How U.S. Bank Saved its Own Bacon

(Hint: It involves not making a f***ing pig out of itself)

Richard Davis, chairman, CEO, and president of U.S. Bancorp, the parent company of U.S. Bank, moved into crisis mode when Lehman Brothers failed in the fall of 2008. His three-day-a-week travel schedule, which had included public meetings with customers, came to a screeching halt.

“I can’t be in a crisis mode from the road,” Davis notes. “I have to be in the cockpit, not in the back of the plane. I needed to be in house, head down.” That fall, he began meeting with his leadership team twice daily and spent at least 14 hours a day at the company’s Minneapolis headquarters.

Like banks everywhere, U.S. Bank was facing a financial crisis whose severity none of its top leaders had ever faced. Money had stopped flowing on a global scale. Davis’s team reviewed its portfolios twice a day to identify and unload risky holdings. At night and over the weekends, they kept their eyes glued to the television and the Internet to follow the overseas markets and monitor whether the situation was worsening—and whether that would mean that access to money, the fuel of a bank’s business, was drying up.

Today, Davis says, his company is feeling “very normal.” He and his leadership team still arrive at the office between 6 and 7 a.m., but he’s typically out the door by around 6 p.m. The crisis, if not completely past, has subsided substantially, though numerous banks in Minnesota and across the country remained troubled. Not U.S. Bank. And as banks continue to falter, U.S. Bank—one of the few top-10 banks in the U.S. to report a profit every year for the past 15 years—looks stronger than ever.

Number 129 on the 2009 Fortune 500 list, U.S. Bancorp (NYSE: USB) is now the fifth-largest commercial bank company in the country, up from number six last year. (As a holding company, U.S. Bancorp is also the parent company of several other subsidiaries, notably Elavon, an Atlanta-based payment processing firm.) Total assets rose from $195 billion in 2004 to $281 billion in 2009. And the bank’s customer base ballooned from 13.1 million to 17.2 million over the same time period. Five years ago, U.S. Bank had 2,370 branches in 24 states. As of April 1, it has 3,012—in the same 24 states.

Davis readily acknowledges that he and his leadership team were not without some culpability in the crisis. But they look close to angelic compared with some of the nation’s largest banks. During the real estate bubble, Davis and his team strayed at most a few feet from U.S. Bank’s long-held conservative policies. But the bank’s old-school roots and its ability to withstand criticism and peer pressure saved it from implosion. U.S. Bancorp will emerge from the downturn without having had to sell any assets to raise capital or divest itself of any poorly performing businesses.

In fact, the company is making itself bigger—vigorously, but without overeating. In essence, U.S. Bancorp got through the crisis by not turning itself into a financial casino, but rather remaining—well, a bank.

What U.S. Bank did—and didn’t do

Leading up to the financial crisis that began more or less in the spring of 2008, Davis became uneasy over interest rates as well as the cash hoarding that began to occur. Then came the failure of Bear Stearns, an investment banking firm that dealt in mortgage-backed securities and other financial instruments that were outside the realm of commercial banking.

“It looked like an isolated Bear Stearns breakdown, and we didn’t intersect with those businesses,” Davis recalls. “When Lehman Brothers failed in September, that was the one-two punch. By the fall of 2008, the world was changing.”

Davis and his executive team did have some warning before 2008 that all was not right with their industry. “We knew that Countrywide and WaMu [Washington Mutual] were digging a hole with option ARMs, pick-a-payment, no-down-payment, and no-doc loans,” says Richard Hartnack, head of consumer banking for U.S. Bank. “What we didn’t know is that they were digging a hole under everyone’s foundation. We didn’t understand the depth to which it would affect world economies.”

Davis, Hartnack, and other top U.S. Bancorp executives got an inkling of how big the shaky-mortgage problem was as early as 2004. “Our people that come face to face with the public—the branch managers, mortgage brokers—they had customers tell them their products were not competitive,” Hartnack recalls. “They would say, ‘Why are we asking for loan documentation when no one else is?’ They were the canary in the coal mine for us.”

During that pre-crash period, the banking team continued steadfast in its conservative lending policies. “The debate wasn’t in the general direction of whether we should remain conservative,” Hartnack says. “We were not going to do no-doc, negative amortization, no-down-payment loans, but we had to remain competitive, so we asked, ‘Where could we loosen up?’”

