U.S. Bancorp Ends 2015 On A High, As Solid Loan Growth Boosts Q4 Earnings
U.S. Bancorp (NYSE:USB) demonstrated the strength of its risk-averse business model once again on Friday, January 15, when the banking giant reported record revenues for the last quarter of the year. This came even as weak equity and debt market conditions hurt top line figures for its larger, more diversified rivals JPMorgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC), Citigroup (NYSE:C) and Bank of America (NYSE:BAC). [1] The traditional loans-and-deposits model gained in Q4 from healthy growth in key loan categories, even as the holiday season boosted card revenues. Also, as U.S. Bancorp’s exposure to the energy sector is substantially smaller than that of its peers, it did not have to raise its loan provisions significantly to cover for the deteriorating quality of loans to energy companies. This helped the bank report its highest ever pre-tax profit figure (adjusted for one-time gains) in Q4 2015. The bottom line shrank marginally compared to Q3 2015 and Q4 2014, though, due to seasonally higher operating expenses and a notable increase in income tax.
With the Fed initiating the process of interest rate hikes, U.S. Bancorp will begin seeing the positive impact of this on its profits in the near future. Also, the bank’s focus on several fee-based revenue sources, and its historical record of making strategic acquisitions to complement its offerings will help unlock more value in the future. That is why we maintain a $47 price estimate for U.S. Bancorp’s stock, which is about 20% ahead of the current market price.
See our complete analysis for U.S. Bancorp
Interest Margins Already Trending Upwards, More Gains To Follow
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 years has been the sharp 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 – in turn squeezing margins.
The chart below details Wells Fargo’s reported NIM as well as net interest income figures for each quarter over the last five years:
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 meet regulatory liquidity requirements. However, the net interest income figure largely remained around $2.65 billion thanks to sharp growth in interest-bearing assets on the bank’s balance sheet.
The trend reversed in Q3 and Q4 2015, as the NIM figure increased to 3.06%. With the Fed also announcing its first rate hike in late December, there should be a notable improvement in the NIM as well as net interest figures over the first half of 2016. Subsequent rate hikes will only add to the interest spread for the bank in the future. You can understand the partial impact of changes in net interest margins on the bank’s total value by making changes to the chart below, which represents U.S. Bancorp’s NIM on investment securities.
Mortgage Banking Woes Likely To Continue
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 improved for the mortgage industry over the next six quarters, though, with U.S. Bancorp’s mortgage origination volumes rising steadily to just under $14 billion in Q3 2015. However, the trend reversed sharply in Q4, and origination volumes fell to $11.4 billion. Also, the pipeline of fresh mortgage applications has now been shrinking for three consecutive quarters, with the bank receiving applications for less than $14 billion new mortgages in Q4 compared to $18.6 billion in Q1 and $17 billion in Q3. This indicates an overall sluggishness in the country’s mortgage industry, and does not bode well for U.S. Bancorp in the near term, because mortgage production volumes are expected to be driven almost entirely by fresh mortgages as the Fed slowly hikes benchmark interest rates.
Card And Payments Division Should Help Make Up For Shortfall
U.S. Bancorp has put in significant effort over recent years to grow its cards and payment business as it looks for ways to counter the impact of shrinking mortgage revenues on the top line. While card payment volumes have been growing steadily over the last few quarters, the additional boost from spending during the holiday spending helped card fee revenues increase to $294 million in Q4 2015 – the highest ever level for the bank. This compares to a figure of $270 million for each of Q3 2015 and Q4 2014. Retail credit card payment volumes crossed $18 billion for the first time while debit card payments were just shy of $16 billion. On the other hand, the bank’s merchant processing revenues and corporate payment fees fell in Q4, because of which total revenues from payment services decreased marginally from $874 million in Q3 2015 to $870 million.
Going forward, we expect a steady increase in U.S. Bancorp’s retail credit card base and sustained growth in corporate and merchant processing volumes to drive overall revenue growth.
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- 4Q 2015 Earnings Release, U.S. Bancorp Press Releases, Jan 15 2015 [↩]