U.S. Bancorp — First-Quarter 2011 Form 10-Q
Business context and period: U.S. Bancorp reported for the three months ended March 31, 2011, with comparative income results for the first quarter of 2010. The bank’s businesses include wholesale and commercial real estate banking, consumer and small business banking, wealth management, payment services, and treasury and corporate support. Balance-sheet comparisons are to December 31, 2010. Amounts are in U.S. dollars unless noted.
Financial results and position
- Earnings: Net income attributable to U.S. Bancorp was $1.046 billion, up 56.4% from $669 million. Diluted EPS was $0.52 versus $0.34. Net income applicable to common shareholders was $1.003 billion.
- Revenue and margin: Taxable-equivalent net interest income was $2.507 billion, up 4.3%; noninterest income was $2.012 billion, up 4.9%. Total taxable-equivalent net revenue was $4.519 billion, up 4.6%. Net interest margin declined to 3.69% from 3.90%.
- Expenses and profitability: Noninterest expense rose 8.3% to $2.314 billion, and the efficiency ratio increased to 51.1% from 49.0%. Return on average assets was 1.38% versus 0.96%; return on average common equity was 14.5% versus 10.5%. Reported income before taxes was $1.395 billion, compared with $824 million.
- Credit: Provision for credit losses fell 42.4% to $755 million. Net charge-offs were $805 million, down from $1.135 billion; the annualized net charge-off ratio declined to 1.65% from 2.39%. The allowance for credit losses was $5.498 billion, or 2.78% of total loans. Total nonperforming assets were $5.020 billion, essentially unchanged from year-end; excluding covered assets, they were $3.479 billion.
- Cash flow: Operating activities provided $6.228 billion, versus $2.876 billion in first-quarter 2010. Investing activities used $7.488 billion, compared with providing $1.081 billion; financing activities provided $573 million, compared with using $1.783 billion. Cash and due from banks declined $687 million during the quarter to $13.800 billion.
- Balance sheet and funding: Total assets were $311.462 billion, up 1.2% from year-end. Loans were $198.038 billion, up 0.5%; deposits were $208.293 billion, up 2.0%. Short-term borrowings fell to $31.021 billion from $32.557 billion; long-term debt was $31.775 billion, up from $31.537 billion. Average deposits grew 11.9% year over year, supported by core deposit growth.
- Capital: Tier 1 capital was 10.8% of risk-weighted assets and total risk-based capital was 13.8%; both exceeded regulatory well-capitalized requirements. Tier 1 common equity under the Basel I definition was 8.2%; tangible common equity to tangible assets was 6.3%.
Material changes and notable items
- Results included a $46 million gain from the FDIC-assisted acquisition of First Community Bank of New Mexico (FCB), which added 38 branches and approximately $2.1 billion in assets and assumed liabilities. Noninterest income also benefited from a $22 million Visa-related gain and lower securities losses than the prior-year quarter.
- Payments-related and commercial products revenue increased, while deposit service charges declined 30.9% year over year, reflecting company and regulatory changes to overdraft policies. Trust and investment management fees also declined, partly following the transfer of the long-term asset management business in late 2010.
- Compensation and employee benefits rose, including higher pension costs; total noninterest expense increased faster than revenue. The company increased its quarterly common dividend from $0.05 to $0.125 per share and authorized repurchases of up to 50 million shares through December 31, 2011. First-quarter repurchases were primarily in connection with employee benefit plans.
- Investment securities increased to $60.461 billion from $52.978 billion, with substantial purchases of Treasury and agency-related securities to increase on-balance-sheet liquidity in anticipation of regulatory requirements. Held-to-maturity securities rose to $8.213 billion from $1.469 billion.
Outlook, risks and contingencies
- Management outlook: The company expected nonperforming assets, excluding covered assets, and net charge-offs to trend lower in the second quarter of 2011. No quantified full-year earnings or revenue guidance is provided in the filing.
- Regulatory matter: On April 13, 2011, the two primary bank subsidiaries entered into consent orders with the OCC and Federal Reserve concerning residential mortgage servicing and foreclosure processes. Management stated it did not expect resolution of outstanding issues to materially affect financial position, results, or normal business activities; the orders could nevertheless lead to fines, restitution, or changes in practices.
- Credit and markets: The company cited continuing commercial real estate stress and residential mortgage weakness, as well as risks from economic conditions, interest-rate changes, loan and collateral quality, securities values, competition, customer behavior, regulation, and its ability to manage credit, market, operational, interest-rate, and liquidity risks. Non-agency mortgage-backed securities have limited market activity and rely on management estimates; adverse market or cash-flow changes could produce further impairment. First-quarter securities impairment charges were $6 million.
- Legal and contingent exposures: Visa litigation remained subject to member-bank indemnification with no specified maximum, partly offset by an escrow-related receivable; the recorded liability was $27 million. The company also disclosed overdraft-fee litigation, with no class certified and no clear loss range, and a $181 million reserve for mortgage loan sale representations and warranties. Merchant processing exposure included $7.0 billion of airline tickets for future delivery, against $596 million of collateral and related protections.
- Other risks: The filing identifies significant judgment in credit-loss allowances, fair-value estimates, purchased loans, mortgage servicing rights, goodwill, and taxes. Interest-rate simulations were within policy limits; management said the company does not use derivatives for speculative purposes.
Key facts for investors to verify
- How much of earnings growth came from the $46 million FCB gain, the $22 million Visa gain, lower credit provisions, and other nonrecurring or variable items.
- Whether credit improvement continues, particularly in commercial real estate, residential mortgages, and consumer portfolios; monitor nonperforming assets, delinquencies, net charge-offs, and allowance coverage.
- The operational, financial, and regulatory consequences of the mortgage servicing and foreclosure consent orders, including any later fines, remediation costs, or required process changes.
- The valuation and impairment sensitivity of non-agency mortgage-backed securities and mortgage servicing rights, including the assumptions supporting fair values and expected cash flows.
- The size and development of contingent obligations, including Visa litigation, mortgage repurchase claims, overdraft litigation, and airline merchant-processing exposure.
- Whether deposit growth, net interest margin, expense growth, and capital levels support the increased dividend and the share-repurchase authorization.