U.S. Bancorp Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 25, 2023

There are 15 speakers on the call.

Operator

Welcome to the U. S. Bancorp 4th Quarter 2022 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 11 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 and Terry Dolan, our Vice Chair and Chief Financial Officer. During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation as well as our earnings release Factors that can materially change our current forward looking assumptions are described on Page 2 of today's presentation, in our press release, our Form 10 ks and then subsequent reports on file with the SEC. Following their prepared remarks, Andy and Terry will take any questions that you have.

Speaker 1

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. This quarter, we completed the acquisition of MUFG Union Bank on December 1. In the Q4, we reported $0.57 per diluted share or $1.20 after adjusting for notable items related to the acquisition.

Speaker 2

This was a complex quarter that included 1 month of Union Bank results, merger and integration charges and balance sheet optimization activity. Terry will provide more details on these notable items. Importantly, we ended the year with a common equity Tier 1 ratio of 8.4%, which was just above our expected level at deal close and we delivered positive operating leverage for U. S. Bancorp legacy operations of 2 30 basis points for the full year.

Speaker 2

Strong year over year pretax provision income growth as adjusted for notable items was driven by net interest income growth and positive operating leverage. Credit quality remains strong, although credit metrics are starting to normalize as expected. Slide 4 details our reported and adjusted income statement results as well as end of period balances and other performance metrics. End of period assets for the company totaled $675,000,000,000 reflecting the acquisition of Union Bank and certain balance sheet optimization actions. Slide 5 highlights key performance ratios.

Speaker 2

This quarter, we delivered a return on average assets of 1.2%, A return of average common equity of 16.8 percent and a return on tangible common equity of 23.4%, each as adjusted for notable items. Turning to Slide 6, the completion of the Union Bank acquisition marked a significant milestone for our company. With double digit percent increases in loan and deposit balances, Union Bank adds meaningful scale to our business that enables us to better serve our customers and communities. Union contributes considerable small business and consumer market share in a demographically attractive California market And we're excited about the potential to deepen existing Unibank relationships by overlaying our leading digital capabilities and robust product set, including wealth management, consumer and business banking and payments offerings across a loyal but underpenetrated consumer base. In many ways, this deal underscores our commitment to creating a stronger, more competitive regional banking organization in a rapidly evolving environment.

Speaker 2

One of the more attractive aspects of this transaction is Union Bank's high quality, low cost consumer deposit franchise, which will support continued loan growth and margins. Let me turn the call over now to Terry, who will provide more detail on the quarter.

Speaker 3

Thanks, Andy. If you turn to Slide 7, as Andy mentioned, we reported diluted earnings per share of $0.57 for the quarter or $1.20 per share after adjusting for notable items related to the acquisition. Notable items related to Union Bank Acquisition are comprised of 3 primary elements that reduced earnings per share by $0.63 related to balance sheet optimization, merger and integration costs and the impacts of on provision expense related to acquired loans and actions taken The balance sheet. During the Q4, the company recognized a onetime $399,000,000 pretax loss On a net basis related to several actions taken to optimize the balance sheet, manage the net the interest rate volatility impact on capital levels and position the company for future growth. Subsequent to obtaining regulatory approval for the transaction, we entered into interest rate hedges to manage rate volatility and its related impact on regulatory capital from the date of approval to the closing of the transaction in December.

Speaker 3

During that timeframe, Long term interest rates increased nearly 50 basis points before declining approximately 65 basis points. The interest rate swaps were terminated at Time of closing and the losses recognized through earnings largely offset the interest rate marks recorded into the balance sheet through purchase accounting. In addition, the company optimized its balance sheet by selling certain loans and repositioning its investment portfolio on certain equity investments. Within non interest expenses, we incurred merger and integration related charges of $90,000,000 that primarily included the impact of specific deal closing costs, professional services and employee related expenses. We also incurred a $791,000,000 charge to the provision for credit losses, which reflects an initial provision impacted by the acquisition of $662,000,000 and a net loss of $129,000,000 related to the securitization of approximately $4,000,000,000 of legacy indirect auto loans.

Speaker 3

Again, these moves enabled us to more effectively position the balance sheet for profitable growth and optimize returns. Slide 8 provides a more detailed earnings summary. Union Bank, which was included in our consolidated results for 1 month, contributed $302,000,000 of revenue, $221,000,000 of non interest expenses, dollars 81,000,000 of operating income and $44,000,000 of net income to the company, representing $0.03 per diluted share. On Slide 9, end of period loans increased 13.3 percent on a linked quarter basis to $388,000,000,000 which included Core loan growth and acquired loans from Union Bank. Union Bank contributed ending loan balances of $54,000,000,000 net of purchase accounting adjustments, partly offset by a reduction in balances $15,000,000,000 related to balance sheet optimization actions, including loan sales and securitizations.

Speaker 3

Slide 10 provides end of period deposit balance composition. End of period deposits increased 11.4% on a linked quarter basis to $525,000,000,000 driven by the acquisition, which contributed $86,000,000,000 of lower cost Deposits and actions taken as a result of the deal to optimize our funding sources. On a core basis, we saw deposit balances decline slightly this quarter. Turning to Slide 11. The investment securities portfolio grew 4.2% linked quarter to $170,000,000,000 The addition of securities from Union Bank were offset by balance sheet optimization actions.

