美國合眾銀行 (USB) 2004 Q4 法說會逐字稿

Welcome to the U.S.

Bancorp's fourth quarter 2004 earnings conference call.

Following a review of the results by Jerry Grundhofer, Chairman and Chief Executive Officer, and David Moffett, U.S.

Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session.

If you would like to ask a question, please press the star and 1 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 4:00 p.m.

Eastern time through Tuesday, January 25th, at 12:00 midnight Eastern time.

I will now turn the conference call over to the Mac McCullough, Senior Vice President of Investor Relations.

Thank you, operator, and thanks to everyone for joining our call this afternoon.

If you have not yet received a copy of our earnings release and supplemental analyst schedules, they are available under the financial information and news and events section of our website at usbank.com.

Jerry Grundhofer, our CEO and David Moffett, our CFO are here today to discuss our results.

I would like to remind you that any forward-looking statements made during today's conference call are subject to risks and uncertainty.

Factors that could materially change our current forward-looking assumptions are detailed in our press release.

I will now turn the call over to Jerry.

Mac, thank you.

Good afternoon.

Thanks for joining us today.

This morning we reported record full-year net income of $4.2 billion resulting in a 13 percent increase in earnings per share over 2003.

Adjusting for the December 31st, 2003, spin-off of Piper Jaffray, full-year 2004 earnings per share from continuing operations were up 13.5 percent over last year.

2004 earnings were driven by strong fee revenue and improved credit quality.

Excluding security gains and losses, full-year fee revenue increased 11 percent over 2003.

The payment fee categories increased 16.6 percent, reflecting recent investments and increased customer penetration with merchant processing at 20.1 percent, credit and debit card revenue increasing 15.8 percent and corporate payments increasing 12.6 percent.

Deposit service charges increased 12.7 percent over 2003 driven by a 6 percent increase in net-new checking accounts and ongoing investments in our branch network.

Mortgage banking fee increased 8.2 percent compared to last year driven by higher servicing revenue.

Now let's take a quick look at full-year business unit results.

Wholesale Banking, which accounted for approximately 19 percent of revenues in '04, increased net operating earnings by 26.8 percent over 2003, driven by improved credit quality and reduced noninterest expense.

Despite a 2.7 percent decline in revenue, Wholesale Banking increased operating leverage by 3.5 percent during the year.

Net charge-offs declined from 91 basis points in '03 to 5 basis points in 2004.

Significant to note, that in the fourth quarter of 2004 we reported our first year-over-year increase in average quarterly commercial loans in over 3 years.

On a linked quarter basis, average commercial loans increased 9.9 percent over the third quarter of 2004.

We expect commercial loan growth to continue to gain traction as 2005 progresses.

Excluding the impact of mortgage servicing rights impairment and securities gains, Consumer Banking which account for approximately 42 percent of revenue in '04, increased net operating earnings by 15.7 percent over 2003, driven by a 5.9 percent increase in revenue and tight expense control resulting in increased operating leverage of 4.9 percent for this very important business.

Fee income increased 15.7 percent over 2003, primarily driven by deposit service charges, mortgage banking revenue and lower lease residual losses on end-of-term leases.

Full-year average retail loans increased 8 percent over 2003, a growth rate that we expect to exceed in '05.

Net charge-offs declined from 74 basis points in 2003 to 59 basis points in '04, reflecting excellent credit quality trends.

Next, Private Client, Trust and Asset Management accounted for approximately 11 percent of revenue in 2004, recorded a 13.1 percent increase in net operating earnings from last year.

Driven by a 6.2 percent increase in revenue and a 0.7 percent decline in noninterest expense.

While total average loans increased just under 4 percent, total average deposits in this business increased $2.4 billion, or 25.4 percent over 2003.

Finally, Payment Services, which accounted for approximately 19 percent of revenue in 2004, increased net operating earnings by 20.2 percent from last year driven by revenue growth of 10.6 percent and a 12.1 percent decline in net charge-offs.

This reflects increased level of -- reflecting increased levels of investment.

Noninterest expense increased 11 percent.

Net charge-offs declined from 413 basis points in 2003 to 342 basis points in 2004.

