Drivers of Bank Valuation, Part II: Growing Loans and Becoming More Efficient


4-10-13_CK_Lee.pngBanks are in business to drive value—for the community, for customers and for shareholders. In our previous article we explored the concept of tangible book value (TBV) and its importance as a baseline for defining shareholder value. Growing TBV inspires confidence in the bank’s relative strength among shareholders, customers and regulators. 

We recommend boards regularly assess their internal operations and take affirmative steps to ensure more of a bank’s revenue production capability turns into TBV growth. In this article, we’ll explore two critical areas that can drive greater earnings and greater growth in the bank’s value. 

Become More Efficient

It is a truism that more efficient companies are more attractive—to investors as well as potential purchasers. If it takes less to make a dollar, greater earnings result. The earnings are then available to provide shareholders a current return on investment, through dividends or to enhance capital and support future growth. Looking at the industry data, there is a direct relationship between banks’ efficiency ratios and their earnings. In the third quarter of 2012, for example, banks with efficiency ratios of 80 percent to 100 percent earned an average of 35 basis points on assets. This compares with 84 basis points on average for banks with efficiency ratios between 60 percent and 80 percent, and a whopping average of 148 basis points on assets for banks with efficiency ratios less than 60 percent. This same pattern holds true going back several years. 

The obvious benefits to earnings of running an efficient organization is certainly payback enough for the effort involved. But controlling this process within your own boardroom is preferable to having inefficiencies dealt with through pressure from third parties, whether they are disgruntled investors, analysts or regulators. This sort of pressure can result in disruptive cost-cutting that could result in the company taking a step backwards before it can move forward. Addressing efficiency on an ongoing basis can head off these challenges, drive greater shareholder value and improve the organization’s overall strength and discipline. 

Grow Loans

The current yield curve has had a painful impact on margins at smaller banks, particularly banks with lower loan-to-deposit (L/D) ratios. So, how do you drive margin in this challenging rate environment? One answer is to make loans.

The disparities within the margin data are interesting. If you look back to the third quarter of 2009, there was little disparity in average margin between banks with higher loan balances and those with lower L/D ratios. Since then, however, margins have expanded, on average, for banks with more than 50 percent L/D (driving margins well above 4 percent), while the banks with less than 50 percent suffer margins in the low 3 percent range. This incremental disparity is a key driver of the industry’s depressed earnings profile and the low valuation placed on banks with lower loan balances.

Now, the interesting question is how to grow loans? The overall economy isn’t exactly helping. But there are steps boards and management can take to improve their ability to grow loans. These include growing the overall bank to allow access to additional customers and products through a higher legal lending limit. Other options include acquiring loan portfolios through M&A, aggressively pursuing lending staff with solid track records and books of business, partnering with nearby institutions on participations, and upgrading your pursuit of loan business within the reach and scope of the bank. Like anything else in the bank, growing loans must be a priority if the board desires to drive margin and earnings, and the managers need to be held accountable in this regard, as in any other bank priority. 

In our final article on the drivers of bank valuation, we will explore the impact of size and business diversification on bank valuation.

Lee’s comments are strictly his views and opinions and do not constitute investment advice.

Facing Headwinds: What Concerns Today’s Banking Leaders


Financial leaders are facing major headwinds this year. Declining net interest margins, loan growth and regulatory challenges are top concerns for banking leaders, according to the results of an audience survey at Bank Director’s Acquire or Be Acquired conference in Arizona in January. Jordan discusses the top concerns and what to do about them.

Download the full survey results in PDF format.


Desperately Seeking Loan Growth


2-22-13_ARS.pngWith no sign of relief anticipated from the Federal Reserve, low interest rates—and their effects on net interest margins—were top of mind for the audience at Bank Director’s 19th annual Acquire or Be Acquired conference in Scottsdale, Arizona, recently. During the audience response survey, conducted by Grant Thornton LLP and Bank Director at the end of the January, 35 percent of the 273 bank executives and directors who answered the survey said continued net interest margin compression was their top concern, while 25 percent cited loan demand. 

According to Jack Barrett, president and CEO of $216-million asset First Citrus Bank, headquartered in Tampa, Florida, concerns with the net interest margin and loan demand are connected. “Because of the dearth of organic loan demand, that engenders the margin compression,” says Barrett.  John Paisley, region president with Adams Bank & Trust, a $550 million commercial bank based in Ogallala, Nebraska, says that while the bank is seeing strong loan demand due to a strong agricultural economy and increased real estate pricing, the bank must offer below market rates to compete, forcing his bank to “learn how to operate with less margin.” 

