U.S. Bancorp (NYSE:USB) did quite well over the last quarter of 2013, announcing better-than-expected figures for the largely lackluster period.  Interestingly, the country’s fifth largest commercial bank reported record earnings for the year despite the pressure on revenues for commercial banks in 2013 from shrinking interest margins as well as dwindling mortgage activity. So how exactly did U.S. Bancorp overcome the limitations of its risk-averse traditional banking model and exposure to the mortgage industry to achieve this feat?
There are two primary factors responsible for this. One is the bank’s own diligent efforts to refocus on areas where revenues are less dependent on interest rates, such as commercial banking and asset management. The second stems from the overall improvement in the country’s economic conditions, as U.S. Bancorp set aside a lower amount of provisions in Q4 2013 than it has done for any quarter since the economic downturn of 2008.
All things considered, U.S. Bancorp’s business model looks sound. It does not promise outsized returns, but the low-risk, steady growth promise it delivers provides comfort to investors. We factored in the anticipated improvement in the interest rate environment, improving asset management fees as well as shrinking provision requirements in our analysis and consequently update our price estimate for U.S. Bancorp’s stock from $40 to $43, which is slightly ahead of the current market price.
Net Interest Margin Is Expected To Reverse Its Trend This Quarter
U.S. Bancorp’s business model, due to its reliance on traditional banking operations, is very sensitive to interest rates. This is why the biggest concern among investors about its performance over recent quarters has been the sequential decline in its net interest margin (NIM). Due to the extended low interest-rate environment, safe investment options with reasonably high rates of return have been difficult to come by, which has squeezed margins.
The table below summarizes U.S. Bancorp’s reported net NIM figures for each quarter since early 2011:
|Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||Q1 2013||Q2 2013||Q3 2013||Q4 2013|
As seen here, the bank’s NIM fell from 3.69% to 3.40% between Q1 2011 and Q4 2013, with a large part of this decline witnessed since late 2012. Thankfully, with the Fed finally announcing plans to implement its tapering plan beginning this month, the interest rate environment should witness some improvement this quarter. This is expected to help U.S. Bancorp’s net interest margin increase for the first time in since the marginal improvement in Q3 2012.
You can understand the partial impact of falling net interest margins on the bank’s total value by making changes to the chart below, which represents U.S. Bancorp’s NIM on credit card loans.
Loan Provisions Should Also Decline For A Couple Of More Quarters Before Normalizing
The steady improvement in credit quality since the economic downturn of 2008 has helped U.S. Bancorp cut down on loan losses over the years. With the proportion of bad loans decreasing, the bank has been able to set aside sequentially lower provisions to cover these loans. The bank reported provisions of $277 million for Q4 2013 – the lowest since Q4 2007, when total provisions were $225 million. The impact of this on the bank’s share value can be partially understood by making changes to the chart below, which shows that provisions for the mortgage banking division have fallen from more than 2.9% of the outstanding loan volume in 2009 to 0.5% presently.Notes: