Assets
Analyzing Bank Financial Statements and Performance Bank Analyst Training Charlottesville, VA July 27, 2016
Erik Oja Emily Parker
Presenter Overview Erik Oja
Emily Parker
Banking Industry Analyst S&P Global Market Intelligence
Product Manager, Financial Institutions Group S&P Global Market Intelligence
Erik Oja has covered U.S. banks at S&P GMI (formerly S&P Equity Research), since 2006. He is a frequent contributor to CNBC, Wall Street Journal, Reuters, BNN, and American Banker. Erik also covers Canadian banks, consumer lenders, and asset managers. Previously, he worked as a buy side analyst at a pension plan for savings banks. Prior to that, he was a financial analyst at the same firm. He has an MA in Economics from New York University, and a BA in Economics from State University of New York at Buffalo.
Emily Parker is a product manager at S&P GMI, with a focus on bank regulatory products, content, and services. Emily is focused on partnering with our banking customers to create new and useful tools that can help meet everyday challenges. Prior to joining S&P, Emily spent six years at JPMorgan Chase working in their Corporate Mergers & Acquisitions Group and Financial Planning & Analysis teams in New York City. Emily has a BS in Finance and International Business from Georgetown University in Washington DC, and is currently based in Richmond, VA.
2
Agenda • Introduction & Session Goals • Risk • Types of risk facing banks • Key risk ratios (CAMELS) • Return • Types of returns available to bank investors • Key return ratios • Drivers of bank ROE/ROA performance • Valuation and Peer Analysis • Key valuation ratios • Case Study • Conclusion
3
Session Goals ●
Learn the objectives, benefits and shortfalls of ratio analysis
●
Examine bank risk using ratios within the CAMELS framework
●
Evaluate bank performance and returns from an investor perspective using earnings metrics and multiples
●
Perform peer analysis by identifying discrepancies in risk, return and valuation ratios across similar and dissimilar banking institutions
4
Warm up QUESTION 1: A bank in your investment portfolio has $40 million of non-performing energy loans. How much of a concern is this, and what else should you look at? QUESTION 2: A bank you are looking to invest in pays an 8% dividend, and has kept its payout steady for 12 years. Before buying this stock what questions should you ask? QUESTION 3: You are an investment banker advising a community bank on a potential sale. A similar bank recently sold for 2.0x tangible book value. What does tangible book value tell you, and what other factors should you consider?
5
Bank Balance Sheet Assets
● Cash ● Securities ● Fed Funds Sold & Reverse Repos ● Loans & Leases ● Allowance for Loan & Lease Losses ● Trading Assets ● Premises & Fixed Assets ● Other Real Estate Owned (OREO) ● Intangible Assets
Liabilities ● ● ● ● ●
Deposits Fed Funds & Repos Trading Liabilities Short Term Debt Long Term Debt
Equity ● ● ● ●
Preferred Equity Common Equity Retained Earnings Minority Interest
6
Bank Income Statement Interest Income -Interest Expense Net Interest Income +Non Interest Income +Realized Gain / (Loss) on Securities - Non Interest Expense - Provision for Loan & Lease Losses Pre-tax Income -Income Tax Net Income
7
PART II: RISK
8
Definition and Types • What is Risk? “The chance that an investment (as a stock or commodity) will lose value” - Merriam Webster • Types of risks facing banking institutions: Credit Risk - default on a debt Market Risk - losses due to financial market performance Operational Risk - system breakdown, procedure & people issues Interest Rate Risk - loss in investment value due to change in interest rates Liquidity Risk - asset cannot be traded quickly enough to prevent losses Foreign Exchange Risk - loss in investment value due to change in currency exchange rates o Sovereign Risk - risk that a government will not comply with terms of contract o Reputational Risk - risk that perceptions of the brand of an institution will result in financial losses o Systemic Risk - risk that a company activity could trigger collapse of an entire industry o o o o o o
9
How do you evaluate bank risk?
C Capital Adequacy A Asset Quality M Management E Earnings L Liquidity S Sensitivity 10
Key CAMELS Ratios Ratios
So what?
