U.S. Bancorp — Q1 2020 Form 10-Q
Business context and reporting period
U.S. Bancorp reported results for the three months ended March 31, 2020. The quarter was materially affected by the COVID-19 pandemic, including higher commercial credit-line utilization, reduced consumer and business spending, and sharply changed economic forecasts. Comparisons below are primarily with Q1 2019 for income results and December 31, 2019 for balance-sheet amounts.
Financial performance and condition
- Earnings: Net income attributable to U.S. Bancorp was $1.171 billion, down 31.1%; diluted EPS was $0.72, down 28.0%. Return on average assets was 0.95% versus 1.49%, and return on average common equity was 9.7% versus 14.3%.
- Revenue and margin: Net interest income was $3.223 billion, down 1.1% year over year; on a taxable-equivalent basis it was $3.247 billion, down 1.2%. The taxable-equivalent net interest margin fell to 2.91% from 3.16%. Total net revenue was $5.772 billion on the taxable-equivalent basis used in management’s analysis. Noninterest income was $2.525 billion, up 10.2%, led by mortgage banking revenue, trust and investment management fees, commercial products revenue, and securities gains. Payment-services revenue weakened late in the quarter.
- Costs and credit: Noninterest expense rose 7.4% to $3.316 billion; the efficiency ratio increased to 58.0% from 55.4%. Management cited approximately $100 million of COVID-related expenses and approximately $49 million of revenue-related production costs. Provision for credit losses was $993 million versus $377 million; net charge-offs were $393 million versus $367 million, or 0.53% versus 0.52% of average loans.
- Balance sheet: Total assets were $542.9 billion, up 9.6% from year-end; period-end loans were $318.3 billion, up 7.5%, with commercial loans increasing $22.5 billion as customers drew on credit facilities. Deposits were $394.9 billion, up 9.1%. Cash and due from banks was $46.8 billion, compared with $22.4 billion at year-end.
- Credit allowance and asset quality: The allowance for credit losses was $6.590 billion, or 2.07% of period-end loans, versus $4.491 billion and 1.52% at year-end. The increase included $1.499 billion from adopting the expected-credit-loss accounting standard and a further $600 million provision-related increase during Q1. Nonperforming assets rose 14.1% to $946 million; the company expects them and net charge-offs to increase under current economic conditions.
- Debt, liquidity and capital: Long-term debt was $52.3 billion, up $12.1 billion from year-end; short-term borrowings were $26.3 billion. Management reported $113.0 billion of unencumbered investment securities and $86.6 billion of additional potential FHLB and Federal Reserve borrowing capacity. The company was compliant with its Liquidity Coverage Ratio requirement. Regulatory CET1 was 9.0%, Tier 1 capital 10.5%, and total risk-based capital 12.7%; all regulatory ratios exceeded “well-capitalized” requirements.
- Cash flows: Cash from operating activities was $2.354 billion; investing activities used $22.259 billion and financing activities provided $44.305 billion. Cash and due from banks increased $24.4 billion during the quarter. These banking cash-flow totals reflect substantial loan growth and deposit and borrowing inflows.
Material changes versus comparable periods
- Net revenue increased 3.5% on the reported taxable-equivalent presentation, but net income attributable to the company declined 31.1%, principally reflecting the much higher credit-loss provision and higher expenses.
- Mortgage banking revenue increased $226 million year over year as refinancing activity and gain-on-sale margins strengthened. Conversely, payment-services revenue fell with lower spending, particularly in March.
- Commercial customers’ use of credit facilities drove substantial loan growth, while deposits also rose significantly. Long-term debt increased notably, including higher FHLB advances and bank-note issuance.
- On January 1, 2020, the company adopted the current expected credit losses methodology, increasing the allowance by approximately $1.5 billion and reducing retained earnings by approximately $1.1 billion after tax.
- Net unrealized gains on available-for-sale securities increased to $3.2 billion from $496 million at year-end, primarily due to interest-rate-related fair-value increases. Shareholders’ equity was $51.5 billion, down slightly from year-end.
Outlook, commentary, risks and unusual items
- Management expected additional downward pressure on net interest margin in Q2 2020, reflecting late-Q1 rate changes, increased cash held to support loan demand, loan mix, and deposit-rate floors. It did not provide a quantified earnings or revenue forecast.
- Management expected continued credit-line draws, reduced lending and payment-services revenue, and increased credit losses while the pandemic and economic disruption persisted. It said mortgage production could remain relatively strong near term but potentially slow later in 2020; lower equity markets and rates were expected to weigh on trust and investment management fees.
- The company had approved approximately $3.1 billion of COVID-related loan modifications by March 31, primarily consumer payment deferrals of 90 days or less. Qualifying modifications for borrowers otherwise current were not treated as troubled debt restructurings under the stated policy.
- Merchant-processing exposure was notable: future-delivery airline tickets processed totaled $8.7 billion; collateral held was $502 million and the related liability was $115 million. COVID-related charge-back risk also contributed to Q1 expenses.
- Common-stock repurchases were suspended through the end of Q2 2020 to preserve capital and liquidity. Management said it believed the dividend could be maintained at its then-current level even if an economic downturn persisted through most of 2020; the filing also cautioned that future capital distributions could be reduced and the dividend could be reduced or suspended.
- Risks include a deeper or longer recession, unemployment and borrower defaults, collateral-value declines, lower rates and margin pressure, depressed payment volumes, operational and cyber risks, and further merchant charge-backs. The company noted that government stimulus and payment-deferral programs could mitigate—but might not prevent—credit losses.
- Litigation and regulatory matters include Visa-related card-association litigation, mortgage-backed-securities trustee litigation, and ongoing regulatory scrutiny. Management believed existing matters would not materially affect the company overall, while acknowledging that individual resolutions could materially affect a particular period. The deferred prosecution agreement related to a legacy matter was dismissed in February 2020.
Important facts for investors to verify
- Whether subsequent-quarter credit provisions, charge-offs, delinquencies, nonperforming assets, and loan-modification outcomes validate the Q1 allowance assumptions and its $600 million pandemic-related increase.
- How quickly commercial credit-line draws, deposit growth, and funding needs normalize—and whether higher borrowing levels persist.
- Whether net interest margin and payment-services revenue deteriorate as management anticipated, and whether mortgage banking gains offset those pressures.
- Whether merchant charge-back exposure, especially related to travel and other future-delivery goods and services, exceeds collateral and recorded liabilities.
- How capital and liquidity ratios evolve, including the effects of the CECL regulatory transition and the suspension or resumption of repurchases and dividends.
- Developments in significant litigation, regulatory inquiries, and the LIBOR transition; the filing does not quantify a clear potential loss for all such matters.