Turning to Capital Management, we aggressively repurchased our stock in 2004 buying back almost 94 million shares.

This, combined with dividend payments, resulted in a 109 percent return of earnings back to our shareholders.

This past December we increased the quarterly dividend 25 percent, authorized 150 million share repurchase program and reaffirmed our goal of returning a minimum of 80 percent of earnings to our shareholders.

Going forward, our primary goal is to demonstrate that our Company is uniquely positioned to achieve consistent 10 percent-plus EPS growth as a result of our balanced business mix, advantage scale, industry-leading returns, reduced ROE for our risk profile, and low-cost leadership position, plus our emphasis on quality customer service.

We believe that there are significant opportunities to further penetrate our 24-state footprint and our diverse customer base with our broad array of industry-leading products and services.

We added 123 net-new in-grocery-store branches in '04 and we'll continue to invest in distribution in high-growth markets as 2005 progresses.

Transaction volumes and our payment businesses continue to show strong growth reflecting investments made over the past 18 months.

We also have a number of payment products -- product initiatives underway to penetrate our existing commercial customer base that are contributing to growth as well.

Finally, we're making investments in our brand and continuing to focus on improving the level of service that we provide to our customers.

In conclusion, 2004 was a year of significant accomplishments.

A 13.5 percent increase in earnings per share from continuing operations, a 5.2 percent increase in total revenue per share, an 11 percent increase in fee revenue. 63 basis points in net charge-offs, a level that we have not seen on a full-year basis in this Company since 1999.

A 6 percent increase in net-new checking accounts, 109 percent of earnings returned to shareholders in the form of share repurchases and dividends, and a 25 percent increase in our quarterly dividend.

And we know what we need to do is to add to this list going forward.

We need continued growth in commercial loans which will help drive net interest income growth in 2005.

Based on what we know today, we expect our commercial lending businesses to help us achieve our earnings growth goals in '05.

Now let me turn it over to David to give you more details on the fourth quarter.

Thanks, Jerry.

Today we reported fourth quarter earnings of 1 billion 56 million or 56 cents per share on a diluted basis.

This was a 12 percent increase in earnings per share over the fourth quarter of 2003.

Several notable items impacted fourth quarter results including, first, a release of the allowance for credit losses of 98.5 million reflecting continued improvement in the Company's credit quality and economic conditions.

A 16.3 million reduction in tax liabilities related to the resolution of a state tax examination.

The recognition of 31.9 million of impairment in the mortgage servicing rights due to a reduction in the yield on both the 10-year treasury note and the 30-year Fanny Mae commitments.

A 20 million net loss on the sale of investment securities and 112.3 million charge for the prepayment of 2.3 billion in borrowings from the Federal Home Loan Bank.

Compared to the fourth quarter of 2003 and excluding securities gains and losses, revenue per share grew 7.7 percent driven by strong fee revenue growth.

The fourth quarter 2004 net interest margin of 420 declined 22 basis points from the fourth quarter of 2003.

This decline primarily reflected the competitive credit pricing environment, a preference to acquire lower yielding floating rate securities, lower loan prepayment fees, a modest increase in the percent of earning assets funded by wholesale borrowings, and higher rates paid on wholesale funds due to the impact of rising interest rates.

Compared to the third quarter of 2004, the net interest margin declined 2 basis points.

We ended the quarter neutral from a rate-risk perspective.

Our focus in 2005 will be to drive commercial and retail loan growth.

This will result in higher earning assets, which will be the driver of net interest income, not margin expansion.

Said another way, increases in earning assets, predominantly loan balances, will drive net interest income in 2005, not margin expansion.

As an example, net interest income in the fourth quarter of 2004 increased approximately 18 million over the third quarter of 2004.

This increase was driven by growth of 2.7 billion in average earning assets.

Partially offsetting the impact that earning asset growth had on net interest income was a 2-basis-point decline in the net interest margin.

We expect our investment securities portfolio to remain flat in 2005.

At December 31, 2004, approximately 40 percent of the portfolio was variable rate and we expect this percentage to increase as 2005 progresses.

At December 31, 2004, the duration of the portfolio was 3 years, down from 3.2 years at September 30th, 2004.

