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

Okay. Great. Thank you everybody for joining us this morning. I'm going to read us the disclosure. For important disclosures, please see Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Okay. There was my disclosure announcement. This morning, we are delighted to have with us today from U.S. Bancorp, Gunjan Kedia, CEO and President of U.S. Bancorp. Thanks so much for joining us, Gunjan.

It's a pleasure.

And John Stern, Vice Chair and Chief Financial Officer.

Good morning. Thank you. Great to be here.

Thanks so much. Well, we have a lot to get through this morning, but I'll let I would like to kick off with strategy, Gunjan.

Sure.

And you've been a very visible member of the management team at U.S. Bancorp for many years, and formerly took over as CEO at the beginning of this year, right? And I suppose I should say, the beginning of this quarter.

That's right.

Okay. You've worn many hats both inside and outside USB. And I would just like to kick off by asking how you think your background varied and diverse background that you have is going to shape the way that you run USB as CEO.

Well, good morning again, Betsy. And this is my first conference after I officially assumed my role. So thank you for hosting. It's a pleasure to have this conversation. So as you said, I joined U.S. Bank about 8.5 years back. So I've been here a fairly long time. But before that, I was at 2 very large banks. And before that, 10 years in consulting, where you see a lot of other companies up close. So as I look at U.S. Bank, I see its high-quality, exceptional franchise value. The diversified businesses we have, the prudent risk management culture for the downside of a bank and the people aspect of the franchise is beautiful. So I see its value in a very clear way. But I've been there also long enough that I see places where we have not executed with as much urgency as we could have to really capture the potential of our businesses. So as I step into the role, and I'm really honored to be leading this iconic company, I lead to preserve the strength of the franchise and the company that all of you are quite familiar with but bring a sharper focus on consistent bottom line results, progress towards our medium-term targets that we shared at the Investor Day and just elevate the level of urgency with which we execute. So that's the leadership balance.

All right. So let's talk about those strategic priorities. Where can you unpack. Well, you just said a little bit and help us understand where there are opportunities to lean in.

Yes. Wonderful. Thank you. So I have been very vocal about 3 major priorities. They are very short-term focused, and we do marching towards our medium-term targets. And the first is stabilizing our expense growth. Betsy, you've been covering us for a long time. We made a very strategic decision almost 10 years back to lean in very heavily to catch up on our digital capabilities. It was strategically important in 2017. It had been 10 years since the iPhone had been introduced at that time. And the consumer expectations had truly elevated to a different level, and we needed to meet that moment. It's now been enough time that we need to harvest some of that benefits and stabilize the expenses. That allows us to deliver positive operating leverage. That's a big commitment we have made and it allows us to continue to fund into organic growth. So we have 4 signature programs with expenses and well underway. I would say last quarter, we presented our sixth stable quarter of expenses. So those programs are well underway. So that's priority #1 is stabilizing our expenses. The second is organic growth. And I'll just leave payments aside for a second. We have a different vision for payments I'll speak to it in a minute. But organic growth is really focused on 15 million clients who truly love us. Our client loyalty, our client satisfaction is very strong, but only 40% of these clients consume multiple products. And our products are very good. So it's a simple premise that we should deepen these relationships and we have made progress on that. We were at 36%, 5 years back, we are at 41% this year. But there's a lot of headroom here. And it goes through many, many fee-based products that we can deepen our client franchise with and then the third is payments. We have this view that most, most consumers who enter the financial services today, do it with a payment mechanism. It's either a P2P payments vehicle or it's your first card or it's some form of even cash payments. So the young consumer will engage with us through a payment cycle. So we are embedding payments in every single relationship, every single product, and that's the payments transformation. That's the third priority.

And this 15 million clients that you're talking about is in the consumer slip. Is that right?

Well, it's consumer, small business and corporate. So obviously, the numbers are largely the consumers.

For sure. Okay. And then just digging in on the valuation here. U.S. Bank stock used to trade with a premium valuation. And it's not treating with the same premium that it used to command. How do you anticipate earning that premium back?

