SECURITIES AND EXCHANGE COMMISSION
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| ☑ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2019
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| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from (not applicable)
Commission file number
1-6880
(Exact name of registrant as specified in its charter)
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(State or other jurisdiction of incorporation or organization) | | |
Minneapolis, Minnesota 55402
(Address of principal executive offices, including zip code)
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
| | | | | |
| | | | Name of each exchange
on which registered |
Common Stock, $.01 par value per share | | USB | | New York Stock Exchange |
Depositary Shares (each representing 1/100th interest in a share of Series A Non-Cumulative Perpetual Preferred Stock, par value $1.00) | | USB PrA | | New York Stock Exchange |
Depositary Shares (each representing 1/1,000th interest in a share of Series B Non-Cumulative Perpetual Preferred Stock, par value $1.00) | | USB PrH | | New York Stock Exchange |
Depositary Shares (each representing 1/1,000th interest in a share of Series F Non-Cumulative Perpetual Preferred Stock, par value $1.00) | | USB PrM | | New York Stock Exchange |
Depositary Shares (each representing 1/1,000th interest in a share of Series H Non-Cumulative Perpetual Preferred Stock, par value $1.00) | | USB PrO | | New York Stock Exchange |
Depositary Shares (each representing 1/1,000th interest in a share of Series K Non-Cumulative Perpetual Preferred Stock, par value $1.00) | | USB PrP | | New York Stock Exchange |
0.850% Medium-Term Notes, Series X (Senior), due June 7, 2024 | | USB/24B | | New York Stock Exchange |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in
Rule 12b-2
of the Exchange Act.
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| Large accelerated filer ☑ | | Accelerated filer ☐ |
Non-accelerated filer ☐ | | Smaller reporting company ☐ Emerging growth company ☐ |
If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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| Class | | Outstanding as of October 31, 2019 |
| Common Stock, $0.01 Par Value | | 1,561,859,164 shares |
Management’s Discussion and Analysis
U.S. Bancorp and its subsidiaries (the “Company”) reported net income attributable to U.S. Bancorp of $1.9 billion for the third quarter of 2019, or $1.15 per diluted common share, compared with $1.8 billion, or $1.06 per diluted common share, for the third quarter of 2018. Return on average assets and return on average common equity were 1.57 percent and 15.3 percent, respectively, for the third quarter of 2019, compared with 1.58 percent and 15.5 percent, respectively, for the third quarter of 2018.
Total net revenue for the third quarter of 2019 was $221 million (3.9 percent) higher than the third quarter of 2018, reflecting a 0.9 percent increase in net interest income (0.8 percent on a taxable-equivalent basis) and an 8.1 percent increase in noninterest income. The increase in net interest income from the third quarter of 2018 was mainly a result of loan growth and higher yields on reinvestment of securities, partially offset by the impact of a flatter yield curve and changes in deposit and funding mix. The noninterest income increase was driven by growth in mortgage banking revenue, payment services revenue, commercial products revenue and other noninterest income, partially offset by a decline in deposit service charges.
Noninterest expense in the third quarter of 2019 was $100 million (3.3 percent) higher than the third quarter of 2018, primarily due to higher personnel expense, in part due to higher fee revenue production in mortgage and capital market activities, and higher technology and communications expense in support of business growth. Partially offsetting these increases was lower other noninterest expense driven by lower Federal Deposit Insurance Corporation (“FDIC”) assessment costs.
The provision for credit losses for the third quarter of 2019 of $367 million was $24 million (7.0 percent) higher than the third quarter of 2018. Net charge-offs in the third quarter of 2019 were $352 million, compared with $328 million in the third quarter of 2018. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
Net income attributable to U.S. Bancorp for the first nine months of 2019 was $5.4 billion, or $3.25 per diluted common share, compared with $5.2 billion, or $3.04 per diluted common share, for the first nine months of 2018. Return on average assets and return on average common equity were 1.54 percent and 14.9 percent, respectively, for the first nine months of 2019, compared with 1.54 percent and 15.2 percent, respectively, for the first nine months of 2018.
Total net revenue for the first nine months of 2019 was $511 million (3.0 percent) higher than the first nine months of 2018, reflecting a 2.4 percent increase in net interest income (2.3 percent on a taxable-equivalent basis) and a 4.1 percent increase in noninterest income. The increase in net interest income from a year ago was mainly a result of loan growth and higher yields on reinvestment of securities, partially offset by the impact of a flatter yield curve and changes in deposit and funding mix. The noninterest income increase was driven by growth in payment services revenue, mortgage banking revenue, commercial products revenue and other noninterest income, partially offset by a decline in deposit service charges.
Noninterest expense in the first nine months of 2019 was $200 million (2.2 percent) higher than the first nine months of 2018, primarily due to higher personnel expense, reflecting higher fee revenue production in mortgage and capital market activities, and higher technology and communications expense in support of business growth. Partially offsetting these increases was lower other noninterest expense driven by lower FDIC assessment costs.
The provision for credit losses for the first nine months of 2019 of $1.1 billion was $98 million (9.7 percent) higher than the first nine months of 2018. Net charge-offs in the first nine months of 2019 were $1.1 billion, compared with $1.0 billion in the first nine months of 2018. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
STATEMENT OF INCOME ANALYSIS
Net interest income, on a taxable-equivalent basis, was $3.3 billion in the third quarter and $9.9 billion in the first nine months of 2019, representing increases of $25 million (0.8 percent) and $220 million (2.3 percent), respectively, over the same periods of 2018. The increases were principally driven by earning assets growth and higher yields on reinvestment of securities, partially offset by declining interest rates and a flatter yield curve, as well as changes in deposit and funding mix. Average earning assets were $20.5 billion (4.9 percent) higher in the third quarter and $14.2 billion (3.4 percent) higher in the first nine months of 2019, compared with the same periods of 2018, reflecting increases in loans, investment securities and other earning assets. The net interest margin, on a taxable-equivalent basis, in the third quarter and first nine months of 2019 was 3.02 percent and 3.10 percent, respectively, compared with 3.15 percent and 3.14 percent in the third quarter and first nine months of 2018, respectively. Net interest margin decreased year-over-year primarily due to the impacts of changes in the yield curve, changes in deposit and funding mix, and higher cash balances, in part related to a change in position on affiliate balances by the regulator of the Company’s Irish subsidiary. Refer to the “Consolidated Daily Average Balance Sheet and Related Yields and Rates” tables for further information on net interest income.
Average total loans in the third quarter and first nine months of 2019 were $11.4 billion (4.0 percent) and $9.6 billion (3.4 percent) higher, respectively, than the same periods of 2018, due to growth in residential mortgages, commercial loans, credit card loans and other retail loans, all driven by higher demand for loans from new and existing customers. These increases were partially offset by decreases in commercial real estate loans due to new originations being more than offset by customers paying down balances, given the later stage of the business cycle, and the fourth quarter of 2018 sale of the majority of the Company’s loans covered
by FDIC loss-sharing agreements
. Subsequent to the fourth quarter of 2018 sale, any remaining covered loan balances were reclassified to their respective portfolio category.
Average investment securities in the third quarter and first nine months of 2019 were $3.7 billion (3.2 percent) and $1.8 billion (1.5 percent) higher, respectively, than in the same periods of 2018, primarily due to purchases of mortgage-backed securities, net of prepayments and maturities.
Average total deposits for the third quarter and first nine months of 2019 were $19.8 billion (6.0 percent) and $10.4 billion (3.1 percent) higher, respectively, than the same periods of 2018. Average total savings deposits for the third quarter and first nine months of 2019 were $18.0 billion (8.4 percent) and $7.9 billion (3.6 percent) higher, respectively, than the same periods of the prior year, driven by increases in Wealth Management and Investment Services, Corporate and Commercial Banking, and Consumer and Business Banking balances. Average time deposits for the third quarter and first nine months of 2019 were $4.4 billion (11.7 percent) and $7.4 billion (19.6 percent) higher, respectively, than the same periods of 2018. The increases were largely related to those deposits managed as an alternative to other funding sources, based largely on relative pricing and liquidity characteristics, in addition to the migration of consumer customer deposit balances to higher yielding products. Average noninterest-bearing deposits for the third quarter and first nine months of 2019 decreased $2.6 billion (3.4 percent) and $4.8 billion (6.2 percent), respectively, from the same periods of the prior year, primarily due to the migration of balances to interest-bearing deposits and the continued deployment by customers of business deposits within Corporate and Commercial Banking given higher earning credit rates from the prior year.
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| | | Three Months Ended
September 30 | | | Nine Months Ended
September 30 | |
| (Dollars in Millions) | | 2019 | | | 2018 | | | Percent
Change | | | 2019 | | | 2018 | | | Percent
Change | |
Credit and debit card revenue | | $ | 366 | | | $ | 344 | | | | 6.4 | % | | $ | 1,035 | | | $ | 1,019 | | | | 1.6 | % |
Corporate payment products revenue | | | 177 | | | | 169 | | | | 4.7 | | | | 506 | | | | 481 | | | | 5.2 | |
Merchant processing services | | | 410 | | | | 392 | | | | 4.6 | | | | 1,192 | | | | 1,142 | | | | 4.4 | |
Trust and investment management fees | | | 421 | | | | 411 | | | | 2.4 | | | | 1,235 | | | | 1,210 | | | | 2.1 | |
| | | 234 | | | | 283 | | | | (17.3 | ) | | | 678 | | | | 817 | | | | (17.0 | ) |
| | | 139 | | | | 146 | | | | (4.8 | ) | | | 438 | | | | 451 | | | | (2.9 | ) |
Commercial products revenue | | | 240 | | | | 216 | | | | 11.1 | | | | 708 | | | | 670 | | | | 5.7 | |
| | | 272 | | | | 174 | | | | 56.3 | | | | 630 | | | | 549 | | | | 14.8 | |
| | | 46 | | | | 47 | | | | (2.1 | ) | | | 138 | | | | 140 | | | | (1.4 | ) |
Securities gains (losses), net | | | 25 | | | | 10 | | | | * | | | | 47 | | | | 25 | | | | 88.0 | |
| | | 284 | | | | 226 | | | | 25.7 | | | | 788 | | | | 600 | | | | 31.3 | |
| | $ | 2,614 | | | $ | 2,418 | | | | 8.1 | % | | $ | 7,395 | | | $ | 7,104 | | | | 4.1 | % |
Provision for Credit Losses
The provision for credit losses for the third quarter and first nine months of 2019 increased $24 million (7.0 percent) and $98 million (9.7 percent), respectively, from the same periods of 2018, primarily as a result of loan growth. Net charge-offs increased $24 million (7.3 percent) and $68 million (6.8 percent) in the third quarter and first nine months of 2019, respectively, compared with the same periods of the prior year, primarily due to higher commercial, commercial real estate and credit card loan net charge-offs, partially offset by lower residential mortgage net charge-offs. Refer to “Corporate Risk Profile” for further information on the provision for credit losses, net charge-offs, nonperforming assets and other factors considered by the Company in assessing the credit quality of the loan portfolio and establishing the allowance for credit losses.
