Jan 17 - Standard & Poor’s Ratings Services today said its ratings on U.S. Bancorp (USB; A+/Stable/A-1) are unaffected by the company’s strong fourth-quarter results, which were in line with our expectations, given the current operating conditions.
Relative to the fourth quarter of 2011, adjusted revenue increased 5.7% to $5.06 billion, reflecting higher earning assets and strong mortgage banking revenues. Results include an $80 million charge from the recent mortgage-related regulatory settlement. USB’s net interest margin (NIM) compressed 5 basis points (bps) to 3.55%. We expect the NIM to remain pressured into 2013 because of continued investments in low-yielding securities and the roll-off of higher-yielding securities. Still, net interest income should benefit from ongoing loan growth. Average total loans rose 1.5% from the third quarter and 6.4% year over year, with strong growth in residential real estate loans. In addition, USB achieved positive operating leverage as expenses declined 0.4% versus the previous year.
Asset quality continues to improve, with a net charge-off ratio of 0.85%, and allowance to nonperforming loans (excluding covered loans) increased to 269% at the end of the fourth quarter (up from 244% the previous quarter). We believe residential mortgage loan underwriting standards, one of the main causes of loan growth, remain strong, as the average weighted loan-to-value ratio of 65% for new retained residential loan originations demonstrates.
USB’s estimated Basel III Tier 1 common equity ratio declined slightly to 8.1% from 8.2% in the previous quarter, likely because of an increase in risk-weighted assets, reflecting USB’s growing balance sheet. Still, the ratio is above management’s target of 8.0%. We believe that USB’s risk-adjusted capital (RAC) ratio, based on our measurement, will rise modestly during the next 12-18 months, which should continue to support the current ratings. Our expectations, based on our calculation for 2013, include maintaining the range of payouts to shareholders of 60%-80% of earnings after the results of the Fed’s Comprehensive Capital Analysis and Review (CCAR) are announced, versus 63% of earnings in 2012. We also envisage a slight increase in net interest income due to loan growth, partially offset by a decline in mortgage banking with declining gain on sale margins, as well as a reduction in qualified borrowers who are able to refinance.
The stable rating outlook on USB reflects our expectation that the company will continue to generate above-peer results and that credit quality will experience further, but more modest, improvement, underpinned by conservative underwriting and strong reserve coverage. We expect USB’s quality of earnings to remain good and relatively predictable, with core earnings as the key source, as opposed to large one-time or noncore items such as reserve releases.