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

Okay. Good morning. Thanks, everyone. We're very happy to start today off with U.S. Bancorp. Joining us again from the company, we have CEO, Andy Cecere; and CFO, John Stern. Thank you both for coming. Good morning.

Thanks for having us.

Great to have you guys. Andy, let's put things in perspective here. We're approaching 2 years since the close of the Union Bank transaction. I think, a year from the conversion, maybe...

Exactly a year, yes.

What's the report card on the deal? How has it benefited growth so far? And what are the opportunities in the new markets?

Thanks, John, and good morning, everyone. It's great to be here. So it's a great place to start, John, because it fits very well into our overall company strategy, which is about our diverse business mix, the scale that we have, taking advantage of the digital investments we've made and cost takeouts and efficiencies. So -- and Union Bank hits on all those marks. So first of all, from a scale perspective, it -- [ main player ] in California, we were [ dependent upon ] the market share [indiscernible], it increased our step function and scale 15% to 20%, depending upon the category you look at. And it really provided the opportunity to leverage those investments we made in technology and in digital to allow us to lift and shift in one weekend about a year [indiscernible], this last weekend, a very successful conversion allowed us to exit the consent order they've had for a while, very quickly. And importantly, achieve $900 million of cost takeouts, which was fully in the run rate at the end of the fourth quarter of '23. So it hit on all those marks. And while we didn't put it into the model, the opportunity to take 1 million customers on the Consumer side, a couple of hundred thousand on the Business Banking side and leverage the banking and payment products that we have to those customers is tremendous. So one example the card penetration of the consumer base at Union Bank was about half of U.S. banks. So they were about 20%, we're at about 40%. We're already at 28% at Union Bank after 1 year. So it really hit on all those marks and then it was a positive deal both strategically as well as financially.

Great. And then on the commercial side, additional opportunities in terms of penetration, what are some other examples?

Yes, one of the benefits of our company is our diverse business mix. So we derive about 40% of our revenue from fee income, which is important in times like this where loan growth is a little tepid and deposit costs are pressured. So it is -- we have this great diverse set of businesses. And it's interesting because we have about 37% is consumer and small business, 30% is institutional corporate commercial and 26% is payments, which serves all those customers. And we have all the traditional businesses that most big banks have, which is consumer banking and corporate banking. But we have a unique set of businesses that are very fee oriented, capital efficient, high return, high barriers to entry like our corporate trust business, our Fund Services business, our capital markets business and our ability to penetrate the Union Bank customer base in those is also tremendous sort of like that card penetration I talked about on the consumer.

Any areas of business mix, Andy, where you might be undersized, you're looking to tweak?

No. Again, we are -- Corporate Trust, we're #1 or 2 market share across all the categories, $65 billion of deposits that come -- operational deposits that flow through their huge fee business, allows us to penetrate municipalities and corporate businesses to service their trustee fund services, a unique business, very fee-oriented, also deposit flows that come from it. So payments is another great business where we have high capabilities across merchant acquiring and card issuing as well as corporate payments. So I think we have the right set of businesses. And really, our focus is on penetrating and selling more [ to ] customers because we can benefit from the businesses we have and they can benefit from the capabilities that we have.

So we think about across the fee income opportunities, what are the kind of the top [ ones ] as well as in commercial.

So I'll start with Commercial products, which is a great story. 2008, 2009, that was a $400 million business, and now it's a $1.4 billion business, and that's providing bond underwriting, FX, interest rate derivatives to our customers that are -- lending customers that we really can expand the relationship. So that's a great opportunity. Our Payments business is another one. So we have a tremendous merchant acquiring business that we're very focused on penetrating the business banking together with payments in this overall ecosystem. In today's environment, John, companies are really trying to melt together what they need from a payments perspective together with what they need from a banking perspective to help them run their business. And we talked about this before, but we have this tremendous opportunity. We had 1,000 small business customers. We said we were going to grow at 20% to 30%. We're already at 30%, which is -- about half of the growth came from Union Bank, about half of it organic because we're really trying to come to this ecosystem, which helps them run their business. That includes our Bento, our talech capabilities, helping run receivables and payables. So it's interesting, again, stepping back this diverse set of businesses, many of which many banks don't have, really allows us to penetrate, serve more, drive fee income and drive returns.

