focused on that.

Terry, is there a way to think about how much excess liquidity or cash you might have on the balance sheet today to where you'd like it to be over time?

Yes. I would say, John, that where we're running today in terms of excess cash is kind of in that $15 billion to $20 billion range currently. And we feel like we'll kind of hold at that level for a while to see what happens with respect to interest rates. If long rates move up into the higher 1.80%, 1.90%, 2% sort of thing, we'll take -- maybe look at that opportunity. But again, maybe on a longer-term basis with inflationary pressures and some of the GDP growth, we do expect the long end of the curve to continue to steepen. And then ultimately, it comes down to timing of when does the Fed start to move as well as taper in terms of some of their programs. Those will have an impact, and we're certainly watching that.

Great. That's really helpful. Maybe we could shift gears and talk about payments a bit. Volume trends have continued to recover, as Andy mentioned at the beginning. Could you give us an update on the 3 parts of your payments business?

Yes. So when you end up looking across the payments business, again, probably broadly all 3 businesses have seen nice momentum and were really kind of in line with what our expectations were. First quarter, excluding airline and entertainment, we were already at pre-pandemic levels and continuing to expand from there. We certainly expect that by the end of the year and certainly going into 2022, that even the airline industry and entertainment will have been on an upward trajectory. And as Andy said and some of your airline clients said, when you get into 2022, it starts to strengthen even on the business side. So when you go across the businesses, credit card, the volumes on the credit card have been particularly strong. Debit card, also strong. In the first quarter, it was in the -- kind of in the 20%, 25% sort of range. We continue to see that in terms of debit card. And then in the short term, we have seen some opportunity with respect to prepaid card balances and volume simply because of the government stimulus. When you end up looking at Elavon, again, the same sort of characteristics. It continues to strengthen nicely, and we would expect it to continue to gain momentum through the rest of the year as the economy grows and consumer spend continues. CPS is one that has taken longer simply because of the T&E expenditures on the business side of the equation. And again, when you end up excluding T&E, that is also at pre-pandemic level and continuing to improve. And then we do see momentum from a cyclical perspective through the second half of the year and into 2022.

Yes. So as you mentioned, besides the T&E, you're above 2019 levels, I think you said in the beginning, Andy. Correct?

Yes.

Correct.

Yes. So aside from the cyclical aspect of recovery in payments, you talked a bit about talech already. But what about other secular growth opportunities in payments? What would you highlight there, Andy?

So I think we talked about the business banking. And as I mentioned, within that, the whole concept of RTP, I think, is a huge opportunity, and we have a number of use cases we're actually working on. I think this is going to be a significant change for corporate America. And we have use cases with regard to requests for pay, daily payroll, activity for -- payments on the road for delivery activity, if you would -- will. And so that whole initiative -- and again, it's combining banking relationships with some of these new payments capabilities, new rails and the more immediate settlement reconciliation process, I think, offers a huge opportunity. And that's one that I believe, because it's so significant, because it's so important to those industries and to those companies, we want to be at the leading edge on. And that's -- we have a lot of focus, investment and use cases in those areas today.

Andy, I know one of the questions you get particularly around merchant is: Are you losing share? And are you the right size? Do you have enough scale on the merchant side of the business? Could you comment on how you respond to that?

Sure, John. So I do think -- and I mentioned this earlier. We did come down more than some of our competitors in terms of the sales volumes, but a lot of that was because of the industries that we serve. So we have -- almost 1/3 of our activity pre pandemic was in airlines, travel and hospitality, which is about 3x what the industry is. So some of that downturn that you saw was impacted by our business mix to start with, which was a big headwind for sure but now becomes a tailwind. And I think that that's a positive. I do think we have more than sufficient scale. We're very focused on a couple of key niches, business -- small business, health care, airlines, travel, hotels and so forth. And in those niches, we have great scale, we have very good capabilities and I think we compete very effectively. And importantly, I think this combination of not just having a payments component, but weaving it with the banking component allows us to also compete very effectively against both the payments-only providers as well as banks who don't have those payment capabilities.

Yes. And that last point about integration, I guess, is how you respond to the question you've got over the years of why this business is best owned by U.S. Bank. Should you spin it off? Are you getting the right credit in your stock for these payments businesses? But maybe you could just elaborate in that context on the integration aspect.