Enterprise Man

Richard Davisu00e2u20acu2122s introduction to life at the helm of a big bank hasnu00e2u20acu2122t exactly been welcoming. The 49-year-old Los Angeles native was named CEO of giant U.S. Bancorp in December 2006. Less than two months later, the first signs of a subprime loan crisis emerged. Since then, heu00e2u20acu2122s been crisscrossing the country, reassuring jittery investors about the Minneapolis-based holding companyu00e2u20acu2122s asset quality, while simultaneously trying to jump-start revenue growth in a core banking business beset by stiff competition and a slowing economy.

For all that, $228 billion USB, the nationu00e2u20acu2122s sixth-largest commercial banking company, has fared relatively well. A 14-year company veteran who was former CEO Jerry Grundhoferu00e2u20acu2122s chief lieutenant, Davis has held steady to USBu00e2u20acu2122s traditional strengths. The company gets more revenue from fees than interest, thanks to a big global payments business that grew 9% for the year, and a wealth management business that generated 11% growth. Heu00e2u20acu2122s also stayed the course on lending conservatism, steering clear of large exposures to commercial real estate and subprime home loans.

In the third quarter, per-share earnings ticked up a penny from year-earlier levels, to 67 cents. While USBu00e2u20acu2122s net-interest margin fell 12 basis points, to 3.44%, over that period, nonperformers rose only modestly, to 0.43% of total assets, from 0.4% a year earlier. Returns on both assets (2.09%) and equity (23.3%) were near the top of the industry. u00e2u20acu0153Theyu00e2u20acu2122ve been one of the best performers of 2007,u00e2u20ac says Mark Fitzgibbon, director of research at investment bank Sandler Ou00e2u20acu2122Neill & Partners in New York.

So what is Davisu00e2u20acu2122s reward for what, compared to other big banks, qualifies as superstar performance? USBu00e2u20acu2122s stock hasnu00e2u20acu2122t been hammered quite as hard as most banksu00e2u20acu2122. Indeed, at a recent price of $31, (off just 15% or so from early-year highs), the companyu00e2u20acu2122s shares were trading at about 11.7 times projected 2008 earningsu00e2u20ac”a healthy premium compared to the 8-to-10 range of many key big-bank rivals.

Will having a relatively strong currency make Davis a buyer in a down market? Donu00e2u20acu2122t count on it. Grundhofer and Davis built USB through a series of acquisitions in the late-1990s and early 2000s. Using the old Star Banc in Cincinnati as a platform, the duo raced across the Midwest acquiring big local names like Mercantile Bancorp in St. Louis and Milwaukeeu00e2u20acu2122s Firstar Corp. before buying USB itself in 2001, taking its name and headquarters. Since then, USB has abstained from big bank deals, focusing instead on beefing up its fee businesses and filling in its 24-state retail franchise with the occasional small acquisition that fits a list of predetermined thresholds.

In the past 18 months, USB has done just two small bank dealsu00e2u20ac”United Financial Corp., a $411 million company in Great Falls, Montana, and $724 million Vail Banks Inc. in Avon, Colorado. u00e2u20acu0153Itu00e2u20acu2122s rare to hear a deal from us lately,u00e2u20ac Davis says, u00e2u20acu0153but itu00e2u20acu2122s not for lack of interest.u00e2u20ac

Looking ahead, the high-energy Davis is preparing to devote time to organic-revenue initiatives aimed at reversing a recent slide in deposit market shares in some key states. Heu00e2u20acu2122s also boosted transparencyu00e2u20ac”ditching recorded conference calls in favor of live give-and-take sessions, and communicating early and often with investors about USBu00e2u20acu2122s risk profile and strategies in a difficult market.

Bank Director recently talked with Davis about the challenges confronting the industry and how USB is addressing them, the M&A market, and the boardu00e2u20acu2122s role in achieving strategic objectives. Below is an edited transcript of that conversation.

First, whatu00e2u20acu2122s your take on the present turmoil in the industry?

