U.S. Bancorp Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 18, 2023

There are 15 speakers on the call.

Operator

Welcome to the U. S. Bancorp Third Quarter 2023 Earnings Conference Call. Following a review of the results, there will be a formal question and answer session. This call will be recorded and available for replay beginning today at approximately 9 o'clock A.

Operator

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.

Speaker 1

Thank you, Brad, and good morning, everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer Terry Dolan, Vice Chair and Chief Administration Officer and John Stern, Senior Executive Vice President and Chief Financial During their initial prepared remarks, Andy and John 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 uncertainty. 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 ks and in subsequent reports on file with the SEC.

Speaker 1

Following our prepared remarks, Andy, Terry and John will take any questions that you have. I will now turn the call over to Andy.

Speaker 2

Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on Slide 3. In the Q3, we reported earnings per share of 0 point 91 which included $0.14 per share of notable items related to merger and integration charges. Excluding those notable items, we delivered earnings per share of $1.05 for quarter.

Speaker 2

3rd quarter results were highlighted by linked quarter and year over year fee revenue growth that benefited from our acquisition of Union Bank, deepening client relationships and strong underlying business activity. We are achieving the cost synergies we anticipated from Union Bank and continue to prudently manage core expense as we identify operational efficiencies across the business. As of September 30, Our common equity Tier 1 capital ratio was 9.7%, an increase of 60 basis points this quarter. This is the same level it was prior to our acquisition of Union Bank. Total average deposits increased 3% or $15,000,000,000 on a linked quarter basis.

Speaker 2

Credit quality continues to normalize this quarter in line with expectations. And we further strengthened the balance sheet by adding $95,000,000 to our loan loss reserve reflective of an evolving credit environment. On October 16, the Federal Reserve granted us full relief from certain Category 2 commitments made in connection with the Union Bank acquisition, given our balance sheet reduction and capital actions. As a result, we are now subject to existing capital rules or if adopted the same transition rules as all other Category 3 banks related to enhanced capital requirements under the Basel III Endgame proposal. As proposed, this would include a 3 year transition period for the expanded risk based approach and AOCI regulatory capital adjustments starting in the Q3 of 2025.

Speaker 2

I will discuss the impacts of these decisions further in my closing remarks. Slide 4 provides income statement results as reported and on an adjusted basis, ending in average balances and other key metrics. Slide 5 provides key performance metrics. Excluding notable volumes, our return on average assets was 1.04% And our return on tangible common equity was 21%. While net interest margin declined 9 basis points to 2.81% this quarter, in line with our expectations, We continue to expect the NIM to bottom in the 4th quarter as we reach the end of the current rate hiking cycle.

Speaker 2

Turning to Slide 6. A great benefit of our business model include includes a balance between our spread and fee income businesses that helps us reduce earnings volatility through a business cycle. On a year over year basis, non interest income grew approximately 12%. Within Payment Services, we continue to invest in our digital capabilities, expanding our payments ecosystem and optimizing our distribution. Emphasis on expanded partnerships and integrated capabilities will continue to support tech led growth across merchant processing and increase opportunities across other areas of our payment services businesses.

Speaker 2

Additionally, we are continuing to make investments that leverage our scale and strategic market positioning across our Corporate Trust, Mortgage Banking and Capital Markets Businesses, which should enhance our already strong annualized growth trajectories. Slide 7 highlights a few of our many post conversion revenue opportunities and expected cost synergies with Union Bank. Early indications of the potential to deepen relationships with legacy Union Bank loyal, affluent and diversified client base are promising And we continue to be on track to realize approximately $900,000,000 in cost synergies, which we expect to be fully reflected in our run rate as we head into the year 2024. Let me now turn the call over to John, who will provide more details on the balance sheet and results for the quarter.

Speaker 3

Thanks, Andy. Turning to slide 8. We ended the quarter with total average assets of $664,000,000,000 In total, average loans of $377,000,000,000 down $9,000,000,000 $12,000,000,000 respectively, on a linked quarter basis as we prudently manage and optimize our balance sheet given the current macroeconomic and regulatory environment. Average total deposits were $512,000,000,000 representing a 3% increase linked quarter, driven by expected seasonality and growth in money market and time deposits time deposit accounts. Specifically, average non interest bearing deposits decreased $16,200,000,000 this quarter, primarily driven by our Union Bank retail customer upgrade at conversion from non interest bearing checking accounts to our interest bearing BankSmartly product.

Speaker 3

Excluding this reclassification, the decrease would have been $6,200,000,000 Our mix of non interest bearing to interest bearing deposits was approximately 19%, consistent with where we expect the mix shift to stabilize based on historical performance and the operational nature of our core deposit base. Slide 9 provides an update on the investment securities portfolio. As of September 30, our available for sale securities were 97% of our total securities. We continue to reduce the effective duration of the AFS portfolio, which is now less than 3.5 years. On Slide 10, we provide a detailed earnings summary for the quarter.

