How does the size of the credit union affect the mix in loan growth?  The 219 credit unions with an asset size greater than $1 billion grew their loan portfolios by 12% while the 238 credit unions with a size between $500 million and $1 billion grew their portfolios by 10%.  The table below illustrates that the majority of this loan growth is firmly entrenched in the larger credit unions.

# of Credit Unions      Asset Size                   Total Assets    Annual Loan Growth

219                              >$1 Billion                  $599 Billion    12%

238                              >$500 Million             $167 Billion    10%

1,068                           >$100 to $500             $234 Billion    7%

5,025                           <$100 Million             $117 Billion    3%

The 457 credit unions with assets greater than $500 million can be expected to continue to outgrow, on average, the smaller credit unions due to their ability to utilize economies of scale in marketing and their superior demographic characteristics.  Much of the growth will come from outside of basic consumer lending as credit unions become more aggressive in commercial and industrial lending.

In comparison, banks ranked 200 or more (Superior) in loan quality by IDC (2,120 banks), grew loans at 12% over the past year and had assets and loans equal to the 219 credit unions with assets over $1 billion.

The 1,070 banks IDC ranked “Excellent” (165 to 199) in loan quality grew loans at 10% and had total loans of $580 billion compared to the 238 credit unions with assets greater than $500 million and less than $1 billion ($167 billion in assets) with loan growth also at 10%.

Even the 1,211 banks with domestic deposits ranked “Average” (125 to 164), with loans of $707 billion, grew at 10%.

Total bank loan growth was held down due to low growth in poor quality banks and large money-center banks with foreign deposits.

Rank of

# of Domestic Banks              Loan Quality               Total Loans     Annual Loan Growth

2,120                                       >200                            $553 Billion                12%

1,070                                       165 to 199                   $580 Billion                10%

1,211                                       125 to 164                   $707 Billion                10%

High to average quality banks with domestic deposits continue to match their credit union competitors.  IDC’s rankings should be used to evaluate the performance of an individual credit union or bank as to their overall financial condition.

Prime Sources of Quality Ratings Since 1985

 IDC’s Savings Institution Quarterly identifies each institution’s strengths and weaknesses by type of financial ratio, providing a summary rating from 300 (the highest) to 1 (the lowest).  The summary rank is categorized 300-200 “Superior”, 199 to 165 “Excellent”, 164 to 125 “Average”, 124 to 75 “Below Average”, and 75 to 1 “Lowest Ratios”.  Included in the CAMEL ratio analysis, IDC calculates a unique Net Operating Profit (After Tax) Return on Equity (ROE) along with its components, which provides a better measure of each institution’s performance, measuring, separately, operating and financial profits.

 Sample Institution Case Study

The Sample Institution case is a study of a superior ranked institution that developed some problems as it dropped its rank from a “190” (excellent) in the third quarter of 2005 to a rank of “75” (below average) in the fourth quarter of 2009. Management at the Sample Institution recognized the problems they were having, reacted quickly to take mitigating action and the institutions rank has since recovered to its current “179” (excellent) in the second quarter of 2014.

Capital risk is determined by Tier I capital as a percent of assets and as a percent of risk based assets.  Tier I & II capital as a percent of risk-based assets (total risk-based capital ratio) measures credit and interest rate risk, as well as estimates risk in the asset base.  The Sample Institution’s Tier 1 capital as a % of assets (column 4) reached 9.0% in the year 2005, declined slightly to 8.7% in the fourth quarter of 2009 and recovered to 10.6% by the second quarter of 2014.  The Sample Institutions total risk-based capital (column 5) rose to 21.0% of risk-based assets and at the same time its Tier 1 risk-based capital (column 6) rose to 20.2% of risk-based assets.

Adequacy of Capital and reserves measures the levels of delinquent loans, nonaccrual loans, restructured and foreclosed assets relative to loan loss reserves and capital.  Risk-adjusted assets as part of the risk-based capital ratio further define the quality of assets.  The Sample Institution’s loans on non-accrual, restructured loans, and OREO as a percent of Tier 1 capital (column 9) along with loans 90 days or more past due as a percent of Tier 1 capital (column 8), added together, were 11% of Tier 1 capital in the third quarter of 2005, rose to 47% of Tier 1 capital in the third quarter of 2009, and subsequently decreased to 13% of Tier 1 capital in the second quarter of 2014.  The decrease is indicative of management’s efforts to control non-performing assets.

