U.S. Commercial Banking Industry's Brighter Future

Includes: USB
by: Randall Hsu, CFA

In Warren Buffett's 1976 letter to Berkshire Hathaway's (NYSE:BRK.A) shareholders, he mentioned that National City Corp. of Cleveland (part of PNC Financial Services today) ran an ad boasting itself as one of the well-managed banks, with the best return on assets in that year for any major banking company--at 1.34%. Mr. Buffett acknowledged that was the best earnings achievement among the really large banks, which averaged below 1%. Meanwhile, the S&P 500 (NYSEARCA:SPY) was recovering from the 1973-1974 stock market crash.

Fast forward to 2012, and we witness the most amazing progress in innovation, technology, and capital accumulation in human history. U.S. GDP improved more than seven times to about $14.6 trillion. People now connect with each other without boundary. Creativity sprouts out of garages and dorm rooms to become multi-billion dollar institutions in an instant. And, U.S. Bancorp (NYSE:USB), the fifth-largest commercial bank in the U.S., reported its 2011 results with a return on assets of 1.53%.

FDIC Quarterly Banking

As shown in the chart above, the banking industry continues to earn a respectable return on assets as a whole, even with all the changes and shocks that we have experienced. Banks continue to be an integral part of the U.S. economy, and capitalism, the country's recipe for success, continues to flourish.

However, despite the basic principles of taking deposits and making loans, no two banks are alike. Well-managed banks, like U.S. Bancorp, have adopted these transformations and continue to have brighter prospects. Recent pessimism in the banking sector should allow those who seek partial ownership of well-managed banks to receive better reward in the coming decade. The comments of Bruce Berkowitz, the mutual fund manager who coined his investment philosophy as "comparing what you give vs. what you get," and "count the cash," are fitting for why these investments will work out in the future.

In my next article, I will compare the riskiness of major U.S. banks' asset portfolios and their operating performance to identify banks that are outstanding like U.S. Bancorp.

Disclosure: I am long USB.