New York | Which are the best performing banks in the US? Equity returns for the entire industry averaged 11.4% in Q1’18, up from 9.6% for all of 2017. There are some smaller banks, however, that generated returns on equity (ROEs) far higher than the average. Large banks tend to significantly underperform smaller peers. Growth rates, margins and equity returns all increase as size declines.
In this issue of The Institutional Risk Analyst, we look at some of the better performers in the industry based on ROE. We use the Q1’18 financials from the Fed and FDIC for the comparison. Results in the first quarter featured significant noise due to the downward adjustment of tax loss assets, and upward adjustment in after-tax returns, so look for bank asset and equity returns to be even higher in the future.
Among the large banks over $100 billion in total assets, the exemplars will surprise most investors. While the lead units of Bank of America (BAC) and JPMorgan (JPM) made it into the top ten, most of the names are new to our readers. Here are the top seven large bank units by return on equity (ROE) as shown from the TBS Bank Monitor published by Total Bank Solutions.
Over $100 Billion Total Assets
1. Discover Bank
2. Charles Schwab Bank
3. Capital One Bank (USA), National Association
4. Morgan Stanley Bank, National Association
5. Fifth Third Bank
6. The Northern Trust Company
7. U.S. Bank National Association
The best performer among large banks above $100 billion in total assets is the credit card unit of Discover Financial (DFS). The bank’s 371bp of default in Q1’18 earns it a “B” rating from the TBS Bank Monitor, but the 12.7% gross loan yield (3x its large bank peers) and resulting 24% ROE tell the tale.
In second place is the $200 billion asset bank unit of Charles Schwab Financial (SCHW), Charles Schwab Bank in Henderson, NV. With a 21% ROE and zero credit losses it ranks “AAA” in the TBS Bank Monitor. Less than 10% of the bank's business involves lending, while 90% of the bank's risk taking is focused on non-interest income and investing.
In third position is the lead bank unit of Capital One Financial (COF), Capital One Bank (USA), which sports a 17% ROE and 711bp of gross defaults in Q1’18, and thus gets a “B” default experience rating. Capital One Bank (USA) outperforms most larger banks by three-fold in terms of equity returns because of the high gross loan spread.
Indeed, among the multi-line banks, only the lead bank units of Fifth-Third (FITB) and US Bancorp (USB) made the top seven among the largest US banks in Q1’18. FITB is a leader among the regionals in terms of ROE and stability overall. At $400 billion in total assets, USB is the smallest money center, with national lending and fiduciary businesses. To their credit, USB has stubbornly refused to heed the siren song of asset growth, the sure road to mediocrity.
$10 Billion to $100 Billion Total Assets
1. American Express Centurion Bank
2. American Express Bank, FSB.
3. Comenity Bank
4. Stifel Bank and Trust
5. Sallie Mae Bank
6. MidFirst Bank
7. Silicon Valley Bank
The next group of banks is between $10 billion and $100 billion in assets and features some strong performers. One and two on the list are the bank units of American Express (AXP). Sporting ROEs of 44% and 38%, respectively, the two bank subsidiaries of AXP have default rates in the BB-B range and asset returns that are four times the industry average. Now you know why the Centurion is smiling. No surprise that credit card specialist AXP trades at 4x book value, a multiple its larger bank peers could never achieve.
Also notable among the top seven banks between $10 billion and $100 billion in assets are Stifel Bank & Trust with a 24% ROE, a unit of Stifel Financial (SF), and Silicon Valley Bank, the subsidiary of SVB Financial (SVB), at 20% ROE. The SF bank unit is evenly split between lending and investing, and has a very low efficiency ratio below 20%.
The $14 billion total asset credit card specialization bank Comenity, a unit of Alliance Data Systems (ADS), is another solid performer in this size class with a 30% ROE. ADS trades at 6x book value by no coincidence.
