Delivering high performance remains a challenge in spite of consecutive years of improvement to the U.S. economy. Nevertheless, some have done it.
To gain insight into how, Capital Performance Group analyzed the 2014 performance for community banks (less than $2 billion in assets), midsize banks ($2 billion to $10 billion) and large banks ($10 billion to $50 billion). CPG defined high performers as those institutions within each group that ranked roughly in the top 10% in terms of three-year average return on equity from 2012 to 2014. A comparison of the high performers with the overall peer group highlights important themes that should inform bank executives as they develop strategic priorities.
Median return on average equity ratios for these three peer groups in 2014 were all in the single digits, ranging between 7.29% (community banks) and 8.90% (midsize banks). Banks must devise plans to get above 10% to attract the capital needed to support growth. In other words, they need to be more like the high performers, which achieved median ROAE ratios of between 12.03% and 13.84%.
Revenue growth High performers in all three size groups had significantly better efficiency ratios than peers, which they achieved through increased revenue production rather than cost containment. For example, Signature Bank and Bank of the Ozarks invested in personnel and systems to support loan and deposit growth; both exceeded the median expense growth of their peers, but also generated even higher revenue growth. High-performing institutions in 2015 and beyond will be those that continue to invest to grow the business and build scale, rather than those that fixate on containing expenses. Successful institutions will evaluate and prioritize investments to ensure they drive increased operating leverage.
Scale Size is clearly important. High-performing community banks and large banks had higher median assets than peers and were more efficient in terms of median noninterest expense to average assets ratios, illustrating the advantages of scale. M&A activity will continue to pick up as banks look to augment organic growth. Banks approaching the $10 billion threshold must plan to go over that amount in a big way if they go over at all so that the benefits of increased scale will outweigh the increased regulatory costs associated with crossing this threshold.
Loan growth Despite the industry's focus on fee income over the past decade, the ratio of noninterest income as a percentage of average assets continues to trend downward for banks of all sizes, so growth in interest income is vital. In 2014, high performers achieved higher interest income via substantially higher loan growth. Examples include Texas Capital Bancshares and Live Oak Banking Co., which achieved impressive commercial loan growth by building relationships within well-defined business segments. Woodforest Financial Group grew 1-to-4 family loans and consumer loans, suggesting other types of lending opportunities exist too. Banks that can successfully target and exploit such loan growth opportunities are best positioned to outperform peers.
Core deposit funding Core deposits are crucial to support loan growth and will become more important when interest rates rise. Though there is strong core deposit growth across all three peer groups, the effort would benefit further from deeper customer relationships and improved product offerings. First Republic Bank is among the high performers that grew core deposits from existing client relationships through effective cross-selling and gained new deposit relationships through referrals.
While unique business models can deliver superior performance, the majority of banks continue to rely on traditional intermediation as the primary source of earnings. These banks need strategies that drive loan and core deposit growth while continually improving operating efficiency. Otherwise, they will struggle to attract capital and keep up with peers. We hope banks will look at not just where they are in the current rankings, but how they can set the bar higher going forward.