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Mercer Capital's Bank Watch | May 2019 | Net Interest Margin Trends and Expectations

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Brought to you by the Financial Institutions Team of Mercer Capital, this monthly newsletter is focused on bank activity in five U.S. regions. Bank Watch highlights various banking metrics, including public market indicators, M&A market indicators, and key indices of the top financial institutions, providing insight into financial institution valuation issues.

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Mercer Capital's Bank Watch | May 2019 | Net Interest Margin Trends and Expectations

  1. 1. www.mercercapital.com Second Quarter 2018 MAY 2019 Bank Watch ARTICLE Net Interest Margin Trends and Expectations In This Issue Net Interest Margin Trends and Expectations 1 Public Market Indicators 5 MA Market Indicators 6 Regional Public Bank Peer Reports 7 About Mercer Capital 8
  2. 2. © 2019 Mercer Capital // www.mercercapital.com 1 Mercer Capital’s Bank Watch May 2019 Net Interest Margin Trends and Expectations Since Bank Watch’s last review of net interest margin (“NIM”) trends in July 2016, the Federal Open Market Committee has raised the federal funds rate eight times after what was then the first rate hike (December 2015) since mid- 2006. With the past two years of rate hikes and current pause in Fed actions, it’s a good vantage point to look at the effect of interest rate movements on the NIM of small and large community banks (defined as banks with $100 million to $1 billion of assets and $1 billion to $10 billion of assets). As shown in Figure 1, NIMs crashed in the immediate aftermath of the financial crisis, primarily because asset yields fell much quicker than banks could reprice term deposits. NIMs subsequently rebounded as the asset refinancing wave subsided while banks were able to lower deposit rates. A several year period then occurred in which asset yields grinded lower at a time when deposit rates could not be reduced. This period was particularly tough for commercial banks with a high level of non-interest bearing deposits. Since rate hikes started, the NIM for both small and large community banks have increased about 20bps through year-end 2018 before experiencing some pressure in early 2019. The nine hikes by the Fed to a target funds rate of 2.25% to 2.50% amounts to a 225bps increase. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 3.00% 3.10% 3.20% 3.30% 3.40% 3.50% 3.60% 3.70% 3.80% 3.90% 4.00% 2008Q 1 2008Q 3 2009Q 1 2009Q 3 2010Q 1 2010Q 3 2011Q 1 2011Q 3 2012Q 1 2012Q 3 2013Q 1 2013Q 3 2014Q 1 2014Q 3 2015Q 1 2015Q 3 2016Q 1 2016Q 3 2017Q 1 2017Q 3 2018Q 1 2018Q 3 2019Q 1 10YRUST NetInterestMargin Avg 10 YR UST NIM Assets $1 B - $10 B NIM Assets $100 M - $1 B Figure 1: Net Interest Margin Trend Source: FDIC
  3. 3. © 2019 Mercer Capital // www.mercercapital.com 2 Mercer Capital’s Bank Watch May 2019 At first pass, the expansion in the NIMs is less than might be expected; however, there are always a number of factors in bank balance sheets that will impact the NIM, including: »» Loan Floors. Many Libor- and prime-based commercial loans had floors that required 100-150bps of hikes before the floors were “out-of-the-money.” »» Competition. Intense competition for loans in an environment in which bonds yielded very little resulted in pressure in the margin over a base rate as bank and non-bank lenders accepted lower margins in order to make loans. »» Asset Mix. Community banks located in rural and semi-rural areas tend to have low loan-to-deposit ratios and, therefore, have not benefited as much as peers located in and around MSAs that are “loaned-up.” Nonetheless, net loans as a percentage of assets among community banks increased by an average of 15bps each quarter since year-end 2016 while bond portfolios declined. What We’re Reading Considering the current intensity of competition for deposits, Bank Director highlights opportunities for smaller banks to profitably grow deposits by investing in technology to improve customer retention, better understand consumer behavior, and develop personalized offerings. Barron’s reports that the federal funds futures markets and the Treasury market indicate increased expectations of a 25 basis point reduction in the federal funds target rate within the year. Following lower-than-expected April retail sales, the yield on two-year Treasury notes reached its lowest level since February 2018. (subscription required) Analysts inquire about CECL on community banks’ first quarter earnings calls as many are not yet providing estimates, SNL reports. (subscription required) With low deal volume to this point in 2019, bankers anticipate a rebound in MA activity in the latter half of the year as sellers adapt expectations to current valuations and become more comfortable with stock offers, SNL reports. (subscription required) »» Loan Mix. Community banks tend to have somewhat more of their loan portfolios allocated to residential mortgages and CRE than regional banks. As a result, it will take much longer for these mostly fixed-rate assets to reprice than Libor-based CI portfolios. »» Deposit COF. In recent quarters the marginal cost of funds (“COF”) has become expensive as depositors who came to accept being paid essentially nothing for their money began to demand more competitive rates once the Fed Funds rate approached 2%. »» Deposit Mix. In addition to depositors demanding higher rates, a mix shift from non-interest bearing and very low-yielding transaction accounts into higher paying money markets and time deposits has pushed the COF higher, too, in recent quarters.