Noninterest income was $2.6 billion in the third quarter and $7.4 billion in the first nine months of 2019, representing increases of $196 million (8.1 percent) and $291 million (4.1 percent), respectively, compared with the same periods of 2018. The increases from a year ago were driven by growth in payment services revenue, mortgage banking revenue, commercial products revenue and other noninterest income, partially offset by a decline in deposit service charges. Payment services revenue increased due to higher credit and debit card revenue, merchant processing services revenue and corporate payment products revenue, all driven by higher sales volume. In addition, credit and debit card revenue further increased in the third quarter of 2019, compared with the third quarter of 2018, due to more processing days. Mortgage banking revenue increased due to higher origination and sales volumes related to home sales and refinancing activities given changing interest rates relative to the prior year, partially offset by changes in mortgage servicing rights (“MSRs”) valuations, net of hedging activities. Commercial products revenue increased primarily due to higher corporate bond fees and trading revenue related to stronger capital markets activities. Other noninterest income also increased from a year ago primarily due to higher equity investment income and transition services agreement revenue associated with the sale of the Company’s ATM third-party servicing business in 2018. Deposit service charges decreased primarily due to the ATM third-party servicing sale.
Noninterest expense was $3.1 billion in the third quarter and $9.4 billion in the first nine months of 2019, representing increases of $100 million (3.3 percent) and $200 million (2.2 percent), respectively, over the same periods of 2018. The increases from a year ago were primarily due to higher personnel costs, technology and communications expense, and professional services expense, partially offset by lower other noninterest expense. Compensation expense increased principally due to the impact of merit increases and higher variable compensation related to business production within mortgage banking and the capital markets business lines, while employee benefits expense increased primarily due to increased medical costs. Technology and communications expense increased, primarily driven by capital expenditures to support business growth. Professional services expense increased primarily due to business investments and enhancements to risk management programs. Other noninterest expense decreased due to lower FDIC assessment costs, driven by the elimination of the surcharge in the fourth quarter of 2018, and lower costs related to
tax-advantaged
projects.
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| | | Three Months Ended
September 30 | | | Nine Months Ended
September 30 | |
| (Dollars in Millions) | | 2019 | | | 2018 | | | Percent
Change | | | 2019 | | | 2018 | | | Percent
Change | |
| | $ | 1,595 | | | $ | 1,529 | | | | 4.3 | % | | $ | 4,728 | | | $ | 4,594 | | | | 2.9 | % |
| | | 324 | | | | 294 | | | | 10.2 | | | | 971 | | | | 923 | | | | 5.2 | |
Net occupancy and equipment | | | 279 | | | | 270 | | | | 3.3 | | | | 837 | | | | 797 | | | | 5.0 | |
| | | 114 | | | | 96 | | | | 18.8 | | | | 315 | | | | 274 | | | | 15.0 | |
Marketing and business development | | | 109 | | | | 106 | | | | 2.8 | | | | 309 | | | | 314 | | | | (1.6 | ) |
Technology and communications | | | 277 | | | | 247 | | | | 12.1 | | | | 804 | | | | 724 | | | | 11.0 | |
Postage, printing and supplies | | | 74 | | | | 84 | | | | (11.9 | ) | | | 219 | | | | 244 | | | | (10.2 | ) |
| | | 42 | | | | 41 | | | | 2.4 | | | | 124 | | | | 120 | | | | 3.3 | |
| | | 330 | | | | 377 | | | | (12.5 | ) | | | 1,077 | | | | 1,194 | | | | (9.8 | ) |
Total noninterest expense | | $ | 3,144 | | | $ | 3,044 | | | | 3.3 | % | | $ | 9,384 | | | $ | 9,184 | | | | 2.2 | % |
| | | 53.3 | % | | | 53.5 | % | | | | | | | 54.3 | % | | | 54.7 | % | | | | |
| a) | See Non-GAAP Financial Measures beginning on page 30. |
The provision for income taxes was $467 million (an effective rate of 19.6 percent) for the third quarter and $1.3 billion (an effective rate of 19.2 percent) for the first nine months of 2019, compared with $460 million (an effective rate of 20.2 percent) and $1.3 billion (an effective rate of 19.4 percent) for the same periods of 2018. For further information on income taxes, refer to Note 12 of the Notes to Consolidated Financial Statements.
The Company’s loan portfolio was $294.6 billion at September 30, 2019, compared with $286.8 billion at December 31, 2018, an increase of $7.8 billion (2.7 percent). The increase was driven by higher residential mortgages, commercial loans, other retail loans and credit card loans, partially offset by lower commercial real estate loans.
Residential mortgages held in the loan portfolio increased $4.3 billion (6.7 percent) at September 30, 2019, compared with December 31, 2018, as origination activity more than offset the effect of customers paying down balances in the first nine months of 2019. Residential mortgages originated and placed in the Company’s loan portfolio include well-secured jumbo mortgages and branch-originated first lien home equity loans to borrowers with high credit quality.
Commercial loans increased $2.2 billion (2.2 percent) at September 30, 2019, compared with December 31, 2018, reflecting higher demand from new and existing customers.
Other retail loans increased $1.0 billion (1.8 percent) at September 30, 2019, compared with December 31, 2018, the result of increases in installment loans and auto loans, partially offset by decreases in home equity loans, revolving credit balances and retail leasing loans.
Credit card loans increased $527 million (2.3 percent) at September 30, 2019, compared with December 31, 2018, reflecting new and existing customer growth in the first nine months of 2019.
Commercial real estate loans decreased $271 million (0.7 percent) at September 30, 2019, compared with December 31, 2018, primarily the result of new originations being more than offset by customers paying down balances, given the later stage of the business cycle.
The Company generally retains portfolio loans through maturity; however, the Company’s intent may change over time based upon various factors such as ongoing asset/liability management activities, assessment of product profitability, credit risk, liquidity needs, and capital implications. If the Company’s intent or ability to hold an existing portfolio loan changes, it is transferred to loans held for sale.
Loans held for sale, consisting primarily of residential mortgages to be sold in the secondary market, were $4.5 billion at September 30, 2019, compared with $2.1 billion at December 31, 2018. The increase in loans held for sale was principally due to a higher level of mortgage loan closings in the third quarter of 2019, reflecting the impact of declining interest rates. Almost all of the residential mortgage loans the Company originates or purchases for sale follow guidelines that allow the loans to be sold into existing, highly liquid secondary markets; in particular in government agency transactions and to government-sponsored enterprises (“GSEs”).
Investment securities totaled $121.1 billion at September 30, 2019, compared with $112.2 billion at December 31, 2018. The $8.9 billion (7.9 percent) increase was primarily due to $7.2 billion of net investment purchases and a $1.7 billion favorable change in net unrealized gains (losses) on
investment securities.
The Company’s
securities are carried at fair value with changes in fair value reflected in other comprehensive income (loss) unless a security is deemed to be other-than-temporarily impaired. At September 30, 2019, the Company’s net unrealized gains on
securities were $476 million, compared with $1.3 billion of net unrealized losses at December 31, 2018. The favorable change in net unrealized gains (losses) was primarily due to increases in the fair value of U.S. Treasury, mortgage-backed and state and political securities as a result of changes in interest rates. Gross unrealized losses on
securities totaled $256 million at September 30, 2019, compared with $1.4 billion at December 31, 2018. At September 30, 2019, the Company had no plans to sell securities with unrealized losses, and believes it is more likely than not that it would not be required to sell such securities before recovery of their amortized cost.
Refer to Notes 3 and 15 in the Notes to Consolidated Financial Statements for further information on investment securities.
Total deposits were $359.7 billion at September 30, 2019, compared with $345.5 billion at December 31, 2018, the result of increases in total savings deposits and noninterest-bearing deposits, partially offset by a decrease in time deposits. Money market deposit balances increased $17.7 billion (17.7 percent) at September 30, 2019, compared with December 31, 2018, primarily due to higher Wealth Management and Investment Services, and Corporate and Commercial Banking balances. Savings account balances increased $1.7 billion (3.9 percent), primarily due to higher Consumer and Business Banking balances. Interest checking balances decreased $1.3 billion (1.8 percent), primarily due to lower Wealth Management and Investment Services, and Consumer and Business Banking balances, partially offset by higher Corporate and Commercial Banking balances. Noninterest-bearing deposits increased $421 million (0.5 percent) at September 30, 2019, compared with December 31, 2018, primarily due to higher Consumer and Business Banking balances, partially offset by lower Corporate and Commercial Banking, and Wealth Management and Investment Services balances. Time deposits decreased $4.3 billion (9.7 percent) at September 30, 2019, compared with December 31, 2018, driven by a decrease in those deposits managed as an alternative to other funding sources, based largely on relative pricing and liquidity characteristics, partially offset by the migration of consumer customer deposit balances to higher yielding products.
The Company utilizes both short-term and long-term borrowings as part of its asset/liability management and funding strategies. Short-term borrowings, which include federal funds purchased, commercial paper, repurchase agreements, borrowings secured by high-grade assets and other short-term borrowings, were $14.6 billion at September 30, 2019, compared with $14.1 billion at December 31, 2018. The $440 million (3.1 percent) increase in short-term borrowings was primarily due to higher commercial paper, federal funds purchased and other short-term borrowings balances, partially offset by lower repurchase agreement balances. Long-term debt was $41.3 billion at September 30, 2019 and December 31, 2018, reflecting $3.3 billion of bank note, $2.6 billion of medium-term note and $1.0 billion of subordinated note issuances, offset by $1.5 billion of medium-term note repayments and $5.3 billion of bank note repayments and maturities during the first nine months of 2019. Refer to the “Liquidity Risk Management” section for discussion of liquidity management of the Company.
Managing risks is an essential part of successfully operating a financial services company. The Company’s Board of Directors has approved a risk management framework which establishes governance and risk management requirements for all risk-taking activities. This framework includes Company and business line risk appetite statements which set boundaries for the types and amount of risk that may be undertaken in pursuing business objectives and initiatives. The Board of Directors, primarily through its Risk Management Committee, oversees performance relative to the risk management framework, risk appetite statements, and other policy requirements.
The Executive Risk Committee (“ERC”), which is chaired by the Chief Risk Officer and includes the Chief Executive Officer and other members of the executive management team, oversees execution against the risk management framework and risk appetite statements. The ERC focuses on current and emerging risks, including strategic and reputational risks, by directing timely and comprehensive actions. Senior operating committees have also been established, each responsible for overseeing a specified category of risk.
