Top Bank Literature

What Makes A Good Bank Good?
Jack Milligan

As our Board Performance Scorecard show, high profitability, a strong balance sheet, and outstanding asset quality are what it takes to be become a high-performance bank.

In an industry that has undergone a tremendous amount of consolidation over the past two decades, it’s important to remember that bigger is not always better when it comes to gauging the performance of a bank. With the objective of identifying the top performers among the 150 largest publicly owned banks and thrifts in the U.S., Bank Director—with assistance from New York-based investment banking firm Sandler O’Neill & Partners—created the Bank Performance Scorecard, which measures each institution across three important categories: profitability, capital adequacy, and asset quality.

The objective was not to use a single yardstick—such as return on average equity (ROAE)—but instead to measure bank performance across all three categories. What makes a good bank good? Because these are all public companies, one defining characteristic is consistent profitability. Since banks and thrifts exist for the purpose of taking on economic risk, they also must be well capitalized—although not so well capitalized that they penalize shareholders by dragging down their investment returns. And since the vast majority of banks and thrifts still make most of their money by making loans, they must demonstrate their skill in that regard by having excellent asset quality.

The calculations in Bank Director’s 2005 Bank Performance Scorecard were based on publicly available data over four linked quarters—the third and fourth quarters of 2004 and the first and second quarters of 2005 (see below for a full explanation of methodology). The winner was Honolulu-based Bank of Hawaii Corp., a $10 billion commercial bank that did not garner a first-place finish in any single performance metric but scored quite high in both the profitability and asset-quality categories. [See story on page 30.] Finishing second was S&T Bancorp of Indiana, Pennsylvania—one of the Scorecard’s smallest institutions with assets of just under $3.1 billion. Third place went to Newark, Ohio-based Park National Corp., a $5.6 billion bank that has adopted an unconventional operating structure. Rounding out the top five were Los Angeles-based City National Corp., which has thrived in the highly competitive California market, followed by $3.5 billion Glacier Bancorp in Kalispell, Montana.

The highest-placed institution with assets of $50 billion or more was 17th-ranked U.S. Bancorp in Minneapolis, which decided a few years ago to suspend its aggressive acquisition program and focus instead on maximizing its financial performance, a move that certainly seems to have paid off. The highest-placed thrift was sixth-ranked Westcorp in Irvine, California—an auto finance specialist that agreed last September to be acquired by Wachovia Corp. in Charlotte, North Carolina.

The ultimate accountability for the performance of any bank or thrift rests with its board of directors, and as such, the Bank Performance Scorecard strives to look beyond singular performance metrics to identify institutions that are superlative in all critical areas. The Scorecard should not be interpreted as an endorsement of any institution’s prospects as an investment since stock performance is ultimately determined by many more factors than the ones isolated here. But it is also highly likely that over the course of time, banks and thrifts with strong balance sheets, superb credit skills, and consistent profitability will be judged as successful public companies by most accepted standards.

The Scorecard uses six performance criteria, beginning with return on average assets (ROAA) and ROAE. The two capital adequacy metrics were the Tier 1 capital and leverage capital ratios. And the institutions’ asset quality was measured by calculating their ratio of nonperforming assets (NPAs) to total loans and Other Real Estate Owned (OREO), and also their percentage of loan loss reserves to total loans. On the theory that profitability is the most important performance criteria for a public company, ROAA and ROAE have been given a greater weight in the Scorecard’s final calculation than the four other metrics.

One trend that is immediately apparent in the Scorecard’s results is that smaller banks and thrifts routinely outperform their larger competitors. There are exceptions to this rule—beginning with U.S. Bancorp., which had the second-highest ROAA and seventh-highest ROAE among the 150 institutions. Pittsburgh-based Mellon Financial Corp., which has assets of $36.9 billion, took the No. 1 spot in the ROAA category and finished ninth overall. And right behind it in the 11th spot was $26.7 billion Synovus Financial Corp. in Columbus, Georgia. But Mellon sold off its retail banking franchise several years ago and now concentrates on investment management and a variety of institutional and corporate services like global custody and benefit consulting. And Synovus augments its four-state regional banking franchise in the Southeast with an electronic payment processing business that operates nationwide.

Most very large institutions that are highly diversified across geographic and product lines did not measure out particularly well on the Scorecard. For instance, the largest bank—$1.5 trillion Citigroup in New York—finished in the 101st spot. Bank of America Corp. in Charlotte, which has assets of $1.24 trillion, finished 62nd. New York-based JP Morgan Chase & Co., which is nearly as large at $1.17 trillion, limped in at the 147th spot. The fourth-largest U.S. bank—Wachovia, with $511 billion in assets—finished 108th. San Francisco-based Wells Fargo & Co.—the fifth-largest bank with assets of $434 billion—did much better coming in at the 38th spot. Although every bank and thrift has its own unique set of circumstances that help determine its performance, it may be that greatly increased size tends to have a ratcheting-down effect when it comes to profitability and asset quality, two of the Scorecard’s key determinants.

