Tuesday, December 29, 2020

Banking's Top 5 Total Return to Shareholders: 2020 Edition

For the past nine years I searched for the Top 5 financial institutions in five-year total return to shareholders because I support long-term strategic decision making that may not benefit next quarter's or even next year's earnings. And I am weary of the persistent "get big or get out" mentality of many industry pundits. If their platitudes about scale are correct, then the largest FIs should logically demonstrate better shareholder returns, right?

Not so over the nine years I have been keeping track. The first bank to crack the Top 5 over $50 billion did so this year. As a reference, the best SIFI bank in five year total return was JPMorgan at 33rd overall. 

My method was to search for the best banks based on total return to shareholders over the past five years. I chose five years because banks that focus on year over year returns tend to cut strategic investments come budget time, which hurts their market position, earnings power, and future relevance than those that make those investments. Short-term focus is a common trait of banks that focus on shareholder primacy over stakeholder primacy.

Total return includes two components: capital appreciation and dividends. However, to exclude trading inefficiencies associated with illiquidity, I filtered out those FIs that trade less than 2,000 shares per day, 1,000 more than past Top 5's. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies such as recent merger announcements, turnaround situations (losses suffered from 2015 forward), mutual-to-stock conversions, stock dividends/splits without price adjustments, and penny stocks. 

As a point of reference, the S&P US BMI Bank Total Return Index for the five years ended December 23, 2020 was 46.3%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2019:

#1.  FS Bancorp, Inc. (Nasdaq: FSBW)
#2.  Fidelity D&D Bancorp, Inc. (Nasdaq: FDBC)
#3.  Plumas Bancorp (Nasdaq: PLBC)
#4.  First Capital, Inc. (Nasdaq: FCAP)
#5.  Meta Financial Group, Inc. (Nasdaq: CASH)

Here is this year's list:

Here we are. The first crypto currency bank to crack the Top 5 and in the top position no less! Most of the price runup has been over the past year, where the stock increased 330% versus 
-16% for the S&P US BMI Banks Index. It's five year total return was a whopping 452%! And in terms of bank stock valuation, Silvergate is punching well above its weight at over 4x tangible book value and 58x latest twelve months earnings per share. This bank has over $2 billion in crypto deposits, and facilitates payments between crypto exchanges via its Silvergate Exchange Network, or SEN. With that type of valuation, investors foresee rapid growth, increased economies of scale that will ultimately result in superior financial performance. It's current performance for the third quarter of 1.13% ROA and 10.14% ROE doesn't merit the valuation, so growth and greater profitability must be what investors see. And there are positive profit trends. Take note, however, the bank grew over 20% year over year, so their current 10.4% leverage ratio combined with their internal profit generation tells me they will be extending the proverbial hat to investors for more capital to support their growth. And at those valuation numbers, who wouldn't? Here is an interesting Motley Fool discussion on the bank. Give Silvergate credit, they picked a niche and are executing on it to the delight of investors. Welcome to the Top 5!

#2. Live Oak Bancshares, Inc. (Nasdaq: LOB)

I'm surprised that this is the first showing of LOB on the Total Return Top 5. It has been an industry darling due to its dedication to technology experimentation. It was the brain child for the nCino platform, which it formed in 2012 and spun off in 2014. Live Oak was founded in 2007 to provide business loans, primarily Small Business Administration (SBA) guaranteed loans, to select industries, like dentists and veterinarians. Live Oak is now the largest SBA 7(a) lender in the United States. They opened in 2007! But it goes beyond traditional banking. Subsidiaries, in addition to the bank, include: Live Oak Private Wealth, LLC, a registered investment advisor; Canapi Advisors, LLC that provides investment advisory services to new funds focused on providing venture capital to new and emerging fintechs; Live Oak Ventures, Inc. that invests in businesses that align with the company's focus on fintech; Government Loan Solutions, Inc., a management and technology consulting firm that engages in the settlement accounting, and securitization process for SBA and USDA guaranteed loans; and, get this, Live Oak Grove, LLC, which is their on-site restaurant for employees in Wilmington, North Carolina. Because of these niches, Live Oak also punches above its weight by traditional bank valuation standards, trading at over 3x tangible book and 51x trailing twelve months earnings. But it's five year total return: 250%! Well done!

