3 Key Metrics For Every CCC Bank, Part 1 - Champions Edition

by: Charles Gooch, Jr.


The banking sector has not been invited to the "green" party of 2016 so far.

There are a number of key metrics to look for when comparing banks.

Here are three key metrics for every CCC Champion.

It has been a well-worn thought for income stock shoppers that among those companies that comprise the CCC universe, there aren't many candidates that look interesting by way of valuation. This YTD heat map pulled from Finviz on 4/6 provides a pictorial representation of what a lot of income investors have been finding:

Speaking up for my own portfolio, it would be great if I could add a utility. However, the utility sector is up over 12% YTD and trades at an aggregate 17 times earnings. This seems a little elongated. I could also stand to add a consumer staple company, but the valuations are stretched there as well.

The way I see it, I generally have three sector choices for bargains. First, there's oil & gas, but as I've already shared I'm far too overweight on that already. Second, I could look towards the healthcare/biotech sector, but (and this is as political as I will get) in my personal view, there will be plenty of opportunity to pick these up because drug prices and their legitimacy will be directly in the crosshairs of a Hillary Clinton Administration. This leaves the banking industry.

Whole Lotta Not to Love

For all the talk about how the Federal Reserve's zero interest rate policy has been good for the consumer - by allowing an opportunity to refinance a mortgage, for example - the banking industry does not thrive in this type of environment.

From the Intro-to-Banking-101 class, banks take in money in the form of checking and savings accounts, and certificates of deposits, and then send it back out the door to provide loans for mortgages, commercial real estate, small and big business lending, etc. Obviously, when interest rates are low, this limits the amount of interest income banks can receive.

Escaping the notice of almost no one, banks have gotten rather creative about noninterest income, ranging from the perfectly understandable (say, an insurance or brokerage arm) to the hideous - fees for everything from seeing a teller too many times in a statement cycle, to fees for choosing to receive your paper statement in the mail, rather than having it available online only.

However, despite their warts in policy and their inherent guilt in the court of public opinion, the banking industry is inextricably linked to the economy. Without it, much of what happens would be impossible.

For the investor who knows this and who has the thesis that zero or near-zero interest rates won't be around forever (allowing the banking industry to return to higher profitability), this sector currently has the potential for bargains.

What to Look For

If you're in the market for a bank, there are a number of things you can traditionally do. You can see what the market capitalization is in relation to its book value of equity - commonly called the Price-to-Book ratio. You can see what the market capitalization is in relation to its earnings - commonly called the Price-to-Earnings ratio. You can see what the current dividend yield is in relation to its historical range.

Useful as these metrics are, they offer very little help in determining which banks are operated better. For instance, US Bancorp (NYSE:USB), and Wells Fargo (NYSE:WFC) both currently trade significantly over book value, while Bank of America (NYSE:BAC) trades at .59x. Does this suggest that the first two are overvalued, while Bank of America is undervalued? Or is there something else going on at Bank of America that does not allow them to enjoy the same range of valuation?

The following three metrics are really good comparative measures that will get you well on your way in your research to determine which of the myriad of banking institutions on David Fish's lists looks genuinely attractive.

Net Interest Margin (NYSE:NIM)

Simply stated, net interest margin represents the spread between the average interest rate a bank pays to its depositors (via checking, savings and CDs) and the average interest received by way of mortgages, home equity lines, business loans, etc., pegged to a balance sheet line item called "total earning assets" or "total interest-earning assets".

So hypothetically, let's say a bank lends out $100 million over the course of a year. Let us also imagine that this bank received $4 million in interest income from this $100 million, and had $1 million paid out in interest to its depositors over the course of the year. The net interest margin would be calculated as:

$4 million - $1 million / $100 million = 3%.

There are two things to keep in mind regarding net interest margin. 1) Generally, smaller banks will have a higher net interest margin than larger banks. So in your comparative analysis, it's important that you compare banks of like-size. 2) Net interest margin by itself is not a good metric of profitability. A bank with a higher NIM isn't necessarily more profitable; it could just mean that they have chosen to go after different types of assets. Also, earlier I mentioned that the noninterest income for banks has grown quite prodigious.

