Update: U.S. Bancorp

January 22, 2024 | In this edition of The Institutional Risk Analyst, we take a look at Q4 2023 results for U.S. Bancorp (USB), one of the bellwethers in our commercial bank group. Would it surprise you to know that the term “commercial real estate” was not mentioned once during the USB investor conference call?

The first thing to note is that USB’s results were cut in half compared to the previous quarter. Why? A list of one-time expenses from selling low yielding securities, to a $740 million special assessment from the FDIC to cover the cost of three bank failures a year ago, and charges related to the acquisition of Union Bank. All told, non-interest expense increased $1.1 billion pretax.

Source: USB Q4 2023

USB CFO John Stern told the conference call: “As of December 31, the ending balance on the total investment securities portfolio was $161 billion. During the quarter, effective duration on the available for sale portfolio declined to less than three years as unrealized losses, net of tax, improved by approximately $2 billion given the movement in rates and repositioning.”

Like other banks we have mentioned over the past few months, USB is cleaning house of legacy COVID-era assets because they have the income and the capital to do so. By rebalancing into higher return assets, the bank will improve its overall performance. We own the USB preferred at present, but have not held the common since 2020. Some highlights on the financials speak to where CEO Andy Cecere wants to take USB over the medium term.

On the asset side, USB is slowly shrinking its balance sheet as it digests the Union Bank acquisition. In that transaction, USB onboarded 1.2 million consumer and small-business customers, and rebranded more than 300 western branches under the U.S. Bank name and back-office system. 

Meanwhile, USB’s off-balance sheet custodial, servicing and administrative footprint grows in the Treasury and mortgage markets. U.S. Bank, for example, just replaced Wells Fargo Bank as the collateral custodian for $2.6 trillion in Ginnie Mae MBS. 

WFC continues to downsize its residential mortgage servicing business, but USB is growing in 1-4s and is now just behind JPMorgan (JPM) among bank issuers of conventional MBS with $30 billion in volume in the first nine months of 2023, according to Inside Mortgage Finance. As and when mortgage volumes grow, USB will be positioned nicely to benefit as an aggregator of loans and issuer of MBS.

On the liability side, USB has seen runoff in non-interest bearing (NIB) deposits, a long-term structural change in the business model of the bank. The relative shrinkage in the business deposit base that is the main source of NIB liabilities has been offset by growth in long-term debt, a development we view positively for USB and all banks. 

Acting Comptroller of the Currency Michael J. Hsu noted in a speech last week:

“The failures of Silicon Valley Bank (SVB) and Signature Bank last year highlighted three vulnerabilities that had been underappreciated. First, uninsured deposits can be withdrawn quickly en masse. Second, having liquid assets is necessary but not sufficient for banks to endure acute liquidity stress. Banks also need to be adequately prepared and have the operational capacity to monetize those assets quickly. Third, contagion to healthy banks does not require interconnectedness and direct exposure to a failing bank. Systemic threats can occur via “guilt by association,” i.e., shared uncertainty with regards to seemingly similar risk profiles, such as high reliance on uninsured deposits for funding.”

We think both banks and nonbank finance companies will gravitate toward term debt issued to institutional investors as a more important component of funding. As Hsu noted: “On March 9, SVB endured over $40 billion of outflows—roughly 25% of its total uninsured deposits—on a single day. By contrast, in 2008 Wachovia lost $10 billion of deposits over eight days and Washington Mutual lost $19 billion over 16 days.”

This quarter’s earnings shows that the cost of paying for volatility in consumer deposits is large deposit insurance assessments from the FDIC. The way to minimize this expense is to fund more of the bank’s liabilities with LT debt. Note that NIB deposits at USB are down 30% YOY, but consumer deposits are growing. Time deposits have also grown over the past year, in line with industry trends. And short-term debt has been reduced by half. 

As we’ve noted previously, USB is going to need years to fully digest the Union Bank acquisition, but bank management is very focused on getting forward performance back into line with the past. So while USB is reporting an efficiency ratio of 76% using GAAP results, the bank’s managed number excluding "notable" items is 61%.  The difference describes the cost of the Union Bank acquisition, but it also shows where Cesare thinks his bank needs to be in terms of LT operating leverage.

Like most of the larger commercial lenders, USB has been rotating into commercial exposures as residential loan volumes have plummeted since 2022. Overall, USB's net credit losses in Q4 2023 were below year-before levels, as shown in the table below. Note that credit card losses were half of the total net loss and have largely returned to pre-COVID levels. Yet gross charge offs were down vs 2022.

Source: USB Q4 2023

We expect to see USB continue to make progress on reducing expenses and also reducing balance sheet assets, even as the bank grows its business. Purchasing Union Bank was a large transaction for USB, but it has positioned the bank nicely in new markets and left the bank among the top three bank mortgage lenders in the US. That said, net interest income at USB was down again for the fourth consecutive quarter, confirming a trend across the banking industry.

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