Bank Valuations: What You Can and Can’t Control

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The Federal Reserve’s decision to pause interest rate increases in June 2023 gave markets hope that the period of rapidly rising rates had ended. “The fact that they paused likely indicates we are near the top,” says Patrick Vernon, senior manager, advisory services at the consulting firm Crowe LLP. But he notes that no one knows for sure whether more rate increases could come.

For financial institutions, this moment has provided a breath of fresh air. Rising rates have cut into bank valuations as bond portfolios went underwater, and investors grew more concerned about an uncertain economy. High-profile regional bank failures, including Silicon Valley Bank and First Republic Bank, further fueled concerns. 

But, for bank directors evaluating their own organization’s valuation, a chaotic environment highlights a simple fact: Many of the external factors that impact a bank’s valuation can be out of leadership’s control. Instead, it requires understanding what the business can plan for and protect against to improve valuation figures. With that awareness, leaders can determine the best way to respond when the unexpected occurs. (To understand more about the metrics that drive a bank’s valuation, click here.)

“What’s driving the decline in multiples — uncertainty of the future or the probability of a recession?” asks Scott Gabehart, chief valuation officer at BizEquity, a technology platform for business valuations. “What’s the impact on the bank’s profitability? As GDP growth goes, so does bank profitability and therefore, value.”

The interest rate environment provides a great example of this balance between what you should expect management to control and what it cannot. 

According to Bank Director’s 2023 Risk Survey, conducted in January, 91% of executives and board members cited interest rate risk as an area of heightened concern, up markedly from 2022. No surprise there, since the federal funds rate increased by roughly 500 basis points since March 2022. For many banks, the bond portfolio has taken a significant hit. Fixed rate assets declined in value as interest rates increased; newer bonds pay a higher rate. Most banks can hold onto the lower yielding bonds until they mature, but a bank that has to sell the bond would record a loss. Acquirers would want to pay less for targets with these assets on their books.

If a bank doesn’t have to sell, then it won’t lose money on the bond’s face value — or the amount the bond would return at the end of its term. For most banks, “it’s paper losses not actual losses,” says Vernon.

A bank may see its valuation shift based on its bond portfolio. But if it has done an effective job of managing assets, then it will likely play a smaller role in the valuation. Asking management for an understanding of the resources available to cover different liquidity concerns within the business will provide an indication of how well it can manage its responsibilities.  

Another area that’s primarily out of the hands of bank management, particularly for an organization looking to be acquired: deflated M&A pricing. This impacts the amount another bank would pay for the business. 

Valuation has a direct connection to what the bank would earn if an acquirer bought it. If another institution will only pay a certain price, it can have an impact on the bank’s value in the market, perceived or otherwise. “Bank stocks trade at lower multiples, and the public market sets the tone for M&A pricing,” says Jeff Davis, managing director of the financial institutions group at Mercer Capital.

The number of bank acquisitions dropped in 2022, according to S&P Global Market Intelligence, and only 32 such deals had occurred through May 2023. Deal value also dropped from 154.3% deal value to tangible common equity in 2022 to 130.6% as of May.

Lower multiples for public stocks and lower valuations for would-be sellers are driving the M&A decline in the bank sector, says Davis. These valuations have suffered due to long-duration bonds and loans made during the lower rate environment. Banks don’t want to sell at depressed prices, preferring to “wait to see if rates fall and public market valuations increase,” says Davis. 

For boards discussing their M&A prospects, directors should know the value of the bank to ensure they do not sell at a time when acquisition prices are depressed — or so they don’t pay too much for a target if they’re the acquirer. The current environment does allow for banks open to buying distressed targets to look for a deal on an acquisition. In doing so, the bank can possibly expand through acquisitions — and at a discounted sales price. 

One of the best ways that banks can control their valuation is to have a plan as the economy moves forward. Whether markets struggle or surge, having a strategy to grow assets, loans and profitability will improve the valuation.

“What are the bank’s plans for maintaining the asset base and/or expanding it?” asks Gabehart. “The focus should be on the future. What can be done to improve the metrics of the bank and profitability?”

Expecting management to have a plan for such scenarios can ensure the organization has a way to respond, no matter what outside forces bring. 

Tactics like diversification can ease the impact of stress in other areas of the business. For instance, mortgage demand has suffered due to rising interest rates. Questioning how the bank can improve its product and service offerings could add new avenues for growth and improve the bank’s valuation.

Or, if the organization has a robust fintech arm, then the bank’s valuation could remain stronger in the current market, since there’s less threat from interest rates on the fintech space, says Vernon.

Asking management how the bank will seek areas of strength can give directors insight into how executives view the future. 

Board members cannot escape the outside forces that affect the bank. But protecting the balance sheet ensures that business doesn’t halt when rates rise or other economic forces batter the bank — improving its long-term value. 

