U.S. Bancorp Q2 Earnings Impress Investors on Organic Growth (Revised)

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U.S. Bancorp (USB) reported an earnings surprise of 1.3%, which was primarily attributable to the company’s strong top-line performance. The company’s second-quarter 2014 earnings per share of 78 cents outpaced the Zacks Consensus Estimate by a penny. Moreover, this compared favorably with 76 cents earned in the prior-year quarter.

Shares of U.S. Bancorp increased marginally in the pre-market session, indicating that investors have been bullish on the results. The price reaction during the trading session will give a better idea about whether U.S. Bancorp has been able to meet expectations.

Notably, in the second quarter, U.S. Bancorp reached a settlement with the U.S. Department of Justice (:DOJ) worth $200 million resolving claims associated with origination of faulty mortgage loans insured by the Federal Housing Administration (:FHA). Prior to this, the company sold 3.0 million shares of the Class B common stock of Visa Inc., which recorded a net pre-tax gain of $214 million. Therefore, the sale of Visa Class B shares neutralized the DOJ settlement charges, thereby not affecting earnings per share.

Net income attributable to U.S. Bancorp was $1.5 billion in the quarter, up around 1% year over year. Higher revenues, a strong capital position, improving credit quality and growth in average loans and deposits were the positives for the quarter.

Furthermore, segment-wise, on a year-over-year basis, quarterly net income in Wholesale Banking and Commercial Real Estate and Consumer and Small Business Banking segments fell 11.9% and 17.6%, respectively, while, Payment Services, Wealth Management and Securities Services and Treasury and Corporate Support segments reported a rise of 5.6%, 16.7% and 19.9%, respectively.

Performance in Detail

U.S. Bancorp’s net revenue came in at around $5.2 billion in the quarter, up 4.9% year over year and surpassed the Zacks Consensus Estimate of $4.9 billion. Results were primarily driven by increase in both net interest and non-interest income.

U.S. Bancorp’s tax-equivalent net interest income stood at $2.7 billion in the quarter, reflecting a 2.7% rise from the comparable last-year quarter. The upsurge was mainly due to increased average earning assets and persistent growth in lower cost core deposit funding. These positives were partially offset by reduced loan fees as well as lower rates on new loans and securities.

Average earning assets were up 7.7% year over year, driven by growth in average total loans and average investment securities. Yet, net interest margin of 3.27% fell 16 basis points year over year and mainly reflected reduced rates on investment securities and  new loans, partly mitigated by lower rates on deposits and reduced higher cost long-term debt.

U.S. Bancorp’s non-interest income moved up 7.4% year over year to $2.4 billion. Increased other income due to the Visa sale along with higher fee income in mostly revenue categories led to the rise. Yet, reduced mortgage banking revenue was on the downside.

U.S. Bancorp’s average total loans climbed 6.8% year over year to $240.5 billion, owing to growth in commercial loans, residential mortgages, total commercial real estate, retail leasing and credit card loans. These increases were partially offset by a drop in home equity and second mortgages and covered loans. Excluding covered loans, average total loans rose 8.3% year over year.

Average total deposits were up 6% from the prior-year quarter to $262.4 billion. The upsurge stemmed from growth in non-interest-bearing deposits, savings deposits as well as interest-bearing deposits.

Non-interest expense increased 7.7% on a year-over-year basis to $2.8 billion at U.S. Bancorp. DOJ settlement and elevated compensation expense primarily led to the rise. These negatives were partially offset by lower employee benefits and other intangibles.

Credit Quality

Credit metrics improved at U.S. Bancorp in the reported quarter. Net charge-offs (excluding covered loans) stood at $347 million, down 7% year over year. On a year-over-year basis, the company experienced improvement in net-charge-offs in the residential mortgage and other retail portfolios.

