U.S. Bancorp — Q3 2016 Form 10-Q
Business context and reporting period: U.S. Bancorp reported for the quarter and nine months ended September 30, 2016. Comparisons below are with 2015 unless otherwise noted; balance-sheet comparisons are generally with December 31, 2015. Amounts are in U.S. dollars.
Key financial results
| Metric | Q3 2016 | Change from Q3 2015 | Nine months 2016 | Change from nine months 2015 |
|---|---|---|---|---|
| Net interest income, taxable-equivalent | $2.943 billion | +4.3% | $8.727 billion | +4.6% |
| Total net revenue | $5.388 billion | +4.7% | $15.873 billion | +5.2% |
| Noninterest expense | $2.931 billion | +5.6% | $8.672 billion | +6.8% |
| Provision for credit losses | $325 million | +15.2% | $982 million | +18.7% |
| Net income attributable to U.S. Bancorp | $1.502 billion | +0.9% | $4.410 billion | +0.2% |
| Diluted earnings per share | $0.84 | +$0.03 | $2.43 | +$0.07 |
| Net interest margin, taxable-equivalent | 2.98% | Down 6 basis points | 3.02% | Down 3 basis points |
| Return on average assets | 1.36% | 1.44% prior year | 1.37% | 1.45% prior year |
| Efficiency ratio | 54.5% | 53.9% prior year | 54.7% | 53.8% prior year |
Balance sheet, credit, liquidity and capital
- At September 30, assets were $454.1 billion, up 7.7% from year-end 2015. Loans were $271.3 billion, up 4.0%; deposits were $334.6 billion, up 11.4%.
- Average loans rose 7.6% in Q3 year over year, supporting net interest income growth. Deposit growth was concentrated in savings and noninterest-bearing balances.
- Period-end long-term debt was $38.0 billion, up 18.4% from December 2015, while short-term borrowings fell 43.7% to $15.7 billion. The filing attributes the debt increase primarily to new notes and higher FHLB advances.
- Allowance for credit losses was $4.338 billion, or 1.60% of period-end loans, compared with $4.306 billion and 1.65% at December 2015. Q3 net charge-offs were $315 million versus $292 million; the annualized charge-off ratio was 0.46% in both periods.
- Nonperforming assets were $1.664 billion, up 9.3% from year-end 2015; the ratio to loans and other real estate was 0.61%, versus 0.58%. The increase was driven chiefly by energy-related commercial loans. Excluding energy, nonperforming assets decreased 6.5%.
- Energy loans totaled $2.732 billion, about 1.0% of total loans. Criticized energy commitments rose to $3.231 billion from $1.886 billion, and energy nonperforming assets rose to $259 million from $19 million.
- Regulatory capital ratios remained above “well-capitalized” requirements: standardized common equity tier 1 was 9.5%, tier 1 was 11.1%, and total risk-based capital was 13.3%. The company reported compliance with the fully implemented Liquidity Coverage Ratio requirement.
- Liquidity included $99.7 billion of unencumbered available-for-sale and held-to-maturity securities and $85.3 billion of additional potential FHLB and Federal Reserve borrowing capacity, subject to available collateral.
- Cash and due from banks ended at $23.664 billion, versus $11.147 billion at year-end 2015. For the first nine months, operating cash flow was $3.238 billion (down from $6.251 billion); investing activities used $15.241 billion, and financing activities provided $24.520 billion.
Material changes and notable items
- Q3 revenue growth reflected higher loan balances and increases in mortgage banking, trust and investment management, and card revenue. Mortgage banking revenue rose 40.2% year over year in the quarter, partly reflecting refinancing activity.
- Expense growth outpaced revenue growth, reflecting higher compensation, technology and communications spending, compliance-related professional services, and a new FDIC surcharge. The surcharge was expected to add about $23 million per quarter through 2018.
- For the first nine months, results included $180 million of equity investment income, primarily associated with the Visa Europe sale; a $110 million increase in legal and regulatory reserves; and a $40 million charitable contribution, all recorded in Q2.
- The company announced a quarterly common dividend increase from $0.255 to $0.28 per share, a 9.8% increase. It also authorized up to $2.6 billion of common share repurchases for July 2016 through June 2017; $1.945 billion remained available at September 30.
- Available-for-sale securities had $879 million of net unrealized gains at quarter-end, versus $180 million at year-end 2015, mainly reflecting interest-rate-related appreciation in agency mortgage-backed securities. Management said it did not plan to sell securities with unrealized losses and did not expect to be required to sell them before recovery.
Outlook, risks and contingencies
- The filing provides no specific forward earnings or revenue guidance. Management describes continued sensitivity to interest rates, funding costs, loan mix, economic conditions, and credit performance.
- Credit risks include deterioration in energy lending: energy criticized commitments and nonperforming assets increased materially. Commercial loan charge-offs also increased, while residential mortgage and home equity credit measures generally improved.
- Management identifies economic contraction, market volatility, real estate weakness, changing interest rates, regulatory and legal developments, competition, cybersecurity, operational and compliance failures, liquidity needs, and Brexit-related uncertainty as risks.
- Legal and regulatory matters include mortgage-related practices, Bank Secrecy Act/anti-money laundering and sanctions compliance, and litigation concerning the company’s trustee role in residential mortgage-backed securities trusts. An OCC consent order addressing BSA/AML program deficiencies remained in effect; further remedies could include fines, penalties or business-practice changes.
- The company’s net Visa litigation liability, after its share of escrow funding, was $19 million. The 2012 interchange settlement approval was reversed on appeal in June 2016 and remanded for further proceedings; ultimate outcomes and timing remain uncertain.
- Management stated that existing legal and regulatory matters were not expected to have a material adverse effect on overall financial condition, results or cash flows, while cautioning that a matter could materially affect a particular period and that estimates may change.
- The filing says the expected adoption of revenue-recognition guidance in 2018 and lease-accounting guidance in 2019 was not expected to be material; the company was still evaluating the expected-loss credit impairment standard, effective in 2020.
Important facts for investors to verify
- Whether energy credit deterioration continues, particularly growth in criticized commitments, nonperforming assets, charge-offs and reserve needs.
- Whether revenue growth can sustainably exceed expense growth, including the recurring impact of compliance, technology, compensation and FDIC surcharge costs.
- How higher deposit and wholesale funding costs affect net interest margin and earnings, given the quarter’s margin decline.
- Whether reported earnings benefited materially from nonrecurring items, especially Visa Europe investment income, and how legal reserves and the charitable contribution affect comparability.
- Developments in the Visa interchange litigation, trustee lawsuits, BSA/AML consent order and other regulatory matters, including any changes to reserves or business requirements.
- Capital and liquidity capacity after dividends and repurchases, and the terms and maturity profile of increased long-term debt.