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, megamoney 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 first bank under the microscope is Westamerica Bancorp
|Tier 1 capital ratio||14.5%||approx. 8%|
|Net interest rate margin||4.9%||>= 3.5%|
|Provision for loan losses (as a % of net interest income)||6.2%||<= 5%|
|Net noninterest expense (as a % of net interest income)||34.8%||<= 33%|
|Return on equity||15.6%||>= 15%|
|Price-to-book ratio||2.3||approx. 1.0|
Sources: Westamerica Bancorp's Q2 2012 10-Q and Yahoo! Finance.
Westamerica's balance sheet provides a near-textbook example of how to manage interest-bearing assets and liabilities. Its biggest strength is its nearly 5% net interest rate margin. Due to its strong deposit base, the bank's cost of funds is a minuscule 0.21%. This is fueled by both its aggregate deposit base -- which accounts for 95% of its liabilities -- and the composition of this base -- 36% of which is non-interest bearing demand deposits. Meanwhile, its retail loans make up 58% of its interest-bearing assets and yield an average of 5.84%. These are diversified between commercial and consumer loans, though weighted in favor of the higher-yielding former.
Moving to the income statement, it seems clear that Westamerica employs quality-focused loan officers and seeks to mitigate its noninterest expenses with offsetting noninterest income. Its provision for loan losses in the second quarter was a reasonable 6.16% of net interest income. And its net noninterest expenses consume only a third of the same.
With these figures in mind, it's no surprise that Westamerica's return on equity exceeds 15%, handily beating the 9% industry average. The only complaint in this regard is that it's overcapitalized, which exerts downward pressure on shareholder return. Its current Tier 1 risk-adjusted capital ratio is a staggering 14.5%; to be considered "well-capitalized" by the FDIC requires a figure of only 6%. At the end of the day, however, there's no question that it's better to have too much capital as opposed to not enough.
My take on Westamerica Bancorp
It's hard to argue with Westamerica Bancorp's statistical performance. Yet this doesn't necessarily mean it's a "buy." Shares in the bank currently trade for 2.32 times book value. Because this is a very high multiple, any future return would likely have to come in the form of dividends and growth in book value. That said, in my opinion, if you're looking for a long-term investment, it's better to spend a little more for value than to risk your capital on securities of dubious quality.
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