Speaker 3

Slide 12 highlights revenue trends. Adjusted net revenue totaled $6,800,000,000 in the 4th quarter, which included revenue contribution of $302,000,000 from Union Bank, primarily representing net interest income. For Legacy U. S. Bancorp, net interest income grew 5.5 percent on a linked quarter basis and 29.2% year over year, driven by Strong earning asset growth and net interest margin expansion, which benefited from rising interest rates.

Speaker 3

Results were partially by higher deposit pricing and short term borrowing costs. Non interest income as adjusted for the legacy company Declined 3.0 percent compared to the 3rd quarter, driven by seasonally lower payment service revenue and lower commercial product revenue offset by stronger mortgage banking revenue. Year over year legacy adjusted non interest income Declined 5.5 percent driven by lower mortgage banking revenue from reduced refinancing activity and lower servicing charges offset by stronger payments services revenue and trust and investment management fees. Turning to Slide 13, adjusted non interest expense totaled $4,000,000,000 in the 4th quarter, including $221,000,000 from Union Bank. Included in expenses was approximately $42,000,000 of intangible amortization due to core posit intangibles established at the time of the acquisition.

Speaker 3

Legacy non interest expense as adjusted increased 3.8% on a linked quarter basis, largely driven by higher compensation related expenses as well as higher expenses related to professional services, marketing, Technology and tax credit amortization. Slide 14 shows credit quality trends. We reported total net charge offs for the quarter of $578,000,000 After adjusting for acquisition impacts The balance sheet optimization activities, net charge offs totaled $210,000,000 or 23 0.23 percent of average loans, up from 0.19% in the 3rd quarter, which reflected the continuing normalization of credit losses. Nonperforming assets for the legacy bank increased slightly, while Union Bank contributed $329,000,000 to the total. On a combined basis, the reported ratio of nonperforming assets to loans and other real estate was 0.26% at December 31 compared with 0.20 percent at September 30 and 0.28 a year ago, reflecting a continued strong credit quality.

Speaker 3

The provision for credit losses was $1,190,000,000 which included a provision of $791,000,000 related to the acquisition and balance sheet optimization activities. This provision includes an initial provision impacted by the acquisition of $662,000,000 $129,000,000 related to our balance sheet optimization activities. The allowance for credit losses as of December 31st Totaled $7,400,000,000 or 1.91 percent of period end loans, which reflects increased economic uncertainty and the incorporation of the Union Bank Portfolio. Slide 15 highlights the drivers of our linked quarter Common Equity Tier 1 Capital Position. As of December 31, our CET1 capital was 8.4%.

Speaker 3

Acquisition impacts of 180 basis points included an increase in goodwill and other intangible assets that reflected the impact of credit and interest rate marks, the initial provision for credit losses, Balance sheet optimization actions as well as the increase in risk weighted assets with the addition of Union Bank. These impacts were partially offset by an increase to equity related to shares issued to MUFG as part of the purchase price of Union Bank. Slide 16 provides our current expectations of certain financial metrics related to the transaction. The financial and strategic merits of the deal remain intact and are very attractive. Earnings per share accretion is now expected to be 8% to 9% in 2023, which is higher than originally estimated.

Speaker 3

While our tangible book value per share dilution is higher than initially estimated Due to the significant impact of rising interest rates on the interest rate marks at close, our estimated earn back period is only slightly longer than our original estimate at 2 years versus our original estimate of 1.5 years. Slide 17 provides a comparison of credit and net fair value marks from the time of our announcement to closing. Credit marks are lower due to favorable changes in portfolio composition and credit quality, partially offset by economic deterioration. Interest rate marks inclusive of loans, securities net of sales and debt are higher than anticipated at announcement due to higher interest rates, but we expect that to accrete quickly back through earnings. The core deposit intangible is also higher than originally estimated, reflecting the increased value of low cost, lower cost core deposits in a higher rate environment.

Speaker 3

I will now provide Q1 and full year 2023 forward looking guidance, which is provided on Slide 18. Starting with the Q1 2023 guidance. We expect average earning assets of between $605,000,000,000 $610,000,000,000 in the first quarter and the net interest margin that is 5 $7,300,000,000 including approximately $100,000,000 of purchase accounting accretion during the quarter. Total non interest expense as adjusted is expected to be in the range of $4,300,000,000 to 4 point $4,000,000,000 inclusive of approximately $125,000,000 of core deposit intangible amortization related to Union Bank. Our income tax rate as adjusted is expected to be approximately 22% to 23% on a taxable equivalent basis.

Speaker 3

We anticipate merger and integration charges of between 200 and $250,000,000 for the quarter. I will now provide guidance for the full year. For 2023, Average earning assets are expected to be in the range of $610,000,000,000 to $620,000,000,000 with net interest margin expansion of between 5 to 10 basis points compared with the Q4 of 2022. Total revenue is expected to be in the range of $29,000,000,000 to $31,000,000,000 inclusive of between $350,000,000 to $400,000,000 of full year purchase accounting accretion. Total non interest expense as adjusted for the year Is expected to be in the range of $17,000,000,000 to $17,500,000,000 inclusive of approximately $500,000,000 tax rate on a taxable equivalent basis as adjusted will be approximately 22% to 23%.

Speaker 3

We expect to have $900,000,000 to $1,000,000,000 of merger and integration charges in 2023. I will now hand it back to Andy for closing remarks. Thanks, Terry. We accomplished a lot this past year, including the completion

Speaker 2

of the Union Bank acquisition And a strong legacy PPNR growth supported by positive operating leverage on an adjusted basis. Union Bank adds Significant scale to our business and deepens our commitment to serving customers and creating economic opportunities for communities across the West Coast. We continue to target the Memorial Day weekend systems conversion incorporating a lift and shift approach to our applications, which mitigates risk and allows us to more quickly capture meaningful cost synergies. There is still a tremendous amount of economic and geopolitical uncertainty and we are preparing for any scenario. I believe we will perform well because of the strength of our business, a strong balance sheet and the great team we have.