Speaker 3

This quarter, we reported diluted earnings per share of $0.91 or $1.05 per share after adjusting for merger and integration charges of $213,000,000 net of tax or $0.14 per diluted common share. Turning to Slide 11. Net interest income on a fully taxable equivalent basis totaled approximately $4,300,000,000 which represented a 4.1% decrease on a linked quarter basis and a 10.7% increase from a year ago due to the impact of rising rates and the acquisition of Union Bank. Our net interest margin declined 9 basis points to 2.81 percent in the 3rd quarter. The linked quarter decline was primarily due to the impact of lower earning assets, deposit pricing and mix shift, offset somewhat by better loan spreads and funding mix.

Speaker 3

Slide 12 highlights trends in non interest income. Fee income increased 11.9% or $295,000,000 on a year over year basis, driven by higher payment service revenue, trust and investment management fees, Commercial products and mortgage banking revenues. On a linked quarter basis, fee income increased 1.4% or $38,000,000 driven by other revenues, which included servicing revenue from previously executed balance sheet optimization actions. Turning to slide 13. Reported non interest expense for the quarter totaled $4,500,000,000 which included $284,000,000 of merger and integration related charges.

Speaker 3

Non interest expense as adjusted Decreased $13,000,000 or 0.3 percent on a linked quarter basis, driven by lower compensation expense that was somewhat offset our investments in marketing and business development. Slide 14 shows our credit quality performance this quarter. While asset quality metrics reflecting changing conditions in the Commercial Real Estate Office segment, results this quarter continue to trend in line with our expectations and key metrics remain below pre pandemic levels. Importantly, given the higher interest rate environment as well as other portfolio considerations, We increased our reserve ratio for commercial real estate office loans to 10%. Our ratio of non performing assets to loans Other real estate was 0.35 percent at September 30 compared with 0.29% at June 30 and 0.20 percent a year ago.

Speaker 3

Our 3rd quarter net charge off ratio of 0.44 percent Increased 9 basis points from a 2nd quarter level of 0.35 percent as adjusted and was higher when compared to a Q3 of 2022 level of 0.19%. Our allowance for credit losses as of September 30 totaled $7,800,000,000 or 2.08 percent of period end loans. Turning to slide 15. We continue to take action to improve our capital ratios this quarter, increasing our CET1 ratio to 9.7% as of September 30. The combination of our debt to equity conversion with MUFG, earnings accretion net of distributions and balance sheet optimization actions resulted in a 60 basis point increase from last quarter.

Speaker 3

Importantly, our CET1 capital ratio is now 270 basis points above our regulatory capital minimum. I will now provide 4th quarter forward looking guidance on slide 16. In the Q4, we expect net interest income of between $4,100,000,000 $4,200,000,000 Total revenue, as adjusted, is estimated to be in the range of $6,800,000,000 to $6,900,000,000 including approximately $65,000,000 of purchase Total non interest expense as adjusted is expected to be approximately $4,200,000,000 inclusive of approximately $115,000,000 of core deposit intangible amortization related to Union Bank Acquisition. On a core basis, we expect full year 2024 expenses to be flat with 2023. Our income tax rate is expected to be approximately 23% on a taxable equivalent basis.

Speaker 3

We expect merger and integration charges of between $250,000,000 to $300,000,000 in the 4th quarter. I'll now hand it back to Andy for closing remarks.

Speaker 2

Thanks, John. Turning to Slide 17, the Federal Reserve notified us on October 16 that they have granted us full relief from Category 2 commitments made in conjunction with the Union Bank acquisition after considering several factors, including actions to reduce our risk profile, Strengthen our capital position and provisions related to Category 3 rules made after each we received approval on the Union Bank acquisition. This important decision now subjects us to the same enhanced capital requirements as all other Category 3 banks, including a 3 year phase in of AOCI into regulatory capital starting in the Q3 of 2025. As expected, We will continue to carefully balance the need to accrete capital with any potential impact to earnings from further balance sheet optimization activities. Measures to manage the interest rate sensitivity and duration of our available for sale securities will continue.

Speaker 2

Since before our acquisition of Union Bank, our priority has been And will continue to be the strategic execution of capital efficient growth opportunities across each of our business lines. As a result of the Fed's decision, we are now well positioned with our enhanced earnings profile and diversified business mix to increase our capital levels, continue our disciplined lending activities and further strengthen our balance sheet. Let me close by thanking our more than 75,000 employees for their dedication supporting the needs of our clients, communities and shareholders. We'll now open up the call to Q and A.

Operator

Thank you. We will now begin the question and answer session. And we go to Ebrahim Poonawala with Bank of America, please go ahead.

Speaker 2

Hey, good morning. Good morning.

Speaker 3

Good morning.

