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

Good morning, everyone. This is Gerard Cassidy from RBC Capital Markets. Welcome to the second day of the RBC Financial Institutions Conference. We're very pleased to have, to kick off the second day, U.S. Bancorp. As many of you know, U.S. Bancorp is the fifth largest bank in the United States with approximately $575 billion in assets. It's headquartered in Minneapolis. As of yesterday, its market cap was about $79 billion, $80 billion. The stock trades at about 1.6x book value. It has about a 3.3% dividend yield. With us today is Terry Dolan, the Vice Chair and Chief Financial Officer of U.S. Bancorp. Terry has been in this position since 2016. From 2010 to 2016, he was in charge of the wealth management area and has been with the company for a number of years. Also joining us is Tim Welsh. He's the Vice Chair of Consumer and Business Banking. Tim has taken this position since the spring of 2019. And prior to that, he was responsible for the consumer banking sales and support area when he joined the bank back in July of 2017. Tim and Terry will have a couple of slides to talk to, and then we'll open it up for a fireside chat. And with that, Tim, I'll hand it over to you. Thank you.

Perfect. Thank you, Gerard. Great to be with you. Really appreciate the opportunity today. And as you described, what we wanted to do is present a little bit of context and then look forward to the conversation. We'll be sharing some slides here as they come up. Here we go. So if we could advance the slides to the second slide. Just wanted to highlight that the -- this presentation includes some forward-looking statements. If you would like additional detail on those, you can see all of the detail here, which is on Page 2 of our presentation. On the next slide, just giving you an overview, Gerard, building on what you described about U.S. Bank. You highlighted some of the financial metrics that you see. Also, just geographically, our Consumer and Business Banking, some of our wealth is -- we have branches in the 26 states that are highlighted in the left. We have some businesses like our Corporate and Commercial and parts of wealth that are national businesses, and our Payments and Investment Services businesses are international in many areas. And this has been consistent for some time, I think, as many of you are aware. On the next slide, you also see our position relative to peers in terms of deposits, assets and market value as of about last week. So you see relative rankings there. And again, on Page 5, what you see is highlights of our overall business mix. I think many of you are quite familiar with the bank, that we have a very diversified set of businesses and diversified revenue streams associated with that. We're going to spend a little bit of time right now going deeper on Consumer and Business Banking on that upper left-hand quadrant. They're representing about 39% of the total revenues of the bank. On the next slide, specifically with regard to consumer banking. What I think many of you are aware is that over the last few years, we've been making a series of investments in our digital plus human capabilities in order to become more central to the lives of our customers, more important to them and to grow. And so what we're going to talk about today is how we're beginning to see that growth materialize in 3 different ways: organic growth, alliances and then acquisitions, so these investments driving growth in those areas. We're also seeing that across the human plus digital, we're creating some quite distinctive capabilities which are being recognized by a variety of third parties. And then perhaps most importantly, we're satisfying our clients, and that's what's helping contribute to the growth as well. So those are the themes of how the investments have paid off and are beginning to pay off in a number of areas and generating that growth. So let's focus first on the organic part of this on the next slide. If you think about different ways that our investments in technology have allowed us to grow organically, I would start first with the left-hand side here, talking about our mortgage business. Several years ago, we decided to aggressively invest both in the digital and the human side of mortgage with a particular focus on the retail purchase market because we believe that's a place where we can have sustainable advantage and an attractive overall position from a market perspective and from a financial perspective. So if you think about the human investments that we've made on the upper left there, we've gone from about 800 MLOs in 29 states to over 1,500 mortgage loan officers in 42 states. So we are really expanding our human connections there and building terrific digital tools, which the vast majority of our loans, well in excess of 90%, 97% here, are in -- going through our portal. And our digital tools are being recognized as industry leaders. Kiplinger has highlighted us as having the best digital tools in mortgage. So when you combine those investments in the human, the mortgage loan officers and the digital, what you see is market share growth. And we're very pleased with how that business is growing organically, and we expect a bright future, particularly given our leading-edge digital capabilities and the attractiveness that they bring to so many mortgage loan officers. Similarly, the investments in the branch experience and in our digital app for consumer have really changed how we're interacting