U.S. Bancorp’s Smooth Operator

Richard Davis remembers the Sunday morning 10 years ago when he got a call at home from his former mentor, Jerry Grundhofer. As president of Security Pacific National Bank, Grundhofer had put the promising young Davis in charge of some retail banking operations. After being swept up by a 1992 buyout, the high-energy Grundhofer spent more than a year as vice chairman of Bank of America before heading east to run Star Banc, a $7 billion disappointment in Cincinnati. Star’s board, shaken by a recent takeover skirmish with rival Fifth Third, was hungry for change. And now Grundhofer was courting Davis, head of BofA’s southern California retail operations, to join him there.

“He said, ‘You know how we always talked about building something from scratch and doing things right? This is it. …a once-in-a-lifetime chance to put all those best practices in place,’” Davis recalls. “I said, ‘Jerry, slow down. I don’t even know where you are.’” A week later, Davis not only could place Cincinnati on the map, he owned a house there. “There’s no better salesperson than Jerry,” Davis chuckles.

It turned out to be a good move. A decade later, Grundhofer is chairman and CEO of U.S. Bancorp, a $190 billion franchise with branches in 24 states stretching from Ohio to California. Davis, well-respected for his operational abilities and vision, is both vice chairman in charge of retail banking and, by most accounts, heir apparent to the throne of the nation’s eighth-largest banking company. The duo, together with another early Grundhofer recruit, Security Pacific alum and present CFO David Moffett, has been at the core of one of the more successful bank leadership teams of the modern era. “They’re one of the most passionate managements in the industry, and they operate one of the best banks in the country,” says Tom Brown, who runs hedge fund Second Curve Capital.

The numbers bear out. Despite the recent recession and inevitable indigestion wrought by a rapid-fire series of large purchases and name changes—in a three-year period, Star Banc bought and became Firstar, which bought St. Louis’ Mercantile Bancorporation, and then US Bancorp (taking its name and Minneapolis headquarters)—erstwhile Star Banc shareholders can boast of a nearly-900 percent return since Grundhofer, 59, took the helm. That includes a total return of 45 percent in 2003 alone—tops among all big banks, except FleetBoston, which got a big purchase premium from BofA. At roughly $56 billion, USB’s market cap nearly equals that of the much larger Wachovia.

The best could be yet to come. In recent months, the company shed its Piper Jaffray investment banking subsidiary (a $730 million legacy of the old USB) and launched a high-profile national advertising campaign. It’s trying to lure more retail banking customers with free Internet bill pay and so-called “checking that pays”—products that Davis, 45, argues go beyond simple free checking by paying out cash or rewards points for usage. Management also commenced its first share buyback in years, part of an aggressive capital-management strategy aimed at returning 80 percent of profits to shareholders.

A recovering economy could be the icing on the cake. Merging with the old USB gave Grundhofer a formidable presence in fast-growth Western states, but also a higher risk profile. The recent recession revealed a mountain of bad loans, forcing the company to boost loan-loss reserves by $1 billion and shaking investor confidence. Credit quality remains an issue, says Fred Cummings, an analyst with McDonald Investments and a longtime follower of the company. The bright spot: an economic rebound could benefit USB more than other banks. “They’ve got some good geography, and the company is perceived as a credit-leverage play,” says Cummings, who has a “buy” rating on the stock with an EPS estimate of $2.20—up 10 percent from his 2003 numbers. “And what everyone understands is that these guys are good operators…they know how to run a bank.”

That’s there’s some sort of banking gene in Grundhofer’s makeup is indisputable. Jerry’s brother, Jack, ran the former USB for a decade before selling to his younger sibling. Separated by six years, the pair was raised by working-class parents in southern California, attended the same college (Los Angeles’ Loyola Marymount), and began their careers in much the same way—Jerry rising through the ranks of Union Bank before jumping to Wells Fargo, and then Security Pacific. The difference between the two is Jerry’s sense of urgency and raw devotion to selling and simplicity. “Jerry runs this very large company like a small company, with a lot of focus and engagement, and he works hard to keep things simple,” says Andy Cecere, the former USB’s CFO, and now head of private client and asset management.

When he first arrived at Star Banc, a sleepy 120-year-old institution, Grundhofer seemed vastly overqualified for the job. Bringing in a crack big-bank management team from the West coast raised even more eyebrows. Wary employees initially dismissed the new boss’s entreaties that they were “better than you think you are” as hype, and worried that a sell-off might be in the offing. Grundhofer’s vision couldn’t have been more different. “He wanted to run a bigger bank,” recalls Brown, who was then a banking analyst, “and this was his foundation.”

Using the relatively blank slate afforded by Star Banc, Grundhofer’s team forged a unique formula aimed at making the business easy for differing constituencies to embrace. To customers, they preached a commitment to community bank-style service quality, backed by a “five-star service guarantee”—first initiated in 1995—that pays customers between $5 and $250 if the bank makes a mistake or gives slow service. “We were looking for a difference we could hold onto, a brand identity that would matter to customers,” Grundhofer recalls. “We said, ‘It’s gotta be the quality of service. If we focus on it hard enough, customers will believe it.’”