Speaker 2

As we've proven during previous economic downturns, our business model is resilient and recession ready, in large part due to our disciplined Through the cycle, credit underwriting standards and robust risk management infrastructure. Our consumer clients are predominantly prime, super prime And our commercial book is generally investment grade and we have very little leverage lending commitments. We are focused on prudent balance sheet growth, High return, high margin opportunities and the prudent allocation of capital to lines of business and products best serve to deliver on our strategic objectives. Our growth strategy is focused on creating value for our customers, communities and shareholders, which allow us to generate industry leading performance. Let me close by saying thank you to our 77,000 employees across the company, including our newest colleagues from Union Bank.

Speaker 2

Your dedication and commitment are what make U. S. Bank special and the destination of choice for all the constituents we serve. We'll now open up the call for Q and A.

Operator

We will now begin the question and answer And we can first go to Scott Siefers with Piper Sandler. Please go ahead.

Speaker 3

Hi, Scott.

Speaker 4

Maybe a question for you, just sort of at a top level, I was hoping you could speak to what sort of balance sheet and capital management will look like for you. So you're still under $700,000,000,000 in assets, but any thought on sort of limiting growth or will there be additional sales or And then I guess on repurchase, I know we're on pause until we get back to the I'm an equity Tier 1 target, but with the sort of looming category move up, would there be any thought to hold off longer than that just to sort of What happens, just any thoughts on either of those would be great, please.

Speaker 2

Scott, I'll start. This is Andy and Terry will add in. So first of all, we're not limiting growth in the company. We one of the reasons we position the balance sheet and took the optimization actions we talked about Terry went through was to allow for profitable growth. It also was related to the credit box that we manage within as well as the returns that some of those Categories of assets that we secured at ICE we're returning.

Speaker 2

So those are all allowing us to grow in a profitable way in the future. As we talked about before, we would not expect to cross the threshold of a CAT II until the earliest at the end of 2024 and that's into the new category at that time. And if we have any further balance sheet optimization actions, securitizations, they would be very nominal and not material in nature. Jerry, what would you have?

Speaker 3

Yes. No, I would just again reiterate, we're ready to be able to adopt Category 2 by the end of 2024, but There's no real cap. We wouldn't expect any real significant balance sheet optimization from here. We spent a lot of time positioning the balance sheet for growth as we go forward.

Speaker 4

Wonderful. And then just Sort of thoughts on repurchase as well? No, we're on pause for now, but it's still Sort of a question mark, so I would be curious to hear your thoughts.

Speaker 3

Yes, Scott. So as we've said and we continue to expect that We are starting about at a good spot, about 8.4% CET1. We expect that to accrete up to add or above 9% by the end of next year and to continue to accrete 2023 and continue to move up from that particular point. So one of the things we'll do is once we get to above 9%, we'll have to make an Assessment as to all the different things that are happening out there from a regulatory perspective. I mean, you have the regulators looking at Basel III and are Having to think about category 2 and all sorts of things, but I think it's really going to be based upon what the landscape at that particular point in time looks like.

Speaker 3

But Certainly in terms of our core CET1, it will accrete nicely throughout 2023. Wonderful.

Speaker 4

All right. I appreciate all the thoughts. Thank you.

Speaker 2

Thanks, Scott.

Operator

Next, we can go to Erika Najarian with UBS. Please go ahead.

Speaker 5

Hi, good morning and thank you for all the detail that you gave us on the slides. My first question is on the Cadence of the cost synergies as it relates to your expected Memorial Day weekend conversion. So first clarification question, The 35% cost synergies, is that a target for full year 2023? And what is that cadence like? Do we expect very little in cost synergies until Memorial Day weekend and then an acceleration in cost synergy capture as the systems converge?

Speaker 3

Yes, Erika, great question. And just to confirm, our expectation is that Of the $900,000,000 of cost synergies, we'll see about 35% of that next year in 2023. And so from a cadence standpoint, with the Memorial Day conversion, the vast majority of those Synergies will start to really kick in subsequent to that system conversion. So Smaller during the first half of the year, much more significant of that 35% in the second half of the year.

Speaker 5

Got it. So the exit so in other words, we should anticipate an exit rate by 4Q 2023 of well above 35%.

Speaker 3

Yes. By the time we get to the end of the Q4, we will have incorporated the vast majority of the cost synergies such that By the time we get to 2024, we will be in a good position to have achieved 100%.

Speaker 5

Got it. And my follow-up question is on the economic outlook. If you could remind us what is being captured in the legacy U. S. Bank reserves in terms of Sure.

Speaker 5

In the legacy U. S. Bank reserves in terms of the GDP outlook and the unemployment outlook, And how are you thinking based on that outlook charge offs for legacy U. S. Bank Would trend, as we anticipate it seems like a lot of your peers are anticipating a mild recession from here.

Speaker 3

Yes. I would say that our expectations are probably consistent with that sort of a thought process. When we are thinking about the reserve, our base case is that there is a mild recession probably in the second half of the year That unemployment ticks up and GDP is either relatively flat or down a bit. When we go through the reserving process, As we said in the past, we end up looking at 5 different potential scenarios all the way from a base case to a severe sort of recession. And I would say that from a reserving perspective, we're a little bit weighted toward that downside scenario, So a little bit more conservative.