The Company’s most prominent risk exposures are credit, interest rate, market, liquidity, operational, compliance, strategic, and reputational. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan, investment or derivative contract when it is due. Interest rate risk is the potential reduction of net interest income or market valuations as a result of changes in interest rates. Market risk arises from fluctuations in interest rates, foreign exchange rates, and security prices that may result in changes in the values of financial instruments, such as trading and
securities, mortgage loans held for sale (“MLHFS”), MSRs and derivatives that are accounted for on a fair value basis. Liquidity risk is the possible inability to fund obligations or new business at a reasonable cost and in a timely manner. Operational risk is the risk of loss arising from inadequate or failed internal processes or systems, people, or adverse external events, including the risk of loss resulting from breaches in data security. Operational risk can also include the risk of loss due to failures by third parties with which the Company does business. Compliance risk is the risk that the Company may suffer legal or regulatory sanctions, material financial loss, or loss to reputation through failure to comply with laws, regulations, rules, standards of good practice, and codes of conduct. Strategic risk is the risk to current or projected financial condition arising from adverse business decisions, poor implementation of business decisions, or lack of responsiveness to changes in the banking industry and operating environment. Reputational risk is the risk to current or anticipated earnings, capital, or franchise or enterprise value arising from negative public opinion. This risk may impair the Company’s competitiveness by affecting its ability to establish new customer relationships, offer new services or continue serving existing customer relationships. In addition to the risks identified above, other risk factors exist that may impact the Company. Refer to “Risk Factors” in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2018, for a detailed discussion of these factors.
The Company’s Board and management-level governance committees are supported by a “three lines of defense” model for establishing effective checks and balances. The first line of defense, the business lines, manages risks in conformity with established limits and policy requirements. In turn, business line leaders and their risk officers establish programs to ensure conformity with these limits and policy requirements. The second line of defense, which includes the Chief Risk Officer’s organization as well as policy and oversight activities of corporate support functions, translates risk appetite and strategy into actionable risk limits and policies. The second line of defense monitors first line of defense conformity with limits and policies, and provides reporting and escalation of emerging risks and other concerns to senior management and the Risk Management Committee of the Board of Directors. The third line of defense, internal audit, is responsible for providing the Audit Committee of the Board of Directors and senior management with independent assessment and assurance regarding the effectiveness of the Company’s governance, risk management and control processes.
Management regularly provides reports to the Risk Management Committee of the Board of Directors. The Risk Management Committee discusses with management the Company’s risk management performance, and provides a summary of key risks to the entire Board of Directors, covering the status of existing matters, areas of potential future concern and specific information on certain types of loss events. The Risk Management Committee considers quarterly reports by management assessing the Company’s performance relative to the risk appetite statements and the associated risk limits, including:
| • | | Macroeconomic environment and other qualitative considerations, such as regulatory and compliance changes, litigation developments, and technology and cybersecurity; |
| • | | Credit measures, including adversely rated and nonperforming loans, leveraged transactions, credit concentrations and lending limits; |
| • | | Interest rate and market risk, including market value and net income simulation, and trading-related Value at Risk (“VaR”); |
| • | | Liquidity risk, including funding projections under various stressed scenarios; |
| • | | Operational and compliance risk, including losses stemming from events such as fraud, processing errors, control breaches, breaches in data security or adverse business decisions, as well as reporting on technology performance, and various legal and regulatory compliance measures; |
| • | | Capital ratios and projections, including regulatory measures and stressed scenarios; and |
| • | | Strategic and reputational risk considerations, impacts and responses. |
The Company’s strategy for credit risk management includes well-defined, centralized credit policies, uniform underwriting criteria, and ongoing risk monitoring and review processes for all commercial and consumer credit exposures. In evaluating its credit risk, the Company considers changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or
customer-specific concentrations), collateral values, trends in loan performance and macroeconomic factors, such as changes in unemployment rates, gross domestic product and consumer bankruptcy filings, as well as the potential impact on customers and the domestic economy resulting from new tariffs or increases in existing tariffs. The Risk Management Committee oversees the Company’s credit risk management process.
In addition, credit quality ratings as defined by the Company, are an important part of the Company’s overall credit risk management and evaluation of its allowance for credit losses. Loans with a pass rating represent those loans not classified on the Company’s rating scale for problem credits, as minimal risk has been identified. Loans with a special mention or classified rating, including loans that are 90 days or more past due and still accruing, nonaccrual loans, those loans considered troubled debt restructurings (“TDRs”), and loans in a junior lien position that are current but are behind a modified or delinquent loan in a first lien position, encompass all loans held by the Company that it considers to have a potential or well-defined weakness that may put full collection of contractual cash flows at risk. The Company’s internal credit quality ratings for consumer loans are primarily based on delinquency and nonperforming status, except for a limited population of larger loans within those portfolios that are individually evaluated. For this limited population, the determination of the internal credit quality rating may also consider collateral value and customer cash flows. Refer to Note 4 in the Notes to Consolidated Financial Statements for further discussion of the Company’s loan portfolios including internal credit quality ratings. In addition, refer to “Management’s Discussion and Analysis — Credit Risk Management” in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018, for a more detailed discussion on credit risk management processes.
The Company manages its credit risk, in part, through diversification of its loan portfolio which is achieved through limit setting by product type criteria, such as industry, and identification of credit concentrations. As part of its normal business activities, the Company offers a broad array of lending products. The Company categorizes its loan portfolio into two segments, which is the level at which it develops and documents a systematic methodology to determine the allowance for credit losses. The Company’s two loan portfolio segments are commercial lending and consumer lending.
The commercial lending segment includes loans and leases made to small business, middle market, large corporate, commercial real estate, financial institution,
non-profit
and public sector customers. Key risk characteristics relevant to commercial lending segment loans include the industry and geography of the borrower’s business, purpose of the loan, repayment source, borrower’s debt capacity and financial flexibility, loan covenants, and nature of pledged collateral, if any. These risk characteristics, among others, are considered in determining estimates about the likelihood of default by the borrowers and the severity of loss in the event of default. The Company considers these risk characteristics in assigning internal risk ratings to, or forecasting losses on, these loans, which are the significant factors in determining the allowance for credit losses for loans in the commercial lending segment.
The consumer lending segment represents loans and leases made to consumer customers, including residential mortgages, credit card loans, and other retail loans such as revolving consumer lines, auto loans and leases, home equity loans and lines, and student loans, a
run-off
portfolio. Home equity or second mortgage loans are junior lien
closed-end
accounts fully disbursed at origination. These loans typically are fixed rate loans, secured by residential real estate, with a
10-
or
15-year
fixed payment amortization schedule. Home equity lines are revolving accounts giving the borrower the ability to draw and repay balances repeatedly, up to a maximum commitment, and are secured by residential real estate. These include accounts in either a first or junior lien position. Typical terms on home equity lines in the portfolio are variable rates benchmarked to the prime rate, with a
10-
or
15-year
draw period during which a minimum payment is equivalent to the monthly interest, followed by a
20-
or
10-year
amortization period, respectively. At September 30, 2019, substantially all of the Company’s home equity lines were in the draw period. Approximately $1.1 billion, or 8 percent, of the outstanding home equity line balances at September 30, 2019, will enter the amortization period within the next 36 months. Key risk characteristics relevant to consumer lending segment loans primarily relate to the borrowers’ capacity and willingness to repay and include unemployment rates and other economic factors, customer payment history and credit scores, and in some cases, updated
(“LTV”) information reflecting current market conditions on real estate-based loans. These risk characteristics, among others, are reflected in forecasts of delinquency levels, bankruptcies and losses which are the primary factors in determining the allowance for credit losses for the consumer lending segment.
The Company further disaggregates its loan portfolio segments into various classes based on their underlying risk characteristics. The two classes within the
commercial lending segment are commercial loans and commercial real estate loans. The three classes within the consumer lending segment are residential mortgages, credit card loans and other retail loans.
The Company’s consumer lending segment utilizes several distinct business processes and channels to originate consumer credit, including traditional branch lending, mobile and
on-line
banking, indirect lending, correspondent banks and loan brokers. Each distinct underwriting and origination activity manages unique credit risk characteristics and prices its loan production commensurate with the differing risk profiles.
Residential mortgage originations are generally limited to prime borrowers and are performed through the Company’s branches, loan production offices, mobile and
on-line
services and a wholesale network of originators. The Company may retain residential mortgage loans it originates on its balance sheet or sell the loans into the secondary market while retaining the servicing rights and customer relationships. Utilizing the secondary markets enables the Company to effectively reduce its credit and other asset/liability risks. For residential mortgages that are retained in the Company’s portfolio and for home equity and second mortgages, credit risk is also diversified by geography and managed by adherence to LTV and borrower credit criteria during the underwriting process.
The Company estimates updated LTV information on its outstanding residential mortgages quarterly, based on a method that combines automated valuation model updates and relevant home price indices. LTV is the ratio of the loan’s outstanding principal balance to the current estimate of property value. For home equity and second mortgages, combined
(“CLTV”) is the combination of the first mortgage original principal balance and the second lien outstanding principal balance, relative to the current estimate of property value. Certain loans do not have a LTV or CLTV, primarily due to lack of availability of relevant automated valuation model and/or home price indices values, or lack of necessary valuation data on acquired loans.
The following tables provide summary information of residential mortgages and home equity and second mortgages by LTV and borrower type at September 30, 2019:
| | | | | | | | | | | | | | | | | |
Residential Mortgages
(Dollars in Millions) | | Interest
Only | | | Amortizing | | | Total | | | Percent
of Total | |
| | | | | | | | | | | | | | | | |
Less than or equal to 80% | | $ | 2,314 | | | $ | 57,346 | | | $ | 59,660 | | | | 86.0 | % |
| | | 14 | | | | 5,614 | | | | 5,628 | | | | 8.1 | |
| | | 1 | | | | 483 | | | | 484 | | | | .7 | |
| | | – | | | | 165 | | | | 165 | | | | .3 | |
| | | – | | | | 28 | | | | 28 | | | | – | |
Loans purchased from GNMA mortgage pools (a) | | | – | | | | 3,413 | | | | 3,413 | | | | 4.9 | |
| | $ | 2,329 | | | $ | 67,049 | | | $ | 69,378 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | |
| | $ | 2,329 | | | $ | 63,010 | | | $ | 65,339 | | | | 94.2 | % |
| | | – | | | | 626 | | | | 626 | | | | .9 | |
Loans purchased from GNMA mortgage pools (a) | | | – | | | | 3,413 | | | | 3,413 | | | | 4.9 | |
| | $ | 2,329 | | | $ | 67,049 | | | $ | 69,378 | | | | 100.0 | % |
| (a) | Represents loans purchased from Government National Mortgage Association (“GNMA”) mortgage pools whose payments are primarily insured by the Federal Housing Administration or guaranteed by the United States Department of Veterans Affairs. |
| | | | | | | | | | | | | | | | | |
Home Equity and Second Mortgages
(Dollars in Millions) | | Lines | | | Loans | | | Total | | | Percent
of Total | |
| | | | | | | | | | | | | | | | |
Less than or equal to 80% | | $ | 11,480 | | | $ | 958 | | | $ | 12,438 | | | | 80.5 | % |
| | | 1,738 | | | | 724 | | | | 2,462 | | | | 15.9 | |
| | | 226 | | | | 65 | | | | 291 | | | | 1.9 | |
| | | 113 | | | | 11 | | | | 124 | | | | .8 | |
| | | 131 | | | | 7 | | | | 138 | | | | .9 | |
| | $ | 13,688 | | | $ | 1,765 | | | $ | 15,453 | | | | 100.0 | % |
| | | | | | | | | | | | | | | | |
| | $ | 13,654 | | | $ | 1,722 | | | $ | 15,376 | | | | 99.5 | % |
| | | 34 | | | | 43 | | | | 77 | | | | .5 | |
| | $ | 13,688 | | | $ | 1,765 | | | $ | 15,453 | | | | 100.0 | % |
Home equity and second mortgages were $15.5 billion at September 30, 2019, compared with $16.1 billion at December 31, 2018, and included $3.9 billion of home equity lines in a first lien position and $11.6 billion of home equity and second mortgage loans and lines in a junior lien position. Loans and lines in a junior lien position at September 30, 2019, included approximately $4.7 billion of loans and lines for which the Company also serviced the related first lien loan, and approximately $6.9 billion where the Company did not service the related first lien loan. The Company was able to determine the status of the related first liens using information the Company has as the servicer of the first lien or information reported on customer credit bureau files. The Company also evaluates other indicators of credit risk for these junior lien loans and lines including delinquency, estimated average CLTV ratios and updated weighted-average credit scores in making its assessment of credit risk, related loss estimates and determining the allowance for credit losses.
