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What Makes USB Tick

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By wabuffo100
July 23, 2009

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Anybody have any thoughtful or quantitative insights on US Bancorp?
Hi Jim -- I like USB a lot though I'll leave it to you to decide on valuation. But I can talk about what makes USB "tick" and why I believe they are very well run.

One of the things I like about USB (and WFC follows a similar business model) is that they have built a significant non-lending related business that compliments their core lending operations. It involves selling other services to its banking customers (ergo, wealth mgmt) as well as adding ancillary services that depend on connectivity to ATMs/VISA & MC interchange systems that only a bank can provide (payment systems, open-loop prepaid debit card services). The result is the generation of significant levels of fee income that don't depend on direct lending. When that non-interest income is added to a culture of very strong cost controls, it creates some competitive advantages.

You can see these advantages in the numbers. I will ignore provisions for credit losses and come back to loan underwriting later. I will also ignore the big banks with investments banks attached since comparability is difficult (C, JPM, BAC). Finally I will look at the latest quarter only since a number of the larger banks have acquired significant competitors that make last trailing twelve numbers meaningless.

[See Post for Chart]

Hopefully the formatting of this table is readable. As you can see, USB generates the highest percentage of fee income to interest income (though WFC is right on its heels - and I think helps to explain Wells advantages too). When this fee income is added to net interest margins and compared to general/admin expenses, it shows how the combination of relatively high fee/non-interest income combined with strong expense control really gives USB a big advantage. USB's business model delivers more net income after expenses but before credit provisions relative to each dollar of net revenue than any other big regional bank.

I believe that this more diversified revenue stream, in turn, gives USB's mgmt the ability to be very picky in its loan underwriting -- creating a much stronger business model than other bank competitors. USB doesn't have to "reach" for more risky loans with higher interest income yields because its structure/model doesn't force it to like other banks with either higher cost structures and/or less non-interest income.

The next table looks at how these stronger operating earnings (i.e., quarterly pre-provision, pre-tax income annualized) compares to tangible equity capital (i.e., equity minus goodwill, intangibles but adding back loan loss allowances -- again looking at the business model before loan performance is factored in).

[See Post for Chart]

The stronger operating earnings help USB generate very strong returns on tangible capital and help explain why it (along with WFC) may justify stock prices that routinely trade at multiples of tangible book value per share. Of course, this is before loan performance -- and I believe this is where it comes all together for USB. Their business model allows them to be more selective and it shows in their credit underwriting. I haven't looked at Delinquencies (Past Due 30+ days) and Non-Performing since last Q but I did post on how WFC (and USB) were doing in some of the types of loans everyone is currently worried about (Commercial and Industrial, Commercial Real Estate, Credit Cards and Other Consumer Loans (ergo Student, Auto Loans, etc) in a post from last quarter.

USB was way ahead of the other big banks as well as the averages for the top regional banks. I can update the results after all banks release this quarter's results and the FDIC's bank holding reports come out for the Q.

Sorry for the long post -- but hopefully I've not confused everybody. Essentially, I think USB's advantages boil down to:
1) diversified revenue stream with highest amount of non-lending income, and
2) strong cost controls, leading to
3) very high levels of pre-provision, pre-tax income that generate the highest return per $1 of tangible capital, which gives USB
4) the ability to be selective in lending creating less losses on their loans.

This adds up to one of the strongest business models in the US banking industry (WFC is close second, but much bigger).

Hope this helps,