$1 Billion to $10 Billion Total Assets
1. WEX Bank
2. Cross River Bank
3. Metro City Bank
4. First National Bank of America
5. Merrick Bank
6. NexBank, SSB
7. Green Dot Bank DBA Bonneville Bank
Once you go below $10 billion in assets, the equity returns tend to increase as well as the diversity of business models. Consider WEX Bank of Midvale, UT, a $2.6 billion asset commercial lender with a gross spread on its loan book of 23%, an ROE of 84% and a “BB” equivalent loan default rate, according to the latest data from the FDIC. The weighted average maturity (WAM) of the WEX Bank’s loan book is just 90 days. Asset returns are just a tad under 10% or 10x the industry average. Did we mention that half of the WEX loan book is funded with brokered deposits?
First National Bank of America is a $1.4 billion residential mortgage lender based in East Lansing, MI. There are a lot of mortgage folks who have made Michigan their home: Quicken Mortgage, Flagstar Bank, Fay Servicing (well, OK, Chicago).
Of note, the annual Fay Servicing event, which is held in late August down the street from Wrigley Field in a fine Chicago pub, is rapidly becoming the most interesting discussion in mortgage finance. Speaking of housing, here is a little chart from The Garrett, McAuley Report (August 5, 2018) that tells you all you need to know about the disastrous state of the mortgage sector in 2018.
First National Bank of America, the bank unit of First National Bancshares (FNBI), has a 2.8% ROA and a 30% ROE, results that are indeed quite miraculous for a small residential mortgage lender. Even more interesting, this little bank has a 16% risk-adjusted return on capital or RAROC in the TBS economic capital simulation, again confirming our empirical observations that the RAROCs of small banks are better that that of the zombie dance queens of Wall Street.
FNBI's bank unit has a 6% NIM, 2x the industry average and 3x large bank results. Loss given default is 85% of par and the bank boasts just 11bp of defaults, well-below peer. First National Bank of America has a collosal WAM of 14.5 years, which means that they are retaining a lot of long-duration mortgage loans. And the gross spreads on the FNBI real estate book are north of 800bp vs maybe half that amount for a large urban lender like JPM or Wells Fargo (WFC). Banks make money on spreads, not interest rates.
Merrick Bank is a subsidiary of CardWorks, Inc., a non-bank financial firm in Draper Utah. The $3.5 billion asset bank is a top-20 issuer of Visa cards and also lends on boats and RVs. Despite the high default rate of 1,400bp, which results in a "CCC" loss experience rating, Merrick generates impressive asset (5.7%) and equity (29%) returns. As with WEX, the key to Merrick's success is a strong credit cutlure and a very short duration loan book with a WAM of well-less than a year.
Then we have Metro City Bank, the $1.3 billion asset subsidiary on MetroCity Bancshares (MCBS). This small institution is generating in excess of 30% ROE's by charging twice the spread on real estate and consumer loans that a larger bank charges, with below-peer defaults and an efficiency ratio in the 37% range. The bank has 15% Tier 1 Risk Based Capital and a net interest margin in the mid-4% range. Total funding costs are just over 1% vs 3x that amount for larger banks.
One of the best performers in the under $10 billion category is NexBank SSB of Dallas, TX. The $8.4 billion bank has a “AAA” rating from the TBS Bank Monitor due to the ultra-low default rate and a 29% ROE. The WAM of NexBank’s loan book is just shy of 10 years or almost two standard deviations above the industry average, reflecting a retained book of hand picked residential and other credits.
The pristine credit performance – NexBank has not reported a charge-off since 2015 – pretty much says it all. Chairman James Dondero, Co-Founder and President of Highland Capital Management in Dallas, leads the bank's board. Most important, NexBank does not pay dividends and instead retains capital to fuel its impressive record of growth and credit management. NexBank Capital, the parent company, has a 41% retained capital ratio to total capital vs 8% for the bank's asset peers, according to the FFIEC.
What all of these superior performers among large to mid sized banks have in common is that they are closer to the customer and thus better able to provide capital to fuel economic growth. The capital and asset returns of these top performers are indeed stellar because these banks know their customers and can thus better create and manage credit.
Part of the reason that the US economy is growing so slowly is that there are far fewer small banks in the US than decades ago, meaning less capacity to provide risk capital, fuel new businesses and manage the credit of small enterprises. If we want faster economic growth, then we need more, smaller banks to provide the capital. Great place to start is by breaking up some of the largest, most poorly performing institutions to get the party started. More on that in a future comment.