The following table provides summary delinquency information for residential mortgages, credit card and other retail loans included in the consumer lending segment:
| | | | | | | | | | | | | | | | | | | | | |
| | | Amount | | | | | | As a Percent of Ending
Loan Balances | |
| (Dollars in Millions) | | September 30,
2019 | | | December 31,
2018 | | | | | | September 30,
2019 | | | December 31,
2018 | |
Residential Mortgages (a) | | | | | | | | | | | | | | | | | | | | |
| | $ | 167 | | | $ | 181 | | | | | | | | .24 | % | | | .27 | % |
| | | 115 | | | | 114 | | | | | | | | .17 | | | | .18 | |
| | | 251 | | | | 296 | | | | | | | | .36 | | | | .46 | |
| | $ | 533 | | | $ | 591 | | | | | | | | .77 | % | | | .91 | % |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 316 | | | $ | 324 | | | | | | | | 1.33 | % | | | 1.39 | % |
| | | 278 | | | | 293 | | | | | | | | 1.16 | | | | 1.25 | |
| | | – | | | | – | | | | | | | | – | | | | – | |
| | $ | 594 | | | $ | 617 | | | | | | | | 2.49 | % | | | 2.64 | % |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 41 | | | $ | 37 | | | | | | | | .48 | % | | | .43 | % |
| | | 4 | | | | 3 | | | | | | | | .05 | | | | .04 | |
| | | 12 | | | | 12 | | | | | | | | .14 | | | | .14 | |
| | $ | 57 | | | $ | 52 | | | | | | | | .67 | % | | | .61 | % |
Home Equity and Second Mortgages | | | | | | | | | | | | | | | | | | | | |
| | $ | 85 | | | $ | 90 | | | | | | | | .55 | % | | | .56 | % |
| | | 52 | | | | 57 | | | | | | | | .34 | | | | .35 | |
| | | 116 | | | | 145 | | | | | | | | .75 | | | | .90 | |
| | $ | 253 | | | $ | 292 | | | | | | | | 1.64 | % | | | 1.81 | % |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 265 | | | $ | 276 | | | | | | | | .78 | % | | | .87 | % |
| | | 46 | | | | 48 | | | | | | | | .14 | | | | .15 | |
| | | 42 | | | | 40 | | | | | | | | .13 | | | | .13 | |
| | $ | 353 | | | $ | 364 | | | | | | | | 1.05 | % | | | 1.15 | % |
| (a) | Excludes $391 million of loans 30-89 days past due and $1.7 billion of loans 90 days or more past due at September 30, 2019, purchased from GNMA mortgage pools that continue to accrue interest, compared with $430 million and $1.7 billion at December 31, 2018, respectively. |
| (b) | Includes revolving credit, installment, automobile and student loans. |
In certain circumstances, the Company may modify the terms of a loan to maximize the collection of amounts due when a borrower is experiencing financial difficulties or is expected to experience difficulties in the near-term. In most cases, the modification is either a concessionary reduction in interest rate, extension of the maturity date or reduction in the principal balance that would otherwise not be considered.
Troubled Debt Restructurings
Concessionary modifications are classified as TDRs unless the modification results in only an insignificant delay in the payments to be received. TDRs accrue interest if the borrower complies with the revised terms and conditions and has demonstrated repayment performance at a level commensurate with the modified terms over several payment cycles, which is generally six months or greater. At September 30, 2019, performing TDRs were $3.8 billion, compared with $3.9 billion at December 31, 2018. Loans classified as TDRs are considered impaired loans for reporting and measurement purposes.
The Company continues to work with customers to modify loans for borrowers who are experiencing financial difficulties. Many of the Company’s TDRs are determined on a
basis in connection with ongoing loan collection processes. The modifications vary within each of the Company’s loan classes. Commercial lending segment TDRs generally include extensions of the maturity date and may be accompanied by an increase or decrease to the interest rate. The Company may also work with the borrower to make other changes to the loan to mitigate losses, such as obtaining additional collateral and/or guarantees to support the loan.
The Company has also implemented certain residential mortgage loan restructuring programs that may result in TDRs. The Company modifies residential mortgage loans under Federal Housing Administration, United States Department of Veterans Affairs, and its own internal programs. Under these programs, the Company offers qualifying homeowners the opportunity to permanently modify their loan and achieve more affordable monthly payments by providing loan concessions. These concessions may include adjustments to interest rates, conversion of adjustable rates to fixed rates, extensions of maturity dates or deferrals of payments, capitalization of accrued interest and/or outstanding advances, or in limited situations, partial forgiveness of loan principal. In most instances,
participation in residential mortgage loan restructuring programs requires the customer to complete a short-term trial period. A permanent loan modification is contingent on the customer successfully completing the trial period arrangement, and the loan documents are not modified until that time. The Company reports loans in a trial period arrangement as TDRs and continues to report them as TDRs after the trial period.
Credit card and other retail loan TDRs are generally part of distinct restructuring programs providing customers modification solutions over a specified time period, generally up to 60 months.
In accordance with regulatory guidance, the Company considers secured consumer loans that have had debt discharged through bankruptcy where the borrower has not reaffirmed the debt to be TDRs. If the loan amount exceeds the collateral value, the loan is charged down to collateral value and the remaining amount is reported as nonperforming.
Acquired loans restructured after acquisition are not considered TDRs for purposes of the Company’s accounting and disclosure if the loans evidenced credit deterioration as of the acquisition date and are accounted for in pools.
The following table provides a summary of TDRs by loan class, including the delinquency status for TDRs that continue to accrue interest and TDRs included in nonperforming assets:
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | As a Percent of Performing TDRs | | | | | | | |
At September 30, 2019
(Dollars in Millions) | | Performing
TDRs | | | 30-89 Days
Past Due | | | 90 Days or More
Past Due | | | Nonperforming
TDRs | | | Total
TDRs | |
| | $ | 264 | | | | 4.8 | % | | | 2.1 | % | | $ | 145 | (a) | | $ | 409 | |
| | | 145 | | | | .9 | | | | — | | | | 37 | (b) | | | 182 | |
| | | 1,322 | | | | 2.9 | | | | 4.3 | | | | 156 | | | | 1,478 | (d) |
| | | 262 | | | | 10.6 | | | | 5.9 | | | | — | | | | 262 | |
| | | 152 | | | | 8.4 | | | | 7.2 | | | | 38 | (c) | | | 190 | (e) |
TDRs, excluding loans purchased from GNMA mortgage pools | | | 2,145 | | | | 4.3 | | | | 4.1 | | | | 376 | | | | 2,521 | |
Loans purchased from GNMA mortgage pools (g) | | | 1,690 | | | | — | | | | — | | | | — | | | | 1,690 | (f) |
| | $ | 3,835 | | | | 2.4 | % | | | 2.3 | % | | $ | 376 | | | $ | 4,211 | |
| (a) | Primarily represents loans less than six months from the modification date that have not met the performance period required to return to accrual status (generally six months) and small business credit cards with a modified rate equal to 0 percent. |
| (b) | Primarily represents loans less than six months from the modification date that have not met the performance period required to return to accrual status (generally six months). |
| (c) | Primarily represents loans with a modified rate equal to 0 percent. |
| (d) | Includes $314 million of residential mortgage loans to borrowers that have had debt discharged through bankruptcy and $37 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed. |
| (e) | Includes $92 million of other retail loans to borrowers that have had debt discharged through bankruptcy and $18 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed. |
| (f) | Includes $144 million of Federal Housing Administration and United States Department of Veterans Affairs residential mortgage loans to borrowers that have had debt discharged through bankruptcy and $416 million in trial period arrangements or previously placed in trial period arrangements but not successfully completed. |
| (g) | Approximately 5.9 percent and 44.6 percent of the total TDR loans purchased from GNMA mortgage pools are 30-89 days past due and 90 days or more past due, respectively, but are not classified as delinquent as their repayments are insured by the Federal Housing Administration or guaranteed by the United States Department of Veterans Affairs. |
The Company makes short-term modifications that it does not consider to be TDRs, in limited circumstances, to assist borrowers experiencing temporary hardships. Consumer lending programs include payment reductions, deferrals of up to three past due payments, and the ability to return to current status if the borrower makes required payments. The Company may also make short-term modifications to commercial lending loans, with the most common modification being an extension of the maturity date of three months or less. Such extensions generally are used when the maturity date is imminent and the borrower is experiencing some level of financial stress, but the Company believes the borrower will pay all contractual amounts owed. Short-term modifications were not material at September 30, 2019.
The level of nonperforming assets represents another indicator of the potential for future credit losses. Nonperforming assets include nonaccrual loans, restructured loans not performing in accordance with modified terms and not accruing interest, restructured loans that have not met the performance period required to return to accrual status, other real estate owned (“OREO”) and other nonperforming assets owned by the Company. Interest payments collected from assets on nonaccrual status are generally applied against the principal balance and not recorded as income. However, interest income may be recognized for interest payments if the remaining carrying amount of the loan is believed to be collectible.
At September 30, 2019, total nonperforming assets were $979 million, compared to $989 million at December 31, 2018. The $10 million (1.0 percent) decrease in nonperforming assets was driven by improvements in nonperforming residential mortgages, other retail loans, commercial real estate loans, and OREO, partially offset by an increase in nonperforming commercial loans. The ratio of total nonperforming assets to total loans and other real estate was 0.33 percent at September 30, 2019, compared with 0.34 percent at December 31, 2018.
OREO was $84 million at September 30, 2019, compared with $111 million at December 31, 2018, and was related to foreclosed properties that previously secured loan balances. These balances exclude foreclosed GNMA loans whose repayments are primarily insured by the Federal Housing Administration or guaranteed by the United States Department of Veterans Affairs.
