BankDirector.com: Charting a course for America's banking leaders

BankDirector Cover

Magazine : Archives : 2nd Quarter 2011

Fast Break

June 3rd, 2011 |

Richard Davis took the helm of U.S. Bancorp at the end of 2006, just before the first winds of a devastating credit storm began to kick up. At the time, the Minneapolis-based banking company was viewed as boring and conservative—a place that was profitable enough, but under former Chairman and Chief Executive Officer Jerry Grundhofer pinched too many pennies and had, to the wonderment of many, all but sat out one of the biggest booms in U.S. financial history.

Davis, Grundhofer’s long-time lieutenant, had something a little more aggressive in mind. A big sports fan, he employed a cross-sports metaphor to help convince his 13-member board to sacrifice some of USB’s industry-leading efficiency and invest more in the technology and infrastructure needed to put the pedal to the metal on revenue growth.

“I told the board we were a great football team. We had a better defense than anyone. Nobody ever scored on us, but we didn’t score a lot either. There were a lot of 0-0 ties,” he recalls. Davis wanted to change USB into more of a basketball team. “I told them we needed to play both offense and defense. The coaches and players needed to be able to execute all the plays on both ends, and that required some investment. … I felt it was non-negotiable.”

Directors embraced Davis’s vision then—and have continued to back it in the teeth of those crisis-driven headwinds. Since the beginning of 2008, the board has signed off on more than $2.1 billion in technology and infrastructure improvements—a 60 percent increase from three years before that.

Those investments have brought a badly needed upgrade to a 20-year-old “green screen” branch teller system, new Internet and mobile applications, a state-of-the-art “Tier 4” data center and a cutting-edge mortgage-origination platform, among other technological improvements.

The company has established more people-oriented initiatives aimed at growing organic revenues, such as a 15-member “enterprise revenue office,” which serves as a central clearinghouse for employee-generated ideas to deepen customer relationships and boost cross-selling numbers.

USB also has opportunistically deployed some of its capital on acquisitions of five failed banks from the Federal Deposit Insurance Corp.—the most of any bank during the crisis—bolstering market share and branch coverage in key markets, such as Chicago and Southern California (where it now ranks third in deposits). In January, it acquired First Community Bank of Taos, New Mexico, giving it $2.3 billion in assets, $1.9 billion of deposits and a No. 3 market share in a state where it had no presence before.

Davis’s approach to investments “was a pretty significant difference from what we were used to,” says David O’Maley, 64, executive chairman and former chairman and CEO of Ohio National Financial Services, a Cincinnati insurer. “But Richard saw some opportunities and had the right management philosophy and temperament to capitalize on them.”

The capital-spending plan was hatched in a different era, before the collapse of the housing bubble, ensuing credit meltdown and recession. The fact it has continued without missing a beat is but one sign that USB is living in the Lake Wobegon of banking—a parallel universe where deposit growth is strong, the loan book is relatively good looking and earnings are well above average.

While some might question the wisdom of tinkering with aformula that both allowed USB to regularly generate 20 percent-plus returns on equity before the crisis, and to survive the event itself in better-than-normal shape, the timing of the offensive thrust couldn’t have been better. 

“When the downturn hit and we discovered the relative strength of this company, it allowed us to accelerate those investments with confidence … and reinvent ourselves as an offensive player,” Davis says.

To be sure, there are challenges. These are tricky times for any bank leadership team, let alone one that’s intent on growth. Unemployment remains higher than anyone would like, restraining loan demand, while many banks continue to struggle with credit quality issues. A heavy regulatory crackdown on fees and higher capital requirements promise to make the task of generating profits more trying for the foreseeable future.

Even so, it’s difficult to dispute USB’s relative results or momentum. The company earned $3.3 billion in 2010 and is one of a small handful of large banks, along with Pittsburgh-based PNC Financial Services Group and JPMorgan Chase & Co. in New York, to report profits in each quarter of the crisis. In the fourth quarter alone, the company earned $974 million, or 49 cents per share—up 62 percent from a year earlier, and about 10 percent higher than most analysts predicted.

