Welcome to U.S. Bancorp's fourth quarter 2019 earnings conference call. Following a review of the results by Andy Cecere, Chairman, President, and Chief Executive Officer, and Terry Dolan, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question and answer session. If you'd like to ask a question, please press star one on your touch-tone phone and press the pound key to withdraw. This call will be recorded and available for replay, beginning today at approximately 12:00 P.M. Eastern through Wednesday, January 22nd at 12 midnight Eastern. I'll now turn the conference call over to Jen Thompson, Director of Investor Relations for U.S. Bancorp.
Thank you, James, and good morning to everyone who's joined our call. Andy Cecere and Terry Dolan are here with me today to review U.S. Bancorp's fourth quarter results and to answer your questions. Andy and Terry will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules, are available on our website at usbank.com. I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, and in our Form 10-K and subsequent reports on file with the SEC. I'll now turn the call over to Andy.
Thanks, Jen. Good morning, everyone, thank you for joining our call. Following our prepared remarks, Terry and I will take your questions. I'll begin on slide three. We reported earnings per share of $0.90, which included $0.18 per share of notable items, which Terry will discuss in more detail in a few moments. Excluding these notable items, we reported earnings per share of $1.08 for the quarter. Loan growth was driven by new client wins and deepening relationships across all our loan portfolios. We delivered very strong deposit growth. We continue to see strong account and volume growth across our two businesses. Credit quality was stable. Our book value per share increased 6.7% from a year ago.
In November, we received approval from the Federal Reserve for an incremental share repurchase plan authorizing repurchases up to $2.5 billion of common stock, in addition to our existing authorization of $3 billion. In the fourth quarter, we returned $2.9 billion of our earnings to shareholders through dividends and share buybacks. As indicated on slide four, digital uptake trends remain strong. We are significantly ramping up the launch of our DIY digital experiences that will continue to drive more and more customer interactions, both on and off the mobile app, as well as higher digital transaction volume. Slide five provides key performance metrics. On a core basis, we delivered an 18.1% return on tangible common equity in the fourth quarter. For the full year, our core return on tangible common equity was 18.8%.
Now I'll turn it over to Terry to provide detail on the quarter as well as forward-looking guidance.
Thanks, Andy. If you turn to slide six, I'll start with a balance sheet review, followed by a discussion of fourth quarter earnings trends. Average loans grew 0.8% on a linked-quarter basis and increased 3.9% year-over-year. Linked-quarter growth was driven by strength in residential mortgages, commercial real estate, and credit card loans. In C&I, paydown activity muted overall growth in the fourth quarter, primarily reflecting the rate environment and robust capital market conditions. New commercial business activity is healthy. Paydown activity is likely to continue to be a headwind near term, albeit a diminishing headwind, assuming that the interest rate environment is stable. Turning to slide seven, deposits increased 1.9% on a linked-quarter basis and grew 6.6% year-over-year. Notably, average savings deposits grew by 11.1%, driven by across-the-board growth in wealth management investment services, consumer banking, and commercial banking.
Turning to slide eight, credit quality was stable in the fourth quarter. On a dollar basis, non-performing assets declined approximately 15% on both a linked-quarter and a year-over-year basis. The ratio of non-performing assets to loans plus other real estate owned also improved linked-quarter and year-over-year. The new accounting standard related to credit losses, commonly known as CECL, became effective January 1st and has no impact on our 2019 results. We estimate that the adoption of CECL will result in a $1.5 billion cumulative effect adjustment to our allowance for loan losses compared with December 31st, 2019, which is in line with our previous guidance. Slide nine highlights fourth quarter earnings results. We reported earnings per share of $0.90, which included several notable items, which reduced earnings by $0.18 per share. Excluding these notable items, we reported earnings of $1.08 per share.
Slide 10 lists the notable items that affected earnings results for the fourth quarter of 2018 and 2019. Fourth quarter 2019 notable items included restructuring charges, including severance and certain asset impairments, and an increased derivative liability related to Visa shares previously sold by the company. As a reminder, we recognized several notable items during the fourth quarter of 2018, including a gain on the sale of our ATM servicing business and the sale of a majority of the company's covered loans, as well as charges related to severance, asset impairments, and an accrual for certain legal matters.
Along with a favorable impact, deferred tax assets and liabilities related to changes in estimates from tax reform, the net impact of notable items in 2018 was an increase of $0.03 per share. My remarks through the remainder of the call will be referencing results excluding notable items incurred in the fourth quarters of 2019 and 2018. Turning to slide 11, net interest income on a fully taxable equivalent basis declined by 3% year-over-year, in line with our expectations, as the impact of loan growth and higher yields on reinvestment of securities was more than offset by the impact of a flatter yield curve and deposit funding mix. Our net interest margin declined by 10 basis points versus the third quarter. About four basis points of the decline was due to higher premium amortization expense in the investment securities portfolio.
