Banks have had a tough go of it in 2023. U.S. Bancorp (USB 0.32%), the fifth-largest bank in the U.S. by assets, has been under the microscope since the failure of a few regional banks earlier this year.
Some of U.S. Bancorp's regulatory capital ratios fell after it made a recent acquisition, placing it on the low end of its peer group on those metrics. Those falling capital ratios helped spark one prominent asset management firm that follows the banking sector to label it "the unsafest and unsoundest of them all" earlier this year.
Admittedly, U.S. Bancorp has made progress in improving its regulatory ratios. But is it enough? Here's what you need to consider before deciding if its stock is right for your portfolio.
March's turmoil dragged down the entire banking industry
In the recent past, U.S. Bancorp traded at a premium to peers, mainly because of its stellar return on common tangible equity and its prudent risk management on loans. However, it came under pressure this past year as the Federal Reserve boosted interest rates to their highest levels in 16 years. The sharp run-up in rates was a contributing factor in the eventual failure of a few banks earlier this year.
With Silicon Valley Bank's (a subsidiary of SVB Financial) collapse, investors put all banks under the microscope to see if they had similar problems. Silicon Valley Bank's failure involved a massive outflow of deposits in a short timeframe combined with an extensive portfolio of long-term bonds whose value had declined significantly. If Silicon Valley Bank had been able to hold the bonds to maturity, it would have collected their full value. But depositors got spooked over concerns about the bank's solvency and began pulling out their cash. SVB was forced to raise capital quickly by selling bonds at a loss. A vicious cycle was initiated, with more depositors, fearing the worst, pulling their money en masse. Before long the bank was forced into receivership and operates thanks to significant government intervention. One of the notable issues that arose during the crisis was that a large majority of the accounts at SVB exceeded the FDIC's maximum insured level of $250,000 per deposit.
At the end of the first quarter, 51% of U.S. Bancorp's deposits exceeded the maximum and contained funds not insured by the FDIC. While that may seem like a lot, a larger figure for big regional banks isn't uncommon. What matters is the composition of those uninsured deposits.
Early-stage tech companies made up a large portion of Silicon Valley Bank's uninsured deposits, and funding in that sector of the economy was drying up quickly. Most of U.S. Bancorp's deposits are in operational wholesale trust and retail deposits -- which tend to be "stickier" and less likely to trigger a bank run.
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U.S. Bancorp's capital ratios are a point of concern
U.S. Bancorp faces investor scrutiny for another reason -- its capital requirements. Last year, it completed its acquisition of MUFG Union Bank, which significantly expanded its footprint in California.
The acquisition put pressure on its common equity tier 1 ratio (CET1), which compares a bank's core capital to its risk-weighted assets, allowing one to gauge its ability to handle losses during an economic crisis. Following the acquisition, U.S. Bancorp's CET1 ratio fell to 8.4%. According to the Federal Reserve's recent stress tests, this was the lowest ratio among the 23 banks tested and well below the average ratio of 12.4%.
Additionally, that acquisition -- which gives U.S. Bancorp assets of around $670 billion now -- will eventually push it over the $700 billion threshold, turning it into a category II bank. Its inclusion in that category will require it to incorporate unrealized losses into regulatory capital calculations and hold even more capital. Terrance Dolan, CFO, said he doesn't expect the bank to hit that threshold until late 2024 at the earliest, giving it time to build up its capital.
On a positive note, U.S. Bancorp's credit quality remains solid -- a testament to its disciplined approach to loan underwriting. The bank also has a strong business that doesn't just focus on holding deposits. It invested heavily in its technology and payment products, which are excellent sources of cash flow -- earning it a premium valuation compared to peers.
Is U.S. Bancorp stock a buy?
U.S. Bancorp's capital position is gradually improving. The bank suspended share buybacks and took other actions to boost its capital, and its CET1 ratio improved from 8.5% to 9.1% in its most recent quarterly report. Additionally, CEO Andy Cecere expects this ratio will rise to 10.5% by the end of 2024.
USB Price to Tangible Book Value data by YCharts.
U.S. Bancorp continues to face a challenging environment due to higher interest rates. However, the stock price reflects investors' concerns -- it trades at 1.98 times its tangible book value -- well below its 10-year average of 2.6. With the stock available at such a steep discount, now looks like a good time to build a stake in U.S. Bancorp and add to it over time -- as long as it continues to improve its capital ratios. And while you wait for the stock to recover, you can collect a generous dividend yielding 5.6%.
