U.S. Bancorp ($USB)

Okay. Up next, we have U.S. Bancorp, and I'm delighted to have with us today Gunjan Kedia, Chairman and CEO of U.S. Bancorp; and John Stern, Vice Chair and CFO. Thanks so much for joining us.

It's my pleasure.

So Gunjan, let's start with, you've completed your first year as a CEO. And as you reflect on the first year of leading the company, what are some of the biggest lessons been that you've take away? And I guess what are you most focused on for the next phase of execution for U.S. Bancorp?

Well, thank you for hosting us and congratulations [indiscernible], and it's been a very real owner and a pleasure to be leading a wonderful bank. Just over 12 months back when I stepped into the role, our focus was very much on delivering the medium-term targets that we had committed to during our Investor Day. So that's what sort of we got very focused on. So what did we do? The first is positive operating leverage. There was a lot of question marks around the efficiency ratio. And over the last 2 years, we brought our efficiency ratio down by 4% or so and delivered very strong positive operating leverage. The [indiscernible] fee growth. As you know, our franchise is unique and being very fee heavy and not just the size of the fee base, but also the mix and the quality of the fee base. So we had committed to mid-single-digit growth, and we are certainly there. And on the upper end of that, we built capital by 30%. We are on the verge of entering a Category II designation, and that was done. And what we were very proud of is we maintain a ROTCE. So the third quarter of last year, we have started operating in our medium-term targets. We are very confident in that range. So looking forward, our focus is on maintaining the profitability and the return profile of the bank, but accelerating EPS growth and we're getting ready to publish our next set of medium-term targets next year at Investor Day. So the focus really is the next era of very profitable growth.

I'm sure that will be an exciting Investor Day. We will look forward to it.

we look forward to it.

Maybe stepping back, U.S. Bancorp has unique lens into consumers, small businesses, corporates. We're hearing from different banks at this conference. So while things [ Selby Data ] might suggest people are being cautious, but you're not really seeing it in the numbers. I guess, what are you seeing from your seat?

Our perspective would be very consistent with that framing. B, earlier in the year, we entered the year with very strong tailwinds in the industry and much of the substance of that is very intact. Starting with consumer, the spend levels stay quite robust. And the things that we watch for is the lowest end of the customer tier. As you know, we have a very affluent high [ FICO ] business. And we are also looking at discretionary spend where you see the stress more and it's all good. You are seeing some extra rotation into gas-related spend, but the consumer is healthy. More importantly, employment is solidifying and strengthening, and real wage growth is strengthening. So we feel good about the customer. What's been the real pleasure this year is core loan demand from not just the AI trade or the data center trade or NDFI. Broad-based mid-American core growth for all the right reasons. So -- but you are right, the sentiment is getting bleaker even as the facts are quite strong. That's what we're looking at.

So it is something you're focused on, but nothing is coming through in the numbers, nothing yours.

Nothing is coming through in the numbers. It's the sentiment and the forward gauge is what we are focused on.

Okay. Perfect. And John, maybe I'll come to you. With the quarter now behind us, I guess, how does that translate into what you're seeing so far in the numbers this quarter?

Sure. Yes. And thanks for hosting a great conference. So we are up for another strong quarter. We would maybe just to give a little color on some of the components. Net interest income, we talked about 6% to 7% year-on-year growth, will be on the -- towards the upper end of the range on that for the quarter. Fee revenue, we also talked about 6% to 7% year-on-year growth, and we'll be above that range this quarter on the strength of capital markets. And expenses will come in as we expected, so 3% to 4% year-on-year growth. So when you put all that together, it's a very positive -- we have a lot of positive operating leverage. We're very excited about the end of the quarter here. I'd also say, just from a full year perspective, no change really to our guidance. We have -- we still have mid-single digits from a -- from a revenue standpoint, and then we expect at least 200 basis points or more positive operating leverage for the full year.

Great.

And just to add, we closed on our BTIG deal, and we'll update the guidance at earnings with that included.

Okay. So this excludes the BTIG?

Yes. So in July, we'll comment on BTIG. How we incorporate that in the guidance, we'll be more clear about that at that time.

