U.S. Bancorp (NYSE:USB) Barclays Americas Select Franchise Conference 2024 May 7, 2024 5:00 AM ET
Company Participants
Terry Dolan – Vice Chair and Chief Administration Officer
John Stern – Senior Executive Vice President and Chief Financial Officer
Conference Call Participants
Jason Goldberg – Barclays
Jason Goldberg
Welcome. I’m Jason Goldberg, and I cover the U.S. large cap bank stocks here at Barclays. Welcome to our Annual Americas Select Franchise Conference.
This started well over 20 years ago with four fledgling thrifts, I think, wanting to play golf in Europe, expanded to a financials only conference for many, many years. And then about maybe 10, 15 years ago, we broadened it to all U.S. industries. And I think I’ve heard we have record attendance this year.
So thank you for all clients or investors for coming over. We have, I think, close to 50 U.S. companies that made the trip over. So thank you to those as well.
We have seven U.S. large cap banks participating this year. And very pleased to kick off that string of companies is U.S. Bancorp. From the company, pleased to have Terry Dolan, Chief Administrative Officer, and John Stern, Chief Financial Officer. And let’s kick it off with Terry.
Terry Dolan
Thank you. Well, good morning, everybody, and John Stern and I appreciate the opportunity to be able to present here today. This is something that we have done many different times. Before I kind of get started. Just know that there may be some forward-looking statements that are made, and I just refer you to the legal disclosure regarding forward-looking statements. That’s kind of on Slide 2 of the deck.
You know, one of the things I think is always helpful is just to spend a little bit of time giving a little background with respect to U.S. Bancorp. And, you know, it’s a company that has a very trusted sort of background and a strong foundation. I would tell you that, with respect to our retail bank branch footprint, we’re in 26 states. So we kind of think of that as a kind of a regional footprint.
We have a number of different national businesses, though, including our mortgage banking business, our auto lending business, our credit card issuing business, and of course, our commercial and corporate banking is a national business as well. So covering all 50 states.
And then we do have some international businesses as well. We have three different businesses, our payments, merchant acquiring businesses throughout all of Europe, as well as our corporate trust and our fund administration.
If you think about U.S. Bank, you know, we are a scale player in the industry. We are fourth in the United States in terms of our peer group and among commercial banking entities with about $654 billion of average assets in the first quarter. And that’s funded with deposits of a little over $500 billion. So it’s a company that certainly has the scale to be successful as we think about the future.
U.S. Bank has always had a very strong record with respect to its financial performance. And this Slide 5 just shows the performance ratios in terms of returns on assets, return on equity and return on tangible common equity over the last 10, 5 and 3 years relative to our peer group. And you’ll see, for example, the return on tangible common equity of about 20% over the last 3 year timeframe. These are adjusted. We just went through an acquisition with respect to Union Bank. These are adjusted to take out the effect associated with the merger related charges. But, you know, this is really driven by the fact that we have a highly diversified business model in businesses that generate high returns and have a lot of earnings power.
I mentioned Union Bank and, you know, this is an acquisition we just completed. So if you step back, we closed on it in December of 2022. By the end of May, so within roughly 6 months, we converted all of the systems of Union Bank onto the backbone or the system platforms of U.S. Bank. So we completed that process and we fully integrated the Union Bank transaction into U.S. Bank by the end of last year. We achieved $900 million worth of cost synergies. That’s kind of fully in the run rate as we go into 2024.
But there’s a lot of different advantages with respect to the Union Bank transaction. Number one, it adds to our scale. So it enables us to be able to get the cost efficiencies that we talked about. It’s an expansion of our customer base. You see about 100 million, or excuse me, about a million new consumer customers, about 190,000 business banking customers and over 50,000 commercial corporate type of customers. And so this is predominantly in California. So it also puts us in, I think, the number 4 position within California, which represents the seventh largest economy in the world. So there’s a lot of opportunity in a lot of different areas of the organization that come along with the Union Bank transaction.