Speaker 4

I guess, maybe the first question just around the Fed decision. In its letter, the Fed said, I guess, the bank anticipates taking further actions to reduce risk profile and reduce assets and increase capital. So if you don't mind talking about just what additional actions we should expect. I think you mentioned that the EPS impact could be neutral from here. But just how should we think about what else the Fed expects from you on the risk mitigation side as we move forward into next year?

Speaker 4

Thank you.

Speaker 3

Sure. Thanks, Ebrahim. Good morning. So as way this is John. As a way of background, the Fed granted us, as you mentioned, Full relief from our Category 2 commitments and that's because of the actions and Andy mentioned this of our actions to reduce risk as well as our ability to strengthen our capital position.

Speaker 3

So importantly, this is going to provide us additional time and flexibility to meet those new regulatory requirements and do so in the same time frame as our Category 3 peers. And additionally, we think it's going to reduce The downside risk given that given a challenging rate environment. But nothing really changes in terms of how we're fundamentally managing the balance Going forward, we're still committed to building regulatory capital. We're still expecting to increase and accrete capital at a 20 to 25 basis points on average per quarter. And our expectation is to accelerate that as we get through the merger related Costs or be in the high end of that range, I should say, as we get through the merger related costs and start to realize the full Union Bank synergies.

Speaker 3

And we're still going to be executing risk weighted asset optimization transactions. But now we have the time and flexibility to do that over in a way that is low to neutral in terms of our earnings impact. And so for all those reasons, we feel like We have the flexibility in our balance sheet to do those sorts of things.

Speaker 2

I think that's exactly right, John. And the only thing I'd add is Part of this decision is reflective of what we've already done for the last 12 months in terms of reducing the risk profile, building capital, optimizing the balance sheet. And I want to be clear, Abraham, we are not under an asset cap at all. We are maintaining flexibility and managing the balance sheet and capital and we'll continue to remain focused on capital efficient growth. And that includes focusing in the high margin, high return businesses that exceed our cost Capital while deepening relationships from our most profitable clients.

Speaker 2

And that has been and will continue to be our focus.

Speaker 4

That's good color.

Operator

Thank you.

Speaker 4

And just a separate question, John, I think I heard you correctly. If I heard you correctly, you mentioned you expect the NIM to trough and I'm assuming NIM And I'd like to trough in the Q4. Maybe just change that assumption in terms of there's a steeper yield curve or Widening in just the curve, is this that assumption around troughing of NII or NIM? And What gives you confidence around mix shift consumer behavior to feel good about that?

Speaker 3

Yes. So I think in terms of The guidance we provided, we have embedded in there our rate forecast, which includes a rate increase in December. Whether or not that happens or not is relatively immaterial since we're fairly neutral from an interest rate risk positioning standpoint. I guess what I would say is, as the Fed is continuing whether they're done or not in terms of the rate hiking, We start to see a lot of the things on the deposit side slow down, so our non interest bearing balances will be relatively stable here at this level. The deposit betas will and the rate paid will start to slow down.

Speaker 3

And then on the other side, your assets will start to reprice, whether that's securities book, the loan book and all those sorts of things. So that's what gives us the confidence really that we will bottom out here in the Q4 from a NIM and net interest Some perspective.

Speaker 4

Got it. Thanks for taking my questions.

Speaker 5

Thank you. Thank you.

Operator

Next, we'll go to John McDonald with Autonomous Research, please go ahead.

Speaker 2

Good morning, John.

Speaker 6

Hi, good morning. John, could I just follow-up on what you were just talking about? What are you looking at in terms of The NIM for the Q4 roughly. And did I hear correctly, you think the deposit mix kind of settles out around 2019, 2020 where you are here and beta of in the mid-40s, you still have those expectations.

Speaker 3

Yes. Maybe just to go off the last couple of questions you mentioned. So from a non interest Yes, we do expect that mix. We're at about 19%. That's about where we will be.

Speaker 3

We expect that to be in that range. And from a beta perspective, we are in the mid-40s right now. It's possible it could creep up higher Depending on where the Fed goes from here, but we feel good about that. And then in terms of your the net interest margin and things like that, we do Anticipate a little bit more pressure here in the Q4, but then that really is the point where we feel that it will bottom out Based on my comments, I just made a previous question.

Speaker 2

And that's reflected in our revenue and net interest income guidance. Yes.

Speaker 6

Okay. And then recognizing with the Fed decision, you've obviously got a lot more time to phase in the AOCI now. John, could you just give us a little more color on what happened in terms of the trend in AOCI this quarter? What are the pieces there? And how do the swaps affect your burn down timeline?

Speaker 6

And just also if you could add on, what do you how do you calculate the Capital with AOCI today, looks like maybe around 7% something like that.

