U.S. Bancorp — Q2 2016 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2016. Comparisons are generally with the corresponding 2015 periods; balance-sheet comparisons are with December 31, 2015. Dollar amounts are in millions unless noted.
Business context and financial performance
U.S. Bancorp reported second-quarter net income attributable to the company of $1.522 billion, up 2.6% year over year, and diluted EPS of $0.83, up 3.8%. For the first half, net income was $2.908 billion, down 0.2%, while diluted EPS was $1.59, up 1.9%.
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net revenue, taxable-equivalent basis | $5,448 | $5,042 | $10,485 | $9,948 |
| Net interest income, taxable-equivalent basis | $2,896 | $2,770 | $5,784 | $5,522 |
| Noninterest income | $2,552 | $2,272 | $4,701 | $4,426 |
| Noninterest expense | $2,992 | $2,682 | $5,741 | $5,347 |
| Provision for credit losses | $327 | $281 | $657 | $545 |
| Net income attributable to U.S. Bancorp | $1,522 | $1,483 | $2,908 | $2,914 |
| Diluted EPS | $0.83 | $0.80 | $1.59 | $1.56 |
| Return on average assets | 1.43% | 1.46% | 1.38% | 1.45% |
| Return on average common equity | 13.8% | 14.3% | 13.4% | 14.2% |
| Net interest margin, taxable-equivalent basis | 3.02% | 3.03% | 3.04% | 3.05% |
| Efficiency ratio | 54.9% | 53.2% | 54.8% | 53.7% |
Balance sheet, liquidity, capital and cash flow
- At June 30, total assets were $438.5 billion, up 3.9% from year-end; loans were $268.5 billion, up 2.9%; and deposits were $317.6 billion, up 5.7%.
- Average loans grew 8.1% year over year in Q2, contributing to higher net interest income. The net interest margin edged down as securities purchases and reinvestments yielded less, partly offset by higher rates on new loans.
- Period-end long-term debt was $36.9 billion, up 15.2% from year-end, reflecting debt issuance and higher FHLB advances, partly offset by repayments and maturities. Short-term borrowings were $18.4 billion, down 33.9%, mainly due to lower commercial paper.
- Liquidity resources included $98.0 billion in fair value of unencumbered available-for-sale and held-to-maturity securities and $78.7 billion of additional borrowing capacity at the FHLB and Federal Reserve. The company reported compliance with the fully implemented Liquidity Coverage Ratio requirement.
- At June 30, Basel III transitional standardized capital ratios were 9.5% CET1, 11.1% Tier 1 and 13.4% total risk-based capital; the leverage ratio was 9.3%. Regulatory capital ratios exceeded “well-capitalized” requirements.
- For the first half, operating cash flow was $2.684 billion, investing cash flow was negative $10.094 billion and financing cash flow was positive $10.301 billion. Cash and due from banks ended at $14.038 billion. Investing outflows included net loan growth and securities purchases; financing inflows included deposit growth.
Material changes and credit quality
- Q2 revenue rose 8.1%, led by loan growth and increased noninterest income. The Visa Europe transaction was a major contributor to noninterest income; card revenue, commercial products and trust and investment management fees also grew.
- Expenses increased 11.6% in Q2, faster than revenue. The filing cites higher compensation, compliance and professional-services costs, technology spending, brand marketing, a charitable contribution, and increased legal and regulatory reserves.
- Credit provision rose 16.4% in Q2 and 20.6% in the first half. Q2 net charge-offs were $317 million versus $296 million a year earlier; the annualized charge-off ratio was 0.48% in both periods.
- Nonperforming assets increased to $1.672 billion from $1.523 billion at year-end, primarily because nonperforming commercial energy loans rose. Excluding energy, nonperforming assets decreased 3.6%. The allowance for credit losses was $4.329 billion, or 1.61% of period-end loans, compared with 1.65% at year-end.
- Energy loans were $3.024 billion, 1.1% of total loans. Criticized energy commitments rose to $3.658 billion from $1.886 billion at year-end, and energy nonperforming assets increased to $222 million from $19 million.
Notable items, outlook and risks
- Q2 included $180 million of equity investment income, primarily associated with the sale of Visa Europe to Visa Inc. on June 21, 2016; a $110 million increase in legal and regulatory reserves; and a $40 million charitable contribution. Together, management said these items increased Q2 diluted EPS by $0.01.
- The filing provides no specific earnings or revenue guidance. Management described loan growth as a key driver of net interest income and noted margin pressure from lower-yielding securities and reinvestments.
- The FDIC premium surcharge was expected to begin in Q3 2016 and increase expenses by approximately $20 million per quarter through 2018.
- Legal and regulatory matters include mortgage-related and Bank Secrecy Act/anti-money-laundering reviews, an OCC consent order concerning BSA/AML program deficiencies, and litigation involving the bank’s role as trustee for mortgage-backed securities. Management said resolution of existing matters was not expected to materially affect overall financial condition, results or cash flows, but acknowledged individual matters could materially affect a particular period.
- The Second Circuit reversed approval of a major Visa antitrust settlement and remanded the case for further proceedings. The company reported a $19 million net liability for Visa litigation matters at June 30; its ultimate exposure remains uncertain.
- The UK referendum to leave the EU introduced uncertainty. The company cited potential market and economic effects and possible changes to European legal structures, operations and authorizations. It held approximately $6.2 billion in deposits at European banks, predominantly the Central Bank of Ireland and Bank of England.
- Other stated risks include economic deterioration, interest-rate changes, credit quality and collateral values, regulation, litigation, competition, cybersecurity and operational failures. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of ongoing revenue and earnings growth remains after separating the Visa Europe gain and other notable Q2 items.
- Whether expense growth moderates, particularly legal and regulatory costs, compliance spending, technology and marketing; and how the announced FDIC surcharge affects subsequent quarters.
- Whether energy criticized commitments, nonperforming loans and charge-offs continue to rise, and how reserve coverage develops as the portfolio grows.
- How the Visa litigation appeal and other legal or regulatory matters affect reserves, potential losses and business practices.
- Whether deposit growth, liquidity resources, debt issuance and capital ratios remain sufficient under stress and as regulatory requirements change.
- Whether the reported cash-flow movements and securities valuation gains are sustainable; first-half cash flow reflects substantial loan growth and investment purchases.