The quality and the fundamental business model should trade at a premium. It's discounted because of skepticism around our execution. So it's a very addressable path to regaining our premium valuation. So why? It's a very high return franchise, not accidently, we make a lot of decisions to lead our businesses for higher returns instead of chasing after sort of really low margin growth, for example. It's also a very diversified franchise. So over a business cycle, you see the value of our fee businesses. Some of them are anchored by GDP and population growth like our mortgage business, some of them are propelled by capital markets growth like our trust and investment fees and some of them are consumer spend like our payments business. So if you look at the general cycles of an economy, we have curated a portfolio that performs with various stages of an economy. And we are very high in terms of fee growth relative to most of our peers. We will bring back our expense discipline. You'll see us be leading the way in terms of efficiency ratio again. And that's not because we are just squeezing the investments out. We had a very, very large franchise that's largely in the U.S. and a little bit in Western Europe. So there's a simplicity aspect that makes us confident that we'll be leading this franchise at a mid- to high efficiency ratio. You put all of that together and just a little bit of growth creates a real valuation premium here. That's the plan and the path.

All right. I'm going to get back into digging through some of the payment opportunities in a little bit but I'd first like to turn to where we are today with the macro, how you're seeing the expectation of tariffs roll through your customer set and is there any color you can give us on how much you've got in C&I that you've got a sharp eye on with regard to tariffs, how are your customers responding to what you anticipate here is going to happen. And Yes, so why don't we start with that? John?

Yes. I mean I think just in terms of the overall macro on tariffs, the areas we're watching from a C&I perspective, areas like automotive, areas like building materials, areas like capital goods, those are the main parts of it. And broadly speaking, corporations are going through this, and they're acknowledging this environment that we're in. There was probably a bit of a slowdown or a pause or kind of a wait-and-see approach, but we're starting to see that thaw a bit, particularly as it relates to larger ticket matters, as it relates to M&A and things like that. In fact, we've seen our utilization rate be relatively -- it increased in the first quarter that has maintained here in the second quarter. So that's good. On the payment side of the equation, where we see money movement, there's been a lot of resilience in the small- and medium-sized businesses, a lot of resilience in the consumer side that's been constructive for us. The one area we are watching is corporate and government T&E, those -- we are seeing slowness in those areas. But other than that, we are observing our clients manage through this. They're seeing pricing actions being put on their cost of goods and they're trying to figure out can I raise prices? And if I can, do I do that on one product? Do I spread it out over multiples? So there's a lot of strategy that our clients are kind of waiting through right now.

And Betsy, I would add to John's comment, after Liberation Day, the first focus was on whether this would be a credit event. And we would say at this point, we are not feeling it's going to be a credit issue. It's the uncertainty around big CapEx. So it's a loan growth postponement type of a thought process rather than any of our clients feeling like the tariff impact will be consequential from a credit standpoint.

Okay, great. And so as we think about how the quarter is going and with most of the quarter behind us, just wondering if there's anything that's changed in your quarterly or annual outlook since you last spoke with us?

Sure. Yes, no change to our Q2 guidance or our full year guidance, we continue to hold that as is. Maybe to give a little bit of color though on the quarter as we're seeing it unfold. We had talked about net interest income being in the range of $4.1 billion to $4.2 billion with rate cuts being pushed out, we would expect to be on the lower end of the range in that. But offsetting that, we have a lot of positive bias on the fee side of the equation. We're seeing good core growth in terms of areas like our trust and investment management fee, which houses our Global Corporate Trust and Fund Services. We're seeing good growth in our treasury management and tax credit syndications, which flow into other revenues. So we're seeing those sorts of things right now, but no change on our expenses. We -- those are very well managed. Our positive operating leverage of 200 basis points or more for this year -- or for this quarter and for the full year as well as the revenue of 3% to 5% for the full year on a year-over-year basis.

Okay. And the fixed asset repricing, that's coming in positive, right, with this deeper curve? Is that fair to say?

