Steady As She Goes Is Fine For U.S. Bancorp

By Stephen D. Simpson, CFA | January 15, 2013 AAA

There never has been anything particularly flashy about U.S. Bancorp (NYSE:USB), and I don't think that will change in the conceivable future. Consequently, this isn't always a stock that generates a lot of excitement - management just goes about its business, building value over time. That said, relative to the company's demonstrated returns and earnings power, I continue to believe that U.S. Bancorp is an undervalued bank stock that is worth buying and owning today.

SEE: The Banking System: Introduction

Fourth-Quarter Results - A Penny Here and There, but Pretty Much Straight Down the Fairway
U.S. Bancorp reported that operating revenue rose 5% versus last year, while falling 1% on a sequential basis. Pre-provision net revenue rose 10% and fell 3%, respectively. Net interest income rose 4.1% annually and was flat sequentially, as the company saw modest declines in net interest margin (5 basis points annually, 4 basis points sequentially) but growth in average earning assets (6% and 1%).

Fee income rose 7% from last year and fell 3% sequentially, as mortgage banking fees weakened 8.3% from the third quarter. Card revenue was quite solid (up 5% and 14%), trust fee income was good (up 13% and 4%), but merchant processing income (down 6% and up 2.6%) seemed a little soft relative to Global Payments (NYSE:GPN (which, admittedly, is not entirely a like-for-like comparison).

U.S. Bancorp continues to do a decent job with expense management - expenses were flat sequentially, and the company's 51.5% efficiency ratio compares very favorably with other banks such as Wells Fargo (NYSE:WFC) and Commerce Bancshares (Nasdaq:CBSH) that have reported so far this quarter.

SEE: Commercial Banking - Key Ratios/Factors

Credit Getting Better, but Spreads Tightening
Compared to other super-regional/money center banks such as Wells Fargo, Bank of America (NYSE:BAC), Fifth Third Bank (Nasdaq:FITB), and so on, U.S. Bancorp has long stood out for its credit quality. For the fourth quarter, U.S. Bancorp saw non-performing loans drop another 12% sequentially, while the non-performing asset ratio improved to below 1%, as did the net charge-off ratio. Credit card charge-offs continue to improve (down to 4% from 4.9% a year ago), and that's likely a positive sign for other large credit card companies such as Capital One (NYSE:COF) and American Express (NYSE:AXP). That said, the company did add $52 million to its mortgage repurchase reserves.

U.S. Bancorp continues to grow - the company's quarter-end loan balances were up 6.9% and 2%, with the best growth in residential mortgages. While still positive, this was the weakest quarter for commercial loan growth in quite a few quarters. Deposits rose 3.7% sequentially and while this bank has also increased its non-interest bearing deposit base, it already had a higher ratio than most. Consequently, USB is in a similar position as most other banks - yields on loans and securities are shrinking, and there's not much wiggle room left to reduce borrowing costs further.

SEE: The Banking System: Commercial Banking - Bank Crises And Panics

More Capital Likely to Flow to Shareholders
Based on management's commentary, there seem to be few worries about the loan book at this point in the cycle. At the same time, management doesn't seem to see all that many excellent business expansion possibilities - at least not those that require substantial capital. Consequently, I would expect to see the company to petition for (and receive) permission to increase its dividend and share buyback programs.

The Bottom Line
Given that there was very little out of the ordinary in this quarter, I see no reason to make meaningful changes to my U.S. Bancorp model or valuation. I still believe that this company can return to mid-to-high teens ROEs, and I also believe the company's demonstrated excellence deserves a reasonable discount rate. All in all, I think these shares ought to trade in the low-to-mid $40 range, and though are not quite as cheap as Wells Fargo, I believe they're, nonetheless, a good buy.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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