Speaker 3

Yes. So I think all in, it's about AOCI is about 250 basis point of impact. So I would say 7.2% is probably roughly kind of where I would about it. In terms of the change in the AFS, obviously, rates backed up on the long end of the curve, 75 to 90 basis points depending on treasuries or mortgages that you're looking at and that had an impact of about $1,400,000,000 in our on an after tax basis on our AFS securities book, which we would have expected and is consistent with the duration of our book, which we have continued to wind down, as I mentioned in our comments about less than 3.5 years is our current duration. So that's the effect To that, we are continuing to see we will continue to see pay downs in that book, whether it's The HTM or AFS, we have about approximately $3,000,000,000 or so per quarter that rolls off that book and we'll reinvest in the AFS side of things over time.

Speaker 7

Okay. Thank you.

Speaker 2

Thanks, John.

Operator

Next, we'll go to Mike Mayo with Wells Fargo Securities. Please go

Speaker 5

ahead. Hi.

Speaker 8

Good morning, Mike.

Speaker 2

Just to be clear, how much

Speaker 8

of the $900,000,000 merger savings were recognized in the 3rd quarter results?

Speaker 3

Well, in terms of, we will get to a full run rate of $900,000,000 It's probably $100,000,000 or so is kind of the in that range is probably what we were seeing. But it's been Growing in terms of the amount and we'll see that full benefit fall through in the 4th quarter.

Speaker 8

So relative to the Q3, the Q1 of 2025 could see $800,000,000 of additional expense savings?

Speaker 3

No, because we've been the savings have been generated all throughout the course of the year. And they accelerate Q3 into Q4 and all that Q2, Q3 into Q4.

Speaker 8

So what's the cumulative merger savings? I guess how much more expense savings should there be when they're fully realized in the Q1 relative to the Q3?

Speaker 3

When we have the savings, we will have Approximately, dollars 400 or so 1,000,000 that has gone through this full year and then we'll expect to see that in the next coming year, but that's embedded into our full year guidance of Flat expenses between 2023 2024.

Speaker 2

So Mike, the way I think about it, this is Andy. By the end of the Q4, we will be on a run rate recognizing $900,000,000 of savings, which will be fully reflected in 2024 in our expense base. And that is consistent with how we think about a relatively flat 23 to 24 expense base, including those savings plus investments we'll continue to make in the business.

Speaker 8

And then The big question then is, so if you have flat 2024 expenses, do you think you can get to positive operating leverage? Or is it too early or too many moving parts? Because this is the sweet spot of the merger savings coming up, right, by

Speaker 9

the next quarter? It is

Speaker 2

a sweet spot, Mike. You're absolutely right. And the savings are great. The opportunities to deepen relationships on the Union Bank customer base, I mentioned that in my comments. I think that is terrific.

Speaker 2

Our fee businesses are doing Extremely well. On a year over year basis, it was up 12% across almost every category. And frankly, very little of that was related to Union Bank. That was Core improvement across a number of categories, capital markets, our corporate and trust, our fee businesses, our payments businesses. The challenge for us and for the entire industry is net interest income and margin.

Speaker 2

And in this environment, that's the one that I there's a lot of moving pieces as you say. Loan growth is relatively tepid as we speak for us and for the industry overall. So it'll be dependent upon that In terms of positive operating leverage, and I would say it's too early to call.

Speaker 8

Okay. And last follow-up, your increase in CET1 ratio due to A lot of balance sheet optimization did come at a cost of less assets, less loan growth, less earnings, right? There's a trade off in that. So now that you're under kind of less pressure and have so much more flexibility, do you think you can be a little bit more Lacks in terms of your growth and in turn that may help NII or is that too much of a stretch?

Speaker 3

Yes. We have flexibility now, in terms of the transactions that we do to optimize. And we still have plans to do those sorts of things. We've identified some things that are going to be relatively neutral, and a little bit on the low end of earnings impact. And of course, you saw some of those transactions in the second quarter You know, flow through in terms of provision and things like that and that did lower our earning assets as you mentioned about $8,000,000,000 or thereabouts this quarter.

Speaker 2

Great. Thank you. Thanks, Mike.

Speaker 3

Thanks, Mike.

Operator

And next we'll go to John Pancari with Evercore. Please go ahead.

Speaker 2

Good morning, John.

Speaker 10

Good morning. I know despite the regulatory change around the CAT II requirement, You maintain the 20 bps to 25 bps generation in CET1 quarterly. Why no Change there, can you just talk to us maybe about the give and takes in that expectation as The need to meet the Category 2 shifted to Category 3, why no change there?

Speaker 3

Well, I think There's no change because we feel like given the new rule set and things like that, over time, we'll have to transition into the new regime, which will include AOCI and so all the other rules. And so we're going to be in a mode to continue to accrete that capital and that 20 to 25 basis points is our earnings stream that We will accrete and right like this quarter, for example, is 20 basis points, but we anticipate going to 25 on the higher end of that range as we get through the merger related costs and we have the union synergies.

