Firstar Meets Earnings Estimates, but Other Numbers Fail to Impress

Firstar (FSR Quote), once a guiding light to other regional banks, reported third-quarter results Tuesday that were hardly, er, stellar.

The Milwaukee-based bank, which last week announced its intention to buy U.S. Bancorp (USB Quote), reported operating earnings of 39 cents per share, matching the consensus estimate from analysts surveyed by First Call/Thomson Financial.

But all wasn't well beyond the headline profits number. Firstar's revenue growth was sluggish and a key bad-loan ratio slipped, which could unnerve investors at a time when industrywide credit quality is worsening. The bank also adjusted some previous merger-related charges in a way that could help its operating numbers.

Firstar didn't return a call seeking comment for this piece.

After the earnings report was released, the bank's stock fell to close Tuesday at $17.31, down 63 cents, or 3.48%. Other large banks fell 3.4% on the day, going by the KBW Banks Index.

Headliners

Third-quarter net operating income, which leaves out merger-related charges, totaled $377 million, up 18% from $320 million in the year earlier, and ahead 4.4% from the second quarter. The per-share operating earnings of 39 cents were 21.9% up from 32 cents in the year-ago number, and 5.4% ahead on the second-quarter figure.

While bottom-line numbers grew at a quick pace, this tempo has been achieved mainly through deep cost cutting and, in the case of per-share earnings, through the bank's stock buyback program, which is being suspended to comply with merger accounting regulations that apply to the U.S. Bancorp acquisition.

However, Firstar's closely watched revenue number was unimpressive. Third-quarter revenue of $1.06 billion was only 4% up from the $1.02 billion posted in the year-ago period. Reflecting a 20% rise in the bank's own borrowing costs, net interest income, which makes up two-thirds of revenues, only grew 2.2%.

"Revenue growth was at the low end of what people had anticipated," says Felice Gelman, an analyst for the New York-based Sunova bank-stock hedge fund, which had no position in Firstar shares. The weak revenue growth supports the view, held by some bank watchers, that Firstar is acquiring U.S. Bancorp as a way of boosting revenue growth.

On a conference call, Firstar's finance chief, David Moffett, said that revenue growth would have been around 7% if the cost of the bank's buyback were added back into net interest income.

A Closer Look

A sharp 37% drop in noninterest expenses contributed much to the earnings growth. But a closer look at how this reduction was achieved suggests it's not so impressive. That's because the high costs associated with actions aimed at bringing down expenses -- like balance-sheet restructuring and personnel cuts -- don't get included in operating earnings.

And in its third-quarter earnings release, Firstar said that it was again increasing the merger-related charges arising from the 1998 merger between Star Banc and the old Firstar and the 1999 merger between Firstar and Mercantile. It's standard to treat merger expenses in this way. But it's not common for companies to increase merger charge estimates with the frequency that Firstar has. And since they keep getting upwardly revised, some investors think it necessary to keep a close eye on the merger charges.

In the third quarter, Firstar also let its loan-loss reserve slip as a percentage of overall loans, even though the bank reported a higher level of nonperforming loans, which are credits that are past due but not yet charged off as losses. The loan-loss reserve slipped to 1.34% of loans in the third quarter, against 1.47% in the year-ago period. Meanwhile, nonperformers jumped 27% to $276 million, from $218 million in the year-earlier period. The loan-loss reserve as a percentage of nonperformers has also dropped -- to 259% of loans, from 326% a year earlier.

Firstar would have to add nearly $70 million, equivalent to roughly 6 cents a share, to bring its loan-loss reserve back to 1.47% of loans. In a response to an analyst's question on the conference call about the falling loan-loss reserve ratio, Moffett stated that the bank's reserve is based on the careful review of its loss trends, and he added: "We are comfortable with our loan-loss reserve."