2007 began as the best of times and ended as the worst of times. Yetthe top-performing banks over $3 billion still managed to excel. Threewinning strategies made the difference for the top 25. 

Part 1

By Vanessa Mambrino,  senior associate, Capital Performance Group LLC, Washington, D.C. The firm provides advisory, planning, analytic, and project management support to the financial services industry.

2007 began as the best of times and ended as the worst of times. Yet the top performers still managed to excel. Here’s how they did it

It’s seems long ago now, but the first quarter of 2007 was a very strong one for banks. After that, things quickly began unraveling, and banks and thrifts faced significant obstacles throughout the rest of the year. Many institutions were adversely affected, even though only a handful of them were directly involved in what turned out to be the last straw of a credit boom—subprime lending.

Despite the Federal Reserve’s aggressive rate cutting in the second half, the cost of funds remained high, resulting in further margin compression at most banks. Many subprime and nontraditional mortgages began to turn sour, affecting both credit quality and the ability of banks to access the secondary markets. As borrowers defaulted on more and more mortgage loans, institutions of all sizes found themselves forced to take large write-downs or increase their provisions.

These conditions led to the first bank failures since 2004 and caused institutions that had previously appeared among our top performers—Citigroup, First Horizon National, IndyMac Bancorp, and National City to name a few—to drop to the bottom of our rankings. By the fourth quarter, the FDIC was reporting that the earnings of insured institutions were the lowest they had been since 2002.

The performance of this year’s top 25 public and top 10 private or foreign-owned banks and thrifts is all the more impressive for exhibiting strength despite the prevailing adverse conditions. The aggregate industry statistics tell an already familiar story, but this year’s top performers managed strong performance in a year where most banks were happy to just squeak by.

In this, Part One of the 16th annual ABA Banking Journal performance report, we will review the financial results and strategies of the nation’s largest banks and thrifts. Part Two, which will appear in June, will highlight the top performing community banks and thrifts of 2007.

Selection criteria
Our study ranks the performance of domestic depository institutions with assets over $3 billion as of Dec. 31, 2007. Two groups were included in our analysis: publicly held depository institutions (banks, thrifts, and bank or financial holding companies) and private or foreign-owned depositories (defined in greater detail below). A total of 157 public banks, thrifts, and holding companies and 43 private institutions qualified under our selection criteria. They were ranked by return on average total equity (“ROAE”) for 2007. In instances where the reported ROAE was identical for two or more institutions, 2007 return on average total assets (ROAA) was used as a secondary ranking criterion.

Data were provided by SNL Financial LC as of December 2007. Securities and Exchange Commission filings were the source for public company data, and regulatory filings were the data source for private and foreign-owned institutions.

(Five banks met our selection criteria but were not included in our analysis because data were not available at the time this article was sent to print. Those institutions are: Doral Financial Corp., San Juan, P.R.; NetBank, Alpharetta, Ga.; BFC Financial Corp., Fort Lauderdale, Fla.; HSBC North America Holdings, Prospect Heights, Ill.; and Fremont General Corp., Santa Monica, Calif.)

Three winning strategies
This year’s top 25 public banks and thrifts are those who made the best of a bad situation. To get an idea of the difference in overall industry performance between 2006 and 2007, one need only look at the drop in the return on average equity (ROAE) that an institution needed to qualify: last year, the 25th institution had an ROAE of 17.26%, while this year, City National of Beverly Hills, Calif. (#25) made it with an ROAE of 13.92%. This year’s top performers used three main strategies to counter the inhospitable operating environment: growing noninterest income, focusing on a particular niche business or consumer segment, and improving overall efficiency.

1. Reliance on noninterest income
Among the top 25 institutions, noninterest income represented on average 32.19% of total revenues, compared to an average ratio of 28.01% for all institutions. This helped to alleviate some of the margin compression and to counter some of 2007’s other negative trends. Very few of this year’s top 25 relied heavily on interest income from mortgages—among top performers, one-to-four family mortgages represented on average about 19.7% of total loans, compared to an average of 25.3% among all institutions. Wells Fargo & Co. of San Francisco, Calif., one of the larger mortgage lenders in our group, was able to improve its position among the top performers—moving from 13th to 9th—by increasing the relative contribution of its fee income.

For the past three years, noninterest income has represented roughly half of the total revenues of TCF Financial Corp., Wayzata, Minn., 2008’s top performing bank. TCF has appeared in our top 5 since 2005 and has returned to the top spot after being displaced last year. During 2007, TCF made a “concentrated effort” to manage and diversify its noninterest income, increasing deposit service charges by 2.9%, raising card revenues by 7.4%, and growing balances in its leasing and equipment portfolio by 14.6%. TCF’s leasing and equipment finance business generated both interest and noninterest income and has become an important source of revenue for the bank.

This, coupled with a decision not to compete with other institutions for high-yield deposits, helped to grow net interest income by 2.4%. At many other institutions, including Wells Fargo, growth in noninterest income was necessary to help counter the loss of revenues from interest-earning assets. Fee income at Wells increased by 17%, driven by a 36% increase in mortgage servicing fees and a 22% increase in card revenues. Though the bank felt the effects of the softening housing market, its strategy of adapting underwriting standards on an MSA-by-MSA basis helped limit the damage. The company was also prescient and exited many of its riskier origination businesses early in the year.

Institutions looked for noninterest income growth in other areas as well. As the cost of funds remained high, trust revenue became an increasingly important source of income for banks and thrifts. Among this year’s top performers, trust revenue represented, on average, 11.2% of total revenue, compared to an average of 9.9% in 2006. At Wilmington Trust Corp. of Wilmington, Del. (#12), revenues from the bank’s Wealth Advisory Services and Corporate Client Services (advisory services for institutional clients) outpaced those of its retail bank for the first time in the company’s history. 

