DBRS Comments on U.S. Bancorp’s 3Q11 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 3Q11 earnings. The trend on all ratings remains Stable. For the quarter, USB reported net income of $1.3 billion, up 6% from 2Q11.

In DBRS’s view, USB’s solid third quarter results highlight the strength of the Company’s franchise. Despite the more difficult environment, USB was able to grow revenues and income before provisions and taxes (IBPT) on a linked quarter basis and generate positive operating leverage. In addition, credit continued to improve, resulting in a 9% decline in provisions from 2Q11 to $519 million. Combined, the above factors enabled the Company to generate record quarterly revenues of $4.8 billion and record net income. IBPT for the third quarter was $2.3 billion, up $54 million from 2Q11.

Third quarter results also evidenced strong underlying balance sheet trends, including 5% growth in average low-cost deposits as well as another quarter of average loan growth. Average total deposits grew $6.0 billion q-o-q to $215.4 billion, and USB reported particularly strong growth in average noninterest-bearing deposits, which grew 20% from 2Q11 to $58.7 billion. Moreover, despite weak loan demand and historically low utilization rates, USB continued to grow loans, with average loan growth (excluding covered loans) of 2% on a linked-quarter basis. Average loan growth in the quarter was strongest in retail leasing and commercial loans, with the latter reflecting continued success in growing its wholesale banking activities.

Strong low cost deposit growth in the quarter enabled the Company to grow net interest income from 2Q11 and minimize the decline in NIM, despite continuing to add low yielding securities and maintaining substantial balances at the Fed. Third quarter net interest income was up 3% from 2Q11 to $2.6 billion and the NIM was 3.65%, down 2 basis points (bps) from the previous quarter. USB also grew noninterest revenues q-o-q. Reflecting the Company’s substantial and well-diversified set of fee-based businesses, noninterest income totaled $2.2 billion for 3Q11 and represented 45% of total revenues. The 1% linked-quarter growth was driven by deposit service charges and payment products and offset a decline in trust and investment management revenues. DBRS notes that USB maintained its guidance that the Durbin amendment would result in a $300 million annual reduction in fee income. In line with that guidance, Durbin is expected to reduce 4Q11 interchange fees by $75 million.

In the quarter, USB successfully achieved positive operating leverage as revenue growth slightly eclipsed the modest increase in noninterest expense. As a result, the efficiency ratio declined 10 bps from 2Q11 to 51.5%. Noninterest expense increased 2% from 2Q11 to $2.5 billion due to higher professional services and marketing expenses. The higher professional services fees reflected the Company’s ongoing review of foreclosures and other mortgage servicing-related projects.

As noted, USB’s credit quality continued to trend positively in the quarter with all credit metrics improving and comparing favorably to peers. Total net charge offs (NCOs) of $669 million declined 10% q-o-q and were 1.31% of average total loans. Nonperforming assets, excluding covered assets, fell by 7% from June 30, to $3.0 billion. Early stage delinquencies, 90+ day delinquencies and criticized assets all also improved relative to 2Q11, supporting a provision that was 78% of quarterly NCOs. The dollar amount of the reserve release did decline relative to 2Q11 as leading indicators for consumer portfolios have started to stabilize after several quarters of more rapid improvement. Still, in DBRS’s view, USB’s $5.2 billion allowance for credit losses provided solid 166% coverage of nonperforming assets (ex-covered loans) and was 2.53% of total loans at the end of 3Q11.

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 tangible equity and Tier 1 Common capital ratios both improved in the quarter. Though the Company will likely be subject to a SIFI buffer, DBRS believes that USB will be less impacted by Basel III than larger U.S. banks given its limited capital markets activities and its comparatively small mortgage servicing business. Evidencing this lesser impact, the Company estimates that at the end of 3Q11, its Tier 1 Common ratio under Basel III was 8.2%, just 30 bps below its Basel I Tier 1 common ratio of 8.5%. USB repurchased some 13 million shares in 3Q11 and reiterated that its long term plan is to distribute 60% to 80% of its earnings to its shareholders in the form of dividends and buybacks. Nonetheless, DBRS sees USB’s current capital levels as providing 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: Alan G. Reid
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 under Related Research.