Category Archives: analysis

Well-run community banks said to be undervalued

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Community banks are building value that’s not being reflected in share prices, presenting investors with an opportunity among the stronger, more-focused local banks, said Jon C. Bruss, CEO and managing principal at Fortress Partners Capital Management, Hartland, Wis.  Speaking at the annual SNL Community Bankers Conference in Atlanta last week, Bruss said many community banks have made needed repairs to their operations and may now be benefiting from a resurgence in U.S. economic activity in manufacturing, transportation, energy, chemicals and other sectors.

“The average community bank is selling at barely over tangible book value – 105 percent to 115 percent – and that means a lot of them are selling at well less than TBV,” said Bruss, whose firm provides strategic capital advice and private equity to community banks. “Well-run community banks are building value that’s not being reflected in transaction prices, and that presents an opportunity.”

Community banks are now valued lower than at any time in the past two decades, Bruss said. During that 20-year period the sector twice saw returns for community bank stocks increase by more than 200 percent.

“Banks that held steady through the crisis have seen their valuations improve and are now in a better position to optimize their value.” Bruss said. The key to investing in the sector, he added, is to determine which companies are both good banks and good investments. He noted that banks that have  dealt appropriately with the interest rate environment, nurtured their net interest margins, scrubbed their loan portfolios, educated their boards of directors regarding value, and have repaid or planned for TARP obligations, “will earn premiums on their sale—if they choose to sell.”

After years of retooling, many community banks find themselves in a strong competitive position, able to “out local” the super-regional or large banks, which are typically headquartered well out of market, said Bruss. “Small business owners trust community banks for financing because of their nimble decision making, accessibility to clients, and intimate local-market knowledge,” he said.

Bruss has nearly 50 years of experience in commercial banking, finance, and investment banking.  He organized and managed Town Bankshares and Town Bank, which were sold in 2004 to Wintrust Financial Corp.  In 1992, he formed Fortress Bancshares, which acquired three banks and was, in turn, acquired by a publicly-traded bank holding company, Merchants & Manufacturers.  It was acquired by BMO Harris.

Overdraft continues to be important to customers, banks

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Overdraft services continue to remain important to customers, and they continue to provide an important revenue stream to banks. Moebs Services, a financial services research firm located outside of Chicago, recently published information showing banks made $32 billion in overdraft fees in 2012. That’s a 1.3 percent increase over 2011.

The research suggests that at the current rate of increase, overdraft fee revenue to banks will reach an all-time high in fourth quarter 2016.

Michael Moebs, the head of the firm, said the increase in bank revenue came from an increase in the number of overdraft transactions, not from an increase in the fees.

The report notes that larger banks tend to charge more for overdrafts than small banks ($35 per overdraft for banks with more than $25 billion in assets, compared to $25 per overdraft for banks with less than $100 million). Also, the median bank fee is $30 and the median credit union fee is $27.

Keep in mind, however, that some banks charge different fees based on the number of times a customer uses an overdraft. Some charge a lower fee for the first three overdrafts per year, and then increase the fee for the fourth and subsequent overdrafts.

For a look at the research, click here.

2012 proves strong year for bank earnings

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The FDIC reported numbers for the fourth quarter and the full year 2012 yesterday that paint an industry experiencing improving conditions. Earnings are up, deposit funds are flowing into banks at record rates, fewer banks are losing money, and fewer banks remain on the agency’s problem list.

The nation’s 7,083 banks and thrifts reported combined earnings of $141.3 billion for the year. That’s the second-highest ever in a single year behind 2006’s $145.2 billion and 19.3 percent ahead of 2011. The FDIC said the increase was attributable to lower expenses for loan-loss provisions and higher fee income. Most of the income was earned by the nation’s largest banks. The nation’s 2,205 banks with less than $100 million in assets reported combined net income for the year of $920 million.

Asset quality improved across the industry with noncurrent loans falling for the 11th consecutive quarter. Deposits continued to pour into banks, with an increase of $313.1 billion. At 3 percent, that’s the biggest quarterly gain ever. The FDIC’s problem list, which peaked first quarter of 2011 at 888, closed 2012 at 651, marketing the seventh consecutive quarterly decline.

Read the FDIC press release by clicking here.

Banks across the Upper Midwest generally reported earnings in line with the national averages. There is a general decline in the number of institutions, with most of the decline occurring among institutions with less than $100 million in assets.

