U.S. Bancorp

Welcome to U.S. Bancorp's fourth quarter 2019 earnings conference call. Following a review of the results by Andy Susseri, Chairman, President, and Chief Executive Officer, and Terry Dolan, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. If you would like to ask a question, please press star 1 on your touchtone phone and press the pound key to withdraw. This call will be recorded and available for replay beginning today at approximately 12 o'clock p.m. Eastern through Wednesday, January 22nd at 12 midnight Eastern. I'll now turn the conference call over to Jen Thompson, Director of Investor Relations for U.S. Bancorp.

Thank you, James, and good morning to everyone who has joined our call. Andy Susseri and Terry Dolan are here with me today to review U.S. Bancorp's fourth quarter results and to answer your questions. Andy and Terry will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbancorp.com. I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation in our press release and in our Form 10-K and subsequent reports on file with the SEC. I'll now turn the call over to Andy.

Thanks, Jen, and good morning, everyone, and thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on slide three. We reported earnings per share of 90 cents, which included 18 cents per share of notable items, which Terry will discuss in more detail in a few moments. Excluding these notable items, we reported earnings per share of $1.8 per quarter. Loan growth was driven by new client lands and deepening relationships across all our loan portfolios, and we delivered very strong deposit growth. We continue to see strong account and volume growth across our few businesses. Credit quality was stable, and our book value per share increased .7% from a year ago. In November, we received approval from the Federal Reserve for an incremental share repurchase plan authorizing repurchaseness up to $2.5 billion of common stock in addition to our existing authorization of $3 billion. In the fourth quarter, we returned $2.9 billion of our earnings to shareholders through dividends and share buybacks. As indicated on slide four, digital uptake trends remain strong. We are significantly wrapping up the launch of our DIY digital experiences that will continue to drive more and more customer interactions both on and off the mobile app, as well as higher traditional transaction volume. Slide five provides key performance metrics. On a core basis, we delivered an .1% return on tangible common equity in the fourth quarter. For the full year, our core return on tangible common equity was 18.8%. Now I'll turn it over to Terry to provide detail on the quarter as well as forward-looking guidance.

