Jeff For Banks: December 2021

Wednesday, December 29, 2021

Banking's Top 5 Total Return to Shareholders: 2021 Edition

For the past decade 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 ten years I have been keeping track. The first bank to crack the Top 5 over $50 billion did so last year. As a reference, the best SIFI bank in five year total return was Bank of America at 26th 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. This, naturally, eliminated many of the smaller, illiquid FIs. I also filtered for anomalies such as recent merger announcements as a seller, turnaround situations (losses suffered from 2016 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 27, 2021 was 60.4%.

Before we begin and for comparison purposes, here are last year's top five, as measured in December 2020:

#1. Silvergate Capital Corporation (NYSE: SI)

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

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

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

#5. Bank First Corporation (Nasdaq: BFC)

Here is this year's list:

#1. Silvergate Capital Corporation (NYSE: SI)

Here we are again. The first crypto currency bank to crack the Top 5 has landed the top position two years running, delivering a 1,257% 5-year total return. You read that right. Silvergate had $150 million in total revenue over the past twelve months, and has a market capitalization of $4.7 billion, or 31.4x revenues. It's five-year compound annual growth rate ("CAGR") in earnings per share was a very strong 27.2% (actually 5.75 years starting full-year 2016 ending LTM 9/30/21). It's Price/LTM EPS is 57x. Investors must be expecting much faster earnings growth to earn the valuation this bank currently enjoys. Average digital currency customer deposits were $11.2 billion at September 30, 2021. Silvergate also facilitates payments between crypto exchanges via its Silvergate Exchange Network, or SEN. It's current performance for the LTM ended September 30, 2021 was a 0.78% ROA and 10.04% ROE, which doesn't merit the valuation, so growth and greater profitability must be what investors see. Here is Silvergate CEO Alan Lane after third quarter earnings announcement on CNBC. Give Silvergate credit, they picked a niche and are executing on it to the delight of investors. Crypto is blazing hot!

#2. MetroCity Bankshares, Inc. (Nasdaq: MCBS)

MetroCity Bankshares, Inc., and it's banking subsidiary Metro City Bank are headquartered in Atlanta. The bank was founded in 2006 and operates 19 full-service branch locations in multi-ethnic communities in Alabama, Florida, Georgia, New York, New Jersey, Texas and Virginia. Quite the geographic expanse, but not uncommon for ethnic banks. What is unique is, after reviewing the management team and board, there are people of Korean, Malaysian, Indian, and Chinese descent in leadership positions. At least that is what I can tell from the bios. The bank has grown over $1 billion in assets over the last twelve months, from $1.7 billion at September 30, 2020 to $2.8 billion at September 30, 2021. This was fueled mainly with loan growth. No acquisitions during this period. MCBS, with a market cap of $705 million, and LTM revenues (net interest income plus fee income) of $125.5 million, trades at 5.6x revenues. And it had an eye popping LTM ROA of 2.49% and ROE of 21.3%. We see these numbers from heavy SBA or, more recently, heavy residential mortgage producers. And for sure, MCBS is both, but it looks like they have been booking their residential mortgages, showing no YTD gain on sale from their residential mortgage loan production. Given that residential mortgages make up 73% of their loan portfolio, and their yield on loans was 5.16%, it makes me think they do a significant volume of non-conforming loans. But still, they have delivered a five-year total return of 439%! Well done!

#3. Triumph Bancorp, Inc. (Nasdaq: TBK)

Triumph Bancorp, and it's subsidiary TBK Bank, SSB were founded in Dallas, Texas in 1981 and provides commercial and consumer banking products focused on meeting client needs in Texas, Colorado, Kansas, New Mexico, Iowa and Illinois. Triumph also serves a national client base with carrier payment solutions through TriumphPay, invoice factoring through Advance Business Capital LLC d/b/a Triumph Business Capital, insurance through Triumph Insurance Group, Inc. and equipment lending and asset based lending through Triumph Commercial Finance. Phew! Needless to say, they have diverse revenue streams and geographies, which produced a LTM net interest margin of 6.35%, driving an ROA/ROE of 1.98% / 15.42%. Profit numbers were aided by an allowance recapture. You would think such a margin would come with higher non-performing assets to total assets but no, as NPAs/Assets were 30 basis points at September 30th. The bank has nearly doubled in size in the past five years, aided by three whole-bank and one multi-branch acquisition. But during that span they delivered a 375% total return to shareholders. Wow!

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

After being conspicuously absent from prior JFB Top Fives, LOB makes it's second showing in a row. 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. It's five year total return: 371%! Well done!

#5. SVB Financial Group (Nasdaq: SIVB)

SVB Financial Group, formerly Silicon Valley Financial Group is the parent company of Silicon Valley Bank, long considered a go-to bank for startups. At $191 billion in total assets, SVB remains the largest financial institution to ever break into the Top 5 Total Return to Shareholders. It's going to be difficult to describe what they do in summary. But here I go. They are a diversified financial services company that operates through four segments: Global Commercial Bank, which provides traditional banking services plus some not so traditional like mezzanine lending, acquisition, finance, and corporate working capital facilities, foreign exchange, export/import and standby letters of credit, vineyard development loans, and on and on I could go. SVB Private Bank segment offers traditional private banking and wealth services. The SVB Capital segment provides venture capital investment services that manage funds on behalf of third party limited partner investors. SVB Leerink segment engages in capital markets activities, M&A, and investment banking services. SVB operates through 30 offices in the USA, Canada, UK, Israel, Germany, Denmark, India, Hong Kong, and China. It was founded in 1983. It's largest acquisition in the last five years was Boston Private Holdings, but it has been active in its other segments, including the acquisition of Leerink. It has a LTM ROA of 1.50%, and an ROE of 19.91%. Even at it's relatively large size and battling the law of large numbers, SVB remains known for it's niche in the venture capital and founders space. It's not easy to fight "general bank", but they seem to be doing it. And delivered a 296% five-year total return! Nice!

