Starting with our second fireside chat today with the management of U.S. Bancorp. As many of you know, U.S. Bancorp recently completed the Union Bank acquisition. As a result, it has about $675 billion in assets, market cap of over $72 billion. On our price to adjusted book value, when you add back the AOCI, we calculate price to book is about 1.3 times. Price to tangible is 1.9, and it trades on a forward PE basis of 9.4 times. I know many of you know the gentleman to my far left, Terry Dolan. As you know, he's Vice Chair and Chief Financial Officer for U.S. Bancorp. He became CFO back in 2016, and he's been very active with the bank for many years of his career.
To my left is Shailesh Kotwal?
Kotwal.
Kotwal. Thank you. Shailesh joined U.S. Bancorp in 2015, and he leads the U.S. Bancorp Payment Services, which we know is one of the unique parts of the U.S. Bancorp story is the Payments business that many of your peers don't have. To kick it off, I'll start with Terry, and maybe Terry, you can share with us what are your broader views on the macroeconomy, and what do you think about what's happening? Are we heading into a recession or a soft landing? We just had David Solomon on before you. He's thinking maybe more of a soft landing than he was six months ago. What are your thoughts?
Yeah. You know, I, maybe just kind of, very broadly, if you think about, you know, at the end of 2022, inflation was starting to moderate and all sorts of things. I think there's a few surprises, you know, kind of in the January, February timeframe with respect to a number of the different indicators. You know, I think what that tells you is that inflation is just something that's very stubborn. As a result of that, I think from a Fed policy perspective, you know, being sufficiently restrictive, I think that's going to be their mantra for a while.
What that tells us is that maybe in terms of our base case, you know, from an interest rate perspective, you know, we would expect rates to probably continue to move up in the near term, you know, closer to that 5%-5.50% sort of range, and then probably stay there for a while before starting to come down. I think kind of earlier this year, there was an expectation that we would move into a recession and rates would start to drop, you know, at the end of 2023. I think that, you know, while we would still expect a recession probably to occur, I would say it's, you know, soft landing is not a bad way of describing it. A mild sort of recession, probably at best a moderate recession.
You know, the timing of that is something that I think we're continuing to kind of push out a little bit. If it does occur probably late 2023, early 2024, kind of in that timeframe. That would be kind of a couple of different things. The other things that I would just say, maybe from a macro perspective, and Shailesh will talk a little bit about this, is that, you know, consumer spend, you know, continues to, I think, be pretty healthy. While I think our expectation is during the year that that continues to moderate, and that'll moderate for a couple of different reasons, one of which is that, you know, consumers have been spending a lot of their excess savings.
You know, relative to pre-COVID, savings still continue to be at a level on average, higher than what we saw pre-pandemic. You know, they continue to kind of spend that down. Consumers, you know, they're fairly bullish with respect to their spending. I think the other thing that we're seeing in terms of excess savings coming down is that some of the revolve rates are starting to move up, and that'll help on the credit card side of the equation. You know, I do think that there's probably a recession. There's certainly, I would say and what we have been talking about is the fact that, you know, there's just a lot of uncertainty out there, Gerard, and we need to be prepared for whatever comes our way.
Yep. Thank you. Maybe taking it down.
Yeah.
U.S. Bancorp, we've got a few weeks left in the first quarter. Could you provide us an update, you know, with any first quarter 2023 guidance or and also any update for the full year 2023 guidance?
Yeah. Yeah. Let me kind of hit that right on, and I'll maybe start with really both of them. We're going to reiterate our guidance that we gave at the beginning of the first quarter, both for the first quarter as well as for the full year. No change to either of that. I'd refer you back to the guidance that we had, in, you know, the presentation that we did back in January. For the first quarter, specifically, you know, that guidance fundamentally said, you know, earnings or excuse me, earning assets in that $605 billion - $610 billion range, in terms of $605 billion - $610 billion. The margin expanding, you know, 5 basis points - 10 basis points.
Revenue, in the $7.1 billion-$7.3 billion range. Core expenses at $4.3 billion-$4.4 billion. Merger and integration costs of somewhere between $200 million and $250 million. Essentially all unchanged.
Yep. Speaking of the merger costs. Maybe you can give us an update on how the Union Bank deal is progressing. Obviously, you closed the deal in December.
Yeah.
The big day is Memorial Day weekend, for the conversion, which is coming up, obviously. Any surprises at this point from the acquisition or any additional color you can provide?