with consumers. I think many of you know, about 3 years ago, we fundamentally relaunched our app brand new from scratch. What you've seen is that huge migration to digital activity. That is on the upper right there. You see a significant increase, and we're now at 2/3 of our loans being processed digitally. We've been able to reduce branches by about 1/4. But importantly, what we've been able to do because of our industry-leading app is we've been able to change the dialogue that we're now having with consumers. What's happening in a branch is fundamentally different than happened just a couple of years ago. What happens in a branch today is people come for technology assistance because we have lots of ways to help our consumers use the technology, and they come to sit down for a 30- or 45-minute appointment and talk holistically about their financial situation. And so the whole nature of what happens in a branch has changed. But we also continue to invest in those people and invest in our branches so that we can serve people in fundamentally new ways and critically so that we continue to serve our communities where these branches are located. So what you're seeing here is, because of our digital plus human investments, growth and transformation in a number of ways that we serve for clients. On the next slide, what you see that our digital capabilities also allow us to do is to invest in alliances. And one of the ones that you are familiar with is that we created an alliance with State Farm, which allows their 19,000 agents in the last year to be able to offer our deposit services, our credit cards and many of our small business banking products. What we're seeing is significant growth out of this investment, many new customers coming to the bank. As you see, 70% of the new -- of the customers are brand new to the bank. More than half of them are outside of our footprint. And already, in less than a year that parts of this have been operating, we are already seeing deposit growth and credit card growth that is significant. On the credit card side, we are seeing productivity that is the equivalent of what we would expect in branches in 4 large metropolitan areas. It's quite significant. And deposits, the equivalent of 1 large metropolitan area, and that's up materially in just a year or so that this has been operating. So we're seeing significant growth from this alliance as well, again, a result of those investments in our digital capabilities. On the next page, you see another area where we've talked about, which is business banking. This gets at how we're using digital capabilities plus some acquisitions to build human plus digital capabilities. I think some of you may be aware that we have banking businesses and small business payments. We see enormous opportunity to become more central to those businesses by offering our payments clients banking services and our banking clients payments services. And we see the opportunity to grow clients by 15% to 20% in the medium term and revenues 20% to 25% -- or 25% to 30% over that same period, and we're seeing very good traction on that. A big part of this is because of investments and acquisitions we've made, talech. Many of you are familiar with the fact that it allows us to create a dashboard. It helps our small businesses manage their cash flow. We're seeing significant growth in consumers, as you can see here, from that talech investment. And we also recently acquired Bento, which helps us on the account payables side. So acquisitions driving growth here with digital plus human on the business banking side as well. And then, of course, on the next slide, what I would also highlight is our digital capabilities allow us to make investments in very large acquisitions. You're all aware of the Union Bank potential acquisition. And what that highlights is the fact that there are 1 million consumers and almost 200,000 small businesses where we can bring our digital capabilities to their tremendous human connections that they have with their clients and small businesses and a whole host of other capabilities that you see there in the center, digital, product, capabilities, that we will be able to serve these clients in fundamentally new ways that we think will generate significant growth. And it positions us very well in California, which you obviously realize is a hugely important market. On the right-hand side are the financial benefits that we expect to accrue from this opportunity. These are the same that were highlighted back in September. So this theme of digital plus human driving growth organically in mortgages and what's happening in branches through alliances with State Farm and through acquisitions in the business banking side and on the -- in the larger Union sense here. The next slide highlights the fact that we are getting recognition from a variety of sources for all of these investments we've been making. You see some of the highlights here, our #1 mobile app, best bank in 12 states; and perhaps most importantly, our client satisfaction on the right-hand side is extraordinarily high, particularly for the new opportunities that we have to serve clients in branches, and you see some of those capabilities on the right-hand side. So the next slide just summarizes. We are very excited about the human plus digital capabilities that we've been investing in. We're seeing real growth, and we think these are going to have benefits for years to come as we go forward. So Terry, with that, I'll turn it over to you.

