U.S. Bancorp (USB) — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Dollar amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
U.S. Bancorp is a diversified bank with Corporate and Commercial Banking, Consumer and Business Banking, Wealth Management and Investment Services, Payment Services, and Treasury and Corporate Support segments. It reported results amid rising interest rates, inflation and economic uncertainty, and was planning its acquisition of MUFG Union Bank’s core regional banking franchise.
Financial performance and position
- Q2 revenue and earnings: Total net revenue was $6.012 billion, up 4.0% year over year. Net income attributable to U.S. Bancorp was $1.531 billion, down 22.8%; diluted EPS was $0.99 versus $1.28. Return on average assets was 1.06% and return on average common equity was 13.9%.
- First-half results: Total net revenue was $11.608 billion, up 3.2%. Net income attributable to U.S. Bancorp was $3.088 billion, down 27.5%, and diluted EPS was $1.97 versus $2.73.
- Net interest income and margins: Q2 net interest income was $3.435 billion, up 9.5%; on a taxable-equivalent basis it was $3.464 billion. Net interest margin on that basis was 2.59%, versus 2.53% a year earlier. First-half taxable-equivalent net interest income rose 6.6% to $6.664 billion, while margin was 2.51%, compared with 2.52%.
- Fees and expenses: Q2 noninterest income fell 2.7% to $2.548 billion, principally as mortgage banking revenue fell 59.0%; payment services and trust and investment management fees increased. Noninterest expense rose 9.9% to $3.724 billion, including $197 million of merger and integration charges. The efficiency ratio was 62.1%, versus 59.0%.
- Credit: Q2 provision for credit losses was $311 million, compared with a $170 million benefit a year earlier; first-half provision was $423 million versus a $997 million benefit. Management cited loan growth and greater economic uncertainty. Q2 net charge-offs were $161 million, or 0.20% of average loans, compared with $180 million and 0.25% a year earlier. At quarter end, nonperforming assets were $770 million, down from $878 million at December 31, 2021; the allowance for credit losses was $6.255 billion, or 1.88% of period-end loans.
- Loans, deposits and debt: Period-end loans were $332.4 billion, up 6.5% from year-end 2021; deposits were $467.1 billion, up 2.4%. Short-term borrowings increased to $25.0 billion from $11.8 billion, while long-term debt declined to $29.4 billion from $32.1 billion.
- Liquidity and cash flow: The company reported $39.1 billion of cash and due from banks at June 30. It reported $10.7 billion of net cash provided by operating activities, $19.5 billion used in investing activities and $19.0 billion provided by financing activities for the first half. It cited $137.5 billion of unencumbered investment securities and $95.5 billion of additional potential FHLB and Federal Reserve borrowing capacity. It was compliant with regulatory LCR and NSFR requirements.
- Capital: CET1 was 9.7%, Tier 1 capital 11.4%, and total risk-based capital 13.2%, all lower than at year-end 2021 but above regulatory well-capitalized requirements. Shareholders’ equity declined to $48.6 billion from $54.9 billion, largely reflecting investment-security valuation losses and dividends. The common dividend was $0.46 per share for Q2.
Material changes versus comparable periods
- Higher rates, loan growth and higher investment-security balances drove net interest income growth, while deposit pricing and lower SBA Paycheck Protection Program-related loan fees partly offset the increase.
- Earnings fell despite revenue growth, as expenses and credit-loss provision increased. The comparison also reflects a prior-year allowance release as economic conditions and credit quality improved.
- Mortgage refinancing activity weakened: Q2 mortgage banking revenue fell to $142 million from $346 million a year earlier. Payment services revenue and trust and investment management fees provided partial offsets.
- Rising rates drove a sharp decline in investment-security fair values. Available-for-sale securities had net unrealized losses of $9.4 billion at June 30, versus net unrealized gains of $722 million at year-end 2021. Shareholders’ accumulated other comprehensive loss widened to $10.4 billion from $1.9 billion.
Outlook, commentary, risks and unusual items
- Acquisition: The planned acquisition of MUFG Union Bank’s core regional franchise had an expected purchase price of approximately $8.0 billion, comprising $5.5 billion cash and approximately 44 million USB shares. The acquired franchise was expected to add about $105 billion in assets, $58 billion in loans and $90 billion in deposits. Management expected U.S. regulatory approvals in time for closing in the second half of 2022; approvals and other closing conditions remained outside the company’s control. No specific earnings guidance was provided in the supplied filing text.
- Acquisition costs and capital returns: Q2 merger and integration charges were $197 million pre-tax ($153 million after tax), reducing diluted EPS by $0.10. Common share repurchases were suspended other than those associated with stock-based compensation; management said it did not expect to resume repurchases until after the acquisition closed and CET1 approached 9.0%.
- Investment securities: During Q2, $17.1 billion amortized cost of available-for-sale securities was transferred to held-to-maturity; an additional $19.8 billion amortized cost was transferred after quarter-end. Management said it had no plans to sell securities with unrealized losses and did not expect to be required to sell them before recovery of amortized cost. The marks are principally rate-driven, but their magnitude and liquidity implications merit attention.
- Economic and risk factors: Management cited supply-chain challenges, inflation, market volatility, higher oil prices related to the Russia-Ukraine conflict, rising interest rates and recession risk. Forward-looking risks also include credit deterioration, securities valuation changes, cybersecurity and operational risks, regulatory and litigation matters, and acquisition execution and integration.
- Regulatory and legal matters: On July 27, 2022, U.S. Bank agreed to a CFPB consent order resolving an investigation into certain consumer sales practices; the company said the financial impact was not material. The filing also discusses Visa-related litigation and other legal and regulatory matters, whose outcomes may differ from current reserves or estimates.
- Interest-rate sensitivity: The company’s modeled next-12-month net interest income sensitivity at June 30 was +1.17% for an immediate 50-basis-point increase and +1.54% for a gradual 200-basis-point increase; the model did not compute a gradual 200-basis-point decrease scenario given interest-rate levels. Actual outcomes may differ materially from modeled results.
Most important facts for investors to verify
- Whether the MUFG Union Bank transaction received approvals and closed as expected, and how purchase accounting, integration costs, synergies and share issuance affected results and capital.
- Whether deposit mix, funding costs and loan yields support continued margin improvement as rates and deposit pricing change.
- Whether loan growth and worsening macroeconomic conditions lead to higher provisions, delinquencies, charge-offs or reserve needs.
- How available-for-sale and transferred held-to-maturity securities’ unrealized losses evolve, and whether liquidity needs ever require securities sales.
- Whether CET1 remains adequate through the acquisition and when capital returns, particularly share repurchases, may resume.
- Developments in the CFPB order, Visa litigation and other legal or regulatory matters, including any changes to reserves or business practices.