Resources
For more information about the metrics behind bank valuations and why it matters, read the first part of this series, “What Drives a Bank’s Valuation?” 

The cover story in the second quarter 2023 issue of Bank Director magazine, “Banking’s New Funding Challenge,” focuses on the rising interest rate environment and its impact on deposits. The Online Training Series library also contains information about understanding and managing interest rate risk. 

Bank Director’s 2023 Risk Survey, sponsored by Moss Adams LLP, surveyed 212 independent directors, CEOs, chief risk officers and other senior executives of U.S. banks below $100 billion in assets to gauge their concerns and explore several key risk areas, including interest rate risk, credit and cybersecurity. Members of the Bank Services Program have exclusive access to the complete results of the survey, which was conducted in January 2023.

Are You Giving Customers What They Value?

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How often do your bankers give customers exactly what they ask for — instead of what they really need?

Most bank executives say meeting customer needs and providing excellent customer service is their top priority. But that doesn’t necessarily translate into a customer-focused mindset in practice.

As changing external factors and heightened competition create new pressures on banks to expand their market share and find new paths to growth, a product-centric mindset that is mostly focused on selling businesses loans or lines of credit isn’t enough. Business leaders have myriad needs and are looking for trusted, personalized advice on everything from reducing their operating costs and minimizing fraud to improving cash flow. They’re not interested in listening to product pitches; they want help making smart decisions for their businesses.

But bankers can’t make these recommendations and create value that matters to their customers until they understand the situation. Just like physicians, bankers need to diagnose before they can prescribe. And for many of your employees, this will require not just new skills but a mindset shift as well.

Beyond the Product Lens
Bankers often struggle to deliver a consistent, holistic experience for customers across channels because they run up against a powerful mental barrier: an aversion to being viewed as “selling.” One bank employee told us that the word sales “makes me buckle at the knees.”

This negative association with selling surfaces in a number of ways, from a reluctance to call customers to a lack of commitment to activities that could increase the bank’s wallet share. Bankers may know they should be able to do more business with certain accounts or that they “need to knock on more new doors,” but they don’t do the things that will make a difference. Instead, they have a conversation or send an email, run through all the products and leave it at that.

Many bankers have personal relationships with the business owners they work with; the last thing they want to do is badger them into buying something. The question is, why do they equate sales with product pushing?

The answer is simple: Many banks haven’t moved beyond a product-focused lens. Metrics such as number of products per customer aren’t driven by what the customer needs, they’re simply goals the banker needs to hit.

But the banks and bankers that are successfully growing and building loyal customer bases approach selling as a higher level of service. Instead of thinking they’re intruding or bothering the customer, these bankers operate by the mantra, “If I can make a difference, then I have an obligation to help.” As a result, they ask good, relevant questions and help the customer make purchasing decisions that are in the customer’s best interests.

Differentiating the Experience
Especially in times of economic uncertainty, bankers need to feel equipped to talk to customers about their businesses and concerns, probing deeper to understand what is most important to them and what will create the most value for them. Often, customers don’t know what they need until they’ve had the chance to talk it through. While it’s natural to be excited about sharing a new product, the real value bankers add for customers is by creating a space for that conversation and serving as true partners and consultants.

As customers engage in more face-to-face interactions, bankers have to make those experiences count. When they have the opportunity to talk with customers, they need to not only help with the immediate problem, but also find out what other issues they might be able to assist with.

This means your bank needs to have a common language across the institution, so customers have a seamless, consultative experience at every touch point. Customers aren’t receiving the best service if their banker doesn’t understand where they are, what’s next and how the bank can help achieve their goals. Everyone in the bank needs to understand this. Invest in developing your people and ensure managers know how to use positive coaching to reinforce this mindset shift.

Whether it’s in commercial or retail banking, your customers have pain points and questions. Your bank’s job is caring enough to ask. Commit to doing the right thing for your customers. Your bankers will have greater purpose in what they do, and they’ll consistently be able to create more value — for their customers and for the bank.

This piece was originally published in the second quarter 2023 issue of Bank Director magazine.

Should More Community Banks Be B Corporations?

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Banks face a highly competitive landscape filled with thousands of other banks, credit unions and financial technology companies. Could proving your values be a powerful way to differentiate your institution in such an environment? A 2021 Edelman survey found that 61% of consumers will advocate for brands they trust, and 86% expect them to “act beyond their product or business,” wrote Richard Edelman, CEO of the global communications firm. “[B]rands will need to operate at the intersection of culture, purpose and society.”

Sunrise Banks, a $1.9 billion community development financial institution (CDFI) based in St. Paul, Minnesota, aspires to be “the most innovative bank empowering financial wellness,” says Bryan Toft, its chief revenue officer. That mission “attracts customers [who] really care about those values,” he says. “Passionate employees are attracted to it as well, who work hard and want to make a difference because of that mission, as opposed to a paycheck.” In addition to its community bank footprint around St. Paul, Sunrise also offers a banking-as-a-service platform, choosing partner fintechs through a “social filter” that considers how those companies align with its mission.

