Sunday, April 22, 2018

Guest Post: Financial Markets and Economic Update by Dorothy Jaworski

The Long Winter
I’m writing this in April, during the winter that is taking forever to end.  We braved the cold of December and January, were teased with some warm days in February, and then found ourselves in March, with its four nor’easters, cursing the snow each week and shivering in the cold.  We have had quite enough!  And I’ve said it before, that snow covered roads and potholes destroy productivity.  I’m sure we won’t get much sympathy from places like Chicago, Buffalo, and Erie, but they signed up for winters like this, not us here in Philly.  Only one thing made winter bearable this year- the fact that the Eagles won Super Bowl LII and the celebrations began.  Now, if Mother Nature would cooperate…

Volatility
The markets have been incredibly volatile in the first quarter of 2018.  This may be the understatement of the year!  The spike in volatility was a wake-up call to every investor and market participant that thought “vols” would stay historically low forever.  Welcome to 2018!  Stocks, bonds, and commodities spike up and down in large percentage changes almost daily, leaving investors wondering what is next.  Nearly everyone expects periodic market corrections, but no one expected to have whiplash!

What prompted volatility to rise so much?  The first sign that markets were about to be rocked was an inflation scare concerning wages in early February.  Wage growth was reported at +2.9% on a year-over-year basis.  Wow!  The Federal Reserve thinks unemployment is too low, which could lead to higher wages and inflation, and they are raising rates.  Aren’t they proven right?  Stocks fell dramatically, rose, fell, rose, fell, rose, well, you get the idea.  Hundreds of points in price changes in the Dow Jones Industrial Average got headlines every day.  Several unusual hedge funds that were based on market volatility levels collapsed, most notably funds from Nomura and Credit Suisse, leading to 90% losses for those “investors.”  Who even knew they were there? 

Alas, inflation was not to be- not yet, anyway.  The year-over-year wage growth fell back in March and April to +2.6% to +2.7%, closer to where it had been in 2017.  This only gives proof that the Fed is still looking at the Phillips Curve (unemployment-inflation tradeoff) to set policy.  During March, we also had the opportunity to see new Fed Chairman, Jerome Powell, in action.  He gave a press conference and was confident and concise.  He is a man with financial markets experience and should understand the effect of Fed policy on the markets.  His recent predecessors were academics.  During March, 2018, Powell and the Fed increased rates by .25% for the sixth time since December, 2015.  Chairman Powell reiterated continued slow and steady rate increases.  At some point, and I believe soon, the Fed will pause.

Tech stocks added to the volatile environment during the past few months.  Facebook continues to be whipsawed and other major names like Google, Amazon, Netflix, and Microsoft fell in sympathy with their social media favorite.  Volatility continued when the Trump Administration announced tariffs on steel and aluminum imports, mostly directed at China, who responded in kind by slapping tariffs on 125 products exported by the US.  The markets hate the idea of tariffs and the trade wars that can be a result and the market price action reflects it. 

The Economy
All indications are that the economy will continue to improve, albeit slowly and at a lesser pace than that of previous recoveries.  Tax cuts are adding stimulus and leading to improved business and consumer optimism, but there are some offsetting factors in the form of Fed tightening, low productivity, and large levels of debt, especially at the federal government as they fund what could be a $1 trillion plus deficit this fiscal year.  Fourth quarter GDP was +2.9% and was +2.3% for all of 2017.  In March, 2018, the Fed revised their GDP forecast for all of 2018 to +2.7%, which is hardly worth writing home about compared to growth in 2017, but is still at a level that I consider to be sustained.  When GDP growth is stuck in the 2s and overall inflation is around the Fed target of 2%, raising interest rates too much can lead to an unhappy ending.  Not only are short term rates rising, but long term ones did, too, in response to the inflation scare and the Fed unwinding some of their balance sheet investments.

Housing, construction, and the auto industry are projected to do well in 2018, as long as rates do not rise too much or too rapidly.  Don’t get me wrong, the US economy is doing well, given the environment and volatility and is expected to outperform Europe and Japan.  Consumer spending and retail sales have shown weakness since the fourth quarter of 2017 but we should see improvement.  Gas prices remain below $3.00 per gallon, adding to a positive consumer spending outlook; let’s hope prices do not rise too much into the summer travel season.  Businesses should do well as they bask in the lower corporate tax rate, which fell from 35% to 21% at the beginning of 2018.