By the time you print this, itu00e2u20acu2122s likely going to matter not, because things are changing so quickly. What I will say is, this is a market thatu00e2u20acu2122s operating off of fear and uncertainty. Investors arenu00e2u20acu2122t sure who is affected, how far it goes, when it ends, and what to do about it. Financial institutions have not helped those concerns by coming out at different times in different ways to talk about the level of risk they think they bear. Weu00e2u20acu2122re all grappling with the need to be specific and perfect, and the need to telegraph accurate information.

You have made a point of boosting U.S. Bancorpu00e2u20acu2122s transparency in your first year. Why?

I believe transparency is the most important thing in times like these. From a governance perspective, thereu00e2u20acu2122s a risk of [revealing bad news] and having to do it more than once and be embarrassed. But the right approach is to make everything you know available to the Street, and try to take out the uncertainty. There are times when you donu00e2u20acu2122t have to know 100% of everything to let it be known that thereu00e2u20acu2122s a general area of risk. If I were a director, Iu00e2u20acu2122d want to make sure the company isnu00e2u20acu2122t telegraphing information thatu00e2u20acu2122s inaccurate.

Until this cycle, when a banking company came out with a mid-quarter financial updateu00e2u20ac”typically an 8-K between the 10-Qsu00e2u20ac”it would be remarkable and newsworthy, and it would happen only once. But those rules werenu00e2u20acu2122t built for these times. This is a chance for the industry to review its protocols around when do you declare what you know. Weu00e2u20acu2122re learning to think and act differently about transparency in this new, quickly changing environment.

How have you addressed the subprime crisis?

We were the first major bank to come forward [at an analyst conference in early September] and lay out a risk assessment regarding subprime. Just 2.8% of our total loan portfolio is exposed to subprime mortgages. Nine weeks later, I was at an investor conference in New York, and used the exact same slide. When we first introduced it, we wanted to disclose the risk. Today, itu00e2u20acu2122s as much about the fact that our risk hasnu00e2u20acu2122t changed, and that we understand it.

Is that a point of differentiation with investors?

I met for six hours with investors and analysts the other day, and the feedback I received was that our story is quite good. But even if it werenu00e2u20acu2122t good, the idea that itu00e2u20acu2122s being told as quickly and honestly and clearly as possible is important. Our stock is trading on certainty. You might not like the certainty weu00e2u20acu2122re presenting, but at least youu00e2u20acu2122re not trading on an extra variable.

Sixty-one percent of my investors are traditional, value-based investors who are in it for the long haul, and we know theyu00e2u20acu2122re not going to overreact. The trade-off is I treat them with respect and donu00e2u20acu2122t surprise them.

Letu00e2u20acu2122s talk strategy. Like most bankers, youu00e2u20acu2122re trying to drive organic growth. Which initiatives excite you the most?

PowerBank is a big deal. About 500 of our 2,500 branches are in our eight legacy metro markets (where a previously acquired bank had its headquarters). In those markets, weu00e2u20acu2122re striving to be more of everythingu00e2u20ac”more hours, more convenience, higher staffing levels, open on Sundays. Weu00e2u20acu2122re not competing on price; weu00e2u20acu2122re working on being a dominant, preferred banku00e2u20ac”reclaiming our position as the big dog.

Weu00e2u20acu2122re also pursuing more in-store and onsite branch initiatives. We think placing new offices closer to our future customersu00e2u20ac”in grocery stores, retirement centers, work campuses, medical centers, and universitiesu00e2u20ac”will allow us to achieve profit growth at levels approaching 25% annually.

Another area is wealth management, which includes private client banking, private asset management, and our investment and insurance sales. We recently separated wealth management from securities services, and we are focused on creating a brand around what weu00e2u20acu2122ve been doing forever but have never given ourselves much credit for.

And then thereu00e2u20acu2122s our corporate banking growth initiative. Outsiders like to focus on the New York office we recently opened. Beyond that, we hired [former National City Corp. capital markets head] Dick Payne as vice chairman and head of corporate banking. Heu00e2u20acu2122s recruited a very strong core of senior national leaders in corporate banking, derivatives, foreign exchangeu00e2u20ac”activities that are very germane to being a top national bank.

