Monthly Archives: January 2015

What does RBC see in City National?

The Royal Bank of Canada (RBC) announced on January 22nd that they were acquiring City National Bank for $5.4 billion dollars.  RBC is paying 2.75x tangible common equity, and 1.86 times book value.  The deal price is one of the richest buyout multiples since the financial crisis.

City National is a $32b bank headquartered in Los Angeles, CA.  The bank has branches in entertainment hotspots throughout the country including, Beverly Hills, Nashville, Las Vegas, New York City, and Reno, Nevada.

The question is what does RBC see in City National that they’d pay such a high premium?

From a quantitative aspect there are a few things about City National that stand out.  The first is they earn a respectable ROA of .8% and have a declining Texas Ratio.  Secondly their foreclosure portfolio is declining and under control.  The bank is well capitalized, but not overly capitalized.  The bank has used excess capital to grow their loan portfolio, which in turn has contributed to growing earnings.

The true value for RBC are City National’s clients.  City National Bank has a reputation for being a primary destination for money coming from the entertainment industry.  This is clearly visible when one looks at their managed assets compared to their lending.  The bank has $13b in managed assets compared to $19b in net loans and leases.  While City National Bank has the word ‘bank’ in their title a significant amount of their earnings come from managing assets outside of the normal course of banking.

Beyond a jet-set list of clients RBC sees the opportunity to expand into Texas.  As a Canadian bank RBC is well versed in energy markets and they are hoping to expand in the US into the previously booming energy market of Texas.

The biggest question is whether RBC overpaid for City National Bank.  When setting the high water mark for deal metrics either one of two things is true.  Either the economy is in a strong recovery and we’ll continue to see deal volume at increasingly higher metrics.  Or RBC overpaid like they did with their last acquisition in the US in the fall of 2007.  A purchase that resulted in a massive write-down and a quick exit from US retail banking.

Only time will tell if RBC’s deal timing is poor, or if they overpaid.

Failed Bank Series: First National Bank of Crestview

The FDIC announced on January 16th that the First National Bank of Crestview in Florida had been taken into FDIC receivership.  The FDIC entered into an agreement with the First NBC Bank of New Orleans to assume all deposits of First National Bank of Crestview.

The First National Bank of Crestview was a $79m bank located in Crestview, Florida.  The bank had three branches all located in Okaloosa County.

The bank had shrunk dramatically from over $250m in assets in 2005 to $79m at the end of Q3, the date of their most recent regulatory filings.  The bank struggled with shrinking retail deposits over the past decade.  In 2005 the bank had $147m in retail deposits a figured that dropped to $85m at the end of Q3 2014.  Without a stable deposit base the bank couldn’t grow their loan portfolio and loans outstanding followed a similar trajectory to their deposits.

What didn’t shrink was the bank’s operating expenses.  In 2005 the bank had an efficiency ratio, a measure of operating expenses to revenue of 45%, a figure that could be considered very low for a small community bank.  This figure crossed 100% in 2010 and was 654% at the end of Q3 2014.  To put that into perspective for every $1 the bank received in interest on money they lent they had $6.40 in operating costs.  With expenses this high the bank quickly spent down their capital.

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Tier 1 capital was 2.36% at the end of the third quarter.  Tier 1 of 2.36% is well below what is considered ‘well capitalized’ by the FDIC.  What is somewhat unusual about this bank is they weren’t struggling with out of control loan losses.  At the end of the third quarter only 1.25% of their loans were non-current.  Their non-current loans to loans had been trending downward as well.

What ended the life of First National Bank of Crestview were high operating costs and a rapidly shrinking capital base.  At the end of the third quarter the bank had $813k in equity capital.  Their operating expenses were averaging $800k.  The bank also had continuing expenses related to their portfolio of foreclosures.  From a simple numbers basis if the bank hadn’t had any issues with their foreclosure portfolio they had about a quarter or possibly two left before running out of capital.  With the FDIC announcement we can ascertain that they weren’t able to get their foreclosure portfolio under control, and before risking the bank’s deposits the FDIC moved to terminate the bank.

Failed Banks Series: Northern Star Bank (NSBK)

The rate of banks taken into receivership by the FDIC has dropped significantly since the financial crisis.  Even though the number of failed banks has slowed considerably it hasn’t ceased completely.

This post is the first in a series that examines failed banks.  Success derives from a variety of factors that are both person and situation dependent.  But failure can be repeated and can often be tied back to a handful of general issues that are reproducible and avoidable.

The first bank I wanted to look at is Northern Star Bank.  Northern Star Bank was taken into FDIC receivership on December 14th 2014.  BankVista of Sartell, MN acquired Northern Star Bank’s deposit accounts.

The bank was established on January 25th of 1999 in Mankato, MN.  They operated two branches, Mankato and St Cloud, MN, which was established in 2001.  The bank’s Mankato branch held $11.6m in deposits as of June 30 2014, and their St. Cloud branch held $8.18m in deposits as of June 30 2014.

