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Growth of deposits fuels dividends.
The U.S. financial sector has faced a difficult headwind in 2016, in the form of a persistent low-interest-rate climate. Since the loans that banks create and assemble are typically long in duration while deposits are short-term, banks earn a spread between the two. This is net interest margin, and low interest rates suppress net interest margin. Bank profitability has suffered throughout 2016 as a result, but the good news is that banks may finally get a boost if the Federal Reserve raises interest rates this year.
A few select banks have continued to perform well over the past year, even in this difficult environment. One example is U.S. Bancorp (USB ), a major U.S. commercial bank. U.S. Bancorp stock has increased 5% over the past 12 months, even though interest rates remain low. That is because of the success the company has seen in its core commercial banking focus. It continues to steadily grow earnings each year, which allows it to reward shareholders with dividend increases.
U.S. Bancorp declared a quarterly dividend rate of $0.28 per share, payable Oct. 17, to stockholders of record at the close of business on Sep. 30. The new dividend rate represents a forward annualized payout of $1.12 per share. The current dividend yield rises to 2.6% based on the current share price.
U.S. Bancorp’s 10% dividend increase is a more significant raise than many other companies in the financial sector have delivered this year. For example, smaller regional bank Community Bank System (CBU ) recently raised its dividend by 3%, which we cover here. U.S. Bancorp is also aggressively repurchasing its own shares. It approved a $2.6 billion share repurchase authorization earlier this year, after receiving no objection from the Federal Reserve. As a major financial institution, with $438 billion in assets as of June 30, U.S. Bancorp must pass the Fed’s annual stress test review in order to increase its capital return program. U.S. Bancorp easily passed the stress test.
The major reason for U.S. Bancorp’s strong dividend growth rate is its diversified business model and focus on commercial banking. The company is off to a very good start this year. It generated record revenue and net income last quarter. These results are highly impressive given interest rates remain low. If interest rates rise as expected in 2017 and beyond, it should support even higher dividend growth in the future. Analysts on average expect U.S. Bancorp to earn $3.53 per share next year, which would represent 7.3% earnings growth in 2017.
This should provide room for the company to increase its dividend again next year, as U.S. Bancorp kept a modest 31% payout ratio last year.
U.S. Bancorp is the fifth-largest commercial bank in the country. It operates more than 3,100 banking offices across 25 states. It provides a wide range of banking, investment, mortgage, and other products and services. As a commercial bank, U.S. Bancorp has mostly avoided the risky trading activities that got many big banks in trouble during the financial crisis. U.S. Bancorp has remained steadily profitable over the past decade and, in the past five years, it has successfully grown earnings and shareholder equity at a high rate.
Over the past five years, the company has grown earnings per share and average shareholder equity by 28% and 39%, respectively. One major reason for this is significant growth in average assets. Assets have grown 28% in the past five years. The company has benefited from rising deposits, which were up 7.7% last year. Consumers are more financially stable – thanks to the steady economic recovery, falling unemployment rates and increasing home values. This has put more cash in consumers’ pockets which they are then depositing into banks, like U.S. Bancorp.
This growth in assets has helped offset a lower return on its assets due to low interest rates. Even though return on assets declined 6.5% last year, the company delivered record net income and record diluted earnings per share. This enabled the company to increase its capital allocation during the year. It returned approximately 72% of profits last year to shareholders through dividends and share buybacks.
Not only is U.S. Bancorp a compelling bank stock for its future earnings growth prospects and above-average dividend yield, it’s also an attractive stock selection on the basis of valuation. The stock trades for approximately 12 times 2017 forecasted earnings per share. This is a lower multiple than the S&P 500 and the reason the stock has attracted legendary investor Warren Buffett.
Buffett’s investment conglomerate Berkshire Hathaway (BRK-B) is U.S. Bancorp’s second-largest institutional holder, and owns approximately 85 million shares, worth $3.4 billion. Berkshire Hathaway owns nearly 5% of the company. It’s likely that U.S. Bancorp’s strong growth and avoidance of risky trading activities are the reasons for Buffett’s ownership of the firm.
U.S. Bancorp is appealing for many types of investors, including value and income investors, because it generates steady growth each year without a great deal of volatility. It rewards investors with a solid current dividend yield and the likelihood of dividend growth each year.