Youu00e2u20acu2122re also doing some behind-the-scenes things to drive growth. Can you talk about those?

We have introduced a corporatewide focus to improve revenue from existing relationships through a new enterprise revenue office (ERO). The ERO is responsible for bringing business lines together to increase the number of products available to our corporate, small business, and consumer clients. A simple example is offering additional credit and payments products to someone who applies for a mortgage. ERO has the resources to put the joint development of sales protocols and processing between those business lines on a fast track. Overall, we believe this effort could generate hundreds of millions of dollars in additional revenue.

Weu00e2u20acu2122ve also begun a high-level new venture group [to grease the funding skids for good ideas]. Take a guy who oversees 335 people selling cash management across the country. He comes in and says, u00e2u20acu0153If I had 10% more people in the right places around our footprint, we could bring in money hand over fist,u00e2u20ac and the people around the table can listen with the whole banku00e2u20acu2122s picture in their heads. Weu00e2u20acu2122ll probably give him a half or third of what he wants as a test. Banks all work on annual cycles, so until the new plan comes out, everyone is stuck in a freeze frame. Weu00e2u20acu2122re trying to get rid of that. Whatu00e2u20acu2122s so special about January 1?

And we have BLAST (Banker Leads Alerts & Sales Tools), which helps us gain more insight into our customers. If youu00e2u20acu2122re a customer, we know how long youu00e2u20acu2122ve banked here, how many products you have, your average balance, and how many checks you write. BLAST introduces some sophisticated tools, provided by third parties, to profile you on a more macro level. We know what street you live on, what your neighborhood looks like, and can make pretty accurate assumptions as to the kind of cars you drive and the kind of magazines you order. And we can use that information to predict, say, your need for a home equity loan by seeing if activities in your neighborhood indicate that people are remodeling. Weu00e2u20acu2122ve launched it in four markets so far, and itu00e2u20acu2122s working across the board.

How does your board play a role in these strategies?

I view the board as my perfect litmus test. Our directors arenu00e2u20acu2122t bankers; theyu00e2u20acu2122re leaders in other businesses. That forces me to winnow down the basic elements of our company: What is our risk? Who are we competing with? I have to expose our company as simply as I can, and sometimes making things simple is extremely challenging.

As a new CEO, Iu00e2u20acu2122m unabashed about saying to directors, u00e2u20acu0153I think I know what I want to do. But if you donu00e2u20acu2122t mind, Iu00e2u20acu2122m going to call on you for some advice: Have you been down this road before? What kind of guidance can you give me?u00e2u20ac Iu00e2u20acu2122m not asking them for guidance on a loan or deposit pricing. We talk about strategy: If I want to move to higher-touch employee engagement, does someone around the table have experience with that? Or if Iu00e2u20acu2122m thinking about a new business line, [Iu00e2u20acu2122ll ask if they] have any opinions on the thought process Iu00e2u20acu2122m employing.

I donu00e2u20acu2122t ever want our directors to think theyu00e2u20acu2122re just supposed to keep us clean and do the audit stuff. I want them to be excited about and involved in the strategy.

Can you give an example of how the board shapes your thinking?

If you look at our investor presentations for the last three or four years, we almost always start with a map of the United States that highlights in dark blue the 24 states where we have retail branches. And then we have all these colored dots that show weu00e2u20acu2122re actually in almost every state in every way.

At our biannual board retreat in October, we spent an entire day walking directors through each line of business. That night at cocktails, one of our very good board members came up and said, u00e2u20acu0153You really helped me realize today how much of a national bank we are, with international skills in the payments area and this great branch network. u00e2u20acu00a6 Instead of starting out with those 24 states, why donu00e2u20acu2122t you start by saying weu00e2u20acu2122re one of the best national banks in the country, and then move to how we have this great branch network in 24 states?u00e2u20ac He was absolutely right. Weu00e2u20acu2122re one of the biggest and best national banks in the country, and that should be the story.

This directoru00e2u20acu2122s expertise is nowhere near financial services, but heu00e2u20acu2122s wholly engaged in our business and our success, and was smart enough to offer that idea. Sometimes it takes someone who isnu00e2u20acu2122t too close to a situation to say, u00e2u20acu0153I think you need to refresh the story.u00e2u20ac

Are there other ways directors contribute?

