On the U.S. Bancorp second quarter 2023 earnings conference call, George Anderson, Senior Vice President and Director of Investor Relations for U.S. Bancorp, welcomed everyone and introduced Andy Cecere, Chairman, President and Chief Executive Officer, Terry Dolan, Vice Chair and Chief Financial Officer, and John Stern, Senior Executive Vice President and Head of Finance. The call was recorded and available for replay and slides, earnings release, and supplemental analyst schedules were available on the website. Andy Cecere reported that the second quarter was successful due to the conversion of Union Bank and an increase in the common equity tier one ratio to 9.1%. Earnings per share totaled $0.84, including $0.28 per share of notable items. Excluding the notable items, earnings per share was $1.12.

The second quarter results were bolstered by new customer accounts and deeper relationships, as well as disciplined expense management. Net interest income was lower, but momentum and fee income businesses remained strong due to a diverse and stable funding mix. Credit quality metrics are normalizing as expected, and the balance sheet was strengthened by increasing the loan loss reserve. The conversion of Union Bank was recently completed and early indications are encouraging, with customers quickly adopting digital product offerings.

Union Bank's balanced mix of consumer, corporate, and commercial deposits continues to be a source of strength, with $522 billion of deposits at the end of the period, a 3.2% increase from the previous quarter. The bank upgraded Union Bank customers to an interest-bearing checking product, which will provide customer retention benefits without a material impact on their net interest margin. Average total loans for the quarter were flat from the previous quarter, but up 19.9% year-over-year.

The company reported diluted earnings per share of $0.84 for the quarter, and net interest income on a fully taxable equivalent basis totaled approximately $4.4 billion. Commercial real estate loans represent 14% of the total loan portfolio, with office exposure representing only 2%. A reserve ratio for commercial real estate office loans was increased to 8.5%. The linked-quarter decline in the net interest margin was due to higher cash levels and deposit pricing pressures, partially offset by higher rates on earning assets. Notable items included $310 million of merger and integration-related charges and $265 million of balance sheet optimization and capital management actions.

Slide 12 highlights an 8.7% or $219 million increase in non-interest income from the previous quarter, driven by higher payment services revenue, trust and investment management fees, and commercial product revenues. Slide 13 shows reported non-interest expenses for the company totaled $4.6 billion in the second quarter, which included $310 million of merger and integration-related charges. Slide 14 shows credit quality trends, which are strong from a historical perspective, but are normalizing. Slide 15 shows a CET1 capital ratio of 9.1%.

The Federal Reserve's 2023 stress test results showed that the CET1 ratio had increased by 60 basis points, with 20 basis points coming from earnings accretion and 40 coming from risk-weighted asset and balance sheet optimization. For the third quarter of 2023, net interest income is estimated to be between $4.2 billion and $4.4 billion, total revenue as adjusted is estimated to be between $6.9 billion and $7.1 billion, total non-interest expense as adjusted is estimated to be approximately $4.3 billion, and the income tax rate as adjusted is expected to be between 23% and 24%. For the full year, net interest income is expected to be between $17.5 billion and $18.0 billion, total revenue as adjusted is expected to be between $28.0 billion and $29.0 billion, and merger and integration charges are expected to be between $150 million and $200 million.

U.S. Bank is well-capitalized and prepared for a potentially more challenging economic environment due to their strong liquidity, diversified business mix, and disciplined approach to credit risk management. This quarter, they successfully converted Union Bank, increasing their scale, reach, and revenue growth opportunities by adding 1.2 million new customers. U.S. Bank also expects to achieve $900 million of cost synergies by 2024.

Terry Dolan of the company thanked the employees for their exceptional service and opened the call for Q&A. Scott Siefers asked about the company's capital build and their target under Category II rules. Dolan responded that they ended the second quarter at 9.1% CET1 and expect to be at least at 9.5% by the end of the year, thanks to earnings accretion and risk-weighted asset optimization. He also mentioned that they have a plan to fully adopt Category II by the end of 2024. Lastly, Siefers asked a question about deposits.

John Stern provides additional context to John Pancari's question regarding non-interest income guidance. He explains that deposit growth is up 3%, and loans have dropped 2% due to capital actions. This gives the bank the ability to be more disciplined and moderate in deposit pricing as they move forward.

Terry Dolan and John Pancari are discussing the net interest income guidance, deposit balances, and the expected NIM for the third quarter and beyond. Dolan is confident that the through-cycle deposit beta will stay around 40%, which is lower than other banks, due to the capital actions and the big flight in of deposits.

Terry Dolan discussed ways to optimize the risk-weighted assets (RWA) position of the company, which will have minimal impact on earnings. Examples of these actions include winding down a cash provisioning business and reducing the mortgage servicing right portfolio over the next several quarters. These actions will help improve the company's RWA position but will not have a significant effect on earnings.