Thanks, Andy. If you turn to slide six, I'll start with a balance sheet review followed by a discussion of fourth quarter earnings trends. Average loans grew .8% on a link quarter basis and increased .9% year over year. Link quarter growth is driven by strength in residential mortgages, commercial real estate, and credit card loans. In C&I, pay down activity muted overall growth in the fourth quarter, primarily reflecting the rate environment and robust capital market conditions. New commercial business activity is healthy. However, pay down activity is likely to continue to be a headwind near term, albeit a diminishing headwind assuming that the interest rate environment is stable. Turning to slide seven, deposits increased .9% on a link quarter basis and grew .6% year over year. Notably, average savings deposits grew by 11.1%, driven by -the-board growth in wealth management, investment services, consumer banking, and commercial banking. Turning to slide eight, credit quality was stable in the fourth quarter. On a dollar basis, non-performing assets declined approximately 15% on both a link quarter and a year over year basis. The ratio of non-performing assets to loans plus other real estate owned also improved link quarter and year over year. The new accounting standard related to credit losses, commonly known as CSEL, became effective January 1st and has no impact on our 2019 results. We estimate that the adoption of CSEL will result in a $1.5 billion cumulative effect adjustment to our allowance for loan losses compared with December 31st, 2019, which is in line with our previous guidance. Slide nine highlights fourth quarter earnings results. We reported earnings per share of 90 cents, which included several notable items, which reduced earnings by 18 cents per share. Excluding these notable items, we reported earnings of $1.08 per share. Slide 10 lists the notable items that affected earnings results for the fourth quarter of 2018 and 2019. Fourth quarter 2019 notable items included restructuring charges, including severance and certain asset impairments, and an increased derivative liability related to visa shares previously sold by the company. As a reminder, we recognized several notable items during the fourth quarter of 2018, including a gain on the sale of our ATM servicing business, the sale of a majority of the company's covered loans, as well as charges related to severance, asset impairments, and an accrual for certain legal matters. Along with a favorable impact, deferred tax assets and liabilities related to changes in estimates from tax reform, the net impact of notable items in 2018 was an increase of three cents per share. My remarks through the remainder of the call will be referencing results excluding notable items incurred in the fourth quarters of 2019 and 2018. Turning to slide 11, net interest income on a fully taxable equivalent basis declined by 3% year over year in line with our expectations as the impact of loan growth and higher yields on the first quarter of 2019. The net interest margin declined by 10 basis points versus the third quarter. About four basis points of the decline was due to higher premium amortization expense in the investment securities portfolio. The remainder of the pressure can be attributed to the yield curve compression and earning asset mix partly offset by lower deposit costs. We expect the net interest margin to be stable in the first quarter compared with the fourth quarter. Slide 12 highlights trends in noninterest income. On a year over year basis we saw good growth in merchant acquiring revenue driven by account and volume improvement. As expected, credit and debit card revenue declined 1% year over year due to two processing days in the fourth quarter of 2019. We look for credit and debit card revenue to return to a mid single digit growth pace in 2020. Corporate payment products revenue declined .1% driven by lower commercial business sales volumes. However, in the past few weeks sales volume growth has returned to a mid single digit growth rate. Trust and investment management growth reflected business growth and favorable market conditions. Deposit service targets were impacted by the sale of the company's ATM servicing business in the fourth quarter of 2018. The decline in treasury management fees from a year ago reflected the impact of changes in earnings credits, a residual effect of the rising rate environments in 2018. Notably treasury management fees increased on a linked quarter basis reflective of the recent interest rate declines in the third and fourth quarters of 2019. Mortgage banking revenue increased .7% year over year on strong origination and sales revenue growth. Compared with the fourth quarter of 2018, mortgage production volume increased by .3% and mortgage application volume increased by 83.8%. Refinancing activity represented approximately 50% in the fourth quarter of 2019 compared to about 40% in the linked quarter. Refinancing represented 52% of applications in the fourth quarter. As of November, our digital mortgage app was being utilized by about 86% of all mortgage applications. Turning to slide 13, the .1% year over year increase in non-interest expense reflected increased personnel expense, higher technology and communication expense, and higher net occupancy and equipment expense reflecting actions to support business growth. Slide 14 highlights our capital position. At December 31, our common equity tier one capital ratio estimated using the Basel III standardized approach was 9.1%. I will now provide some forward-looking guidance. For the first quarter of 2020, we expect fully taxable equivalent net interest income to decline at a low single-digit pace year over year but to be relatively flat linked quarter normalized for day count. We expect -single-digit growth in fee revenue year over year. We expect low single-digit growth in non-interest expenses on a year over year basis. Credit quality in the first quarter is expected to remain stable compared to the fourth quarter. And we expect our taxable equivalent tax rate to be approximately 20% on a full year basis. I'll hand it back to Andy for closing comments.

Thanks, Terry. We are operating in a dynamic environment, and this quarter's results reflected the challenging interest rate environment facing the entire industry as well as the impact of actions we took to better position our company for the future. However, as our core financial metrics indicate, we ended the year on a solid note and we are in a strong position as we head into 2020. We view the interest rate environment as a manageable headwind, and we are confident in our ability to permanently grow our balance sheet and gain market share in our fee businesses. Fee growth was negatively impacted by several headwinds in 2019. As Terry discussed, we expect a return to normalized growth in credit and debit card revenue this year. In a more stable interest rate environment, as a refi-driven market shifts to a purchase-driven market, the investments we have made in our mortgage business over the past several years will become increasingly evident in the form of market share gains. We are proud of our strong and consistent financial track record, but we are always looking for ways to improve. That means we are changing the way we think, the way we work, and the way we do business. As we move into 2020 and beyond, we will continue to increase workflow agility and speed the market for our products and services, while at the same time optimizing our core operation to fund investment for the future. Our ability to leverage the combined power of our rapidly improving digital capabilities and our complete payment ecosystem will lead to higher customer satisfaction, stronger revenue growth and efficiencies, and ultimately improved returns. In summary, we remain focused on managing this company for the long term while delivering new products as a pathway to the future. I'd like to thank our employees for all we accomplished this year, supported by their hard work and commitment to creating value for our customers. We will now open up the call for Q&A.

