U.S. Bancorp - Q3 2024

Transcript

Operator (participant)

Hello, and welcome to the U.S. Bancorp third quarter 2024 earnings conference call. Following a review of the results, there will be a formal question and answer session. If you would like to ask a question, please press star then one on your telephone keypad. If you wish to withdraw your question, please press star then one again. This call will be recorded and be available for replay beginning today at approximately 10 A.M. Central Time. I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for U.S. Bancorp.

George Andersen (SVP, Director of Investor Relations)

Thank you, Ellie, and good morning, everyone. Today, I'm joined by our Chairman and CEO, Andy Cecere, CAO, Terry Dolan, President, Gunjan Kedia, and CFO, John Stern. Together with their prepared remarks, Andy and John will be referencing a slide presentation. A copy of the presentation, our earnings release, and supplemental analyst schedules can be found on our website at usbank.com. Please note 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, our press release, and in reports on file with the SEC. Following our initial prepared remarks, Andy, Terry, Gunjan, and John will take any questions that you have. I will now turn the call over to Andy.

Andy Cecere (CEO)

Thanks, George. Good morning, everyone, and thank you for joining our call. I'll begin on slide three. In the third quarter, we reported diluted earnings per share of $1.30 and generated total net revenue of $6.9 billion. The quarter was highlighted by strong growth in net interest income, good momentum across several fee business initiatives, and continued expense discipline, which supported modest positive operating leverage on an adjusted basis compared with the third quarter of last year. Our return on tangible common equity was 17.9% this quarter. Turning to slide four. Revenue growth on a linked quarter basis was driven by improved spread income from more favorable loan mix, continued fixed asset repricing, proactive and disciplined liability management, as well as strategic actions taken on our investment securities portfolio. John will provide more detail on these actions in his prepared remarks.

On the upper right-hand side of the slide, you will see that non-performing assets, the net charge-off ratio, and late-stage delinquency metrics were all relatively stable compared with the second quarter levels. At September 30th, our Common Equity Tier 1 capital ratio was 10.5%, an increase of 20 basis points from last quarter, driven by continued earnings accretion. Our tangible book value per share increased to $24.71, a 6.7% improvement linked quarter and an 18.5% higher than last year. Slide five provides key performance metrics. This quarter, our return on average assets increased to 1.03%, the efficiency ratio improved to 60.2%, and net interest margin expanded 7 basis points to 2.74%.

Turning to slide six, we continue to see good momentum across many of our fee businesses. This quarter, we achieved year-over-year double-digit growth in both commercial and investment products revenue, driven by underlying capital markets activity and wallet share gains across our targeted industry verticals. Additionally, we also saw good year-over-year growth in trust and investment management, payment services, mortgage banking, and treasury management fee revenues as we benefited from a combination of improved underlying market conditions, deepening client relationships, and expanded product set and expanded distribution channels. Let me now turn the call over to John, who will provide more detail on the quarter as well as forward-looking guidance.

John Stern (CFO)

Thanks, Andy. If you turn to slide seven, I'll start with a balance sheet summary, followed by a discussion of third quarter earnings trends. This quarter, total average deposits decreased 1.0% on a linked quarter basis to $509 billion as we continued to prioritize relationship-based deposits and maintained our pricing discipline. Average loans totaled $374 billion, a modest decrease of 0.2% on a linked quarter basis. Industry loan growth remains muted, and the decline we saw this quarter was driven by slightly lower commercial balances, given continued headwinds from capital markets related paydowns and continued relatively low utilization rates. Within retail, higher credit card loan balances and improved revolver rates drove more favorable loan mix and margins.

As Andy mentioned, this quarter, we opportunistically restructured a portion of our investment portfolio to enhance our net interest income growth trajectory and to further strengthen our capital and liquidity profiles. At September 30th, the ending balance on our investment portfolio declined slightly to $167 billion, with an average yield for the quarter of 3.20%. Slide eight highlights our credit quality performance. Asset quality metrics continued to develop in line with our expectations and reflected ongoing macroeconomic stability. This quarter, we saw a slight reduction in our exposure to commercial real estate office portfolio, which remained appropriately reserved at 10.8%.

Late-stage delinquencies and non-performing asset metrics were relatively flat on a linked-quarter basis, and the ratio of non-performing assets to loans and other real estate was unchanged at 0.49% linked quarter versus 0.35% year over year. Our net charge-off ratio of 0.60% increased two basis points from a second quarter level of 0.58%, in line with our expectations. At September 30th, our allowance for credit losses totaled $7.9 billion or 2.1% of period end loans. We expect our fourth quarter net charge-off ratio to remain relatively stable compared with the third quarter level. In the near term, we expect changes to the loan loss reserve to be driven primarily by loan balance growth and mix. Slide nine provides a more detailed earnings summary.