Margins are the best measurement of management’s financial controls.  Margins represent the spreads between 1) operating profit and net operating revenues, 2) after-tax return on earning assets and cost of funding, and 3) the return on equity compared to estimated cost of equity capital.  The Sample Institution’s net interest margin (column 23) in the fourth quarter of 2005 was 2.88%, dropped to 2.19% by the fourth quarter of 2008 and recovered to 2.77% by the second quarter of 2014.  The operating profit margin (column 34) reflected a similar change dropping from 40.3% to 10.7% and recovering to 32.0%.

Earning returns measure the success of the institution’s operating strategy.  Ratios of revenue yields from investments, loans, and noninterest income with comparison to operating costs, less loan loss provision, plus net loan charge-offs, and net non-operating income ratios are the major components of the net operating after-tax return on earning assets (ROEA). Earnings from financial leverage measure the level of leverage and after-tax cost of funding compared to the ROEA.  Operating assets are financed with the leverage of deposits and borrowings to Tier I capital and its comparative cost.  The leverage multiplier illustrates the degree of leverage, while the leverage spread measures its cost relative to operating returns.  The Sample Institution’s net operating after-tax return on equity (column 39) decreased from 8.9% in the fourth quarter of 2005 to -2.5% in the second quarter of 2010 and recovered to 5.7% in the second quarter of 2014.  Although ROEA (column 36) decreased from 2.52% in the fourth quarter of 2005 to 1.08% in the second quarter of 2014, the driver of the net operating after-tax return on equity was the leverage spread (column 37), which changed dramatically through the study period, decreasing from .65% in the fourth quarter of 2005 to -0.38% in 2010, subsequently, rising to its current 0.58% in the second quarter of 2014.

Liquidity measures (1) balance sheet cash flow as a percent of Tier I capital (column 17) and (2) loans compared to stable deposits and borrowings plus estimated unused lines of credit at the Federal Home Loan Institution (column 16).  The Sample Institution’s balance sheet cash flow percentage dropped to a negative position in the third quarter of 2009 and remained negative for 5 consecutive quarters before recovering.  Loans as a percent of stable deposits and borrowings decreased slightly through the study period but remained fairly stable.

Congratulations to a Sample Institution that is well capitalized, controls nonperforming assets, provides sufficient margins to earn an ROE greater than COE, and maintains a high level of balance sheet liquidity to support future growth.

Prime Sources of Bank Quality Ratings Since 1985

 IDC’s Bank Financial Quarterly identifies each bank’s strengths and weaknesses by type of financial ratio, providing a summary rating from 300 (the highest) to 1 (the lowest).  The summary rank is categorized 300-200 “Superior”, 199 to 165 “Excellent”, 164 to 125 “Average”, 124 to 75 “Below Average”, and 75 to 1 “Lowest Ratios”.  Included in the CAMEL ratio analysis, IDC calculates a unique Net Operating Profit (After Tax) Return on Equity (ROE) along with its components, which provides a better measure of each institution’s performance, measuring, separately, operating and financial profits.

 Sample Bank Case Study

 The Sample Bank case is a study of a superior ranked bank that developed some problems as it dropped its rank from a “221” (superior) in the first quarter of 2005 to a rank of “116” (below average) in the fourth quarter of 2009. Management at the Sample Bank recognized the problems they were having, reacted quickly to take mitigating action and the banks rank recovered to “210” in the third quarter of 2012.  Sample Bank’s current rank of “155” indicates management needs to again take actions to strengthen their balance sheet and enhance income.

 Capital risk is determined by Tier I capital as a percent of assets and as a percent of risk based assets.  Tier I & II capital as a percent of risk-based assets (total risk-based capital ratio) measures credit and interest rate risk, as well as estimates risk in the asset base.  The Sample Bank’s Tier 1 capital as a % of assets (column 3) began the year 2005 at 9.8% and receded all the way to 7.2% in the third quarter of 2009.  Subsequent earnings increases added to its capital base and Tier 1 capital rose to 9.3% by the second quarter of 2014.  Total risk-based capital (column 4) in the first quarter of 2005 was 19.4% and dropped to 10.9% in the first quarter of 2009. It recovered from there to its present 15.3%.

