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

Okay. We're ready to get started. Next up is U.S. Bancorp. And with us today is Gunjan Kedia, Head of Wealth Management and Investment Services. This is a fireside chat format. So Gunjan, welcome.

And I just thought from a high-level leading question, your businesses don't get as much attention as, say, payments, or right now, everyone is so focused on interest rates and loans. But they are 15% of USB's revenues, and they are a big driver of the high ROEs that USB enjoys. So I did want to just start off, how do your businesses fit into USB overall? Some like wealth management are a little more obvious maybe than others, but maybe we can start with that.

Wonderful. It's very nice to be here, Matt. Thank you for having us. The legacy of this set of businesses, the investment business is really the old trust company that most banks had. And out of that spawned the retail wealth businesses, which we know very well, as well as institutional trust businesses, which is our investment services business. So that's why they're all together. This is the collection of investment businesses. And you are right, they were very small. Just 5 years back, they were 8% of our company, and we are steadily growing them out. And they complete the life cycle really of our consumers. So if you think of an average consumer, maybe at the age of 15, they start with some kind of a payment product. You might have a credit card or you might have Zelle. They have banking, then they get into loan products. And somewhere, after 10 years of a productive sort of income-generating career, they have investments. So we complete -- our business sort of completes the life cycle of financial services.

And maybe as we drill down on the businesses, let's start with Investment Services. And I think there's a few segments in here. You've got corporate trust, you've got custody, fund services. Maybe initially just frame which are these are the bigger drivers, and then we can talk about them individually.

Yes. So corporate trust is the biggest of the Investment Services business. And collectively, the Investment Services are sort of the bigger part of the Wealth Management and Investment Services business. And the question that you just asked around sort of what is the synergy between these businesses is they have to be owned by a bank, first of all. The legacy of a trustee has to be a bank, a very significant deposit-generating businesses. So just to give you a very simple example, if you are a trustee on a bond deal, we hold the deposits pending bond coupon payment day. And in that period of time, we would hold the deposits. So we have $100 billion in deposits within this business unit, which is 20% of the banks. So being a bank is sort of the foundation of these businesses. We have grown them a fair amount, about 26 acquisitions done in the last 2 decades. We -- our balance sheet is very strong, and it's a very strong asset to these businesses. A lot of times, if you have a privately held trust company doing this business, you don't get the benefits of the deposits. So the combination of sort of being a very large, very highly rated balance sheet servicing but is really investment operations business has been a very sort of unique combination for us, and we've just garnered market share. So we are the largest market share in the corporate trust world here. Now collectively, we have about $10 trillion in assets across Investment Services. So some of our competitors are significantly larger. The second side of our business is Fund Services. There, our focus is very much on the very complex credit mandates. We're not that much of an equity shop. And our business model just is attractive for that kind of business. So we've sort of continued to grow that business out as well. And they are very high-ROE businesses. They're largely fee businesses and deposits. So you can see why the ROE profile is very, very strong. The risk profile is very, very attractive in these businesses.

And what's the growth opportunity from here? You did mention that there's been a lot of consolidation in the last couple of decades. Obviously, markets have held up until recently. But as we think kind of the next, call it, 5, 10 years, what are the real drivers of growth here?

The real attractiveness of -- the real growth profile of these businesses, the underlying deepening of the financial markets that we serve. So globally, the stock markets have grown at 6% to 7% in any time frame that you can think about. And the bond markets have grown at about that, outpacing sort of debt in general. So we have a built-in growth engine that is much higher than population growth or GDP growth and some of the other drivers in our financial services. On top of that, it's growth through market share. And so we don't think that will be constraining to us for a long time. I mean we are large in the U.S., but we have a very nice presence in Western Europe, and we're just getting going there. So I think for the foreseeable future, both sort of bolt-on M&A, which we do very effectively in this space, and then just organic growth, but it takes you -- we've always thought of these businesses as being about 6% to 8% revenue growth through a cycle.