Common Equity Tier 1 Capital Ratio Tier 1 Risk Based Capital Ratio Leverage Ratio
-Ability of bank to cover losses in times of stress -Measures risk of balance sheet (RWA) -Strips away less stable sources of equity to better measure financial stability and health
Non-Performing Loans / Loans Net Chargeoffs / Avg Loans Texas Ratios
-Quality of loans and health of portfolio -Highlights percentage of loans in default (or expected to be) -Ability of bank to underwrite and fund operations
Compensation growth Enforcement actions Legal settlements
-Qualitative assessments of how the bank is being run -Identifies if CEO is overcompensated, operational issues -Legal issues can result in bank failure or FDIC conservatorship
ROE ROAA Efficiency Ratio Net Interest Margin
-Ability of bank to generate net income using its balance sheet -How well a bank is able to turn its expenses into revenue -Bank’s focus on returning earnings back to its shareholders
Liquidity Coverage Ratio Net Stable Funding Ratio Liquidity Ratio Liquid Assets / Assets
-Measures bank’s ability to pay its own short term debt obligations with funding on hand -”Run on the bank” - Asset allocation - treasuries (liquid) vs. private equity (illiquid)
Long-Term Assets / Assets Rate-Sensitive Liabilities / Total Liabilities Assets Repricing within 1 year / Assets
-Sensitivity of a bank’s balance sheet to changes in interest rates -Leads to liquidity risk and drains on earnings if duration is mismatched
11
Capital Adequacy Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Minimum
Common Equity Tier 1 Capital Ratio
Common Equity Tier 1 Capital Total Risk Weighted Assets
9.27%
12.45%
4.5%
Tier 1 Risk Based Capital Ratio
Tier 1 Capital Total Risk Weighted Assets
9.46%
12.54%
6.0%
Leverage Ratio
Tier 1 Capital Average Total Assets
7.57%
9.54%
4.0%
• • • • •
Common Equity Tier 1 Capital: “Core” capital to protect against losses. Common stock, retained earnings, AOCI, deductions, qualifying minority interest. Tier 1 Capital: Next phase of capital to protect against losses. Common equity tier 1 capital, noncumulative perpetual preferred stock, qualifying minority interest. Risk Weighted Assets: Bank assets weighted according to their risk (e.g., cash = 0%, high volatility commercial real estate loans = 150%) Main focus of regulation post 2008 Evolution of Basel rules - Basel I vs. II vs. III Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial 12
Is meeting the regulatory minimums enough?
Source: FDIC
13
Stress Testing •
Comprehensive Capital Analysis and Review (CCAR) Capital Plans and Stress Tests • 2009 was the first year of post-crisis stress tests (SCAP) • CCAR is mandated by Dodd-Frank Act of 2010 • March 2011 marked the first CCAR stress test results and capital plans • Large and regional banks increased their dividends and repurchases • A few banks did not get their capital plans approved right away • March 2012 - June 2016 • Additional CCAR requirements each year • Expansion of CCAR to mid-sized regional banks and to foreign banks • Further increases of dividends and repurchases • Some banks did not get their capital plans approved
14
Stress Testing •
•
2011 CCAR: • 19 U.S. banks with assets over $100 billion • “Severely adverse” scenario assumed: • 1% GDP decline • 10% housing price fall • 11% unemployment 2016 CCAR: • 33 bank holding companies with assets over $50 billion • Severely adverse scenario assumes: • 10% unemployment • Negative yields for short-term Treasuries • Mild deflation and moderate recession
15
CCAR Results
16
Capital Adequacy in the News
17
Asset Quality Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Non-Performing Loans / Loans
(Nonaccrual Loans + Restructured Loans) Total Loans
1.59%
1.77%
Net Chargeoffs / Avg Loans
(Loan Chargeoffs - Loan Recoveries) Avg Loans
1.25%
0.45%
Texas Ratio
(Nonperforming Assets + Loans 90D Past Due) (Tangible Equity + Loan Loss Reserve)
17.21%
13.96%
• Nonaccrual Loan: No longer generating interest due to financial difficulties of the borrower. More likely to default than a performing loan. • Nonperforming Loan: Principal or interest has been overdue for over 90 days. • Texas Ratio: Banks tended to fail when >100% Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial
18
Asset Quality Impact on Bank Failure
19
Asset Quality Today - Oil Prices
20
Case Study: Cullen/Frost
• Disclosures vary by bank in their SEC documents, but some disclose their exposure by type of loan • Cullen/Frost has 14% of its loan book in the energy sector
