U.S. Bancorp

Moat: 2.5/5

Understandability: 2.5/5

Balance Sheet Health: 4.5/5

U.S. Bancorp is a diversified financial services company, providing a range of banking, investment, and payment services across the United States, with a strong presence in the Midwest.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

U.S. Bancorp operates primarily as a regional bank, with a substantial presence in the Midwest and strong franchises in some other regions. Its primary revenue drivers are categorized as follows:

  • Net Interest Income (NII): The difference between the interest income generated on loans and securities and the interest expense paid on deposits and borrowings, is the major revenue generator for the bank. It’s largely determined by the yield curve and interest rate changes.
  • Non-Interest Income: This stream includes fees from credit and debit card processing, wealth management, mortgage banking, and other service charges. This part of income is highly dependable upon consumer spending and fee schedules.
  • Net Revenue: Consists of NII and non-interest income

Industry Trends The banking industry is currently experiencing the following key trends:

  • Rising Interest Rates: Interest rates set by the Federal Reserve have risen drastically over the past year, increasing the cost of funding for banks. This can greatly impact net interest margin.
  • Increased competition: The banking industry is becoming more competitive, with traditional banks facing challenges from fintech companies and non-banks. The rate of technological change has also accelerated within the banking industry, and those who can implement better technology are likely to win in the long term.
  • Heightened regulatory scrutiny: Regulatory oversight is increasing, and there is a greater scrutiny on a bank’s reserves and risk management.
  • Increased digitization: Customers are increasingly demanding mobile and digital banking channels, and banks are adapting to meet those expectations.

Financials

U.S. Bancorp’s financial performance can be characterized by the following:

  • Net Interest Income: NII has benefited from rising rates during the latest couple of quarters. For Q1 2024, the company’s NII stood at $4.05 billion, compared to $3.85 billion in the prior year. This is because the company’s earning assets are being re-priced as rates increase, but also is affected by an increase in funding costs.
  • Non-Interest Income: This stood at $2.6 billion in Q1 2024, up from $2.5 billion in the previous year, largely due to an increase in payment and mortgage banking income.
  • Net Revenue: This has totaled $6.7 billion during Q1 2024 up from $6.4 billion in Q1 2023, driven by increase in both NII and non-interest income.
  • Profitability:
    • Net income for Q1 2024 was reported as $1.25 billion versus $1.7 billion in Q1 2023. However the company’s effective tax rate has risen significantly over the past year, due to changes in the tax treatment of certain equity investments. This negatively impacted the net income, despite improvement in top line revenues.
    • Net income for Q1 2023 has been boosted from recoveries of credit loss. It will be a challenge for the bank to maintain and improve the results of Q1 2024, with tax rates likely remaining at the current elevated levels, and with an increased allowance for credit losses, a sign that economic troubles may be coming. The long-term trend for banks have shown that the provision for credit losses are correlated with unemployment.
  • Capital Ratios: Tier 1 capital ratio of 10.1% is above the regulatory requirements, and the CET 1 ratio of 9.1% is above the requirement of 7%, highlighting capital strength.
  • Loan Portfolio: The loan portfolio is diversified across Commercial, consumer, and wholesale banking, with reasonable diversification of risks. Credit quality has remained largely resilient throughout the past year, but is expected to deteriorate if interest rates stay high and the labor market slows down.
  • Expense Management: The company is focused on keeping its expenses under control, which resulted in a slight decrease in noninterest expenses during Q1 2024. However, increasing regulatory costs and personnel costs remain challenges.
  • Asset Quality: Net charge-offs (bad debt) were $190 million in Q1 2024, compared to $82 million in Q1 2023, indicating a greater concern over credit losses. Management sees a strong probability of increased credit losses if the labor market deteriorates.

Competitive Landscape The banking industry is highly competitive, with several national and regional players. USB competes with other large national banks such as JPMorgan Chase and Bank of America, and regional banks, as well as fintech firms and online banks. It benefits from a brand name, strong client relationships, and large branch network, but these can be considered a commoditized good in the current financial world. The bank has a reputation as being well-managed, with good employee morale, and a strong customer service reputation that helps it differentiate itself from smaller players. However, given the increasing digitalization and technological changes in the industry, maintaining that position will be a challenge, given the costs that have to be undertaken and the fact that consumers are readily moving to online/mobile banking.