So we oftentimes get the question, what drives our higher returns? And it’s kind of a combination of things. Probably one of the most important is just our business mix. When you think about the different types of businesses that we’re in, but it’s also the fact that when we do conversions and when we think about the business, we want to try to run on single platforms.
We have a very strong risk management philosophy, which enables us to be able to have strong, sustainable earnings through a lot of different points in the business cycle. And then just our culture and our focus on corporate social responsibility. Those are all aspects that help to drive the higher returns.
So let me talk a little bit about the business mix on this slide and on the next slide. Our business mix is centered around three major business lines. Our payments business, which is a differentiator for us, represents about 26% of our overall revenue stream. And then consumer and business banking, which is kind of more of the traditional consumers, represents about 37%. And the wealth management, corporate commercial and institutional banking, or think about the wholesale side of the equation, represents about 37% of the business as well.
The thing that’s unique about maybe the payments business and the corporate trust or the institutional banking businesses is these are very high return businesses. They’re relationship businesses. They are not as capital intensive and they have strong barriers to entry and they’re deposit gatherers.
So for a lot of different reasons, they help differentiate U.S. Bank and help to create the type of financial performance that I was talking about.
Maybe take a little bit deeper in terms of the sustainable earnings power. You know, that is a mix of geographic distribution or diversification, business diversification. But when you end up looking at our revenue diversification, about 40% of it is fee-based revenue as opposed to other organizations. And so that higher percentage of fee-based revenue is a very important aspect.
Within payments, about 65% of the payments revenue is card issuing, about 25% of it is merchant acquiring, and the rest of it is our corporate payments businesses and our treasury management services that we perform.
And then, as I said, the institutional side includes corporate trust and fund administration and asset money market funded management, if you will. And, you know, to kind of give you some perspective in terms of the corporate trust, we have a number one market position with respect to corporate bond issuance, a number one position with respect to municipal or government bond issuance, and a number one position with respect to structured finance positions or structures as well. And so, you know, it’s a very nice combination of businesses that enable us to be very successful.
If you end up looking at this slide on Slide 10, it just kind of shows the different market positions that we have in a variety of the different businesses that we run. I want to spend a little bit of time talking about our payments business. We have been focusing on thinking about how we end up bringing payments and business banking together.
And so we talk about it in terms of a business banking payments ecosystem. We started this initiative about 3 years ago. And if you think about it, we have a very strong payments and merchant acquiring business. We also had very strong banking products and services, but they kind of grew up in their silos.
And so what we have been really working on over the last couple of years is how do we end up bringing them together in a way that is integrated, seamless, and more convenient from a customer point of view. So over the last 3 years, we’ve seen business banking relationships growing at a pace of about 35% over that 3-year timeframe, and revenues growing at about 30% over that timeframe.
So, and I would say that we’re probably still in the middle innings associated with that. And we think that there’s near-term continued opportunity that exists with respect to the payment ecosystem and a way that it ends up differentiating us.
Digital, digitization of the business is another area of strategy for the company. It’s an area of focus. Today in the United States, we have the number one mobile app in terms of product feature and functionality. And the benefit of it is that we’re kind of at the point in the investment curve when a lot of that investment has been kind of built into the cost structure or the run rate. We actually see this an area of opportunity of growth from a revenue standpoint, as well as efficiencies in terms of our cost structure.
So as we are implementing these digital capabilities, we’re thinking about it across the entire organization. And so we measure ourselves in terms of reusability of that platform across many different products and services. And it’s those types of things that will help it to generate efficiencies as we go forward.
Another thing that has always differentiated U.S. Bank is just our credit quality. And I think what we are currently seeing is that credit charge-offs have kind of normalized a pre-pandemic level. We would expect in 2024 that it’s going to be kind of the mid to high 50 basis point range. And that is really at pre-pandemic, maybe a little bit higher because of inflation and the higher interest rate environment. But the credit quality of the company is performing very well. We feel like from a reserve standpoint, that we’ve adequately taken all that into consideration.