Adequacy of Capital and reserves measures the levels of delinquent loans, nonaccrual loans, restructured and foreclosed assets relative to loan loss reserves and capital.  Risk-adjusted assets as part of the risk-based capital ratio further define the quality of assets.  The Sample Bank’s loans on non-accrual, restructured loans, and OREO as a percent of Tier 1 capital (column 8) was 11% at the end of the fourth quarter of 2009 and improved to 8% in the second quarter of 2014.  The loan loss reserve as a percent of Tier 1 capital (column 6) remained stable at 7% of Tier 1 capital in the second quarter of 2005, the fourth quarter of 2009, and the current 8% in the second quarter of 2014, reflecting the bank’s ability to remain relatively risk-free with regard to non-performing assets.

Margins are the best measurement of management’s financial controls.  Margins represent the spreads between 1) operating profit and net operating revenues, 2) after-tax return on earning assets and cost of funding, and 3) the return on equity compared to estimated cost of equity capital.  The Sample Bank’s net interest margin (column 24) in the first quarter of 2005 was 3.75%, dropped to 3.24% by the fourth quarter of 2009, recovered to 3.71% by the fourth quarter of 2011, and has since receded to its current 3.36%.  The operating profit margin (column 30) reflected a similar change dropping from 37.5% to 28.2%, recovering to 35.1%, and dropping to its current 22.9%.  Management will need to take some action to improve their margin and stabilize their recovery.

Earning returns measure the success of the bank’s operating strategy.  Ratios of revenue yields from investments, loans, and noninterest income with comparison to operating costs, less loan loss provision, plus net loan charge-offs, and net non-operating income ratios are the major components of the net operating after-tax return on earning assets (ROEA). Earnings from financial leverage measure the level of leverage and after-tax cost of funding compared to the after-tax return on earning assets (ROEA).  Leverage returns (ROFL) measure the efficiency of the bank’s financial strategy. Operating assets are financed with the leverage of deposits and borrowings to Tier I capital and its comparative cost.  The leverage multiplier illustrates the degree of leverage, while the leverage spread measures its cost relative to operating returns.  The Sample Bank’s ROEA (column 32) fell from 2.54% in the first quarter of 2005 to .04% by the fourth quarter of 2009, rose to 1.71% by the fourth quarter of 2011, and decreased markedly to its current 1.16%.  The return on financial leverage (ROFL) (column 38) dropped from 9.1% in the first quarter of 2005 to a negative 14.4% in the fourth quarter of 2009, recovered to 9.3% by the third quarter of 2011, and dropped to 5.8% in the third quarter of 2013.  ROEA plus ROFL equals net operating ROE (column 15) of 6.9% in the third quarter of 2013, compared to a cost of equity (column 14) of 6.1%.

Liquidity measures (1) balance sheet cash flow as a percent of Tier I capital (column 9) and (2) loans compared to stable deposits and borrowings plus estimated unused lines of credit at the Federal Home Loan Bank (column 10).  The Sample Bank’s balance sheet cash flow percentage was a positive 5% in the first quarter of 2005, negative 59% in the third quarter of 2009 and improved to at or near positive for the most current 14 quarters.  Loans as a percent of stable deposits and borrowings rose through the study period from 53% to 70%.

Congratulations to a Sample Bank that is well capitalized, controls nonperforming assets, and maintains a high level of balance sheet liquidity to support future growth.   Management will need to improve margins and enhance earnings to keep from experiencing financial troubles in the near future.

With credit unions charging less for loans and paying more for deposits, a case can be made that this will be the norm for some time to come.  Credit unions should be anticipating gaining more customer relationships at the expense of the banks.

But how does the size of the credit union affect the mix?  The 219 credit unions with an asset size greater than $1 billion grew their loan portfolios by 12% while the 238 credit unions with a size between $500 million and $1 billion grew their portfolios by 10%.  The table below illustrates that the majority of this loan growth is firmly entrenched in the larger credit unions.

# of Credit Unions      Asset Size                   Total Assets    Annual Loan Growth

219                              >$1 Billion                  $599 Billion    12%

238                              >$500 Million             $167 Billion    10%

1,068                           >$100 Million             $234 Billion    7%

5,025                           <$100 Million             $117 Billion    3%

The 457 credit unions with assets greater than $500 million can be expected to continue to outgrow, on average, the smaller credit unions due to their ability to utilize economies of scale in marketing and their superior demographic characteristics.  Much of the growth will come from outside of basic consumer lending as credit unions become more aggressive in commercial and industrial lending.

