Ernest Hemingway, Albert Camus, and Credit Risk Management

In the March 2020 Bank Watch, we provided our first impressions of the “reshaping landscape” created by the COVID-19 pandemic and its unfolding economic consequences.  This month, we expand upon the potential asset quality implications of the current environment. 

A Reshaping Landscape

March 2020 probably will prove to be among the most dramatic months for financial markets in US history.  Likewise, the fallout for banks may take a year or so to fully appreciate.  Nonetheless, in this issue of BankWatch, we offer our initial thoughts as it relates to the industry.

Community Bank Valuation (Part 5): Valuing Controlling Interests

To close our series on community bank valuation, we focus on concepts that arise when evaluating a controlling interest in another bank, such as arises in an acquisition scenario.  While the methodologies we described with respect to the valuation of minority interests in banks have some applicability, the M&A marketplace has developed a host of other techniques to evaluate the price to be paid, or received, in a bank acquisition.

Quality Of Earnings Study: The “Combine” to Help Harvest Top FinTech Acquisition Targets

This article discusses a number of considerations that buyers may want to assess when performing due diligence on a potential FinTech target. While the ultimate goal is to derive a sound analysis of the target’s earning power and potential, there can be a number of different avenues to focus on, and the QoE study should be customized and tailored to the buyer’s specific concerns as well as the target’s unique situations.

2020 Outlook: Good Fundamentals, Moderate Valuations but Limited EPS Growth

Bank fundamentals did not change a lot between 2018 and 2019; however, bank stock prices and the broader market posted strong gains following a short but intense bear market that bottomed on Christmas Eve 2018. Our expectation is that 2020 will not see much change in fundamentals either, while bank stocks will require multiples to expand to produce meaningful gains given our outlook for flattish earnings.

Community Bank Valuation (Part 4): Valuing Minority Interests

While it would streamline the valuation process, there is no single value for a bank that is applicable to every conceivable scenario giving rise to the need for a valuation. Instead, valuation is context dependent. This edition of the series focuses on the valuation of minority interests in banks, which do not provide the ability to dictate control over the bank’s operations. The next edition focuses on valuation considerations applicable to controlling interests in banks that arise in acquisition scenarios.

2019 Core Deposit Intangibles Update

Alongside fluctuations in the interest rate environment, the banking industry has seen increasing competition for deposits in recent years. Improved loan demand in the post-recession period has led to greater funding needs, while competition from traditional banking channels has been compounded by the increased prevalence of online deposit products, often offering higher rates. All of these trends have combined to make strong core deposit bases increasingly valuable in bank acquisitions in the post-recession years. One question to ponder, however, is how much the value attributable to core deposits may ease given the reduction in rates that has occurred recently.

Community Bank Valuation (Part 3)

Part 3 of the Community Bank Valuation series explores important relationships between banks and their holding companies, focusing particularly on cash flow and leverage.

Community Bank Valuation (Part 2)

The June BankWatch featured the first part of a series describing key considerations in the valuation of banks and bank holding companies. While that installment provided a general overview of key concepts, this month we pivot to the analysis of … Continued

Bank M&A 2019 Mid-Year Update

Through late July, M&A activity in 2019 is on pace to match the annual deal volume achieved in the last few years. Since 2014, approximately 4%-5% of banks have been absorbed each year via M&A. According to data provided by S&P Global Market Intelligence, there were 136 announced transactions in the year-to-date period, which equates to 2.5% of the 5,406 FDIC-insured institutions that existed as of year-end 2018.

Community Bank Valuation (Part 1)

This article begins a series focused on the two issues most central to our work at Mercer Capital: What drives value for a depository institution and how are these drivers distilled into a value for a given depository institution? At its core, though, value is a function of a specified financial metric or metrics, growth, and risk.

Net Interest Margin Trends and Expectations

Since Bank Watch’s last review of net interest margin (“NIM”) trends in July 2016, the Federal Open Market Committee has raised the federal funds rate eight times after what was then the first rate hike (December 2015) since mid2006. With the past two years of rate hikes and current pause in Fed actions, in this article, we’ll look at the effect of interest rate movements on the NIM of small and large community banks.

Credit Quality at a Crossroads

Last week, the Mercer Capital Bank Group headed south for a scenic trip through the fields of the Mississippi Delta, including the town of Clarksdale located about 90 miles from Memphis.