The remainder of the pressure can be attributed to the yield curve compression and earning asset mix partly offset by lower deposit costs. We expect the net interest margin to be stable in the first quarter compared with the fourth quarter. Slide 12 highlights trends in non-interest income. On a year-over-year basis, we saw good growth in merchant acquiring revenue driven by account and volume improvement. As expected, credit and debit card revenue declined 1% year-over-year due to two fewer processing days in the fourth quarter of 2019. We look for credit and debit card revenue to return to a mid-single-digit growth pace in 2020. Corporate Payment Products revenue declined 3.1%, driven by lower commercial business sales volumes. In the past few weeks, sales volume growth has returned to a mid-single-digit growth rate. Trust and investment management growth reflected business growth and favorable market conditions.
Deposit service charges were impacted by the sale of the company's ATM servicing business in the fourth quarter of 2018. The decline in treasury management fees from a year ago reflected the impact of changes in earned credits, a residual effect of the rising rate environments in 2018. Notably, treasury management fees increased on a linked-quarter basis, reflective of the recent interest rate declines in the third and fourth quarters of 2019. Mortgage banking revenue increased 42.7% year over year on strong origination and sales revenue growth. Compared with the fourth quarter of 2018, mortgage production volume increased by 92.3%, and mortgage application volume increased by 83.8%. Refinancing activity represented approximately 50% in the fourth quarter of 2019 compared to about 40% in the linked quarter. Refinancings represented 52% of applications in the fourth quarter.
As of November, our digital mortgage app was being utilized by about 86% of all mortgage applications. Turning to slide 13, the 3.1% year-over-year increase in non-interest expense reflected increased personnel expense, higher technology and communication expense, and higher net occupancy and equipment expense, reflecting actions to support business growth. Slide 14 highlights our capital position. On December 31st, our common equity Tier 1 capital ratio, estimated using the Basel III standardized approach, was 9.1%. I will now provide some forward-looking guidance. For the first quarter of 2020, we expect fully taxable equivalent net interest income to decline at a low single-digit pace year-over-year, but to be relatively flat linked quarter, normalized for day count. We expect mid-single-digit growth in fee revenue year-over-year. We expect low single-digit growth in non-interest expenses on a year-over-year basis.
Credit quality in the first quarter is expected to remain stable compared to the fourth quarter, and we expect our taxable equivalent tax rate to be approximately 20% on a full-year basis. I'll hand it back to Andy for closing comments.
Thanks, Terry. This quarter's results reflected the challenging interest rate environment facing the entire industry, as well as the impact of actions we took to better position our company for the future. However, as our core financial metrics indicate, we ended the year on a solid note, and we are in a strong position as we head into 2020. We view the interest rate environment as a manageable headwind, and we are confident in our ability to prudently grow our balance sheet and gain market share in our fee businesses. Fee growth was negatively impacted by several headwinds in 2019. As Terry discussed, we expect a return to normalized growth in credit and debit card revenue this year.
In a more stable interest rate environment, as a refi-driven market shifts to a purchase-driven market, the investments we have made in our mortgage business over the past several years will become increasingly evident in the form of market share gains. We are proud of our strong and consistent financial track record, but we are always looking for ways to improve. That means we are changing the way we think, the way we work, and the way we do business. As we move into 2020 and beyond, we will continue to increase workflow agility and speed to market for our products and services, while at the same time optimizing our core operation to fund investment for the future.
Our ability to leverage the combined power of our rapidly improving digital capabilities and our complete payment ecosystem will lead to higher customer satisfaction, stronger revenue growth and efficiencies, and ultimately, improved returns. In summary, we remain focused on managing this company for the long term while delivering a pathway to the future. I'd like to thank our employees for all we accomplished this year, supported by their hard work and commitment to creating value for all our customers. We will now open up the call for Q&A.
At this time, I'd like to remind everyone, in order to ask a question, please press star followed by the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of John Pancari from Evercore. Go ahead, please. Your line is open.
Morning.
Morning, John.
Just want to talk a little bit about the operating leverage expectation. We got your comments around the quarter, but for full year 2020, I know you had previously indicated that it could be a challenge to attain positive operating leverage for the full year, given the rate backdrop, et cetera. Wanted to get your updated thoughts on that if you see that there is a chance you could see positive operating leverage, and what type of magnitude would that could you see?