So I guess more near term here, obviously, the declines we've seen in pretty much every asset class is probably not very good. I don't need an expert on that to know that. But on the flip side, interest rates are going up and much more further increases are expected. So both talk about kind of the cyclical positives and negatives and specifically on interest rate sensitivity.

Yes. Well, interest rates are a far more positive driver to these businesses than short-term market volatility. And why do I say that? One is only 15-ish percent of our assets are truly sort of equity assets. So the volatility that you get in the equity markets is generally sort of muted given the mix. Now this has been an unusual stretch of also having volatility in the credit markets, but we have floors in our fees. We have a lot of noncapital markets-related anchor fees. So the capital markets volatility certainly helps and hurts us, but interest rate increases are very positive for our business model.

So there's a lot of debate on deposit betas. And obviously, it depends by kind of customer base. But I don't know if you want to talk about your segment overall or if you want to split it in a couple of different buckets because there's a lot of deposits with wealth, a lot of deposits in corporate trust, either in aggregate or individually.

That is true, and they behave very differently. So let me unpack that a little bit. The wealth deposits truly behave much like the consumer retail bank deposits, and those deposit betas tend to be even really low because our customers sort of staging their deposits in support of investment activity or in support of their taxation and things. So that's why you see very low betas on the wealth side. Even on the IS side, much of our deposits are what I would call truly frictional in nature. People are not choosing to deposit large quantities of deposit to us. We are holding them in preparation for a payment date or in preparation for an investment activity. So much of those are noninterest-bearing deposits where the deposit betas are 0. Then you get the subset where we do sort of compensate our clients appropriately. That can be target like 50% to 60% type of deposit betas across the cycle on that subset. Now historically, we were comparing this rate cycle with the prior rate cycle. We are sitting at about 15% of the higher deposit beta, deposits this cycle, and we were at about 22% last time. So that's sort of the nature of the corporate trust deposits, and they are lower beta than an average corporate deposit. So think about it that way.

And then maybe switching to pricing trends. There's been margin erosion over time, but obviously, volumes have gone up and offset it. But again, kind of coming back to like tougher markets. Is that something that could cause even more pricing pressure from here? Or because of the consolidation, certainly at corporate trust, does that help?

Yes. It's pricing -- there's a lot going on with pricing. And the question that -- because historically, if you had sort of basis points of assets, then there's a lot of value created as assets grow and you get fee pressure. So that's sort of the dynamic that is underlying your question here. So I would say 2 things. The nature of our business is not very price sensitive. So we are on the least price-sensitive part of this industry. And what do I mean by that is our entire corporate trust services are a minuscule part of what it takes to stand up a deal. And what we hear from our clients is they value speed because when a deal is being done, they want it done very, very quickly. So we don't see that kind of intense pressure because it comes and goes. A job well done is worth it. A lot of the revenue yield is also anchored around just our complexity factor, where we do get a little bit of a premium from the services here. So we watch it very carefully just because it's so much talked about in the industry. But our operating leverage within these businesses is very generously, very easily positive. So whatever we are sort of giving up in terms of pricing advantage, we are getting back in productivity and natural growth of assets that is coming in. So it's an important driver to watch, but not as challenging given our mix of businesses here.

And you mentioned complexity a couple of times, I think, with respect to credit mandates. Can you maybe just give an example of what's like more complex and something that you could do that maybe some others couldn't?

We might have a customer -- so you might have a plain ETF that is tracking S&P 500, and you're custodying that, that would be sort of on the easier side of the mandate. On the other side, we might have a private equity fund that has 9 feeders going into 8 masters that are interconnected with each other in weird ways, and you have to set up that deal and you have to track all of the appreciation across. And that kind of thing takes a lot of learning by the team. And our model, because we are not sort of a big-scale global model, has always been these dedicated teams that support particular clients base. So that's just a niche that we have chosen to play in.