All right. Perfect. So just to recap, full year guide, no change there. For the quarter, you're seeing even more operating leverage because you're coming in at the high end of the NII guide above the range of the fee guide and in line in the expense?

That's right. In summary.

That's a good update. Thank you for that. And I think let's start on deposits because that's been an area of debate amongst the investor community. I think at earnings, you said the deposit costs should remain relatively stable even if the Fed doesn't cut rates this year. We're starting to see a hike getting priced in toward the end of the year. Can you provide us with an update on how you're thinking about deposit costs here?

Yes, sure. Really no change to our outlook on deposits. I think, how you summarize how, we still think about it, there really isn't too much change in terms of how our deposit base is presented. We feel like where we've gone is really more focused on consumer deposits. So we've been doing that for the last couple of years in terms of moving the -- shifting the mix to more consumer base. Over the last several quarters, we've moved that mix up 2 points. We expect another, in terms of total amounts and a record, amount of consumer deposits so that the consumer part of the deposit and is working very well. What has changed, as you pointed out, the rates have changed. But for us, we're pretty agnostic to that move and shift in sentiment just because we're neutral from an interest rate risk positioning. And so if rates go up or down, that's not going to impact us too much. What I would say, though, is where we're focused is really on how we go to market and how we accumulate deposits. And so there's 3 areas I always focus on with the team. First, it's going to be about our distribution. We've made a lot of investments in branches over the last several years. We've improved our -- the way we go to market with our bankers, either in the call center or in the branches. Updated incentive plans things of that variety. The second thing would be on the modeling capabilities. So really getting really surgical on the pricing, whether it's on an individual basis or it's within MSA type level so we can get very granular with respect to that sort of pricing. And then thirdly, is just the products. We've been enhancing our product set over the last couple of years. As an example, Bank Smartly is a flagship product that we use in the savings product of that, has actually gone from nothing a couple of years ago to nearly $50 billion right now. So we've seen a lot of good momentum in that space, and we feel really good about the deposit base right now.

So one area of, I guess, was a competition that might not be near term, but people are talking about as the impact of having a stable coin and agent AI agent -- well, agentic AI and that driving deposit costs. What are you thinking about that debate in terms of the longer-term impact on deposit costs across the industry?

We are not seeing the impact, and the noise is far outpacing any observed behavior in the franchise. The bare case on bank deposits with AI and stable coin that we hear about is AI tools create transparency to deposit pricing and rewards on stable coin will provide one way to risk deposits out of the system. So that's sort of what the bar piece is. There's a lot of barriers to that coming through really around consumer behavior. So on the institutional side, man, there's a lot of price transparency, and that part of the business can get the rate they want. It's a very efficient market. There may be some exposure on the small cross-border flows to inflationary economies where stable coin seems to have been -- but we don't have almost no exposure to that business. On the consumer side, it's even more robust. If this narrative that people are just sleepy and sit on deposits without earning, is not the world we experience. We add value by access to physical branches by advice from people, by ability to call into a call center. If your entity gets stolen, assurance that a bank will be around for 100 years, and you can rely on that assurance, that if you have a fraud event somebody will be there to help you. And all of this collectively is the value proposition of a bank, and we spend a lot of time trying to strengthen that. And the AI tools will be a real positive benefit from our point of view. The positivity is the ability to provide a personalized set of advice to people, which is not affordable today. But if the AI tools do what we are beginning to see them do, we could have the same client adviser in a branch, handle twice the customer base. Our AI tool at the branch, we call it Pearl, what it is meant to do is to read the notes that have been written about every customer's interaction across all channels and give to the adviser, a very precise view of what's the best product for the customer, not for the bank. And that increases your leverage. So I would just say to you with quite sort of real conviction that this narrative is overblown on sort of the impact of AI and stable coins on sort of core deposits of the bank in the near term.

I definitely want to dig in on the AI side, but maybe to round out the conversation on deposits and AI. Gunjan, you've emphasized that you're winning deposits through deeper relationships and differentiated capabilities. And you're also densifying in certain markets, right, as you expand in in some -- and you're densifying in others, how are those strategies working together to drive the post growth? And which products or capabilities resonate amongst clients?