On that small business opportunity, how much of that is in the new markets, in some of the acquired areas and how much is kind of just legacy U.S. Bank?

It's a little bit of both. And so I would say almost half and half. And part of the penetration comes from the Union Bank customer base, which, again, very affluent, loyal customer base, but they just didn't have all the products and services that we did. So that's why that opportunity and the revenue drivers is so substantial.

Yes. I think you recently launched a private capital business...

Yes, private capital is another great example. So I think of it more as a partnership than as a competition. So we provide a lot of service that private capital doesn't or can utilize in part of their business. So we can provide FX and derivatives. We can provide the bond underwriting. We can provide the fund [ service ] components to really partner with those private equity firms and really be part of the banking relationship as they expand their business.

On the Payments, Andy, just a follow-up, what are the ongoing needs for tech investment in the Payments business? And how much ongoing spend does it take just...

Yes. So we're at the point of the curve that we've leveled out in terms of the spend -- tremendous focus for us for the last 5 years. A lot of it was in tech-led. If you think about traditional merchant processing, it is not becoming part of the software that helps them run their business, and that's where we put most of our investments. But we're at the level point on that investment spend right now. So -- it is -- it was a key area of emphasis for us, and it's now over 30% of our activity is tech-led processing and tech-led sales. So at the point of the curve where it's flattened out, but it's been a tremendous focus.

So also just kind of rounding out this discussion around the business mix. When you think about M&A and how big is big enough in banking. One of your peers, Bill Demchak at PNC has kind of pointed to the size advantages of the G-SIBs and megabanks, Bank of America, JPMorgan and their ability to kind of really grow market share. How do you feel on that? Do you feel like you have the right size, superregional banks like yourself or virtually national, in your reach? Is that big enough? And how do you think about that...

No, we're $650 billion, $660 billion. So we are the largest non-G-SIB, so I think we have sufficient scale. But I agree with Bill, scale would be more important in banking. Scale around technology investment, marketing spend, the ability to have your brand leverage. So I do think M&A will be an outcome of them because -- all those things plus regulatory changes. However, I don't think it's imminent because of the marks on the balance sheet, but I think we're well positioned. And importantly, you have to have the technology framework to do an integration in a successful way, which is what we did with Union.

And for now, it sounds like you're internally focused. You've got a lot of opportunity to optimize...

We're focused, we have tremendous organic growth opportunities across so many categories that I talked about, but we are also -- would be well positioned for M&A when and if that is...

Okay. So John, let's get you involved here a little bit. We'll dive into the obligatory NII questions. But before we do that, any comments in terms of quarterly trends, update to guidance for the year or the quarter, maybe just kind of level set us there.

Sure. Since last time we've all talked, there's really no change in our -- the view of the economy, view of the economy is it's resilient, it's strong, it's constructive and all those sorts of things for growth in terms of how the quarter is coming in and our guidance that we provided, there's no change in terms of the quarter, things are coming in as expected.

Okay. Okay. Well, let's drill in a little bit there. At the first quarter earnings, you lowered the full year outlook to NII, you gave us a range. The main driver that you talked about was the kind of continuation of yield-seeking behavior among [ commercial ] customer. What are you seeing that's a little different than your original expectations when it came in the year on NII? And what are the assumptions that kind of get you to the low end of your range, kind of the mid and the upper end? Maybe just kind of help us give us an idea there.