Yes, that's fair to say. I mean, we've talked and articulated about our fixed rate assets, helping us achieve our net interest margin expansion over time. We still have a lot of confidence in that, and that's just going to continue to occur. If I think about our investment portfolio, we have $3 billion of securities that roll off a quarter. We generate anywhere from 150 to 200 basis points in terms of replacement when that rolls off. On the loan side, we have about $5 billion to $7 billion of loans that roll off at $150 million to $200 million as well. But given some competition and things like that, it's probably more on the lower end at this particular juncture. But that is certainly all that is helping us from a net interest income expansion standpoint.

And your net interest margin, 2.72% last quarter, you're looking for that to expand to?

Yes. We talked about going to 3% over the medium term, which we would define as 2026 to 2027. The speed in which you get there is the 3 things we talked about, fixed asset repricing, remixing our book as well as deposit stabilization. And Betsy, what I would say is that to the extent that the curve is inverted, which it is on the short end, then it's a little bit slower versus if the curve is upward sloping, then that's more helpful for us in terms of expansion on the margin side.

Okay. Great. Thanks so much, John. Gunjan, back to you. I do want to dig into payments and some of the other fee lines too. But let's start with payments. So clearly, USB has unique payments franchise that's a key strength. There has been some growth opportunities that frankly, some of the investors are thinking you could do more there. So can you share your insight on how you're looking to accelerate the growth rate in payments.

Yes. And just let me give you some sort of context setting numbers here. Payments is about 25% of our revenue. The bigger part is the card issuing business for consumer, for small business and for corporate. There, we have a very, very strong product set and our positioning, which a lot of people ask me about is right in the middle of some large banks that are super prime and some sort of specialty players that tend to be more on the sub-prime angle. And our positioning is right in the middle of people who revolve because our credit card business is a very important source of loan growth for us and NII. I know we talk always about payments being a fee business, but it's almost $42 billion in loans for us from that business and a balance of the spenders. Now on the spend category, we have traditionally focused on nondiscretionary, high affluent spend. And it stabilizes the downside because that's where you see the least volatility of consumer spend. So the strategy going forward to lift the growth rate is to elevate the sales and marketing efforts we are putting around brand building and client acquisitions and really creating products that leverage the rest of our franchise because there's about 40% penetration of the card business and our consumer franchise, lots of upside still with the Union Bank base that we brought in 2 years back. And then the product mix is shifting towards a more spend category affluent client base. So you will see us maintain a loan growth, which is absolutely tracking to slightly better for the industry. Our fee growth has been traditionally about 100 basis points lower than the industry and our new products are focused on that gap. That's the plan with the card issuing business. The merchant business is about 6% of our revenue. It's a very unique property to us. We like the business a lot. Strategically, the reason to be in that business is not a stand-alone sort of fee source. But it's a very important product to introduce to a small business when they first open. So let me just think about what happens to someone who's setting up a barbershop. What do they need? They need a core bank account and they need a basic merchant offer. We want to be there right with them. Small businesses love their banks. Surveys after service will say, given a choice, they will consolidate their business with us because at some point, they're going to need a line of credit and credit from us. So their psychology is very consistent with our growth and that's the vision we have that our MPS business will anchor our small business franchise, which is very large. This business has a lot of misunderstanding. So I've heard it doesn't grow, it's unprofitable and it's going to need a lot of investments. All of the investments, the big surge is behind us. It does benefit from very healthy investments because it's a very fast-paced business, it's in the run rate now for us. So we feel very good about it. It's actually a very profitable business. If anything, we have found through our analysis, I've just been focused on this MPS since I sort of stepped into my role last year. It's running at a 10 to 15 points of margin higher than most of our competition. The trade-off is lower growth. And our transformation is to move us from being a commodity acquiring business, which is what it was in 2000 when we acquired Nova that became MPS to a more software-led business where the growth is higher, and we are about 37% of the way there. That's sort of what the revenue mix is. This is a slow transformation. We are very committed to the transformation and I would say, Betsy, this business has very little downside for us, but potentially a lot of upside for us. That's why we are focused on it. And you'll see the growth rates sort of inching up as the transformation unfolds. And it's software-led. It's a very cryptic term. But what it is really is the upfront software that runs your GL, that runs your tax payments, integrates all the way back to your acquiring business. And that makes it very specific to the vertical that you are serving rather than generic to any business. So the 5 verticals that we have selected are very large verticals. We have unique capabilities in health care. We have unique capabilities in retail and services and travel and entertainment have been sort of bellwether sectors for us. So these are some choices. We are walking away from some business that is large volume, almost no revenue. We're walking away from some businesses that are outside of these verticals. But once the transformation sort of takes hold, you'll see not a breakneck growth rate but a healthier growth rate, still a healthy margin business and strategically very important to a small business story.