#3. Fidelity D&D Bancorp, Inc. (Nasdaq: FDBC)

Fidelity D&D Bancorp, Inc. is over two times the asset size it was in 2016 due to the combination of organic growth and an acquisition that was announced in late 2019 and closed in May in the middle of a pandemic. When the pandemic hit, FDBC's stock took a tumble along with most everyone in the industry. But throughout the year, their stock bounced back to where it was a year ago. While the S&P US BMI Banks Index was down 16%, FDBC held serve. This puts its price to tangible book ratio slightly north of 2x, high by traditional community bank standards today. But it's price/earnings for the 3Q annualized was 15.9x. They had special charges in earlier periods as a result of the acquisition. Their 3Q ROA was 1.15% and ROE was 12.42%. A consistent performance record, plus the ability to profitably grow even though their core franchise is in a slow growth market, earned them their third consecutive year in the Top 5 delivering a 236% total return to shareholders! This is a bank that demonstrates what I like to term operating discipline. Well done!

#4. Silicon Valley Financial Group (Nasdaq: SIVB)

This must be the year of the niche bank. One that focuses nationwide on one or more niches to generate top five shareholder returns. Silicon Valley Financial Group is the parent company of Silicon Valley Bank, long considered a go-to bank for startups. At $97 billion in total assets, SVB is the largest financial institution to ever break into the Top 5 Total Return to Shareholders. And like Silvergate Capital Corporation above, it did not conform to banking's Covid decline. It's one year price change was +51% compared to the 16% decline of the S&P US BMI Banks Index. This bank lends to startups without positive cash flow. So one would think that the pandemic would cause a spike in non-performing assets. Except their NPAs/Assets was 12 basis points at September 30th. and their YTD ROA was 1.43% and ROE 16.20%. And they're trending better! This type of through-the-cycle financial performance earned them a five year total return to shareholders of 228%, good enough for Top 5 hardware! Nice!

#5. Bank First Corporation (Nasdaq: BFC)

They are blocking and tackling in Manitowac, Wisconsin! Which is home to my favorite news parody, the Manitowac Minute where they aptly describe Midwest nice! And I got my football reference in there, especially since the Packers are having a great year. Like Fidelity, Bank First demonstrates operating discipline by consistently delivering financial performance that gives them the investor credibility needed to rebound from the pandemic driven recession. Looking at their ROA slash line 2017-YTD you'll see 1.04%/1.43%/1.37%/1.44%. That level of consistent credibility is likely the reason why their stock is down only 4% over the past year versus 16% for all bank stocks. I searched for what they do different than traditional community banks. I found that they do core processing services for other financial institutions. That's a throw back to earlier days. But that only accounts for just over 3% of their total revenue. Like Fidelity, they announced an acquisition at the end of last year and closed on it during the pandemic. But it was only a $183 million in assets bank compared to the pro forma $2.6 billion Bank First. No, what Bank First does is be good. Consistently. It earned their shareholders a five year 197% total return. Go Packers! **** the Bears!

There you have it! The JFB Top 5 all stars. As in all prior years, no SIFI banks on the list. Increasingly on the list, though, are niche financial institutions that are making strategic bets that are being rewarded by their shareholders in the form of higher valuations. 

I thought about ending my nine-year run of recognizing these best in class performers in long-term total return to shareholders. Especially since my friends at BankDirector.com do such a nice job in their RankingBanking series. Perhaps in the future they'll add five year total return! I'll keep going as long as I can add value.

Congratulations to all of the above that developed a specific strategy and is clearly executing well. Your shareholders have been rewarded!

Are you noticing themes that 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 well.

