U.S. Bancorp (USB) Q2 2013 Earnings Call July 17, 2013 9:00 AM ET
Judith T. Murphy - Senior Vice President, Director of Investor Relations and Analyst
Richard K. Davis - Chairman, Chief Executive Officer, President, Chairman of Executive Committee, Member of Risk Management Committee, Chairman of U.S. Bank, Chief Executive Officer of U.S. Bank and President of U.S. Bank
Andrew Cecere - Vice Chairman and Chief Financial Officer
P. W. Parker - Chief Credit Officer and Executive Vice President
Jessica Ribner - FBR Capital Markets & Co., Research Division
Jack Micenko - Susquehanna Financial Group, LLLP, Research Division
Kenneth M. Usdin - Jefferies & Company, Inc., Research Division
Stephen Scinicariello - UBS Investment Bank, Research Division
Erika Penala - BofA Merrill Lynch, Research Division
Betsy Graseck - Morgan Stanley, Research Division
Kevin Barker - Compass Point Research & Trading, LLC, Research Division
Dan Werner - Morningstar Inc., Research Division
Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division
Welcome to U.S. Bancorp's Second Quarter 2013 Earnings Conference Call. Following the review of the results by Richard Davis, Chairman, President and Chief Executive Officer; and Andy Cecere, U.S. Bancorp's Vice Chairman and Chief Financial Officer, there will be a formal question-and-answer session. [Operator Instructions] This call will be recorded and available for replay beginning today at approximately noon Eastern Daylight Time through Wednesday, July 24 at 12:00 midnight Eastern Daylight Time.
I will now turn the conference call over to Judy Murphy, Director of Investor Relations for U.S. Bancorp.
Judith T. Murphy
Thank you, Lorie, and good morning to everyone who has joined our call. Richard Davis, Andy Cecere and Bill Parker are here with me today to review U.S. Bancorp's second quarter 2013 results and to answer your questions. Richard and Andy will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as our earnings release and supplemental analyst schedules, are available on our website at usbank.com.
I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on Page 2 of today's presentation, in our press release and in our Form 10-K and subsequent reports on file with the SEC.
I will now turn the call over to Richard.
Richard K. Davis
Thank you, Judy, and good morning, everyone. Thank you for joining us today to review U.S. Bank's second quarter results. I'll begin with a view of our quarterly highlights on Page 3 of the presentation.
U.S. Bancorp reported record net income of $1.5 billion for the second quarter of 2013 or $0.76 per diluted common share. Total average loans grew year-over-year by 5.2% and 1.2% or 5% annualized on a linked quarter basis. We experienced strong loan growth in total average -- strong growth in total average deposits of 7% over the prior year and 1% or 4% annualized linked quarter. Credit quality remained strong.
Total net charge-offs decreased by 9.5% from the prior quarter, while nonperforming assets declined linked quarter by 5.4%.
We generated significant capital this quarter. Our estimated Tier 1 common ratio under Basel III rules issued in early July was 8.6% at June 30, while our Basel I Tier 1 common equity ratio was 9.2% and our Tier 1 capital ratio was 11.1%. We purchased 18 million shares of common stock during the second quarter. These buybacks, along with our dividend, which was increased by 18% in June, resulted in a 73% return of earnings to our shareholders in the second quarter.
On Slide 4, you can see that our performance metrics continue to be among the best in the industry. Return on average assets in the second quarter was 1.7%. The return on average common equity was 16.1%. Our net interest margin and efficiency ratio are shown on the graph on the right-hand slide -- side of Slide 4. This quarter's net interest margin of 3.43% was, as expected, 5 basis points lower than the prior quarter's rate of 3.48%. And Andy will discuss the margin in more detail in just a few minutes.
Our efficiency ratio for the second quarter was 51.7%. We anticipate that this ratio will remain in the low-50s going forward as we continue to manage expenses in relation to revenue trends, while continue to invest in and grow our businesses.
Turning to Slide 5. The company reported total net revenue in the second quarter of $4.9 billion, a 2.4% decrease from prior year, but a 1.5% increase over the first quarter. The decline in revenue year-over-year was largely driven by lower Mortgage Banking revenue and net interest income. While the favorable linked quarter variance reflected strong seasonal fee revenue trends led by payments, partially offset by a decrease in net interest income.
