DBRS Comments on U.S. Bancorp’s 2Q12 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 2Q12 earnings. The trend on all ratings remains Stable. For the quarter, USB reported net income of $1.4 billion, 5.8% higher than 1Q12 and 17.6% higher than 2Q11.

In DBRS’s view, USB’s solid second quarter results highlight the strength of the Company’s franchise, consistent financial performance split between spread and fee income, 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. These characteristics differentiate the Company from many of its struggling competitors and support its high rating level.

Driving the improvement again was earning asset growth and a strong quarter in mortgage banking, an area of focus where USB is already a top five originator and servicer. Moreover, credit performance continued to improve, resulting in a 2.3% decline (albeit slowing) in the credit loss provision from 1Q12 to $470 million. As a result, the above factors enabled the Company to generate ample quarterly revenues of $5.0 billion and strong quarterly net income of $1.4 billion. DBRS-calculated IBPT for the second quarter was $2.4 billion, 5.1% above 1Q12 and up 7.7% from 2Q11.

Second quarter results also evidenced positive underlying balance sheet trends. Specifically, the Company delivered another quarter of loan growth with average loans growing $3.9 billion, or 1.9% (2.4% excluding covered loans), primarily reflecting 5.1% growth in commercial and industrial (C&I) loans. Moreover, despite historically low utilization rates, USB continued to grow loans by actively marketing and acquiring new customers. Average C&I loans represented 78% of the growth in the quarter with a strong contribution from residential mortgages. Meanwhile, average total deposits grew $3.0 billion, or 1.3%, q-o-q to $231.3 billion. Even though low cost deposits decreased 0.7% in the quarter, they were still up 12.8% from 2Q11.

While loans grew in the quarter, end of period investment securities declined 0.4% and management intends to maintain this level over the next few quarters (assuming stable cash balances and current Basel III liquidity requirements). In the quarter, U.S. Bancorp transferred about $12 billion in securities from AFS to HTM signaling its intention to hold the securities until maturity, which will also reduce future OCI volatility. The Company grew net interest income modestly from 1Q12, as the loan growth in the quarter coupled with lower debt yields and a reduction in its cash position at the Fed more than offset the lower rates on investment securities and loans. The net interest margin eased a slight 2 basis points (bps) q-o-q from similar dynamics to 3.58%, but management expects it to be fairly stable in 2H12 with lower funding costs offsetting security and loan repricing pressure.

Reflecting the Company’s substantial and well-diversified set of fee-based businesses, noninterest income totaled $2.4 billion for 2Q12 and represented 47% of total revenues (non-FTE). Noninterest income was up 5.2% over the quarter and 9.7% from 2Q11. The increase over the quarter came from a $38 million increase in mortgage banking revenue and higher payment revenue primarily from increased transaction volume.

Underscoring its solid financial performance in the quarter, USB achieved positive operating leverage as adjusted revenue grew at about twice the rate of noninterest expense. As a result, the efficiency ratio improved 80 bps from 1Q12 to 51.1%. Noninterest expense increased 1.6% from 1Q12 to $2.6 billion primarily from higher professional services, and “other” expenses that were only partially offset by lower marketing expense.

As noted, USB’s credit quality continued to trend positively in the quarter with most credit metrics improving and comparing favorably to those of peers. Total net charge offs (NCOs excluding covered loans) of $520 million declined 8.8% q-o-q and were 1.04% of average total non-covered loans and 0.98% of total average loans; close to the Company’s 1.0% normalized range. Nonperforming assets (excluding covered assets) fell 6.9% from 1Q12, to $2.3 billion. Total early-stage delinquencies (excluding covered assets) improved 9 bps over the quarter. Positively, the delinquencies improved in every loan category with the exception of retail leasing, which increased 1 bp to 0.13%, and other retail, which was flat at 0.51%. Accruing 90+ day delinquencies (excluding covered loans) declined 12%, or 5 bps, to 0.33%. Rounding out the improvements, criticized assets improved 7% relative to 1Q12 and the provision was 90% of quarterly NCOs (excluding covered loans). The dollar amount of the reserve release declined from $90 million in 1Q12 to $50 million in 2Q12, as the improvement in leading credit quality indicators appears to be stabilizing. In DBRS’s view, USB’s $4.9 billion allowance for credit losses provided a very solid 210% coverage of nonperforming assets (ex-covered loans) and was 2.25% of total loans at the end of 2Q12.

USB’s financial fundamentals and capital position remain sound and support the Company’s rating levels and Stable trend. 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, using the latest proposal (NPR), the Company estimates that at the end of 2Q12, its estimated Basel III Tier 1 Common ratio (on a fully implemented basis) was 7.9%, or 90 bps below its Basel I Tier 1 common ratio of 8.8%. Moreover, USB should easily reach its 8% Basel III target in the next quarter. DBRS sees USB’s current capital levels as continuing to provide substantial loss absorption capacity given its moderate risk profile and strong organic capital generation capacity.

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organizations, 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 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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 see the linking document under Related Research.