U.S. Bancorp beats expectations, but faces more challenges in credit

U.S. Bancorp (USB), the nation's sixth largest commercial bank, reported earnings before the market opened today. Earnings for the second quarter of 2009 were $471 million -- down from $950 million a year ago -- or 12 cents per share, compared to the average of 10 cents per share expected from analysts. Revenues were a record $4.2 billion, on the high end of expectations, as the company experienced better fee-based business and grew its loan book. Record mortgage loan volume was one specific factor cited in the release.

Shares were up four percent in morning trading following the announcement.

Discussing the news, Chairman and CEO Richard K. Davis said, "Although the challenges continue and some uncertainty remains in the economy as a whole, our company is focused on the future and on every opportunity to capitalize on the strength of our balance sheet, the breadth of our franchise and the depth of our diversified mix of businesses."

U.S. Bancorp, widely regarded as one of the country's stronger banks, has completely exited the Troubled Asset Relief Program (TARP) after repaying the government's $6.6 billion preferred stock investment and repurchasing the warrants issued to the Treasury Department. The company was one of the ten major "stress-test" banks to first be approved to repay TARP funds, after the tests revealed that the company did not need additional capital.

As has been the story with good banks, U.S. Bancorp organically grew deposits at a double-digit pace, and the cost of deposit funds went down. Growth in deposits was aided by the acquisitions of Downey Savings & Loan and PFF Bank & Trust, both California institutions taken over at the end of 2008 by the FDIC. This allowed the company to absorb credit losses and increase future reserves by $466 million, which the company said was necessary because of "continuing stress in residential real estate markets" and "deteriorating economic conditions and the corresponding impact on the commercial, commercial real estate, and consumer loan portfolios."

One factor working in U.S. Bancorp's favor right now is its strong asset quality. Non-performing loans to total loans and real estate owned was 2.20 percent at the end of the quarter; this compares to the 4.40 percent recently reported by Citigroup (C). Higher quality assets lead to lower credit losses and more stable earnings. The company reported the rate of the rise in delinquencies slowed to a 15 percent increase from the prior quarter, suggesting that falling credit quality (a phenomenon at all banks) was moderating. Net charge-offs, a measure of losses, increased 18 percent quarter-over-quarter.

U.S. Bancorp shares have more than doubled since the March lows, and the stock trades for 4.3x run-rate pre-tax, pre-provision profit. Pre-tax, pre-provision profit is a way to smooth out changes in credit losses, which are very lumpy, and tax rates, to focus on a bank's core operational earnings. At the height of the housing boom in early 2007, the stock traded for 7.8x the comparable metric. Banks aren't likely to see those valuations again for some time, if ever -- so the upside for the stock is likely limited from here compared to large caps in other industries.

James Cullen edits and writes at CollegeAnalysts.com. He has no personal position in the stocks mentioned above.

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