U.S. Bancorp — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Comparisons are with the corresponding 2009 periods unless otherwise noted. Dollar figures are in U.S. dollars; “billion” and “million” are abbreviated for readability.
Business context and results
U.S. Bancorp is a diversified banking and financial services company. Its businesses include Wholesale Banking, Consumer Banking, Wealth Management & Securities Services, Payment Services, and Treasury and Corporate Support.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net interest income, taxable-equivalent | $2.477bn | $2.157bn | $7.289bn | $6.356bn |
| Total net revenue, taxable-equivalent | $4.587bn | $4.250bn | $13.427bn | $12.292bn |
| Noninterest income, as reported | $2.110bn | $2.093bn | $6.138bn | $5.936bn |
| Noninterest expense | $2.385bn | $2.053bn | $6.898bn | $6.053bn |
| Provision for credit losses | $995m | $1.456bn | $3.444bn | $4.169bn |
| Net income attributable to U.S. Bancorp | $908m | $603m | $2.343bn | $1.603bn |
| Diluted earnings per common share | $0.45 | $0.30 | $1.24 | $0.66 |
Financial position, credit, and liquidity
- Margins and returns: Q3 net interest margin was 3.91%, up from 3.67%; return on average assets was 1.26% versus 0.90%, and return on average common equity was 12.8% versus 10.0%. The efficiency ratio worsened to 51.9% from 47.5%.
- Balance sheet at September 30: Assets were $290.7bn; loans $194.6bn; investment securities $49.0bn; deposits $187.4bn; short-term borrowings $34.3bn; long-term debt $30.4bn; and U.S. Bancorp shareholders’ equity $29.2bn. Compared with year-end 2009, assets grew 3.4%, deposits 2.3%, and long-term debt declined 6.8%; loans were essentially unchanged.
- Cash flow: Nine-month operating cash flow was $2.806bn, down from $4.220bn. Investing activities used $7.715bn and financing activities provided $3.173bn. Cash and due from banks ended at $4.470bn, versus $6.206bn at year-end 2009.
- Credit: Q3 net charge-offs were $995m, down from $1.041bn; for nine months they were $3.244bn, up from $2.758bn. The allowance for credit losses was $5.540bn, or 2.85% of loans (3.10% excluding FDIC-covered loans). Total nonperforming assets were $5.414bn, down from $5.907bn at year-end; excluding covered assets, they were $3.563bn, down 8.7%. Covered-loan delinquency remained a concern: 90-day-past-due ratios including nonperforming loans were 11.12% for covered loans versus 2.37% for loans excluding covered loans.
- Capital: Tier 1 capital was 10.3%, total risk-based capital 13.3%, and leverage 9.0%; all exceeded regulatory “well-capitalized” requirements. Tier 1 common equity to risk-weighted assets was 7.6%.
- Dividends: Common dividends declared were $0.05 per share for Q3 and $0.15 for the first nine months, unchanged from 2009.
Material changes versus prior periods
- Q3 net income attributable to the company rose 50.6%; nine-month net income rose 46.2%. Revenue growth and lower credit-loss provision supported the improvement, while noninterest expense increased 16.2% in Q3 and 14.0% year to date.
- Higher net interest income reflected growth in earning assets, acquisitions, more lower-cost core deposits, and improved net interest margin. Q3 noninterest income was nearly flat; payments-related, commercial-products, and mortgage-banking revenue gains were partly offset by lower deposit service charges and trust fees.
- Expense growth reflected acquisitions, compensation and benefits, business initiatives, and tax-advantaged investment costs. The efficiency ratio’s deterioration indicates expenses grew faster than the relevant revenue base.
- Credit trends were mixed: Q3 charge-offs declined year over year and delinquencies eased in most major categories during the quarter, but nine-month charge-offs increased. Nonperforming assets excluding covered assets declined, while residential mortgage and credit-card stress and foreclosed properties remained notable.
- Year-to-date 2010 diluted EPS included a reported nonrecurring $0.05 net benefit from the income trust securities exchange. The comparison with 2009 is also affected by 2009’s $1.4bn provision above net charge-offs, $293m net securities losses, $123m FDIC special assessment, $92m real-estate transaction gain, Visa-related gain, and preferred-stock redemption accounting. The filing’s EPS calculation also identifies a $118m equity portion of the 2010 exchange; investors should distinguish this item from recurring earnings.
Outlook, commentary, risks, and unusual items
- Management expected nonperforming assets excluding covered assets and net charge-offs to trend lower in Q4 2010, and expected overall loan modifications to moderate through year-end. These are expectations, not guarantees.
- The company described its liquidity position as strong, citing core deposits and access to domestic and global capital markets. It reported approximately $4.0bn of dividends available from banking subsidiaries to the parent after meeting well-capitalized requirements.
- The company recorded $85m of investment-security impairment charges in the first nine months, mainly on non-agency mortgage-backed and structured investment-related securities. It warned that adverse market changes could cause additional impairment.
- U.S. Bancorp announced a strategic alliance involving the long-term asset-management business of FAF Advisors, with closing expected in Q4 2010; the company planned to retain its money-market fund business.
- Management said it had no plans to halt foreclosures and believed its foreclosure procedures followed established safeguards, while noting increased industry scrutiny of foreclosure documentation and review.
- The Dodd-Frank Act was expected to adversely affect results once implemented, including through interchange-fee regulation, deposit-insurance assessment changes, and capital-rule changes. The company said the eventual impact could not yet be quantified; instruments affected by the capital exclusion added 1.4 percentage points to the Tier 1 ratio as of quarter-end.
- Other identified risks include a weak or renewedly contracting economy, commercial and residential real-estate deterioration, credit and collateral losses, interest-rate and market movements, legislation and regulation, competition, customer behavior, and operational, liquidity, and legal risks.
- Contingencies include Visa litigation, with a $91m recorded liability and no specified maximum indemnification amount; mortgage-sale representation-and-warranty exposure, for which $147m was reserved; and overdraft-fee class-action cases, for which no loss range could be determined. Airline-ticket merchant-processing exposure included $4.8bn of tickets for future travel, partly supported by $474m of collateral and other protections.
Important facts for investors to verify
- Whether falling Q4 charge-offs and nonperforming assets materialized, particularly in covered loans, residential mortgages, commercial real estate, and credit cards.
- How much of the earnings improvement is recurring after considering acquisitions, the ITS exchange, securities impairments, Visa items, and prior-year comparison effects.
- Whether deposit growth and funding costs sustain the improved net interest margin, and how short-term borrowing growth affects liquidity and funding risk.
- Whether rising expenses and the higher efficiency ratio moderate, and whether fee income is affected by Dodd-Frank implementation and overdraft-policy changes.
- Developments in foreclosure reviews, Visa litigation, mortgage repurchase claims, and other legal or regulatory contingencies.
- Capital resilience after the planned regulatory changes; confirm the filing’s non-GAAP capital measures and definitions when comparing them with peers.