It's been a challenging year for bank stocks. The collapse of regional banks earlier in the year put the sector in the spotlight. Financial stocks have struggled as investors scrutinize the sector, and one bank stock that has felt that pressure is U.S. Bancorp (USB -1.06%).
The bank hasn't faced the same issues as those that went under in March, but it has dealt with a cloud of uncertainty over its capital situation. If you're considering buying U.S. Bancorp today, here are five things you should know first.
1. The fifth-largest bank in the U.S. has historically traded at a premium to peers
With over $660 billion in assets, U.S. Bancorp, the parent company of U.S. Bank National Association, is the fifth-largest bank in the U.S. The only banks that are larger than it are JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo.
The bank has historically displayed a conservative approach to loan underwriting. This track record is why the bank's average annual return on equity since 2000 is 16.6%, a stellar measure for the industry. It also operates a strong payments business, which is why it has historically traded at a premium valuation relative to peers.
2. Its acquisition last year put pressure on its capital ratios
U.S. Bancorp has thousands of offices across the Midwest and West regions of the U.S. It recently expanded its presence on the West Coast when it acquired MUFG Union Bank. The transaction closed last December, but it put pressure on U.S. Bancorp's capital ratios and subjected it to similar regulations to its larger peers.
Regulators enforce capital ratios to ensure banks have enough set aside to weather financial distress brought on by significant loan losses. One measure of a bank's capital strength is the common equity Tier 1 (CET1) ratio. This measure takes the bank's core capital as a percentage of its risk-weighted assets, such as loans.
When U.S. Bancorp acquired MUFG Union Bank, its CET1 ratio fell from 9.7% to 8.4%. According to the Federal Reserve's annual stress test, this ratio was below 23 of its banking peers, whose average CET1 ratio was 12.4%.
The acquisition also increased U.S. Bancorp's asset base to $660 billion. This matters because U.S. Bancorp could be subject to even more stringent capital requirements. Currently, the bank is considered a Category III bank. But if it crosses over $700 billion in assets, it would become a Category II bank. That means it would have to incorporate unrealized losses into its regulatory capital calculations, and thus set aside even more capital.
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3. Regulators recently released it from certain commitments (for now)
When U.S. Bancorp acquired MUFG Union Bank, it agreed to submit quarterly implementation plans for complying with Category II requirements by the end of 2024. The acquisition dented U.S. Bancorp's capital ratio, while also requiring it to set aside even more capital.
This month, the Federal Reserve released U.S. Bancorp from these requirements. This takes some pressure off the bank to meet its regulatory requirements. It also means the bank doesn't expect its assets to exceed the $700 billion Category II threshold in the next few quarters. As a Category III bank, it can phase accumulated other comprehensive income (AOCI), typically unrealized gains and losses, into regulatory capital over three years beginning in 2025. One analyst described the news as a "game changer."
Although it has been released from its commitments, investors must know that if the bank crosses that $700 billion threshold and stays there for four consecutive quarters, it will be subjected to Category II requirements.
4. U.S. Bancorp currently trades at a cheap valuation
The bank also trades at an affordable valuation compared to its recent history. Today, the bank is valued at 1.83 times its tangible book value. Historically, it has traded at a much higher premium. Over the last 15 years, U.S. Bancorp's average price-to-tangible book value has been 2.8.
USB Price to Tangible Book Value data by YCharts
Its cheap valuation can provide investors with a margin of safety, while it has made significant progress on its capital ratios. In its most recent quarterly earnings, the bank has improved its CET1 ratio to 9.7% -- its CET1 ratio before its acquisition. This is a great sign for investors and shows that the bank's capital management plans are working.
However, it's important to note that bank stocks aren't quite in the clear yet, and could face further volatility amid the higher-for-longer interest rate environment.