21
Case Study: Cullen/Frost
22
Management: Compensation • Key Themes: • Shift in compensation from bonus to salary to discourage risk taking • Size differences in compensation structure • Clawbacks • % of cash vs. stock
23
Management: Enforcement Actions
24
Management: Legal Settlements
25
Earnings Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Return on Average Equity (ROAE)
Net Income Average Equity
3.45%
8.42%
Return on Average Assets (ROAA)
Net Income Average Assets
0.35%
0.96%
Efficiency Ratio
Operating Expense Operating Revenue
58%
60%
Net Interest Margin
NII (Interest Income - Interest Expense) Average Earning Assets
3.27%
3.00%
Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial
26
Earnings in the News
27
Liquidity Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Liquidity Coverage Ratio (LCR)
High Quality Liquid Assets (HQLA) Net Cash Outflows
N/A
122%1
Liquidity Ratio
Liquid Assets Total Liabilities
27.56%
35.25%
Liquid Assets / Assets
Liquid Assets Total Assets
24.74%
31.26%
Minimum 100%
• What types of assets are liquid vs. illiquid? • Cash • Securities • Repos • OREO • Pledged Securities Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) 1Based on those financial institutions reporting LCR as of 2015 year end in their SEC filings Source: SNL Financial
28
Resolution Planning
29
Sensitivity Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Long-Term Assets / Assets
Securities & Loans that mature in >5 years Total Assets
21.62%
25.21%
Rate-Sensitive Liabilities / Total Liabilities
Deposits & Other Borrowings that mature < 1 year Total Liabilities
30.55%
13.13%
Assets Repricing within 1 year / Assets
Securities & Loans that mature in 5 years Total Assets
Rate-Sensitive Liabilities / Total Liabilities
Deposits & Other Borrowings that mature < 1 year Total Liabilities
Assets Repricing within 1 year / Assets
Securities & Loans that mature in
Erik Oja Emily Parker
Presenter Overview Erik Oja
Emily Parker
Banking Industry Analyst S&P Global Market Intelligence
Product Manager, Financial Institutions Group S&P Global Market Intelligence
Erik Oja has covered U.S. banks at S&P GMI (formerly S&P Equity Research), since 2006. He is a frequent contributor to CNBC, Wall Street Journal, Reuters, BNN, and American Banker. Erik also covers Canadian banks, consumer lenders, and asset managers. Previously, he worked as a buy side analyst at a pension plan for savings banks. Prior to that, he was a financial analyst at the same firm. He has an MA in Economics from New York University, and a BA in Economics from State University of New York at Buffalo.
Emily Parker is a product manager at S&P GMI, with a focus on bank regulatory products, content, and services. Emily is focused on partnering with our banking customers to create new and useful tools that can help meet everyday challenges. Prior to joining S&P, Emily spent six years at JPMorgan Chase working in their Corporate Mergers & Acquisitions Group and Financial Planning & Analysis teams in New York City. Emily has a BS in Finance and International Business from Georgetown University in Washington DC, and is currently based in Richmond, VA.
2
Agenda • Introduction & Session Goals • Risk • Types of risk facing banks • Key risk ratios (CAMELS) • Return • Types of returns available to bank investors • Key return ratios • Drivers of bank ROE/ROA performance • Valuation and Peer Analysis • Key valuation ratios • Case Study • Conclusion
3
Session Goals ●
Learn the objectives, benefits and shortfalls of ratio analysis
●
Examine bank risk using ratios within the CAMELS framework
●
Evaluate bank performance and returns from an investor perspective using earnings metrics and multiples
●
Perform peer analysis by identifying discrepancies in risk, return and valuation ratios across similar and dissimilar banking institutions
4
Warm up QUESTION 1: A bank in your investment portfolio has $40 million of non-performing energy loans. How much of a concern is this, and what else should you look at? QUESTION 2: A bank you are looking to invest in pays an 8% dividend, and has kept its payout steady for 12 years. Before buying this stock what questions should you ask? QUESTION 3: You are an investment banker advising a community bank on a potential sale. A similar bank recently sold for 2.0x tangible book value. What does tangible book value tell you, and what other factors should you consider?