Average loan and deposit growth is summarized on Slide 6. Average total loans outstanding increased by over $11 billion, or 5.2% year-over-year, and 1.2% linked quarter, accelerating from the 1% linked quarter we experienced in the first quarter. Overall, and excluding covered loans, which is a run-off portfolio, average total loans grew by 7.2% year-over-year and 1.6% linked quarter.
Once again, the increase in average loans outstanding was led by strong growth in average commercial loans, which grew by 11.2% year-over-year and 2.2% over the prior quarter.
Total average Commercial Real Estate also increased over the prior quarters, with average construction loans growing by 9.9% year-over-year and 4.9% linked quarter.
Residential real estate loans also continued to show a strong growth, 19.7% over the same quarter of last year and 3.9% over the prior quarter. Within the retail loan categories, average credit card loan outstandings fell slightly as consumers paid down their balances. And average home equity lines and loans continue to decline, as paydowns more than offset new loan originations. Auto loans and leases, however, posted a very good growth year-over-year and linked quarter.
We continue to originate and renew new loans and lines for our customers. New originations, excluding mortgage, plus new and renewed commitments, totaled approximately $48 billion in the second quarter, compared with $46 billion in the second quarter of last year and $36 billion last quarter. Total average revolving corporate and commercial commitments increased year-over-year by 10.2% and 2.2% on a linked quarter basis, while utilization remained flat at approximately 25%, close to where it's been for the past 6 quarters.
Given early industry indicators, our linked quarter average loan growth of 1.2% signifies that we are continuing to gain market share. Additionally, our current expectation is that linked quarter average loan growth will accelerate again in the third quarter to the higher end of our previously stated range of 1% to 1.5%.
Total average deposits increased by $16.1 billion, or 7%, over the same quarter of last year, and by $2.4 billion on a linked quarter basis, with growth in low-cost money market and savings deposits particularly strong on both a year-over-year and linked-quarter basis.
Turning to Slide 7 and credit quality. Total net charge-offs in the second quarter decreased by $41 million or 9.5% from the first quarter of 2013. While nonperforming assets, excluding covered assets, decreased by $108 million or 5.3%. The ratio of net charge-offs to average loans outstanding in the second quarter declined to 0.70% from 0.79% in the first quarter.
During the second quarter, we released $30 million of reserves, equal to the first quarter, and $20 million less than the second quarter of 2012. Given the mix and quality of our portfolio, we expect net charge-offs and nonperforming assets to remain relatively stable in the third quarter.
Andy will now give you a few more details about our second quarter results.
Thanks, Richard. Slide 8 gives you a view of our second quarter 2013 results versus comparable time periods. Our diluted EPS of $0.76 was 7% higher than the second quarter 2012 and 4.1% higher than the prior quarter. The key drivers of the company's second quarter earnings are summarized on Slide 9.
The $69 million or 4.9% increase in net income year-over-year was the result of a decrease in expense and lower provision for credit losses, partially offset by a decline in net revenue.
Net interest income declined year-over-year by $41 million or 1.5%, the result of a 2.7% increase in average earning assets, offset by a 15 basis point decline in net interest margin. The $8.2 billion growth in average earning assets year-over-year included increases in average total loans and the securities portfolio.
Offsetting a portion of the growth in those categories was a $3.1 billion reduction in average other earning assets, primarily due to the deconsolidation of a number of community development entities, and a $1.1 billion reduction in average loans held for sale, reflecting lower mortgage origination activity this quarter versus the same quarter of last year.
The net interest margin of 3.43% was 15 basis points lower than the second quarter of 2012, primarily due to lower-yielding investment securities and lower loan rates, partially offset by lower rates on deposits and wholesale funding, including long-term debt.
Noninterest income declined by 3.4% year-over-year, primarily due to Mortgage Banking revenue, reflecting lower origination and sales revenue, partially offset by higher servicing revenue and a favorable change in the addition to the mortgage rep and warranty repurchase reserve.
Also contributing to the decline in noninterest income year-over-year were reductions in corporate payments, the result of lower government and transportation-related transactions, and other income, which reflected fewer equity investment gains in the prior year and lower retail products revenue, primarily due to end-of-term lease valuations.
Offsetting these declines were year-over-year increases in trust and investment management fees, retail payments, merchant processing revenue, deposit service charges and investment product fees.