And regarding deposit growth, we are focused on growing high-value accounts and associated deposit balances in the branches.

In 2004, we grew net-new checking accounts in the branches by 6 percent.

In 2003, the growth rate was 4.7 percent.

Growth rates in 2002 and 2001 were 3.4 percent and 1.5 percent respectively.

Since year-end 2001, branch-based checking account deposits plus savings account balances have grown at an average compounded rate of 6.4 percent, and we actually exceeded that growth rate in the 3 of the 4 quarters of 2004.

Credit quality continues to show improvement once again, exceeding our expectations for the quarter.

Nonperforming assets declined $56 million, or approximately 7 percent during the quarter to $748 million at December 2004, or 59 basis points of loans and OREO.

Net charge-offs fell on a linked-quarter basis to $163.6 million or 52 basis points of average loans.

The allowance for credit losses to nonperforming loans was 354 percent at December 31.

The allowance for credit losses to period-end loans at December 31 was 1.8 percent.

Our capital ratios remain strong as well.

We are comfortably above the minimum regulatory targets to achieve well-capitalized status, with a Tier 1 capital ratio of 8.6 percent and total capital ratio of 13.1 percent.

Tangible common ratio ended the quarter at 6.4 percent.

In conclusion, we continued to make good progress in the quarter, and the quality of our earnings remain high.

Our high value fee generating businesses continued to show strong growth.

We are adding distribution in high-growth markets and investing our capital efficient payments businesses.

In addition, we never stop investing in customer service.

We have a number of initiatives underway in systems and in people, which will allow us to make progress on this front.

We believe that our balanced business mix, our advantage scale, our reduced risk profile, our low-cost leadership position, and our emphasis on customer service will allow us to achieve our long-term goal of 10 percent-plus earnings per share growth.

This concludes our prepared comments.

We will now take questions from institutional investors and analysts.

Very good. (Operator Instructions).

We'll go first to the line of Nancy Bush with NAB Research, LLC.

Go ahead, please.

Good afternoon, guys.

Hi, Nancy.

Good afternoon.

Couple of questions for you.

The release of the loan loss reserve, you were sort of the last holdout here.

Was this just you got to a point where you had to do it?

Is it a discretionary move?

Can you just kind of help us parse this out?

Yes, Nancy.

As you know we have a standard process that we go through every quarter to determine the adequacy of our allowance for our credit losses.

The release of the 98.5 million in the fourth quarter was a result of this standard process.

We considered changes in credit quality metrics, the portfolio mix and our outlook for the improving economic conditions and based in part, in fact, that we began to experience commercial loan growth in our footprint in the quarter.

We believe that the allowance for credit losses is adequate and we will continue to evaluate the allowance every quarter based on applying this methodology on a consistent manner.

Secondly, could you just give us some of the metrics on how the in-store branches are performing?

And sort of as you went through the year, you know, have your thoughts about the break-even point of these changed at all?

And, you know, are you generally happy with what you're seeing in the performance of the new ones?

Nancy, this is Jerry.

We are very happy with it.

They've exceeded our expectations, as far as performance.

We put in place when we started the accelerated, in particular, Safeway initiative. 18 to 24 months, we believe they will break even.

They're doing that.

Some a little sooner, maybe a few -- a few months later, but it is exceeding our expectation in excess of 33 percent internal rate of return.

It is everything we thought it was.

It is a cost-efficient way to service our customers and grow that raw material, that net-new checking account.

Any thoughts, then that we might see some near-term announcements of further initiatives, or are you just going to go with what you've got right now?

We're always looking at opportunities with partners, and we have been consistent over the months and years in doing smaller ones.

Certainly the Safeway initiative was a very, very large one, and, again, we're out there trying to stir up business there and we are seeing as a preferred provider, but nothing that I can talk about, Nancy.

Great.

Thank you.

Thank you.

Our next question comes from the line of Carol Berger with Crest Investments.

Hi, guys.

Hi, Carol.

Could you just tell me what went on in other, other income?

It was up 15 percent quarter-to-quarter, it's $20 million.

Yeah, Carol.

First of all, in the prior quarter, in the third quarter, as you may remember, we had a pick up in insurance from the result of the -- basically reimbursement from the insurance on our car leasing business, so that was in the third quarter.