In Illinois, for example, the number of banks in the state has declined to 560 from 607 in 2010, although the number of banks with less than $100 million in assets has declined by 33 in that time to 226, compared to banks with more than $100 million in assets which have declined by 14 to 334. Nonetheless, earnings at the smaller banks are improving. The smaller banks reported collective earnings of $68 million for 2012 compared to $26 million last year. That’s a 161 percent improvement in earnings despite a 7 percent drop in the number of institutions in that size category. Still, the return on assets and return on equity for smaller banks were below the national average: 0.54 percent for Illinois banks versus 0.72 percent for the country on ROA, and 4.73 percent versus 5.95 percent on ROE.

Banks in Iowa and the Dakota were among the nation’s leaders based on ROA and ROE. Iowa banks (of all sizes) averaged 1.16 percent ROA compared to the all-bank national average of 1.00, and 11.16 percent ROE compared to the national all-bank average of 8.92 percent. Larger banks did better in Iowa than smaller banks: 1.17 percent ROA for large banks versus 1.06 percent for smaller banks; and 11.47 percent ROE for large banks compared to 8.98 percent for smaller banks. All North Dakota banks averaged 15.32 percent ROE (11.72 percent for smaller banks and 15.62 for larger banks), and 1.61 percent ROA (1.16 percent for smaller banks and 1.65 percent for larger banks). South Dakota’s numbers came in at 9.98 percent ROE (10.03 percent for smaller banks and 9.98 percent for larger banks) and 1.11 percent ROA (1.14 percent for smaller banks 1.11 percent for larger banks).

Minnesota’s 379 banks earned $603 million for all of 2012. This total does not include earnings from Wells Fargo or U.S. Bank which have their charters in other states. There are 205 banks with less than $100 million in assets in the state; that’s down from 231 two years ago. The smaller banks collectively earned $87 million last year, compared to $43 million two years ago. All banks combined, returned 0.93 percent on assets (0.83 percent for small banks; 0.95 percent for larger banks), and returned 8.92 percent on equity (7.71 percent for small banks; 9.17 percent for larger banks). The percentage of unprofitable institutions in the state continues to decline. In 2012, 10 percent of the banks lost money, compared to 2010 when 23.27 percent of the banks lost money.

After $100 million, economies of scale hard to find at community banks

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The FDIC’s Community Banking Study published in December includes an interesting discussion on economies of scale in the community banking sector. Conventional wisdom generally says banks achieve greater economies of scale as they get larger. But the FDIC suggests that beyond a relatively low threshold, greater efficiencies really are not achieved at community banks.

The FDIC conducted research specifically designed to determine if economies of scale exist among community banks. (See chapter 5 of the study.) The FDIC looks at banks specializing in agricultural lending and banks that specialize in commercial real estate lending. It isolates the years 2006 and 2009 for the analysis.

The FDIC analysis found that CRE specialists, in fact, have a potential benefit from economies of scale according to 2006 data. Their average costs declined by about 400 basis points between asset sizes of $10 million and $10 billion.

However, the analysis showed almost no cost difference for CRE lenders ranging from $100 million to $1 billion. The benefits beyond $1 billion were very small, the FDIC said.

“In other words, the majority of efficiency gains are achieved by $100 million in total assets,” the FDIC said.

The average cost curve estimated for CRE specialists in 2009 looks somewhat different, although it still shows that average costs level off above $500 million, indicating that most cost advantages are realized by $500 million.

For the agricultural lending specialty group, there is less evidence of economies of scale, the FDIC said. There is very little difference in estimated costs between the smallest and largest banks, and there are no statistically significant cost advantages beyond $100 million in total assets, the FDIC says in the report.

The FDIC’s conclusion is striking: “These results show that while some small community banks may be able to reduce their average costs through growth, there is no indication of any significant benefits beyond $500 million in asset size. Much of the benefit from economies of scale appears to dissipate once community banks reach $100 million in total assets.

“Therefore, while economies of scale may create incentives for banks to grow toward $100 million in total assets, depending on lending specialty, scale considerations are probably not the most important factors driving consolidation above that size threshold.”

Midwest has strong local economies

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Bankers can find NorthWestern Financial Review’s 2013 economic outlook feature in our Feb. 1-14, 2013 edition.

Titled “A strong Midwest,” we report economists’ expectation of a stable and growing U.S. economy in the coming year. We also report that the Midwest leads the country for economic strength in its small town economies. Our analysis is based an economic strength ranking created by POLICOM Corporation, an independent economics research firm based in Palm City, Fla.

