DBRS Comments on Q3 2009 Earnings of U.S. Bancorp – Senior at AA Unchanged

DBRS has today commented on the Q3 2009 earnings of U.S. Bancorp (USB or the Company). The Company reported net income of $603 million for the quarter, 28% above Q2 2009 results and 5% above the year ago quarter. A record quarterly revenue performance and income before provision and taxes (IBPT) of $2.2 billion enabled USB to absorb a loan loss provision of $1.5 billion, 4.4% higher than the prior quarter’s. Importantly, the pace of credit deterioration continued to decline and USB’s credit quality remained strong relative to peers. The third quarter provision exceeded net charge-offs (NCOs) by $415 million, resulting in a reserve build somewhat lower than last quarter’s $466 million.

Third quarter results show that USB remains relatively well-positioned to manage the difficult credit environment. Unlike many competitors, the Company continues to generate strong IBPT and maintain healthy financial fundamentals, enabling USB to continue to invest in its franchise via acquisitions, partnerships and joint ventures and through organic growth initiatives. DBRS sees USB’s strong revenue performance, strong deposit growth and well-controlled expenses as reflecting the strength of its growing franchise and validating its AA level ratings. Therefore, DBRS’s ratings for the Company, including its AA rating for Senior obligations and Stable Trend, remain unchanged.

Net interest income (NII) accounted for $2.2 billion, or about 51%, of USB’s total Q3 2009 revenues.
Reduced loan demand and declining line utilization among borrowers drove a modest linked quarter decline in average earning assets in the quarter, but a decline in borrowing costs led to NII growth from Q2 2009 and USB’s reported net interest margin (NIM) increased 7 bps to 3.67%. Despite a decline in rates paid on interest-bearing deposits, core deposit growth was strong in the quarter. Core balances were up 5% from Q2 2009 to $139 billion. Average total deposits grew less (2%), as wholesale CD balances decreased by $4 billion.

Third quarter noninterest income of $2.1 billion increased 2% from Q2 2009. Fees were up across most categories reflecting some seasonality in items such as merchant processing, but also reflecting successful Company initiatives aimed at growing certain fee items (commercial products, for example). Mortgage banking revenues were again strong at $276 million, but declined 10% from the prior quarter when USB had record mortgage production.

USB reported an efficiency ratio of 47.5% as the Company generated positive core operating leverage relative to Q2 2009, largely due to the absence of the FDIC special assessment but offsetting this was a significant increase in marketing expense. DBRS also notes that USB generated positive operating leverage compared to the prior year quarter.

With respect to asset quality, NCOs and nonperforming assets (NPAs) continued to trend higher in Q3 2009, but, as noted, growth was slower than in prior periods. Total Q3 2009 NCOs of $1.0 billion were 12% higher than Q2 2009. Losses trended slightly higher across loan portfolios, but the bulk of the linked quarter increase in NCOs was driven by USB’s $9.5 billion (average) Construction & Development portfolio. Excluding covered assets, third quarter NCOs represented 241 bps of average loans compared to 215 bps in Q2 2009.

NPAs increased 9% from Q2 2009 and were $4.4 billion at the end of the third quarter. Included in the total were $672 million of covered assets. As a percent of loans plus OREO and excluding covered assets, NPAs increased to 2.14% from 1.94% in the prior quarter. Construction & Development loans continued to account for the largest portion (37%) of total nonperforming loans (ex-covered assets), but deterioration was evident in all categories as commercial and retail borrowers continue to be affected by high unemployment and weak economic conditions. Reserve coverage of NPLs (excluding covered assets) was a strong 150% at September 30, 2009.

The Company saw an 8% increase in 90+ day delinquencies, reflecting some seasonality in card and higher residential mortgage delinquencies. Early stage delinquencies increased (but at a slower rate) in USB’s retail portfolios and actually declined in the C&I, CRE and Small Business portfolios indicating the possibility for improved credit costs going forward. DBRS continues to believe that loan losses and nonperforming asset levels will rise over the next few quarters, though likely at a moderating pace. DBRS notes, however, the Company has a strong capacity to absorb higher loss provisions, if needed, given the stability and strength of its IBPT.

DBRS considers USB’s financial fundamentals and capital position as sound and supportive of the Company’s high ratings. Reflecting its general strength, the Company’s Tier 1 ratio was 9.5% at September 30, 2009 and the Tier 1 Common ratio improved 10 bps from the end of the second quarter to 6.8% (even including a $139 million direct reduction to equity for the repurchase of TARP-related government issued warrants). USB’s third quarter results again validate DBRS’s view of USB’s capital position and its view on the Company’s strong internal capital generation ability.

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 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.