U.S. Bancorp’s nonperforming assets (excluding covered assets) were $1.8 billion, down 5.3% year over year. Total allowance for credit losses was $4.4 billion, down 4.3% year over year. Provision for credit losses decreased 10.5% year over year to $324 million in the reported quarter.

Capital Position

During the quarter under review, U.S. Bancorp maintained a solid capital position. Effective Jan 1, 2014, the regulatory capital requirements for the company follows Basel III, subject to certain transition provisions from Basel I over the next four years to full implementation by Jan 1, 2018.  Additionally, as of Apr 1, 2014, the company exited its parallel run qualification period, resulting in its capital adequacy. The transitional common equity tier 1 capital ratio was 9.6% as of Jun 30, 2014 compared with 9.7% as of Mar 31, 2014.

The tier 1 capital ratio was 11.3% compared with 11.1 % as Jun 30, 2013. The tangible common equity to tangible assets ratio was 7.5%, in line with the prior-year quarter.

All regulatory ratios of U.S. Bancorp continued to be in excess of “well-capitalized” requirements. Moreover, based on the Basel III fully implemented advanced approach, the Tier 1 common equity to risk-weighted assets ratio was estimated at 11.7% as of Jun 30, 2014.

U.S. Bancorp posted an improvement in book value per share, which increased to $20.98 as of Jun 30, 2014 from $18.94 at the end of the prior-year quarter.

Capital Deployment Update

Reflecting the company’s capital strength during the second quarter, U.S. Bancorp returned 75% of earnings to shareholders through common stock dividends of $445 million and the stock buyback of $631 million. This was within the range of its long-term goal of returning 60–80%.

In Conclusion

We believe that U.S. Bancorp’s attractive core franchisee, diverse revenue streams and strong performance in the past years are impressive. A solid capital position, improving credit quality and increase in lending activities augur well for the company. It adheres to a conservative growth stratagem and has made small but strategic acquisitions.

Recently, U.S. Bancorp doubled its deposit market share in Chicago with the closure of the acquisition of the Chicago branch network of the Charter One Bank franchise owned by RBS Citizens Financial Group, a subsidiary of The Royal Bank of Scotland Group plc (RBS). With this deal, U.S. Bank now has over 160 branches in Chicago.

Moreover, the latest hike of 6.5% in the quarterly common stock dividend marks U.S. Bancorp’s 4th dividend increase since 2011, reflecting its commitment to return value to shareholders with strong cash generation capabilities.

However, the top-line headwinds are expected to persist, given the protracted economic recovery. Also, a low interest-rate environment would keep U.S. Bancorp’s margins under pressure. Moreover, absence of credible improvement in the mortgage market remains a negative.

Though there are concerns related to the impact of legal issues and its global exposures, equity-centric activities in the U.S. are expected to support U.S. Bancorp’s results in the upcoming quarters with continued recovery in the capital markets. The shares of U.S. Bancorp currently carry a Zacks Rank #3 (Hold).

Performance of other Major Banks

The second-quarter earnings season kick started with Wall Street biggie – Wells Fargo & Company (WFC). Driven by prudent expense management, Wells Fargo earned $1.01 per share in second-quarter 2014, thereby surpassing 98 cents earned in the year-ago quarter. However, the reported figure was in line with the Zacks Consensus Estimate.

Continuing the positive note, Citigroup Inc. (C) reported impressive second-quarter 2014 results. Adjusted earnings per share came in at $1.24, outpacing the Zacks Consensus Estimate of $1.08. However, earnings were below the year-ago figure by a penny.

Results in the reported quarter were impacted by credit valuation adjustment (CVA) and debt valuation adjustment (DVA). Moreover, results included charges worth $3.8 billion ($3.7 billion after-tax) related to the aforementioned deal. Including these, Citigroup reported net income of $181 million or 3 cents per share in the second quarter compared with $4.2 billion or $1.34 per share in the prior-year quarter.

(We are reissuing this article to correct a mistake. The original article, issued on July 16, 2014, should no longer be relied upon.)

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