DBRS Comments on U.S. Bancorp 1Q12 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 1Q12 earnings. The trend on all ratings remains Stable. For the quarter, USB reported net income of $1.3 billion, 1.7% lower than 4Q11 (which included a $263 million pre-tax merchant processing settlement) but was 27% higher than 1Q11.

In DBRS’s view, USB’s solid first quarter results highlight the strength of the Company’s franchise, consistent financial performance and the benefits of a solid balance sheet. Despite the difficult operating environment, USB was able to grow adjusted revenues and adjusted income before provisions and taxes (IBPT) on a y-o-y and linked quarter basis. Driving the improvement was earning asset growth and a strong quarter in mortgage banking, an area of focus where USB expects to be a top 5 originator and servicer. In addition, credit performance continued to improve, resulting in a 3% decline in credit loss provision from 4Q11 to $481 million. Combined, the above factors enabled the Company to generate ample quarterly revenues of $4.9 billion and strong quarterly net income of $1.3 billion. Adjusted income before provisions and taxes (IBPT) for the first quarter was $2.3 billion, 3.8% above 4Q11 and up 7.4% from 1Q11.

First quarter results also evidenced positive underlying balance sheet trends, including 2.8%, or $5 billion, growth in average low-cost deposits as well as another quarter of average loan growth. Average total deposits grew $5.0 billion q-o-q to $228.3 billion and the deposit mix continued to shift to interest-bearing checking and savings accounts and away from time deposits. Average noninterest-bearing deposits were roughly flat over the quarter after a strong growth trajectory of 43.9% over the past year. Moreover, despite weak loan demand and historically low utilization rates, USB continued to grow loans, with average loan growth (excluding covered loans) of 1.9% on a linked-quarter basis. Average commercial loans represented 50% of the growth in the quarter with a strong contribution from residential mortgage and, to a lesser extent, credit cards. Management cited demand from loans, commitments and lines from new and existing borrowers while the Company purchased about $700 million in consumer credit card balances in December 2011.

Significant loan and investment securities growth in the quarter enabled the Company to grow net interest income from 4Q11. The flat net interest margin q-o-q also reflected the reduction of cash at the Federal Reserve and the reclassification of credit card balance transfer fees from noninterest to net interest income despite the headwinds of continuing to add low yielding securities and maintaining substantial balances at the Fed. Fourth quarter net interest income was up 0.6% from 4Q11 to $2.7 billion and the NIM was stable at 3.60% from the previous quarter. Reflecting the Company’s substantial and well-diversified set of fee-based businesses, noninterest income totaled $2.2 billion for 1Q12 and represented 46% of total revenues. Linked-quarter noninterest income was up 2.8% (excluding the 4Q11 $263 million merchant settlement gain and $9 million securities loss), but grew 11% when compared to 1Q11. In the quarter, the $149 million increase in mortgage banking revenue more than offset the lower credit/debit/ATM card revenues due to reclassifications, seasonally lower card and deposit service charges, and lower merchant processing revenue.

In the quarter, USB achieved positive operating leverage as adjusted revenue grew while noninterest expense contracted. As a result, the efficiency ratio improved 80 bps from 4Q11 to 51.9%. Noninterest expense (excluding a 4Q11 $130 million mortgage servicing charge accrual) decreased 0.2% from 4Q11 to $2.6 billion primarily from lower professional services and the reclassification of ATM surcharges benefits that were only partially offset by increased employee benefit expenses.

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 $570 million declined 8.1% q-o-q and were 1.17% of average total non-covered loans and 1.09% of total average loans; close to the Company’s 1.0% normalized range. Nonperforming assets (excluding covered assets) fell by 5.9% from 4Q11, to $2.4 billion. Total early stage delinquencies (excluding covered assets) improved 11 basis points (bps) over the quarter and the delinquencies improved in every loan category except CRE while 90+ day delinquencies declined 11%, or 5 bps. Rounding out the improvements, criticized assets improved 6% relative to 4Q11 and the provision was 84% of quarterly NCOs. The dollar amount of the reserve release did decline relative to 4Q11 as the improvement in leading credit quality indicators appears to be stabilizing. Still, in DBRS’s view, USB’s $4.9 billion allowance for credit losses provided a very solid 199% coverage of nonperforming assets (ex-covered loans) and was 2.32% of total loans at the end of 1Q12.

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, nearly all the Company’s capital ratios improved in the quarter. DBRS sees USB as less impacted by Basel III than larger U.S. banks given its limited capital markets activities and its comparatively smaller mortgage servicing business. Evidencing this lesser impact, the Company estimates that at the end of 1Q12, its Tier 1 Common ratio under Basel III was 8.4%, just 30 bps below its Basel I Tier 1 common ratio of 8.7%. The Company’s CCAR results were consistent with solid capitalization, including one of the best PPNR outcomes, and resulted in no regulatory objection to its capital distribution plan. USB raised its annual dividend 56% from $0.50 to $0.78 per share and repurchased some 16 million shares in 1Q12. It also authorized a 100 million share repurchase through 1Q13 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 continuing to 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 DBRS Criteria – 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 see the linking document under Related Research.