The Big Squeeze

July 10th, 2017
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This story describes the following:

  • The top ranked banks in Bank Director's 2017 Bank Performance Scorecard based on asset size were M&T Corp., Bank of the Ozarks and Sun Bancorp. (Sun Bancorp announced after press time that it was selling itself to OceanFirst Financial Corp. in Toms River, New Jersey.)
  • Second and third ranked finishers were First Republic Bank, PNC Financial Services Group, Eagle Bancorp, BofI Holding, Cardinal Financial Corp., and People's Utah Bancorp.
  • Profitability improved in the banking industry because of increased loan volume and efficiency.

Seven years into one of the longest interest rate slumps in U.S. economic history, where the federal funds rate ranged between zero and 1.25 percent as of early June, should we start referring to it as the “no fun(ds)” rate instead? Indeed, based on the results of Bank Director’s 2017 Bank Performance Scorecard, the 300 largest publically traded banks included in our ranking had to work very hard to produce a result in 2016 that, in the aggregate, looked a lot like the year before.

The Federal Reserve has been gradually tightening the fed funds rate—which is the rate that banks lend reserve balances to each other overnight—since December 2015. Bankers can only hope that the Fed continues to increase interest rates, because it has literally been no fun trying to grow revenue and earnings through this prolonged period of historically low rates.

A brief examination of the banking industry’s net interest margin, or NIM, over the past two decades pretty much tells the tale. The margin has been steadily falling since the first quarter of 1994, when it stood at 4.91 percent. It bottomed out at 3.15 percent in the fourth quarter of 2008, then rose to 3.83 in the first quarter of 2010 before plunging to a new low of 2.95 percent in the first quarter of 2015. The margin has been meandering upward since, hitting 3.10 percent in the first quarter of this year.

Despite the continued margin pressure in 2016, the industry still managed to report a 4.9 percent increase in net income compared to 2015, buoyed in part by a 5.3 percent increase in total loan balances. For the 300 Scorecard banks, however, 2016 seemed to bring more of the same. The Scorecard uses five key metrics that measure performance across a spectrum of attributes that collectively define what it means to be a good bank. Return on average assets (ROAA) and return on average equity (ROAE) are used to measure profitability. The ratio of tangible common equity (TCE) to total assets is used to measure capitalization, while the ratio of nonperforming assets (NPA) to total loans and other real estate owned, and the ratio of net charge offs (NCO) to average loans, are used to gauge the strength of a bank’s asset quality.

The Scorecard is divided into three asset categories: $50 billion and above, $5 billion to $50 billion and $1 billion to $5 billion. Of the 15 individual metrics for 2016 (five metrics across the three asset categories), seven were down slightly compared to 2015, six were up slightly and two were even. The only metric that moved in the same direction across the board was the TCE ratio—which was down slightly in all three asset categories from 2015, an indication perhaps that banks were trying to boost their performance by leveraging their balance sheets a bit more.

The 2017 Scorecard was notable for several close finishes among the top ranked banks. The winner of the large bank category was Buffalo, New York-based M&T Bank Corp. (see story on page 22), followed by First Republic Bank in San Francisco and PNC Financial Services Group in Pittsburgh. Only two points separate M&T in first place and PNC in third. In the midsize category, Little Rock, Arkansas-based Bank of the Ozarks took first place honors for the third year in a row, while BofI Holding in San Diego finished second (for the second year in a row) and Eagle Bancorp in Bethesda, Maryland, placed third. Only a half a point separated BofI and Eagle. The small bank category was won by Sun Bancorp in Vineland, New Jersey, followed by Cardinal Financial Corp. in Tysons Corner, Virginia, and American Fork, Utah-based People’s Utah Bancorp. Just two points separated Cardinal and People’s. Cardinal was acquired this spring by United Bankshares in Charleston, West Virginia.