What will loan demand look like in 2013? Fifty-seven percent of respondents expect to see an increase in loan demand in 2013, with 10 percent expecting to see a decline and one-third expecting no change. David H. Dunn, president and CEO of Wolverine Bancorp, Inc., a $284-million, publicly-traded bank holding company headquartered in Midland, Michigan, plans to fuel growth via organic loan origination, but also sees a challenge. “Everybody is looking for organic growth, and they’re doing it in an economy that’s not growing,” he says. Nichole Jordan, national banking and securities industry leader at Grant Thornton, agrees. “Growth will be hard to come by in 2013 without significant strides made in overall economic recovery,” says Jordan.  Barrett sees a market that is “erratic”, but expects to see more loan demand in 2013. “I think it’s going to be more stable in terms of loan demand. I think there’s more certainty,” he says. 

Bankers plan to address the challenges presented by loan demand in a variety of ways. Jeff Brotherson, chief financial officer of Two Rivers Financial Group, a $679-million bank holding company based in Burlington, Iowa, says that his bank focuses on hiring experienced loan producers. Data can help banks grow loans as well. Barrett supports using data analytics to better understand the market. Jordan agrees, adding that by investing in technology that allows for effective analysis and use of data, bank management teams can better monitor customer trends and be more proactive.  

While 60 percent of bankers surveyed chose loan origination as their top plan for growth, 28 percent plan a traditional merger. Not everyone who wants to buy a bank will. In fact, 83 percent of bankers surveyed at the conference want to buy a bank in 2013, although the conference itself tends to attract people interested in acquisitions. For smaller banks looking to grow quickly, this could be a wise choice. Adams Bank & Trust plans to eventually double in size, likely via acquisition. “Through organic growth, I just don’t think we’re going to get there fast enough,” says Paisley. 

Barrett is actively seeking a merger of equals in order to achieve some economies of scale, but the deal has to be right, in part due to capital concerns. ”In order to garner regulatory approval, you have to overcapitalize the transaction so high that our existing ROE [return on equity] would go down,” he says.  “We are not about reducing our returns [to] shareholders.” Many of those surveyed don’t plan to raise capital, with 66 percent giving a flat “no” to raising capital over the next year, compared to 25 percent that plan to raise capital, and 9 percent that would like to raise capital, but aren’t certain of their ability to do so. Even with Basel III looming, Brotherson does not foresee a need to raise capital at his bank, and confirms that his bank is prepared for the proposed Basel III rules that increase minimum capital ratios and make other changes to regulatory capital. Dunn characterizes his bank as extremely well-capitalized. So are banks ready—or at least preparing—for Basel III?

Perhaps banks are as prepared as they can be. Only 18 percent of bankers surveyed expressed a feeling of certainty about the political landscape, with 71 percent deeply concerned about the future of their bank and their customers. Barrett feels that the regulatory burden is unfairly placed in the laps of community banks. But as banks seek to grow, Paisley says, the regulatory burden grows right along with it. 

The survey was conducted on January 28, 2013, at Bank Director’s annual Acquire or Be Acquired conference, using an electronic survey of the audience. The 273 participants are mostly CEOs or directors of banks across the United States.

Download the full survey results in PDF format.

Loan Notes: Big Banks Lose Ground


The largest banks trailed the rest of the industry in terms of loan growth in the third quarter compared to the same period a year ago, according to SNL Financial.

Loan growth among the top 25 bank holding companies was just 3.27 percent during the quarter, compared to 4.2 percent for all bank holding companies above $1 billion in assets in the United States.

SNL called it a sign of how competitive the industry has been. The most active lending segments are commercial and industrial, as well as mortgage and housing-related lending. Credit card and auto lending also has been strong.

Among big banks, the leader in loan growth was TD Bank US Holding Co., the U.S. subsidiary of The Toronto-Dominion Bank of Toronto, Canada, which had 16 percent growth. Tied for second place was BB&T Corp. in Winston-Salem, North Carolina, and Discover Financial Services of Riverwoods, Illinois.

Among banks that saw declining loan portfolios were JPMorgan Chase & Co. in New York, Capital One Financial Corp. in McLean, Virginia, and Regions Financial Corp. in Birmingham, Ala.

Bank Assets Loan Growth Y/Y 3Q (%)

JPMorgan Chase & Co.

$2.3 trillion

-2.87

Bank of America Corp.

$2.2 trillion

-4.27

Citigroup

$1.9 trillion

.13

Wells Fargo & Co.

$1.4 trillion

3.27

U.S. Bancorp

$352 billion

7.46

Source: SNL Financial