Well, thank you for asking. It's a big conversation and a big focus for us to improve the quality of the deposits, and we define that by anchor around a real relationship value proposition. We do not subscribe to the pieces sort of lazy customers are the way to prosperity going forward. Also very focused on the Gen Z customer base and not just sort of create a model that is attractive to only one generation. So our strategy is, how do you be really exciting to the person, like my dad, and how do you be very excited to my son? And that's sort of the range. John talked about two of the big strategies to deepen the client relationships, which is precision pricing by micro MSA so that you are really balancing both with the cost of deposits. But the big push has been acute product. The Bank Smartly, which is now up to $50 billion, allows you to earn attractive returns and rewards on your credit card based on your checking and savings relationship. So there is something in it for the customer to consolidate their relationship. And our deepening statistics have steadily improved, and that's what's driving the consumer deposit. Then the densify is a matter of expanding our reach, not just deepening our share of wallet with the client. Just a quick sort of history lesson on how we grew up. U.S. Bank really grew up over -- since the '90s with a lot of bank M&A roll-ups. So the markets were put together with a deep emphasis on what I would call Tier 3 and 4 markets within our 26 state footprint. What we have been working on for the last 10 years now is changing the format of in-store service-oriented branches to large advice hubs that deliver maybe 2 to 3x the deposit per branch. They are nice branches. This is where you really get into the advice part. And we are moving to Tier 1 and 2 markets within our franchise. So that's the densified strategy. There are about a dozen or so markets where the household growth is about twice national average. Within our 26, and we are really wanting to get the branch density above 8% there. That's when you get disproportionate deposit growth and the acquisition costs are low. And our goal is to be top 4 depositor in these high-growth densify markets. In addition, we are now inching out to 1 or 2 contiguous states, which is what we would expect to do. So go up from 26 to a few more. Before we did the Union Bank deal, the CapEx investment into branches just to be roughly $200 million on average, and we think that will inch up to $300 million or so. And that's really part of our POL commitment. It's designed. It's just the evolution of having what I call renovated the existing franchise enough that we are now taking the model out. And these branches are very tech enabled. They are very different from a servicing mindset. So that's sort of the branch densify strategy.

And you mentioned 8%. Is 8% right number to get more deposit trend in the market and have enough scale?

It seems to be the sweet spot where you're not overbranched and where your acquisition costs are low and the brand is very present. Certainly, within the densified region, the cost of branding and marketing is very efficient. So the ROI and the breakevens are, which is really very attractive there. So there's a formula here. Of course, we tweak it based on competitive actions, but that's the focus of the strategy right now.

Got it. So maybe pivoting to loans. And we spoke about deposit competition, maybe let's talk about loan competition. Recuring the loan spreads are coming in, are you seeing any of that? Any specific trends to call out across any loan categories there?

Sure. Yes. So Manan, you touched on it just a little bit ago, loan demand is broad-based across. There is virtually all categories that we care to be active in. So maybe just to double-click on a couple of those commercial and industrial loans wide range in demand in all different geographies, all different industries, very much focused on CapEx for their own -- or M&A for their own business and their growth needs. And so that has been a very big focus. So you see a tremendous amount of growth there. Commercial real estate also is doing well from a growth standpoint. That's being led more or less by multifamily. But what I'd also say there is there's just fewer paydowns than we had. So we've been having growth in that, but we -- it's just been masked by the paydowns over the last couple of quarters. Now that's starting to abate, and you're starting to see growth in the commercial real estate side of the equation. And then credit cards, Gunjan also mentioned, spend levels are still robust. It's almost a carbon copy from prior quarter, maybe with a plus to the gasoline purchases that people are making, and so that is also driving more spend and more balance sheet in terms of balances that we have from a credit card standpoint. All those areas are areas where we're used on multiservice seeing the client, multiple products in a variety of different areas. And not just growing for [indiscernible] sake, it's got to make sure we make hurdles and things of that variety. But we feel really good about it. You mentioned loan spreads, I might just touch on that. We do see that has grinded in a little bit over the course of the year, in line with where credit spreads just from a macro standpoint. And I think a little bit is the mix too, you see more large corporates and things that command a little bit tighter spread, still good returning loans. So that's kind of the lay of the land of the loan market.