One of the reasons for our performance is that we always underwrite with a through the cycle sort of an approach. We don’t expand the credit box in good times and contract the credit box during bad times. We think about what do you need to be able to do in order to be able to effectively manage through the credit cycle. And so when we go into a recessionary sort of times or more challenging times from a credit point of view, that’s a time when U.S. Bank typically outperforms.
And then the last thing I’ll just touch on is our culture. And one of the things, if you think about kind of our mission or our focus, it’s really around how do we end up powering human potential or the potential of businesses that are our customers. And that permeates through our core values. And the way that I would maybe describe it is that tone at the top matters. And you see that in U.S. Bank in terms of how we’re recognized within the industry in terms of most admired super regional bank, et cetera, et cetera.
And then I won’t go into a lot of detail with respect to our commitment regarding corporate social responsibility. I’ll just refer you maybe to our ESG report that’s out at usbank.com. And you can see a lot of the wonderful things that we end up doing within our communities to help them thrive.
And now what I’m going to do is I’m going to turn over to John Stern, who’s going to give a little bit of a financial update. So John?
John Stern
Thank you, Terry. Morning, everyone. Good to be with you all. Going to this slide, as Terry mentioned, I was just going to comment a few highlights that we have for the quarter. It starts really with, as Terry mentioned, our return on tangible common equity at north of 17% for the quarter. Continues to be industry-leading returns, and that’s really powered by, especially this quarter, our fee revenue businesses.
So we have a lot of different fee revenue streams, whether that’s capital markets or payment systems, the ecosystem that Terry talked about, or other categories like trust and investment management fee. But these have been performing very well, and we’re near 8% on a year-over-year basis.
The other items I’d like to just mention is just on the expense side of things. We’re continuing to see the synergies realized from the Union Bank transaction, and starting to see that come through. As Terry mentioned, we have all $900 million of cost saves that have been incorporated here, and we’re starting to see that expenses tick down.
And along with that, our capital ratio has continued to improve. We’re at 10% from a common equity Tier 1 ratio, and that is up 160 basis points since the Union Bank transaction where we were at 8.4 at the close of that just over a year ago.
On the balance sheet side, we’re very much focused on capital efficient growth. At this stage of the game, we are tending to be very good stewards of the balance sheet, and so we have seen loans tick down a little bit. But that is a lot of that has to do with the industry and just more or less uncertainty in client bases in terms of loan growth and things of that variety. So that has ticked down. I’ll share with you some of the details in a moment.
But deposits continue to be pretty much in a flat pace, and that’s in large part to the Federal Reserve’s quantitative tightening policies that’s putting pressure on deposits and cash balances within the industry. We’re no exception. However, the one thing that we’re focused on is very much is on the consumer side. We have been growing consumer deposits over the last several quarters, and we’ve been doing that because we have a number of different outlets in order to grow that. And Terry mentioned and showed the map that we have of our consumer base. Obviously, we have the branches in more of the Midwest and West Coast, but we also have the digital capabilities to open up CDs and other accounts in all 50 states, and we also have partnerships such as State Farm that are able to acquire customer deposits as well. So we have a lot of different ways, methods, and capabilities, and channels in order to grow our consumer base.
On the loan side, this slide provides a little bit more detail of how loans have performed over the last quarter and over the last year. We’ve seen good growth in our credit cards, and that’s a reflection of constructive payment trends in the United States, which has been leading to more balances, and that’s been offset by our commercial real estate, which, as you are well aware, there’s a little bit less activity in that space, as well as in a category of other retail.
Now, that’s principally auto loans. We just have not been growing auto loans. In fact, we’ve been running off that portfolio for some time, just given the return profile of those loans continue to be subscale of where we’d like it to be, and so those loans have been running off.
On the right-hand side of this page talks really to the credit quality of the book. We have, obviously, in our commercial real estate footprint, we have a portion of that which is office-related. It’s a very small component. Obviously, there’s a lot of our loan book, I should say, at just under 2% of total loans, and obviously, this is something that the industry is watching, but we feel like we’re in a comfortable spot because we have a 10% coverage ratio on our office portfolio.