Speaker 10

Okay. So the less BSO activities didn't materially benefit that expectation.

Speaker 3

I'm sorry, can you say that more? I couldn't hear you.

Speaker 10

The less risk weighted asset optimization efforts That would be needed now under the Need to Meet Category 3 did not materially impact the 20 basis points to 25 basis points of Earnings generation expected.

Speaker 3

No, that did not. And like for example, this quarter, we had 20 basis points of RWA actions, which included, some of the asset reduction. You saw our earning assets lower, For example, as well as some other transactions embedded. So we separate out the core earnings, when we're talking about 20 to 25 basis points core earnings from Other RWA optimization transactions that we have the ability to do. Okay.

Speaker 10

And then separately, is there any OpEx Impact of the of now needing to conform to the Category 3 versus the more immediate requirements of Category 2 Anything on the expense side and then separately on the on your margin bottoming comment, anything in terms of the trajectory in the margin that you would expect after you see this bottoming as we head into 2024? Thanks.

Speaker 3

Yes. So in terms of OpEx, No, there's no further investment. You may recall before tailoring, we had many of the same Rules and standards that we had in terms of liquidity rules and reporting and all those sorts of things. So We have all the capabilities built up or can quickly get to that level from an operational standpoint. So there's no worries there.

Speaker 3

In terms of the net interest margin, we mentioned just a little bit of pressure in the Q4 and then bottoming out, likely stable, but it will depend on interest rates, frankly, at that particular point in time.

Speaker 10

Okay. Thank you.

Speaker 5

Thanks, John. Thank you.

Operator

And next we'll go to John McDonald with Autonomous Research. Please go ahead. One moment here.

Speaker 2

We'll

Operator

move past that. Pardon me. We'll go to Scott Siefers with Piper Sandler.

Speaker 2

Good morning, Scott. Good morning, Scott.

Speaker 11

Hey, thanks for taking the question. Just as it relates to sort of the Balance sheet growth dynamic. So great to see you out of that Fed restriction. Do you see any risk that you'd exceed $700,000,000,000 in assets organically Or come into contact with any of the other CAT II restrictions organically in a timeframe that would Object you to cap 2 rules before your peers would have to get there under new levels. In other words, I'm just trying to Kind of make sure that this is indeed just a full free and clear.

Speaker 11

So just curious your thoughts there.

Speaker 3

It is. As Andy mentioned, there's no asset cap, so that we have complete flexibility here on our balance sheet going forward. So if we Like to grow or want to grow and we do want to grow in a capital efficient manner, we will do so. I what I would say So is that we're going to be emphasizing higher return loans and deemphasizing lower return type of assets. And I think that will Manifested Selson is the balance sheet churns.

Speaker 3

And in addition to that, I would just highlight that in this environment right now, the loan outlook It's pretty low. The demand for loans is quite low given a number of different reasons out there. But that gives us kind of the confidence that we have a lot Have more time and flexibility here. Yes.

Speaker 11

Perfect. Okay. Thank you. And then, I think you might have touched on this in an earlier question, but Maybe if you can sort of re walk us through the sort of AOCI burn down and cash flow expectations coming off the both the AFS and HTM books. And then I think you might have given the duration of the AFS book, but do you have that for the HCM book as well?

Speaker 3

Sure. So in terms of the AFS And HTM, we're at about, in terms of balances, about $162,000,000,000 or so. And it's about a fifty-fifty mix, As we mentioned on the call in terms of AFS and HTM. So we have about, as I mentioned, dollars 3,000,000,000 of runoff per quarter on average, Just given the current interest rate environment and things of that variety. In terms of our profile, we've been able to hedge About 30% of the fixed rate portion of the AFS book.

Speaker 3

And so that's what has driven the Duration of that particular book in the 3.5 less than 3.5 years as we have the HCM book is principally all agency mortgage backed Securities, which have longer lives. And so it's more in the 6 or so, 6.5 range in terms of the duration of that book.

Speaker 11

Perfect. All right, wonderful. Thank you guys for taking the question.

Speaker 2

Thanks, Scott.

Operator

And next we'll go to Erika Najarian with UBS. Please go ahead.

Speaker 12

Hi, good morning.

Speaker 2

Good morning, Erica. Good morning.

Speaker 12

Andy, my first question is for you. Clearly yesterday's announcement It's a big win for the company. And as we think about combining that Relief with a generally tighter regulatory environment, what T1, are you looking at and what level are you looking at in terms of, okay, now I'm at the right level, this is now My target in the new world and now in an environment where balance sheet growth is minimal at best, right, I can now return capital back to shareholders through buybacks. I guess I'm just wondering because there's your printed your GAAP CET1, There's the adjusted that John gave, right? But then you only have to take into account 25% of that 250% by July 1, 2025, if we get to a final date by then.