IDC’s credit union rankings should be used to evaluate the performance of individual credit unions and assess the overall financial condition of the institution.

Banks ranked 200 or more (Superior) in loan quality by IDC (2,120 banks), grew loans at 12% over the past year and had assets and loans equal to the 219 credit unions with assets over $1 billion.  Small, high quality banks with domestic deposits continue to match their credit union competitors.

The 1,070 banks IDC ranked “Excellent” (165 to 199) in loan quality grew loans at 10% and had total loans of $580 billion compared to the 238 credit unions with assets greater than $500 million and less than $1 billion ($167 billion in assets) with loan growth also at 10%.

Even the 1,211 banks with domestic deposits ranked “Average” (125 to 164), with loans of $707 billion, grew at 10%.

Total bank loan growth was held down due to low growth in poor quality banks and large banks with foreign deposits.

# of Domestic Banks              Rank                Total Loans     Annual Loan Growth

2,120                                       >200                $553 Billion                12%

1,070                                       165 to 199       $580 Billion                10%

1,211                                       125 to 164       $707 Billion                10%

Independent Banks

 IDC Financial Publishing, Inc. (IDC) has been providing financial ratio ranks of financial institutions since 1984. In recent IDC stress tests applied to loan portfolios at commercial and savings banks, results showed a strong correlation between the IDC ranks of financial ratios when compared with the results of stress tests. Of 6,559 independent banks tested, 5,160 (79%) passed the stress test with no requirement for additional capital. The 1,399 (21%) that failed the test are summarized in the table below. IDC ranks banks using its unique CAMEL methodology which provides a one number summary rank from 1 (the lowest) to 300. IDC’s lowest ranks range from 1-74 followed by a below average ranking of 75-124. Ranks from 125-164 (average), 165-199 (Excellent), and 200-300 (Superior), round out the categories of IDC rankings. The table clearly shows that the lower ranked banks require more new capital in dollars and as a % of Tier 1 Capital. Banks ranked “1” required $2.0 billion in new capital, had $8.9 billion in loans and numbered 96. The 163 banks ranked greater than 200, required $15.6 billion in new capital and had loans of $227.7 billion. The majority of banks ranked less than 125 failed the IDC stress test while the majority of banks ranked greater than 124 passed. A positive indicator that IDC’s rating methodology can indicate trouble within an institution prior to testing.

The National Bureau of Economic Research has listed the last recession as lasting from December, 2007 until June, 2009, a period of 18 months. During that time period, banks faced problems with accelerated levels of delinquent and non-accrual loans, foreclosed assets, and an inability to generate sufficient income to maintain a strong capital base.  During and immediately after this “Great Recession” banks worked diligently to shore up capital and improve their balance sheets.

IDC Financial Publishing, Inc. (IDC) ranks banks using its unique CAMEL methodology which provides a one number summary rank from 1 (the lowest) to 300.  IDC’s lowest ranks range from 1-74 followed by a below average ranking of 75-124.  Ranks from 125-164 (average), 165-199 (Excellent), and 200-300 (Superior), round out the categories of IDC rankings.  IDC considers banks rated greater than “124” to be “investment grade”.  The graph below indicates the IDC “investment grade” banks as a percent of the total banks rated for the period from December 1985 through June 2014.  The percentage of “investment grade” banks remained fairly steady through the years 1994 to 2006. The 3 year period from 2007 through 2009 saw this percentage drop precipitously followed by its current recovery in 2010 to 2014.  Banks have more to improve to reach the 90% level of 7 years ago.

 Large capitalized banks continue to price equity market capitalization to book value of common equity relative to IDC’s return on equity (ROE) less IDC’s cost of equity capital (COE) in a straight line (see chart).

US Bancorp (USB) with a ROE greater than COE (a difference of 8 percentage points) sells at 2 times book value.  Each dollar of growth in USB’s  common equity translates into two dollars of incremental market value.  Banks add value with ROE above COE with price greater than book value.  Banks increasing ROE above COE, or the spread, add even more value.