National housing indices continue to rise by +6% on a year-over-year basis and are projected to rise at least +5% during 2018, provided that long term mortgage rates do not spike and cut off demand.  Locally, Bucks County has seen its best year-over-year increases in the last two quarters of 2017, rising +5% and +6%.  One factor that is impacting prices is limited supply compared to prior years.  In many cases, inventories of unsold homes represent three to four months’ worth of sales, compared to a more normal level of six months. 

The Federal Reserve Beige Book is released in advance of the Federal Reserve meetings.  The recent March, 2018 report for our Philadelphia Region was overall quite positive; the words “modest” or “moderately” were used 16 times on two pages.  The implication is that the economy here is okay and still growing.  The Philadelphia Fed’s Business Outlook survey confirms this, with most of the survey results positive.  And most of all, it is a great time to be a Philadelphia sports fan!  The Eagles won the Super Bowl, bringing joy to fans who were experiencing their first Super Bowl win for their city in their lifetimes.  Villanova won the NCAA title again, the Sixers just completed a 16 game winning streak to end the regular season and have made the playoffs, the Phillies have been hitting lots of grand slams and show promise, and the Flyers made the playoffs, however faltering in their first game but it is a long series, as they say… 


Thanks for reading!  DJ 04/12/18







Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Thursday, April 12, 2018

Consumer Lending: Should Banks Do It?

We’re running out of assets.

When I first read Standards Needed for Safe, Small Installment Loans from Banks, Credit Unions by the Pew Charitable Trusts that encouraged financial institutions to get back into small ticket consumer lending, I thought “what are they nuts!”

Consumer loans for those banks that utilize my firm’s outsourced profitability reporting service lost (0.26%) as a percent of the average consumer loan portfolio in the fourth quarter. And it wasn’t an anomaly. Ever since we formed our company in 2001, this has been the case.

Sure, home equity lines of credit made 0.71% for the fourth quarter. But it was the only sub-product that showed a profit. Fixed home equity loans… nope. Indirect loans, unsecured personal loans? No and no. So why would banks expand small-ticket, unsecured personal lending?

Because we’re running out of assets. Pretty soon we’ll be left with small to mid-sized business loans and commercial real estate that isn't big enough for large banks or conduits. And there are FinTechs, loan brokers, insurance companies, and investment funds chipping away at them.

Mortgage lending is getting away from us. Mortgage bankers and brokers own a significant share of market (although less than prior to the 2007-08 financial crisis). And Quicken Loans is in the top 5 HMDA market share in nearly every market we analyze. Oh, and Quicken is hammering away at home equity lending too.

We lost auto loans to the indirect market. Who comes to our branch for a car loan today? If we don’t consider how we intend to defend our small business and CRE lending, and re-enter some of these other loan markets, we may end up as a balance sheet for hire. Which we already do via buying mortgage back securities and using loan brokers in metro areas.

Are you ready to be Web Bank, part deux?

So I reconsidered my knee-jerk reaction to the Pew Charitable Trusts report. Most community financial institution strategies has some sort of “community” focus. It’s implied whenever someone says “we’re a community bank”. Which nearly everyone does. Even the big banks. So maybe we should put some moxy behind those words. Profitable moxy, though. Not charitable moxy.

Why do consumer loans consistently lose money? Looking at our peer group numbers, the consumer loan costs a little above $1,100 per year in operating expense to originate and maintain. Expensive. This is a fully absorbed number. Meaning that all bank resources that are dedicated to the consumer loan function is fully allocated to the product, whether they are being used or not. And recently, they have not been used.

For example, there is a fair amount of branch expense in that number, because branches are typically responsible for originating those loans, and participate in their maintenance. If we got rid of consumer loans, that expense would migrate elsewhere. And if we are not originating new loans, then resources dedicated to origination, such as branch staff and credit, for example, are dormant but must be paid for by the existing loans in the portfolio.


Four Ways to Bring Back Consumer Loans, Drive Volume, and Increase Profits


1.  Make consumer loans more than an accommodation. Not many financial institutions consider consumer loans as a strategically important product group that will drive growth and profitability into the future. Perhaps it is because of the hurdles to achieving meaningful growth and market share. Or the competitors that wedged themselves into the dominant market position. But if executive management and the Board aren't committed to pursuing consumer lending to be more prominent on your balance sheet, then you will not succeed.


