Tuesday, October 09, 2018

Financial Institutions: What Drives Value v2

In a follow up to my last post on the subject, that was driven by my friends from Performance Trust, I was asked in the comments section of that post if there was a correlation between non-interest bearing checking accounts and price-to-tangible book multiples.

That nugget was asked by Mike Higgins, a bank consultant from Kansas City, who penned a guest post on these pages in the past. Rather than answer Mike in the comments, I opted for the wider audience distribution of a standalone post.

It's my blog. I can do what I want.

I am somewhat limited to how financial institutions report their deposit mix. Call report categories are easiest, and the closest metric is transaction accounts to total deposits. I thought this would give us what we needed.

So, is their a correlation between a bank's relative level of transaction accounts to their price-to-tangible book trading multiple?

See for yourself.


The data, courtesy of S&P Global Market Intelligence, is all publicly traded US banks with trading volumes greater than 1,000 shares per day, and that have non-performing assets to total assets less than 2%. That filtered out most of the very small, inefficiently traded financial institutions, and those with asset quality issues. I also eliminated banks that had NA in the transaction accounts/total deposits ratio.

The filters resulted in 306 financial institutions, which I divvied up into quartiles based on transaction accounts to total deposits. The top quartile, with 56.78% transaction accounts to total deposits traded at 208% price to tangible book at market close on October 4, 2018. The bottom quartile, with 24.71% transaction accounts to total deposits, traded at 145% price to tangible book. The line is linear. Which reads funny as I proofread.

So I would say: yes, community bank investors reward banks funded with a higher proportion of checking accounts with greater trading multiples. So when I wrote in June 2018, in a post titled Branch Talk, my Point 1 was that banks needed to build a cost of funds advantage by having a relatively higher proportion of checking accounts, the above chart is why.

In reviewing the data that fed the above chart, size was likely not a significant issue. All of the numbers above are medians, not averages. And the median asset size from bottom quartile to top were: $1.6B, $2.2B, $3.2B, $2.1B. Wells Fargo and JPMorgan, the nation's largest FIs, were both in the 3rd quartile.

A bonus table:


So there is a neat line in Return on Average Assets too. Price to earnings is not so neat, but I find it rarely is. Still, the message is clear. More checking, better performance, higher trading multiples.


Do you see it differently?

~ Jeff


Wednesday, September 26, 2018

For Financial Institutions, What Drives Value?

Not all financial institutions are publicly traded. But there are enough of them to help those that do not trade to measure what metrics drive the value of their franchise. 

So what metrics drive value? Umrai Gill, Managing Director of Performance Trust in Chicago presented his findings to the Financial Managers Society at their East Coast Regional Conference this month. Some results were surprising.

He first cited a survey performed by PT, asking their clients "what are the generally accepted drivers of institutional value?" Without identifying ranking or more details about their survey, the preponderance of responses were as follows, in no particular order: loan-to-deposit ratio, investment portfolio size, net interest margin, efficiency ratio, return on average assets (ROAA), return on average tangible equity (ROATE), capitalization, and asset size. 

Some were not very interesting to me, such as investment portfolio size, which might have been influenced by PT's specialty. Others might have been too investment community-like, such as ROATE, which doesn't count high premiums bank buyers pay for bank sellers that results in goodwill on the buyers' books, which is deducted from their regulatory capital. But others struck my curiosity to see if there were correlations between the metric and market valuations. 

And I thought I would share with my readers.The charts in the slides below was PT's analysis of data from S&P Global Market Intelligence based on June 30, 2018 financial information using market data from 08/17/18.

First, the metrics that showed correlation to price to tangible book values. Not surprising, in my opinion.

Asset Size



Efficiency Ratio




Profitability / ROAA





Next, the ratio that did not show a correlation to price to tangible book multiples, at least not over 3.5%. I was a little surprised at this one.


Net Interest Margin



Lastly, and most interesting from my point of view, were ratios that showed mixed results. In other words, they showed positive correlation to price-to-tangible book ratios, up to a point. After which, they showed a correlation, but not what bankers would hope for.


