U.S. Bancorp Tops Zacks Estimates - Analyst Blog

U.S. Bancorp (USB) reported third quarter 2010 earnings attributable to common shareholders of $871 million or 45 cents per share, two cents ahead of the Zacks Consensus Estimate of 43 cents. The results also compare favorably with the prior quarter's earnings of $862 million or 45 cents per share and the prior-year quarter's earnings of $583 million or 30 cents per share.

The improvement in U.S. Bancorp's earnings primarily stemmed from a strong growth in revenues, reflecting the business growth initiatives taken by the company, including acquisitions. Credit metrics also showed improvements.

U.S. Bancorp also reported a decrease in provision for credit losses, both sequentially and year over year with both net charge-offs and nonperforming assets revealing a declining trend. Provision for credit losses was $995 million, down 12.6% sequentially and 31.7% year over year.

Inside the Headline Numbers

Revenues were strong at $4.6 billion, up 1.5% sequentially and 7.9% year over year, primarily reflecting growth in interest income. Revenues also came in above the Zacks Consensus Estimate of $4.5 billion.

Tax-equivalent net interest income was $2.5 billion, up 2.8% sequentially and 14.8% from the prior-year quarter, driven by an increase in average earning assets and continued growth in lower-cost core deposit funding.

Average earnings assets were up 1.8% sequentially and 7.6% year over year. Net interest margin of 3.91% was up 1 basis point sequentially and 24 basis points (bps) year-over-year as a result of favorable funding rates and improved credit spreads.

Average loans were up 0.7% sequentially and 5.8% year over year, reflecting acquisitions. Though average deposits declined slightly by 0.4% sequentially, the figure was up 9.8% year over year due to acquisitions.

Non-interest income remained flat sequentially but increased 0.8% year over year to $2.1 billion. The increase in payments-related revenue and other fee-based businesses were partly offset by the negative impact from the recent legislative actions and current economic conditions.

However, non-interest expense increased 0.3% sequentially and 16.2% year over year to $2.4 billion. The year-over-year increase reflects the impact of acquisitions, compensation and employee benefits expense.

Sequentially, favorable variances in many of the expense categories were being offset by higher compensation, marketing and business development and professional services expense. The tangible efficiency ratio was 49.9% in the reported quarter compared with 50.4% in the prior quarter. However, the ratio deteriorated from 45.3% reported in the year-ago quarter.

Credit Quality

U.S. Bancorp's credit metrics improved from the prior quarter. Net charge-offs (excluding covered loans) were 226 bps of average loans outstanding, down 35 bps sequentially and 15 bps year over year. Nonperforming assets as a percentage of related assets (excluding covered assets) were 2.02%, down 15 bps sequentially and 12 bps year over year.

Capital Ratios

U.S. Bancorp's capital position remained strong. Capital generated from earnings resulted in improved metrics both sequentially and year over year. Return on average assets and return on average common equity were 1.26% (up 17 bps sequentially and 36 bps year over year) and 12.8% (down 60 bps sequentially but up 280 bps year over year), respectively.

U.S. Bancorp also posted an improvement in book value per share, which increased to $14.19 as of September 30, 2010, from $13.69 at the end of the prior quarter and $12.38 at the end of the prior-year quarter.

Tier 1 capital ratio also improved to 10.3% from 10.1% in the prior quarter and 9.9% in the year-ago quarter. Tier 1 common equity ratio increased to 7.6% from 7.4% reported in the prior quarter and 7.1% in the year ago quarter.

U.S. Bancorp's management and board of directors are confident of the company's capital position and expect it to be one of the first banks to get the regulatory approval to increase dividend.

Competitors

Similar to U.S. Bancorp, Citigroup Inc. (C) and JPMorgan Chase & Company (JPM) have reported impressive third quarter results on lower loan loss provisions. This trend is encouraging and inspires confidence on the economic improvement, though its pace may be sluggish. However, the recent legislative actions are posing challenges for the fee income to grow.

Going forward, we expect a number of provisions of the financial reform act to negatively impact both the top and bottom line results of these banks and the results of other biggies such as Goldman Sachs (GS), Bank of America (BAC), Wells Fargo (WFC) and Morgan Stanley (MS).

Our Take

We expect U.S. Bancorp to post growth in core earnings and benefit from its diversified revenue base and strategic acquisitions. The company is one of the biggest retail banks in the U.S. and is one of the nation's top 10 banks. It has weathered the economic downturn relatively well and was one of the first few companies to repay the TARP bailout money. The sequential improvement in the credit quality was impressive.

Nevertheless, we believe that the regulatory issues would continue to pose as headwinds for both top and bottom lines. Additionally, the protracted economic recovery and a substantially competitive landscape challenge the company.

U.S. Bancorp shares are maintaining a Zacks #3 Rank, which translates into a short-term Hold' recommendation. We have a long-term “Neutral” recommendation on the stock.