Speaker 12

So there's a lot of moving pieces. So As your investors think about all this progress that you've made plus this relief, what is your new target? Is that transitional or fully phased in? And what's the bogey that investors could look forward to that you would hit before returning, capital through buybacks?

Speaker 2

Yes, Eric, I understand the question. And first of all, I just want to highlight we're back to 97,000,000 which is where we started before the deal And we're able to build and we went from 9.7 to 84 and build 130 basis points in basically less than a year, which I thought was a great effort across the company. In terms of what our new target is, I think our short term target is to continue to build as we talked about. Remember there's 2 sets of rules that are yet to be finalized and coming down. Number 1 are the Basel III endgame finalization of rules, which will in one shape one way shape or form increase capital levels.

Speaker 2

And the second is Clarity on CCAR. We'll set those targets once we have clarity on those two items.

Speaker 12

And so just to follow-up here, At least until June 2020 for CCAR results, regardless of how quickly you build the capital, Either on an adjusted or on a GAAP basis, you're going to continue to be at pause on the buyback until at least then until we see the CCAR and the SCB?

Speaker 2

That's my expectation, Erica. We want clarity on the finalization of the Basel III and then CCAR importantly. So we'll be continuing to build capital And determine our capital targets and buffers and all that activity once we have more clarity in the finalization of the rules.

Speaker 12

Got it. That's very clear. And just one more for John, if I may. Sure. In terms of the net interest income trajectory, I think the Q4 bottom is good news, especially relative to what we thought 2 days ago, which would be more RWA mitigation.

Speaker 12

As we think about the RWA mitigation ahead that's less impactful to EPS, should we think about it similar to what we saw early in the year in terms of Securitizations, are you more actively are you going to continue to use credit linked notes, which I assume is Cost you 12.5% or so of the pool plus SOFR in the spread. And as we think about those dynamics, Do you feel like you have to warehouse more liquidity as we anticipate LCR rules for regional banks? We're also hearing that there could be pretty significant haircuts on, how they're thinking about HTM as HQLA.

Speaker 3

Sure. Erica, so maybe I'll start with your last point. On LCR, we will in addition to what Andy said on the capital side, we're going to have to wait and see what it is on side, in terms of any potential changes that come out of LCR. We feel very comfortable that we'll be able to achieve whatever that change is and feel that we'll be able to achieve that whatever that scenario is. We'll work into it.

Speaker 3

In terms of You talked about the net interest income. We feel like it's again, just to kind of reiterate, we are looking for that to bottom At this particular point in time, in the Q4 and where it kind of goes from there, post, it will depend in part by interest rates.

Speaker 12

Got it. And congratulations on the release of commitments.

Speaker 2

Thanks, Erica. Thank you.

Operator

And next we'll go to Gerard Cassidy with RBC. Please go ahead.

Speaker 2

Good morning, Gerard.

Speaker 7

Hi, Andy. How are you? Good. Andy, obviously, U. S.

Speaker 7

Bancorp has developed a reputation of being a strong underwriter and we've talked about this in the past with you folks. And I was wondering if you could frame out the environment because every bank is talking about credit normalization as you guys did, Because we have such great numbers coming out of the pandemic on credit. And if you just exclude for a moment the economy, because obviously none of us can control that. But I'd really be interested in what you guys are seeing from a competitive standpoint in terms of underwriting. And if you could compare it to Past cycles, obviously, we've been around for a few cycles and can compare it.

Speaker 7

But I'm curious from your guys' vantage point, is it as Risky today as it may have been in 2005, 2006 or 2019, 2000, any color there that you can share with us?

Speaker 2

Let me give you the big picture and I'm going to ask Terry to highlight some specifics. I would say the consumers entering this cycle in very strong shape From a balance standpoint, from the perspective of savings accounts that they have, the spend activity, I think are all starting to normalize, but normalize To a pre pandemic, what I would say normal level. The companies and small businesses are also in very good shape. The one area that we're all very focused Don, it's commercial real estate office, which is one of the areas that we increased our reserve to. As you know, it's at 10% in this quarter.

Speaker 2

So maybe Terry, you can go into some specifics.

Speaker 9

Yes. And I would what I would add to that, Gerrard, is as you know, when we think about underwriting, we really underwrite through a cycle. We try to take into consideration and stress From an underwriting perspective, what could happen in terms of rising interest rates or other economic factors that come into play. So we haven't adjusted our underwriting standards a lot as we have been thinking about this particular cycle. I do think that when you end up looking at the industry, I think there is some tightening that's going on out there.

Speaker 9

Certainly, from a competitive standpoint, we are seeing that to some extent. But No, we feel like we're in pretty good shape. If you end up looking at our situation, As Andy said, probably the area that we're monitoring the most is commercial real estate office space specifically. No, we have a reserve that's about 10% of the overall balance there. We have been increasing that and we're likely to continue to increase that Because that's going to be a pressure point.

