Investment Thesis – US Bancorp

Warren Buffett / Charlie Munger’s Four Filters + Risk Factors

  1. Understand the Business
  2. Enduring Competitive Advantages
  3. Able and Trustworthy Managers
  4. Risk Factors
  5. Bargain Price = Margin of Safety (I will not explore this as everyone should devise their own fair value)

1. Understand the Business

US Bancorp engages in 4 businesses:

2. Enduring Competitive Advantages

US Bancorp’s Competitive Advantages stem from the following sources:

  • Low Cost Efficiency Ratio
  • High Asset Quality
  • Well-Capitalized
  • Low Derivative Exposure

Low Cost Efficiency Ratio, High Asset Quality and Well-Capitalized constitutes a positive reinforcing cycle:

US Bancorp Business Model.png

By being cost efficient, US Bancorp is able to be well-capitalized (retaining liquid capital that isn’t lent out) whilst being profitable. This ensures US Bancorp can play in the game of lending to companies with great credit rating and only engage when the interest rates are good since US Bancorp would still be profitable even at the extremely low interest rates that US Bancorp can charge to these companies whilst US Bancorp can afford to not make loans if it doesn’t make business sense.

By statistics, companies with great credit rating default much less than those without, which thus builds resilience to profitability as US Bancorp is expected to keep raking in the net interest income regardless of economic cycle.

This then further drives / maintains the low cost efficiency ratio since as long as expenses don’t increase faster than growth of profits, the resilience in profitability allows for the profit side of profit / expense to drive / maintain the cost efficiency ratio down.

I further deem having a low derivative exposure to be another key competitive advantage. The reason is simple, it’s extremely hard to decipher the real value of derivatives on a balance sheet, so the more derivative exposure a bank has, the higher the catastrophe risk. Whilst competitors are potentially blowing up left and right, US Bancorp’s low derivative exposure allows it to stay profitable throughout economic cycles.

And when you look at the derivative exposure of the Top 5 US Banks in Asset Size, you’ll understand what I mean by US Bancorp having a low derivative exposure:

Rank – Bank – Asset Size – Derivative Exposure $ – Derivative Exposure X

1 – JPMorgan Chase – 2.42 trillion48.76 trillion – 20.1x

2 – Bank of America – 2.15 trillion40.20 trillion – 18.7x

3 – Citigroup – 1.77 trillion53.47 trillion – 30.2x

4 – Wells Fargo – 1.75 trillion5.83 trillion – 3.3x

5 – US Bancorp – 0.42 trillion0.18 trillion0.4x (!!!)

3. Able and Trustworthy Management

Ever since former CEO John F. Grundhofer brought Wells Fargo’s playbook of simple banking, disciplined loan underwriting, and low cost efficiency over to US Bancorp in 1990, he and his successor Richard Davis has been diligently focusing on 5 priorities only:

And the results demonstrate management’s ability, since US Bancorp is now the best US bank in terms of ROA, ROE, Cost Efficiency Ratio, and 2nd place in terms of Charge-Off Ratio.

US Bancorp’s track record also demonstrates management’s trustworthiness of focusing on its 5 priorities over the 20+ years as US Bancorp has stuck to growing 4 pretty much the same core businesses, driven down cost efficiency ratio to be the best, never exceeded 2.4% net-charge offs even during 2008=2009 financial crisis, improved credit rating to be the best, and kept all of the aforementioned metrics on target whilst acquiring many institutions.

4. Risk Factors

I find US Bancorp to be extremely low risk if risk is defined as destroying shareholder value.

There are however 2 ways I can see US Bancorp destroying shareholder value.

One way is if US Bancorp starts destroying shareholder value is if it abandons its current 5 priorities. As long as it suddenly decides to change direction in just one of the 5 priorities (eg. aggressively grow investment banking business or being less disciplined in cost control, asset quality, being well-capitalized and acquisitions), then the positive reinforcing cycle mentioned above will fall apart. The scary part of this is that any change in culture will be hard to observe, so being tipped off by a delay in deterioration of metrics could already be too late as there’s going to be a delay between cause and effect.

Another way is pure bad luck. US Bancorp for all its conservatism could still be ruined by large scale debt defaults since it is currently 9.8x leveraged [1]. This is always an inherent risk that comes with the banking business.

As a result of these two key risks, I would at most allocate a 1/3 position size to US Bancorp based on Charlie Munger’s diversification rule of “In the United States, a person or institution with almost all wealth invested, long term, in just three fine domestic corporations is securely rich“.

[Footnotes]

[1] Reference – https://infogr.am/bank_comparison-4

14.3% ROE and 1.46% ROA implies 9.8x leverage as only through that leverage is US Bancorp able to juice up returns from 1.46% to 14.3%.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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