U.S. Bancorp sees stronger growth ahead despite light lending activity

UPDATE: This article includes comments made during U.S. Bancorp's earnings call and in an interview with Chief Financial Officer John Stern.

U.S. Bancorp faced modest loan demand in the third quarter, contributing to lower net interest income and revenue on a year-over-year basis. But its outlook for the operating environment is brightening.

"There definitely is more interest" from borrowers, Chief Financial Officer John Stern said in an interview after U.S. Bancorp posted its results Wednesday. Should interest rates continue to decline as expected, lower borrowing costs would likely translate into stronger loan demand and eventually notable growth, he said. "The sentiment in the economy is positive."

The benefits of lower rates are already taking root on the deposit side, Stern said. About half of the company's deposit base is made up of institutional accounts that effectively reset lower alongside Federal Reserve rate cuts, he said. Lower funding costs contributed to stabilizing net interest income during the third quarter.

That noted, the Minneapolis-based banking giant said its net interest income and revenue both fell by more than 2% from a year earlier. Its net interest margin contracted seven basis points to 2.74%.

The $686 billion-asset bank's average total loans slipped 1% from the year-ago quarter, led by a fall in commercial credits. Declines in business lending and commercial real estate loans more than offset a rise in credit card balances and an uptick in residential mortgages.

The parent company of U.S. Bank, like many of its peers, has tried to navigate a lending landscape marked by pockets of weakness following the COVID-19 pandemic.

U.S Bancorp said it did generate momentum from the prior quarter.

Net interest income of $4.1 billion was up from $4 billion in the second quarter, marking the second consecutive quarterly advance. Average loans of $374 billion were flat with the prior quarter.

Total interest expenses decreased slightly from the previous quarter to $3.95 billion.

"Bottom line, some mixed trends, but the NII performance was a real plus," Piper Sandler analyst Scott Siefers said.

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Stern said that while U.S. Bancorp posted some signs of modest credit deterioration, its credit quality has leveled off at healthy levels. U.S. Bancorp's third-quarter ratio of nonperforming assets to loans and other real estate, for example, was 0.49%, up from 0.35% a year earlier. The increase was primarily due to higher rates of nonperformance in the company's commercial and commercial real estate loan portfolios. Nonetheless, anything under 1% has been considered sound historically.

U.S. Bancorp Chairman and CEO Andrew Cecere said loan growth in the coming quarters "is a key factor," and as interest rates fall further, loan demand should rise.

"As recent industry headwinds become tailwinds," he said on the company's earnings call, lower rates should complement investments in technology, business line diversification and overall expense control and mark an "inflection point in our story."

U.S. Bancorp's modest lending levels come amid a still murky environment for big banks overall. A day earlier, PNC Financial Services Group said loan growth proved elusive in the third quarter, while Bank of America said its loans ticked up.

"Signals are mixed on the return of loan demand," said Chris Stanley, a Moody's analyst.

For all U.S. banks over the four quarters that ended June 30, loans inched up just 1%, according to S&P Global Market Intelligence.

An American Bankers Association panel of senior bank economists recently projected commercial and industrial loan growth would contract by 0.2% this year before rising by 3.3% in 2025.

The bank economists blamed lofty interest rates for the modest lending activity this year. Over the course of 2022 and last year, the Fed boosted rates to the highest level of this century to combat inflation. The central bank's campaign brought inflation from a peak above 9% in 2022 down below 3% this year.

Following that improvement, the Fed cut its benchmark rate by 50 basis points in September and signaled further reductions could follow. The bank economists said they expect loan demand to increase next year as borrowing costs fall. They see rates declining by an additional 150 basis points by the end of 2025.

"It's the longer-term path that matters more, and our expectation is for the Fed's policy rate — which is still restrictive — to reach a more neutral level by the end of next year," Luke Tilley, chair of the ABA committee and chief economist at M&T Bank's Wilmington Trust, told reporters in September.

U.S. Bancorp expects to grow at the pace of the industry, Cecere said Wednesday. He is focused on positioning the bank for steadier organic growth in the year ahead, as well as continued improvement in interest income, as rates decline.

The bank expects to invest further in technology, talent and branches within its footprint. Cecere ruled out bank mergers and acquisitions, noting that the level of regulatory scrutiny surrounding larger companies is elevated.

"There's too much uncertainty for M&A, and I don't want to focus all our efforts on that when we have so much opportunity on the organic growth front," Cecere said. "So in this role, what you do is prioritize against the opportunity set that you have in front of you. And our organic growth opportunities are far more important and much more tangible to us right now."

The nation's seventh-largest bank by assets reported net income of $1.7 billion, or $1.03 per share, up from $1.5 billion, or 91 cents, a year earlier. The results included an $89 million after-tax net securities loss largely offset by lower income tax expense.

Net revenue was $6.9 billion, down from $7 billion in the year-ago period.

Noninterest income fell 2% to $2.7 billion.

Adjusted for notable items in prior quarters, the bank reported a 1% decline in noninterest expenses from a year earlier to $4.2 billion.