Many banks, but particularly the large banks like Citigroup (NYSE:C), have found the quality of their recent earnings reports challenged by those who do not approve of the large loan loss reserve releases that have buoyed the reported numbers. Does that change now, though, since conservatively-run U.S. Bancorp (NYSE:USB) has joined the list of banks recognizing reserve releases? While USB's reserve release was quite modest and the company's credit quality stands out as quite good, it may ultimately be a sign that conditions really are getting better for the banks.
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The Quarter That Was
It is easy to get bogged down in the details of bank earnings releases, so here are some of the most significant take-away points.
USB saw revenue increase 1% on a sequential basis and 3% on an annual basis for the fourth quarter. Net interest income was up 1% and 6%, respectively for those time periods, while non-interest income was up 5% and 10%. Non-interest income has long been a very significant part of U.S. Bancorp's business (and a reason that the company fared better during the recession), but investors should realize that the numbers this quarter were inflated by some "other" items that may not be repeatable. Netting out all of the "other," this item would have been down 3% sequentially and up 9% annually.
USB saw its net interest margin fall slightly, but 3.83% is still a very good result. Average earning assets were up 3%, and the company increased its loan book by 2% (or 1% net of acquisitions). Although a higher net interest margin would be much better, this is what bank investors should want to see - loan growth, net interest income growth, and so on.
Credit quality continued to improve in the fourth quarter. The company recognized a small reserve release ($25 million, or about one cent of EPS), and non-performing asset and charge-off ratios all improved (and are at good levels on a relative basis). Investors should also note that U.S. Bancorp has reserves well in excess of current non-performing loans (162%) - that is very conservative relative to other banks like Comerica (NYSE:CMA) or the also extremely well-run M&T Bank (NYSE:MTB).
The Road Ahead
Relative to many other banks, U.S. Bancorp is in good shape. While the bank's size limits what it can do in terms of domestic acquisitions, and the company's conservative policies may preclude overseas expansion, the company is nevertheless at least in good position to resume lending and build its market share organically. A strong capital and credit position also leaves the company in good shape to boost its dividend payout, and that appears to be a priority for the bank. (For more, see 2010: A Year Of Banking Dangerously.)
Longer term, U.S. Bancorp does have some challenges when it comes to growth. Bank of Montreal (NYSE:BMO) is knocking on the door in some of USB's markets, and other competitors are likely to enter the U.S. as well. What's more, smaller banks like TCF Financial (NYSE:TCB), City National (NYSE:CYN) and PNC (NYSE:PNC) have options that USB does not in terms of M&A activities (as well as smaller bases from which to grow).
U.S. Bancorp also has to navigate the challenges offered up by the new regulatory environment. USB has long relied on various fees and non-interest revenues for a sizable chunk of its profits, and the Feds are crimping that business to some extent. By the same token, do not underestimate management - history says they will find new sources of fees and new profitable business ventures that fit into their risk preferences.
The Bottom Line
So, what is U.S. Bancorp worth? That question really centers around the sort of return on equity the company can get in the future. Assuming a long-term ROE of 15%, the shares look to be worth about $29 per share. If the company can match its 5-year average ROE of about 17.5%, that target moves to $35, and if investors believe the bank can recapture prior high ROE levels around 20%, the target jumps to over $41.
It seems as though it will be difficult for USB to get back to ROEs in the 20's or even the very high teens, but with even modest ROE recovery assumptions leading to attractive price targets, investors looking to build some exposure to financials should give very serious consideration to U.S. Bancorp shares. (For related reading, see Citi: More, Better, Faster, Please.)
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