A lot of the clients that we service here are high-performing and strong developers and managers, and we tend to have Class A properties, and less than half of the book is really in central business district, and so you take that all into consideration. We feel very good about our commercial real estate office portfolio.
The other thing that gets some attention is in the multifamily sector, and here, somewhat the opposite of the office properties, which have a little bit less valuation. Multifamily valuations continue to hold up very strongly, and while we may have stress in the client base given higher interest rates, higher inflation, and all those sorts of things, we don’t feel like the loss content is going to be pronounced on that book of business.
On the deposit side, you’ll hear me say 50-50 a lot in this. We have 50% retail, 50% wholesale/institutional, so it’s a very evenly distributed book of business there. It’s also 50% roughly insured versus uninsured. However, the parts of uninsured deposits that we have, really, we consider operational in nature.
So these are clients that we’re utilizing for either treasury management services, they may be corporate trust clients, they may be fund services clients that are holding deposits for things that we’re administrating, or activities that we are administrating for them.
Along with that, we have non-interest bearing account activity that we are monitoring very closely. What’s unique about our deposit profile, and this is on the bottom right-hand side of the page, a majority, if not all, of our non-interest bearing accounts are either commercial, corporate, or institutional. Anything that, on the retail side, is in our low-cost deposit bucket.
And so, as a percentage of total deposits, we have a little bit less mix in terms of DDA or non-interest bearing accounts. And as you can tell, that has been drifting lower over the last several quarters, but the pace of it has been slowing and is starting to stabilize in many aspects.
On the investment security side of things, we have a very high-quality book of securities. Virtually all of it is either government-issued or government-guaranteed in some form or fashion, so certainly U.S. Treasuries, U.S. agency mortgage-backed securities, as well as commercial mortgage-backed securities that are backed by the U.S. agencies, and some municipal securities as well.
It’s about a 50-50 mix in terms of available for sale and held to maturity, and so that has been pretty constant over the last several quarters, maybe trending more into the AFS side as we start to experience higher interest rates.
And I would also say that the yield book has continued to grow as well, so we’ve been growing anywhere from 7 to 8, nine 9 points per quarter. Last quarter, we didn’t. We were basically flat last quarter, and that’s just a reflection of some hedging activities that I’m happy to take questions on as we go.
The other thing we’re mindful of is the profile and the duration of the securities book. Obviously, with pending rules that are coming through, we know that the unrealized gain-loss will go through the capital ratio, and so at this point, that amount is about 2.2 percentage points relative to our current common equity Tier 1 ratio, but we do expect it to burn down. In this exhibit, we have it down 25% over the next year and a half or so by the end of ’25, and that, of course, is based off of the end-of-the-month yield curve.
But we have been taking a lot of action to hedge that portfolio. We’ve been taking a lot of action to maintain and lower the duration of the portfolio, which is just under 3 years at this point in time.
Finally, our guidance slide hasn’t changed since we talked during the April earnings call. We continue to maintain relative stability in terms of net interest income for the second quarter. Our net interest income for the full year at $16.1 billion to $16.4 billion, fee revenues maintaining at mid-single-digit growth, and expenses coming in at $16.8 billion, which is a little bit less than the $17 billion number that we had last year, $16.8 or lower, I should mention.
So we’re very much focused on these actions that we’ve been talking about, very much focused on being good stewards of balance sheet, capital-efficient growth, and continuing our leadership in terms of high returns, and then, obviously, in the second half of the year, we are very much targeting positive operating leverage as well.
So, Jason, those would be our comments, and happy to take questions from you or the audience. Sneak back here.
Question-and-Answer Session
Q – Jason Goldberg
Helpful comments, we’ve got 20 minutes left. So a lot to get through that I want to follow up on. But maybe first, Terry, before we jump in, we’re a month into the quarter. Can you provide us an update on business trends? What are you hearing from customers running the operating environment, outlook for loan growth and whatnot?
