DBRS Comments on Q4 2008 Earnings of U.S. Bancorp – Senior at AA

DBRS has today commented on the Q4 2008 earnings of U.S. Bancorp (USB or the Company). The Company reported net income of $330 million for the quarter, 43% lower than the third quarter and down 65% from the same quarter in 2007. USB’s operating performance was negatively affected by a $1,267 million loan loss provision that exceeded net charge-offs (NCOs) by $635 million, a $253 million impairment charge mostly related to its structured investment vehicle (SIV) exposure and $82 million in auto lease residual losses. Credit quality deterioration continues to drag on financial results; however, USB continues to do relatively well when compared to peers. Importantly, underlying trends were strong as the Company produced strong growth in net interest income, robust year-over-year growth in average loans and deposits (even excluding acquisitions), an expanded net interest margin (NIM) and higher fee-based revenue. Operating efficiency at 50.6% was up slightly over the prior quarter and is among the best in the banking sector. The quarterly results are in line with USB’s current ratings at AA for senior obligations and Stable trend.

On November 21, 2008, USB acquired the banking operations of Downey Savings & Loan and PFF Bank & Trust in a transaction assisted by the Federal Deposit Insurance Corporation (FDIC). DBRS views the acquisitions positively as they vault the Company to the sixth largest bank by deposits in California, with the fourth largest branch network in the state. The transactions had no cash consideration, assets were marked to fair value at closing and a loss-sharing agreement with the FDIC minimizes the downside loss potential.

Asset quality continued to deteriorate during Q4 2008 as credit losses and non-performing assets (NPAs) trended higher. Total NCOs in the quarter were $632 million, $134 million higher than in the prior quarter and over $400 million more than in the same quarter a year ago. Meanwhile, NPAs as a percentage of loans and other real estate increased to 142 basis points (bps) at December 31, 2008 (including covered assets from the Downey and PFF acquisitions), compared with 88 bps at September 30, 2008, and 45 bps at December 31, 2007. The increase in NCOs and NPAs was driven primarily by deteriorating conditions in the residential housing market, home-building and related industries, as well as growth in consumer loans. The Company provisioned $1,267 million for loan losses in the quarter, $635 million in excess of NCOs, increasing its allowance for credit losses as a percentage of period-end loans to 2.09%. Given the trajectory of NPAs and NCOs, DBRS believes further erosion in loan quality and rising loan losses are likely to continue through at least the first half of 2009. DBRS also anticipates further valuation losses in USB’s securities portfolio despite losses already recognized. DBRS notes, however, that the Company can cope with higher loss provisions and valuation losses given the stability and strength of its earnings – which were over $1.6 billion in income before provision and taxes in the current quarter.

Although mindful of likely further weakening in asset quality, DBRS considers USB’s credit fundamentals as sound. Regulatory capital ratios benefited from the Company’s $6.6 billion issuance of Treasury Capital Purchase Program preferred stock, including a Tier 1 ratio of 10.6% and total capital ratio of 14.3%. DBRS’s calculation of tangible common equity to tangible assets, however, dropped to 3.19% in Q4 2008 from 4.57% in Q3 2008 due to the Downey and PFF acquisitions. DBRS believes that USB should be able to restore this ratio to its prior level in the next four quarters from its internal capital generation. Liquidity for both the operating bank and the holding company remains ample.

Net interest income rose 9.9% over the prior quarter and 22.6% over Q4 2007 due to growth in average loans as well as improved NIM over a year ago. NIM widened to 3.81% in the quarter from 3.65% in the prior quarter and 3.51% in Q4 2007 as a result of growth in higher-spread assets, the benefit of the Company’s liability-sensitive balance sheet position in a declining interest rate environment, its wholesale funding mix and net free funds. Non-interest income in the quarter declined 19% from the prior year’s quarter due to changing customer behavior in the current environment, impairment charges on various investment securities and higher retail lease residual losses.

Average loans were up 17% from Q4 2007 (13.4% excluding acquisitions), driven by growth across the majority of loan categories but were more commercially focused. On a sequential quarter basis, average loans grew by 6.4% (3.1% excluding the Downey and PFF acquisitions), reflecting growth across most loan categories also favoring commercial loans. The Company benefited from a flight to quality as average deposits were up 15.2% (9.6% excluding acquisitions) in the quarter compared with the same quarter a year ago, with strong sequential quarter growth of 8.2% (4.3% excluding acquisitions).

DBRS believes that USB is relatively well-positioned to manage the very difficult current operating environment by continuing to generate strong operating results and maintain healthy financial fundamentals as reflected by the Stable trend assigned to its ratings.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.