U.S. Bancorp Continues To Churn Out Steady Profits From Its Risk-Averse Model

Falling mortgage banking revenues and shrinking net interest margins could not stop U.S. Bancorp (NYSE:USB) from reporting a solid earnings figure for the first quarter, as the regional banking player tightened its grip on expenses to combat the issues that have plagued commercial banks for several quarters now. ^[1] Also, the bank has effectively refocused its efforts on areas where revenues are less dependent on interest rates, such as commercial banking, asset management and payment systems, to help maintain its top line figures.

Although the bank reported its best-ever earnings figures for the last three months of 2013, it must be remembered that those results benefited considerably from an income tax credit. The bank performed much better operationally in Q1 2014, with pre-tax income improving almost 2% quarter-on-quarter. Compared to the same quarter last year, the bank reported largely identical results as the impact of significantly lower mortgage banking fees between the two periods was mitigated by lower provisions this time around.

All things considered, U.S. Bancorp’s business model remains sound. It does not promise huge returns, but the low-risk, steady growth promise it delivers provides comfort to investors. We maintain a $42 price estimate for U.S. Bancorp’s stock, which is about 5% ahead of the current market price.

See our complete analysis for U.S. Bancorp

Net Interest Margins A Source Of Concern, But Reversal In Trends Likely

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:

As seen here, the bank’s NIM fell from 3.69% to 3.35% between Q1 2011 and Q1 2014, with a large part of this decline witnessed since late 2012. This has been due to lower interest income from variable sources, a steady growth in interest-bearing customer deposits and also because of actions undertaken by the bank to ensure regulatory liquidity requirements.

However, with the Fed initiating its tapering plan in January, the interest rate environment has shown some improvement over the last couple of months. This should help U.S. Bancorp’s net interest margin increase for the first time in almost two years 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.

Other Revenue Sources Offset Hit To Mortgage Banking Fees

U.S. Bancorp has a significant share of the country’s mortgage industry, with the bank ranking third among all banks in terms of mortgage originations for the year 2012 – after Wells Fargo and JPMorgan. The bank surpassed larger rivals Bank of America and Citigroup for this period as it figured high on customers’ preference list for mortgage refinances. But things changed drastically in 2013 as the refinancing wave died out almost completely. To put things in perspective, mortgage banking fees for U.S. Bancorp fell from a peak level of $519 million in Q3 2012 to $236 million in Q1 2014 – a 55% decline.

However, over the same period, card revenues have jumped by 12% to $239 million, and trust & investment management fees have shown a 15% hike. In fact, the bank reported its highest-ever trust & investment management fee figure of $304 million this quarter.

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1. 1Q 2014 Earnings Release, U.S. Bancorp Press Releases, Apr 16 2014 [↩]