Yeah, John, thanks. As a reminder, we had a goal of achieving positive operating leverage in 2019, and we did that on a core basis for the full year. When we think about 2020, our objective is to target positive operating leverage, and we expect our expense growth to continue to remain in those low single digits. I think we have a number of levers that we continue to look at and pull in terms of optimization. We continue with our physical asset optimization of the branch system, our back office activities, and a number of different things. That's our goal. That's our objective at this particular point in time. Now, that said, as you said in your question, 2020 is a more difficult year simply because of the revenue outlook.
I think part of being able to achieve it is going to be really based upon what happens with respect to interest rates, et cetera. That's kind of how we're thinking about it.
Okay, great. Thanks. Then in terms of some of the headwinds that had impacted your fee progression, I know there was accounting change that impacted it as well as a couple other items. Can you just talk about where do you expect underlying momentum to build in the fee businesses as you look at 2020?
When we end up looking at fee income, I think there's a number of different things that we end up looking at. I think the credit card revenue is stronger again, mid-single digits as we think about next year. That particular line item was impacted by both an accounting item in 2018 as well as a pretty slow first quarter, which we had talked about. I think merchant acquiring continues to accelerate and get strong, and we expect mid-single digits there. The CPS revenue, while we saw a decline in the fourth quarter because of a little slower commercial spending, that has come back in the first several weeks of the year. Our expectation in that category is kind of mid-single digits as well. Deposit service charges has been a drag this year because of the sale of the ATM business in 2018.
That kind of normalize is at least flat in 2020. I think treasury management revenue is another area that we would expect it's kind of hit an inflection point. While it's down on a year-over-year basis, it is up on a linked quarter basis. We would expect that to be better than 2020. I think there's a number of different things. I think the offset to that is and if you think about mortgage, and we talk about mortgage has been particularly strong the last couple of quarters. In 2019, it was also quite a bit of a drag in the first several quarters. Again, depending upon what happens with interest rates, but in the current environment, I think that continues to be a positive story. I think there's a number of different areas.
Okay, Terry, that's helpful. Thank you.
Your next question comes from the line of Erika Najarian from Bank of America. Go ahead, please. Your line is open.
Yes, good morning.
Hey, Erika. How you doing this morning?
Good, thank you. I heard you loud and clear on your expense growth. I'm wondering, though, if the increased severance charges that we've seen could lead to a different geography in terms of expense growth. I guess I'm just looking back at your headcount, which seems to have risen sort of along coincident with the consent order. I'm wondering if part of the initial statement up front, Andy, in terms of continuing to transform the business is trying to take some of the compensation growth that you experienced over the last three years and really putting that back in technology. Is that sort of how we should expect the geography could change underneath that low single digit expense growth that you're expecting for 2020?
I think that's not an unfair description, Erika. It's not just technology, but it's people and technology. It's optimizing the way we're doing business to continue to invest in the future. Our expense growth was higher during the consent order periods. As you know, it's been in the low single digits the last couple of years and including notable items, 2.4% year-over-year in 2019. That includes optimization and expense takeout, while at the same time investing in technology and people for the future. I would expect that to continue into 2020.
I guess I'm wondering if our takeaway from that is because that seems like it's behind you, again, feels like the severance charges are setting up for further optimization and rationalization, that you're accelerating the amount of dollars that you're putting into the future, so to speak, whether it's headcount related to that or technology itself.
Yeah, I think that's a fair comment, Erika. Again, I think the shift is optimizing what I would call the back office and the branch network which are being impacted by customer behaviors as we transition to more of a digital environment. At the same time, we're reinvesting that in technology spend to support that digital transformation. Maybe a little bit of a shift from compensation to technology type of cost. No, our expectation when we think about 2020 is to continue to make the investments in the business that we have been making over the last couple of years.
Thank you. And just one more, if I could squeeze it in. Deposit costs were down 15 basis points quarter-over-quarter, and I'm wondering, underneath the 1Q NII outlook, what you expect for deposit cost trends for the first quarter, and also if the curve outlook continues to be stable from here, could net interest margin for the rest of the year stabilize or potentially increase from 1Q levels?
Yeah. Well, certainly, if the rate environment continues where it is today, our expectation is that 2020 net interest margin would be pretty flat to the fourth quarter with some possible positive bias, depending upon what happens on the long end of the curve. That's kind of our thought process. The reason for that is the premium amortization that we've experienced in the third and fourth quarter is stabilizing at this particular point in time. When we think about deposit cost, deposit pricing, we have been pretty responsive on the institutional deposits in terms of bringing those, repricing those down as rates have come down. I think from here on out, deposit pricing will be a function of both competition and what happens on the short end of the curve.