The survival of a bank rests on their ability to earn a profit, and adequate capital.  If a bank isn’t able to break even or earn a very small profit each quarter losses will reduce their capital.  When capital starts to disappear the clock begins to tick.  Either management needs to reverse the profit decline or they need to raise more capital extending their runway.

The reason Northern Star Bank failed is they failed to achieve the scale in their banking operation that would allow them to operate profitably.  The last time the company earned a profit on an annual basis was in 2003.  Since then there have been a few sporadic quarters of profitability, but nothing sustainable.

The bank’s income statement is shown below for 2005-2013:


If the financial crisis never happened it’s possible Northern Star Bank might have been able to grow into enough assets to cover their fixed expenses.  But unfortunately history wasn’t kind to them.  The bank was started at the beginning of the real estate boom and it appears they rode a portion of the wave.  Their day of reckoning came in 2010 when they were forced to set aside $1.33m in reserves for potential losses on loans.  This loan loss provision was 35% of their capital at the time.

At the end of 2009 the bank was considered well capitalized with an 10.14% Tier 1 ratio.  Their Tier 1 ratio dropped to 6.51% in 2010 with their outsized loan loss provision and continued to decline from there.  When the bank failed they had a Tier 1 ratio of 3.31%, well below what is considered adequate.

Northern Star Bank is owned by Northern Financial Inc, a bank holding company.  The bank holding company held a substantial amount of short term debt, which most likely limited their ability to raise capital.

Northern Star Bank’s continued losses and eroding capital led to an FDIC take-over.  But the story would have been different if the bank had been able to grow.  Bad lending and thin capital is always problematic.  But in my view the failure of Northern Star Bank started back in the early 2000’s when they failed to grow to a scale that overcame their operating expenses.  Without sufficient scale and high operating costs the bank ran out of time and became another statistic on the FDIC failed bank list.

You can access Northern Star Bank’s financials here:


All banks valued in five graphs

A new feature we’re working on is graphing all banks against each other based on valuations or operating metrics.  I put together five graphs that I feel depicts where we are in terms of general bank valuations at this point in the market cycle.

The first graph is of all listed banks measured by their P/E and P/B ratio against relevant banking indices.  This is a unique graph for two reasons.  It clearly shows that the US banking system is filled with a number of small banks and a few larger banks.  The second reason this graph is unique is that it highlights that relative banking value lies in two areas, very small banks, and a few larger banks.

The giant red line on the chart is a relative value of 1.  If a bank is plotted above this line they are trading for a multiple that’s richer than the bank index multiples.  If a bank trades below the red line they are trading for less than index multiples.  On the far right side of the graph are three points they are JPMorgan, Bank of America and Citigroup.  The three largest banks in the US are slightly undervalued on a relative basis.


Seeing as how the banking industry is comprised of so many small banks I thought it might be helpful to zoom in on banks with less than $1b in assets.  Most of the banks with less than $1b in assets are trading for less than their relative value.  The problem for investors is that many banks with less than $1b in assets are considered too small to be invested in.  This size factor is a likely explanation for the valuation difference.


The next graph shows banks plotted by their market cap and P/E ratio.  As in the other graphs there is a large cluster of banks around the bottom left corner representing hundreds of smaller community banks.

Most banks are trading for less than 20x earnings.  There are a number of small banks trading with high P/E ratios.  When a small stock trades for a high P/E ratio usually it’s because investors expect future growth.  For small banks it’s more likely they are barely profitable but investors are valuing them by P/B or pro-forma earning power to an acquirer rather than current earnings.


A misconception I hear often is that a bank earning less than 10% on their equity is ‘worthless’.  With low rates and higher required capital ratios fewer banks are earning high returns on equity.  In the most recent quarter 2217 banks earned more than 10% on their equity out of 6598 banks, or 33.6%.  This is down from the highs of 2005 and 2006 when 50% of banks earned more than 10% on equity.

When looking for an investment the sweet spot on the below graph are banks trading for less than book value but earning more than 10% on equity.  There are not many banks like this, but more than enough to dedicate further research time to, and many that are worth investment consideration.  As a note, I excluded banks with less than $500m in assets to screen out the majority of the negative outliers.  These are banks with considerable losses trading for returns on equity well below 1.


The last graph I have included is return on equity graphed against the P/E ratio for large banks.  I’ve included this graph to highlight what I mentioned above that there are a number of very large banks still trading very cheaply.  Right on the intersection of a P/E of 10 and ROE of 10% you have Fifth Third Bancorp (FITB).  Below a P/E of 15 there are 11 banks trading with ROE’s greater than 10%.  The one outlier is Discover Financial with an ROE of 22% and P/E of 12.valuation04

As I reviewed these graphs the conclusion I came to was that there are still plenty of banks trading at favorable valuations.  Many investors feel like they missed the boat for not investing in financials in 2009/2010/2011/2012, but I’m not sure they missed anything.  In 2009 and 2010 if an investor purchased any bank and the bank survived they earned multiples on their money.  So yes, those opportunities are gone, but the chance to own an undervalued bank in an environment with increased M&A and rising multiples hasn’t disappeared.