We have a conference tonight with 700 commercial bankers, and one of our directors will be the keynote speaker. Before he speaks, Iu00e2u20acu2122m going to take those bankers through a slideshow with pictures and quick bios of the entire board, and Iu00e2u20acu2122m going to tell our people they should be proud of their board members. Then heu00e2u20acu2122ll say, u00e2u20acu0153Iu00e2u20acu2122ve been a director for this many years. Let me tell you what I think of this company, how I feel about my name being associated with it and what our roles are in moving this company forward.u00e2u20ac Thatu00e2u20acu2122s very powerful.

You serve on one public company board (Minneapolis-based Xcel Energy) and a number of private boards. Have you learned anything about being a good CEO from your outside directorships?

Sometimes I can see what [Xcel CEO] Dick Kelly is trying to do as heu00e2u20acu2122s communicating, and I think to myself, u00e2u20acu0153I know what heu00e2u20acu2122s trying to do, but itu00e2u20acu2122s not quite hitting the mark.u00e2u20ac So the next time Iu00e2u20acu2122m doing the same thing, Iu00e2u20acu2122m asking [myself], u00e2u20acu0153Am I hitting the mark?u00e2u20ac

Beyond that, itu00e2u20acu2122s the use of executive sessions and routine communicationsu00e2u20ac”the way you send written updates to your board, how often you call them, and whatu00e2u20acu2122s considered important enough to make it an emergency. Iu00e2u20acu2122m learning all that anyway, but Iu00e2u20acu2122m learning in great part from any experiences elsewhere. Most boards want their CEO to be on at least one, but probably not more than two, outside boards. To be a good leader is to also be a good director.

You run a large bank with a relatively strong currency. What does the M&A universe look like from where youu00e2u20acu2122re sitting?

Iu00e2u20acu2122m getting a lot of investment bankers telling me what we should do with that [currency] advantage. But prudence comes back and says, u00e2u20acu0153Just because I can doesnu00e2u20acu2122t mean I will.u00e2u20ac

When times are clear and good, and your PE is better than the average, that advantage is like money. When times are tough and you have an advantage, itu00e2u20acu2122s usually because there are uncertainties or asset-quality problems. The risks are infinitely greater than just the math that might accrue at a typically good time. If youu00e2u20acu2122re an acquirer, youu00e2u20acu2122d better be sure you donu00e2u20acu2122t buy someone elseu00e2u20acu2122s problems.

Some people think the current environment might present opportunities for you to acquire aggressively, perhaps even move into some new geographies.

Our disciplines are so basic that the environment wonu00e2u20acu2122t change what we do. Weu00e2u20acu2122ll continue to make in-market acquisitions of small banks. Weu00e2u20acu2122ll also buy small payments and fiduciary companies. But weu00e2u20acu2122re not going to do something just because we can.

With acquisitions, we have a few paradigms. One is, a deal canu00e2u20acu2122t be dilutive. A lot of companies will forgive dilutive deals because they want to get to the other side. Someone might say, u00e2u20acu0153Itu00e2u20acu2122s such a small deal, eight branches or something, and you really want to get into that market, so why not just do it?u00e2u20ac But if itu00e2u20acu2122s not accretive, it doesnu00e2u20acu2122t matter how small it is. We wonu00e2u20acu2122t pursue it.

The second is, size doesnu00e2u20acu2122t matter. If we donu00e2u20acu2122t do one more deal as long as Iu00e2u20acu2122m CEO, it doesnu00e2u20acu2122t matter to me. Iu00e2u20acu2122m all over being the best bank we can be, not the biggest.

And last, we want to make sure weu00e2u20acu2122re using our capital wisely. That means we donu00e2u20acu2122t necessarily take the first deal that comes along, because there are only so many transactions we can do. A deal has to be relevant both on its own merits and compared to whatever else might emerge.

How do you keep directors in the loop on the M&A environment?

