Last week, the Federal Reserve released the first part of the annual banking stress tests results, which examined the impact of a severe economic downturn on the largest U.S. banks. While it stood out as one of the strongest banks during last year's stress tests, U.S. Bancorp (NYSE:USB) again posted especially encouraging results. The results highlighted the strength and sustainability of U.S. Bancorp's balance sheet and profit engine.
How it fared last week
In addition to posting a higher actual Tier 1 common ratio in Q3 in 2012 compared to 2011, U.S. Bancorp posted an impressive minimum Tier 1 common ratio of 8.3% under the severely adverse scenario. During the previous year's tests, USB's minimum Tier 1 common in the doom-and-gloom scenario was 7.7% without the proposed 56% dividend increase included. This year's test assumes that elevated dividend remains constant through the nine-quarter stress period, making the 8.3% ratio that much more impressive. Regardless of some investors clamoring about the ease of the tests this year, it is hard to deny the improvements U.S. Bancorp has made to its balance sheet and business prospects.
These strong results have driven investors to tune into the Comprehensive Capital Analysis and Review results, which will be released on Thursday afternoon. Within this release from the Fed, investors will know if the participating banks sought and received approval for any increases in dividends or share buyback programs. Investors will also get to see the impact of any new capital plans on stressed ratios.
Should US Bancorp request another bump?
Last year, U.S. Bancorp asked and received approval for a 56% increase in quarterly dividend payment. Additionally, the Fed did not reject the company's proposal for a new 100 million share repurchase program. USB ultimately repurchased 59 million shares of common stock in 2012 for roughly $1.9 billion, around $500 million more than it returned in the form of common stock dividends. Given the substantial improvement of its balance sheet under a stressed scenario, U.S. Bancorp seems to have ample leverage in negotiating any additional actions to return more cash to shareholders.
While it seems U.S. Bancorp is strong enough to request a substantial increase in its dividend, I believe investors may want to temper their expectations. The Fed has explicitly said that dividend payout ratios above 30% will receive "particularly close scrutiny." U.S. Bancorp's dividend payout ratio has hovered around the 30% level for the last three quarters. If the Fed and the bank cannot agree on a substantial dividend increase, U.S. Bancorp may request to ramp up share repurchases. Therefore, I expect USB to ask and receive approval for a slight dividend increase, as well as a share buyback program.