Tangible Common Equity / Tangible Assets



Loan-to-Deposit Ratio



The highest market multiples were afforded to banks with a 70%-80% loan to deposit ratio. Now that may be related to size of institution, as the very largest, JPMorgan Chase (67% loan/deposit ratio) and Wells Fargo (76%) tend to have lower ratios. But there is likely something to the fact that a bank that still has strong liquidity as represented by a relatively lower loan-to-deposit ratio in a good economy has room to improve earnings by growing loans faster than deposits. While the less liquid must price up their deposits to get funding.

And capital, well, I refer you to a prior post where I clearly stated there was such a thing as too much capital. Investors will not pay a premium for hoarded capital. Performance Trust's research puts that sweet spot in the 9%-10% tangible common equity / tangible assets range. Enough capital to grow and/or absorb recessionary losses without selling off assets at a discount to bolster capital during hard times.

Where are your sweet spots?


~ Jeff














Sunday, September 16, 2018

Are Bank Products Simple, Fair, and Transparent?

I was on a road trip discussing banking with a colleague, and I mentioned that bank products are anything but simple, fair, and transparent. He said, “sounds like a blog post.”

I have never heard a bank customer say, “gee, I wish my bank relationship was more complex.” Yet we charge business checking fees based on a complex analysis, offer a 7-month special CD only to roll it into a lower yielding 6-monther if the customer isn’t attentive, and require high-interest checking customers to have 10 debit transactions, e-statements, and a partridge in a pear tree to get that rate. Sound simpler, fairer, and more transparent?
On the other side of the coin, bank customers don’t necessarily understand what it takes to run their accounts profitably. Dear customer, the Federal government requires financial institutions to monitor your account for suspicious activity and report anything untoward. That costs time and resources that drive up the cost for your checking account. That is why every overdraft fee, interchange transaction, and minimum balance fee counts. Your government drives up bank costs.
It costs $423 per year for a bank to run a retail interest-bearing checking account, based on my firm’s product profitability database. To cover that cost solely on the spread that your balances generate would require an average balance of $21,363 in your account. All. The. Time.
I have written on these pages that I thought the past practices of relying on customers to be asleep at the switch and accept rates significantly different than market rates will soon be over. Banks must shift business models to pay depositors something closer to market rates for “accumulation accounts”, which are accounts for long-term savings such as an emergency money market account, or a CD ladder.
Cost of funds advantages should be built on having relatively higher “store of value” accounts such as checking, or special purpose savings where convenience and safety are more important to the customer than accumulation.
So I don’t point out a problem without proposing a solution, I have an idea for a Simpler, Fairer, and more Transparent small business banking deposit product. Call it the Jeff For Banks (JFB) Business Banker Account. As I mentioned in past posts, I’m a narcissist and I’m trying to get something named after me.

JFB Business Banker Account
The product is a combined store of value checking account, and an accumulation money market and/or sweep account. But no sweep here into a repo where we have to pledge investment securities against balances. That wouldn’t meet the simple test.
Banks can pay businesses interest on their checking accounts. So I propose banks segment business checking accounts by their resource utilization, and create minimum balances based on this segmentation. So the college bar that drops off bags of money each morning at the local branch has a higher threshold before it doesn’t get charged a monthly maintenance fee and receives interest.
So the average balance for high utilization quartile account might be $70,000, above which the account receives a competitive interest rate, and below which the account is charged a monthly maintenance fee. Here is what the math might look like for Pete’s Corner Bar.

JFB Business Banker Account Profitability Estimates
1 Average Balance $92,102
2 Checking Average Balance 70,000
3 Checking FTP Spread* 1,463
4 Money Market Average Balance 22,102
5 Money Market FTP Spread* 197
6 Total Account Spread $1,660
7 Fees** $540
8 Annualized Operating Cost per Account* $784
9 Pre-tax Profit $1,416
10 Pre-tax ROA 1.54%
11 Equity Allocation* 1.00%
12 Pre-tax ROE 154%
13 Total Account Cost of Funds*** 0.30%
*Per TKG product profitability peer data
**Assumes one incoming/outgoing wire/month
***Money market balance * 1.25%


The bank would still charge per use fees for things like wires, ACH’s, overdrafts. And receive interchange income. But the spread should cover items presented plus profit for the bank. Imagine having 10,000 of the JFB’s Business Banker Account. Instead of 1,000 of this account, 2,000 of that account, 4,000 of another account, and 3,000 old grandfathered accounts. Which would be easier for your branch and business bankers to explain to your customers? And marketing people tell me that bankers sell what they know.
Does the JFB Business Banker account pass the Simple, Fair, and Transparent test?

