Larger banks, particularly well-run companies like U.S. Bancorp (NYSE:USB), haven't been at the top of most investors' buy lists recently. While U.S. Bancorp shares are up about 10% from when I last wrote about the company (after first quarter earnings), there seems to be a general sense of “why bother?” on the Street, given weak loan demand, aggressive pricing, and limited scope for earnings leverage. While U.S. Bancorp's conservative ways will likely limit aggressive capital deployment and the bank is pretty economically-sensitive, even near a 52-week high these shares appear to offer solid long-term potential.
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The Economy Is Not Helping
All banks are economically-sensitive, but U.S. Bancorp may be a little more so than investors commonly expect. While this bank is often lauded for its strong non-interest income-generating operations, many of those are still highly sensitive to economic conditions.
On one side, U.S. Bancorp is seeing fairly sluggish loan demand, even though the bank's funding cost advantage allows it to stay pretty competitive on pricing. Even so, it would seem that the bank is willing to let others be more aggressive, as the company's mortgage origination share has fallen to #5 (from #3 a year ago) and it is not growing its auto lending business nearly as much as others like Fifth Third (Nasdaq:FITB) and SunTrust (NYSE:STI). On the other side, though, weak payment processing and corporate treasury services (which is tied to payroll and net working capital management) are also struggling a bit at present.
Too Conservative, Or Just Prepared For The New Realities?
While many banks appear to be in a rush to try to recreate business-as-usual circa 2005, U.S. Bancorp is taking a more conservative path. The bank is still increasing its dividend payout and buying back shares, but the impact is relatively modest. USB may be doing more than Wells Fargo (NYSE:WFC), SunTrust, or PNC (NYSE:PNC) to return capital, but the bank is sticking with a fairly conservative overall capital policy.
To that end, U.S. Bancorp has also structured itself pretty conservatively with respect to rates. If rates rise relatively soon, banks like Bank Of America (NYSE:BAC) and Comerica (NYSE:CMA) are likely to see a much bigger impact, though USB will do better if rates stay more or less where they are (and there's really no possibility of rates going meaningfully lower). Consequently, if more chatter picks up regarding the Fed tightening up, I would think these shares could be relative underperformers.
U.S. Bancorp has also positioned itself pretty conservatively with respect to Basel 3 stress tests and the potential passage of Brown-Vitter (a bill that would target large banks by upping their capital requirements). If and/or when regulators get more serious about accurately calculating and representing bank capital (which is a long subject for another time...), U.S. Bancorp should be in relatively better shape than its peers, but at the cost of underperforming a bit if that day of reckoning doesn't come.
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The Bottom Line
I still maintain that U.S. Bancorp is one of the better banks to own in the U.S. financial sector. The company has a good record of managing risk and returning capital to shareholders, and I continue to believe that much of Wall Street underestimates the bank's long-term “normalized” return on equity (ROE). On the basis of mid-to-high teens ROE, I believe U.S. Bancorp shares are worth about $41 today. That's not tremendous upside to today's share price (nor is the yield all that high), but it's not a bad value-quality option in the sector today.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.