No surprises. I mean, I think it's, the integration process is progressing as we would've expected. You know, everything is on track. As you say, Memorial Day weekend is the large system conversion that we'll go through. We're making good progress on a lot of different fronts. You know, our employee systems were all integrated already. We did that right away, in December and January. You know, we're making decisions with respect to employees and leadership adjustments and some of those sorts of things that are all pretty much on track. You know, we needed to close or excuse me, sell three branches as part of the DOJ order, we've done that. You know, we're in the process of starting the communications with respect to branch consolidations.
You know, there are a lot of branches that are within kind of that one-mile radius, and so we'll be making, we are making decisions, and we'll be making announcements related to that soon. Things like our credit card, sales origination, our mortgage origination, those are already going through our, U.S. Bank platforms.
Yes.
Everything is very much on track. You know, the cost synergy estimates, you know, that we have articulated are still on track. You know, the integration itself is progressing very well.
You'd be a good one to maybe answer this question. U.S. Bancorp, over the years, has done a number of transactions, obviously, with Union being the most recent. It also, I think, took the longest to get the approval. What's your view on just the whole process, you know, what you just went through with Union versus your memory of the prior deals seemingly to go quicker?
Well, definitely the regulatory approval process is elongated. You know, not only did we experience that, but I think others that are going through it or have gone through it have experienced it as well. You know, I think that, you know, in our situation, you know, while, you know, a lot of what I would say the regulatory processes were completed fairly early, you know, they were waiting for Michael Barr to kind of get into his position and all sorts of things. You know, I think the challenge with that is that, especially in this sort of an environment when rates are moving up, you know, is it puts more pressure with respect to capital management and things like that because of the mark-to-markets that we experienced as part of that process. Yo u know, it is what it is. You just kind of manage through it.
Yeah. Very true. Coming back to the Union Bank deal, obviously, you've created an extra level of protection with the marking-to-market of the loan book of Union Bank.
Yep.
The way the ACL works with CECL accounting. Can you share with us some of your thoughts on that whole process and what you actually did?
Yeah. You know, as part of the closing, you know, you go through the process of evaluating the portfolio. Of course, we did a lot of that in due diligence. Actually, the credit mark that we booked in December was a little bit less than what we had originally estimated for a couple of different reasons. Maybe just kind of give you a little bit of background.
We ended up selling, any of the loans that were originated through the LendingClub kind of channel. We did that right away as part of the closing process. We also sold about $1 billion worth of commercial real estate and did a number of different balance sheet optimization, securitization, risk transfer sort of structures to move another about $4 billion worth of assets off the balance sheet. We did some things from a balance sheet positioning perspective to align the portfolios from a credit risk profile a little bit better. At closing, we ended up booking, in terms of the reserve, we ended up building it about $819 million.
It's a little over 1.9% at the end of the year. You know, we think that that's a good healthy reserve coverage, especially when you look at it relative to non-performing assets, and you know, some of the other credit quality sort of metrics. You know, we feel pretty good about that. As you know, in CECL, one of the things you end up having to do is you end up having to look at your performing loans and your non-performing loans. We ended up booking a little over $170 million related to non-performing type of assets. For performing assets, we booked another $646 million associated with that.
Now, part of the CECL process is that you book that reserve, and then you have a little bit of a double count in the sense that you set up a credit discount, and that piece of it ends up accreting back in income over time. You know, overall, I would say that, you know, the portfolios are fairly consistent in terms of, in terms of risk profile, and the reserve coverage is strong.
Yep. Interesting on the loans you sold at the time of the deal, you mentioned LendingClub. What kind of commercial real estate? Were they mortgages on retail or when you-
Yeah. It was. We ended up looking at different things in the portfolio. What we were most focused on is, you know, where did we have kind of overlap with respect to customers? From a hold perspective, we didn't want that to be too large, you know. As much that as anything else.
Got it. Shailesh, maybe turning to you and obviously the business you run, Payments. As I mentioned, it's a real differentiator for U.S. Bancorp. It accounts for about 30% of annual revenue. Maybe can you give us an overview of the Payments business?
Yeah, sure. Let me just kind of big picture that 30% that you talked about breaks up. There are four compartments that make up the Payments business. The first and the largest is our Issuing business. RPS is what we call it. That's about 65% of our revenue. RPS essentially is the debit and credit card issuing that most banks do for our own customers, but we also have the classic co-brand business. In addition to that, there's also a business within our RPS where we issue credit cards for other financial institutions.