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. In fact, all on the list are niche financial institutions. #Instructive

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

~ 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.

And please consider reading my book: Squared Away-How Can Bankers Succeed as Economic First Responders.

Ten percent of author royalties go to K9sForWarriors.org, who work to bring down the suicide rate among our veterans.

Kindle

Paperback

Hardcover

Thank you!

Wednesday, December 15, 2021

Row in the Same Direction: Branch Profitability in Practice

Chris Nichols from Southstate Bank Correspondent Bank Division recently wrote an excellent piece about branch profitability, a subject near and dear to my heart because it is one of our core competencies at my firm, The Kafafian Group, Inc.

In that piece, titled Branch Profitability in 7 Steps Using Data, Step 1 was start with Potential Branch Profitability. In that step, Chris made the case for calculating relative profitability to the competition using hypotheticals. And I thought, what if we didn't use hypotheticals? We used our actual profitability metrics, synced them up with our strategic plan, and calculated our journey from current profitability to desired profitability?

This is a tall order because in my experience, branch profitability is not widely calculated, and certainly not widely used in creating the operating discipline needed to deliver to the bank's stakeholders. Instead, it is more common to use easily available metrics that we can draw from our general ledger, core processor, or other systems. We measure aggregate deposit growth, period over period expenses, and number of accounts opened.

But what if this motivates behavior that is not consistent with strategy? For example, growing aggregate deposits might be aligned with overall asset growth objectives, but at what cost? It's a sure way to have the un-empowered branch manager calling the regional manager for rate exceptions to win new money or keep money at the bank.

I rarely hear bankers state as a strategic objective to grow assets, loans, or deposits at any cost. But that is certainly what you are motivating branch managers to do if you use deposit growth as one of their strategic goals.

Instead, what if the bank aspires to be the number one business bank in their markets? And a strategic objective is to achieve top quartile cost of funds with an emphasis on growing business deposits?

How does that translate to the branch manager? What's their plan?

I'm currently reading Extreme Ownership, How U.S. Navy SEALS Lead and Win, by Jocko Willink and Lief Babin. This book was given to me by a banker, by the way. In the book, the authors say this about empowering junior leaders, like branch managers (parentheticals are mine):

"Teams must be broken down into manageable elements of four to five operators (i.e. a branch), with a clearly designated leader (i.e. a branch manager). Those leaders must understand the overall mission, and the ultimate goal of that mission. Junior leaders must be empowered to make decisions on key tasks necessary to accomplish that mission in the most effective and efficient manner possible. Teams within teams (i.e. retail/small business banking-regionals-branches) are organized for maximum effectiveness, with leaders who have clearly delineated responsibilities. Every tactical-level team leader must understand not just what to do but why they are doing it."

So what of that Schmidlap National Bank plan: Vision-Be the number one business bank in our markets. Strategic Objective-Achieve top quartile cost of funds with an emphasis on growing business deposits.

The head of retail, or the regional manager if a larger bank, can set the strategic goal for the Elm Street Branch (My Branch in the below chart) to achieve top quartile deposit spread in the branch network.

Deposit spread is a key metric in any worthwhile branch profitability system. Understanding how deposit spread is calculated and how to impact it is easily taught and understood. I wasn't from the Finance function, and I once was a branch manager, and I understand it. In fact, I believe not using branch profitability because we don't think branch managers, regional managers, or even the head of retail/ small business banking will understand it is patronizing. Or quite possibly you've made these reports overly complex. Which is the enemy of effectiveness.

No, I think My Branch's goal of achieving top quartile deposit spread by some future period is specific, measurable, aggressive yet achievable (a quarter of your own branches achieve it), relevant (to the strategic objective), and time based (i.e. a SMART goal).

After setting the strategic goal, and ensuring the branch manager understands how it is calculated and how to impact it, the regional manager can then empower the branch manager to develop a tactical plan to achieve it. Some may include dependencies, as many of the Chris Nichols' "7 Steps" require Marketing support. This support can be coordinated over the franchise, as in "how will Marketing help our branches achieve their goals?"

But this doesn't mean the branch manager can't highlight tactics to help the branch succeed, such as:

1. Develop list of businesses within five miles of branch by NAICS code, cross reference with existing branch customers.

2. Focus on the most promising businesses' in industries where our bank can be successful competitively.

3. Perform competitor analysis using Amberoon tool (Step 3 in Chris Nichols article)

4. Leverage bank-developed and curated business-focused content to communicate with businesses identified in (2).

5. Branch manager/assistant branch manager to complete ABA Small Business Banker certification.

6. Implement business calling program as developed/instructed by [Internal training/ external consultant, etc.]

This, of course, is a summary list of strategic initiatives to achieve the goal that emanated from the whole bank's strategic objective to "achieve top quartile cost of funds with an emphasis on growing business deposits."

And if the bank is a learning organization, then each branch is empowered to experiment (within guidelines) to develop what works well, what must be refined, and what doesn't work. If the bank creates appropriate feedback loops, this can exponentially increase the effectiveness of strategic initiatives that are laser-focused on achieving the overall bank strategic objectives and vision.

It is the very definition of rowing in the same direction. And it creates a culture where branch managers own their role in strategy execution, goal achievement, and the tactics to succeed.

Have you experienced this level of ownership?