Tax law takes bite out of U.S. Bank cash cow

U.S. Bancorp, like a lot of banks, needs all the help it can get when it comes to fee income.

Revenue from its payments business — a coveted niche — continues to lag, and mortgage banking fees — a problem area for everybody these days — are declining.

But the company took an additional hit during the first quarter, when its fast-growing capital markets business, which primarily underwrites debt for high-grade companies, reported a double-digit decline in revenue. So-called commercial products revenue sunk 11% to $220 million, as customers, awash in newfound cash from the tax law, pulled back from the capital markets.

The decline illustrates one of the many knock-on effects of tax reform rippling through the industry. With customers’ cash balances getting a boost from tax savings and repatriated earnings, many feel less of a need to draw on credit lines or issue debt.

More importantly, the decline in capital markets fees, which were U.S. Bancorp’s fourth-largest source of noninterest income during the first quarter, underscores the growing importance of the business.

The Minneapolis company invested heavily in building the division after the financial crisis, stepping into the market as foreign banks and other larger banks began to scale back. It has since risen rapidly through league tables and added staff. U.S. Bancorp expects debt issuance to pick back up later in the year — perhaps as soon as the second quarter — once customers adjust to the tax law.

“We do believe that, later in the year, things will start to move,” Chief Financial Officer Terry Dolan said in an interview after the company’s earnings call.

Still, the decline in capital markets revenue, while expected, was ill-timed. Growth in fee-based revenue was lackluster at the $460 billion-asset company. That is due in part to a decision made last year to exit two joint payment ventures with other big-name banks.

Mortgage banking fees also weighed on the results, thanks to industrywide declines in gain-on-sale margins, as competition from correspondent lenders has increased, Dolan said during the call. Overall, noninterest income rose by less than 1% to $2.3 billion.

“We do believe there is going to be some sort of a transition, and we expected that,” Dolan said.

The impact of the new tax law on quarterly profits at big banks has been a major topic in the past week. The law, among other changes, slashed corporate rates to 21% from 35%.

U.S. Bancorp and other banks have said corporate borrowers have hesitated to take out new loans, choosing to focus, instead, on paying down debt. Other banks have said the tax cuts have fueled additional price competition in the commercial lending market, as banks use a portion of their tax savings to offer lower prices to borrowers.

Like many of its peers, U.S. Bancorp has faced relatively weak demand for commercial loans, the company said Wednesday. Total loans rose 2% to $279.4 billion.

When asked about his expectations for loan growth in the coming months, Dolan sounded cautious, though somewhat optimistic.

“It does appear to be a little stronger in the second quarter than the first,” Dolan said during the conference call, saying that loan growth will likely track the gross domestic product for 2018. “But we still think it’s probably going to pick up mostly in the second half of the year."

Dolan emphasized that despite the headwinds the company is facing in its lending book, small businesses have “a lot” more confidence than they did a year ago.

Meanwhile, U.S. Bancorp continues to explore plans to expand its retail division. During the interview, Dolan said the company likely will not add branches in new markets but will instead focus on expanding its customer base by offering new digital products.

To that end, executives on Wednesday reiterated plans to boost expenses over the coming year to fund the tech investments.

Expansion plans are still in their “early” phase, Dolan said. He also said the company is looking at ways to offer services such as wealth management or corporate lending in areas of the country where it already serves customers through its corporate trust unit.

“It’s certainly part of the game plan,” Dolan said.