Toft views this as a competitive advantage, not one that detracts from profitability. Sunrise Banks’ quarterly return on assets averaged 1.22% from March 2018 through Sept. 30, 2021. Performance during this period was fueled by commercial loan growth, new fintech relationships and fee income through the Paycheck Protection Program.

Certifying as a B corporation, Toft says, was a natural fit for the bank. These businesses are redefining what it means to run a successful enterprise, according to B Lab, which certifies B corporations. B Lab likens its certification to Fair Trade USA’s standard for coffee, providing a way to assess and verify a company’s social and environmental impact. The nonprofit has certified more than 4,600 companies worldwide and 1,691 B corporations in the U.S., including ice cream manufacturer Ben & Jerry’s and clothing retailer Patagonia. Eleven of these B corporations are U.S. banks. Becoming a B corporation doesn’t guarantee higher profits; few reported an ROA on par with Sunrise as of third quarter 2021.

B corporations must score a minimum 80 points on B Lab’s “B Impact Assessment,” a tool the nonprofit developed to “measure, manage, and improve a company’s positive impact performance” in the following areas:

  • Governance, including mission, ethics and transparency.
  • Workers, including health, wellness and safety, and career development.
  • Community, including economic impact, civic engagement and diversity, equity and inclusion.
  • Environment, including the company’s impact on air, water, land and biodiversity.
  • And customers, including products and services as well as data privacy and security.

“We have to look at all aspects of our business,” says Toft. The assessment features 200 questions, he says, and explores questions such as, “What percent of your employees are paid a living wage? How do you support diversity, equity and inclusion? What are some of the things that you measure in terms of environmental impact? … How do you know [that] your products make an impact positively in your customers’ lives?”

The assessment is free and can help a company benchmark its performance in the examined areas.

While the assessment is free to use, certification isn’t. The annual fee charged by B Lab to verify B corporation status ranges from $1,000 to $50,000 or more, based on the company’s revenue. In addition to the initial assessment, B Lab selects a subset of questions for additional documentation, and assessed companies must meet B Lab’s risk standards. And B corporations are legally required to consider all stakeholders; opting to become a public benefit corporation — a legal structure available in most states where a company commits to creating a positive social impact — offers a way to fulfill this requirement.

For $2.5 billion Mascoma Bank, the multi-stakeholder approach aligns with its mutual bank charter. “Our governance does not require us to give primacy to shareholders, because the community is primarily the shareholder,” says Clay Adams, CEO of the Lebanon, New Hampshire-based bank. “We measure ourselves versus peers. How do we maximize profitability but also maximize stakeholder results?”

B Corporation companies must recertify every three years, says Adams, a process he compares to a “kinder, gentler version of a regulatory exam.” Average scores range from 40 to 100 out of 200 possible points, according to B Lab. (The score for each bank appears in the below table.) And companies demonstrate different strengths; both Sunrise and Mascoma scored in the top 5% globally in the governance category in 2021.

Toft and Adams both believe that B corporation values align with community banking values, with customers and employees seeking to do business with banks that do good in their communities.

“Where [customers] put their money matters” to them, says Toft. “A lot of banks do great things in their communities, and this is a way to have a third party verify that. … A lot of banks probably could be certified as B corps, because inherently what they do is all about the mission in their respective community.”

B Corporation Banks

Bank Name/Location Asset Size (000s) Return on Assets (ROA) 9/30/2021 B Corp Start Date B Impact Score
Beneficial State Bank
Oakland, CA		 $1,496,354 1.21% 9/17/2012 158.9
Virginia Community Capital (VCC Bank)
Richmond, VA		 $235,502 1.14% 5/14/2012 149.3
City First Bank, N.A.
Washington, DC		 $1,061,371 -0.20% 4/17/2017 146.8
Sunrise Banks
St. Paul, MN		 $1,882,632 1.16% 6/23/2009 144.2
Spring Bank
Bronx, NY		 $336,177 1.42% 4/13/2016 136.2
Southern Bancorp Bank
Arkadelphia, AR		 $1,967,438 1.00% 9/9/2019 122.3
Amalgamated Bank
New York, NY		 $6,866,385 0.77% 1/11/2017 115.1
Mascoma Bank
Lebanon, NH		 $2,546,655 0.88% 6/28/2017 114.9
Brattleboro Savings & Loan
Brattleboro, VT		 $304,363 0.51% 12/18/2018 96.7
Androscoggin Savings Bank
Lewiston, ME		 $1,371,816 0.57% 1/26/2021 91.1
Piscataqua Savings Bank
Portsmouth, NH		 $338,598 0.43% 5/16/2019 81.1

Source: B Lab, Federal Deposit Insurance Corp.