This year’s top-ranked institution—Bank of Hawaii—is perhaps an unlikely winner based on its recent history. It was only a few years ago that the bank tried to expand well beyond the Hawaiian Islands, but loan quality ended up deteriorating so badly it was placed on a short leash by its primary regulators, the Federal Reserve Bank of San Francisco and the Federal Deposit Insurance Corp. But former Chief Executive Officer Michael O’Neill engineered an impressively quick turnaround, and O’Neill’s successor as CEO—Alan Landon, previously the bank’s chief financial officer—now has the company focused on the lush Hawaiian market. Bank of Hawaii scored particularly well in both the profitability and asset quality categories. Its highest finish in the individual metrics was for ROAE, where it ranked third.

The second-place finisher, S&T, does business in a part of the country that could hardly be more different from Hawaii. Headquartered in Indiana, a small community of 15,000 people located about 60 miles northwest of Pittsburgh, S&T must scratch and claw for its revenue growth. It’s an area where the median household income level is below the state average—and unemployment is above the state average. For the most, part it is not a market where top-line growth comes easily, yet S&T scored well across the board—particularly on ROAA, where it ranked seventh.

S&T operates a 51-branch network in a 10-county area, and also has both an investment management and insurance agency operation. Chairman and CEO James C. Miller says the bank is particularly focused on servicing small and medium-sized businesses. “The driver for us continues to be commercial lending, particularly family-owned businesses and entrepreneurs,” he says. “We think we bring a little higher level of service to the customer.” Andy Borrmann, an analyst with SunTrust Robinson Humphrey in Atlanta, says S&T’s relationship focus is particularly distinctive. “I would call it a pure community bank,” he says. “It is as relationship-focused as any management team I’m familiar with.”

In recent years S&T has tried to accelerate its top-line growth by expanding into faster-growing Allegheny and Westmoreland Counties to the south, which are driven primarily by the large Pittsburgh market. The bank also does a considerable amount of commercial real estate lending and in recent years has followed some of its best customers when they’ve developed projects well out of S&T’s normal territory—including upstate New York, Florida, Arizona, and California. The bank currently has approximately $250 million in such loans. While banks can sometimes get themselves in trouble by going out of market, Miller is comfortable with the strategy because S&T knows its customers so well. “It comes down to people doing business with people,” he says.

This year’s third-place finisher, Park National, also sits in a part of the country that does not offer abundant growth opportunities. “A lot of the MSAs (Metropolitan Statistical Areas) it’s located in are projected to decline in the next few years,” says Sandler O’Neill analyst Brad Milsaps. Yet the bank still managed to notch high rankings in each individual performance metric except for its nonperforming asset ratio, where in came in 114th. In fact, overall, Park National finished just one-half of a point behind S&T.

Park National focuses primarily on small Ohio communities where it operates 11 subsidiary banks that each trade under a different name. The bank has done nine acquisitions since 1987, and in each instance, it has centralized many of the core service, administrative, and back-office functions while allowing the new subsidiary to operate semi-autonomously under its old name. Chairman and CEO C. Daniel DeLawder believes that strategy makes sense given that Park National is essentially a large community bank that emphasizes personal service. “We do a reasonably good job relative to the rest of the industry, which suggests to us that that is still the right strategy,” says DeLawder—who is only the fourth CEO to run the company since 1927.

While Park National offers a full range of commercial and trust banking services, most of its subsidiaries are located in small towns—in many cases, the country seat—where there is not much organic growth. This has led the bank to slowly expand into such larger Ohio cities as Columbus, Dayton, and Cincinnati where the opportunities for revenue growth are much better—and where DeLawder figures Park National’s strong service culture will be especially well received.

“Our intention is to be the bank of choice in all the communities we operate in,” says DeLawder.

How the Scorecard Works

The Bank Director Bank Performance Scorecard is determined by using six performance criteria that measure profitability, balance sheet strength, and asset quality. The criteria are:

Return on average assets, which measures a bank’s profitability relative to its total assets. This metric was given a full weighting in the Scorecard calculation.

• Return on average equity, a second measurement of profitability that focuses on shareholder returns. This metric also received a full weighting in the Scorecard calculation.
  
• Tier-1 capital ratio, which is comprised of shareholders’ equity, retained earnings, and convertible preferred stock divided by total assets. This received a half weighting.
  
• Leverage ratio, which is shareholders’ equity divided by total assets. This received a half weighting.
  
• Nonperforming asset ratio, which is the ratio of nonaccrual loans and foreclosed assets to total loans and Other Real Estate Owned. This received a half weighting.
  
• Reserve coverage, which is loan loss reserves divided by total loans. This received a half weighting.
  

The institutions received a numerical rating in each individual category, with the highest ranked bank getting a score of one and the lowest ranked bank a score of 150. Each bank’s and thrift’s scores were then added across and the bank with the lowest score won. In the four categories that received a half weighting, the institutions’ actual scores were divided by two before they were added up. For example, a bank that finished 20th in the leverage ratio category only received 10 points for scoring purposes.

Sandler O’Neill & Partners, a New York-based investment banking firm that focuses on the financial services sector, helped Bank Director devise the Scorecard formula and performed the calculations.