Terry Dolan
Yeah, maybe from a macroeconomic perspective, and I think the economy in the United States is generally doing well. I would say it’s stable and resilient. I think there are uncertainties around where inflation is going, and it’s been a little bit sticky, but generally coming down, and I think the Fed is doing a really nice job in terms of kind of managing through that.
I think the other uncertainty that is kind of tied to that is just what’s going to happen with respect to interest rates. I think while it may be higher for longer, I don’t think that there is a risk associated with rates increasing from here, and I think it’s more of the timing of when rates start to come down, which is good, but there is a fair amount of uncertainty that exists out there.
Consumer spend is continuing to hold up, pretty stable, and I would say that the things that are impacting them is inflation. The labor market is tight. Unemployment has only had 3.9%. All those things kind of come back to, from a consumer perspective, they’ve been pretty resilient. From a business, banking, or a commercial perspective, CFOs, I think, are optimistic, but cautious.
And so one of the things we’re seeing is that while there’s relatively weak loan demand, pipelines look like they’re getting stronger, which is good, and then the capital markets started to strengthen in the first quarter, and those are all signs that I think people are feeling a little bit more comfortable in terms of getting out their funding and making some business investment, which I think is all good.
Jason Goldberg
Got it. And maybe, John, let me just start on deposits. Maybe just update us in terms of what you’re seeing from customer behavior, kind of mixed shift from non-interest bearing to interest bearing. And then in the first quarter, we saw non-interest bearing shoot up into quarter end, which maybe just talk about what we’re seeing there as kind of 2Q and had to normalize and how to think about that.
John Stern
Yeah, yeah, so a couple things there. I would say deposit trends continue to be pretty much as we expected. I’ll get to the trends component in a moment. We have that seasonality. I mean, if you look at how deposits perform for us, there are certainly spikes that occur during the course of the year, but we kind of ebb and flow through that.
And so in terms of the non-interest bearing mix that you asked about, that has continued to, there has been some rotation there, but that rotation is slowing. We continue to see – expect that to stabilize over the course of the year.
And in terms of going back to the surge [ph] Jason, you know, I mean, we saw a pretty big surge. It was bigger than normal. There was a little, the Easter holiday was there. It was quarter end. There was a lot of factors. And what drives that really is the number of businesses that we have for either in corporate trust or fund administration and things of that variety. A lot of funds, a lot of capital market activities getting ready to deploy their funds. They deposit those flows with us.
There’s also a lot of corporations that make bond payments and things like that at the first of the month. And then there was a lot of tax receipts getting ready for tax payments in mid-month of April. So all that kind of happened all at the same time, but it all very much went out very quickly as well.
And so if you think about kind of a go-forward basis, the surge really is only there for three or four or so days. And so it’s a very tiny impact to the quarter on an average balance perspective. And so I point people really to average balances as being really a good trend for us to kind of look at for deposits to go forward.
Jason Goldberg
And how do you think that, I guess, trends over the remainder of the year?
John Stern
Yeah, I think it’s going to be pretty stable, pretty steady. I think that wild card will be, obviously the quantitative tightening is starting to abate from the Federal Reserve. They just announced that. And so that should put less pressure on industry deposits. And so that should bode well for us. And of course, we’re continuing to focus on consumer deposits. We have all the levers and capabilities to grow that. We continue to be focused on that very much.
Jason Goldberg
Got it, and maybe just delve deeper into the $16.1 billion to $16.4 billion NII guide for the year. And maybe just gank [ph] around the kind of lower end of that guide. Can we just talk to kind of some of the assumptions for deposit balances, mixed beta, loan growth kind of baked into that lower guide? And does that lower guide include maybe the possibility of no Fed cuts?
John Stern
Oh, sure. So, you know, in terms of, maybe I’ll start on the asset side of things. So we do assume in our base case, modest loan growth. So kind of the same trends you’ve been seeing. Credit cards growing. We feel like there’s a decent pipeline in commercial and industrial loans. They’ll probably be offset by commercial real estate as well as auto loans continuing to roll off. So net-net, that’s probably, modest growth is at best is what I would say from that standpoint.
