My grandfather used to say, though never to me directly, that "banking is like sex. When it's good, it's great. And when it's bad, it's still pretty good."
While the financial crisis may have led the average investor to question this -- 454 banks have been seized by regulators since the beginning of 2008 -- the industry is back on its feet and growing again -- albeit at a less frenetic pace than before. In its most recent quarterly banking profile, for instance, the FDIC noted that the industry's first-quarter aggregate net income of $35.3 billion is the highest it's been since the second quarter of 2007.
Yet many banks are still trading for fractions of book value. While the average savings and loan institution is selling for an 11% discount, mega-money center banks like Bank of America and Citigroup are trading for less than half of their book value. In this environment, it's become exceedingly important for investors in financial stocks to be able to separate the winners from the losers. And to do this appropriately, one must look under the proverbial hood.
In this series, I examine six of the most important metrics to assess the quality of a bank's operations. The current bank under the microscope is People's United Financial
|Tier 1 capital ratio||14.1%||approx. 8%|
|Net interest rate margin||3.97%||>= 3.5%|
|Provision for loan losses (as a % of net interest income)||4.49%||<= 5%|
|Net noninterest expense (as a % of net interest income)||55.09%||<= 33%|
|Nonperforming loans (as a % of total loans)||1.3%||<=1%|
|Return on equity (TTM)||4.24%||>= 15%|
|Price-to-book ratio||0.80||approx. 1.0|
Sources: People's United Financial's Q2 2012 10-Q and Yahoo! Finance.
People's statistics provide an interesting study in contradictions.
On one hand, it operates a solid core banking business. Nearly three-quarters of its assets consist of loans, the majority of which are commercial, yielding an above-average 4.8%. A full 93% of its liabilities are low-cost deposits, 22% of which are non-interest-bearing demand deposits, costing a below-average 0.45%. People's net interest margin for the second quarter accordingly came in at 3.97%, well above the industry's first-quarter average of 3.52%. And to top this off, its loan loss provisions consume a currently reasonable 4.49% of its net interest income.
Beyond this, People's has more than doubled both its loan and deposit portfolios since the onset of the financial crisis, though most of this growth has come in the form of acquisitions. At the beginning of 2008, it acquired a bank holding company with $5.7 billion in loans and $6.2 billion in deposits. Two years later, in 2010, it acquired four institutions with a cumulative $3 billion in loans and $2.5 billion in deposits. Last year it purchased a Massachusetts-based bank with $1.9 billion in loans and $2.1 billion in deposits. And earlier this year, it completed the acquisition of 57 new branches with $324 million in deposits.
Equally as robust as these strengths, however, are the bank's four principal weaknesses. First, it's woefully overcapitalized. As you can see in the table above, its tier 1 risk-adjusted capital ratio is a staggering 14.1%. This is more than twice the 6% level necessary to be considered "well-capitalized" by the FDIC. And while it's inarguably better to have too much capital as compared to too little, as the saying goes, it is possible to have too much of a good thing. And that's the case here, as evidenced by the bank's lackluster 4.24% return on equity.
Second, its net noninterest expense is too high, consuming nearly 58% of its net interest income after provisions. Its compensation and benefits alone is 61% greater than its net income, meaning that its employees get a bigger piece of the proverbial pie than its owners -- not exactly how capitalism is supposed to work.
Third, while deposit and loan growth is a good thing, it's not an end in and of itself, as People's appears to have assumed. Quite simply, acquisitive growth, which explains the vast majority of its ascent, is far more expensive than organic growth, and People's balance sheet reveals the telltale signs of this, with over $2 billion in goodwill and other intangible assets. Of course, it could also be argued, and perhaps legitimately so, that People's is adroitly exploiting current weaknesses in the industry and would be foolish not to do so by growing aggressively via whatever means are available. Only time will tell.
Finally, People's board of directors has demonstrated an unfortunate affinity for share buybacks that seem to have destroyed shareholder value as opposed to adding to it. Over the last few years, the bank has spent hundreds of millions of dollars doing so while at the same time its share count has increased by 20% and its tangible book value per share has plummeted from over $14.40 at the beginning of 2008 to $8.37 today.
So, should you buy People's United?
As I said earlier, People's presents a complex case of contradictions. On one hand, it has a strong commercial banking foundation upon which to grow. But on the other, it appears to be squandering much of this advantage via excessive noninterest expenses, non-accretive acquisitions, and wasteful stock buyback programs. Whether the benefit to shareholders of the acquired loans and deposits may eventually come to fruition is hard to say, but I don't believe it's worth the typical investor's time and money to wait around to see.
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