Yes. So maybe just backing up to where we were at the beginning of the year. So -- the beginning of the year, clients as well as the market was looking at multiple cuts. Our commercial clients, particularly if you look at our DDA balances, it's all commercial, it's institutional and corporate type deposits, none of the retail is really in there. And so those are the accounts we're positioning for a different interest rate environment -- in different interest rate environment. And so when everything shifted to more higher-for-longer and that sort of thing, we saw more sensitivity with those clients to be more efficient with their cash, all those sorts of things. And so that's really what drove us -- the decisioning on changing the range that we have. And so now the range, we provide a range because it accounts for a lot of different factors, which can come into play, meaning there may be -- even though we continue to see stabilization and slowing of our DDA migration, if that were to be a little bit more -- not stabilize as fast as we would have thought then that's on one end of the range. But if it stabilizes quicker, it's going to be in the higher end from an NII guidance of range. But it's not just about the deposits. It's going to be about loans and in terms of loan mix, in terms of how their assets are repricing on that side of the balance sheet, particularly as rates continue to be high on the longer end of the curve. And then a little bit of modest loan growth we have built into the forecast as well. So all those are kind of factors in different interest rate environment. So we try to incorporate all of those things into the range is kind of how we thought about it going forward.

Yes. Is -- the base case though allows for a little bit more mix shift down and some moderate loan growth, would you say? And then kind of the lower end is more severe?

Yes. I mean in our base case, we have a couple of cuts right now. And really, I think it's at the end of the year. So it's really -- it's not really consequential to 2024, if you think of it that way. So if you're thinking about cuts and things like that, I mean that -- those are going to be -- it's really more about the deposit behavior, loan growth, as you mentioned, but the loan growth, again, very modest in our forecast or base case.

John, simply stated that we're comfortable with the guidance because the math makes us comfortable with the guidance. Security portfolio turnover, the increased yield on the new purchases, modest loan growth and deposit migration flowing all those things lead us to...

Yes. In the commentary you talked about NII being relatively stable for the second quarter and then some moderate pickup in the back half.

Yes. So I can go into that a little bit in detail. So again, on the deposit side, we -- there is some migration and rotation, but that is out of DDA and into interest bearing. But that is stabilizing and slowing. We very much see that, particularly in many of our different client bases. On the loan side of things, as we mentioned, we have a little bit of loan growth, and that will be favorable because the loans that are coming on should help our mix profile. So if you think about cards are growing, commercial a little bit and auto loans and -- well, auto loans and commercial real estate are probably more less stable or dropping. And so that loan mix will be beneficial to us as well. Andy mentioned and I'll maybe go in a little more detail here on the repricing characteristics of the book. So -- we have -- obviously, about half of our loan book is a fixed rate variety. And we have obviously the investment portfolio. So if you can think of the investment portfolio that's kind of churning 7 to 8 basis points on average per quarter positively. You think about the mortgage book that's growing anywhere from 5 to 6 basis points per quarter positively. And then we have the fixed rate assets such as retail, leasing, auto loans, things of that variety that are all helping in that regard. So the deposit costs are diminishing in terms of rate paid and the rotation and the assets repricing will be beneficial. And that's what kind of gives us that tailwind for the growth going forward.

In an effort to simplify a really complicated thing at a high level, John, would it be fair like kind of relatively stable, it means that the reprice on the asset side is kind of enough to offset a little bit more mix shift.

Yes. That's the simple way to say it.

And in the back half of the year, the -- [ hoping ] your card growth and some more reprice, you get stability in the mix, you get a little bit of growth?

Yes. And I would say the loan growth component, obviously, it's important we want to grow, but it's not going to be as consequential to the views that we have. It's not going to be as impactful. It's going to be more about that -- the impact of deposit rate paid as well as mix that impact decreasing over time and ultimately stabilizing as well as on the offset that continual repricing that we're going to get on the fixed rate asset side of things.

Yes. Has anything surprised you on competitive pricing around deposits? It seems like bigger banks have been -- being able to hold the line for the most...

Yes. It's been quite stable for a period of time here, and we anticipate that to be the case going forward. The Fed has -- from a quantitative tightening standpoint, has really started to slow that down a bit. I think that's conducive to the continued stabilization of pricing. Loan growth has been pretty meager in the industry. And so there's not as much fight over the deposits on that side. So we just -- we see stability pretty much across the board from a rate-paid standpoint.

Okay. One more on this topic here. Just in terms of the yield curve shape, John, and your efforts to be relatively neutral. Maybe you could just explain that a little bit how you've used some hedges to kind of keep a relatively neutral position, but ultimately, even within that rate cuts could be a little helpful.

