Is U.S. Bancorp Undervalued Compared to its Peers?

By Maxwell Fisher - March 1, 2012 | Tickers: BBT, PNC, USB | 0 Comments

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Just below the levels of the large, money center banks come the large, multi-state regional banks. The biggest of these banks is U.S. Bancorp (NYSE: USB), overall the fifth largest bank in this country by assets. I am going to look at what underlies its successful 2011, along with two of its regional bank peers, BB&T Corp. (NYSE: BBT) and PNC Financial Services Group (NYSE: PNC). These banks do not rely upon  investment banking the way some money center banks do, nor do these banks have overseas assets. Their challenges at present include maintaining their interest margins in light of a flattening yield curve, growing their loan portfolios, and making up for non-interest income lost when interchange fees were slashed in the Durbin Amendment to the Dodd Frank Financial Reform package. One thing I am not going to discuss today is book value. Many banks were forced to write down billions of dollars due to overstating the value of assets in recent years. It will take a while before I trust any bank's skills at valuation of assets.

This table will lay out basic statistical background of importance in valuing any bank. 

By the numbers, U.S. Bank is everything I could hope for a large bank to be in this day and age. All of the above statistics, save the dividend yield, are simply superb. And more than that, while many a bank complains of the lack of qualified borrowers, U.S. Bank is growing. Loans outstanding at the end of 2011 were up by $16 billion, or 9% from the year earlier. Thus, despite a gently declining interest margin, U.S. Bank managed to up its interest income for the year by 6%, to $10.35 billion for the year, standing out greatly from the pack.

All is not quite as well for U.S. Bank  though, as the base numbers suggest. While it is entirely true that profits were up by $1.5 billion in 2011 versus 2010, provisions made during the year for loan losses declined from $4.4 billion in 2010 to $2.3 billion in 2011. That accounts, after tax, for virtually all of the profit gain. I like U.S. Bank, but 2012 is the year it is going to have to show all of us it can increase profits by growing its business, and not by massaging its balance sheet. Of course, U.S. Bank is far from the only bank that grew its profits solely on the back of credit improvements. Over the course of 2011 U.S. Bank's net interest margin averaged 3.65%, but it declined sequentially throughout the year, bottoming out in the fourth quarter at $3.60. That margin is something that absolutely must stabilize in 2012 and beyond. U.S. Bank's capital levels are more than sufficient, as the bank was able to repurchase 6 million of its own shares in the fourth quarter.

BBT's profits increased by about $470 million in 2011 from 2010, to $1.33 billion from $854 million. Its provision for loan losses posted in 2010 was $2.64 billion in 2010, and declined nearly $1.5 billion to $1.19 billion in 2011. How is that going to work out for BBT in 2012? BB&T has done a fine job whittling down its distressed properties, and I expect its expenses, and its efficiency ratio, to be even lower in 2012 than in 2011. BBT managed to keep net interest margins very stable, at about 4.05%, throughout all of 2011. I do not expect that will be maintainable in 2012 in a flattened yield curve environment.

PNC's profits for 2011 were up modestly, by just over one percent, or $32 million, to $3.04 billion. The 12% per share improvement in the table above is based upon adjustments to earnings, mostly from 2010. In 2009, 2010, and 2011, PNC's loan loss provisions were $3.9 billion, $2.5 billion, and $1.15 billion, respectively. Again, we have a case where the bulk of PNC's profit growth the past two years is based upon accounting issues, and not upon a revenue driven model. Profit growth cannot continue unless revenues increase going forward. PNC did close in 2011 on Royal Bank of Canada's (NYSE: RY) domestic branch network. Cost savings from integrating the acquired branch network and some earlier purchases should help to drive PNC's 2012 earnings.

The common theme, is that while all of these banks can wring a few hundred million dollars more out of reserves in 2012, the days of multi-billion-dollar annual reductions in reserves is in the banks' rear view mirrors. U.S. Bank carries a five-year estimated PEG of 1.05, and a stated desire, pending regulatory approval, to return over half its profits to shareholders. I am anxious about its next earnings report, but U.S. Bank's retail franchise and history suggest a buy at its current valuation. PNC's five-year estimated PEG is an even stronger 0.74, suggesting that stock is seriously undervalued. BBT lacks the forward earnings power of the other two, and already is trading at a richer price to earnings estimate. As a result, I would avoid investing in BBT.

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