In addition, we also had some improvements in valuations in our equity portfolio, our venture capital portfolio also showed some improvements, but those are essentially the 2 differences between the 2.

And how much is -- how much of that is recurring?

Well, clearly the insurance residual piece will not reoccur except maybe at the end of every year when we work with the insurance companies to basically get reimbursed.

The venture capital piece is hard to say.

We've had reasonably good results really in the third and fourth quarter of last year and we expect to see some improvement in the fourth quarter, so I think the answer to your question, we'll see some of it, some additional in the first quarter and probably some lingering over into the second quarter.

And how much was the venture capital?

It's about 17 million.

Okay.

Thanks.

Thank you.

Our next question comes from the line of Lori Appelbaum with Goldman Sachs.

Go ahead, please.

Hi.

Jerry, congratulations on the turn in commercial loan demand in the quarter.

I just wanted to ask you what you would see as the underlying reasons for the turn, whether it be any regional differences or some of the changes that you've made in management in the field.

Lori, I really do think it's the latter for the most part.

As you know, we have really retooled a substantial portion of our middle market business, and I think we're starting to bear the fruits of that, frankly, and I would give the vast majority of it to that.

We've got some fighter pilots out there now, and there has been some pick up in demand I think, but we're out there aggressively calling and I think we're seeing the fruits of that.

Were there regional difference at all?

Yes, there was.

I mean, frankly, the Midwest was a little stronger than the West, which, as you know, is always surprising, but that Midwest footprint still is home to us, if you know what I mean.

It did pretty well.

In particular, you know, the Cincinnati area, Chicago starts some uptick, St. Louis, and then we're starting to see in the West as well, Chicago, I said that, yeah.

So the point is that the pieces of franchise that have been in the Company the longest are seeing better trends and the upside is in the newer parts where you have new management?

Yeah, and as I said in my comments, my expectation is you will start seeing better growth in the newer parts of the franchise, in particular the West and that would be my expectation.

Thanks.

Thank you.

Our next question comes from the line of Mike Mayo with Prudential.

Go ahead, please.

Hi.

Hi, Mike.

Just one technicality, I guess period-end commercial loans were flat even though average loans were up?

Yeah.

What's going on there, or how do you explain it?

Well, there's a couple of period-end loans.

One is a lot of companies, as you probably may know, take a great deal of effort to pay off borrowing and don't want to show leverage on their balance sheet.

That's the principal reason.

The second reason is, particularly in a lot of middle market businesses who have covenants and leverage constraints, particularly in the middle market business, will pay off balances right at the end of the period, but the averages are really the ones -- the best indicator of the overall growth, but that does happen at year end.

So you said in the introductory comments you expect commercial loan growth to fuel kind of earnings asset growth which help fuels the earnings this year.

Maybe if you could just give some outlook for 2005 and term to that commercial loan growth, margin, operating leverage, EPS growth, whatever.

Thanks.

Mike, I think the secret to improving net interest income next year is to grow earning assets, and as you know we've been growing the consumer loans at a 10 percent plus.

This is one of the first quarters where we've seen both solid commercial growth really across the board in all the markets and is running around an annualized rate of growth of 9 percent.

And that's, to me, what's going to be most important in driving net interest income.

As I stated, I think what you can look for us to do is continually to emphasize the commercial loan growth as well as the continuation of the retail loan growth, drive growth and earnings assets, which will drive net interest income.

The impact of that would be lower net interest margin, but quite frankly, that doesn't bother me because returns are already high, return on equity, return on tangible equity, return on assets, is already high, so to the extent that we can grow net interest income in lieu of increasing margins I think we're better off, and that's what we're going to be driving to.

Last question.

I think the last few years you mentioned you're looking for 10 percent earnings growth for that particular year, and you said now it's a long-term goal.

Are you hedging some to that 10 percent growth this year?

Did you modify the language of the growth target, or am I just --?

No, Mike.

No, we meant '05 and on out.

Okay.

So you still expect 10 percent growth this year?

Yes, that's correct.

Okay, thanks.

Again, for questions, please press the star and 1 on your phone.

