It had to spend money to make money, but U.S. Bancorp earned enough in the second quarter to put more distance between itself and rivals that are struggling in their core businesses.
Smart acquisitions, an investment in corporate banking capabilities and opportune improvements in demand for payments and processing services helped U.S. Bancorp post record revenue of $4.5 billion, up 8.7% from the second quarter of 2009.
The Minneapolis company has been one of the few big banks to pair better news on the credit front with strong core earnings, setting a high bar for Fifth Third Bancorp, PNC Financial Services Group Inc. and other large regionals that will report results on Thursday.
There were no reserve releases to inflate the bottom line for U.S. Bancorp, which grew 63%, to $766 million, or 45 cents a share, beating Wall Street's 38-cent average forecast. And though borrowing demand remains disturbingly weak, the company showed its earnings strength was built on more than just favorable interest rates and better loan spreads. There also were higher fees on standby letters of credit, investment product commissions, credit and debit card revenue and a host of other income sources to more than offset the 20% hit to deposit service charges from new regulations.
Analyst Christopher Whalen, known for his ruthless assessments of banks' performances, found little to criticize Wednesday.
"Stability and consistency are the words which come to mind," Whalen, managing director of Institutional Risk Analytics, said in his commentary on the results. "This is the best [second-quarter] earnings report by a large U.S. bank so far. You'd almost think that Middle America is recovering faster than the coasts looking at U.S. Bancorp."
Company officials might agree with the first two conclusions, but they would probably take exception to the last one. In contrast to JPMorgan Chase & Co. and Citigroup Inc., U.S. Bancorp declined to release reserves for loan losses, despite signs of improved credit trends in the portfolio.
"We're looking at current credit trends and then an expectation around the economy, and one is offsetting the other," U.S. Bancorp Chief Financial Officer Andrew Cecere said in an interview. "We're seeing some improvement across most categories in delinquencies, but there is still a bit of uncertainty around the economy on a go-forward basis."
Continued economic weakness, and the anemic loan demand that such a scenario would likely entail, make the company's other fee-based businesses all the more vital. The need to offset new regulatory costs is another motivating factor: U.S. Bancorp estimates that revenue for the full year will be trimmed $230 million to $280 million by new rules and voluntary pricing changes regarding overdraft fees, while new credit card rules will have an estimated impact of $170 million to $190 million for the year.
But making a grab for noninterest income comes at a cost.
Noninterest expenses at U.S. Bancorp rose 11% from the year-earlier quarter, with increases showing up in nearly every line item from compensation and occupancy costs to marketing and technology. The rate of growth in expenses far outstripped the 2.7% increase in noninterest income.
"Fees were better than we forecast but expenses were worse," analyst R. Scott Siefers of Sandler O'Neill & Partners LP wrote in a note to clients.
One of the biggest drivers of costs, a 24% year-over-year jump in compensation, followed the reversal of a broad, 5% salary cut put into effect last year, plus a round of merit-based bonuses awarded in the first quarter of 2010, Cecere said.
The company also has made targeted investments in areas such as corporate banking.
With big customers turning more to wholesale financing sources instead of bank credit, credit line utilization rates for U.S. Bancorp's corporate borrowers hit an all-time low of 19%, down from a high of 34% two years ago. But at least now, with the recent expansion of its investment-grade bond desk, the company at least has a chance of recouping some of the traditional lending revenue that has been lost to the capital markets.
Corporate banking activities helped drive a 42% increase in revenue from commercial products, such as syndicated loans and derivatives. Other big gains in second-quarter revenue came from merchant processing services, up 15.1% from last year's second quarter as retail spending picked up; corporate payment products, up 6%; and investment product fees and commissions, up 11.1%.
Net interest income, up nearly 15% from the year-earlier quarter, was driven by an increase in earning assets and favorable funding rates. Growth in average low-cost deposits, such as interest checking and money market and savings accounts, was 17.4%, outpacing the 12.3% increase in average total deposits.
Deposit growth was aided by acquisitions, including the October purchase of FBOP Corp. in a Federal Deposit Insurance Corp.-assisted deal that expanded U.S. Bancorp's presence in Chicago and California. In May, the company converted 150 FBOP branches into U.S. Bank branches.
Acquisitions helped boost average total loans by 4%. Excluding the franchise additions, loans dropped 2.7%. But the company renewed or extended $29.3 billion of loan commitments to commercial customers and commercial real estate borrowers.
"Our company's results this quarter demonstrated the underlying strength of our franchise and provided further evidence that our growth initiatives and investments are taking hold," Chairman and Chief Executive Richard K. Davis said. "Over the past many months, a time of both economic uncertainty and industry change, we have maintained our strong defense, while establishing our new offense."
Davis showed no indication of letting up on offense when it comes to acquisitions, despite the new, higher costs of being big. (New calculations based on assets rather than deposits will contribute to an expected $200 million increase in the company's deposit insurance assessment for 2011.)
But the downside to getting larger "actually makes me wonder if the parties we might be interested in working with might be more interested, and I'm not sure yet," Davis said on a conference call. "I'll sit and wait, and in the meantime we'll manage what we have."