  4. 4. © 2019 Mercer Capital // www.mercercapital.com 3 Mercer Capital’s Bank Watch May 2019 Fed to Cut Rates? Recent incremental pressure on NIMs notwithstanding, community banks’ balance sheets were poised to take advantage of rising rates the past several years. The outperformance of bank stocks beginning in November 2016 reflected several factors, including an economic and regulatory backdrop that would allow the Fed to raise rates further and faster, and thereby support NIM expansion. The underperformance of bank stocks since last fall reflects investor concern that this tailwind is ending in addition to more general concerns about what a possible economic slowdown implies for credit costs. Telltale signs include the inversion of the Treasury yield curve and yields on the two-year and five-year Treasuries that, as of the date of the drafting of this article, are below the low-end of the Fed Funds target range. Also, the spot and forward curves for 30-day Libor imply the Fed will cut the Funds target rate and other short-term policy rates one or two times by early 2020 (or stated differently, the December rate hike was a mistake). The Federal Funds rate, the predominant influence on short-term interest rates, has remained unchanged since year-end 2018 at a target range of 2.25%–2.50% due to concerns about lower inflation figures and what they may forewarn about future economic growth as reflected in falling U.S. Treasury yields. The FOMC reiterated its wait-and-see approach on May 1. However, the sand appears to be shifting beneath the Fed’s feet. The Wall Street Journal’s most recent Economic Forecasting Survey revealed an increasing belief that the Fed’s next move will be to cut rates. 51% of respondents said that a rate cut would be the next move, up from 44% in April. 25.5% replied that the next rate raise would occur in 2020 or later. Fed officials have maintained their stance that a rate move in either direction will not occur soon. 1.5 1.7 1.9 2.1 2.3 2.5 2.7 Jun-19 D ec-19 Jun-20 D ec-20 Jun-21 D ec-21 Jun-22 D ec-22 Jun-23 D ec-23 Jun-24 Percent 1 Mo. Spot Curve 1 Mo. Forward Curve Figure 3: 1 Month Libor Projected Spot and Forward Curve Source: Bloomberg -0.50 0.00 0.50 1.00 1.50 2.00 D ec-16 Feb-17 Apr-17 Jun-17Aug-17 O ct-17D ec-17 Feb-18 Apr-18 Jun-18Aug-18 O ct-18D ec-18 Feb-19 Apr-19 Percent UST 10/2 Spread UST 5/3 Mo T-Bill Spread Figure 2:Treasury Spreads Source: Federal Reserve Bank of St. Louis
  5. 5. © 2019 Mercer Capital // www.mercercapital.com 4 Mercer Capital’s Bank Watch May 2019 The Importance of Deposits and Next Steps As deposit costs initially lagged, but more recently moved with short-term interest rate hikes, the composition of a bank’s deposit base and funding structure has become increasingly important. As shown in Figure 4, the percentage of banks experiencing a rising cost of interest bearing deposits has steadily increased. Total funding costs have nearly doubled since year-end 2016 as depositors have reoriented funds toward accounts offering higher rates. Banks searching for funding either must engage in intense deposit competition or tap into higher-cost sources such as wholesale funding. Going forward community banks may face a modest reduction in NIMs because the yield curve is flat and the cost of incremental funding is expensive. Some community banks will choose to slow loan growth in order to protect margins; others will accept a lower margin. The predicament demonstrates yet again why deposit franchises are a key consideration for acquirers as banks with low cost deposit franchises and excess liquidity are particularly attractive in the current market. 