Fitch: Solid 2Q16 Earnings for U. S. Bancorp
USB's annualized return on average assets (ROAA) remained strong at 1.43% in 2Q16, up from 1.32% in the sequential quarter, but incrementally down from 1.46% in the year ago quarter. Similarly, the company's annualized return on average equity (ROE) was 13.8% in 2Q16 up from 13% from the sequential quarter but down from 14.3% from the year-ago quarter.
USB's results continue to consistently be above Fitch's estimate of a range of the company's long-term cost of equity assumption of between 10%-12%.
There were a couple of notable items in the quarter including $180 million of equity investment income due to the company's membership in Visa Europe Limited, which was sold to Visa, Inc. in mid-June 2016. This gain was offset by $110 million of accruals related to regulatory and legal matters as well as a $40mn charitable contribution.
USB's total net revenue was up 8.2% from the sequential quarter and 8.1% from the year ago quarter.
Net interest income (NII) was up relative to both the sequential and year-ago quarter as some improvement in loan yields and loan mix were offset by lower rates on new securities purchases as well as lower reinvestment rates on maturing securities. As a result, the company's net interest margin declined modestly to 3.02% as of 2Q16.
The bigger driver of the revenue increase was higher non-interest income, which increased 18.8% relative to the sequential quarter and 12.3% relative to the year-ago quarter. This was driven by the Visa gain noted above as well as higher credit and debit card revenue, higher commercial products revenue, and higher mortgage banking income incrementally offset by lower investment products revenue.
USB's mortgage banking revenue was seasonally higher by 27.3% relative to the sequential quarter, with 65% of mortgage volume driven by new home purchases and 35% driven by refinancings. Given the rally in mortgage rates in the latter part of the quarter, USB expects an additional 30% growth in mortgage banking revenue over the next quarter.
The company's overall provision expense declined incrementally relative to the sequential quarter after a significant build last quarter related to higher levels of criticized energy loans.
This quarter's improvement was driven by modestly lower energy exposure as both energy loans and commitments declined relative to the sequential quarter as many loans moved through the spring redetermination period and USB lowered is average oil price deck to $35 per barrel. Additionally, the improvement in overall oil prices during the quarter likely helped to shelter performance of underlying borrowers.
Fitch continues to believe that potential problems within USB's energy portfolio will be manageable given the company's reserves to energy loans of 8.8% at 2Q16, which compare well with peers. Additionally, the bulk of the company's criticized energy loans are still performing.
USB's non-interest expenses increased relative to both the sequential and year-ago quarters. This was due to higher compensation expense reflecting merit increases during the quarter as well as higher professional services expenses due to compliance related matters. USB continues to address its consent order related to its anti-money laundering program.
Nevertheless the company's efficiency ratio remained strong at 54.9% in 2Q16, inclusive of the notable items mentioned above.
Credit quality remains good and the company's ratio of non-performing assets to loans plus other real estate owned (OREO) (excluding covered assets) improved incrementally to 0.62 due to some modest improvement in the energy portfolio noted above.
USB has continued to exhibit good loan growth, with average loans (excluding covered loans) up 1.7% relative to the sequential quarter and 8.6% relative to the year-ago quarter. The growth was generally broad based but highlighted by higher commercial loan balances as well as higher construction and development loans.
In 2Q16, USB's Basel III Common Equity Tier 1 (CET1) ratio was relatively unchanged both under the standardized and advanced approaches. The fully phased-in Basel III CET1 ratio under the standardized approach was 9.3% (USB's binding constraint) and under the advanced approach was 12%.
USB recently received a non-objection to its capital plan under the Comprehensive Capital Analysis and Review (CCAR) stress tests. As a result USB announced a $2.6bn share repurchase program and a 9.8% increase in its common dividend.
In 2Q16 USB returned 77% of earnings to owners via dividends and buybacks, and Fitch believes the company's total payout ratio will remain between 60%-80% over the balance of the year.
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