That's a big piece of our business that's unique to us, that no other large institution has. We distribute our products through 1,300 financial institutions. That's a big, big, big asset for us. Second is our merchant acquiring business that most people are familiar with. That's another differentiator versus our peer group. That's about 25% of our business. Merchant acquiring, obviously, we help merchants of different categories, accept payments, classic debit, credit, et cetera. We also help merchants accept ACH and eChecks and, you know, all other what we call a large area of adjacent payment products that provide merchants more holistic solutions. That's helpful to our merchants.
In addition to that, our merchant business also provides point-of-sale devices that are now becoming central to particularly the small business, and we call it talech. I'll get into that in a little bit. That's another area for our merchant acquiring business. Then the third piece is our Corporate Payments business, which is about 10% of our revenue. Corporate Payments services middle market, large market customers all the way to the federal government. Federal government is in fact our biggest customer. Actually, the other way around too, we are the largest provider of commercial cards to the federal government. It's a big customer, long-standing relationship, well over several decades now.
The fourth component, which is not included in that 30% that we just talked about, is our treasury management business. We include that in payments because there's natural synergies with the other payment products that we have, but the revenue is accounted for in the respective areas that manage that relationship because of the adjacency that that particular product category has with other products. Working capital would be the best example. That, that lines up with our corporate commercial business for the most part. Those four parts make up what we call Payment Services. We serve everybody from consumers at one end, small businesses, which is a big component, and as I said, all the way to the federal government. A couple of interesting areas you guys are probably familiar with, kind of general market share.
We are 5%, 6% for the main product categories that people are familiar with, debit card, credit card, merchant acquiring. A few stats I said, we are the number one provider of commercial cards to the federal government. We're also the largest freight payment processor, which is a big business for us, unique to our business. These are a couple of areas that make up our Payments business and pieces that are somewhat unique to our Payments business versus most of our peer groups.
When you look at the different buckets in payments, once you get build that relationship, how hard is it for a competitor to, like, pick off one of your customers once you really get in? I would think it's just from our own personal accounts, we know we have our payments lined up, and it's very hard to dislodge us.
It is very hard, isn't it? What is true in our consumer lives is true of most pieces.
Yeah.
That's largely because payments has really evolved. Payments has become so much more embedded in the businesses that we serve. Typically, most of our payment products are intertwined into our customers' technical environment.
Right.
That provides them a more holistic solution, but it also makes the relationship that much more sticky. That's just from a payment standpoint. The equally important part is it's not just payments. Payments more and more is becoming an entry point into these relationships.
Yeah.
And then allows us to broaden that relationship with other banking products, and those banking products are another glue, that help that relationship become that much more stickier, from our perspective, provide value, a broader value to our customers. It's a good mutual exchange of value for us with our customers.
Yeah. When you look at some of your differentiators, or differentiated products, how are they your competitive advantage over your customers and over your competitors, I should say? How much do you have to invest annually or just on a go-forward basis to maintain that edge?
Yeah. Let me take the second part first.
Sure.
How much do we need to invest? I'd say most of you might remember we stepped up our investments...
Yes.
Several years ago, that's in our run rate. I think I feel pretty good about the investment envelope that we are operating with allows us to stay competitive from a marketplace standpoint. That's kind of the simple answer to the investment profile. The former part, which is more interesting in terms of what allows us to be differentiated in the marketplace, a few things come to my mind. One is the breadth of offering. We really cover the waterfront when it comes to payments. That's important because when we work with our customers, you know, it's not whether we have the best ACH processing or we have the best corporate card offering or we have the best whatever. Oftentimes, customers are looking for optimization, particularly when you get to middle market and above.
Having that suite of products and allowing our customers to optimize that payment. There's a big cost difference between an ACH payment versus a commercial card. There's also a different value derived from these. RTP is another example, which is emerging quite rapidly now. Oftentimes, what happens is we work with our customers and they send us what we say it's a payment file exchange. We take that off the customer's hands and then optimize the payments for our customers to say, "Well, you know, of these payments that you're looking to make, here is the best way to split it, that will allow you to get the best value, and then allow us to make the most of that relationship as well." Breadth of payments optimization is important. Second is distribution.