In the third quarter, we reported $1.03 per diluted share, which included $119 million of net losses, or $189 million after tax on sales and securities rebalancing actions within our investment portfolio. These actions were largely offset by tax favorability in the quarter, primarily due to settlements in various tax jurisdictions. Turning to slide 10, net interest income on a taxable equivalent basis totaled approximately $4.17 billion, an increase of 2.8% linked quarter. Our net interest margin increased seven basis points to 2.74%. Both net interest income and net interest margin growth this quarter benefited from a combination of earning asset repricing and mix, further supported by higher card revolve rates, investment portfolio actions, and disciplined deposit pricing. Slide eleven highlights trends in non-interest income.

Non-interest income totaled $2.7 billion, and as mentioned, included $119 million of net security losses related to rebalancing activity within our investment portfolio. Importantly, year-over-year, we saw good growth across our core business offerings, including trust and investment management, commercial products, mortgage banking, and investment products. As a reminder, last quarter's mortgage banking fees included an approximately $30 million gain on sale of mortgage servicing rights. Service charges decreased 6.2% linked quarter, partly reflecting the impact of exiting our ATM cash provisioning business. The exit is now fully reflected in our run rate for the third quarter of 2024. Turning to slide 12, non-interest expense for the quarter totaled $4.2 billion, which was relatively flat to the prior quarter and 1.0% lower than a year ago, as adjusted.

The linked quarter increase of $16 million, or 0.4%, was driven by higher compensation and employee benefit expense, primarily due to higher performance-based incentives. On a year-over-year basis, the $42 million decrease, as adjusted, was driven by prudent expense management initiatives and the identification of operational efficiencies across the company. Turning to slide 13, our Common Equity Tier 1 ratio of 10.5% as of September 30th increased 20 basis points from the second quarter. Looking ahead, we intend to balance our continued capital accretion of 20-25 basis points per quarter with capital distributions, starting with a modest share repurchase in the near term. I will now provide forward-looking guidance on slide 14. We expect net interest income for the fourth quarter on an FTE basis to be relatively stable to this quarter's $4.17 billion.

This guidance is reflective of our current expectation for more modest loan growth and continued QT impacts on deposits. Full-year 2024 net interest income on an FTE basis is expected to come in at the higher end of our $16.1 billion-$16.4 billion range. For the full year, we still expect mid-single-digit growth in total non-interest income, as adjusted, but likely at the lower end of the range. We expect full-year non-interest expense, as adjusted, to be $16.8 billion. I'll now hand it back to Andy for closing remarks.

Andy Cecere (CEO)

Thanks, John. Third quarter results showcase the resiliency of our unique and differentiated business model, which featured solid top-line revenue growth, supported by healthy linked quarter margin expansion, as well as continued year-over-year income momentum and steady expense discipline. This quarter, we reported modest operating leverage, excluding net securities losses and prior year notable items, and consistent with our message at Investor Day. We expect to deliver expanding positive operating leverage in the fourth quarter that will continue into 2025.

As recent industry headwinds become tailwinds, and we realize the benefits of our now run rate investment spend on industry-leading digital capabilities, integrated payment solutions, and continued technology modernization, it will be the combination of our scale, our interconnected business model, and our deep and talented management team that will allow us to capitalize on the many objectives and targets at this important inflection point in our story. As always, let me close by thanking our over 70,000 employees for their everyday commitment to our clients, communities, and shareholders. We'll now open the call for Q&A.

Operator (participant)

Thank you. At this time, as a reminder, if you would like to ask a question, please press star and then number one on your telephone keypad. Our first question comes from Scott Siefers from Piper Sandler. Your line is now open.

Scott Siefers (Senior Research Analyst)

Morning, everyone. Thanks for taking the question.

Andy Cecere (CEO)

Hi, Scott. Good morning.

Scott Siefers (Senior Research Analyst)

Hey. John, I guess I wanted to start with NII. So, you know, at least relative to what I had anticipated, it looked like it came in better than you might have thought, even as recently as a month or so ago at the Investor Day. I guess, just in sort of simple terms, can you walk through what, in your mind, ended up coming in better than you might have anticipated?

John Stern (CFO)

Sure, Scott, and good morning. So a couple factors I would say there. First, I think, the remixing of our portfolio, we continue to see strength in our credit card and the revolve rate, as we discussed in our opening comments. It's great to see that business has been growing, you know, at 8% year over year, on the loan side of things. You know, our fixed asset repricing continues, and then the other factor I would just say is that on the, you know, what we didn't know was the Fed was gonna cut 50 basis points, and we had the ability to really price on our deposits. And so I think the combination of all those things really helped us power and get and see nice momentum here in the third quarter.

Scott Siefers (Senior Research Analyst)

Okay. All right, perfect. And then if I could switch gears to fees for just a second. Just wanted to chat about sort of the implied fourth quarter number. So even if we get to the lower end of the full-year fee guide, I guess that sort of implies that fourth quarter fees would get back up near sort of $2.8 billion-$2.9 billion level that might be more typical of one of your seasonally stronger quarters, like, you know, typically, I think of you all doing best in the second quarter. Maybe you could just sort of walk through the main flips and takes and where you would see sort of a re-acceleration in momentum into the fourth quarter, please.