2. Align your credit culture and risk appetite to be successful consumer lenders. It is not lost on me that the last bastion of consumer lending at banks is home equity loans. Real estate secured. Hard collateral. Relatively low charge-offs. It is difficult to change that mindset when doing loans with little to no collateral, such as small ticket consumer or credit cards. Charge-off rates of 4%-5% with no collateral? Yes. Get used to it (other than home equity). Or don't do it.


3. Drive down costs. Regulation has driven up costs and made us gun shy. But we can't continue to put $1,100 of resources per year into a consumer loan. Especially if the loan balance is $2,500. How can we possibly make money on that? We can't. The ABA recently conducted a survey on the State of Digital Lending (see chart) that said that, although consumers were happy with how smooth and quick online lending decisions were made, online lenders only received a 26% approval rating, versus 75% for banks. Driving more volume will drive down costs by putting under-utilized resources to work, and digitizing end-to-end will reduce the amount of resources needed for consumer lending. 


4. Price right. Even if banks cut the cost of originating and maintaining consumer loans in half, to $550, what rate will they have to charge to make a reasonable profit? Let's say a reasonable profit is a 1.5% pre-tax profit as a percent of the portfolio. And the non-home equity portion experienced a 4.5% charge-off rate. And the cost of funds for such lending is 1%. If the average loan size was, say, $3,000, the bank would have to charge an effective yield of 25.3% (($550/3,000)+1%+4.5%+1.5%). Those rates get the scrutiny of do-gooders and "champions of the people" that could cause negative press. And keeps community financial institutions out of this business. Take note Pew Charitable Trusts. However, knowing this math, the bank can work at pressing the levers needed to do this lending profitably, at the right price, that benefits borrowers and the banks. And keeps those borrowers out of the hands of the sharks that prey on their misfortune.


Should we give up on consumer lending?


~ Jeff


Saturday, March 31, 2018

A Time of Reckoning for Your Bank's Core Deposits?

Bye-bye municipal deposits. 

So worries New Jersey Banker's Association CEO John McWeeney since state-owned bank advocate Phil Murphy was elected governor. The state's municipal deposits approximate $20 billion, $13 billion of which are in community banks. A significant source of liquidity.

I got news for you John. We might lose municipal deposits regardless.

And we might lose a lot more than municipal deposits.

According to the Investment Company Institute, money market funds stood at $2.8 trillion this week. And as the chart below shows, these funds are typically paying more than double the community bank money market account rate. 


These rates were at March 29, 2018. I used Wells Fargo because it is a money market fund that I use. By default. When they bought Strong Asset Management. Marcus is Goldman Sachs online bank. FDIC insured. And Mid Penn Bank is a $1.2 billion in assets financial institution based near Harrisburg, Pennsylvania. I had to call Mid Penn for their rate. It is a tiered money market, and the 0.55% is their top tier for accounts greater than $50,000. The next lower tier is 0.35%. 

Mid Penn boasted about their cost of deposits and funds in their 2016 annual meeting investor presentation (pages 21-22). They currently have a 0.58% cost of funds. Can they maintain it? Will their ALCO model betas prove true? Or will customers demand they bridge the rate gap, so vividly portrayed above?

My colleague recently sent me a link for meetbeam.com, a soon to be released banking app that boasts a 2%-4% rate for your cash, FDIC insured (they are partnering with a bank). They haven't launched. But they have over 76,000 customers that signed up already. Could some be your customers?

In strategy sessions the past couple of months, I'm hearing more bankers talk about pressure from large depositors on rate. The old arguments are starting to play out. Not bringing large deposits with their loan deal because rates are too low. Municipalities hemming and hawing. Will the traditional retail and small business depositor be next?

There is an inflection point where our Rip Van Winkle bread-and-butter depositor will wake up to think "hey, I'm getting screwed by my bank!" What sized rate gap will trigger it? I don't know. I'm no futurist. The above rates are still below the inflation rate. So keeping money in any of those accounts will result in a real decline in value. Do you know where your customer inflection point is?

Because a business model based on the sleepiness of your depositors is unsustainable. 

Are you feeling the pressure yet?


~ Jeff




Saturday, March 03, 2018

Bankers and Strategic Bets. A Slow Embrace.

There are a lot of crazy ideas out there in banking causing us to think... "remember when such and such ridiculous idea was the new craze?" And we would laugh, continue to drink our cocktail, and lament that another financial institution threw in the towel to merge with a bigger brother.

That's what I thought about while reading a recent Financial Brand post about Innovation in Banking: Killer Ideas? or Idea Killers? More talk about fintech, dinosaur bankers, and flavors of the month.