Thursday, December 17, 2020

The Bank Branch Manager's Wish List

Now is the time for wishes. And if I were a branch manager, given all of the demands on me, here is what I would wish for:

1. Clarity of Expectations. Do you want me, your branch manager, to grow small business customers by being a trusted advisor to small business owners within a five mile radius of the branch? Why don't you tell me?

2. Clarity on Accountabilities. If you know me, you would know that I am a big fan of making branch managers responsible for the continuous improvement of their branch's income statement. All other accountability schemes you might have in place are unnecessary unless the branch manager is on a performance improvement plan. Number of net new accounts? Why do you care if the branch continuously improves its profitability? Aggregate deposit growth? What if the branch manager doesn't grow deposits at all, but replaces maturing CDs with small business deposits, and grows small-ticket business loans?

3. Empowerment. Stop calling me about waived overdraft fees. So long as I own my branch's profitability, if knowing the unique customer's situation leads me to waive their fee, so be it. Do you know the customer's situation better than me? I know a waived fee reduces my profitability. I'll find it somewhere else.

4. Support. My favorite line from Grease: "If you can't be an athlete, at least be an athletic supporter." You know those nasty e-mails I get from operations because I didn't fill a Know Your Customer line- item out correctly? You might want to pay a visit to operations and give them a lesson on how the bank makes money. I'm not saying that I shouldn't be trained how to do it right. But sometimes the self-righteousness coming out of HQ demonstrates a profound misunderstanding about who drives profits... customers, and who serves customers... me. So create a culture of empathy and wanting to support people that have customers sitting across their desk.

5. Offload Operations. Do you really want me counting vault cash, reconciling daily branch capture, and servicing the ATM? Take inventory of operational duties given to branches. Yes, there will be people other than the branch manager that can execute on them, but the manual timecard checks, continuous hounding about BSA training, printing and signing forms then rescanning because nobody can use our imaging system as intended, is a bit much. Always, always look for ways to reduce operational duties of people that are the tip of the spear between bank and customer. 

6. Develop Me. I have no idea how to use the small business loan underwriting system. Our online account opening solution has no relation to how we open accounts in branches. So I can't help a customer when they call me from home wondering how to advance past a certain page. Merchant services? Nobody trained me on that. Small business cash flow management? Isn't that what you mentioned in Clarity of Expectations above? If you want me to be awesome at what you expect of me, help me get there. 

Because I want to be awesome. And so too, do your branch managers.

~ Jeff

Wednesday, December 09, 2020

The Slippery Slope of Using Banks to Advance a Political Agenda

On October 29, 2020, the New York State Department of Financial Services (DFS) issued a letter to all depositories and non-depositories regulated by them regarding climate change and financial risks. This post is not about climate change. It is about how an unchecked bureaucracy can implement an agenda it cannot get through duly elected legislative bodies by wielding the power of regulation.

In her letter, Linda Lacewell, the DFS superintendent, said she expected regulated depositories under DFS supervision to:

1. Start integrating the financial risks from climate change into governance frameworks, risk management processes, and business strategies. For example, institutions should designate a board member, a committee of the board (or an equivalent function), as well as a senior management function, as accountable for the organization's assessment and management of the financial risks from climate change. This should include an enterprise-wide risk assessment to evaluate climate change and its impacts on risk factors such as credit risk, market risk, liquidity risk, operational risk, reputational risk, and strategy risk; and

2. Start developing their approach to climate-related financial risk disclosure and consider engaging with the Task Force for Climate-related Financial Disclosures framework and other established initiatives when doing so.

I visited the Task Force for Climate-related Financial disclosures website and downloaded their report to see what Superintendent Lacewell was talking about (see picture). 

Not sure what they mean by metrics and targets. But the report does suggest that financial institutions in their annual reports disclose all of the above, including how much lending they do to climate related industries. Meaning how much lending do you do to industries that a partisan might not like, so that the power of the mob could agitate such a high level of reputational risk that the reporting financial institution would reduce or eliminate serving the out-of-favor industry(s).

A reminder, this is a far bigger issue than climate change. So don't come at me if you want to talk about climate change. This is about using the power of regulation to exert political will that does not have enough popular support amongst the governed to enact legislation.

