The Arrow is Pointing Up for Large Public Banks

Large banks are on a rising performance curve, based on the results of Bank Director’s 2014 Bank Performance Scorecard, which is a ranking of the 200 largest publicly traded bank holding companies in the United States based on their 2013 financial data. Generally they are more profitable and have higher levels of capital than a year ago, which also means that they are safer. And driving the results of most of the top finishers on this year’s Scorecard is good old-fashion loan growth-which is a good sign for the industry and economy alike because this is how most banks make most of their income.

A perfect case in point is Abilene, Texas-based First Financial Bankshares Inc., which placed first in the $5 billion to $50 billion asset category. First Financial posted loan growth in 2013 of 22 percent, aided in part by an acquisition that it closed in the middle of the year. (For a profile of First Financial, please see the digital edition.) The bank also had a net interest margin (which is the difference between the interest rate on its loans and the cost of the funds it used to make those loans) of an impressive 4.27 percent despite widespread margin pressure across the industry, which means that it was able to charge attractive rates for credit even as its loan portfolio was growing.

Bank of the Ozarks Inc., which for the second year running finished first in the $1 billion to $5 billion asset category, did even better when it came to loan growth in 2013. The Little Rock, Arkansas-based bank grew loans at a stellar 24 percent. Its loan growth also got a boost from a significant acquisition that it closed in the middle of the year. As with First Financial, the bank’s net interest margin of 5.63 percent helped drive its strong profitability in 2013.

The Bank Performance Scorecard is a ranking of publicly traded banks listed on the NASDAQ OMX and NYSE exchanges. The Scorecard uses five key metrics that measure profitability, capital strength and credit quality. Core return on average equity (ROAE) and core return on average assets (ROAA) are used to measure each bank’s profitability. Capital strength is determined through the use of the ratio of tangible common equity (TCE) to tangible assets, which is a conservative measurement of capital. (Tangible common equity eliminates intangible assets like goodwill, which is the amount of money that a company has spent to acquire another company above book value. Goodwill is common in industries like banking that have experienced heavy acquisition activity.) The last metric, credit quality, is gauged through the use of two benchmarks: The ratio of nonperforming assets to total loans and other real estate owned, (i.e. foreclosed properties), and the ratio of net charge-offs to average loans.

Click here to review the Bank Performance Scorecard
on the digital edition of Bank Director.

This year’s Scorecard focused on the 200 largest public banks, which were sorted into three asset categories and ranked separately within those categories. The banks were given a numerical score for each of the five metrics based on where they ranked. (The banks with the highest ROAA in each of the asset categories, for example, were assigned the number one for that metric.) The scores for all five metrics were added across and the banks were then ordered lowest to highest in their respective asset categories. The bank with the lowest combined score in each asset category was the winner. For scoring purposes, ROAA, ROAE and the TCE ratio were given full weighting, while the two asset quality metrics were each given a half weighting. Banks that rank high on the Bank Performance Scorecard typically do well in all of the metrics rather than dominate just one or two. The Scorecard rewards banks that are well balanced across the full spectrum of profitability, capitalization and asset quality-but with a slight bias towards profitability.

As in previous years, the investment banking firm Sandler O’Neill + Partners L.P. in New York constructed the rankings using data provided to it by SNL Financial LLC, a research and database firm in Charlottesville, Virginia.

“As a generality, 2013 was a pretty decent year for this group (of banks),” says Scott Siefers, a managing director for equity research at Sandler O’Neill. “Loan growth began to return, with the growth coming more on the commercial side including C&I lending.” The industry also saw its margin compression pressure ease slightly in the second half of last year, largely because the short end of the yield curve began to edge upwards in anticipation that the Federal Reserve Board would tighten its accommodative monetary policy, and also because many banks were able to renew existing loans at higher rates. According to Siefers, this reversed a trend in recent years where commercial loans often renewed at a lower interest rate.

Another trend that helped boost earnings was the continued improvement in the industry’s asset quality, which allowed many banks to either decrease the amount of money they put into loss reserves last year, and in some instances even draw down their reserves and report those funds as income. The industry is now in year three of its asset quality recovery after the punishing effects of the financial crisis. “Most of the bad stuff has already worked its way through the snake,” says Siefers. “We expect to see continued improvement this year into 2015.”

Capitalization levels are also at historic or near historic highs across the banking industry, and the Scorecard banks are no exception. The reasons for this are varied, including the caution of prudent management teams and boards of directors that chose voluntarily to strengthen their balance sheets in the face of economic uncertainty; pressure from the bank regulatory agencies on institutions that were perceived to be undercapitalized or risky; and the significantly higher mandated capital levels under the new Basel III requirements, which will take effect for most banks in January 2015. The median TCE ratio of the Scorecard banks in this year’s ranking rose for both the $50 billion and above and $1 billion to $5 billion categories, although it dropped for banks in the $5 billion to $50 billion category-most likely the result of significant acquisition activity in that segment, according to Siefers. A higher capital level does have a negative impact on a bank’s ROAE since it reduces the amount of leverage it can deploy. “We’ve definitely set the [performance] bar higher by forcing banks to carry more capital,” says Siefers. “The payoff, you hope, is a safer industry.”

