U.S. Bancorp Shares Jump Despite Lukewarm Q2 Results On Interest Rate Optimism
At first look, the second quarter of the year appeared to be a rather lackluster period for U.S. Bancorp (NYSE:USB), with the regional banking giant reporting revenue and earnings figures that were in-line with investor expectations. [1] Although revenues for Q2 2015 were 5% higher sequentially, they fell 7% compared to the year-ago period.
But adjusting prior period revenues for the one-time gain recorded from the bank’s sale of Visa shares shows that the performances were nearly identical. U.S. Bancorp has done well to ensure that its interest-earning assets grew rapidly enough to make up for the significant reduction in its net interest margin (NIM) figure year-on-year. The sizable decline in loan provisions over Q2 2014 also indicates that growth has not come at the expense of loan quality – something that is necessary for sustainable growth in the future. On the downside, the bank reported a year-on-year increase in non-interest expenses (adjusting for the mortgage settlement in Q2 2014). This was largely unavoidable, though, as a bulk of the increase stems from additional headcount in risk and compliance activities.
All things considered, U.S. Bancorp’s low-risk business model looks poised to gain significantly once the Fed hikes benchmark interest rates. We maintain a $48 price estimate for U.S. Bancorp’s stock, which is slightly ahead of the current market price.
See our complete analysis for U.S. Bancorp
U.S. Bancorp’s Management Believes That Interest Margins Won’t Shrink Anymore
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 chart below details Wells Fargo’s reported NIM as well as net interest income figures for each of the last eighteen quarters:
As seen here, the bank’s NIM fell drastically from 3.69% to 3.03% between Q1 2011 and Q2 2015, 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. To put the impact of falling interest margins in perspective – if U.S. Bancorp’s net interest margin for Q2 2015 was 3.90%, then it would have reported a net interest income of $3.5 billion instead of the $2.7 billion it actually reported. The net interest income figure remained around $2.65 billion over the last five quarters thanks to sharp growth in interest-bearing assets on the bank’s balance sheet.
However, the management expressed optimism about the falling NIM trend, with the figure expected to remain stable around the current level for a couple of quarters before rising in response to the long-awaited hike in benchmark interest rates by the Federal Reserve. [2] 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 commercial loans.
Mortgage Business Also Picking Up Pace As Industry Grows
U.S. Bancorp was one of the few banks in the country that increased its focus on the mortgage industry after the economic downturn of 2008. The strategy paid off for the regional banking giant over subsequent years, as the mortgage refinancing wave of 2011-2012 drove its revenues to record levels. U.S. Bancorp originated $21 billion in mortgages (fresh as well as refinanced) on an average in each quarter over the Q1 2012 – Q1 2013 period. But with refinances dying out and with the demand for new mortgages not growing appreciably over 2013-2014, origination volumes sunk to a low of $6.2 billion in Q1 2014 – the lowest level since early 2007.
Things have been upbeat in the mortgage industry over recent quarters, though. U.S. Bancorp’s mortgage origination volumes rose to $10.5 billion on an average over Q3 2014 – Q1 2015, and jumped further to $13.4 billion for Q2 2015. Notably, the trend is expected to continue over coming quarters, as mortgage application volumes remained around $18.5 billion for each of the two quarters this year – up from around $13.5 billion for each quarter in 2014. This will positively impact U.S. Bancorp’s mortgage banking revenues in the future, as we capture in the chart below.
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More Trefis Research
- 2Q 2015 Earnings Release, U.S. Bancorp Earnings Releases, July 15 2015 [↩]
- U.S. Bancorp Says Pressure From Low Rates Looks to Ease, The Wall Street Journal, July 15 2015 [↩]