The asset churn will continue to be favorable. The investment portfolio will continue to generate kind of that 7, 8, 9 basis point link quarter pickup in yield over time. The residential mortgage book will continue to pick up that 4, 5, 6 basis points of accretion over time as we maintain these higher yields. So those will all be favorable tailwinds for us.
On the deposit side, I just, I talked about the trends. I think the quantitative tightening and starting to abate will help our deposit flows. I believe that, you know, the non-interest bearing rotation while it’s still happening will stabilize and start to slow.
So those are kind of our base case assumptions, Jason. And then I would say, you know, if the lower end would be more deposit pressure than what we would anticipate or maybe loan growth doesn’t materialize to the extent that we would think, that probably is the area that gets it a little bit lower on the lower end.
Jason Goldberg
Got it. And I guess on the securities portfolio, you talked about it being, I guess, down a basis point in the first quarter due to hedging. And now you’re saying up 7, 8 basis points kind of in the second quarter. And just how do we think about that kind of progressing?
John Stern
Yeah. You know, maybe if I could just step back or just to talk about the reason why we did some activity and had a lower investment portfolio yield this quarter. When we look at our asset liability profile, we look at it in totality. And so what we’re targeting is really a neutral shock. And you saw that in our recent filings in terms of up and down shocks.
And so we start there. And then the tools that we use to get us there is the investment portfolio hedges or purchases, long-term debt hedges, as well as hedges on the commercial and industrial loan book. So those are kind of the tools that we use to help maintain that neutral profile from an asset liability standpoint. Just happened to be this quarter, we tore up some pay fix swaps too, which took away some positive carry. And that’s just a temporary thing just in order to maintain that neutrality.
But going forward, we expect the churn. We have about $3 billion of securities that roll off on a quarterly basis, and that will be replaced at a higher rate. You know, it’s a 3% yield on the book today, but replacement yields are somewhere in that 5, 5.5 and a half plus area. And so that churn will be positive momentum we expect going forward.
Jason Goldberg
And then on the fee income side, you were talking about mid-single digit growth for this year. Maybe just talk about some of the key drivers of that.
John Stern
Sure, sure. Payments is a big part of that. Terry had mentioned the ecosystem on the payment side of things. That’s a very big component. Credit card has been very strong for us over the last several quarters. It may not maintain that same level of pace that we had, but it’s still going to be positive on a year-over-year basis for us in that mid-single digit area.
Merchant acquiring continues to be strong. This last quarter, everything was growing quite well. Tech led, non-travel and leisure all performing very well. We had a little bit of slowness in travel and hospitality and things of that variety during this quarter.
And then the other thing would be on the payment side would be our corporate payments, which actually has been trending down over the last few quarters, but that’s been weighted down by commercial freight activity, which has been quite low. We’re starting to lap that, and so we’ll see that in the second quarter and beyond as we get into the – throughout the year, we’ll start to see a pickup in growth in the commercial payments area.
Outside of that, the capital markets activity has been robust and strong in a number of different fronts whether it’s foreign exchange or derivatives activity or debt, capital markets, things of that variety. Terry mentioned our number one position in trust, corporate trust, and some administrative functions there, that has been, that goes, so does the capital markets. And so we feel like that’s on a good pace. And mortgage has actually been bouncing back as well. So all those things have give us that confidence and favorability to mid single digit growth for the year.
Jason Goldberg
I guess both of you mentioned, maybe Terry, you could dive more into it. Kind of just this whole payment ecosystem. You have this business banking customer base, just maybe talk to kind of what gets that going and when do we actually see it drive results?
Terry Dolan
Yeah. So a couple of years ago, we kind of stepped back and we looked strategically at how we could kind of enhance that business. And we started to think about that. We have a very strong payments business from a merchant acquiring standpoint. We have very good banking products and services in terms of small business or business banking.
