U.S. Bancorp — Q3 2009 Form 10-Q
Reporting period: Three and nine months ended September 30, 2009. The financial statements are unaudited. Amounts below are in U.S. dollars; “billion” and “million” are abbreviated as B and M.
Business context and results
U.S. Bancorp is a diversified banking and financial services company. Third-quarter results reflected revenue growth but sharply higher credit costs amid weak economic conditions, continued residential real estate stress, and deterioration in commercial, commercial real estate and consumer portfolios. Results also reflected acquisitions, including the 2008 Downey and PFF transactions.
Financial performance
| Metric | Q3 2009 | Q3 2008 | First nine months 2009 | First nine months 2008 |
|---|---|---|---|---|
| Net interest income, taxable-equivalent | $2.157B | $1.967B | $6.356B | $5.705B |
| Noninterest income | $2.093B | $1.412B | $5.936B | $5.348B |
| Net revenue, taxable-equivalent | $4.250B | $3.379B | $12.292B | $11.053B |
| Noninterest expense | $2.053B | $1.813B | $6.053B | $5.410B |
| Provision for credit losses | $1.456B | $748M | $4.169B | $1.829B |
| Net income attributable to U.S. Bancorp | $603M | $576M | $1.603B | $2.616B |
| Diluted EPS | $0.30 | $0.32 | $0.66 | $1.46 |
- Q3 return on average assets was 0.90% and return on average common equity was 10.0%, compared with 0.94% and 10.8%. Nine-month figures were 0.81% and 7.7%, versus 1.45% and 16.6%.
- Net interest margin, taxable-equivalent, was 3.67% for Q3 and 3.62% for the nine-month period, compared with 3.65% and 3.60% in 2008. The efficiency ratio was 47.5% for Q3 and 48.1% for the nine months, versus 47.8% and 45.9%.
- Common-shareholder earnings were $583M for Q3 and $1.223B for the first nine months. Nine-month common earnings and EPS include preferred dividends, discount accretion and a $154M deemed dividend related to the Treasury preferred-stock redemption.
- Mortgage banking revenue increased to $276M in Q3 from $61M, and to $817M for nine months from $247M, principally reflecting production and loan-sale profitability in the lower-rate environment. Q3 also included a $39M Visa-related gain; net securities losses were $76M in Q3 and $293M for nine months.
Balance sheet, liquidity and capital
- At September 30, 2009, total assets were $265.1B, loans $183.1B, deposits $169.8B, and shareholders’ equity $25.2B. Compared with December 31, 2008, assets declined 0.3%, loans 1.2%, deposits increased 6.5%, and shareholders’ equity declined 4.3%.
- Deposits increased, which management attributed partly to customer flight to quality. Short-term borrowings were $28.2B, down from $34.0B, and long-term debt was $33.2B, down from $38.4B. Cash and due from banks was $5.0B.
- For the first nine months, operating cash flow was $4.220B, investing activities used $55M, and financing activities used $6.008B. Cash and due from banks decreased $1.843B to $5.016B. These cash-flow figures should be considered in the context of a bank’s deposit and funding activities.
- Regulatory capital ratios at September 30 were 9.5% Tier 1, 13.0% total risk-based capital and 8.6% leverage; all exceeded well-capitalized requirements. Tier 1 common equity to risk-weighted assets was 6.8%, and tangible common equity to tangible assets was 5.4%.
- The company raised $2.7B through common-stock issuance in Q2, redeemed $6.6B of Treasury preferred stock in June, and repurchased the related warrant for $139M in July. The common dividend declared was $0.05 per share in Q3, versus $0.425 a year earlier.
Material changes and credit quality
- Q3 net charge-offs were approximately $1.041B, up from $498M; nine-month net charge-offs were $2.758B, versus $1.187B. The allowance for credit losses rose to $4.986B from $3.639B at year-end, equal to 2.72% of total loans.
- Nonperforming assets increased to $4.392B from $2.624B at December 31, 2008; excluding FDIC-covered assets, they were $3.720B. Nonperforming assets were concentrated in commercial and commercial real estate lending, with increases also in residential mortgages and foreclosed property.
- Loans 90 days or more past due, including nonperforming loans, were 3.34% of total loans, versus 2.14% at year-end. Covered assets had higher delinquency rates but were subject to FDIC loss-sharing agreements.
- Commercial loans fell $5.9B from year-end, while commercial real estate, residential mortgage and retail balances increased. Total loans declined, partly due to lower commercial lending and covered-asset balances.
- Securities impairment charges recognized in earnings included $228M for perpetual preferred securities and $183M for non-agency mortgage-backed and structured-investment-related securities during the first nine months. Management cautioned that further adverse market changes could cause additional impairment.
Outlook, risks and unusual items
- Management expected net interest margin to remain relatively stable, with a bias toward modest improvement in Q4 2009.
- Management expected delinquencies to continue rising and nonperforming assets to increase, though at a slower rate than prior periods. It also expected net charge-offs to continue increasing through the remainder of 2009, but at a decreasing rate. These expectations depended on economic conditions, home prices and unemployment.
- Management cited higher FDIC insurance expense, including a $123M special assessment in the first nine months, acquisition-related costs, and increased marketing expense for new credit-card products. A $92M corporate real estate transaction gain was also included in nine-month results.
- Visa litigation remained a contingency: the company reported a $113M liability at September 30, and described its member-bank indemnification exposure as having no specific maximum amount. It also reported significant merchant-processing guarantees and chargeback exposure, including $4.0B of airline tickets purchased for future delivery, supported by $489M of collateral.
- On October 30, 2009, after the reporting date, U.S. Bancorp acquired nine banking subsidiaries of FBOP from the FDIC, receiving approximately $18.4B of assets and assuming $18.3B of liabilities, including $15.4B of deposits. Substantially all loans were covered by an FDIC loss-sharing agreement.
- Forward-looking risks included a weak or renewed economic contraction, real estate and credit deterioration, market volatility and funding constraints, interest-rate changes, increased regulation, competition, and legal, operational and compliance risks. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether credit deterioration, charge-offs, delinquency trends and allowance coverage evolved as management projected, especially in commercial real estate, residential mortgages and credit cards.
- The remaining impairment exposure in non-agency mortgage-backed, structured-investment and preferred securities, including sensitivity to housing prices and valuation assumptions.
- The financial and integration effects of the FBOP acquisition, including the scope and operation of FDIC loss-sharing protections.
- The status, potential cost and indemnification arrangements for Visa litigation, and the scale and collateral protection of merchant and other contingent obligations.
- How sustainable mortgage banking revenue, deposit growth, funding costs and the projected net-interest-margin trend proved to be, and whether capital and liquidity remained adequate after the acquisition.