5
Bank Balance Sheet Assets
● Cash ● Securities ● Fed Funds Sold & Reverse Repos ● Loans & Leases ● Allowance for Loan & Lease Losses ● Trading Assets ● Premises & Fixed Assets ● Other Real Estate Owned (OREO) ● Intangible Assets
Liabilities ● ● ● ● ●
Deposits Fed Funds & Repos Trading Liabilities Short Term Debt Long Term Debt
Equity ● ● ● ●
Preferred Equity Common Equity Retained Earnings Minority Interest
6
Bank Income Statement Interest Income -Interest Expense Net Interest Income +Non Interest Income +Realized Gain / (Loss) on Securities - Non Interest Expense - Provision for Loan & Lease Losses Pre-tax Income -Income Tax Net Income
7
PART II: RISK
8
Definition and Types • What is Risk? “The chance that an investment (as a stock or commodity) will lose value” - Merriam Webster • Types of risks facing banking institutions: Credit Risk - default on a debt Market Risk - losses due to financial market performance Operational Risk - system breakdown, procedure & people issues Interest Rate Risk - loss in investment value due to change in interest rates Liquidity Risk - asset cannot be traded quickly enough to prevent losses Foreign Exchange Risk - loss in investment value due to change in currency exchange rates o Sovereign Risk - risk that a government will not comply with terms of contract o Reputational Risk - risk that perceptions of the brand of an institution will result in financial losses o Systemic Risk - risk that a company activity could trigger collapse of an entire industry o o o o o o
9
How do you evaluate bank risk?
C Capital Adequacy A Asset Quality M Management E Earnings L Liquidity S Sensitivity 10
Key CAMELS Ratios Ratios
So what?
Common Equity Tier 1 Capital Ratio Tier 1 Risk Based Capital Ratio Leverage Ratio
-Ability of bank to cover losses in times of stress -Measures risk of balance sheet (RWA) -Strips away less stable sources of equity to better measure financial stability and health
Non-Performing Loans / Loans Net Chargeoffs / Avg Loans Texas Ratios
-Quality of loans and health of portfolio -Highlights percentage of loans in default (or expected to be) -Ability of bank to underwrite and fund operations
Compensation growth Enforcement actions Legal settlements
-Qualitative assessments of how the bank is being run -Identifies if CEO is overcompensated, operational issues -Legal issues can result in bank failure or FDIC conservatorship
ROE ROAA Efficiency Ratio Net Interest Margin
-Ability of bank to generate net income using its balance sheet -How well a bank is able to turn its expenses into revenue -Bank’s focus on returning earnings back to its shareholders
Liquidity Coverage Ratio Net Stable Funding Ratio Liquidity Ratio Liquid Assets / Assets
-Measures bank’s ability to pay its own short term debt obligations with funding on hand -”Run on the bank” - Asset allocation - treasuries (liquid) vs. private equity (illiquid)
Long-Term Assets / Assets Rate-Sensitive Liabilities / Total Liabilities Assets Repricing within 1 year / Assets
-Sensitivity of a bank’s balance sheet to changes in interest rates -Leads to liquidity risk and drains on earnings if duration is mismatched
11
Capital Adequacy Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Minimum
Common Equity Tier 1 Capital Ratio
Common Equity Tier 1 Capital Total Risk Weighted Assets
9.27%
12.45%
4.5%
Tier 1 Risk Based Capital Ratio
Tier 1 Capital Total Risk Weighted Assets
9.46%
12.54%
6.0%
Leverage Ratio
Tier 1 Capital Average Total Assets
7.57%
9.54%
4.0%
• • • • •
Common Equity Tier 1 Capital: “Core” capital to protect against losses. Common stock, retained earnings, AOCI, deductions, qualifying minority interest. Tier 1 Capital: Next phase of capital to protect against losses. Common equity tier 1 capital, noncumulative perpetual preferred stock, qualifying minority interest. Risk Weighted Assets: Bank assets weighted according to their risk (e.g., cash = 0%, high volatility commercial real estate loans = 150%) Main focus of regulation post 2008 Evolution of Basel rules - Basel I vs. II vs. III Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial 12
Is meeting the regulatory minimums enough?