Noninterest expense was lower year-over-year by $44 million or 1.7%. The majority of this favorable variance is attributable to a favorable variance for professional services expense, primarily due to the reduction in third-party foreclosure settlement-related costs, as well as an accrual for a Visa-related settlement charge taken in the second quarter of last year, and lower intangible expense.
These favorable variances were partially offset by higher compensation and benefits expense and increases in marketing and technology expense.
Net income was higher on a linked quarter basis by $56 million or 3.9%, as a result of a 1.5% increase in revenue and lower provision for credit losses, partially offset by a 3.5% increase in expense.
On a linked quarter basis, net interest income was lower, as average earning assets declined by $2.1 billion and net interest margin declined by 5 basis points. The decrease in average earning assets was a result of the reduction in other earning assets and loans held for sale, while the expected 5 basis point decline in net interest margin was primarily due to lower loans on rates and securities.
Given the current interest rate environment, we expect net interest margin to be relatively stable in the third quarter, which, combined with our expectation for a linked quarter loan growth, should lead to a modest increase in net interest income in the third quarter.
On a linked quarter basis, noninterest income was higher by $111 million or 5.1%. This favorable variance reflected seasonally higher payments and growth in all fee categories with the exception of Mortgage Banking revenue. In June, we had expected Mortgage Banking revenue to be higher in the second quarter than the first quarter, primarily due to very strong application volumes earlier in the quarter. However, since the time we made that statement to the end of the quarter, rates moved up by about 60 basis points and refinance activity slowed significantly. As a result, Mortgage Banking revenue actually came in slightly lower this quarter than last.
The $5 million decline in revenue reflected an increase in origination and sales revenue, including a favorable change in the reps and warranty reserve, offset by a lower gain on hedging activity than the prior quarter. Although applications were higher in the second quarter than the first quarter, the increase in volume was offset by a reduction in gain on sale margin. We calculate gain on sale margin based on applications expected to close.
On a linked quarter basis, noninterest expense was higher by $87 million or 3.5%, mainly due to other expense, which include higher insurance and regulatory expense relative to the first quarter. In addition, marketing and business development expense and professional service expenses were higher in the current quarter versus the prior quarter due to the timing of business line projects and initiatives.
Turning to Slide 10. Our capital position remains strong and continues to grow. Based on our assessment of the final rules for the Basel III standardized approach released earlier this month, we estimate that our Basel III Tier 1 common equity ratio at June 30 was 8.6%, compared with 8.3% calculated under the previously proposed rules. At 8.6%, we are well above the 7% Basel III minimum requirement and above our targeted ratio of 8%.
Turning to Slide 11. In June, the Board of Directors declared an 18% increase in our common stock dividend. As a result, in the second quarter, we returned 73% of our earnings to shareholders. Dividends accounted for 30% of the return to shareholders and the 18 million shares of stock we repurchased in the second quarter accounted for the remaining 43%.
Of note, our tangible book value per share rose to $13.48 in the second quarter, which represented an 11% increase over the same quarter last year and a 1.6% increase over the prior quarter.
Finally, Slide 12 provides updated detail on the company's mortgage, repurchase-related expense and the reserve for expected losses on repurchases and make-whole payments. Rep and warranty's repurchase reserve was reduced this quarter by $43 million and the outstanding repurchase and make-whole request balance at June 30 was $64 million, compared with $66 million at March 31.
I'll now turn the call back to Richard.
Richard K. Davis
Thanks, Andy. Last Friday, Andy and I had the honor of commemorating the 150th anniversary of the signing of our national bank charter, by ringing the closing bell at the New York Stock Exchange. We were joined on the stage by 10 U.S. Bank employees who proudly represented and celebrated the rich heritage that they and their coworkers, along with many who came before them, have helped to create and build over the past 150 years.
Importantly, as we took that moment to observe and reflect on our past, we also celebrate the present and the strong foundation upon which we are building our company's future. U.S. Bancorp posted record earnings for the second quarter, while once again achieving industry-leading profitability metrics.
We continue to build our future as we have in the past by investing in our well-diversified mix of businesses, by maintaining prudent risk management, by focusing on operating integrity and compliance, by sustaining strong capital and liquidity and by providing superior returns for our shareholders. As always, we remain focused on producing consistent, predictable and repeatable results for the benefit of our customers, our employees, our communities and our shareholders.
That concludes our formal remarks. Andy, Bill and I would now be happy to answer questions from our audience.
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