The value of the banking stock has experienced a substantial 35% slump since March. The recent fall of SVB Financial’s Silicon Valley Bank and Signature Bank in March, followed by the federal takeover of First Republic Bank in early May, increased tension among investors in the banking sector.
One such institution under the spotlight amidst this turmoil is U.S. Bancorp (NYSE: USB). The bank has been a traditionally higher-valued stock but hasn’t been impervious to the recent market unrest. If you’re contemplating an investment in this stock, it is essential to consider a few factors.
Banking Industry Challenges As the parent company of the U.S. Bank National Association, with over $591 billion in assets, U.S. Bancorp ranks as the fifth-largest bank in the U.S. It operates nearly 2,500 banking branches across the Midwest and West U.S.
U.S. Bancorp shares have historically garnered a higher value than its competitors due to their selective lending practices and emphasis on high-quality loans. This has consistently ensured an impressive return on equity (ROE). However, after the escalating fears of a banking sector contagion, the stock experienced a 35% fall, reflecting the widespread selling-off of banking shares.
As mentioned above, the Primary reasons behind the banks’ downfall include a large volume of uninsured deposits and significant unrealized losses in the banks’ balance sheets. These resulted in rapid outflows of deposits, leading banks to hastily raise capital and suffer massive losses on their held-to-maturity portfolios.
In the case of U.S. Bancorp, 51% of its deposits are uninsured. However, its deposit base is broader and more diversified than Silicon Valley Bank. Due to their contractual obligations, approximately 80% of their uninsured deposits come from more stable operational wholesale trust and retail deposits.
Investor Worries While U.S. Bancorp boasts a diversified deposit base, it has raised eyebrows for another reason: its acquisition of the U.S. Banking arm of Mitsubishi UFJ Financial Group, Union Bank. The purchase expanded its influence in California, scaled up its operations, and led to a more extensive deposit base. The bank’s deposits saw a 5.9% growth from the fourth to the first quarter, owing to the acquisition.
However, this move had an undesired repercussion: a decline in regulatory capital ratios. The bank’s CET1 ratio, an indicator of capital strength, dropped from 9.8% last year to 8.5% this year. This meets the 7% regulatory requirement, but issues might arise if U.S. Bancorp is classified as a Category II bank.
Being a Category II bank means incorporating unrealized losses into capital calculations. This could bring down the CET1 ratio to 5.8% — below the required threshold. HoldCo Asset Management, a stakeholder in the banking industry, has thus labelled the bank as “the unsafest and unsoundest of them all,” primarily due to its capital position.
Should You Buy?
In this month’s earnings call, CEO Andy Cecere didn’t express excessive concern about the bank’s CET1 ratio. He projected it to reach 9% by the end of this year as the integration of Union Bank continues and cost synergies from the acquisition are realized. Cecere reported the deal exceeding revenue expectations and costs being lower than anticipated. He also dismissed the possibility of being a Category II bank until late 2024 at the earliest.
Like many other banks, U.S. Bancorp has been under significant pressure recently. The bank’s current price-to-earnings ratio (P/E) stands at 8.1, and its price-to-tangible book value of 1.75 is nearly the lowest in twenty years, making its current valuation seemingly attractive.
However, the recent move by Warren Buffett and his team at Berkshire Hathaway to entirely withdraw their long-standing position in the bank, held since 2006, adds a note of caution. Given the ongoing uncertainty in the banking sector, particularly with potential interest rate increases, it may be prudent to refrain from buying U.S. Bancorp shares.
While U.S. Bancorp’s stock may appear enticing due to its low valuation, it’s essential to consider the various challenges the bank and the broader industry face. It’s wise for potential investors to closely monitor the situation and make informed decisions based on the evolving landscape. The banking sector can often be volatile, and in times of increased uncertainty, it’s better to err on the side of caution. Despite the current difficulties, U.S. Bancorp has the potential for recovery, but it might be more prudent to wait for signs of stability before taking a position.
