Corporate Valuation, Financial Services

June 22, 2016

A Watched Pot Never Boils: Still Waiting on Margin Relief

As expected after lackluster job gains in May, the Federal Open Market Committee declined to raise the Fed Funds target at the latest policy meeting on June 15th. While the majority of policymakers still expect the Fed to boost rates twice before the end of this year, the number of officials who forecast just one rate hike increased from one to six from the previous forecasting round in March. In addition, Fed officials lowered their expectations for future years, now expecting the fed funds rate to rise to 1.6% by year-end 2017, down from the 1.9% estimate in March, and 2.4% in 2018, down from the previous estimate of 3.0%. During a press briefing on June 3rd, members of the Economic Advisory Committee of the American Bankers Association said they still expect the Fed to boost rates twice before the end of this year, but after years of speculation regarding timing of rate increases, when that will happen remains anyone’s best guess. The bond market never believed the forecasts.

Rate increases are long awaited by community bankers as banks are facing profitability challenges. Net interest margins continue to compress and loan growth remains stymied by intense competition for high quality loans. Margin relief remains out of the grasp of most community banks, absent further rate hikes beyond the December 2015 hike. After rebounding modestly in the third and fourth quarter of 2015, the median net interest margin of community banks (defined as those with assets between $100 million and $5 billion), ticked down modestly in the first quarter of 2016 as intense competition for quality loans drove down loan yields and the decline in long-term rates put downward pressure on securities’ yields (Charts 1 and 2).

Chart1-Trends-Net-Interest-MarginsChart2-Trends-Net-Interest-Margins   Overall, median net interest income continued to increase as growth in loans offset margin compression, but intense competition raises concerns over how much credit standards have been relaxed to drive loan growth. Although the majority of banks’ balance sheets are poised to take advantage of rising rates, the lift to net interest margins is dependent on asset yields rising faster than the cost of funds (Chart 3). Chart3-Interest-Rate-Sensitivity While deposits costs essentially reached a floor several quarters ago, data suggests the threat of rising deposit rates may limit margin expansion in a rising rate environment. As shown in Chart 4, the percentage of banks reporting quarter-over-quarter increases in the cost of interest bearing deposits has been trending upward over the last eight quarters. In a higher rate environment, customers are more likely to shop around for higher rates. The increase observed in interest bearing accounts could reflect the fact that higher loan growth has compelled some banks to raise rates or perhaps an effort to build goodwill with customers in anticipation of rising rates and increased rate sensitivity. For banks with asset sensitive balance sheets, the benefit of rising interest rates will be greater the stickier low cost deposits are. Chart4-Trend-Bearing-Deposit-Costs While net interest margin is a key metric for banks, focusing on other drivers of profitability is one way to combat margin compression in the face of further delays in interest rate hikes or upward pressure on deposit costs. Consider the following:
  • Look for opportunities to grow non-interest income. One strategic option may be to expand bank offerings into non-traditional bank business lines that are less capital intensive and offer prospects for non-interest income growth such as acquisitions or partnerships with insurance, wealth management, specialty finance, and/or financial technology companies. FinTech’s consumer-focused technology and ability to quickly adapt can pair well with community banks who can provide an established customer base and knowledge of the regulatory process and environment. For more information, we recently wrote an article on why current market conditions may be ripe for FinTech partnerships.
  • Leverage technology to curb efficiency ratios. Compliance and regulatory costs continue to rise and represent a bigger burden to community banks who lack the scale to accommodate these expenses in comparison to their larger peers. A recent article from American Banker included data presented by Chris Nichols, chief strategy officer of CenterState Banks, at a recent fintech conference in Atlanta that shows why engaging customers digitally is more efficient. Furthermore, a recent article published on SNL highlights how, in some regards, community banks can be quicker to adopt new technology than larger peers. While size may limit what projects are feasible for community banks, agility has its benefits.
  • Increase scale. Create economies of scale and improve profitability organically or by merging with a larger company. Organic loan growth is an obvious cure to the margin blues, but must be achieved while maintaining credit quality and holding adequate capital. M&A remains a classic solution to revenue headwinds in a mature industry, and bank acquirers can potentially have savings beyond expense synergies with some NIM relief resulting from potential accretion income on the acquired assets, which are marked to fair value at acquisition.
Mercer Capital has a long history of working with banks and helping to solve complex problems ranging from valuation issues to considering different strategic options. If you would like to discuss your bank’s unique situation in confidence, feel free to contact us.