And what our customers were saying is that simple, convenient, integrated approaches, products and services, is really kind of what they’re using in order to make decisions as to how to grow their relationships with whoever. And so we’ve been very focused in terms of making investment, in terms of integrating our payments capabilities into software that they use to run their business, and also to linking and integrating it with our banking products and services. So that if you think about we made investments in Talech [ph] We made investments in a company called Bento and TravelBank.
And all of those were intended to on the small business, business banking and even in the middle market space, to be able to kind of create a – you think about it in terms of a dashboard for small businesses. One place where they could go to be able to manage their receivables, their payables, their cash flow, and to tie it into the overall performance of their company.
And that’s hugely valuable from a small business perspective. Somebody who’s running a restaurant or whatever might be the case, they don’t want to spend their time having to deal with all the bookkeeping and the banking processes. They want it to be integrated and seamless.
So we made some nice investment in that particular space. We’re starting to see some nice traction. You saw business banking relationships up about 35% over the last couple of years, revenues up about 30%. And when we think about next 3 to 5 year sort of timeframe, having nice growth in that space will continue. So those are some of the things that we’ve been doing in terms of creating that payment ecosystem.
Jason Goldberg
Helpful, I guess. Beyond the co payment ecosystem, what other strategic initiatives are you focused on near term?
Terry Dolan
Yeah, I mean, it’s a number of different things where we’re making investment. I mean, obviously, over the last several years, we’ve been focused around digital products and capabilities. We have in the States, we have the number one mobile app in terms of product feature and functionality. Get very strong feedback on that. As John said, we built out the capabilities in order to be able to develop relationships, deposit relationships, to be able to issue CDs in all 50 states. We don’t have to have a branch network in order for us to be able to distribute.
So some of that investment in terms of digital capabilities is not just serving our existing customers, but also thinking about how do we end up expanding that beyond our branch footprint, which is critically important.
Think about the State Farm alliance. Some of that was investment, and we made investment in that as well, in part because we can utilize our digital capabilities in order to distribute through 19,000 agents. And they have one of the largest small business insurance companies. Well, small business or business banking is an area of focus for us. So all these things kind of tie together.
And then the other thing I would say is we continue to make investment in tech led capabilities. So integrating our merchant acquiring into, you know, the software that companies use to run their businesses. So if you’re a hotel like this one, and you have digital capabilities in terms of, you know, your restaurant operations and your beverages and booze and rooms and all those sorts of things, that all ties into systems that then link to our payments capabilities. That broadens our distribution from a payment standpoint. And all of those things are investments that we’re making.
And the last thing I would just say is just modernization of our technology moving to the cloud, those are all investments that we’re making as well.
Jason Goldberg
You talked a lot about investments. You have this expense reduction program. Just how does that one impact the other? And are you kind of spending enough to keep up with kind of fintechs in the payment space? I know it’s pretty competitive.
Terry Dolan
Yeah. I’ll come back to the Union Bank transaction. The timing of that was fantastic. From that perspective, it enables us to be able to look at our cost structure, to revamp our cost structure, and to be able to get the savings associated with Union Bank.
In addition, we’ve brought the operations functions across the bank together in order to be able to drive business automation and efficiencies in how we just operate. And so it’s kind of a broad strategic initiative around operational excellence. Those are all things that we’re using to be able to reduce the overall cost structure.
And then think about digitization. You know, we’ve been making investment in digitization. We’re kind of at the, the top of that investment curve such that we should see the benefit of revenue growth from digitization, as well as efficiencies of how we kind of link that together. So you have straight through processing and those sorts of things, all of that kind of comes together.
I’m going to link that back to our investment. We’re continuing to make roughly $2.5 billion of investment. We started that several years ago. It’s fully kind of in our expense cost structure now. We’re going to continue to make that investment because we know that that’s critically important for us to be successful.
So investing for the future, driving revenue growth using digitization and business automation and operational sort of restructuring in order to be able to drive the cost structure down.
Jason Goldberg
Sounds good, John. So 4 minutes left. Lightning rounds.