~ Jeff

Saturday, August 25, 2018

The Real Reason for Bank Scale: Trading Multiples

"Get big or get out." "You must be twice the size that you are to succeed." These are bromides that some industry talking heads might be telling you. I hear it and read it frequently. And in today's social media, non fact-based opinion society, if you say it enough, people may start to believe it.

I moderated a strategic planning retreat with a bank that achieved top quartile financial performance. Their growth was solid too. Their asset size was less than $500 million. A director challenged me: Does our size matter so long as we continue to perform the way we have performed? My answer: Not really, with one exception.

Trading multiples. I referenced this phenomenon in a 2013 blog post, Too Small to Succeed in Banking. In that post I opined, "As we migrate towards greater institutional ownership, stock liquidity is becoming increasingly important." What I said then likely remains true today. Institutional owners (funds, etc.) now own two-thirds of shares outstanding in publicly traded US banks. 

But why does this matter to my sub $500 million in assets bank client?

So I ran some charts for you (courtesy of S&P Global Market Intelligence).




The bottom table was a bonus so readers can see that at the end of 2017 bank p/e's relative to the S&P 500 p/e surpassed their 10-year median in every asset category. Significantly so for banks $500 million to $5 billion in assets. So, on a relative basis, valuations are higher. 2008 was an anomaly because the S&P 500 companies traded at stratospheric p/e's because they had no "e".

Back to my main point. Over the past 10 years, banks that have less than $500 million in total assets have traded at lower price-to-tangible book multiples. In every year. And the differences in multiples match up nicely by asset size. The price-to-earnings chart is a little murkier based on the choppiness of earnings. However, investors tend to value smaller financial institutions more on book value than earnings. A good earner, like my client, tend to trade at relatively low p/e's because they have great earnings. 

Does that sound right? Earn better, and get rewarded with a lower p/e?

Fair is in the eye of the beholder. If you remove nearly 2/3 of the potential shareholder base because you have little daily trading volume, then you have less buyers seeking your shares. Supply and demand.

And that is where the economies of scale argument has merit. If you intend to remain independent, and continue to perform well and grow sufficiently, then you are likely delivering total returns acceptable to shareholders. Even without trading multiple expansion.

But if you would like to acquire a nearby financial institution, and you are trading at lower trading multiples than other would-be acquirers, you would be at a disadvantage. Your "currency" isn't worth as much as your larger competitors. Which may also make you vulnerable to an aggressive buyer's offer to buy you, if the buyer is large and has much better trading multiples than your bank.  

Fortunately, unsolicited offers are not common in our cordial industry. But we shouldn't rely on it.


~ Jeff



Sunday, August 12, 2018

Guest Post: FInancial Markets and Economic Update by Dorothy Jaworski


Economy and Momentum

At the end of June, 2018, the current economic expansion turned nine years old.  We have one year to go to match the longest expansion since World War II, which was the prosperous period engineered by Maestro Greenspan from March, 1991 to March, 2001.  He also ended that expansion by tightening and then keeping interest rates too high for too long.  After easing and keeping rates low


for three years, the Fed began tightening from June, 2004 to June, 2006.  By the time it was clear to all of us that the economy was being dragged down by the housing and mortgage crisis, the Fed finally lowered rates, but it was too late.  They were forced then to take rates to zero to deal with the financial crisis.  Rates that were too high did not cause the crisis, but certainly did contribute to it.  And here we are, all of these years later, looking to match the record length of GDP growth of ten years and watching a Fed that continues to raise interest rates.  We know that even the best of them raise rates too much, keep them too high for too long, and then are forced to lower them to try to save economic growth, usually too late.  There was a reason they had to lower rates to zero and keep them there for seven years.