Thanks, Tim. And let's go to the next slide. What we wanted to do is just reiterate some of the things we have been talking about with respect to the Union Bank transaction. And by and large, the overall message is that we continue to believe that the deal is moving on track. We have filed all the applications. We're working with the regulators kind of in normal course. And we have integration teams that are working on and looking at all the different things we need to do in order to be able to integrate the systems and the customers into our U.S. Bank platforms relatively soon after the legal close. One of the things we have been going through is a lot of town halls with our Union Bank partners to get to know and learn more about that organization as well as with community organizations. And if you were tracking, yesterday, we did participate in a joint public meeting with the Fed and the OCC, which, in all honesty, was something that we had fully expected and taken into consideration when we announced the deal back then. We're still targeting and expect a transaction closing in the first half of 2022 and with conversions anticipated in late second half of 2022. So all of that is on track. The last thing I'd like to do, if you go to the next slide, is just give a little bit of guidance -- update with respect to our guidance. And generally, the guidance is consistent with the information that we provided during our first quarter earnings call in January, maybe with a couple of updates. And since that previous guidance, one of the things we are seeing is that linked-quarter growth is a little bit stronger than what we had anticipated. And just by reference, in fourth quarter, we saw linked-quarter growth of about 2%, and it's a little bit stronger than that at least in terms of what we are expecting in the first quarter. So where net interest income was expected to be stable, our guidance would be that it's going to be stable to slightly higher in the first quarter relative to the fourth quarter. And then the other piece of guidance that we would give is related to our mortgage banking business. With the credit spreads widening on the long end and mortgage rates moving up, we would expect, consistent with the industry, that mortgage banking revenue will be down on a year-over-year basis somewhere between 25% and 30%. And so as people are thinking about the first quarter, on a year-over-year basis, mortgage banking being down that 25% to 30%. Everything else is pretty much in line with our expectations. Maybe just a couple of things. From a payments revenue perspective, we had guided that credit card revenue would be relatively stable on a year-over-year basis. Merchant acquiring and corporate payments would be up nicely on a year-over-year basis in double digits relative to a year ago. And we expect other revenue to range between $125 million and $150 million. And then finally, maybe on the expense side. We had guided that expenses would be relatively stable on a linked-quarter basis to fourth quarter, and we still expect that. Credit quality continues to be strong. And our tax rate, on a taxable equivalent basis, in the range of about 21%, so again, by and large, unchanged from -- or very consistent with the guidance we had given. So with that, Gerard, I'll turn it to you.

Thank you, Terry, and thank you, Tim, for those opening remarks. And maybe, Terry, we could start off. The conference obviously is being held in a period of quite a bit of geopolitical turmoil with what's going on over in the Ukraine, of course. So maybe when you look at the broader macro environment and pandemic appears to be heading behind us, but there are still lingering labor and supply chain issues. Inflation obviously is a concern for everybody. Expectation for higher interest rates is still on the table, I think. So what are you guys hearing from your clients? And what are you thinking as going forward -- in talking to those clients, how your business will move forward?

Yes. That's a great question. Maybe in terms of a macroeconomic environment, we continue to see the economy being relatively strong, and consumer spend and actually, business activity starting to pick up. And I think we see that in the loan growth that we saw in the fourth quarter as well as what we are experiencing in the first quarter. A lot of -- on the -- especially on the C&I side, there is a pent-up demand to be able to rebuild inventories, and we're starting to see some capital expenditure as well, as businesses are maybe kind of catching up from where they were relative to the pandemic. Gerard, I would agree that in terms of the geopolitical environment, that certainly created uncertainty in the marketplace, the -- with the S&P kind of moving up and down and interest rates. But our expectation -- and if you end up looking at the market today, the market expectation is that we will see rising interest rates, some rate hikes in 2022 as the Fed looks to deal with some of the inflationary pressures that are out there. But by and large, it's been pretty positive from a client perspective at this particular point in time in terms of how they view the economy.

Very good. Terry, have you guys kind of thought about how many rate increases we may have this year? I mean at the beginning of the year, there were some extraordinary assumptions of about 6 or 7 rate increases. That's been toned down in the last couple of weeks obviously. Do you guys have a sense that maybe we'll see 3 or 4? Or what are you guys thinking on that?