Union Bank is focusing on profitable growth and capital efficiency by deepening relationships with existing customers in a capital efficient way. This is done by offering a broad product set, such as credit cards, to the 80% of customers who are single service customers, which has a penetration rate half of US Bank's. This will allow Union Bank to maximize their franchise and take market share without feeling constrained by capital levels.

Terry Dolan and Ebrahim Poonawala discuss the slowing growth rate of payment services year-over-year compared to the first quarter. Dolan attributes this to consumer spending normalizing and softening, citing yesterday's retail sales information as an example. Although sales have softened, margins in some businesses have improved.

Terry Dolan and John Stern of T&E discuss their outlook for the rest of the year, forecasting high single digits revenue on the merchant acquiring side and mid-single digits on the credit card fee side. They also discuss their CET1 calculation, which is at 6.9% including AOCI, and their plan to get to their target levels by the end of 2024. They estimate the burndown between now and the end of 2024 to be around 25%.

Terry Dolan explains that the bank expects to see capital accretion of 20-25 basis points on average. This is due to lower merger and integration charges and cost synergies. Additionally, the bank has implemented hedging strategies to protect them from any upside risk due to rising rates. Lastly, the bank is expecting to see additional capital accretion from risk-weighted asset actions.

Terry Dolan and Erika Najarian discussed the ability for the company to reduce risk-weighted assets and reach the target of 8.5-9% fully-loaded CET1 by 4Q ‘24. John McDonald then asked about the credit charge-off trajectory, to which Dolan replied that it will continue to normalize, reaching the mid-40s by the end of the year or early next year, and normalize around 50 basis points in 2024. Finally, Dolan clarified that the full year guidance on expenses for this year does incorporate some achievement of merger saves in the fourth quarter.

John McDonald and Terry Dolan discussed the cost synergies they plan to achieve by the end of the fourth quarter of this year. They also discussed the average duration of their securities portfolio, which has been decreasing, and their goal to de-risk the AFS portfolio by keeping more in short-term securities or cash. Chris Kotowski asked about the HTM portfolio and Terry Dolan responded that it will continue to burn down over time and they are not adding to it.

Vivek Juneja and Terry Dolan discuss merchant processing fees, which have only increased by 2% year-on-year. Dolan explains that this is due to the higher portion of airline travel in the mix, which has a lower margin. John Stern then explains that the AOCI has declined by $250 million due to the rise in rates, but that hedges have helped to mute this. Finally, Dolan mentions that net charge-offs will normalize in 2024.

Terry and Andy discussed their assumptions for charge-offs, which include a probability of either a soft landing or mild recession, pricing pressure, and a Fed rate hike. Terry also mentioned that credit card balances are increasing and that commercial real estate office space may be lumpy over the next few years. Gerard asked about the upcoming Basel III end gain capital requirements, which may expose residential mortgages to higher risk-weighted assets.

Terry Dolan and Gerard Cassidy discussed the potential risk of their RWA strategies with respect to mortgages, and Dolan indicated they are continuing to de-risk their portfolio. Betsy Graseck asked about the asset sales they completed in the quarter, and Dolan said most of them were completed at the end of the quarter. Dolan also noted that their revenue outlook for the year incorporates their capital actions between now and the end of the year. Mike Mayo then asked if there was a chance they would need to raise capital or cut the dividend, to which they did not provide an answer.

Andy Cecere of U.S. Bank discussed the bank's capital walk plan and their ability to reach 9% RWA by the end of 2024. He is confident in the bank's plan. Mike Mayo then asked about NII, as rates have risen faster than expected, competition has increased, and guidance has been lowered. Cecere said the third quarter could be down a little bit, but they expect to maintain that level as they exit the year and NIM should remain flat.

Terry Dolan and Andy Cecere discussed the downward pressure on NII and NIM, and the expectation that it will be a few basis points down in the third quarter and relatively stable from there. They believe they are in the late innings of this due to Fed policy, and also noted that the diversity of revenue and $900 million of cost synergies will help to mitigate the impact of the downward pressure.

Terry Dolan believes that the company can achieve a 50 basis point reduction in their fully loaded RWA by the end of 2024, with low to neutral impacts and repositioning of the balance sheet. He states that the target for the fully adopted RWA by the end of 2021 is 8.5-9%. John McDonald asked for clarification on the impacts and Dolan confirmed that there may be episodic one quarter impacts, but that they are taken into consideration when calculating the net RWA impacts. The call ended with George Anderson thanking participants for listening and encouraging follow-up questions.

This summary was generated with AI and may contain some inaccuracies.