Wednesday, December 26, 2012

Banking's Total Return Top 5

Last year I searched for the Top 5 financial institutions in total return to shareholders because I grew weary of the "get big or get out" mentality of many bankers and industry pundits. If their platitudes about scale and all that goes with it are correct, then the largest FIs should logically demonstrate better shareholder returns.

Not so last year, and not so again this year.

My method was to search for the best banks based on total return to shareholders over the past five years... capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered for those FIs that trade over 2,000 shares per day. This, naturally, eliminated many of the smaller, illiquid FIs.

For comparison purposes, here are last year's top five, as measured during September, 2011:

This year's list is in the table below:

 The two report A-listers are BofI Holdings, Inc., and Bank of the Ozarks, Inc. Special mentions are Signature Bank that was #7 this year, and German American Bancorp that was #9. No slouches there.

BofI Holdings Inc. and its subsidiary BofI Federal Bank aspire to be the most innovative branchless bank in the United States providing products and services superior to their competitors, branch-based or otherwise. In its latest investor presentation, BofI highlighted it's expense ratio (operating expense as a percent of average assets) compared to peer as 1.67% versus 3.17%, respectively, and efficiency ratio (operating expense as a percent of total revenue) compared to peer as 35% versus 63%, respectively. So, as a branchless bank, BofI has leveraged its significantly lower operating expenses into profit. That profit led to the top spot in five year total return to shareholders, two years running. Well done!

In 1979, George Gleason, a 25-year-old attorney, purchased controlling interest and assumed active management of the bank as Chairman of the Board and Chief Executive Officer. At the time, the bank had a couple dozen employees and total assets of $28 million. Today the bank has more than 100 offices in seven states. It's growth since 2010 has been fueled by seven purchases of failed banks. This has led to $863 million of covered loans (loss share arrangements with FDIC), and a yield on such loans of 8.69%, according to its latest investor presentation. This has led to a mind blowing net interest margin of 6.01% for the quarter ended September 30, 2012. OZRK moved up three places in total return to shareholders from last year's ranking. Well done!

New to the august list is Access National, whose mission is to provide credit, treasury management and private banking services to emerging businesses with revenues of up to $100 million... very specific, and refreshing given that so many banks cannot choose a specific niche for fear of alienating other constituencies. Those buckshot banks don't have much representation in this top 5 list. Coincidence? You decide. Another interesting fact is that Access National's management team, which owns 15% of the bank, is relatively young, ranging in age between 41 and 53 years old. To be fair, Access National is headquartered in Reston, VA, one of the best banking markets in the country. Focused mission, young management team, great markets... great ingredients in a success recipe.

Founded in 1834, Hingham Savings' mission is  to provide the finest in community banking, with integrity and teamwork. This usually earns the jfb blah, blah, blah statement since we can affix that mission to 90% of the banks across the US. But slow and steady wins the race, in this case. Hingham's ROA from 2007-2011 was 0.63%, 0.81%, 0.93%, 1.05%, and 1.14% respectively. It's third quarter 2012 ROA was 1.15%. Slow, steady improvement. By the way, 0.63% represented it's lowest ROA in a 10-year stretch. But looking at their performance, it's fair to ask... "what financial crisis?" Hingham's tagline, "Simple Banking. Honest Value. Happy Customers" is consistent with a typical industry theme described by one of my colleagues: "boring banking is beautiful". It's this simplicity and consistent performance that most likely resulted in their superior, long-term total return to their shareholders.

Texas Capital Bank delivers highly personalized financial services to Texas-based businesses with more than $5 million in annual revenue. Recognizing the inherent link between business owners and their personal wealth, TCB manages the personal wealth of Texans with net worth of more than $1 million. Similar to three of the five banks on our list, TCB is a relatively recent addition to banking, being founded in 1998. Actually, since Bank of the Ozarks has significantly changed since it's FDIC acquisition spree, one might include them in the list of "new" banks. TCB is largely a growth story, and mostly organic growth since it has not been very acquisitive. Since 2007, operating revenue has grown at a 22% compound annual growth rate (CAGR), while non-interest expenses grew at a 17% CAGR. This positive operating leverage generated net income CAGR of 32% during the same period, supporting their Top 5 position in total return to shareholders. Well done TCB!

There you have it! The jfb all stars in top 5 total return. Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Do you think there are themes that have led to these banks' performance?

~ Jeff

Note: I make no investment recommendations in my blog. Please do not claim to invest in any security based on what you read here. You should make your own decisions in that regard. FINRA makes people take a test to ensure they know what they are doing before recommending securities. I'm sure that strategy works out.

Friday, December 21, 2012

Bankers: What should the magi bring you?

The Gospel of Matthew reads (Chapter 2):

"When Jesus was born in Bethlehem of Judea, in the days of King Herod, behold, magi from the east arrived in Jerusalem, saying, 'Where is the newborn king of the Jews?' We saw his star at its rising and have come to do him homage."

King Herod dispatched them to Bethlehem. Matthew's Gospel goes on to say:

"And behold, the star that they had seen at its rising preceded them, until it came and stopped over the place where the child was. They were overjoyed at seeing the star, and on entering the house they saw the child with Mary his mother. They prostrated themselves and did him homage. Then they opened their treasures and offered him gifts of gold, frankincense, and myrrh."

I'm no biblical scholar, so I am not aware of any significance to the three gifts bestowed on Jesus by the magi. Three wise men, men of stature, traveling long distance, with nothing to guide them but a star, to bestow a gift to a child, a child born under the most humble conditions, was symbolic enough.

