Barclays Conference: Look to Regions, SunTrust for Best Value
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For many years, U.S. Bancorp (NYSE: USB) has been without peer among large domestic banks in terms of its efficiency and profitability. That shows no signs of changing. This, the nation's fifth largest commercial bank by assets, was represented at the recent Barclays Capital 2012 Global Financial Services Conference by its Chairman and Chief Executive Officer, Richard Davis. It must be fun to present when things, by any objective measure, have been better for U.S. Bancorp than any of its peers. It operates as a commercial bank in a little over half the country, as a wholesale and trust bank across the United States and a payment processing institution across all of North America, Brazil, and much of Western Europe.
In the second quarter of 2012, U.S. Bancorp posted a 1.67% return on assets 26 basis points higher than any other bank with more than $50 billion in assets. It also posted a return on common equity of 16.5% a full 360 basis points higher than the number 2 bank among its peers. Its efficiency ratio was 51.1. Anecdotally, I note that most banks have a goal to have an efficiency level of under 0.60. Part of U.S. Bancorp's recent success is its long series of some 30 acquisitions, mostly of a smaller nature, of retail banks, trust banks, and payment processors since 2008. These acquisitions, most of which with FDIC support, have added about $30 billion in loans and deposits, and over $1 trillion of trust assets.
The issue that has bedeviled most banks has been revenue. Low interest rates plus low loan demand by qualified applicants and soft capital markets equal revenue challenges for large banks and small ones. Not so with U.S. Bancorp. 2011 revenue was a company record $19.1 billion, up 5.3% from 2010. Second quarter 2012 revenues came to $5.07 billion, up 8.1% from the same period of 2011. As the bank's catchphrase goes, indeed, “the momentum continues.” The loan portfolio average during the second quarter stood at $231 billion, up 11% from the same period a year earlier.
U.S. Bancorp's capital position is strong, though not really as strong as one might expect. At the end of the second quarter, its Tier One capital stood at 10.7%. Its Basel 3 Tier One capital stood at 7.9%. Over the long run, the bank, between share buybacks and dividends, is intent on returning 60% to 80% of after tax profits to shareholders. And U.S. Bancorp is betting in part on technology to help drive future growth. Each of the past four years, it has spent between $500 million and $900 million on its capital budget.
The other thing U.S. Bancorp wants and needs to do more of in the future is cross sell, a la Wells Fargo (NYSE: WFC). As of January 2012, Wells Fargo was averaging 5.9 products per customer in its retail banking segment, more than any other bank.
Similarly, U.S. Bancorp has grown its market share and business faster in certain segments than any other bank in the past few years. Its share of the new mortgage market has risen from 0.7% in 2007 to 5.6% in the second quarter of 2012. Its credit card market share has increased from 4% to 6% in the same time frame. Most of the company's revenue generators have shown similar gains since 2007.
It is not entirely sunshine and roses for U.S. Bancorp. The Federal Reserve announced what we all knew was coming, a third round of quantitative easing, which along with a continuing Twist program, is designed to further lower already historically low long term interest rates. The new QE3 is specifically focused on mortgage debt. Yet, for most banks, their mortgage divisions have been the strongest component of their businesses. And I don't believe a ten to twenty basis point reduction in mortgage rates will do much of anything other than narrow the interest margins of these banks. This will reduce all commercial banks' incomes going forward. U.S. Bancorp's net interest margin in the second quarter of 2012 was 3.58% down from 3.67% in the second quarter of 2011. Further declines in this key metric, already likely, are now nearly certain. In the second quarter of 2012, U.S. Bancorp's net interest income comprised 55% of the bank's overall revenue.
U.S. Bancorp is selling at its 52 week high, and just a few cents below its 12 month target price of $35.45 per share. I look for earnings of up near $2.90 per share this year, giving it a current price to earnings ratio of 12. This is high relative to its peer banks and also high as I believe that because of interest pressures U.S. Bancorp's earnings momentum will be losing some steam. While this is still a fine choice for conservative investors seeking a bank issue, I believe those looking for growth can do better elsewhere.
I have a fondness for value plays in banking, and nothing I see right now is as undervalued relative to its potential as Regions Financial (NYSE: RF). David Turner, Regions Chief Financial Officer, represented the troubled large regional bank at the Barclays conference. This year, Regions will turn around four years of annual losses on the strength of (1) no more preferred stock payment dividends as Regions paid pack its TARP debt; (2) an improving credit profile in its loan portfolio, and (3) greatly reduced loan loss provision requirements. Regions is on track to save about $1.1 billion this year from its 2011 loan loss provision, which was in turn $1.3 billion less than the 2010 loan loss provision.
The single worst segment of Regions’ loan portfolio late last decade was its real estate construction book. Through paydowns, write offs and sales, that portfolio segment has fallen by 2/3 since 2007, to $9.4 billion. Those loans, which equaled 27% of the bank's loan portfolio in 2006, now comprise only 12% of Regions' outstanding loans. Mid-market and small business loans, and mortgage loans, now make up the vast bulk of Regions' loan portfolio.
As Regions has been able to dump its high cost TARP debt, its credit costs have fallen enough to support some margin expansion in the second quarter, up to 3.16%. It is also getting its non interest house in order, benefiting from revenue gains from mortgage fee income, while at the same time reducing expenses in the second quarter three percent below the previous quarter.
The one thing that Regions has now to do is find a way to reignite loan growth. Its footprint is focused along the Gulf Coast states, an area of the country I expect to outperform the nation as a whole in the years ahead. This advantage is not unique to Regions, but is shared by banks such as SunTrust (STI), BB&T (BBT), and less so by Wells Fargo and Bank of America (BAC), as well. If Regions Financial grows its loan portfolio responsibly, I expect the stock price to double out to mid-decade.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