And so this transformation is about increasing the growth rate of the merchant acquiring business?

Business, right.

And the transformation is executed through software enabling such that verticals.

The value is very specific. So for example, grocery is a vertical that has a very unique sort of software-led model. It's quite complex because of food stamps, coupons. So we've decided that, that's something we can do from an acquiring standpoint. We do have large clients, we do that for. But we are not doubling down on the software-led part of it, whereas health care, health care as an industry loves banks because they have enormous HIPAA compliance issues. They have a lot of regulatory data privacy issues. They like a bank provider instead of sort of a stand-alone, and we integrate it all the way back with our balance sheet services with our -- so we've been very intentional about saying where can we play. These 5 sectors are massive sectors. These are not small sectors. And that's been the transformation we had underway, almost going on to 5 or 6 years now. And just picking up the pace of that transformation now. So thank you for allowing me to talk about that business. I feel it's one of the more misunderstood businesses within our portfolio and worth the dialogue and the effort.

One last question, well, 2 last questions on this. One is on the fact that you have an issuing business, as you indicated, and a merchant acquiring business. And I wonder, have you ever thought about the connectivity that will maybe also having a network piece, maybe renting a piece of Visa or MasterCard or something like that, so that you can have all of that and be setting pricing to merchants more directly through.

It would require a fairly substantive shift to the market dynamics of how things work. And I don't know if we would have enough of a scale to shift it to a payables and receivables business because then issuing is a payables business and a merchant is the receivables business, sort of being interconnected. It's a complex piece that we have got plenty of very attractive, easier to execute growth opportunities. So it isn't a priority right now to try and do. What we do have that we bring the 2 sites together is the back end. Because they're all transaction processing business. And in today's environment, the fraud monitoring, the transaction monitoring, the real-time payments, there's so much that you have to do on both sides. And over the last 5 or 6 years, we have really consolidated the -- what I would say, the plumbing and the guts of both businesses that gives us a lot of operating leverage, but not on the front end or the pricing side.

Excellent. Okay. Thanks so much. And then on commercial product revenue, where capital markets comes through. Can you talk a little bit about how that is shaping up, given the fact that we've had some volatility this year?

Yes. So just to step back with the premise of that business, it's one of our highest organic growth focus areas is we have about a $250 billion balance sheet that we deployed towards our corporate and commercial clients. It's a very sizable support structure for their businesses. Our clients truly tell us that they would give us more fee businesses because they appreciate us being in their bank group. So we are taking that feedback and we are growing our capabilities where we have the scale and the capabilities. So we've chosen to deepen on the fixed income, loan capital markets, derivatives, FX and commodities type of businesses, and we have let go equity trading and investment banking. We got out of that business 20 years back. It is a very focused play. We -- it's not a technology play. You have to hire talent and we're just building out capabilities to deepen the relationship there. And John, I'll let you comment on what this year is looking like.

Well, I mean in terms of -- I was going to add is the investment that we've made over the years into those platforms. I think about foreign exchange, our commodities and building out other trading desks and things like that. The market -- and so those have all been very positive things that we've been able to incorporate in terms of investment that we make in. In terms of how capital markets are shaping up, there's been some bumps in some of the things earlier in the quarter, but things are shaping up nicely. So we feel like it's on a good track.

So we've got a bit of an inflection happening.

Yes, I think so.

Okay. And then Gunjan, as the GENIUS Act, we're looking further ahead here. But as the GENIUS Act makes its way through Congress, it seems like banks will be able to do more with crypto clients or crypto assets. And how are you thinking about that with all the digitization that you've done? How is the organization set up to provide services there or enable digital?