John Stern (CFO)

Sure. So I think we, you know, I think it's just in a number of different things, and as we discussed in our opening comments, you know, the core business components are performing quite well. We had strong growth in trust. You know, 6% commercial products was over double digits at 12%. Mortgage had a nice year-over-year growth at 8%. You know, and payments, while it came in at 3% or so, you know, this quarter, we do have expectations of growth in those particular businesses in the fourth quarter. So all that kind of leads into, you know, some momentum there from a fee standpoint side.

We, of course, have some headwinds there that we've talked about, you know, like in our ATM, exiting our ATM business, some of the prepaid card metrics, and some of the other things like that in the payments. But, you know, by and by, all in all, that's what gets us and gives us confidence in our mid-single-digit growth on the fee side of things.

Scott Siefers (Senior Research Analyst)

Perfect. Okay, good. Thank you very much.

John Stern (CFO)

Thanks, Scott.

Operator (participant)

Your next question comes from John Pancari from Evercore ISI. Your line is now open.

John Pancari (Managing Director)

Morning.

Andy Cecere (CEO)

Morning.

John Pancari (Managing Director)

I know you cited the partial securities repositioning in the quarter. I want to see if you could give us a little bit more color on what you restructured in the quarter and the sizing of that and the yield. And then, do you expect further actions on that front? And would further actions already be factored into your NII expectations? Thanks.

John Stern (CFO)

Sure. Thanks, John. So, you know, in terms of the securities repositioning, we did take action, you know, on what $119 million of losses. There was in total there was about, you know, $10 billion in total of notional that was transacted. But, you know, importantly for you all, I mean, it's we consider that more or less a two-year payback is kind of how we're thinking about it. I would call the impact to the quarter maybe around $10 million or so. So there's probably a little bit more pickup in the fourth quarter related to it. And as I think about, you know, in the future, we don't have any other, you know, of these sorts of things contemplated in our guidance or anything like that.

It's just this was an opportunity that came up with, you know, as we saw interest rates fall quite a bit. We were able to take advantage of that, and we feel good about the transaction. You know, we're constantly looking at these things, but we don't have anything contemplated at this particular point in time.

John Pancari (Managing Director)

Okay. All right, thank you. And then separately, on the expense side, you put up some pretty good positive operating leverage this quarter, and implied that fourth quarter, you'll see that as well. And I believe at the Investor Day, you expressed confidence in continued positive operating leverage. As you look at 2025, can you maybe help us get a sense of the magnitude of that operating leverage that you think is reasonable as you enter 2025 and longer term? I believe the Street's looking at about 150-200 basis points operating leverage next year. Wanted to get your thoughts on that as we look at your return profile in the coming years.

Andy Cecere (CEO)

Thanks, John. This is Andy. So as you saw, we reported positive operating leverage, approximately 30 basis points in Q3 here. The guidance that John provided would indicate that our expectation for positive operating leverage in the fourth quarter of 2024 will be north of 1%, and we would expect it to continue to expand from there into 2025. So building upon that 1% plus into 2025. Exactly where we'll get, we'll give more guidance as we get the forward-looking guidance as we think about 2025 across the categories.

John Pancari (Managing Director)

Great. Very helpful, Andy. Thank you.

Andy Cecere (CEO)

You bet.

Operator (participant)

Your next question comes from Betsy Graseck from Morgan Stanley. Your line is now open.

Betsy Graseck (Managing Director)

Oh, hey, good morning.

Andy Cecere (CEO)

Hey, Betsy.

Betsy Graseck (Managing Director)

Yeah, just to, one follow-up on that is, in the guidance for 4Q, you indicated, you know, expenses at, you know, ~$16.8 billion. And I know in the past you had been saying $16.8 billion or less. So is there, is there anything we should take away from that very ever so slight, guidance change?

John Stern (CFO)

Hey, Betsy, it's John. So, I think it's just reflective of we're in the third, we're complete with the third quarter. We're at the fourth quarter. Right now, we have a very good line of sight into what our expense base will be, and so we were just being more precise with that particular number. In addition, you know, we saw good growth in our net interest income, and so, you know, it's kind of the expense was coupled in part with the net interest income. You'll recall when we shifted our discussion points on that, and since we're at the higher end of our range, we feel like $16.8 billion is the appropriate expense side of things this quarter.

Betsy Graseck (Managing Director)

Got it. Okay, now that's helpful. And then on the rate discussion earlier, you know, you got the surprise 50%, which, you're able to pass through on to, the depositor side. So as we're thinking about the next several quarters here, does NIM expand further as rates continue to cut down, come down? Or is there a catch-up on the asset side that we should be, you know, skewing to?

