U.S. Bancorp (NYSE:USB) has long been one of the top-performing regional banks. Just ask legendary investor Warren Buffett, whose company, Berkshire Hathaway, has maintained a large position in the stock even as it's sold numerous other banks during the COVID-19 pandemic. Buffett is not alone. For its consistently strong performance, investors have rewarded U.S. Bancorp with a high valuation -- at recent prices, the stock was trading just under its average of 2.5 times tangible book value (equity minus intangible assets and goodwill).

A big reason for this valuation is the bank's unique payments system. I think the payments business not only helps support the high valuation, but it also may be able to drive it higher. Here's why.

Understanding the payments business

U.S. Bancorp is unique in that it can offer a wide range of payments services to consumers, merchants, corporations, small and medium-sized businesses, and government customers. It does this through three main segments:

  • The retail payment solutions segment issues consumer and small-business credit cards, debit cards, and prepaid cards.
  • The global merchant acquiring segment provides technology that allows merchants to accept cards and other electronic payments globally. The merchant acquiring business has a lot of success in the hotel and airline industries, and as of 2016, had 1 million customers and could process more than 100 currencies in 26 different countries.
  • Lastly, the corporate payment systems segment serves corporations, businesses, and governments by allowing them to run a host of corporate card programs, payment services, and account management services, among others. The corporate payments systems predominantly cater to the aviation, fleet, transportation, and travel industries.

Payments have become a big piece of revenue and profits at U.S. Bancorp over the years. The three businesses contributed $1.3 billion, or 25.6% of the bank's net income in 2020, and that's down 12.7% compared with 2019. The payments business was on full display at the end of the second quarter, as spending levels rebounded and total sales volume for each of the three business segments topped 2019 levels. Payments revenue was up nearly 40% from the second quarter of 2020, helping to offset a big decline in mortgage banking revenue, which surged in 2020.

A farmer takes a credit card payment at a market.

Image source: Getty Images.

The opportunities ahead

While U.S. Bancorp's payments business has been a significant contributor to its success, management has been investing in the business for some time now to keep building on its capabilities and drive more revenue. But analysts are still wondering about the overall strategic vision for the bank. U.S. Bancorp runs a great commercial banking business, and it also has this unique and powerful payments business. So how can the bank really integrate these businesses to build a moat that can't be duplicated?

The bank has unveiled some of its plans. On the first-quarter earnings call back in April, CEO Andrew Cecere noted that less than 40% of customers in the merchant acquiring business had a business banking product. With existing relationships from the merchant business, U.S. Bancorp can hopefully cross-sell other business banking products, wether it's a bank account, a line of credit, or something else. On the other end of the equation, Cecere said that even fewer business banking clients have a merchant account, so there should be significant opportunities to drive more revenue from existing clients.

Additionally, U.S. Bancorp is one of the first banks to be on the RTP network, which is a real-time payments platform that enables customers to send and receive payments that are cleared and accessible instantly. Business clients can send and receive messages on the RTP network, and consumers can receive RTP credits. Real-time payments is not mainstream yet, but it has gotten much more attention since the pandemic and the further adoption of digital payments. So this is another tool that has the potential to be a big driver of growing deposits and fee income.

Ultimately, U.S. Bancorp will be looking to further integrate the commercial bank and payments businesses in order to further penetrate its existing customer base and attract new customers. Cecere said on the bank's most recent earnings call that the bank plans to release more specifics later this year about how it will combine these two businesses, and its overall strategy.

Supporting a higher valuation

Already trading around 2.4 times tangible book value (TBV), U.S. Bancorp has traded at 3 times TBV and higher on multiple occasions over the last decade, so I'm sure it can do so again in a more normalized rate and revenue environment. The growing payments business, depending on its success, could also support a higher valuation when you consider fintech payments companies can trade at much higher multiples than traditional banks.

I doubt U.S. Bancorp will ever get a full fintech valuation, because as a large bank, it must hold regulatory capital. But I also think the payments business is capable of doing more and becoming an even larger part of U.S. Bancorp's strategic direction, so I'll certainly be watching management's announcements regarding the future of this business with great interest.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.