Not all banks are created equal. But even a seasoned bank analyst can struggle to tell one from another. While all banks take deposits and make loans, that’s essentially where the similarities between institutions end.
The most frequent distinction relates to size. The largest are the now-notorious too-big-to-fail banks, followed by regional lenders, and finally down to community banks that service the immediately surrounding vicinity. Yet, as an investor, I’ve always been dissatisfied with this over-simplified characterization. More telling to me are statistics about the underlying operation itself. And it’s for this reason I found the following chart so interesting.
3 interesting takeaways
As you can see, the chart separates the assets of the nation’s largest bank holding companies into four different categories: loans, total investments (these are mainly securities such as government bonds), cash and equivalents, and other assets. It then charts the proportion of total assets that each category accounts for. On the far left, 81% of M&T Bank’s (NYSE: MTB) assets consist of loans. On the far right, only 6% of State Street’s assets are loans. Suffice it to say, the chart is sorted from left to right with respect to the percentage of assets made up of loans.
Source: S&P's Capital IQ.
While it may not be immediately apparent, there are a number of interesting takeaways from this chart. In the first case, it illustrates the point I made at the beginning that not all banks are created equal. Some banks make lots of loans. Others hardly make any at all, choosing instead to invest in things like government and corporate securities.
Why does this matter? This matters because, as an investor, you can’t look at the same metrics for each bank and assume they mean the same thing. For example, over the last few quarters, one of the biggest impediments to share-price appreciation among bank stocks has been declining net interest margins -- that is, the difference between a bank’s yield on earning assets and its cost of funds.
But the mere fact that Bank of America’s (BAC +1.01%) 2.3% net interest margin is significantly less than, say, US Bancorp’s (USB +1.79%) 3.6% really shouldn’t be a surprise after looking at this chart. This is because loans typically yield more than other types of investment grade securities. It’s not unexpected, then, that a bank with 65% of its assets represented by loans would yield more on its overall asset portfolio than a bank with only 42% of its assets made up of loans.
A second point here is that the three so-called custodial banks -- Northern Trust, Bank of New York Mellon, and State Street -- are grouped up together on the right side of the chart. The reason is that these “lenders” hardly make any loans at all. In State Street’s case, a mere 6% of its assets are loans.
Conversely, their business model consists of holding and administering assets for others, much like a trustee does for a trust. Take one look at a custodial bank’s income statement and you’ll see why this matters. Unlike a traditional bank that relies on interest income for a large share of earnings, a custodial bank looks to investment management and servicing fees for the bulk of its business. In BNY Mellon’s case, it generates nearly $2.9 billion in quarterly fees from the latter sources, but only $749 million in net interest revenue.
The third and final insight concerns the four too-big-to-fail banks -- Wells Fargo (WFC +1.76%), Bank of America, Citigroup (C +2.85%), and JPMorgan Chase -- amassed between the custodial banks on the far right and the regional banks on the left. As you can see, with the exception of Wells Fargo, less than half of the assets on these banks’ balance sheets are loans, with considerably more securities and cash than their peers.
What gives? The answer is that all of these banks have large trading and investment banking operations that demand assets of their own. JPMorgan is a perfect example. While it has an enormous retail presence through its Chase subsidiary, it is first and foremost an investment bank. And it’s for this same reason that these banks are obligated to hold so much cash (notice the concentration of yellow on the chart above these banks) in case something goes wrong, as JPMorgan saw with the $6 billion London Whale scandal.
What’s the point?
The point here is simple. Bank stocks have paid off in spades over the past year as the housing market recovers and lenders make more and better loans. But some banks are better positioned than others to reap the benefits of these tailwinds -- namely, those with large retail lending operations. And it’s for this reason you should always get to know a bank before investing in it.
