Skip to main content

Bank Stocks: Taking Off the Rose-Colored Glasses

The banking industry's numbers and analyst opinion highlight a growing focus on traditional deposit gathering and prudent loan underwriting.



) -- The credit crisis has changed the way analysts perceive bank stocks, and industry numbers back-up the general feeling that by "getting back to basics" the sector is setting itself up for a long healthy period.

Gone are the heady days of determining if a bank stock was simply overpriced relative to peers or earnings projections. Today, measures such as

normalized earnings


tangible common equity

and the

Texas Ratio

have come to the fore as investor as analysts consider a difficult landscape.

Tangible Book Value

For example, in an uncertain environment an investor considering a bank or thrift stock might take some comfort if the shares are trading at a low multiple of the company's tangible book value per share.

Tangible book value is common equity less intangible assets, which can include goodwill, deferred tax assets and other intangibles.

A remarkable number of banks are currently trading at the low end of this important metric. As of Tuesday's market close 632 out of 997 publicly-traded bank stocks were trading below tangible book value, according to



At the end of 2007 (when the writing was already on the wall), 141 out of that group of bank stocks traded below tangible book value. During the go-go period of easy credit at the end of 2006, only 22 traded below tangible book.

Scroll to Continue

TheStreet Recommends

That shows just how far the sector has fallen.

The largest bank trading below book value at Tuesday's close was


(C) - Get Citigroup Inc. Report

, which closed at $3.71 or 0.9 times tangible book value according to


. The shares were down 7% since


featured the company in June among

10 Bank Stocks Trading Below Book Value


Out of 23 analysts covering the shares, 12 have the equivalent of a buy rating on Citigroup, with 8 holding ratings and 2 analysts recommending investors sell the shares.

Here are some other key measures of increased importance to investors, analysts and members of the media considering bank stock valuation in a difficult landscape:

Normalized Earnings

At the end of 2007 before the credit crisis hit in earnest and many stocks (in hindsight) were over-valued, numerous bank stocks were trading for over 20 times earnings, including

Synovus Financial

(SNV) - Get Synovus Financial Corp. Report

, whose shares closed that year at $24.08, or 24 times annualized fourth-quarter 2007 earnings, according to

SNL Financial

. Since the consensus among analysts polled by

Thomson Reuters

is that the company will continue losing money through 2011, the best price-to-earnings multiple we can consider is one based on the consensus earnings projection of 31 cents a shares for 2012. Synovus Financial's shares closed at $2.15, or just 7.2 times that estimate.

Analysts are using price to "normalized" earnings, or the earnings expected for a bank or thrift holding company once it emerges from the credit crisis, as a major component of their stock valuations. John Rodis of Howe Barnes Hoefer & Arnett told


that the real trick is determining "when is


going to occur?" He added, "clearly with all the issues out there,


continues to be pushed out. Then again

what is normal


That's a good question, especially in light of the weak loan demand and the increased regulatory burdens that have yet to unfold following already strict new rules covering credit card disclosures and fees and ATM and debit card overdraft fees. Over the next year, the industry will fight many battles as the

Federal Reserve


Federal Deposit Insurance Corporation

and the

Office of the Comptroller of the Currency

translate the banking reform legislation into workable regulations.

Out of the 21 bank holding companies he covers, mainly in the Midwest, Rodis has buy ratings on just six, most recently upgrading

Enterprise Financial Services

(EFSC) - Get Enterprise Financial Services Corp Report

of St. Louis and

Southwest Bancorp



of Stillwater, Okla., saying that recent pullbacks presented buying opportunities for both.

Tangible Common Equity

This term that almost became a household word when Meredith Whitney famously said in October 2007 that Citigroup lacked sufficient capital to navigate the financial crisis and would have to cut its dividend.

A bank's tangible common equity ratio is its common equity less intangible assets, then divided by tangible assets. Since other types of equity, including preferred and trust-preferred securities are excluded in part from regulatory capital and some equity classes feature cumulative dividends, regulators became much more focused on capital ratios derived from tangible common equity. This was especially true during the U.S. Treasury's stress tests on the largest 19 domestic bank holding companies, which were completed in May 2009.

For regional banks, Rodis said that in the current environment he "likes to see tangible common equity north of 7%."

The largest banks have historically tended to hold less capital than smaller regional players. Of course, if a company remains profitable in a crisis, this might be of little concern, since cutting dividends and limiting expansion may be enough to maintain capital levels as loan losses mount. But as we have seen, most of the large holding companies had to raise signifiant capital to repay the government for bailout funds received via the Troubled Assets Relief Program, or TARP.

Among the largest 10 U.S. bank and thrift holding companies by total assets as of June 30, seven had tangible common equity ratios below 7%, however, all but

Capital One

(COF) - Get Capital One Financial Corporation Report

had significantly higher tangible common equity ratios than they did at the end of 2007.