Well, we had quite a large custodian. We have about $11 trillion in assets under custody and administration. We were very early to introduce cryptocurrency custody offering. They were geared not towards the payment side of cryptocurrency, but the investment thesis. And it was really on the request of some institutional clients that wanted to hold a small fraction of the portfolio and invest in that asset class and would rather have custody with the bank rather than sort of a fintech. And the product didn't really take off because the regulatory regime at that point was very uncertain for large institutional investors. That product is back, and we are very able to provide it. The bigger conversation right now is around the payment side with stable coin, and that's what we are studying and watching. Standing up your own stable coin will be something we can do with partnerships. We have enough pilots going on. The other role we could play is as the institutions that hold the collateral that backs it either USD in forms of deposits or treasury, which we can custody as well or a whole surround sound of systems that are trust-based products like escrow services that are yet to be figured out. But the market infrastructure decisions around that are quite consequential and the GENIUS Act is just getting started with some of those questions. So we'll see. There are a lot of big numbers that are being thrown out. And of course, I have disaggregated them to understand it. The headline number sometimes says that the transaction volume with stablecoin is beginning to reach Visa MasterCard type of volumes. But underneath that 90% of it is just cryptocurrency to cryptocurrency trading volume. It isn't really yet commonplace. It would also be, I think, more consequential to large wholesale cash managers that do cross-border payments rather than someone like us where most of our work is sort of consumers within the world of U.S. So that's a long way of saying, we are watching it. And there's a lot to be sorted out before the role we play solidifies in our mind.

Right. Because I've just one other question on that is that we do have clearing house real-time payments, which enables real-time payments domestically.

And the value proposition against stablecoins and real time for the domestic everyday transactor is less compelling than cross-border -- small ticket cross-border payments, for example, where the economics become viable, but that's also where the market infrastructure gets a lot more complex. So that's why, again, I say, Betsy, for a profile of our payments franchise, we'll probably be second or third horizon figuring it out versus a large wholesale cross-border cash transaction type of a business like a wholesale cash transaction type of a business, which we just don't have much of.

And you also, with your payments business are servicing other financial institutions, right?

Yes. I mean, if stablecoin progresses, the ability to accept it in various storms will be sort of required of most banks, I would guess. So that would be innovation that we are not -- that we are studying and that's not something that we can stand up once the rule making gets clearer. And all of the clearing house, they're all thinking about that as well.

Okay. Moving on to other ways that you are leveraging your digital infrastructure, and that's through the partnerships that you have with State Farm and Edward Jones, where you're leveraging your digital capabilities to roll out your product set to a broader scale than just your branch footprint enables. Can you speak to how much growth you anticipate delivering through these partnerships? And is there an opportunity to do more partnerships?

Yes, yes. So we are in 26 states. And with the Union Bank acquisition in 2022, our footprint has become very attractive because of the California West Coast that rounded out our sort of north of the country type of footprint in the Southwest. So it's a very expansive branch footprint today. What is interesting, Betsy, to remind ourselves is that about 2/3 of our total business is operating in a fully national capacity today, which is our wealth and institutional business and our payments business. The brand difference is quite relevant. Where we have branches, we see almost a 15 to 20 points higher brand recognition than where we don't have branches. So a lot of our focus with the national bank expansion and the partnership expansion is introducing future customers to our brand, which gives us optionality to build out branches over time because we are building out new branches in new areas. For example, Arizona has been a big focus for us. Nevada has been a big focus. So these are within our footprint, but we could deepen our branch presence there. So with that context, how do partnerships fit in? When we did the State Farm partnership, we had access to all of their insurance agents that could represent a product for those people who needed it. Edward Jones has 19,000 financial advisers, and they are present in a lot of rural markets that have become very unbanked over time. So their premises that through our digital capabilities, and their human touch, we can bring banking to a lot of rural communities without the CapEx required. How do the economics work? We have actually built out a partnership platform. So with very little incremental benefit we are standing up Edward Jones later this year. We revenue share with them, but we avoid a lot of the upfront CapEx. And as you know, a branch roughly takes 5 to 7 years to breakeven on your investments. And here, we are in business day 1 and does not preclude us from eventually following up with our own branches in the areas that we want. So we think of it as quite an interesting optionality for introducing a brand to potentially having a revenue driver and not losing anything in terms of ability to open branches. We have a lot of interest. We have a lot of interest from other financial advisory like firms who don't want to become banks who want to round out there. But we want to do a good job. So let's see, let's stand up Edward Jones, see how that goes. And we are very open to more conversations around that.