Got it. Thank you.
Again, as a reminder, if you'd like to ask a question, please press star followed by the number 1 on your telephone keypad. Our next question comes from the line of Scott Siefers from Piper Sandler. Go ahead, please. Your line is open.
Morning, Scott.
Morning, guys.
Scott.
Hi. Thank you for taking the question. Just curious if you might be able to offer any just top-level comments on the overall kind of pace of loan growth and overall demand. If you look at the Household data, it's definitely been held up or supported by the consumer side, but it's been a little surprising to see the slowdown in growth on the commercial side, however. I'm just curious, given the breadth of your guys' franchise and different types of customers you look at, what you're seeing at a very top level.
Well, at a very high level, again, I think economically, we feel pretty optimistic in terms of what the outlook there is. If you end up looking at the components of loan growth, I think we saw pretty strong and good growth with respect to consumer lending. The area that was a little bit softer in the fourth quarter was really our C&I or our corporate sort of lending. That's principally while we saw production and the pipeline continuing to be reasonably strong. We saw pretty significant pay-downs that were taking place in that space driven by capital markets activities, and that's a function of the long end of the curve coming down in the third and early fourth quarter. With that stabilizing, while we would expect some of the pay-downs to continue into the first quarter, I think that will moderate.
Okay. Perfect. Thank you. Just any additional updates on ramification from the LCR rules? I think you guys have been talking about $11 billion-$15 billion of liquidity free up. Any updated thoughts on how you're thinking about that dynamic?
That's in the ballpark in terms of the amount of what the impact is with respect to LCR. We're continuing to look at different alternatives. Part of it is thinking about extending duration a little bit, possibly investing a little bit more in agency mortgage-backed securities, which would provide a little bit better yield. I think it'll be on the margin, and it won't be anything dramatic.
Okay. All right. That's perfect. Thank you very much.
There are no further questions in queue at this time. I'd like to turn the call back over to Jen Thompson for closing remarks. Oh, it looks like we did get one question. We do have a question from the line of Vivek Juneja from JPMorgan Chase. Go ahead, please. Your line is open.
Thank you. Hi, Andy. Hi, Terry. Just wanted to clarify on credit debit card fees. What was the impact from two fewer processing days? What does that do, and is there a reversal in 2020?
Good question. There was an impact of 2 days that ended up really taking our fee income from kind of that low to middle single digits to the -1% in the fourth quarter. There is one extra day in 2020 relative to 2019. Let me just kind of dissect it a little bit because I think that that is maybe helpful. When you end up looking at the growth rate for 2019, it was really impacted by 3 different things. One is that there was an accounting change that occurred in the first quarter of 2018 that because of the lapping effect ended up depressing growth rates in 2019. In addition, if you remember, the consumer spend level in the first quarter was significantly lower and is kind of at an unusually low level.
Of course, as concerns around the economy stabilize, that consumer spend has come up. That has been in the mid-single digits in the second, third, and kind of fourth quarter in terms of sales volumes. Then, as you know, just getting back to the processing days, quarterly results can be lumpy. When we think about 2020 in terms of on a full-year basis, we really think that mid-single digits is a good target for us and a good estimate for us. Our sales volumes over the last several quarters have been kind of in that range. When you think about it on a day-adjusted basis, it's been pretty consistent from quarter to quarter. In 2020, there's one more day, and that will help a little bit. Mid-single digits for 2020, I think is a good estimate. Again, quarterly results will be a little bit lumpy.
When we think about the year, that's kind of how we're thinking about it.
When I look back over the prior couple of years, this line item was growing at sort of more like 9%-9.5% when you look at 2017-2018. Going to the mid-single digits, has there been any reduction in pricing, a shift in the kind of contracts, or is this higher rewards expense? What, Terry, is driving that slowdown from that high single-digit level to the mid-single-digit run rate?
The growth rates in 2017, 2018 were influenced, in some respect because of some portfolios that we were acquiring during that particular timeframe, more so than other factors. When we think about pricing, there hasn't been a lot of compression with respect to pricing. We feel pretty good about that.
Rewards has been relatively flat, Vivek. That isn't a factor. That mid-single-digit number is a good way to think about the next 12 months.
Okay. As you think about from, in terms of other fee revenues, Andy and Terry, you said treasury management should be good. Corporate card fees, when I look at that was also a little bit softer this quarter.
Yeah.
It's actually down year-over-year. Any color on that? I'll just let you answer that.
