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U.S. Bancorp (NYSE:USB) is America’s fifth largest commercial bank, with total assets of nearly $557 billion as of September 30, 2021. In a world of hyper-growth tech stocks, it is easy to overlook banks as investment opportunities. Yet, U.S. Bancorp is a profitable bank that, between 2016 and 2020, had a 5-year return on invested capital (ROIC) of 7.38%, and grew net operating profit after-tax (NOPAT) at a 5-year compound annual growth rate (CAGR) of 3.94%, within a conservative framework. The bank was profitable during the Great Recession and the bank typically has credit losses below 0.5% of its loan book. Deposits make up around 71.6% of the bank’s assets, with management focusing its business on commercial real estate and residential mortgages (39% of total loans), commercial loans (34.5% of total loans) and consumer loans. Management has grown economic earnings from -$42.05 million in 2016, to over $1.5 billion in 2020. Yet, U.S. Bancorp’s success has not been broadly recognized by the market. Although its share price rose in 2021, from $42.85 to $56.17 per share, this still left the company significantly underpriced.
A History of Profitability
The company’s 2020 annual report reveals a company that has a history of profitability. In the 2016 to 2020 period, U.S. Bancorp grew revenue from $22.75 billion to $25.24 billion. Revenue for the current/trailing twelve month (TTM) period stands at $23.85 billion. In that period, NOPAT grew from $5.89 billion to $7.15 billion, falling to $6.4 billion in the current/TTM period.
The company, as we mentioned, grew economic earnings in that 2016 to 2020 period, but economic earnings took a hit in 2021, falling to their current/TTM level of $525 million. Against 2020’s results, this is obviously a significant deterioration, but in the context of the five year period, the company has still grown economic earnings by 1350%.
U.S. Bancorp is Built to Be Resilient
Since the Great Recession, banking regulations have significantly improved bank capitalization, such that banks as an asset class have very strong balance sheets. It’s not a surprise that they have been able to go through the pandemic without any significant damage. U.S. Bancorp is one of the beneficiaries of this epoch of banking regulation and prudential management. According to the third quarter earnings report, the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) showed that U.S. Bancorp’s common equity Tier 1 (CET1) ratio increased from 9.4% in September 30, 2020, to 10.2% in the same period in 2021. This is twice the regulatory minimum and 2% higher than the effective minimum level of capital banks need to avoid capital distribution restrictions, such as dividends and share repurchases, and some classes of discretionary executive compensation.
The company only suspended its share buyback program in Q3 2021 after its announcement that it was going to buy MUFG Union Bank. The share buyback program will resume in the second quarter of 2022. Once the acquisition is closed, the company will operate at a CET1 capital ratio of between its target ratio of 7% and 9%.
The Fed’s stress test assumed a global recession that substantially stressed commercial real estate and corporate debt markets. Under this scenario, unemployment would rise 4%, peaking at 10.75%. Economic activity would decline by 4% between the fourth quarter of 2020 and the third quarter of 2022. In that period, asset prices would plummet, with stocks falling 55%. The country’s 23 largest banks would lose $470 billion, including $160 billion in commercial real estate and corporate loans. Capital ratios would decline to 10.6% which would still be double their minimum requirements. In this scenario, U.S. Bancorp’s revenue would fall to $16.2 billion and provisions for loans and leases would rise to $14.7 billion. Despite this scenario, the company would be able to maintain a CET1 ratio above regulatory requirements.
According to Wells Fargo & Company (WFC), U.S. Bancorp’s loss absorbing capital, (which measures capital in excess of CET1 requirements, reserves for credit losses, additional capital required to meet future capital requirements, and new earnings across three years), could survive a scenario in which pre-provision net revenue (PPNR) declined by 30 in year 1 and was still down by 15% in the third year of a hypothetical scenario, where loan losses would also fall 13$ compared to 8% in the Great Recession.
U.S. Bancorp’s Profitability Shines Among Its Peers
U.S. Bancorp compares favorably with its peers, JPMorgan Chase (JPM), Bank of America Corp (BAC), Wells Fargo & Company, and Citigroup (C). According to data obtained from New Constructs, the company enjoys the second highest ROIC within the group, behind JPMorgan Chase. Its NOPAT margin again trails just JPMorgan Chase. Its average invested capital turns, which measures the efficiency of its balance sheet, are not as impressive, third among the group.
Company |
Ticker |
Average Invested Capital Turns |
NOPAT Margin |
ROIC |
U.S. Bancorp |
USB |
0.25 |
26.80% |
6.70% |
JPMorgan Chase |
JPM |
0.39 |
30% |
11.70% |
Bank of America Corp |
BAC |
0.27 |
23.10% |
6.30% |
Wells Fargo & Company |
WFC |
0.33 |
18.70% |
6.20% |
Citigroup Inc. |
C |
0.23 |
18.60% |
4.30% |
Source: New Constructs
As the economy reopens, and normality returns, the demand for commercial real estate and residential mortgages, commercial loans and consumer loans will rise, alongside demand for other bank products, and this will lift the company’s results. The company’s excellent profitability is likely to improve.
The Bear Case Against U.S. Bancorp
The question for many investors is how the company would survive in the face of an adverse yield curve. Although it may feel as if net interest margins (NIMs) should decline with bond yields, the evidence suggests that this is not the case. According to FRED, NIMs for all U.S. banks have remained within a relatively tight band of between 3% and 3.4% since the Great Recession, only falling below that in 2020 to 2.8%.
Source: FRED
There is no real link between US NIMs and US bond yields, so there is no reason to believe that banks, and in particular, U.S. Bancorp, which, in Q3 2021 had a NIM of 2.53%, should fear Japan-style NIMs of around 1%. This also implies that an anticipated rise in bond yields will not have a dramatic impact on the company’s NIMs.
U.S. Bancorp had an earnings asset yield of 2.72% in Q3 2021, which reflects its strong starting point, and that, along with its ability to reprice its cost of funding, would help the company, as it did in 2020, to survive a shock to asset yields.
Is U.S. Bancorp a Buy?
Investing is about buying low expectations and selling high expectations. U.S. Bancorp is trading at around $63 per share and has a price-to-economic-book-value (PEBV) ratio of 1. That makes the company very attractive because it implies that the market predicts NOPAT will remain the same and there are no expectations for profit growth reflected in the price.
U.S. Bancorp’s current EBV, which is the zero growth value of the firm, is around $92.4 billion, or $62.31 per share.
Given that the company has a history of growing NOPAT, this seems rather pessimistic and suggests that any profitability over the next few years would result in upside for the investor.
Conclusion
As one of the largest commercial banks in the country, U.S. Bancorp has still found ways to grow revenue and profits and create shareholder value. In the post-Great Recession era, this has also meant that the company’s success has come despite very conservative regulatory demands on top of management’s own prudential standards. U.S. Bancorp has a balance sheet that is built for resilience and that will likely survive the most stringent scenarios. A case might be made that adverse yields would hurt the company net interest margin, but evidence suggests that there is no relationship between net interest margins and bond yields. The company’s profitability looks good when measured against that of its peers and given the zero-profit growth assumptions embedded in the company’s pricing, there is value in the company and upside. The market has priced in a lot of bad news. U.S. Bancorp is not the most glamorous stock and has no dreams of changing the world, but it is a prudent investment with room to grow.
Source: seekingalpha.com