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 45.0% 2008Q 12008Q 32009Q 12009Q 32010Q 12010Q 32011Q 12011Q 32012Q 12012Q 32013Q 12013Q 32014Q 12014Q 32015Q 12015Q 32016Q 12016Q 32017Q 12017Q 32018Q 12018Q 32019Q 1 % Rate Sen sitive Assets % Rate Sen sitive Liabilities * % of assets (liabilties) expected to mature or reprice within 1 year Figure 5: Interest Rate Sensitivity Source: SP Global Market Intelligence 0.00% 0.30% 0.60% 0.90% 1.20% 1.50% 1.80% 2.10% 2.40% 2.70% 3.00% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0% 2008Q 2 2008Q 4 2009Q 2 2009Q 4 2010Q 2 2010Q 4 2011Q 2 2011Q 4 2012Q 2 2012Q 4 2013Q 2 2013Q 4 2014Q 2 2014Q 4 2015Q 2 2015Q 4 2016Q 2 2016Q 4 2017Q 2 2017Q 4 2018Q 2 2018Q 4 CostofFunds %ofBanks % of Banks with Declining Costs of IB Deposits % of Banks with Increasing Cost of IB Deposits COF Assets $1 B - $10 B COF Assets $100 M - $1 B Figure 4: Cost of Funds Trend Source: FDIC, SP Global Market Intelligence Brian F. Adams 901.322.9706 | adamsb@mercercapital.com
  6. 6. © 2019 Mercer Capital // Data provided by SP Global Market Intelligence 5 Mercer Capital’s Bank Group Index Overview Return Stratification of U.S. Banks by Asset Size Median Valuation Multiples MedianTotal Return as of April 30, 2019 Median Valuation Multiples as of April 30, 2019 Indices Month-to- Date Year-to- Date Last 12 Months Price/ LTM EPS Price / 2019 (E) EPS Price / 2020 (E) EPS Price / Book Value Price / Tangible Book Value Dividend Yield Atlantic Coast Index 4.2% 8.5% -6.4% 13.5x 12.9x 11.8x 116% 132% 2.3% Midwest Index 2.5% 8.9% -7.5% 12.7x 11.7x 10.5x 125% 142% 2.5% Northeast Index 5.4% 14.3% 11.0% 13.4x 12.1x 11.1x 124% 138% 2.6% Southeast Index 3.3% 6.4% -5.8% 14.1x 12.3x 11.8x 122% 136% 1.6% West Index 4.2% 2.7% -9.6% 13.1x 12.5x 11.9x 122% 136% 2.1% Community Bank Index 3.7% 9.4% -1.2% 13.1x 12.0x 11.2x 122% 137% 2.2% SNL Bank Index 9.5% 18.9% -0.2% Mercer Capital’s Public Market Indicators May 2019 Assets $250 - $500M Assets $500M - $1B Assets $1 - $5B Assets $5 - $10B Assets $10B Month-to-Date 3.96% 0.88% 4.49% 6.57% 9.77% Year-to-Date 10.80% 8.22% 9.85% 13.84% 19.41% Last 12 Months -3.60% -0.30% -6.66% -0.17% -0.05% -10% 0% 10% 20% 30% AsofApril30,2019 70 75 80 85 90 95 100 105 110 115 120 4/30/20185/31/20186/30/20187/31/20188/31/20189/30/201810/31/201811/30/201812/31/20181/31/20192/28/20193/31/20194/30/2019 April30,2018=100 MCM Index - Community Banks SNL Bank SP 500
  7. 7. © 2019 Mercer Capital // Data provided by SP Global Market Intelligence 6 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 LTM 2019 U.S. 20.0% 18.4% 12.0% 6.9% 6.3% 5.4% 4.3% 5.5% 7.5% 7.5% 6.1% 10.0% 9.6% 8.9% 0% 5% 10% 15% 20% 25% CoreDepositPremiums 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 LTM 2019 U.S. 243% 228% 196% 145% 141% 132% 130% 134% 155% 148% 143% 170% 178% 178% 0% 50% 100% 150% 200% 250% 300% 350% Price/TangibleBookValue 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 LTM 2019 U.S. 22.0 22.1 19.9 19.3 21.7 21.9 17.0 16.5 17.5 18.8 18.1 19.5 22.4 20.1 0 5 10 15 20 25 30 Price/Last12Months Earnings Regions Price / LTM Earnings Price/ Tang. BV Price / Core Dep Premium No. of Deals Median Deal Value ($M) Target’s Median Assets ($000) Target’s Median LTM ROAE Atlantic Coast 21.3x 178% 11.2% 14 109.9 476,158 9.6% Midwest 16.6x 163% 7.6% 77 41.7 172,520 10.4% Northeast 23.9x 191% 10.9% 11 62.0 487,870 7.2% Southeast 20.1x 178% 8.8% 29 37.5 221,519 9.2% West 23.8x 208% 10.9% 18 76.0 259,228 8.9% National Community Banks 20.1x 178% 8.9% 149 54.3 213,017 9.6% Median Valuation Multiples for MA Deals Target Banks’ Assets $5B and LTM ROE 5%, 12 months ended April 2019 Median Core Deposit Multiples Target Banks’ Assets $5B and LTM ROE 5% Median Price/Tangible Book Value Multiples Target Banks’ Assets $5B and LTM ROE 5% Median Price/Earnings Multiples Target Banks’ Assets $5B and LTM ROE 5% Mercer Capital’s MA Market Indicators May 2019 Source: SP Global Market Intelligence
  8. 8. Updated weekly, Mercer Capital’s Regional Public Bank Peer Reports offer a closer look at the market pricing and performance of publicly traded banks in the states of five U.S. regions. Click on the map to view the reports from the representative region. © 2019 Mercer Capital // Data provided by SP Global Market Intelligence 7 Atlantic Coast Midwest Northeast Southeast West Mercer Capital’s Regional Public Bank Peer Reports Mercer Capital’s Bank Watch May 2019
  9. 9. Mercer Capital assists banks, thrifts, and credit unions with significant corporate valuation requirements, transaction advisory services, and other strategic decisions. Mercer Capital pairs analytical rigor with industry knowledge to deliver unique insight into issues facing banks. These insights underpin the valuation analyses that are at the heart of Mercer Capital’s services to depository institutions. »» Bank valuation »» Financial reporting for banks »» Goodwill impairment »» Litigation support »» Stress Testing »» Loan portfolio valuation »» Tax compliance »» Transaction advisory »» Strategic planning Depository Institutions Team MERCER CAPITAL Depository Institutions Services BUSINESS VALUATION FINANCIAL ADVISORY SERVICES Jeff K. Davis, CFA 615.345.0350 jeffdavis@mercercapital.com Andrew K. Gibbs, CFA, CPA/ABV 901.322.9726 gibbsa@mercercapital.com Jay D. Wilson, Jr., CFA, ASA, CBA 469.778.5860 wilsonj@mercercapital.com Eden G. Stanton, CFA 901.270.7250 stantone@mercercapital.com Mary Grace Arehart 901.322.9720 arehartm@mercercapital.com Madeleine G. Davis 901.322.9715 davism@mercercapital.com Brian F. Adams 901.322.9706 adamsb@mercercapital.com William C.Tobermann 901.322.9707 tobermannw@mercercapital.com Copyright © 2019 Mercer Capital Management, Inc. All rights reserved. It is illegal under Federal law to reproduce this publication or any portion of its contents without the publisher’s permission. Media quotations with source attribution are encouraged. Reporters requesting additional information or editorial comment should contact Barbara Walters Price at 901.685.2120. Mercer Capital’s Bank Watch is published monthly and does not constitute legal or financial consulting advice. It is offered as an information service to our clients and friends. Those interested in specific guidance for legal or accounting matters should seek competent professional advice. Inquiries to discuss specific valuation matters are welcomed. To add your name to our mailing list to receive this complimentary publication, visit our web site at www.mercercapital.com. www.mercercapital.com
  10. 10. Mercer Capital www.mercercapital.com

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