Bank Holding Companies

IDC Financial Publishing, Inc. (IDC) has been providing financial ratio ranks of financial institutions since 1984.  In recent IDC stress tests applied to loan portfolios at Bank holding companies (BHC’s) for the period ending June 30, 2014, results showed a strong correlation between the IDC ranks of financial ratios when compared with the results of stress tests.  Of 1,020 BHC’s tested, 607 (60%) passed the stress test with no requirement for additional capital.  The 413 (40%) that failed the test are summarized in the table below.  IDC ranks BHC’s using its unique CAMEL methodology which provides a one number summary rank from 1 (the lowest) to 300.  IDC’s lowest ranks range from 1to74 followed by a below average ranking of 75-124.  Ranks from 125-164 (average), 165-199 (Excellent), and 200-300 (Superior), round out the categories of IDC rankings.  The table clearly shows that the lower ranked BHC’s require more new capital as a % of Tier 1 Capital.  BHC’s ranked “1” required over $6.9 billion in new capital (779% of Tier 1 Capital), had $41.2 billion in loans and the number of BHC’s was 24. The 118 BHC’s ranked greater than 200, required only $122.4 billion in new capital (21% of Tier 1 Capital) and had loans of $2,442.5 billion.  Almost all BHC’s ranked less than 125 failed the IDC stress test while the majority of BHC’s ranked greater than 124 passed.  A positive indicator that IDC’s rating methodology can indicate trouble within an institution prior to testing.  IDC believes that the growth in the banking industry combined with a growth in profitability and capital will substantially decrease the number of BHC’s failing the test in the near future.

Large Cap Bank Stocks Continue to Price Equity Market Capital to Book Value Compared to Return on Equity (ROE) less IDC’s Cost of Equity Capital on a Straight Line (See Chart)

Banks as custodians for large portfolios, such as Bank of New York Mellon Corp (BK) and State Street Corp (STT) sell at a discount to the valuation line (see chart).  Custodial banks tend to increase in profitability as interest rates rise due to their asset lending activities.  Large real estate lenders with high real estate delinquency (WFC) also sell at a discount.

IDC compares the “Honor Roll” of 432 bank fixed-income portfolios with top quartile performance and ranks over 200 (Superior) to 2,559 bank fixed-income portfolios ranked below 100 with the lowest performance and gains trading.

Gains trading was identified by the market-to-market total return for fixed-income investment assets over 5 years being less than the percentage booked income and realized gains.  Portfolios with gains trading realized gains, while allowing unrealized losses to remain on their books.

Bank Fixed-Income Portfolios with Less Than 10% Tax-Exempt Income

 “Honor Roll”

                                                      Ranked over 200                     Ranked Less Than 100

Number of Banks                                62                                            892

Total Value of Investment      $148,304 million                     $318,007 Million

Portfolio

Annual Total Return                           4.6%                                        1.2%

5 Year Period

Booked Income and                           3.4%                                        1.5%

Realized 5 Year Period

Realization Ratio                                73.9%                                      125.0%

Bank Fixed-Income Portfolios with 10% to 40% Tax-Exempt Income

“Honor Roll”

                                                Ranked over 200                     Ranked Less Than 100

Number of Banks                                127                                          1,155

Total Value of Investment       $28,942 million                                   $200,981 Million

Portfolio

Annual Total Return                            4.3%                                        1.7%

5 Year Period

Booked Income and                            3.8%                                        2.1%

Realized 5 Year Period

Realization Ratio                                 88.4%                                      123.5%

Bank Fixed-Income Portfolios with Over 40% Tax-Exempt Income

“Honor Roll”

                                                      Ranked over 200                     Ranked Less Than 100

Number of Banks                                243                                          512

Total Value of Investment       $29,269 million                                   $41,528 Million

Portfolio

Annual Total Return                            4.6%                                        2.1%

5 Year Period

Booked Income and                            4.4%                                        2.4%

Realized 5 Year Period

Realization Ratio                                 95.6%                                      114.3%

Bank fixed-income investment portfolios ranked less than 100 (Lowest) in total return performance and experiencing gains trading over the last 5 years have a particularly hard road ahead as interest rates rise in the future.  With gains realized and losses left on the books, rising interest rate yields on fixed-income securities reduce market values and force banks with losses to hold to maturity with sub-par yields on securities held.

What a difference between the “Honor Roll” banks and lowest performers!

Compare bank portfolio total returns to booked income plus realized gains over a 5-year period.