The Banking Tortoise That Won the Race

10/04/2010 9:12 am EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, equity strategist and editor of Morningstar DividendInvestor, and analyst Jaime Peters say conservative US Bancorp is well-capitalized and ready to hike its dividend big time.

With a footprint stretching from the West Coast to the Midwest, US Bancorp (NYSE: USB) is a conservative, customer-focused bank where profitability has been shielded by two strong sources of fee income. [Its] strong capital position [lets the company take] full advantage of today’s banking crisis.

About 60% of US Bancorp’s earnings comes from traditional consumer and wholesale banking. Prudent underwriting practices, which restrained asset growth in the bubblier years of the economic expansion, are resulting in lower net charge-offs in the current downturn.

Moreover, through [purchases of troubled banks assisted by the Federal Deposit Insurance Corporation], the company added to its branch and deposit base in the (normally) rapid-growth California market. Loss guarantees from the FDIC have allowed the bank to expand cheaply with little risk to its core franchise.

What really sets US Bancorp apart from other conservative lenders is its two large fee-based businesses. The larger of these two, payment processing, is a highly scalable business that includes debit and credit cards, as well as merchant processing. This unit makes up 27% of normalized revenue and [has strong] growth and profitability, [even though] consumers have cut spending.

US Bancorp also has a large wealth-management business, accounting for 13% of normalized revenue (revenue adjusted for yearly swings—Editor). Account growth is holding up fairly well, but fees have come down as clients trade less and the unit’s mutual funds take a hit in the equity markets.

[Neither of these is] taking credit-quality hits like the lending unit; both businesses have “wide moats” (durable competitive advantages—Editor) and are likely to go on providing US Bancorp with the resources to capture market share as peers suffer.

With revenue rising to record levels and credit losses falling, per-share earnings more than doubled in the first half of 2010 to 74 cents (excluding a five-cent benefit from the conversion of certain preferred shares).

Since the quarterly dividend is still only a nominal five cents per share, the bank is building excess capital very quickly. It already meets all the standards proposed by global regulators, the most notable of which is a Tier 1 common equity ratio of 7.4%. This compares favorably with the Basel III [international banking regulatory] standards calling for a 7% requirement to be phased in by 2019.

On the basis of our earnings expectations ($1.51 per share in 2010 and $2.44 in 2011), I estimate that US Bancorp’s dividend rate could reach [80 cents to a dollar a share] by the end of next year, with the potential for 8%–10% annual growth for several more years thereafter.

This would put a yield on a purchase made at my Dividend Buy price of $21 in the 3.8%–4.8% range—a level competitive with many regulated utilities despite offering at least double the potential for dividend growth thereafter. (It closed below $22 Friday—Editor.)

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