A Few Banks We Like: NTRS, USB, WFSL, SCHW, BOH

by: Christopher Whalen

Integrity Bank, Alpharetta, Georgia, with $1.1 billion in total assets and $974.0 million in total deposits as of June 30, 2008, was closed today by the Georgia Department of Banking and Finance, and the Federal Deposit Insurance Corporation was named receiver. The FDIC Board of Directors today approved the assumption of all the deposits of Integrity Bank by Regions Bank, Birmingham, Alabama. All depositors of Integrity Bank, including those with deposits in excess of the FDIC's insurance limits, will automatically become depositors of Regions Bank for the full amount of their deposits, and they will continue to have uninterrupted access to their deposits. Depositors will continue to be insured with Regions Bank so there is no need for customers to change their banking relationship to retain their deposit insurance.
FDIC, August 29, 2008

Several smaller bank closures occurred last week, including the transaction excerpted above. The people at the FDIC are doing their jobs in fine fashion, but where is Treasury Secretary Hank Paulson regarding the GSEs? We were kind of hoping for a press conference regarding the creation of a conservatorship for "Frannie Mae" on Friday, but its seems Paulson could not get there, to use bankster vernacular.

The good news is that the statutory mechanism to enforce capital discipline against banks is working well. Insolvent banks mostly are being absorbed by other institutions, often helped by the encouragement of regulators, with a subsidy from the FDIC required for poor quality assets not purchased. Closures still are the exception rather than the rule, at least so far, something that is good news for depositors, the banking industry and the taxpayer. But the adjustment process is still underway. The coloration of bank resolutions could change, though, should loss rates continue to climb.

This week we thought to strike a blow against the nattering nabobs of negativism by focusing on some of the better performing names in the US banking sector. If these particular names don't suit you, then there are dozens of other banks in the US with strong capital positions and above-peer earnings. All you have to do is find them. But are you willing to do the work?

For example, the screen in The IRA Bank Monitor for under-capitalized banks as of Q2 2008 includes 113 names, while the FDIC's problem bank list is 117 names as of the end of Q2 2008. Wanna bet the former list is largely a subset of the latter? Keep in mind as you read these profiles below that the US banking industry did 0.37% ROA and 3.58% ROE in Q2 2008, with 116bp in net charge offs, according to the FDIC's Quarterly Banking Profile.

Switching to our Steven Root voice over (the radio man in "Oh Brother Where Art Thou?) "All of you penny pinching, portfolio pickin' vulture investors hanging around out there do take notice!"

Northern Trust Co (NASDAQ:NTRS)

With an ROE of 27% and ROA of 1.5%, the lead unit of NTRS is one of the top performing large banks in the US. Of course, when we talk performance, we mean the financial performance of the group's bank units, not the stock's gyrations or some supposed "spread" in the credit default insurance market (more on this topic shortly). In the case if NTRS, we're talking profits a full standard deviation above peer as of June 30, 2008. The aggregate leverage ratio for the groups subsidiary banks is above 6%.

With just 3bp of default in Q2 2008 and a 4:1 ratio between non-interest income and net interest income, loan loss rates are not of particular concern. NTSR is far less dependent upon asset returns and net-interest income than most depositories, with more than 60% of net earnings coming from non-interest sources. It's performance margin vs. its peers is likely to widen in the next few quarters as banks with credit exposure take a beating.

US Bancorp (NYSE:USB)

The lead unit of USB reported an ROA over 2% and an ROE of 22%, both annualized, in Q2 2008. Subscribers to The IRA Bank Monitor will see that the 80bp plus in current period loan defaults is nowhere near the 2001 peak, thus our view that the adjustment process for the industry as a whole and for names like USB is not quite half way done. While the aggregate leverage ratio for USB's lead bank unit is below 6%, the strong profitability and high proportion of non-interest bearing liabilities is, in our view, a sweet combination.

The fact that USB is profitable enough to be charging off 1% of total loans and adding to its loan loss reserves at a 2:1 ratio to losses, this without cutting dividends or otherwise breaking a sweat, says a lot about management. So long as the bank generates sufficient capital internally to maintain reserves, USB should have no need to go to the markets.

Of note, we're pleased to hear the recent announcement by USB that the bank intends to remain independent. It's hard to sell out when you are consistently one of the best performing commercial banks in the world.

Washington Federal Inc. (NASDAQ:WFSL)

The $12 billion asset thrift unit of WFSL, Washington Federal Savings and Loan Association, reported a 1.2% ROA in Q2 vs. negative results for the peer group. Likewise WFSL did 10.10% ROE vs. -4% for the peers. Since 2001, WSFL's asset returns have tracked almost a full SD above peer. The lead unit of WFSL reported just 21bp of loan defaults vs. 126bp for the peers for the period ending June 2008.

WFSL is into the FHLBs to fund assets equal to 16% of total, but the strong, stable profitability and equally strong capital position make us inclined to put WFSL's lead unit on a list of places where we'd keep our money. With an almost 10% leverage ratio and 18% total risk weighted capital to total risk weighted assets, WSFL is one of the best capitalized depositories of its size in the US.

Note to CEO Roy Whitehead: Be a good boy and get those FHLB advances below 15% of total assets.

Charles Schwab Bank (NASDAQ:SCHW)

The $21 billion assets subsidiary of SCHW is a strong financial performer with excellent liquidity. The larger bank unit of SCHW reported an aggregate ROA of almost 2% in Q2 2008 and an eye-popping ROE of 27%, 1.26 SDs above peer, suggesting an almost counter-cyclical business strategy by this bank. The one caveat is that much of the bank's assets are invested in MBS. Asset returns tracked below peer for much of the 2002-2005 period, but since 2005 the bank's asset returns have been strongly above peer.

With core deposits above 80% and virtually no credit losses reported in Q2 2008, the thrift subsidiary of SCHW looks, to us at least, like a pretty safe place to stash your loot. While the bank's ratio of Economic Capital ("EC") to Risk Based Capital is 6:1, the 11% RAROC suggests that SCHW's bank unit is being well-compensated for its investment risks. Kudos to SCHW for turning this bank's performance around in a declining credit market.

Bank of Hawaii (NYSE:BOH)

The single bank unit of BOH reported ROA of 1.95% and ROE of 26% in Q2 2008, both measures more than 2 SDs above peer. The bank's conservative lending posture is illustrated by the 87% exposure to assets metric. But what we really love is the 77% core deposits vs. assets measure. Right now, being a full SD above peer in the funding category is a beautiful thing.

The 9.7 year weighted average maturity or "WAM," some 3 SDs above peer, is a bit breathtaking, but hey, the banking industry is a coral reef. BOH has loads of duration risk on both the lending and securities side, but the bank has produced excellent results with this asset mix. With an 7% leverage ratio and 46bp of current period defaults, BOH comes in with a ratio of EC to Risk Based Capital below 1:1 and a RAROC in the teens.

Disclosure: None