Moving to Wealth Management. You serve about 8% of the affluent USB customers, which I think is about 6 million, you said once. I guess, first, is that a good amount so far? Or I feel like banks kind of show you different numbers, different subsets. So I guess, first, how are you doing so far? 8% is not that big of a number, but 6 million is a lot of customers.

It is true. It's both a good number and not enough, I would say. So about 50% of American households invest. So not all affluent customers will really be viable customers. So that's sort of data point number one. We are thinking about people who value a holistic sort of set of advice that includes investments, tax, financial planning, insurance planning, credit planning. So we do fairly complex area of financial planning. So I start by saying only half the crowd will actually want the service. Then the question is, will they like a bank-owned model? Many of them are self-service investors who enjoy dabbling, but you get another chunk that are not just -- they're just not advice seekers even if there are investments. So I have always thought 15% to 20% is the theoretical maximum you will get to with all of these factors. So we have the headroom to penetrate up from 8%, 8.5% where we are to twice that number.

And so talk about how you're going after that opportunity to, call it, roughly double from here.

Yes, roughly double. So the history of the Wealth Management business, it was so buried in branches. We had trust offices in the branches, and that's how we served our clients. Because it was quintessentially a trust business, much like many other banks, it was the high end of the Wealth Management businesses. The dilemma with that is -- and that's a very profitable business and we know how to do that very well. We're very big in it. It's a very attractive set of businesses for us. And in that, I would also include a family office business. It's called Ascent, and that does very well for us. There is a decade, though, Matt, where somebody has enough investable assets, but they're not big enough to get the kind of full-scale advice that our traditional model had. So a lot of our focus to get that penetration number up has been building out a digital and human service model in that decade before the person really feels the need for the kind of complexity that we can bring to the table. So a few years back, we introduced Automated Investor. That's the name of our robo adviser. It's very well integrated with our mobile app, with our credit card app. And our view is that a new investor that is just about to think about investing can certainly play with the app, choose their goal, figure out how to start in really small ways. You can start with $1,000 and then add $10 to it each month if you want. Or you could start in a big way. You can also click a button and get a live adviser, who's a licensed adviser who can talk you through some of those sort of nuances. $1,000 may not seem to you -- may not seem like a lot, but to the first-time investor, it's a big step in learning. So we want to support them. And our goal is that as they grow in their needs, they grow with us and they have access to human advisory. And then at a certain point, which for us is about 250,000 in investable assets, we give them a dedicated adviser. And that has been the growing part of our business over the last 5 years. Much of our sort of growth in that space has come from building out the capabilities of our traditional higher-end private wealth businesses into the affluent space.

And how has that effort been impacted by branches were closed, advisers weren't doing as much in person, obviously, during COVID, still COVID. But on the flip side, to your point, there's been technology efforts, and there's been obviously adoption of technology by consumers. So how do you think kind of that's played out where -- how important is it still to do in person? Or is it the combination and...

The COVID experiment was quite interesting. As you know, our branches were, by and large, open in communities, and many of our advisers were going in. But a lot of it was advice over a virtual forum. You'll remember in March, the markets were going completely crazy, too. So the need for advice was very high. So we had this twin effect where we had the most personal and meaningful touch points with more of our clients happening at that point. We had a lot more clients calling us to just talk to somebody, and they were more accepting of a virtual forum. So our client acquisition in wealth was actually quite good over the last 2 years. And the markets were helping, too, right? There's a lot of positive momentum. There was a lot of conversation in everyday news around stock market returns in Wealth Management. So we benefited from that. We've had a couple of very successful years in Wealth Management. Now where it goes from here will be quite interesting. We did -- we must have done literally like 150 virtual events last year. And instead of being local events, it was like the Phantom of the Opera nationwide for a lot of people. We were able to get so many sort of celebrities almost because we were doing these virtual events. And our last one had 5,000 people in it. So we are also reconsidering whether some of it needs to go back to the traditional way of working, but this digital and human model, the co-browsing capability, the ability to meet a few times, but not all the time, I think, will be the model of the future. And clients have been very accepting of that so far.