And importantly, the platform is the reusability of the technology is really impressive, so it allows us to do that with very little cost. And the Ed Jones, just as a matter of starting this -- in the third quarter, fourth quarter will be fully rolled out.

And we love these platforms because we are so used to the Elan platform on payments, for example. Elan is a white label fully third-party enabled platform to provide white label credit cards to smaller banks, 1,200 banks get very meaningful fee income out of our platform. So this is something we are quite interested in developing scale in an unusual capital-light way. And the credit card side is very mature. We have been doing this for a long time. And our vision is that perhaps that model becomes very real on the banking side as well.

And so when should we start to see the benefits of this impacting your operating leverage? Is that this year and into next is Edward Jones?

Early next year, it stands up in a limited rollout way, starting with the third quarter. So we'll have some insight into the model.

The other key driver of your operating leverage that you are looking for this year, 200 basis points, right, for the full year. Can you speak to key drivers there and the legs to those drivers?

Yes. I mean we are looking for operating leverage of 200 bps or more this year. And the expense areas that we're focused on really come in AI automation type areas, real estate and organizational simplicity. So those are really the areas that we're focused on right now. And I can go into details about that, but the crux of that is we've been very focused on managing our expenses and taking that discipline very seriously. We've had the 6 straight quarters of straight expense being flat, we can take the savings from all these different programs and invested in things like the digital platforms that we just talked about, things like our payments platforms and things of that variety. So that allows us and the $2.5 billion tech budget that we set out for us is already embedded in our run rate. And so what we're really focused on is do we have the right resource allocation, holistically, OpEx, CapEx and people in the right spots for all these initiatives.

So then lastly, on capital. We have a new administration with an outlook for some changes coming in the near term seems like. And Gunjan, can you help us understand how you are anticipating utilizing your capital as you roll through the next several years?

Well, we are building capital still just because we have a capital transition at some point in the future, not until 2027, but just we want to be ready for it, which we will be sometime next year, and we are building capital. But after that, our business model generates a very healthy amount of capital build. Betsy, you'll remember, we were at a very depleted level of capital in '22 because we just bought Union Bank. We went into the banking failures, and we have built up our capital very rapidly over the last 2 years. So we will then have this decision on how do we balance loan growth, how do we balance share repurchases, how do we think about investments into our business. And we have a very thoughtful process to think about that. And as things unfold and as we actually have some clarity around capital rules with now Governor Bowman's confirmation, that decision will become very real for us and we'll communicate that.

And just lastly, with the multiple low relative to history, what do you think investors are missing as it relates to your current valuation?

Well, thank you for this dialogue, and I'll close it out with you. I would say that the skepticism around our execution has overclouded the quality of the underlying franchise that is U.S. Bank. It's not inappropriate. I accept and acknowledge that we do need to execute with urgency and consistency, and that is our commitment that we are taking that mandate very seriously. But what I would like to just remind investors, especially with the long term is that our execution is showing very rapid improvement and the expenses are a proof point of that, but it's really the underlying franchise, a very high return, a very diversified fee intensive businesses. The quality of fees is very good. It's not consumer fees that have regulatory pressures. It's trust and investments. It's payments, it's mortgage, it's capital markets. It's a very high-quality fee franchise. And then we are a very good stock for the downside. So it's a very good franchise and John and I are very committed to shifting the narrative around execution, and we believe that brings the multiple back.

Excellent. Thank you so much for joining us this morning, Gunjan and John.

Thank you. It's a pleasure.