I touched on the financial institutions that we have. That is really unique to U.S. Bank. Another less-known fact through our partnerships that we have, we have over 40,000 different distribution points, which is in addition to the branch network that U.S. Bank has. That provides us unique distribution capabilities. We now have increasing capabilities of working with software vendors. You know, we tech-led is a terminology you probably hear a lot from us. That provides added distribution. We don't have kind of single dependency on a particular partner, widely distributed distribution capabilities. Tech platform is increasingly important. You know, all of these things are dependent on technical capabilities.
We own all of our tech platforms, and that allows us to move money from left pocket to right pocket to make sure we are staying close to what our customer needs are and whatever the market demands might be. That's third. The last one, probably the most important one, again, something you perhaps hear a lot, which is our payment ecosystem play. You know, that is in the simplest of context, it is bringing best of payment capabilities that I talked about with best of banking and providing that in some simple, holistic solutions. We're starting that with small businesses, obviously, with the acquisition of talech. That's where that journey really began in earnest.
Increasingly we're finding that that is also true in the middle market area, where providing one-stop holistic solutions of putting payments and banking together is really meaningful to our customers. This is a classic case where the whole is materially more valuable than the sum of its parts. Those are the four kind of big picture differentiators.
Yeah. To follow up on that holistic approach, how do you bring your commercial bankers together with your payments people so that they work as a unified team?
I think unified is the best way to capture it. It truly is a collective effort. Our corporate, you know, commercial bankers typically are broader relationship managers.
Yes.
They have good reach into the C-suites of the organization. We understand from them kind of what is the big picture that the customer is looking for. Depending on what their needs are, they'll bring in the subject matter experts, and that is really where our payments people will fit in terms of understanding their particular payment needs. Once that need is established, the payments relationship managers or product experts in many cases will take over the conversation and say, "Well," again, oftentimes it starts in one place, but it ends up in kind of, "How are you gonna help me optimize A, B, or C?" You get to the smaller end of middle market, most often it ends up in sort of, "Okay, help me run my business better. Can you do that for me?"
I think that is where the magic of banking and payments together really comes in.
Good. Following up on Terry's comments earlier about the Union Bank deal, can you share with us the opportunities that you see here?
Yeah.
For the payments part of the business?
We are quite excited for a couple of reasons. One is obviously California is a very attractive market, and this customer base is a more affluent customer base. Union Bank really brings in great customer base and terrific relationship managers. I think those are at 40,000 ft, probably the best adds to our franchise. We have terrific products and great technology, much better than what Union Bank was offering. The combination of giving those RMs that have got great relationships with these customers, feeding them with best-of-breed products coupled with terrific technology, I think is a powerful combination. Let me give you a couple examples. Credit card, simple example.
Yeah.
Their penetration into their DDA base offering credit cards is half of what U.S. Bank is. We can easily see that doubling in a very near future. That's what I would say, easy low-hanging fruit. We know how to do that really well. Another example, corporate commercial payment products that I just talked about. There too, their penetration into their base is a third of what our penetration is into our customer base. Again, these are businesses, these are products we know how to run really well, and they've got great relationships. I think these are two kind of simple examples of why I am excited about what this franchise brings to us.
When you dived into why their numbers are so much lower than your folks, is it they just didn't make the investments into the payment space, so they really weren't that competitive?
This is my understanding. I think a few things. One is you have to have best-of-breed products.
Yes.
In order to be able to make valuable inroads into your, into your relationships. Technology plays a big role in payments. Even if you have the interest and the aptitude or the relationships, if you don't have the underlying technology, that road becomes that much harder. It's, you know, payments, once you've got the capabilities and the technology in place, it's a lot of blocking and tackling.
It's working with our customers. Payments has really evolved from what used to be, you know, maybe 10 years ago, sort of point of sale, get the device quick, and you got the relationship. It is working on these technical integrations with the customers that becomes so much more important. That's why having the platform capabilities that we have, but are all in-house, are a key differentiator. I think Union Bank didn't have that.
Got it. Speaking of technology, I noticed in your fourth quarter when you guys have your slide deck out on payments, you talk about e-commerce and the tech-led payments businesses, and you've shown how they've grown quite meaningfully. Maybe you can share with us just how you're looking to expand those businesses going forward.
You know, tech-led is really trying to bring to life in a simple way these elements that I talked about, which is how do we integrate into the customer's environment? That's really what tech-led is about. That's what e-commerce is about. In order to get the e-commerce business, you really need to be embedded into your, into your client's environment, technical environment. We started this journey a few years ago, as you pointed out, it's been terrific from a ultimately driving success for us and for our customers. What it really adds is it allowed us to integrate with key software vendors. That partnership is critical in order to provide that integrated solution to the ultimate buyer or user of that service. That's one area that we have invested in. It's providing results.