At this time, I'd like to remind everyone in order to ask a question, please press star followed by the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. And your first question comes from the line of John Pancari from Evacor. Go ahead, please. Your line is open.

Morning. Morning, John. Just want to talk a little bit about the operating leverage expectation. I mean, we got your comments around the quarter, but for four-year 20, I know you had previously indicated that it could be a challenge to attain positive operating leverage for the four-year, given the rate backdrop, et cetera. I wanted to get your updated thoughts on that. If you see that there is a chance you can get, you can see positive operating leverage in what type of magnitude could you see?

Yeah, John, thanks. And as a reminder, you know, we had a goal of achieving positive operating leverage in 2019, and we did that on a core basis for the full year. You know, when we think about 2020, you know, our objective is to target positive operating leverage, and we expect, you know, our expense growth to be, you know, to continue to remain in those low single digits. So, you know, I think we have a number of levers that we continue to look at and pull in terms of optimization, continuing with our physical assets, optimization of the branch system, our back office activities, and a number of different things. You know, so, you know, that's our goal. That's our objective at this particular point in time. You know, that said, as you said in your question, you know, 2020 is a more difficult year simply because of the revenue outlook, and I think, you know, part of being able to achieve it is going to be really based upon, you know, what happens with respect to interest rates, et cetera. So that's, you know, kind of how we're thinking about it.

Okay, great. Thanks. And then in terms of your some of the headwinds that had impacted your fee progression, I know there was the accounting change that impacted as well as a couple other items. Can you just talk about where do you expect underlying momentum to build in the fee businesses as you look at 2020?

Yeah. So, you know, when we end up looking at fee income, I think there's a number of different things that we end up looking at. I think the credit card revenue is stronger. You know, again, mid-segal digits as we think about next year. And, you know, that particular line item was impacted by both an accounting item in 2018 as well as, you know, a pretty slow first quarter, which we had talked about. I think merchant acquiring continues to accelerate and get stronger. We expect mid-single digits there. And then the CPS revenue, while we saw a decline in the fourth quarter because of a little slower commercial spending, you know, that has come back in the first several weeks of the year. And so, you know, our expectation in that category is kind of mid-single digits as well. Deposit service charges, you know, has been a drag this year because of the sale of the ATM business in 2018, you know, so that kind of normalizes at least flat in 2020. I think Treasury management revenue is another area that we would expect, you know, it's kind of hit an inflection point. So while it's down on a -over-year basis, it is up on a linked quarter basis. And, you know, we would expect that to be, you know, better than 2020. So I think there's a number of different things. I think the offset to that is, and if you think about mortgage and we talked about mortgage, mortgage has been pretty strong the last couple of quarters, but in 2019, it was also quite a bit of a drag in the first several quarters. So, again, depending on what happens with interest rates in the current environment, I think that that continues to be a positive story. So that, I mean, I think there's a number of different areas.

Okay, Terry, that's helpful. Thank you.

And your next question comes from the line of Erica Najarian from Bank of America. Go ahead, please. Your line is open.

Yes, good morning.

Hey, Erica. How are you doing this morning?

