Regulators have been working on proposed bank changes, called Basel III endgame, which they argue would help strengthen the financial system by requiring banks to hold more capital on their balance sheets. Banks pushed back against these rules, arguing they are well capitalized, and further capital requirements could limit them and their ability to lend to their customers.
U.S. Bancorp (USB 0.41%) was one bank facing big questions because of these rule changes. However, the bank got some good news a couple of weeks ago when Federal Reserve Chair Jerome Powell said there would be "broad and material" changes to proposed Basel III rules. Here's why the changes matter and why U.S. Bancorp could be a no-brainer buy for investors today.
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Proposed rules would require banks to hold more capital
The Basel Committee on Banking Supervision was established in 1974 and aims to improve stability by improving banking oversight. Following the global financial crisis in 2008, the Basel Committee established measures called Basel III. The measures looked to strengthen regulations and supervision over banks. These regulations assess a bank's risk and capital ratios to ensure it can withstand economic downturns.
The most recent set of proposed rules in the U.S. is called the Basel III "endgame." In July 2023, the Fed, the Office of Comptroller of the Currency, and the Federal Deposit Insurance Corp. published the proposed changes that would align U.S. bank capital rules with Basel III standards. Some of the proposed changes include:
- Lowering the threshold for banks facing the most stringent capital requirements to those with $100 billion in assets, down from the current threshold of $700 billion.
- Require a standard measure of calculating capital requirements for loans.
- Require banks to hold more capital for trading activities and operations risks.
U.S. Bancorp's capital constraints
U.S. Bancorp is already faced with rebuilding capital after acquiring MUFG Union Bank at the end of 2022. The acquisition expanded the bank's presence on the West Coast, but it was also a big drag on the bank's common equity tier 1 (CET1) ratio.
The CET1 ratio measures the financial strength of the bank. It takes the bank's core capital as a percentage of its risk-weighted assets, like loans or investment securities. After acquiring Union Bank, U.S. Bancorp's CET1 ratio fell from 9.7% to 8.4%. For perspective, this was the lowest ratio among the 23 banks subjected to the Fed's annual stress test and well below the average ratio of 12.4%.
The acquisition increased U.S. Bancorp's assets to $675 billion. This matters because once a bank reaches $700 billion in assets, it becomes a Category II bank, subjecting it to more stringent capital requirements.
The Fed required the bank to submit quarterly implementation plans to comply with these requirements. However, last fall it released the bank from these commitments after the bank came up with a plan for "further net reductions in assets and increases in regulatory capital."
Banks and other advocates strongly opposed the proposed rules
Banks have pushed back firmly on the proposed endgame regulations put forward by the Fed last July. Those in the industry argued it would raise the cost of lending, push consumers outside the banking system, and inhibit banks' trading and other activities.
Numerous others joined banks in opposing the changes, including some unlikely allies. Consumer advocacy groups worry that the revisions would lead to reduced credit availability. They also argued that it could undercut homeownership and community reinvestment activities. Both Republican and Democratic representatives have also joined in opposing the proposed rule changes.
Last month, the Fed's Powell said, "I do expect there will be broad material changes to the proposal," which "has broad support at the Fed and in the broader world." The revamped proposal will likely be presented by the end of this year, and should eliminate some of the risks of the more stringent capital requirements originally proposed.
Why U.S. Bancorp should be on your radar
U.S. Bancorp faced big question marks over its capital ratios after its acquisition of Union Bank. The bank is making progress on rebuilding its capital. At the end of last year, U.S. Bancorp improved its CET1 ratio to 9.9%, and its total assets remained steady at $663 billion.
The bank stock remains 23% below its all-time high price two years ago. The stock has gained 37% during the past six months, so it's not quite the bargain it was back in November. However, the bank is priced at 13 times earnings and 2.3 times tangible book value, both below its 10-year averages.
USB PE Ratio data by YCharts
Although the bank still has to work to improve its capital ratios further, it looks like it will be spared from the more stringent capital requirements as long as its assets remain below the $700 billion threshold. Analysts at Compass Point said that U.S. Bancorp has the potential for greater capital relief compared to its peers thanks to the pending changes to Basel III and that its capital overhang is "greatly diminished."
U.S. Bancorp has historically traded at a premium to peers thanks to its solid return on equity. Now that some of the more stringent capital requirements appear to be off the table, today could be an excellent time to scoop up shares of the bank stock.
