U.S. Bancorp (NYSE:USB) Q2 2023 Earnings Call Transcript

U.S. Bancorp (NYSE:USB) Q2 2023 Earnings Call Transcript July 19, 2023

U.S. Bancorp reports earnings inline with expectations. Reported EPS is $1.12 EPS, expectations were $1.12.

Operator: Welcome to the U.S. Bancorp second quarter 2023 earnings conference call. (Operator instructions). This call will be recorded and available for replay beginning today at approximately 11:00 a.m. Central Time. I will now turn the conference call over to George Anderson, Senior Vice President and Director of Investor Relations for U.S. Bancorp.

George Anderson: Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; Terry Dolan, our Vice Chair and Chief Financial Officer; and John Stern, Senior Executive Vice President and Head of Finance. During initial prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules are available on our website at usbank.com. Please note that any forward-looking statements made during today’s call are subject to risk and uncertainties. Factors that can materially change our current forward-looking assumptions are described on Page 2 of today’s presentation, our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following our prepared remarks, Andy, Terry, and John will take any questions that you have. I will now turn the call over to Andy.

Andy Cecere: Thanks, George. Good morning, everyone, and thank you for joining our call. I’ll begin on Slide 3. The second quarter was highlighted by our successful conversion of Union Bank and a meaningful increase in our common equity tier one ratio to 9.1%, 60 basis points higher than the first quarter, driven by earnings accretion and balance sheet optimization actions. Earnings per share totaled $0.84 in the second quarter, including $0.28 per share of notable items. Excluding the impact of notable items, earnings per share was $1.12. Slide 4 provides reported and adjusted income statement results and other key metrics. Our second quarter results were supported by new customer account growth and deepening of relationships across our business lines, as well as continued disciplined expense management.

Net interest income was lower compared with the first quarter, primarily due to pressures on deposit pricing. However, momentum and fee income businesses continue strong. One of the strengths of our business model is our diverse and stable funding that includes a mix of both consumer and operational wholesale deposits. This quarter, while our average deposit balances decreased by 2.6% linked-quarter, period end deposits were higher by 3.2% or approximately $522 billion, largely reflective of seasonal operational deposit flows in areas such as our corporate banking and trust businesses. Credit quality metrics remained strong versus pre-pandemic levels, but are normalizing as expected. This quarter, we strengthened our balance sheet by increasing the loan loss reserve, reflective of our prudent approach to credit risk management.

Slide 5 provides key performance metrics. Excluding notable items, our return on average assets was about 1.07%, and our return on tangible common equity was 22.3%. Slide 6 provides a summary of our recently completed conversion of Union Bank. Following our main systems conversion on Memorial Day weekend, all credit cards, trust and investment accounts, were transitioned to our platform in June. Early indications are encouraging, and I’m even more confident today of the strategic and financial merits of this deal. We continue to expect meaningful revenue opportunities, and our cost synergy targets remain intact. One highlight is the Union Bank customers are adopting our digital capabilities more quickly than expected. As of June 30, just one month following conversion, we’ve had over a half a million enrollments in our digital product offerings, and this number continues to grow.

Our teams are working diligently to leverage the value of overlaying all of our products and services to Union Bank customers as we continue to provide – and we’ll continue to provide updates on our progress. I’ll now turn the call over to Terry, who’ll provide more detail on the quarter.

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Terry Dolan: Thanks, Andy. Turning to Slide 7, our balanced mix of consumer, corporate and commercial deposits continues to be a key source of strength for the bank. As Andy highlighted, while average total deposits declined 2.6% or $13.1 billion on a linked-quarter basis, we ended the period with $522 billion of deposits, representing a 3.2% increase in ending balances on a linked-quarter. This quarter, our end of period percent of non-interest bearing deposits declined to approximately 20% from 25% in the first quarter, due to both industry dynamics and a change we made to Union Bank retail accounts at conversion. Specifically, about half of the decline was related to an increase in deposit volumes and mix shift, while the other half was primarily driven by a customer-friendly product conversion decision by us.

To create a more positive customer experience, we upgraded Union Bank customers to our interest-bearing Bank Smartly checking product, which offers a better checking solution, as well as other benefits. This change will provide customer retention benefits without a material impact on our net interest margin. Given current interest rate volatility and the significant competition for deposits across the industry, we now expect our cumulative deposit beta to be in the mid 40% range by the end of this rate cycle, slightly higher than our previous expectation, but consistent with the deposit pricing dynamics in the industry. On Slide 8, average total loans this quarter were $389 billion, which was flat on a linked-quarter basis, and up 19.9% year-over-year.

