It’s All Relative

By Chris Bledsoe, Banker’s Dashboard

In banking, as in life, everything is relative. That’s why peer group analysis should be a regular part of every bank’s “high performance” routine – it’s critical to determining how your bank stacks up and where senior management needs to focus. The fact of the matter is that you, your fellow directors and senior management can’t truly know how the bank is performing until you compare the institution with its peers. For example, the bank might be meeting its budget numbers, but is the budget really where it needs to be?

Banks should perform a peer group analysis on either a quarterly or semi-annual basis. When selecting peers for any analysis, it is important that your team include banks of similar markets and size, and include some that are of the size your institution “aspires” to be, not just where it is positioned today. Additionally, I recommend limiting the peer group to ten banks.

How does the bank determine what measurements should be used to evaluate and rank bank performance? Should you compare Return on Assets (ROA) or Return on Equity (ROE)? It’s best to conduct your evaluation as if you were going to consider making an investment in the bank. Look for consistent performance in key measurements over a one to two-year time frame and carefully consider future growth opportunities.

Directors should examine a peer analysis comprised of the following four categories – together they will help to identify the bank’s fundamental strengths and weaknesses and provide an overall and decisive comparison.

Profitability – the most common measurement of high performance banking is profitability. On the average, high and consistently delivered return on equity (ROE) and return on assets (ROA) tend to reflect increasing profitability and superior management. In evaluation, focus on the most recent twelve months and the most recent twenty-four months – looking at both recent performance and consistency.

Growth – this is the second most important factor in determining if the bank’s performance is headed in the right direction. Many banks make the mistake of comparing total assets. Instead, growth should be determined by looking at loan and deposit growth over the last twelve and twenty-four month periods. Loan growth should receive a higher weighting than deposit growth. If the bank has multiple branches, your team should also evaluate and compare loan and deposit growth by branch.

Margin Management – the net interest margin drives ninety percent (90%) of the average community bank’s bottom line. It is the single most significant factor in determining profitability and performance. Have your team consider breaking the margin into four separate measures including a year-over-year comparison of net interest margin, year-over-year comparison of earning asset yield, year-over-year comparison of cost of funds and two-year average net interest margin. 

Efficiency – demonstrates a bank’s ability to utilize its resources for maximum production. Be sure that your team calculates and compares assets per FTE, the actual efficiency ratio itself and deposits per FTE, as these ratios typically highlight those banks that leverage efficient operations to contribute to their high performance.

In the end, understanding where your bank ranks in each of the above categories relative to your peers will give you the true measure of its performance and enable your team to spot opportunities for improvement and reallocate time appropriately.

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