Speaker 3

From a charge off perspective, our expectation kind of using The baseline of about 23 basis points in the 4th quarter, that will continue to normalize throughout the year. We'll see Both delinquencies and charge offs moving up. But to kind of give you some perspective, our Pre pandemic was at 50 basis points. We probably don't see that until sometime into 2024.

Speaker 5

Got it. Thank you.

Speaker 6

Thanks, Erica.

Operator

And next we can go to Mike Mayo with Wells Fargo Securities. Please go ahead.

Speaker 1

Morning, Mike.

Speaker 7

Hi. Hey, good morning. I just wanted to clarify. So you made your positive operating leverage in 2022 over 200 basis points. If you back into the numbers, I'm getting positive operating leverage year over year all in somewhere between, I don't know, 100 to 900 basis I'm not sure if that's correct.

Speaker 7

And just if you back in the numbers, what do you get? And why there's such big variance in the revenue guide? That's $29,000,000,000 versus $31,000,000,000 And why is the margin still increasing 5 to 10 basis points in the 4th quarter? That's a bit More of an improvement versus others.

Speaker 2

So I'll start on a couple of things and Ontario will add in. So let me sort of go backwards on your questions. The margin increasing principally because of the value of the low cost deposits that Union Bank brings on. We talked about that a lot Mike and $85,000,000,000 of principally consumer low cost Stable deposits in this environment is very valuable in driving up that margin on a quarterly basis and that's reflected in that 5 to 10 basis points. We did achieve 2 30 basis points of positive operating leverage in 2020.

Speaker 2

A little bit of background.

Speaker 1

Hey, Mike, we're getting a little background. Can you mute your line? Thanks.

Speaker 2

We did achieve 2 30 basis points of positive operating leverage in 2022. We would To achieve continued positive operating leverage into 2023, but 2023 is going to have the merger related charges in it as well. So I'm looking at it on And Terry, what would you add?

Speaker 3

Yes. I just maybe kind of coming back to the net interest margin, we expect you'll see a lift related to Union Bank coming on, that 5 to 10 basis points. And then from there, kind of flattish to maybe moderate increase or expansion in net Margin to the rest of the year, but clearly deposit betas and things like that are going to accelerate a bit in 2023.

Speaker 7

And as a follow-up, look, U. S. Bancorp had been a low cost producer for a long time. It looks like you're going to Trend back in that direction. So it sounds like you still have no change in expected synergies.

Speaker 7

I get it, Union Bank is Performing better and that's why the accretion you had brought higher to 8% to 9%, but still no change in expected synergies from the acquisition. And then separate from that, Andy, you mentioned in December that the big kind of tech investment cycle It's now turning positive versus being a drag for the last 5 or so years. If you could elaborate on that. Thank you.

Speaker 2

Sure, Mike. And you're right, we still are projecting as Terry went through $900,000,000 of cost savings, 35% in 2023, 100% We'll be implemented in 2024. Importantly, we have not in the guidance that we provided, provided any revenue synergies. That's without revenue synergies, which we think there are going to be some particularly after the integration and conversion process. We are past the heavy spend on tech.

Speaker 2

You're right. We're more of at a flat line and starting to gain the benefits of that. And part of the Benefit of this transaction is leveraging the investments we've made in the company over the last 3 or 4 years to allow us to lift and shift to our technology platform in a very low cost So that benefit is driving through the synergies that we talk about.

Speaker 7

Thank you.

Speaker 3

Thanks, Mike. Thanks, Mike.

Operator

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

Speaker 3

Good morning, John.

Speaker 2

Good morning. Hey, John.

Speaker 8

Good morning. So on the credit metrics, I know you indicated that you're Starting to see normalization in charge offs and delinquencies. I want to see if you can elaborate a bit more on what income cohorts Are you seeing the normalization? We're hearing from some of the consumer finance players that they are seeing some normalization impacting moving beyond just The non prime and low income, but into prime and super prime. And also what asset classes are you seeing The normalization most obviously, is it just on the card side or in other asset classes?

Speaker 8

Thanks.

Speaker 3

Yes, I mean, this is Terry. So maybe to address your first question in terms of where we're seeing it Maybe as kind of a reminder, from an underwriting perspective, we focus on prime, super prime really in all of our consumer portfolios. To the extent that we're seeing delinquencies starting to tick up, it's more so in the credit card space. And you're right, it would be probably on the lower bands as opposed to the upper bands at this particular point in time. But one of the things we talked about is that when you look at savings or excess savings from a consumer perspective, They're fairly significant.

Speaker 3

That is coming down. As that's coming down, people are revolving more in their credit cards. And I think it's just kind of a natural progression that we are seeing. And again, starting more with the unsecured and the credit card portfolio, not as much with respect to The other portfolios, yet, but as things continue to normalize, we would expect that too.

Speaker 8

Okay. Thanks, Terry. That's helpful. And then I guess related, how does this development in consumer behavior and your macro assumptions as Well, how does that impact your expectations for your payments revenue and your card revenue and merchant processing revenue as you look out through the year considering The macro dynamics. Thanks.

Speaker 2

Yes. So the payments revenues you saw still is well above pre COVID levels, the card spends 25% above on a year over year basis were plus 5%. So spend continues to be strong. The categories of spend are shifting a little bit. And we would expect continued strong spend, but moderating a bit as we go into the rest of 2023 for the reasons that Terry mentioned.