Yes, Vivek. The impact of that is because we saw in the last half of the fourth quarter, corporate spend activity slowed. That had been running in the mid-single digits, a little bit higher in the first few quarters. Fourth quarter saw a slowdown to almost flat. As Terry mentioned in his prepared remarks, we did see a pickup in the first two weeks of January back to the mid-single digits. That was attributable to that slowdown, but it seems to have come back.
I think that one of the reasons for that is, if you think about where the yield curve, how rates were moving, there was concerns about recession. People were uncertain with respect to economic data, and then you had the hangover of tariffs. I think the sentiment on the corporate side appears to be looking better. We're going to be signing a trade agreement with China today, I believe, in terms of phase one. The U.S., Mexico, Canada agreement is well on its way. I think that some of that uncertainty that might have been impacting discretionary spend in the commercial side of the equation has been alleviated. We feel pretty good.
I want to confirm one last thing. CECL day two, could you talk a little bit what do you see that doing to your provision expense, Andy, Terry?
Yeah. We've talked about certainly day one and day two as part of Investor Day. The provision will increase. We think that in terms of loan growth, providing basically at kind of that 2% level versus 1.5% is kind of how we're thinking about it. There's going to be more volatility related to CECL, and I think one of the things we'll end up looking at is just what is the stability in the overall portfolio and what are net charge-offs doing on a quarter-to-quarter basis?
Okay. All right. Thank you.
Yeah.
Thanks, Vivek.
We do have another question from the line of Ken Usdin with Jefferies. Go ahead, please. Your line is open.
Hi, everyone. This is Amanda Larsen on for Ken.
Hey, Amanda. How are you doing?
Great, thanks. I think it's understood that 2020 will likely be an aberration versus the long-term trends that you set out at Investor Day related to revenue growth headwinds. That you'll still strive to achieve positive operating leverage in 2020. I'm wondering how negative could negative operating leverage be in 2020 before you do take actions related to slowing the pace of investment spend or creating more saves?
As Terry mentioned again earlier, we expect and target positive operating leverage for 2020. We have a number of levers that we can continue to pull to optimize the current organization structure to continue to invest in the future. Amanda, the way we think about it is the balance of optimizing today and investing in the future while always targeting that positive operating leverage, and that's how we're managing the company.
Okay, great. Can you guys talk about the capability as of Sage Pay and how you see U.S. Bank's position evolving in the e-commerce payments arena over the medium term? Thanks.
Yeah. We're very excited about Sage Pay. It is a kind of leader in the e-commerce space within the U.K. and Ireland, and we also have the opportunity to be able to extend that into the rest of Europe. We have a pretty big footprint across Europe, so pretty excited about that as we think about next year. We ended up rolling out sort of similar e-commerce capabilities over the course of the last 12-18 months here domestically. We believe that that gives us more capabilities in terms of being able to take advantage of e-commerce in the future.
Awesome. Thanks.
Thanks, Amanda.
Thank you.
Your next question comes from the line of John McDonald with Autonomous. Go ahead, please. Your line is open.
Hey, guys. Sorry, I jumped on a little bit late. Did you give an update on the Charlotte expansion, Andy, and how that's going and whether you're kind of targeting new areas for this year to expand on the retail side?
Good morning, John. Charlotte's going well. We opened a branch about three months ago. We've had new customer acquisition growth and current customers. Employees are fired up. We are targeting a number of new branches to be opening yet this year and still targeting that number of 10. We're learning a lot from that investment. We continue to track that and measure our activity. I would expect us to continue to expand in new markets, but our first focus is expanding to our target number in Charlotte.
Got you. Okay. Terry, just a couple clean-up things on NII. I think you mentioned the amortization kind of stabilizes early this year. Is that right? The roll-off rates, like where the 10-year is today, are those kind of break even or slightly accretive where you're putting new money to work in the bond portfolio today relative to what's rolling off?
Yeah. Addressing kind of your second question first. The reinvestment with respect to securities is still about 15 basis points or so accretive. We would expect that based on where rates are today. The premium amortization does stabilize in the first quarter. When we think about net interest margin for the year, we think it's going to be relatively flat, maybe a little bit of positive bias relative to the fourth quarter of 2019.
Okay. The down NII for the year is just the tough comps of where you started last year, I guess, right? Things from a sequential standpoint, though, feels relatively stable.
Yes.
Okay. Thank you.
Sure.
With that, there are no further questions in queue. I'd like to turn the call back over to Jen Thompson for closing remarks.
Thank you everyone for listening to our earnings call. Please contact the investor relations department if you have any follow-up questions.
This concludes today's conference call. You may now disconnect.