The following table provides an analysis of OREO as a percent of their related loan balances, including geographical location detail for residential (residential mortgage, home equity and second mortgage) and commercial (commercial and commercial real estate) loan balances:
| | | | | | | | | | | | | | | | | | | | | |
| | | Amount | | | | | | | |
| (Dollars in Millions) | | September 30,
2019 | | | December 31,
2018 | | | | | | September 30,
2019 | | | December 31,
2018 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 10 | | | $ | 11 | | | | | | | | .22 | % | | | .25 | % |
| | | 8 | | | | 11 | | | | | | | | .03 | | | | .04 | |
| | | 6 | | | | 8 | | | | | | | | .69 | | | | .97 | |
| | | 5 | | | | 5 | | | | | | | | .08 | | | | .08 | |
| | | 4 | | | | 5 | | | | | | | | .12 | | | | .15 | |
| | | 47 | | | | 66 | | | | | | | | .11 | | | | .16 | |
| | | 80 | | | | 106 | | | | | | | | .09 | | | | .13 | |
| | | | | | | | | | | | | | | | | | | | |
| | | 3 | | | | 3 | | | | | | | | .01 | | | | .01 | |
| | | – | | | | 1 | | | | | | | | – | | | | .09 | |
| | | 1 | | | | 1 | | | | | | | | – | | | | – | |
| | | 4 | | | | 5 | | | | | | | | – | | | | – | |
| | $ | 84 | | | $ | 111 | | | | | | | | .03 | % | | | .04 | % |
| | | |
| | Net Charge-offs as a Percent of Average Loans Outstanding |
| | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended
September 30 | | | | | | Nine Months Ended
September 30 | |
| | | 2019 | | | 2018 | | | | | | 2019 | | | 2018 | |
| | | | | | | | | | | | | | | | | | | | |
| | | .29 | % | | | .27 | % | | | | | | | .27 | % | | | .25 | % |
| | | .22 | | | | .22 | | | | | | | | .20 | | | | .27 | |
| | | .29 | | | | .26 | | | | | | | | .27 | | | | .25 | |
| | | | | | | | | | | | | | | | | | | | |
| | | .04 | | | | (.07 | ) | | | | | | | .02 | | | | (.04 | ) |
Construction and development | | | .11 | | | | (.14 | ) | | | | | | | .02 | | | | (.04 | ) |
Total commercial real estate | | | .06 | | | | (.09 | ) | | | | | | | .02 | | | | (.04 | ) |
| | | (.02 | ) | | | .03 | | | | | | | | .01 | | | | .03 | |
| | | 3.53 | | | | 3.75 | | | | | | | | 3.85 | | | | 3.91 | |
| | | | | | | | | | | | | | | | | | | | |
| | | .14 | | | | .14 | | | | | | | | .14 | | | | .15 | |
Home equity and second mortgages | | | (.03 | ) | | | (.02 | ) | | | | | | | (.03 | ) | | | (.03 | ) |
| | | .72 | | | | .74 | | | | | | | | .75 | | | | .76 | |
| | | .43 | | | | .43 | | | | | | | | .44 | | | | .45 | |
| | | .48 | % | | | .46 | % | | | | | | | .49 | % | | | .48 | % |
Analysis of Loan Net Charge-Offs
Total loan net charge-offs were $352 million for the third quarter and $1.1 billion for the first nine months of 2019, compared with $328 million and $1.0 billion, respectively, for the same periods of 2018. The ratio of total loan net charge-offs to average loans outstanding on an annualized basis for the third quarter and first nine months of 2019 was 0.48 percent and 0.49 percent, respectively, compared with 0.46 percent and 0.48 percent, respectively, for the same periods of 2018. The year-over-year increases in net charge-offs reflected higher commercial, commercial real estate and credit card loan net charge-offs, partially offset by lower residential mortgage net charge-offs.
Analysis and Determination of the Allowance for Credit Losses
The allowance for credit losses reserves for probable and estimable losses incurred in the Company’s loan and lease portfolio, including unfunded credit commitments. The allowance for credit losses is increased through provisions charged to earnings and reduced by net charge-offs. Management evaluates the appropriateness of the allowance for incurred losses on a quarterly basis.
The allowance recorded for loans in the commercial lending segment is based on reviews of individual credit relationships and considers the migration analysis of commercial lending segment loans and actual loss experience. For each loan type, this historical loss experience is adjusted as necessary to consider any relevant changes in portfolio composition, lending policies, underwriting standards, risk management practices or economic conditions. The results of the analysis are evaluated quarterly to confirm the selected loss experience is appropriate for each commercial loan type. The allowance recorded for impaired loans greater than $5 million in the commercial lending segment is based on an individual loan analysis utilizing expected cash flows discounted using the original effective interest rate, the observable market price of the loan, or the fair value of the collateral, less selling costs, for collateral-dependent loans, rather than the migration analysis. The allowance recorded for all other commercial lending segment loans is determined on a homogenous pool basis and includes consideration of product mix, risk characteristics of the portfolio, delinquency status, bankruptcy experience, portfolio growth and historical losses, adjusted for current trends.
The allowance recorded for TDR loans and purchased impaired loans in the consumer lending segment is determined on a homogenous pool basis utilizing expected cash flows discounted using the original effective interest rate of the pool, or the prior quarter effective rate, respectively. The allowance for collateral-dependent loans in the consumer lending segment is determined based on the fair value of the collateral less costs to sell. The allowance recorded for all other consumer lending segment loans is determined on a homogenous pool basis and includes consideration of product mix, risk characteristics of the portfolio, bankruptcy experience, delinquency status, refreshed LTV ratios when possible, portfolio growth and historical losses, adjusted for current trends. Credit card and other retail loans 90 days or more past due are generally not placed on nonaccrual status because of the relatively short period of time to
charge-off
and, therefore, are excluded from nonperforming loans and measures that include nonperforming loans as part of the calculation.
When evaluating the appropriateness of the allowance for credit losses for any loans and lines in a junior lien position, the Company considers the
delinquency and modification status of the first lien. At September 30, 2019, the Company serviced the first lien on 40 percent of the home equity loans and lines in a junior lien position. The Company also considers information received from its primary regulator on the status of the first liens that are serviced by other large servicers in the industry and the status of first lien mortgage accounts reported on customer credit bureau files. Regardless of whether or not the Company services the first lien, an assessment is made of economic conditions, problem loans, recent loss experience and other factors in determining the allowance for credit losses. Based on the available information, the Company estimated $268 million or 1.7 percent of its total home equity portfolio at September 30, 2019, represented
non-delinquent
junior liens where the first lien was delinquent or modified.
The Company uses historical loss experience on the loans and lines in a junior lien position where the first lien is serviced by the Company, or can be identified in credit bureau data, to establish loss estimates for junior lien loans and lines the Company services that are current, but the first lien is delinquent or modified. Historically, the number of junior lien defaults has been a small percentage of the total portfolio (approximately 1 percent annually), while the long-term average loss rate on loans that default has been approximately 90 percent. In addition, the Company obtains updated credit scores on its home equity portfolio each quarter, and in some cases more frequently, and uses this information to qualitatively supplement its loss estimation methods. Credit score distributions for the portfolio are monitored monthly and any changes in the distribution are one of the factors considered in assessing the Company’s loss estimates. In its evaluation of the allowance for credit losses, the Company also considers the increased risk of loss associated with home equity lines that are contractually scheduled to convert from a revolving status to a fully amortizing payment and with residential lines and loans that have a balloon payoff provision.
In addition, the evaluation of the appropriate allowance for credit losses on purchased
non-impaired
loans acquired after January 1, 2009, in the various loan segments considers credit discounts recorded as a part of the initial determination of the fair value of the loans. For these loans, no allowance for credit losses is recorded at the purchase date. Credit discounts representing the principal losses expected over the life of the loans are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for credit losses only when the required allowance exceeds any remaining credit discounts.
The evaluation of the appropriate allowance for credit losses for purchased impaired loans in the various loan segments considers the expected cash flows to be collected from the borrower. These loans are initially recorded at fair value and, therefore, no allowance for credit losses is recorded at the purchase date.
Subsequent to the purchase date, the expected cash flows of purchased loans are subject to evaluation. Decreases in expected cash flows are recognized by recording an allowance for credit losses. If the expected cash flows on the purchased loans increase such that a previously recorded impairment allowance can be reversed, the Company records a reduction in the allowance. Increases in expected cash flows of purchased loans, when there are no reversals of previous impairment allowances, are recognized over the remaining life of the loans.
The Company’s methodology for determining the appropriate allowance for credit losses for both loan segments also considers the imprecision inherent in the methodologies used. As a result, in addition to the amounts determined under the methodologies described above, management also considers the potential impact of other qualitative factors which include, but are not limited to, the following: economic factors; geographic and other concentration risks; delinquency and nonaccrual trends; current business conditions; changes in lending policy, underwriting standards and other relevant business practices; results of internal review; and the regulatory environment. The consideration of these items results in adjustments to allowance amounts included in the Company’s allowance for credit losses for both loan segments.
Refer to “Management’s Discussion and Analysis — Analysis of the Allowance for Credit Losses” in the Company’s Annual Report on Form
10-K
for the year ended December 31, 2018, for further discussion on the analysis and determination of the allowance for credit losses.
At September 30, 2019, the allowance for credit losses was $4.5 billion (1.52 percent of
period-end
loans), compared with an allowance of $4.4 billion (1.55 percent of
period-end
loans) at December 31, 2018. The ratio of the allowance for credit losses to nonperforming loans was 541 percent at September 30, 2019, compared with 544 percent at December 31, 2018. The ratio of the allowance for credit losses to annualized loan net charge-offs was 321 percent at September 30, 2019, compared with 328 percent of full year 2018 net charge-offs at December 31, 2018.
Market Value of Equity Modeling
The Company also manages interest rate sensitivity by utilizing market value of equity modeling, which measures the degree to which the market values of the Company’s assets and liabilities and
off-balance
sheet instruments will change given a change in interest rates. Management measures the impact of changes in market interest rates under a number of scenarios, including immediate and sustained parallel shifts, and flattening or steepening of the yield curve. A 200 bps increase would have resulted in a 2.2 percent decrease in the market value of equity at September 30, 2019, compared with a 2.3 percent decrease at December 31, 2018. A 200 bps decrease would have resulted in a 13.9 percent decrease in the market value of equity at September 30, 2019, compared with a 7.3 percent decrease at December 31, 2018. Refer to “Management’s Discussion and Analysis — Market Value of Equity Modeling” in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018, for further discussion on market value of equity modeling.
Use of Derivatives to Manage Interest Rate and Other Risks
To manage the sensitivity of earnings and capital to interest rate, prepayment, credit, price and foreign currency fluctuations (asset and liability management positions), the Company enters into derivative transactions. The Company uses derivatives for asset and liability management purposes primarily in the following ways:
| • | | To convert fixed-rate debt from fixed-rate payments to floating-rate payments; |
| • | | To convert the cash flows associated with floating-rate debt from floating-rate payments to fixed-rate payments; |
| • | | To mitigate changes in value of the Company’s unfunded mortgage loan commitments, funded MLHFS and MSRs; |
| • | | To mitigate remeasurement volatility of foreign currency denominated balances; and |
| • | | To mitigate the volatility of the Company’s net investment in foreign operations driven by fluctuations in foreign currency exchange rates. |
In addition, the Company enters into interest rate and foreign exchange derivative contracts to support the business requirements of its customers (customer-related positions). The Company minimizes the market and liquidity risks of customer-related positions by either entering into similar offsetting positions with broker-dealers, or on a portfolio basis by entering into other derivative or
non-derivative
financial instruments that partially or fully offset the exposure from these customer-related positions. The Company may enter into derivative contracts that are either exchange-traded, centrally cleared through clearinghouses or
The Company does not utilize derivatives for speculative purposes.
