My old friend David C. Cates has sent me two T-shirts over the years - one with the message "Own a bank stock for fun and profit" and the other stating "Bring back book value."

Dave, who has run training programs for bankers and examiners and has been a leading bank analyst on the Street, is now an independent consultant in Maplewood, N.J., specializing in helping banks of all sizes show their best side to analysts, market makers, and investors.

But as we talked about what these three groups look for in deciding what a bank or its stock should be worth, I decided that maybe I should return the second shirt.

To Dave, and to most other analysts today, he feels, book value is a far less useful guide to value than the earnings potential of the bank and its operational efficiency.

"The efficiency ratio - operating income over operating expenses, with nonrecurring items removed - is a key test of bank competitiveness," Dave stresses. And he breaks this down even further by comparing banks on the basis of operating income per employee versus average compensation per employee. A guideline of over $100,000 for the former and under $30,000 for the latter is Dave's ballpark figure for a well-run bank, and anything narrower than a 3-to-10 spread worries him, except for banks stressing special fee-based products.

"What if a bank has a lot of low-cost employees because it has not automated routine functions?" I asked.

His answer: "That will show up in lower income per employee, so the spread will be hurt anyway."

Dave Cates also likes a new ratio he has developed, based on a bank's reinvention budget. This ratio measures temporarily unproductive expense as a fraction of total operating expenses. Assuming the bank is spending its reinvention outlays wisely, this ratio helps explain why operating efficiency ratios are poorer than other banks' numbers might be. But it also implies that this investment will pay off through an even better efficiency ratio than if the reinvestment were not taking place - unless, as indicated, the bank is spending unwisely.

"What do you do with the numbers once you have them?" I asked Dave.

He replied that they should be used both to show directors and managers how the bank is doing and also as a tool for creating better investor understanding, leading to improved bank stock performance. This understanding can be achieved through analyst meetings, visits to market makers, and one-on-one presentations.

What about the annual report?

Dave compared this to Pascal's wager: "As to whether I should believe in God, the best choice is to do so, for if there is a God, it's good to have shown your faith in him."

Similarly, while some annual reports seem a big waste of time and money to the bank, to serious investors they can be a major plus. And one thing is certain - a poor one can turn investors and analysts off.

"Too often the annual report is a disjointed document, for the marketing department does half and the controller does the rest. Rather, there should be a strategic theme, and the numbers stressed should buttress that theme.

For example, if a key theme is the strength of customer relationships, the numbers can show longevity of customers, cross-selling ratios, and other data that document the strength of the bank in drawing customers.

"Lawyers, too often, say to give the minimum data required, as too much can lead to suits. But the numbers are a real opportunity to sell the bank," Cates explains.

In sum, Dave concludes that the worth of a bank for investors and for M&A purposes, and for fairness opinions, should include the estimated earning power of a branch's deposits, trust accounts, the value of noncredit income, and investments and other marketable assets marked to market.

"To rely on nominal book value is letting the bank be dominated by accountants," he asserts.

"Then what about my T-shirt," I complained. "Should you have sent me one that says 'Don't bring back book value' instead of the one you did?"

Dave explained that when he sent those out, many banks were publishing fictitious earnings. They included inadequate loan-loss reserves, a failure to recognize the risk in the portfolio, nonrecurring income from sale of assets and the hiding of asset losses through keeping them on the books at cost.

The Securities and Exchange Commission and Financial Accounting Standards Board are now far more demanding and informed, and the analysts in particular have overcome their late '80s naivete that allowed so many banks to misrepresent their true picture.

So, Dave keeps working to make bank statements more realistic and useful. And when I asked him if he considered the term "fairness opinion" to be an oxymoron, he replied that preparing these opinions is "an assignment in applied honesty that can stand up in court."

But I did leave him feeling I should stop wearing my T-shirt that praises the virtues of book value. Mr. Nadler is a contributing editor of the American Banker and professor of finance at Rutgers University Graduate School of Management.

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