In response to this alarming tactic, the OCC proposed in November a rule to ensure fair access to banking services provided by national banks, federal savings associations, and federal branches and agencies of foreign bank organizations. In its letter, acting Comptroller of the Currency Brian Brooks said "Fair access to financial services, credit, and capital are essential to our economy. This proposed rule would ensure that banks meet their responsibility to provide their services fairly since they enjoy special privilege and powers because if the system fails to provide fairness to all, it cannot be a source of strength for any."

The OCC's proposal would apply to the largest banks (>$100B in assets) in the country that may exert significant pricing power or influence over sectors of the national economy. If that last sentence isn't a testament to the importance of diversifying financial services, not sure what is. The proposal would require a covered bank to ensure it makes its products and services available to all customers in the community it serves, based on consideration of quantitative, impartial, risk-based standards established by the bank. Under the proposal, a covered bank's decision to deny services based on an objective assessment of the person's creditworthiness, ability to pay, or other quantitative, impartial, risk-based reasons would not violate the bank's obligation to fair access. Not sure what's worse. Bank's being bullied to "not lend" to industries based on the shrill of the mob or being forced to lend to industries that are against their values.

Now you may be in full agreement with strong-arming financial institutions to not lend to coal burning utilities. 

But what about when you don't agree? Think about an industry or issue that you favor. And a bureaucrat waves the magic wand to cut off financial services or make it so difficult for the financial institution to bank your "favored" cause that it wouldn't be worth it.

The top 10 banks already control over 50% of all US banking assets. This is a testimony to decentralize banking. It's also a glimpse of how governments, without a will of the people mandate, can advance their agendas without consulting the people. It's a glimpse into tyranny.

~ Jeff

Tuesday, December 01, 2020

Could Net Interest Margin Woes Spell Opportunity?

When an in-person strategic planning retreat has to be hastily switched to a virtual one, sacrifices must be made. And in this case, I simply didn't have the time to review the long-term implications of the Fed's guidance that they were not inclined to raise the Fed Funds Rate until inflation hit or passed 2%. And they didn't anticipate that until 2023.

So we're in this environment together. Negative rates are not likely. Fed Chairman Powell is against that approach. The change from 2.25%-2.5% in 2019 to the 0%-0.25% year to date has resulted in the revenues per product to go down in all deposit products with the exception of money market accounts (see table).

The table is from my firm's profitability peer database, where we measure product profitability for dozens of community financial institutions. The above are peer averages.

The net revenue decline in business loans makes sense because these portfolios tend to have a high proportion of variable rates. What we learned from 2007-08 was to put floors in them, so hopefully the downward trend won't continue. Residential mortgages net revenue went up although we intuitively know that the 30-year rate has gone down. But for measuring product profitability, this number represents what the bank portfolios. Which is probably very little given the rate environment. The coveted gain on sale revenues from secondary market activities goes in the secondary market product, and the residential mortgage line of business.

In 2009, being armed with the above product profitability data, plus the profit trends in their branches, the very large financial institutions began closing branches en-masse. And since the floor fell out on the Fed Funds Rate this year, several including PNC, Wells, and US Bank announced more accelerated closures. From March through August, banks submitted closure requests to regulators for 893 branches. During the same time last year, 967 were submitted. So there was an 8% drop.   

But I think, faced with the declining revenues and their high depositor retention from past closures, more will be announced. Does this signal an opportunity for the financial institution with a long-term view to aggressively pursue core deposits in the face of reduced short-term profitability of those deposits? Especially if the bank could put those deposits to work at some positive spread, which we have to believe we can. 

It wouldn't bode well for your net interest margin. But could certainly generate growth in net interest income. And position your bank for the often repeated cycle of positive economic growth where loans grow faster than deposits for multiple years. When that happens, your competitors will start offering $400 for customers to switch deposit accounts. 

But you would have already won them.

~ Jeff

Note: The above data was taken from my firm's profitability peer database. If you want to learn how you can measure product profitability, line of business profitability, or customer profitability, click here.