One attraction put Clarksdale on the map – the Crossroads. At the intersection of Highways 49 and 61, the bluesman Robert Johnson (who lived from 1911 to 1938), as the story goes, met the Devil at midnight who tuned his guitar and played a few songs. In exchange for his soul, Johnson realized his dream of blues mastery.

The point of this article is not that Lucifer lurked behind the revaluation of asset prices in the fourth quarter of 2018. Instead, the market gyrations laid bare the dichotomy between bank expectations regarding asset quality and the market’s view of mounting credit risk that was overlaid by a need to meet margin calls among some investors. Indeed, credit quality faces its own crossroads.

2019 Outlook: Gasping for Air Replaces 2018’s Rainbow Chasing

To state the obvious: markets—but not fundamentals so far—are signaling 2019 (and maybe 2020) will be a more challenging year than was assumed a few months ago in which the economy slows and credit costs rise. The key question for 2019 then is: how much and is a slowdown fully priced into stocks?

Noncompete Agreements for Section 280G Compliance for Banks

Golden parachute payments have long been a controversial topic. These payments, typically occurring when a public company undergoes a change-in-control, can in some cases draw the ire of political activists and shareholder advisory groups. Golden parachute payments can also lead to significant tax consequences for both the company and the individual. Strategies to mitigate these tax risks include careful design of compensation agreements and consideration of noncompete agreements to reduce the likelihood of additional excise taxes.

Views from the Road: What Do Community Banks, FinTech, and Buffalo Have in Common?

In the last few weeks, I presented at two events geared towards helping community banks achieve better performance: the Moss Adams Community Banking Conference in Huntington Beach, California and the FI FinTech Unconference in Fredericksburg, Texas.

Much of the discussions at both conferences focused on the ability of community banks to adapt, survive, and thrive rather than thin out like the once massive North American buffalo herd. Beyond thinking that I will miss the great views and weather I had for both trips, I came away with a few questions bankers should consider.

Venture Capitalists in the Family

Many family offices are built from the success of once fledgling businesses that many would now know as household names. Successor generations seek to maintain and build that wealth through prudent investments in equities, fixed income, and private equity investments in mature companies. In recent years, however, family offices have started taking notes from their entrepreneurial beginnings and are investing more in early-stage ventures. Though more often seen as LPs in traditional venture capital funds, family offices are also increasingly taking on the role of direct—and sometimes lead—venture investors.

2018 Core Deposit Intangibles Update

With the Fed positioned to hike the Fed Funds and IOER rates several more times following the September meeting, it is a good time to look at the recent trend in core deposit values.

Beach Reading: Notice of Proposed Rulemaking – Qualified Business Income Deduction

Struggling to find a page-turning read for that late summer beach escape?  May we recommend the 184 pages of blissful decadence that comprise the Internal Revenue Service’s August 2018 Notice of Proposed Rulemaking (NPR) regarding the Qualified Business Income (QBI) deduction under the Tax Cuts & Jobs Act (TCJA).  Like a tightly wound murder mystery, the regulations weave a complex web.  Tax code sections take the place of characters, the regulation’s intricacies unspooling as the narrative continues, relationships between Tax Code sections becoming (somewhat) clearer as the story (i.e., the regulation) progresses.  As the NPR continues its inexorable march, certain storylines (i.e., planning opportunities) are forestalled, yet the NPR creates a glimmer of other opportunities.1

M&A Update: Good Gets Better

After a slow start, M&A activity among U.S. commercial banks and thrifts picked up to the point where 2018 should look like recent years. Historically, approximately 2% to 4% of the industry is absorbed each year via M&A. Since 2014, the pace has been at or slightly above 4% as a well performing economy, readily available financing, rising stock prices for bank acquirers, and strong asset quality and earnings of would be sellers have supported activity.

AICPA Publishes Guide for FV Marks

On May 15, the AICPA’s Financial Reporting Executive Committee released a working draft of the AICPA Accounting and Valuation Guide Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies. The document provides guidance and illustrations for preparers of financial statements, independent auditors, and valuation specialists regarding the accounting for and valuation of portfolio company investments of venture capital and private equity funds and other investment companies. In this introduction to the Guide, we provide a brief overview of the chapters and appendices with which PE and VC managers should develop familiarity.

Takeaways from FinXTech 2018: The Rise of Bank and FinTech Partnerships

Jay Wilson recently attended FinXTech, an industry event where the hosts at Bank Director bring together FinTech founders and bank directors and executives for productive conversations about the road ahead as partners (and competitors). In this post, Jay gives an overview of three key takeaways from the conference.