Low interest rates failed to inspire borrowing. Maybe a rate hike will do the trick.
That’s the perhaps counterintuitive logic of Richard Davis, chief executive of U.S. Bancorp. Fears of another economic collapse have subsided, but apathy has set in among business customers, he says.
Essentially, they are not borrowing because they think low rates and the slow recovery will last awhile, Davis said during the $355 billion-asset company’s first-quarter earnings call Tuesday.
"There is no reason to take a bite right now of the apple and invest in something that will cost you more with the uncertainty of not knowing whether or not there is going to be a customer base for you," Davis says. "Most companies are going to continue to just do what they do well…and they are going to wait for a catalyst — which I think will be interest rates eventually starting to move up."
In other words, an imminent threat of higher rates could jolt businesses into rushing out to get loans. However, Davis made no predictions when that might happen.
The remarks could be wishful thinking from Davis, as U.S. Bancorp, often applauded for its performance, reported a slowdown in revenue.
The Minneapolis company’s revenue shrank 1.1%, to $4.9 billion, from a year earlier because of lower fee income and minor growth in net interest income. Meanwhile, loans totaled $222.4 billion at March 31, just 0.9% higher than at yearend.
Some of its problems are widespread in the industry. U.S. Bancorp reported that mortgage revenues fell in the first quarter, just as Wells Fargo (WFC) and JPMorgan Chase (JPM) did last week. U.S. Bancorp's mortgage revenues dropped nearly 16% from the previous quarter and 11.3% from a year earlier.
To offset the declines, U.S. Bancorp pared its expenses. Noninterest expenses were $2.47 billion in the quarter, down 8% from the fourth quarter and down 3.5% from a year earlier. The cost-cutting maneuvers helped it hit earnings estimates of 73 cents per share. It reported earnings of $1.43 billion, up 6.7% from a year earlier.
Analysts would prefer the company to find operating leverage in revenue growth, but are content to see it adjust expenses.
U.S. Bancorp's "profitability is still better than virtually anyone else’s," says R. Scott Siefers, an analyst at Sandler O’Neill. "They had weakness in revenue, particularly in fee income, but they did a nice job on the cost side."
Company officials say they try to keep it simple — prevent expenses from growing faster than revenues.
"We don’t have a cost savings program or initiative. We manage the expense growth in conjunction with the revenue opportunities," Chief Financial Officer Andrew Cecere said in an interview. "As long as we continue to manage the expenses, we will continue to achieve strong returns."
Cecere says he and Davis meet with 60 different employee teams each month to ensure business activity is on par with expenses, and they make adjustments as needed.
Most of the revenue decline was seasonal, U.S. Bancorp says. A brief uptick in rates slowed its refinance business, which is expected to rebound this quarter, the company says.
"As we look into the second quarter, we believe mortgage revenue will grow and we believe the application volumes that we have seen thus far will increase," Cecere said during the earnings call. "We are starting to see some strength there so we expect an increase in mortgage revenue in Q2."
Loans are expected to grow between 1% and 1.5% in the second quarter, Davis says.
"If we get the seasonal lift that we expect and we normally see in the springtime, then we will be in the middle to high end of that range," Davis says. "If we see a continued cautious nature by our customers which we have now seen for the last few months, then it might be on the low end of that range but it will be somewhere in between."
Analysts are willing to give U.S. Bancorp the benefit of the doubt but appeared guarded.
"The proof will be in the pudding," Siefers says. "But they tend not to say things that they can’t back up."
Marty Mosby, an analyst at Guggenheim Partners, says year-over-year results in the second quarter will be the most telling.
"Seasonally, the first quarter is when they run into these issues, so we will naturally see sequential pickups," Mosby says. "What is more concerning to me is that year over year was kind of flat in the first quarter."
Investors were clearly displeased. U.S. Bancorp's stock was down 2% on a good day for the markets Tuesday, with shares trading at $32.63 in late afternoon.
"When I saw the revenue numbers, I expected the stock to be down," says Paul Miller, an analyst with FBR Capital Markets. "Look, they have one of the highest valuations and had a lackluster quarter with seasonally slow revenues."