DBRS Comments on U.S. Bancorp’s 1Q13 Earnings – Senior at AA Unchanged

DBRS, Inc. (DBRS) has today commented on the ratings of U.S. Bancorp (USB or the Company), including its Issuer & Senior Debt rating of AA. The ratings are unchanged following the release of the Company’s 1Q13 earnings and the trend on all ratings remains Stable. For the quarter, USB reported net income to common shareholders of $1.4 billion, slightly higher than 4Q12 and 5.7% higher than 1Q12.

In DBRS’s view, USB’s solid first quarter results show the strength of the Company’s franchise but also highlight the difficult operating environment for even the best bank operators. USB was unable to achieve revenue growth year-over-year (YoY) or quarter-over-quarter (QoQ) while DBRS-adjusted income before provisions and taxes (IBPT) increased 1.3% YoY but declined 4.3% QoQ. The Company sustained a drop in revenue on a linked quarter basis primarily due to weaker mortgage revenue and a decline in net interest income driven by net interest margin (NIM) compression and weak earning asset growth. However, the Company continued to generate good returns for the quarter, including an ROCE of 16.0% and ROAA of 1.65%, which differentiates it from many of its competitors. At the same time, capital remains solid, funding remains robust, and credit continues to normalize; all of which are constructive for fixed income investors and supportive of the Company’s high ratings.

Specifically, the Company’s well-diversified revenues, which are split 56%/44% between spread and fee income, decreased 1.1% in 1Q13 from 1Q12 to $4.8 billion. IBPT was up 1.3% to $2.3 billion over the same period. For the first quarter, net interest income was flat as a 7 basis point (bps) decline in the NIM to 3.48%, was only partially offset by a relatively modest 0.6% ($1.8 billion) increase in average earning assets. DBRS expects continued moderate net interest margin (NIM) pressure in the coming quarter, in the mid-single digit range, given the relatively low reinvestment rate.

Mortgage banking revenues declined 16% from the prior quarter, as origination and sales volume decreased and overshadowed improvement in net servicing revenues. The Company still benefits from mortgage banking activity which represents 19% of non-interest income and accounts for the largest source of the Company’s highly diversified fee income stream. Seasonally lower credit and debit card revenue, merchant processing services and deposit service charges all contributed to lower fee income QoQ.

On a DBRS-adjusted basis (excluding one-time items and securities gains/losses), USB was able to generate solid operating leverage YoY as the modest 1.2% decline in DBRS-adjusted revenues was outpaced by a larger 3.5% drop in DBRS-adjusted expenses. Likewise, the same DBRS-adjusted basis produced positive operating leverage QoQ as expenses declined 5.2% while revenues fell 4.7%. As a result of the improvement, the efficiency ratio decreased to 50.7% from 52.6% and remains a competitive advantage for the Company.

First quarter results also evidenced positive underlying balance sheet trends. Average loans (excluding covered loans) increased 1.4% in the quarter, and were up 8.0% YoY. Growth over the quarter was driven by 2.1% growth in average commercial loans and 4.5% growth in average residential mortgages. USB again added mortgage loans to the portfolio in the quarter (average balances up $2.0 billion). DBRS also notes that average total deposits grew 0.5% QoQ to $245.0 billion. A decline in non-interest bearing accounts was offset by growth in interest checking and savings products.

Credit continues to improve at USB, evidenced by further improvement in most key credit metrics but management has been signalling that commercial loan metrics have mostly normalized, residential mortgage and home equity have a year or two to go to normalization and reserve releases are nearing their end. Total net charge offs (NCOs) of $433 million declined $35 million QoQ and were 0.79% of total average loans, below what the Company sees as its normalized range of 1.0% annually. Nonperforming assets (excluding covered assets), fell 2.8% from 4Q12, to $2.0 billion. Accruing 90+ day delinquencies (excluding covered loans) were $609 million, down 7.7% from the end of 4Q12. Given current trends, USB released $30 million of reserves in the quarter, up 20% from the $25 million in the fourth quarter and one-third of the $90 million in the first quarter of 2012. In DBRS’s view, USB’s $4.7 billion allowance for credit losses continues to provide solid coverage. At March 31, reserves covered 221% of nonperforming assets (ex-covered loans) and were 2.11% of total loans.

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 contained impact, the Company’s estimated Basel III Tier 1 Common ratio (on a fully implemented basis) was 8.2%, up 10 bps QoQ and only 90 bps below its Basel I Tier 1 common ratio of 9.1%. DBRS views USB’s current capital levels as continuing to provide substantial loss absorption capacity given its moderate risk profile and strong organic capital generation capacity.

During the quarter, USB announced a $2.25 billion share repurchase program and is expected to increase its annual dividend 18% from $0.78 to $0.92 in 2Q13 following the Federal Reserve’s non-objection to its capital plan. The Company continues to target returning 60% to 80% of earnings to shareholders.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]