So here we are with, as I mentioned before, basically, every asset class selling off, right? Equity selling off. Credit selling off. Government debt selling off. Like it's rare to have that happen. I think it's like 2 quarters in a row. I guess the first is like the advisers and people like us in the business, like we notice this every day. So are they thinking differently about kind of long-term strategies? And then obviously, I want to ask about the investors themselves, your clients, because maybe some know, but not everyone until they get statements.

Yes. Well, I'll tell you, it's been a heavy time for planning. Some time back, we completely shifted sort of our lead approach to not being any single wealth product or holistic planning, which we think creates a lot of value for customers, just being able to plan both sides of the balance sheet together with them. There's a lot of planning discussions around what inflation means for retirement preparedness and what a pandemic means for health care cost planning and what work has meant for people. How are they thinking about retirement differently? Now add to it the stock market turmoil. Now we really do encourage clients not to overreact to a quarters of changes. And if we have done our job right and then advisers have done their job right, clients have enough liquidity, so they do not have to make enough -- make major reactions over time. So we are watching the recessionary impact of inflation and whether that turns out to be a good story or a tough story because that will make a big difference to how quickly we get out of it and seeing things bottoming out. There's a lot of data points you can look at, Matt, that would say that the consumer is quite healthy right now. It's not an unhealthy consumer story. The consumer spend is quite healthy. So then it becomes a matter of macroeconomic, geopolitical issues, inflation and how that settles. So we are not entirely pessimistic about where we are heading into here, although the sentiment is very volatile right now.

That's for sure. ESG, obviously, has become very important for the industry. You've made a big push along with others. Talk about the role it plays in the wealth management product and how much demand there is for that among your clients.

We, as a company, have truly spent -- especially in the last 2 quarters, there's been a lot of work done in ESG, but not only from the investment side. This is just ESG commitments for us as a company. I will tell you, the grounds-up demand for ESG is not as strong as what I read about every day. So this is sort of my honest answer about what happens. We have a very nice lineup of sustainability impact products. Our advisers are trained to talk about what an investor is looking at when they're choosing these products. And there is some interest. The growth rates are very high, but off of a very small base. So it's what I would consider a quiet relentless trend, which is very different than, for example, the cryptocurrency mania or the kind of sort of buzz you get in some other classes. ESG is -- it's quiet and growing off of a small base for us. Lots of conversation around it.

Well, since you brought up crypto...

My fault.

I think on the institutional side, you did roll out a custodial service for that. So maybe I want to ask about wealth as well since that what you just brought up. But I do want to get into that service that you rolled out, too.

Well, cryptocurrency sort of became bigger than a small group of people dabbling in it. Sometime mid last year, it was reaching $1.7 trillion, $1.8 trillion, depending on which day you anchored. What we were finding in our client base was need for administrative and custody support, because all our investment management clients, whether they were going to get into it or not, were preparing for it. So the question they would ask is, what can you do if you were to decide to launch a hedge fund that has a certain allocation to cryptocurrency or if ETFs do get approved by the SEC, what can you do to help us? And the reason for them to ask us is a bank custody model has a lot of safety for institutional assets -- institutionally professionally managed assets than sort of retail brokerage-driven custody model. I won't go into a lot of detail, but our controls are quite heavy. And our tracking of and verification that a private key indeed exists and we can prove it is higher. So they wanted someone of our disciplined procedures and process. So we partnered with a firm called Nidec, and we rolled out the service. It has a lot of interest. But the regulatory environment around cryptocurrency is very, very dynamic. There's a lot of movement, and it's all from different angles. So we remain quite interested in the -- both the underlying technology, which is not -- which is much broader than just cryptocurrency, and to stay responsive to our clients' needs as their needs evolve. So we were the first to roll out the cryptocurrency custody product, and we have made some financial investments in a couple of different applications, just to be ready, if that's where the market goes.

