BG05052009
OLD SCHOOL
When it comes to running a bank or an economy – it really doesn’t take much more that genuine common sense.
By Neil George
We’re all waiting with bated breath over the so-called government’s stress test results that were supposed to be out and public by now – but instead are being held up. Supposedly, the guys over at the Federal Reserve Bank are having their sit-downs with banking leaders from the selected 19 banks that are part of this review.
Then, on Thursday the 7th – we’re supposed to get the results of the tests and what steps that the banks involved are going to do to fix their status.
This of course is kind of like watching students at the end of a term filing into their professor’s office and after getting a heads up on their poor grade doing their song and dance as well as pleading for a better mark.
Now, the media loves this. It gets us gullible investors and even innocent bystanders all hyped up over the concept that the banks are either all fixed – or if not – then the fix to make them all okay-dokey.
The trouble with this process is that none of us should care. And instead we should be focused on the banks that are in good shape as well as avoiding those that are in dire shape – with or without the Fed’s grade book release.
And none of this should be a new course of action – but how all of us should continue to operate.
The key thing to ask yourself is whether you want the US government to be your analyst of the markets and of stocks – or if you’d rather instead rely on the private sector.
You might say that it’s been the private sector analysts that got us into the mess that we’re in – and perhaps it might be a good idea to nationalize stock and market analysis as the government is a better judge of whether a bank or any other company is in good or sad shape.
That’s the new school of thought that continues to quietly insinuate itself into the thought process of the markets.
But here’s an alternative. Rather than just going blindly along with the usual Wall Street analysts that rarely blow the whistle on any bad bank – let alone any bad company’s stock – and rather than going with Washington’s government employees’ market calls – how about just doing your own stress test of bank.
Yes, the old school way of investing – by doing your own homework and looking at stocks as companies that you’d actually be buying and investing in.
Let’s look at a few straight-forward measures of how to look at a bank.
First, let’s look at the operations. Banks really come down to a pretty simple business model. They pull in deposits to which then are liabilities to fund loans that they invest in as the assets. Then they have to simply manage how they service the liabilities of paying their deposits against how their loans pay them.
So, first up – when looking at a bank – look to the deposit and loan growth rates. Rake for example Regions Financial (NYSE: RF). Currently trailing deposit growth is actually falling by over 4 percent. This means that unless the bank can reverse this – that it will have to scale back lending and shrink the size of its assets.
Meanwhile, loan growth is running at over 2.5 percent. This is good – as it shows that the bank is continuing to run its core business rather than just pulling in its horns.
Next we need to see how the margins from its operations are running. We can do this by looking at net interest margin – which boils down to the difference between how much that the bank is paying for deposits against what its receiving from its assets. For Regions – that number is running at over 3 percent. Good – but it could be better.
To see the relative performance of the bank – we can look at the efficiency rate. This is the measure of how much it costs to generate profits from normal operations. The lower the number the less it costs the bank to generate a dollar of revenue. A good number is around .40 with some questionable ones hitting the .60 to .70 levels.
Regions right now is running at .66 – which is understandable given many of the massive market changes underway.
Then we hone in on the profits – by looking at a return on assets and return on equity. Looking at the ROA – banks should be above 1.0 percent as normal – with 1.25 being pretty good. Right now with charge-offs – Regions is running at an ROA of -3.90 percent.
And on shareholder’s equity – the ROE on good banks should be in the teen’s – but again with charge-offs – Regions is running at a current reported loss of 33 percent ROE.
Ok – so we’ve looked at the operations and profits from operations – but to really look at the bank as to whether it can survive – we need to hone in on the balance sheet.
First – we need to look at non-performing loans as a percent of all loans and all assets. Again – in better times – the NPLs should work out to less than .40 with a number of .25 being good. Regions is now running at 1.3 percent to loans – not great – but a whole lot better than many in its peer group. And in terms of total assets the number drops back to .89 percent – not great – but better than many.
But what we need to look at are the reserves and provisions taken against the potential further write-offs of NPLs to become bad loans. Regions has reserves to loans running at 1.8 percent and to total assets running at 1.4 times current non-performing loans – a good cushion and higher than others – but it could be bigger.
Yet, when it comes down to the capital of a bank and the ability to absorb losses – we need to look at the core capital and the effective leverage of that capital in funding its loans and other assets.
A core capital rate in the lower double-digits is good – the higher the better for safety – the lower the better for current financial performance. Regions is running at over 10 percent. And for leverage its running at around 8.5 percent – which could be higher in better times – but is pretty much inline with a bank looking to scale back during tougher times.
And the final rundown on any bank should be just like for any company – by looking at the debt and risk that the debt will break the company.
Regions – like many to most financials has debt – both credit lines and bonds spread out over the next many years. Yet more is front-loaded in the next 2 to 3 years. This is where the real rub comes in. If indeed the bank continues to slow down deposit growth – and in turn has to scale back loan growth. And if in turn it has to ramp up its reserves against its current loan assets – revenue will suffer – reducing the attractiveness of lending to the bank via the bond market or other parts of the credit market.
And given the debt roll-overs in 2010 through 2012 – Regions has to come up with a game plan to issue new debt or new stock to roll or retire its debts. This amounts to some 6.2 billion – which is not too far shy of nearly twice its market cap – but is less than half of its total assets – meaning that it should be able to meet newer creditor/bond buyer needs even if it means shrinking the bank a bit more over the coming quarters.
Now that you’ve read some of my bits on Regions – it will be interesting to see how the government’s verdict comes out – I’ll let you know.
And one fellow that was one of Wall Street’s truly old-school guys – died at a whopping 107 years. Al Gordon was the guy that led one of Wall Street’s stalwarts – Kidder Peabody – as its chairman. And while it’s now part of UBS – the flag still flies at least on some bits of underwriting now and again – perhaps even for some of the new bank stock and bond offerings that we should expect coming our way in the coming months?
Neil George is editor By George.
The above is only opinion and does not represent and/or offer to buy or sell any security and/or any financial advice. The opinions contained may not be suitable for all investors who should consult their own financial adviser before making any investment or other decisions. I may own some of these same securities noted in accounts under my control or for my benefit.
Errors/Omissions: I always welcome being called on facts, figures and commentary from readers and look forward to your feedback. I can be reached by email at njgeorge@att.net or njgeorgejr@gmail.com or at 01-314-616-3325.