Speaker 2

But still expect growth, But again, probably more moderate in nature as we go forward and the savings level start to normalize and the consumer behavior starts to change.

Speaker 3

Yes. The thing that I would end up adding, John, is that one of the things we've talked about in the merchant processing is that we think that business is kind of a high single digits. And when we look at 2023, that's kind of our expectation for that particular business, relative to 2022, we anticipate that our credit card revenue And that is primarily because prepaid Sales and prepaid revenue, which has been a drag, kind of starts to moderate. And then on the corporate payment card Business, we continue to think that that's going to be reasonably strong, certainly high single digits, if not low double digits. And that's we're continuing to see travel and entertainment recover very nicely in that particular space.

Speaker 3

We feel pretty good about the payment revenue trends for 2023.

Speaker 8

Great. Thank you, Terry. Appreciate it.

Operator

Next, we go to Ebrahim Poonawala with Bank of America. Please go

Speaker 3

ahead. Hey, good morning, Ebrahim. Good morning, Ebrahim.

Speaker 9

I just want to follow-up one on credit. So you talked about consumer, Looking at the CRE slide, just if you don't mind talking sharing your perspective around the CRE book, if you're beginning to see any softening Either in certain markets, maybe California or within the office CRE book, which is about 10% of loans?

Speaker 3

Yes. I mean, maybe at a high level, Certainly, from a CRE perspective, valuations, I think, are moderating to some extent. The areas that we have had Probably the greatest focus on, if you will, is really office space and that is really probably as much tied to Return to office sort of behaviors or patterns. And I think that that is probably a longer Term sort of structural adjustment that's going to end up happening, we're just going to have to watch it over time. But when we just kind of look at the Core CRE portfolio continues to perform pretty well from a credit perspective at this particular point.

Speaker 9

Got it. And I guess just one separate question around payments. When you think about in your slide, you mentioned about Some of the tech investments and partnerships, just give us a sense of remind us around competitive positioning for USB, how you're thinking about just market share outlook? And from these partnership standpoint, like areas of like secular growth that you see in this business?

Speaker 2

As you mentioned, we've made a lot of investments in tech led activity and our tech led investments have led to that being the principal area of growth for the merchant processing categories. And then on the card side, the partnerships component continues to be an important strength for us and a point of growth as we look forward. So those two areas, Techlight on merchant and partnerships on card are doing well and it's partly due to the investments we've made over the past few years.

Speaker 9

And is the strategy there to just build this in house or do you see more kind of bolt on acquisitions within that business?

Speaker 2

Many of the investments we made are internal investments that we've developed our capabilities and our platforms to allow for different And allow for integration with some of the software that the companies use to run their business. We've added as well as you know Miscellaneous M and A acquisitions that you said bolt ons like a Talic or Bento that add capabilities around the edges. And I think we'll continue to do a little of both as we look forward.

Speaker 3

Thank you.

Speaker 7

Sure.

Operator

And we can go to Gerard Cassidy with RBC. Please go ahead.

Speaker 10

Hey, Gerard.

Speaker 2

Hey, Gerard.

Speaker 11

Hi, Andy. Hi, Terry. Congratulations on closing the deal. Question for you, Terry, on the balance sheet optimization where you guys decided to sell off certain loans that were acquired, can you give us some color on What types of credits were in those sales and why would they chose I know they didn't meet your credit profile, but what was The driver of that, I mean, some of the details of the credit profiles?

Speaker 3

Yes. Maybe as a starting point, when we thought The balance sheet optimization, the things that we were thinking about is really repositioning the balance sheet to position ourselves for growth going forward To be able to optimize or improve profitability and looking at profit margins across the various portfolios and returns and then the risk profile. So maybe from a risk profile perspective, we ended up looking at Union Bank portfolios that we end And there were a couple of different areas that we focused on. One is that they had acquired a number of loans related through a LendingClub channel, if you will. And that was something that we had planned to run off over time originally when we looked at the deal And we made a decision that when we looked at the kind of the credit risk profile, how it's originated, etcetera, that we thought that Taking care of that upfront made a lot of sense.

Speaker 3

The other area that we ended up selling was some commercial real estate in their particular portfolios in order to be able to kind of bring that concentration down a bit. And then the other areas of optimization was more on the U. S. Bank side. We ended up looking at Lower margin indirect auto loan portfolio, we securitized about $4,000,000,000 associated with that Clear portfolio.

Speaker 3

And then the other things that we ended up looking at in the C and I book of business and across kind of our corporate space It's just relationships that maybe had lower returns associated with it that where we could optimize That and so we allowed some of that to run off, so to speak, during the quarter. And those were the primary areas of focus with respect to the balance sheet Last thing I would maybe say on the investment portfolio side is that we ended up selling About $15,000,000,000 of securities, the vast majority of that coming from Union Bank and that was really to kind of Think about it from an interest rate risk perspective, HTM perspective, etcetera. But that was the other area where we did some balance sheet optimization.

Speaker 11

Terry, were there in the corporate loans, were there any shared relationships, meaning you had an exposure to XYZ Company as the Union Bank And the total was maybe too much and you guys decided to take that down as well?

Speaker 3

Yes, exactly. So maybe from a risk perspective, looking at Hold levels or concentrations with respect to specific customers, yes, that was a part of the strategy.

