US BANCORP quarterly report, Q3 FY2015

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U.S. Bancorp — Q3 2015 Form 10-Q

Business context and period: U.S. Bancorp is a diversified bank holding company. This unaudited report covers the quarter and nine months ended September 30, 2015; income comparisons are year over year, and balance-sheet comparisons are generally with December 31, 2014. Amounts are in U.S. dollars.

Financial performance and condition

  • Quarterly results: Taxable-equivalent total net revenue was $5.147 billion, up 3.1%. Net income attributable to U.S. Bancorp was $1.489 billion, up 1.2%; diluted EPS was $0.81 versus $0.78. Return on average assets was 1.44% and return on average common equity was 14.1%.
  • Nine-month results: Taxable-equivalent total net revenue was $15.095 billion, up 0.7%. Net income attributable to U.S. Bancorp was $4.403 billion, up 0.9%; diluted EPS was $2.36 versus $2.29.
  • Interest income and margins: Taxable-equivalent net interest income increased 2.7% in Q3 to $2.821 billion and 1.8% for nine months to $8.343 billion. Net interest margin declined to 3.04% in Q3 from 3.16%, and to 3.05% for nine months from 3.26%, reflecting loan mix, lower-yielding securities growth and lower reinvestment rates; lower loan fees also affected the nine-month comparison.
  • Fees and expenses: Q3 noninterest income rose 3.7% to $2.326 billion, while nine-month noninterest income fell 0.6% to $6.752 billion. Noninterest expense increased 6.2% in Q3 to $2.775 billion and 2.7% for nine months to $8.122 billion. The efficiency ratio worsened to 53.9% in Q3 from 52.4% and to 53.8% for nine months from 52.8%.
  • Credit costs and quality: Provision for credit losses was $282 million in Q3, down 9.3%, and $827 million for nine months, down 12.1%. Net charge-offs were $292 million in Q3 versus $336 million; the annualized charge-off ratio improved to 0.46% from 0.55%. Nonperforming assets were $1.567 billion, down 13.3% from year-end 2014; the allowance was $4.306 billion, or 1.69% of period-end loans, versus $4.375 billion and 1.77% at year-end.
  • Balance sheet and funding: At September 30, assets were $415.9 billion, loans $254.8 billion, investment securities $105.1 billion and deposits $295.3 billion. Loans rose 2.8%, deposits 4.4%, and securities 4.0% from year-end. Short-term borrowings were $26.9 billion, down from $29.9 billion; long-term debt was $32.5 billion, slightly above $32.3 billion.
  • Cash flow: For nine months, operating activities provided $6.251 billion, investing activities used $13.111 billion and financing activities provided $6.656 billion. Cash and due from banks decreased $204 million to $10.450 billion. Bank cash-flow figures reflect substantial loan and securities activity.
  • Capital and shareholder returns: Standardized Basel III CET1 was 9.6%, Tier 1 capital 11.1% and total risk-based capital 13.1%; all regulatory ratios exceeded well-capitalized requirements. Shareholders’ equity was $45.1 billion. The quarterly dividend was raised 4.1% to $0.255 per share; the company repurchased $1.781 billion of common stock in the first nine months.

Material changes and unusual items

  • Q3 results included an approximately $135 million gain from selling Visa Class B shares and a $58 million write-down on student loans transferred from held for sale back to held for investment after disruption in the securitization market.
  • Higher compensation, benefits and risk- and compliance-related costs drove much of the expense growth. Nine-month comparisons also reflect the 2014 Charter One branch acquisition and the 2014 FHA DOJ settlement, which reduced prior-year expenses.
  • Mortgage banking revenue declined 13.8% in Q3 and 10.2% for nine months, mainly due to unfavorable mortgage servicing rights valuation changes, partly offset by stronger production revenue.
  • Business-line performance was mixed: Wholesale Banking and Commercial Real Estate and Consumer and Small Business Banking reported lower net income, while Payment Services and Treasury and Corporate Support reported increases.

Outlook, risks and contingencies

  • The filing provides no specific earnings or revenue guidance. Management cited growth in average earning assets, loans and core deposits, while noting continued pressure on net interest margin and mortgage banking revenue.
  • Management identifies credit, interest-rate, market, liquidity, operational, compliance, strategic and reputational risks. A reversal in economic recovery, higher credit losses, rate changes, regulatory developments, litigation, competition and cybersecurity incidents could adversely affect results.
  • Liquidity resources included $90.4 billion fair value of unencumbered available-for-sale and held-to-maturity securities and $78.2 billion of additional potential FHLB and Federal Reserve borrowing capacity. The company reported compliance with the fully implemented LCR requirement under its interpretation of the rule. Parent-company liquidity was stated to cover 12 months of expected obligations including common dividends, or 24 months assuming dividends were reduced to zero.
  • On October 23, 2015, the company entered into an OCC Consent Order concerning deficiencies in its Bank Secrecy Act/anti-money-laundering compliance program. Required enhancements were underway and were not expected to be material, according to the filing. The company also described an amended OCC mortgage-servicing consent order, pending examinations and other investigations.
  • Visa litigation remains unresolved; the net recorded liability was $19 million after escrow offsets, and 6.8 million remaining Class B shares were not yet marketable pending final settlement. The company also disclosed mortgage-backed securities trustee litigation and other contingencies. Management said ultimate resolution of existing legal and regulatory matters was not expected to materially affect financial condition, results or cash flows, but emphasized uncertainty and possible adverse outcomes.

Important facts for investors to verify

  • How much of Q3 earnings growth depended on the Visa share-sale gain, and what are the recurring revenue and expense trends excluding unusual items?
  • Whether margin pressure continues, given the decline in net interest margin and growth in lower-yielding securities.
  • Whether rising compensation, compliance and legal costs persist, and the financial or operational consequences of the OCC orders and other regulatory matters.
  • Whether credit quality and reserves remain adequate, particularly for energy-related commercial exposures, consumer loans and the student-loan portfolio.
  • Whether reported liquidity and capital measures remain resilient under stressed conditions; review the filing’s assumptions and definitions, including non-GAAP capital measures.
  • Cash-flow interpretation, share repurchases, and the status and potential exposure of Visa litigation and other contingencies should be assessed alongside the full financial statements and notes.