The Company does not designate all of the derivatives that it enters into for risk management purposes as accounting hedges because of the inefficiency of applying the accounting requirements and may instead elect fair value accounting for the related hedged items. In particular, the Company enters into interest rate swaps, swaptions, forward commitments to buy
securities (“TBAs”), U.S. Treasury and Eurodollar futures and options on U.S. Treasury futures to mitigate fluctuations in the value of its MSRs, but does not designate those derivatives as accounting hedges.
Additionally, the Company uses forward commitments to sell TBAs and other commitments to sell residential mortgage loans at specified prices to economically hedge the interest rate risk in its residential mortgage loan production activities. At September 30, 2019, the Company had $5.8 billion of forward commitments to sell, hedging $2.9 billion of MLHFS and $3.9 billion of unfunded mortgage loan commitments. The forward commitments to sell and the unfunded mortgage loan commitments on loans intended to be sold are considered derivatives under the accounting guidance related to accounting for derivative instruments and hedging activities. The Company has elected the fair value option for the MLHFS.
Derivatives are subject to credit risk associated with counterparties to the contracts. Credit risk associated with derivatives is measured by the Company based on the probability of counterparty default. The Company manages the credit risk of its derivative positions by diversifying its positions among various counterparties, by entering into master netting arrangements, and, where possible, by requiring collateral arrangements. The Company may also transfer counterparty credit risk related to interest rate swaps to third parties through the use of risk participation agreements. In addition, certain interest rate swaps, interest rate forwards and credit contracts are required to be centrally cleared through clearinghouses to further mitigate counterparty credit risk.
For additional information on derivatives and hedging activities, refer to Notes 13 and 14 in the Notes to Consolidated Financial Statements.
In July 2017, the United Kingdom’s Financial Conduct Authority announced that it would no longer require banks to submit rates for the London InterBank Offered Rate (“LIBOR”) after 2021. The Company holds financial instruments that
will
be impacted by the discontinuance of LIBOR, including certain loans, investment securities, derivatives, borrowings and other financial instruments that use LIBOR as the benchmark rate. The Company anticipates these financial instruments will require transition to a
new reference rate. This transition will occur over the next several years as many of these arrangements do not have an alternative rate referenced in their contracts. The Company has commenced an enterprise-wide project to address the needed operational changes, and identify, assess and monitor risks associated with the transition. Refer to “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, for further discussion on potential risks that could adversely affect the Company’s financial results as a result of the LIBOR transition.
In addition to interest rate risk, the Company is exposed to other forms of market risk, principally related to trading activities which support customers’ strategies to manage their own foreign currency, interest rate risk and funding activities. For purposes of its internal capital adequacy assessment process, the Company considers risk arising from its trading activities, as well as the remeasurement volatility of foreign currency denominated balances included on its Consolidated Balance Sheet (collectively, “Covered Positions”), employing methodologies consistent with the requirements of regulatory rules for market risk. The Company’s Market Risk Committee (“MRC”), within the framework of the ALCO, oversees market risk management. The MRC monitors and reviews the Company’s Covered Positions and establishes policies for market risk management, including exposure limits for each portfolio. The Company uses a VaR approach to measure general market risk. Theoretically, VaR represents the statistical risk of loss the Company has to adverse market movements over a
one-day
time horizon. The Company uses the Historical Simulation method to calculate VaR for its Covered Positions measured at the ninety-ninth percentile using a
one-year
look-back period for distributions derived from past market data. The market factors used in the calculations include those pertinent to market risks inherent in the underlying trading portfolios, principally those that affect the Company’s corporate bond trading business, foreign currency transaction business, client derivatives business, loan trading business and municipal securities business, as well as those inherent in the Company’s foreign denominated balances and the derivatives used to mitigate the related measurement volatility. On average, the Company expects the
one-day
VaR to be exceeded by actual losses two to three times per year related to these positions. The Company monitors the accuracy of internal VaR models and modeling processes by back-testing model performance, regularly updating the historical data used by the VaR models and regular model validations to assess the accuracy of the models’ input, processing, and reporting components. All models are required to be independently reviewed and approved prior to being placed in use. If the Company were to experience market losses in excess of the estimated VaR more often than expected, the VaR models and associated assumptions would be analyzed and adjusted.
The average, high, low and
period-end
one-day
VaR amounts for the Company’s Covered Positions were as follows:
| | | | | | | | | |
Nine Months Ended September 30 | | 2019 | | | 2018 | |
| | $ | 1 | | | $ | 1 | |
| | | 2 | | | | 1 | |
| | | 1 | | | | 1 | |
| | | 1 | | | | 1 | |
The Company did not experience any actual losses for its combined Covered Positions that exceeded VaR during the nine months ended September 30, 2019 and 2018. The Company stress tests its market risk measurements to provide management with perspectives on market events that may not be captured by its VaR models, including worst case historical market movement combinations that have not necessarily occurred on the same date.
The Company calculates Stressed VaR using the same underlying methodology and model as VaR, except that a historical continuous
one-year
look-back period is utilized that reflects a period of significant financial stress appropriate to the Company’s Covered Positions. The period selected by the Company includes the significant market volatility of the last four months of 2008.
The average, high, low and
period-end
one-day
Stressed VaR amounts for the Company’s Covered Positions were as follows:
| | | | | | | | | |
Nine Months Ended September 30 | | 2019 | | | 2018 | |
| | $ | 6 | | | $ | 5 | |
| | | 9 | | | | 8 | |
| | | 4 | | | | 2 | |
| | | 7 | | | | 6 | |
Valuations of positions in client derivatives and foreign currency activities are based on discounted cash flow or other valuation techniques using market-based assumptions. These valuations are compared to third party quotes or other market prices to determine if there are significant variances. Significant variances are approved by senior management in the Company’s corporate functions. Valuation of positions in the corporate bond trading, loan trading and municipal securities businesses are based on trader marks. These trader marks are evaluated against third party prices, with significant variances approved by senior management in the Company’s corporate functions.
The Company also measures the market risk of its hedging activities related to residential MLHFS and MSRs using the Historical Simulation method. The VaRs are measured at the ninety-ninth percentile and employ factors pertinent to the market risks inherent in the valuation of the assets and hedges. A
one-year
look-back period is used to obtain past market data for the models.
The average, high and low VaR amounts for the residential MLHFS and related hedges and the MSRs and related hedges were as follows:
| | | | | | | | | |
Nine Months Ended September 30 | | 2019 | | | 2018 | |
Residential Mortgage Loans Held For Sale and Related Hedges | | | | | | | | |
| | $ | 3 | | | $ | 1 | |
| | | 8 | | | | 2 | |
| | | – | | | | – | |
Mortgage Servicing Rights and Related Hedges | | | | | | | | |
| | $ | 6 | | | $ | 6 | |
| | | 11 | | | | 7 | |
| | | 4 | | | | 4 | |
Liquidity Risk Management
The Company’s liquidity risk management process is designed to identify, measure, and manage the Company’s funding and liquidity risk to meet its daily funding needs and to address expected and unexpected changes in its funding requirements. The Company engages in various activities to manage its liquidity risk. These activities include diversifying its funding sources, stress testing, and holding readily-marketable assets which can be used as a source of liquidity if needed. In addition, the Company’s profitable operations, sound credit quality and strong capital position have enabled it to develop a large and reliable base of core deposit funding within its market areas and in domestic and global capital markets.
The Company’s Board of Directors approves the Company’s liquidity policy. The Risk Management Committee of the Company’s Board of Directors oversees the Company’s liquidity risk management process and approves a contingency funding plan. The ALCO reviews the Company’s liquidity policy and limits, and regularly assesses the Company’s ability to meet funding requirements arising from adverse company-specific or market events.
The Company regularly projects its funding needs under various stress scenarios and maintains a contingency funding plan consistent with the Company’s access to diversified sources of contingent funding. The Company maintains a substantial level of total available liquidity in the form of
on-balance
sheet and
off-balance
sheet funding sources. These liquidity sources include cash at the Federal Reserve Bank and certain European central banks, unencumbered liquid assets, and capacity to borrow from the FHLB and at Federal Reserve Bank’s Discount Window. At September 30, 2019, the fair value of unencumbered
and
investment securities totaled $110.2 billion, compared with $100.2 billion at December 31, 2018. Refer to Table 4 and “Balance Sheet Analysis” for further information on investment securities maturities and trends. Asset liquidity is further enhanced by the Company’s practice of pledging loans to access secured borrowing facilities through the FHLB and Federal Reserve Bank. At September 30, 2019, the Company could have borrowed an additional $101.7 billion from the FHLB and Federal Reserve Bank based on collateral available for additional borrowings.
The Company’s diversified deposit base provides a sizeable source of relatively stable and
low-cost
funding, while reducing the Company’s reliance on the wholesale markets. Total deposits were $359.7 billion at September 30, 2019, compared with $345.5 billion at December 31, 2018. Refer to “Balance Sheet Analysis” for further information on the Company’s deposits.
Additional funding is provided by long-term debt and short-term borrowings. Long-term debt was $41.3 billion at September 30, 2019, and is an important funding source because of its multi-year borrowing structure. Short-term borrowings were $14.6 billion at September 30, 2019, and supplement the Company’s other funding sources. Refer to “Balance Sheet Analysis” for further information on the Company’s long-term debt and short-term borrowings.
In addition to assessing liquidity risk on a consolidated basis, the Company monitors the parent company’s liquidity. The Company establishes limits for the minimal number of months into the future where the parent company can meet existing and forecasted obligations with cash and securities held that can be readily monetized. The Company measures and manages this limit in both normal and adverse conditions. The Company maintains sufficient funding to meet expected capital and debt service obligations for 24 months without the support of dividends from subsidiaries and assuming access to the wholesale markets is maintained. The Company maintains sufficient liquidity to meet its capital and debt service obligations for 12 months under adverse conditions without the support of dividends from subsidiaries or access to the wholesale markets. The parent company is currently well in excess of required liquidity minimums.
At September 30, 2019, parent company long-term debt outstanding was $18.5 billion, compared with $16.3 billion at December 31, 2018. The increase was primarily due to $2.6 billion of medium-term note and $1.0 billion of subordinated note issuances, partially offset by $1.5 billion of medium-term note repayments. As of September 30, 2019, there was no parent company debt scheduled to mature in the remainder of 2019.
The Company is subject to a regulatory Liquidity Coverage Ratio (“LCR”) requirement which requires banks to maintain an adequate level of unencumbered high quality liquid assets to meet estimated liquidity needs over a
30-day
stressed period. At September 30, 2019, the Company was compliant with this requirement.
Refer to “Management’s Discussion and Analysis — Liquidity Risk Management” in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018, for further discussion on liquidity risk management.