Every year, we spend one segment of a board meetingu00e2u20ac”this year it was at the biannual retreatu00e2u20ac”with one of our investment banking partners, discussing the current environment in the financial services world. We talk about everything from emerging trends in M&A to the valuations investors are placing on dividends versus buybacks.

Then management will say, u00e2u20acu0153Here are the current acquisition candidates in our world who would be worthy of consideration.u00e2u20ac Weu00e2u20acu2122ll show them a short list of companies we could partner with. It might be a merger of equals or a straight-out acquisition.

If, at midyear, an opportunity comes alongu00e2u20ac”and it may or may not be one of those companies we discussedu00e2u20ac”we can say, u00e2u20acu0153This company just became available. Let us update the current thinking.u00e2u20ac And we get the directorsu00e2u20acu2122 permission to move forward. If we go much further from there, we get them together and walk them through the details.

You have to give your directors the respect of keeping them up to speed on the category. We put things out there all the time, so that when something specific comes along, itu00e2u20acu2122s a matter of just getting a little caught up, not starting from scratch.

How are potential deals evaluated?

When one of those market presidents has what might be a good opportunity, theyu00e2u20acu2122ll first roll it up through Joseph Otting, our head of commercial banking, or Rick Hartnack, who runs consumer banking. Theyu00e2u20acu2122ll say, u00e2u20acu0153Thereu00e2u20acu2122s a company Iu00e2u20acu2122ve got access to that looks interesting. I want you to go with me to meet them.u00e2u20ac Rick or Joseph will have that initial meeting. If they think thereu00e2u20acu2122s something worth considering, theyu00e2u20acu2122ll bring it to our investment committee to get the resources to conduct a financial evaluation.

What is the investment committee, and what does it do?

Every Wednesday morning at 9:15 we have a meeting that includes [CFO] Andy Cecere, and the heads of technology, risk, and legal, as well as myselfu00e2u20ac”the top managers in the company. One of the things that group does is look at M&A opportunities. So Rick [Hartnack] might come to us and say, u00e2u20acu0153We have a bank in Colorado. Itu00e2u20acu2122s this size, it looks like this, weu00e2u20acu2122ve made some initial contacts, and it looks promising. We need the support of the M&A teamu00e2u20ac”the financial people, the credit team, and the technology teamu00e2u20ac”to help us build a white paper, based on publicly available information, to examine that bank more closely.u00e2u20ac The investment committee can approve that investment.

So this isnu00e2u20acu2122t formal due diligence?

Right. Weu00e2u20acu2122re looking primarily at financial returns. Two weeks later, theyu00e2u20acu2122ll come back and say, u00e2u20acu0153Weu00e2u20acu2122ve all done our public due diligence. This deal is still alive. We need a nonbinding bid to present [to the target].u00e2u20ac The investment committee has the ability to make that nonbinding approval. Weu00e2u20acu2122ll present that bid to make the deal more credible to the seller. And if the seller says, u00e2u20acu0153Yeah, thatu00e2u20acu2122s in the range of what weu00e2u20acu2122d be willing to do,u00e2u20ac then we start the real due diligence. And if the deal pans out, it comes back to us.

Do you need the boardu00e2u20acu2122s approval?

To a certain level, management can approve the deal and itu00e2u20acu2122s done. Above a certain levelu00e2u20ac”itu00e2u20acu2122s in the tens and tens of millions of dollarsu00e2u20ac”deals are taken to a committee of the board, which would then give us permission to go forward.

Practically speaking, does the board always sign off on managementu00e2u20acu2122s recommendations?

We do a superbly good job of due diligence. We are very careful about making clear the details of a deal, so we donu00e2u20acu2122t have confusion. As a result, we get a supportive response from our board members. But itu00e2u20acu2122s never passed without a lot of questions and involvement from directors.

Do you do post-mortems on acquisitions?

We are merciless about rigor in following our performance after the dealu00e2u20acu2122s done. Every three months in the first year, every six months in the second year, and every year for the next couple thereafter, weu00e2u20acu2122ll go back to the basic tenets of why we did the deal and check every aspect of how right we were in our basic expectations of the deal. It helps us improve the process so we can do better the next time.

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