Strong Loan Growth Helps U.S. Bancorp Exceed Q3 Expectations Despite Higher Costs
Staying true to a risk-averse business model that relies on the traditional loans-and-deposits business for long-term growth, U.S. Bancorp (NYSE:USB) churned out better-than-expected results for the third quarter on Wednesday, October 15, thanks to all-around growth in its loan portfolio. [1] The country’s largest regional bank saw its loan portfolio cross the $250-billion mark for the first time in Q3, which – coupled with a sequential reduction in the size of deposits – allowed the bank to report its highest ever net interest income figure. This is a commendable feat given the reduction in revenues across the banking industry over recent years due to the prevalent low interest rate environment. The top line also received a boost from a record performance by the bank’s card and payments services division.
With revenues increasing year-on-year as well as quarter-on-quarter, and with loan provisions remaining unchanged, U.S. Bancorp managed to post a slight increase in pre-tax profits despite incurring higher employee-related costs. In fact, the bank’s pre-tax income figure was the second highest ever – behind only Q2 2014, when results benefited from a one-time gain on the sale of Visa shares.
It should be noted that the increase in U.S. Bancorp’s operating expenses over the last couple of quarters has largely been unavoidable, as a bulk of the increase stems from additional headcount in risk and compliance activities. This factor is unlikely to affect profits in the future, especially since the bank’s asset base looks set to gain significantly once the Fed hikes benchmark interest rates in the near future. This is why we maintain our $47 price estimate for U.S. Bancorp’s stock, which is about 15% ahead of the current market price.
See our complete analysis for U.S. Bancorp
Net Interest Margin Expanded For The First Time In Three Years
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 declines 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 in turn has squeezed margins.
U.S. Bancorp’s NIM fell drastically from 3.90% to 3.03% between Q1 2010 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 Q3 2015 was 3.90% then it would have reported a net interest income in excess of $3.6 billion instead of the $2.8 billion it actually reported.
Notably, U.S. Bancorp’s net interest income for the quarter nudged higher from around $2.7 billion over the previous five quarters as a direct result of an increase in total loans even as the deposit base shrunk marginally. This helped the NIM figure increase 1 basis point (0.01% point) from 3.03% in Q2 2015 to 3.04% now. The recent trend justifies the optimism expressed by the bank’s management about its interest margins in July. And with the Fed likely to announced a rate hike in the near future, U.S. Bancorp should be able to leverage the improving interest rates to grow its top line. ((U.S. Bancorp Says Pressure From Low Rates Looks to Ease, The Wall Street Journal, July 15 2015))
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 Fees Fell, But Offset By Card And Payment Services
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. Although the strategy paid off over subsequent years, as the mortgage refinancing wave of 2011-2012 drove revenues to record levels, things turned for the worse over 2013-2014 with mortgage activity levels sinking. Thankfully, the mortgage industry has shown signs of recovery over recent quarters, with U.S. Bancorp’s origination volumes improving from $10.4 billion in Q3 2014 to $14 billion in Q3 2015. This did not positively impact the bank’s top line figure, though, as mortgage banking fees fell for a second consecutive quarter to reach $224 million. This is 14% lower than the $260-million figure for the year-ago period.
U.S. Bancorp’s card business picked up the slack, with credit and debit card revenues increasing to $269 million in Q3 2015. The bank’s card and payment services operations, which also includes corporate payment and merchant processing services, saw revenues increase to an all-time high of $859 million. This compares to revenues of $839 million in the previous quarter, and $833 million a year ago. With U.S. Bancorp focusing its efforts on expanding its payment services business over recent years, we expect this division to unlock considerable value for the bank in the future.
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- U.S. Bancorp Reports Third Quarter 2015 Earnings, U.S. Bancorp Press Releases, Oct 15 2015 [↩]