Speaker 11

Very good. And then just as a follow-up, You guys obviously gave us very good detail in your slides. And on the credit quality, Slide 14, you give us the breakout in the net charge offs and You show us the reported number at 64 bps versus your core legacy number of 23 basis points. If I pull out the $189,000,000 from the optimization, it looks like the net charge off ratio is around 43 basis points, including the Union Bank numbers. Is that kind of the level we should kind of gear ourselves to for 2023 now that Union will be fully implemented into your business?

Speaker 3

Yes. Let me clarify. So 64 basis points on a reported basis, 23 basis points on a core basis. And there's 2 components To that core, the balance sheet securitization that I talked about that you articulated. But then, under CECL, what you end up having to do is you have to recapture loans that they have charged off.

Speaker 3

You have to make an assessment. And then if you believe that, that charge off was appropriate, you have to charge that off on day 1, so to speak. And there was about $173,000,000 of charge offs related to those, to that Day 1 effect associated with CECL. So there's really kind of 3 components, but 64 on a reported basis, 23 On a core basis and when we think about going forward, I would use the 23 basis points as kind of the start point. And that's about $210,000,000 worth of core charge offs.

Speaker 11

Thank you for clearing that up. I appreciate it.

Speaker 3

Yes.

Operator

And next we can go to Betsy Griseck with Morgan Stanley. Please go ahead.

Speaker 6

Hi, good morning. Hi and congratulations from my end too. And the deck is super clear. Really appreciate all the effort To make it simple and straightforward. So a couple of questions for me, just to follow-up on the discussion we just had.

Speaker 6

Could we also talk a little bit about How we should think about the reserving level as we go through 2023 and into 2024 because Like you said, you've got the fair value marks, you had to do the day, you had to do the add as per the CECL rules. So does reserve ratio Stabilize from here? Does it actually inch down? Is there a scenario in which it would move higher? Could you just frame out how we should think about that?

Speaker 6

Thanks.

Speaker 3

Yes. I mean, obviously, it is impacted by a lot of different things in terms of how economic uncertainty ends up changing and the mix of the portfolio, how it might change. But as we kind of think about 2023, I think that, that 191 basis points is probably a good is a good metric throughout the year. It might inch down a little bit, but I think that by and large, we feel pretty comfortable with that As we think about 2023 based upon our kind of base case, so to speak. Okay.

Speaker 6

And then I have one other question on the growth of the balance sheet. I know you addressed this a bit before, But when I look at the 2023 guide versus 1Q 2023, it's a slower growth rate than I think we're used Seeing at USB. So maybe you could help us understand, is this a moderated growth rate during the Integration phase and maybe second half that should accelerate up or is this the level of growth that we should anticipate? And then don't mind, I have just a couple of ticky tackies on the purchase accounting and the CDI and how we should expect that steps down into 2023 and 2024?

Speaker 2

Sure. Betsy, this is Andy. So first on the growth rate, I think 2022 had exceptional loan growth Across many categories led by commercial as well as CRE. So what we would see is that more normalizing. You're starting to see that in the Q4.

Speaker 2

I think the other fact is that the growth rates are impacted by average balances and some of the optimization activity that we took down in the Q4. It was a partial Q4, full quarter in the Q1 and the rest of 2023. But the principal driver is a function of loan demand, which Is moderating a bit across most categories. So still growing, but a little less than what we saw in 2022.

Speaker 3

And then, Betsy, maybe related to your second question, which was Around the recognition of the core deposit intangible over time, probably the way that I would think about it is It's it will amortize into income over about a 10 year period. It will step down and probably a good Way of just modeling it is assuming kind of a sum of the year's digit sort of approach.

Speaker 6

And same thing for PAA or how should we think about that?

Speaker 7

I mean, I know it's different, but Yes.

Speaker 3

So that's tied obviously to the life of the loans, And it will end up being impacted by prepayments and those sorts of things. If you end up looking at their portfolio that we About half of it is residential mortgage and half of it is corporate and shorter term. So probably if you ended up An average life of 4, 5 years, 4 to 6 years, that's our time frame. And of course, that will also accrete Probably a little bit faster on the front end.

Speaker 6

Okay. Thank you for that.

Speaker 2

Yes. Thanks, Betsy.

Operator

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

Speaker 8

Good morning, Vivek.

Speaker 3

Good

Speaker 10

morning. Congratulations. A couple of questions. The tangible book value recovery, the crossover and the fact that you'd Recover that back quickly. Can you just give any color on sort of what's the key driver of that?

Speaker 10

Is it just simply earnings or is there something else Amit, that also that's going to help that come back so quickly.

Speaker 3

Yes. It's principally the accretion Effect that we're going to see with respect to Union Bank, the marks and the underlying earnings of the company.

Speaker 10

Okay. So the accrete because I just heard you say The accretion the question that Betsy asked, the purchase accounting accretion that half the loans are mortgages. So that will take come down, I guess, Over more slowly, so is that part of it that prepurchase accounting accretion is going to stay high for longer?

Speaker 3

Yes. No, I really think it's just it really is the kind of 8% to 9% accretion levels that we're expecting.

Speaker 10

On the EPS side? Yes. Okay. Got it. Okay.

Speaker 10

A couple of other little ones. Deposits, the decline that you had in the balance sheet optimization, I think it's pretty sizable, dollars 24,000,000,000 Is it all UB or is it some of yours and which Types of deposits?

Speaker 3

Yes, it's a great question. From a deposit standpoint, when you think about kind of the optimization that we went through, We had kind of a focus on a couple of different things. We ended up looking at LCR ratios, we ended up looking at higher cost deposits, whether that would be brokerage Type deposits or euro dollar deposits, those sorts of things. We made a very conscious decision after getting regulatory approval to kind of reposition that. On the Union Bank side, the one thing that I would point out is that, there's about $8,000,000,000 to $9,000,000,000 worth of deposits Came over that we're more transitionary.

