Bank Valuation II

In this article I will continue to discuss other financial condition metrics. If you are just joining us now, its a good idea to review Bank Valuation I first.

Again, what I present here are just the techniques (qualitative & quantitative) that I use & have found useful. There are many other techniques and methods. In the last article Bank Valuation I, we covered the following:
– Net Interest Margin (NIM)
– Return On Assets (ROA)
– Loan Loss Reserve, and losses related to the loan portfolio

Remember the two important ideas:
1. Keep It Simple
2. Conservative numbers & viewpoint


Return on Equity (ROE) – ROE is a key performance measurement. It assesses how efficiently management uses the company’s existing capital base to produce more money. I usually filter out anything that has an avg of less than 10% over the course of many years. I like to see companies with a ROE of close to 20% and higher. We also want to look at each individual year, and not just the average to see that the numbers are not jumping all over the place (inconsistency). Also, ROE at the expense of risky returns is not very good. We need to look at the other metrics to see if there are hints that ROE numbers are too good to be true (bumping up ROE through increased risky debts at higher rates of return, sound familiar?). Because its difficult to determine exactly what is in the loan portfolio, we need to trust the bank’s management. Also see my article on Banks and The Lure Of High Returns.

WFC has a 10yr average ROE of about 17.9%, USB 18.1%, Canadian Imperial Bank Of Commerce CIBC (CM) 17.7%. Although upon closer inspection WFC and USB both have pretty consistent ROE performance except in 2001 (tech bust), while CIBC has had a negative ROE of -0.34% in 2005, and a huge dip in 2002 at 6.93%. CIBC had a record ROE of 31.24% in 2007, far out matching USB’s recorded 2006 ROE of 23.60%. However, looking at CIBC’s 2006Q4 report, we can see that their total Off-Balance sheet instruments (credit-related arrangements, and derivatives) increased significantly over the past few years, compared to On-Balance sheet assets such as mortgage loans (decreasing). Although we don’t know more detail than that its interesting to note that their traditional mortgage loans were decreasing.

In WB’s 2006 Annual report, they stated they are the number one market leader real estate and structured products (master servicer of US CMBS, CMBS fixed rate loans, manager of US CDOs, etc). Commercial mortgage backed securities, Collateralized debt obligations, are all familiar sources of the US toxic debt problems.

When we look at Citigroup’s impressive ROE of 18.5% in 2006, and then later see its stock price decline in at the end of 2007 and early 2008 we might think its a quality bargain. But if we take into consideration its 2008 and late 2007 charge offs & loss percentages, the picture becomes a bit more clear. Warning signs that the stock was declining for good reason, and perhaps not a good investment.


Profit Margins – Is calculated by dividing net income (net profits) by revenues (sales). It is used to measure how much money a company keeps/earns from its sales. Also called Net Margins. Companies operating in different industries will also have different profit margins, so its a good idea to compare with other companies within the same industry. One example of a low margin industry is the airline industry (single digit margins are common). I generally look for consistent (5yr, & 10yr) net profit margins around 20% or higher. Low margin industries do not necessarily mean the industry is bad or not profitable to invest in. Some industries with low margins may enjoy few competitors, little or no alternatives, high barriers to entry, sustainability, or even government subsidies. But with everything, you need to research all advantages & disadvantages, and their affect on the investment. A negative profit margin means the company is not profitable (lost money). Whenever I see a negative profit margin within the last 10yrs of a company’s operation, I will go the annual report of that year, and look to see what management’s explanation for the losses were. There had better be a good reason, else why should I invest in a company that loses money?

WFC has a 5yr avg of 22.4%, with a trailing twelve month (TTM)of 17.3%. CIBC (CM) has a 5yr of 17.2%, with a TTM of -35.6%. Citigroup’s 5yr is 19.5%, with a TTM of -24.4%. I didn’t calculate the 10yr margin for each of these examples here, but feel free to investigate & calculate them yourself as an exercise.

This completes the financial condition metrics. In the next article Bank Valuation III, I will move on and discuss other metrics.

Data sources from S&P, Morningstar, Reuters, MSN Money, corresponding bank websites & financial reports.

Thanks & Happy Investing!
The Investment Blogger


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