But their animation caught my attention. And it stirred images of a few strategic planning sessions I have moderated. Much to my chagrin.


How do we balance strategic direction, customer demand, and the futurist or wildly over-caffeinated millennial that tells us we have to implement every shiny new object or we'll die?

Six years ago I asked in a blog post Will Plain Vanilla Kill Community Banking? Did I get caught up in the change-or-die crowd? Was I, gulp, a futurist? When I wrote that post in January 2011 there were 7,700 FDIC insured financial institutions. Today there are less than 5,700. A 26% decline. Was I a futurist?

This brings me to the subject of Strategic Bets. They can be a strategic shift of your franchise, a new product line, or a new operating environment. Something you are not doing, will require some investment to do, and risks failing miserably. Bankers are slow to embrace strategic bets, opting for tweaks to business as usual. Which runs the risk of making the cartoon above become a reality.

Let me highlight some strategic bets for you. In the above blog post, I discussed Apple and Bank of New York Mellon.

Sticking with the Apple theme, in 2007, they launched the iPhone. Here was a personal computer company that decided... "mobile phones, yeah, mobile phones". Much like they did "digital music, yeah, digital music. Thanks Napster!" in the early 2000's. 

How about Amazon? When they started in 1995, they sold books. Maybe those millennial futurists don't remember this. Online book stores. Competing with Barnes and Noble and Borders? In 1998, they decided "why don't we sell everything online?" And boom! Now my friend orders toilet paper through Amazon Prime.


The iPhone represents 62% of Apple sales. Didn't even exist in 2006. Physical stores grew from nothing to 3.3% of Amazon sales and is likely to grow. Because Amazon, with their culture of online sales and fulfillment, had that strategic bet meeting where they agreed "new-fangled brick and mortar store, yeah, let's do that." 

Some other strategic bets that have the chance to transform or have transformed a company:

Pepsi - I listened to a podcast where Indra Nooyi, their CEO said they are focusing on their "healthy for you" line. Pepsi? Also, they are developing female friendly snacks. Apparently females like snacks that don't crunch loudly or leave a residue on your fingers, and fit into a purse. 

Overstock - Announced this year they are getting into Robo Advising. They have a heavily female customer base, and see opportunity to build an offering attractive to those that visit their stores and online space.

Leader Bank - A $1.2 billion in assets Massachusetts bank developed Zrent so it's landlord customers could more efficiently collect rent from tenants. The bank now licenses the product to other financial institutions.

SunTrust - Developed Lightstream, a national online lending platform to provide consumer loans for practically any purpose. It's proprietary technology gives consumers a virtually paperless experience. 


I think there are enough examples of strategic bets transforming businesses. Combined with the alarming rate of those that don't take strategic bets deciding to sell, shouldn't you be thinking about calculated strategic bets that could become a significant part of your future success?


~ Jeff

Wednesday, February 28, 2018

A Bank Consultant Is a Road Warrior: So Here Are My 3 Driving Pet Peeves!

To the followers that spend a lot of time in your car, I'm with you! Most times it can be a relaxing time to listen to podcasts, sports, or relaxing music. Sometimes, though, it's blow-your-top nerve wracking!

In the below video blog, I highlight my Top Three Road Warrior Pet Peeves! Not a banking post. But, hey, it's my blog, and perhaps you would be interested to peel back the onion on what makes me tick, even if it's about my pet peeves.

What are your Road Warrior Pet Peeves? Leave me and the rest of the readers a comment!


~ Jeff




Note: If you like podcasts and banking, try my firm's podcast, This Month In Banking!


Saturday, February 10, 2018

For Banks, Acquire or Be Acquired Is a Hobson's Choice

Bank Director recently held their Acquire or Be Acquired (AOBA) conference in the Arizona desert. It is a well run, well attended conference. When not there, which I wasn't this year, I follow the hashtag on Twitter. But the title of the conference bugs me. It's a Hobson's Choice.

According to Wikipedia, which is how I might have written college papers had it been available, Thomas Hobson was an English horse stable owner that gave buyers the choice of taking the horse in the closest stall or none at all. Translated to AOBA, merge or die.

But is that your choice: acquire or be acquired? What if, I don't know, you want to execute your strategic plan without merging?

I often say that "it all comes down to a spreadsheet". It doesn't mean that I wish it so. I want financial institutions to build an enduring and independent future. For the benefit of their customers, communities, and employees. If you have accepted shareholder money, i.e. you are owned by stockholders, you must also function for their benefit. One reason for the continued decline in the number of financial institutions, in my opinion, is the lack of balance in serving constituencies. 