Speaker 3

And over time, those will transition Back to their global investment bank, as those customers kind of migrate. So about half of that migrated in the 4th quarter, And I would expect probably the other half of that to migrate in early 2023. But those were kind of the things we ended up looking at with respect to deposit and deposit flows. So I was really looking at trading out low cost deposits High cost deposits for low cost deposits that are coming over from Union Bank and then some of the Union Bank effect.

Speaker 10

What was the OCI number at the end of the year? So as we think about where going to category 2, how quickly Do you expect that to come down so that you can be in better shape?

Speaker 3

Yes. So OCI at the end of the year is about 8 $1,000,000,000 And the duration of the portfolio is a little over $5,000,000 So if you can kind of take a look at that, Obviously, that's assuming that rates don't move from here. Our positioning from an investment portfolio perspective is about 52%, 53% HTM. We've also entered into some pay fixed swaps that In effect, kind of get that up to the high 50s. So we feel like we're in a pretty good position to be able to Deal with, if rates move up a bit or if rates come down, we have some flexibility there as well.

Speaker 3

So we feel like we're in a pretty good spot.

Speaker 10

All right. Thank you.

Operator

And next we can go to Matt O'Connor with Deutsche Bank. Please go ahead.

Speaker 7

Good morning. Can you talk about the pace of the capital build from the 8.4% to around 9% by the end of the year? And then also, if the macro is worse than expected and you have to build reserves more, I realize that doesn't move the capital that much. But obviously, everyone else is starting at a higher point of capital and there is focus on how quickly you can get to that 9% or even higher. So I guess the question is like what levers can you pull that kind of aren't that painful if you need a little bit more such as issuing preferreds or some other assets that you could kind of exit without hitting on that much?

Speaker 7

Thank you.

Speaker 3

Yes. I mean, obviously, Matt, from a balance sheet optimization perspective, We're going to be very focused on profitability, returns and capital Precious. So we want to make sure that we are dedicating our resources from an asset growth perspective in the right spots. The pace of growth from 8.4% to a little above 9% by the end of 2023, It's fairly, fairly, ratable across the 4 quarters. Obviously, 1st is going to be a little bit lower simply because we will not have seen the cost synergies and we will be going through and incurring more merger related costs Probably in the earlier part of the year, simply because of the timing of the system conversion.

Speaker 3

So the pace is probably a little bit more weighted toward the back end, But that hopefully kind of gives you some perspective. Again, I'd kind of come back from a reserve point of view. We Feel like, we look at a lot of different scenarios. We look at the 5 different approaches, one of which is a severe recession. We take that into consideration.

Speaker 3

We can see unemployment move up to around 6%, 6.5%, and we still feel like we would be in a pretty good spot from a reserving point of view. So if it ends up being at a level that's higher than it, then we'll have kind of focus on other balance sheet optimization activity.

Speaker 7

Okay. Thank you very much. Thanks, Matt.

Speaker 3

Thanks, Matt.

Operator

And we'll go to Ken Usdin with Jefferies. Please go ahead.

Speaker 12

Hey, good morning guys. First question I just wanted to ask is just to follow on the outlook for the year. Can you walk us through just your underlying assumptions for kind of how NII just trajects, if we just think about kind of the core business In terms of what deposit costs and betas do and how that impacts the kind of underlying trajectory from this first from the Q4 of NII?

Speaker 3

Yes. So obviously, net interest income is going to be driven by the earning asset growth that we have in here as well as the margin We expect that margin expansion to take place, 5 to 10 basis points in the Q1 because of the union full quarter of effective Union Bank. And then again, our modeling is that the margin is reasonably Moderates from there, reasonably flat, maybe up just a little bit. From a deposit point of view, Clearly, deposit betas are going to accelerate. I think that's the reason why you'll see the moderation In terms of net interest income or net interest margin expansion in the second half of the year.

Speaker 3

But keep in mind, And again, this is kind of we see that in the Q1. The Union Bank effect associated with the value of those So we're bringing on and we'll continue to look at opportunities to kind of optimize the deposit portfolio.

Speaker 12

Okay. And then just one follow-up on the deal impact. Can you just remind us what type of like amortization period you're using for both The purchase accounting accretion and the CDI in terms of like, is this the run rate that we keep around for a few years or does that change as you look past 2023? Thanks.

Speaker 3

Well, I think that, again, in 2023, we expect the purchase Accounting accretion to be $350,000,000 to $400,000,000 and the CDI to be about $500,000,000 As I mentioned earlier, I think on the CDI, it steps down over time, but if you use kind of a 10 year assumption and some of your years digits, I think that'll get you from a modeling perspective Pretty close to how I think it will end up amortizing off. The purchase accounting is really going to be tied to the asset lives Because about half of it is mortgage and half of it is corporate and commercial, etcetera, and shorter lived assets, I think you can think about kind of that 4 to 5 year sort of timeframe and it probably accretes down in a kind of a similar sort of fashion, a little more front end weighted.

Speaker 12

Okay, got it. Thank you, Terry.

Speaker 3

Yes.

Operator

And next we can go to Chris Kotowski with Oppenheimer. Please go ahead.

Speaker 10

Hi, Chris.

