America’s Best Banks

View the 2007 America’s Best Banks results.

The top 10 finishers in this year’s Scorecardu00e2u20ac”which measures the performance of the 150 largest U.S. banks and thrifts across a range of profitability, capitalization, and asset quality metricsu00e2u20ac”offer up a surprising mix of business models, geographies, and size.

There are three lessons that boards of directors should take from the results of this year’s Bank Performance Scorecard. One is that a bank’s location and the strength of its regional economy appear to be less important than other factors in determining how well it performs. While being situated in a booming economy is an undeniable advantage, banks that operate in more slowly growing regions can still perform at a very high level.

“There really wasn’t a correlation between geography and performance,” says Mark Fitzgibbon, director of research at Sandler O’Neill & Partners L.P., a New York-based investment banking firm that specializes in financial services industry. “If you look at the first five companies on the ranking, they’re in states as disparate as Illinois, Missouri, Montana, California, and Ohio.”

Another important lesson is the value of having a market niche or distinct strategy that sets an institution apart from its competitors. Bankers are often criticized for having a herd mentality, and the fact that most institutions do follow essentially the same strategy of spread lending can provide those companies that have figured out meaningful ways of differentiating themselves in the marketplace with a competitive advantage.

“Companies that have carved out unique niches are seeing really robust growth,” says Fitzgibbon. “This would include companies that have a large amount of their revenue tied to fee sources that are less susceptible to the yield curve than traditional community banking.”

But merely being different isn’t enough to ensure success, which leads us to the thirdu00e2u20ac”and probably most importantu00e2u20ac”lesson from this year’s Scorecard. Perhaps because its core products and services have become so highly commoditized, banking is still a business of execution. Even those institutions employing a conventional business model in a region with average economic prospects can achieve a high level of financial performance if their management teams are very good at executing their strategies.

For bank directorsu00e2u20ac”who bear a fiduciary responsibility to their institution’s shareholdersu00e2u20ac”the message is clear: Don’t allow your management team to use geography as an excuse for poor performance, do look for a strategic advantage, and always make sure your senior executives are focused on sharp execution.

Fitzgibbon says that all of the top-ranked banks on this year’s Scorecard have a couple of characteristics in common. “I think they all have very charismatic and driven leaders,” he says. “I think they all have a disciplined focus on cost control and I think each has carved out a unique niche where they have become extraordinarily good and have been able to garner premium pricing.”

The Bank Director Bank Performance Scorecard measures the country’s 150 largest banks and thrifts across a range of indicators, beginning with two profitability metricsu00e2u20ac”return on average assets (ROAA) and return on average equity (ROAE). The Scorecard also uses Tier 1 capital and leverage capital ratios to measure the strength of an institution’s capitalization. The final categoryu00e2u20ac”asset qualityu00e2u20ac”is determined by calculating each institution’s ratio of nonaccrual loans and other real estate owned to total loans (generally referred to as the nonperforming asset ratio) as well as its ratio of loan loss reserves to total loans (otherwise known as reserve coverage).

Assuming that profitability is the single most important performance measurement of any public company, the Scorecard gives the two profitability metrics a full weighting in the final score for each institution. The other four metrics are each given a half weighting in the final tally. The Scorecard was developed by Bank Director in consultation with Sandler O’Neill, which also performed all of the necessary calculations using publicly available data. The ROAA and ROAE calculations were based on data from four linked quartersu00e2u20ac”the third and fourth quarters of 2005 and the first two quarters of 2006. The capital and asset quality metrics were based on period-ending numbers for the second quarter of 2006.

Institutions that tend to do well on the Scorecard are the all-around good performers that are highly profitableu00e2u20ac”but don’t achieve their profitability by leveraging up their balance sheets at the expense of capital. This year’s winner is Corus Bankshares, a Chicago-based commercial bank that jumped all the way up from a 20th-place finish in 2005. Coming in second was Commerce Bankshares Inc. in St. Louis, which improved upon a sixth-place finish in 2005. Rounding out the top five were Kalispell, Montana-based Glacier Bancorp.; City National Corp. in Beverly Hills, California; and Park National Corp. in Newark, Ohio. Glacier also ranked third on the 2005 Scorecard, while City National and Park National essentially traded their 2005 rankings when they finished fifth and fourth, respectively.

The highest-ranked bank in 2006 with assets exceeding $100 billion was $213 billion U.S. Bancorp in Minneapolis, which finished in the ninth spot after placing 14th in 2005. The top ranked thrift in 2006 was Harbor Florida Bancshares Inc. in Fort Pierce, Florida, which finished 12th. However, only five of the top 50 finishers on this year’s Scorecard were thriftsu00e2u20ac”clear evidence the thrift sector’s performance lags behind the banking sector. The last-placed finisher in this year’s ranking was Alpharetta, Georgia-based NetBank Inc., a thrift whose retail distribution system includes the Internet, telephone, automated teller machines, and the mail.

Banks and thrifts today are operating in an extremely challenging operating environment. A relatively flat yield curve, which is the difference between short-term and long-term interest rates, has made it increasingly more difficult for most financial institutions to earn a satisfactory return on their lending activities. The rise in short-term rates has forced many banks to pay up for consumer deposits, which drives up their funding costs, while the commercial loan market remains very competitiveu00e2u20ac”which limits how much they can charge their business borrowers.This interest rate vice has squeezed profit margins throughout the industry.