The Company provides merchant processing and corporate trust services in Europe either directly or through banking affiliations in Europe. Revenue generated from sources in Europe represented approximately 2 percent of the Company’s total net revenue for both the three and nine months ended September 30, 2019. Operating cash for these businesses is deposited on a short-term basis typically with certain European central banks. For deposits placed at other European banks, exposure is mitigated by the Company placing deposits at multiple banks and managing the amounts on deposit at any bank based on institution-specific deposit limits. At September 30, 2019, the Company had an aggregate amount on deposit with European banks of approximately $7.5 billion, predominately with the Central Bank of Ireland and Bank of England.
In addition, the Company provides financing to domestic multinational corporations that generate revenue from customers in European countries, transacts with various European banks as counterparties to certain derivative-related activities, and through a subsidiary, manages money market funds that hold certain investments in European sovereign debt. Any deterioration in economic conditions in Europe, including the potential negative impact of the United Kingdom’s upcoming withdrawal from the European Union (“Brexit”), is not expected to have a significant effect on the Company related to these activities. The Company is focused on providing continuity of services, with minimal disruption resulting from Brexit, to customers with activities in European countries. The Company has been making certain structural changes to its legal entities and operations in the United Kingdom and European Union, where needed, and migrating certain business activities to the appropriate jurisdictions to continue to provide such services and generate revenue.
Off-Balance
Sheet Arrangements
Off-balance
sheet arrangements include any contractual arrangements to which an unconsolidated entity is a party, under which the Company has an obligation to provide credit or liquidity enhancements or market risk support. In the ordinary course of business, the Company enters into an array of commitments to extend credit, letters of credit and various forms of guarantees that may be considered
off-balance
sheet arrangements. Refer to Note 16 of the Notes to Consolidated Financial Statements for further information on these arrangements. The Company does not utilize private label asset securitizations as a source of funding.
Off-balance
sheet arrangements also include any obligation related to a variable interest held in an unconsolidated entity that provides financing, liquidity, credit enhancement or market risk support. Refer to Note 6 of the Notes to Consolidated Financial Statements for further information related to the Company’s interests in variable interest entities.
The Company is committed to managing capital to maintain strong protection for depositors and creditors and for maximum shareholder benefit. The Company also manages its capital to exceed regulatory capital requirements for banking organizations. The regulatory capital requirements effective for the Company follow Basel III, which includes two comprehensive methodologies for calculating risk-weighted assets: a general standardized approach and more risk-sensitive advanced approaches, with the Company’s capital adequacy being evaluated against the methodology that is most restrictive. Currently, the standardized approach is most restrictive.
The Company’s regulators recently issued final rules which tailor regulations to reduce compliance requirements for banking organizations with less risk, while maintaining existing stringent capital requirements for the largest and most complex banks. These rules are expected to reduce the Company’s capital and liquidity requirements and no longer subject the Company to calculating its capital adequacy under advanced approaches. As a result of the rule changes, the Company has made a request to the Board of Governors of the Federal Reserve System to increase the authorization amount of its common stock repurchase program currently in effect, which if approved would enable it to begin reducing its common equity tier 1 capital ratio from the current level of 9.6 percent to approximately 9.0 percent.
Table 10 provides a summary of statutory regulatory capital ratios in effect for the Company at September 30, 2019 and December 31, 2018. All regulatory ratios exceeded regulatory “well-capitalized” requirements.
The Company believes certain other capital ratios are useful in evaluating its capital adequacy. The Company’s tangible common equity, as a percent of tangible assets and as a percent of risk-weighted assets calculated under the standardized approach, was 8.0 percent and 9.7 percent, respectively, at September 30, 2019, compared with 7.8 percent and 9.4 percent, respectively, at December 31, 2018. Refer to “Non-GAAP Financial Measures” beginning on page 30 for further information on these other capital ratios.
| | | |
| | Regulatory Capital Ratios |
| | | | | | | | | |
| (Dollars in Millions) | | September 30,
2019 | | | December 31,
2018 | |
Basel III standardized approach: | | | | | | | | |
Common equity tier 1 capital | | $ | 37,653 | | | $ | 34,724 | |
| | | 43,667 | | | | 40,741 | |
| | | 51,684 | | | | 48,178 | |
| | | 390,622 | | | | 381,661 | |
| | | |
Common equity tier 1 capital as a percent of risk-weighted assets | | | 9.6 | % | | | 9.1 | % |
Tier 1 capital as a percent of risk-weighted assets | | | 11.2 | | | | 10.7 | |
Total risk-based capital as a percent of risk-weighted assets | | | 13.2 | | | | 12.6 | |
Tier 1 capital as a percent of adjusted quarterly average assets (leverage ratio) | | | 9.3 | | | | 9.0 | |
| | | |
Basel III advanced approaches: | | | | | | | | |
Common equity tier 1 capital | | $ | 37,653 | | | $ | 34,724 | |
| | | 43,667 | | | | 40,741 | |
| | | 48,620 | | | | 45,136 | |
| | | 299,309 | | | | 295,002 | |
| | | |
Common equity tier 1 capital as a percent of risk-weighted assets | | | 12.6 | % | | | 11.8 | % |
Tier 1 capital as a percent of risk-weighted assets | | | 14.6 | | | | 13.8 | |
Total risk-based capital as a percent of risk-weighted assets | | | 16.2 | | | | 15.3 | |
Tier 1 capital as a percent of total on- and off-balance sheet leverage exposure (total leverage exposure ratio) | | | 7.4 | | | | 7.2 | |
Total U.S. Bancorp shareholders’ equity was $53.5 billion at September 30, 2019, compared with $51.0 billion at December 31, 2018. The increase was primarily the result of corporate earnings and changes in unrealized gains and losses on
investment securities included in other comprehensive income (loss), partially offset by common share repurchases and dividends.
On June 27, 2019, the Company announced its Board of Directors had approved an authorization to repurchase up to $3.0 billion of its common stock, from July 1, 2019 through June 30, 2020.
The following table provides a detailed analysis of all shares purchased by the Company during the third quarter of 2019:
| | | | | | | | | | | | | | | | | |
| Period | | Total Number
of Shares
Purchased | | | Average
Price Paid
Per Share | | | Total Number of
Shares Purchased
as Part of Publicly
Announced
Program (a) | | | Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Program
(In Millions) | |
| | | 10,442,260 | | | $ | 56.40 | | | | 10,442,260 | | | $ | 2,411 | |
| | | 3,751,874 | | | | 53.98 | | | | 3,751,874 | | | | 2,209 | |
| | | 63,199 | | | | 55.46 | | | | 63,199 | | | | 2,205 | |
| | | 14,257,333 | | | $ | 55.76 | | | | 14,257,333 | | | $ | 2,205 | |
| (a) | All shares were purchased under the July 1, 2019 through June 30, 2020, $3.0 billion common stock repurchase authorization program announced June 27, 2019. |
On September 17, 2019, the Company announced its Board of Directors had approved a 13.5 percent increase in the Company’s dividend rate per common share from $0.37 per quarter to $0.42 per quarter.
Refer to “Management’s Discussion and Analysis — Capital Management” in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018, for further discussion on capital management.
LINE OF BUSINESS FINANCIAL REVIEW
The Company’s major lines of business are Corporate and Commercial Banking, Consumer and Business Banking, Wealth Management and Investment Services, Payment Services, and Treasury and Corporate Support. These operating segments are components of the Company about which financial information is prepared and is evaluated regularly by management in deciding how to allocate resources and assess performance.
Basis for Financial Presentation
Business line results are derived from the Company’s business unit profitability reporting systems by specifically attributing managed balance sheet assets, deposits and other liabilities and their related income or expense. The allowance for credit losses and related provision expense are allocated to the lines of business based on the related loan balances managed. Refer to “Management’s Discussion and Analysis — Line of Business Financial Review” in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018, for further discussion on the business lines’ basis for financial presentation.
Designations, assignments and allocations change from time to time as management systems are enhanced, methods of evaluating performance or product lines change or business segments are realigned to better respond to the Company’s diverse customer base. During 2019, certain organization and methodology changes were made and, accordingly, 2018 results were restated and presented on a comparable basis.
Corporate and Commercial Banking
Corporate and Commercial Banking offers lending, equipment finance and small-ticket leasing, depository services, treasury management, capital markets services, international trade services and other financial services to middle market, large corporate, commercial real estate, financial institution,
non-profit
and public sector clients.
Corporate and Commercial Banking contributed $365 million of the Company’s net income in the third quarter and $1.2 billion in the first nine months of 2019, or decreases of $26 million (6.6 percent) and $10 million (0.8 percent), respectively, compared with the same periods of 2018.
Net revenue decreased $19 million (2.0 percent) in the third quarter and was essentially flat in the first nine months of 2019, compared with the same periods of 2018. Net interest income, on a taxable-equivalent basis, decreased $32 million (4.3 percent) in the third quarter and $36 million (1.6 percent) in the first nine months of 2019, compared with the same periods of 2018. The decreases were primarily due to lower noninterest-bearing deposit balances from the prior year and lower rates on loans, reflecting a competitive marketplace, partially offset by the impact of higher rates on the margin benefit from deposits and loan growth. Noninterest-bearing deposits are declining as customers deploy balances to support business growth
. Noninterest income increased $13 million (6.5 percent) in the third quarter and $37 million (5.9 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to higher trading revenue and corporate bond underwriting fees.
Noninterest expense increased $11 million (2.9 percent) in the third quarter and $24 million (2.0 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to increases in net shared services expense driven by technology development and investment in infrastructure, higher salary expense driven by merit increases, and increases in production incentives within capital markets. These increases were partially offset by lower FDIC assessment costs. The provision for credit losses increased $5 million (14.3 percent) in the third quarter of 2019, compared with the third quarter of 2018, reflecting an unfavorable change in the reserve allocation and higher net charge-offs. The provision for credit losses decreased $10 million (27.0 percent) in the first nine months of 2019, compared with the same period of 2018, due to a favorable change in the reserve allocation, partially offset by higher net charge-offs.
Consumer and Business Banking
Consumer and Business Banking delivers products and services through banking
offices, telephone servicing and sales,
on-line
services,
direct mail, ATM processing and mobile devices. It encompasses community banking, metropolitan banking and indirect lending, as well as mortgage banking. Consumer and Business Banking contributed $640 million of the Company’s net income in the third quarter and $1.7 billion in the first nine months of 2019, or increases of $60 million (10.3 percent) and $82 million (4.9 percent), respectively, compared with the same periods of 2018.
Net revenue increased $111 million (5.2 percent) in the third quarter and $155 million (2.4 percent) in the first nine months of 2019, compared with the same periods of 2018. Net interest income, on a taxable-equivalent basis, increased $26 million (1.7 percent) in the third quarter and $139 million (3.0 percent) in the first nine months of 2019, compared with the same periods of 2018. The increases were primarily due to the impact of higher rates on the margin benefit from deposits, as well as growth in both interest-bearing deposit balances and loan balances, partially offset by lower rates on loans. Noninterest income increased $85 million (14.6 percent) in the third quarter and $16 million (0.9 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to higher mortgage banking revenue driven by higher origination and sales volumes, as well as transition services agreement revenue associated with the sale of the Company’s ATM third-party servicing business during 2018, partially offset by reductions in ATM processing services revenue due to the sale.
Noninterest expense increased $17 million (1.3 percent) in the third quarter and decreased $9 million (0.2 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to higher net shared services expense and higher production incentives, offset by lower FDIC assessment costs and lower mortgage banking costs. The increases in net shared services expense reflected the impact of technology development and investment in infrastructure supporting business growth, as well as higher costs to manage the business, while production incentives were higher in support of business growth. The provision for credit losses increased $15 million (27.8 percent) in the third quarter and $54 million (32.9 percent) in the first nine months of 2019, compared with the same periods of 2018, due to unfavorable changes in the reserve allocation and higher net charge-offs.
Wealth Management and Investment Services
Wealth Management and Investment Services provides private banking, financial advisory services, investment management, retail brokerage services, insurance, trust, custody and fund servicing through four businesses: Wealth Management, Global Corporate Trust & Custody, U.S. Bancorp Asset Management and Fund Services. Wealth Management and Investment Services contributed $234 million of the Company’s net income in the third quarter and $682 million in the first nine months of 2019, or increases of $11 million (4.9 percent) and $57 million (9.1 percent), respectively, compared with the same periods of 2018.
Net revenue increased $18 million (2.5 percent) in the third quarter and $66 million (3.1 percent) in the first nine months of 2019, compared with the same periods of 2018. Net interest income, on a taxable-equivalent basis, increased $10 million (3.5 percent) in the third quarter and $44 million (5.2 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to the impact of higher deposit balances. Net interest income further increased in the first nine months of 2019, compared with the same period of 2018, due to the impact of higher rates on the margin benefit from deposits. Noninterest income increased $8 million (1.8 percent) in the third quarter and $22 million (1.7 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to favorable market conditions and business growth.
Noninterest expense was essentially flat in the third quarter and decreased $10 million (0.8 percent) in the first nine months of 2019, compared with the same periods of 2018, reflecting lower costs related to FDIC assessment and litigation settlements. These decreases were offset by increased net shared services expense due to technology development and higher compensation expense, reflecting the impact of merit increases, increased staffing, and increases in medical costs.
Payment Services includes consumer and business credit cards, stored-value cards, debit cards, corporate, government and purchasing card services, consumer lines of credit and merchant processing. Payment Services contributed $416 million of the Company’s net income in the third quarter and $1.1 billion in the first nine months of 2019, or increases of $24 million (6.1 percent) and $11 million (1.0 percent), respectively, compared with the same periods of 2018.
Net revenue increased $62 million (4.1 percent) in the third quarter and $125 million (2.8 percent) in the first nine months of 2019, compared with the same periods of 2018. Net interest income, on a taxable-equivalent basis, increased $15 million (2.4 percent) in the third quarter and $27 million (1.5 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to growth in average loans as well as loan fees, offset by compression on loan rates. Noninterest income increased $47 million (5.2 percent) in the third quarter and $98 million (3.7 percent) in the first nine months of 2019, compared with the same periods of 2018, due to higher credit and debit card revenue, merchant processing services revenue and corporate payment products revenue, all driven by higher sales volumes. In addition, credit and debit card revenue further increased in the third quarter of 2019, compared with the third quarter of 2018, due to more processing days.
Noninterest expense increased $34 million (4.6 percent) in the third quarter and $87 million (4.0 percent) in the first nine months of 2019, compared with the same periods of 2018, principally due to higher net shared services expense to support business growth, technology development and investment in infrastructure, in addition to increases in personnel expense in support of business development and merit increases. The provision for credit losses decreased $4 million (1.5 percent) in the third quarter and increased $24 million (2.9 percent) in the first nine months of 2019, compared with the same periods of 2018, reflecting higher net charge-offs, offset by favorable changes in the reserve allocation.
Treasury and Corporate Support
Treasury and Corporate Support includes the Company’s investment portfolios, funding, capital management, interest rate risk management, income taxes not allocated to the business lines, including most investments in
tax-advantaged
projects, and the residual aggregate of those expenses associated with corporate activities that are managed on a consolidated basis. Treasury and Corporate Support recorded net income of $253 million in the third quarter and $710 million in the first nine months of 2019, compared with $229 million and $662 million, respectively, in the same periods of 2018.
Net revenue increased $49 million (13.5 percent) in the third quarter and $164 million (16.0 percent) in the first nine months of 2019, compared with the same periods of 2018. Net interest income, on a taxable-equivalent basis, increased $6 million (7.2 percent) in the third quarter and $46 million (17.1 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily due to growth in the investment portfolio. Noninterest income increased $43 million (15.3 percent) in the third quarter and $118 million (15.6 percent) in the first nine months of 2019, compared with the same periods of 2018, primarily reflecting higher income from equity investments and gains on the sale of securities. The increase in noninterest income in the first nine months of 2019, compared with the same period of the prior year, was partially offset by the impact of a gain on the sale of student loans in 2018.
Noninterest expense increased $38 million (21.6 percent) in the third quarter and $108 million (20.6 percent) in the first nine months of 2019, compared with the same periods of 2018, due to higher compensation expense, reflecting the impact of increased staffing and merit increases, and higher implementation costs of capital investments to support business growth. These increases were partially offset by lower net shared services expense and lower costs related to
tax-advantaged
projects. The provision for credit losses was $4 million (57.1 percent) higher in the third quarter of 2019, compared with the third quarter of 2018, reflecting higher net charge-offs. The provision for credit losses was $28 million higher in the first nine months of 2019, compared with the same period of the prior year, due to an unfavorable change in the reserve allocation and higher net charge-offs.
Income taxes are assessed to each line of business at a managerial tax rate of 25.0 percent with the residual tax expense or benefit to arrive at the consolidated effective tax rate included in Treasury and Corporate Support.
NON-GAAP
FINANCIAL MEASURES
In addition to capital ratios defined by banking regulators, the Company considers various other measures when evaluating capital utilization and adequacy, including:
| • | | Tangible common equity to tangible assets, and |
| • | | Tangible common equity to risk-weighted assets. |
These capital measures are viewed by management as useful additional methods of evaluating the Company’s utilization of its capital held and the level of capital available to withstand unexpected negative market or economic conditions. Additionally, presentation of these measures allows investors, analysts and banking regulators to assess the Company’s capital position relative to other financial services companies. These capital measures are not defined in generally accepted accounting principles (“GAAP”), or are not defined in banking regulations. As a result, these capital measures disclosed by the Company may be considered
non-GAAP
financial measures. Management believes this information helps investors assess trends in the Company’s capital adequacy.
The Company also discloses net interest income and related ratios and analysis on a taxable-equivalent basis, which may also be considered
non-GAAP
financial measures. The Company believes this presentation to be the preferred industry measurement of net interest income as it provides a relevant comparison of net interest income arising from taxable and
tax-exempt
sources. In addition, certain performance measures, including the efficiency ratio and net interest margin utilize net interest income on a taxable-equivalent basis.
There may be limits in the usefulness of these measures to investors. As a result, the Company encourages readers to consider the consolidated financial statements and other financial information contained in this report in their entirety, and not to rely on any single financial measure.
The following table shows the Company’s calculation of these
non-GAAP
financial measures:
| | | | | | | | | |
| (Dollars in Millions) | | September 30,
2019 | | | December 31,
2018 | |
| | $ | 54,147 | | | $ | 51,657 | |
| | | (5,984 | ) | | | (5,984 | ) |
| | | (630 | ) | | | (628 | ) |
Goodwill (net of deferred tax liability) (1) | | | (8,781 | ) | | | (8,549 | ) |
Intangible assets, other than mortgage servicing rights | | | (687 | ) | | | (601 | ) |
Tangible common equity (a) | | | 38,065 | | | | 35,895 | |
| | | |
| | | 487,671 | | | | 467,374 | |
Goodwill (net of deferred tax liability) (1) | | | (8,781 | ) | | | (8,549 | ) |
Intangible assets, other than mortgage servicing rights | | | (687 | ) | | | (601 | ) |
| | | 478,203 | | | | 458,224 | |
| | | |
Risk-weighted assets, determined in accordance with the Basel III standardized approach (c) | | | 390,622 | | | | 381,661 | |
| | | |
| | | | | | | | |
Tangible common equity to tangible assets (a)/(b) | | | 8.0 | % | | | 7.8 | % |
Tangible common equity to risk-weighted assets (a)/(c) | | | 9.7 | | | | 9.4 | |
| | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended
September 30 | | | | | Nine Months Ended
September 30 | |
| | | 2019 | | | 2018 | | | | | 2019 | | | 2018 | |
| | $ | 3,281 | | | $ | 3,251 | | | | | $ | 9,845 | | | $ | 9,616 | |
Taxable-equivalent adjustment (2) | | | 25 | | | | 30 | | | | | | 79 | | | | 88 | |
Net interest income, on a taxable-equivalent basis | | | 3,306 | | | | 3,281 | | | | | | 9,924 | | | | 9,704 | |
| | | | | | |
Net interest income, on a taxable-equivalent basis (as calculated above) | | | 3,306 | | | | 3,281 | | | | | | 9,924 | | | | 9,704 | |
| | | 2,614 | | | | 2,418 | | | | | | 7,395 | | | | 7,104 | |
Less: Securities gains (losses), net | | | 25 | | | | 10 | | | | | | 47 | | | | 25 | |
Total net revenue, excluding net securities gains (losses) (d) | | | 5,895 | | | | 5,689 | | | | | | 17,272 | | | | 16,783 | |
| | | | | | |
| | | 3,144 | | | | 3,044 | | | | | | 9,384 | | | | 9,184 | |
| | | | | | |
| | | 53.3 | % | | | 53.5 | % | | | | | 54.3 | % | | | 54.7 | % |
| (1) | Includes goodwill related to certain investments in unconsolidated financial institutions per prescribed regulatory requirements. |
| (2) | Based on a federal income tax rate of 21 percent for those assets and liabilities whose income or expense is not included for federal income tax purposes. |
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding the Company’s financial statements. Critical accounting policies are those policies management believes are the most important to the portrayal of the Company’s financial condition and results, and require management to make estimates that are difficult, subjective or complex. Most accounting policies are not considered by management to be critical accounting policies. Those policies considered to be critical accounting policies relate to the allowance for credit losses, fair value estimates, MSRs, and income taxes. Management has discussed the development and the selection of critical accounting policies with the Company’s Audit Committee. These accounting policies are discussed in detail in “Management’s Discussion and Analysis — Critical Accounting Policies” and the Notes to Consolidated Financial Statements in the Company’s Annual Report on
Form 10-K
for the year ended December 31, 2018.
Under the supervision and with the participation of the Company’s management, including its principal executive officer and principal financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in
Rules 13a-15(e)
and
15d-15(e)
under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon this evaluation, the principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
During the most recently completed fiscal quarter, there was no change made in the Company’s internal control over financial reporting (as defined in Rules
13a-15(f)
and
15d-15(f)
under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