Something just popped in my head here on -- as I think about wealth management customer and things kind of evolving and their demand. The home equity product is not something that we've really seen be used by much. But obviously, there's a lot of untapped equity in people's homes right now. Is that a product that you guys are thinking more about pushing into the wealth management customer? Are they seeing kind of demand more from them?

It's a very good liquidity product, and it has been sort of not used that much in the last couple of years because rates were plummeting so much. People were focused on refinancing their mortgages rather than getting a home equity product out of it. You could just release a lot of capital by just refinancing. So you saw there was this massive increase in the refinancing demand for it. But even today, people do have home equity. And if they have liquidity needs that start up again, then you will certainly see a pickup in home equity. The way we think about it is not really -- like our conversation with the client wouldn't be, "Hey, think about our home equity product." It would be, "What do you need liquidity for? And what's the cheapest tax-efficient way for us to get you that liquidity?" And we have an array of products, by the way, that can help. Home equity is one of them. If you have an investment portfolio that has a lot of appreciation built into it still even after the last 2 quarters, people are sitting on portfolios with a lot of [indiscernible] and you don't want to liquidate that for capital gains. We can do a credit facility around your investment portfolio. So it's really us asking the client, what is the liquidity need? And what is the most cost-effective, tax-efficient way of tapping that liquidity? And home equity is a very important part of that equation from a product standpoint.

So switching gears here. USB's acquisition of UB or is -- or Union Bank...

Say that fast 5x.

No. I can't even say it once. It's pending and you recently updated that it's expected to close in the back half of this year. Just remind us the strategy behind that acquisition and why it's important for USB overall, and then obviously, the opportunities in wealth, I would think, in particular.

Very significant. It's a great acquisition for us. You couldn't really design if you were doing it a more significant culture fit as well as business mix fit. Now within our -- the [ Blue MIS ] business, we know Union Bank very well. They have been divesting of various parts of their investment servicing business for almost 6 or 7 years now, and we have always been the buyer on that. And so we've had 3 Union Bank sort of investment services transactions kind of separate from the big deals, so we know them quite well. They have a very, very attractive wealth franchise, and it will add quite meaningful 15% to 20% to the wealth business. It's also a very attractive, very high-end affluent base. Obviously, California is a very attractive market for us. The California affluent wealth market is -- has very unique characteristics that play well to our strength and to Union Bank's strength. They tend to be sort of real estate investors, for example. The credit parts of our offering are very, very attractive in that part of the market. So we are very much looking forward to the integrated set of capabilities. There's a lot of sort of revenue synergies across the 2 sites. They have some very nice products from what we can tell. We are still in due diligence on the credit side, and they are very keen on our digital capabilities and our sort of family office capabilities. So I think when this thing comes together, we will be sort of very strong wealth franchise together. And in the scheme of things, a relatively easier integration effort, too, just because the business models are so consistent with each other. So very nice team.

And I do want to ask on the integration. Some bank deals take quite some time to fully integrate. And then often, the revenue synergies don't come until after. If I remember correctly, I think the conversions are expected to happen pretty quickly here. So does that kind of give you optimism of revenue synergies coming sooner than at least maybe some deals?

Well, it is very, very true that the sooner you are actually on the same set of platforms, you can actually realize the revenue synergies. It's hard to cross-sell each of those products if you're in completely different platforms. You also know, Matt, that we have invested very significantly into our data analytics capabilities. Our customer view 360 degrees across all U.S. bank products integrated on our mobile platform. So all of that will be -- does require the back-end platforms to be integrated together. So we are -- our plan is to focus on that, get it done quickly, get the teams bedded down. We are picking up a lot of extraordinary talent and get, what I would say, the foundations stabilized so that you can realize the revenue benefits here. Yes.

Switching to maybe some current events here. As we think about USB, you're mostly domestic, but you have a global payments business, a presence in Europe. I think the Investment Services business is also global, a presence in Europe. Talk about some of the strategy there, and there's a lot of geopolitical stuff going on. And does that kind of make you slow things or impact you at all or not much?