John Stern (CFO)

Yeah, I think broadly speaking, rate cuts are a positive thing for us in the sense that we're able, we have a deposit base that's conducive really to cuts. We have the ability, as you know, we have 50% of our deposit base is in institutional, and 50% is retail. We're able to cut institutional rates fairly quickly. And so, you know, the beta for this particular juncture was around that, you know, I'll call it 30% area for this particular cut. And we expect that to continue to migrate closer to, you know, or up to just north of 50% as we kind of get through the cycle and that sort of thing. And so that's going to be helpful.

And I think the other thing is, over time, as the cuts happen, then that implies a more upward sloping curve, which should help us in our trajectory going forward as well. So those are the two pieces that I would point to.

Betsy Graseck (Managing Director)

Right. And the 30% and 50%, that's on total IB deposits or total deposits, what's your denominator?

John Stern (CFO)

Total IB.

Betsy Graseck (Managing Director)

Got it.

John Stern (CFO)

Total interest-bearing deposits. Yep.

Betsy Graseck (Managing Director)

Yeah. Super. Thanks so much.

John Stern (CFO)

You bet. Betsy.

Operator (participant)

Your next question comes from Erika Najarian from UBS. Your line is now open.

Erika Najarian (Managing Director)

Hi, good morning. Just a few follow-up questions. First, on John's previous question

Gunjan Kedia (President)

Sorry, Erika, can you just, we're having a hard time hearing you.

Erika Najarian (Managing Director)

Can you hear me better now?

Andy Cecere (CEO)

Yeah, that's better. Thank you.

Erika Najarian (Managing Director)

Okay. Sorry about that. Just wanted to follow up on John's question. You mentioned 10 billion of notional was sold. Could you, so that we can understand the impact for fourth quarter, could you tell us what the average yield was of what was sold and what you invested in? And just to follow up to Betsy's line of questioning, you said that you, you know, saw a 30% beta, and the terminal would be north of 50%. As we think about the fourth quarter, is it a sort of a smooth glide path, you know, to that 50%? Do you expect it to significantly accelerate from that 30% initial beta?

John Stern (CFO)

Sure. So, maybe I'll just take those in pieces. The first one on the, on the securities book. You know, I think it was just an opportunity there to remix in a couple different things, and it was really there to improve our liquidity profile, as well as, you know, some lower-yielding securities that have seasoned to reposition those. So it's just a number of different securities, so it's hard to just summarize it in one thing. But I would just say, on the beta side of things, you know, 30% or so terminal beta, I think that just is a gradual increase as we look forward.

The reason for that is, you know, on the institutional side, you're going to get that benefit on each cut. On the retail side, you're going to get that benefit. It's kind of, as I mentioned in the past, kind of an arc to the retail pricing sort of thing. And so as CDs reprice and as the money market rates come down on retail, that's going to be kind of that glide path into the 50% terminal that I spoke to earlier.

Andy Cecere (CEO)

And John, all of that, all that you said, which is spot on, is all baked into your flat or stable net interest income projection for quarter four.

John Stern (CFO)

That's exactly right. Yep.

Erika Najarian (Managing Director)

Got it. And my second question is for you, Andy, and this is sort of a broader question. You know, you hosted a very comprehensive Investor Day, and I think the investor reception, at least as it followed through to the stock, was probably less than desired. And as I think about the feedback from investors, I'm wondering if you could sort of readdress this on this call. You know, you seem determined, and you have showed us positive operating leverage. Maybe some quick notes on 2025. You know, the comments on the Southeast expansion was also hit on as a potential negative. And the third would be, you know, you're now in a place where you're building capital. Loan growth hasn't yet come back. You know, what would allow you to be a little bit more aggressive, more quickly on acting on that $5 billion authority?

Andy Cecere (CEO)

So I'll take them in pieces, Erika. So first of all, I, I thought the team did a terrific job articulating the strategy in Investor Day, and part of that strategy was the inflection point discussion we talked about, which is controlled expenses, delivering on operating leverage, and stronger revenue growth, given the interconnectedness of the businesses, and we're hitting on all those. And I think part of what the analyst community and investor community wants is, is examples and, and execution, and this quarter started that execution. And as I said, on operating leverage, we expect that to expand into the fourth quarter and into 2025, so we're going to deliver on that. Secondly, with regard to the M&A environment, you know, given this environment, large bank M&A is just not a priority for us. That's not something we're focused on.

What we are focused on is organic growth and the components that Gunjan talked about, and I'm going to ask her to just highlight some of those key aspects of that right now.

Gunjan Kedia (President)

Good morning, Erika. As we shared in, during the Investor Day, we do have very meaningful organic growth opportunities in our portfolio, and as Andy said, our attention is very much on executing against those priorities, deepening our client relationships, enhancing our product interconnectivity, and broadening our reach. We are very focused on delivering meaningful, positive operating leverage and the execution that goes with it. We have optimized our distribution via investments in our digital capabilities, and our Southeast expansion is very much focused on our partnerships and our digital capabilities. Thank you.