Good. Thank you. Hard to loud and clear on your expense growth. And I'm wondering, though, if the increased severance charges that we've seen could lead to a different, you know, different geography in terms of expense growth. And I guess I'm just looking back at your headcount, which seems to have risen sort of along coincident with the consent order. And I'm wondering if, you know, part of the initial statement up front, Andy, in terms of continuing to transform the business is trying to take some of the compensation growth that you experience over the last three years and really putting that back in technology. Is that sort of how we should expect the geography could change underneath that, you know, low single digit expense growth that you're expecting for 20?

I think that's not an unfair description, Erica. You know, it's not just technology, but it's people and technology. But it's optimizing the way we're doing business to continue to invest in the future. And, you know, our expense growth was higher during the consent order periods. But as you know, it's been in the low single digits the last couple of years and a notable, truly notable items, .4% year over year in 2019. And that includes optimization and expense takeout while at the same time investing in technology and people for the future. And I would expect that to continue into 2020.

And I guess I'm wondering if the our takeaway from that is because that seems like it's behind you. And again, it feels like the severance charges are setting up for further optimization and rationalization that you're accelerating the amount of dollars that you're putting into the future, so to speak, whether it's headcount related to that or technology itself.

Yeah, I think that that's a fair comment, Erica. And again, I think the shift is optimizing what I would call the back office in the branch network, which are being impacted by customer behaviors as we transition to more of a digital environment. But at the same time, we're reinvesting that in technology spend to support those digital transformation. And so maybe a little bit of a shift from compensation to technology type of cost. But our expectation when we think about 2020 is to continue to make the investments in the business that we have been making over the last couple of years.

Thank you. And just one more, if I could squeeze it in. Deposit costs were down 15 basis points quarter over quarter. And I'm wondering underneath the one Q and I outlook, what do you expect for a deposit cost trend for the first quarter? And also, if the curve outlook stable continues to be stable from here, could net interest margin for the rest of the year stabilize or potentially increase from one Q levels?

Yeah, well, certainly, you know, if the rate environment continues where it is today, our expectation is that 2020 net interest margin would be pretty flat the fourth quarter with some possible positive bias depending upon what happens on the long end of the curve. But, you know, that's kind of our thought process. And, you know, the reason for that is the premium amortization that we've experienced in the third and fourth quarter is stabilized at this particular point in time. When we think about, you know, deposit cost, deposit pricing, you know, we have been pretty responsive on the institutional deposits in terms of bringing those repricing those down as rates have come down. And I think from here on out, deposit pricing will be a function of both competition. What happens on the short end of the curve?

Got it. Thank you.

And again, as a reminder, if you'd like to ask a question, please press star followed by the number one on your telephone keypad. And our next question comes from the line of Scott Seifers from Piper Sandler. Go ahead, please. Your line is open.

Hi, Scott. Hi, Scott. Hi, thank you for taking the question. Just curious if you might be able to offer any just top level comments on the overall kind of pace of loan growth and overall demand. You know, if you look at the H8 data, it's definitely been held up or supported by the consumer side. But it's been a little surprising to see the slow down in growth on the commercial side, however. So I'm just curious, given the breadth of your guys' franchise and, you know, different types of customers you look at, what you're seeing at a very top level.

Yeah, well, at a very high level, again, I think economically we feel pretty optimistic in terms of what the outlook there is. If you end up looking at the components of loan growth, I think we saw pretty strong and good growth with respect to consumer lending. You know, the area that was a little bit softer in the fourth quarter was really our C&I or our corporate sort of lending. And that's principally why we saw, you know, production and the pipeline continuing to be reasonably strong. We saw pretty significant paydowns that were taking place in that space driven by capital markets activities. And that's a function of the long end of the curve coming down in the third and early fourth quarter. You know, with that stabilizing, while we would expect some of the paydowns to continue into the first quarter, I think that will moderate.