Speaker 9

But we're starting from if you think about the overall portfolio, we're starting at Fairly low points. Our non accrual loans is only 35 basis points of total loans. Our allowance is strong at 208 delinquencies are still at relatively low levels, although increasing. And our expectation as we go into 2024 is that, that normalization will continue. Delinquencies will continue to kind of move up And nonperforming assets will continue to move up.

Speaker 9

But I think we're in a Really good position in terms of the allowance coverage that we have, and we feel pretty good about that.

Speaker 7

Very good. Good to hear your voice, Terry. Just to follow-up on what you were saying. From a competitive standpoint, Do you sense the extreme of course was 2005, 2006 when all of the crazy lending was being done by some banks, but also the non banks. When you guys look at the non bank competitors, are there rogue players out there that are just doing crazy things so that the second derivative Impacts the banks, not because any of the banks yourself included made a poor underwriting decision, but it was the competitors that really did something Foolish.

Speaker 7

And now the banks are suffering a bit. Or again, not like 2006. I'm not suggesting we're there, but from a comparison

Speaker 9

I think both in the bank and in the non bank space, I think that people are being fairly rational. Part of the issue is that It's maybe more so on the demand side of the equation as much as anything. I think Corporate America is Being relatively cautious out there, they're still waiting to see where interest rates settled in at. And until they see More certainty with respect to what the interest rate inflationary environment looks like. I think Corporate America is being relatively cautious, And therefore, demand is relatively soft.

Speaker 9

But we're not seeing, what I would say, crazy things either on the bank or on the non bank side at this particular point in time. In fact, we're probably seeing if you end up looking at commercial real estate, probably a pullback across the board.

Speaker 7

Great. And then as my second follow-up question. Andy, it was obviously great news that you guys had yesterday about the release. Is there any read Drew, obviously you sat down with the regulators to get that release and they seem to be fairly rational in their decision to make that change. There's been a lot of hope and criticism that the Basel III endgame proposals are pretty darn strict.

Speaker 7

Do you think is there any read through where we may actually see some rationality with the regulators and they may kind of pair back some of those requirements? Or is that too far of a stretch?

Speaker 2

I think the regulators have asked for feedback. The banks will provide feedback both collectively and individually. I think a lot of the feedback is good feedback because of the consequences to our customers. And I think that's the area of focus that we're going to be very pointed on in terms of our feedback. And we want to make sure that From a banking standpoint, we're able to serve our customers and the rules that will create some friction around that in certain categories and that's where we're going to focus.

Speaker 2

And my anticipation is that the Fed will listen to our perspectives and that's my hope.

Speaker 9

Good. Thank you. Go ahead. I'm

Speaker 7

sorry to go.

Speaker 9

No, I was just going to say, particularly it can be punitive with respect to low and moderate income customer base. You see some capital rules related to renewable energy, tax credits that don't make that seem punitive at this particular So I do think there's a number of different areas where there's opportunity for adjustment.

Speaker 7

Great. Thank you guys.

Speaker 2

Thanks, Derek.

Operator

And next we'll go to Vivek Juneja with JPMorgan. Please go ahead.

Speaker 2

Good morning, Vivek. Good morning.

Speaker 5

Shifting gears from capital, given that you've made a lot of progress to just your normal business. Payments, you've talked, Andy, about wanting to grow merchant processing, mid to high single digits, Really more in the high single digits, and some of the others in the low double digits, like corporate payments.

Speaker 4

Any color

Speaker 5

on any thoughts on how you get back up there because that hasn't been the case last couple of quarters? What do you need to do or change or what would help you get there?

Speaker 2

I'm going to ask John to start then I'll add in.

Speaker 3

Sure. So in terms of merchant processing, we have been making a number of investments Over the years and continue to expect that high single digit in terms of the merchant sort of thing. The numbers are Have been strong this quarter, but there's normalization that has been happening. And so in the quarters The quarter to quarter here, the last several quarters, there's been a lot of the nuances coming out of the COVID and all those sorts So if you think about airline tickets and hotels and corporate G and A, those have been very strong, but they're normalizing. That said, Services and retail have been strong.

Speaker 3

And so and the retail print that we saw yesterday was very So we feel like there's good underpinnings there in addition to the investments that we make, to continue to believe and give us confidence in our projections there.

Speaker 2

And I think 2 of those most important investments Vivek are our tech led initiative, which is about a third of our revenue base right now is tech led from a Effective of new activity. And secondly is that what we've talked a lot about, which is this business payments ecosystem, which continues to be a top priority for the company, because I think it's a huge Tunity for our business banking customer base as well as our commercial customer base. And then you add in what we're getting from Union Bank, I think that's why we're confident in that higher single digit increase.

