The Benefits of Living on the Positive Valuation Slope The mission of a bank is to operate a safe and sound financial institution, while creating shareholder value. The value of a bank, defined by the ratio of market value to common equity, most often is directly related to the return on equity (ROE) less the cost of equity capital (COE).

1. Creating Shareholder Value in
Midcap Banks
The Benefits of Living on the Positive Valuation Slope
The mission of a bank is to operate a safe and sound financial institution,
while creating shareholder value. The value of a bank, defined by the
ratio of market value to common equity, most often is directly related to
the return on equity (ROE) less the cost of equity capital (COE). The
enclosed chart illustrates the benefits of living on the slope, or realizing a
higher market value to common equity as the spread between ROE and
COE increases.

2. The Market Capitalization/Book Common Equity compared to IDC’s
ROE less COE for midcap bank holding companies in the enclosed
chart demonstrates the usefulness of a cost of equity capital tied to the
long term U.S. Treasury yield to determine the price to book value.
IDC defines ROE as net operating profit after tax (NOPAT ROE) for the
past four quarters ending March 31, 2016, and the level of long term
bond yields as of March 31, 2016. Size of the bank and standard
deviation of the operating margin (inverse to the efficiency ratio) define
risk in calculating COE.
The benefits of a high market capitalization to common equity are
twofold. As an example, one benefit is Commerce Bancshares (CBSH)
sells at a market value equal to 2.0 times equity due to a spread of
ROE less COE of 7.1%. The second benefit is a high ROE generates
a high reinvestment rate or growth in common equity, thereby
increasing market value at the reinvestment rate.

3. Commerce Bancshares, with $25 billion in assets, has a very clean
balance sheet and high noninterest income when compared with its
peers. Although heavily weighted in real estate loans, Commerce
Bancshares has been able to maintain low levels of non-performing
assets. They also prefer to avoid high-risk derivatives. Their banking
segment offers various banking products and services, including
consumer deposits; consumer loans, such as automobile, motorcycle,
marine, tractor/trailer, recreational vehicle, fixed rate and revolving
home equity, and other consumer loans; real estate loans; indirect and
other consumer financing; personal mortgage banking; and consumer
debit and credit bank cards. The company, through its non-banking
subsidiaries, offers private equity investment, securities brokerage,
insurance agency, and mortgage banking activities. It provides its
services through a network of 346 locations in Missouri, Kansas,
Illinois, Oklahoma, and Colorado, as well as commercial offices and
387 automated-teller machines in the United States. All of these
characteristics with a high ROE provided an increase in share value
over the last 10 years of over 44%, while the KBW Bank Index lost
33%.

6. Bank stocks corrected in price in January and February 2016 as predicted by
the weakening of the Chinese currency (CNY) a month prior. The reversal in
the CNY in early January predicted a recovery in bank stocks into mid-to-late
April 2016. Strength in the CNY below 6.50 would indicate higher bank
stock prices in the second quarter 2016. Weakness in CNY toward 6.60 and,
then, 7.00 would forecast another bank stock price correction. Chinese
equities are back in the sights of short sellers as the weakening of the Yuan,
which fell by the most in May since August’s devaluation, puts pressure on
stocks and bonds.