We'll move next to the line of Ben Crabtree with Piper Jaffray.

Go ahead, please.

Hi.

Just wondered if you could run through what the economic -- ongoing economic impact of some of your balance sheet moves might be.

For example, the securities gains and then the prepayment of the FHLB advance.

You talked about the duration of your portfolio coming in.

I imagine that could be one of them, but I'm just wondering if there was a savings, an ongoing interest expense from the restructuring, or what was behind all this?

Yeah, there's a couple of movements in the balance sheet.

First of all, on the investment portfolio side, essentially what we did is we sold some securities that were about a 15-year duration, and we bought essentially a bond 30-year duration, and the reason for that, Ben, is if you look over time with the duration of our portfolio, our duration has dropped rapidly from 3.6 -- or 3.7 last year to 3.0 this year.

That's occurred because we keep investing more and more in the overall and floating rates, securities of variable rate securities.

What's happened, as a result of that, we have not had as an effective hedge as we need for the mortgage servicing right portfolio.

So essentially what we did was we bifurcated the portfolio to a portfolio of large and short duration with this one piece of long duration so in the event that rates drop -- the longer rates drop and we have MSR impairment, we'd be able to cover that.

So essentially we created, for all practical purposes, kind of a barbell to support the ongoing hedging of the MSR rights.

So that's essentially what we did with regard to that

And that subpart of the barbell would be proportional then to your MSR -- size of your MSR?

Yes, exactly.

So we feel like we covered that.

The second thing that we did is, as you saw, we prepaid $2.3 billion in Federal Home Loan Bank advances.

Those advances were maturing in '08, and they're all putable back to the Company presently until 2008 when they mature.

So what we were trying to accomplish is essentially reduce what I would call the refinance risk of the Federal Home Loan Bank basically putting back that debt back to us and therefore us being prone to experience higher interest rates in our funding costs.

So what we essentially did then was we turned around and refinanced that on a fixed rate basis essentially eliminating that prepayment risk.

That would actually lower the overall cost of borrowing by about 100 basis points on the $2.3 billion beginning really in '05, is really the impact of that.

And if rates moved higher, the savings would be bigger.

Yes, exactly.

So it's a much better way to finance ourselves and it reduces the risk that our financing costs would go up at the point in time where we least want it to.

One follow-on question on the MSR valuation issue.

I've seen some interesting cross-currents in terms of people, how they're valuing it so far this quarter.

You talked about rates on, you know, mortgage rates, coming down.

Did you actually see some kind of a movement in that direction in terms of the MSR valuations, or are you being pretty anticipatory here?

No, no, no.

This is the actual experience that we saw during the period of time.

And we mark that every quarter.

In fact we mark it every month.

By the way, as an aside, just a general comment to you all, you may have seen that just about an hour ago Moody's upgraded U.S.

Bancorp and its subsidiaries in the bank have been upgraded to AA1, which is one below AAA, so we're very proud of that.

That's the third upgrade we've had over the last few years, I believe, right, Mac?

So we're very proud of that here at U.S. Bancorp.

Thank you.

Our next question comes from the line of Matt O'Connor with UBS.

Go ahead, please.

David, I was a little surprised at the yield on the commercial loans is relatively flat linked quarter.

And I was just wondering, does that reflect some of the off-balance-sheet actions?

Well, no.

You mean the loan portfolio?

No.

The loan portfolio wouldn't have been effected by any of these transactions.

It's probably 2 things.

One is, lower revenue on the derivatives portfolio because, as you know, we have not been expanding the derivatives portfolio, so that's going to have one sort of negative impact on that.

The other impact, quite frankly, as we've said before, there's a lot of competition, and we -- we expect that competition to continue over time, but I would say it's mainly the fact that we've continued to work on reducing the overall derivative portfolio where we've swapped some loans, but I think over the longer term it's more price competition than anything.

In terms of the yield, the -- kind of the new planned [inaudible] middle market loans, are they -- what's that running?

Like LIBOR plus 200 or?

Yes, I think that's an appropriate number.

We tend to be running at the 200-basis-point range, and that's down from higher spreads than the 225 to 220 range.