John Stern
We still got to do expenses…
Jason Goldberg
Cap – expenses, capital and asset quality, okay.
Terry Dolan
We can’t run out the clock.
Jason Goldberg
No overtime. So expenses. You guys, on the first quarter call talked about a $2 million – $200 million dollar expense reduction program. Just, you know, what are you cutting? Where are you on that process? And then how do we think about that as a jumping off point for 2025?
John Stern
Sure. So I would say the expense, expense reductions that we’re looking at, largely coming off the heels of what Terry mentioned. The Union Bank side is going to be – that plus looking at our cost structure just in total. So the third party spend that we’re looking at, it’s going to be real estate strategies that we’ve been utilizing across our footprint and rationalizing that, especially now with the Union Bank, we were able to take some actions there as well as operational efficiency. So we’ve combined our operations unit and continue to find efficiencies along the way. And that’s going to be the driver.
To your question of where are we on that journey, we are very far along in that journey. We’ve identified the vast majority of that and feel good about it, and that will be fully incorporated in our run rate go forward. So it’s not like a temporary blip and then goes back up. It’s something that’s embedded in our cost structure. Go forward.
Jason Goldberg
Got it. And then you mentioned positive operating leverage in the back half of 2024. I guess, does that kind of require loan growth coming back? You know, kind of what needs – you know, kind of what are your concerns of maybe not getting that or if you can’t get it, do you cut further levers to reduce expenses?
John Stern
Yeah. So we said 16.8 or lower. So that’s going to be – we’ll throttle that a little bit to the extent you can with the revenue outlooks and things like that. That’s kind of the, you know, why we have that ability in terms of operating that way.
I think it comes down to really deposit being behavior and how that’s going to play out the second half of the year. As we kind of talked about loan growth, we feel good about that modest loan growth being there for the remainder of the year. So those combinations along with relatively stable interest rates allow us to kind of get into that positive operating leverage that we’re targeting for the back half of the year.
Terry Dolan
So modest loan growth, fixed asset churn in terms of yields kind of coming up and then you know, continuing to be very focused on kind of expenses.
Jason Goldberg
On capital, you’re about a little less than $50 billion from Category II. Does that impact anything? And then, you know, what do you need to see to restart the buyback?
Terry Dolan
Yeah, so in terms of the – we’re at $650 or so billion. You know, we have to be north of $700 billion for four quarters on average to get to that next category. So we have a lot of runway. If you just think about loan growth being probably – a good way to think about it is look at GDP in the U.S. and tack on that, plus maybe a little bit of growth for loans. And so that gets you quite a few years before you actually trip over into that $700 billion marker. So we have some time to do that.
In terms of buybacks and all that sort of thing. We are looking at – we need to see Basel III of endgame [ph] rules. We’ve seen some reports that that might get finalized or some ports of it finalized this summer and then stress test results. We should have that and hopefully comment on that this fall.
Jason Goldberg
Got it. And just lastly, credit quality. We’re kind of low 50s charge offs in the first quarter. You talked about mid to high 50s, maybe 60 for the year. Just kind of what areas of stress are you kind of seeing in the book or kind of what are you most focused on?
Terry Dolan
Yeah, let me take that question. So as John mentioned earlier, one of the things we’re seeing is credit card growth. And so part of that is just kind of the normalization of credit cards over time, a little bit more pressure that you’re seeing in terms of delinquencies and things like that because of inflation and just higher interest rates. But again, I think all of that is very manageable.
I think the other area, and John mentioned this in his remarks, that commercial real estate is going to continue to be a pressure point in the industry, not just for us, but for everybody. It represents, again, about less than 2% of our overall loans outstanding. We have really good diversification. But what I would say is that charge offs and NPAs are going to be a little bit lumpy as those loans come through maturity. And, you know, but we also said on the first quarter, we feel like we’ve been very proactive in terms of recognizing that reserving for it. And so the P&L impact associated with that shouldn’t be significant.
Jason Goldberg
Great. Thank you, Terry and John for the time today.
Read the full article here
