Our Top Rated Banks for Q2 2024
M&T, East West Bancorp, Bank OZK
The numbers have been crunched, the data analyzed, and now the winners can be revealed
How We Choose
We analyze our group of 30 banks across a number of performance and market-related metrics and use a proprietary scoring algorithm to assign ratings to individual banks and defined industry segments. The derived score is based on both absolute and relative performance and is used to rank each company relative to its industry sector and to inform our valuation estimates and projections. We examine banks in three primary sectors – Super Regional, Regional and Super Community. The definitions of these sectors and a listing of the banks we follow can be found on the home page of our website. Every quarter, and for the year as a whole, we name our top-rated banks in each sector and an overall champion. And now that Second Quarter results are in and analyzed, we can report the long-anticipated results.
Our Three Sector Winners
All three of our top ranked banks are consistently high performers with Bank OZK being our returning champion in the Super Community category and overall. We also have identified the losers in each category. However, because we choose to accentuate the positive, the current rankings of all of the banks we cover (including the losers) are only available to subscribers of our in-depth reports.
These banks have several factors in common that contribute to their performance – they run traditional business models, perform extremely well on the basics, and deliver consistent and sustained results. In our view, the key attribute that connects these three companies is focus – they know what they do well and don’t get distracted or dissipate resources by chasing hobby businesses or unfamiliar markets. This is a testament to what we consider to be strong, experienced, and effective management teams in all three banks. While performance on various metrics varies, each of these companies is ranked at or above average on every metric we analyze and lead their sector in a few key categories. It is also not surprising that all three rank highly on both efficiency ratio and net interest margin (particularly important in this interest rate environment). This shows that they rigorously manage their business mix and cost structures.
Highest Ranked Metrics
Does the Market Care?
In a perfect world and with an efficient market, we would expect our ratings and rankings to translate into higher market multiples and stronger market performance. And, often they do, but not always. We use our scoring algorithms and proprietary valuation model to set a target price for each of our companies’ stock. We don’t really expect to call the price with precision but we use it to assess whether we believe the company is overvalued, undervalued or fully valued relative to the banking sector and market as a whole In most cases we would expect our top rated banks to outperform both the sector and their peers, however, for the most part that has not been the case as the entire sector, and especially larger banks have come under pressure. Exceptions have been Western Alliance (WAL) and, up until the week of 5/27, Bank OZK (OZK), with both outperforming both the industry benchmark and their peers. We had highlighted both of these banks as being undervalued relative to their performance last quarter. However, Bank OZK got hammered on 5/30 as a result of a Citi double downgrade to sell based on concerns regarding two large CRE loans and has not recovered. We believe this concern was overblown and thought the stock was punished too severely. It has since rebounded nicely. If the market continues to appreciate, we would expect a few of our other highly rated banks that have underperformed in terms of their stock performance to catch up and ultimately exceed industry averages.
Deposits and Funding Costs in the Spotlight for 2024
Deposits are the lifeblood of all banks but for years have been underappreciated, undervalued, and basically ignored by executives who were more concerned about growing their loan portfolios and ancillary businesses than investing in the ability to build strong core deposit franchises. This neglect was exacerbated by the pandemic, when interest rates dropped to zero, stayed there, and consumers and businesses hoarded cash. The result was plentiful and cheap funding that was more than sufficient to support loan growth. A number of banks not only took the deposit portfolio for granted but adopted the incredibly stupid strategy to invest excess balances in longer term securities to juice yield and optimize net interest margin. That strategy had disastrous consequences for a few high profile banks as nervous depositors staged a 19the century style run on these banks using 21st century technology and crashed them seemingly overnight. While the impact on the shareholders of these failed banks was catastrophic, the fallout impacted bank investors across the entire industry. The question is have both bankers and investors learned their lessons and started to pay attention to the size, characteristics, and strength of the core deposit portfolio as a primary driver of shareholder value?
Balance Sheet Strategies Vary
During the second quarter, most banks saw decreases on both sides of the balance sheet. There were a few exceptions as a few Regional and Super Community banks grew both loans and deposits at a significant annualized rate. These include Western Alliance, Bank OZK, and Wintrust, three of our highly rated banks . We expect most banks to grow only marginally over the next 12 months as they continue to focus on funding costs, net interest margin and cost reduction to drive performance rather than loan growth. Additionally, banks that are heavily concentrated in Commercial Real Estate (CRE) will likely trim those portfolios and seek to replace those balances with a more diversified mix.
A key driver of performance will continue to be a bank’s ability to generate core, stable funding at an acceptable cost. Those banks that can consistently generate lower cost funds will significantly outperform those that rely purely on high interest rates to achieve funding objectives. These charts identify banks that have been able to generate industry leading deposit growth while effectively managing cost of funds. Strong performers can be found in each of our industry sectors. Additionally, some of these larger banks have been the beneficiary of a flight to quality after the meltdown in the Spring. Less diversified banks such as BK and NTRS grew their deposit portfolios significantly but at very high cost. Banks that have been most successful in growing deposits at a manageable tend to cluster in our Super Regional category, such as KEY, HBAN, RF, and MTB. The clear loser is NYCB as they continued to struggle to shore up their balance sheet and liquidity positions in light of their high risk position.
Does the Market Care?
As with all of our statistics, we constantly ask "Does the market care". The analysis may be interesting but if it doesn't translate into market valuation we want to know why or why not. In this case, and in this environment when funding is a hot topic, we would expect those banks that have shown the ability to grow the deposit portfolio at a relatively low cost would outperform those that have shown low to no deposit growth while experiencing high cost of funds. To test our hypothesis, we placed all our banks into categories based on whether their deposit growth and cost of funds was higher or lower than the median peer performance. Our categories were:
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High Deposit Growth/Low COF
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High Deposit Growth/High COF
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Low Deposit Growth/Low COF
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Low Deposit Growth/High COF
Well, a funny thing happened on our way to proving our hypothesis. What we have found is that there is no consistent correlation between cost of funds, deposit growth, and share price performance. The market doesn't really care about the inputs, it cares about the outputs, how has balance sheet management translated to overall financial results. However, while the stock price has not reflected this growth/COF ratio, market valuations have, with banks achieving relatively low funding costs, even while sacrificing growth, trading at higher market multiples. While we do understand the difference between correlation and causality, we do expect deposit generation, and especially cost, to continue as a primary driver of market performance. We continue to believe the banks that can manage their funding costs lower than peers will over time realize better net interest margins and superior financial performance.
