U.S. Bancorp — Q3 2020 Form 10-Q
Reporting period: Quarter ended September 30, 2020; comparisons are with Q3 2019 unless noted. U.S. Bancorp is a diversified banking and financial services company. Results reflect the continuing effects of the COVID-19 pandemic.
Financial performance and condition
| Metric | Q3 2020 | Comparison |
|---|---|---|
| Net interest income | $3.227 billion | Down 1.6% |
| Net interest income, taxable-equivalent basis | $3.252 billion | Down 1.6% |
| Total net revenue, taxable-equivalent basis | $5.964 billion | Up 0.7% |
| Noninterest income | $2.712 billion | Up 3.7% |
| Noninterest expense | $3.371 billion | Up 7.2% |
| Provision for credit losses | $635 million | Up 73.0% |
| Net income attributable to U.S. Bancorp | $1.580 billion | Down 17.2% |
| Diluted earnings per share | $0.99 | Versus $1.15 |
| Net interest margin, taxable-equivalent basis | 2.67% | Versus 3.02% |
| Efficiency ratio | 56.6% | Versus 53.3% |
| Net charge-offs / average loans | 0.66% | Versus 0.48% |
First nine months: Net income attributable to U.S. Bancorp was $3.440 billion, down 36.6%; diluted EPS was $2.11, versus $3.25. Net revenue was $17.574 billion, up 1.5%; provision for credit losses was $3.365 billion, versus $1.109 billion.
Balance sheet at September 30: Total assets were $540.5 billion, loans $307.0 billion, deposits $413.2 billion, short-term borrowings $13.7 billion, long-term debt $42.4 billion and shareholders’ equity $52.6 billion. Since December 31, 2019, assets increased 9.1%, loans 3.7% and deposits 14.2%.
Credit quality and capital: Allowance for credit losses was $8.010 billion, or 2.61% of period-end loans, up from $4.491 billion and 1.52% at year-end 2019. Nonperforming assets rose 53.2% to $1.270 billion. Regulatory CET1, Tier 1 and total risk-based capital ratios were 9.4%, 11.0% and 13.1%, respectively; the CET1 ratio reflecting full CECL implementation was 9.0%.
Cash flow and liquidity: For the first nine months, operating cash flow was $4.785 billion, investing cash flow was negative $21.850 billion and financing cash flow was $38.707 billion. Cash and due from banks increased $21.642 billion to $44.047 billion. The company reported $123.6 billion of fair value in unencumbered investment securities and additional borrowing capacity of $97.0 billion from the FHLB and Federal Reserve. It was compliant with the regulatory Liquidity Coverage Ratio requirement.
Material changes and drivers
- Lower interest rates reduced net interest income and margin; loan growth and improved deposit and funding mix partly offset the pressure.
- Mortgage banking revenue increased substantially amid refinancing activity, and commercial products revenue grew on capital-markets activity. These gains were partly offset by lower payment-services revenue and deposit service charges as spending weakened.
- Credit-loss provisions increased sharply amid pandemic-related economic deterioration. The allowance also rose $120 million in Q3, primarily for expected losses in the acquired State Farm Bank credit-card portfolio.
- Noninterest expense increased, reflecting COVID-related and prepaid-card costs, higher mortgage and capital-markets production expenses, personnel costs, and technology investment. The filing identifies $157 million of incremental costs in Q3 and $456 million for the first nine months.
- On January 1, 2020, U.S. Bancorp adopted CECL, increasing its allowance by approximately $1.5 billion and reducing retained earnings by approximately $1.1 billion, net of deferred taxes.
Outlook, risks and contingencies
- Management expected Q4 net interest income to be relatively flat or decline slightly from Q3, with continued low rates and higher securities premium amortization. It anticipated additional margin pressure from maintaining higher liquidity following the State Farm Bank transaction.
- Management expected Q4 noninterest expense to be relatively stable versus Q3 and mortgage banking revenue to decline as refinancing activity slowed and home-sale activity became seasonal. Payment-services revenue was expected to remain under pressure from reduced spending and lower prepaid-card volume.
- The company acquired the State Farm Bank credit-card portfolio in Q3. It also expected to acquire approximately $10 billion of State Farm Bank deposits in early October, after quarter-end.
- COVID-19 remains a major uncertainty affecting credit losses, customer payment capacity, spending, interest income, operations, counterparties and service providers. The company reported approximately 329,000 COVID-related loan modifications totaling $26.9 billion approved from March through September; about 91,000 accounts totaling $12.1 billion remained active at September 30. Relief programs may delay delinquency and charge-off recognition.
- Management said nonperforming assets and net charge-offs could increase under current economic conditions. Commercial exposures included pandemic-affected retail, energy, media and entertainment, lodging and airline sectors. The allowance is sensitive to estimates: specified adverse changes in commercial risk ratings or loss estimates and consumer loss estimates would raise it by approximately $219 million, $343 million and $313 million, respectively.
- Federal Reserve restrictions for Q3 and Q4 2020 prohibited common-stock repurchases and capped dividends at existing rates, subject to an earnings limit. U.S. Bancorp had suspended ordinary repurchases, while continuing certain purchases connected with employee plans. The declared common dividend was $0.42 per share for Q3.
- Contingencies include Visa-related card-brand litigation, residential mortgage-backed securities trustee litigation, and ongoing regulatory examinations. Management said it believed the ultimate resolution of existing matters would not materially affect overall financial condition, but noted that particular periods could be materially affected. Merchant-processing exposure included $12.0 billion of airline tickets for future delivery, $517 million of collateral and a $176 million liability.
- Other risks include LIBOR transition, interest-rate and market risk, cybersecurity and operational risks, and uncertain legal and regulatory developments. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether credit costs, nonperforming assets and charge-offs rise further, particularly in commercial real estate and pandemic-sensitive industries; also assess the assumptions behind the CECL allowance.
- How State Farm Bank portfolio and deposit integration affects credit losses, funding, liquidity and net interest margin.
- Whether mortgage refinancing and capital-markets fees normalize, and how persistent weakness in consumer and business payment volumes proves to be.
- Whether active loan-relief balances, subsequent delinquencies and customer repayment trends indicate risks not yet reflected in reported credit metrics.
- Any change in Federal Reserve restrictions on dividends and buybacks, capital ratios, or the company’s liquidity position.
- Developments in Visa and mortgage-backed securities litigation, regulatory inquiries, and the airline charge-back exposure.