The economics firm uses data collected by Bureau of Economic Analysis to rank 942 local economies across the country. POLICOM subdivides these local economies into 366 small towns with population between 10,000 and 50,000; and 576 cities with a population of 50,000 or more. POLICOM ranks each city based on what local workers earn, how much they work, and how many jobs are available in the area. The ranking also incorporates data on earnings, wages and jobs provided by small businesses, and the construction and retail industries. It also takes into account negative economic indicators such as welfare and Medicaid payments in a community.

For a ranking of the Midwest’s largest cities and highest-ranked towns, click here.

For a ranking of all Midwestern cities, click here.

For a ranking of Midwestern towns, click here.

POLICOM’s full U.S. ranking can be found here.

To download and manipulate any of the spreadsheets:
1. click the link.
2. click “file” in the document.
3. click “download as” in the file menu.

Stress tests reveal some industry weak spots

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Trepp, LLC, a New York-based information and analytics firm, ran stress tests on more than 6,000 banks in the country and about one in eight failed. Colorado, Minnesota, Illinois, and North Dakota had a disproportionately higher percentage of banks that failed. The company said banks that had greater exposure to commercial real estate loans also had a higher likelihood of failing the test.

Trepp looked at June 30, 2012 call report data at 6,151 banks. Assuming a severely adverse economic scenario, Trepp judged a bank to pass if it maintained these four thresholds:

  • Tier 1 Leverage Ratio of 4 percent
  • Tier 1 Common Ratio of 4.5 percent
  • Tier 1 Risk-Based Capital Ratio of 6 percent, and
  • Total Risk-Based Capital Ratio of 8 percent.

The company found that 784 banks, or 12.7 percent of the total, failed the test because one or more of these thresholds was not met. These results assumed banks did not change their dividend policy as their condition deteriorated. When Trepp adjusted by ending the payment of dividends at the banks, only 615 banks failed, or 10 percent.

Larger banks did better in the stress test than smaller banks. The strong results for banks with more than $10 billion in assets reflected their greater success with raising capital. Since the credit crisis began in 2007, larger banks have raised more than 90 percent of the $371 billion in new capital that has been issued by banks. This additional capital has bolstered the large banks’ core capital by 32 percent, compared to only 5 percent for banks with under $1 billion in assets, Trepp said.

Banks in Ohio, Indiana, Massachusetts, Louisiana, Nebraska, Texas and Iowa scored strongly on the test. In each of the states, more than 92 percent of the total banks tested passed the severely adverse Trepp scenario. For banks in these states, the average Teir 1 Leverage Ratio was in the double digits. In addition, these states were able to generally avoid the excesses of the housing boom and bust. As a result, banks in these states face moderate to below-average loss rates on their more significant loan exposures.

On the other end of the spectrum, Florida, Georgia, Illinois and Minnesota did not score as well, with fewer than 84 percent of their total banks tested passing. These four states’ banks have comparatively weaker balance sheets, Trepp said. Tier 1 Leverage Ratios for the lower scoring states trailed the stronger states by 1.1 percent of average. The banks in these states also face larger loan losses and have somewhat higher exposures to residential loans, CRE loans and consumer loans. In addition to this exposure, they are forecast to be hit with higher loss severities in the three loan segments. Combined, the lower starting capital ratios and higher losses pushed more banks in these states below the minimum capital ratio thresholds necessary to achieve a passing test grade.

Trepp noted that Basel III capital requirements make it even more difficult for banks to pass its stress test. The company ran each bank through a second round of testing, this time based on presumed Basel III rules. In order to pass, Trepp required a bank to meet these four thresholds:

  • Tier 1 Leverage Ratio of 4 percent
  • Tier 1 Common Ratio of 7 percent
  • Tier Risk Based Capital Ratio of 8.5 percent, and
  • Total Risk Based Capital of 10.5 percent.

Under this criteria, 1,447 banks or 23.5 percent failed. If you assume the banks change their dividend policy, only 1,150 banks failed.

Here is the Trepp web site, where you can request a copy of the report.

Here is the American Banker story, which appeared in today’s edition.

While the Trepp testing considers many factors, anyone can get a pretty good snapshot of the health of the industry by looking at the equity capital ratio of the banks in any state. Paid subscribers to NorthWestern Financial Review can see this information on the “state pages” link in our premium section.