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March 2026 | Capital Allocation: The Strategic Decision in a Slower Growth Environment
Bank Watch: March 2026

Capital Allocation: The Strategic Decision in a Slower Growth Environment

Following several years of balance sheet volatility and margin pressure, the operating environment for banks improved in 2025 as most posted higher earnings on expanded net interest margins. The outlook for 2026, at least prior to the outbreak of the U.S./Israel-Iran war, reflects(ed) a relatively stable operating environment.Stability, however, introduces a different challenge. Loan growth has moderated across much of the industry, and the benefit from asset repricing has largely been realized. In this environment, earnings growth is less dependent on external tailwinds and more dependent on internal discipline. As a result, capital allocation has moved to the center of strategic decision-making.The Expanding Capital Allocation ToolkitCapital allocation discussions are often framed around dividends and, to a lesser extent, share repurchases. In practice, the range of capital deployment decisions is broader and more interconnected. Banks today are balancing:Organic balance sheet growthTechnology and infrastructure investmentDividendsShare repurchasesM&ABalance sheet repositioningRetained capital for flexibilityEach alternative carries different implications for risk, return, and long-term franchise value.Organic growth often is the preferred use for internally generated capital when the risk-adjusted returns exceed the cost of equity. However, competitive loan pricing and a tough environment to grow low cost deposits have narrowed spreads, reducing the margin for error. Similarly, technology investments may improve efficiency over time but require upfront capital with uncertain timing of returns.Returns, Valuation, and Market DisciplinePublic market valuations provide a useful lens for evaluating capital allocation decisions. As shown in Figure 1(on the next page), banks that generate higher returns on tangible common equity (ROTCE) tend to command higher price-to-tangible book value multiples. This can also be expressed algebraically, at least on paper, whereby P/E x ROTCE = P/TBV, while P/Es reflect investor assessments about growth and risk.This relationship reflects a straightforward principle: capital should be deployed where it earns returns in excess of the cost of equity. When internal opportunities meet that threshold, reinvestment should be appropriate. When returns are below the threshold, returning capital to shareholders through special dividends or repurchases may create greater per-share value.Share repurchases, in particular, can be an effective tool when executed below intrinsic value and when capital levels remain sufficient to support strategic flexibility. However, repurchases that do not improve per-share metrics or are offset by dilution from other sources may have limited impact.Figure 1: Publicly Traded Banks with Assets $1 to $5 BillionBalance Sheet Repositioning as Capital AllocationIn some cases, capital allocation decisions are embedded within the balance sheet itself. One example is securities portfolio repositioning.Many banks continue to hold securities originated during the low-rate environment of 2020 and 2021. While unrealized losses associated with these portfolios have moderated, the yield on these assets often remains well below current market rates.Repositioning the portfolio, by realizing losses and reinvesting at higher yields, represents a tradeoff between near-term capital impact and longer-term earnings improvement. In effect, this decision can be evaluated similarly to other capital deployment alternatives, with management weighing the upfront reduction in Tier 1 Capital against the expected lift to net interest income and returns over time.As with M&A, the concept of an “earnback period” can be applied. Institutions that approach repositioning with a clear understanding of the payback dynamics are better positioned to evaluate whether the strategy enhances long-term shareholder value. We offer the caveat that institutions who evaluate restructuring transactions should compare the expected return from realizing losses (i.e., reducing regulatory capital) with instead holding the securities and repurchasing shares. If the bank’s shares are sufficiently cheap, then it could make sense to continue to hold the underwater bonds until the shares rise sufficiently.M&A and Capital FlexibilityM&A remains a viable capital deployment option, particularly for institutions seeking scale or improved operating efficiency. However, transaction activity continues to be constrained by pricing discipline, tangible book value dilution, and investor expectations around earnback periods.Public market valuations ultimately serve as a governor on deal pricing, reinforcing the importance of aligning capital deployment decisions with shareholder return expectations.Conclusion: Discipline Drives OutcomesIn a slower growth environment, capital allocation is not a secondary consideration; it is a core driver of performance. While banks cannot control market multiples, they can control how capital is deployed across competing opportunities.Institutions that consistently allocate capital with a clear focus on risk-adjusted returns, strategic alignment, and per-share value creation are more likely to generate sustainable growth in earnings and tangible book value. In the current environment, disciplined execution may prove more valuable than more aggressive but less certain alternatives.
The Tariff Hangover: How a Year of Trade Volatility Is Reshaping Transportation
The Tariff Hangover: How a Year of Trade Volatility Is Reshaping Transportation
The past year has been defined by a series of rapid and often unpredictable shifts in trade policy. New tariffs, temporary pauses, retaliatory measures, and evolving global supply chains have left a measurable impact on the transportation and logistics industry. These developments have influenced freight volumes, pricing dynamics, capital allocation, and ultimately the valuation of transportation companies.
Specialty Finance Acquisitions
Specialty Finance Acquisitions
In 2021, there were 21 deals announced with a U.S. bank or thrift buyer and a specialty lender target. This represents a significant uptick from the prior two years and the highest level since 2017. Deals in 2021 were largely driven by a desire to deploy excess liquidity and grow loans. Other drivers of deal activity include efforts to find a niche in the face of competition or diversify revenue and earnings. Through May 19, six deals had been announced in 2022.

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