Andy Cecere (CEO)

Thanks, Gunjan. And then finally, on your last question with regard to capital, Erika, as you know, we as we talked about and as John articulated in his comments, we would expect to go to some level of modest buybacks here shortly. And then we would expect to build upon that once we have more clarity on Basel III and some of the capital rules. And then loan growth, as you talked about, is a key factor as well. But given all that, we would still expect to be up at our capital targets, even under the Cat 2 when we've crossed that threshold, which again, as a reminder, we talked about, is not expected till 2027.

Erika Najarian (Managing Director)

I guess just to follow up on that, the Basel III shouldn't impact you that much, right? Other than and everybody's already put in the impact of AOCI, actually more immediately than whatever phase in Basel III Endgame has. I guess I'm wondering, you know, as a regional bank, are you, you know, do you think it's just a, you're just a prudent constituent in terms of not wanting to be aggressive ahead of, you know, a new set of revisions? Or, you know, are you also considering, like, the ratings agencies? Just sort of wondering, you know, what the, and I completely understand that you're about to buy back in the first quarter, but I think that it's probably, you know, an important component of long-only investors starting to, you know, increase their position in U.S. Bank.

Andy Cecere (CEO)

Yeah, all those constituencies you talked about are factors in our thinking. You know, loan growth, the final capital rules, the rating agencies, those are all factors. But we're very confident in our accretion ability. As you saw this quarter, 20 basis points. We've articulated 20 to 25. We're very comfortable with our capital position, and we're very comfortable with the ability to start to buy back and distribute, as well as accrete, the level of which we'll continue to determine and judge over time, given all those factors you talked about.

Erika Najarian (Managing Director)

Thank you, Andy.

Andy Cecere (CEO)

You bet, Erika. See ya.

Operator (participant)

Your next question comes from Mike Mayo from Wells Fargo Securities. Your line is now open.

Andy Cecere (CEO)

Morning, Mike.

Mike Mayo (Managing Director)

Hi. First, Hey, good morning. First, a cleanup question. So are you interested in buying a bank in the Southeast? Because that got a lot of play, just following up to the prior question.

Andy Cecere (CEO)

No.

Mike Mayo (Managing Director)

Not even a small bank?

Andy Cecere (CEO)

Mike, the environment right now is just not conducive. There's too much uncertainty for M&A, and I don't want to, you know, focus all our efforts on that when we have so much opportunity on the organic growth front, so in this role, what you do is prioritize against the opportunity set that you have in front of you, and our organic growth opportunities are far more important and much more tangible to us right now, and as you know, Mike, the M&A environment is just so uncertain right now that would not be a good place to focus our efforts.

Mike Mayo (Managing Director)

Okay, so my main question here goes back to the operating leverage, which is, how much of this is expenses versus revenues? And on the expense side, you know, your investments for the last three, five more years, it's all in the run rate, as you said at Investor Day. And, you know, how much benefit do you get from being a scale player? Because some smaller banks say they can just buy a lot of these things off the shelf and compete with the likes of U.S. Bancorp. So that's the expense question. And then the revenue question is, Gunjan, I know you're leading the go-to-market strategy. Kind of what stage is that go-to-market strategy in? Are we seeing the results now, or do we expect to see more of that in the results ahead? Thanks.

Andy Cecere (CEO)

So Mike, I'll start, and then Gunjan will add on. I think to answer your question, I would think about it on both components. I think it's going to be both increased revenue growth and managed expenses. So as we talked about, we were flattish this time. We might have some modest increases as we go into next year, but we're not going to have expenses growing above revenue levels, and I would expect growing revenue and those jaws widening from the expense revenue differential. The revenue will be driven by the activities that Gunjan's focused on, and I'll let her comment.

Gunjan Kedia (President)

Good morning, Mike. The go-to-market is in its third and final year of our transformation, so we are beginning to see the results in some of the areas, like the consumer deposit. We've built out a lot of capabilities to manage deposit pricing. We benefited from that in this downgrade cycle. We are seeing a lot of momentum with our multi-serve clients and deepening our relationships on the institutional side. We saw that with the capital markets growth over this quarter. So the impact of a good, scaled business model is delivering good, positive operating leverage, including expense management. So this is what we would continue to focus on from an organic growth standpoint.

Mike Mayo (Managing Director)

All right. Thank you.

Andy Cecere (CEO)

Thanks, Mike.

Operator (participant)

Your next question comes from Gerard Cassidy from RBC Capital Markets. Your line is now open.

Andy Cecere (CEO)

Morning, Gerard.

John Stern (CFO)

Morning, Gerard.

Gerard Cassidy (Managing Director)

Hi, Andy. Hi, John. John, on the deposits, on the deposit pricing, I can you share with us, the loan-to-deposit ratios for the industry and yourselves are not as high as in previous cycles. Do you think that can give you added flexibility in lowering the costs, aside from obviously, you talked about the institutional deposits that are essentially, I think, index priced, so they come down quickly. But in the other deposit classes, do you think you're going to have some leverage to lower those rates because, you know, the loan-to-deposit ratio is not at 90% or something like that?

