U.S. Bancorp Is Strong But Needs Growth

By Stephen D. Simpson, CFA | April 16, 2013 AAA

This earning season is starting to feel like a broken record, or at least for the high-quality banks. Economic uncertainty has led many would-be borrowers to delay taking out loans, low interest rates make it tough to make money on the spread, and new regulations have hurt fee income and increased costs.
Add U.S. Bancorp (NYSE:USB) to that list of banks where the Street seems to be saying “yeah, we know you're good, but we want growth.” While this large super-regional bank looks like a very solid long-term banking holding, this stock may not really get going unless or until the economy picks up and/or investors shift funds from overheated sectors towards the financials.

U.S. Bancorp's First Quarter Report Sounds Pretty Familiar
It doesn't really matter if you look at larger banks like JPMorgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) or smaller banks like Commerce Bancshares (Nasdaq:CBSH) and Comerica (NYSE:CMA); the themes driving U.S. Bancorp's first quarter will look very familiar.
Operating revenue fell 1% from last year and 5% from the prior quarter, as the company saw a one-two punch from both credit and fee income. Net interest income rose 1% and fell 3%, as on-target growth in average earning assets was offset by erosion in the net interest margin (12bp year over year and 7bp sequentially). Fee income was also soft (down 4% and 7%), as the company saw double-digit declines in mortgage banking and sequential declines in nearly every line item (though trust/management fees were up very slightly). Expense control was strong, though, and that helped to offset the poor fee income performance. U.S. Bancorp's efficiency ratio has dipped back below 51% (lower is better), and the bank remains one of the most profitable large banks in the country. With this expense control and lower loan loss provisions, pre-provision net revenue grew 1% annually and fell 4% sequentially.

SEE: Analyzing A Bank’s Financial Statements

Sluggish Demand For Lending Limits Growth Prospects
Although the bank's average loan balance increased more than 5% on an annualized sequential basis, period-end loans were flat sequentially. U.S. Bancorp's commercial loan growth was consistent with Commerce and Wells Fargo, a little weaker than JPMorgan, and better than Comerica. Mortgage lending wasn't bad (up more than 4% sequentially), while card lending was soft.
Barring a turnaround in the economy, I'm not sure there's reason to expect a big turnaround in lending or spreads. That puts more pressure on management to step up the fee income growth. U.S. Bancorp's wealth management operations are doing pretty well, but I do worry a bit about the card business. Wells Fargo has made this a priority area and JPMorgan's partnership with Visa (NYSE:V) is a competitive threat, so management may have to work a little harder here.
SEE: Citigroup Looking More Like A Normal Bank These Days

The Bottom Line
As is the case at other regional/super-regional banks like Wells Fargo, U.S. Bancorp looks undervalued today provided you're willing to project improving returns (equity, tangible assets, et al) in the future. That assumption, in turn, rests on the idea that rates are going to go back up in a few years and that banks like U.S. Bancorp can then leverage their quality capital positions and superior operating platforms.
For now, that's my expectation. I do believe that U.S. Bancorp will be able to add to its return on equity and post results in the mid/high teens three to five years down the line. If the bank can do that, the shares are worth more than $41 today. Remember, though, that that's something of a contrarian call today as many analysts are projecting long-term ROEs at the mid-teens or lower. Given U.S. Bancorp's history, I believe you'd see sizable returns of capital to shareholders if management can't do better than that.
With operating revenue and operating profit growth under stress this year, there may not be a reason to rush to own these shares. I do believe that U.S. Bancorp is an undervalued high-quality company, but I also know that investors like growth and it may take a little while before investors warm up to the “slow today, better tomorrow” story at banks like USB.

At the time of writing, Stephen Simpson owned shares of JP Morgan.

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