U.S. Bancorp: Strong Acquisitions & Partnerships Grow Core Business

Investment Thesis

U.S. Bancorp (NYSE:USB) is primarily a large U.S. (United States) regional bank with $601 billion in assets. USB operates 2,205 depository branches, mostly concentrated in the central and western U.S., and offers investment and corporate services throughout the U.S.

Full year 2022 guidance is revenue up 6% compared to FY21, with core expenses increasing in 4Q22 by 2% due to the acquisition of Union Bank. Once the integration of Union Bank is completed, USB expects a low double-digit increase in EPS. Additionally, USB has been increasing its footprint through partnerships with State Farm, a strategic acquisition of the payment system Talech, and an increased online presence. The shift toward a more online mix has significantly reduced operating costs while increasing revenue.

Due to higher interest rates, interest income should bulge, offsetting the fee decreases from fewer new lending activities. Additionally, the labor market remains strong despite quantitative tightening and persistent macroeconomic sensitivity. This should lead to less-than-expected delinquencies in the loans on the balance sheet. Due to its recent expansion and high return on equity, we believe that USB makes a compelling dividend income investment.

Estimated Fair Value

EFV (Estimated Fair Value) = E23 EPS (Earnings Per Share) times P/E

EFV = $4.75 x 11.0x = $52.25.

Our P/E calculation is in the middle of the typical 9-13x, at which regional banks usually sell depending on investor sentiment and economic conditions.

Union Bank Acquisition

USB completed the acquisition of Union Bank on December 1, which meaningfully increased the branch footprint in California and improved its California bank size ranking to the #5. In addition, the acquisition increased average deposits per branch by 60% in California.

At the cost of a one-time $1.4 billion transaction, deposits will increase by $85 billion, and loans will increase by $53 billion. This will translate to $900 million in net revenue by 2024, increasing core expenses by only 2%.

The transaction will add 190,000 business customers, 700 commercial customers, and over 1,000,000 individual customers. As a result, EPS is expected to get a low double-digit boost at full integration, with an 8% increase into 2023.

Operations

Consumer Banking has benefited from increased digitization and from partnering with State Farm. USB now offers depository and credit services to State Farm customers. In 2020, State Farm and USB announced that USB would be assuming control of State Farm’s deposit and credit card accounts. Later this partnership would extend to further banking products. When this was announced, State Farm Bank had $11.2 billion in deposits and $1.5 billion in credit card accounts across an undisclosed number of customers. 80% of these accounts are new customers, with 50% being outside the geographic footprint of USB.

For Q3 2022 year-over-year, consumer mortgages are up 13.4%, and credit card balances are up 10%. In addition, with consumers seeking to take advantage of higher interest rates, interest-bearing deposits are up 13.3%, offsetting the decrease in non-interest-bearing deposits.

USB’s business banking division purchased Talech in 2019. Talech provides point-of-sale and accounting systems for restaurants, retail, and service companies and has increased its own customers by 540% since 2020. Across USB’s 1.1 million small business customers, only 29% utilize payment services providing a nice target for Talech expansion. Business customers using both payments and business banking increased 7% year-over-year, and new relationships grew 4% over the same period.

Commercial and Large Corporate accounts make up an increasingly large portion of USB customers. A key driver is RTP (Real Time Payment) technology which allows banking transactions to settle almost instantly, rather than ACH (Automated Clearing House), which can take as long as 3 days. RTP transactions make up an increasing portion of corporate transactions, with RTP transactions increasing by 1700% since FY20. The increase in RTP transactions has also helped increase the fees gained from corporate customers by 21.8% year over year. Commercial loans on the balance sheet have increased 26.2% year over year to $128.5 billion.

USB has benefited from increases in digital activity from customers. Since 2020, mobile app usage has increased by 16% with 82% of USB’s customers engaging with the firm online. As a result, digitized deposits and withdrawals now make up 82% of all transactions. Additionally, 62% of loans are now made online or through the app rather than in a branch location. This has allowed USB to close around 1,000 branches with insignificant loss of customers.

Financial Performance

For 3Q22, net interest income increased 20.6% year-over-year. However, noninterest income decreased by 8.3% year-over-year, primarily due to losses on the securities portfolio and decreases in consumer mortgages and refinancing activity.

Non-performing assets are down 28.3% year-over-year, indicating a healthier environment in the commercial banking sector. In addition, delinquencies declined 13 basis points year over year to 0.3% of all loans.

US Bancorp	E2022	E2023	E2024
Price-to-Sales	2.9	2.4	2.4
Price-to-Earnings	10.7	9.3	8.5

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Risk

Inflation is the primary risk to USB and most financial companies because the assets they own are priced in nominal dollars and go down in real value with inflation.

Higher rates are a double-edged sword that allows for higher interest income but is being at least partially offset as depositors move from interest-free deposits to interest-bearing deposits. While we expect net interest rates to improve, competitive pressures from potential bidding wars on interest-bearing deposits need to be monitored.

Conclusion

With interest rates on the rise and the labor market remaining persistently strong, some of the banking sector’s major risks (in this case, interest rate sensitivity and default risk) have been greatly reduced. Even during this economically uncertain time and period of quantitative tightening, expansion is still on the books for USB. USB has begun expanding its footprint geographically and in the services it offers. We believe that U.S. Bancorp makes a compelling dividend income investment, likely continuing to pay out its current yield for the foreseeable future. For these reasons, we rate it a buy at this time.