Yes. Gerard, when we gave our guidance in the first quarter with respect to the year, we had planned for 3 rate hikes and -- with the first one being in May. So I think certainly, our expectation is that we would achieve at least that, and of course, the first one will come in March. That's been telegraphed pretty significantly. But we're also -- when you end up looking at our forecast right now, we really are looking at something that's probably closer to that 5 rate hike on the short end. A big part of it will also be in terms of the benefit to net interest income, what happens in terms of the shape of the yield curve as well. And I think one of the things that we kind of expect to see is that while the short end will come up, the long end may come up a little bit. But probably just given the geopolitical environment and the flight to quality, some of the longer-term rates may be held a little bit lower for some period of time anyway. But that's kind of our expectations right now.

Very good. And Tim, in your presentation, it struck me about the success that you've had with the State Farm alliance. Those are some impressive numbers. What do you point to for the achievement of that success? Again, the numbers were pretty impressive, as you pointed out. Is there any 1 or 2 items that you could say, "This is what's really driven the numbers here."

A couple of things I'd highlight, Gerard. First of all, I think what it highlights is something we had anticipated as we got into this alliance, which is the strength of the relationship between the State Farm agent and their clients. There's a very deep, trusted relationship there, and the clients really value the advice that the State Farm agent provides in so many ways. And then the other piece, which we had hoped would be true and it certainly turned out to be true, is that the digital capabilities make it very easy to apply for an offer, which is, frankly, fairly compelling. On the card side, as an example, you get real benefits. As a State Farm client, you get points paid -- points towards your auto insurance payment, so it helps. There's a real return there for using the card. And we make it very easy. We can text you a link to apply, you can apply right through your phone and you get it quickly. So that trust plus the simple digital capabilities make it, I think, a very attractive offer.

Very good. You pointed out also in your presentation the number of branches that have been reduced in the footprint and the success you're having in the digital sales improvement. Can you -- when you look out over the next -- and excluding the Union Bank transaction for a moment, when you look out over the next 2 or 3 years, where do you see those branch numbers going? Will there be a continued transition of opening up some new branches in new markets like Charlotte that you've entered into and shutting down maybe some overlapping branches in Minneapolis?

Well, it's exactly as you described, Gerard. We're constantly looking at ways of refining our footprint, right? So we have -- there are places where we have -- we may have some additional capacity and so we look to close some, but then we're also opening new branches because these markets are shifting all the time. Certainly, Charlotte is an attractive place, but across our 26-state footprint, we actually see lots of opportunities in emerging suburbs or places like that. So we're constantly looking for those kinds of opportunities. I think frankly, the more exciting piece is not just the opening and closing but what's happening in those branches. They really are becoming hubs for technology assistance and real consultative financial discussions. I mean just a simple example on the technology side. If -- our app at this point has so many features in it that many consumers are eager to use it but don't know how, right, the common thing. So they can either come into a branch or call a branch and we have the ability with our cobrowse technology to go right on their phone in a perfectly private and protected way and show them exactly how to do whatever it is they're trying to do, right? Consumers love that, right? The client satisfaction as we showed on chart is ridiculous because it's a very powerful way to help them. That's an example of this human plus digital and a branch activity that 2 or 3 years didn't exist, right? So what's exciting to me is how we use those physical locations to fundamentally reshape how we interact with our clients and help them to do things themselves and to get advice from us on times when they need it that they wouldn't have been able to do before even just a few years ago. So I'm really excited about that.

No, very insightful. And coming back to you, Terry. In your comments, on the updated guidance in the residential mortgage business, you indicated it will be down year-over-year. You also cited wider spreads. Is it also -- have you seen a slowdown of just business? I know seasonally -- it's a seasonal business, but on a year-over-year basis, is it due to the fact there's just not many houses out there? Or any sense of what's contributing to -- aside from the wider spreads, what's contributing to the lower numbers in the mortgage business in 1Q '22 versus 1Q '21?