Speaker 5

Okay. And then another fee business that you mentioned, you're expanding capital markets, Since you're not doing your Investor Days anymore, any color on what you're doing there to expand that? You've always had the loan syndications and Debt Capital Markets, what else are you doing to step that up in terms of the level of revenues from that?

Speaker 3

Sure. This is John. So the we've this is another area where we have continued to make investments in back Systems and the frontline and acquiring talent and all these sorts of things. And it's been a great story for us and we continue to Invest in this going forward and along with high grade and underwriting, there's high yield as well as what other The areas that have been very strong is in the derivative market, providing interest rate, hedging products for our clients, especially in this time where Interest rates are moving around quite a bit. That's a service that has been highly needed.

Speaker 3

Foreign exchange has been a growing component here as well. And particularly now with Union Bank, we have more of a West Coast customer base and more of a foreign exchange need. In addition to some of the businesses that we work with in the Corporate Trust side, we have as you know, we have businesses in Europe as well. So there's always some Form of foreign exchange and so we've seen a lot of growth there. In addition to that, we've been gaining market share in the investment grade business and high yield over the coming Dave, I think we've had an investment grade in the top 10 now in terms of market share.

Speaker 3

So that has been a business that has continued to advance Slow and steady and it's been a good item for us business for us.

Speaker 2

Thanks.

Operator

Before we take our next question, I'd like to remind everybody it is one zero to ask a question. And next we'll go to Matt O'Connor with Deutsche Bank.

Speaker 2

Good morning, Matt. Good morning.

Speaker 13

I was wondering Slide 7 that shows some of the revenue opportunities. I was wondering if you could size that? Revenue synergies related to the UB deal that you outlined in Slide 7. Is there any way to frame how big that might be and over what timeframe?

Speaker 2

It is a high priority for each of our businesses. Probably the greatest priority is that first one you talked we highlight, which is our credit card opportunity. The payments business is a strength of U. S. Bank.

Speaker 2

Our card offering is terrific and we've already had a penetration increase from where we started and that continues to be a focus. And then you think about that with the business clients as well. I think it is a material impact, but we're still working through Exactly the sizing and timing and we'll continue to update on that, but it is a priority and a focus area for each of our businesses.

Speaker 13

Okay. And then separately, a little bit of a technical question actually gets to my CFA Materials, when we look at the securities book of a duration of less than 3.5 years, but you're only burning down 25% through 25%. Remind me how that math works and does the burn down kind of step up as we think about 2026, right? Because the duration is pretty short and the burn down is Not all that much in the 1st couple of years.

Speaker 3

Yes. The function of the curve really changed as the we saw the curve Flatten out quite a bit this quarter. What I'd say on that is we have a number of securities that obviously are fixed Trade that have longer durations to them or longer average lives. And so and then we have a number of with our The security portion where we have swaps, that is very, very low duration. It's 3 months or so because of how it Swap to floating rate index.

Speaker 3

So in addition to that, we've as we've added on some of the security book, we have about $8,000,000,000 or so of When we did some of the auto repack transactions, in the Q4 of last year as well as the Q2 of this year, That is very short as well in addition to some of the floating rate securities within that book. So that it's kind of more of a barbell approach, which Gives you the duration of it, which just gives us a value change for a move in interest rates. But in terms of The burn down that will depend on part about how the shape and the type of securities that are within the book.

Speaker 13

Okay. That's helpful. Obviously, less relevant now given the Fed's decision, but still something we're all tracking. So thank you.

Speaker 3

Thanks, Matt. Thanks, Matt.

Operator

And next we can go to Ken Usdin with Jefferies. Please go ahead.

Speaker 14

Hey, guys. Thanks. So just one more follow-up on the category 2 news. I just want to make sure we're super clear. So Does $700,000,000,000 stop being a bind forever?

Speaker 14

Or obviously, you don't have to cross on the prior potential timeframe. But to the prior question, just wondering, you said there's you don't have an asset cap. So does that mean that category 2 is now a non thing for U. S. Going forward in any time period or when you cross naturally, do you still get on the natural clock of having to eventually comply?

Speaker 14

Wondering how that fits in with the renews you got yesterday?

Speaker 2

So we're bound Ken by the current rule set, which is after 4 quarters of an average of $700,000,000,000 then you would go to category 2 or The new Basel III rule set, which is yet to be finalized as you said. But the current rule set is what we're bound on. So 700 still is important, But what we're saying is given where we think asset growth will be, given our continued optimization in certain categories, given our focus on high return businesses, We do not see that as a hurdle to growth.

Speaker 14

Understood. Okay. That's what I wanted to clarify. Thank you, Andy.

Speaker 13

You bet.

Operator

And with no further questions, I'll hand the call back over to George Anderson.

Speaker 1

Thanks, Brad. Thank you, everyone,

Operator

This does conclude the conference for today. Thank you for participating. You may now disconnect.

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Earnings Conference Call
U.S. Bancorp Q3 2023
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