John Stern (CFO)

Sure, Gerard. So I would say that we don't target necessarily loan-to-deposit ratios. You know, what we look at is holistically just overall serving of our clients, making sure we have the right mix of deposits and loans. And, you know, loan growth is obviously going to be a driver, or not, of deposits and where they're at. This quarter, loans were flat to down just slightly, and so we took this opportunity to bring down some deposits that were at a higher cost side, and you saw that in the results here. And so if that continues, I would continue to expect that. On conversely, if loan growth continues to take up, we're going to be making sure that we have the deposit base to suffice that.

You know, the other thing we always try to manage around that is our liquidity needs as well as interest rate risk, profile as well. So it's kind of more of a holistic nature as it relates to that.

Gerard Cassidy (Managing Director)

Very good. And then, for Andy or Gunjan, on the organic growth strategy, some of your peers, the bigger banks in particular, have embarked upon a branch build-out across the country. Even, you know, a few, one or two regional banks have done this as well. Can you share with us, as part of your organic strategy, how do you guys view new branches into maybe newer territories, combined with your ongoing digital outreach that of course you have?

Gunjan Kedia (President)

Good morning, Gerard. Maybe I'll start here. So first, the branches are very critical to our business strategy. We see deep client relationships are anchored around the branch. It really drives brand recognition, and we are very steady in investing in our branch network. Our strategy focus is to create density in the highest growth areas within our current footprint rather than use branches to expand out of our footprint. And the reason for that is that we have built some very good, strong digital capabilities that allow us to deliver our services nationally, and we are combining that with our very, strong partnerships with other partners that have brand recognition and client reach in areas where we don't have. It's a powerful combination. It's a capital-light way of expanding into other markets. Second is our national businesses from the institutional side.

There, we are actually growing client centers in areas where we are not to expand our reach. So you'll see us continue to invest in our branch network, both inside, digitally enabling them, but within our current footprint.

Gerard Cassidy (Managing Director)

Very good. Thank you.

Andy Cecere (CEO)

Thanks, Gerard.

Operator (participant)

Your next question comes from Vivek Juneja from JPMorgan. Your line is now open.

Vivek Juneja (Managing Director)

Hi. Thanks for taking my questions. Just wanted to understand on payments and delve a little bit into that. You talked last quarter about corporate payments will be lapping this quarter because your tough comps with your trucking related fees last year, but we didn't really see the benefit of that lap in this quarter. So anything there that has caused it to be delayed? Nor have we seen really merchant payments pick up in terms of year-on-year fee growth. So any color on what's going on and why the delay, and what gives you confidence that it'll actually materialize in the coming quarters?

John Stern (CFO)

Sure. So, Vivek, I would start by saying that I think there was still a little aftermath here on the freight side in the third quarter, but we expect that to completely lap here in the fourth quarter. And then we do see corporate spend being stronger. We saw some nice momentum at the end of the third quarter and into the fourth quarter, and that's what's really giving us the confidence that that will grow from the level that you saw in this quarter's results from a corporate payments perspective.

Gunjan Kedia (President)

Maybe, John, I'll add. Good morning, Vivek. Just a little point on the long-term expectation for payments. You know, where payments in is in the mix with the client relationship, it creates really sticky, enduring relationships. We do see good core growth in many of the categories of payments. They are partially offset by some unique items. Freight is one of them, which was very disrupted post-COVID and just is beginning to normalize, and there are some others as well. So the long-term confidence question that you asked is, we look at the client value, and we look at the core dynamics, and you'll see that continue to improve over time.

Vivek Juneja (Managing Director)

Thanks for that. I have another follow-up for John. John, your comment earlier in response to a question just piqued my interest. You said expenses were up because net interest income was up. Is there incentive comp tied to growing net interest income, or is there something else that would drive expenses up when you get net interest income up? That's not really, you know, any color on that?

John Stern (CFO)

Yeah, Vivek. No, there's no linkage. What I was getting at is we're in the fourth quarter, we have a very good line of sight in what our expense level. So we're just being more precise really with it. I was comparing that to our net interest income that has gone up higher and is in the higher end of our range. I was just making a comparison. There's no linkage from a compensation perspective, in that sense. So we're just being more precise, is the short answer.

Vivek Juneja (Managing Director)

Okay. Thank you.

Operator (participant)

Your next question comes from Ebrahim Poonawala from Bank of America. Your line is now open.

Andy Cecere (CEO)

Morning, Ebrahim.

Ebrahim Poonawala (Managing Director)

Morning, Andy. I guess one question maybe first on fees, and I appreciate you're not talking about 2025 right now. But just talk to us in terms of the linkage of the fee momentum accelerating from this mid-single digits into next year, and how much of that is dependent on loan growth picking up? Or how much of that can happen where even if loan growth or loan demand is fairly muted in the first half, we see better fee revenue momentum being a differentiator for USB?