Ignore one constituency to focus on another leads to problems, or the lack of alternatives, i.e. Hobson's Choice. AOBA.

So here is how I propose you work your strategy for the benefit of constituencies while keeping your eye on shareholders at the same time.


Strategy and The Option to Sell

Build a strategic plan that is aspirational. Shoot to become the financial institution you want to be. Identify it, and set strategy to achieve it. When you target such a future, which should benefit all constituencies, develop financial projections on what success would look like, in financial terms, if you nailed it! 

How far out should you project? As far out as you estimate it would take for the full economic value of your plan to play out. This could be three, four, five or even more years. Long term projections allow management teams to make strategic investments to build an enduring future. Budgets allow management teams to think short term, and delay strategic investments.

Naturally, I have a spreadsheet for you from our hypothetical banking company, Schmidlap Bancorp. 



Full disclosure, I used Evans Bancorp in Hamburg, NY. A well run, $1.3 billion in assets financial institution near Buffalo. They are not a client, so I know no inside information about the bank. Although the base period are their 2017 numbers, the projections are my own, not theirs. But I will refer to them as my hypothetical bank name.

Schmidlap's strategic plan includes near-term strategic investments that will adversely impact their earnings in Years 1 and 2. Their strategy is to achieve a 1%+ ROA in four years. Their plan has them achieving their aspiration.

The board and management team, in balancing their duty to shareholders, developed the present value per share of implementing this strategy. The table above shows the per share results. Schmidlap currently trades at 18x earnings, and their per share price was $40.70 at last close. If they execute this plan, and maintain an 18x earnings multiple, then the present value of executing this plan is $42.97 using a 10% discount rate. Perhaps you think this is uninspiring. But we are discounting results by 10%. So this plan should result in a 10% plus compound annual growth rate in their stock price if they succeed. Note that Schmidlap pays a 2% dividend yield. So the annual total return of this plan would be 12%+, all things being equal.

Not too shabby. 

But wait. An investment banker presents to the board that Schmidlap could reasonably achieve $46 per share in a sale. A 13% premium to their current stock price of $40.70, and a 7% premium to the present value of their strategy. This is termed the "strategy gap". If the gap is beyond board tolerance levels, management could revisit their strategy and sharpen their pencils, seek a downsteam merger partner to stoke earnings growth, or some combination. If they can't bridge the strategy gap, then perhaps a sale is in their future. And the investment banker smiles.

Hold on though. By remaining independent, and assuming management does not do wild things to materially elevate risk, Schmidlap maintains the option to sell into the future if they are not successful in executing their strategic plan. In most instances you can achieve a premium in a sale due to the synergies of the combination with a buyer. The oft-cited "cost savings". 

But what is the value of that "option to sell". I have ideas, and they are in the spreadsheet below.


If, in year 4, Schmidlap was not able to achieve their strategy, and they decide to sell, the buyer and Schmidlap would split the benefit of "synergies". In the accompanying table, by 50% although merger negotiations may be more or less. In addition, those added earnings are tax effected, and a terminal multiple applied equal to the difference of Schmidlap's trading multiple, and the multiple currently prevailing if Schmidlap were to sell (23x minus 18x). This yields a per share value of Schmidlap's option to sell at $3.82.

So, the present value of Schmidlap's plan, if including their option to sell, is $46.79 ($42.97 + $3.82). And exceeds what they can reasonably achieve in a sale. 

Since strategic plans and merger multiples will always be estimates when a board makes a decision, I do believe there ought to be reasonable tolerance levels of the strategy gap. For example, if the above math resulted in less than $46, should Schmidlap sell? Probably not if within a board specified strategy gap tolerance level, such as 5% to 10%. There is so much uncertainty in predicting the future, and the bank is operating for customers, employees, and communities in addition to shareholders. 

But ignoring shareholder value... as one of my Navy captains once said, bad news doesn't get better with age.

And the AOBA false choice will be your only choice.


Do you apply these principles in strategic planning?


~ Jeff


Saturday, February 03, 2018

The State of Banking

Where are we and where have we been? Trends are telling. In 2013, there were 6,812 FDIC-insured financial institutions. At September 30, 2017 there were 5,737, a 16% decline. There were 166 mergers, and four new charters in the first three quarters of 2017. As an industry, the trend is down. Ski slope down.

