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Against the backdrop of a potential recession, U.S. Bancorp CEO Andy Cecere told equity analysts Wednesday that boosting the bank’s capital base is “priority one.”
The adequacy of Minneapolis-based U.S. Bancorp’s capital to withstand financial distress has been a topic of discussion in recent days. The issue was raised April 17 by a Florida investment firm, and it was repeatedly explored by analysts Wednesday during a quarterly earnings call. On Friday, the Wall Street Journal reported that U.S. Bancorp and its peer banks could face tougher regulations from the Federal Reserve.
The scrutiny focused on a statistic called the common equity tier 1 (CET1) ratio. In a nutshell, the ratio is used to compare a bank’s core capital to its risk-weighted assets, so one can determine a bank’s ability to absorb losses during a financial downturn.
“Our common equity tier 1 capital ratio ended the [first] quarter at our target level of 8.5%, and we expect that ratio to expand over the next several quarters as we realize the accretive benefit of recently-acquired Union Bank,” Cecere said in a written statement Wednesday. “The integration is proceeding as planned, and we continue to target conversion over the upcoming Memorial Day weekend.”
Fort Lauderdale-based HoldCo Asset Management criticized U.S. Bancorp in a lengthy April 17 report for having an 8.4% CET1 in the fourth quarter of 2022. Meanwhile, it noted that U.S. Bancorp’s four larger competitors had double digit ratios.
The big four banks had the following ratios: J.P. Morgan at 13.2%, Bank of America at 11.2%, Wells Fargo at 10.6%, and Citi at 13%. “When analyzing only the five largest banks in the nation, U.S. Bancorp’s capital ratios fall significantly short of its largest competitors, including the uncannily similar Wells Fargo,” HoldCo said in its report.
In a press statement, HoldCo disclosed that it owns Wells Fargo stock and that it “holds a short position in U.S. Bancorp through selling short and purchasing put options relating to U.S. Bancorp common stock.”
Despite being systemically important in the nation’s banking system, U.S. Bancorp “has been allowed by the Federal Reserve to hold shockingly low amounts of capital relative to assets,” HoldCo stated.
U.S. Bancorp is classified as a Category III bank by the Federal Reserve, while its four biggest competitors are Category II banks. That distinction is important, HoldCo noted, saying that the largest banks must include available-for-sale unrealized losses in their regulatory capital numbers, but that U.S. Bancorp and other Category III banks were exempted from that requirement in 2019 because of a loosening of Federal Reserve rules.
“If U.S. Bancorp’s common equity tier 1 ratio was hypothetically adjusted today to reflect the inclusion of ‘available-for-sale’ unrealized losses in regulatory capital, its resulting common equity tier 1 ratio would fall below the Fed’s own mandated CET1 capital requirement of 7% and it would rank as having one of the lowest such ratios of large and small traded banks,” HoldCo said in a written statement.
“Following the completion of our acquisition of Union Bank, our CET1 capital ratio declined from 9.7% at the end of the third quarter of 2022 to 8.4% as of Dec. 31, which reflected the impacts of balance sheet optimization and purchase accounting adjustments that will accrete back into capital over the next few years,” Terrance Dolan, U.S. Bancorp CFO, said during an earnings call Wednesday.
Dolan told analysts that U.S. Bancorp is prepared for multiple economic scenarios. “If you end up looking at the consensus in the marketplace, some form of recession, probably a softer or moderate sort of recession [will occur] late this year, early next year,” he said.
At the end of the first quarter, U.S. Bancorp had assets totaling $682 billion. When it reaches $700 billion, it would move from a Category III to Category II bank and face stricter regulations by the Federal Reserve.
Under current asset rules, Dolan estimated that U.S. Bancorp would become a Category II bank “no earlier than the end of 2024.”
Federal Reserve weighs tougher regulations
However, the Wall Street Journal reported Friday that the Federal Reserve is weighing whether to close a loophole that allows midsize banks to “effectively mask losses on securities they hold.” Large U.S. regional banks, including U.S. Bancorp, currently don’t have to include unrealized gains and losses for securities considered “available for sale” in their capital ratios.
The Federal Reserve is contemplating more stringent regulations in the financial services sector following the March collapses of Silicon Valley Bank and Signature Bank.
U.S. Bancorp and other regional banks might need to boost capital if the Federal Reserve changes its regulatory framework. The Wall Street Journal reported “that could prompt steps such as trimming buybacks, retaining more earnings or raising new capital from investors.”
During Wednesday’s quarterly earnings call, CFO Dolan told analysts: “We feel pretty confident that we don’t have to go through a capital raise.”
Relating to buybacks, Cecere said, he anticipates regulatory changes affecting capital positions. “We’re not going to do anything until we have more clarity around that, which we hope to have in the second half of the year,” Cecere said. “But the focus on getting to the appropriate capital levels as quickly as possible, accreting capital, and building that capital base is priority one.”
Cecere expects U.S. Bancorp will exceed 9% for its CET1 capital ratio by the end of 2023. “We were well above 9% and came down to 8.4% as a result of the Union Bank transaction,” said Cecere, who also serves as the organization’s president and chairman.
“We’re going to learn, with respect to exactly how moving to Category II and the inclusion in unrealized losses gets incorporated into the CCAR process,” Dolan said, referring to the annual Comprehensive Capital and Analysis Review conducted by the Federal Reserve to assess a bank’s capital position.
“We have a pretty significant amount of buffer that already exists just based upon our credit performance and our PPNR [pre-provision net revenue] performance because of the earnings capacity,” he said.
Dolan reported that the bank’s available liquidity was $315 billion as of March 31.
U.S. Bancorp made several financial moves in preparation for completing the Union Bank acquisition. “We repositioned our balance sheet by selling fixed rate loans and investment securities, paid off borrowings, and increased cash balances in response to economic uncertainty, industry dynamics, rising interest rates, and increased market volatility,” Dolan said.