Speaker 13

Good morning. Following up a bit on Mike and Ken's questions. I look at your very helpful Slide 18 on the guidance and I take the midpoint of the $7,100,000,000 to 7.3 $1,000,000,000 revenue range and I kind of day weight that to the full year. I kind of get the lower range end of the full year guidance at 29.2% is actually what I get. So that implies like a couple percent growth in the back half of the year, which again, I guess is Better than what a lot of banks are saying.

Speaker 13

And I'm wondering, is that just underlying loan growth or The income growth or is it the tag ends of the benefits of rising rates or what do you see driving that?

Speaker 3

Well, again, I think you do see kind of the full year effect associated with rising interest rates kind of come into play. Fee revenue On a legacy basis, as an example, we should see a little bit more of a tailwind next year as opposed to what we this year. So I think that those are kind of coming into play. And then I think that just timing of being able to get cost synergies on the expense side.

Speaker 2

Yes. And I'd add, it's probably just mathematically as you're talking about it, you're right. And it's a little bit of a growth in the earning asset You see there going up from 605 to 610 to 610 to 620, that's number 1. And then maybe going towards the high end of that range in net interest margin versus the mid or low end in the early

Speaker 13

Yes. It's interesting because if I did the same analysis on the non interest expense side, you're at the high end of that. So it implies kind of nice growth in pre provision earnings the course of the year. So, but anyway, that's it for me.

Speaker 7

All right.

Operator

And our last question in queue will come from Mike Mayo with Wells Fargo Securities.

Speaker 2

Hey Mike.

Speaker 7

I've never heard before. ASCI,

Speaker 10

was it I'm just going to

Speaker 7

remember here, dollars 12,000,000,000 now it's 8,000,000,000 And where is it as of today?

Speaker 3

OCI, overall is at 10, at the end of the year and expected to come down from there. And at a lower level today, Mike.

Speaker 7

And then Andy, just can you pull the lens back

Speaker 10

a little bit? It's been

Speaker 7

a rough 3, 5 10 years when you look at operating leverage and stock, not last year on the operating leverage. But that comment you made in December and you addressed briefly, but you've been in this investment cycle multi years And now you said that you're coming out of it or the drag less or maybe the spending is less and the payoffs are more. Can you just give us more color on both the Spending side and the payback side and where you've invested the most in and where you expect that payback because it sounds like You're crossing a line, based on your comment from December that you reiterated today. Thanks.

Speaker 2

Yes. Thanks, Mike. I think that's a fair representation. So we our Spend levels on pure CapEx were grew from about $800,000,000 to $900,000,000 to $900,000,000 to $1,200,000,000 $1,300,000,000 And that growth has been in the run rate for the last couple of years. So you would not expect to see additional continued expense increase related to CapEx.

Speaker 2

Importantly, we also migrated that spend from about 60% defensive to 60% offensive. So The spend is on activities like digital capabilities, reaching customers, products and services and so forth. So all of that is what's coming through right now. So A level set on the expense side, plus a return on the investments from a revenue side, that coupled with overlaying all that on the Union Bank basis why we're projecting the numbers that we're giving you.

Speaker 7

Okay. Thank you.

Speaker 2

Thanks, Mike.

Operator

We do have time for one more question. We'll go to John McDonald with Autonomous Research. Please go ahead.

Speaker 2

Good morning, John.

Speaker 14

Good morning, guys. Hey, just a couple of quick follow ups. So Terry, where does the balance sheet repositioning and the merger leave you in terms of Interest rate positioning, how would you describe it here? Fairly neutral, a little bit asset sensitive. Where are you ending up now?

Speaker 3

Yes. I would say that, Legacy U. S. Bank is fairly neutral. When we add Union Bank on, it probably adds About 50 basis points, of asset sensitivity in a 50 up sort of shock environment.

Speaker 14

Okay. And then on the fee income, you said some more tailwinds this year, so some helpers On legacy U. S. Bancorp, what are those on the fee income front? What are the helpers this year that you can grow fee income?

Speaker 14

Maybe just puts and takes on fees real quick.

Speaker 3

Yes. Well, if you just kind of look at the different components, I think the payments revenue continues to be reasonably strong. I think that the Expectation is the market comes back a little bit in terms of investment income. But deposit service charges, we saw a drag in 2022 because of some pricing changes we implemented in May That starts to dissipate. So I think it will be kind of a combination of things, but probably one of the biggest ones is just mortgage banking revenue.

Speaker 3

That has been a pretty significant drag, especially on a year over year basis. And in the Q4, we actually started to see that inflection point with linked quarter revenue starting to come up and we would expect that to be a little bit stronger as we go into 2023.

Speaker 12

Okay, got it. And then

Speaker 14

the last clarification, I think on reserves, you said the 1.9 ratio looks pretty good for this year and even if unemployment went to 6%, 6.5%, you'd be okay?

Speaker 3

Yes. Again, we go through a lot of different scenarios and we take that downside into consideration. And as part of of that weighted average process, we think 6%, 6.5% unemployment It's already incorporated into our reserving process. So but again, it all is going to depend upon what ends up happening, how severe the economic Recession is if there is one at all. So I think there's just a lot of moving parts.

Speaker 14

Got it. Thank you.

Operator

And we have no further questions at this time. I will now turn it back to George Anderson. Please continue.

Speaker 1

Thank you for listening to our call. Please contact the Investor Relations

Operator

And that does conclude today's conference. Thanks for your participating. You may now disconnect.

Powered by Quartr
Earnings Conference Call
U.S. Bancorp Q4 2022
00:00 / 00:00