Returns on common equity (13.7 percent) and assets (1.31 percent) both ranked best among a group of 11 large regional bank peers, including PNC, tracked by SNL Financial, while the company’s capital position keeps getting stronger. USB was among the first banks to buy its way out of the Troubled Asset Relief Program, paying back $6.6 billion to the U.S. Treasury Department in June 2009. At the end of 2010, its Tier 1 capital ratio was 10.5 percent, while Tier 1 common equity stood at 7.8 percent—both well above industry averages.

The bank also announced in late March that after passing a second round of stress tests, it has received Federal Reserve approval to increase its annual dividend 150 percent to 50 cents.

Analysts say that USB, circa 2011, is about as well oiled of a banking machine as there is. “They’re arguably the best company in the industry at this point, from a business model, earnings momentum and management perspective,” says Scott Siefers, who follows the company for Sandler O’Neill + Partners. Siefers projects USB will earn $2.19 per share this year, a 26 percent jump over 2010 levels.

Surviving the industry’s troubles in relatively good shape has, itself, become something of a calling card for organic growth. Americans are doing more homework on banks nowadays, analysts say, weighing an institution’s health as much as pricing or convenience.

“Not stepping into the same potholes as most competitors has allowed (USB) to meaningfully enhance its brand and take advantage of a flight-to-quality” among jittery customers, says David George, an analyst with Robert W. Baird & Co. “Reputation matters now more than it used to.”

USB has leveraged that reputation to capitalize on the crisis fallout better than most any other bank. A top 10 player heading into the crisis, USB has emerged as a true powerhouse, with 17 million banking customers in 25 states in the Midwest and West. It ranks No. 5 among the nation’s banks in assets ($308 billion) and market capitalization ($51 billion).

Deposits have ballooned by nearly 50 percent over the past three years, to $190 billion from $130 billion—the increase split about 50-50 between failed-bank acquisitions and organic growth. And while clients haven’t been borrowing like they used to, USB also has managed to grow total loans by 28 percent over the past three years—a testament, officials say, to its balance sheet strength and Davis’ offensive thrust.

Even more impressive is that despite all the crisis fallout, net revenues jumped 7.9 percent in the fourth quarter versus a year earlier. “We’re coming out of this downturn as a much stronger bank, in both relative and absolute terms, than we were three years ago,” says Andy Cecere, USB’s chief financial officer. “We have more loans, more deposits, more customers—both wholesale and retail—greater market share, more employees, more capabilities, a better platform and technology. …Very few banks are able to say that.”

No one seems to be benefiting from USB’s enhanced status more than its CEO. The son of a truck-driver dad and secretary mom in the working class Hacienda Heights section of Los Angeles, Davis landed a job as a teller at the old Security Pacific National Bank on his 18th birthday, and never looked back.

By age 21, Davis was married to his high school sweetheart, Theresa, attending night school at California State University, Fullerton, and managing his own branch. “I did things totally backwards—got a job first, then got married and had kids, and then got my degree,” he says.

In 1987, Grundhofer arrived at SecPac from San Francisco-based Wells Fargo & Co. to head up all of retail banking. The two hit it off, and Davis, then 30, was put in charge of a portfolio of retail banking activities, including marketing, human resources, fraud prevention and corporate culture.

Grundhofer left in 1993, and two years later became CEO of Cincinnati-based Star Banc, a $6–billion-asset company that had recently survived a hostile takeover attempt by crosstown rival Fifth Third Bancorp. Grundhofer recruited Davis to run his consumer bank. A short while later, Star commenced a Midwest acquisition spree—Milwaukee’s old Firstar Corp. and Mercantile Bancorp of St. Louis were among the victims—before buying USB in 2000 and taking both its target’s name and Minneapolis headquarters.

When Grundhofer retired in 2006, board members didn’t have to look far for their next leader. “Richard was a known commodity,” recalls O’Maley, the director. “There wasn’t a period of needing to read the tea leaves with a new person. The board was inclined to follow Richard’s lead, and we’ve been rewarded for that.”

Whip-smart and with a penchant for using 50-cent words, the wiry Davis was active in industry issues and trade groups before becoming CEO. USB’s performance in recent years clearly has elevated his profile. As the elected chairman of the Washington, D.C.-based Financial Services Roundtable in 2010, Davis emerged as a point man on making the industry’s case in Washington.