John Stern (CFO)

Sure. You know, from a, you know, from Investor Day, we talked about, you know, mid-single digits being in terms of our, our range from a financial metric performance. And I think, you know, what you saw this, this quarter, is a good example of that, particularly look at commercial products, you know, which, has benefited, of course, from, loan growth, being done more in the capital market space. We see that benefit in our businesses. But we've also grown and have new products, new capabilities in that space. Mortgages is continuing to see nice growth, as that has gone.

The service charges, you know, has, is, will start to lap the ATM exiting business as we think about that starting in 2025. Corporate trust continues to be just a very strong growth rates, and that is tied in part to the markets, of course, and so as that continues to develop, we have good momentum there, and Gunjan just talked about the payments side of the house, and so I think all those things put together really gives us a lot of confidence in terms of that mid-single digit growth that we think of it from a medium-term standpoint.

Gunjan Kedia (President)

Ebrahim, I would just add that we do have a very beautifully diversified fee mix. So right now, we are seeing a lot of growth in capital markets, and to some extent that's impacting loan growth. But our capital markets businesses are very strong otherwise too. Wealth is seeing a very good year because the stock markets are very strong. Our investment services businesses benefit from that. And then as the rate environment changes, we would expect mortgage to have sort of momentum. So really, as we go into the next year, it isn't any one thing, but it's the diversified mix because they play off of each other depending on different macroeconomic environments.

Ebrahim Poonawala (Managing Director)

That's helpful. And I guess one follow-up, John. When I look at the seven basis points NIM expansion, I think you mentioned $10 million lift from the bond book restructuring. That's probably a basis point. Should we expect this seven basis point expansion as getting better as we move forward with a couple more rate cuts this year, the back book repricing? Like, how should we think about the cadence of the NIM from your perspective, any kind of bond restructuring actions? And is it conceivable that we could be at a 3% NIM in the back half of next year?

John Stern (CFO)

Sure, so I maybe just to go off of a couple of those points. You know, from a net interest income standpoint, in the fourth quarter, we expected to have relative stability, and that's just thinking about, you know, our earning assets are going to be relatively flat, we expect, and our asset repricing and liability repricing are going to be largely offsetting, so that's kind of how we think about the stability component in the fourth quarter. Beyond that, all the positive momentum that I've talked about in terms of continuing remixing in terms of our assets into higher return parts of the portfolio, our ability to reprice on deposits, as I mentioned, on the institutional side, and then ultimately on the retail side.

And then our deposit rotation, as you have observed, is slowing down and for all intents and purposes complete. And so that's all conducive to growth and continued expansion. I can't put a time frame on when exactly the 3% occurs, but that's a good level to think about, and it's obviously embedded within our medium-term guidance that we provided to you during Investor Day.

Ebrahim Poonawala (Managing Director)

One last one. I guess maybe, Andy, I think you mentioned, and you mentioned this on the Investor Day on the 2027 crossing of the Cat 2 becoming a Cat 2 bank. Is that, in any which way, a constraint as you think about pursuing loan growth? Like, with, is there any reason to believe USB is disadvantaged on pursuing loan growth next year because you're kind of, you have an eye on the $700 billion asset number? Just address this, that, if you don't mind.

Andy Cecere (CEO)

No, there's no constraint on our loan growth. The loan growth activity right now is more a function of demand and consistent with the market overall and the H.8 data that you're seeing, and we have no constraints on loan growth. And again, as a reminder, Ebrahim, you know, the way it works is you are at that $700 billion for four quarters on average. So when we think about 2027, that's four quarters of impact, so we have no constraints on our assets or our balance sheet.

John Stern (CFO)

We would expect that our growth will be in line with the industry. So I mean.

Andy Cecere (CEO)

Which is GDP, GDP plus.

John Stern (CFO)

Yep, exactly.

Ebrahim Poonawala (Managing Director)

Got it. All very clear. Thank you so much.

Andy Cecere (CEO)

Thank you.

Operator (participant)

Your next question comes from Matt O'Connor, from Deutsche Bank. Your line is now open.

Andy Cecere (CEO)

Morning, Matt.

Matthew O'Connor (Managing Director)

Good morning. I think you guys announced that you are looking for a new payments head, and we're looking externally, and we're just wondering if you could update us on if there's any updates on that. And then I guess, you know, what type of person are you looking for, and is it to kind of continue the strategy that you've had or, you know, potentially reevaluate some areas? I think there's the general view that, you know, maybe you could do more with payments, given what the, you know, revenue pool out there is overall, and that you kind of under punched a little bit. So I don't know if you would agree with that, but, you know, what's the thought in terms of what you're looking for in the new leadership? Thank you.