Yes. It's a great question, and Tim, you certainly can kind of add to it. But I think that the -- with the wider credit spreads and the higher rates on the long end, the refinancing activity has really slowed down. When you end up looking at our business, though, Gerard, we really have focused on retail and the purchase mortgage business. And so home sales, I think, continue to be relatively strong. Even with rates moving up, people are still looking for that first new home and that opportunity, which is why we have been making the investment in the business. The investment that we've also made has been on the retail side of the equation where we see stronger margins and where those digital capabilities really do come into play. And so that's a big reason why we have been able to take market share, is because of the investment that we've made in both mortgage loan officers as well as digital capabilities. But a little slower on the refinance side of the equation. Home sales continue to kind of hold up reasonably well.

And the only thing I would add there, Terry, is I think, as you alluded to, there was just this question of supply and how much -- prices are going up, how much supply will be out there. And so we just have to see how that evolves.

Very good. Terry, maybe a little bit on the balance sheet. Obviously, the securities portfolio available for sale is an important part of all banks' balance sheets. And in your 10-K, I think it showed about a weighted average maturity of 5.5 years, and that was up from a year earlier of about 3.5 years. Can you share with us just your thinking of how you manage that portfolio in a rising rate environment? Assuming it's not just the short rate environment that goes up, it's also the long end of the curve, which doesn't seem to be the case today. But that may change obviously in the second and third quarters of this year.

Yes. So I think there's a couple of different dynamics, Gerard. One of the things we talked about in the fourth quarter is that we were maintaining a fairly high level of cash and trying to keep our investment securities, both in terms of what we were investing in as well as through hedging strategies, relatively short term. And the reason why we were doing that is because we did anticipate that the long end of the curve would start to move up and that we think we would have better entry points. We really put a strategy around starting to extend out and invest more on the long end as we started to see rates move up to the 1.80, 1.90 and 2 percentage points, and we were able to take advantage of those rising rates at that particular point in time. So we did deploy more on the longer end of the curve when we saw that particular opportunity, and we've used a whole variety of different strategies in order to be able to do that. One of the things that we also did because we have to start thinking about the position of the balance sheet relative to the acquisition of Union Bank and get into that category, too, which is probably still a couple of years out, in all honesty, but in preparation of it and thinking about a rising rate environment, we ended up reclassifying about $43 billion into the held-to-maturity category because AOCI associated with the held-to-maturity is not a part of the capital calculation. So trying to take a number of those things into consideration as we're thinking about the balance sheet, but we did take advantage of the opportunity to be able to reinvest some of that cash longer term during the first quarter when the opportunity came about.

Very good. Maybe coming back -- we're running out of time here. But Tim, obviously, you've touched on the talech acquisition. Then also, you guys bought Bento for business. Obviously, the Union Bank deal is pending. When you look at the consumer business, the way you're approaching it today, are there any pockets of products or areas that you really, over time, need to maybe inorganically enter into with other acquisitions or something?

I think we're always looking for those kinds of opportunities, Gerard. And I think what talech and Bento are examples of are how we want to integrate for small businesses, our products and services into their software, the software that runs their operations. We then add into it the cash flow management tools, and that allows us to serve them and for them, frankly, to easily manage their business. So we're constantly looking for opportunities like that. As we move toward more of a digital world, we see lots of this situation where it's not just the traditional product like a loan or a deposit, but it's also that digital, the software component that links into other systems that we're constantly looking at. So I think there will continue to be opportunities like that.

Yes. And Gerard, what I would add to that is think about the buy now, pay later, the opportunity to be able to look at products that are like that. Certainly, our investment in real-time payment, there's going to ultimately be a B2C sort of element associated with that. We want to make sure that we are prepared to be able to provide those products and services to our consumer, customers as well as on the business side of the equation. So I think there's everything payments. And that's why strategically, when we think about the importance of being in the payments business maybe relative to our peer group, we think that's a differentiator for us that's going to be important.

Very much so. I noticed that we're on the half hour. So unfortunately, I have to call this to a close. And I want to thank both of you, Terry and Tim, for joining us today. As always, very insightful to what's going on at U.S. Bancorp. And again, gentlemen, thank you very much for joining us.

Great to be with you. Thank you.

All right. Thank you. We appreciate the opportunity.

Okay.