U.S. Bank did give in just a little, offering adjustable-rate mortgages with teaser rates that allowed homebuyers to purchase bigger, more expensive homes by providing low initial payments. That was as far as it strayed from its traditional caution. Homebuyers still needed to qualify with the usual documentation.

“We have always had a very conservative culture,” Davis notes. “The only way a bank makes money is to make loans, [but the riskier loans] didn’t feel right to us.” As the real estate bubble expanded, lenders and customers defected to competing banks, where they could make more in commissions or get bigger mortgages with fewer questions asked.

During the exodus, U.S. Bank’s leaders say that none of them pushed for the bank to offer dangerous mortgages. “When [the financial system] started to unravel, you’d think we would have been giving each other high fives,” Hartnack says. Instead, they spent long hours monitoring the situation, cleaning out what shaky mortgages and investments were on the bank’s ledgers.

“Being careful when it would have been easier not to was one of the best things that ever happened to us,” Davis says. By the end of 2009, as the dust began to settle, U.S. Bank had gained about 1.25 million new customers through acquisitions and organic growth. Deposits in the fourth quarter of last year grew by 25.2 percent over the fourth quarter of 2008; loans grew by 8.2 percent.

True, banks in the Federal Reserve’s Ninth District, where the company is rooted, have long held a reputation for being more conservative than banks on either coast. But an irony of the U.S. Bancorp story is that Davis, Hartnack, and several others on U.S. Bank’s executive team learned the business in banking’s Wild West—namely, California.

Parallel lines meet

“We brought experience and patience from a state with very wild swings,” Davis says. Thanks to factors including a tendency for housing bubbles to inflate and pop with some regularity, the Golden State is a volatile banking market. “We learned that nothing is for sure and to always set up a contingency plan,” Davis adds. “The best skill we didn’t know we had was how to deal with a volatile economy.”

Davis’s predecessor as CEO of U.S. Bank was Jerry Grundhofer. The two had a professional relationship spanning about 25 years. In 1987, after leaving a position at San Francisco–based Wells Fargo, Grundhofer became head of retail banking at Los Angeles–headquartered Security Pacific. At that time, Davis—who started in the banking business as a teller—was heading up quality assurance for Security Pacific.

In 1993, Grundhofer left that bank—which had completed a massive merger with San Francisco-based BankAmerica, predecessor of today’s Bank of America—to become CEO of a regional bank in need of better expense management, Star Banc in Cincinnati. He asked Davis, then heading up BankAmerica’s Southern California retail business, to direct Star Banc’s consumer banking. In 1998, Grundhofer’s cost cutting helped Star Banc buy Milwaukee-based Firstar, taking the latter’s name and headquarters. Davis continued as head of consumer banking.

Meanwhile, in Minnesota, Grundhofer’s older brother John, known as Jack, was following a similar career. Jack Grundhofer had been named CEO of Minneapolis-based First Bank System in 1990.

Like his brother, Jack Grundhofer was hired to return his bank to stability. Founded in 1929 as a confederation of 85 banks in the Ninth District (mostly in Minnesota), First Bank had long been known for its conservatism— but that reputation took some blows in the late 1980s, when management pursued riskier business, notably securities trading.

Soon, First Bank was again strong enough to play in a consolidating industry. Its largest acquisition: an Oregon-headquartered regional bank called U.S. Bancorp. The deal was finalized in 1997. First Bank System kept its Minneapolis headquarters but took the Oregon bank’s name.

That same year, First Bank/U.S. Bancorp acquired Minneapolis-based investment services firm Piper Jaffray. In 2003, it spun it off, deciding that it didn’t fit U. S. Bancorp’s traditional focus.

In 2001, the Grundhofers’ parallel lines intersected when Firstar purchased U.S. Bancorp. The Minneapolis headquarters and the U.S. Bancorp name stayed in place. Firstar’s Jerry Grundhofer retained his CEO title; Jack stayed on as chairman, then retired a couple of years later. Davis headed up the merged entity’s consumer banking division.

The following year, U.S. Bancorp was ranked as the nation’s eighth-largest bank company, with $174 billion in assets. Davis became CEO in December 2006—not too long before the global financial tsunami began to crest.

Bigger and stronger

“Three to five years ago, analysts were critical of U.S. Bank for not growing its portfolio fast enough,” says Jon Arfstrom, a banking industry analyst with RBC Capital Markets in Minneapolis. At that time, U.S. Bank was cleaning up a risky portfolio of transportation loans, mostly to the once-booming airline industry, that ran into problems following the September 11 terrorism attacks.