Yes. So what we try to aim for is being relatively neutral from a from an interest rate risk standpoint. So we're using -- our balance sheet is relatively neutral just as is. We have kind of a 50% mix in terms of fixed and floating assets. Our deposits are relatively 50-50 in terms of retail versus institutional. So it gives us a nice starting point from a balance standpoint. So what we're doing from a hedging standpoint is how do we need to work around the edges and maybe some of the portfolios to get the overall neutrality that we're looking for from an interest rate risk perspective. So for an example, in our investment portfolio to protect against upshocks in rates, we're going to put on pay-fixed swaps to help protect that -- the valuation of the investment portfolio to offset that a little bit, but also to protect ourselves in a down-rate -- a sudden down-rate scenario, we're going to put on receive-fixed swaps and have put on receive-fixed swaps both -- currently spot [ trading ] as well as forward starting to help with that to go forward in case rates were to suddenly fall. So that -- those are kind of the different places where we utilize hedges to help us weather those sorts of storms.

And that's why the cuts versus no cuts is not that meaningful to the outlook relative to, say, the deposit mix and loan growth.

Yes. That's right. And I would say we aim for from a -- we're looking at our base curve and we're protecting ourselves from shocks up and down, is the point of the hedges and everything. That all said, we would still be more favorably tilted if the curve would need more in a regular shape, right, more upward sloping. And so that's where cuts will probably be on the margin be more beneficial to us because it relieves the pressure on the deposit side as we have quite a bit of institutional corporate type deposits that we can immediately reduce rate on the Fed cuts and that's going to be helpful versus a higher-for-longer. So those are kind of the puts and takes to it.

Okay. Great. And Andy, where do we stand on commercial loan growth and thinking kind of from the industry right now, what's holding clients back? And then also underneath the surface, what's going on at USB in terms of account growth and maybe some precursors to loan growth.

Yes. So we just had our financial review, the last few days and utilization, first of all, I'll say, is relatively flat -- it has been flat for last few quarters. So customers are being a little careful because of the uncertainty in the environment and pulling down more of their client utilization. That being said, pipelines are firming up in a positive way. But I don't -- I would expect loan growth to be modest as we've talked about, and that's baked into the guidance we provided. But versus where we were 90 days ago, I would say it's a little bit better, from a sort of perspective, attitude, confidence level, still little bit of uncertainty out there. And that's true at both middle market [indiscernible] as well as high-end corporate.

And John, one follow-up on the revolving credit card [indiscernible]. What are you seeing in terms of payment rates in revolve? And then where are you on kind of the seasoning new accounts that you've added?

Sure. On the payment rate side, it's kind of interesting, it's been as flat as a pancake over the last several quarters. We kind of went through the change in the -- during the COVID time frame, but our payment rate is very much settled in kind of, I'll call it, 33%, 34% range, and it's been very stable, and we expect it to be stable going forward. And so that was -- that level was probably in the low 30s prior to COVID and had some spikes and things of that variety. So -- the same is true in the revolve rate, just in the opposite format, so we're kind of in the low 60% from the revolve-rate standpoint. So it's -- those are kind of the puts and takes. So we really see that not being as much of a factor to NII. It's more going to be account growth and putting on new balances and certainly spend levels have been constructive. And so that's continuing to add to balances and things of that variety as well as what Andy talked about with the penetration rate improving and things like that from our Union acquisition. So all those factors are -- really give us a positive bias on the card side of things.

Okay. So shifting gears over to the fee revenue side of things. John, you've given an outlook for fee revenue to grow in mid-single digits this year. Can you talk a little bit about new drivers of that and what gives you confidence in the ability to meet that?