Matt, with our cost structure, being the low-cost provider, no one can make more money at it, regardless of what's charged.

So that is a significant advantage for us that we're going to exploit.

Lastly, and I know I've talked to both of you about it with the deposit rates being so low, but have you factored in more meaningful deposit rate increases throughout 2005?

Yeah, Matt, we have.

We have a plan over the next 4 quarters, assuming that we see a continuation with the rise in interest rates, and we will in selective markets, and we have done so far this year in selective markets, focused on pricing, improving pricing in both the money market accounts, the interest checking products, in fact, we've begun to develop some new products, some standard products, as well as the overall CDs in both the small CDs, and the larger CDs, so yes, we definitely have and will continue to focus on that.

That's not true for every market, but we're selective in using a budgeted interest expense for different markets in order to get the most value out of it and grow the most in the branches.

So the answer is absolutely yes.

And I assume that's a big driver behind the relatively cautious stance on the margin outlook.

Yes, definitely.

Thank you.

Thank you.

We'll move next to the line of Fred Cummings with Keybanc Capital.

Go ahead, please.

Good afternoon.

Good afternoon, Fred.

Good quarter.

David, just a conceptual question on capital management.

You guys have been one of the leaders at returning capital to shareholders.

Now, David, assuming the stock price keeps going up, is there a point at which you would prefer to, say, pay a special dividend to shareholders as opposed to repurchasing stock in order to return capital to shareholders?

Well, Fred, as you know, this question on special dividends came up with the -- the special dividend of Microsoft.

As you know in banking, and I think this is true for most banks, we don't build excess capital over time in order to distribute it.

What we prefer to do, obviously, is distribute that over the quarters as we earn it and by essentially increasing the dividend by 25%.

We essentially basically said, yeah, we're committed to the 80%, but we're going to change the mix more to dividends.

Quite frankly, and less buybacks, and, again, the reason -- our reasoning and logic is, one, we think dividends is a more solid expression of our commitment to the shareholders long term.

As you know, dividends are essentially sort of a semi-permanent commitment to the shareholders, and I think shareholders -- we are convinced shareholders value that more than they do buybacks, but at the same time, we believe that the buyback is a very effective way to continue to distribute capital back to our shareholders.

As you see from last year, we really, for all practical purposes, didn't find any attractive economic acquisitions for the use of the excess capital.

And our view is that if we can't find attractive investments, then we have the obligation to return that back to the shareholders, which is what we're doing.

And that's literally what we're restating today, is that commitment to continue, but we felt over time the shareholders have a preference for dividends, but again, as you can see with our new buyback of 150 million shares, we're committed to doing that as well.

So we're going to continue that process for the rest of the year.

Fred, as you know, we've paid a dividend for 141 straight years, and have increased our dividend for the last 33 consecutive years.

So that is pretty consistent.

Yes.

And, Jerry, one question on kind of future management changes.

With Richard being promoted, are you actively looking for a replacement for Richard, someone to run your retail banking business?

And if so, is that person more likely to be internal candidate or an external candidate?

Yes, we are.

And I can't tell you whether it's internal or external.

But, yes, Richard's position, he's a busy man, but he has -- we have great people that are doing a hell of a job so it's all covered.

Lastly, David, it looks like to me that there's a significant difference between your cash earnings and your GAAP earnings, and I'm surprised you don't talk about that more.

Well, I think the way we try to highlight that, quite frankly, Fred, I mean, you're right, and many of our longstanding shareholders have pointed to that many, many times.

I think the way we like to think about it is that at the end of the day that difference between cash and GAAP basically ends up going to capital, and our view is we basically show that when we've paid dividends and increased our buyback, and particularly our commitment to return 80% of our earnings to our shareholders.

And we think at the end of the day that's where you make distinguishing difference.

But, Fred, you're right, many of our -- as I said, many of our long-term shareholders have pointed that out many times.

You're right, we don't talk about it a lot, but it's there, and it's embedded in the dividend and the buy-back.

Thanks, David.

Thanks, Jerry.

Thanks, Fred.

It appears we have no further questions at this time.

I'd like to turn the call back over to management.

Great.

Thank you for joining us today, and please call with questions.

Thank you.

Thank you.