However, net interest margin does provide a good measure of flexibility in a myriad of interest rate environments.

Efficiency Ratio

Whereas net interest margin gives an idea of interest expense paid out to customers, the bank efficiency ratio will give you an idea of how a bank does in managing its non-interest costs. So, everything from paper clips to light bills, and from signage to salaries, the non-interest expense is divided into interest income + non-interest income to derive a number which gives a pretty good idea of how effective a bank is at managing its costs.

Lower is better, but for a fair-to-middling bank, the efficiency ratio will be 0.7 to 0.8. Under 0.7 and you're starting to get pretty efficient, and really efficient and lean banks will run under 0.6, Put another way, for every $1 in revenue a bank gets, the efficiency ratio represents how many cents are going out the door by way of costs. Put still another way, the leaner a bank's operations are, the less they have to swing for the fences in terms of their loan portfolio.

This isn't fail safe, however. For example, banks that pride themselves on high-touch customer service will run higher efficiency ratios than banks who abandon their customers to automated voice recognition menus. Also, if banks derive a significant amount of income from fee-based business, the efficiency ratio can suffer as a result.

In your research, it is important to think of your candidates' strategy in addition to the numbers.

Return on Net Worth

Commonly called the Return-on-Equity (ROE) ratio, the return-on-net-worth ratio measures how effective a company is in bringing money they've made back to their shareholders. Calculated as net income / shareholders' equity, return-on-net-worth represents how effective a company is at generating profits from the money that has been invested in them. Obviously higher would be better, but anything 15% and above would be exemplary.

This metric isn't fail safe, either, however. For banks who are overleveraged, they can make not a lot of income look like a lot of return. So it is important to look at debt-to-equity in conjunction with the return on equity ratio to determine whether or not they are "cheating".

Without Further Ado

As promised, here are these three key metrics from the financial statements for all the Champions from David Fish's CCC list. By way of caveat, the simple equation was used. For example, if a bank gave themselves a break because of a one-time charge related to an acquisition, I didn't give that break to them. There was no "GAAP to non-GAAP reconciliation" or footnote perusing to speak of.

As a result, even though I used the most recent annual report (rather than a quarterly) in the hopes of normalizing those events to try to get a more typical number, it's very possible that the numbers I have will differ sometimes from what the company officially gave:

Bank Name (Symbol) NIM Efficiency Ratio ROE
1st Source Corporation (NASDAQ:SRCE) 3.57% 59.37% 8.93%
Commerce Bankshares (NASDAQ:CBSH) 2.80% 60.89% 11.25%
Community Trust Bancorp (NASDAQ:CTBI) 3.75% 55.26% 9.76%
Eagle Financial Services (OTCQX:EFSI) 3.94% 39.93% 9.17%
Farmers & Merchants (OTCQX:FMCB) 3.82% 49.08% 11.21%
First Financial Corporation (NASDAQ:THFF) 3.81% 66.55% 7.46%
Tompkins Financial Corporation (NYSEMKT:TMP) 3.30% 57.49% 11.51%
United Bankshares (NASDAQ:UBSI) 3.52% 46.59% 8.06%

Investor Takeaway

There is a lot that must be taken into account when deciding whether or not to invest in a bank. These three key ratios will not exhaust your necessary research, but will get you well on your way in deciding whether or not the bank you're mildly interested in is a good place to put your investment dollars.

In Part 2 of this series, I'll be doing the same for the 38 banks that have increased their dividend from 10-24 years. Part 3 will culminate with a look at the remaining 74.

Disclosure: I am not a professional investor, and as such, the companies and/or positions mentioned and any associated analysis are related to my personal experience and expertise, and is not intended to be a recommendation to buy or sell. As everyone has their own risk tolerance, goals and needs, it is important that you perform your own due diligence.

Disclosure: I am/we are long WFC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.