Our Top Rated Banks for Q4 2024
Regions, 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 Fourth Quarter earnings 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, that does not always occur. In fact often some of our top rated banks are considered overvalued and underperform on a relative basis. this has been the case over the past few months as one of our top-rated banks in each sector has significantly underperformed: Regions (RF), Atlantic Union (AUB), Columbia (COLB). If the market appreciates, we would expect these banks to catch up quickly.
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 reckless strategy of investing excess liquid funding 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 19th 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 Fourth Quarter, there was considerable variation in the balance sheet strategies across the industry. We expect an increased focus on growth in most of these banks over the next 12 months, either organically or through acquisition, as loan demand increases, and many banks continue to pursue elusive scale economies. While continued reductions in Commercial Real Estate (CRE) will likely trim those portfolios, we expect these reductions to be replaced 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 likely outperform those that rely purely on high interest rates to achieve funding objectives. These charts identify the top two deposit organic growth banks in each industry category, as well as their cost of funds relative to their peers. The only two banks to rank high on deposit growth and low on cost of funds HBAN and WAL. Less diversified banks such as BK grew their deposit portfolios significantly but at very high cost.
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.
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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 higher deposit growth rates, even while paying a higher funding cost, being rewarded with both higher PE and P/B multiples. While we do understand the difference between correlation and causality, we do expect deposit generation, within a reasonable 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.
