At a recent industry conference, U.S. Bancorp (USB 0.32%), the fifth-largest bank by assets in the U.S., reiterated its guidance for the second quarter of the year, which not all large regional banks have been able to do, given the difficult environment.
But the stock is still down nearly 25% this year, as investors soured on the name following the banking crisis, much like they did to most of the sector. After this positive guidance update, is U.S. Bancorp now a buy?
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It's all about capital
At a conference hosted by Morgan Stanley on June 12-13, U.S. Bancorp's management team reiterated the guidance it provided on its first-quarter earnings call in April. Management still expects the net interest margin (NIM) -- the difference between the rate the bank charges on its interest-earning assets, such as loans, and pays on its interest-bearing liabilities, such as deposits -- to end the year between 3% and 3.05%.
In this environment, I would consider this pretty good because it means the margin is likely to fall only a little bit from the 3.10% number the bank reported at the end of Q1.
But I think the most important thing for U.S. Bancorp, in terms of getting its stock price to rebound, concerns capital and, ultimately, boosting its capital ratios. The bank has seen one of its key capital ratios, the common equity tier 1 capital ratio, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets, fall from 9.7% at the end of the third quarter to about 8.5% at the end of the first quarter of this year. This reflects the money U.S. Bancorp spent to acquire Union Bank, a transaction that closed in the fourth quarter of the year.
Although U.S. Bancorp's CET1 ratio is still well above its regulatory requirement, it's toward the bottom of its peer group, and the bank currently has a lot of unrealized bond losses due to the rapidly rising interest rate environment, which has put many bank bond portfolios underwater.
Currently, large regional banks do not have to incorporate these unrealized bond losses into their capital ratios. But after everything that happened during the banking crisis, regulators will likely require large regional banks to incorporate a portion of the unrealized losses into their CET1 ratios. If U.S. Bancorp did have to incorporate the unrealized bond losses from its available-for-sale bond portfolio (bonds the bank intends to sell prior to maturity and that are marked at their fair value each quarter), its CET1 ratio would fall below its required minimum.
Now, if this change is incorporated, which I suspect it will be, I also suspect U.S. Bancorp would have time to make the transition. But there will likely be other regulatory capital changes as well that will require U.S. Bancorp to build capital. At the conference, U.S. Bancorp CEO Any Cecere said the bank's target CET1 ratio is 9% by year-end and 10.5% by the end of 2024. These changes might not sound like much, but they will require the bank to build billions of dollars of capital in the coming years.
U.S. Bancorp CFO Terry Dolan said the Union Bank acquisition will improve U.S. Bancorp's earnings power and that he expects the bank to boost its CET1 ratio by 0.20% to 0.25% each quarter. Dolan also said the bank would be able to lower the bank's risk-weighted assets through "low impact actions" that will help boost the CET1 ratio by about a half point this year.
Is the stock a buy?
Ultimately, I think investors will want to see how bank capital requirements are going to shape up and then see U.S. Bancorp get closer to a 9% CET1 ratio before they feel a bit better about the bank's situation.
While the bank has laid out a clear path, the risk is if profitability doesn't come in as expected and unrealized bond losses worsen. The Fed did just indicate that they expect two more rate hikes this year, which would not be great for banks.
But management has been working to reduce the unrealized bond losses, and I believe the bank has a strong deposit base that can help it weather the difficult environment. Given the long-term success of this bank and management's track record, I do think the stock can rebound long term, but I, like most investors, will ultimately feel much better as the bank accretes capital.
