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Jonathan J. Smith

U.S. Bancorp (NYSE:USB), headquartered in Minneapolis, MN, is the nation's 6th largest bank.^[1] The bank offers loans, credit, and insurance products to consumers primarily in the Midwestern and Western United States. USB competes against large banks such as Bank of America (BAC), as well as regional banks such as Regions Financial Corporation (RF).

U.S. Bancorp, like other U.S. banks, has been hurt by the 2008 Financial Crisis. In 2008, USB held $2.64 Billion in non-performing ("toxic") assets, which caused the bank to increase its loan loss provision to $3.1 Billion. This caused USB's net income to decline over 31% from 2007 to 2008.^[1] Unlike its competitors, USB did profit in Q4 08, however. The bank made $264 million in the quarter. Comparatively, Bank of America (BAC), Wells Fargo (WFC), and Regions Financial Corporation (RF) lost $1.8 Billion, $2.7 Billion and $5.6 Billion, respectively. USB was given $6.6 Billion in TARP funds to improve its financial health. To pay back the TARP funds immediately, the bank cut its dividends for the first time in 75 years.^[2] In addition, volatile interest rates are inversely proportional to USB profitability. Rising interest rates cause decreased demand from consumers, as they cannot afford to take out a loan, and makes consumers more likely to default. Thus, if interest rates increase, USB net income decreases. The Federal Funds Rate and Prime Rate have decreased in the past year, which caused USB net interest income to increase over 15%.^[1]

Business Financials

USB operates in four business segments:

Payment Services (27.9% of Net Income)

The Payment Services segment offers corporate payment systems as well as debit, credit, and small business retail payment methods. Its Elavon brand also offers electronic check and gift card merchant processing. From 2007 to 2008, Payment Services net income remained the same.

Wholesale Banking (26.6% of Net Income)

The Wholesale Banking segment provides market knowledge and banking products to companies. Banking products range from treasury management to loans and trade financing. From 2007 to 2008, Wholesale Banking net income decreased 7.0%.

Wealth Management and Securities Services (14.1% of Net Income)

The Wealth Management and Securities Services segment provides investment, trust, and insurance products to businesses and individuals. From 2007 to 2008, Wealth Management and Securities Services net income increased 0.7%.

Consumer Banking (31.4% of Net Income)

The Consumer Banking segment offers banking products to more than 14 million consumers. Segment products include consumer lending, home mortgages, and transactions. From 2007 to 2008, Consumer Banking net income decreased 34.3% due to holding delinquent (toxic) loans.

left^[1]

From 2007 to 2008, USB net interest income increased 15.6%, net interest expense decreased 27.3%, but net income decreased 32%.^[1]

USB had over $2.5 billion of toxic assets in 2008, so the bank had to dramatically increase its provision for credit losses Provision for credit losses is how much money a bank sets aside for loans that are not being repaid.‎^[1]

Trends and Forces

Unlike other banks, USB Profits in Subprime Meltdown

The 2008 Financial Crisis has crippled many banks, ranging from large, well-known banks like Bank of America (BAC) to smaller, regional banks such as Regions Financial Corporation (RF). Subprime lending and holding toxic assets make banks lose money, as the bank is not being repaid for lending credit. For example, BAC and RF lost $1.8 Billion and $5.6 Billion in Q4 08, respectively. Unlike its competitors, USB profited during the crisis, as it made $260 Million in Q4 08 and $2.95 Billion for the year.

However, USB had $2.64 Billion in non-performing assets, such as loans, which caused the bank to increase its Provision for Loan Losses to $3.1 Billion in 2008. This led to a 31.9% decrease in net income from 2007 to 2008. A 31.9% decrease in net income would be alarming in other years, but it is a smaller decline than other banks have had due to the crisis. USB's relatively conservative portfolio has protected the bank from getting as crushed as its competitors. In addition, USB acquired two banks held by the FDIC: California-based Downey Financial (DSL) and PFF Bank & Trust ^[3] The move added $16.5 Billion in assets to USB's portfolio. Furthermore, USB had a Tier 1 Capital Ratio of 10.6% in December 2008. Tier 1 Capital Ratio is a bank's equity capital to its total risk-weighted assets, and the ratio is used to describe the financial health of the bank. In addition, USB was ranked the 2nd safest U.S. bank (behind Wells Fargo (WFC)) by Global Finance.^[4]

To repay TARP funding, USB cuts dividend for first time in 75 years.