As in past years, the Bank Performance Scorecard was calculated by Sandler O’Neill + Partners in New York using data from S&P Global Market Intelligence, the former SNL Financial, in Charlottesville, Virginia.

Mark Fitzgibbon, principal and director of research at Sandler O’Neill, says the industry’s performance in 2016 was driven in part by “unusually strong commercial real estate and C&I loan growth.” Fitzgibbon says that some of the larger U.S. banks pulled back from the commercial loan market last year, in part because pricing had softened beyond their liking. “At the same time, the smaller banks really took share in that space,” he says. “Pricing was definitely thinner, and I think that small and midsize banks were certainly chasing floating rate assets, and that was a big part of their competitive push into C&I [lending]. They didn’t mind taking a little bit thinner spreads in order to protect the balance sheet in the eventuality that rates were to go up.”

Fitzgibbon also notes a “heightened focus on efficiency” in 2016, which also contributed to the industry’s performance. In fact, the industry’s efficiency ratio dropped from 59.85 percent in 2015 to 58.27 percent last year, according to data from the Federal Deposit Insurance Corp. Fitzgibbon attributes much of the improved efficiency to branch closures and branch size reductions. Other important factors in 2016 were asset quality and interest rates. “Credit costs remained relatively benign, and margins were more resilient than I had anticipated,” Fitzgibbon says. “We all thought that interest rates were going to go up a lot last year. That didn’t happen, but net interest margins held in better than we all had anticipated at the beginning of the year.”

Eagle Bancorp’s strong performance in 2016 was largely driven by 13 percent loan growth, 12 percent deposit growth and a 6 percent increase in revenue compared to the prior year. Eagle concentrates on commercial real estate and C&I lending in the Washington, D.C., market, Chairman and and Chief Executive Officer Ronald Paul attributes the bank’s high level of profitability to a large percentage of low-cost core deposits, a high loan-to-deposit ratio and the higher pricing it gets for its commercial loans—the latter the result of its relationship-based strategy. “We get paid for what we do,” says Paul. “We’re not afraid to ask for what we think we’re entitled to.”

Sun Bancorp is a very interesting turnaround story. The bank had underperformed for several years but has been making a comeback under President and CEO Thomas O’Brien, who joined the bank in 2014. Last year was Sun’s second consecutive year of profitability, and its 2016 earnings include a $53.7 million deferred tax asset valuation allowance, which helped boost it to the top of the $1 billion to $5 billion asset category. O’Brien has made deep cuts in the bank’s overhead, including employee layoffs, simplified its deposit products and refocused its strategy on commercial banking.

“I said at the beginning of my tenure here that we were going to focus on the business lines where we can bring value and be profitable and where we had the expertise to be effective,” O’Brien says. “We’re pretty much focused now on commercial in the C&I space and on commercial real estate.”

People’s Utah enjoys the distinction of being located in one of the most attractive banking markets in the country. President and CEO Richard Beard points out that Utah’s population growth is the fastest in the U.S., at 1.9 percent in 2016, and its job growth rate is about double the national average. Beard cites Utah’s strong economy as one of the factors behind its excellent performance last year. Loans grew 7 percent year-over-year, while deposits grew 8.9 percent, and the bank posted a net interest margin of 4.61 percent. Commercial real estate, C&I and construction and land development are its primary loan categories, and all three benefit from a growing state economy.

People’s Utah is also the largest independently owned bank in Utah, a state where Beard says people value the distinction. People’s Utah ranks sixth in deposit market share behind a pack of very large regional and national banks, but Beard says he has no trouble competing with them for business. “Our model is basically to try to preserve community banking,” Beard says. “We think that resonates with people in Utah. They want their banks to be local, or at least a lot do.”

Click to view the full scorecard, on the digital version of Bank Director!

jmilligan

Jack Milligan is editor in chief of Bank Director, an information resource for directors and officers of financial companies. You can connect with Jack on LinkedIn or follow @BankDirectorEd on Twitter.