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Morningstar | Decent Quarter for U.S. Bancorp, Maintaining Best-in-Class Returns

Wide-moat U.S. Bancorp reported solid second-quarter results. Revenue was up 3%, with equal support coming from both fee income and net interest income. This occurred on top of 2% expense growth, leading to growth in net income of 4%. Combined with share repurchases (average diluted shares were down 3%), EPS grew 7% year over year. Again, we are seeing many of the same themes play out across the sector, as net interest margin expansion is essentially over, but expense control and share buybacks are still leading to decent earnings per share growth. U.S. Bancorp remained best in class with a return on tangible equity of 19.2% for the quarter, squarely in line with the 18%-20% range the bank has been in for the last several quarters. We are now incorporating three rate cuts into our forecasts through 2020, and as a result of these and other changes, we are lowering our fair value estimate to $51 per share from $52.

Average loan growth picked up again in the quarter, up 3.8%, and excluding FDIC-covered loan sales, growth was 4.5%. This was a strong result for the bank, and was driven by stronger performances coming from mortgages, commercial, and cards. Management remains cautious on CRE and advised that given the current environment, runoff could continue here. Average deposit levels were up 3.1%, an improvement over last quarter, although much of this growth was driven by money market accounts, as growth in interest checking account deposits was only 0.7%. Balances increasingly shifted toward interest bearing. Management highlighted their higher corporate trust and wholesale deposits concentrations, meaning they should be able to price deposits back down a bit faster than most as these deposits tend to be more price sensitive.

After incorporating the updated guidance, we still see net interest income increasing for the bank for full-year results. Depending on loan growth, deposit repricing, and the movement of the long end of the curve, we think USB may be able to grow NII in 2020, as well. Credit costs were roughly stable for the quarter, remaining range bound, as nonperforming assets continued to decline and net charge-offs also remained range bound. There were no discernible patterns of negativity from a credit standpoint.

Fee income is making a bit of a comeback, even with the headwind of the sale of the bank’s third-party ATM business. Merchant processing is growing at a mid-single-digit rate again, and management believes it can get even more here, and we would also expect mortgage related revenue to improve for the remainder of the year, as well. Finally, expense control will remain important for the bank, especially with the headwind of lower rates coming up. We’ll be watching for low-single-digit expense growth going forward.