Gunjan Kedia (President)

Matt, good morning, it's Gunjan, and we are indeed excited to be out in the market looking for new leadership for payments. We have a lot of interest in our franchise. It's unique, it's different, it's very important for us, and we do have big aspirations for not just a standalone sort of payments franchise, but how much it embeds and integrates with the everyday lives of our customers. So with that, we are looking for someone who is talented from a payments perspective, but culturally embraces this concept of an interconnected set of solutions for our client base. And and that's what we are looking for. And as just to reiterate what we shared, we have a long transition time.

Very grateful that, Shailesh has given us, you know, enough time to plan a very smooth and careful transition.

Matthew O'Connor (Managing Director)

And I guess just from a strategic point of view, and this isn't really trying to lead you one way or the other, but, like, are you set on kind of the long-term strategic path that you have in payments? Or are you open to, you know, potentially, you know, fairly decent-sized changes, you know, one way or the other? Again, not really a leading question, but it seems like it might be an opportunity to take a fresh look and look for some opportunities that maybe you haven't before.

Gunjan Kedia (President)

Thank you, Matt. You know, we have deep conviction around the strategy and the path that we are on today. When you meet clients and you see the impact of the payments product sets on the relationships we have, you sort of build that conviction. So the question that we are focused on is how do you execute perhaps differently? How do you accelerate the execution? How do you stay current with the digital capabilities? And all of the strategies that we shared with you on Investor Day are really focused on accelerating the how, rather than sort of rethinking our strategy, where we do have a lot of conviction that payments becomes the center point of how people manage their day-to-day lives, and it needs to be embedded in every product, every relationship that we have.

Matthew O'Connor (Managing Director)

Okay, that's helpful. Thank you.

Andy Cecere (CEO)

Thanks, Matt.

Operator (participant)

Again, if you'd like to ask a question, press star and the number one on your telephone keypad. Your next question comes from Mike Mayo from Wells Fargo Securities. Your line is now open.

Mike Mayo (Managing Director)

Hi, just to follow up to my earlier question, related to the benefits of scale and specifically AI. Do you look to be an AI leader or a close follower, or do you think you can get those tools off the shelf, and you'll just kind of wait and see in the context of the benefits of scale, again, after your years of investing?

Andy Cecere (CEO)

Yeah, Mike. So you know, we, as you know, we do have scale. We invest $2.5 billion a year in technology and technology initiatives. We did a great job with the digital capabilities. We highlighted those at Investor Day, and we're following that same model with the AI initiatives, which is a center of excellence and then the business lines surrounding them in terms of use cases. As we talked about, we have a number of use cases underway. I would say, you know, on traditional AI, we've been doing it for a while. Generative AI is in the early innings, and what is important is we have a structure, expertise, leadership, and technology to deliver on it, but it is early innings.

Mike Mayo (Managing Director)

Okay. And just one cleanup from Investor Day as it relates to the digital strategy. I mean, going through State Farm, it's just, just one, one more time, and spent the whole day with management in New York City, and, more information always better. But the idea of going out of market, where you don't have too much branches and going through State Farm with the digital strategy, it's just, are there other examples of banks or non-banks that have succeeded with that sort of approach? It's just, we've heard a lot of those stories over the last 20 years, and they haven't always played out so well. Eventually, you have to build more branches than you expected or something. So again, that's just a little bit of cleanup from Investor Day.

Andy Cecere (CEO)

Yeah, I'm going to start.

Mike Mayo (Managing Director)

That's the strategy, yeah.

Andy Cecere (CEO)

Yeah, I think, I think to, for the strategy to work, I think you have to have a couple of key components. One is the, the digital capabilities to allow it to work with the, with the other partner. The second is a partner who has the need from a banking product standpoint for their customer base, and then, alignment in terms of how that gets done. And I think both with State Farm and certainly with Edward Jones, those pieces are in place, and we've seen good results on that. So opening up core banking products, checking accounts, savings accounts, outside of our market through that partnership, we, we have strong conviction on, and we believe it will be successful because of those attributes. Gunjan, what would you add?

Gunjan Kedia (President)

Andy, I would add, Mike, that you know, we have been in this partnership business for some time now. We have a very strong franchise called Elan, which is a white label credit card provider to other banks. So it does take a unique skill set to make these partnerships work, and many of these partnerships are restricted in terms of the number of products we are providing. So to your point, there might come a time when you think about expanding. For example, Charlotte was a market where we organically expanded, and we are building out branches there. For core product sets and having put in place both the digital and the operational capabilities to fulfill servicing needs for people outside, we've become very good at it, so we are expanding it now with Edward Jones.

And as Andy said, you know, good early successes and good momentum as a starting point to get your name and your brand in areas that we are not in today.

Mike Mayo (Managing Director)

Thank you.

Andy Cecere (CEO)

Thanks, Mike.

Operator (participant)

There are no further questions at this time. Mr. Andersen, I turn the call back over to you.

George Andersen (SVP, Director of Investor Relations)

Thank you, and thanks to everyone who joined our call this morning. Please contact the investor relations department if you have any follow-up questions. Ellie, you may now disconnect the call.

Operator (participant)

Thank you. This concludes today's conference call. You may now disconnect.