Five more quarters to go and I believe in 2019 we will set a new record length for an expansion, albeit without hitting 3% GDP growth for any one of those ten years.  This is because the economy has been gaining momentum, however modest, from the tax cuts and deregulation.  The economy has grown 2.2% annually since 2009, while the record expansion of the 1990s saw growth of 3.6%.  The second quarter of 2018 saw growth of 4.1% (the highest quarterly growth since 2014) and the third quarter may be close.  Growth for the entire year of 2018 is expected at 2.8% and 2019 at 2.4% to 2.5%.


Why Worry?

You know me by now.  I worry about the economy and the Fed’s tightening campaign.  In my career, I’ve lived through many years of the Fed raising interest rates and it’s my experience that they usually tighten too much and keep rates high for too long, just like in 2001 and 2006-2007.  And does the following sound familiar?  They often cite unemployment they think is too low and inflation that could soar as their reason to keep raising rates.  They often fail to appreciate the message of the flattening, or inverting, yield curve.  Their reliance on the Phillips Curve continues to surprise me.  Unemployment is low, but there is considerable capacity in the higher pool of available workers and wage increases remain modest.  Inflation had risen earlier this year, but has been heading back down recently.

As well as the economy has been doing from the momentum of tax cuts and reduced regulation, there are always looming issues.   Consider the trade wars and tariffs.  There are some signs of slowing in the housing markets; both existing and new home sales in June fell amidst rising mortgage rates and fewer gains in home prices.  The flat yield curve is showing the pressure on short term rates to rise from both the Fed and unusually high issuance of T-Bills by the US Treasury, while longer term rates are sensing that inflation is falling back and growth may eventually slow.  Hedge funds are not happy with longer term rates as they keep shorting Treasuries and futures, expecting rates to rise and they do not.  The 10 year Treasury has touched 3.00% once in the past several months and is hovering just below that level at 2.95%.  The two year Treasury today is 2.66%, so one can see how flat the yield curve has become.  By the way, JP Morgan’s CEO, Jamie Dimon, recently said he thinks the 10 year Treasury should be at 5%...

Debt levels are still extremely high and economic growth will be restrained if debt service is not covered by income growth.  US Treasury debt now stands at 103.9% of GDP; levels above 90% have been demonstrated to slow economic growth.  Aha!  One of the causes of low growth since 2009 is uncovered!  Low productivity continues, just as it has since this recovery began in 2009, averaging only 1.3% since that time.  Low productivity is often associated with weak economic growth.  Another of the causes of low growth since 2009 is unveiled!  An obvious one is low inflation.  Gas prices pushed above $3.00 per gallon a few months ago and could lead to slower consumer spending.  And for all of the Fed watchers out there, money supply growth, as measured by M2, has continued to weaken on a year over year basis, from +7.1% for the year ending June, 2016, +5.6% for the year ending June, 2017, and +4.2% for the year ending June, 2018.   Milton Friedman, anyone?

In our local area, we are still seeing modest growth in Philadelphia and surrounding counties.  The Fed’s Beige Book remains fairly positive, citing “modest” growth.  Housing has done well, despite median sales price growth which is less than national averages and lower inventories of properties for sale, which may be propping up prices.  In 2Q18, Bucks County median prices rose year-over-year by 3.9%, compared to the national Case Shiller index at over 6.0%.  We have to live with national interest rates and the Fed and the yield curve affect us all.

Regardless of what I may worry about, we are faced with the reality that The Fed continues to indicate that they will raise interest rates- one or two times more in 2018- and several times in 2019.  Short term rates will rise along with them.  Long term rates may hold steady, unless stronger inflation makes a comeback, or may begin to fall back if economic growth slows.  Let’s hope we make it five more quarters to a record expansion before that happens. 


