DBRS Comments on Q1 2009 Earnings of U.S. Bancorp – Senior at AA

DBRS has today commented on the Q1 2009 earnings of U.S. Bancorp (USB or the Company). The Company reported net income of $529 million for the quarter (before preferred dividends), 60% higher than the fourth quarter, but down 51% from the same quarter in 2008. USB’s operating performance was negatively affected by a $1,318 million loan loss provision that exceeded net charge-offs (NCOs) by $530 million, $198 million in net securities losses partially offset by a $92 million Corporate real estate gain. The credit quality deterioration was pronounced in the quarter, although USB continues to do relatively well when compared to peers. Importantly, underlying trends were positive as the Company generated higher fee-based revenues, double-digit organic loan growth and robust organic deposit growth that were only partially offset by net interest margin (NIM) compression. Operating efficiency at 45.8% has improved from 50.0% in the prior quarter and remains among the best in the banking sector. DBRS stated that USB’s financial results were within its expectations, acceptable for its rating range and therefore its AA for senior obligations ratings and Stable trend were unaffected.

Asset quality continued to deteriorate during Q1 2009 as credit losses and non-performing assets (NPAs) trended sharply higher. Total NCOs in the quarter were $788 million, $156 million or 25% higher than in the prior quarter and $489 million more than in the same quarter a year ago. Meanwhile, NPAs as a percentage of loans and other real estate increased to 185 basis points (bps) at March 31, 2009 (including covered assets from the Downey and PFF acquisitions), compared with 142 bps at December 31, 2008, and 53 bps at March 31, 2008. The increase in NCOs and NPAs continued to be driven primarily by deteriorating conditions in the residential housing market, home-building and related industries along with consumer loans but is also becoming more pronounced for other commercial borrowers. Delinquent loans 90 days or more past due also worsened in every asset class except commercial real estate, which can be less predictable than other classes. The Company provisioned $1,318 million for loan losses in the quarter, $530 million in excess of NCOs, increasing its allowance for credit losses as a percentage of period-end loans to 2.37% (excluding covered assets). Given the trajectory of NPAs and NCOs, DBRS believes further erosion in loan quality and rising loan losses are likely to continue through the balance of 2009. DBRS also anticipates further valuation losses in USB’s securities portfolio despite losses already recognized including $198 million of net losses in Q1 2009. DBRS notes, however, that the Company can cope with higher loss provisions and valuation losses given the stability and strength of its income before provision and taxes which was over $2.0 billion in the current quarter.

Although mindful of likely further weakening in asset quality, DBRS considers USB’s financial fundamentals and capital position as sound. This view was supported by the Company’s recent Supervisory Capital Assessment Program (SCAP) or “stress test” results. Both regulatory and tangible capital ratios rose in the quarter primarily from earnings. The Tier 1 ratio climbed 30 bps to 10.9%. DBRS’s calculation of tangible common equity to tangible assets was up 51 bps to 3.70% in 1Q 2009 from 3.19% in 4Q 2008 primarily reflecting an improvement in AOCI. DBRS believes that these results also validate DBRS’s view of USB’s strong internal capital generation ability. Liquidity for both the operating bank and the holding company remains ample.

With a clean stress test result and subject to consultation with the Company’s banking regulators, USB intends to repay its $6.6 billion in TARP funds as soon as it is permitted. To that end, the Company is completing a $2.5 billion common stock offering and $1.0 billion medium-term note offering as partial replacement for the TARP capital. DBRS views this as a prudent action and views the addition of common equity positively as it adds to the layer of protection for bondholders, while the senior debt issuance is a necessary condition for the TARP capital repayment.

Net interest income declined 3.1% over the prior quarter but rose 14.5% over Q1 2008. Growth in average loans, as well as improved NIM, explains the gain compared to last year. Lower net interest income compared to last quarter reflects a decline from the volatile short-rate environment in the fourth quarter, a decline in interest rates and the impact of the Downey and PFF acquisitions. NIM fell 22 bps to 3.59% in the quarter from 3.81% in the prior quarter and rose 4 bps compared to 3.55% in Q1 2008. Non-interest income in the quarter grew 22% from the prior year’s quarter due to a very strong mortgage banking fee performance given the low interest rate environment, higher ATM processing and treasury management fees. However, these were partially offset by weaker fees due to economic conditions in most other categories.

Average loans were up 20% from Q1 2008 (12% excluding covered balances from acquisitions), while loans grew 4.8% sequentially (1.4% excluding the Downey and PFF covered balances) driven by growth across the majority of loan categories, although overdraft and corporate credit card demand was weaker in the quarter. The Company also continues to enjoy good deposit growth with average balances up 22.7% (12.3% excluding acquisitions) in the quarter compared with the same quarter a year ago and strong sequential quarter growth of 11.1% (6.6% 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 despite the continuing negative credit headwinds.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.