U.S. Bancorp — Q3 2011 Form 10-Q
Business context and reporting period
U.S. Bancorp reported unaudited results for the quarter and nine months ended September 30, 2011. Comparisons are primarily with the same 2010 periods; balance-sheet comparisons are with December 31, 2010. The bank attributed growth in interest income to larger earning assets and lower-cost core deposits, while credit costs declined as loan performance improved.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income, taxable-equivalent | $2.624bn | $2.477bn | $7.675bn | $7.289bn |
| Total net revenue, taxable-equivalent | $4.795bn | $4.587bn | $14.004bn | $13.427bn |
| Net income attributable to U.S. Bancorp | $1.273bn | $908m | $3.522bn | $2.343bn |
| Diluted earnings per common share | $0.64 | $0.45 | $1.77 | $1.24 |
| Provision for credit losses | $519m | $995m | $1.846bn | $3.444bn |
| Net charge-offs | $669m | $995m | $2.221bn | $3.244bn |
- Profitability and margins: Q3 return on average assets was 1.57% versus 1.26%; return on average common equity was 16.1% versus 12.8%. Net interest margin fell to 3.65% from 3.91%. The efficiency ratio was 51.5% versus 51.9%.
- Revenue and expenses: Q3 noninterest income was $2.171bn, up 2.9%; noninterest expense was $2.476bn, up 3.8%. Nine-month noninterest expense rose 4.6% to $7.215bn. Higher compensation, benefits, pension costs, professional services and business initiatives contributed to expense growth.
- Credit quality: Q3 net charge-offs were 1.31% of average loans, down from 2.05%. Nonperforming assets were $4.339bn at quarter-end, down 14.0% from December 2010. The allowance for credit losses was $5.190bn, or 2.53% of period-end loans, compared with $5.531bn and 2.81% at year-end.
- Balance sheet and funding: At September 30, assets were $330.1bn, loans $204.8bn, deposits $222.6bn, short-term borrowings $32.0bn, long-term debt $30.6bn and U.S. Bancorp shareholders’ equity $33.2bn. Since year-end, loans rose 3.9%, deposits 9.0%, assets 7.3% and long-term debt declined 2.9%. Growth in deposits included strong noninterest-bearing account balances.
- Liquidity and capital: Cash and due from banks were $13.7bn. For the first nine months, operating cash flow was $8.755bn, investing cash flow was negative $24.189bn, and financing cash flow was positive $14.655bn; cash declined $779m. Regulatory Tier 1 and total risk-based capital ratios were 10.8% and 13.5%; leverage was 9.0%. Management said regulatory capital ratios exceeded “well-capitalized” requirements and parent liquidity was considerably above its stated requirements.
Material changes versus comparable periods
- Q3 net income attributable to U.S. Bancorp increased 40.2%; nine-month earnings rose 50.3%. Lower credit provisions were a major driver: the provision was below net charge-offs by $150m in Q3 and $375m year to date.
- Net interest income grew, supported by higher average earning assets and lower-cost core deposit funding, but margin compressed as lower-yielding securities and Federal Reserve cash balances increased.
- Average loans rose 5.0% in Q3 and deposits 17.9% year over year; average investment securities increased 38.4%, reflecting purchases to build on-balance-sheet liquidity.
- Noninterest income benefited from payments-related and commercial products revenue, while mortgage banking revenue declined 21.0% in Q3 and 9.3% year to date, mainly due to lower mortgage origination and sales revenue.
- Net charge-offs and nonperforming assets declined from prior comparison levels. Commercial and commercial real estate credit costs improved, although the filing notes continuing stress in commercial real estate and residential mortgages.
Outlook, commentary, risks and unusual items
- Management expected nonperforming assets and net charge-offs to trend lower in Q4 2011. The filing provides no broad earnings or revenue guidance.
- The Durbin Amendment was expected to reduce future noninterest income by approximately $300m annualized beginning in Q4 2011, before any mitigating actions.
- The first nine months included a $46m gain on the FDIC-assisted First Community Bank of New Mexico acquisition and $22m related to Visa litigation escrow/share arrangements. Net securities losses were $22m, and securities impairment charges were $24m year to date.
- Mortgage servicing and foreclosure Consent Orders with federal banking regulators require process changes, an action plan, independent foreclosure review and remediation of identified deficiencies. The company reported progress and did not expect outstanding issues to materially affect financial position, results or normal operations; the orders could nevertheless lead to fines, penalties, restitution or business changes.
- Mortgage representation-and-warranty reserve was $162m, with $115m of unresolved claims from government-sponsored enterprises. The company also disclosed Visa litigation indemnification exposure with no specific maximum under the relevant member-bank provisions; the recorded liability for remaining matters was $29m.
- Other exposures include $5.8bn of airline tickets purchased for future delivery in its merchant-processing business, against $526m of collateral, and a stated maximum potential future payment of $18.760bn for standby letters of credit. These are contingent exposures, not reported losses.
- Investment securities included $646m of unrealized losses on available-for-sale securities; $334m related to non-agency residential mortgage-backed securities. Management said it did not plan to sell loss-position securities and believed it was more likely than not that it would not be required to sell them before recovery. Further adverse market or collateral developments could cause additional impairments.
- The company identified broad risks from economic weakness, real estate markets, interest-rate and market movements, credit deterioration, regulation, competition, legal matters and its ability to manage credit, liquidity and other risks. Disclosure controls were judged effective, with no material quarterly change in internal controls reported.
Important facts for investors to verify
- Whether credit improvement continues, especially in commercial real estate, residential mortgages, card loans and restructured loans, and whether the allowance remains adequate as it declines.
- How the anticipated $300m annualized Durbin-related revenue reduction affects results from Q4 onward and what mitigation the company implements.
- The financial and operational outcome of the mortgage servicing Consent Orders, including independent review findings, remediation costs, potential restitution and any penalties.
- Changes in mortgage repurchase claims and reserve adequacy, and developments in Visa and overdraft litigation.
- Whether the large securities portfolio, including non-agency mortgage-backed securities and unrealized losses, produces additional impairment or valuation risk.
- Cash-flow and funding trends, deposit mix, debt maturities and capital ratios. Also distinguish taxable-equivalent revenue and non-GAAP capital measures from GAAP figures when comparing performance.