'Higher-for-longer' hits U.S. Bancorp as funding costs stay elevated

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David Paul Morris/Bloomberg

U.S. Bancorp felt the sting of higher-for-longer interest rates in the first quarter as more commercial depositors started collecting interest, which elevated the bank's funding costs and dampened the growth of its spread income.

The $684 billion-asset company reported net interest income totaling $4 billion for the quarter ending March 31, and it expects a similar outcome in the second quarter. It predicts full-year spread income will total between $16.1 billion and $16.4 billion, suggesting a stronger second half to 2024, as the bank had previously forecast.

Still, the higher-for-longer scenario took some of the luster off the bank's outlook. Its initial projection for 2024 called for $16.6 billion of net interest income.

While the pace of commercial deposit migration into interest-bearing accounts has diminished, U.S. Bancorp had figured that the slowdown would play out more rapidly, Chief Financial Officer John Stern said Wednesday on a conference call with analysts.

"The pace of this action is slowing. We absolutely see that," Stern said. "It's just not slowing as fast as we would have anticipated. So to boil that all together, what we do see now with our guidance is that second-quarter net interest income will be relatively stable, and we should see growth in the second half of the year."

Corporate clients are stretching for yield to "optimize" their balance sheets, according to Stern. "Now that they know [this higher rate environment] is going to be here for a longer period, they're taking a closer eye to it," Stern said. "We're just seeing that more and more."

Noninterest deposits totaled $85 billion at March 31, or 17% of U.S. Bancorp's $503 billion total. They amounted to about 18% of total deposits at the end of last year and 25% of the total on March 31, 2023.

At least one analyst, HSBC's Saul Martinez, termed U.S. Bancorp's adjusted spread income forecast "disappointing." Shares in the bank fell nearly 4% Wednesday to $39.52.

The Minneapolis-based company, nevertheless, insists that brighter times lie ahead. That's due in part to asset churn, including $3 billion of securities that are set to roll off the books and be replaced at higher yields, according to Stern.

U.S. Bancorp's results reflected some of the tests facing regional banks generally, Fitch Ratings Senior Director Theresa Paiz-Fredel wrote in a research note.

"The broader higher for longer rate environment will continue to challenge net interest income, with some institutions facing declines due to higher funding costs or changes in deposit mix and pricing," Paiz-Fredel wrote.

U.S. Bancorp is responding to the net interest income headwinds by seeking to balance the revenue dropoff with $200 million in corresponding expense cuts, Piper Sandler analyst Scott Siefers noted Wednesday. "While this won't likely work out to a dollar-for-dollar offset, at least it signals a level of seriousness in attempting to maintain profitability," Siefers wrote in a research note.

Wrapping up the first quarter, U.S. Bancorp reported net income totaling $1.32 billion. Net revenue of $6.7 billion dipped 6% year over year, reflecting a 14% decline in net interest income. However, fee income increased by 7% to $2.7 billion, driven by payments, capital markets and mortgage banking revenues.

"Any time we can differentiate ourselves with these sorts of fee categories, that's helpful," Stern said in an interview following the conference call. "They're not limited to our branch area. We can service clients all over the country. … Broadly speaking, this is the offset in this type of environment."

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Payments continued to be a strong suit, generating income totaling $977 million in the quarter, up 4% year over year and 14% from the first quarter of 2022. U.S. Bancorp is projecting high-single-digit growth in payment revenues through the remainder of 2024.

"We have made a lot of investment, put a lot of dollars in all the different payment capabilities," Stern said in the interview. "The payments mechanism and rails, the product capabilities we've built are unique. Not many banks have the suite of products we have."

Small business banking is emerging as another differentiator. Through the first seven months of the federal government's 2024 fiscal year, U.S. Bancorp ranked as the fifth-largest lender in the Small Business Administration's flagship 7(a) program, with loan volume of $294 million. That puts the company on pace to substantially exceed its 7(a) loan volume of $407 million during the previous fiscal year.

Credit quality was in line with expectations during the first quarter, according to U.S. Bancorp executives. Though nonperforming assets jumped by 51% to $1.8 billion, Chief Administration Officer Terry Dolan said on the conference call that the company's $7.9 billion allowance for credit losses, which was equal to 2.1% of end-of-period loans, should cover losses in the portfolio.