This data shows that at the end of the second quarter, there were four banks in the region with a capital ratio of less than 1 percent (three in Illinois and one in Kansas.) There were four banks with ratios between 1 percent and 2 percent (one in Kansas, Minnesota, Missouri, and Wisconsin. The one in Minnesota has since been closed.) There are 11 banks with ratios between 2 percent and 3 percent (three in Illinois, one in Kansas, two in Michigan, one in Minnesota and four in Missouri.)

Following is a list of Upper Midwest states followed by the number of banks in the state with an equity capital ratio of less than 8 percent: Colorado 9; Iowa 14; Illinois 62; Indiana 7; Kansas 21; Michigan 15; Minnesota 43; Missouri 27; Montana 2; North Dakota 12; Nebraska 15; South Dakota, 4; Wisconsin, 14; and Wyoming 1.

Need for community banks assures their survival, bright future

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This is a pretty dark view of the community banking industry, published in the American Banker newspaper on June 19. The author cites several factors which may limit the growth — and even contribute to the demise — of community banks.

Cam Fine of the Independent Community Bankers of America followed up quickly with this response. And yesterday, the American Banker published this response from Marty Madden, an EVP at a bank in LaGrange, Ill.

I have been writing about banking since the mid-1980s. Ever since I wrote my first story, I have been hearing from experts that the community banking industry is on the verge of extinction. It is easy to get swept up in the emotion of the current crisis. Certainly if you had talked to an ag banker in 1987, he was likely to tell you that things didn’t look good. Similarly, if you talked to a banker heavy into real estate lending in 2009, he or she might also have had a pessimistic view.

Someone once said that the only way we lose is if we quit. There is a lot of wisdom in that statement. Certainly, if you give up on your bank when times get tough, it isn’t likely to survive. But if you remain determined to stick it out, you may make it. In some cases, of course, the bank still fails or gets sold but if the bank lacks committed management it has no chance of succeeding on its own.

In all small businesses when times get tough, it forces the business owner and manager to take a hard look at his or her own processes, employment practices, marketing and product offerings. This kind of scrutiny, which rarely happens when things are going well, is essential to the long-term survival of any organization. Because markets change, organizations have to change too. Challenging times are often a signal that your company, bank, firm or organization needs to change — usually only modestly, but sometimes substantially. Good mangers recognize what kinds of changes are needed sooner than poor managers.

Community banks will survive as an industry because there are too many small businesses that rely on them for their own survival. Community banks serve the small business sector in a way the very large banks simply cannot. As long as people have entrepreneurial drive, there will be small businesses and, therefore, community banks.

At the same time, significant market forces are working to commoditize all products and homogenize every  sales experience. This is not what people want. Customers want to be treated as humans; most don’t want every sales experience to be reduced to a transaction. Community banks have long been good at relationships. The good banks connect with people, and that’s becoming a more valuable skill every day.

Small business entrepreneurship guarantees the survival of the community banking industry and the relationship skills of community bankers position the industry for a bright future.

Industry conditions improving but earnings questions linger, expert at ICBA convention says

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Thomas Mecredy of Vining Sparks offered the follow observations about the community banking industry landscape yesterday during a breakout session at the ICBA national convention, taking place in Nashville, Tenn.:

  • Industry earnings are beginning to recover from a low point in the cycle, as credit loss provisioning is beginning to decrease and lending activity is beginning to improve.
  • However, reduced fee income, increased costs of doing business and narrow margins will hamper any significant improvement for many community banks.
  • Regulators, rating agencies, analysts and investors still do not have the necessary balance sheet and earnings clarity to bring the sector “out of the penalty box” and accurately identify “core earnings.”
  • Credit quality remains the largest questions mark for 2012 earnings.
  • With uncertain earnings, and in certain regions of the U.S., asset quality concerns, industry stakeholders still point to two primary drivers of bank valuations: asset quality and capital.
  • The landscape has changed since 5%-6%-10% were the capital standards — effective minimums seem to be 8%-9%-12% for most banks.
  • M&A activity will begin to increase in 2012 from the previous three historically quiet years and valuations will begin to improve for healthy and profitable community banks.

It is a vary vibrant convention, with some 1,700 bankers and 3,000 total attendees at the meeting, which is taking place at the Gaylord Opryland Resort & Convention Center. The first general session is this morning. FDIC Acting Chair Gruenberg, Acting OCC John Walsh are one the schedule, as is ICBA President/CEO Cam FIne and columist George Will.