The fifth-largest U.S. bank by deposits and among the very best in terms of return on capital, U.S. Bancorp (NYSE:USB) has been finding it more and more challenging to surpass expectations. It may be a good problem to have, from an operational standpoint, but U.S. Bancorp's quality is well known on the Street and reflected in the share price. While the bank can still make sense as a long-term holding given its superior risk characteristics, shareholders should not expect dramatic short-term capital gains from these levels.
Better Than The Rest, But That Was Expected
Relative to the average large bank, Minneapolis-based U.S. Bancorp did well in its first quarter. That sort of performance has become the baseline expectation, though, and it will likely take higher rates to really start moving the earnings higher.
Revenue fell 1% yoy and 2% from the December quarter. Net interest income was down 1% sequentially as reported, which was on par with Winston-Salem, N.C.'s BB&T Corp. (NYSE:BBT) and a bit better than the 2% declines of San Francisco's Wells Fargo & Co. (NYSE:WFC), New York's Citigroup Inc. (NYSE:C), and Charlotte, N.C.-based Bank of America Corp. (NYSE:BAC), and the 3% decline at Pittsburgh-based PNC Financial Services Group Inc (NYSE:PNC). The five basis-point decline in net interest margin was pretty much on par with the comps, as U.S. Bancorp saw pressure from more competitive loan pricing and the winding down of its payroll lending operations.
Fee income performance was a little better, though, as U.S. Bancorp's earnings here fell 2% (about half the average of its peers). Mortgage banking was up a reported 2%, though core mortgage-related earnings were down about 16% on a 27% decline in production volume. Relative to peers like Wells Fargo or BB&T, this was not a particularly surprising outcome, though U.S. Bancorp did better on deposit service charges.
U.S. Bancorp has always done particularly well on expenses, so it's not surprising to see the bank surpass its peer group here – expenses were down 5% sequentially, while the peer group saw an average 2% decline with Wells Fargo down 1%, BB&T down 3%, and Citi up 1%. All told, this lead to a 3% sequential increase in pre-provision profits, one of the better results of the large banks.
Lending Still Sluggish, But Credit Quality Stays Strong
Like its peer group, U.S. Bancorp saw a 1% increase in period-end loans, with most of the growth in commercial lending. The spring selling season should help mortgage demand, but competition in commercial and CRE lending remains fierce as smaller banks get more aggressive on pricing.
On the credit side, U.S. Bancorp saw the non-performing asset ratio tick down two basis points (to 0.78%), while the net charge-of ratio rose five basis points to 0.60%. Both of these numbers compare favorably to the peer group and U.S. Bancorp remains one of the strongest credit stories among the large banks.
Where Do You Go From The Top?
One of the challenges facing U.S. Bancorp management is finding new business opportunities that can generate profits on par with the existing operations. The company's large payment systems operation is a significant source of profits (around one-quarter of company profits) and unlike the insurance operations of Wells Fargo and BB&T, it doesn't require large levels of capital to support. As integrated payment services are becoming more important in the acquiring/processing space, U.S. Bancorp should be well-positioned to offer these value-added services, but it remains to be seen if the company will commit the capital to build a larger non-U.S. business.
There still remain opportunities to improve the core banking operations. Its wholesale banking operations have enjoyed national scale for only a relatively short period of time, while the company has also built up its share in auto and mortgage lending to compete more significantly with Wells Fargo and Bank of America.
U.S. Bancorp also recently availed itself of an opportunity to grow its Chicago-area business. U.S. Bancorp agreed to acquire RBS's Charter One branches in Chicago for $315 million (a 6% deposit premium). This move roughly doubles the company's share to 3.5%, but at #8 in the market (and well behind the likes of J.P. Morgan Chase & Co. (NYSE:JPM), Bank of Montreal (NYSE:BMO) and Bank of America) there's more work to do. Strong local market share can be an invaluable source of low-cost funding, but U.S. Bancorp really needs to get into the top five to reap those benefits in the Chicago area.
The Bottom Line
U.S. Bancorp has virtually all of the quality that an investor could want, but at a value. A long-term ROE estimate of 17% supports a fair value of about $42.50, while the company's return on tangible equity supports a multiple to tangible book value of about 3.0x to 3.1x. Neither of those argue that these shares aren't basically fairly valued today. There are worse things than holding the fairly-valued shares of an excellent company, so I would not be in a hurry to sell out of a position in U.S. Bancorp. That said, the next couple of quarters will likely see sluggish growth prospects and there are slightly cheaper options like Wells Fargo and BB&T that could offer a little more appreciation potential.
Disclosure – As of this writing, the author owned shares of JPMorgan and BB&T.