USB received $6.6 Billion in TARP funding, and then announced it will pay all of it back.^[5] USB has either maintained or increased its dividend for the past 75 years, and has paid its dividend for 146 consecutive years.^[6] This month, USB announced it would pay back the TARP funds by cutting its dividend -- breaking the 75-year streak.^[7] Furthermore, it is the first time in 37 years that USB has not increased its dividend.^[8] USB made the move to increase its ever-important common equity ; the cut will preserve $2.6 billion in capital.^[9] In other words, USB will save money to repay its TARP funds back. In addition, the bank announced it would issue $750 million in 2.25% notes on March 13th, 2012. Credit rating agency Fitch gave the deal its highest credit rating -- AAA.^[10] The AAA credit rating signifies that USB can be relied on to pay its debt (i.e. it has zero credit risk).^[11]

USB Profitability is Sensitive to Interest Rate Fluctuations

Changes in interest rates inversely affect a bank's net interest margin — the difference between the yield the bank earns on assets and the interest rate it pays for deposits and other sources of funding. Interest rate fluctuations, such as in the Federal Funds Rate (the rate at which financial institutions lend federal funds to other depository institutions)^[12] and Prime Rate (rate at which banks lend to their highest-credited consumers)^[13] affect bank products such as loans, deposits, securities, and short-term lending. As interest rates rise, banks are forced to pay higher rates on deposits and other interest bearing accounts. Meanwhile consumer demand for mortgages and other loan products diminishes as borrowing becomes more expensive. The combination of these two effects reduces both the volume of loans and the profitability of each loan. Rising interest rates also have the potential to increase a bank's defaults as holders of adjustable rate mortgages find themselves unable to meet their obligations. This is especially true of subprime borrowers, as seen in the 2007 Credit Crunch.

U.S. Bancorp derives 68% of their income from net interest income ^[1], so increasing interest rates hurt the bank's profitability. As seen from the graph, as the FFR and Prime rates increase, USB's net interest income decreases, with the converse also being true. From 2007 to 2008, the average FFR decreased 55.4%, which caused USB net interest income to increase 15.9%.^[1]

USB income, like other banks, is inversely proportional to interest rates.

Competition

Financial Services

• U.S. Bancorp (USB) -- USB is the nation's 10th largest bank and offers a product line of Consumer and Wholesale Banking.^[14]
• SunTrust Banks (STI) -- STI is an Atlanta-based bank with 20% of outlets in retail centers. It is the nation's 9th largest bank and offers a similar product line of Consumer and Wholesale Banking.^[15]
• Capital One Financial (COF) -- COF is the 11th largest bank in the nation, and unlike USB and STI, it has a credit card business.^[16]
• Regions Financial Corporation (RF) -- RF is another bank based in the Southeast U.S. and offers a similar product line as STI.^[17]
• BB&T (BBT) -- Like RF and STI, BBT is a bank based in the Southeast U.S. and has a similar product line.^[18]
• Bank of America (BAC) -- A national competitor, BAC has about half of all the wealthy households in the U.S. as customers, and holds the leading share of the market for small business banking.^[19]
• Wells Fargo (WFC) -- WFC competes against USB for customers in the Midwest, Northwest, and West. WFC was ranked the number one safest U.S. bank by Global Finance.

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7}
2. ↑ Seeking Alpha, "U.S. Bancorp Dividend Cut Anything But Tarp," 03/23/09
3. ↑ Trading Markets, "Three More Banks Fail; U.S. Bancorp. Buys Downey Financial, PFF Bank & Trust From FDIC," 11/24/08
4. ↑ [www.gfmag.com/admin/mods/abmRepository/root/Docs/2009/safest_mid_year.pdf Global Finance, "World's Safest Banks 2008"]
5. ↑ Bloomberg, "U.S. Bancorp, Northern Trust Return TARP, Frank Says," 03/05/09
6. ↑ U.S. Bancorp website, "U.S. Bancorp Announces Quarterly Dividends," 12/09/08
7. ↑ Seeking Alpha, "U.S. Bancorp Dividend Cut Anything But Tarp," 03/23/09
8. ↑ Seeking Alpha, "U.S. Bancorp Cuts Dividend by 88%," 03/04/09
9. ↑ U.S. Bancorp website, "U.S. Bancorp Announces Reduction in Quarterly Dividend," 03/04/09
10. ↑ Another Financial Portal, "US Bancorp Comes to Market with $750 Million FDIC-Backed Deal," 03/13/09
11. ↑ Wikipedia, "Bond Credit Rating"
12. ↑ Answers.com, "Federal Funds Rate"
13. ↑ Answers.com, "Prime Rate"
14. ↑ USB website, "About"
15. ↑ SunTrust Website, "Investor Relations"
16. ↑ Capital One Website, "About"
17. ↑ Regions Financial website, "About"
18. ↑ BB&T Website, "Business"
19. ↑ Bank of America website, "About Bank of America"
20. ↑ Reuters, USB
21. ↑ Reuters, STI Income Statement
22. ↑ Reuters, COF
23. ↑ Reuters, RF
24. ↑ Reuters, BBT
25. ↑ Reuters, BAC
26. ↑ Reuters, WFC, "Financial Statements"