Moat Analysis

U.S. Bancorp’s moat is considered to be 2.5 out of 5, which means the bank has a narrow, but somewhat durable, moat due to the following factors:

  • Scale Advantages: The size of USB’s operations, with its extensive branch network and large balance sheet, creates some scale advantages. These are mostly relevant in the local markets where USB has a high density of branches, and they may be quickly negated through online/mobile banking.
  • Switching Costs: The complexity of moving a large or small bank account creates switching costs, which leads to clients remaining sticky to their current bank. This moat has become weaker, as banking operations have been shifting to become digitally oriented and are available through multiple platforms.
  • Brand Recognition: U.S. Bancorp has a brand name, especially in the midwest, but its brand does not create an economic moat, because consumers are readily willing to choose banks with superior pricing.
  • Long-term Contracts: Certain long-term contracts and established relationships with businesses also provide some moat. However, these relationships are becoming more transactional as consumers are more price-sensitive than before.

These moats are not strong enough to allow USB to consistently generate higher returns than the competition in the long-term, especially considering the increasing digitization and competition in the industry, but should ensure somewhat stable profits.

Risks to the Moat and Business Resilience

Several risks could harm U.S. Bancorp’s moat and business resilience:

  • Economic Downturn: A recession could lead to lower loan demand, higher credit losses, and a decline in fee income, which will erode the company’s profitability.
  • Rising Interest Rates: The Federal Reserve has increased interest rates several times over the last year. A rising rates could lead to higher financing costs, which could erode net interest margin, and could affect the demand for loans.
  • Fintech Disruption: Technology-focused companies have been entering the financial services space, and might challenge the way banking services are offered. They have the potential to rapidly disrupt the traditional banking model.
  • Regulatory Changes: Increased regulatory scrutiny could lead to higher compliance costs, negatively impacting the profitability of the company. In addition, certain rules imposed on credit or lending practices could limit revenue growth or reduce profitability.
  • Cybersecurity Threats: As banking becomes more digital, cybersecurity risks become much more prevalent. A major hack, a data breach or some other issue could erode customer trust and lead to business losses.
  • Increased Competition: Competition in the banking industry has increased dramatically, and it is getting difficult for the existing players to defend their market share from new entrants, especially from those that are digitally oriented and have lower operating costs.
  • Reputational Risk: A scandal, a legal battle, bad employee or customer reviews, or various other incidents could damage the brand name and decrease the customer base.
  • Acquisition Risks: Integration of acquired businesses may present unexpected challenges and may fail to meet the expected synergies, thereby destroying value.

Understandability The business is relatively complex to understand, given the many moving parts (interest rates, government regulations, various financial instruments and economic trends that affect banks), and is given a rating of 2.5 out of 5. It does require a fair degree of business acumen and accounting knowledge to analyze the business correctly.

Balance Sheet Health

U.S. Bancorp’s balance sheet health is relatively good, and is given a rating of 4.5 out of 5. There is strong capital position and diversified loan portfolio. However, certain trends have emerged and may weaken the balance sheet stability if those are not properly addressed:

  • Capital: The company has maintained a healthy capital position, and has reserves that are well above the regulatory mandates.
  • Leverage: The leverage ratio of the company is well in control. However, rising interest rates and potential credit losses from a recession may affect this metric.
  • Liquidity: USB has a solid liquidity position that can handle potential withdrawals from deposits. A reliance on deposits to secure funding may make the company slightly more vulnerable to a liquidity crisis.
  • Loan-loss Provision: Loan loss provision was increased drastically from Q1 2023 to Q1 2024, given worries about the economy. A further increase in provisions could impact the net income of the company in the short term.

In conclusion, U.S. Bancorp is a well-managed regional bank with a somewhat narrow moat that is increasingly vulnerable to changing technological trends and increasing competition. The bank has a good balance sheet and sound financial policies, which should help it navigate any economic turbulence. There are some risks related to a potential recession, rising interest rates, technological disruptions and the changes in the regulatory environment. The stock market, however, may not be factoring in these potential headwinds.