DBRS Comments on U.S. Bancorp 4Q11 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 4Q11 earnings. The trend on all ratings remains Stable. For the quarter, USB reported net income of $1.3 billion, up 6% from 3Q11.

In DBRS’s view, USB’s solid fourth quarter results highlight the strength of the Company’s franchise and consistent financial performance. Despite the more difficult environment, USB was able to grow adjusted revenues and net income on a sequential and linked quarter basis. In addition, credit performance continued to improve, resulting in a 4% decline in provisions from 3Q11 to $497 million. Combined, the above factors enabled the Company to generate record quarterly revenues of $5.1 billion ($4.8 billion excluding the $263 million merchant settlement gain) and strong quarterly net income of $1.35 billion. Adjusted income before provisions and taxes (IBPT) for the fourth quarter was $2.2 billion, roughly flat with the prior two quarters but was up 3.8% from 4Q10.

Fourth quarter results also evidenced strong underlying balance sheet trends, including 5.5% growth in average low-cost deposits as well as another quarter of average loan growth. Average total deposits grew $7.9 billion q-o-q to $223.3 billion and average noninterest-bearing deposits continued their strong growth trajectory, growing 8.6% from 3Q11 to $63.6 billion. Moreover, despite weak loan demand and historically low utilization rates, USB continued to grow loans, with average loan growth (excluding covered loans) of 3.0% on a linked-quarter basis. Commercial loans represented 60% of the growth in the quarter and management cited success in increasing its market share in both corporate refinancings and syndicated loans.

Strong low cost deposit growth in the quarter enabled the Company to grow net interest income from 3Q11 and minimize the decline in NIM, despite continuing to add low yielding securities and maintaining substantial balances at the Fed. Fourth quarter net interest income was up 2% from 3Q11 to $2.6 billion and the NIM was 3.60%, down 5 bps from the previous quarter. Reflecting the Company’s substantial and well-diversified set of fee-based businesses, noninterest income totaled $2.4 billion for 4Q11 ($2.2 billion excluding the $263 million merchant settlement gain) and represented 48% of total revenues (45% excluding the gain). Linked-quarter adjusted noninterest income was flat, but grew 2.3% when compared to 4Q10 (and adjusted for the $102 million Nuveen transaction gain). DBRS notes that, per prior guidance, USB’s interchange fees declined by $77 million in the quarter. In the quarter, lower credit/debit card fees, corporate payment product fees and deposit service charges were roughly offset by increased mortgage banking and merchant processing service revenues.

In the quarter, USB did not achieve positive operating leverage as noninterest expense exceeded revenue growth (on an unadjusted or adjusted basis). As a result, the efficiency ratio increased 120 bps from 3Q11 to 52.7%. Noninterest expense (excluding a $130 million mortgage servicing charge accrual) increased 3.6% from 3Q11 to $2.7 billion due to higher compensation expense, 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 excluding covered loans) of $620 million declined 6.9% q-o-q and were 1.28% of average total non-covered loans. Nonperforming assets (excluding covered assets) fell by 15% from September 30, to $2.6 billion. Early stage delinquencies ticked up modestly, 90+ day delinquencies were flat and criticized assets improved 6% relative to 3Q11, while the provision was 80% of quarterly NCOs. The dollar amount of the reserve release did decline relative to 3Q11 as leading indicators for consumer portfolios appear to be stabilizing after several quarters of more rapid improvement. Still, in DBRS’s view, USB’s $5.0 billion allowance for credit losses provided solid 191% coverage of nonperforming assets (ex-covered loans) and was 2.39% of total loans at the end of 4Q11.

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 Common capital ratios improved in the quarter while its tangible common equity ratio was flat. USB has not been identified as a G-SIFI but may 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 4Q11, its Tier 1 Common ratio under Basel III was 8.2%, just 40 bps below its Basel I Tier 1 common ratio of 8.6%. USB repurchased some 6 million shares in 4Q11 and reiterated its long term plan 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 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 under Related Research.