Globe Trotting

We were on vacation in Paris during July and got to experience France’s semifinal and final wins of the World Cup.  The streets of Paris looked just like South Philly after the Super Bowl win.  The fans there are as passionate as Eagles fans, but I will keep that a secret.  Philly has a chance to go wild again this year if the Phillies keep playing well; they are in first place for the first time since the end of 2011.  We also traveled to Metz and Normandy and accepted more honors for my Uncle Stephen by the great French people who live along the Moselle River.  We stood on Omaha Beach, with families enjoying vacation there, paid tribute to the fallen soldiers at the Normandy Cemetery, and climbed the 900 steps to the top of Le Mont Saint Michel.  Along the way, we witnessed building construction and renovation in Paris and in the small towns of France, showing an economy on the way to recovery.

Our economy here in the US is gaining momentum, too, especially on the concert circuit.  I got to see Rod Stewart again last week.  Life is good!


Thanks for reading!  DJ 08/09/18











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.

Saturday, July 28, 2018

For Financial Institutions, Is There Such A Thing As Too Much Capital? Yes. Yes There Is.

I was on a panel at a bankers conference with an investment banker and two bank fund investors. One of the investors' opening remarks was about banks that were over-capitalized. I panned the audience to see if regulators were present.

But there were enough open jaw gapes to see that many bankers share the regulatory belief that there is no such thing as too much capital. And that may be true for financial institutions that don't take investor money. But if your bank is shareholder owned, then you may be hoarding their money. And as a bank shareholder myself, I like to make my own hoarding decisions.

I have written on these pages about a method to estimate your "well capitalized", a question your regulators may have asked you. Having done this, and seeing that your strategic plan has you comfortably above your well capitalized and trending higher, what do you do with the excess capital?

Derek McGee of Austin law firm Fenimore, Kay, Harrison, and Ford had four to-the-point ideas in a recent Bank Director Magazine article. I would like to lay out his four ideas with my take on them.


1. Dividends. "Returning excess capital to shareholders through enhanced dividend payouts increases the current income stream provided to shareholders and is often a well-received option. However, in evaluating the appropriate level of dividends, including whether to commence paying or increase dividends, banks should be aware of two potential issues. First, an increase in dividends is often difficult to reverse, as shareholders generally begin to plan for the income stream associated with the enhanced dividend payout. Second, the payment of dividends does not provide liquidity to those shareholders looking for an exit. Accordingly, dividends, while representing an efficient option for deploying excess capital, presents other considerations that should be evaluated in the context of a bank's strategic planning." 

My take: Amen Derek! In a blog post this year, Bank Dividends: Go Ahead and Drink the Kool Aid, I called for the same thing. And to use special dividends and deliberate shareholder communications to help overcome shareholder expectations mentioned above. I have not experienced a bank that made the pivot from being a growth company to a cash cow, where profits are maximized and dividends are plentiful. It is a natural evolution of a company built to endure. 


2. Stock Repurchases. "Stock repurchases, whether through a tender offer, stock repurchase plan or other discretionary stock repurchase, enhance liquidity of investment for selling shareholders, while creating value for non-selling shareholders by increasing their stake in the bank. Following a stock repurchase, bank earnings are spread over a smaller shareholder base, which increases earnings per share and the value of each share. Stock purchases can be a highly effective use of excess capital, particularly where the bank believes its stock is undervalued. Because repurchases can be conducted through a number of vehicles, a bank may balance its desire to effectively deploy a targeted amount of excess capital against its need to maintain operational flexibility."

My take: Institutional shareholders own greater than two thirds of publicly traded financial institutions' shares outstanding. And share buybacks are a favorite of theirs. The challenge is that they would like to liquidate their ownership when the value is at its peak. Meaning the financial institution purchasing its shares would likely enjoy minimal earnings accretion and create book value dilution. But, as Derek pointed out, it is a highly effective use of excess capital when the bank believes it is undervalued. One bank stock analyst thinks every bank should calculate the earnings accretion of a prospective merger versus the earnings accretion of a share buyback. If the buyback is more accretive, why do a riskier merger?


3. De Novo Expansion in Vibrant Markets. "Banks can also reinvest excess capital through organic expansion into new markets through de novo branching and the acquisition of key deposit or loan officers."

My take: When a race car enters the pits, it is losing time. If not to recalibrate, refuel, and re-tire, drivers wouldn't do it. If you compare bank strategy to a 500-mile race, banks would also enter the pits. But if you compare bank strategy to a few times around the track, you would be foolish to do so. Think of the short race as budgets, and the 500-miler as strategy. You have to be willing to accept the short-term setback of entering the pits (i.e. making strategic investments like Derek mentioned) to position you to win the race. 


