U.S. Bancorp: Get Out Before The Fed Pivot (NYSE:USB)

Sundry Photography U.S. Bancorp (NYSE:USB) beat second-quarter earnings consensus estimates last week Wednesday, despite the commercial bank reporting a 9% decline in its net interest income. I believe, the lender’s net interest income will continue to decline as the Fed gets ready for its rate pivot, which, generally speaking, should make cyclical bank investments less attractive. Considering that shares of USB now trade at a 41% premium to net asset value, I believe the risk profile remains unappealing. Data by YCharts Previous rating I rated shares of U.S. Bancorp a sell in April — Headwinds Persist — because shares went through a major revaluation to the upside in Q4. Additionally, U.S. Bancorp fully recouped its valuation losses that the regional lender suffered during the regional banking crisis of Q1’23 and Q2’23. While the bank delivered a solid earnings sheet for the second-quarter, the regional lender remains fully valued, in my opinion, especially in the context of growing net interest income risks as the Fed gets ready to lower the Federal Fund rate for the first time, likely in September. USB beats earnings, strong bank profitability, but NII is on a downward trajectory U.S. Bancorp topped Wall Street’s average predictions for both its top and bottom line last week: USB’s adjusted quarterly earnings totaled $0.97, beating the consensus estimate by $0.02 per-share while U.S. Bancorp’s revenues came in at $6.84B, beating the consensus prediction by $38M. Seeking Alpha U.S. Bancorp’s second-quarter results had a number of takeaways, including strong core bank profitability, lower credit provisions on a year-over-year basis (which I will discuss further below) and a high-single digit decline in net interest income. As to the first point, U.S. Bancorp remained a widely profitable regional banking franchise: the lender earned $1.5B in the second-quarter, showing a year-over-year growth rate of 19%. The reasons behind U.S. Bancorp’s strong profitability are chiefly favorable macro conditions (moderate U.S. economic growth, low unemployment and also moderating inflation). U.S. Bancorp U.S. Bancorp’s earnings scorecard mainly drew attention because of the lender’s falling net interest income. USB’s NII declined 8.9% year-over-year due to a combination of factors, including the negative headwind of higher interest rates on the bank’s deposit mix/pricing. U.S. Bancorp’s loan assets generated $4.1B in net interest income in the second-quarter, and the lender stated that it sees a similar NII level for the third-quarter. U.S. Bancorp also confirmed its full-year net interest income guidance of $16.1-16.4B, which, at the mid-point, implies a 7% year-over-year drop-off. The longer-term outlook implies a continual, cyclical decline in this core metric, which is why I continue to rate USB a sell. U.S. Bancorp Stable balance sheet quality Favorable macro conditions have resulted in stable credit metrics for U.S. Bancorp and the lender’s balance sheet quality looks solid. The lender reported $568M in credit provisions in the second-quarter, showing a 2.7% increase Q/Q. However, on a year-over-year basis, provision for credit losses declined by almost 31%. U.S. Bancorp The provision trend therefore does not raise any specific red flags for me yet, but as I stated last time, U.S. Bancorp does have a large commercial real estate loan book and the lender could suffer from rising loan defaults the sector doesn’t recover. Office valuations have slumped in the last two years due to weaker income and occupancy metrics, which has been a result of changing work trends (acceptance of remote working) since the pandemic. About 13% of U.S. Bancorp’s CRE loan book consists of offices and the non-performing loan ratio has increased to 1.85% in Q2’24, up 0.14 PP, mainly due to distressed office investments. Going forward, this part of U.S. Bancorp’s portfolio is definitely worth paying attention to. U.S. Bancorp U.S. Bancorp’s valuation U.S. Bancorp is likely fully valued, in my opinion. U.S. Bancorp is trading at a 41% premium to book value and as I clarified in the introduction, USB has limited upside potential in FY 2024 given that 1) Shares have revalued much closer to their longer term valuation average P/B ratio and losses sustained during the regional banking sector sell-off in 2023 have been recouped, and 2) The Fed appears set to lower the Federal Fund rate in the coming months which should lead to slowly growing pressure on U.S. Bancorp’s net interest income and margin. U.S. Bancorp’s longer term P/B ratio is 1.53X while the industry group — including Fifth Third Bancorp (FITB), PNC Financial Services (PNC) and KeyCorp (KEY) — has an average P/B ratio of 1.40X. Since USB is trading slightly above the industry group average P/B ratio, I believe shares are fully valued at $45 and the upside here may be limited, especially in the context of falling Federal Fund rates that are set to limit the earnings power of lenders going forward. Data by YCharts Risks with U.S. Bancorp The biggest near term risk for U.S. Bancorp as well as other lenders with large variable-rate loans on their balance sheets is a continual drop-off in net interest income, which is a key revenue source for banks. The Fed is set to pivot this year, which implies headwinds for banks in terms of their net interest income trajectories. Additionally, U.S. Bancorp’s commercial real estate exposure is worth watching, especially since the lender has a lot of exposure to the troubled commercial real estate sector. Final thoughts U.S. Bancorp delivered a solid earnings sheet for the second fiscal quarter. The bank maintained a high level of core profitability, given favorable macro conditions in the U.S. economy, and the drop in net interest income was expected. The outlook for Q3’24 and FY 2024 net interest income is stable and with the Fed set to pivot in terms of the Federal Fund rate (likely in September), I believe U.S. Bancorp will continue to see falling net interest income in 2025. In my opinion, shares are fully valued, which translates to an unattractive risk profile!

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