Commercial real estate loans represent approximately 14% of our total average loan portfolio, with commercial real estate office exposure representing only 2% of total loans, and 1% of total commitments. Our office exposure is well balanced amongst suburban, specialty, and central business districts, and had a weighted average loan-to-value ratio of approximately 55% at initial underwriting. Given current macro factors, as well as other portfolio considerations, we increased the reserve ratio for commercial real estate office loans to 8.5%. Turning to Slide 9, we reported diluted earnings per share of $0.84 for the quarter, or $1.12 per share after adjusting for notable items in the amount of $575 million or $0.28 per diluted common share. Notable items this quarter included $310 million of merger and integration-related charges associated with the acquisition of Union Bank, as well as $265 million related to balance sheet optimization and capital management actions, largely driven by a provision charge of $243 million related to the securitization of approximately $4.4 billion of indirect auto loans, as well as an additional $4.2 billion sale of Union Bank mortgage loans.

These moves enable us to more effectively position the balance sheet for profitable growth and optimize returns. Slide 10 provides a more detailed earnings summary for the quarter. Turning to Slide 11, net interest income on a fully taxable equivalent basis totaled approximately $4.4 billion, which represented a 4.7% decrease on a linked-quarter basis, and a 28.4% increase from a year ago due to the impact of rising rates in the acquisition of Union Bank. Our net interest margin declined from 3.10% in the first quarter to 2.9% in the second quarter, which is somewhat lower than expected. The linked-quarter decline was primarily due to the impact of maintaining higher cash levels given the debt ceiling concerns and deposit pricing pressures, partially offset by higher rates on earning assets.

Slide 12 highlights trends in non-interest income. Non-interest income increased 8.7% or $219 million on a linked-quarter basis, driven by higher payment services revenue, trust and investment management fees, and commercial product revenues. Within payment services, revenue increased $112 million on a linked-quarter basis, reflecting credit card revenue growth of $62 million or 17.2%, driven by higher margins and sales volume, and an increase in merchant processing revenue of $49 million or 12.7%, driven by pricing. Also noteworthy were increases in trust and investment management fees of $31 million or 5.3%, driven by core business growth and commercial product revenue of $24 million or 7.2%, driven by strong debt capital markets activity in the quarter.

Compared with a year ago, non-interest income for the company increased $178 million or 7.0%, largely driven by higher core fee income. Turning to Slide 13, reported non-interest expense for the company totaled $4.6 billion in the second quarter, which included $310 million of merger and integration-related charges. Non-Interest expense, as adjusted, decreased $52 million, or 1.2% on a linked-quarter basis. Slide 14 shows credit quality trends, which continue to be strong from a historical perspective, but are normalizing as expected. The ratio of non-performing assets to loans and other real estate was 0.29% at June 30, compared to 0.3% at March 31, and 0.23% a year ago. Our second quarter net charge-off ratio of 0.35%, as adjusted, increased five basis points from a first quarter level of 0.3%, as adjusted, and was higher when compared to the second quarter 2022 level 0.2%.

Our allowance for credit losses as of June 30, totaled $7.7 billion or 2.03% of period end loans. Turning to Slide 15, we accelerated our capital actions and ended the quarter with a CET1 capital ratio of 9.1%. The 60 basis points linked-quarter increase in the CET1 ratio, reflected 20 basis points of earnings accretion net of distributions, and an additional 40 basis points attributable to risk-weighted asset and other balance sheet optimization initiatives, with low to neutral earnings impact. During the quarter, we received the results of the Federal Reserve’s 2023 stress test, and we expect to be subject to the minimum stress capital buffer requirement of 2.5%, which is unchanged from last year. Despite this year’s more stressful economic scenario and an additional $1.4 billion of merger-related charges, with limited recognition of cost synergies related to Union Bank.

I will provide third quarter and updated full year 2023 forward-looking guidance on Slide 16. Starting with third quarter 2023 guidance, we expect net interest income of between $4.2 billion and $4.4 billion in the third quarter. Total revenue as adjusted is estimated to be in the range of $6.9 billion to $7.1 billion, including approximately $75 million of purchase accounting accretion. Total non-interest expense as adjusted is expected to be approximately $4.3 billion, inclusive of approximately $120 million of core deposit intangible amortization related to the Union Bank acquisition. Our income tax rate as adjusted is expected to be approximately 23% to 24% on a taxable equivalent basis. We expect merger and integration charges of between $150 million to $200 million in the third quarter.