I'll add one thing, Manan. The loan mix, we are intentionally also evolving. And you talked to deposits. And here, our focus is on C&I and credit card. We are oversized in mortgage after our Union Bank acquisition. They brought a lot of California mortgages to it. So the C&I and the credits are bringing really significant fees associated with it. Credit card is, obviously, you know the fee business there. And on the C&I side, because we have such a big instrument services business, it's a very positive. So there's a little bit of extra sort of execution effort around those categories of the loans in the market. It's very favorable to do that.

So let's talk about fees. You've talked about fees becoming a bigger driver of growth and returns over time. Where are the biggest opportunities here?

So we have 42% of our revenues is fees. It's organized in 4 different chunks, very attractive chunks of fees. The biggest is payments. The second is our trust and investment fees, [indiscernible] and our investment services. And the third is capital markets and, of course, the traditional consumer fees. So there's opportunity in the first 3 categories that we are very excited about. And mortgage, we are maintaining. The market is not favorable for mortgage right now. And as I said, we are overweight in that business. Capital markets has been the big focus. We were -- we had product gaps there that we built with the BTIG. And honestly, Manan, we were just underweight the balance sheet that we are deploying. So it's about getting a fair share of rotations into it. We had great products on the fixed income. As John said, that's been a big driver even of this quarter fee growth. And we expect that to grow to about 11% of our revenue, is a target we think. And we are -- with BTIG about 7%. So that will be a big driver of both. The second is payments, where we have had sort of sluggish growth for some time, a lot of momentum there, being -- and trust and investment been performing very well for us over a very big at business. So all 3 of them will drive growth. And we do expect to grow fees higher than our NII and over time, have that 42% inch up. It gives us a stable earnings profile, and it gives us a structurally high return profile, and it create sticky client relationships. So there's a strategic issue here, not just sort of fees for the sake of a financial portfolio.

So I want to double-click on card and payments. Let's start with card. You've talked about how the [indiscernible]. Like, you have a customer acquisition strategy, there's upfront cost associated with that, and then you have some more of the [indiscernible] and profitability there. So can you talk about that trajectory and how you see that evolving?

Yes. So our credit card business is about 3/4 of our total payments business. I know we get a lot of questions on merchant, but it's the card business that is sort of the dominant business. After COVID there was just a period when our marketing spend had settled at an inappropriate level to drive the growth that we aspire to. About 2 years back, we really started to enhance very meaningfully both the marketing spend, but also the product set that would be focused on transactors. Traditionally, we had done very well the loan balances on the credit card side because the products leaned into that. And now we are beginning to see the revenue growth start to inch. It's a 12- to 18-month cycle before the upfront rewards, which are negative revenue phase out. So just last quarter, we showed a trajectory of how the growth is strengthening. And of course, with the Amazon deal coming online, in the third quarter, we expect that to strengthen. The products are doing really well in the market. The Smartly is bringing a lot of card fees as well. So we are very confident. And the new thing this quarter is the corporate card is actually beginning to revive a little bit after a tough year last year. So a lot of good strategies, a lot of good momentum on the card side.

Got it. And then payments, that's been a high priority as well. It feels like it has a little bit more of a longer tail to it. But I guess, how are you thinking about the near-term aspects of it 3relative to the longer-term aspects of it?

So the merchant business, and I'll just repeat a few things because so many investors ask me the question, and I think there's a little bit of a misunderstanding. First, it's a very high-margin business. So often people think it's a tread bare business and it's not for us. It's also a business that's very interconnected with our core small business franchise. Of course, the enterprise side, too, but the core small business franchise. And it's been operated for a very high profit margin for the needs of the business. So what we have done with our transformation over the last 2 years is to refocus the efforts around 5 vertical segment strategies. which is a shift from the way we operated for the last 20 years, which is broad generic clearing and across the entire industry set. That model has sort of gone away. So that transformation is a little bit slower. You have to wait for contracts to undue. You have changed the distribution. And we track about 1% to 2% to 3% improvement in what we think are the vertical business models, and we are about 1/3 of the way there. And each quarter, it sort of inches up. There's some natural variation based on sort of spend levels. But we like the business. We are committed to it. We think we will prevail. Our value proposition is very different from the fintechs. It appeals to industries like healthcare that are regulated, that have HEPA requirements, that data privacy requirement, they expect a level of resiliency and fraud protection that -- so we're very -- we've become very focused on where our value proposition works. But as you say, it is a slow transformation.