“They put their focus on reducing risk and getting back to basics,” Arfstrom says. “Are they lucky, or good? I think you can say they are good.”

Arfstrom notes that the current financial crisis has improved substantially over the past year or so; the industry no longer talks about solvency or the nationalization of banks. “We are now seeing the separation of those banks that were careful and those that were not,” he says. “U.S. Bank continues to make money every quarter. U.S. Bank is one of the strongest, if not the strongest, of the regional banks today.”

U.S. Bank was one of the first banks to pay back Troubled Asset Relief Program (TARP) funds. The four-step process, according to Davis, was arduous and required that U.S. Bank pass the government-administered Supervisory Capital Assessment Program stress test, which it did on May 7, 2009. The bank had to show it could attract capital; four days later, U.S. Bank raised $2.5 billion in a common stock offering and $1 billion in non-guaranteed debt issuance.

On June 17, U.S. Bank redeemed the $6.6 billion in preferred stock exchanged for TARP funds in the fall of 2008. And on July 15, 2009, it repurchased the TARP warrant for $139 million, leaving it free from ongoing stipulations—including restrictions on executive pay—placed on banks still operating with unpaid TARP loans.

As Arfstrom notes, “U.S. Bank’s strength has also allowed it to acquire attractive companies that other competitors have not been able to take advantage of, expanding its franchise and adding value to the company.” Since late 2008, U.S. Bancorp has acquired four banks with the assistance of the Federal Deposit Insurance Corporation and one without the FDIC’s help. (See page 34. All acquisitions were rebranded as U.S. Banks.)

U.S. Bancorp also has picked up credit card portfolios from Citigroup and Texas-based Town North Bank, several merchant-processing portfolios (services that help merchants process credit and debit card transactions), ATM-related services (which allow customers not only to get and deposit money, but also buy stamps, phone minutes, and other “products”), a wholesale bank (which provides services to large corporations and other banks), and several trust businesses.

Davis plans to continue to infill his company’s territory by purchasing banks with 50 to 100-plus branches. “There will be very few of them,” he says. He also plans to divest U.S. Bank of any branches it acquires that aren’t in its 24-state region. The company shed the Texas branches of one 2009 acquisition, for instance. Also in the works: new branches in supermarkets to lure new customers without having to build costly standalone branches.

Home truths

Before the crisis, U.S. Bank ranked between 18th and 22nd in terms of its share of U.S. mortgage lending. As the financial foundations of flashier mortgage lenders crumbled, U.S. Bank’s share of a smaller market has grown. It was the sixth-largest mortgage loan originator in the country in 2009. In the fourth quarter of 2009, $45 billion of U.S. Bank’s loan portfolio—about 23 percent of the total—was in residential real estate.

“We all learned that a home is not a Wall Street investment,” Hartnack says. “The middle-class working family who didn’t go off the deep end in housing or in taking on debt, and who, for whatever reason, did not have changes in employment status, represents somewhere between 40 and 60 percent of the families in America, and has been relatively untouched by this recession.”

Others, who took on too much or poorly structured debt, continue to learn difficult lessons—through foreclosure, higher interest-rate credit cards, and bankruptcy. But whether a family’s finances have been troubled or stable, Hartnack believes that “we are seeing a sea change in consumers’ refusal to take on more debt and an effort to increase their savings.”

In response to the change Hartnack speaks of, U.S. Bank has been rolling out new savings products. One is its S.T.A.R.T. program: Customers who set up recurring transfers every month or pay period (or with every credit- or check-card purchase they make) into their U.S. Bank savings account are eligible for a $50 U.S. Bank Rewards Visa card once they have saved $1,000.

“There are two ways to make money,” Hartnack says. “We can lend it out at a nice spread, or take it in at a nice spread.” The key to continued success will be continuing to offer a full line of services, whether customers are saving or borrowing. And U.S. Bank is in a position to lend.

“Part of what went wrong was the banks didn’t have diverse portfolios,” Hartnack says. “Many were over-concentrated geographically and by product type.” Think of the entities that lent out billions of real estate dollars in, say, Arizona, Florida, or Nevada, using those bubble-inflating loans, for instance. U.S. Bank is sticking to conventional mortgages for qualified consumers and to products like car loans, home equity loans, and small-business lines of credit.

You know. Old school. Like a bank.