He’s visited with President Obama several times, met regularly with the likes of FDIC Chairman Sheila Bair and Treasury Secretary Timothy Geithner, and become a confidante of key decision-makers. “When (Federal Reserve Chairman) Ben Bernanke is looking for a view from our industry, he calls Richard Davis,” says Steve Bartlett, the Roundtable’s C.E.O.

Davis has used this access and his formidable persuasiveness to become one of the industry’s most influential leaders. He’s urged patience with Obama as the president criticized banks early in his term, and convinced the leadership of the Roundtable—a group of 100 large financial services companies—to embrace Washington’s reform effort. “That was hard, because there were a lot of elements of (reform) that we didn’t like,” Bartlett recalls. Davis’ argument: “We couldn’t pretend that there hadn’t been a crisis, or that banks weren’t at the center of it.”

He’s also prodded bankers to stand up for themselves with the public. After a key 2009 meeting between the president and a dozen big-bank CEOs, Davis convinced several colleagues to join him in making the industry’s case to reporters on the west lawn of the White House. He then took the lead, standing in the cold for 2 1/2 hours until every reporter’s questions had been answered.

“It was a courageous moment, one that actually turned the industry,” Bartlett says. “Big bank CEOs were notorious for not commenting on public policy issues. Richard brought a new willingness to speak the truth publicly and candidly. From that moment, other CEOs became more willing to have those kinds of discussions with the media.”

Davis has reached out to his own employees in much the same way. Less obvious than the big spending on technology and acquisitions have been investments in new hires and employee engagement—measuring things like workers’ happiness and sense of well-being, which Davis and many other CEOs believe improve performance.


Davis holds an annual all-employee meeting via television and phone to update workers on the company’s position, and powwows with USB’s top 200 leaders in a Q&A session once every six weeks. He also hosts regular “town hall” meetings when visiting local markets, and answers employee queries through a weekly “Ask the CEO” column on the company’s intranet.

USB also has added leadership training and other educational programs, and boosted incentive compensation tied to individual and business unit performance. “Morale is extraordinarily high,” says Richard Hartnack, head of the retail bank. “Part of it is that the company is doing well. But it’s also that our boss spends a lot of time making sure employees are engaged and understand the mission and their roles in helping achieve it.”

That USB has had the time and money to spend on fine-tuning revenue initiatives, as opposed to putting out balance-sheet fires, is due mostly to a unique business model that allowed it to avoid blindly chasing credit risk during the boom times of the mid-2000s.

In addition to retail and wholesale banking, the company is a global titan in payment services, which includes both commercial and individual credit cards and merchant processing. The subsidiary, Elavon, generated 27.3 percent of USB’s earnings in the fourth quarter—most of it in processing fees—and boasts growing operations in Europe. In 2010, it entered joint ventures in Mexico and Brazil, and is presently negotiating another in India, and acquired several card portfolios from struggling banks.

The company is also a national player in corporate and institutional trust. The business requires a lot of infrastructure, meaning the barriers to entry are high. A November acquisition of Merrill Lynch & Co.’s corporate trust business from Charlotte-based Bank of America Corp. eliminates another rival and gives it a 15 percent market share beachhead in Western Europe.

Earnings from those non-bank businesses, neither of them big capital eaters, have allowed USB to be relatively conservative on the lending side. Diversified by geography and type, with only small pockets of subprime mortgages and other riskier loans, its balance sheet has been insulated from the worst of the industry’s credit woes. Non-performing loans and real estate owned peaked at 3.02 percent of loans in the fourth quarter of 2009, and have dropped since, to 2.55 percent in the fourth quarter of 2010.

Net charge-offs have declined steadily over the same period. Though the company still wrote off $937 million in loans in the fourth quarter, that was 16 percent lower than a year earlier. “They’ve called a turn in credit,” Siefers says. “People are waiting for them to draw down their reserve, (which stood at $5.5 billion at the end of the year), but they are being conservative.”

And while all that investment spending helped push up USB’s non–interest expense 13.3 percent in 2010, its efficiency ratio–a measure of expenses as a percentage of operating revenues—remains lowest in its large bank peer group, at 51.73 percent. “Efficiency is too deeply ingrained in the culture for it to be lost,” Davis says.
To thrive in this post-crisis environment, Davis says USB must adapt quickly to changes in customer behaviors and expectations. People want to be smarter with their money, he says, so the company must devote more attention to “teaching people how to save, … and being good stewards of their money,” and less to pushing loans.