The second is distribution, obviously, that I touched upon. We're also bringing that complete omni-commerce capability. Yeah, omni-commerce, for those of you that might not be familiar is classic example, you order something online, but you wanna go return it.
Yeah.
At the mall, close to your home.
Or Walmart.
Or Walmart, yeah, whichever your choice. Just don't return Nordstrom to Walmart. That would be a problem. That's really what it is is that closing that loop from online purchases to offline returns or vice versa. Bringing those capabilities together is what our tech-led businesses and will continue to be. The other area that is evolving from a tech-led standpoint is the other acquisitions that we have done. Bento is a piece of technology we bought recently. talech we bought several years ago. TravelBank is another one. What those pieces are adjacencies around payments. Payments is really changing. Payments is no more about, you know, can you make the payment on time effectively? Of course, we can, and many can.
Mm-hmm.
Payments is increasingly about the surround sound that goes around the activity of payment, and that is where capabilities like Bento and TravelBank really come in. Bento is early innings. You'll see a big announcement coming later this year on how it's going to be the first of its kind, where we are bringing for the benefit of small business operators, combining payments, you know, classic, small business cards, but adding a very powerful expense management capability that small businesses are screaming for. I think that is kind of the evolution of our tech-led journey.
Yeah. Maybe talk a little bit more about TravelBank. You just mentioned what's going on with Bento.
Yeah.
Maybe some more information.
TravelBank is again, as I said, payments is really evolving from the act of payment to can you help me manage the activity around payment? TravelBank, what Bento is to small business, TravelBank is to middle market. That's the simple way. It is about combining classic corporate commercial payment product with expense management, which is a big deal for middle market. Now, there are a lot of when people like Terry and I travel, we have a corporate card in our wallet, and there's a significant expense management capability that caters to large companies like U.S. Bank. You get to middle market, those solutions are really overdone, overwhelming, and don't fit the needs of middle market.
That piece of business, which is a very attractive piece of business, is kind of they don't fit the small business profile because it's too simple and they can't use what large companies use. That middle market is where TravelBank will fit in very nicely, with combining you know, commercial corporate card payments together with this expense management that I just talked about.
Very good. In the last few minutes, maybe Terry pivoting back to you. Obviously, U.S. Bancorp has earned a reputation of being a very good underwriter in credit through the cycle. You guys kinda stand out. What are you guys seeing in credit? It seems incredibly strong for the industry and for you guys as well. What are your thoughts there?
Yeah. Maybe to kind of put a little bit of context, you know, we have been through a period of historically low charge-offs. I think, if you and I'm looking at the third quarter, 19 basis points, our core charge-offs in the fourth quarter is 23 basis points. You know, pre-pandemic, it was closer to 50 basis points. We continue to perform at very low levels. You know, our expectation is that that will continue to moderate over time. It probably doesn't get back to 50 basis points anywhere in 2023, but, you know, it'll continue to kinda move up. You know, broadly though, you know, across our particular portfolios, you know, we're not necessarily seeing any what I would say hotspots. I do think that delinquencies with respect to credit cards will, you know, slowly start to move up.
You know, we saw a little bit of that in fourth quarter, and we'll see that in first quarter. I think that, you know, that progression will continue. You know, but generally, the portfolios for us have been performing very well. I think one area that people are concerned about is just in the commercial real estate space, specifically in the office space. You know, for us, that represents, you know, 3 percentage points of the overall commitment, so it's not major. You know, it is one of those things that over time, structurally, you know, we do expect that is going to have to go through some evolution, I guess, if you will. A big part of that is just the whole return to office.
You know, what sort of progression does that take over the course of the next several years? The positive thing or, and maybe the challenge is that it is gonna, you know, have some stress, I think some structural stress there. The positive thing is that it is structural, it'll take time.
Yeah.
Those leases come due over an extended period of time, and that I think will give the industry the opportunity to be able to kinda work through it.
Which is so different than the last commercial real estate debacle...
Yeah.
In 1990 when it was construction loans that couldn't be termed out.
Yeah.
And everything came on the market.
All at the same time. Yep.
Just, crushed. I see we got the red blinking light. Terry and Shailesh, I really thank both of you for joining us. Join me in a round of applause thanking these gentlemen.
Thank you.