Banking stocks came under pressure in recent months following the collapse of SVB Financial's Silicon Valley Bank and Signature Bank in March. In early May, First Republic Bank was another bank that federal regulators seized. The failure of these banks set off a chain reaction of investor concern across the industry.
One bank that came under scrutiny amid this backdrop is U.S. Bancorp (USB -1.23%). The bank traditionally traded at a premium valuation, but that didn't make it immune to the current market turbulence. If you're considering buying shares in this bank stock, there are a few things you should know first.
Struggles across the banking industry
With over $591 billion in assets, U.S. Bancorp, the parent company of U.S. Bank National Association, is the fifth-largest bank in the U.S., and has almost 2,500 banking offices located throughout the Midwest and West regions of the U.S.
Historically, U.S. Bancorp stock traded at a premium valuation to its peers thanks to its selective lending and focus on high-quality loans, which historically gave it an excellent return on equity (ROE). Despite this, U.S. Bancorp stock fell 35% as investor fears about contagion in the banking sector resulted in a steep sell-off in all banking stocks.
Some of the factors that led to the failure of these banks were a large number of uninsured deposits and large amounts of unrealized losses on the bank's balance sheets. The outflow of deposits at those banks created a scenario where banks would need to raise capital quickly, forcing them to realize significant losses on their held-to-maturity portfolios.
At U.S Bancorp, 51% of its total deposits were uninsured. However, the bank has a wider, more diverse deposit base compared to Silicon Valley Bank. Roughly 80% of its uninsured deposits are in operational wholesale trust and retail deposits, which can be more stable due to contractual obligations for those customers.
Image source: Getty Images.
Why investors are concerned
While U.S. Bancorp has a diverse deposit base, it has come under scrutiny for another reason: its purchase of Mitsubishi UFJ Financial Group's U.S. Banking arm, Union Bank. The deal gave it a larger presence in California, increased its scale, and created a bigger deposit base. U.S. Bancorp's deposits grew 5.9% from the fourth to the first quarter thanks to the acquisition.
However, it came with an unwanted side effect: lower regulatory capital ratios. In the first quarter, U.S. Bancorp's CET1 ratio, a regulatory measure used to assess a bank's capital strength, fell from 9.8% last year to 8.5% this year. While this is above its 7% regulatory requirement, a problem arises if U.S. Bancorp becomes what is known as a Category II bank.
As a Category II bank, U.S. Bancorp must incorporate unrealized losses into its regulatory capital calculations. If that happens, its CET1 ratio will fall to 5.8% -- below its requirement. Its capital position is one reason HoldCo Asset Management, an investor in the banking industry, called the bank "the unsafest and unsoundest of them all."
Is it a buy?
During its earnings call this month, CEO Andy Cecere didn't sound too concerned about the bank's CET1 ratio. Cecere told analysts that he expected the CET1 ratio to reach 9% by the end of this year. The bank sees the ratio improving as it integrates Union Bank and realizes cost synergies from the acquisition. Cecere said that the transaction is exceeding revenue expectations, and expenses are lower than expected. He also noted that he didn't believe it would become a Category II bank until late 2024 at the earliest.
USB PE Ratio data by YCharts
U.S. Bancorp has come under pressure, as many banks have in recent months. From a valuation perspective, the bank trades at a price-to-earnings ratio (P/E) of 8.1, while its price-to-tangible book value of 1.75 is near its lowest level in two decades. Its cheap valuation makes it look appealing at today's prices.
However, Warren Buffett and his team at Berkshire Hathaway recently eliminated the holding company's position in the bank, which Berkshire had held since 2006. Given the uncertainty in the banking sector, especially if interest rates move higher from here, I'd avoid buying U.S. Bancorp stock right now.