“There’s not a lot of lending right now, so we’d better be good at the other side of the balance sheet,” Davis explains. “Banks have never really practiced that.”

It also must be light-footed in addressing the impact of Washington’s regulatory crackdown. Cecere expects USB to lose more than $1.1 billion of its $17 billion in annual revenues from just three regulatory mandates: Regulation E, which imposes limits on overdraft charges and requires customers to opt-in for protection; the CARD Act, which caps some credit card rates and fees; and the Federal Reserve’s proposed 12 cent-per-transaction cap on the interchange fees banks can charge merchants for processing debit-card transactions, in compliance with the Durbin Amendment of the Dodd-Frank Act.

Like many banks, the company is responding to the changes with new account pricing schemes. Officials won’t disclose how many customers have opted-in to overdraft protection, but say it’s higher than most other banks. According to a study by Moebs Research in Lake Bluff, Illinois, more than 75 percent of checking account customers in the country have signed up for overdraft protection.

In return, USB has eased off on fees for small overdrafts, and won’t charge at all for very small ones. “We’ve gotten rid of the iconic $32 cup of coffee,” Hartnack says, referring to charges for overdrawing an account by a couple dollars. “If you have an overdraft for a coffee at Starbucks at our bank, it’s free.”

The threat to interchange revenue poses a much greater challenge to overcome. Davis initially said he would wait and see how things played out. When the Federal Reserve announced its 12-cent limit on debit interchange, however, he joined a chorus of bank CEOs who attacked the potential effects during the January earnings call season.
The chief complaint, echoed by bankers everywhere, is that the price point is arbitrary and unrealistic. “Twelve cents per transaction is less than our cost,” Cecere says. “So in order to have a sustainable model, we’re going to need to change our product features and pricing.” As this story went to press, the new price ceiling was still on track, but encountering more opposition in Congress.

Davis thinks he can recoup about half of that $1.1 billion in lost revenue by tweaking the company’s product offerings. Free checking, for instance, will only be available to customers with high balances or enough other products to justify it. But he also argues the prospects for well-run banks aren’t as gloomy as some pundits have asserted, because remaining revenues will be more stable.

“We’re not going to find a way to claw back $1 billion. … The goal was to give some of that back to customers, at the expense of shareholders,” Davis explains. Earnings won’t be as high with the lower revenue tally. “But if the industry is respected at a higher level, … and we no longer have the overhang risk of losing the fees we charge, then our (price-earnings ratio) and share prices could go up,” he adds. “So to a degree I can see this working out.”

That would be welcome news to investors, who also are watching USB’s capital-management plans closely. Pre-crisis, the company returned 80 percent of operating earnings to shareholders, via dividends and share repurchases. Recently, after years of government-mandated dividend cuts and capital hoarding, that payout ratio was about 10 percent. The company’s annual dividend today is 50 cents, compared to $1.70 in 2008.
A few years from now, Davis would like things to return to what once was normal. “We intend to get back to that 80 percent payout.”

Of course, USB also could deploy its capital for a transformational deal—one that would give it a coast-to-coast retail franchise. “Everyone runs the maps and says, wouldn’t it make sense for a company this strong to blanket the entire United States?” Siefers says.

Analysts note that Wells Fargo and PNC both doubled their sizes with megadeals during the crisis by acquiring Wachovia Corp. and National City Corp., respectively. USB made a play for Nat City but Davis allowed himself to be outbid because he didn’t like the pricing, and the bank hasn’t publicly pursued any other large transactions.
It’s still not too late, analysts say. Two troubled regionals—$132-billion-asset Regions Financial Corp. in Birmingham, Alabama, and Atlanta’s $173-billion-asset SunTrust Banks—are considered the most-likely candidates. Davis deflects such questions, while making it clear that size alone doesn’t impress him much.

“I’ll never say it’s out of the question,” he says, “but bigger doesn’t mean better. Better means better.” By that measure, Davis and his team are at the top of the standings. |BD|

Bank Director Staff Writer