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Good times can make it easier for investors to confuse the pretenders with the long-term winners, particularly if those pretenders are willing to ratchet up the risk and leverage in their business model to reap easy profits. When times get tough though, it is the best models and management teams that rise to the top. With the banking sector still firmly in the midst of malaise, U.S. Bancorp (NYSE:USB) is making a case that it may be the best bank investors can buy.
The Quarter That Was
Two significant points jump out with U.S. Bancorp’s third quarter release – first, the company actually beat the consensus revenue estimate, and it did not need to release any reserves to meet or beat its earnings target.
Revenue rose 1.5% on a sequential basis, helped by a 3% sequential increase in net interest income. Unlike many banks, USB showed an increase in net interest margin (tiny as it may have been), and loans actually grew on a sequential basis. Total non-interest income was flat on a sequential basis, but fees did rise 5% as the company was able to offset deposit fee declines prompted by new banking regulations.
On the credit side, the picture continues to slowly improve. Net charge-offs improved sequentially, as did the ratio of non-performing assets. Better still, the company made only modest reserves for mortgage repurchases, and the company seems well-positioned relative to other large banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC) when it comes to this particular controversy. (For related reading, check out What Drives A Bank Of America Recovery?)
The Road Ahead
With a relatively clean balance sheet and a strong fee-generating business outside of deposit fees, U.S. Bancorp looks like it is in good shape for the future. On the other hand, while the company does appear to have a growing loan portfolio (relatively rare in this market), the company is paying up for deposits, with relatively high CD rates relative to Wells Fargo (NYSE:WFC), Zions (Nasdaq:ZION), TCF (NYSE:TCB) and so on. If the company can profitably (and safely) put this money to work, it can capture deposit marketshare that may be hard for banks to regain later. What’s more, even if the company is willing to pay for CDs, the overall cost of funding is still quite competitive.
U.S. Bancorp is in an enviable position on multiple fronts. This bank can probably hike its dividend more (and faster) than any other major bank, and the odds that there is still a ticking credit time-bomb in the balance sheet are low. If there is a problem with USB, it may be that its options to outperform are shrinking on a relative basis. The company did not fall as far as Bank of America or Citigroup (to name two examples), and does not have the same rebound opportunity. Also, the company’s growth initiatives will take time to bear fruit and USB is limited in some respects – the company is too large to just buy into areas where it does not currently operate (like the South/Southeast regions). (For more, see The Evolution Of Banking.)
The Bottom Line
U.S. Bancorp was not a profligate mortgage lender, nor a rapacious collector of deposit fees. That suggests that the company has less restructuring to do to compete in the new banking world, and that the company’s historical ROE may be more attainable than for other banks. Investors who think USB can post long-term ROE in the 16% range can probably expect solid long-term returns from this stock.
Regards,
Don
