DBRS Comments on U.S. Bancorp’s 2Q11 Earnings – Senior at AA Unchanged

DBRS Inc. (DBRS) has today commented that the ratings of U.S. Bancorp (USB or the Company), including its Issuer & Senior Debt rating of AA, are unchanged following the release of the Company’s 2Q11 earnings. The trend on all ratings remains Stable. For the quarter, USB reported net income of $1.2 billion, up 15% from 1Q11.

USB continued to exhibit its franchise strength underpinned by its ability to generate consistent revenues, achieve loan and deposit growth, while successfully managing credit quality in a sluggish economy. DBRS views second quarter results as reflecting strong underlying balance sheet trends, supported by its fourth consecutive quarter of significant growth in average deposits coupled with its fifth consecutive quarter of average loan growth. Deposits trends were favorable, particularly in its average noninterest-bearing deposits that grew 10.3% from 1Q11 (adjusted for acquisitions) and 22.1% from 2Q10. Moreover, despite weak loan demand and historically low utilization rates, USB continued to have success in achieving average loan growth of 0.5% on a linked-quarter basis (adjusted for acquisitions) and 4% (or $7.6 billion) from 2Q10. Reflecting its conservatism, the Company also continues to deploy excess liquidity into short-term, high quality securities.

In DBRS’s view, USB has managed the challenges of the financial crisis better than its peers attributable to its conservative culture and good execution skills. Credit quality continued to trend favorably in the quarter with all credit metrics improving. Nonperforming assets (NPAs) excluding covered assets, net charge-offs (NCOs), criticized asset levels, excluding covered assets, and early stage and 90+ day delinquencies all declined in the quarter forecasting further credit cost improvement in the coming quarters. Total NCOs of $747 million declined 7.2% QoQ and NPAs, excluding covered assets, decreased by $217 million or 6.2%. The trend in criticized assets was again positive declining 8% in the quarter and early stage delinquencies (30 to 89 days) fell 12 basis points (bps) QoQ to 0.72% at 2Q11. USB therefore anticipates the level of both NCOs and NPAs to trend lower again in the third quarter. DBRS notes that these trends supported the reduction in reserves that was $175 million below NCOs. USB’s $5.3 billion allowance for credit losses provide ample loss absorption, comprising 2.83% of period-end loans (excluding covered loans) and 159% of NPAs (excluding covered assets), in DBRS’s view.

Net income primarily benefitted from the reduction in provisions for credit losses in the quarter. Total net revenue grew 3.8% to $4.7 billion, attributable to increases in both non- and net-interest income. Non-interest income of $2.1 billion grew 6.7% QoQ with fees comprising 46% of 2Q11 revenues. Higher payments-related fees, deposit services charges, commercial products revenue and mortgage banking revenue, partially offset by the FCB gain recorded in the prior quarter and an $8 million securities loss contributed to the growth in fee income, despite the impact of new regulations. With the new interchange rules, USB now expects a $300 million annual reduction in fee income. The Company plans to mitigate one-third to one-half of the reduction in revenue due to regulatory changes by modifying its product offerings and pricing. Net-interest income of $2.5 billion grew 1.5% QoQ, largely as a result of the expected growth in its investment securities that bolstered the Company’s average earnings assets. Net-interest margin (NIM) remained relatively flat, declining 2 bps to 3.67% in the quarter as a result of the lower yielding assets despite the partial offset by reduced cash balances at the Federal Reserve.

In the quarter, USB successfully achieved positive operating leverage as revenue growth outpaced the modest increase in non-interest expense. Non-interest expense increased $111 million or 4.8% compared to the seasonally lower expense levels of 1Q11. Compensation expense, professional services and marketing and business expenses, and other expenses primarily from FDIC deposit insurance expenses increased in the quarter.

USB’s financial fundamentals and capital position remain sound and support the Company’s rating levels and Stable trend. Reflecting its capital strength and indicative of its capital generation ability, the Company’s Tier 1 and Tier 1 Common capital ratios both improved 20 bps QoQ to 11.0% and 8.4%, respectively. In addition, the Company estimates that its Tier 1 Common ratio under Basel III was 8.1% at quarter end, up from 7.7% at 1Q11, and above the level required by 2019 under current guidelines. USB commented that its long term plan is to distribute the majority of its earnings to its shareholders in the form of dividends and buybacks (each at 30% to 40% of earnings). The Company repurchased approximately 2.5 million shares at the end of the second quarter and will continue to redeploy capital once the final capital requirements for the systemically important financial institutions (SIFI) are determined. DBRS perceives that USB’s current capital levels provide substantial loss absorption capacity.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit
Insurance Corporation and SNL Financial. DBRS considers the information available to it for the
purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 4 April 2005
Most Recent Rating Update: 6 July 2011

For additional information on this rating, please refer to the linking document below.