Among this group, the companies with the highest tangible equity levels were

Wells Fargo

(WFC) - Get Wells Fargo & Company Report

, which had a tangible common equity ratio of 7.14%,

PNC Financial

(PNC) - Get PNC Financial Services Group, Inc. Report

, which had a ratio of 8.64% and


(STI) - Get SunTrust Banks, Inc. Report

which had, by far, the highest tangible common equity ratio among the group, at 10.08%.

For SunTrust, the high level of tangible common equity is a good thing since the Atlanta lender still owes $4.85 billion in TARP money - the only bank holding company among the largest ten with this distinction. SunTrust also had the highest nonperforming assets ratio among the group, at 4.53% as of June 30. For this set of data, SNL defines nonperforming assets as nonaccrual loans (less government-guaranteed balances), restructured loans and repossessed assets.

FIG Partners analyst Christopher Marinac has a neutral rating on SunTrust and said in an August 10 report that his earnings projections for the company "include $ 1 billion of new common equity to permit STI to repay TARP by early 2011."

Texas Ratio

While this isn't a new ratio, the term "Texas ratio" is much easier on the tongue than nonperforming assets plus loans past due 90 days or more divided by tangible common equity and loan loss reserves.

This ratio was developed by

RBC Capital Markets

analyst Gerard Cassidy, after Texas banks were hit hard during the early 1980's recession.

The Texas ratio is a useful quick look at how much of an institution's capital is exposed to nonperforming loans. The real estate crisis has shown that it's easy for a bank to lose 50% on a problem real estate loan, so -- with the caveat that we're being overly simplistic -- a real estate lender with a 100% Texas ratio better have very high capital ratios, to absorb what may be a 50% hit to its capital.

Rodis said that a Texas ratio "north of 100% is a good indicator that a bank might fail." For his coverage group, the median Texas ratio is "25% to 30%, which isn't too bad," but he tends to worry when the ratio exceeds 50%.

The largest U.S. bank or thrift holding company with a Texas ratio above 100% as of June 30 according to

SNL Financial


First Bancorp

(FBP) - Get First Bancorp Report

of San Juan, Puerto Rico, which had a 191.22% ratio of nonperforming assets to tangible common equity and reserves.

The largest U.S. holding company with a Texas ratio above 50% as of June 30 was SunTrust at 53.89%. The second largest was


(BBT) - Get BB&T Corporation Report

, which had a 50.69% ratio of nonperforming assets to tangible common equity and reserves.

Loans to Deposits Ratio

With loan demand stalled and consumers and businesses building cash, it's no surprise that banks are having a pretty easy time increasing deposits. With short-term interest rates near zero, the majority of U.S. banks have seen a rise in net interest margins through the crisis. The net interest margin is the difference between a bank's average yield on earning assets and its average cost of funds.

During the years leading to the real estate boom and bust, many banks relied more and more on wholesale funding, as they concentrated on increasing fee and interest income on the lending side of their businesses, while paying less attention to their traditional deposit gathering activities. According to aggregate data for U.S. commercial banks provided by


, The industry's ratio of loans to deposits dropped from 90.65 at the end of 2007 to 77.94 at the end of 2009.

Another sign of growing reliance on deposits for funding is that

Federal Home Loan Bank

advances -- wholesale loans made by the 12 members of the Federal Home Loan Bank System to member banks, thrifts, credit unions and insurance companies -- declined 14% from the end of 2009 to $540 billion as of June 30.

Granted both numbers reflect the economic malaise, but some deposits are bound to stick even as the economy improves, and banks will be better served if they can continue focusing on funding expansion with lower-priced deposits.

Looking Ahead

The banking sector is certainly worth a look, since these historically low valuations are likely to set up enormous gains for patient investors who pick the right stocks and stay in until loan demand picks up significantly and normalizes profits.

For investors with shorter-term horizons, such as Mike McGervey, president McGervey Wealth Management in North Canton, Ohio, the domestic banking sector isn't attractive yet. "It's unclear how the housing market will play out," McGervey told


, adding that the recently-passed banking reform legislation "reduces the ability of investment banks and banks to make profits."

McGervey did add one bank position recently, which was

HDFC Bank Ltd.

(HDB) - Get HDFC Bank Ltd. Report

of Mumbai, India, citing the bank's strong earnings growth.

For the domestic industry, Rodis said that commercial real estate problems will continue, and that "most banks are working with their borrowers and clearly there will be losses but the severity won't be as high as it was for the construction portfolios." He also said that after the slow period through Labor Day, he expects capital raising activities for banks to pick up.

Finally, Rodis added that as a result of the crisis, when loan demand eventually increases, community and regional banks will be more prudent in their commercial real estate loan underwriting, focusing more on owner-occupied properties and less on the speculative projects that wounded so many lenders


Written by Philip van Doorn in Jupiter, Fla.

>To contact the writer of this article, click here:

Philip van Doorn


To follow the writer on Twitter, go to


>To submit a news tip, send an email to:

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.