We are downgrading our recommendation on U.S. Bancorp (USB) to Neutral from Outperform based on a tepid economic recovery and low interest rate environment. We anticipate a compression in interest margin and expect only modest fee income growth in the upcoming quarters.
Fourth Quarter Results
U.S. Bancorp reported fourth-quarter 2011 earnings of 69 cents per share. Excluding the gain from a litigation settlement and expense accrual related to mortgage servicing matters, the company reported earnings of 64 cents per share. Earnings surpassed the Zacks Consensus Estimate of 63 cents per share.
The better-than-expected results at U.S. Bancorp were driven by growth in revenue, which was supported by increases in both net interest income and fee-based revenue, and reduced credit costs. These positives were partially offset by an increase in non-interest expenses.
Stress Test and Capital Redeployment
U.S. Bancorp has a disciplined approach to capital management, and capital redeployment remains a top priority for the company. We believe that the passing of the stress test along with the capital redeployment plans serve as positive catalysts for the company’s stock price.
After receiving the approval from the Federal Reserve, the company has announced a 56% hike in its dividend and a 100 million share repurchase authorization. In fact, management expects to return 60–80% of earnings to its shareholders in the form of dividends and buybacks over the long term. Such shareholder-friendly approach inspires investors’ confidence in the stock.
Besides U.S. Bancorp, the other major banks on Wall Street that have cleared the stress test requirements – and therefore increased their capital redeploying efforts through dividend increases and share buybacks – include Wells Fargo & Company (WFC) and JPMorgan Chase & Co. (JPM).
With a wide range of product offerings, U.S. Bancorp remains well positioned for organic growth. Its strong retail banking franchise and leadership in payment processing should continue to help in growing its earnings. Moreover, the company is also focused on expanding its business through acquisitions. It has a well-balanced business model, with non-interest revenue representing nearly half of its total revenue.
U.S. Bancorp’s loan growth, improving credit quality and solid capital levels appear impressive. A rise in dividend payouts and share buybacks following the stress test results give a fillip to investors’ confidence.
However, we believe that the positive factors have already been priced in the current valuation. Moreover, a sluggish economy that adversely affected consumer and business spending has impacted a number of fee-based categories over the last several quarters. Though we expect the fee-based category to pick up over time with an improvement in the economy, we think that the progress will be tardy with a sluggish economy recovering. Moreover, we believe that given the current interest rate environment and the company’s cash position, net interest margin will remain under pressure.
Although U.S. Bancorp made efforts to recapture a part of lost revenues from the regulatory initiatives, we believe that such stringent regulations upon full implementation will limit the company’s revenue or impose additional costs thereby affecting its financial results adversely.
Therefore, the risk-reward profile seems balanced for U.S. Bancorp and we rate the stock Neutral for the long term.
U.S. Bancorp currently retains the Zacks #2 Rank, which translates into a short-term “Buy” rating.
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