2. A high-end niche focus
In addition to focusing on noninterest income growth over the past year, Wilmington Trust pursued another strategy that was prevalent among 2007’s top performers: a focused, high-end niche strategy. While the bank’s retail services are offered to a broad clientele, its Wealth Advisory Services and Corporate Client Services focus on two specific segments: high net worth individuals and global enterprises.

Other institutions apply more precise definitions to their target markets for traditional retail banking services and have succeeded by sticking to these definitions and not attempting to be all things to all people. Northern Trust Corp., Chicago (#7), also provides asset management and banking services to commercial institutions and individuals with between one million and one billion dollars of investable assets. Noninterest income represents over 76% of total revenues at the bank; trust revenues alone represent 58%.

SVB Financial Group, Santa Clara, Calif. (#6), provides banking services only to businesses within specific industry sectors (including technology services, private equity, biotechnology, and premium wine) and private client services to the executives and officers of these businesses and other high net worth individuals. Noninterest income from services offered to these segments represented 29% of total revenues at SVB; the rest came from the return on the higher yield C&I loans that make up 72% of the bank’s loan portfolio.

We expect more banks to develop a focus on the segments that they are already positioned to serve well. In particular, we expect to see an increased focus on high-end consumer segments, including the mass affluent.

3. A focus on efficiency
All of this year’s top performers maintained better levels of efficiency than their counterparts. The average efficiency ratio among the top 25 was 53.23%, while among all institutions the average was 60.73%. Frontier Financial Corp., Everett, Wash. (#5), had the lowest efficiency ratio of the top 25 at 37.99%, despite incurring one-time costs from acquiring a bank in Oregon in June 2007.

The efficiency ratio of Westamerica Bancorp., San Rafael, Calif. (#3), has not exceeded 40% since 2003. The bank instituted across-the-board expense cuts in 2007, resulting in a 2% reduction in operating expenses. Westamerica’s net interest income has been declining for the past few years despite efforts to control interest expenses by focusing on low cost funding—DDAs represent 31% of total deposits, while MMDAs and savings accounts represent 33%. Recent growth in noninterest income has not been sufficient to counter this trend. Meanwhile, noninterest expenses have remained flat or declined since 2005. Without its determined focus on expense control, Westamerica would have seen much greater declines in its net income and may not have remained so highly ranked.

U.S. Bancorp, Minneapolis (#4), maintained an efficiency ratio of 44.22%, despite making significant investments in the payment services that act as a major driver of noninterest income growth. The bank introduced new online payments systems for commercial and middle market business customers—which U.S. Bancorp was able to do because it controlled expenses in previous years. The bank has implemented 15 different revenue growth initiatives focused on building deeper consumer, small business, and wholesale relationships and created a new Enterprise Revenue Office, reporting directly to the CEO, to manage them.

Plain, old-fashioned, cost cutting will continue to be a trend in 2008, as the revenue side of the business and credit quality continue to impose significant growth challenges on the industry.

Private and foreign-owned results
This year’s group of top-ranked private or foreign-owned institutions contains only three new entrants. The pool used for this analysis includes nonpublicly traded banks, thrifts, and holding companies as well as wholly owned financial institution subsidiaries of both privately-held and publicly traded foreign financial services companies, where the company is not listed on a major U.S. exchange and the subsidiary’s results are broken out separately. Like the public list, the private and foreign-owned rankings consider only institutions with more than $3 billion in total assets. Wholly owned financial institution subsidiaries of publicly traded companies in other industries have been excluded from these rankings, as these institutions are not truly comparable to other private financial institutions. A total of 43 institutions were included in this year’s analysis.

Private or foreign-owned banks appear to have fared as well as their public counterparts—the average ROAE among the top ten was 19.76%, compared to 19.97% for the top ten public institutions. However, they seem to have followed different strategies. Noninterest income represented an average of 26.4% of total revenues at the top ten institutions, compared to 36.9% at the top ten public institutions. At 52.67%, the average efficiency ratio among the top ten was slightly higher than the average ratio for the top ten public companies, or 51.65%. The niche focus of these institutions, however, was on a region or industry, rather than a particular set of individuals.

The top-ranked private or foreign-owned institution, Intrust Financial Corp., Wichita, Kan., is primarily a commercial lender. The bank was helped by its location—it operates primarily in the Plains States, which have remained relatively unaffected by the slowdown in the housing market. Also, Intrust converted to a Subchapter S Corporation at the end of 2006. Together, these factors helped Intrust move from twelfth on last year’s list to the top spot for 2007.

Other newcomers include Great Western Bancorp., Inc. of Omaha, Neb. (#8) and Riverside Banking Company of Fort Pierce, Fla. (#10). Great Western focuses on the agribusiness sector—a focus that not only gave it access to a sector of the economy that did very well last year, but also brought it to the attention of a buyer. National Australia Bank, Melbourne,  announced in November that it will be acquiring Great Western.

Deals to come?
Events in early 2008 suggest the banking industry will continue to face challenges related to capital adequacy and earnings performance.  The strategies used by top performers in 2007—diversification of income sources, increased focus on specific segments of the consumer and business markets, and efficiency programs that demonstrate an ability to control costs—will remain important for achieving performance goals in 2008. New strategies will also emerge to generate new top performers. For example, bank valuations are at levels not seen since 1994. Those banks in a position to make acquisitions will find better prices than seen in many years. BJ

May 08 Digital Magazine 

[This article was posted on May 1, 2008 on www.ababj.com, the website of ABA Banking Journal, copy right2008 by the American Bankers Association.]