Sure. Yes. Andy talked a little bit about some of those things, but just to paint a picture of why we feel confident in that is we have a lot of different products. And obviously, we're seeing really nice and strong growth, core growth in our corporate trust areas, in our capital markets areas. Clearly, mortgage has continued to show some good [indiscernible] as well and our Payments business are all areas where we expect to see growth over the time frame that gives us the confidence. I think putting some of these pieces together, along with the Union transaction, Andy talked about the commercial products group and how it's grown from $400 million to $1.4 billion in that area. It's really about putting the pieces together for our clients and growing share in wallets. So if you think about the life cycle, just to give you an example, if you take out a life cycle of how a client might approach an M&A transaction for an example, so we can do the bridge financing upfront for that to help out with that. Eventually, that client will want to take their transaction public and go do a debt offering. Well, we can underwrite that. They're going to need a trustee for that sort of activity. And so we can provide that sort of capability. And then after the transaction has settled then we can hold the balances in escrow for a period of time, which is very beneficial to us from a deposit standpoint and then -- or we can have an invested -- or the client can direct it to invest it and we can use -- utilize our U.S. Bank asset management standpoint. And then along the way, if they have hedging capabilities or needs through foreign exchange or derivatives or whatever the case may be. We can provide that. So it's kind of all the years of investment that we've put in, in terms of systems and people and technology are really starting to pay off. Now we can pull it all together. And so that's just one example. And the same thing can be said as Andy talked on the Payments ecosystem in terms of tech-led on the merchant side of things and how we can be beneficial to our business banking clients and putting product together in a simple form. So you put all those things together, John, it's not just about the actual business lines, but capabilities that we have and pulling it all together for the benefit of the client is really what gives us the confidence.

And all those unique aspects, the categories that we have, again, we're not just dependent upon deposit service charges and traditional [indiscernible] we have all these unique sets of business. John mentioned a number of them, [indiscernible] is the one where we can provide on the accounting front-end and [ DDA ] funds that is a great business for us, very capital efficient. So all these things drive that fee growth by expanding the business set to the customers we serve.

Great. That's very helpful. So on the expense side, you recently indicated in the first quarter that expenses are likely to come in better for this year than your previous forecast, $16.8 billion versus the prior $17 billion, what got better? Is that kind of a pull through of the cost saves achieved through Union at the end of the year? And does that demonstrate that you've got further flex if needed on expenses?

Sure. So maybe just to kind of get the context around that. As we were kind of going through the year, and I mentioned the challenge on the net interest income side of things. As we go through our review process, as Andy talked about, we just had one a couple of days ago, but we do these regularly. As we were talking through that, what we found is that we -- a lot of different groups had different ideas on how to continue to pull in the expenses. That was around a variety of topics. It wasn't one core thing or another. So it had to do with third-party spend that could be like procurement related or consulting areas and things like that. We've been more active on the real estate side, so we've been going into more of a hub strategy in terms of where our people are located and things of that variety. So that allowed us to close [indiscernible] in different locations that will provide us savings on a go-forward basis. And then on the operations side and technology side, we've spent a lot of money and investment in our processes and improvements and things of that variety. And that -- those things that have -- are coming to fruition, we're able to reduce process time and the amount of people that it needs to complete processes. We've also centralized our operations team, and we've been able to find efficiencies with call centers and things of that nature. So it's just a variety of things. And so as we kind of go through that, we wanted to announce that as -- at the same time with the change in the net interest income component. But we also think that as we go forward with those additional levers that we [indiscernible] that's just going to be kind of a game-time decision as we go through the year and we look at our forecast of revenue and things like that, that's where we will decide the trade-off between should we take cost action or not because sometimes you do want to invest, you do want to continue to move forward on certain projects. And so those are the sort of trade-offs you have to weigh as you kind of go throughout the course of the year.

John, I'd keep it really simple. We've invested a lot in the company in digital and technology capabilities over the last 5 years that are starting to pay off. We're at part of the curve now that those are no longer investment [ increases ] but return payback. And that allowed us to get the $900 million of cost savings from Union Bank. We're able to shift their entire network onto our platform in one fell swoop. And that allows us to continue to drive efficiencies as well as new products on a go-forward basis.

So yes, I should clarify, it was $16.8 billion or better and as you said, you'll kind of manage that throughout the year of doing this flex without cutting into muscle. And you feel like you do have some optionality to manage that and still make all the investments...

And while making investments, that's an important point you make. While making the investments.