The B Impact score reflects the most recent score received by the bank in B Lab’s B Impact Assessment; a company can receive a maximum of 200 points. On average, companies score between 40 and 100 points; a minimum of 80 is required to be certified as a B corporation.

Risk & Innovation: Bridging The Gap

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In today’s age of innovation, risk management can no longer be the office of ‘no.’ When risk managers are included in strategic discussions, they can help drive innovation and provide additional value to their organizations. In this video, Crowe’s John Epperson explains how successful banks bridge the gap between risk and innovation to truly bring value to their institutions.

  • Why Banks Should Transform Risk Management
  • Creating a Competitive Advantage Through Risk and Compliance

Well Conceived and Executed Bank Acquisitions Drive Shareholder Value

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acquisition-2-21-18.pngRecent takeovers among U.S.-based banks generally have resulted in above-market returns for acquiring banks, compared to their non-acquiring peers, according to KPMG research. This finding held true for all banks analyzed except those with greater than $10 billion in assets, for which findings were not statistically significant.

Our analysis focused on 394 U.S.-domiciled bank transactions announced between January 2012 and October 2016. Our study focused on whole-bank acquisitions and excluded thrifts, acquisitions of failed banks and government-assisted transactions. The analysis yielded the following conclusions:

  • The market rewards banks for conducting successful acquisitions, as evidenced by higher market valuations post-announcement.
  • Acquiring banks’ outperformance, where observable, increased linearly throughout our measurement period, from 90 days post-announcement to two years post-announcement.
  • The positive effect was experienced throughout the date range examined.
  • Banks with less than $10 billion in assets experienced a positive market reaction.
  • Among banks with more than $10 billion in assets, acquirers did not demonstrate statistically significant differences in market returns when compared to banks that did not conduct an acquisition.

Factors Driving Value

Bank size. Acquiring banks with total assets of between $5 billion and $10 billion at the time of announcement performed the strongest in comparison with their peers during the period observed. Acquiring banks in this asset range outperformed their non-acquiring peers by 15 percentage points at two years after the transaction announcement date, representing the best improvement when compared to peers of any asset grouping and at any of the timeframes measured post-announcement.

Performance-chart.png 

Acquisitions by banks in the $5 billion to $10 billion asset range tend to result in customer expansion within the acquirer’s market or a contiguous market, without significant increases in operational costs.

We believe this finding is a significant factor driving the value of these acquisitions. Furthermore, banks that acquire and remain in the $10 billion or less asset category do not bear the expense burden associated with Dodd-Frank Act stress testing (DFAST) compliance.

Conversely, banks with nearly $10 billion in assets may decide to exceed the regulatory threshold “with a bang” in anticipation that the increased scale of a larger acquisition may serve to partially offset the higher DFAST compliance costs.

The smaller acquiring banks in our study—less than $1 billion in assets and $1 billion to $5 billion in assets—also outperformed their peers in all periods post-transaction (where statistically meaningful). Banks in these asset ranges benefited from some of the same advantages mentioned above, although they may not have received the benefits of scale and product diversification of larger banks.

As mentioned earlier, acquirers with greater than $10 billion in assets did not yield statistically meaningful results in terms of performance against peers. We believe acquisitions by larger banks were less accretive due to the relatively smaller target size, resulting in a less significant impact.

Additionally, we find that larger bank transactions can be complicated by a number of other factors. Larger banks typically have a more diverse product set, client base and geography than their smaller peers, requiring greater sophistication during due diligence. There is no substitute for thorough planning, detailed due diligence and an early and organized integration approach to mitigate the risks of a transaction. Furthermore, alignment of overall business strategy with a bank’s M&A strategy is a critical first step to executing a successful acquisition (or divestiture, for that matter).

Time since acquisition. All three acquirer groups that yielded statistically significant results demonstrated a trend of increasing returns as time elapsed from transaction announcement date. The increase in acquirers’ values compared to their peers, from the deal announcement date until two years after announcement, suggests that increases in profitability from income uplift, cost reduction and market expansion become even more accretive with time.

Positive performance pre-deal may preclude future success. Our research revealed a positive correlation between the acquirer’s history of profitability and excess performance against peers post-acquisition. We noted this trend in banks with assets of less than $1 billion, and between $1 billion and $5 billion, at the time of announcement.

This correlation suggests that banks that were more profitable before a deal were increasingly likely to achieve incremental shareholder value through an acquisition.

Bank executives should feel comfortable pursuing deals knowing that the current marketplace rewards M&A in this sector. However, our experience indicates that in order to be successful, acquirers should approach transactions with a thoughtful alignment of M&A strategy with business strategy, an organized and vigilant approach to due diligence and integration, and trusted advisers to complement internal teams and ensure seamless transaction execution.