We are very -- on the Investment Services side, we're very opportunistic about how we think about global. So our payments business is a very attractive partner for us. They have a bank, a Dublin-based bank, an Irish bank. From our point of view, we were very keen on establishing very significant capabilities in London, in Dublin and in Luxembourg because a lot of the U.S. clients that we have here have sister products, same strategies offered in sort of a Luxembourg [ USAT ] or a Dublin product. So we did not want that to become a reason for a competitor to be servicing our clients. So those beachheads are more defensive than trying to sort of globalize. So I don't expect that we'll have a lot of Asian presence or expand into the rest of the continent because those 3 jurisdictions, along with the U.S., are the most significant part of the Investment Services hubs that we have. So we are in very -- and we have sort of growing capabilities in those areas. Now the payments business has a different dynamics. They're chasing population. So they have a much broader presence on the continent itself, but it's a nice business and synergistic with each other from a regulatory and banking side.

So last business, asset management. It's small, but it's growing. It's an area of focus. You did an acquisition last year. And I think it's mostly cash and fixed income. I looked at your disclosures. But talk a little bit about what you are there right now and what you're trying to do.

And what's the plan? Well, thank you for asking that. And a lot of people also sort of noticed that we sold our -- the bulk of our asset management business sometime back. What we sold were First American Funds' actively managed equity products because scale was so important in that. At that point, the asset management world was indeed barbelling into alpha players and these very significant passive players. And sort of if you're in between, it was not a tenable position. So it was a very sound decision to divest of that capabilities. It also gives us a completely conflict-free, open-architecture wealth platform because we are entirely sort of non -- our own assets on equity side. So the only thing we have is the cash side and those money market funds we kept. The synergy there is equally on the IS side as it is on the Wealth Management side. A lot of the times when liquidity is [ sloshing ] through our system, waiting for a payment day, clients will want a choice. They leave it on our deposits, we talked about that, or they want it swept into money market funds for better returns. And so we have that option, too, for them. Sometimes, they want us to ladder a treasury, ladder for them because they're not going to need their cash, so we can do that for them. So out of our investment servicing business is a growing sort of cash and cash equivalent business. We recently acquired PFM, very nice. It was a busy year for acquisitions for us. PFM has an array of cash products that services local government investment pools, a lot of distributed players, and our distribution is very consistent with their distribution. So simply put, what we were looking at was these capabilities that we knew very well and a distribution that is already in place for us. For us, we're just adding a product to an existing distributions -- mixed distribution sort of very cost effective. So it was a very synergistic product, and it gives us sort of a growing presence in liquidity. And for the right deal, we want to keep growing that. We are very good with how we manage deposits. And we'd like to be equally good with sort of cash equivalent investment products because that's something we just do very well. And we can truly fine-tune a client's liquidity needs based on sort of very precise expectation duration and where they want to go, what their liquidity needs are. So it's sort of a nice complementary product to the rest of the product than trying to stand up a separate business in itself.

So obviously, more helps when it's a scale game.

Yes.

But you did mention not having the scale on the equity side, and I think it's -- when I look at the disclosures, maybe a couple of hundred billion of fixed income AUM, a couple of hundred billion of cash roughly. Is that scaled? I mean you just said you want more, but how much do you need to really get scale? Because I thought both of those are also very scale-oriented businesses.

They are highly scaled because the product is highly scaled at that level. It's mostly the distribution resources. How many salespeople are higher if you're selling tiny municipalities across the U.S. And if you have to stand up all of that, you really want sort of a different level of scale. But remember, we have a very large government practice out of our corporate and commercial business. We have a very significant municipal practice out of our corporate trust business. We have a very real presence in communities out of our retail bench presence. So that's what gives us sort of the ability to just add product capability to the scale. So if we don't do any more, that's just fine, too. If you find some more, that would be good, too.

All right. Well, this was very thorough. I got through all my questions. And so I really appreciate you joining, and this is a really nice update of your business.

Very good. Thank you for having us here, Matt.