To investors, meanwhile, the company touted efficiency. The two goals may seem contradictory; Grundhofer says they’re not, because it takes scale to be efficient, and the only way to get it is by getting more business from existing customers—something that, in a commodity industry, is driven by service quality. “It’s simple math: if you grow revenues faster than expenses, then your efficiency ratio will go down,” Grundhofer says, “and we grow revenues by providing better service.” A low efficiency ratio, adds Davis, “isn’t just about watching pennies. It’s the most unequivocal and provable outcome that you’re providing better service than competitors.”

Most important, Grundhofer instilled a high-octane sales culture. Relative costs fell, customer retention numbers rose. Revenues and profits followed. Investors rewarded Star with a monstrous multiple that approached 30 times earnings. Employees who owned shares through stock-purchase or 401(k) plans became true believers. Then came three big deals in less than three years. The size of the company doubled, and then doubled again. And again.

The potential for distraction was inevitable, especially with an organization driven so much—and so strongly—from the top. As Grundhofer himself likes to note, on issues like systems integration, “We don’t have a team come in and tell us how things are going. We run it ourselves.” Investors “doubted they could add that much to their size and still be a great growth company,” and pummeled the stock, Cummings says. Price-to-earnings dropped to below 10. Even today, critics say Grundhofer bit off too much. “They didn’t need to do all those acquisitions,” Brown says. “If they had gone slower, the PE wouldn’t have collapsed, and they could have grown faster.” Grundhofer counters that the “girth, strength and geography” of today’s USB make it more cost-effective to offer a full slate of services. One example: an in-house response team that helps customers deal with identity theft, which would be too expensive for a smaller institution to run. “Small banks can be successful,” he says. “But you can be more successful if you have a bigger franchise to spread the costs.”

Today, nearly three years after the USB deal, Grundhofer seems vindicated. The service guarantee and efficiency thrust carried over from the Star days helped earnings for the first three quarters of 2003 jump 16 percent over the previous year. Key metrics—return on equity of 20.5 percent, return on assets of 2.05 percent and an efficiency ratio of 42 percent (best among big banks)—are once again wowing the Street.

That USB has rebounded, observers say, is attributable to a culture that has evolved with changes in size and new technologies, while remaining true to the same core formula of service, efficiency and sales. Driving it all is Grundhofer, a whirlwind of a boss whose omnipresence can be almost unsettling. To hear his lieutenants tell it, the CEO blends the motivational skills of Tony Robbins with the sales acumen of P.T. Barnum and travel habits of Santa Claus. In high-level sales-management meetings the CEO is said to exhort executives to boost cross-sales. More telling are the stories about the folksy salesman-in-chief’s spontaneity and love of selling, like the time he convinced the woman next to him in the supermarket checkout lane to change accounts to his bank. On field visits, Grundhofer regularly accompanies account managers on sales calls, wringing new business from seemingly tapped-out clients. “He’ll identify four or five new opportunities that the salesperson didn’t see,” Moffett says. He also likes to drop in on unsuspecting branches, urging employees to sell more before disappearing as fast as he came.

Word of such exploits travels quickly through the company, reinforcing the sales message and all that goes with it. Even jaded longtime former USB employees in Minneapolis seem impressed. “He’s definitely energized the place,” says one. Equally important is a high-level caring that fosters loyalty and inspires people to do better. In September 2002, the CEO took his family on a trip to Italy—his first vacation in years—but just hours after he arrived, news came of four USB employees had been killed in a Nebraska bank robbery. “Without hesitating, he got on a flight and went to Nebraska,” where he attended all four funerals, Moffett recalls. “There are a lot of CEOs who love being CEO more than they love the business,” Brown says. “That’s not the case with Jerry. He loves to sell, and he cares.”

On the nuts-and-bolts side, Grundhofer and Davis also have revamped the organizational structure to encourage teams to steer customers each others’ ways. One example: where loan officers in the former USB reported to product-line leaders, they now answer to their own branch manager. And while incentives are used extensively to drive cross-sales—about 60 percent of an average employee’s pay is non-base-salary, Moffett says—the company doesn’t measure cross-selling ratios, for fear of alienating customers with a needless product. Better, Davis says, to use the information derived from predictive modeling tools to make targeted, needs-based sales calls. “We don’t pay employees for cross-selling at any certain moment, or for selling any particular product. We pay them over the course of time for growing the business and selling products that are relevant,” Davis says. “We have much better processes and leadership and oversight in place [than with the old USB], and as a result we’re much better today at selling,” Cecere adds.

The corner turned, can USB’s success continue? The challenges revolve largely around self-restraint. After years of merger-related excitement, can this management team find happiness tinkering with what they already have? Some analysts have their doubts. “It’s a consolidating industry, and sometime in the not-too-distant future, there will be an attractive merger partner for US Bancorp,” Brown contends. A combination with Wachovia, for instance, would create a truly national bank. A deal with Union’s owner, Bank of Tokyo Mitsubishi, could position USB as No. 3 in California’s huge market. Fears of such a big deal could hold the company’s valuations down. “People want to see them focus on the business, not another big integration,” Cummings says. Grundhofer says not to worry. He’s focusing his attention on smaller deals and de novo expansion. “We’re as big as we need to be,” he says. Whether that’s true or simply a sales pitch to wary investors, remains to be seen.