I've long said that U.S. Bancorp (NYSE:USB) is one of the (if not the) best banks in the United States, and so far nothing in 2012 has led me to rethink that view. Not only has management served investors well with a balanced approach to lending and fee income generation, but the company's capital and credit positions are in excellent shape. At this point, the only real problem with U.S. Bancorp is that other investors are well aware of the bank's quality and the shares don't seem to offer much capital undervaluation at present.
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Another On-Target Quarter
U.S. Bancorp delivered another solid quarter, though not one that was all that much stronger than expected. When coupled with a tougher outlook for lending, the bank may be at some risk of seeing its momentum stall a bit in the next quarter.
Operating revenue rose 9% from last year and 3% from the second quarter, with pre-provision net revenue (PPNR) up about 3%. Growth was fueled by net interest income, which rose 3% on a combination of higher earnings assets (up 2%), lower interest expense (down 12% sequentially) and flat net interest margin. While flat net interest margin may not be exciting, it was nevertheless better than what other super-regional banks like Wells Fargo (NYSE:WFC), PNC (NYSE:PNC) and Comerica (NYSE:CMA) produced.
Not surprisingly for U.S. Bancorp, credit quality and expenses are well in hand. The bank's efficiency ratio improved again (to 50.4%), while non-performing assets dropped 3% net of new reporting regulations (and 8% by the old method).
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Fees a Little Sluggish, and Lending May Slow
If there's a blemish on U.S. Bancorp's report, it would be in the fee income numbers. While reported income rose 3%, operating/adjusted growth was more on the order of 1%. That's hardly a disaster, and maybe that's a good testament to U.S. Bancorp's quality when that passes for the bad news.
That said, declining loan growth in the next quarter could sap momentum. Management suggested that uncertainties regarding the fiscal cliff and national election could take a couple of percentage points out of annualized loan volume growth. I expect management to offset some of that pressure with ongoing reductions in funding costs, but it will likely still weigh on net interest margins and maybe on sentiment as well.
I would also suggest that investors get ready to see lower credit card balances and maybe lower transaction/processing revenue. Major credit card players such as Citigroup (NYSE:C) are seeing lower balances as consumers continue to delever, so I expect U.S. Bancorp will see some of that as well.
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The Bottom Line
U.S. Bancorp has done a good job of managing the housing crunch and the evolutions in the regulatory environment. Moreover, with better than 4% growth in mortgage and commercial lending, the bank seems to be in no danger of losing share. It's not really surprising, then, that this has been a pretty strong stock over the past year.
Unfortunately, there's not as much capital undervaluation apparent in the shares today. Using a 17% long-term return on equity estimate, fair value looks to be in the high $30s - that's down a little bit from my last write-up on U.S. Bancorp, as I've increased my assumptions regarding share buybacks and capital returns to shareholders. If investors believe U.S. Bancorp can get back to the old ROE level of 19% or so, the fair value increases about 10%.
Either way, while U.S. Bancorp looks like a solid long-term hold in the bank sector, investors wanting more capital appreciation potential should probably shop around with an eye toward undervalued money center banks or smaller regional players.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.