One of the few exceptions to the importance of loan growth in this year’s Scorecard is McLean, Virginia-based Capital One Financial Corp., which took top honors on the $50 billion and above asset category. Capital One, which is one of the largest credit card providers in the country, actually shrank its balance sheet in 2013u2013with loans declining about 4 percent for the year-as the bank significantly lowered its risk profile. The bank let some of its credit card loans run off and also sold a $7 billion credit card portfolio to Citigroup.

Sometimes less is more when it comes to performance, and Capital One falls into a category of large financial institutions that federal bank regulators have paid especially close attention to since the financial crisis. Lowering its risk profile by actually getting smaller-it had approximately $313 billion in assets at year-end 2012 compared to $297 billion at the end of 2013-enabled Capital One to achieve two important objectives last year. The Federal Reserve signed off on a $1 billion share repurchase program, and also allowed it to raise its quarterly dividend from $0.05 per share to $0.30. Both were contingent on the sale of the portfolio to Citigroup. “I think it’s a higher quality balance sheet than it was a few years ago,” says analyst Chris Donat, a Sandler O’Neill managing director who covers Capital One.

It would be hard to find too many things that didn’t go well for $4.8-billion asset Bank of the Ozarks in 2013. Asked what drove his bank’s performance last year, Chief Executive Officer George Gleason offers this explanation via email: “Every year we strive to be a top-decile performer in three key metrics: net interest margin, efficiency ratio and asset quality. Our combination of a 5.63 percent net interest margin, 46 percent expense ratio and 0.13 percent net charge-off ratio were the keys to our profitability in 2013.”

Gleason also explained that Bank of the Ozark’s exceptionally high net interest margin last year resulted in part from a change in its funding mix: Its percentage of non-interest bearing demand deposits and interest bearing transaction deposits increased while more expensive certificates of deposits declined. The bank benefited from this improved cost of deposits, yields on portfolios of acquired and legacy loans, as well as covered loans through seven FDIC-assisted acquisitions of failed banks. “We are very disciplined, and we simply will not engage in transactions in which we do not think we are getting an appropriate risk-adjusted return,” Gleason writes.

Bank of the Ozarks’ stellar organic loan growth in 2013, which investment bank Stephens Inc. analyst Matt Olney says “accelerated to levels we haven’t seen before,” was driven in large part by its Real Estate Specialties Group in Dallas, which does business with commercial real estate developers around the country. The bank has also focused on expanding its branch network well outside of its Arkansas home base, particularly in Texas, where it has 14 offices, and in the Southeast where it has offices in Georgia, North Carolina, Florida, Alabama and South Carolina. “I would expect more live bank acquisitions going forward,” says Olney.

Another bank that posted strong loan growth last year was Lakeland Financial Corp., a $3.2-billion asset bank headquartered in Warsaw, Indiana, which saw its loan portfolio expand 12 percent. Lakeland, which finished fourth in the $1 billion to $5 billion asset category, has a commercial banking focus with an emphasis on C&I lending, and it benefited from an economic rebound in its northern Indiana market. “We saw growth and investment in C&I lending in 2013 that we hadn’t seen in a few years,” says President and CEO David Findlay. “Our success is predicated in consistency, stability and predictability. There’s nothing sexy about the story.” Adds Sterne Agee research analyst Peyton Green, “They have an infrastructure-light business model. They’re very conscious of the profitability of everything they do.”

Lakeland also achieved this loan growth without the benefit of an acquisition. In fact, the bank has never done a deal and it’s unlikely that it ever will. Findlay believes that organic growth has fewer risks. “We don’t want to do an acquisition that would hurt the culture of the company,” he says.

The primary performance drivers at $6.6-billion asset CVB Financial Corp. in Ontario, California, which finished fourth in the $5 billion to $50 billion asset category, were a 10 percent growth in non-interest bearing deposits, 3 percent loan growth-much of that occurring in the second half of the year-and asset quality that was strong enough that the bank was able to release money from its loss reserves. CEO Chris Myers says much of the bank’s deposit growth came from the kinds of small businesses that form the core of its customer base. The bank also benefited from a new jumbo mortgage loan product and growth in its multi-family housing portfolio.

This performance was especially impressive considering that the languid California economy is still recovering from the Great Recession. And a drought that has a tight grip the on the Western United States isn’t helping. “We’re making slow progress,” says Myers. “It’s better this year than last year, and it was better last year than the year before.”