Got it. Very clear. Maybe we'll pivot over to expenses. You're currently tracking ahead of your guide of 200 basis points in operating leverage, but you've also said that you're keeping the guide because you might want to make some investments as well. Where are those investments being directed today? And well, let's stop there maybe we can pivot over to the longer-term efficiency

Sure. Yes. So I think the -- from an expense standpoint, we made a lot of progress as we talked about over the last couple of years, we've moved about [ 490 basis points ] on our efficiency ratio positively. We've made a lot of efficiencies. We've had some areas where we've been able to just take costs out that weren't aligned with the strategic priorities that we set out with. And so we've been able to do that. We think there's still room and improvement that we can do, particularly on things like AI and efficiencies and simplification and things of that variety. Where are the expenses, as you mentioned, how is that going to relay. We're very committed to positive operating leverage. And so as revenues are stronger, we want to lean in more. And where you'll see that spend is going to be more on the technology side for products, some of the branch items that Gunjan just talked about as well as the marketing, brand awareness, things of that variety. So that's really where we're going to spend most of our emphasis as we move forward.

And then how do you think about the longer-term efficiency ratio and operating leverage at the bank?

Sure. So as I said, we've made significant progress. We're now kind of in that upper 50s right now. We want to be in that mid-50s to upper 50s over long periods of time. And the reason for that is, as we gain more into the fee categories, as we gain more into capital markets, and we have high expectations for growth there as well as payments and other areas, those are going to naturally have more of an efficiency ratio that is going to put upward pressure, and that's okay. And so that's why we think the mid- to high 50s over a long period of time is the right area for us to be at, to make sure we're balance between investments as well as making sure we have good ratios for us to produce.

Sure, I would just add, though, that we have flexibility, and I want to reiterate our commitment to bringing the efficiency ratio in line with our targets and positive operating leverage. So to that extent, to the extent that something happens in the economy, we have been very clear that we'll take care of the shareholder, interest and commitment. And some of these investments are not -- they're variable investments, we can flex a little bit up and down as needed.

Another thing you've spoken about is the $2.5 billion or so in tax spend. It goes a lot further today because of the advancements in AI and automation. Given that the base of AI continues to accelerate, how are you thinking about the right level of investment there? You spoke about Pearl, you spoke about the various tools that you have for FAs and for the rest of the organization. Talk about like the right level of investment for AI and where you see that whole process going?

Sure. Yes. And maybe I'll back up just a little bit to level set on the number of $2.5 billion. We actually did some work internally to just look at what -- comparing that number to how peers represent it and what's included or not in that, we actually -- there are some expenses that have already embedded in our cost structure that actually should be applied to that. So we think of it more as like a $3.2 billion, is really the amount of tech spend that we have collectively. And the way I would think about that number is that's somewhere in that 10% to 11% of revenues. And so that will give you kind of a gauge of where we'll migrate depending on kind of the revenue spend. So that's just kind of as a big picture, how we think about where we need to spend. Now from an AI perspective, as you mentioned, we're getting efficiencies on some of the coding. And as that happens, we can allocate more and more cost into things like AI and several dozens and dozens, if not hundreds of projects that we have around the bank right now, in terms of utilizing that. One of the things that we did, Manan, is that we've gained so much efficiency from just sort of the simplifications that we've been doing and the focus on our strategic priorities, that we've been able to open up some costs for the business lines. We've established a growth fund. And so if there are good, ready, shovel made projects, if you will, that are ready to go, and have AI use cases or other sorts of automation type of use case, we will fund that. That's something that we can do very quickly. And to Gunjan's point, if things don't go quite as planned on the revenue side, we can also pull back. So we feel like we have a lot of flexibility on this front to move forward.