I will now provide updated guidance for the full year. For 2023, net interest income is expected to be in the range of $17.5 billion to $18.0 billion. Total revenue as adjusted is now expected to be in the range of $28.0 billion to $29.0 billion, inclusive of approximately $330 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be approximately $17 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis, as adjusted, is expected to be approximately 23% to 24%. We continue to expect to have $900 million to $1 billion of merger and integration charges in 2023, and total merger and integration cost of approximately $1.4 billion, consistent with earlier guidance.

I will now hand it back to Andy for closing remarks.

Andy Cecere: Thanks, Terry. I’ll finish up on Slide 17. The strength and stability of our balance sheet remains a differentiator for our company. As these metrics indicate, we are well capitalized and prepared for a potentially more challenging economic environment, given our strong liquidity, diversified business mix, and consistent and disciplined approach to credit risk management. Building capital remains a top priority as we prepare for Category II designation, and we are confident in our ability to execute on our strategic growth opportunities and key initiatives. Following the successful conversion of Union Bank this quarter, we entered the second half of the year well-positioned as a national banking franchise, with increased scale, broader reach, and meaningful revenue growth opportunities provided by the addition of 1.2 million new consumer and small business customers.

Across the business, from consumer to wealth management and commercial to business banking, we see significant opportunities to provide legacy Union Bank customers with a broad set of our products and services and industry-leading digital capabilities. Additionally, the $900 million of identified cost synergies are still expected to be fully reflected in run rate savings as we head into 2024. Let me close by thanking our employees for all that they do to help provide exceptional service that makes us a destination of choice for our clients and a valued partner to all our stakeholders. We’ll now open up the call for Q&A.

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Q&A Session

Operator: [Operator Instructions] We’ll first go to Scott Siefers with Piper Sandler. Please go ahead.

Scott Siefers: Hey. I was hoping maybe we could start out with a couple of thoughts or expand the thoughts on capital. Maybe just sort of a refresher on anticipated capital build from here, especially in light of just how quickly you – just how quick the pace was in the second quarter. And then ideally sort of what you’re targeting, presumably under Category II rules and when you might get there in your view.

Terry Dolan: Yes, thanks, Scott. I think that we ended up at 9.1% CET1 at the end of the second quarter. Our expectation now through the rest of this year is that we’ll be at least at 9.5% by the end of the year, and that’s going to be a function of earnings accretion net of distributions, as well as some continued actions from a risk-weighted asset perspective. We had originally articulated about 50 basis points of risk-weighted asset optimization over kind of the two-year time horizon. We felt like we could accelerate that a lot because the vast majority of them were what I would call low to neutral impact on earnings accretion. We still have a number of different levers that we can pull, some of which we’ll be able to execute on this year, some of which is in preparation for 2024, but we feel very confident that we have a game plan in order to be able to get to at least 9.5% by the end of this year, and to be in a position to be able to fully adopt Category II by the end of 2024, if necessary.

Scott Siefers: Okay. All right, perfect. Thank you. And then maybe a question on the deposits. Appreciate all the commentary on the non-interest-bearing runoff being – I guess about half driven by the product change as you integrated the Union Bank customers. But just given sort of the optics of it, just curious about any thoughts – is that pretty much done or would you expect for the broader or entirety of the firm, could NIB balances still continue to flow out, just in light of where interest rates are, and where would you see those fleshing out maybe as the percent of total deposits?

John Stern: Hey, Scott, this is John. So, in terms of the DDA mix, you illustrated that correctly. We moved about $15 billion of deposits over into that Bank Smartly interest checking product. And so, that gets us to about a 20% ratio. We think that that’s about where we land here. It’ll be plus or minus of course, as we kind of go through the quarters, but we think that we’re at a low point here.

Scott Siefers: Perfect. Okay, good. Thank you very much.

Operator: And next, we’ll go to John Pancari with Evercore. Please go ahead.

John Pancari: Good morning. Regarding your non-interest income guidance of the 17.5 to 18, beyond the non-interest-bearing mix commentary that you just provided, can you also help unpack that guidance in terms of overall deposit growth expectations, as well as maybe the margin assumption behind that and loan growth as well, if possible. Thanks.