4. Mergers & Acquisitions. "Banks can deploy excess capital to jumpstart growth through merger and acquisition opportunities. In general, size and scale boost profitability metrics and enhance earnings growth, and mergers and acquisitions can be an efficient mechanism to generate size and scale. Any successful acquisition must be complementary from a strategic standpoint, as well as from a culture perspective."

My take: Derek's "complementary" comment was right on. Listen to my firm's most recent podcast on M&A cultural integration featuring an interview with Jim Vaccaro, Chairman and CEO of Manasquan Bank, that is in the process of merger integration as I type. In addition to a cultural fit, the geography and balance sheets should be complementary, and the earnings accretion should exceed what the buying institution could achieve on its own. Tangible book value dilution, which tends to get a lot of play in the investment media, should not be to the level to cause long-term downward pressure on the buyer's stock price. 

Out of the four, M&A is the least within the control of the financial institution, as this takes a willing partner.


What other uses of excess capital do you propose? 


~ Jeff



Sunday, July 08, 2018

Bank Innovation: Three Ideas

I usually take more time researching blog posts than writing them. Today is an exception. Rather than searching reputable sources for how this bank or that bank innovates, I thought I would give it to you straight from the gut.

Because experience tells me that bankers are struggling with innovation. There is so much buzz about it, we are challenged to separate the wheat from the chaff. Fintech, regtech, martech (new one), AI, RPA, Chat Bot, actual bot. What's a banker to do?

At its core, innovation should solve problems. Problems we know we have. Problems we may not know we have. Customer problems. Process problems.

And who knows or can anticipate these problems better than 1) our customers, and 2) our people. 

Here is my opinion that may not sit well with some of my readers: Innovation through rapid change will rarely be led by those long in the tooth. Their experience clouds their view of the pace of change, especially if their experience is with slow, methodical, decades-in-the making change. Because we tend to believe past is prologue.

I'm full of idioms when I shoot straight from the gut.

I'm not telling you to build an innovation culture surrounded by young people. Make innovation a bank wide call to arms. But in creating a culture of innovation, don't have your long in tooth leaders shooting down innovation arrow after arrow offered by your short timers.

Here is how I think you could foster such a culture:


1.  Make Innovation Problem-Resolution Based. Nothing is more frustrating than expending organizational resources on a non-existent problem. Changing IHOP's name to IHOB comes to mind. HSBC putting actual robots in branches is closer to home. Community financial institutions' resources are already taxed by technology and regulation. Don't over-tax by encouraging innovation on problems that don't exist either internally or with our customers. So when you establish an innovation culture, the subject line of the memo proposing the innovation should be the problem the institution is trying to solve. Let your competitors waste resources on cool gizmos that only end up being resume' bullets for tech weenies.


2.  Coach Long-Timers. I've called them stoppers, sergeants, and old-schoolers. These are the people that implemented processes in the past that your innovators are now trying to solve. Like the cumbersome process that may exist in your bank to send wires. The story goes like this: a fraudulent wire got through, the bank CEO sternly directed ops personnel to ensure it doesn't happen again, and it now takes a DNA sample for someone to get a wire out. And the owner of that process is the department manager of the innovator trying to solve for a problem created by their boss. Here is where senior management will earn their leadership chops. Turn the stoppers into innovators. Or at least facilitators of innovation.


3.  Recognize and Reward. I called for a bank wide awards ceremony in a post two years ago (Five Ideas to Build an Accountability Culture at Your Bank). Innovation awards should be a part of the ceremony. Perhaps a central feature of it. Hand out a trophy. Give out meaningful cash and/or vacation time. Salute Long-Timers for fostering the culture that led to innovation. Demonstrate tangible results. Emphasize the problem solved.


These are my ideas on how to build an innovation culture that focuses innovation efforts on solving problems, real or emerging.

What other ideas do you have, or have heard of, that can move financial institutions forward fast enough to build a long-term future?


~ Jeff