And the $3.2 billion number is not an additional number?

Not an addition number.

This is what you've already been...

We weren't including some of the information systems, some of the securities, some of these other things that should have been embedded in that number. So we just wanted to update investors on how much our actuator -- how we think about internally, our tech and digital spend is collectively. And all that number is just embedded in our run rate that we have right now.

Got it. Right. So maybe in the last 5 minutes or so that we have pivoting over to regulatory capital. Gunjan, one of the bigger strategic debates right now -- well, actually, before we get into capital, let's talk about the Clarity Act and the broader evolution of stable coins in tokenized deposits. Given the scale that U.S. Bancorp has, how are you thinking about the risk versus the opportunities there?

We are thinking but not doing as much. It's very experimental still. If you look at the world of digital assets, it comes in the form of the capital markets trading side and the commerce payment side. Much of the numbers are on capital market side. We do see revenue momentum from that. It comes in form of very rapid increase in ETFs that are chasing some form of digital assets. And we have some unique products for start-up ETFs. So we are quite attentive to that, and that's in production and operational, cryptocurrency custody, et cetera. The real debate though, in the industry, as you know, is around core commerce and payments and where it is very experimental. Even large e-commerce platforms are not reporting client demand for stable point related. But we are ready with the product set. What is very interested just in the last 6 months is the amount of work we are doing to get -- capture the tokenized technology benefits in the [ Fiat ] system of banking. And much good will come out of that real-time payments, better, cheaper payments, just in the -- with the safety and the banking. So I'm actually more excited about that part of the work we are doing. So lots of experimentation, not much real client demand on the payment side.

Got it. All right. Perfect. So then to talk about capital, John, you're already offering close to that 10% CET1 target. And I think you mentioned the Basel Endgame proposal is about 5% to 7% RWAs. Is there a potential to step up capital returns over the 70% to 75% long-term payout ratio that you've highlighted?

Sure. A couple of points I'd make here is that we're very much focused on our -- we're very close to Category II. And so that's kind of where we're aiming for right now. We know there are pending rules that could be on indexing, on the Basel III Endgame, and all that sort of thing, and that may come to be, but we want to make sure we're ready, and we are from a Category II standpoint and getting that capital to be at that level. We're also, at the same time, very much committed to our long-term payout ratios, in that 70% to 75%. We're just under that today, but we are guiding that up. And over time, you'll see that happening. And as the rules come and go in terms of how that -- the timing of all basins occur, that's something that we'll just -- we'll deal with at that particular juncture. But for now, it's steady as it goes, and we're preparing for that Category II level.

Got it. And are there any changes to how you might allocate capital as you -- as the news come through?

I don't think so. Not materially. I think we're interested in the Endgame is getting finalized, and we will lever as early as practical to adhere to it. We would love to get into that rule set as soon as we can. I think that smarter way from a capital perspective. And I think those risk weights that apply to those will help us just refine where we are from a pricing standpoint, but I don't expect wholesale changes there.

Got it. All right. Perfect. So Gunjan, maybe to conclude one final question. You're generating the 7% to 8% ROTCE, which is in line with the high teens medium-term target. As you think about returns from here, which areas of the franchise you think have the biggest opportunity from here? And where do you see the biggest opportunity to improve profitability?

Well, thank you for letting me close it out. Our first year, my first year was really about getting the foundations in place, getting the leadership transition. We have a fantastic team, wonderful chemistry in the team. We wanted to execute very sharply put some points on the board and are better medium-term targets. That has created a lot of confidence. It's restored investor confidence. So looking forward, our goal is to stay a very high-return bank but accelerate EPS growth and lean into the stature of our franchise. We are the largest non-GSIB. We will be Category II, which means a high quality of data. We have a great fee mix and just execution momentum. So I would expect that the opportunity here is to sustain the efficiency and the return, but just really drive EPS growth, which we think will be very valuation enhancing.

All right. Perfect. With that, we're right out of time. So Gunjan and John, thanks so much for joining us.

Thank you.

Thank you. Pleasure.