Okay, perfect. Thank you. And then just any additional updates on ramification from the LCR rules? I think you guys have been talking about, you know, $11 billion to $50 billion of liquidity free up. Any updated thoughts on how you're thinking about that dynamic? Yeah,

that's in the ballpark in terms of the amount of how, what the impact is with respect to LCR. You know, we're continuing to look at different alternatives. And, you know, part of it is thinking about extending duration a little bit, possibly investing a little bit more in agency mortgage backed securities, which would provide a little bit better yield. But I don't think, I think it'll be on the margin and it won't be anything traumatic.

Okay. All right. That's perfect. Thank you very much.

Mm hmm.

And there are no further questions in queue at this time. I'd like to turn the call back over to Jennifer Thompson for closing remarks. Oh, it looks like we did get one question. We do have a question from the line of Vivek Juna from JP Morgan Chase. Go ahead, please. Your line is open.

Thank you. Hi, Andy. Hi, Terry. Just wanted to clarify on credit debit card fees. What was the impact from two low fee or processing days? How should, what does that do? And is there a reversal in 2020?

Yeah, good question. You know, there was an impact of two days that ended up really taking our fee income from kind of that low to middle single digits to the negative 1% in the fourth quarter. There is one extra day in the, in 2020, relative to 2019. But let me just kind of dissect it a little bit because I think that that is maybe helpful. When you end up looking at the growth rate for 2019, it was really impacted by three different things. One is that there was an accounting change that occurred in the first quarter of 2018 that because of the lapping effect ended up depressing growth rates in 2019. In addition, if you remember, the consumer spend level in the first quarter was significantly lower and is kind of at an unusually low level. And of course, as the as concerns around the economy stabilized, that consumer spend has come up. That has been in the mid single digits in the second, third and kind of fourth quarter in terms of sales volumes. And then as you know, to get back to the processing days, quarterly results can be lumpy. But when we think about 2020 in terms of on a full year basis, we really think that mid single digits is a good target for us and a good estimate for us. Our sales volumes over the last several quarters have been kind of in that range. And, you know, and when you think about it on a on a day adjusted basis, you know, it's been pretty consistent from quarter to quarter. So in 2020, there's one more day and that will help a little bit. But, you know, mid single digits for 2020, I think is a good estimate. Again, quarterly results will be a little bit lumpy. But when we think about the year, that's kind of how we're thinking about it.

And when I look back over the prior couple of years, you'd had, you know, this line item was growing at sort of more like nine to nine and a half percent when you look at 17 to 18. Has it been either going to the mid single digits, has there been any reduction in pricing, a shift in the kind of contracts or is it? This higher rewards expense, what Terry is driving that slow down from that high single digit level to the mid single digit? Yeah,

the growth rates in 2017, 2018 were influenced in some respect because of some portfolios that we were acquiring during that for their time frame. More so than other factors. And so when we think about pricing, you know, there hasn't been a lot of compression with respect to price. We feel pretty good about that. And rewards has been relatively

flat. So that is a factor. So that mid single digit number is a good way to think about the next 12 months. OK,

and as you think about from in terms of other fee revenues, Andy, you said and Terry, Treasury management should be good. Corporate card fees when I look at that, that was also a little bit softer this quarter. You know, it's actually down year on year. Any color on that? Because I know the yeah, I'll just let you answer that.

Yes, that the the impact of that is because we saw in the last half of the fourth quarter corporate spend activity slow. That had been running in the mid single digits a little bit higher in the first few quarters. Fourth quarter saw a slowdown to almost flat. And as Terry mentioned in his prepared remarks, we did see a pick up in the first two weeks of January back to the mid single digits. So that was trivial slowdown, but it seems to have come back.

And I think that one of the one of the reasons for that is, you know, if you think about where the yield curve, how rates were moving, there was concerns about recession. People were uncertain with respect to economic data. And then you had the hangover of tariffs. I think the sentiment on a corporate side appears to be looking better. You know, we're going to be signing a trade agreement with China today, I believe, in terms of phase one. And the U.S., Mexico, Canada agreement, you know, is well on its way. So I think that some of that uncertainty that might have been impacting discretionary spending in the corporate and the commercial side of the equation has been alleviated. So we feel pretty good.

