U.S. Bancorp — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Comparisons are primarily with the corresponding 2019 periods; balance-sheet comparisons are with December 31, 2019. Amounts are in U.S. dollars.
Business context and performance
U.S. Bancorp reported results amid the COVID-19 pandemic and associated economic disruption. Fee growth, particularly in mortgage banking and commercial products, supported revenue, while lower interest rates and a sharp increase in expected credit losses substantially reduced earnings.
Key financial metrics
| Metric | Q2 2020 | Comparison |
|---|---|---|
| Total net revenue | $5.84 billion | Up 0.3% year over year |
| Net interest income, taxable-equivalent | $3.22 billion | Down 3.2%; net interest margin 2.62%, versus 3.13% |
| Noninterest income, including securities gains | $2.61 billion | Up 5.0%; mortgage banking revenue was $648 million |
| Noninterest expense | $3.32 billion | Up 5.2%; efficiency ratio 57.6%, versus 54.3% |
| Provision for credit losses | $1.74 billion | Up from $365 million |
| Net income attributable to U.S. Bancorp | $689 million | Down 62.2%; diluted EPS $0.41, versus $1.09 |
| Net charge-offs | $437 million | 0.55% of average loans, versus 0.49% |
For the six months ended June 30, net income attributable to U.S. Bancorp was $1.86 billion, down 47.2%, and diluted EPS was $1.12, versus $2.10. Total net revenue rose 1.9% to $11.61 billion; provision expense increased to $2.73 billion from $742 million.
Balance sheet and credit: At June 30, total assets were $546.7 billion, loans $310.3 billion, deposits $413.3 billion, long-term debt $42.6 billion, and shareholders’ equity $51.9 billion. Deposits increased 14.2% from year-end, while loans increased 4.8%. Cash and due from banks was $52.4 billion. The allowance for credit losses was $7.89 billion, or 2.54% of period-end loans, versus $4.49 billion and 1.52% at year-end. Nonperforming assets rose 41.5% to $1.17 billion.
Capital and liquidity: Common equity Tier 1 capital was 9.0%, Tier 1 capital 10.6%, and total risk-based capital 12.8%; all regulatory capital ratios exceeded “well-capitalized” requirements. The company reported $116.3 billion of unencumbered investment securities and $97.8 billion of additional borrowing capacity from the FHLB and Federal Reserve. It was compliant with the regulatory Liquidity Coverage Ratio requirement.
Cash flows, six months: Operating activities provided $1.50 billion; investing activities used $18.00 billion; financing activities provided $46.48 billion. Cash and due from banks increased $29.99 billion to $52.39 billion, principally alongside a $51.39 billion increase in deposits.
Material changes versus comparable periods
- Credit provisioning was the main driver of the earnings decline. The allowance increase during the first half included $1.50 billion from adopting the expected-credit-loss accounting standard and a further $1.90 billion for deteriorating economic conditions.
- Net interest margin fell amid lower rates and higher cash balances held for liquidity. Higher loan and deposit balances partly offset lower yields and spreads.
- Mortgage banking revenue surged with refinancing activity; commercial products revenue also grew. These gains were partly offset by lower card, merchant-processing, corporate-payment and deposit-service revenues as spending and transaction volumes weakened.
- Expenses rose due to COVID-related costs, mortgage and capital-markets production expenses, and technology and digital investment. Management identified $79 million of COVID-related expense in Q2.
- Available-for-sale securities increased to $128.1 billion from $122.6 billion at year-end, with net unrealized gains of $3.6 billion versus $496 million. Shareholders’ equity was essentially unchanged from year-end.
Outlook, risks and unusual items
- Management expected net interest margin to be relatively stable in Q3 compared with Q2, and expected mortgage banking revenue to decline as industry refinancing activity slowed. It anticipated payment-services revenue to remain pressured through 2020, while expecting gradual improvement in transaction volumes.
- Management expected nonperforming assets and net charge-offs to increase given economic conditions. Credit-loss estimates depend on uncertain pandemic duration and severity, unemployment, economic recovery, government stimulus, and borrower payment-relief outcomes.
- By June 30, approximately 249,000 COVID-related loan modifications had been approved, representing about $20.0 billion, or 6.4% of on-balance-sheet loans; approximately 130,000 borrowers remained active in relief programs. Payment delays may postpone recognition of delinquencies or nonaccrual status.
- The Federal Reserve’s Q3 capital-preservation restrictions suspended share repurchases and capped dividends subject to earnings limits. U.S. Bancorp had already suspended repurchases apart from transactions associated with employee compensation programs and said future capital distributions would depend on conditions and regulatory requirements.
- Merchant-processing chargeback exposure included $9.5 billion of airline tickets purchased for future delivery; the company held $743 million of collateral and recorded a $144 million liability primarily related to airline-processing arrangements.
- Visa card-brand litigation and other legal and regulatory matters remain unresolved. The company said existing matters were not expected to materially affect overall financial condition, results or cash flows, while acknowledging that a particular period could be materially affected and that estimates are uncertain.
- Other risks include sustained low rates, pandemic-related operational and cybersecurity disruption, borrower and counterparty stress, payment-volume weakness, and the transition away from LIBOR. The company reported no material change in internal control over financial reporting and concluded disclosure controls were effective.
Accounting item: U.S. Bancorp adopted the current expected credit losses methodology on January 1, 2020, increasing the allowance by about $1.5 billion and reducing retained earnings by about $1.1 billion, net of deferred taxes. It elected regulatory-capital transition relief for the adoption and subsequent reserve increases.
Important facts for investors to verify
- Whether the allowance for credit losses adequately reflects later economic forecasts, loan-risk migration, relief-program exits, and actual delinquencies and charge-offs.
- Trends in payment-relief balances, particularly commercial real estate and residential mortgage exposures, and the timing of resumed payments.
- Whether mortgage refinancing and commercial-products gains persist as rates, market activity and customer demand change, and whether payment-services volumes recover.
- Capital ratios under full CECL implementation, regulatory restrictions on dividends and repurchases, and the sustainability of the common dividend.
- Potential losses from airline chargebacks, Visa litigation, mortgage representations and warranties, and other legal or regulatory proceedings.
- How deposit growth, cash balances, borrowing capacity and funding costs evolve as customer liquidity and market conditions change.