Source: FDIC
13
Stress Testing •
Comprehensive Capital Analysis and Review (CCAR) Capital Plans and Stress Tests • 2009 was the first year of post-crisis stress tests (SCAP) • CCAR is mandated by Dodd-Frank Act of 2010 • March 2011 marked the first CCAR stress test results and capital plans • Large and regional banks increased their dividends and repurchases • A few banks did not get their capital plans approved right away • March 2012 - June 2016 • Additional CCAR requirements each year • Expansion of CCAR to mid-sized regional banks and to foreign banks • Further increases of dividends and repurchases • Some banks did not get their capital plans approved
14
Stress Testing •
•
2011 CCAR: • 19 U.S. banks with assets over $100 billion • “Severely adverse” scenario assumed: • 1% GDP decline • 10% housing price fall • 11% unemployment 2016 CCAR: • 33 bank holding companies with assets over $50 billion • Severely adverse scenario assumes: • 10% unemployment • Negative yields for short-term Treasuries • Mild deflation and moderate recession
15
CCAR Results
16
Capital Adequacy in the News
17
Asset Quality Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Non-Performing Loans / Loans
(Nonaccrual Loans + Restructured Loans) Total Loans
1.59%
1.77%
Net Chargeoffs / Avg Loans
(Loan Chargeoffs - Loan Recoveries) Avg Loans
1.25%
0.45%
Texas Ratio
(Nonperforming Assets + Loans 90D Past Due) (Tangible Equity + Loan Loss Reserve)
17.21%
13.96%
• Nonaccrual Loan: No longer generating interest due to financial difficulties of the borrower. More likely to default than a performing loan. • Nonperforming Loan: Principal or interest has been overdue for over 90 days. • Texas Ratio: Banks tended to fail when >100% Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial
18
Asset Quality Impact on Bank Failure
19
Asset Quality Today - Oil Prices
20
Case Study: Cullen/Frost
• Disclosures vary by bank in their SEC documents, but some disclose their exposure by type of loan • Cullen/Frost has 14% of its loan book in the energy sector
21
Case Study: Cullen/Frost
22
Management: Compensation • Key Themes: • Shift in compensation from bonus to salary to discourage risk taking • Size differences in compensation structure • Clawbacks • % of cash vs. stock
23
Management: Enforcement Actions
24
Management: Legal Settlements
25
Earnings Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Return on Average Equity (ROAE)
Net Income Average Equity
3.45%
8.42%
Return on Average Assets (ROAA)
Net Income Average Assets
0.35%
0.96%
Efficiency Ratio
Operating Expense Operating Revenue
58%
60%
Net Interest Margin
NII (Interest Income - Interest Expense) Average Earning Assets
3.27%
3.00%
Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) Source: SNL Financial
26
Earnings in the News
27
Liquidity Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Liquidity Coverage Ratio (LCR)
High Quality Liquid Assets (HQLA) Net Cash Outflows
N/A
122%1
Liquidity Ratio
Liquid Assets Total Liabilities
27.56%
35.25%
Liquid Assets / Assets
Liquid Assets Total Assets
24.74%
31.26%
Minimum 100%
• What types of assets are liquid vs. illiquid? • Cash • Securities • Repos • OREO • Pledged Securities Based on U.S. Commercial Banking Aggregated data from Call Reports (FFIEC 031 / 041) 1Based on those financial institutions reporting LCR as of 2015 year end in their SEC filings Source: SNL Financial
28
Resolution Planning
29
Sensitivity Quarter Ended CAMELS Ratio
Calculation
2008Q2
2016Q1
Long-Term Assets / Assets
Securities & Loans that mature in >5 years Total Assets
21.62%
25.21%
Rate-Sensitive Liabilities / Total Liabilities
Deposits & Other Borrowings that mature < 1 year Total Liabilities
30.55%
13.13%
Assets Repricing within 1 year / Assets
Securities & Loans that mature in 5 years Total Assets
Rate-Sensitive Liabilities / Total Liabilities
Deposits & Other Borrowings that mature < 1 year Total Liabilities
Assets Repricing within 1 year / Assets
Securities & Loans that mature in
