DBRS Comments on U.S. Bancorp’s 2Q13 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 2Q13 earnings and the trend on all ratings remains Stable. For the quarter, USB reported net income to common shareholders of $1.4 billion, improved from both 1Q13 and 2Q12, by 3.5% and 4.5%, respectively. The Company continues to generate strong, industry-leading returns, including a ROCE of 16.1% and ROAA of 1.70%, differentiating USB from many of its competitors and peers. Additionally, capital remains solid, funding remains ample, and asset quality indicators continue to improve; all of which support the Company’s high ratings.

In DBRS’s view, USB’s solid quarterly results reflect the strength of the Company’s franchise but also highlight the revenue headwinds (namely net interest income and mortgage banking) still facing the industry. USB achieved modest 1.5% revenue growth quarter-over-quarter (QoQ) although revenues declined 2.4% YoY. Meanwhile, DBRS-adjusted income before provisions and taxes (IBPT) decreased 4.2% YoY and a more modest 0.6% QoQ. The Company saw an increase in revenue on a linked quarter basis primarily due seasonally higher payments revenue partially offset by weaker mortgage revenue and a decline in net interest income driven by net interest margin (NIM) compression and a decline in earning assets.

For 2Q13, the net interest income decline reflected the five basis point (bps) dip in the NIM to 3.43%, and a slight drop in average earning assets in the quarter. The Company expects stabilization of the NIM in 3Q13 given the current interest rate environment, improving reinvestment rates and the outlook for continued loan growth.

Seasonally higher credit and debit card revenue, merchant processing services and deposit service charges all contributed to higher fee income QoQ. The only noninterest income line item to decline on a linked quarter basis was mortgage banking revenues which declined just 1.2% as an increase in origination and sales volume was more than offset by an unfavorable change in the valuation of mortgage servicing rights (net of hedging activities). While the interest rate driven decline in refinance activity is expected to pressure the mortgage banking line item in the future, increased home purchase activity, as the housing market continues to improve, may provide some offset. The USB revenue stream benefits from mortgage banking activity which accounts for the largest source of the Company’s highly diversified fee income stream. However, the Company is less exposed to this line item as compared to some other peers as it represents 17% of non-interest income and 8% of revenues. Noninterest expense increased on a linked quarter basis by 3.5% largely reflecting higher insurance and regulatory expense as compared to the previous quarter. In addition, the Company’s efficiency ratio increased modestly to 51.7% from 50.7%. USB’s operating efficiency remains an important competitive advantage for the Company and it is expected to remain in the low 50% range.

2Q13 results also evidenced positive underlying balance sheet trends. Average loans (excluding covered loans) increased 1.6% in the quarter, and were up 7.2% year-over-year. Growth over the quarter was driven by 2.2% growth in average commercial loans and 3.9% growth in average residential mortgages. DBRS also notes that average total deposits grew 1.0% QoQ to $247.4 billion.

Credit continues to improve at USB, evidenced by further improvement in most key credit metrics. Total net charge offs (NCOs) of $392 million declined $41 million QoQ and were 0.70% of total average loans; remaining below what the Company sees as its normalized range of 1.0% annually. Nonperforming assets (excluding covered assets), fell 5.3% from 1Q13, to $1.9 billion and represent just 0.88% of loans and other real estate owned. Accruing 90+ day delinquencies (excluding covered loans) were $580 million, down 4.8% from the end of 1Q13. Given current favorable trends, USB released $30 million of reserves in the quarter, the same as the linked quarter. In DBRS’s view, USB’s $4.6 billion allowance for credit losses continues to provide solid coverage. At June 30, reserves covered 231% of nonperforming assets (ex-covered loans) and were 2.02% 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 (using the July 2013 released final rules) was 8.6%, only 60 bps below its Basel I Tier 1 common ratio of 9.2%. 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 increased its annual dividend 18% from $0.78 to $0.92 following the Federal Reserve’s non-objection to its capital plan. The Company continues to target returning 60% to 80% of earnings to shareholders and returned 73% of earnings to shareholders in 2Q13.

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

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