And I want to confirm one last thing. Cecil Day two. Could you talk a little bit about what do you see that doing to your provision expense? Yeah,

you know, we talked about certainly day one and day two as part of investor day, you know, the provision will increase. You know, we think that in terms of loan growth, providing basically at kind of that 2% level versus one and a half percent is kind of how we're thinking about. But there's going to be more volatility related to Cecil. And I think one of the things we'll end up looking at is just, you know, what is the stability in the overall portfolio and what are net charge ups doing on a quarter to quarter basis?

All right. Thank you. Yeah,

we do have another question from the line of Ken Houston with Jeffries. Go ahead, please. Your line is open.

Hi, everyone. This is Amanda Larson on for Ken. Hey, Amanda, how you doing? Great. Thanks. I think it's understood that 2020 will likely be an aberration versus the long term trends that you set out at investor day related to revenue growth headwinds, but that you'll still strive to achieve positive operating leverage in 20. But I'm wondering how negative could negative operating leverage be in 20 before you do take actions related to slowing the pace of investment spend or creating more saves?

So, as Terry mentioned again earlier, we expect and target positive operating leverage for 2020. We have a number of levers that we can continue to pull to optimize the current organization structure to continue to invest in the future. So, Amanda, the way we think about it is the balance of optimizing today and investing in the future while always targeting that positive operating leverage. And that's how we're managing the company.

OK, great. And then can you guys talk about the capability as the SagePay and how you see US banks position evolving in the e-commerce payment arena over the medium term? Thanks.

Yeah, we're very excited about SagePay. You know, it is a kind of leader in the e-commerce space within the UK and Ireland. And we also have the opportunity to be able to extend that into the rest of Europe. We have a pretty big footprint across Europe. So pretty excited about that as we think about next year. You know, we ended up rolling out sort of similar e-commerce capabilities over the course of the last 12 to 18 months here domestically. And so, you know, we believe that that gives us more capabilities in terms of being able to take advantage of e-commerce in the future.

Awesome. Thanks. Thanks, Amanda. Thank you.

Your next question comes from the line of John McDonald with Autonomous. Go ahead, please. Your line is open.

Hey, guys. Sorry. I jumped on a little bit late. Did you give an update on the Charlotte expansion, Andy, and how that's going and whether you're targeting new areas for this year to expand on the retail side?

Good morning, John. Charlotte's going well. We opened the branch about three months ago. We've had new customer acquisition growth in current customers. Employees are fired up. We are targeting a number of new branches to be opening at this year and still targeting that number of 10. We're learning a lot from that investment. We continue to track that and measure our activity. And I would expect us to continue to expand in new markets, but our first goal is expanding to our target number in Charlotte.

Gotcha. Okay. And then, Terry, just a couple of cleanup things on NII. I think you mentioned the amortization kind of stabilizes earlier this year. Is that right? And then the roll-off rates, like where the tenure is today, are those kind of break even or slightly accretable? Were you putting new money to work in the bond portfolio today relative to what's rolling off?

Yeah. So addressing kind of your second question first, the reinvestment with respect to securities is still about 15 basis points or so accretive. And we would expect that based on where rates are today. The premium amortization does stabilize in the first quarter. And so when we think about net interest margin for the year, we think it's going to be relatively flat, maybe a little bit of positive bias relative to the fourth quarter of 2019.

Okay. So the down NII for the year is just the tough comps of where you started last year. I guess, right? Things from a sequential standpoint, though, feels relatively stable.

Yes.

Okay. Thank you.

Thanks, John.

And with that, there are no further questions in queue. I'd like to turn the call back over to Jennifer Thompson for closing remarks.

Thank you, everyone, for listening to our earnings call. Please contact the investor relations department if you have any follow up questions.

This concludes today's conference call. You may now disconnect.