Sunday, January 18, 2009

USB Analysis

US Bancorp (USB) is bank with presence in north america and europe. It has the following lines of business.

1. Payment Services. USB got 27% of its revenue in 2007 through payment services segment. This segment involves corporate payment systems, merchant payment services, NOVA information systems, Retail payment services (debit, credit card) and transaction services.

2. The second segment involves wholesale banking - which earned 19% of USB revenue in 2007. This involves corporate, commercial and real estate banking.

3. The third segment involves wealth management and securities services. This accounted for 12% of USB's earnings in 2007. USB allows individuals, muncipalities and businesses build, manage, preserve and protect wealth and distribute obligations.

4. Consumer banking which involves home mortages supplied 40% of USB revenue in 2007.

This mix changed slightly into 3Q 2008 where payments accounted for 27% of revenue, consumer 41% of revenue, wealth management 13% of revenue and wholesale accounted for 19% of revenue.

Let us analyze USB with the criteria that WEB established for Wells Fargo in 1990.

a. Is the management team able?

b. Dont have a larger headcount than necessary.

c. Attack costs when profits are at record levels as they are under pressure.

d. Stick with what they understand and let their abilities, not their egos determine what they attempt.

For the first question, USB seems like a well run company without being affected by the problems in subprime and other lending despite its large exposure to the California market. Richard Davis has run the company well.

USB hasnt had any layoffs as experienced by Citi, BAC and other players. Wells Fargo also played its hand conservatively. However, its acquisition of Wachovia probably altered its asset mix.

Attack costs when profits are at record levels as they are under pressure. This is somewhat answered by no layoffs - keeping the costs under control with personnel has paid off for USB.

Finally, USB hasnt tried to swallow smaller companies using TARP money. Let us take a look at the 3Q conference call. This was an exchange between Mike Mayo and Richard Davis.

Mike Mayo - Deutsche Bank
Following up on the deal question, why wouldn’t you go out and buy another bank that’s less efficient, especially if you had a government guarantee? Also, are there certain parts of the country that you are interested in, either near or long term?
Richard Davis
Did you say “why wouldn’t we?”
Mike Mayo - Deutsche Bank
Yes, why wouldn’t you? I mean it makes sense what you have done and now the price has come down and maybe even some government assistance. Everyone asks, “what about U.S. Bancorp?” Everyone else has shown some kind of move, whether it is JP Morgan or Bank of America or Wells Fargo.
Richard Davis
I hear you. Now first of all, you know me and I am not motivated by what everybody else is doing. It only works if it works for us. The prices actually don’t come down. I mean the fact of the matter is that there is more money in the market. I suspect that the target prices might actually go up. So for us it’s just going to have to be a deal, like I said, that fits all of our criteria which is immediate accretion and long-term value. I do think that there is more of that out there. I am telegraphing that we are more active and more interested than we might have been before, but it doesn’t change any of the parameters and it doesn’t change our appetite for taking risk. It’s got to be the right deal and it’s got to make sense. So sure, we are looking at it more.

Let us look at the bank as a whole and how it compares to others.

Asset Size: 247 billion
Deposit: 140 billion
Loans: 170 billion
Customers: 14.9 million
Market Cap: 32.1 billion
Branches: 2769
ATMs: 5159

Through 3Q 2008, the ROA was 1.45% and and ROE was 16.6%. Let us see how this compares to Buffett's Wells Fargo buy in 1990. The ROA and ROE numbers were hampered by Q3 weakness. This is likely to reduce further with Q4 numbers.

Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets.

The growth in net charge offs and loan loss reserve build is expected to accelerate in Q4 2008. It is expected that the company will take 600 million in charge offs and 650 million to build reserves in Q4 2008. This compares to a total cost of 748 million in Q3 2008. While the increase in charge offs and loan losses will reduce the income, we expect the income to be still positive. The company paid out more in dividends than what it earned in Q3 and we definitely expect the dividend to come under pressure in 2009.


From Buffett's 1990 letter to share holders on Wells Fargo:

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

USB is likewise in a strong position. The recession in 2008 is more severe than the one in 1990-1991. The economy will likely continue to contract in Q1 2009 and Q2 2009. The stress in residential housing market may continue into 2009. It is likely that the stress will spread to other areas such as commercial real estate - this can put further pressure on the bank. However, there are segments of the bank that continue to do well.


In 2008, the company received 6.599 billion in TARP payments. At a rate of interest of 5%, the company is required to pay out $330 million to the federal government every year.

Dividend payout:

Another factor is the dividend yield. While the stock paid out $1.70 in 2008, the earning as well as payout is likely come under pressure in 2009.

We expect 2009 to be a good year to invest in USB if the current market conditions dont lead to a full blown depression.

No comments: