Why did reported net income fall in 1993 if underlying earnings rose sharply?

Reported 1993 net income of $298.0 million was 4.4% below 1992's $311.8 million. However, 1992 included a $157.3 million cumulative effect of accounting changes (a one-time benefit), which inflated that year's figure. 1993 also carried $50.0 million of after-tax merger-related charges from the CNB acquisition. Excluding these items, income before merger charges and accounting changes rose 47.3% to $348.0 million, or $2.83 per share versus $1.96 in 1992.

How much of the earnings improvement came from cost cuts versus revenue growth?

Both contributed. Management reported more than $100 million in annualized savings from integrating recent acquisitions, and noninterest expense excluding merger charges rose only 2.4%, while pro forma expense declined 6.9% against 1992 including acquired BSI. On the revenue side, net interest income on a taxable-equivalent basis rose 13.0% to $1.15 billion, helped by a 22 basis point margin expansion to 5.07% and growth in noninterest-bearing deposits, and noninterest income rose 6.3% to $569.6 million.

What are the main risks to the sustainability of 1993 results?

The filing points to several: the net interest margin depends on wide spreads between prime rates and short-term funding costs, and management estimates a 50 basis point drop in prime without matching funding relief would cut net interest income by about $35 million. Loan growth relied heavily on a $700 million mortgage-banking-related extension of credit, and correspondent mortgage loan purchases are being exited, so 1994 mortgage production is expected to decline. Mortgage servicing assets also took a roughly $28 million charge from accelerated prepayments, and the 1993 low-rate environment drove refinancing activity.

Is the company's capital base strong enough to support its acquisition and buyback plans?

Based on the filing, yes. At year-end 1993 the Tier 1 capital ratio was 9.2% and total risk-based capital was 13.3%, both well above the 6.0% and 10.0% 'well capitalized' thresholds, and all bank subsidiaries met that standard. Shareholders' equity was 8.5% of assets. Pro forma for the announced $159.3 million preferred redemption, the Tier 1 ratio would be 8.4% and the leverage ratio 7.0%. Common equity was $18.09 per share at year-end 1993.

How has asset quality changed, and how well reserved is the loan book?

Asset quality improved materially. Nonperforming assets declined to $226.0 million from $412.1 million, and the ratio of nonperforming assets to loans plus other real estate fell to 1.20% from 2.39%. The allowance for credit losses was $423.2 million, equal to 2.25% of loans and 268.5% of nonperforming loans. Net charge-offs fell 26% to $150.0 million, and the provision for credit losses dropped to $125.2 million from $183.4 million. Credit card charge-offs remained the largest consumer risk at 3.57% of average balances.

US BANCORP \DE\ 10-K FY1993 Annual Report

01—Abstract

Summary

Summary of the 10-K filed March 1, 1994. Cited figures are marked; the original filing is the authoritative source.

First Bank System (FBS), a six-state Midwest bank holding company headquartered in Minneapolis with $26.4 billion^a in assets, reported 1993 net income of $298.0 million, or $2.39 per share, down 4.4% from $311.8 million in 1992.

That decline is misleading on its face: 1993 results absorbed $50.0 million^b of after-tax merger-related charges tied to the Colorado National Bankshares (CNB) acquisition, while 1992 included $81.8 million of such charges and a $157.3 million cumulative accounting benefit. Before these items, income rose 47.3% to $348.0 million ($2.83 per share), and return on average common equity improved to 16.4% from 12.0%. Management attributes the gain to completed integration of CNB, Western Capital and Bank Shares, which it says delivered more than $100 million in annualized cost savings, and an efficiency ratio (excluding merger charges) that improved to 59.8% from 64.7%.

The balance sheet shows continued asset quality improvement. Nonperforming assets fell 45.2% to $226.0 million^c, the allowance covered nonperforming loans 268.5%, and the nonperforming-assets-to-loans-plus-OREO ratio dropped to 1.20% from 2.39%. Loans grew 10.0% to $18.8 billion, though part of that growth reflects a single $700 million low-margin, Treasury-secured extension of credit to a mortgage banking customer.

Capital is solid: the Tier 1 ratio was 9.2% and total risk-based capital 13.3%, and the company returned capital through $275 million^d of planned common repurchases and $125 million of preferred repurchases, plus a 16% dividend increase announced in February 1994. Pending acquisitions include Boulevard Bancorp (Chicago, $1.6 billion in assets), J.P. Morgan's domestic corporate trust unit, and several smaller Minnesota and North Dakota banks.

For investors, the key questions are whether the cost-savings and integration story holds as acquisitions are absorbed, how dependent earnings are on the large mortgage-banking-related lending and the expected 1994 decline in correspondent mortgage production, and whether the reported 1993 margin strength (net interest margin 5.07%) is sustainable as interest-rate spreads change. Note that the 1993 results include a roughly $28 million charge on mortgage servicing assets from accelerated prepayments.

02—Key points

Key Highlights

Reported 1993 net income of $298.0 million ($2.39/share), down 4.4% from 1992, but income before merger-related charges rose 47.3% to $348.0 million ($2.83/share).
Efficiency ratio excluding merger charges improved to 59.8% from 64.7%, with management targeting the mid-50s within two years.
Return on average common equity (before merger charges) rose to 16.4% from 12.0%; return on average assets (before merger charges) rose to 1.36% from 1.00%.
Nonperforming assets fell 45.2% to $226.0 million; allowance coverage of nonperforming loans reached 268.5% versus 179.1% a year earlier.
Total loans grew 10.0% to $18.8 billion, but the increase was partly driven by a single $700 million low-margin, Treasury-secured lending arrangement expected to run through Q3 1994.
Capital position remained strong with a 9.2% Tier 1 ratio and 13.3% total risk-based capital ratio, supporting $275 million of planned common repurchases and $125 million of preferred repurchases, plus a 16% dividend increase announced in February 1994.
Pending acquisitions include Boulevard Bancorp ($1.6 billion in assets, Chicago entry), the J.P. Morgan domestic corporate trust business, and several smaller Minnesota and North Dakota banks.

03—Questions

Frequently Asked Questions

Why did reported net income fall in 1993 if underlying earnings rose sharply?
Reported 1993 net income of $298.0 million was 4.4% below 1992's $311.8 million. However, 1992 included a $157.3 million cumulative effect of accounting changes (a one-time benefit), which inflated that year's figure. 1993 also carried $50.0 million of after-tax merger-related charges from the CNB acquisition. Excluding these items, income before merger charges and accounting changes rose 47.3% to $348.0 million, or $2.83 per share versus $1.96 in 1992.
How much of the earnings improvement came from cost cuts versus revenue growth?
Both contributed. Management reported more than $100 million in annualized savings from integrating recent acquisitions, and noninterest expense excluding merger charges rose only 2.4%, while pro forma expense declined 6.9% against 1992 including acquired BSI. On the revenue side, net interest income on a taxable-equivalent basis rose 13.0% to $1.15 billion, helped by a 22 basis point margin expansion to 5.07% and growth in noninterest-bearing deposits, and noninterest income rose 6.3% to $569.6 million.
What are the main risks to the sustainability of 1993 results?
The filing points to several: the net interest margin depends on wide spreads between prime rates and short-term funding costs, and management estimates a 50 basis point drop in prime without matching funding relief would cut net interest income by about $35 million. Loan growth relied heavily on a $700 million mortgage-banking-related extension of credit, and correspondent mortgage loan purchases are being exited, so 1994 mortgage production is expected to decline. Mortgage servicing assets also took a roughly $28 million charge from accelerated prepayments, and the 1993 low-rate environment drove refinancing activity.
Is the company's capital base strong enough to support its acquisition and buyback plans?
Based on the filing, yes. At year-end 1993 the Tier 1 capital ratio was 9.2% and total risk-based capital was 13.3%, both well above the 6.0% and 10.0% 'well capitalized' thresholds, and all bank subsidiaries met that standard. Shareholders' equity was 8.5% of assets. Pro forma for the announced $159.3 million preferred redemption, the Tier 1 ratio would be 8.4% and the leverage ratio 7.0%. Common equity was $18.09 per share at year-end 1993.
How has asset quality changed, and how well reserved is the loan book?
Asset quality improved materially. Nonperforming assets declined to $226.0 million from $412.1 million, and the ratio of nonperforming assets to loans plus other real estate fell to 1.20% from 2.39%. The allowance for credit losses was $423.2 million, equal to 2.25% of loans and 268.5% of nonperforming loans. Net charge-offs fell 26% to $150.0 million, and the provision for credit losses dropped to $125.2 million from $183.4 million. Credit card charge-offs remained the largest consumer risk at 3.57% of average balances.

04—Continue

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