We’re all familiar with the effects recent financial reform has had on major banks. By all accounts, new overdraft protections and the cap on debit card interchange fees in particular have cost them over $30 billion in annual revenue. And while reactionary measures like the testing of new debit card fees or increased costs for basic checking accounts may have surprised a lot of consumers, these plans were in the works from the moment banks caught wind of impending legislative changes.
Or at least they should have been. Unfortunately, recent comments from U.S. Bancorp (NYSE:USB) CEO Richard K. Davis indicate that this was not the case for the sixth largest bank in the U.S. in terms of deposits, a fact which leads one to wonder: Is U.S. Bank being mismanaged?
In response to a question about U.S. Bank’s efforts to recoup lost revenue during the company’s recent Q3 2011 earnings conference call, Davis had this to say:
Right now I'm making something very clear. We will not get that $75 million that we started the quarterly loss for Durbin beginning this month. We're not going to try to have it back this quarter or even in the first quarter of next year. We'll start working our way toward different ways of charging for services and customers are willing to pay for. We've got a great laboratory of watching a number of banks that have been doing the debit fee and we'll learn whether or not that's inelastic or elastic. We'll find out if customers complain and move, or just complain. We'll take all that in time and we'll make our decision. But over the course of now to the end of next year, we will have achieved 50% of that total cost of loss, but it will take the rest of the year to get the extra 20%.
There are a few different problems with this. First of all, U.S. Bank should have been testing new fees and monetization strategies from the time the Dodd-Frank Wall Street Reform Act was signed into law in July 2010 and not 15 months later, after the provisions concerning debit card interchange fees had already taken effect. Saying “We’ll start working our way toward different ways of charging for services” in mid-October 2011 (when the earning’s call took place), hints at poor planning and a general lack of organizational leadership.
In addition, based on my experience, if U.S. Bank had used advanced testing techniques and statistical simulations, it should have been able to make the changes necessary to recoup around 50% of Durbin Amendment losses in the first quarter of 2011 and 100% after a year. Perhaps Davis is trying to manage expectations by saying that it will take a year-plus to make up just 50% of the lost revenue, but is it wise to manage expectations in a manner that makes you seem inept?
The sense that Davis’ management approach might be somewhat primitive is underscored during that same earnings call when discussions turn to U.S. Bank’s credit card operations.
“All of our portfolios, they're just at the high quality. We don't have any book of prime in our portfolio,” Davis said.
But we think that's the right mix and probably the right quality to go after. And we're not going to get greedy and try to reach further back and change the underwriting that we have under credit cards, as the world gets maybe a little bit better. We're going to stick with our old knitting.
U.S. Bank’s lack of sophistication—in this case, as it relates to underwriting—is both holding back the company’s growth and costing investors money. The idea that you can’t simultaneously manage risk and make money is, simply put, an antiquated one. Just look at Capital One’s (NYSE:COF) credit card division, which made close to $1 billion in net income during 2009, the worst year of the Great Recession.
Furthermore, Davis mentions that U.S. Bank’s primary credit card marketing strategy is to leverage its co-branded cards. What he fails to understand is that retailers only care about maximizing the number of people approved for such cards. Therefore, if U.S. Bank is only going to be offering credit cards for people with excellent credit, retailers will sooner or later gravitate toward other major banks that can also cater to people with average or below-average credit histories.
In light of all this, the question may no longer be whether U.S. Bank is mismanaged, but rather what investors are going to do about it.
Disclosure: I am long COF.