But the gifts were chosen by the givers. We can all reflect this Christmas on what three gifts we would give to improve the lives of those around us. Not gifts such as the fruitcake, or piece of jewelry. Something more profound.

This got me thinking about what three gifts I would like to give to bankers, if I had such power. Here is what I came up with:

1. The Gift of Leadership

Leadership is not managing the day to day affairs of the bank. Leadership is motivating others to follow you through difficult and uncertain circumstances, keeping firmly focused on a vision. In no other time during my career in banking, has there been a more difficult and uncertain road ahead. Banking needs leaders that form a vision, communicate it so effectively your team lines up behind you, and pursues it with incredible passion.

2. The Gift of Talent

Banking used to be more about efficiently processing transactions and less about helping customers navigate financial complexity. As a result of automation, transactions are handled less and less by human hands. Efficient transaction processing is more likely executed in the IT department than on the teller line. At the branches, and at our customers' offices, there is a need for bankers to make customers' financial lives less complex. We need the talent so we are capable of doing it.

3. The Gift of Prudence

Yes, bankers must be prudent in developing and executing their strategy. But if I could bestow prudence, I would first focus on bank regulators. We long for a regulator that interprets laws for their intention, and implements rules that follows the spirit of the law with a watchful eye towards minimizing unintended consequences. Have you ever sat at a mortgage closing? The volume of documents and disclosures that few borrowers read are the result of imprudent regulation. Did it help us? We are on the precipice of making the same mistakes again. It would be a beautiful gift to have regulators that know this and act accordingly.

So, in the spirit of the magi, I offer three gifts to bankers. I wish I had the power to make it so. What gifts do you want from the magi?

Merry Christmas everyone!

~ Jeff

Thursday, December 13, 2012

jfb Toons: Bank Strategy Execution

Welcome to my first installment of jfb Toons, a cynical look at how financial institutions operate.

In this version, I migrate from the strategy development retreat to how that strategy is translated to day to day execution. I am occasionally confronted with facilitating plans for clients, only to come back one year later to find little has changed.

If I were to fill in the gap between strategy development and how it is executed, this is how I think it would go...

~ Jeff

Sunday, December 02, 2012

Preamble to a Bank Strategic Alternatives Analysis

Bloggers pepper me with insights on how to be a more successful blogger. One such insight is to create a compelling title. In this regard, this blog's title is an outright fail. Try to say it three times fast!

I recently sat in front of a client board committee reviewing the bank's strategic alternatives (see a prior post on performing such analysis here). Before you think this bank is on the auction block, think again. This bank's board was delivering on its fiduciary duty to shareholders to maximize value.

Before getting into the details, I prefaced my analysis on where a strategic alternatives analysis fits in the overall scheme of executing strategy. Because, my readers, it occupies a far too important perch than you might think.

The following is my paraphrased preamble to the analysis:

"Strategic Alternatives Analysis is a critical component to strategy development and execution. For example, we see various planning tools as subsets to your overall strategic plan: Marketing and IT Plans, ERM/Risk Appetite, Capital Plan, Budget, and a Strategic Alternatives Analysis. All are linked.

'We espouse multiple projection scenarios when developing strategy. The first, we typically call the base scenario. The base represents the likely outcome of executing your strategy. In banking parlance, this is the basis for your budget. It is the starting point for the remaining scenarios. You should have a 50%-75% confidence level you can achieve the base scenario.

'The second is the stress scenario. Here you are trying to gauge what could go wrong based on relevant and defensible stressors, such as credit or interest rate shocks. This scenario is important to determining the risk-level of your strategy and the adequacy of your capital to withstand shocks. Your capital plan, of course, will have additional scenarios to identify the most attractive capital augmentation strategies should the stress case come to pass.

'The third projection scenario is the stretch. When developing strategy, it is critical to envision what success would look like upon successful execution. Rare is the case that achieving your vision would result in solely hitting your budget. You want to envision what success would look like in financial terms, too. Your management team should have a 30%-50% confidence level you can achieve stretch goals. Stretch projections should be your base for a Strategic Alternatives Analysis.

'Evaluating strategic alternatives goes beyond what you can pay for a target or what a buyer can pay for you. True, it is an important element of it. But the decision to buy should be based on your perceived inability to achieve stretch goals on your own. It is a lower risk strategy to achieve earnings and tangible book growth organically than through acquisition. But if your strategy does not deliver the shareholder value improvement you desire, then perhaps buying a competitor can bridge that gap. The strategic alternatives analysis shows the targets you have the greatest opportunity to buy.

'How do you know if you should sell? This analysis will show what buyers can likely pay. Normally, and in this case, the values are greater than where your bank currently trades. So, absent additional analysis or other considerations such as employees and customers, you should sell, right? Not so fast.

'Stretch projections should be discounted back to present day to determine the present value of successfully executing your strategy. If such an analysis delivers a present value in acceptable proximity to your take-out value, then your Board may conclude that it is best to remain independent and execute your plan. This keeps the keys to your shop in your hands, where you may have greater confidence than in somebody else's hands. Without developing stretch projections, how would you know if and when to sell? How would you know that there is a value gap and your management team must develop more aggressive strategies? You wouldn't. You would be guessing.

'This is the critical link to strategic planning and strategic alternatives analysis. It keeps the management team focused on delivering value to shareholders, keeps the Board focused on their fiduciary duties, and models successful execution of strategy, in financial terms. It is the very definition of your right to remain indepenedent, or is the basis to putting M&A as a critical component to your strategy."

Does your FI perform routine strategic alternatives analysis?

~ Jeff