U.S. Bancorp’s Q1 Results Were Solid Despite Seasonal And Mortgage-Related Headwinds
The first quarter of a year usually sees overall loan balances for the industry nudge lower as people use bonuses and tax refunds to reduce their loan burdens. And loan growth in Q1 2017 was also hurt in particular by the Fed’s decision to hike interest rates last December, and again in March. Taking this into account, along with the fact that the U.S. mortgage industry is still witnessing weak activity, U.S. Bancorp’s (NYSE:USB) results for Q1 2017 look rather good. [1] After all, the bank has focused its growth efforts largely on the mortgage and payment industries since the economic downturn, and despite the headwinds on both fronts, it managed to grow pre-tax income by 4% year-on-year.
There were a few factors that worked in U.S. Bancorp’s favor, though. Firstly, the rate hikes have helped increase net interest margins across the industry, and elevated demand for wealth management services also boosted the bank’s wealth management fees. Another factor that contributed was the overall improvement in economic conditions in the U.S., which helped U.S. Bancorp maintain loan provisions at roughly the same level over the last five quarters.
U.S. Bancorp’s Q1 performance is testimony to the fact that its business model remains sound. It does not promise huge returns, but the low-risk, steady growth promise it delivers, along with its demonstrated ability to make strategic acquisitions to add to its banking capabilities, is something that has helped the bank trade at nearly twice its book value (currently $25) since early 2012. We maintain a $50 price estimate for U.S. Bancorp’s stock, which is slightly below its current market price.
See our complete analysis for U.S. Bancorp
The table above summarizes the factors that aided U.S. Bancorp’s pre-tax profit figure for Q1 2017 compared to the figures in Q1 2016 and Q4 2016. As evident from the table, revenues for the bank fell compared to the previous quarter, but improved compared to the year-ago period. The sequential decline can be attributed to weaker mortgage industry conditions as well as to a seasonal decline in fees related to card and payment services.
Another thing that stands out here is the sizable increase in compensation expenses. The sequential increase in compensation is largely due to the payment of bonuses and other performance-linked payouts by the bank. Notably, compensation expenses swelled 10% in Q1 2017 compared to Q1 2016 – much faster than the 6% growth in revenues over the same period. This is because the bank is spending more to increase its headcount in growth areas as well as in compliance functions. But we expect the bank’s non-interest expenses as a proportion of revenues to largely trend lower in the long run, as seen in the chart below.
Biggest Near Term Growth Driver Will Be Improving Net Interest Margins
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 2013-15 was the sequential decline in its net interest margin (NIM). The bank’s NIM figure fell from 3.7% in early 2011 to a low of 2.98% in Q4 2016. The Fed’s rate hikes helped the figure trend upward after falling for five consecutive quarters to settle at 3.03% in Q1 2017.
The table above summarizes how changes in NIM and the interest-earning asset base have affected U.S. Bancorp’s net interest revenues (fully-taxable equivalent basis) in Q1 2017. Although the NIM figure was higher at 3.06% in Q1 2016, the total interest-earning asset base was much lower in Q1 2016 compared to Q1 2017 ($378 billion vs. $399 billion) – resulting in a sharp increase in net interest revenues year-on-year. On the other hand, a seasonal reduction in interest-earning assets compared to Q4 2016 mitigated gains from improved NIM to lead net interest revenues lower.
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.
Mortgage Banking Activity Was Unusually Low, But It Should Recover Soon
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 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. The mortgage industry has largely seen sub-par activity levels over recent years, with origination volumes for Q1 2017 being just under $10 billion, which was the lowest in the last six quarters.
The table below summarizes the factors that affected U.S. Bancorp’s mortgage-related fees for the quarter compared to Q1 2016 and Q4 2016.
As seen here, an increase in U.S. Bancorp’s mortgage servicing portfolio could not mitigate the impact of weak originations and increased fee pressure. The bank received applications for just $13.4 billion new mortgages in Q1 2017 compared to $16.7 billion a year ago and $14.2 billion in the previous quarter – something that indicates that the bank’s mortgage pipeline will be nearly empty.
While the increase in interest rates following the Fed’s rate hike is an important factor behind the lower origination volumes, there are seasonal effects also at play here. As the Fed is looking to raise interest rates at regular intervals in the near future, we believe that people looking to buy new homes will do so earlier rather than later to benefit from lower rates. This should help volumes recover over subsequent quarters.
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- First Quarter 2017 Earnings, U.S. Bancorp Investor Relations, Apr 19 2017 [↩]