“We have not been through a period of time where the yield curve stayed this flat for this long, and it’s really putting to the test all the tools that managements have at their disposal,” says Fitzgibbon. And that tough business climate makes the performance of the industry’s leaders even especially impressive.

Corus, which notched high scores on the ROAA, ROAE, and nonperforming asset ratio metrics, specializes in commercial real estate lending in Florida, California, New York City, and Washington, D.C.u00e2u20ac”with a strong emphasis on the construction of new condominiums. Although the bank does operate a network of 11 branches in metropolitan Chicago, it also markets its various deposit products nationwide. Commercial real estate lending generally offers much higher returns than many other asset categories, which partly explains Corus’s strong profitability. But the bank’s share price fell sharply from May through October of this year, signaling that some investors had lost their enthusiasm for the stock. “There’s a large contingency of investors who are worried about [the bank’s] aggressive growth in the Florida condo market,” Fitzgibbon says. It should be pointed out, however, that Corus maintains one of the stronger balance sheets in the industry.

Commerce Bankshares, this year’s second-place finisher, offers a distinct contrast to Corus. The largest independent bank left in the St. Louis market, Commerce is a careful lender with relatively little appetite for excessive credit risk. In recent years, the bank has also grown its payments systems businessu00e2u20ac”including a variety of credit, debit, and corporate purchase cardsu00e2u20ac”and the resulting fee-based revenue has helped boost its profitability despite the effects of a flat yield curve. (See story on page 26.)

Glacier is a highly decentralized, multibank holding company that operates a number of community bank subsidiaries in Montana and Idaho. This network of local banks was assembled through a series of acquisitions that Glacier has made in recent years, and each unit maintains its original name and local identity. “There are several different banking models out there and Glacier is a community bank at its core that has been an acquirer in the past,” says Brett Rabatin, an equity analyst with FTN Midwest Securities Corp. in Nashville. “They want to be in markets where community banks don’t have the majority of market share and there are no dominant commercial banks.” Glacier’s policy of keeping local management in place following a buyout has made it a preferred acquirer in many of its markets, Rabatin adds.

Once known for banking the movie industry in Hollywood, City National has in recent years focused much of its attention on successful entrepreneurs and other wealthy people with a variety of trust and investment management products. “City National has always been more of a deposit franchise,” says Rabatin. “Its clients are going to be more high net worth.” Although it does not pretend to be a mass market purveyor of financial services, the company also enjoys the distinction of being the largest independently owned bank in the Los Angeles area.

Finishing in fifth place was Park National, which has adopted a business model not unlike Glacier’s in some respects. The company, which placed third on last year’s Scorecard, services both businesses and individuals with a broad range of banking products, but does so through a network of 11 separate banking subsidiaries, each operating under its own name. Like Glacier, Park National has also been highly acquisitive and the company believes that each unit should maintain its own identity.

Rounding out the top 10 was sixth-place finisher Synovus Financial Corp. of Columbus, Georgia, which has combined the local service and high touch of a supercommunity bank with a highly profitable payments system business that helped it post the fourth-best ROAA on this year’s Scorecard. (See story on page 30.) Cullen Frost Bankers in San Antonio, Texas, was ranked seventh, followed by the 2005 Scorecard winneru00e2u20ac”Honolulu-based Bank of Hawaii Inc.u00e2u20ac”which this year slid down to the number eight spot. Ninth-place finisher U.S. Bancorp also benefited from a substantial payments systems operation, and ranked first and fifth in the ROAA and ROAE categories, respectivelyu00e2u20ac”a truly impressive performance for such a large institution. And coming in 10th was San Rafael, California-based Westamerica Corp., a conservatively managed institution that had the second-best ROAE, third-best ROAA, and third-best reserve coverage on this year’s Scorecard.

Looking ahead to 2007, Fitzgibbon expects the business climate for banks and thrifts to remain fundamentally unchanged. “If you look at the futures market today, it’s suggesting that the yield curve is going to stay fairly flat into 2007,” he says. “Although we think banks have done an amazing job across the board at improving their asset/liability modeling and management, I think it will become extraordinarily difficult for them to get through a flat yield curve environment when it stays flat for an extended period of time.”

While loan quality remains very high throughout the industryu00e2u20ac”the median nonperforming asset ratio for the 150 banks on this year’s scorecard was just .39%u00e2u20ac”Fitzgibbon would not be surprised to see some tightening in 2007. “We’re probably in the eighth or ninth inning in terms of credit quality, and our expectation is that we’ll see some softening in the U.S. economy,” he says. “It probably won’t be pervasive across the country, but there will be pockets that weaken during the course of 2007, which means that credit costs will go up.”

Fitzgibbon also expects to see an increase in merger activity next year as some banks find they can no longer grow their earnings. “Our sense is that as more banks begin to struggle with this flat yield curve and realize that it’s not going away any time real soon, their backs will be to the wall, and they’ll be forced to contemplate partnering with somebody else who might have better flexibility to manage through this difficult period.”

And if that’s the case, it will be interesting to see which names may disappear from next year’s Performance Scorecard and who the top ranked banks will be.

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View the 2007 America’s Best Banks results.

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