What about the financial performance and condition of our industry? The Presidential State of the Union address was supposed to report to Congress the Administration's view of the condition and performance of our country. It has turned into a sea of words amounting to nothing more than a wish list and priorities. Because the nation's balance sheet and income statement is not improving.

But what of banking? 

I broke down banking's financial condition, performance, and trading multiples into thirteen charts, seen below. Charts 1-6 are financial condition trends, 7-10 are financial performance, and 11-13 are trading multiples.

The numbers are medians from all publicly traded financial institutions between $1 billion and $10 billion in total assets. That yielded 291 total institutions, broken down by region. 

Financial condition ratios are promising. So I will say to you that the condition of the industry is strong. Assets, Loans, and Deposits continue to grow, although at a more moderate pace. And capital ratios have held steady and strong. In fact, if you listen to some institutional investors, the industry is over-capitalized. Many view an 8% leverage ratio as the "right" number. Although this should depend on an institution's risk profile and growth trajectory. And I have never heard a regulator say the phrase "over capitalized".

Non-performing asset ratios are in a long term downward trend. They have leveled off in the 60-80 basis point range. Some regions are experiencing slightly elevated non-performers from the previous year. A trend to watch.

The challenge with industry balance sheets is that loans have grown faster than deposits over the past few years. And loan/deposit ratios are steadily increasing as liquidity positions steadily decrease. Many bankers are less concerned about this citing their access to wholesale funding to bridge any shortfalls, or that they have been mopping up excess liquidity.

But rates have been rising slowly, and I believe Fed rate increases will accelerate this year, perhaps crossing the rate threshold where depositors now care what you pay them, and dooming those Betas in your ALCO assumptions to irrelevance. My opinion is that one or two more rate increases will trigger more skirmishes on the deposit battlefield. Those that have not positioned their bank to have strong liquidity will have to compete, giving back deposit mix gains they have worked so hard to achieve.

Net interest margins have leveled off from long-term industry declines. Good news! In 2017, NIMs ranged from a high of 3.8% in the West and Southwest, to a low of 3.1% in the Northeast. Are these anomalies due to region, competition, or business models? I would argue a mix of all three. But if I were a Northeast bank, I would ask why other regions achieved between 3.5%-3.8% NIMs and we're at 3.1%. That's a tidy sum to leave on the table.

Efficiency ratio trends look fantastic! And since NIMs are holding steady, it leaves me to think that operating expense control or increased profitability in fee-based businesses are at work. Based on my firm's experience with the profitability of fee lines of business, I am guessing the former. As balance sheets grow, operating expenses grow less, creating greater efficiency. Positive operating leverage!

Both ROAA and ROAE declined 2016-17, although efficiency is better. So what doesn't the Efficiency Ratio measure? Provision, and income taxes. Most of the institutions, if not all of them, probably took a Deferred Tax Asset (DTA) writedown in the income tax line item, impacting these bottom line ratios. But this probably doesn't account for all of the decline. Are assets growing faster than profits, therefore reducing ROAA? Is equity accumulating faster than an institution's ability to deploy it, therefore reducing ROAE? Or, is provision expense up throughout the industry. I believe a combination of the three. But if provision expenses are rising, credits could be moving from pass, to watch, to substandard, and onward. Take note.

Trading mutliple trends are jolting. Banking is not a long-term growth industry. In a past blog post I wrote about the PEG ratio (P/E divided by EPS growth), and to keep an eye out for anything that moves too far from 1. I further deconstructed a bank's p/e ratio because the industry is more capital dependent than most, if not all industries. I estimate that a bank's p/e can be reduced by 5-7 times to calculate PEG due to high capitalization. If I took 7x, and applied it to the Mid Atlantic's 22.1x p/e (the lowest of the six regions), then those banks would have to achieve earnings growth rates of 15% to earn that valuation. Note that p/e measurements for the below charts were done on 12/31, after the new tax law passed, and after most bank's announced their DTA writedowns. But prior to their earnings releases, so the reduced earnings were not yet baked in the cake.

Banks might earn that valuation depending on how they take advantage of the new tax law. Do they take the one-time earnings injection, or make strategic investments for longer term earnings growth. If the former, I do not believe the p/e's will last long term. And therefore I believe, as an industry, bank stocks are likely at peak valuations.

Or as industry stock analysts put it: Neutral.


What are your thoughts on the state of banking?


~ Jeff


Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works well.


Source for all charts: S&P Global Market Intelligence